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MEEC > SEC Filings for MEEC > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for MIDWEST ENERGY EMISSIONS CORP.

Form 10-K for MIDWEST ENERGY EMISSIONS CORP.


14-Mar-2014

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.

Results of Operations

2013 was a year of intense sales and marketing efforts as the utilities began to focus on mercury control technologies they plan to install to meet the MATS 2015
(or 2016 if they received a one-year extension from their individual state EPA)
operational deadline. During the year, we performed demonstrations of our technology on eight customer units with very positive results in every case. We anticipate that utilities will continue to evaluate various mercury control technologies during 2014 and the first half of 2015 (if granted an extension) before deciding on their technology solution and installing their chosen system during 2014 and 2015. Based on excellent results during numerous demonstrations on various units and various coal combinations, MEEC was awarded early in 2014 contracts to supply mercury control systems to the nine unit fleet of a major utility and another large unit of an electric cooperative. Parts of the agreements involve designing and having installed the capital systems for the front end position of our injection technologies. This work will generate some revenue in 2014. We expect to sign agreements with other utilities in 2014. 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.

In December of 2013, MEEC and the Energy & Environmental Research Center Foundation (EERCF) signed Amendment 4 to their exclusive Licensing Agreement which provided MEEC two new patents and two new patent applications in mercury control. The Agreement also eliminated certain contract provisions and compliance issues and restructured the fee payments and buyout provisions while providing EERCF with a small equity ownership in MEEC. With this agreement, MEEC now has exclusive U.S. and international rights to 25 patents or patents pending in its licensing portfolio, spanning numerous technologies in the area of mercury emissions control.

Also, beginning January 2014, Mr. Jim Trettel joined our company as Vice President, Operations. Jim's addition is a critical component of our ability to execute the installation and operation of our systems on the ten new customer units we have recently won as well as on future awards. Jim supported our numerous demonstrations during 2013 as a contractor to the company and knows our company and technologies very well.


Revenues

Sales - We generated revenues for delivered product and performing demonstrations of approximately $1,668,000 and $788,000 for the years ended December 31, 2013 and 2012, respectively.

Cost and Expenses

Costs and expenses were $5,891,000 and $4,765,000 during the years ended December 31, 2013 and 2012, respectively. The increase in costs and expenses from the prior year is primarily attributable to (i) $875,000 of license maintenance fees incurred in association with an amendment to the patent license, (ii) an increase in operating expenses of $624,000 in the current year and (iii) and an increase in stock compensation expense of $497,000 recorded for the grants of equity compensation to management. The cost increases were offset by the impairment of fixed assets of $800,000 recorded in 2012 and a decrease in depreciation expense of $241,000 in 2013.

Cost of goods sold during the years ended December 31, 2013 and 2012 was $371,000 and $233,000, respectively. The increase in cost is attributable to the increase in product sales in 2013.

Operating expenses during the years ended December 31, 2013 and 2012 were $887,000 and $263,000, respectively. The increase in current year is associated with the increase in number and length of demonstrations of our mercury emissions control technology in 2013 versus 2012.

License Maintenance Fees were $1,075,000 and $200,000 for the years ended December 31, 2013 and 2012, respectively. In December 2013, the Company executed Amendment No. 4 of its "Exclusive Patent and Know-How License Agreement Including Transfer of Ownership" with the Energy and Environmental Research Center Foundation, a non-profit entity ("EERCF") expanding the number of patents covered, eliminating certain contract provisions, restructuring the license maintenance and royalty fee payment schedules and restructuring the buyout provisions. Pursuant to the amendment, the Company paid a cash fee of $50,000 and agreed to issue shares valued at $825,000.

Marketing and development expenses were $339,000 and $414,000 for the years ended December 31, 2013 and 2012, respectively. The decrease in marketing and development expenses is primarily attributed to stock awards paid to consultants in 2012 of $135,000 and no similar costs in 2013. This decrease was offset by an increase in fees paid to consultants for technical services related to our sales efforts in 2013.

Selling, general and administrative expenses were $2,474,000 and $1,653,000 for the years ended December 31, 2013 and 2012, respectively. The increase in selling, general and administrative expenses is primarily attributed to a stock based compensation expense of $855,000 in 2013 compared to $359,000 in 2012 and increased expenses related to selling efforts and investor relations in 2013 as we continue to expand our operational efforts and grow the company.

