QSAM Biosciences, Inc. - Quarter Report: 2016 June (Form 10-Q)

See notes to the condensed consolidated financial statements.

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Q2POWER TECHNOLOGIES, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS

Q2Power Technologies, Inc. (hereinafter the “Company”) was incorporated in Delaware on August 26, 2004. The Company is primarily a holding company for its sole subsidiary, Q2Power Corp.  Formerly, the Company’s name was Anpath Group, Inc. (“Anpath”), and prior to that, Telecomm Sales Network, Inc. 

The Company, through its subsidiary, Q2Power Corp. (the “Subsidiary” or “Q2P”), operates a renewable power company focused on the conversion of waste to energy and other valuable “reuse” products.  The operations of the Company are essentially those of the Subsidiary.  In May 2016, the Company began exploring other synergistic business lines, such as composting from waste water biosolids, although no operations in these fields have commenced.  

On November 12, 2015, the Company and its special purpose merger subsidiary completed a merger (the “Merger”) with Q2P. As a result of the Merger, all outstanding shares of Q2P were exchanged for 24,034,475 shares of the Company’s common stock, which represented an exchange ratio of 0.34 shares of the Company for every one share of Q2P (the “Exchange Ratio”).  In addition, the Company assumed both the Q2P 2014 Founders Stock Option Plan and the 2014 Employees Stock Option Plan (the “Option Plans”), and 1,095,480 options outstanding thereunder. Also pursuant to the Merger, the officers and directors of Q2P assumed control over the management and Board of Directors of the Company.  Subsequent to the Merger, the Company officially changed its name to Q2Power Technologies, Inc.

On December 1, 2015, in connection with the Merger the Company also sold its prior operating subsidiary, EnviroSystems Inc. (“ESI”), to three former shareholders in exchange for a return of 470,560 shares of the Company’s common stock. ESI assumed all debt, payables and a litigation judgment that was on its books as of the Merger date.

On February 12, 2016, the Board of Directors of Q2Power Technologies, Inc. (the “Company”) approved a change in the fiscal year end for the Company from March 31 to December 31.  This change is a result of the Merger, and reflects the fiscal year-end period for Q2P.

NOTE 2 – BASIS OF PRESENTATION AND GOING CONCERN

The unaudited condensed financial statements include all accounts of the Company.  The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to interim financial information.  Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements.  Interim results are not necessarily indicative of results for a full year.  In the opinion of management, all adjustments considered necessary for a fair presentation of the financial position and the results of operations and cash flows for the interim periods have been included.  The December 31, 2015 balance sheet information contained herein was derived from the audited consolidated financial statements as of that date included in the Annual Report on Form 10-KT filed on April 14, 2016.  The audited consolidated financial statements contained an explanatory paragraph in the Report of the Independent Registered Public Accounting Firm, regarding substantial doubt about the Company’s ability to continue as a going concern.

The Company has incurred a net loss of $795,621 for the six months ended June 30, 2016, which included a gain from the change in fair value of derivative liabilities of $696,543. The accumulated deficit since inception is $6,161,002, which is comprised of operating losses (which were paid in cash, stock for services and other equity instruments) and other expenses. The Company has a working capital deficit at June 30, 2016 of $1,971,559.  These conditions raise substantial doubt about the Company’s ability to continue as a going concern.  There is no guarantee whether the Company will be able to generate enough revenue and/or raise capital sufficient to support its operations. The ability of the Company to continue as a going concern is dependent on management’s plans which include implementation of its business model to generate revenue from power purchase agreements, product sales,

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and continuing to raise funds through debt or equity offerings. The Company will also likely continue to rely upon related-party debt or equity financing, which may not be available at the time required by the Company. 

The condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

U.S. Generally Accepted Accounting Principles (“GAAP”) requires the Company to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, the reported amounts of revenues and expenses, cash flows and the related footnote disclosures during the period. On an on-going basis, the Company reviews and evaluates its estimates and assumptions, including, but not limited to, those that relate to the realizable value of identifiable intangible assets and other long-lived assets, derivative liabilities, income taxes and contingencies. Actual results could differ from these estimates.

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its Subsidiary. All significant inter-company transactions and balances have been eliminated in consolidation. References herein to the Company include the Company and its subsidiary, unless the context otherwise requires.

Cash

The Company considers all unrestricted cash, short-term deposits, and other investments with original maturities of no more than ninety days when acquired to be cash and cash equivalents for the purposes of the statement of cash flows.  The Company maintains cash balances at two financial institutions, and has experienced no losses with respect to amounts on deposit.

At June 30, 2016 and December 31, 2015, cash held in banks totaled $3,342 and $1,012, respectively.

Revenue Recognition

Revenue is recognized at the date of shipment of engines and systems, engine prototypes, engine designs or other deliverables to customers when a formal arrangement exists, the price is fixed or determinable, the delivery or milestone deliverable is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as deferred revenue. The Company will not allow its customers to return prototype products.

For the three and six months ended June 30, 2016, the Company recognized revenue of $0 and $40,000, respectively.  The $40,000 was related to the first achieved milestone and delivery under a technology sales agreement.  The Company also received an additional $50,000 upon signing of that agreement, which is accounted for as deferred revenue that will be recognized upon contract completion.  

Research and Development

Research and development activities for product development are expensed as incurred. Costs for the three months ended June 30, 2016 and 2015 were $122,300 and $361,936, respectively.  Costs for the six months ended June 30, 2016 and 2015 were $309,429 and $684,391, respectively.

Stock Based Compensation

The Company applies the fair value method of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718, “Share Based Payment”, in accounting for its stock based compensation. This standard states that compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. The Company values stock

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based compensation at the market price for the Company’s common stock and other pertinent factors at the grant date.

The Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on the fair value of the equity instruments exchanged, in accordance with ASC 505-50, “Equity Based payments to Non-employees”. The Company measures the fair value of the equity instruments issued based on the market price of the Company’s stock at the time services or goods are provided.

Common Stock Options

The Black-Scholes option pricing valuation method is used to determine fair value of these options consistent with ASC 718, “Share Based Payment”. Use of this method requires that the Company make assumptions regarding stock volatility, dividend yields, expected term of the awards and risk-free interest rates.

Derivatives

Derivatives are recognized initially at fair value. Subsequent to initial recognition, derivatives are measured at fair value, and changes are therein generally recognized in profit or loss.

Software, Property and Equipment

Software, property and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives of the assets as follows:

Expenditures for maintenance and repairs are charged to operations as incurred.

Impairment of Long Lived Assets

The Company continually evaluates the carrying value of intangible assets and other long lived assets to determine whether there are any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company has not recognized any impairment charges.

