ORIGINCLEAR, INC. - Quarter Report: 2016 September (Form 10-Q)

ORIGINCLEAR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015

(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements  

ORIGINCLEAR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements  

ORIGINCLEAR, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements  

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

The accompanying unaudited condensed financial statements of OriginClear, Inc. (the “Company”) (formerly OriginOil, Inc.) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information refer to the financial statements and footnotes thereto included in the Company's Form 10-K for the year ended December 31, 2015.

Going Concern

The accompanying condensed consolidated financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities and commitments in the normal course of business. The accompanying condensed financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The Company has not generated significant revenue, and has negative cash flows from operations, which raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern and appropriateness of using the going concern basis is dependent upon, among other things, additional cash infusion. Management believes the existing shareholders, the prospective new investors and future sales will provide the additional cash needed to meet the Company’s obligations as they become due, and will allow the development of its core business operations. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing, or cause substantial dilution for our stockholders, in case of equity financing.

This summary of significant accounting policies of the Company is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of the Company’s management, which is responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of OriginClear, Inc. and its wholly owned operating subsidiaries, Progressive Water Treatment, Inc., (PWT) and OriginClear Company, Ltd. All material intercompany transactions have been eliminated upon consolidation of these entities.

Revenue Recognition

Equipment sales

We recognize revenue upon delivery of equipment, provided that evidence of an arrangement exists, title, and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured. Title to the equipment is transferred to the customer once the last payment is received. We record revenue as goods are shipped, and the equipment has been fully accepted by the customer. Generally, we extend credit to our customers and do not require collateral. We do not ship a product until we have a purchase agreement signed by the customer with a payment arrangement.

Percentage of completion

Revenues and related costs on construction contracts are recognized using the “percentage of completion method” of accounting in accordance with ASC 605-35 – “Accounting for Performance of Construction-Type and Certain Production Type Contracts”. Under this method, contract revenues and related expenses are recognized over the performance period of the contract in direct proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs include direct material, direct labor, subcontract labor and any allocable indirect costs. All un-allocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize the loss as it is determined.

The asset “Costs in excess of billings” represents revenues recognized in excess of amounts billed on contracts in progress. The liability “Billings in excess of costs” represents billings in excess of revenues recognized on contracts in progress. Assets and liabilities related to long-term contracts are included in current assets and current liabilities in the accompanying balance sheets, as they will be liquidated in the normal course of the contract completion.

Revisions in cost and profit estimates during the course of the contract are reflected in the accounting period in which the facts for the revisions become known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements, may result in revisions to costs and income, which are recognized in the period the revisions are determined.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

Contract Receivable

The Company bills its customers in accordance with contractual agreements. The agreements generally require billing to be on a progressive basis as work is completed. Credit is extended based on evaluation of clients financial condition and collateral is not required. The Company maintains an allowance for doubtful accounts for estimated losses that may arise if any customer is unable to make required payments. Management performs a quantitative and qualitative review of the receivables past due from customers on a monthly basis. The Company records an allowance against uncollectible items for each customer after all reasonable means of collection have been exhausted, and the potential for recovery is considered remote. The allowance for doubtful accounts was approximately $50,000 as of September 30, 2016 and 2015, respectively. The net contract receivable balance was $391,035 and $0 at September 30, 2016 and 2015, respectively, due to the acquisition of PWT.

Stock-Based Compensation

The Company periodically issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded in the period of the measurement date.

On September 29, 2015, the Company adopted and approved a new incentive stock option plan and reserved 8,000,000 shares of common stock at par value $0.0001 per share of the Corporation for issuance.

Fair Value of Financial Instruments

Fair Value of Financial Instruments, requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value. As of September 30, 2016, the balances reported for cash, prepaid expenses, accounts payable, and accrued expenses approximate the fair value because of their short maturities.

We adopted ASC Topic 820 for financial instruments measured as fair value on a recurring basis. ASC Topic 820 defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.

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. ASC Topic 820 established a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

The following table presents certain liabilities of the Company’s financial assets measured and recorded at fair value on the Company’s balance sheets on a recurring basis and their level within the fair value hierarchy as of September 30, 2016:

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

The following is a reconciliation of the derivative liability for which Level 3 inputs were used in determining the approximate fair value:

Loss per Share Calculations

Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of common shares available. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include securities or other contracts to issue common stock that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.

For the nine months ended September 30, 2016, the Company has excluded 113,916,311 stock options, 17,824,259 common stock purchase warrants outstanding, and $4,214,068 convertible notes that are convertible into shares of common stock, because their impact on the loss per share is anti-dilutive. 

For the nine months ended September 30, 2015, the Company has excluded 3,954,644 stock options, 23,749,549 common stock purchase warrants outstanding, and $4,741,858 convertible notes that are convertible into shares of common stock, because their impact on the loss per share is anti-dilutive.  

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the U.S requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period. Significant estimates are used in valuing our stock options, warrants, convertible notes, and common stock issued for services, among other items. Actual results could differ from these estimates.

Principles of Consolidation

The Company adopted the guidance of ASC Topic 810 “Consolidation” of the FASB Accounting Standards Codification to determine whether and how to consolidate another entity. Pursuant to ASC Paragraph 810-10-15-10 all majority-owned subsidiaries—all entities in which a parent has a controlling financial interest—shall be consolidated except (1) when control does not rest with the parent, the majority owner; (2) if the parent is a broker-dealer within the scope of Topic 940 and control is likely to be temporary; (3) consolidation by an investment company within the scope of Topic 946 of a non-investment-company investee. Pursuant to ASC Paragraph 810-10-15-8, the usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree. The Company consolidates all less-than-majority-owned subsidiaries, if any, in which the parent’s power to control exists.

The consolidated financial statements include all accounts of the entities at September 30, 2016.

All inter-company balances and transactions have been eliminated.

Foreign Currency Matters

We adopted ASC Topic 830 – Foreign Currency Matters, which relates to translating the records of a foreign subsidiary from its functional currency into the reporting currency. The records are in conformity with generally accepted accounting principles (GAAP). The financial position and results of operations of the Company’s foreign subsidiary is measured using the foreign subsidiary’s local currency as the functional currency. Revenues and expenses of such subsidiary has been translated into U.S. dollars at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of shareholders’ equity, unless there is a sale or complete liquidation of the underlying foreign investments. During the nine months ended September 30, 2016, the foreign currency translation adjustments resulted in a loss of $17. 

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

Recently Issued Accounting Pronouncements

In March 2016, FASB issued accounting standards update ASU-2016-09, “Compensation –Stock Compensation (Topic 718) – Improvements to Employee Share-Based Payment Accounting”. The amendments are intended to improve the accounting for employee share-based payments and affect all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payments award transactions are simplified, including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows. For public companies, the amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any organization in any interim or annual period. The Company is currently evaluating the impact of the adoption of ASU 2016-9 on the Company’s financial statements. 

