UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

FORM 10-Q

 

 

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

For the quarterly period ended March 31, 2017

Commission File Number: 001-33540

 

 

 

 

EnSync, Inc.

(Exact name of registrant as specified in its charter)

 

 

Wisconsin	39-1987014
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
N93 W14475 Whittaker Way Menomonee Falls, Wisconsin	53051
(Address of principal executive offices)	(Zip Code)

 

(262) 253-9800
(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). þ Yes ¨ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) ¨ Yes þ No

 

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

 

Class		Shares Outstanding as of May 11, 2017
Common Stock, $0.01 Par Value Per Share		48,010,347

 

 

ENSYNC, INC.

TABLE OF CONTENTS  

 

		Page
	PART I. FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited)	2
	Condensed Consolidated Balance Sheets	2
	Condensed Consolidated Statements of Operations	3
	Condensed Consolidated Statements of Comprehensive Loss	4
	Condensed Consolidated Statements of Changes in Equity	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Mine Safety Disclosures	48
Item 5.	Other Information	48
Item 6.	Exhibits	48
Signatures		49

 

 

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

 

EnSync, Inc.

Condensed Consolidated Balance Sheets

 

		(Unaudited)
		March 31, 2017				June 30, 2016
Assets
Current assets:
Cash and cash equivalents		$	12,399,671			$	17,189,089
Accounts receivable, net			237,265				172,633
Inventories, net			1,947,982				1,869,942
Prepaid expenses and other current assets			745,265				600,591
Customer intangible assets			8,249				76,293
Note receivable			174,148				171,140
Deferred PPA project costs			-				5,690,307
Deferred customer project costs			202,548				419,765
Project assets			408,761				1,190,853
Total current assets			16,123,889				27,380,613
Long-term assets:
Property, plant and equipment, net			3,549,822				3,889,106
Investment in investee company			1,993,810				2,165,626
Goodwill			809,363				809,363
Right of use assets-operating leases			163,959				27,264
Total assets		$	22,640,843			$	34,271,972
Liabilities and Equity
Current liabilities:
Current maturities of long-term debt		$	338,942			$	332,707
Accounts payable			630,121				569,226
Accrued expenses			488,067				501,031
Customer deposits			104,577				201,352
Accrued compensation and benefits			286,791				257,087
Total current liabilities			1,848,498				1,861,403
Long-term liabilities:
Long-term debt, net of current maturities			802,952				1,057,720
Deferred revenue			13,712,638				13,290,000
Other long-term liabilities			260,443				25,789
Total liabilities			16,624,531				16,234,912
Commitments and contingencies (Note 15)
Equity
Series B redeemable convertible preferred stock ($0.01 par value, $1,000 face value) 3,000 shares authorized and issued, 2,300 shares outstanding, preference in liquidation of $5,549,840 and $5,317,800 as of March 31, 2017 and June 30, 2016, respectively			23				23
Series C convertible preferred stock ($0.01 par value, $1,000 face value), 28,048 shares authorized, issued, and outstanding, preference in liquidation of $466,472 and $12,719,260 as of March 31, 2017 and June 30, 2016, respectively			280				280
Common stock ($0.01 par value); 300,000,000 authorized, 48,010,347 and 47,752,821 shares issued and outstanding as of March 31, 2017 and June 30, 2016, respectively			1,188,418				1,185,843
Additional paid-in capital			139,205,625				137,585,233
Accumulated deficit			(133,923,648	)			(120,550,108	)
Accumulated other comprehensive loss			(1,584,697	)			(1,585,583	)
Total EnSync, Inc. equity			4,886,001				16,635,688
Noncontrolling interest			1,130,311				1,401,372
Total equity			6,016,312				18,037,060
Total liabilities and equity		$	22,640,843			$	34,271,972

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

EnSync, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

		Three months ended March 31,								Nine months ended March 31,
		2017				2016				2017				2016
Revenues
Product sales		$	50,505			$	64,756			$	9,268,635			$	550,986
Engineering and development			-				95,382				175,000				264,389
Total revenues			50,505				160,138				9,443,635				815,375
Costs and expenses
Cost of product sales			206,157				89,794				9,703,858				394,402
Cost of engineering and development			-				221,628				937,725				357,795
Advanced engineering and development			1,414,858				1,397,645				3,493,326				5,089,297
Selling, general, and administrative			2,743,618				2,212,871				8,331,773				6,727,823
Depreciation and amortization			98,318				209,991				454,387				569,647
Total costs and expenses			4,462,951				4,131,929				22,921,069				13,138,964
Loss from operations			(4,412,446	)			(3,971,791	)			(13,477,434	)			(12,323,589	)
Other income (expense)
Equity in gain (loss) of investee company			(170,084	)			(101,832	)			(171,816	)			(170,429	)
Interest income			10,809				14,935				33,436				33,645
Interest expense			(11,115	)			(12,047	)			(37,219	)			(39,694	)
Other income			-				-				8,432				76,437
Total other income (expense)			(170,390	)			(98,944	)			(167,167	)			(100,041	)
Loss before expense (benefit) for income taxes			(4,582,836	)			(4,070,735	)			(13,644,601	)			(12,423,630	)
Expense (benefit) for income taxes			-				172				-				(468	)
Net loss			(4,582,836	)			(4,070,907	)			(13,644,601	)			(12,423,162	)
Net loss attributable to noncontrolling interest			128,722				123,344				271,061				277,589
Net loss attributable to EnSync, Inc.			(4,454,114	)			(3,947,563	)			(13,373,540	)			(12,145,573	)
Preferred stock dividend			(79,264	)			(71,810	)			(232,040	)			(218,390	)
Net loss attributable to common shareholders		$	(4,533,378	)		$	(4,019,373	)		$	(13,605,580	)		$	(12,363,963	)
Net loss per share
Basic and diluted		$	(0.09	)		$	(0.08	)		$	(0.28	)		$	(0.26	)
Weighted average shares - basic and diluted			48,010,347				47,608,821				47,870,082				46,983,174

 

See accompanying notes to condensed consolidated financial statements.

 

 

EnSync, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

 

		Three months ended March 31,								Nine months ended March 31,
		2017				2016				2017				2016
Net loss		$	(4,582,836	)		$	(4,070,907	)		$	(13,644,601	)		$	(12,423,162	)
Foreign exchange translation adjustments			1,636				5,151				886				4,878
Comprehensive loss			(4,581,200	)			(4,065,756	)			(13,643,715	)			(12,418,284	)
Net loss attributable to noncontrolling interest			128,722				123,344				271,061				277,589
Comprehensive loss attributable to EnSync, Inc.		$	(4,452,478	)		$	(3,942,412	)		$	(13,372,654	)		$	(12,140,695	)

 

See accompanying notes to condensed consolidated financial statements.

 

 

EnSync, Inc.

Condensed Consolidated Statements of Changes in Equity

(Unaudited)

 

																																		Accumulated
																																		Other
		Series B Preferred Stock								Series C Preferred Stock								Common Stock								Additional				Accumulated				Comprehensive				Noncontrolling
		Shares				Amount				Shares				Amount				Shares				Amount				Paid-in Capital				Deficit				Income (Loss)				Interest
Balance: June 30, 2015			2,575			$	26				-			$	-				39,129,334			$	1,099,608			$	117,104,936			$	(102,674,049	)		$	(1,589,486	)		$	1,734,194
Net loss																															(17,876,058	)							(386,436	)
Net currency translation adjustment																																			3,903
Issuance of common and preferred stock, net of costs and underwriting fees											28,048				280				8,000,000				80,000				19,211,913
Stock-based compensation																			270,791				2,708				1,271,908
Contribution of capital from noncontrolling interest																																							53,614
Conversion of preferred stock			(275	)			(3	)											352,696				3,527				(3,524	)
Balance: June 30, 2016			2,300				23				28,048				280				47,752,821				1,185,843				137,585,233				(120,550,108	)			(1,585,583	)			1,401,372
Net loss																															(13,373,540	)							(271,061	)
Net currency translation adjustment																																			886
Stock-based compensation																			108,364				1,083				1,553,484
Exercise of stock options																			120,000				1,200				67,200
Exercise of warrants																			29,162				292				(292	)
Balance: March 31, 2017			2,300			$	23				28,048			$	280				48,010,347			$	1,188,418			$	139,205,625			$	(133,923,648	)		$	(1,584,697	)		$	1,130,311

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

EnSync, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

		Nine months ended March 31,
		2017				2016
Cash flows from operating activities
Net loss		$	(13,644,601	)		$	(12,423,162	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation of property, plant and equipment			379,450				523,441
Amortization of customer intangible assets			68,044				46,206
Stock-based compensation, net			1,554,567				893,739
Equity in (gain) loss of investee company			171,816				170,429
Provision for inventory reserve			234,675				-
Gain on sale of property and equipment			(8,432	)			-
Interest accreted on note receivable			(3,008	)			(9,041	)
Gain on bargain purchase			-				(76,437	)
Changes in assets and liabilities
Accounts receivable			(64,632	)			75,567
Inventories			(312,715	)			(1,010,493	)
Prepaids and other current assets			(144,366	)			(187,735	)
Deferred PPA project costs			5,690,307				(159,978	)
Deferred customer project costs			217,217				(1,009,730	)
Project assets			782,092				(7,091,533	)
Accounts payable			60,895				(470,831	)
Accrued expenses			(53,683	)			(877,806	)
Customer deposits			(96,775	)			53,236
Accrued compensation and benefits			29,704				(105,228	)
Deferred revenue			422,638				13,290,000
Other long-term liabilities			137,983				-
Net cash provided by (used in) operating activities			(4,578,824	)			(8,369,356	)
Cash flows from investing activities
Cash paid for business combination			-				(225,829	)
Change in restricted cash			-				60,193
Expenditures for property and equipment			(46,364	)			(389,266	)
Proceeds from sale of property and equipment			15,325				-
Net cash provided by (used in) investing activities			(31,039	)			(554,902	)
Cash flows from financing activities
Payment of financing costs			-				(261,982	)
Repayments of long-term debt			(248,533	)			(242,375	)
Proceeds from equipment financing			-				331,827
Payments for finance leases			-				(10,077	)
Proceeds from issuance of preferred stock			-				13,300,000
Proceeds from issuance of common stock			-				6,800,000
Proceeds from the exercise of stock options			68,400				-
Contributions of capital from noncontrolling interest			-				53,614
Net cash provided by (used in) financing activities			(180,133	)			19,971,007
Effect of exchange rate changes on cash and cash equivalents			578				(33	)
Net increase (decrease) in cash and cash equivalents			(4,789,418	)			11,046,716
Cash and cash equivalents - beginning of period			17,189,089				10,757,461
Cash and cash equivalents - end of period		$	12,399,671			$	21,804,177
Supplemental disclosures of cash flow information:
Cash paid for interest		$	37,612			$	39,994
Supplemental noncash information:
Right of use asset obtained in exchange for new finance lease		$	-			$	13,521
Right of use asset obtained in exchange for new operating lease			178,124				41,048
Asset retirement obligation			19,454				18,527

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

EnSync, Inc.

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business

 

EnSync, Inc. and its subsidiaries (“EnSync,” “we,” “us,” “our,” or the “Company”) develop, license, and manufacture innovative energy management systems solutions serving the commercial and industrial (“C&I”) building, utility, and off-grid markets. Incorporated in 1998, EnSync is headquartered in Menomonee Falls, Wisconsin, USA with offices in Madison, Wisconsin, Petaluma, California, Honolulu, Hawaii, and Shanghai, China. We regularly use the name EnSync Energy Systems for marketing and branding purposes.

 

EnSync develops and commercializes distributed energy resource systems and internet of energy control platforms aiming to ensure the most cost-effective and resilient electricity, delivered from an electrical infrastructure that prioritizes the use of all available resources, including renewables, energy storage and the utility grid. As a project developer, our distinctive engagement methodology encompasses load analysis, system design consulting and technical and financial modeling to ensure energy systems are sized and optimized to meet the performance and value goals of our customers. EnSync delivers fully integrated systems utilizing proprietary direct current power control hardware, energy management software, and extensive experience with energy storage technologies. Our internet of energy control platform adapts to ever-changing generation and load variables, as well as changes in utility prices and programs, aiming to ensure the means to make and/or save money behind-the-meter while concurrently providing utilities the opportunity to use distributed energy resource systems for various grid enhancing services. The Company also develops and commercializes energy management systems for off-grid applications such as island or remote power.

 

We recently began addressing our target markets through power purchase agreements (“PPAs”) under which we agree to provide, and the customer agrees to purchase, electricity from us at a fixed rate for a 20-year period. Under this structure we develop and supply a system that uses our and other companies’ products and the customer receives the benefit of a low and fixed price for electricity without any upfront costs. Because this business model requires significant capital outlays, our monetization strategy is we either sell the PPA projects outright or enter into sale-leaseback transactions.

 

The condensed consolidated financial statements include the accounts of the Company and those of its wholly-owned subsidiaries ZBB Energy Pty Ltd. (formerly known as ZBB Technologies, Ltd.), DCfusion, LLC, various PPA project subsidiaries, its eighty-five percent owned subsidiary Holu Energy LLC, and its sixty percent owned subsidiary ZBB PowerSav Holdings Limited located in Hong Kong, which was formed in connection with the Company’s investment in a China joint venture.

  

Interim Financial Data

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) for interim financial data and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of adjustments of a normal and recurring nature) considered necessary for fair presentation of the results of operations have been included. Operating results for the three and nine months ended March 31, 2017 are not necessarily indicative of the results that might be expected for the year ending June 30, 2017.

 

The condensed consolidated balance sheet at June 30, 2016 has been derived from audited financial statements at that date, but does not include all of the information and disclosures required by US GAAP. For a more complete discussion of accounting policies and certain other information, refer to the Company’s annual report filed on From 10-K for the fiscal year ended June 30, 2016 filed with the Securities and Exchange Commission on September 8, 2016.

 

 

Basis of Presentation and Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries and have been prepared in accordance with US GAAP and are reported in US dollars. For subsidiaries in which the Company’s ownership interest is less than 100%, the noncontrolling interests are reported in stockholders’ equity in the condensed consolidated balance sheets. The noncontrolling interests in net income (loss), net of tax, are classified separately in the condensed consolidated statements of operations. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company’s fiscal year end is June 30.

 

Use of Estimates

 

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. It is reasonably possible that the estimates we have made may change in the near future. Significant estimates underlying the accompanying condensed consolidated financial statements include those related to:

 

·

the timing of revenue recognition;

·

allocation of purchase price in the business combination;

·

the allowance for doubtful accounts;

·

provisions for excess and obsolete inventory;

·

the lives and recoverability of property, plant and equipment and other long-lived assets, including goodwill;

·

contract costs, losses, and reserves;

·

warranty obligations;

·

income tax valuation allowances;

·

discount rates for finance and operating lease liabilities;

·

asset retirement obligations;

·

stock-based compensation; and

·

valuation of equity instruments and warrants.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, a note receivable, accounts payable, bank loans, notes payable, equipment financing, lease obligations, asset retirement obligations, equity instruments, and warrants. The carrying amounts of the Company’s financial instruments approximate their respective fair values due to the relatively short-term nature of these instruments, except for the bank loans, notes payable, equipment financing, asset retirement obligations, equity instruments, and warrants. The carrying amounts of the bank loans and notes payable approximates fair value due to the interest rate and terms approximating those available to us for similar obligations. The interest rate on the equipment financing obligation was imputed based on the requirements described in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 842-40-30-6. The asset retirement obligation is calculated as the present value of the estimated fair value of the future obligation using the Company’s credit-adjusted risk-free rate. The fair value of the nonconvertible attribute and conversion option of the Series C Preferred Stock and related Warrant was determined using the Option-Pricing Method (“OPM”) as described in the AICPA Accounting and Valuation Guide entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation and a “with” and “without” methodology to bifurcate the Series C Preferred conversion feature. The OPM model treats the various equity securities as call options on the total equity value contingent upon each security’s strike price or participation rights. The Black-Scholes inputs utilized for the OPM model were: (i) an aggregate equity value estimated based on the back-solve methodology to reconcile the closing common stock price as of the valuation date; (ii) a term in alignment with the terms of our supply agreement with SPI Energy Co., LTD.; (iii) a risk free rate from the Federal Reserve Board’s H.15 release as of the transaction date; (iv) the volatility of the price of the Company’s publicly traded stock; and (v) the performance vesting requirements of the equity instruments that were expected to be met.

  

The Company accounts for the fair value of financial instruments in accordance with FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The degree of judgment utilized in measuring the fair value of assets and liabilities generally correlate to the level or pricing observability. FASB ASC Topic 820 describes a fair value hierarchy based on the following three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

 

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

 

Level 2 inputs are inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for similar assets or liabilities in active markets.

 

Level 3 inputs are unobservable inputs for the asset or liability. As such, the prices or valuation techniques require inputs that are both significant to the fair value measurement and are unobservable.

 

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with maturities of three months or less to be cash equivalents. The Company maintains its cash deposits at financial institutions predominately in the United States, Australia, Hong Kong, and China. The Company has not experienced any losses in such accounts.

 

Accounts Receivable

 

Credit is extended based on an evaluation of a customer’s financial condition. Accounts receivable are stated at the amount the Company expects to collect from outstanding balances. The Company records allowances for doubtful accounts based on customer-specific analysis and general matters such as current assessments of past due balances and economic conditions. The Company writes off accounts receivable against the allowance when they become uncollectible. The Company had no allowance for doubtful accounts  as of March 31, 2017. Accounts receivable are stated net of an allowance for doubtful accounts of $10,878  as of June 30, 2016. The composition of accounts receivable by aging category is as follows as of:

 

		March 31, 2017				June 30, 2016
Current		$	52,796			$	165,114
30-60 days			3,979				2,219
60-90 days			-				-
Over 90 days			180,490				5,300
Total		$	237,265			$	172,633

 

Inventories

 

Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. The Company provides inventory write-downs based on excess and obsolete inventories based on historical usage. The write-down is measured as the difference between the cost of the inventory and market based upon assumptions about usage and charged to the provision for inventory, which is a component of cost of sales. At the point of the loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

 

Customer Intangible Asset

 

Customer intangible assets are reviewed quarterly for impairment due to the expected short-term nature of the asset. The customer intangible asset is amortized as revenue from the acquired contracts is recognized in our consolidated statements of operations. To date, there have been no write-offs recorded for impairments.

The customer intangible asset is comprised of the following as of:

 

		March 31, 2017				June 30, 2016
Gross carrying value		$	169,322			$	169,322
Accumulated amortization			(161,073	)			(93,029	)
Net carrying value		$	8,249			$	76,293

 

There was $68,044  of amortization expense recognized during the nine months ended March 31, 2017. Amortization expense recognized during the three and nine months ended March 31, 2016 was $31,759 and $46,206, respectively.