Income Taxes

Income taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “Income Taxes” (“ASC 740”).  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets 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. Under ASC 740, the effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation allowance is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.  

In the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of June 30, 2016, the Company does not

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believe it has any uncertain tax positions that would result in the Company having a liability to the taxing authorities. Interest and penalties related to the unrecognized tax benefits is recognized in the condensed consolidated financial statements as a component of income taxes.

Basic and Diluted Loss Per Share

On July 22, 2015, the previous Board of Directors authorized that the Company effectuate a reverse split of its issued and outstanding Common Stock in the ratio of one (1) post-split share of Common Stock for every seven (7) shares of pre-split Common Stock, while retaining the current par value of $0.0001 per share, with appropriate adjustments being made in the additional paid-in capital and stated capital accounts of the Company, with all fractional shares that would otherwise result from such reverse split being rounded up to the nearest whole share. The reverse stock split has been retroactively adjusted throughout the condensed consolidated financial statements.

Net loss per share is computed by dividing the net loss less preferred dividends by the weighted average number of common shares outstanding during the period. Diluted net loss per share is calculated by dividing the net loss less preferred dividends by the weighted average number of common shares outstanding during the period plus any potentially dilutive shares related to the issuance of stock options, shares issued from the conversion of convertible preferred stock and shares issued for the issuance of convertible debt. There were no potentially dilutive shares as of June 30, 2016 and 2015.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update (“ASU”), No. 2014-09, “Revenue from Contracts with Customers”, to replace the existing revenue recognition criteria for contracts with customers and to establish the disclosure requirements for revenue from contracts with customers. The ASU is effective for interim and annual periods beginning after December 15, 2017. Adoption of the ASU is either retrospective to each prior period presented or retrospective with a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. The Company is currently assessing the future impact of the ASU on its financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation—Stock Compensation (Topic 718)” or ASU 2014-12. ASU 2014-12 requires that a performance target that affects vesting and could be achieved after the requisite service period be treated as a performance condition. The amendments in ASU 2014-12 were effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. The Company adopted this ASU effective January 1, 2016.  The adoption of this ASU did not have a material impact to the Company’s financial position, results of operations or cash flows.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements – Going Concern”, to provide guidance within GAAP requiring management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and requiring related disclosures. The ASU is effective for annual periods ending after December 15, 2016. The Company is currently assessing the impact of the ASU on its financial statements.

In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”, or ASU 2015-03. ASU 2015-03 amends current presentation guidance by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. We adopted the provisions of ASU 2015-03 effective January 1, 2016.  The adoption of ASU 2015-03 did not have a material impact our consolidated financial position, results of operations or cash flows.

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Assets”, requiring management to provide a classification of all deferred taxes as noncurrent assets or noncurrent liabilities. This ASU is effective for annual periods beginning after December 15, 2016.  The Company does not anticipate this ASU will have a material impact to the Company’s financial position, results of operations or cash flows.

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”, requiring management to address certain aspects of recognition, measurement,

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presentation, and disclosure of financial instruments.  This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The Company is currently assessing the impact of the ASU on its financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842) (the Update)”, requiring management to recognize any right-to-use-asset and lease liability on the statement of financial position for those leases previously classified as operating leases.  The criteria used to determine such classification is essentially the same as under the previous guidance, but it is more subjective. The lessee would classify the lease as a finance lease if certain criteria at lease commencement are met.  This ASU is effective for fiscal years beginning after December 15, 2018.  The Company is currently assessing the impact of the ASU on its financial statements.

In March 2016, the FASB issued ASU 2016-06, “Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (a consensus of the FASB Emerging Issues Task Force)”, which applies 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, and requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One criterion is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract.  This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the impact of the ASU on its financial statements.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which amends ASC Topic 718, “Compensation – Stock Compensation.”  The ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax effects of share-based payments and accounting for forfeitures.   This ASU is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period.  The Company is currently assessing the impact of the ASU on its financial statements.

In April 2016, the FASB issued ASU No. 2016-10: “Identifying Performance Obligations and Licensing”, which amends certain aspects of the guidance set forth in the FASB’s new revenue standard related to identifying performance obligations and licensing implementation. The effective date is the same as ASU No. 2014-09 for interim and annual periods beginning after December 15, 2017.  We are currently in the process of evaluating the future impact of adoption of these updates on our consolidated financial statements.

In May 2016, the FASB issued ASU No. 2016-12: Revenue from Contracts with Customer (Topic 606), Narrow-Scope Improvements and Practical Expedients”, which amends certain aspects of the guidance set forth in the FASB’s Topic 606. The ASU is effective for interim and annual periods beginning after December 15, 2017. Adoption of the ASU is either retrospective to each prior period presented or retrospective with a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. The Company is currently assessing the future impact of the ASU on its financial statements.

Concentration of Risk

The Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash and accounts receivable to be the two assets most likely to subject the Company to concentrations of credit risk. The Company’s policy is to maintain its cash with high credit quality financial institutions to limit its risk of loss exposure.

The Company maintains cash accounts in two quality financial institutions. The Company has not experienced any losses in its bank accounts through June 30, 2016.

The Company purchases much of its machined parts through Precision CNC, a related party company that sublet office space to Q2P through June 27, 2016 and owns a non-controlling interest in the Company.   Should Precision CNC no longer be able to provide such manufacturing services to the Company, it may prove difficult to

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find a suitable replacement in a timely and affordable manner, thus, the loss of this supplier could have a materially adverse impact on the Company’s operations and financial position. For the three month periods ended June 30, 2016 and 2015 the amounts paid to Precision CNC totaled $5,000 and $96,676, respectively, and for the six months ended June 30, 2016 and 2015, amounts paid totaled $13,868 and $194,434. Such amounts consisted of rent and research and development expenses for machined parts.

NOTE 4 – SOFTWARE, PROPERTY AND EQUIPMENT, NET

Software, property and equipment, net consists of the following:

At December 31, 2015, the Company had software under capital leases with gross value of $24,671, net of accumulated depreciation and amortization of $15,419.  The software was included in the disposal discussed below, however, the Company must continue to pay all outstanding amounts under the capital leases, a balance of $5,855 as of June 30, 2016.

Depreciation and amortization expense for the three months ended June 30, 2016 and 2015 was $13,267 and $5,129, respectively, and for the six months ended June 30, 2016 and 2015 was $26,533 and $7,166, respectively.

The Company disposed of $70,495 of net software, property and equipment during the six months ended June 30, 2016 (see Note 6).