In March 2016, FASB issued accounting standards update ASU-2016-06, “Derivatives and Hedging (Topic 815) – Contingent Put and Call Options in Debt Instruments”. The amendments apply to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. U.S. GAAP provides specific guidance for assessing whether call (put) options that can accelerate the repayment of principal on a debt instrument meet the clearly and closely related criterion. The guidance states that for contingent call (put) options to be considered clearly and closely related, they can be indexed only to interest rates or credit risk. Public companies must apply the new requirements for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of ASU 2016-06 on the Company’s financial statements. 

In May 2016, FASB issued accounting standards update ASU-2016-12, Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients. The amendments do not change the core revenue recognition principle in Topic 606. The amendments provide clarifying guidance in certain narrow areas and add some practical expedients. These amendments are effective at the same time Topic 606 is effective. Topic 606 is effective for public entities for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein (i.e., January 1, 2018, for a calendar year entity). The Company is currently evaluating the impact of the adoption of ASU 2016-12 on the Company’s financial statements.

In August 2016, FASB issued accounting standards update ASU-2016-15, “Statement of Cash Flows” (Topic 230) – Classification of Certain Cash Receipts and Cash Payments”, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in this ASU are effective for public and nonpublic entities for fiscal years beginning after December 15, 2018, and interim periods with fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact of the adoption of ASU 2016-15 on the Company’s financial statements. 

Management does not believe that any other recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying unaudited condensed consolidated financial statements.

Segment Reporting

Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker, or decision making group, in deciding the method to allocate resources and assess performance. The Company currently has one reportable segment for financial reporting purposes, which represents the Company’s core business.

On October 1, 2015, the Company acquired PWT from Marc Stevens through the transfer of all issued and outstanding shares of PWT in exchange (the “Exchange”) for 10,000 shares of a new series of preferred stock, the Series B Preferred Stock, filed with the State of Nevada by the Company on October 1, 2015.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

Each share of Series B Preferred Stock has a stated value of $150 per share and is convertible into shares of the Company’s common stock in three annual increments beginning 12 months from closing. The conversion price is subject to adjustment in the case of reverse splits, stock dividends, reclassifications and the like. In addition, the conversion price is subject to certain full ratchet anti-dilution protection. The Series B Preferred Stock is entitled to vote with the holders of the Company’s common stock on all corporate actions, including the election of the Company’s directors. The holders of the Series B Preferred Stock are entitled to cast one vote for each share of Series B Preferred Stock owed. This brief description of the Certificate of Designation is only a summary of the material terms.

The acquisition was accounted for under ASC 805. PWT is engaged in providing water treatment systems and services for a wide variety of applications and component sales. The acquisition is designed to enhance our services in water treatment. PWT became a wholly-owned subsidiary of the Company.

Under the purchase method of accounting, the transactions were valued for accounting purposes at $1,500,000, which was the fair value of PWT at the time of acquisition. The assets and liabilities of PWT were recorded at their respective fair value as of the date of acquisition. Since, the Company determined there were no other separately identifiable intangible assets, any difference between the cost of the acquired entity and the fair value of the assets acquired and liabilities assumed is recorded as goodwill. The acquisition date estimated fair value of the consideration transferred consisted of the following:

As of September 30, 2016, the Company has not identified any intangible assets other than goodwill. However, the above estimated fair value of the intangible assets of PWT is based on a preliminary purchase price allocation prepared by management. As a result, during the preliminary purchase price allocation period, which may be up to one year from the business combination date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. After the preliminary purchase price allocation period, we record adjustments to assets acquired or liabilities assumed subsequent to the purchase price allocation period in our operating results in the period in which the adjustments were determined.

Proforma results

The following tables set forth the unaudited pro forma results of the Company as if the acquisition of PWT had taken place on the first day of the periods presented. These combined results are not necessarily indicative of the results that may have been achieved had the companies been combined as of the first day of the periods presented.

Preferred Stock

As of September 30, 2016, the Company’s preferred stock consisted of Series A and Series B shares. There were 25,000,000 preferred shares authorized and 11,000 shares outstanding. The shares have a par value of $0.0001 per share. The Series A preferred stock provides for supermajority voting rights to the holder and the Series B stock is convertible into shares of common stock to the holder.

Common Stock

During the nine months ended September 30, 2016, the Company issued 123,247,474 shares of common stock for the settlement of convertible promissory notes in an aggregate principal in the amount of $782,000, plus interest in the amount of $96,040, based upon conversion prices per share ranging from $0.0047 to $0.0098.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

During the nine months ended September 30, 2016, the Company issued 65,013,845 shares of common stock for services at fair value of $999,931.

During the nine months ended September 30, 2016, the Company issued 96,321,672 shares of common stock for cash in the amount of $963,217 for the purchase of shares of commons stock at a price of $0.01 per share.

During the nine months ended September 30, 2016, the Company issued 81,445,772 shares of common stock for make good shares at fair value of $787,971.

On various dates the Company entered into unsecured convertible Notes (the “Convertible Promissory Notes” or “Notes”), that mature between six and nine months from the date of issuance and bear interest at 10% per annum. The Notes mature on various dates through January 25, 2016. The Notes may be converted into shares of the Company’s common stock at conversion prices ranging from the lesser of $0.06 to $0.14 (subject to adjustment for stock splits, dividends, combinations and other similar transactions) or 50% of the lowest trade price on any trade day following issuance of the Notes. The Notes include customary default provisions related to payment of principal and interest and bankruptcy or creditor assignment. In the event of default, the Notes shall become immediately due and payable at the mandatory default amount. The mandatory default amount is 150% of the Note amount and such mandatory default amount shall bear interest at 10% per annum. In addition, for as long as the Notes or other convertible notes in effect between the purchaser and the Company are outstanding, if the Company issues any security with terms more favorable than the terms of the Notes or such other convertible notes or a term was not similarly provided to the purchaser of the Notes or such other convertible notes, then such more favorable or additional term shall, at the purchaser’s option, become part of the Notes and such other convertible notes. The conversion feature of the Notes was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the Notes. As of December 31, 2015, the outstanding principal balance was $2,535,000. During the nine months ended September 30, 2016, the Company issued 93,866,797 shares of common stock upon conversion of $518,000 in aggregate principal, plus accrued interest of $96,040. As of September 30, 2016, the Notes had an aggregate remaining balance of $2,017,000. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $1,691 during the nine months ended September 30, 2016.

