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MEEC > SEC Filings for MEEC > Form 10-K on 13-Mar-2013All Recent SEC Filings

Show all filings for MIDWEST ENERGY EMISSIONS CORP. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for MIDWEST ENERGY EMISSIONS CORP.


13-Mar-2013

Annual Report


ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Background

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

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

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

1. Persuasive evidence of an arrangement exists;

2. Delivery has occurred or services have been rendered;

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

4. Collectability is reasonably assured.

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

Goodwill

The Company evaluates the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to (1) a significant adverse change in legal factors or in business climate; (2) unanticipated competition, or; (3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit's carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies' data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. In conjunction with our reverse merger, the Company evaluated the carrying amount of the resulting goodwill and determined that the entire amount of goodwill of $3,555,000 was impaired.

Stock-Based Compensation

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

Results of Operations

2012 was a year of intense sales and marketing efforts as the EPA MATS rule came into effect and utilities began to focus on mercury control technologies they plan to install to meet the 2015 operational deadline. During the year we performed demonstrations of our technology on five customer units with very positive results in every case. We anticipate that utilities will continue to evaluate various mercury control technologies during 2013 and the first half of 2014 before deciding on their technology solution and installing their chosen system during 2014. We are contracted for demonstrations on three more units in the first half of 2013 and we expect to do more. Our goal is to execute supply contracts for as many customer units as possible for operation in 2015, when the greatest revenue opportunities from mercury control in the United States begin. We also believe that there will be significant growth opportunities beyond 2015 as utilities switch to lower cost alternatives such as ours as the industry gains more experience in mercury control.

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Revenues in 2012 from our two large customer units were depressed from our expectations because these units did not operate for approximately six months due to low natural gas prices and hydroelectric power availability in their region. In addition, our technology was able to achieve their current state mercury emissions limit (approximately 50% removal) using even less of our sorbent material than we had anticipated. In 2015, these units will have to meet the much higher EPA MATS rule limits.

In the area of Intellectual Property in mercury emissions control during 2012, the Energy and Environmental Research Center Foundation, a non-profit entity ("EERCF"), was awarded two new US Patents and one patent in Europe. These new patents join two other US patents, two patents in Canada and one in China as part of a major asset base for the Company as we have the exclusive, world-wide rights to these technologies. In addition, the EERCF has four more mercury emission control patent pending applications in the US, two more in China and two more in Europe. When granted, these will join our intellectual property asset base. We anticipate that enforcement of our patent rights, including the licensing our technology to others, will be an important part of our business going forward.

Revenues

Sales - We generated revenues of approximately $788,000 and $458,000 for the years ended December 31, 2012 and 2011, respectively. During the year ended December 31, 2012, the Company generated revenues of $424,000 for delivered product to its commercial customer and $364,000 from three potential customers to perform demonstrations of our system at their facilities. The Company generated revenue for the year ended December 31, 2011 by delivering product to its commercial customer for use in the system commissioning process in preparation for the system launch in 2012.

Cost and Expenses

Costs and expenses were $4,765,000 and $9,875,000 during the year ended December 31, 2012 and 2011, respectively. The decrease in costs and expenses from the prior year is primarily attributable to the impairment of goodwill of $3,555,000 discussed below and stock based compensation of $3,424,000 for the grants issued to officers upon the signing of their employment agreements in 2011. These cost decreases were offset by (i) increased depreciation expenses associated with the placement in service of equipment related to the deployment of our mercury emissions control technologies of our first two commercial coal-fired boilers,
(ii) the impairment charge of $800,000 discussed below and (iii) increased general and administrative expenses associated with our recent efforts to commercialize our mercury emissions control technologies for coal-fired boilers in the U.S. and Canada for the entire year in 2012.

Cost of goods sold during the years ended December 31, 2012 and 2011 was $233,000 and $444,000, respectively. The decrease in cost is attributable to the mix of products delivered during the periods and to negotiating improved pricing from suppliers as well as increased costs in the prior year associated with product optimization efforts during the system commissioning process in preparation for the system launch of our first commercial units.

Operating expenses during the years ended December 31, 2012 and 2011 were $263,000 and $255,000, respectively. The costs during the year ended December 31, 2012 were related to servicing the Company's first commercial customer as well as carrying out demonstrations of our mercury emissions control technology at three sites of potential customers. The costs in the year ended December 31, 2011 were related to the system commissioning process for our first commercial customer in preparation for the system launch in 2012.

License Maintenance Fees were $200,000 and $150,000 for the year ended December 31, 2012 and 2011, respectively. The expenses relate to the amortization of the annual maintenance fee for the respective year.

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Marketing and development expenses were $414,000 and $764,000 for the years ended December 31, 2012 and 2011, respectively. The decrease in marketing and development expenses is primarily attributed to decreased fees paid to consultants in 2012. Consulting fees paid for business development were $188,000 and $385,000 for the years ended December 31, 2012 and 2011, respectively. Stock awards to consultants for business development were $135,000 and $271,000 for the years ended December 31, 2012 and 2011, respectively.

Selling, general and administrative expenses were $1,653,000 and $3,878,000 for the years ended December 31, 2012 and 2011, respectively. The decrease in selling, general and administrative expenses is primarily attributed to a stock based compensation expense of $3,424,000 recorded for the grants issued to officers upon the signing of their employment agreements in 2011. This decrease is offset by our increased costs associated with our efforts to commercialize our mercury emissions control technologies and the increase in salary and benefit expenses associated with having full time employees for the full year in 2012.

Depreciation and amortization expenses were $420,000 and $23,000 for the years ended December 31, 2012 and 2011, respectively. The increase in depreciation and amortization expenses during 2012 is primarily attributed to the depreciation recorded on the system installed at our first commercial customer and was placed in service during the 2012.