NOTE 5 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE

In 2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone Power Technologies’ (“Cyclone”) patented technology on a worldwide, exclusive basis for 20 years with two 10-year renewal terms for Q2P’s waste heat and waste-to-power business.   This agreement contains a royalty provision equal to 5% of gross sales payable to Cyclone on sales of engines derived from technology licensed from Cyclone. Also, as part of a separation agreement with Cyclone, Q2P assumed a license agreement between Cyclone and Phoenix Power Group, which included deferred revenue of $250,000 from payments previously made to Cyclone for undelivered products.  The net balances as of June 30, 2016 and December 31, 2015 for the Cyclone licensing rights were $91,146 and $113,021, respectively, and the net balances as of June 30, 2016 and December 31, 2015 for the Phoenix deferred revenue were $250,000 and $250,000, respectively, which are included as a component of deferred revenue on the condensed consolidated balance sheets.  Under the terms of the revised agreement with Phoenix Power Group, revenue associated with these deferrals will be recognized subject to the achievement of certain milestones, as follows:  (1) on the completion of certain performance testing of the engine, deferred revenue of $150,000 will be recognized; and (2) on the delivery of the first 10 “Generation 1 Engines”, other deferred revenue will be recognized at a rate of $10,000 per delivered engine.

In connection with the separation agreement with Cyclone, the Company also assumed a contract with Clean Carbon of Australia and a corresponding $10,064 prepayment for services or other value to be provided in the future.  This deposit has been presented as deferred revenue on the June 30, 2016 and December 31, 2015 condensed consolidated balance sheets.

The licensing rights are amortized over its estimated useful life of 4 years. Amortization expense for the three months ended June 30, 2016 and 2015 was $10,938 and $10,938 respectively.

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On April 8, 2016, the Company and Cyclone resolved a dispute regarding a 2014 Stock Purchase Agreement, whereby the parties agreed to terminate that agreement and all amounts owed by either party to the other, including a release of all claims, and Cyclone retained 212,500 shares of common stock of the Company and the Company has no obligation to buy these shares.  The Company paid a consultant 100,000 shares of restricted common stock valued at $26,000 in connection with the negotiation and signing of that agreement.

NOTE 6 – RELATED PARTY TRANSACTIONS

Expenses prepaid with common stock at June 30, 2016 and December 31, 2015 totaled $108,333 and $135,321, respectively.  The balance at June 30, 2016 relates to stock issued to Greenblock Capital (“GBC”) for future services with a remaining amount of $108,333.  The balance at December 31, 2015 relates to stock issued to GBC for future services with a remaining amount of $119,167, and shares purchased by the CEO and paid for through salary deductions with a remaining amount of $16,154.

The Company previously sublet approximately 2,500 square feet of assembly, warehouse and office space within the Precision CNC facility located at 1858 Cedar Hill Road in Lancaster, Ohio.  The sublease provided for the Company to pay rent monthly in the amount of $2,500, which covered space and some utilities.  Occupancy costs for the quarter ended June 30, 2016 and 2015 were $7,500 and $7,500, respectively, and for the six months ended June 30, 2016 and 2015 were $15,000 and $15,000, respectively.  The sublease has been terminated as of June 27, 2016, but may be reinstated at any time by the mutual agreement of the parties, and the Company is still able to use that facility in the short-term rent free.  The Company also purchases much of its machined parts through Precision CNC.  Precision CNC owns a non-controlling interest in the Company. The Company also maintains an executive office in Florida, which is leased by GBC. The Company has no formal agreement for this space.

For the three months ended June 30, 2016 and 2015, the amounts invoiced from Precision CNC totaled $11,560 and $51,134, respectively, and for the six months ended June 30, 2016 and 2015, the amounts invoiced totaled $32,119 and $84,243, respectively.  These amounts consisted of rent and research and development expenses for machined parts. On June 27, 2016, the Company and Precision CNC entered into an agreement to eliminate $49,299 in payables owed to Precision CNC in return for the transfer of certain net assets of the Company with a remaining book value of $70,495, which included office furniture, software and computer systems, and 50,000 shares of restricted common stock valued at $10,500.  The Company recorded a loss on this transaction in the amount of $31,696. Accounts payable and accrued expenses at June 30, 2016 and December 31, 2015 include $0 and $31,048, respectively, to Precision CNC.

In connection with the Merger, GBC received 1,000,000 shares of unregistered common stock for consulting services to be rendered in the amount of $260,000. The Company’s (Anpath’s) former director, Christopher J. Spencer, owns a majority interest in GBC, and our CEO is a Managing Director of GBC, although he has no equity or voting rights in GBC.

On January 8, 2016, a member of the Board of Directors made an advance to the Company totaling $10,500 with a 6% per annum rate, payable on demand.  As of the date of this filing, such advance is still outstanding.

On April 29, 2016, the Company’s three independent Directors loaned to the Company a total of $60,200 pursuant to three Convertible Notes which are automatically convertible into the equity securities issued in the Company’s next financing of at least $1,000,000 at the same price and same terms.  The Convertible Notes bear 8% interest and have a 10% Original Issuance Discount.  The total principal amount of all three Notes was $66,000. The Notes mature in six months, and can be converted to common stock at $0.26 per share if a qualified financing event has not occurred by such time.  On June 13, 2016, one of the Company’s independent directors loaned another $15,000 to the Company on the same terms, with a principal amount of $16,667.

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NOTE 7 – NOTES PAYABLE AND DEBENTURES

On September 23, 2015, the Company entered into a Modification and Extension Agreement to modify the terms of the debentures to extend the maturity date of the debentures to July 31, 2016, and reset the conversion price of the debentures to $0.21. Pursuant to the Merger, the debentures and warrants remained an outstanding obligation of the Company, thus were assumed by Q2P.  The Company and the holders are currently negotiating an additional term extension to the debentures.

In January 2016, another accredited investor purchased $105,000 in outstanding principal amount of the convertible debentures from the current holder.  The Company did not receive any consideration in this transaction as it was a transfer amongst the holders of the convertible debentures.

During the six months ended June 30, 2016, aggregate principal of $103,000 was converted to 490,476 shares of common stock (see Note 9).

On March 15, 2016, the Company entered into a 120-day term loan agreement with one accredited investor in the principal amount of $150,000.  The loan bears 20% interest with interest payments due monthly. The Company incurred loan issuance costs of 100,000 shares of common stock valued at $26,000, $3,000 cash and provided second security interest in the assets of the Company to the holders.  Issuance costs expensed in the three months and six months ended June 30, 2016 were $3,595 and $21,810, respectively, with a balance of $3,585 to be amortized to interest expense over the remaining term of the loan.  At June 30, 2016, the loan balance net of unamortized debt issuance costs was $146,415 and accrued interest related to the loan was $1,250.  This loan matured on July 15, 2016, and the Company is currently in default thereunder.  A 10% late penalty has been assessed, and the Company is currently in negotiations with the lender to amend the terms of its loan to extend the maturity term and correct the default.