On February 24, 2015, the unsecured convertible promissory notes (the “OID Notes”), with an aggregate remaining principle balance of $273,124, plus accrued interest of $13,334 were amended. The OID Notes included an original issue discount and one time interest, which has been fully amortized. The OID Notes were extended and matured on various dates through September 19, 2014. On each maturity date, each note was extended one year from its maturity date through September 19, 2015. On February 24, 2015, the Notes were amended and have a maturity date of December 31, 2015. The Notes were analyzed under ASC 470 (Extinguishment & Modification of debt) to determine if there was a 10% change between the fair value of the embedded conversion option immediately before and after the modification or exchange. The change of the fair value of the conversion feature was greater than 10% of the carrying value of the debt. As a result, in accordance with ASC 470-50, the Company deemed the terms of the amendment to be substantially different and treated the convertible note as an extinguishment. The OID Notes were convertible into shares of the Company’s common stock at a conversion price initially of $0.4375. After the amendment the conversion price changed to the lesser of $0.08 per share, or b) fifty percent (50%) of the lowest trade price of common stock recorded since the original effective date of this note, or c) the lowest effective price per share granted to any person or entity after the effective date. On May 19, 2015, a holder of a note with a more favorable term converted a note at a price of $0.02, which became part of this note due to the reset provision mentioned above. The conversion feature of the notes was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the notes. During the nine months ended September 30, 2016, the Company issued 10,470,588 shares of common stock upon partial conversion of principal in the amount of $89,000, leaving a remaining balance of $184,124.

The Company entered into various unsecured convertible Notes (the “Convertible Promissory Notes” or “Notes”), for an aggregate amount of $1,900,000. As of September 30, 2016, the Company has received advances in the aggregate of $1,325,000. The notes matured between nine and twelve months from the date of issuance of each advance and bears interest at 10% per annum. The Notes were extended and mature on various dates ending on May 31, 2017. The Notes may be converted into shares of the Company’s common stock at conversion prices ranging from the lesser of $0.02 to $0.08 (subject to adjustment for stock splits, dividends, combinations and other similar transactions) or 50% of the lowest trade price on any trade day following issuance of the Notes. The Notes include customary default provisions related to payment of principal and interest and bankruptcy or creditor assignment. In the event of default, the Notes shall become immediately due and payable at the mandatory default amount. The mandatory default amount is 150% of the Note amount and such mandatory default amount shall bear interest at 10% per annum. In addition, for as long as the Notes or other convertible notes in effect between the purchaser and the Company are outstanding, if the Company issues any security with terms more favorable than the terms of the Notes or such other convertible notes or a term was not similarly provided to the purchaser of the Notes or such other convertible notes, then such more favorable or additional term shall, at the purchaser’s option, become part of the Notes and such other convertible notes. The conversion feature of the Notes was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the Notes. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $96,104 during the nine months ended September 30, 2016.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

On September 30, 2015, the Company issued a convertible note in exchange for an accounts payable in the amount of $432,048, which could be converted into shares of the Company’s common stock after December 31, 2015. The note was accounted for under ASC 470, whereby, a beneficial conversion feature was recorded at time of issuance. The note did not meet the criteria of a derivative, and was accounted for as a beneficial conversion feature, which was amortized over the life of the note and recognized as interest expense in the financial statements. On January 1, 2016, the note meet the criteria of a derivative and was accounted for under ASC 815.The note has a zero stated interest rate, and the conversion price shall be equal to 75% of the average three lowest last sale prices traded during the 25 trading days immediately prior to conversion. On February 12, 2016, the Company issued 18,910,088 shares of commons stock upon conversion of $175,000 in principal, leaving a remaining balance of $257,048. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $161,574 during the nine months ended September 30, 2016.

On March 31, 2016, the Company issued a convertible note in exchange for an accounts payable in the amount of $430,896, which could be converted into shares of the Company’s common stock after September 15, 2016. The note was accounted for under ASC 470, whereby, a beneficial conversion feature was recorded at time of issuance. On September 15, 2016, the note met the criteria of a derivative and was accounted for under ASC 815. The note has a zero stated interest rate, and the conversion price shall be equal to 75% of the average three lowest last sale prices traded during the 25 trading days immediately prior to conversion. The note did not meet the criteria of a derivative at the time it was entered into and was accounted for as a beneficial conversion feature, which was amortized over the life of the note and recognized as interest expense in the financial statements. The conversion feature of the Note was considered a derivative in accordance with current accounting guidelines because of the reset conversion feature of the Note. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $114,065 during the nine months ended September 30, 2016.

We evaluated the financing transactions in accordance with ASC Topic 815, Derivatives and Hedging, and determined that the conversion feature of the convertible promissory note was not afforded the exemption for conventional convertible instruments due to its variable conversion rate. The note has no explicit limit on the number of shares issuable so they did not meet the conditions set forth in current accounting standards for equity classification. The Company elected to recognize the note under paragraph 815-15-25-4, whereby, there would be a separation into a host contract and derivative instrument. The Company elected to initially and subsequently measure the note in its entirety at fair value, with changes in fair value recognized in earnings. The derivative liability is adjusted periodically according to the stock price fluctuations.

For purpose of determining the fair market value of the derivative liability for the embedded conversion, the Company used the Binomial Lattice valuation model. The significant assumptions used in the Binomial Lattice formula valuation of the derivative are as follows:

The derivative liability recognized in the financial statements as of September 30, 2016 was $12,189,026

Options

The Board of Directors adopted the OriginClear, Inc. (formerly OriginOil, Inc.) 2009 Incentive Stock Option Plan (the “2009 Plan”) for the purposes of granting stock options to its employees and others providing services to the Company, which reserves and sets aside for the granting of options for Five Hundred Thousand (500,000) shares of Common Stock.

On May 25, 2012, the Board of Directors adopted a new OriginClear, Inc. (formerly OriginOil, Inc.) 2012 Incentive Stock Option Plan (the “2012 Plan”) for the purposes of granting stock options to its employees and others providing services to the Company, which reserves and sets aside for the granting of options for One Million (1,000,000) shares of Common Stock. Options granted under the 2012 Plan may be either incentive options or nonqualified options and shall be administered by the Company's Board of Directors. Each Option shall be exercisable to the nearest whole share, in installments or otherwise, as the respective option agreements may provide. Notwithstanding any other provision of the 2012 Plan or of any option agreement, each Option shall expire on the date specified in the option agreement, which date shall not be later than the tenth (10th) anniversary from the effective date of grant. 