 

Note Receivable

 

The Company has one note receivable from an unrelated party. On June 20, 2016, the Company and the unrelated party amended the terms of the note receivable. The note matured on the earlier of (a) the date on which the unrelated party has secured a total of $500,000 or more in additional financing from any source or (b) December 31, 2016 and is classified as “Note receivable” in the financial statements. On January 27, 2017, the Company negotiated new repayment terms with the borrower and extended the maturity date to the earlier of the date on which the borrower has secured a total of $500,000 or more in additional financing from any source and December 31, 2022. We regularly evaluate the financial condition of the borrower to determine if any reserve for an uncollectible amount should be established. To date, no such reserve is required.

 

 

Deferred PPA Project Costs

 

Deferred PPA project costs represents the costs that the Company capitalizes as project assets for arrangements that we accounted for as real estate transactions after we have entered into a definitive sales arrangement, but before the sale is completed or before we have met all criteria to recognize the sale as revenue. We classify deferred PPA project costs as current if the completion of the sale and the meeting of all revenue recognition criteria are expected within the next 12 months.

 

If a project is completed and begins commercial operation prior to entering into or the closing of a sales agreement, the completed project will remain in project assets or deferred PPA project costs until the sale of such project closes. Any income generated by such project while it remains within project assets or deferred PPA project costs is accounted for as a reduction in our basis in the project, which at the time of sale and meeting all revenue recognition criteria will be recorded within cost of sales.

 

Once we enter into a definitive sales agreement, we reclassify project assets to deferred PPA project costs on our consolidated balance sheet until the sale is completed and we have met all of the criteria to recognize the sale as revenue, which is typically subject to real estate revenue recognition requirements. We expense project assets to cost of sales after each respective project asset is sold to a customer and all revenue recognition criteria have been met (matching the expensing of costs to the underlying revenue recognition method). We classify project assets as current as the time required to develop, construct, and sell the projects is expected within the next 12 months.

 

We review project assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. We consider a project commercially viable or recoverable if it is anticipated to be sold for a profit once it is either fully developed or fully constructed. We consider a partially developed or partially constructed project commercially viable or recoverable if the anticipated selling price is higher than the carrying value of the related project assets. We examine a number of factors to determine if the accumulated project costs will be recoverable, the most notable of which include whether there are any changes in environmental, ecological, permitting, market pricing, or regulatory conditions that impact the project. Such changes could cause the costs of the project to increase or the selling price of the project to decrease. If a project is not considered recoverable, we impair the respective project assets and adjust the carrying value to the estimated recoverable amount, with the resulting impairment recorded within operating expenses. The Company did not record any impairment charges during the three or nine months ended March 31, 2017. The Company recognized $1.9 million  of impairment charges during the year ended June 30, 2016.

 

Deferred Customer Project Costs

 

Deferred customer project costs consist primarily of the costs of products delivered and services performed that are subject to additional performance obligations or customer acceptance. These deferred customer project costs are expensed at the time the related revenue is recognized.

 

Project Assets

 

Project assets consist primarily of capitalized costs which are incurred by the Company prior to the sale of the photovoltaic, storage or energy management systems and power purchase agreement to a third-party. These costs are typically for the construction, installation and development of these projects. Construction and installation costs include primarily material and labor costs. Development fees can include legal, consulting, permitting, and other similar costs.

 

Property, Plant and Equipment

 

Land, building, equipment, computers, furniture and fixtures are recorded at cost. Maintenance, repairs and betterments are charged to expense as incurred. Depreciation is provided for all plant and equipment on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives used for each class of depreciable asset are:

 

		Estimated Useful Lives
Manufacturing equipment		3 - 7 years
Office equipment		3 - 7 years
Building and improvements		7 - 40 years

 

The Company completed a review of the estimated useful lives of specific assets for the nine months ended March 31, 2017 and determined that there were no changes in the estimated useful lives of assets.

 

 

Impairment of Long-Lived Assets

 

In accordance with FASB ASC Topic 360, "Impairment or Disposal of Long-Lived Assets," the Company assesses potential impairments to its long-lived assets including property, plant, equipment and intangible assets when there is evidence that events or changes in circumstances indicate that the carrying value may not be recoverable.

 

If such an indication exists, the recoverable amount of the asset is compared to the asset’s carrying value. Any excess of the asset’s carrying value over its recoverable amount is expensed in the statement of operations. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate. Management has determined that there were no long-lived assets impaired as of March 31, 2017 and June 30, 2016.

 

Investment in Investee Company

 

Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, an investee company’s accounts are not reported in the Company’s condensed consolidated balance sheets and statements of operations; however, the Company’s share of the earnings or losses of the investee company is reflected in the caption ‘‘Equity in gain (loss) of investee company” in the condensed consolidated statements of operations. The Company’s carrying value in an equity method investee company is reported in the caption ‘‘Investment in investee company’’ in the Company’s condensed consolidated balance sheets.

 

When the Company’s carrying value in an equity method investee company is reduced to zero, no further losses are recorded in the Company’s condensed consolidated financial statements unless the Company guaranteed obligations of the investee company or has committed additional funding. When the investee company subsequently reports income, the Company will not record its share of such income until it equals or exceeds the amount of its share of losses not previously recognized.

 

Goodwill

 

Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized but reviewed for impairment annually as of June 30 or more frequently if events or changes in circumstances indicate that its carrying value may be impaired. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.

 

The first step of the impairment test requires the comparing of a reporting unit’s fair value to its carrying value. If the carrying value is less than the fair value, no impairment exists and the second step is not performed. If the carrying value is higher than the fair value, there is an indication that impairment may exist and the second step must be performed to compute the amount of the impairment. In the second step, the impairment is computed by estimating the fair values of all recognized and unrecognized assets and liabilities of the reporting unit and comparing the implied fair value of reporting unit goodwill with the carrying amount of that unit’s goodwill. The Company determined fair value as evidenced by market capitalization, and concluded that there was no need for an impairment charge as of March 31, 2017 and June 30, 2016.

 

Accrued Expenses

 

Accrued expenses consist of the Company’s present obligations related to various expenses incurred during the period and includes a reserve for estimated contract losses, other accrued expenses, and warranty obligations.

 

Warranty Obligations

 

The Company typically warrants its products for the shorter of twelve months after installation or eighteen months after date of shipment. Warranty costs are provided for estimated claims and charged to cost of product sales as revenue is recognized. Warranty obligations are also evaluated quarterly to determine a reasonable estimate for the replacement of potentially defective materials of all energy storage systems that have been shipped to customers within the warranty period.

 

While the Company actively engages in monitoring and improving its evolving battery and production technologies, there is only a limited product history and relatively short time frame available to test and evaluate the rate of product failure. Should actual product failure rates differ from the Company’s estimates, revisions are made to the estimated rate of product failures and resulting changes to the liability for warranty obligations. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise.

 

 

As of March 31, 2017 and June 30, 2016, included in the Company’s accrued expenses were $34,324  and $27,207 , respectively, related to warranty obligations. The following is a summary of accrued warranty activity  as of:

 

		March 31, 2017				June 30, 2016
Beginning balance		$	27,207			$	176,967
Accruals for warranties during the period			35,473				44,645
Settlements during the period			(196,244	)			(318,698	)
Adjustments relating to preexisting warranties			167,888				124,293
Ending balance		$	34,324			$	27,207

 

The Company offers extended warranty contracts to its customers. These contracts typically cover a period up to twenty years and include advance payments that are recorded initially as long-term deferred revenue. Revenue is recognized in the same manner as the costs incurred to perform under the extended warranty contracts. Costs associated with these extended warranty contracts are expensed to cost of product sales as incurred. A summary of changes to long-term deferred revenue for extended warranty contracts is as follows:

 

		March 31, 2017				June 30, 2016
Beginning balance		$	-			$	-
Deferred revenue for new extended warranty contracts			422,638				-
Deferred revenue recognized			-				-
Ending balance			422,638				-
Less: current portion of deferred revenue for extended warranty contracts			-				-
Long-term deferred revenue for extended warranty contracts		$	422,638			$	-

 

Asset Retirement Obligations

 

The asset retirement obligation represents the estimated present value of amounts expected to be incurred to remove a solar power system, repair the property to which it is affixed, pack and ship the equipment offsite at the end of the lease term. The asset retirement obligation is recognized in accordance with FASB ASC Topic 410, “Asset Retirement and Environmental Obligations.” FASB ASC Topic 410 requires that the fair value of an asset’s retirement obligation be recorded as a liability in the period in which it is incurred and the corresponding cost capitalized by increasing the carrying amount of the related long-lived asset. Periodic accretion of the discount of the estimated liability is treated as accretion expense and included in depreciation and amortization in the condensed consolidated statement of operations.

 

Revenue Recognition

 

Revenues are recognized when persuasive evidence of a contractual arrangement exists, delivery has occurred or services have been rendered, the seller’s price to buyer is fixed and determinable, and collectability is reasonably assured. The portion of revenue related to installation and final acceptance, is deferred until such installation and final customer acceptance are completed.

 

From time to time, the Company may enter into separate agreements at or near the same time with the same customer. The Company evaluates such agreements to determine whether they should be accounted for individually as distinct arrangements or whether the separate agreements are, in substance, a single multiple element arrangement. The Company evaluates whether the negotiations are conducted jointly as part of a single negotiation, whether the deliverables are interrelated or interdependent, whether the fees in one arrangement are tied to performance in another arrangement, and whether elements in one arrangement are essential to another arrangement. The Company’s evaluation involves significant judgment to determine whether a group of agreements might be so closely related that they are, in effect, part of a single arrangement.

 

 

Our collaboration agreements typically involve multiple elements or deliverables, including upfront fees, contract research and development, milestone payments, technology licenses or options to obtain technology licenses, and royalties. For these arrangements, revenues are recognized in accordance with FASB ASC Topic 605-25, “Revenue Recognition – Multiple Element Arrangements.” The Company’s revenues associated with multiple element contracts is based on the selling price hierarchy, which utilizes vendor-specific objective evidence (“VSOE”) when available, third-party evidence (“TPE”) if VSOE is not available, and if neither is available then the best estimate of the selling price is used. The Company utilizes best estimate for its multiple deliverable transactions as VSOE and TPE do not exist. To be considered a separate element, the product or service in question must represent a separate unit under SEC Staff Accounting Bulletin 104, and fulfill the following criteria: the delivered item(s) has value to the customer on a standalone basis; there is objective and reliable evidence of the fair value of the undelivered item(s); and if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. For arrangements containing multiple elements, revenue from time and materials based service arrangements is recognized as the service is performed. Revenue relating to undelivered elements is deferred at the estimated fair value until delivery of the deferred elements. If the arrangement does not meet all criteria above, the entire amount of the transaction is deferred until all elements are delivered.

 

The portion of revenue related to engineering and development is recognized ratably upon delivery of the goods or services pertaining to the underlying contractual arrangement or revenue is recognized as certain activities are performed by the Company over the estimated performance period.

 

The Company recognizes revenue for the sales of PPA projects following the guidance in FASB ASC Topic 360, “Accounting for Sales of Real Estate.” We record the sale as revenue after the initial and continuing investment requirements have been met and whether collectability from the buyer is reasonably assured. We may align our revenue recognition and release our project assets or deferred PPA project costs to cost of sales with the receipt of payment from the buyer if the sale has been consummated and we have transferred the usual risks and rewards of ownership to the buyer.

 

The Company charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in product revenues and shipping costs in cost of sales. The Company reports its revenues net of estimated returns and allowances.

 

Total revenues of $50,505 and $9,268,635 were recognized for the three and nine months ended March 31, 2017, respectively. Revenues for the three months ended March 31, 2017, were comprised of five significant customers (90% of revenues, collectively) and revenues for the nine months ended March 31, 2017, were comprised of four significant customers (93% of revenues, collectively). Total revenues of $160,138 and $815,375 were recognized for the three and nine months ended March 31, 2016, respectively. Revenues for the three months ended March 31, 2016 were comprised of two significant customers (95% of revenues, collectively) and revenues for the nine months ended March 31, 2016 were comprised of three significant customers (85% of revenues, collectively).  

 

The Company had three significant customers with outstanding receivable balances of $158,026, $47,683, and $23,744 (67%, 20%, and 10% of accounts receivable, net) as of March 31, 2017.  The Company had one significant customer with an outstanding receivable balance of $23,000 (62% of accounts receivable, net) as of March 31, 2016. 

 

Engineering, Development, and License Revenues

 

We assess whether a substantive milestone exists at the inception of our agreements. In evaluating if a milestone is substantive we consider whether:

 

·

Substantive uncertainty exists as to the achievement of the milestone event at the inception of the arrangement;

·

The achievement of the milestone involves substantive effort and can only be achieved based in whole or in part on our performance or the occurrence of a specific outcome resulting from our performance;

·

The amount of the milestone payment appears reasonable either in relation to the effort expended or the enhancement of the value of the delivered item(s);

·

There is no future performance required to earn the milestone; and

·

The consideration is reasonable relative to all deliverables and payment terms in the arrangement.

 

If any of these conditions are not met, we do not consider the milestone to be substantive and we defer recognition of the milestone payment and recognize it as revenue over the estimated period of performance, if any.

 

On April 8, 2011, the Company entered into a Collaboration Agreement (the “Collaboration Agreement”) with Honam Petrochemical Corporation, now known as Lotte Chemical Corporation (“Lotte”), pursuant to which the Company and Lotte collaborated on the technical development of the Company’s third generation zinc bromide flow battery module (the “Version 3 Battery Module”) and Lotte received a fully paid-up, exclusive and royalty-free license to sell and manufacture the Version 3 Battery Module in South Korea and a non-exclusive royalty-bearing license to sell the Version 3 Battery Module in Japan, Thailand, Taiwan, Malaysia, Vietnam and Singapore.

 

 

On December 16, 2013, the Company and Lotte entered into a Research and Development Agreement (the “R&D Agreement”) pursuant to which the Company has agreed to develop and provide to Lotte a 500kWh zinc bromide flow battery system, including a zinc bromide chemical flow battery module and related software (the “Product”), on the terms and conditions set forth in the R&D Agreement (the “Lotte Project”). Subject to the satisfaction of certain specified milestones, Lotte was required to make payments to the Company under the R&D Agreement totaling $3,000,000 over the term of the Lotte Project. We recognized revenue under the R&D Agreement based upon a Performance Based Method pursuant to the model described in FASB ASC Subtopic 980-605-25, where revenue is recognized based on the lesser of the amount of nonrefundable cash received or the amounts due based on the proportional amount of the total effort expected to be expended on the contract that has been provided to date as there does not exist substantial doubt that the milestones will be achieved. The Company recognized $0  and $175,000  of revenue under this agreement for the three and nine months ended March 31, 2017, respectively. The Company recognized $95,382 and $264,389 of revenue under the R&D Agreement for the three and nine months ended March 31, 2016, respectively.

 

Additionally, on December 16, 2013, we entered into an Amended License Agreement with Lotte (the “Amended License Agreement”). Pursuant to the Amended License Agreement, we granted to Lotte (1) an exclusive and royalty-free limited license in South Korea to use the Company’s zinc bromide flow battery module, zinc bromide flow battery stack and the technical information and know how related to the intellectual property arising from the Lotte Project (collectively, the “Technology”) to manufacture or sell a zinc bromide flow battery (the “Lotte Product”) in South Korea and (2) a non-exclusive (a) royalty-free limited license for Lotte and its affiliates to use the Technology internally in all locations other than China and South Korea to manufacture the Lotte Product and (b) royalty-bearing limited license to sell the Lotte Product in all locations other than China, the United States and South Korea. Lotte was required to pay us a total license fee of $3,000,000 under the Amended License Agreement plus up to an additional $1,000,000 if certain specific milestones are successfully achieved. In addition, Lotte is required to make ongoing royalty payments to the Company equal to a single digit percentage of Lotte’s net sales of the Lotte Product outside of South Korea until December 31, 2019. The original license fees were subject to a 16.5% non-refundable Korea withholding tax.

 

Overall since December 16, 2013 through March 31, 2017 there were $5,425,000  of payments received and $5,425,000 of revenue recognized under the Lotte R&D and Amended License Agreements. The Company does not expect to receive any additional cash payments under these agreements.

 

Engineering and development costs related to the Lotte Project totaled $0  and $937,725  for the three and nine months ended March 31, 2017, respectively. Engineering and development costs related to the Lotte Project totaled $221,628 and $357,795  for the three and nine months ended March 31, 2016, respectively. As of March 31, 2017 and June 30, 2016, the Company had no unbilled amounts from engineering and development contracts in process.

 

Advanced Engineering and Development Expenses

 

In accordance with FASB ASC Topic 730, “Research and Development,” the Company expenses advanced engineering and development costs as incurred. These costs consist primarily of materials, labor, and allocable indirect costs incurred to design, build, and test prototype units, as well as the development of manufacturing processes for these units. Advanced engineering and development costs also include consulting fees and other costs.

 

To the extent these costs are separately identifiable, incurred and funded by advanced engineering and development type agreements with outside parties, they are shown separately on the condensed consolidated statements of operations as a “Cost of engineering and development.”

 

Stock-Based Compensation

 

The Company measures all “Share-Based Payments," including grants of stock options, restricted shares and restricted stock units (“RSUs”) in its condensed consolidated statement of operations based on their fair values on the grant date, which is consistent with FASB ASC Topic 718, “Stock Compensation,” guidelines.

 

Accordingly, the Company measures share-based compensation cost for all share-based awards at the fair value on the grant date and recognizes share-based compensation over the service period for awards that are expected to vest. The fair value of stock options is determined based on the number of shares granted and the price of the shares at grant, and calculated based on the Black-Scholes valuation model.

 

The Company compensates its outside directors with RSUs and cash. The grant date fair value of the RSU awards is determined using the closing stock price of the Company’s common stock on the day prior to the date of the grant, with the compensation expense amortized over the vesting period of RSU awards, net of estimated forfeitures.

 

The Company only recognizes expense for those options or shares that are expected ultimately to vest, using two attribution methods to record expense, the straight-line method for grants with only service-based vesting or the graded-vesting method, which considers each performance period, for all other awards. See further discussion of stock-based compensation in Note 11.

 

 

Advertising Expense

 

Advertising costs of $3,710  and $24,825  were incurred for the three and nine months ended March 31, 2017, respectively. Advertising costs of $4,103 and $14,362  were incurred for the three and nine months ended March 31, 2016, respectively. These costs were charged to selling, general, and administrative expenses as incurred.