In May 2016, three investors loaned to the Company a total of $26,709 pursuant to three Convertible Notes, which are automatically convertible into the equity securities issued in the Company’s next financing of at least $1,000,000 at the same price and same terms.  The Convertible Notes bear 8% interest and have a 10% Original Issuance Discount.  The total principal amount of all three Notes was $33,000. The Notes mature in six months, and can be converted to common stock at $0.26 per share if a qualified financing event has not occurred by such time.

NOTE 8 – FAIR VALUE MEASUREMENT AND DERIVATIVES

The Company measures fair value in accordance with a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

NOTE 10 – STOCK OPTIONS AND RESTRICTED STOCK UNITS

On July 31, 2014, the Board of Directors of Q2P approved the Founders Stock Option Plan (“Founders Plan") and the 2014 Employee Stock Option Plan (the “2014 Plan”), collectively the “Option Plans”. The Option Plans were developed to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted incentive or non-qualified stock options to purchase restricted common stock of the Company. On February 25, 2016, to accommodate the appointment of new Board members and additional incentive stock options and stock grants to key employees of the Company, the Board approved the 2016 Omnibus Equity Incentive Plan (“2016 Plan”), which allowed for an additional 4 million shares of common stock, stock options, stock rights (restricted stock units), or stock appreciation rights to be granted by the Board in its discretion.

In recognition of and compensation for services rendered by employees for the six months ended June 30, 2016, the Company issued 710,000 common stock options under the Founders Plan on February 25, 2016, 350,000 of which contained vesting provisions that provide for vesting in full on August 25, 2016, 150,000 of which contain provisions for immediate vesting of 50,000 and 100,000 and fully vest on August 25, 2016, and 210,000 of which contain semi-annual vesting provisions over the next year.  One option grant of 40,000 shares to an employee was cancelled due to termination of employment.

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In recognition of and compensation for services rendered by the Company’s Board Chairman, the Company issued 400,000 common stock options under the 2014 Plan on February 25, 2016, which contained vesting provisions that provide for immediate vesting of 200,000, and 200,000 on August 25, 2016.

In recognition of and compensation for services rendered by employees and members of the Company’s board of directors, the Company issued 2,200,000 common stock options, 450,000 restricted stock units and 450,000 shares of common stock under the 2016 Plan. On February 25, 2016, the Company issued 1,800,000 common stock options to the Company’s Board Chairman, which contain provisions for vesting upon the achievement of specific milestones.  As of June 30, 2016, 150,000 had vested upon one milestone achievement.  The 450,000 restricted stock units were issued on February 25, 2016 and provide for vesting in full on February 21, 2017, and the 450,000 shares of common stock were issued on February 25, 2015 and provide for immediate vesting.  On March 21, 2016, the Company issued 400,000 common stock options to a member of the board of directors, which provides for immediate vesting of 200,000 shares and 200,000 shares vest on September 21, 2016.

In June 2016, the Company issued 150,000 common stock options under the 2016 Plan to one new Board of Advisor Member. The options vest one-half in six months and the balance in 12 months, with a 10-year term and exercisable at a price of $0.30 per share.  The options were valued at $15,300 (pursuant to the Black Scholes valuation model, and as shown in the table detailing the calculation of fair value below), based on an exercise price of $0.30 per share and with a maturity life of 3.5 years.

Options awarded under the Option Plans and the 2016 Plan for the six months ended June 30, 2016 were valued at $378,300 (pursuant to the Black Scholes valuation model, and as shown in the table detailing the calculation of fair value below), based on a weighted average exercise price of $0.48 per share and with a maturity life of 3.5 years.

For the six months ended June 30, 2016, the charge to the consolidated statement of operations for the amortization of stock option grants awarded under the Option Plans and the 2016 Plan was $260,080. On May 27, 2016, the majority of the employees of the Subsidiary were terminated in an effort to reduce expenses, and were allowed to retain their options, which were immediately vested.  The expense related to the outstanding options previously granted to these terminated employees was recognized in full in this period as they were no longer subject to a service requirement with respect to vesting of the award.

A summary of the common stock options issued under the Option Plans and the 2016 Plan for the period from December 31, 2015 through June 30, 2016 follows:

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The vested and exercisable options at period end follows:

The fair value of new stock options granted using the Black-Scholes option pricing model was calculated using the following assumptions:

Expected volatility is based on historical volatility of two securities which the Company believes best match the characteristics of the Company for purposes of measuring volatility in the absence of a market trading history of the Company’s common stock. Short Term U.S. Treasury rates were utilized as the risk free interest rate. The expected term of the options was calculated using the alternative simplified method codified as ASC 718 “Accounting for Stock Based Compensation,” which defined the expected life as the average of the contractual term of the options and the weighted average vesting period for all issuances.

NOTE 11 – COMMITMENTS AND CONTINGENCIES

The Company has employment agreements with Christopher Nelson, CEO and Sudheer Pimputkar, CTO (collectively, the “Executives”).

Christopher Nelson’s agreement provides for a term of three (3) years from its Effective Date (July 31, 2014), with automatically renewing successive one-year periods starting on the end of the third anniversary of the Effective Date.  If the Executive is terminated “without cause” or pursuant to a “change in control” of the Company, as both defined in the respective agreements, the Executive shall be entitled to (i) any unpaid Base Salary accrued through the effective date of termination, (ii) the Executive’s Base Salary at the rate prevailing at such termination through 24 months from the date of termination or the end of his Term then in effect, whichever is longer, and (iii) all of the Executive’s stock options shall vest immediately.

On June 2, 2015, in connection with the Right Offering, the Company’s CEO agreed to an amendment to his employment agreement reducing his base salary from $180,000 per year to $138,000, and cancelled $28,000 in debt owed to him by the Company.  Also concurrently with the closing of the Rights Offering, our CEO satisfied a promissory note he owed to the Company in the amount of $99,900 created in connection with the 2014 exercise of his warrants, which were issued in 2010 related to his services previously rendered, by returning to the Company 370,000 shares of common stock.  The Company forgave $5,250 in accrued interest.  All other provisions detailed in the July 31, 2014 employment agreement remain unchanged.