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

On June 14, 2013, the Board of Directors adopted a new OriginClear, Inc. (formerly OriginOil, Inc.) 2013 Incentive Stock Option Plan (the “2013 Plan”) for the purposes of granting stock options to its employees and others providing services to the Company, which reserves and sets aside for the granting of options for Four Million (4,000,000) shares of Common Stock. Options granted under the 2013 Plan may be either incentive options or nonqualified options and shall be administered by the Company's Board of Directors. Each Option shall state the number of shares to which it pertains. The exercise price will be determined by the holders percentage owned as follows: If the holder owns more than 10% of the total combined voting power or value of all classes of stock of the Company, then the exercise price will be no less than 110% of the fair market value of the stock as of the date of grant; if the person is not a 10% holder, then the exercise price will be no less than 100% of the fair market value of the stock as of the date of grant. Notwithstanding any other provision of the 2013 Plan or of any option agreement, each Option shall expire on the date specified in the option agreement, which date shall not be later than the tenth (10th) anniversary from the date of grant. If the status of an employee terminates for any reason other than disability or death, then the Optionee or their representative shall have the right to exercise the portion of any Options which were exercisable as of the date of such termination, in whole or in part, not less than 30 days nor more than three (3) months after such termination. 

On October 2, 2015, the Board of Directors adopted a new OriginClear, Inc. 2015 Equity Incentive Stock Option Plan (the “2015 Plan”) for the purposes of granting stock options to its employees and others providing services to the Company, which reserves and sets aside for the granting of options for One Hundred Sixty Million (160,000,000) shares of Common Stock. Options granted under the 2015 Plan may be either incentive options or nonqualified options and shall be administered by the Company's Board of Directors. Each Option shall be exercisable to the nearest whole share, in installments or otherwise, as the respective option agreements may provide. Notwithstanding any other provision of the 2015 Plan or of any option agreement, each Option shall expire on the date specified in the option agreement, which date shall not be later than the fifth (5th) anniversary from the effective date of grant.

Options granted under these Plans may be either incentive options or nonqualified options and shall be administered by the Company's Board of Directors. Each Option shall be exercisable to the nearest whole share, in installments or otherwise, as the respective option agreements may provide. Notwithstanding any other provision of the Plan or of any option agreement, each Option shall expire on the date specified in the option agreement, which date shall not be later than the tenth (5th) anniversary from the effective date of grant. If the status of an employee terminates for any reason other than disability or death, then the Optionee or their representative shall have the right to exercise the portion of any Options which were exercisable as of the date of such termination, in whole or in part, not less than thirty (30) days nor more than three (3) months after such termination.

With respect to Non-statutory Options granted to employees, directors or consultants, the Board of Directors or Committee may specify such period for exercise that the Option shall automatically terminate following the termination of employment or services as to shares covered by the Option as the Board of Directors or Committee deems reasonable and appropriate.

During the nine months ended September 30, 2016, the Company granted 1,000,000 incentive stock options, and recognized compensation costs of $155,112 based on the fair value of the options vested for the nine months ended September 30, 2016.

A summary of the Company’s stock option activity and related information follows:

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

The weighted average remaining contractual life of options outstanding issued under the 2009 Plan, 2012 Plan, and 2013 Plan as of September 30, 2016, was as follows:

As of September 30, 2016, there was no intrinsic value with regards to the outstanding options.

Restricted Stock

CEO

On May 12, 2016, the Company entered into a Restricted Stock Grant Agreement (“the RSGA”) with its Chief Executive Officer, Riggs Eckelberry, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance shares and none have yet vested nor have been issued. The RSGA provides for the issuance of up to 60,000,000 shares of the Company’s common stock, with a fair value of $1,218,000 to the CEO, provided certain milestones are met in the following stages: a.) If the Company’s consolidated gross revenue, calculated in accordance with GAAP, equals or exceeds $15,000,000 for the trailing twelve month period, the Company will issue 30,000,000 shares of common stock; b.) If the Company’s consolidated net profit, calculated in accordance to GAAP, equals or exceeds $1,500,000 for the trailing twelve month period, the Company will issue 30,000,000 shares of the Company’s common stock. As the performance goals are achieved, the shares shall become eligible for vesting and issuance. As of September 30, 2016, no milestones have been met.

On August 10, 2016, the Company entered into a Restricted Stock Grant Agreement (“the RSGA”) with its Chief Executive Officer, Riggs Eckelberry, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance shares and none have yet vested nor have been issued. The RSGA provides for the issuance of up to 60,000,000 shares of the Company’s common stock, with a fair value of $570,000 to the CEO, provided certain milestones are met in the following stages: a.) If the Company’s consolidated gross revenue, calculated in accordance with GAAP, equals or exceeds $15,000,000 for the trailing twelve month period as reported in the Company’s quarterly or annual financial statements filed with the U.S. Securities and Exchange Commission (“SEC Reports”), the Company will issue 30,000,000 shares of common stock; b.) If the Company’s consolidated operating profit (operating profit=operating revenue – cost of goods sold –operating expenses – depreciation & amortization), calculated in accordance to GAAP, equals or exceeds $1,500,000 for the trailing twelve month period reported in the Company’s SEC Reports, the Company will issue 30,000,000 shares of the Company’s common stock. As the performance goals are achieved, the shares shall become eligible for vesting and issuance. As of September 30, 2016, no milestones have been met.

Employees

On May 12, 2016, the Company entered into a Restricted Stock Grant Agreement (“the RSGA”) with an employee, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance shares and none have yet vested nor have been issued. The RSGA provides for the issuance of up to 20,000,000 shares of the Company’s common stock, with a fair value of $406,000 to the employee, provided certain milestones are met in the following stages: a.) If the Company’s consolidated gross revenue, calculated in accordance with GAAP, equals or exceeds $15,000,000 for the trailing twelve month period, the Company will issue 10,000,000 shares of common stock; b.) If the Company’s consolidated net profit, calculated in accordance to GAAP, equals or exceeds $1,500,000 for the trailing twelve month period, the Company will issue 10,000,000 shares of the Company’s common stock. As the performance goals are achieved, the shares shall become eligible for vesting and issuance. As of September 30, 2016, no milestones have been met.