Depreciation and amortization expenses were $181,000 and $420,000 for the years ended December 31, 2013 and 2012, respectively. The decrease in depreciation and amortization expenses during 2013 is primarily attributed to the depreciation recorded on the system installed at our first commercial customer, which had an impairment charge of $800,000 recorded against its value during 2012.


Professional fee expenses were $566,000 and $782,000 for the years December 31, 2013 and 2012, respectively. The decrease in professional fee expenses is attributed to a decrease in professional fees related to the maintenance, expansion and defense of our intellectual property and SEC reporting compliance.

Impairment of fixed assets was zero and $800,000 for the years ended December 31, 2013 and 2012, 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.

Other Income and Expenses

Given our financial constraints and our reliance on financing activities, interest expense related to the financing of capital was $712,000 and $262,000 during the years ended December 31, 2013 and 2012, 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 and in 2013 Mr. MacPherson forgave a debt of $81,000 for funds he had previously advanced the Company.

Net Loss

For the years ended December 31, 2013 and 2012, we had a net loss from operations of approximately $4,854,000 and $3,978,000, respectively. The increased net loss is primarily attributed to the increased license maintenance costs, stock based compensation expense and 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. These increases were offset by a decrease in depreciation expense, and the impairment charge on equipment of $800,000 in 2012.

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 dissolved the following foreign entities:

Youth Media (BVI) Ltd.

Youth Media (Hong Kong) Limited

Youth Media (Beijing) Limited

Rebel Crew Films, Inc. is now dormant while the Company evaluates its future usefulness to the company.

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, 2013, our deferred tax assets are primarily related to accrued compensation and net operating losses. A 100% valuation allowance has been established due to the uncertainty of the utilization of these assets in future periods. As a result, the deferred tax asset was reduced to zero and no income tax benefit was recorded. The 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, 2013, our cash and cash equivalents were $510,000. We had a working capital deficit of approximately $900,000 at December 31, 2013 and we continue to have recurring losses. Our anticipated cash needs for working capital and capital expenditures for 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.

Total assets were $1,924,000 at December 31, 2013 versus $1,152,000 at December 31, 2012. The change in total assets is primarily attributable to the increases in cash on hand at the end of the year and the long term debt issuance costs and is offset by depreciation 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 $1,547,000 of cash during the year ended December 31, 2013 compared to $2,560,000 during the year ended December 31, 2012. The change in cash used for operating activities is primarily attributable to the increase in accounts payable and accrued liabilities in 2013.

Investing activities used zero and $8,000 during the years ended December 31, 2013 and 2012, respectively.

Financing activities provided $1,867,000 during the year ended December 31, 2013 due to proceeds from the issuance of convertible promissory notes of $2,413,000 which was offset by payments on notes payable of $150,000 and payments of debt issuance costs of $396,000. Financing activities provided $2,658,000 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, which was offset by the payment of debt issuance costs of $126,000.


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.

Critical Accounting Policies and Estimates

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

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

Accounts Receivable

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

Revenue Recognition

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

1. Persuasive evidence of an arrangement exists;

2. Delivery has occurred or services have been rendered;

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

4. Collectability is reasonably assured.

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


Income Taxes

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

The recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise's consolidated financial statements are based on a more-likely-than-not recognition threshold. The Company did not have any unrecognized tax benefits at December 31, 2013 or 2012. When necessary, the Company would accrue penalties and interest related to unrecognized tax benefits as a component of income tax expense.

The Company and its subsidiaries file a consolidated income tax return in the U.S. federal jurisdiction and three state jurisdictions. The Company is no longer subject to U.S. federal examinations for years prior to 2010 or state tax examinations for years prior to 2009. Prior to the Reverse Merger, MES, Inc. was taxed as an S corporation and income and losses were passed through to the stockholders.

Stock-Based Compensation

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

Warrants

The Company utilized a Black-Scholes options pricing model to value the warrants sold and issued. This model requires the input of highly subjective assumptions such as the expected stock price volatility and the expected period until the warrants are exercised. When calculating the value of warrants issued, the Company uses a volatility factor of 1.0, a risk free interest rate and the life of the warrant for the exercise period.

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