Sudheer Pimputkar has an employment agreement providing $170,000 per year base salary for a term of one (1) year from its Effective Date (April 1, 2015), with automatically renewing successive one year periods starting on the end of the first anniversary of the Effective Date.  If the Executive is terminated “without cause” or pursuant to a “change in control” of the Company, as both defined in the respective agreements, the Executive shall be entitled to (i) any unpaid Base Salary accrued through the effective date of termination, (ii) the Executive’s Base Salary at the rate prevailing at such termination through 2 months from the date of termination or the end of his Term then in effect, whichever is longer, and (iii) all of the Executive’s stock options shall vest immediately.

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In June 2015, the Company implemented a compensation package for a director who also serves as SEC counsel of $4,000 per quarter and 250,000 stock options per year vesting quarterly with a 10-year term and exercisable at $0.27 per share.  These stock options converted as part of the Merger to 84,000 shares, which were vested in full at the date of the Merger, and are exercisable at $0.30 per share.  For the three months and six months ended June 30, 2016, the charge to the consolidated statement of operations was $4,000 and $8,000 respectively. The Director’s grant of 250,000 options for 2016 is effective as of July 1, 2016.

NOTE 12 - SUBSEQUENT EVENTS

On July 11, 2016, one of the Company’s debenture holders converted $27,250 of its debenture for 129,762 shares of common stock. The same debenture holder converted the following amounts as of the dates provided: on July 14, $30,500 for 145,238 shares of common stock; on July 19, $30,500 for 145,238 shares of common stock; on July 26, $10,500 for 50,000 shares of common stock; and on August 16, $49,000 for 233,333 shares of common stock.  On July 26, 2016, a second debenture holder converted $20,000 of its debenture for 95,238 shares of common stock.  

In July and August  2016, the Company received subscription agreements from six accredited investors (four of whom were previous shareholders) to purchase 750,000 shares of restricted common at a price of $.21 per share for an aggregate of $157,500, less $610 in financing costs.  

Due to this issuance of common stock at $.21, the Company’s Convertible Preferred Stock was repriced to $.21 per share. Holders of the Company’s warrants issued in connection with convertible debentures have agreed to reduce the exercise price of 415,000 of such warrants from $2.35 to $.50, which also required the number of shares into which those warrants are exercisable to increase to 2,033,500 shares.  The holders agreed to maintain the exercise price of $.50 for 1,153,845 warrants issued in connection with the Company’s Preferred Stock. As part of this agreement, the debenture holders also agreed to extend the maturity date of the Company’s debentures to July 31, 2017, for an aggregate fee of 150,000 common shares.     

On August 12, 2016, the Company, ERTH Products LLC and Exceptional Products Inc. (the “ERTH Companies”), entered into a binding letter of intent (the “LOI”) contemplating the acquisition of the ERTH Companies by the Company.  The ERTH Companies, based in Georgia, manufacture agricultural compost and engineered soils for the construction industry from waste water biosolids.  Under the LOI, the ERTH Companies have agreed to a 90 day exclusivity period, for a nominal amount of funds, to negotiate the terms of this acquisition, which 90-day period may be extended for an additional 275 days in return for a deposit equal to approximately 5% of the presumed purchase price for the ERTH Companies.  The LOI also contemplates adding Wayne King Sr., the founder of the ERTH Companies, to the Company’s Board of Advisors.

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ITEM 2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND PLAN OF OPERATIONS

Overview

The following discussion contains forward-looking statements that reflect the Company’s plans, estimates and beliefs, and actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Current Report.

The Company’s operating subsidiary, Q2P was originally formed by Cyclone Power Technologies Inc. (“Cyclone”) in April 2010 in the state of Florida as a limited liability company called “Cyclone-WHE LLC.” The purpose of the Company at such time was essentially the same as it is today: to pursue waste-to-power and waste heat recovery business opportunities on a global basis.  Since May 2016, the Company has also begun to pursue other lines of business, such as composting from waste water biosolids, and has limited some of its previous R&D operations. The Company re-domiciled to Delaware as a corporation in April 2014, formally split from Cyclone in July 2014 pursuant to a Separation Agreement, and changed its name to “Q2Power Corp.” in February 2015.  It is licensed to do business in Florida and Ohio, where it maintains offices.  

On November 12, 2015, Q2P consummated its Agreement and Plan of Merger (the “Merger Agreement”) with the Company (then called Anpath Group, Inc.) and the Company’s newly formed and wholly-owned subsidiary, AnPath Acquisition Sub, Inc., a Delaware corporation (“Merger Subsidiary”), resulting in the Merger Subsidiary merging with and into Q2P.  As a result, Q2P was the surviving company and a wholly-owned subsidiary of AnPath (the “Merger”).  

As a result of the Merger, all outstanding shares of Q2P were exchanged for 24,034,475 shares of the Company’s common stock, representing approximately 93% of the total issued and outstanding common stock of the Company, excluding stock options, warrants and convertible notes outstanding at such time.  In addition, the Company assumed both the Q2P 2014 Founders Stock Option Plan and the 2014 Employees Stock Option Plan (the “Option Plans”), and 1,095,480 options outstanding thereunder.  Also pursuant to the Merger, the officers and directors of Q2P took over the management and Board of Directors of the Company.  

In connection with the Merger, the Company sold the former operating entity of Anpath, ESI, to three former officers and shareholders of Anpath in exchange for the return of 470,560 shares of common stock of the Company and ESI retaining all of the old liabilities of ESI including a litigation judgment.

In December 2015, the Company officially changed its name to Q2Power Technologies, Inc. to reflect the new business direction of the Company – that of Q2P – after the Merger.  In February 2016, the Company changed its fiscal year end from March 31 to December 31 to reflect the year-end of its operating Subsidiary, and up-listed its common stock to the OTCQB.  The financial statements and footnotes to the financial statements reflect this change of fiscal year end.

A.

Plan of Operation

In the second quarter of 2016, the Company announced that it had taken several important steps to expand its business model into the commercial composting and sustainable soils sector.  This included starting an alliance with a leading company in this space based in Georgia, and adding a key advisor with over 40 years of experience in this industry to our team.  Two of the Company’s independent Directors also have significant experience and contacts in waste water, biosolids, waste management and other areas that are synergistic and overlapping with composting.  