On May 12, 2016, the Company entered into a Restricted Stock Grant Agreement (“the RSGA”) with employee, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance shares and none have yet vested nor have been issued. The RSGA provides for the issuance of up to 30,000,000 shares of the Company’s common stock, with a fair value of $609,000 to the employee, provided certain milestones are met in the following stages: a.) If the Company’s consolidated gross revenue, calculated in accordance with GAAP, equals or exceeds $15,000,000 for the trailing twelve month period, the Company will issue 15,000,000 shares of common stock; b.) If the Company’s consolidated net profit, calculated in accordance to GAAP, equals or exceeds $1,500,000 for the trailing twelve month period, the Company will issue 15,000,000 shares of the Company’s common stock. As the performance goals are achieved, the shares shall become eligible for vesting and issuance. As of September 30, 2016, no milestones have been met.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2016

On August 10, 2016, the Company entered into a Restricted Stock Grant Agreement (“the RSGA”) with an employee, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance shares and none have yet vested nor have been issued. The RSGA provides for the issuance of up to 15,000,000 shares of the Company’s common stock, with a fair value of $142,500 to the contractor, provided certain milestones are met in the following stages: a.) If the Company’s consolidated gross revenue, calculated in accordance with GAAP, equals or exceeds $15,000,000 for the trailing twelve month period as reported in the Company’s quarterly or annual financial statements filed with the U.S., Securities and Exchange Commission (SEC Reports), the Company will issue 7,500,000 shares of common stock; b.) If the Company’s consolidated operating profit (Operating Profit=Operating Revenue – Cost of Goods Sold – Operating Expenses – Depreciation & Amortization), calculated in accordance to GAAP, equals or exceeds $1,500,000 for the trailing twelve month period as reported in the Company’s SEC Reports, the Company will issue 7,500,000 shares of the Company’s common stock. As the performance goals are achieved, the shares shall become eligible for vesting and issuance. As of September 30, 2016, no milestones have been met.

Contractors

On August 10, 2016, the Company entered into a Restricted Stock Grant Agreement (“the RSGA”) with a contractor, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance shares and none have yet vested nor have been issued. The RSGA provides for the issuance of up to 15,000,000 shares of the Company’s common stock, with a fair value of $142,500 to the contractor, provided certain milestones are met in the following stages: a.) If the Company’s consolidated gross revenue, calculated in accordance with GAAP, equals or exceeds $15,000,000 for the trailing twelve month period as reported in the Company’s quarterly or annual financial statements filed with the U.S., Securities and Exchange Commission (SEC Reports), the Company will issue 7,500,000 shares of common stock; b.) If the Company’s consolidated operating profit (Operating Profit=Operating Revenue – Cost of Goods Sold – Operating Expenses – Depreciation & Amortization), calculated in accordance to GAAP, equals or exceeds $1,500,000 for the trailing twelve month period as reported in the Company’s SEC Reports, the Company will issue 7,500,000 shares of the Company’s common stock. As the performance goals are achieved, the shares shall become eligible for vesting and issuance. As of September 30, 2016, no milestones have been met.

Warrants

During the nine months ended September 30, 2016, the Company did not grant any warrants.

A summary of the Company’s warrant activity and related information follows:

At September 30, 2016, the weighted average remaining contractual life of warrants outstanding:

On May 1, 2016, the Company entered into a subtenant agreement with the sub-landlord in the amount of $36,560 to be paid over a period of twelve months starting June 1, 2016. As of September 30, 2016, the balance remaining is $31,636.

On May 1, 2016, the Company entered into a Sub-user agreement for commercial space. The term of the agreement is from May 1, 2016 to July 31, 2016. The term will automatically renew for successive periods until terminated in accordance with the agreement. The monthly payment for the space is $3,500.

Management evaluated subsequent events as of the date of the financial statements pursuant to ASC TOPIC 855, and reported the following events:

On October 14, 2016, a holder of OriginClear, Inc.’s (the “Company”) Series B Preferred Stock converted 3,334 shares of the Company’s Series B Preferred Stock into an aggregate of 50,010,000 shares of the Company’s common stock. The shares of common stock issued included 16,670,000 shares issued upon conversion of the 3,334 shares of Series B Preferred Stock at $0.03 per share and 33,340,000 shares as a one-time make good issuance as per the Certificate of Designation of Series B Preferred Stock and agreement between the Company and the holder.

On October 17, 2016 (the “Grant Date”), the Company entered into a Consultant Nonstatutory Stock Option Agreement (the “Option Agreement”) with two consultants pursuant to which the consultants were granted options, subject to vesting to purchase an aggregate of 15,000,000 shares of the Company’s common stock at $0.084 per share. Subject to early termination as provided in the Option Agreements, the options expire five years from the Grant Date.

On October 17, 2016 (the “Grant Date”), the Company entered into an Incentive Stock Option Agreement (the “Option Agreement”) with a non-executive officer employee of the Company pursuant to which the employee was granted an option, subject to vesting to purchase 500,000 shares of the Company’s common stock at $0.084 per share. Subject to early termination as provided in the Option Agreement, the option expires five years from the Grant Date.

Between October 19, 2016 and October 22, 2016, the Company sold, in a private placement, an aggregate of 14,000,000 shares of its common stock to accredited investors for an aggregate consideration of $140,000 (the “Offering”). The shares issued in this Offering are subject to price protection for a period of one year from the issuance of the shares providing that under certain circumstances, the Company will issue additional shares of common stock of the Company for no additional consideration to the subscribers thereunder. The subscribers agree to the lock-up provision, under which subject to certain terms and conditions therein, the subscribers shall not sell any of their shares of common stock of the Company obtained in this Offering for a period of twelve months.

In connection with certain one-time make good agreements, on October 31, 2016, the Company issued an aggregate of 1,596,360 shares of its common stock to certain holders of its common stock.

On October 31, 2016, the Company issued to consultants an aggregate of 3,525,641 shares of the Company’s common stock in lieu of cash consideration. 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This Form 10-Q contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control, which may include statements about our:

All statements, other than statements of historical fact included in this report, regarding our strategy, intellectual property, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. All forward-looking statements speak only as of the date of this report. You should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this report are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved.  These statements may be found under “Management's Discussion and Analysis of Financial Condition and Results of Operations,” as well as in this report generally.  Actual events or results may differ materially from those discussed in forward-looking statements as a result of various factors.  In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this filing will in fact occur 

Organizational History

OriginClear, Inc. (“we”, “us”, “our”, the “Company” or “OriginClear”) was incorporated on June 1, 2007 under the laws of the State of Nevada.  We have been engaged in business operations since June 2007. We recently moved into the commercialization phase of our business plan having been primarily involved in research, development and licensing activities. Our principal offices are located at 525 S. Hewitt St., Los Angeles, California 90013. Our main telephone number is (323) 939-6645. Our website address is www.OriginClear.com.  In addition to announcing material financial information through our investor relations website, press releases, SEC filings and webcasts, we also intend to use the following social media channels as a means of disclosing information about our products, our planned financial and other announcements, our attendance at upcoming investor and industry conferences, and other matters and for complying with our disclosure obligations under Regulation FD:

The information we post through these social media channels may be deemed material. Accordingly, investors should monitor these accounts, in addition to following the company’s press releases, SEC filings, public conference calls and webcasts. This list may be updated from time to time. 

We have not incorporated by reference into this report the information in, or that can be accessed through, our website or social media channels, and you should not consider it to be a part of this report.