 

Income Taxes

 

The Company records deferred income taxes in accordance with FASB ASC Topic 740, “Accounting for Income Taxes.” FASB ASC Topic 740 requires recognition of deferred income tax assets and liabilities for temporary differences between the tax basis of assets and liabilities and the amounts at which they are carried in the financial statements, based upon the enacted tax rates in effect for the year in which the differences are expected to reverse. The Company establishes a valuation allowance when necessary to reduce deferred income tax assets to the amount expected to be realized. There were no net deferred income tax assets recorded as of March 31, 2017 and June 30, 2016.

 

The Company applies a more-likely-than-not recognition threshold for all tax uncertainties as required under FASB ASC Topic 740, which only allows the recognition of those tax benefits that have a greater than fifty percent likelihood of being sustained upon examination by the taxing authorities.

 

The Company’s US Federal income tax returns for the years ended June 30, 2013 through June 30, 2016 and the Company’s Wisconsin and Australian income tax returns for the years ended June 30, 2012 through June 30, 2016 are subject to examination by taxing authorities. As of March 31, 2017, there were no examinations in progress.

  

Foreign Currency

 

The Company uses the United States dollar as its functional and reporting currency, while the Australian dollar and Hong Kong dollar are the functional currencies of its foreign subsidiaries. Assets and liabilities of the Company’s foreign subsidiaries are translated into United States dollars at exchange rates that are in effect at the balance sheet date while equity accounts are translated at historical exchange rates. Income and expense items are translated at average exchange rates which were applicable during the reporting period. Translation adjustments are recorded in accumulated other comprehensive loss as a separate component of equity in the condensed consolidated balance sheets.

 

Loss per Share

 

The Company follows the FASB ASC Topic 260, “Earnings per Share,” provisions which require the reporting of both basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (net loss) per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. In accordance with the FASB ASC Topic 260, any anti-dilutive effects on net income (loss) per share are excluded. For the three and nine months ended March 31, 2017 and March 31, 2016 there were 16,873,337 and 14,000,034  shares of common stock underlying convertible preferred stock, options, restricted stock units and warrants that are excluded, respectively.

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable.

 

The Company maintains significant cash deposits primarily with one financial institution. The Company has not previously experienced any losses on such deposits. Additionally, the Company performs periodic evaluations of the relative credit rating of the institution as part of its banking strategy.

 

Concentrations of credit risk with respect to accounts receivable are limited due to accelerated payment terms in current customer contracts and creditworthiness of the current customer base.

 

Reclassifications

 

Certain amounts previously reported have been reclassified to conform to the current presentation. The reclassifications did not impact prior period results of operations, cash flows, total assets, total liabilities, or total equity.

 

Segment Information

 

The Company has determined that it operates as one reportable segment.

 

 

Recent Accounting Pronouncements

 

From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective and not included below will not have a material impact on our financial position or results of operations upon adoption.

 

In August 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-15 – Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force). The amendments in ASU 2016-15 addresses eight specific cash flow issues and is intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect adoption of this guidance to have a significant impact on its condensed consolidated financial statements.

 

In May 2016, the FASB issued ASU 2016-11 – Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (SEC Update). ASU 2016-11 rescinds the certain SEC Staff Observer comments that are codified in Topic 605, Revenue Recognition, and Topic 932, Extractive Activities – Oil and Gas, effective upon the adoption of Topic 606. Specifically, registrants should not rely on the following SEC Staff Observer comments upon adoption of Topic 606: (a) Revenue and Expense Recognition for Freight Services in Process, (b) Accounting for Shipping and Handling Fees and Costs, (c) Accounting for Consideration Given by a Vendor to a Customer (including Reseller of the Vendor’s Products), (d) Accounting for Gas-Balancing Arrangements (that is, use of the “entitlements method”). In addition, as a result of the amendments in Update 2014-16, the SEC staff is rescinding its SEC Staff Announcement, “Determining the Nature of a Host Contract Related to a Hybrid Instrument Issued in the Form of a Share under Topic 815,” effective concurrently with ASU 2014-16. The Company is currently evaluating the effects of ASU 2016-11 on its condensed consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09 – Compensation – Stock Compensation (Topic 780): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 modifies US GAAP by requiring the following, among others: (1) all excess tax benefits and tax deficiencies are to be recognized as income tax expense or benefit on the income statement (excess tax benefits are recognized regardless of whether the benefit reduces taxes payable in the current period); (2) excess tax benefits are to be classified along with other income tax cash flows as an operating activity in the statement of cash flows; (3) in the area of forfeitures, an entity can still follow the current US GAAP practice of making an entity-wide accounting policy election to estimate the number of awards that are expected to vest or may instead account for forfeitures when they occur; and (4) classification as a financing activity in the statement of cash flows of cash paid by an employer to the taxing authorities when directly withholding shares for tax withholding purposes. ASU 2016-09 is effective for annual periods beginning after January 1, 2017, including interim periods. Early adoption is permitted. The Company is currently assessing the impact the adoption of ASU 2016-09 will have on its condensed consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-07 – Investments – Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting, which simplifies the accounting for equity method investments by removing the requirements that an entity retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership or degree of influence. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. ASU 2016-07 is effective for fiscal years beginning after December 15, 2016, and interim periods within those years, and must apply a prospective adoption approach. Early adoption is permitted. The Company does not expect adoption of this guidance to have a significant impact on its condensed consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-06 – Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (a consensus of the Emerging Issues Task Force), which requires that embedded derivatives be separate from the host contract and accounted for separately as derivatives if certain criteria are met, including the “clearly and closely related” criterion. The amendments in this update clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. The amendments apply to all entities that are issuers or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. ASU 2016-06 is effective for fiscal years beginning after December 15, 2016 and interim periods within those years, and must apply a modified retrospective transition approach. Early adoption is permitted. The Company does not expect adoption of this guidance to have a significant impact on its condensed consolidated financial statements.

 

 

In March 2016, the FASB issued ASU 2016-05 – Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (a consensus of the Emerging Issues Task Force), which provides guidance clarifying that the novation of a derivative contract (i.e. a change in counterparty) in a hedge accounting relationship does not, in and of itself, require dedesignation of that hedge accounting relationship. This ASU amends ASC 815 to clarify that such a change does not, in and of itself, represent a termination or the original derivative instrument or a change in the critical terms of the hedge relationship. ASU 2016-05 allows the hedging relationship to continue uninterrupted if all of the other hedge accounting criteria are met, including the expectation that the hedge will be highly effective when the creditworthiness of the new counterpart to the derivative contract is considered. The amendments of this ASU are effective for reporting periods beginning after December 15, 2016. Early adoption is permitted. Entities may adopt the guidance prospectively or use a modified retrospective approach. The Company does not expect adoption of this guidance to have a significant impact on its condensed consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02 – Leases (Topic 842): Amendments to the FASB Accounting Standards Codifications, to increase transparency and comparability among entities by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for reporting periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Companies must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company has early adopted ASU 2016-02 effective January 1, 2016. With the adoption of ASU 2016-02, the Company has elected to apply the package of practical expedients and use of hindsight detailed in ASC 842. Additionally, the Company elects the practical expedient in ASC Subtopic 842-10 to not separate nonlease components from lease components and instead account for each separate lease component and nonlease components associated with that lease component as a single lease component by class of the underlying asset. The Company also elected not to recognize right of use assets and lease liabilities for short term leases, which has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the Company is reasonably certain to exercise.

 

In January 2016, the FASB issued ASU 2016-01 – Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance makes specific improvements to existing US GAAP for financial instruments, including requiring equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; requiring entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes; requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset and requiring entities to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017. Early adoption of the own credit provision is permitted. The Company does not expect adoption of this guidance to have a significant impact on its condensed consolidated financial statements.

 

In September 2015, the FASB issued ASU 2015-16 – Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this update eliminate the requirement for entities to retrospectively account for adjustments made to provisional amounts recognized in a business combination. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2015, including interim reporting periods within those fiscal years. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date. The Company was required to adopt this standard beginning July 1, 2016. The adoption of this pronouncement did not have a material impact on the Company’s condensed consolidated financial statements.

 

In August 2015, the FASB issued ASU 2015-14 – Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. The amendment defers the effective date of ASU 2014-09 for all entities by one year. Public business entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.

 

In July 2015, the FASB issued ASU 2015-11 – Inventory (Topic 330): Simplifying the Measurement of Inventory. The amendment was issued to modify the process in which entities measure inventory. The amendment does not apply to inventory measured using last-in, first-out (“LIFO”) or the retail inventory method. This amendment requires entities to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments are effective for fiscal years beginning after December 31, 2016, including interim periods within those fiscal years on a prospective basis with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not expect adoption of this guidance to have a significant impact on its condensed consolidated financial statements.

 

 

In February 2015, the FASB issued ASU 2015-02 – Consolidation (Topic 810): Amendments to the Consolidation Analysis. The amendment is intended to improve certain areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures. The amendment simplifies reporting requirements by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of application of related-party guidance when determining a controlling financial interest in a variable interest entity (“VIE”), and changing consolidation conclusions for public companies in several industries that typically make use of limited partnerships or VIEs. The amendment is effective for fiscal years beginning after December 31, 2015. The Company was required to adopt this standard beginning July 1, 2016. The adoption of this pronouncement did not have a material impact on the Company’s condensed consolidated financial statements.

 

In January 2015, the FASB issued ASU 2015-01 – Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The amendment was issued to reduce complexity in the accounting standards by eliminating the concept of extraordinary items from US GAAP. The amendment is effective for annual periods ending after December 15, 2015. The change may be applied prospectively or retrospectively to all prior periods presented in the financial statements. The Company was required to adopt this standard beginning July 1, 2016. The adoption of this pronouncement did not have a material impact on the Company’s condensed consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-15 – Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40). The update requires management to perform a going concern assessment if there is substantial doubt about an entity’s ability to continue as a going concern within one year of the financial statement issuance date. Under the new standard, the definition of substantial doubt incorporates a likeliness threshold of “probable” that is consistent with the current use of the term defined in US GAAP for loss contingencies (Topic 450 – Contingencies). Management will need to consider conditions that are known and reasonably knowable at the financial statement issuance date and determine whether the entity will be able to meet its obligations within the one-year period. Additional disclosures are required if it is probable that the entity will be unable to meet its current obligations. The amendments in this ASU will be effective for annual periods ending after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material effect on our financial position, results of operations or cash flows.

 

In June 2014, the FASB issued ASU 2014-12 - Compensation – Stock Compensation (Topic 718). The amendment requires that entities treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting and, accordingly, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation expense should be recognized in the period in which it becomes probable that the performance target will be achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. The Company was required to adopt this standard beginning July 1, 2016. The adoption of this pronouncement did not have a material impact on the Company’s condensed consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09 – Revenue from Contracts with Customers (Topic 606). The amendment outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue model to contracts within its scope, an entity identifies the contract(s) with a customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction price to the performance obligations in the contract and recognizes revenue when the entity satisfies a performance obligation. ASU 2014-09 also includes additional disclosure requirements regarding revenue, cash flows and obligations related to contracts with customers. See ASU 2015-14 above for applicable effective date of ASU 2014-09. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through a cumulative adjustment. In April 2016, the FASB issued ASU 2016-10 – Revenue from Contracts with Customers – Identifying Performance Obligations and Licensing, clarifying the implementation guidance on identifying performance obligations and licensing. Specifically, the amendments reduce the cost and complexity of identifying promised goods or services and improves the guidance for determining whether promises are separately identifiable. The amendments also provide implementation guidance on determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). In March 2016, the FASB also issued ASU 2016-08 – Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments in ASU 2016-08 affect the guidance in ASU 2014-09. ASU 2016-08 requires when a third party is involved in provided goods or services to a customer, an entity is required to determine whether the nature of its promise is to provide the specified good or services itself to the customer (that is, the entity is a principal) or to arrange for that good or service to be provided by the third party to the customer (that is, the entity is an agent). If the entity is a principal, upon satisfying a performance obligation, the entity recognizes revenue in the gross amount of consideration to which it expects to be entitled in exchange for the specified good or service transferred to the customer. If the entity is an agent, the entity recognizes revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the specified good or service to be provided by the third party. In May 2016, the FASB issued ASU 2016-12 – Revenue from Contracts with Customers – Narrow-Scope Improvements and Practical Expedients, which contains certain clarifications and practical expedients in response to certain identified implementation issues. The effective date and transition requirements for ASU 2016-10, 2016-08, and 2016-12 are the same as the effective date and transition requirements for ASU 2014-09. The Company is currently evaluating the effect that implementation of this update will have on its condensed consolidated financial position and results of operations upon adoption.

 

 

NOTE 2 - GLOBAL STRATEGIC PARTNERSHIP WITH SPI ENERGY CO., LTD.

 

On July 13, 2015, the Company entered into a global strategic partnership with SPI Energy Co., Ltd. (“SPI”), (formerly known as Solar Power, Inc.), which includes a Securities Purchase Agreement, a Supply Agreement, and a Governance Agreement.

 

Pursuant to the Securities Purchase Agreement, SPI purchased, for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares of common stock (the “Purchased Common Shares”) and (ii) 28,048 shares of Series C Convertible Preferred Stock (the “Purchased Preferred Shares”) which were potentially convertible, subject to the completion of projects under our Supply Agreement with SPI (as described below), into a total of up to 42,000,600 shares of Common Stock.  

  

The aggregate purchase price for the Purchased Common Shares was based on a purchase price per share of $0.6678, and the aggregate purchase price for the Purchased Preferred Shares was determined based on a price of $0.6678 per common equivalent.  Pursuant to the Securities Purchase Agreement, the Company also issued to SPI a warrant to purchase 50,000,000 shares of Common Stock for an aggregate purchase price of $36,729,000 (the “Warrant”), at a per share exercise price of $0.7346.

 

The Company incurred $807,807 of financing related costs in connection with the transaction. The specific costs directly attributable to the Securities Purchase Agreement have been charged against the gross proceeds of the offering.

 

The Company also entered into a supply agreement with SPI pursuant to which the Company agreed to sell and SPI agreed to purchase certain products and services offered by the Company from time to time, including certain energy management system solutions for solar projects (the “Supply Agreement”). Under the Supply Agreement, SPI agreed to purchase energy storage systems with a total combined power output of 40 megawatts (MW) over a four-year period. As described below, on May 4, 2017, the Company terminated the Supply Agreement.  

 

The Company also entered into a governance agreement with SPI (the “Governance Agreement”) that provides SPI certain rights regarding the Company’s Board of Directors and other select governance rights.

 

Terms of the Purchased Preferred Shares

 

The Purchased Preferred Shares are perpetual, are not eligible for dividends, and are not redeemable. Upon any liquidation, dissolution, or winding up of the Company (a “Liquidation”) or a Fundamental Transaction (as defined in the Certificate of Designation for the Series C Preferred Stock), holders of the Purchased Preferred Shares are entitled to receive out of the assets of the Company an amount equal to the higher of (1) the Stated Value, which was $28,048,000 as of March 31, 2017 and (2) the amount payable to the holder if it had converted the shares into common stock immediately prior to the Liquidation or Fundamental Transaction, for each share of the Purchased Preferred Stock after any distribution or payment to the holders of the Series B Preferred Stock and before any distribution or payment shall be made to the holders of the Company’s existing Common Stock, and if the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed shall be ratably distributed in accordance with respective amount that would be payable on such shares if all amounts payable thereon were paid in full, which was $466,472 as of March 31, 2017.

 

Except as required by law or as set forth in the Certificate of Designation for the Series C Preferred Stock, the Purchased Preferred Shares do not have voting rights. While the Series C Preferred Stock is outstanding, the Company may not pay dividends on its common stock and may not redeem more than $100,000 in common stock per year.

 

 

The Purchased Preferred Shares were sold for $1,000 per share and are contingently convertible into 42,000,600 shares calculated utilizing a conversion price of $0.6678, subject to adjustment for stock splits, stock dividends, and other designated capital events. Convertibility of the Purchased Preferred Shares is dependent upon SPI making purchases of and payments for energy storage systems under the Supply Agreement as follows:

 

·

The first one-fourth (the “Series C-1 Preferred Stock”) of the Purchased Preferred Shares only become convertible upon the receipt of final payment for five megawatts worth of solar projects that are purchased by SPI in accordance with the Supply Agreement (the “Projects”);

·

The second one-fourth (the “Series C-2 Preferred Stock”) only become convertible upon the receipt of final payment for an aggregate of 15 megawatts worth of Projects;

·

The third one-fourth (the “Series C-3 Preferred Stock”) only become convertible upon the receipt of final payment for an aggregate of 25 megawatts worth of Projects; and

·

The last one fourth (the “Series C-4 Preferred Stock”) only become convertible upon the receipt of final payment for an aggregate of 40 megawatts worth of Projects.

 

As described below, because EnSync terminated the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert any shares of the Series C Preferred Stock into shares of EnSync common stock.

 

Terms of the Warrant

 

The Warrant entitles SPI to purchase 50,000,000 shares of the Company’s common stock for an aggregate exercise price of $36,729,000, or $0.7346 per share, subject to adjustment for stock splits, stock dividends, and other designated capital transactions. The Warrant may not be partially exercised.

 

The Warrant would have become exercisable only once SPI purchased and paid for 40 megawatts of Projects. Prior to exercise, the Warrant provided SPI with no voting rights.

 

As of March 31, 2017, no purchases had been made under the Supply Agreement and the Warrant was therefore not vested or exercisable. As described below, because EnSync terminated the Supply Agreement, it is no longer possible for the Warrant to become exercisable. The closing price of the Company’s common stock at March 31, 2017 was $0.61, which was below the exercise price of the Warrant, as such, the Warrant was out-of-the-money at that date.  

 

Terms of the Supply Agreement

 

Pursuant to the Supply Agreement, the Company agreed to sell and SPI agreed to purchase products and services offered by the Company from time to time, including energy management system solutions for solar projects.  Pursuant to the Supply Agreement the Company agreed to sell and SPI agreed to purchase products and related services that have an aggregated total of at least 5 megawatts of energy storage rated power output within the first year of the Supply Agreement, 15 megawatts within the first two years, 25 megawatts within the first three years, and 40 megawatts within the first four years of the Supply Agreement.

 

Termination of Supply Agreement

 

SPI never made any purchases under the Supply Agreement. Due to SPI’s failure to meet its purchase obligations, on May 4, 2017  the Company terminated the Supply Agreement. As a result of the termination of the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert the Purchased Preferred Shares or exercise the Warrant.

 

 

Accounting for the Securities Purchase Agreement and the Supply Agreement

 

At closing of the SPI transaction on July 13, 2015, the Company recognized the fair value of the Purchased Common Shares ($6.8 million, determined by reference to the closing price of the Company’s common stock on the NYSE MKT) as an increase to equity. The Company also recognized as equity the fair value of the Series C Preferred Stock ignoring the contingent convertibility on the closing date. The closing date fair value of the Series C Preferred Stock ignoring the contingent convertibility of those shares was estimated at $13.3 million. This price was determined using the Option-Pricing Method (“OPM”) as described in the AICPA Accounting and Valuation Guide entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation and a “with” and “without” methodology to bifurcate the Series C Preferred conversion feature. The OPM model treats the various equity securities as call options on the total equity value contingent upon each securities strike price or participation rights. At closing of the transaction, the Black-Scholes inputs utilized for the OPM model were: (i) an aggregate equity value of $122.8 million, estimated based on the back-solve methodology to reconcile the closing common stock price ($0.85) as of the valuation date; (ii) a term of four years, in alignment with the terms of the Supply Agreement; (iii) a risk free rate of 1.4%, from the Federal Reserve Board’s H.15 release as of the transaction date; (iv) a volatility of 101.3%, based on the volatility of the Company’s publicly traded stock price; and (v) the performance vesting requirements of the Purchased Preferred Shares were expected to be met.

 

Offering expenses of $807,807 were recognized as a reduction of the offering proceeds. The specific costs directly attributable to the Securities Purchase Agreement have been charged against the gross proceeds of the offering.

 

The cash received by the Company in excess of the fair value of the Purchased Common Shares and the nonconvertible attribute of the Purchased Preferred Shares was recorded as deferred revenue of $13,290,000. This amount was allocated to the Supply Agreement under which the Company expects to perform in the future. The deferred revenue will be recognized as revenue as sales occur under the Supply Agreement.

 

Because the Purchased Preferred Shares will only become convertible when the Company receives final payment for the stated purchases under the Supply Agreement, the value of the conversion option on each tranche of Series C Preferred Stock will be recognized as a sales incentive (a reduction of revenue) and an addition to equity as purchases that lead towards convertibility of that tranche occur, so long as the Company believes it is probable that the particular tranche will become convertible, pursuant to guidance in FASB ASC Topic 605-50, “Revenue Recognition – Customer Payments and Incentives.”

 

Because the Warrant will only vest and become exercisable if SPI makes sufficient purchases under the Supply Agreement, the same guidance provides that the fair value of the Warrant be recognized as a sales incentive (a reduction of revenue) and an addition to equity as sales occur, so long as the Company believes it is probable that SPI will make sufficient purchases during the term of the Warrant for the Warrant to vest.

 

As SPI does not face a penalty for not purchasing Projects under the Supply Agreement beyond the convertibility of the Purchased Preferred Shares and the exercisability of the Warrant, FASB ASC Topic 505-50, “Equity – Equity-Based Payments to Non-Employees,” requires that the fair value of each tranche of Series C Preferred Stock be updated at each reporting date until that tranche vests according to its terms, and that the fair value of the Warrant be updated at each reporting date until the Warrant vests according to its terms.

 

 

As of March 31, 2017, the value of the conversion option on the Series C Preferred Stock was estimated to be $185,000 and the value of the Warrant was estimated to be $214,000, which was determined using the Option-Pricing Method (“OPM”) as described in the AICPA Accounting and Valuation Guide entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation and a “with” and “without” methodology to bifurcate the Series C Preferred conversion feature. The OPM model treats the various equity securities as call options on the total equity value contingent upon each security’s strike price or participation rights. At March 31, 2017, the Black-Scholes inputs utilized for the OPM model were: (i) an aggregate equity value of $64.4 million, estimated based on the back-solve methodology to reconcile the closing common stock price ($0.61) as of the valuation date; (ii) a term of 2.25 years, in alignment with the terms of the Supply Agreement; (iii) a risk free rate of 1.33%, from the Federal Reserve Board’s H.15 release as of the transaction date; (iv) a volatility of 101.2%, based on the volatility of the Company’s publicly traded stock price; and (v) the performance vesting requirements of the equity instruments were expected to be met.

 

As no sales under the Supply Agreement occurred prior to March 31, 2017, no revenue has been recognized pursuant to the Supply Agreement, and no amounts related to the convertibility option on the Series C Preferred Stock or the Warrant have been reflected in the financial statements.

 

Terms of Governance Agreement

 

In connection with the closing of the SPI transaction and pursuant to the Securities Purchase Agreement, the Company entered into a Governance Agreement with SPI (the “Governance Agreement”).  Under the Governance Agreement, for so long as SPI holds at least 10,000 Purchased Preferred Shares or 25 million shares of Common Stock or Common Stock equivalents (the “Requisite Shares”) SPI had the right to initially nominate one director to the Company’s board of directors and to nominate additional directors as it completed and paid for Projects under the Supply Agreement and the Purchased Preferred Shares became convertible; provided in no event is SPI entitled to nominate a number of directors to the Board that would represent a percentage of the Board greater than the percentage determined by dividing the number of Common Stock Equivalents held by SPI by the sum of (A) the total shares of the Company’s Common Stock outstanding and (B) the number of shares of Common Stock into which the Preferred Stock held by SPI is convertible.

  

The Governance Agreement provides that for so long as SPI holds the Requisite Shares, the Company will not take any of the following actions without the affirmative vote of SPI: (a) change the conduct by the Company’s business; (b) change the number or manner of appointment of the directors on the board; (c) cause the dissolution, liquidation or winding-up of the Company or the commencement of a voluntary proceeding seeking reorganization or other similar relief; (d) other than in the ordinary course of conducting the Company’s business, cause the incurrence, issuance, assumption, guarantee or refinancing of any debt if the aggregate amount of such debt and all other outstanding debt of the Company exceeds $10 million; (e) cause the acquisition, repurchase or redemption by the Company of any securities junior to the Purchased Preferred Shares; (f) cause the acquisition of an interest in any entity or the acquisition of a substantial portion of the assets or business of any entity or any division or line of business thereof or any other acquisition of material assets, in any such case where the consideration paid exceeds $2 million, or cause the Company to engage in other Fundamental Transactions (as defined in the certificate of designation of preferences, rights and limitations of the Series C Convertible Preferred Stock); (g) cause the entering into by the Company of any agreement, arrangement or transaction with an affiliate that calls for aggregate payments (other than payment of salary, bonus or reimbursement of reasonable expenses) in excess of $120,000; (h) cause the commitment to capital expenditures in excess of $7 million during any fiscal year; (i) cause the selection or replacement of the auditors of the Company; (j) enter into of any partnership, consortium, joint venture or other similar enterprise involving the payment, contribution, or assignment by the Company or to the Company of money or assets greater than $5 million; (k) amend or otherwise change its Articles of Incorporation or by-laws or equivalent organizational documents of the Company or any subsidiary in any manner that materially and adversely affects any rights of SPI; (l) amend or otherwise change the Articles of Incorporation or by-laws or equivalent organizational documents of any Subsidiary in any manner; (m) grant, issue or sell any equity securities (with certain limited exceptions); (n) declare, set aside, make or pay any dividend or other distribution, payable in cash, stock, property or otherwise, with respect to any of its capital stock; provided, however, that the dividends called for by Section 3(b) of the Certificate of Designation of Preferences, Rights and Limitations of the Company’s Series B Convertible Preferred Stock shall nonetheless continue to accrue and accumulate on each share of the Company’s Series B Convertible Preferred Stock; (o) reclassify, combine, split or subdivide, directly or indirectly, any of its capital stock; (p) permit any item of material intellectual property to lapse or to be abandoned, dedicated, or disclaimed, fail to perform or make any applicable filings, recordings or other similar actions or filings, or fail to pay all required fees and taxes required or advisable to maintain and protect its interest in such intellectual property; or (q) enter into any contract, arrangement, understanding or other similar agreement with respect to any of the foregoing.

 

Additionally, the Governance Agreement provides a preemptive right to SPI in the case of issuances of equity securities. As of June 30, 2016, SPI owned approximately 17% of the Company’s outstanding common stock. As of March 31, 2017, SPI did not own any shares of the Company’s outstanding common stock.

 

 

On August 30, 2016, SPI entered into a share purchase agreement (the “Share Purchase Agreement”) with Melodious Investments Company Limited (“Melodious”) pursuant to which SPI sold to Melodious all of the Purchased Common Shares, all 7,012 outstanding shares of Series C-1 Preferred Stock and 4,341 shares of Series C-2 Preferred Stock for a total purchase price of $17.0 million (which is equal to the price SPI paid for such securities). The Share Purchase Agreement provides that if the purchased shares of Series C-1 Preferred Stock and Series C-2 Preferred Stock are not converted into shares of common stock within six months following the closing date, Melodious will have the right to require SPI to repurchase such shares for a price equal to approximately 102% of the price paid by Melodious for such shares (plus 10% interest accrued from the closing date). As of March 31, 2017, Melodious had not elected to exercise such right. Following the sale of such securities, SPI continues to hold the Requisite Shares, and the Governance Agreement remains in effect.

  

NOTE 3 - CHINA JOINT VENTURE

 

On August 30, 2011, the Company entered into agreements providing for establishment of a joint venture to develop, produce, sell, distribute and service advanced storage batteries and power electronics in China (the “Joint Venture”). Joint Venture partners include ZBB PowerSav Holdings Limited (“Holdco”), AnHui XinLong Electrical Co. and Wuhu Huarui Power Transmission and Transformation Engineering Co. The Joint Venture was established upon receipt of certain governmental approvals from China which were received in November 2011.

 

The Joint Venture operates through a jointly-owned Chinese company located in Wuhu City, Anhui Province named Anhui Meineng Store Energy Co., Ltd. (“Meineng Energy”). Meineng Energy intends to initially assemble and ultimately manufacture the Company’s products for sale in the power management industry on an exclusive basis in mainland China and on a non-exclusive basis in Hong Kong and Taiwan. In addition, Meineng Energy manufactures certain products for EnSync pursuant to a supply agreement under which we pay Meineng Energy 120% of its direct costs incurred in manufacturing such products.

 

The Company’s President and Chief Executive Officer (“President and CEO”) has served as the Chief Executive Officer of Meineng Energy since December 2011. The President and CEO owns an indirect 6% equity interest in Meineng Energy.

 

In connection with the Joint Venture, on August 30, 2011, the Company and certain of its subsidiaries entered into the following agreements:

 

	·	Joint Venture Agreement of Anhui Meineng Store Energy Co., Ltd. (the “China JV Agreement”) by and between ZBB PowerSav Holdings Limited, a Hong Kong limited liability company, and Anhui Xinrui Investment Co., Ltd, a Chinese limited liability company; and
	·	Limited Liability Company Agreement of ZBB PowerSav Holdings Limited by and between ZBB Cayman Corporation and PowerSav New Energy Holdings Limited (the “Holdco Agreement”).

 

In connection with the Joint Venture, upon establishment of Meineng Energy, the Company and certain of its subsidiaries also entered into the following agreements:

 

	·	Management Services Agreement by and between Meineng Energy and Holdco (the “Management Services Agreement”);
	·	License Agreement by and between Holdco and Meineng Energy (the “License Agreement”); and
	·	Research and Development Agreement by and between the Company and Meineng Energy (the “Research and Development Agreement”).

 

Pursuant to the China JV Agreement, Meineng Energy was capitalized with approximately $13.6 million of equity capital. The Company’s only capital contributions to the Joint Venture were the contribution of technology to Meineng Energy via the License Agreement and $200,000 in cash. The Company’s indirect interest in Meineng Energy equaled approximately 33%. On August 12, 2014, Meineng Energy received a cash investment of 20,000,000 RMB (approximately $3.2 million) from Wuhu Fuhai-Haoyan Venture Investment, L.P., a branch of Shenzhen Oriental Fortune Capital Co., Ltd., for a post-closing equity position of 8%. Required governmental approval was obtained in October 2014. This investment capital was used to fund ongoing operations and development of the China market, and provided Meineng Energy a 250,000,000 RMB (approximately $42 million) post-closing valuation. Following this investment, the Company’s indirect investment in Meineng Energy equals approximately 30%. The Company’s indirect gain as a result of the investment was $775,537, which is net of the gain attributable to the noncontrolling interest of $481,870.

 

The Company’s investment in Meineng Energy was made through Holdco. Pursuant to the Holdco Agreement, the Company contributed technology to Holdco via a license agreement with an agreed upon value of approximately $4.1 million and $200,000 in cash in exchange for a 60% equity interest. PowerSav agreed to contribute to Holdco $3.3 million in cash in exchange for a 40% equity interest. The initial capital contributions (consisting of the Company’s technology contribution and one half of required cash contributions) were made in December 2011. The subsequent capital contributions (consisting of one half of the required cash contribution) were made on May 16, 2012. For financial reporting purposes, Holdco’s assets and liabilities are consolidated with those of the Company and PowerSav’s 40% interest in Holdco is included in the Company’s condensed consolidated financial statements as a noncontrolling interest. As of March 31, 2017, the Company’s indirect investment in the China JV was $794,467.

 

 

The Company’s basis in the technology contributed to Holdco was $0 due to US GAAP requirements related to research and development expenditures. The difference between the Company’s basis in this technology and the valuation of the technology by Meineng Energy of approximately $4.1 million is accounted for by the Company through the elimination of the amortization expense recognized by Meineng Energy related to the technology.

 

The Company has the right to appoint a majority of the members of the Board of Directors of Holdco and Holdco has the right to appoint a majority of the members of the Board of Directors of Meineng Energy.

 

Pursuant to the Management Services Agreement, Holdco will provide certain management services to Meineng Energy in exchange for a management services fee equal to five percent of Meineng Energy’s net sales for the five year period beginning on the first day of the first quarter in which the JV Company achieves operational breakeven results and three percent of Meineng Energy’s net sales for the subsequent three years, provided the payment of such fees will terminate upon Meineng Energy completing an initial public offering on a nationally recognized securities exchange. To date, no management service fee revenues have been recognized by Holdco.

 

Pursuant to the License Agreement (as amended on July 1, 2014), Holdco granted to Meineng Energy (1) an exclusive royalty-free license to manufacture and distribute the Company’s ZBB EnerStore, zinc bromide flow battery, version three (V3) (50KW) (and any other zinc bromide flow battery product developed internally by us based on the V3 EnerStore, ranging from 50kWh to 500kWh module design) and ZBB EnerSection, power and energy control center (up to 250KW) (the “Products”) in mainland China in the power supply management industry and (2) a non-exclusive royalty-free license to manufacture and distribute the Products in Hong Kong and Taiwan in the power supply management industry.

 

Pursuant to the Research and Development Agreement, Meineng Energy may request the Company to provide research and development services upon commercially reasonable terms and conditions. Meineng Energy would pay the Company’s fully-loaded costs and expenses incurred in providing such services.

 

Activity with Meineng Energy for the three and nine months ended March 31, 2017 and March 31, 2016 is summarized as follows:

 

		Three months ended March 31,								Nine Months Ended March 31,
		2017				2016				2017				2016
Product sales to Meineng Energy		$	360			$	55,326			$	68,954			$	109,418
Cost of product sales to Meineng Energy			343				1,480				72,399				40,609
Product purchases from Meineng Energy			168,044				399,470				920,233				1,045,668

 

As of March 31, 2017 and June 30, 2016, the total amount due to Meineng Energy is as follows:

 

		March 31, 2017				June 30, 2016
Net amount due from (due to) Meineng Energy		$	(16,057	)		$	(85,011	)

 

The operating results for Meineng Energy for the three and nine months ended March 31, 2017 and March 31, 2016 are summarized as follows:

 

		Three months ended March 31,								Nine Months Ended March 31,
		2017				2016				2017				2016
Revenues		$	79,986			$	235,322			$	1,218,817			$	955,799
Gross profit (loss)			10,156				(28,187	)			119,008				(7,259	)
Income (loss) from operations			(585,748	)			(468,340	)			(1,089,799	)			(1,160,750	)
Net income (loss)			(580,152	)			(455,840	)			(1,059,162	)			(1,112,460	)

 

NOTE 4 - BUSINESS COMBINATIONS

 

DCfusion, LLC

 

On February 28, 2017, EnSync formed and became the controlling owner of DCfusion, LLC, partnering with two industry veteran consultants (the “DCfusion Founders”) who are highly regarded leaders in direct current (DC) system engineering design and consulting. Each DCfusion Founder became an employee of DCfusion, LLC upon the closing of the DCfusion transaction on February 28, 2017. The transaction was accounted for as a business combination under US GAAP. The primary reason for the business acquisition was to benefit from the DCfusion Founders’ decades of customer applied DC system design and consulting experience, which complements EnSync Energy's application engineering.  DCfusion also brings a unique and substantial pipeline of potential projects in vertical markets that rely on the consultative expertise of the DCfusion Founders, and the authoritative voice of policies, programs and standards shaping the DC-centric technical and market landscape.

 

No cash was required to complete the transaction.  DCfusion will operate as a subsidiary of EnSync, Inc., similar to our Holu Energy subsidiary.

 

Acquisition Related Expenses

 

Included in the consolidated statement of operations for the three months ended March 31, 2017 were transaction expenses totaling approximately $31,700 for advisory and legal costs incurred in connection with the business acquisition of DCfusion, LLC.

 

 

Holu Energy LLC 

 

On August 17, 2015 (the “Closing Date”), Holu Energy LLC (”Holu”), the Company’s 85%-owned subsidiary, entered into an Asset Purchase Agreement under which Holu acquired substantially all of the assets of Tian Shan Renewable Energy LLC (“Seller”). The transaction was accounted for as a business combination under US GAAP. The primary reason for the business acquisition was to penetrate the Hawaii and Pacific market in general, by acquiring a local team of respected expertise, solid projects, and healthy pipeline.

 

The aggregate purchase consideration has been allocated to the assets acquired, including customer intangible assets, based on their respective fair values. Measurement period adjustments based on new information obtained after the acquisition date have been recorded as a change in goodwill (bargain purchase) as allowed under ASC 805-10, Business Combinations – Overall. The fair values of the assets purchased approximate the unbilled portion of each contract per the original terms of the contracts. The business acquisition resulted in the recognition of $6,284 of goodwill attributable to the anticipated profitability of Tian Shan Renewable Energy LLC. Calculation of the goodwill was measured as follows:

 

Fair value of the consideration transferred		$	327,127
Identifiable net assets acquired			320,843
Goodwill		$	6,284

 

The fair value of total consideration paid includes (1) $225,829 of cash, and (2) $101,297 of contingent consideration. The contingent consideration is comprised of 20% of the value of the unbilled portions of certain purchased assets. Holu will pay immediately to the Seller any amount of the contingent consideration collected in full after the closing date. Holu is not obligated to pay the Seller any amount not collected in full after six months after the date of a project’s completion. All acquired projects are expected to be completed and billed within the next 12 months. As of March 31, 2017, $14,453  of the contingent liability has been settled and the Company expects to pay the entire contingent consideration.

 

The following table summarizes the fair value of the assets acquired as of the date of acquisition:

 

Project assets		$	151,522
Customer intangible assets			169,321
Identifiable net assets		$	320,843

 

In addition to the consideration paid for the assets identified above, the Company settled pre-existing transactions that were accounted for separately in the amount of $171,205. These transactions related to development and consulting services provided to the Company by the Seller prior to the acquisition date. $159,205 of the development fees were initially capitalized within the “Project assets” line of the Company’s condensed consolidated balance sheet and subsequently recognized within “Cost of product revenue” and $12,000 has been recognized in the “Selling, general, and administrative” expense line of the Company’s condensed consolidated statements of operations. The development and consulting services were settled with cash based on the original contract prices.

 

For financial reporting purposes, Holu’s assets and liabilities are consolidated with those of the Company and the minority shareholder’s 15% interest in Holu is included in the Company’s condensed consolidated financial statements as a noncontrolling interest.

 

Pro-forma results of operations have not been presented because the effects of the acquired operations were not material individually or in the aggregate.

 

Acquisition Related Expenses

 

Included in the condensed consolidated statement of operations for the period from August 17, 2015 to June 30, 2016 were transaction expenses totaling approximately $33,700 for advisory and legal costs incurred in connection with the business acquisition  of Holu Energy, LLC.

 

NOTE 5 - MANAGEMENT’S PLANS AND FUTURE OPERATIONS

 

The accompanying condensed consolidated financial statements have been prepared on the basis of a going concern which contemplates that the Company will be able to realize assets and discharge its liabilities in the normal course of business. Accordingly, they do not give effect to any adjustments that would be necessary should the Company be required to liquidate its assets. The Company incurred a net loss of $13,373,540 attributable to EnSync, Inc. for the nine months ended March 31, 2017, and as of March 31, 2017 had an accumulated deficit of $133,923,648 and total EnSync, Inc. equity of $4,886,001.  The ability of the Company to settle its total liabilities of $16,624,531 and to continue as a going concern is dependent upon increasing revenues and achieving profitability. The accompanying condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

 

We believe that cash and cash equivalents on hand at March 31, 2017 and other potential sources of cash, will be sufficient to fund our current operations through the first quarter of fiscal year 2018 and that we will need to raise additional investment capital to fund our operations thereafter. We are currently exploring potential financing options that may be available to us. However, we have no commitments to obtain any additional funds, and there can be no assurance such funds will be available on acceptable terms or at all. If the Company is unable to obtain additional required funding, the Company’s financial condition and results of operations may be materially adversely affected and the Company may not be able to continue operations.

 

 

NOTE 6 - INVENTORIES

 

Net inventories are comprised of the following as of:

 

		March 31, 2017				June 30, 2016
Raw materials		$	1,939,710			$	1,857,471
Work in progress			8,272				12,471
Total		$	1,947,982			$	1,869,942

 

NOTE 7 – NOTE RECEIVABLE

 

On September 23, 2014, the Company was issued a $150,000 convertible promissory note from an unrelated party. The note accrues interest at 8% per annum on the outstanding principal amount. The note matured on the earlier of (a) the date on which the unrelated party has secured a total of $500,000 or more in additional financing from any source or (b) December 31, 2016, and is classified as “Note receivable” in the financial statements. On January 27, 2017, the Company negotiated new repayment terms with the borrower and extended the maturity date to the earlier of the date on which the borrower has secured a total of $500,000 or more in additional financing from any source and December 31, 2022. If at the maturity date the note and accrued interest has not been paid in full, the Company may convert the principal and interest outstanding into shares of the unrelated party’s convertible preferred stock at the then-current valuation. To date no such reserve is required.

  

NOTE 8 - PROPERTY, PLANT & EQUIPMENT

 

Property, plant, and equipment are comprised of the following as of:

 

		March 31, 2017				June 30, 2016
Land		$	217,000			$	217,000
Building and improvements			3,931,129				3,931,129
Manufacturing equipment			3,856,630				3,953,788
Office equipment			468,052				424,359
Total, at cost			8,472,811				8,526,276
Less: accumulated depreciation			(4,922,989	)			(4,637,170	)
Property, plant and equipment, net		$	3,549,822			$	3,889,106

 

The Company recorded depreciation expense of $98,318 and $379,450  for the three and nine months ended March 31, 2017, respectively. The Company recorded depreciation expense of $173,524 and $523,441 for the three and nine months ended March 31, 2016, respectively.

 

NOTE 9 - GOODWILL

 

The Company acquired ZBB Technologies, Inc., a former wholly-owned subsidiary, through a series of transactions in March 1996. ZBB Technologies Inc. was subsequently merged with and into EnSync, Inc. on January 1, 2012. The goodwill amount of $1.134 million, the difference between the price paid for ZBB Technologies, Inc. and the net assets of the acquisition, amortized through fiscal 2002, resulted in the net goodwill amount of $803,079.

 

During fiscal year 2016, the Company recorded goodwill totaling $6,284 in connection with the Tian Shan Renewable Energy LLC business acquisition. See Note 4 for further information.

 

Information with respect to the carrying amount of goodwill is as follows as of:

 

		March 31, 2017				June 30, 2016
Beginning balance		$	809,363			$	803,079
Goodwill acquired during the year			-				6,284
Ending balance		$	809,363			$	809,363

 

NOTE 10 – DEBT

 

The Company’s debt consisted of the following as of:

 

 

		March 31, 2017				June 30, 2016
Current maturities of long-term debt		$	338,942			$	332,707
Long-term debt			802,952				1,057,720
Total		$	1,141,894			$	1,390,427

 

Bank loans, notes payable, and other debt consisted of the following as of:

 

		March 31, 2017				June 30, 2016
Note payable to Wisconsin Economic Development Corporation payable in monthly installments of $23,685, including interest at 2%, with the final payment due May 1, 2018; collateralized by equipment purchased with the loan proceeds and substantially all assets of the Company not otherwise collateralized.  The Company is required to maintain and increase by a specified number of employees, and the interest rate is increased in certain cases for failure to meet this requirement.		$	327,478			$	534,009
Bank loan payable in fixed monthly installments of $6,800 of principal and interest at a rate of 0.25% below prime, as defined, subject to a floor of 5% with any remaining principal and interest due at maturity on June 1, 2018; collateralized by the building and land.			482,590				524,592
Equipment finance obligation, interest payable in quarterly installments ranging between $1,510 and $2,555 at an imputed interest rate of approximately 2.44% over 20 years.  See Note 15 for discussion of sale-leaseback transaction.			331,826				331,826
		$	1,141,894			$	1,390,427

 

Maximum aggregate annual principal payments for fiscal periods subsequent to March 31, 2017 are as follows:

 

2017		$	83,878
2018			317,500
2019			408,690
2020			-
2021			-
2022 and thereafter			331,826
		$	1,141,894

 

NOTE 11 - EMPLOYEE AND DIRECTOR EQUITY INCENTIVE PLANS

 

The Company previously adopted the 2002 Stock Option Plan (“2002 Plan”) in which a stock option committee could grant up to 1,000,000 shares to key employees or non-employee members of the board of directors. The options vest in accordance with specific terms and conditions contained in an employment agreement. If vesting terms and conditions are not defined in an employment agreement, then the options vest as determined by the stock option committee. If the vesting period is not defined in an employment agreement or by the stock option committee, then the options immediately vest in full upon death, disability, or termination of employment. Vested options expire upon the earlier of either the five year anniversary of the vesting date or termination of employment. No shares are available to be issued under the 2002 Plan.

 

The Company also previously adopted the 2007 Equity Incentive Plan (“2007 Plan”) that authorized the board of directors or a committee to grant up to 300,000 shares to employees and directors of the Company. Unless defined in an employment agreement or otherwise determined, the options vest ratably over a three-year period. Options expire 10 years after the date of grant. No shares are available to be issued under the 2007 Plan.

 

 

In November 2010, the Company adopted the 2010 Omnibus Long-Term Incentive Plan (“Omnibus Plan”) which authorizes a committee of the board of directors to grant stock options, stock appreciation rights, restricted stock, restricted stock units, unrestricted stock, other stock-based awards, and cash awards. The Omnibus Plan authorized up to 800,000 shares plus shares of Common Stock underlying any outstanding stock option of other awards granted by any predecessor employee stock plan of the Company that is forfeited, terminated, or cancelled without issuance of shares, to employees, officers, non-employee members of the board of directors, consultants, and advisors. Unless otherwise determined, options vest ratably over a three-year period and expire 8 years after the date of grant.

 

At the annual meeting of shareholders held on November 7, 2012, the Company’s shareholders approved an amendment of the Omnibus Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the Omnibus Plan by 900,000 shares and the creation of the 2012 Non-Employee Director Equity Compensation Plan (“2012 Director Equity Plan”), under which the Company may issue up to 700,000 restricted stock unit awards and other equity awards to our non-employee directors pursuant to the Company’s director compensation policy.

 

At the annual meeting of shareholders held on November 18, 2014, the Company’s shareholders approved an amendment of the Omnibus Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the Omnibus Plan by 1,250,000. The shareholders also approved an amendment of the 2012 Director Equity Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the 2012 Director Equity Plan by 1,000,000.

 

At the annual meeting of shareholders held on November 17, 2015, the Company’s shareholders approved an amendment of the Omnibus Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the Omnibus Plan by 5,000,000. The shareholders also approved an amendment of the 2012 Director Equity Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the 2012 Director Equity Plan by 1,500,000.

 

At the annual meeting of shareholders held on November 14, 2016, the Company’s shareholders approved an amendment of the Omnibus Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the Omnibus Plan by 4,000,000. The shareholders also approved an amendment of the 2012 Director Equity Plan which increased the number of shares of the Company’s common stock available for issuance pursuant to awards under the 2012 Director Equity Plan by 1,200,000. As of March 31, 2017, there were a total of 2,786,460 shares available to be issued under the Omnibus Plan and 1,710,989 shares available to be issued under the 2012 Director Equity Plan. 

 

In aggregate for all plans, at March 31, 2017, there were a total of 7,041,250   options and 5,592,696 RSUs outstanding.

 

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing method. The Company uses historical data to estimate the expected price volatility, the expected option life and the expected forfeiture rate. The Company has not made any dividend payments nor does it have plans to pay dividends in the foreseeable future. The following assumptions were used to estimate the fair value of options granted during the nine months ended March 31, 2017 and March 31, 2016 using the Black-Scholes option-pricing model:

 

		Nine months ended March 31,
		2017		2016
Expected life of option (years)		4		4
Risk-free interest rate		0.85 - 1.7%		1.12 - 1.50%
Assumed volatility		101.06 - 110.31%		100.77 - 101.70%
Expected dividend rate		0.00%		0.00%
Expected forfeiture rate		7.20 - 9.18%		6.23 - 12.63%

  

Time-vested and performance-based stock awards, including stock options and RSUs are accounted for at fair value at date of grant. Compensation expense is recognized over the requisite service and performance periods.

 

During the three and nine months ended March 31, 2017 and March 31, 2016, the Company’s results of operations include compensation expense for stock options and RSUs granted under its various equity incentive plans. The amount recognized in the condensed consolidated financial statements related to stock-based compensation was $499,462  and $1,554,567  based on the amortized grant date fair value of options and RSUs during the three and nine months ended March 31, 2017, respectively. The amount recognized in the condensed consolidated financial statements related to stock-based compensation was $422,923 and $886,463, based on the amortized grant date fair value of options and RSUs during the three and nine months ended March 31, 2016, respectively.

 

 

Information with respect to stock option activity is as follows:

 

		Number of Options				Weighted Average Exercise Price				Average Remaining Contractual Life (in years)
Balance at June 30, 2015			1,577,778			$	2.60
Options granted			4,782,100				0.49
Options forfeited			(248,518	)			4.16
Balance at June 30, 2016			6,111,360				0.88				5.18
Options granted			1,297,000				0.58
Options exercised			(120,000	)			0.57
Options forfeited			(247,110	)			1.18
Balance at March 31, 2017			7,041,250			$	0.82				6.41

 

The following table summarizes information relating to the stock options outstanding as of March 31, 2017:

 

		Outstanding												Exercisable
Range of Exercise Prices		Number of Options				Average Remaining Contractual Life (in years)				Weighted Average Exercise Price				Number of Options				Average Remaining Contractual Life (in years)				Weighted Average Exercise Price
$0.28 to $1.00			6,065,217				6.76			$	0.50				1,150,553				6.16			$	0.58
$1.01 to $2.50			677,983				5.44				1.50				359,565				4.86				1.67
$2.51 to $5.00			86,200				2.23				3.96				86,200				2.23				3.96
$5.01 to $6.95			211,850				1.08				6.48				211,850				1.08				6.48
Balance at March 31, 2017			7,041,250				6.41			$	0.82				1,808,168				5.12			$	1.65

 

During the nine months ended March 31, 2017, options to purchase 1,297,000  shares were granted to employees exercisable at $0.35 to $1.02  per share based on various service-based and performance-based vesting terms from July 2016 through March 2020 and exercisable at various dates through March 2026. During the nine months ended March 31, 2016, options to purchase 2,776,600 shares were granted to employees exercisable at $0.31 to $0.85  per share based on service based vesting terms from July 2015 through March 2019 and exercisable at various dates through March 2024.

 

The aggregate intrinsic value of outstanding options totaled $872,870  and was based on the Company’s adjusted closing stock price of $0.61  as of March 31, 2017.

 

A summary of the status of unvested employee stock options as of March 31, 2017 and June 30, 2016, and changes during the nine months and year then ended is presented below:

 

		Number of  Options				Weighted Average Grant Date Fair Value Per Share				Average Remaining Contractual Life (in years)
Balance at June 30, 2015			776,525			$	1.19
Options granted			4,782,100				0.49
Options vested			(596,993	)			0.89
Options forfeited			(109,265	)			0.88
Balance at June 30, 2016			4,852,367				0.54				7.40
Options granted			1,297,000				0.58
Options vested			(727,001	)			0.59
Options forfeited			(189,284	)			0.81
Balance at March 31, 2017			5,233,082			$	0.54				6.85

 

 

Total fair value of options granted for the nine months ended March 31, 2017 and March 31, 2016 was $541,264 and $1,113,441, respectively. At March 31, 2017, there was $749,060 in unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average period of 1.43 years.

 

The Company compensates its directors with RSUs and cash. On November 14, 2016, 581,816 RSUs were granted to the Company’s directors in partial payment of director’s fees through November 2017 under the 2012 Director Equity Plan. As of March 31, 2017, 290,908 of the RSUs from the November 14, 2016 grant had vested and there were $143,999 and $395,999 in director’s fees expense settled with RSUs for the three and nine months ended March 31, 2017.

 

On November 14, 2016, the Company’s CEO was awarded 750,000 RSUs; 250,000 of these vested immediately and the remaining 500,000 will vest over the next two years. Additionally, an executive of the Company was awarded 340,000 RSUs that will vest in August of 2019.

 

On November 17, 2015, the Company’s CEO was awarded 1,500,000 RSUs. 750,000 of these RSUs vest over three years, beginning on November 17, 2016. As of March 31, 2017, 250,000 of the 750,000 that vest over three years beginning on November 17, 2016 from the November 17, 2015 grant had vested. The remaining 750,000 of these RSUs vest upon the satisfaction of certain performance targets that must be met on or before December 31, 2017.

  

As of March 31, 2017, there were 2,380,908 unvested RSUs and $1,793,638 in unrecognized compensation cost. Generally, shares of common stock related to vested RSUs are to be issued six months after the holder’s separation from service with the Company.

 

The table below summarizes the activity of the RSUs for the nine months ended March 31, 2017 and the year ended June 30, 2016:

 

		Number of Restricted Stock Units				Weighted Average Valuation Price Per Unit
Balance at June 30, 2015			1,936,035			$	1.53
RSUs granted			2,364,000				0.50
Shares issued			(270,791	)			0.63
Balance at June 30, 2016			4,029,244				1.03
RSUs granted			1,671,815				1.15
Shares issued			(108,363	)			0.66
Balance at March 31, 2017			5,592,696			$	1.07

 

NOTE 12 - WARRANTS

 

At March 31, 2017, the following warrants to purchase the Company’s common stock were outstanding and exercisable:

 

·

45,000 warrants are exercisable at $0.37 per share and expire in February 2019 issued as partial payment for services. In October 2016, 45,000 warrants were exercised via a cashless exercise resulting in the issuance of 29,162 shares of common stock of the Company.

 

·

306,902 warrants exercisable at $2.375 per share and which expire in June 2017 issued in connection with the Underwriting Agreement entered into with MDB Capital Group, LLC as part of underwriting compensation which provided for the sale of $12 million of common stock on June 19, 2012. In March 2014, 272,159 warrants were exercised via a cashless exercise resulting in the issuance of 53,048 shares of common stock of the Company.

 

·

511,604 warrants exercisable at $2.65 per share and which expire in May 2017 issued in connection with Securities Purchase Agreements entered into with certain investors providing for the sale of a total of $2,465,000 of Zero Coupon Convertible Subordinated Notes on May 1, 2012.

 

·

81,579 warrants were exercisable at $0.95 per share and expired in September 2016 issued as placement agent’s compensation in connection with the sale of $3.0 million of preferred stock on September 27, 2013 as described in Note 14.

 

·

1,710,525 warrants were exercisable at $0.95 per share and expired in September 2016 issued in connection with Securities Purchase Agreements entered into with certain investors providing for the sale of a total of $3.0 million of preferred stock on September 27, 2013 described in Note 14. In March 2014, 1,447,369 warrants were exercised via a cashless exercise resulting in the issuance of 850,169 shares of common stock of the Company.

 

 

·

224,375 warrants were exercisable at $5.20 per share and expired in September 2015 issued to certain purchasers of Company shares in March 2010.

 

·

71,667 warrants were exercisable at $6.65 per share and expired in August 2015 issued to certain purchasers of Company shares in August 2009.

 

·

15,000 warrants were exercisable at $2.10 per share and expired in July 2015 issued as partial payment for services.

 

·

6,300 warrants were exercisable at $5.00 per share and expired in July 2015 issued as partial payment for services.

 

The table below summarizes warrant balances and activity for the nine months ended March 31, 2017 and the year ended June 30, 2016:

 

		Number of Warrants				Weighted Average Exercise Price Per Share
Balance at June 30, 2015			2,927,952			$	1.88
Warrants granted			45,000				0.37
Warrants expired			(317,342	)			5.38
Balance at June 30, 2016			2,655,610				1.43
Warrants granted			-				-
Warrants exercised			(45,000	)			0.37
Warrants expired			(1,792,104	)			0.95
Balance at March 31, 2017			818,506			$	2.55

 

NOTE 13 – BASIC AND DILUTED NET LOSS PER SHARE

 

Basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period reported. Diluted net loss per common share is computed giving effect to all dilutive potential common shares that were outstanding for the period reported. Diluted potential common shares consist of incremental shares issuable upon exercise of stock options and warrants and conversion of preferred stock. In computing diluted net loss per share for the three and nine months ended March 31, 2017 and March 31, 2016, no adjustment has been made to the weighted average outstanding common shares as the assumed exercise of outstanding options and warrants and conversion of preferred stock is anti-dilutive.

 

Potential common shares not included in calculating diluted net loss per share are as follows:

 

		As of March 31,
		2017				2016
Stock options and restricted stock units			12,633,946				8,245,271
Stock warrants			818,506				2,655,610
Series B preferred shares			3,420,885				3,099,153
Total			16,873,337				14,000,034

 

NOTE 14 - EQUITY

 

Amendment to the Articles of Incorporation

 

On November 17, 2015, the Company filed with the Wisconsin Department of Financial Institutions an amendment to the Company’s Articles of Incorporation (the “Articles of Amendment”) increasing the number of authorized shares of common stock from 150,000,000 shares to 300,000,000 shares. The Articles of Amendment were approved by the Company’s shareholders on November 17, 2015.

 

 

SPI Energy Co., Ltd. Securities Purchase Agreement

 

On July 13, 2015 we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with SPI Energy Co., Ltd. (“SPI”), (formerly known as Solar Power, Inc.), pursuant to which we sold SPI for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares of common stock (the “Purchased Common Shares”) and (ii) 28,048 shares of Series C Convertible Preferred Stock (the “Purchased Preferred Shares”) which were potentially convertible, subject to the completion of projects under our supply agreement with SPI (as described below), into a total of up to 42,000,600 shares of Common Stock. The aggregate purchase price for the Purchased Common Shares was based on a purchase price per share of $0.6678 and the aggregate purchase price for the Purchased Preferred Shares was determined based on a price of $0.6678 per common share equivalent. Pursuant to the Purchase Agreement, SPI was also issued a warrant to purchase 50,000,000 shares of Common Stock for an aggregate purchase price of $36,729,000 (the “Warrant”).

  

In connection with the Purchase Agreement, the Company incurred $807,807 of financing related costs. The specific costs directly attributable to the Purchase Agreement have been charged against the gross proceeds of the offering.

 

The Company also entered into a supply agreement with SPI pursuant to which the Company agreed to sell and SPI agreed to purchase certain products and services offered by the Company from time to time, including certain energy management system solutions for solar projects (the “Supply Agreement”). Due to SPI’s failure to meet its purchase obligations, on May 4, 2017 the Company terminated the Supply Agreement.  

 

The Purchased Preferred Shares were sold for $1,000 per share and were potentially convertible at a conversion price of $0.6678 based upon SPI’s satisfying its purchase obligations under the Supply Agreement. The Warrant represents the right to acquire 50,000,000 shares of Common Stock at an exercise price equal to $0.7346 but only becomes exercisable upon SPI’s fully satisfying its purchase obligations under the Supply Agreement. As a result of the termination of the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert the Purchased Preferred Shares or exercise the Warrant.

 

On August 30, 2016, SPI entered into a share purchase agreement (the “Share Purchase Agreement”) with Melodious Investments Company Limited (“Melodious”) pursuant to which SPI sold to Melodious all of the Purchased Common Shares, all 7,012 outstanding shares of Series C-1 Preferred Stock and 4,341 shares of Series C-2 Preferred Stock for a total purchase price of $17.0 million (which is equal to the price SPI paid for such securities). The Share Purchase Agreement provides that if the purchased shares of Series C-1 Preferred Stock and Series C-2 Preferred Stock are not converted into shares of common stock within six months following the closing date, Melodious will have the right to require SPI to repurchase such shares for a price equal to approximately 102% of the price paid by Melodious for such shares (plus 10% interest accrued from the closing date). As of March 31, 2017, Melodious had not elected to exercise such right. Following the sale of such securities, SPI continues to hold the Requisite Shares, and the Governance Agreement remains in effect. 

 

March 13, 2013 Aspire Capital Financing

 

On March 13, 2013, the Company entered into a Common Stock Purchase Agreement (“Common Stock Purchase Agreement”) with Aspire Capital Fund, LLC, an Illinois limited liability company (“Aspire Capital”), which provided that, upon the terms and subject to the conditions and limitations set forth therein, Aspire Capital was committed to purchase up to an aggregate of $10 million of shares of the Company’s common stock over the two-year term of the Common Stock Purchase Agreement. On August 18, 2014, the Company provided notice to Aspire Capital electing to terminate the Common Stock Purchase Agreement.

 

August 27, 2014 Underwritten Public Offering

 

On August 27, 2014, the Company completed an underwritten public offering of its common stock at a price to the public of $1.12 per share. The Company sold a total of 13,248,000 shares of its common stock in the offering for aggregate proceeds of approximately $14.8 million. The Company received approximately $13.7 million of net proceeds from the offering, after deducting the underwriting discount and expenses.

 

Series B Convertible Preferred Stock Securities Purchase Agreement

 

On September 26, 2013 the Company entered into a Securities Purchase Agreement with certain investors providing for the sale of 3,000 shares of Series B Convertible Preferred Stock (the “Preferred Stock”). Certain Directors of the Company purchased 500 shares.

 

Shares of Preferred Stock were sold for $1,000 per share (the “Stated Value”) and accrue dividends on the Stated Value at an annual rate of 10%. The net proceeds to the Company, after deducting $96,966 of offering costs, were $2,903,004. During the year ended June 30, 2014, 425 shares of Preferred Stock were converted into 470,171 shares of common stock of the Company. During the year ended June 30, 2016, 275 shares of Preferred Stock were converted into 352,696 shares of common stock of the Company.

 

 

At March 31, 2017, 2,300 shares of Preferred Stock were convertible into 3,420,885 shares of common stock of the Company (“Common Stock”) at a conversion price equal to $0.95. Upon any liquidation, dissolution or winding up of the Company, holders of Preferred Stock are entitled to receive out of the assets of the Company an amount equal to two times the Stated Value, plus any accrued and unpaid dividends thereon. At March 31, 2017 the liquidation preference of the Preferred Stock was $5,549,840.

 

In connection with the purchase of the Preferred Stock, investors received warrants to purchase a total of 3,157,895 shares of Common Stock at an exercise price of $0.95. The warrants were exercisable at any time prior to September 27, 2016. During the year ended June 30, 2014, 1,447,369 warrants were exercised via a cashless exercise resulting in the issuance of 850,169 shares of common stock of the Company. In addition, the Company issued a total of 81,579 warrants to a placement agent in connection with the transaction. These warrants expired on September 27, 2016.

 

NOTE 15 - COMMITMENTS

 

Asset Retirement Obligations

 

FASB ASC Topic 410, “Asset Retirement and Environmental Obligations,” requires the fair value of a liability for an asset retirement obligation be recorded in the period in which it is incurred if a reasonable estimate of fair value can be made and that the associated asset retirement costs be capitalized as part of the carrying amount of the long-lived asset. The retirement obligation relates to estimated costs for the removal and shipment of a solar power system under an equipment lease. Accrued asset retirement obligations are recorded at net present value and discounted over the life of the lease. The Company had an asset retirement obligation of $19,454 as of March 31, 2017 and $18,759 as of June 30, 2016. The asset retirement obligation is classified as “Other long-term liabilities” in the condensed consolidated balance sheets. The table below summarizes the asset retirement obligation balances and activity:

 

		March 31, 2017				June 30, 2016
Balance at beginning of period		$	18,759			$	-
Liabilities incurred			-				18,527
Accretion expense			695				232
Balance at end of period		$	19,454			$	18,759

 

Leasing Activities

 

Sale-leaseback Transactions

 

During the year ended June 30, 2016, the Company entered into a sale-leaseback transaction with a non-related party. The Company evaluated the transaction under FASB ASC Subtopic 842-40, “Sale and Leaseback Transactions” and concluded that the transfer of the asset did not qualify as a sale and is accounted for in accordance with other Topics. The liability is presented in the debt table in Note 10 as an equipment financing obligation.

 

Operating Leases

 

The Company leases office space in Petaluma, California from a non-related company under the terms of a lease that expires July 15, 2019. Monthly rent for the first twelve months of the lease is $3,000 and increases by 2.5% for each succeeding 12 month period.

 

The Company leases office space in Madison, Wisconsin from a non-related company under the terms of a lease that expires October 31, 2017. Monthly rent for the first twelve months of the lease is $1,580 and increases by 3% for each succeeding 12 month period.

 

The Company leased an Australian research and development facility from a non-related Australian company under the terms of a lease that was due to expire on October 31, 2016. Subsequently, the Company entered into a lease termination agreement that was effective January 1, 2016. The Company was required to pay a rent shortfall of $36,521 and a leasing fee of $7,313.

 

Operating lease expense recognized during the three and nine months ended March 31, 2017 was $16,642 and $45,739, respectively. Operating lease expense recognized during the three and nine months ended March 31, 2016 was $37,510 and $95,422, respectively. Operating lease expense is included in operating expenses in the condensed consolidated statements of operations. As of March 31, 2017 and June 30, 2016, the carrying value of the right of use asset was $163,959 and $27,264, respectively, and is separately stated on the condensed consolidated balance sheets. The related short-term and long-term liabilities as of March 31, 2017 were $67,983 and $95,977 and as of June 30, 2016 were $20,234 and $7,030, respectively. The short-term and long-term liabilities are included in “Accrued expenses” and “Other long-term liabilities,” respectively, in the condensed consolidated balance sheets.

 

 

Information regarding the weighted-average remaining lease term and the weighted-average discount rate for operating leases as of March 31, 2017 and June 30, 2016 are summarized below:

 

		March 31, 2017				June 30, 2016
Weighted-average remaining lease term (in years)
Operating leases			2.54				1.33
Weighted-average discount rate
Operating leases			5.0	%			5.0	%

 

The table below reconciles the undiscounted cash flows for the first five years and total of the remaining years to the operating lease liabilities recorded in the condensed consolidated balance sheets as of March 31, 2017:

 

		Operating Leases
2017		$	16,533
2018			69,805
2019			64,297
2020			24,955
2021			-
Thereafter			-
Total undiscounted lease payments			175,590
Present value adjustment			(11,630	)
Net operating lease liabilities		$	163,960

 

Short-term Leases

 

The Company leases facilities in Honolulu, Hawaii, Milwaukee, Wisconsin, and Shanghai, China from non-related parties under lease terms that expire between May 31, 2017 and July 31, 2017. Monthly rent for the twelve-month rental periods is between $400 and $4,250 per month. Rent expense of $22,497 and $66,122 was recognized during the three and nine months ended March 31, 2017. Rent expense of $22,989 and $34,000 was recognized during the three and nine months ended March 31, 2016. Short-term rent expense is included in operating expenses in the condensed consolidated statement of operations.

 

Employment Contracts

 

The Company has entered into employment contracts with executives and management personnel. The contracts provide for salaries, bonuses and stock option grants, along with other employee benefits. The employment contracts generally have no set term and can be terminated by either party. There is a provision for payments of up to six months of annual salary as severance if the Company terminates a contract without cause, along with the acceleration of certain unvested stock option grants. During the three and nine months ended March 31, 2017, the Company recorded $35,613  of severance for a former Vice President. During the year ended June 30, 2016, the Company recorded $125,000 of severance for a former CEO.

 

NOTE 16 - RETIREMENT PLANS

 

The Company sponsors a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code, the EnSync, Inc. 401(k) Savings Plan. Employees may elect to contribute up to the Internal Revenue Service annual contribution limit. The Company matches employees’ contributions up to 4% of eligible compensation and Company contributions are limited in any year to the amount allowable by government tax authorities. Eligible employees are 100% immediately vested. Total employer contributions recognized in the condensed consolidated statements of operations under this plan were $61,448 and $146,005 for the three and nine months ended March 31, 2017, respectively. Total employer contributions recognized in the condensed consolidated statements of operations under this plan were $26,260 and $71,963 for the three and nine months ended March 31, 2016, respectively

 

 

NOTE 17 - INCOME TAXES

 

The provision (benefit) for income taxes consists of the following:

 

		Three and nine months ended March 31,
		2017				2016
Current		$	-			$	(468	)
Deferred			-				-
Provision for income taxes		$	-			$	(468	)

 

The Company accounts for income taxes using an asset and liability approach which generally requires the recognition of deferred income tax assets and liabilities based on the expected future income tax consequences of events that have previously been recognized in the Company’s financial statements or tax returns. In addition, a valuation allowance is recognized if it is more likely than not that some or all of the deferred income tax assets will not be realized in the foreseeable future. Deferred income tax assets are reviewed for recoverability based on historical taxable income, the expected reversals of existing temporary differences, tax planning strategies and projections of future taxable income. As a result of this analysis, the Company has provided for a valuation allowance against its net deferred income tax assets as of March 31, 2017 and June 30, 2016.

 

The Company’s combined effective income tax rate differed from the U.S. federal statutory income rate as follows:

 

		Three and nine months ended March 31,
		2017		2016
Income tax expense/(benefit) computed at the U.S. federal statutory rate		-34%		-34%
Change in valuation allowance		34%		34%
Total		0%		0%

  

Significant components of the Company’s net deferred income tax assets as of March 31, 2017 and June 30, 2016 were as follows:

 

		March 31, 2017				June 30, 2016
Federal net operating loss carryforwards		$	22,120,693			$	18,018,631
Federal - other			2,883,738				2,446,635
Wisconsin net operating loss carryforwards			3,752,097				2,929,157
Australia net operating loss carryforwards			1,290,134				1,290,134
Deferred income tax asset valuation allowance			(30,046,662	)			(24,684,557	)
Total deferred income tax assets		$	-			$	-

  

The Company has U.S. federal net operating loss carryforwards of approximately $65.1 million as of March 31, 2017, that expire at various dates between June 30, 2018 and 2035. The Company also has $7.9 million in other federal deferred tax assets comprised of charitable contributions carryforwards and intangible amortization. The Company has U.S. federal research and development tax credit carryforwards of approximately $340,028 as of March 31, 2017 that expire at various dates through June 30, 2034. As of March 31, 2017, the Company has approximately $66.5 million of Wisconsin net operating loss carryforwards that expire at various dates between June 30, 2016 and 2029. As of March 31, 2017, the Company also has approximately $4.3 million of Australian net operating loss carryforwards available to reduce future taxable income of its Australian subsidiaries with an indefinite carryforward period.

 

The Company’s issuance of additional shares of common stock has constituted an ownership change under Section 382 of the Internal Revenue Code which places an annual dollar limit on the use of net operating loss (“NOL”) carryforwards and other tax attributes that may be utilized in the future. The calculation of the annual limitation of usage is based on a percentage of the equity value immediately after any ownership change. The annual amount of tax attributes that may be utilized after the change in ownership is limited. Previous issuances of additional shares of common stock also resulted in ownership changes and the annual amount of tax attributes from previous years is limited as well. The estimated U.S. federal net operating loss carryforward expected to expire due to the Section 382 limitation is $44.5 million and the estimated state net operating losses expected to expire due to the limitation is $28.2 million. The net operating loss deferred tax assets reflect this limitation.

 

 

NOTE 18 – RELATED PARTY TRANSACTIONS

 

On September 7, 2016, the Company entered into a Membership Interest Purchase Agreement with Theodore Peck, the CEO of the Company’s 85% owned subsidiary, Holu Energy, LLC. Pursuant to the Membership Interest Purchase Agreement, the Company will sell to Theodore Peck all of the issued and outstanding membership interests of a PPA entity for $592,000, subject to the terms of a Promissory Note, a Security Agreement, and a Pledge Agreement. The transaction is considered to be executed upon terms that are in the normal course of operations. Revenues of $592,000 and expenses of $573,353 have been recognized in the Company’s condensed consolidated statement of operations for the three and nine months ended March 31, 2017.

 

NOTE 19 – SUBSEQUENT EVENTS

 

Termination of SPI Supply Agreement

 

On July 13, 2015, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with SPI Energy Co., Ltd. (“SPI”), (formerly known as Solar Power, Inc.), pursuant to which we sold SPI for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares of common stock (the “Purchased Common Shares”) and (ii) 28,048 shares of Series C Convertible Preferred Stock (the “Purchased Preferred Shares”). Pursuant to the Purchase Agreement, SPI was also issued a warrant to purchase 50,000,000 shares of Common Stock for an aggregate purchase price of $36,729,000 (the “Warrant”). We also entered into a supply agreement with SPI pursuant to which we agreed to sell and SPI agreed to purchase certain products and services offered by the Company from time to time, including certain energy management system solutions for solar projects (the “Supply Agreement”).

 

The Purchased Preferred Shares were sold for $1,000 per share and were potentially convertible at a conversion price of $0.6678 into a total of up to 42,000,600 shares of Common Stock based upon SPI’s satisfying its purchase obligations under the Supply Agreement. The Warrant represents the right to acquire 50,000,000 shares of Common Stock at an exercise price equal to $0.7346 but only becomes exercisable upon SPI’s fully satisfying its purchase obligations under the Supply Agreement. Due to SPI’s failure to meet its purchase obligations, on May 4, 2017 the Company terminated the Supply Agreement. As a result of the termination of the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert the Purchased Preferred Shares or exercise the Warrant.

 

As the result of the termination of the Supply Agreement, the deferred revenue that was recorded upon closing of the SPI transaction will be reversed and a corresponding amount of gain will be recorded reducing the Company’s accumulated deficit by the same amount and ultimately resulting in a $13,290,000 increase in stockholders’ equity. The following table sets forth total EnSync, Inc. equity as of March 31, 2017 on an actual basis and on a pro forma basis giving effect to the termination of the Supply Agreement.

 

Total EnSync, Inc. equity as of March 31, 2017		$	4,886,001
Pro forma increase in Total EnSync, Inc. equity		$	13,290,000
Pro forma Total EnSync, Inc. equity as of March 31, 2017		$	18,176,001

 

Sale of PPA Entity

 

On May 2, 2017, the Company entered into a Membership Interest Purchase Agreement with a leading US infrastructure investor. Pursuant to the Membership Interest Purchase Agreement, the Company will sell to the leading US infrastructure investor all of the issued and outstanding membership interest of a PPA entity for $2,550,000. Subject to the terms of the Membership Interest Purchase Agreement revenue will be recognized over the construction term of the project.

 

 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

EnSync, Inc. and its subsidiaries (“EnSync,” “we,” “us,” “our,” or the “Company”) develop, license, and manufacture innovative energy management systems solutions serving the commercial and industrial (“C&I”) and multi-tenant building, utility, and off-grid markets. Incorporated in 1998, EnSync is headquartered in Menomonee Falls, Wisconsin, USA with offices in Madison, Wisconsin, Petaluma, California, Honolulu, Hawaii, and Shanghai, China. We regularly use the name EnSync Energy Systems for marketing and branding purposes.

 

EnSync develops and commercializes distributed energy resource systems and internet of energy control platforms aiming to ensure the most cost-effective and resilient electricity, delivered from an electrical infrastructure that prioritizes the use of all available resources, including renewables, energy storage and the utility grid. As a project developer, our distinctive engagement methodology encompasses load analysis, system design consulting and technical and financial modeling to ensure energy systems are sized and optimized to meet the performance and value goals of our customers. EnSync delivers fully integrated systems utilizing proprietary direct current power control hardware, energy management software, and extensive experience with energy storage technologies. Our internet of energy control platform adapts to ever-changing generation and load variables, as well as changes in utility prices and programs, aiming to ensure the means to make and/or save money behind-the-meter while concurrently providing utilities the opportunity to use distributed energy resource systems for various grid enhancing services. The Company also develops and commercializes energy management systems for off-grid applications such as island or remote power.

 

We recently began addressing our target markets through power purchase agreements (“PPAs”) under which we agree to provide, and the customer agrees to purchase, electricity from us at a fixed rate for a 20-year period. Under this structure we develop and supply a system that uses our and other companies’ products and the customer receives the benefit of a low and fixed price for electricity without any upfront costs. Because this business model requires significant capital outlays, we are developing a monetization strategy under which we either sell the PPA projects outright or enter into sale-leaseback transactions.

 

The condensed consolidated financial statements include the accounts of the Company and those of its wholly-owned subsidiaries ZBB Energy Pty Ltd. (formerly known as ZBB Technologies, Ltd.), DCfusion, LLC, various PPA project subsidiaries, its eighty-five percent owned subsidiary Holu Energy LLC, and its sixty percent owned subsidiary ZBB PowerSav Holdings Limited located in Hong Kong which was formed in connection with the Company’s investment in a China joint venture.

  

SPI Energy Co., Ltd.

 

In July 2015, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with SPI Energy Co., Ltd. (“SPI”), (formerly known as Solar Power, Inc.), pursuant to which we sold to SPI for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares of common stock (the “Purchased Common Shares”) and (ii) 28,048 shares of Series C Convertible Preferred Stock (the “Purchased Preferred Shares”) which were potentially convertible, subject to the completion of projects under our supply agreement with SPI (as described below), into a total of up to 42,000,600 shares of Common Stock. The aggregate purchase price for the Purchased Common Shares was based on a purchase price per share of $0.6678. The aggregate purchase price for the Purchased Preferred Shares was determined based on a price of $0.6678 per common share equivalent. Pursuant to the Purchase Agreement, SPI was also issued a warrant to purchase 50,000,000 shares of Common Stock for an aggregate purchase price of $36,729,000 (the “Warrant”).

  

The cash received by the Company in excess of the fair value of the Purchased Common Shares and the nonconvertible attribute of the Purchased Preferred Shares was recorded as deferred revenue of $13,290,000. This amount was allocated to the Supply Agreement under which the Company expected to perform in the future. The deferred revenue was to be recognized as revenue as sales occured under the Supply Agreement.

 

The Company also entered into a supply agreement with SPI pursuant to which we agreed to sell and SPI agreed to purchase certain products and services offered by us from time to time, including certain energy management system solutions for solar projects (the “Supply Agreement”). The Supply Agreement contemplated the sale of at least (i) 5 megawatts of Products and Services (as defined in the Supply Agreement) within the first year, (ii) an additional 10 megawatts in the second year, (iii) an additional 10 megawatts in the third year, and (iv) an additional 15 megawatts in the fourth year. We had planned on achieving a significant amount of revenues under the Supply Agreement. SPI never made any purchases under the Supply Agreement. Due to SPI’s failure to meet its purchase obligations, on May 4, 2017 the Company terminated the Supply Agreement. As a result of the termination of the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert the Purchased Preferred Shares or exercise the Warrant.

  

 

The Purchased Preferred Shares were sold for $1,000 per share and were potentially convertible at a conversion price of $0.6678 per share based upon SPI’s satisfying its purchase obligations under the Supply Agreement. The Warrant represents the right to acquire 50,000,000 shares of Common Stock at an exercise price equal to $0.7346 but only becomes exercisable upon SPI’s fully satisfying its purchase obligations under the Supply Agreement.

 

We also entered into a governance agreement with SPI (the “Governance Agreement”) under which for so long as SPI holds at least 10,000 Purchased Preferred Shares or 25 million shares of Common Stock or Common Stock equivalents (the “Requisite Shares”) SPI had the right to initially nominate one director to the Company’s board of directors and to nominate additional directors as it completed and paid for Projects under the Supply Agreement and the Purchased Preferred Shares became convertible; provided in no event is SPI entitled to nominate a number of directors to the Board that would represent a percentage of the Board greater than the percentage determined by dividing the number of Common Stock Equivalents held by SPI by the sum of (A) the total shares of the Company’s Common Stock outstanding and (B) the number of shares of Common Stock into which the Preferred Stock held by SPI is convertible.

 

On August 30, 2016, SPI entered into a share purchase agreement (the “Share Purchase Agreement”) with Melodious Investments Company Limited (“Melodious”) pursuant to which SPI sold to Melodious all of the Purchased Common Shares, all 7,012 outstanding shares of Series C-1 Preferred Stock and 4,341 shares of Series C-2 Preferred Stock for a total purchase price of $17.0 million (which is equal to the price SPI paid for such securities). The Share Purchase Agreement provides that if the purchased shares of Series C-1 Preferred Stock and Series C-2 Preferred Stock are not converted into shares of common stock within six months following the closing date, Melodious will have the right to require SPI to repurchase such shares for a price equal to approximately 102% of the price paid by Melodious for such shares (plus 10% interest accrued from the closing date). As of March 31, 2017, Melodious had not elected to exercise such right.

 

DCfusion, LLC

 

On February 28, 2017, EnSync formed and became the controlling owner of DCfusion, LLC, partnering with two industry veterans (the “DCfusion Founders”) who are highly regarded leaders in direct current (DC) system engineering design, consulting and policy. Each DCfusion Founder became an employee of DCfusion, LLC upon the closing of the DCfusion transaction on February 28, 2017. The primary reason for the business acquisition was to benefit from the DCfusion Founders’ decades of customer applied DC system design and consulting experience, which complements our application engineering.  DCfusion also brings a unique and substantial pipeline of potential projects in vertical markets that rely on the consultative expertise of the DCfusion Founders, and the authoritative voice of policies, programs and standards shaping the DC-centric technical and market landscape.

 

Holu Energy LLC

 

On August 17, 2015, our eighty-five percent owned subsidiary, Holu Energy LLC (“Holu”), entered into an Asset Purchase Agreement under which Holu acquired substantially all of the assets of Tian Shan Renewable Energy LLC, a Honolulu-based energy systems project development company. Holu is focused on the development of renewable energy projects in the Hawaii and greater Pacific markets for commercial, industrial, utility and nonprofit entities, generally via power purchase agreements under which the customer agrees to purchase electricity at a fixed rate for a 20-year period.

 

China Joint Venture

 

Anhui Meineng Store Energy Co., Ltd. (“Meineng Energy”) was established in late 2011 to develop, produce, sell, distribute and service advanced storage batteries and power electronics in China. Meineng Energy assembles and manufactures certain of the Company’s products for sale in the power management industry on an exclusive basis in mainland China and on a non-exclusive basis in Hong Kong and Taiwan.

 

 

Our investment in Meineng Energy was made through ZBB PowerSav Holdings Limited (“Holdco”), a limited liability Hong Kong holding company, formed with PowerSav New Energy Holdings Limited. We own 60% of Holdco’s equity interests. We have the right to appoint a majority of the members of the Board of Directors of Holdco and Holdco has the right to appoint a majority of the members of the Board of Directors of Meineng Energy. Our indirect interest in Meineng is approximately 30%.

 

Meineng Energy manufactures certain products for EnSync pursuant to a supply agreement under which we pay Meineng Energy 120% of its direct costs incurred in manufacturing such products.

 

Bradley L. Hansen, our President and Chief Executive Officer, has served as the Chief Executive Officer of Meineng Energy since December 2011. Mr. Hansen owns an indirect 6% equity interest in Meineng Energy.

 

Pursuant to a management services agreement, Holdco will provide certain management services to Meineng Energy in exchange for a management services fee equal to five percent of Meineng Energy’s net sales for the subsequent three years, provided the payment of such fees will terminate upon Meineng Energy completing an initial public offering on a nationally recognized securities exchange. To date, no management service fee revenues have been recognized by Holdco.

 

Lotte Chemical Corporation

 

In April 2011, we entered into a Collaboration Agreement (the “Collaboration Agreement”) with Lotte Chemical Corporation (“Lotte”), pursuant to which we collaborated with Lotte on the technical development of our third generation zinc bromide flow battery module (the “Version 3 Battery Module”). Lotte received a fully paid-up, exclusive and royalty-free license to sell and manufacture the Version 3 Battery Module in South Korea and a non-exclusive royalty-bearing license to sell the Version 3 Battery Module in Japan, Thailand, Taiwan, Malaysia, Vietnam and Singapore.

 

In December 2013, we entered into a Research and Development Agreement (the “R&D Agreement”) with Lotte pursuant to which we agreed to develop and provide to Lotte a 500kWh zinc bromide flow battery system, including a zinc bromide chemical flow battery module and related software (the “Product”), on the terms and conditions set forth in the R&D Agreement (the “Lotte Project”). Subject to the satisfaction of certain specified milestones, Lotte was required to make payments to us under the R&D Agreement totaling $3,000,000 over the term of the Lotte Project.

 

Additionally, in December 2013, we entered into an Amended License Agreement with Lotte (the “Amended License Agreement”). Pursuant to the Amended License Agreement, we granted to Lotte, (1) an exclusive and royalty-free limited license in South Korea to use the Company’s zinc bromide flow battery module, zinc bromide flow battery stack and the technical information and know how related to the intellectual property arising from the Lotte Project (collectively, the “Technology”) to manufacture or sell a zinc bromide flow battery (the “Lotte Product”) in South Korea and (2) a non-exclusive (a) royalty-free limited license for Lotte and its affiliates to use the Technology internally in all locations other than China and South Korea to manufacture the Lotte Product and (b) royalty-bearing limited license to sell the Lotte Product in all locations other than China, the United States and South Korea. Lotte was required to pay us a total license fee of $3,000,000 under the Amended License Agreement plus up to an additional $1,000,000 if certain specific milestones are successfully achieved. In addition, Lotte is required to make ongoing royalty payments to the Company equal to a single digit percentage of Lotte’s sales of the Lotte Product outside of South Korea until December 31, 2019. The original license fees were subject to a 16.5% non-refundable Korea withholding tax.

 

Through March 31, 2017, the Company has received $5,425,000 of payments under the Lotte R&D and Amended License Agreements. The Company does not expect to receive any additional cash payments under these agreements.

 

 

RISKS AND UNCERTAINTIES

 

The following discussion of the condensed consolidated financial position and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and the Company’s Annual Report filed on Form 10-K for the fiscal year ended June 30, 2016. In addition to the historical information, this discussion contains forward looking statements such as statements of the Company’s expectations, plans, objectives, and beliefs. These statements use words such as “may,” “will,” “expect,” “anticipate,” “believe,” “plan,” and other similar terminology. In addition to the risks and uncertainties faced generally by participants in the renewable energy industry, we face the following uncertainties:

 

·

We have incurred losses since our inception in 1998 and anticipate incurring continuing losses.

·

We will require a substantial amount of additional funds to finance our capital requirements and the growth of our business, and we may not be able to raise a sufficient amount of funds, or be able to do so on terms favorable to us and our stockholders, or at all.

·

Our stock price could be volatile and our trading volume may fluctuate substantially.

·

Melodious Investments Company Limited and its affiliates (the “Melodious Group”) could sell or transfer a substantial number of shares of our common stock, which could depress the price of our securities or result in a change in control of the Company.

·

Our industry is highly competitive and we may be unable to successfully compete.

·

Our ability to achieve significant revenue growth will be dependent on the successful commercialization of our new products, including our Matrix Energy Management System and Agile Hybrid Storage System.

·

To achieve profitability, we will need to expand our sales, lower our costs and increase our margins, which we may not be able to do.

·

If our products do not perform as planned, we could experience increased costs, lower margins or harm to our reputation.

·

We need to continue to improve the performance of our products to meet future requirements and competitive pressures.

·

We must build quality products to ensure acceptance of our products.

·

To succeed, we will need to rapidly grow and we may not be successful in managing this rapid growth.

·

Our relationships with our strategic partners may not be successful, and we may not be successful in establishing additional partnerships, which could adversely affect our ability to commercialize our products and services.

·

We depend on sole and limited source suppliers and outsource certain manufacturing activities, and shortages or delay of supplies of component parts may adversely affect our operating results until alternate sources can be developed.

·

We have no experience manufacturing our products on a large-scale basis and may be unable to do so at our manufacturing facilities.

·

We are subject to risks relating to product concentration and lack of revenue diversification.

·

SPI has significant influence over key decision making of the Company and the Melodious Group may acquire the ability to significantly influence key decision making or may ultimately acquire complete control of the Company.

·

Our business could be negatively affected as a result of actions by activist shareholders, including the Melodious Group.

·

We have implemented, and Wisconsin law contains, anti-takeover provisions that may adversely affect the rights of holders of our common stock.

·

Our China joint venture could be adversely affected by the laws and regulations of the Chinese government, our lack of decision-making authority and disputes between us and the Joint Venture.

·

Business practices in Asia may entail greater risk and dependence upon the personal relationships of senior management than is common in North America, and therefore some of our agreements with other parties in China and South Korea could be difficult or impossible to enforce.

·

Our success depends on our ability to retain our managerial personnel and to attract additional personnel.

 

 

·

We market and sell, and plan to market and sell, our products in numerous international markets. If we are unable to manage our international operations effectively, our business, financial condition and results of operations could be adversely affected.

·

Our sales cycle is lengthy and variable, which makes it difficult for us to forecast revenue and other operating results.

·

Our increased emphasis on larger and more complex system solutions and customer concentration may adversely affect our ability to accurately predict the timing of revenues and to meet short-term expectations of operating results.

·

We recently entered into our first target markets through power purchase agreements (“PPAs”), which represents a new business for us. We have very limited experience in the PPA business, which is very complex, and there can be no assurance that we will be able to successfully develop such business.

·

We expect to rely on third-party suppliers and contractors when developing and constructing systems for our PPA business.

·

Business and consumers might not adopt alternative energy solutions as a means for obtaining their electricity and power needs, and therefore our revenues may not increase, and we may be unable to achieve and then sustain profitability.

·

Our business depends in part on the regulatory treatment of third-party owned solar energy systems.

·

The success of our business depends on our ability to develop and protect our intellectual property rights, which could be expensive.

·

While we take steps to protect our proprietary rights to the extent possible, there can be no assurance that third parties will not know, discover or develop independently equivalent proprietary information or techniques, that they will not gain access to our trade secrets or disclose our trade secrets to the public. Therefore, we cannot guarantee that we can maintain and protect unpatented proprietary information and trade secrets. If we fail to protect our intellectual property, our planned business could be adversely affected.

·

We may be subject to claims that we infringe the intellectual property rights of others, and unfavorable outcomes could harm our business.

·

We may engage in acquisitions that could disrupt our business, cause dilution to our stockholders and reduce our financial resources.

·

We have never paid cash dividends and do not intend to do so.

 

NEW ACCOUNTING PRONOUNCEMENTS

 

Refer to Note 1 of the Notes to Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of our financial statements conforms to accounting principles generally accepted in the United States of America (“US GAAP”), which requires management, in applying our accounting policies, to make estimates and assumptions that have an important impact on our reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of our financial statements. On an on-going basis, management evaluates its estimates including those related to revenue recognition, inventory valuations, warranty obligations, and income taxes. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from management’s estimates.

 

CRITICAL ACCOUNTING ESTIMATES

 

Revenue Recognition

 

Application of the accounting principles related to the measurement and recognition of revenue requires the Company to make judgments and estimates. Even for the same product, the Company has to interpret contract terms to determine the appropriate accounting treatments. When services, installation and training, etc. are rendered with product sales, the Company determines whether the deliverables should be treated as separate units of accounting. When there are multiple transactions with the same customer, significant judgments are made to determine whether separate contracts are considered as part of one arrangement according to the contract’s terms and conditions. When the installed equipment is accepted by the customer in different periods, the Company determines whether the completed project is able to be used by the customer, whether the receivable is collectible and whether revenue is recognized in stages.

 

 

Revenue recognition is also impacted by various factors, including the credit-worthiness of the customer. Estimates of these factors are evaluated periodically to assess the adequacy of the estimates. If the estimates were changed, revenue would be impacted.

 

Excess and Obsolete Inventory

 

The Company determines inventory write-downs of excess and obsolete inventories based on historical usage. The write-down is measured as the difference between the cost of the inventory and market based upon assumptions about usage.

 

We believe our accounting estimate related to excess and obsolete inventory is a critical accounting estimate because it requires us to make assumptions about usage, which can be highly uncertain. Changes in these estimates can have a material effect on our financial statements.

 

Accrued Expenses

 

Accrued expenses consist of the Company’s present obligations related to various expenses incurred during the period and includes a reserve for estimated contract losses, other accrued expenses, and warranty obligations.

 

Warranty Provision

 

The Company’s products are generally covered by a warranty for 12 or 18 months. The Company accrues for warranty costs as part of costs of sales based on associated material costs, technical labor costs, and associated overheads at the time revenue is recognized.

 

If the Company experiences an increase in warranty claims compared with historical experience, or if the cost of servicing warranty claims is greater than expected, the Company’s gross margin could be adversely affected.

 

Stock Based Compensation

 

The Company’s Board of Directors approves grants of stock options to employees to purchase our common stock. Stock compensation expense is recorded based upon the estimated fair value of the stock option at the date of grant. The accounting estimate related to stock-based compensation is considered a critical accounting estimate because estimates are made in calculating compensation expense including stock price, expected option lives, forfeiture rates and expected volatility. Expected option lives and forfeiture rates may be different from estimates and may result in potential future adjustments, which would impact the amount of stock-based compensation expense recorded in a particular period.

 

Accounting for the Securities Purchase Agreement and Supply Agreement with SPI

 

As discussed in Note 2 of the condensed consolidated financial statements, the Company entered into several agreements with SPI on July 13, 2015, including the Securities Purchase Agreement and the Supply Agreement. Determining the appropriate accounting for the arrangement required the Company to take into account the interrelated nature of the agreements and the terms of the securities issued.

 

As the Series C Preferred Stock issued to SPI becomes convertible and the Warrant issued to SPI becomes exercisable only if SPI makes certain purchases from the Company, the Company concluded that the guidance in FASB ASC Topic 605-50, “Revenue Recognition – Customer Payments and Incentives” requires that the fair value of the conversion option on the Series C Preferred Stock and the Warrant must be reflected as a sales incentive, and presented as a reduction of revenue and increase to additional paid in capital when that value is recognized in the condensed consolidated statement of operations. The sales incentive will be recognized as SPI makes purchases that progress toward the vesting of each tranche of the conversion option of the Series C Preferred Stock and the Warrant, so long as the Company believes that it is probable SPI will make sufficient purchases to cause the applicable tranche of the Series C Preferred Stock to become convertible or the Warrant to vest. As of March 31, 2017, no purchases under the Supply Agreement had occurred and therefore no sales incentive had been recognized. Once such purchases occur, the Company will utilize all available information, including forecasts, in assessing whether each tranche of the Series C Preferred Stock is probable of becoming convertible and the Warrant is probable of vesting.

 

 

Any amount that is recognized as a sales incentive will be determined based upon the fair value of the convertibility provision on the applicable tranche of Series C Preferred Stock and/or the Warrant during the period in which sales to SPI occur. Because SPI does not face a penalty for not making purchases under the Supply Agreement other than the loss of the convertibility of the Series C Preferred Stock and the loss in value of the Warrant, the provisions of FASB ASC Topic 505-50, “Equity – Equity-Based Payments to Non-Employees” require that the sales incentive be measured based upon the fair value of the conversion provisions at the time they become exercisable and the Warrant at its vesting date and the value. The Company will therefore be required to update its estimates of the fair value of these items each period until SPI has purchased 40 megawatts of Projects under the Supply Agreement, at which point all tranches of the Series C Preferred Stock will be convertible and the Warrant will vest. As there are no observable prices for conversion provisions or the Warrant, the fair value estimates need to be determined using option pricing or other valuation techniques. See Note 2 to the condensed consolidated financial statements for further information about the measurement of fair value of these instruments as of March 31, 2017.

 

On August 30, 2016, SPI entered into a share purchase agreement (the “Share Purchase Agreement”) with Melodious Investments Company Limited (“Melodious”) pursuant to which SPI sold to Melodious all of the Purchased Common Shares, all 7,012 outstanding shares of Series C-1 Preferred Stock and 4,341 shares of Series C-2 Preferred Stock for a total purchase price of $17.0 million (which is equal to the price SPI paid for such securities). The Share Purchase Agreement provides that if the purchased shares of Series C-1 Preferred Stock and Series C-2 Preferred Stock are not converted into shares of common stock within six months following the closing date, Melodious will have the right to require SPI to repurchase such shares for a price equal to approximately 102% of the price paid by Melodious for such shares (plus 10% interest accrued from the closing date). As of March 31, 2017, Melodious had not elected to exercise such right. Following the sale of such securities, SPI continues to hold the Requisite Shares, and the Governance Agreement remains in effect.

  

RESULTS OF OPERATIONS

 

Three months ended March 31, 2017 compared with the three months ended March 31, 2016

 

Revenue:

 

Our revenues for the three months ended March 31, 2017 and March 31, 2016 were $50,505  and $160,138, respectively. The decrease of $109,633 in the three months ended March 31, 2017 was the result of a $14,251 decrease in product sales and a $95,382 decrease in engineering and development revenue as compared to the three months ended March 31, 2016.

 

Costs and Expenses:

 

Total costs and expenses for the three months ended March 31, 2017 and March 31, 2016 were $4,462,951  and $4,131,929, respectively. This increase of $331,022 in the three months ended March 31, 2017 was due to the following factors:

 

·

$116,363 increase in costs of product sales principally due to $53,000 in excess and obsolete inventory and $36,000 in severance incurred in the three months ended March 31, 2017;

 

·

$221,628 decrease in costs of engineering and development due to timing of costs incurred under the Lotte R&D Agreement for the three months ended March 31, 2017 compared to the three months ended March 31, 2016;

 

·

$17,213 decrease in advanced engineering and development expenses;

 

·

$530,747 increase in selling, general, and administrative expenses as a result of a $186,000 reversal of an unused reserve for the system upgrade initiative in the three months ended March 31, 2016, in addition to the incurrence of approximately $71,000 in additional stock compensation expense, $73,000 in additional expenses for wages and benefits, $97,000 in legal fees partially related to the acquisition of DCfusion, LLC, and $58,000 in additional director fees in the three months ended March 31, 2017; and

 

·

$111,673 decrease in depreciation and amortization expense as a result of aging fixed assets that have reached the end of their useful life

 

Other Income (Expense):

 

Total other income (expense) for the three months ended March 31, 2017 decreased by $71,466 to a loss of $170,390 from a loss of $98,944 for the three months ended March 31, 2016, which is principally reflective of the change in our investee company earnings.

 

 

Income Taxes (Benefit):

 

The benefit for income taxes during the three months ended March 31, 2017 decreased by $172 to $0 from $172 for the three months ended March 31, 2016. The benefit as of March 31, 2016 related to a refund received from the government of Australia related to a refundable tax credit for qualified research and development expenditures we incurred during the fiscal year ended June 30, 2014.

 

Net Loss:

 

Our net loss attributable to EnSync, Inc. for the three months ended March 31, 2017 increased by $506,551 to $4,454,114 from the $3,947,563 net loss for the three months ended March 31, 2016. This increase in loss was primarily from decreased revenues and increased costs and expenditures incurred during the three months ended March 31, 2017.

 

Nine months ended March 31, 2017 compared with the nine months ended March 31, 2016

 

Revenue:

 

Our revenues for the nine months ended March 31, 2017 and March 31, 2016 were $9,443,635  and $815,375, respectively. The increase of $8,628,260 in the nine months ended March 31, 2017 was the result of a $8,731,900 increase in product sales attributable to our sales of PPA systems to AEP Onsite Partners in July 2016 and two other investors, partially offset by a $89,389 decrease in engineering and development revenue in the nine months ended March 31, 2017 as compared to the nine months ended March 31, 2016.

 

Costs and Expenses:

 

Total costs and expenses for the nine months ended March 31, 2017 and March 31, 2016 were $22,921,069 and $13,138,964,  respectively.  This increase of $9,782,105 in the nine months ended March 31, 2017 was due to the following factors:

 

·

$9,309,456 increase in costs of product sales principally due to $9 million cost of product sales associated with the sale of the PPA systems to AEP Onsite Partners in July 2016 and two other investors and other product shipments;

·

$579,930 increase in costs of engineering and development due to timing of costs incurred under the Lotte R&D Agreement for the nine months ended March 31, 2017 compared to the nine months ended March 31, 2016;

·

$1,595,971 decrease in advanced engineering and development expenses as a result of a $911,000 decrease in expenditures for temporary labor and a $367,000 decrease in expenditures of materials and supplies on projects;

·

$1,603,950 increase in selling, general, and administrative expenses as a result, in part, of a $186,000 reversal of an unused reserve for the system upgrade initiative in the nine months ended March 31, 2016, in addition to the incurrence in the nine months ending March 31, 2017 of approximately $499,000 in additional stock compensation expense, $561,000 in additional expenses for wages and benefits, $210,000 in additional director fees, and severance of $77,000, offset by a $204,000 decrease in recruiting expenses; and

·

$115,260 decrease in depreciation and amortization expense as a result of aging fixed assets that have reached the end of their useful life.

  

Other Income (Expense):

 

Total other income (expense) for the nine months ended March 31, 2017 decreased by $67,126 to a loss of $167,167 from a loss of $100,041 for the nine months ended March 31, 2016, which is reflective of the change in our investee company earnings.

 

Income Taxes (Benefit):

 

The benefit for income taxes during the nine months ended March 31, 2017 decreased by $468 to $0  from $468 for the nine months ended March 31, 2016. The benefit as of March 31, 2016 related to a refund received from the government of Australia related to a refundable tax credit for qualified research and development expenditures we incurred during the fiscal year ended June 30, 2014.

 

Net Loss:

 

Our net loss attributable to EnSync, Inc. for the nine months ended March 31, 2017 increased by $1,227,967 to $13,373,540 from the $12,145,573 net loss for the nine months ended March 31, 2016. This increase in loss was primarily from the increase in costs of product sales incurred during the nine months ended March 31, 2017.

  

 

Liquidity and Capital Resources

 

Since our inception, our research, advanced engineering and development, and operations have been primarily financed through debt and equity financings, and engineering, government and other research and development contracts. Total capital stock and paid in capital as of March 31, 2017 was $140,394,346 compared with June 30, 2016 total capital stock and paid in capital of $138,771,379 . We had a cumulative deficit of $133,923,648  as of March 31, 2017 compared to a cumulative deficit of $120,550,108  as of June 30, 2016. At March 31, 2017 we had net working capital of $14,275,391 compared to June 30, 2016 net working capital of $25,519,210. Our shareholders’ equity as of March 31, 2017 and June 30, 2016, exclusive of noncontrolling interests, was $4,886,001 and $16,635,688 , respectively.

 

On September 26, 2013, the Company entered into a Securities Purchase Agreement with certain investors providing for the sale of 3,000 shares of Series B Convertible Preferred Stock (the “Preferred Stock”). Shares of Preferred Stock were sold for $1,000 per share (the “Stated Value”) and accrue dividends on the Stated Value at an annual rate of 10%. At March 31, 2017, the Preferred Stock was convertible into a total of 3,337,448  shares of common stock of the Company (“Common Stock”) at a conversion price equal to $0.95. Upon any liquidation, dissolution or winding up of the Company, holders of Preferred Stock are entitled to receive out of the assets of the Company an amount equal to two times the Stated Value, plus any accrued and unpaid dividends thereon. The net proceeds to the Company, after deducting $96,967 of offering costs, were $2,909,873. At March 31, 2017, the liquidation preference of the Preferred Stock was $5,549,840. 

 

On August 27, 2014, we completed an underwritten public offering of our common stock at a price to the public of $1.12 per share. We sold a total of 13,248,000 shares of our common stock in the offering for aggregate proceeds of approximately $14.8 million. We received approximately $13.7 million of net proceeds from the offering, after deducting the underwriting discount and expenses.

 

On July 13, 2015, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with SPI Energy Co., Ltd. (“SPI”), (formerly known as Solar Power, Inc.), pursuant to which we sold to SPI for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares (the “Purchased Common Shares”) of Common Stock and (ii) 28,048 shares (the “Purchased Preferred Shares”) of Series C Convertible Preferred Stock. The aggregate purchase price for the Purchased Common Shares was based on a purchase price per share of $0.6678 and the aggregate purchase price for the Purchased Preferred Shares was determined based on a price of $0.6678 per common share equivalent. Pursuant to the Purchase Agreement, SPI was also issued a warrant to purchase 50,000,000 shares of Common Stock for an aggregate purchase price of $36,729,000 (the “Warrant”).

 

On August 30, 2016, SPI entered into a share purchase agreement (the “Share Purchase Agreement”) with Melodious Investments Company Limited (“Melodious”) pursuant to which SPI sold to Melodious all of the Purchased Common Shares, all 7,012 outstanding shares of Series C-1 Preferred Stock and 4,341 shares of Series C-2 Preferred Stock for a total purchase price of $17.0 million (which is equal to the price SPI paid for such securities). The Share Purchase Agreement provides that if the purchased shares of Series C-1 Preferred Stock and Series C-2 Preferred Stock are not converted into shares of common stock within six months following the closing date, Melodious will have the right to require SPI to repurchase such shares for a price equal to approximately 102% of the price paid by Melodious for such shares (plus 10% interest accrued from the closing date). As of March 31, 2017, Melodious had not elected to exercise such right. Following the sale of such securities, SPI continues to hold the Requisite Shares, and the Governance Agreement remains in effect.

  

At March 31, 2017, our principal sources of liquidity were our cash and cash equivalents which totaled $12,399,671 and accounts receivable of $237,265.

 

We believe that cash and cash equivalents on hand and other potential sources of cash will be sufficient to fund our current operations through the first quarter of fiscal year 2018 and that we will require additional investment capital to fund our operations thereafter. We are currently exploring potential financing options that may be available to us. However, we have no commitments to obtain any additional funds, and there can be no assurance such funds will be available on acceptable terms or at all.

  

If we are unable to obtain additional required funding, we may not be able to:

 

·

remain in operation;

·

execute our growth plan;

·

take advantage of future opportunities; or

·

respond to customers and competition.

 

 

Operating Activities

 

Our operating activities used net cash of $4,578,824 for the nine months ended March 31, 2017. Cash provided by operations resulted from a net loss of $13,644,601, which was decreased by $2,397,112 in non-cash adjustments and by $6,668,665 in net changes to working capital. Non-cash adjustments included $447,494 of depreciation and amortization expense, $1,554,567 of stock compensation expense, $234,675 provision for inventory reserve, and $171,816 in equity in loss of investee company, partially offset by $8,432 gain on sale of property and equipment, and $3,008 of interest accreted on the note receivable. Net increases in working capital were primarily from decreases of $5,690,307 in deferred PPA project costs, $782,092 in project assets, $422,638 in deferred revenue, $217,217 in deferred customer project costs, $137,983 in other long term liabilities, $60,895 in accounts payable, and a $29,704 decrease in accrued compensation and benefits, offset by increases of $144,366 in prepaids and other current assets, $64,632 in accounts receivable, $312,715 in inventories, $53,683 in accrued expenses, and $96,775 in customer deposits.

 

Investing Activities

 

Our investing activities used net cash of $31,039  for the nine months ended March 31, 2017, related primarily to expenditures for new property and equipment of $46,364, partially offset by cash proceeds in the amount of $15,325 from the sale of property and equipment.

 

Financing Activities

 

Our financing activities used net cash of $180,133 for the nine months ended March 31, 2017 for repayments of long-term debt of $248,533 offset by proceeds from the exercise of stock options of $68,400.

 

Off-Balance Sheet Arrangements

 

We had no off-balance sheet arrangements as of March 31, 2017.

 

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

Item 4.

CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Administrative Officer (“CAO”), of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report as defined in Exchange Act Rule 13a-15(e) and Rule 15d-15(e). Based on that evaluation, the CEO and CAO have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including the our CEO and CAO, as appropriate, to allow timely decisions regarding required disclosure.

 

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). Under the supervision and with the participation of our management, including our CEO and CAO, we conducted an evaluation of the effectiveness of our internal controls over financial reporting based on the framework in Internal Controls – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on our evaluation under the framework in Internal Control – Integrated Framework, our management concluded that our internal controls over financial reporting were effective as of December 31, 2016. The Company’s internal control over financial reporting is designed to provide reasonable assurances regarding the reliability of financial reporting and the preparation of the financial statements of the Company to conform with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements of fraud. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or because the degree of compliance with the policies or procedures may deteriorate.

 

This quarterly report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to SEC rules adopted in conformity with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the nine months ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

 

We are not currently a party to any pending legal proceeding that we believe will have a material adverse effect on our business, financial condition or results of operations. We may, however, be subject to various claims and legal actions arising from the ordinary course of business from time to time.

 

Item 1A. RISK FACTORS

 

We operate in a rapidly changing environment that involves a number of risks that could materially affect our business, financial condition or future results, some of which are beyond our control. In addition to the other information set for the in this report, the risks and uncertainties that we believe are most important for you to consider are discussed in Part I, “Item 1A, Risk Factors,” in our most recent Annual Report on Form 10-K and in any subsequent Quarterly Reports on Form 10-Q.

 

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

In January and February 2017, the Company issued a total of 270,000 stock option awards to three new non-executive employees as inducement grants to enter into employment with the Company. Of these stock options, 90,000 vest and become exercisable in three equal annual installments and 180,000 vest and become exercisable in full on the third first anniversary of the date of grant. These new hire inducement awards were granted pursuant to the exemption from registration made available under Section 4(a)(2) of the Securities Act of 1933. The Company intends to file a registration statement on Form S-8 to register the shares of common stock underlying these awards prior to the time at which they vest.

 

Item 3. DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

Item 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

Item 5. OTHER INFORMATION

 

Not applicable.

 

Item 6. EXHIBITS

 

The exhibits required to be filed as a part of this report are listed in the Exhibit Index.

 

 

SIGNATURES

 

Pursuant to the requirements of the Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned on May 11, 2017, thereunto duly authorized.

 

	ENSYNC, INC.
	By:	/s/ Bradley L. Hansen
	Name:	Bradley L. Hansen
	Title:	Chief Executive Officer
		and President and Director
	(Principal Executive Officer)
	By:	/s/ Frederick P. Vaske
	Name:	Frederick P. Vaske
	Title:	Chief Administrative Officer
	(Principal Financial Officer)
	By:	/s/ Dilek Wagner
	Name:	Dilek Wagner
	Title:	Vice President of Finance
	(Principal Accounting Officer)

 

 

EXHIBIT INDEX

 

Exhibit No.		Description		Incorporated by Reference to
3.1		Articles of Incorporation of EnSync, Inc., as amended		Incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed on September 28, 2015
3.2		Articles of Amendment to Articles of Incorporation of EnSync, Inc.		Incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on February 16, 2016
3.3		Certificate of Designation of Preferences, Rights and Limitations of Series B Convertible Stock		Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on September 27, 2013
3.4		Certificate of Designation of Preferences, Rights and Limitations of Series C Convertible Preferred Stock		Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on July 14, 2015
3.5		Amended and Restated By-laws of EnSync, Inc. (as of November 4, 2009)		Incorporated by reference to Exhibit 3.4 to the Company’s Annual Report on Form 10-K filed on September 28, 2015
4.1		Form of Stock Certificate		Incorporated by reference to Exhibit 4.1 to the Company’s Annual Report on Form 10-K filed on September 28, 2015
4.2		Form of Underwriter Warrant		Incorporated by reference to the Company’s Registration Statement on Form S-1 filed on April 10, 2012
4.2		Form of Warrant		Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed on May 2, 2012
4.4		Form of Warrant		Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on September 27, 2013
4.5		Form of Warrant issued to Solar Power, Inc.		Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on April 17, 2015

 

31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		Interactive Data Files

 

* Indicates a management contract or any compensatory plan, contract or arrangement.