On August 12, 2016, the Company, ERTH Products LLC and Exceptional Products Inc. (the “ERTH Companies”), entered into a binding letter of intent (the “LOI”) contemplating the acquisition of the ERTH Companies by the Company.  The ERTH Companies, based in Georgia, manufacture agricultural compost and engineered soils for the construction industry from waste water biosolids.  Under the LOI, the ERTH Companies have agreed to a 90 day exclusivity period to negotiate the terms of this acquisition, which 90-day period may be

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extended for an additional 275 days in return for a deposit equal to approximately 5% of the presumed purchase price for the ERTH Companies.  The LOI also contemplates adding Wayne King Sr., the founder of the ERTH Companies, to the Company’s Board of Advisors.  During the second half of 2016, the Company expects to advance these plans by completing this acquisition, and possibly acquiring other established businesses in this sector.  

The Company’s strategy in composting and sustainable soils is supported by a Research & Markets report published May 2016 stating that the global market for these products -  specifically engineered soils, of which composting is a major component -- is projected to reach $7.8 billion by 2021, at a CAGR of 6.7% from 2016 to 2021. The growth of this market is being driven by soil productivity, water conservation and pollution concerns in the United States and worldwide. According to these and other reports, 99 million acres (28% of all cropland) in the U.S. are eroding above soil tolerance rates, meaning the long-term productivity of the soil cannot be maintained and new soil is not adequately replacing the lost soil.  This erosion reduces the ability of the soil to support plant growth and hold water, adding significant pressure on this critical depleting resource. Further, soils produced with compost are being used with more frequency in construction, infrastructure and land reclamation projects to reduce costs, accelerate permitting, and create more sustainable landscapes. Management sees an opportunity in the composting and engineered soils markets to build a strong, cash flowing company, while doing good for the environment.     

In connection with these new plans, the Company has also taken steps to reduce its R&D overhead in the second quarter, including scaling back a large portion of its engineering and technical personnel in order to dedicate more resources to pursuing partnerships and acquisitions in the compost industry.  Management anticipates that this plan will get the Company to consistent revenue and profitability quicker, and increase shareholder value over the short and long term.

Management continues to believe that the Company’s engine and power system technology is viable as a commercial product, targeted to many of the same customers that the Company plans to work with in the composting business.  These include waste water treatment plants that produce methane, and can benefit from the conversion of that otherwise flared fuel to electricity and process heat.  The IP that the Company has licensed and developed over the last two years is a valuable asset which we intend on maintaining and protecting moving forward.  For the short term, however, the cost of fully commercializing this technology places great strains on the Company’s limited resources, and raising funding to support these R&D activities will, in management’s opinion, be dilutive to shareholders. We intend on completing current projects for our customers, and will continue to seek strategic partnerships and alternative plans for these products in the interest of monetizing our technology over the long term.         

During the next 12 months, we expect to spend approximately $1.0 million on operations, reduced from $2.0 to $2.5 million with respect to operations to support an R&D project. We will need to raise additional funds to operate at full capacity and on schedule with these plans. Our average monthly burn-rate is currently about $50,000 per month, which has been reduced by management from about $15,000 per month in the first half of 2016. However, we estimate that this will increase again in 2017 as we ramp-up partnerships and acquisitions in the compost sector, including the hiring of new operational and sales personnel.  Funds to cover operational short-falls over the following 12 months may be raised through the issuance of equity securities and/or debt funding.  Management is actively pursuing such financing, however, there can be no assurance that financing will be available when required in sufficient amounts, on acceptable terms, or at all.

B.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Change in Fiscal Year and Financial Statement Presentation.

On February 12, 2016, the Board of Directors approved a change in the fiscal year end for the Company from March 31 to December 31.  This change is a result of the Merger, and reflects the fiscal year end period for Q2P, the operating Subsidiary.  The Company’s financial statements further reflect the operations of Q2P in 2015 up until the date of the Merger, November 12, 2015, and thereafter, the combined operations of Q2P and the public Company.  

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Statement of Operations for the three months ended June 30, 2016 vs. 2015

During the quarters ended June 30, 2016 and 2015, the Company recorded no revenues.

The Company recorded loss from operations of $715,082 in the quarter ended June 30, 2016, a decrease of $349,767 (33%) from our loss from operations of $1,064,849 in the same period in 2015.  Additionally, the Company realized additional expenses including interest expenses and loss from disposal of assets, which were offset by a gain on derivative liability that resulted in net income of $411,166 for the three months ended June 30, 2016, an increase of $1,478,498 (139%) from our net loss of $1,067,332 for the three months ended June 30, 2015.  Some of the principal factors behind these results included, higher payroll in 2016, offset by lower professional fees and R&D expenses in 2016.  The difference between loss from operations and total gain for the quarter ended June 30, 2016, was primarily due to a $1,229,377 gain on derivative liabilities (a non-cash item) and interest expense in the same period of $71,433.

As noted above, included in the expenses for the quarter ended June 30, 2016 and 2015 were the following material items:  Payroll increased to $226,181 in 2016 from $195,021 in the prior year (16%), which was principally due to the addition of more technical staff and management in 2016.  Professional fees decreased to $294,820, from $428,878 in the prior year period (31%) due primarily to the hiring of contract professionals, and research and development decreased to $122,300 in 2016 from $361,936 in the previous year period (66%) primarily due to constriction of funds.  

Statement of Operations for the six months ended June 30, 2016 vs. 2015

During the six months ended June 30, 2016 and 2015, the Company recorded $40,000 and $-0- in revenue, respectively.

The Company recorded loss from operations of $1,328,215 in the six months ended June 30, 2016, a decrease of $612,475 (32%) from our loss from operations of $1,940,690 in the same period in 2015.  Additionally, the Company realized additional expenses including interest expenses and loss from disposal of assets, which were offset by a gain on derivative liability that resulted in a net loss of $795,621 for the six months ended June 30, 2016, a decrease of $1,148,107 (59%) from our net loss of $1,943,728 for the six months ended June 30, 2015.  Some of the principal factors behind these results included, higher payroll in 2016, offset by lower professional fees and R&D expenses, and further offset by $40,000 in revenue in 2016.  The difference between loss from operations and total gain for the six months ended June 30, 2016, was primarily due to a $676,543 gain on derivative liabilities (a non-cash item) and interest expense in the same period of $112,253.

As noted above, included in the expenses for the six months ended June 30, 2016 and 2015 were the following material items:  Payroll increased to $442,167 in 2016 from $302,678 in the prior year (45%), which was principally due to the addition of more technical staff and management in 2016.  Professional fees decreased to $516,054, from $791,669 in the prior year period (35%) due primarily to the hiring of contract professionals, and research and development decreased to $309,429 in 2016 from $684,391 in the previous year period (55%) primarily due to constriction of funds.  