Overview of Business

OriginClear is a leading provider of water treatment solutions and the developer of a breakthrough water cleanup technology. Through its wholly owned subsidiaries, OriginClear provides systems and services to treat water in a wide range of industries, such as municipal, pharmaceutical, semiconductors, industrial, and oil & gas. To rapidly grow this segment of the business, we strategically acquire profitable and well-managed water treatment companies, which allow us to expand our global market presence and technical expertise. To enable a new era of clean and socially responsible water treatment solutions, we invented Electro Water Separation™, a breakthrough high-speed water cleanup technology using multi-stage electrochemistry that we license worldwide to water treatment equipment manufacturers. Water is our most valuable resource, and the mission of The OriginClear Group™ is to improve the quality of water and help return it to its original and clear condition.

The Group

Outsourcing is a fast-growing reality in water treatment. Tougher regulations, water scarcities and general outsourcing trends are driving industrial and agricultural water treatment users to delegate their water problem to service providers. As Global Water Intelligence pointed out in their report on October 30, 2015, “Water is often perceived as a secondary importance, with end-users increasingly wanting to focus solely on their own core business. This is driving a move away from internal water personnel towards external service experts to take control of water aspects.” External service experts are typically small–privately owned and locally operated. Consolidating these companies could lead to enormous economies of scale through sharing of best practices, technologies, and customers. Again, Global Water Intelligence report, dated May 8, 2014 indicated, “…the market is incredibly fragmented…There needs to be some sort of aggregation of customers before it becomes a truly good business.” Therefore, OriginClear is assembling a group of such water treatment companies to create an opportunity for significant growth and increased company value for the stockholders.

Progressive Water Treatment

On October 1, 2015, Dallas-based Progressive Water Treatment, Inc. (“PWT”) became the first company in The OriginClear Group. PWT is profitable and is a fast-growing designer, builder and service provider for a wide range of industrial water treatment applications. PWT reported revenue of $4,831,788 in 2015, of which $773,699 was included in the consolidated financial statements for period ending December 31, 2015. For the first nine months of 2016, PWT reported revenue of $4,070,136 which is included in the consolidated financial statements ending September 30, 2016.

PWT’s Business

Since 1995, PWT of McKinney, Texas has been designing and manufacturing a complete line of water treatment systems for municipal, industrial and pure water applications. Known as an OEM (Original Equipment Manufacturer), PWT utilizes a wide range of technologies, including chemical injection, media filters, membrane, ion exchange and SCADA technology that it integrates into turnkey systems that it designs and builds. The Company also offers a broad range of services including maintenance contracts, retrofits and replacement assistance. In addition, PWT rents equipment in contracts of varying duration. Customers are primarily served in the United States and Canada, with the Company’s reach extending worldwide from Japan to Argentina to the Middle East. As OriginClear’s technology matures and enters commercial distribution channels, PWT intends to integrate it into applicable field situations, such as clarifying very oily, turbid water prior to processing with filters and membranes.

OriginClear is currently in discussions for additional, accretive acquisitions of companies specializing in complementary markets and applications.

Technology Licensing

For its first eight years of existence, OriginClear focused uniquely on development and commercialization of its breakthrough Electro Water Separation™ technology. In 2015, the Company established the OriginClear Technologies division, operating in parallel to the OriginClear Group. The mission of OriginClear Technologies is to develop Electro Water Separation™ and achieve its full recognition as an international industry standard in treating our increasingly complex wastewater treatment challenges. For this purpose, OriginClear Technologies relies on an ongoing strong R&D and engineering activity for the development of its technology, while actively building its network of partners, licensees and joint venture partners for commercial development. A key element of this strategy is OriginClear Technologies, Inc., (previously OriginClear (HK)), OriginClear’s wholly-owned subsidiary in Hong Kong that manages Asia-Pacific market development, with a special focus on China sales and manufacturing. While OriginClear Technologies focuses on developing and monetizing the Company’s internally-developed Intellectual Property, best practices and trade secrets, it is expected to do the same for technologies which may come in the future with OriginClear Group’s acquisition of profitable water treatment companies.

The Technology

OriginClear is the proprietary developer of Electro Water Separation™ (EWS), the high-speed, primarily chemical-free technology to clean up large quantities of water. It removes oils, suspended solids, certain dissolved solids, and pathogens, in a continuous and energy-efficient process. The Company originally developed this technology to solve the challenge of removing microalgae from a highly dilute state. The EWS technology remains an efficient mechanism for the concentration of live algae cells from water. The electro-chemical process was then extended, first to cleaning up oil and gas waste water and most recently, to industrial, agricultural and urban effluents. EWS is designed to be an early step in removal of oils, solids and pathogens; reducing the work that more expensive, downstream processes such as Ultra Filtration or Reverse Osmosis must do, therefore enabling more cost-efficient and high-volume water cleanup overall.

EWS, combined with an iSep ultrafiltration membrane, has demonstrated up to a 99.9% removal of dispersed oil, 99.5% removal of suspended solids as well as successful treatment of chemical oxygen demand (COD), including specific contaminants such as ammonia, phosphorus and hydrogen sulfide. These results were presented at the International Water Conference in 2015.

In March of 2016, OriginClear announced that it had successfully developed and proved Advanced Oxidation as the last stage of EWS. University laboratory tests have shown that EWS with Advanced Oxidation (EWS:AOx™) can now extract certain dissolved contaminants, which are otherwise difficult to remove without chemicals such as chlorine. Overall, the system has shown a dramatic reduction in Total Organic Compounds which includes all forms of organic contamination, solids, miscible or dissolved, to meet new stringent global discharge requirements. In 2016, OriginClear filed for a patent to protect the new AOx process and system configuration. Our technology integrates easily with other industry processes and we have begun to embed our technology into larger systems through licensing and joint ventures.

Beginning in July of 2016, OriginClear participated in a 60-day pilot test of a system which incorporated its technology. The client was an organization which specializes in the treatment of Produced water in Kern County. In May 2016, the client agreed to implement a 60-day pilot test of a multi-step produced water treatment system that culminates in reverse osmosis. The pilot treatment system would be designed and installed with the intent that the treated water would meet Proposition 65 safe harbor levels and any applicable specifications. On July 20, 2016, the client commenced the pilot test of the multi-step produced water treatment system which was provided by ECT Ser-vices & Solutions, under license from OriginClear. After an initial commissioning period, the pilot demonstrated the ability to safely and reliably treat the produced water to below the limits contained in the treated water specifications. When the complete system was fully operational its energy consumption was roughly 20kWh for 30 bbl of water per hour with a reject rate of 25% or 23 bbl/hour. This translated to about 1 kWh per barrel treated. At 15 cents per kWh this cost is approximatively 15-20 cents per 42-gallon barrel.

Additional Information

On October 17, 2016 (the “Grant Date”), the Company entered into a Consultant Nonstatutory Stock Option Agreement (the “Option Agreement”) with two consultants pursuant to which the consultants were granted options, subject to vesting to purchase an aggregate of 15,000,000 shares of the Company’s common stock at $0.084 per share. Subject to early termination as provided in the Option Agreements, the options expire five years from the Grant Date.

On October 17, 2016 (the “Grant Date”), the Company entered into an Incentive Stock Option Agreement (the “Option Agreement”) with a non-executive officer employee of the Company pursuant to which the employee was granted an option, subject to vesting to purchase 500,000 shares of the Company’s common stock at $0.084 per share. Subject to early termination as provided in the Option Agreement, the option expires five years from the Grant Date.

On October 22, 2016, the Company sold, in a private placement, an aggregate of 13,000,000 shares of its common stock to accredited investors for an aggregate consideration of $130,000 (the “Offering”). The shares issued in this Offering are subject to price protection for a period of one year from the issuance of the shares providing that under certain circumstances, the Company will issue additional shares of common stock of the Company for no additional consideration to the subscribers thereunder. The subscribers agree to the lock-up provision, under which subject to certain terms and conditions therein, the subscribers shall not sell any of their shares of common stock of the Company obtained in this Offering for a period of twelve months.

In connection with certain one-time make good agreements, on October 31, 2016, the Company issued an aggregate of 1,596,360 shares of its common stock to certain holders of its common stock. 

On October 31, 2016, the Company issued to consultants an aggregate of 3,525,641 shares of the Company’s common stock for services in lieu of cash consideration. 

The securities above were offered and sold pursuant to an exemption from the registration requirements under Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”) since, among other things, the transactions did not involve a public offering and the securities were acquired for investment purposes only and not with a view to or for sale in connection with any distribution thereof. 

On November 1, 2016, the Company received a notice from the OTCQB Marketplace (the “OTCQB”) advising the Company that its bid price has closed below $0.01 for more than 30 consecutive calendar days and no longer meets the Standards for Continued Eligibility for OTCQB as per the OTCQB standards. Pursuant to the OTCQB standards, the Company has been granted a period of 180 calendar days in which to regain compliance with Section 2.3, or until April 30, 2017. If, at that time, the Company’s bid price has not closed at or above $0.01 for any ten consecutive trading days then the security will be removed from the OTCQB marketplace.

Critical Accounting Policies

The Securities and Exchange Commission ("SEC") defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Not all of the accounting policies require management to make difficult, subjective or complex judgments or estimates. However, the following policies could be deemed to be critical within the SEC definition.  

Revenue Recognition 

Equipment sales

We recognize revenue upon delivery of equipment, provided that evidence of an arrangement exists, title, and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured.  Title to the equipment is transferred to the customer once the last payment is received. We record revenue as goods are shipped, and the equipment has been fully accepted by the customer. Generally, we extend credit to our customers and do not require collateral. We do not ship a product until we have a purchase agreement signed by the customer with a payment arrangement.  

Percentage of completion

Revenues and related costs on construction contracts are recognized using the “percentage of completion method” of accounting in accordance with ASC 605-35 – “Accounting for Performance of Construction-Type and Certain Production Type Contracts”. Under this method, contract revenues and related expenses are recognized over the performance period of the contract in direct proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs include direct material, direct labor, subcontract labor and any allocable indirect costs. All un-allocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize the loss as it is determined.

The asset “Costs in excess of billings” represents revenues recognized in excess of amounts billed on contracts in progress. The liability “Billings in excess of costs” represents billings in excess of revenues recognized on contracts in progress. Assets and liabilities related to long-term contracts are included in current assets and current liabilities in the accompanying balance sheets, as they will be liquidated in the normal course of the contract completion.

Revisions in cost and profit estimates during the course of the contract are reflected in the accounting period in which the facts for the revisions become known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements, may result in revisions to costs and income, which are recognized in the period the revisions are determined.

Use of Estimates 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Significant estimates made in preparing these financial statements include the estimate of useful lives of property and equipment, the deferred tax valuation allowance, and the fair value of stock options, warrants, convertible notes and common stock for services. Actual results could differ from those estimates. 

Fair Value of Financial Instruments 

Fair value of financial instruments requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value. As of September 30, 2016, the amounts reported for cash, prepaid expenses, accounts payable and accrued expenses approximate the fair value because of their short maturities.  

Recently Issued Accounting Pronouncements 

Management reviewed accounting pronouncements issued during the three months ended September 30, 2016, and no pronouncements were believed by management to have a material impact on our present or future financial statements.  

Results of Operation 

Results of Operations for the three months ended September 30, 2016 compared to the three months ended September 30, 2015. 

Revenue and Cost of Sales 

For the three months ended September 30, 2016, our revenue for the Company increased by $1,015,919 to $1,019,919 compared to $4,000 for the three months ended September 30, 2015. Cost of sales for the three months ended September 30, 2016, was $574,105 compared to $0 for the three months ended September 30, 2015. Revenue and cost of sales increased primarily due to PWT’s inclusion of three months operations. 

Our gross profit increased by $441,814 to $445,814 compared to $4,000 for the three months ended September 30, 2016 and 2015, respectively. The gross profit increased primarily due to the inclusion of PWT’s revenue.

Selling and Marketing Expenses

For the three months ended September 30, 2016, we had selling and marketing expenses of $303,496, compared to $467,991 for the three months ended September 30, 2015. Selling and marketing expenses decreased primarily due to overall expense reduction efforts.

General and Administrative Expenses

General and administrative expenses increased to $629,455, for the three months ended September 30, 2016, compared to $552,167 for the three months ended September 30, 2015. General and administrative expenses increased primarily due to PWT’s inclusion of three months operations.

Research and Development Cost

Research and development cost for the three months ended September 30, 2016 and 2015, were $106,259 and $131,483, respectively.  The decrease in research and development costs was primarily due to the decrease in salaries of $74,987, with an overall increase in other research and development costs of $49,763.

Other Income and (Expenses)

Other income and (expenses) for the three months ended September 30, 2016 and 2015, were $(8,411,891) and $ ($2,742,137), respectively. The increase was the result of an increase in non-cash accounts associated with the fair value of derivatives in the amount of $5,250,890, loss on commitment fees in the amount of $787,971, fair value of debt financing cost of $157,677, and foreign exchange loss of $6, with an offset by a decrease in interest expense of $211,441, which includes amortization of debt discount of $201,828.

Net Loss

Our net loss increased by $5,122,613 to $9,016,618 for the three months ended September 30, 2016, compared to a net loss of $3,894,005 for the three months ended September 30, 2015. The majority of the increase in net loss was due primarily to an increase in other income and (expenses), which consisted of non-cash accounts associated with derivatives, an increase in gross profit due to the acquisition of PWT, and a decrease in total operating expenses.  

Results of Operations for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

Revenue and Cost of Sales

For the nine months ended September 30, 2016, our revenue for the Company increased by $4,181,098 to $4,321,378 compared to $140,280 for the nine months ended September 30, 2015. Cost of sales for the nine months ended September 30, 2016, was $2,899,507 compared to $86,294 for the nine months ended September 30, 2015. Revenue and cost of sales increased primarily due to PWT’s inclusion of nine months operations.

Our gross profit increased by $1,367,885 to $1,421,871 compared to $53,986 for the nine months ended September 30, 2016 and 2015, respectively. The gross profit increased primarily due to the inclusion of PWT’s revenue.

Selling and Marketing Expenses

For the nine months ended September 30, 2016, we had selling and marketing expenses of $1,419,566, compared to $1,616,209 for the nine months ended September 30, 2015. Selling and marketing expenses decreased primarily due to overall decrease in public relations.

General and Administrative Expenses

General and administrative expenses increased to $1,860,239, for the nine months ended September 30, 2016, compared to $1,700,488 for the nine months ended September 30, 2015. General and administrative expenses increased primarily due to PWT’s inclusion of nine months operations.

Research and Development Cost

Research and development cost for the nine months ended September 30, 2016 and 2015, were $447,034 and $592,225, respectively.  The decrease in research and development costs was primarily due to the decrease in salaries of $267,668, with an overall increase in other research and development costs of $122,477.

Other Income and (Expenses)

Other income and (expenses) for the nine months ended September 30, 2016 and 2015, were $(3,389,184) and $($3,494,515), respectively. The decrease was the result of a decrease in non-cash accounts associated with the fair value of the derivatives in the amount of $267,001, decrease in gain on sale of asset of $1,552 and a decrease in interest expense of $640,325, which includes amortization of debt discount of $648,696, offset by an increase in loss on commitment fees in the amount of $736,274, fair value financing cost of $67,267 and foreign exchange loss of $6.

Net Loss

Our net loss decreased by $1,634,794 to $5,728,054 for the nine months ended September 30, 2016, compared to a net loss of $7,362,848 for the nine months ended September 30, 2015. The majority of the decrease in net income was due primarily to a decrease in total operating expenses, with an overall increase in other income and (expenses), which consisted of non-cash accounts associated with derivatives, and an increase in gross profit.

Liquidity and Capital Resources

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise operate on an ongoing basis. Significant factors in the management of liquidity are funds generated by operations, levels of accounts receivable and accounts payable and capital expenditures.

The condensed consolidated financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities and commitments in the normal course of business. The accompanying condensed consolidated financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The Company has not generated significant revenue, and has negative cash flows from operations, which raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern and appropriateness of using the going concern basis is dependent upon, among other things, additional cash infusion. We obtained funds from our shareholders during the nine months ended September 30, 2016. Management believes the existing shareholders, the prospective new investors and future sales will provide the additional cash needed to meet the Company’s obligations as they become due, and will allow the development of its core business operations. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing, or cause substantial dilution for our stockholders, in case of equity financing.

At September 30, 2016 and December 31, 2015, we had cash of $867,661 and $695,295, respectively and working capital deficit of $15,348,850 and $13,471,476, respectively.  The increase in working capital deficit was due primarily to derivative liabilities and convertible promissory notes, an increase in cash, cost in excess of billing and accrued expenses with a decrease in contracts receivable, work in process, prepaid expenses, accounts payable, billing in excess of cost, and deferred income.

During the nine months of 2016, we raised an aggregate of $125,000 in an offering of unsecured convertible notes, and $963,217 through private placements. Our ability to continue as a going concern is dependent upon raising capital from financing transactions and future revenue.

Net cash used in operating activities was $910,146 for the nine months ended September 30, 2016, compared to $2,350,071 for the prior period ended September 30, 2015. The decrease in cash used in operating activities was due to a decrease in net loss due to the acquisition of PWT.

Net cash flows used in investing activities was $5,699 for the nine months ended September 30, 2016, as compared to $45,168 for the prior period ended September 30, 2015. The net decrease in cash used in investing activities was due to less equipment purchased in the current period.

Net cash flows provided by financing activities was $1,088,217 for the nine months ended September 30, 2016, as compared to $3,135,732 for the prior period ended September 30, 2015. The decrease in cash provided by financing activities was due to a decrease in debt financing offset by an increase in equity financing. To date we have principally financed our operations through the sale of our common stock and the issuance of debt.

We do not have any material commitments for capital expenditures during the next twelve months.  Although our proceeds from the issuance of convertible debt together with revenue from operations are currently sufficient to fund our operating expenses, we will need to raise additional funds in the future so that we can expand our operations. Therefore, our future operations are dependent on our ability to secure additional financing.  Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our common stock and a downturn in the U.S. equity and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. The inability to obtain additional capital may restrict our ability to grow and may reduce our ability to continue to conduct business operations. If we are unable to obtain additional financing, we may have to curtail our marketing and development plans and possibly cease our operations.

We have estimated our current average burn, and believe that we have assets to ensure that we can function without liquidation over the next twelve months, due to our cash on hand, growing revenue, and our ability to raise money from our investor base. Based on the aforesaid, we believe we have the ability to continue our operations for the foreseeable future and will be able to realize assets and discharge liabilities in the normal course of operations.

Off-Balance Sheet Arrangements

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

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

Item 4.  Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Pursuant to Rules 13a-15(b) and 15-d-15(b) under the Securities Exchange Act of 1934, as amended ("Exchange Act"), the Company carried out an evaluation, with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer ("CEO/CFO") of the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report. The term "disclosure controls and procedures", as defined under Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

As disclosed in our annual report filing for the year ended December 31, 2015, there was a material weakness in the Company's internal control over financial reporting due to the fact that the Company had a lack of segregation of duties and failure to implement accounting controls of acquired businesses. Based upon the evaluation of the disclosure controls and procedures at the end of the period covered by this report, the Company's CEO/CFO concluded that the Company's disclosure controls and procedures were not effective due to a material weakness in the Company's internal control over financial reporting.

To address the material weaknesses, we performed additional analysis and other post-closing procedures in an effort to ensure our condensed consolidated financial statements included in this review report have been prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this quarterly report on Form 10-Q fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15f of the Exchange Act) that occurred during the first nine months of 2016 that has materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on Internal Controls

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

PART II

Item 1.  Legal Proceedings.

None.

Item 1A. Risk Factors.  

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3.  Defaults Upon Senior Securities.

None.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information.

None.

Item 6.  Exhibits.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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