Professional fee expenses were $782,000 and $806,000 for the years December 31, 2012 and 2011, respectively. The decrease in professional fee expenses is attributed to transaction costs incurred in connection with the Merger Agreement of $319,000 in 2011. This decrease was offset by an increase in 2012 of $275,000 in professional fees related to the maintenance, expansion and defense of our intellectual property.

Impairment of fixed assets was $800,000 and zero for the years ended December 31, 2012 and 2011, respectively. Due to the short-term idling of both power units at the Company's commercial customer in the quarter ended March 31, 2012, the Company recorded an impairment charge against the value of the equipment. The Company recorded an additional impairment charge of $400,000 in the quarter ended December 31, 2012 after further review of the expected revenues from the customer prior to the bargain purchase option date of January 1, 2015.

Goodwill impairment expenses were zero and $3,555,000 for the years ended December 31, 2012 and 2011, respectively. The expense during 2011 was related to the determination of management that the goodwill created in the Merger was impaired.

Other Income and Expenses

Given our financial constraints and our reliance on financing activities, interest expense related to the financing of capital was $262,000 and $54,000 during the years ended December 31, 2012 and 2011, respectively. During 2012, Richard MacPherson, a director of the Company, forgave the unpaid consulting fees due to him and a consulting firm that he controls for services rendered in 2011 totaling $280,000.

Net Loss

For the years ended December 31, 2012 and 2011 we had a net loss from operations of approximately $3,978,000 and $9,471,000, respectively. The decreased net loss is primarily attributed the impairment of goodwill and stock based compensation expense discussed above and is offset by an increase to general and administrative expenses associated with our increased efforts to commercialize our mercury emissions control technologies for coal-fired boilers in the U.S. and Canada, depreciation expenses, and the impairment charge on equipment of $400,000 in 2012.

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Discontinued Operations

During 2012, the Company had a gain on debt forgiveness of $104,000 related to liabilities that were eliminated by the dissolution of its foreign entities. Pursuant to the terms of the Merger Agreement, during the year ended December 31, 2012 the Company has dissolved the following foreign entities:

Youth Media (BVI) Ltd.
Youth Media (Hong Kong) Limited
Youth Media (Beijing) Limited

The Company is in the process of dissolving Rebel Crew Films, Inc.

The operations and cash flows of these subsidiaries have been eliminated from the accounts of the Company's ongoing operations and major classes of assets and liabilities related thereto have been segregated. The gains and losses from discontinued operations, including the impairment of certain assets of discontinued operations and gains from forgiveness of liabilities, have been reflected in the consolidated financial statements. The Company does not expect to derive any revenues from the discontinued operation in the future and does not expect to incur any significant ongoing operating expenses.

Taxes

As of December 31, 2012, our deferred tax asset primarily related to accrued compensation and net operating losses. A 100% valuation allowance has been established due to the uncertainty of the utilization of these assets in future periods. As a result, the deferred tax asset was reduced to zero and no income tax benefit was recorded. The net operating loss carryforward will begin to expire in 2025.

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

Liquidity and Capital Resources

Our principal source of liquidity is cash generated from financing activities. As of December 31, 2012, our cash and cash equivalents were $189,000. We had a working capital deficit of approximately $1.8 million at December 31, 2012 and we continue to have substantial recurring losses. Our anticipated cash needs for working capital and capital expenditures for at least the next twelve months is approximately $3.0 million. In the past, we have primarily relied upon financing activities and loans from related parties to fund our operations. No assurances can be given that the Company can obtain sufficient working capital through financing activities, borrowings or that the continued implementation of its business plan will generate sufficient revenues in the future to sustain ongoing operations. Success in our fund raising efforts is crucial. We are actively seeking sources of additional financing in order to maintain and expand our operations and to fund our debt repayment obligations. Due to these efforts, we could dilute current shareholders and the dilution could be significant. Even if we are able to obtain funding, there can be no assurance that a sufficient level of sales will be attained to fund such operations or that unbudgeted costs will not be incurred. Our current cash flow needs for general overhead, sales and operations is approximately $250,000 per month with additional funds often needed for demonstrations of our technology on potential customer units. With our expected gross margins on customer contracts, we anticipate we will be at break-even on a cash flow basis when our revenues reach approximately $12 million annually. This break-even target is subject to achieving sales at that level with our expected gross margins, no assurance can be made that we will be able to achieve this target.

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Total assets were $1,152,000 at December 31, 2012 versus $2,062,000 at December 31, 2011. The change in total assets is primarily attributable to the depreciation and impairment charge taken on the carrying value of heavy equipment related to the deployment of our mercury emissions control technologies for our two commercial coal-fired boilers in the U.S.

Operating activities used $2,560,000 of cash during the year ended December 31, 2012 compared to $1,460,000 during the year ended December 31, 2011. The change in cash used for operating activities resulted primarily from our increased efforts to commercialize our mercury emissions control technologies for coal-fired boilers in the U.S. and Canada and the associated increase in operating expenses.

Investing activities used $8,000 of cash during the year ended December 31, 2012 compared to $1,393,000 during the year ended December 31, 2011. This change resulted from the construction of equipment for our first commercial customer during 2011.

Financing activities provided $2,784,000 during the year ended December 31, 2012 due to proceeds from the issuance of convertible promissory notes of $2,570,000 and stock of $214,000 compared to $2,946,000 provided during the year ended December 31, 2011 primarily due to proceeds from the issuance of stock of $2,247,000 and net related party advances of $549,000.

Off-Balance Sheet Arrangements

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

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