Balance Sheet

Material changes in the Company’s balance sheet at June 30, 2016 over December 31, 2015 included: an increase of $180,389 in accounts payable and accrued expenses; the addition of a $150,000 term note (offset by $29,000 of debt issuance costs), $90,000 of notes payable from two board members and four investors, and another $10,500 note from the Company’s director, plus accrued interest; a decrease of $723,479 in derivative liabilities as a result of $103,000 worth of convertible debentures converted to common stock and an decrease in valuation from December 31, 2015; a decrease of $70,495 in software, property and equipment related to the transfer of those assets to Precision CNC in settlement of accounts payable; and an increase of $50,000 in deferred revenue from a technology sales contract.  Total liabilities as of June 30, 2016 were $1,983,814, as compared to $2,465,292 as of the end of 2015.  

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Primarily as a result of the $795,621 net loss for the six months ended June 30, 2016, accumulated deficit was $6,161,002 at June 30, 2016, resulting in total stockholders’ deficit at the period end of $2,298,951.

Cash Flow

The net loss for the six months ended June 30, 2016, of $795,621 was off-set by non-cash operating expenses of: $289,154 in stock issued for services and related amortization expense, $305,408 in stock options and restricted stock units issued to employees, $676,543 in derivative liability gains, $48,408 of depreciation and amortization, and $283,320 increase in accounts payable and accrued expenses.  As a result, net cash used in operating activities amounted to $349,195 in the first six months of 2016.

On January 11, 2016, the Company issued 100 shares of Preferred Stock to an accredited investor (the “Preferred Stock”) for $100,000.  The Preferred Stock is convertible at $0.26 per share of the Company’s common stock (the “Conversion Price”). The Preferred Stock bears a 6% dividend per annum, calculable and payable per quarter in cash or additional shares of common stock as determined in the Certificate of Designation. The Preferred Stock has no voting rights until converted to common stock, and has a liquidation preference equal to the Purchase Price.

On March 15, 2016, the Company entered into a 120-day term loan agreement with one accredited investor in the principal amount of $150,000.  The loan bears 20% interest with interest payments due monthly. The holders received loan issuance costs of a 100,000 share equity kicker valued at $26,000, $3,000 cash and a second security interest in the assets of the Company.  

On April 29, 2016, the Company’s three independent Directors loaned to the Company a total of $60,200 pursuant to three Convertible Notes which are automatically convertible into the equity securities issued in the Company’s next financing of at least $1,000,000 at the same price and same terms.  The Convertible Notes bear 8% interest and have a 10% Original Issuance Discount.  The total principal amount of all three Notes was $66,000. The Notes mature in six months, and can be converted to common stock at $0.26 per share if a qualified financing event has not occurred by such time.   In June 2016, three other shareholders of the Company provided an additional $30,000 to the Company on the same loan terms.  

In July and August  2016, the Company received subscription agreements from six accredited investors (four of whom were previous shareholders) to purchase 750,000 shares of restricted common at a price of $.21 per share for an aggregate of $157,500, less $610 in financing costs.  

Financial Condition, Liquidity and Capital Resources

The Company’s limited funds raise substantial doubt about the Company’s ability to operate as a going concern. See “Note 2 – Basis of Presentation and Going Concern” in the Company’s condensed consolidated financial statements.  

Since July 2014, the Company through Q2P has primarily devoted its efforts to commercializing the Q2P engine and CHP system, developing its business model and recruiting executive management and key employees.   As a new entity, the Company has limited current business operations and nominal assets. The Company currently operates at a loss with minimal revenue. Since the change in business direction to focus on strategic partnerships and acquisitions in the compost space, the Company has reduced its operating expenses from approximately $150,000 per month to approximately $50,000 per month by laying-off some employees and restricting our R&D budget.  Currently, we have two employees on payroll and four more as consultants, two of whom are continuing engine development efforts and two others in administration. Other expenses include legal and accounting, marketing, and other general expenses. We have also used equity, including common stock and stock options, to pay some expenses over the last year; and we reduced approximately $50,000 in payables through the transfer of some furniture, equipment and other assets to an affiliated vendor. Our monthly burn is expected to increase as our plan for growth in the composting sector starts to materialize, and initial acquisitions are in process.

Since July 2014, Q2P has raised approximately $4.2 million in capital over several financings, inclusive of cash invested and some debt and payables converted to stock. With these funds, the Company has been able to

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complete the prototype stage of its technology, place our first operating pilot unit in the field, recruit a solid engineering and business team, and secure strong Directors with significant industry experience. Many of these investments in people and contacts will assist us in the development of our new business line.  With respect to our technology, we will attempt to deliver on our commercial sales contracts with reduced staff, and look for other opportunities to monetize this intellectual property.  We will attempt to raise additional funding in 2016 to advance the Company’s growth plans, although there can be no assurances as to whether such funds can be raised and if they can, at what terms. Details of the Company’s prior financings follows:

During the year ended December 31, 2014, Q2P raised $353,501 in its initial Seed Round Funding, excluding transaction costs of $51,000, in a convertible debt security, which automatically converted to common stock at a post-Merger equivalent of approximately $0.35 per share on September 30, 2014.  

Q2P raised $1,416,367 at a post-Merger stock price equivalent of approximately $0.79 per share in its Series A Funding Round during the year ended December 31, 2014.  Direct offering costs related to the Series A Funding Round were $30,000.  In January 2015, Q2P closed a continuation round of its Series A Funding, whereby it raised an additional $362,360 at the same price and terms.

On May 14, 2015, Q2P’s Board of Directors authorized a Rights Offering whereby each shareholder of Q2P received one Subscription Right for each share of common stock owned as of that date. The Subscription Rights allowed participating shareholders to purchase shares of common stock in Q2P at a post-Merger stock price equivalent of approximately $0.18 per share. The Rights Offering closed on June 3, 2015, at which time Subscriptions from approximately 90% of the Q2P shareholders totaling $1,061,975 had been received, inclusive of $821,516 in cash, the cancellation of $83,158 and $103,251 of payables and accrued expenses incurred in 2014 for outside and employee services, respectively, and $54,050 of subscriptions receivable.  Transaction costs associated with the Rights Offering totaled $10,000.  

At the time of the Merger, Q2P had 70,689,632 shares of common stock outstanding, which converted to 24,034,475 shares of the Company pursuant to the Merger. Shares purchased in the Rights Offering accounted for approximately 75% of the shares converted for Company common stock.   

Subsequent to the Merger, the Company raised an additional $600,000 in its Series A 6% Convertible Preferred Stock (the “Preferred Stock”) from two separate accredited investors in November 2015 and January 2016, respectively.  The Preferred Stock was convertible at $0.26 per share at the discretion of the holders, and contains price protection provisions in the instance that the Company issues shares at a lower price, subject to certain exemptions. As a result of the July 2016 common stock offering described below, the conversation price for these Preferred Shares automatically reduced to $0.21 per share.  Preferred Stock holders also received other rights and protections including piggy-back registration rights, rights of first refusal to invest in subsequent offerings, security over the Company’s assets (secondary to the Company’s debt holders), and certain negative covenant guaranties that the Company will not incur non-ordinary debt, enter into variable pricing security sales, redeem or repurchase stock or make distributions, and other similar warranties.  The Preferred Stock is redeemable after two years if not converted, and has no voting rights until converted to common stock.  The Preferred Stock holders also received 50% warrant coverage at an exercise price of $0.50, with a five-year term and similar price protections as in the Preferred Stock. Pursuant to an agreement with the warrant holders, this conversion price did not change as a result of the July 2016 common stock offering at $0.21; however, should the Company fail to sign its first acquisition to a letter of intent by October 2016, then the conversion price will be reduced to $0.21 and the number of shares that the warrant is convertible into will increase proportionally to maintain the same dollar value of the warrant as a whole.

On March 15, 2016, the Company entered into a 120-day term loan agreement with one accredited investor in the principal amount of $150,000.  The loan bears 20% interest with interest payments due monthly. The holders received a 100,000 share equity kicker valued at $26,000, $3,000 cash and a second security interest in the assets of the Company.  The loan balance was $150,000, and accrued interest related to the loan totaled $1,250 at June 30, 2016. As of July 15, 2016, this loan was in default, and the Company was obligated to pay a 10% penalty charge.  The loan holder and the Company are in negotiations to extend the maturity date.  

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On April 29, 2016, the Company’s three independent Directors loaned to the Company a total of $60,200 pursuant to three Convertible Notes which are automatically convertible into the equity securities issued in the Company’s next financing of at least $1,000,000 at the same price and same terms.  The Convertible Notes bear 8% interest and have a 10% Original Issuance Discount.  The total principal amount of all three Notes was $66,000. The Notes mature in six months, and can be converted to common stock at $0.26 per share if a qualified financing event has not occurred by such time.  In June 2016, three investors of the Company provided an additional $26,709 to the Company on the same loan terms.  

In July and August  2016, the Company received subscription agreements from six accredited investors (four of whom were previous shareholders) to purchase 750,000 shares of restricted common at a price of $.21 per share for an aggregate of $157,500, less $610 in financing costs.       

All promissory notes and shares in these offerings were sold pursuant to an exemption from the registration requirements of the Securities Exchange Commission under Regulation D to accredited or sophisticated investors who completed questionnaires confirming their status. Unless otherwise described in this Current Report, reference to “restricted” common stock means that the shares have not been registered and are restricted from resale pursuant to Rule 144 of the Securities Act of 1933, as amended.

Separation from Cyclone and Related License Agreement

On July 28, 2014, Q2P (which at such time was called WHE Generation Corp., and renamed Q2Power Corp. on January 26, 2015) commenced operations as an independent company after receiving its initial round of seed funding and signing a formal separation agreement (the “Separation Agreement”) from Cyclone.  The Separation Agreement between Q2P and Cyclone provided for a formal division of certain assets, liabilities and contracts related to Q2P’s business, as well as establishing procedures for exchange of information, indemnification of liability, and releases and waivers for the principals moving forward.  As part of the separation from Cyclone, Q2P also purchased for $175,000 certain licensing rights to use Cyclone’s patented technology on a worldwide, exclusive basis for 20 years with two 10-year renewal terms for Q2P’s waste heat and waste-to-power business (the “License Agreement”).   The License Agreement contains a royalty provision equal to 5% of gross sales payable to Cyclone on sales of engines derived from technology licensed from Cyclone.

Also, as part of the separation from Cyclone, Q2P assumed a license agreement between Cyclone and Phoenix Power Group, which included deferred revenue of $250,000 from payments previously made to Cyclone for undelivered products.  The net balances as of June 30, 2016 and December 31, 2015 for the Cyclone licensing rights were $91,146  and $113,021, respectively; and the net balances as of June 30, 2016 and December 31, 2015 for the Phoenix deferred revenue were $250,000 and $250,000, respectively, which are included as a component of deferred revenue on the condensed consolidated balance sheets.   Under the terms of the revised agreement with Phoenix Power Group, revenue associated with these deferrals will be recognized subject to the achievement of certain milestones, as follows:  (1) on the completion of certain performance testing of the engine, deferred revenue of $150,000 will be recognized; and (2) on the delivery of the first 10 “Generation 1 Engines”, other deferred revenue will be recognized at a rate of $10,000 per delivered engine.

The Company also assumed a contract with Clean Carbon of Australia and a corresponding $10,064 prepayment for services or other value to be provided in the future.  This deposit has been presented as deferred revenue on the June 30, 2016 and December 31, 2015 condensed consolidated balance sheets.

The licensing rights are amortized over its estimated useful life of 4 years. Accumulated amortization for the periods ended June 30, 2016 and December 31, 2015 was $83,854 and $61,979, respectively.

Stock Repurchase Agreement

On April 8, 2016, the Company and Cyclone resolved a dispute regarding a 2014 Stock Purchase Agreement, whereby the parties agreed to terminate that agreement and all amounts owed by either party to the other, including a release of all claims, and Cyclone retained 212,500 shares of common stock of the Company and the Company has no obligation to buy back these shares.  The Company paid a consultant 100,000 shares of restricted common stock valued at $26,000 in connection with the negotiation and signing of that agreement.

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Cash and Working Capital

We have incurred negative cash flows from operations since inception. As of June 30, 2016, the Company had an accumulated deficit of $6,161,002. Details of this are discussed above in the Balance Sheet disclosure.

Critical Accounting Policies

Our financial statements are prepared in conformity with U.S. generally accepted accounting principles (GAAP).  Disclosures regarding our Critical Accounting Policies are provided in Note 3 – Summary of Significant Accounting Policies of the footnotes to our condensed consolidated financial statements.   

Off-Balance Sheet Arrangements

The Company did not engage in any "off-balance sheet arrangements" (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) as of June 30, 2016.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for smaller reporting companies.

ITEM 4: CONTROLS AND PROCEDURES

In connection with the preparation of this Quarterly Report, management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this Quarterly Report. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.  

Management’s Quarterly Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting.  The Company’s internal control over financial reporting is a process, under the supervision of the Chief Executive Officer and the Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles in the United States (GAAP). Internal control over financial reporting includes those policies and procedures that: