Stabilis Solutions, Inc. - Quarter Report: 2018 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED September 30, 2018

FOR THE TRANSITION PERIOD FROM                 TO                

Commission File No. 000-24575

AMERICAN ELECTRIC TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

6575 West Loop South, Suite 500, Bellaire, TX 77401

(Address of principal executive offices)

(832) 241-6330

(Registrant’s telephone number)

* * * * * * * * * * * * * * * * * * * * * *

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (S. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

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

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

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

As of November 12, 2018 the registrant had 8,969,437 shares of its Common Stock outstanding.

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AMERICAN ELECTRIC TECHNOLOGIES, INC. AND SUBSIDIARIES

FORM 10-Q Index

For the Quarterly Period Ended September 30, 2018

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PART I – FINANCIAL INFORMATION

American Electric Technologies, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)  

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

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American Electric Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

Unaudited

(in thousands, except share and per share data)

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

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American Electric Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

(in thousands)

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

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American Electric Technologies, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

Unaudited

(in thousands)

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

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AMERICAN ELECTRIC TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of American Electric Technologies, Inc. and its wholly-owned subsidiaries (“AETI”, “the Company”, “our”, “we”, “us”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and include all adjustments which, in the opinion of management, are necessary for fair financial statement presentation. All adjustments are of a normal recurring nature. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The statements should be read in conjunction with the Company’s consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017, which was filed on March 29, 2018. The December 31, 2017 balance sheet was derived from the audited financial statements contained in our 2017 Form 10-K.

2. Summary of Certain Significant Accounting Policies

Adoption of New Revenue Recognition Standard

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU No. 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU No. 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU No. 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). In July 2015, the FASB issued ASU No. 2015-14 which delayed the effective date of ASU No. 2014-09 by one year (effective for annual periods beginning after December 15, 2017). The Company adopted ASU No. 2014-09, effective January 1, 2018, using the modified retrospective method. The adoption of the standard did not have a material impact on the Company’s revenue recognition policies, other than enhanced disclosures related to the disaggregation of revenues from contracts with customers, the Company’s performance obligations and any significant judgments.

In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, to clarify two aspects of Topic 606: (i) identifying performance obligations; and (ii) the licensing implementation guidance. The amendments do not change the core principle of the guidance in Topic 606. The effective date and transition requirements for ASU No. 2016-10 are the same as the effective date and transition requirements for ASU No. 2014-09. This standard was adopted effective January 1, 2018.

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. ASU No. 2016-12 provides narrow-scope improvements to the guidance on collectability, noncash consideration, and completed contracts at transition. The amendment also provides a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers and are expected to reduce the judgment necessary to comply with Topic 606. The effective date and transition requirements for ASU No. 2016-12 are the same as the effective date and transition requirements for ASU No. 2014-09. This standard was adopted effective January 1, 2018.

In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. ASU No. 2016-20 allows entities not to make quantitative disclosures about remaining performance obligations in certain cases and require entities that use any of the new or previously existing optional exemptions to expand their qualitative disclosures. The amendment also clarifies narrow aspects of ASC 606, including contract modifications, contract costs, and the balance sheet classification of items as contract assets versus receivables, and corrects unintended application of the guidance. The effective date and transition requirements for ASU No. 2016-20 are the same as the effective date and transition requirements for ASU No. 2014-09.

The Company recognizes revenue when or as it satisfies a performance obligation by transferring promised goods or services to a customer using the over-time method to account for certain long-term contracts and the point in time method for non-time and material jobs. The non-time and material jobs are of a short-term nature (typically less than one month) and are determined after considering the attributes of such contracts. This method is used because these contracts are typically completed in a short period of time and the financial position and results of operations do not vary materially from those which would result from use of the over-time method. Earnings are accrued based on the ratio of costs incurred to total estimated costs. Costs include direct material, direct labor, and job related overhead. For our manufacturing activities we have determined that labor incurred, rather than total costs

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incurred, provides an improved measure of percentage-of-completion. For contracts with anticipated losses, the estimated losses are charged to operations in the period such losses are determined.

Costs and estimated earnings in excess of billings on uncompleted contracts related to our continuing operations was $1.2 million at September 30, 2018 and $0.6 million at December 31, 2017. Costs and estimated earnings in excess of billings on uncompleted contracts related to our discontinued operations was $0.0 million and $5.8 million at September 30, 2018 and 2017, respectively, and included in current assets held for sale.  

The order backlog at September 30, 2018 and December 31, 2017 was $1.0 million and $2.2 million, respectively. This backlog is for continuing operation and related to work in Brazil and is expected to be recognized in revenue during the remainder of 2018 and 2019.

The table below shows the revenue by geographic area for the three and nine months ended September 30, 2018 and 2017 (dollars in thousands). During the three months ended September 30, 2018, the Company sold the net assets of its wholly owned subsidiary that generated all revenues in North America (See Note 11). All revenues and expenses associated with this business has been reported as discontinued operations for all periods presented and excluded from the below presentation. These revenues reflect continuing operations in Brazil:

The table below shows North America and International revenue disaggregated by sectors for the three and nine months ended September 30, 2018 and 2017 (dollars in thousands). These revenues reflect continuing operations in Brazil:

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Uses and Sources of Liquidity

The Company’s primary need for liquidity is to fund working capital requirements of the Company’s business, capital expenditures and for general corporate purposes. The Company has incurred losses and experienced negative operating cash flows for the past several years, and accordingly, the Company has taken a number of actions to continue to support its operations and meet its obligations.

During 2017, the Company refinanced its outstanding loan which at that time provided approximately $1.0 million of working capital. In addition, the Board of Directors of the Company created a special committee to address strategic initiatives that include addressing liquidity. The loan was paid in full in August 2018.  

During the three months ended September 30, 2018, the Company sold its operations in the United States of American “U.S.” to a third-party.  

The Company expects to continue to optimize its international operations including expansion of its service business in Brazil and diversification of its joint venture operations in China into downstream oil & gas markets.        

3. Earnings per Common Share

Basic earnings per share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of common stock outstanding for the three months and nine months ended September 30, 2018 and 2017 .

Diluted earnings per share is computed by dividing net income (loss) attributable to common stockholders, by the sum of (1) the weighted-average number of shares of common stock outstanding during the period, (2) the dilutive effect of the assumed exercise of convertible instruments and (3) the dilutive effect of the exercise of stock options and other stock units to our common stock.

For the three months and nine months ended September 30, 2018, common stock equivalents from convertible instruments, stock options and other stock units have been excluded from the calculation of weighted average diluted shares because all such instruments were anti-dilutive.                       

The following table sets forth the computation of basic and diluted weighted average common shares.

4. Recently Issued Accounting Pronouncements

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU No. 2016-01 requires (1) an entity to measure equity instruments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) at fair value with changes in fair value recognized in net income; (2) entities to use the exit price notation when measuring the fair value of financial instruments for disclosure purposes; (3) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset; and (4) elimination of the requirement to disclose the methods and significant assumptions used to estimate fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU No. 2016-01 is effective for fiscal years beginning after December 15, 2017 with early adoption permitted. The adoption of ASU No. 2016-01, effective January 1, 2018 had no significant impact on the Company’s consolidated financial position, results of operations or disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires lessees to  recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under ASU No. 2016-02, lessor accounting is largely unchanged. ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2018 with early application permitted. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases expiring before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. Management is currently reviewing the Company’s various leases to identify those affected by ASU No. 2016-02.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 eliminates the probable initial recognition threshold in current U.S. GAAP

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and, instead, requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, ASU No. 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU No. 2016-13 is effective for annual periods beginning after December 15, 2019, with early application permitted in annual periods beginning after December 15, 2018. The amendments of ASU No. 2016-13 should be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. Management is currently evaluating the future impact of ASU No. 2016-13 on the Company’s consolidated financial position, results of operations and disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU No. 2016-15 addresses eight specific cash flow issues and is intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 is effective for reporting periods beginning after December 15, 2017. Early adoption is permitted. The adoption of ASU No. 2016-15 effective January 1, 2018 did not have a significant impact on the Company’s consolidated financial position, results of operations and disclosures.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. ASU No. 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of a business or as acquisitions (or disposals) of assets. ASU No. 2017-01 is effective for annual periods beginning after December 15, 2018, with early adoption permitted under certain circumstances. The amendments of ASU No. 2017-01 should be applied prospectively as of the beginning of the period of adoption. Management is currently evaluating the future impact of ASU No. 2017-01 on the Company’s consolidated financial position, results of operations and disclosures.

In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements. ASU No. 2018-11 provides entities with an additional (and optional) transition method to adopt the new lease standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). ASU No. 2018-11 also provide lessors with a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue guidance (Topic 606) and certain criteria are met: If the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with Topic 842. The amendments in ASU No. 2018-11 are effective at the same time the amendments in ASU No. 2016-02 discussed above.

5. Investments in Foreign Joint Venture

We have interests in one joint venture, outside of the U.S. which is accounted for using the equity method:

BOMAY Electric Industries Company, Ltd. (“BOMAY”), in which the Company holds a 40% interest, Baoji Oilfield Machinery Co., Ltd. (a subsidiary of China National Petroleum Corporation) holds a 51% interest, and AA Energies, Inc., holds a 9% interest. BOMAY was formed in 2006 in China with a term of 12 years and was set to expire in 2018. In March 2018, an agreement was approved by the BOMAY Board of Directors extending the joint venture agreement until April 17, 2028.

The Company disposed of its M&I Electric Far East (“MIEFE”) joint venture interest during the second quarter of 2018.

The Company made no sales to its joint venture for the three months and nine months ended September 30, 2018 and 2017.   

Summary (unaudited) financial information of our foreign joint venture in U.S. dollars was as follows at September 30, 2018 and December 31, 2017 and for the three and nine months ended September 30, 2018 and 2017 (in thousands):

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The following is a summary of activity in investments in foreign joint ventures for the nine months ended September 30, 2018 (unaudited):

Under the equity method of accounting, the Company’s share of the joint ventures’ operations’ earnings or loss is recognized in the condensed consolidated statements of operations as equity income from foreign joint ventures’ operations. Joint venture income increases the carrying value of the joint venture investment and joint venture losses, as well as dividends received from the joint venture, reduce the carrying value of the investment.

The Company reviews its equity method investment for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment may not be recoverable or the inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. Based on this analysis, there was no indication of impairment at September 30, 2018 and December 31, 2017.

6. Notes Payable

Senior Secured Term Note

On March 23, 2017, the Company and its subsidiaries, M&I Electric Industries, Inc. and South Coast Electric Systems, LLC (collectively, the “Sellers”) issued and sold to HD Special-Situations III, L.P. (the “Purchaser”) a $7.00 million principal amount Senior Secured Term Note (the “Note”)  bearing interest at 11.5% per annum with principal of $0.50 million due and paid on June 30,

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2017, and the remaining balance due 48 months after issuance for cash at par pursuant to a Note Purchase Agreement  (the “Purchase Agreement”). Proceeds from the sale of the Note were used to fully repay and terminate the Company’s prior revolving credit facilities with approximately $1.00 million being available for the Company’s working capital and general business purposes.

On November 13, 2017, the Company entered into an agreement modifying the terms of its Senior Secured Term Note. The modification included revisions to the original revenue and EBITDA covenants along with the requirement of minimum principal reductions of $30,000 per month beginning in April 2018.  In consideration for the modified terms, the Company issued 500,000 warrants to purchase the Company’s common stock at an exercise price of $2.26 which expire in November 2023.

The fair value of the warrants of approximately $0.37 million was recognized as additional paid-in capital with a corresponding discount to long-term notes payable. The discount is accreted to interest expense through the Note’s maturity.    

During the quarter ended September 30, 2018, the Company paid off the debt in full. Total interest expense recognized for the three months ended September 30, 2018 and 2017 was $0.08 million and $0.22 million, respectively. Total interest expense recognized for the nine months ended September 30, 2018 and 2017 was $0.64 million and $0.54 million, respectively. Interest expense related to the Note has been allocated to discontinued operations because the debt is required to be repaid as a result of the disposal transaction discussed in Note 11.

On March 29, 2018, the Company’s subsidiary, M&I Brazil, extended the terms of its Loan Agreement with the former chairman of AETI to June 7, 2019. The Loan Agreement provides M&I Brazil with a $0.30 million loan facility of which $0.20 million is drawn and is outstanding as of September 30, 2018 and with any balance outstanding due June 7, 2019. Under the loan agreement, the interest rate on the loan facility is 10.0%, per annum, payable each quarter. The loan facility is secured by the assets held by M&I Brazil.

7. Inventories

Inventories consisted of the raw materials of $0.04 million as of September 30, 2018 and $0.00 million as of December 31, 2017.  

8. Income Taxes

The tax provision for the three and nine months ended September 30, 2018 reflects the provision from taxes on our earnings from our Brazilian subsidiary and dividends received from BOMAY. The Company has established a valuation allowance on its deferred tax assets due to uncertainty regarding future realization.

9. Fair Value of Financial Instruments and Fair Value Measurements

The carrying amounts of cash and cash equivalents, short-term investments, trade accounts receivable and accounts payable approximate fair value as of September 30, 2018 and December 31, 2017 because of the relatively short maturity of these instruments.

10. Redeemable Convertible Preferred Stock and Common Stock

Redeemable Convertible Preferred Stock

In conjunction with the issuance of 1,000,000 shares of Redeemable Convertible Preferred Stock, Series A in May 2012, warrants to purchase 325,000 shares of our common stock (the “Warrants”) were issued.

The initial value allocated to the Warrants was recognized as a discount on the Series A Convertible Preferred Stock, with a corresponding charge to additional paid-in capital. The discount related to the Warrants is accreted to retained earnings through the scheduled redemption date of the redeemable Series A Convertible Preferred Stock.  Discount accretion totaled $0.01 million for both the three months ended September 30, 2018 and 2017. Discount accretion totaled $0.03 million for both the nine months ended September 30, 2018 and 2017.

The Series A Convertible Preferred Stock accrues cumulative dividends at a rate of 6% per annum payable quarterly in cash or in shares of Common Stock, at the option of the Company, based on the then current liquidation market price value of the Series A Convertible Preferred Stock, which is currently $5.00 per share. Quarterly dividends not paid in cash or Common Stock accumulate without interest and must be fully paid before any dividend or other distribution can be paid on or declared and set apart for the holders of Common Stock or the conversion of the Series A Convertible Preferred Stock to Common Stock. At September 30, 2018 and December 31, 2017, the company had accrued but unpaid dividends totaling $0.08 million which is included in accounts payable and other accrued expenses in the condensed consolidated balance sheets. During the nine months ended September 30, 2018 and 2017, the Company issued 182,025 and 149,422 shares of common stock as payment of dividends, respectively.

On or after April 30, 2017, the holders of a majority of the outstanding shares of the Series A Convertible Preferred Stock may require the Company to redeem the Series A Convertible Preferred Stock at a redemption price equal to the lessor of (i) the liquidation preference per share (initially $5.00 per share, subject to adjustments for certain future equity transactions defined in the Securities Purchase Agreement) and (ii) the fair market value of the Series A Convertible Preferred Stock per share, as determined in good faith by the Company’s Board of Directors. As of September 30, 2018 and December 31, 2017, the redemption price per share

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was $5.00 in both years. If the holder of the Series A Convertible Preferred Stock exercise their right of redemption, the redemption price, plus any accrued and unpaid dividends, shall be payable in 36 equal monthly installments plus interest at an annual rate of 6%.

In connection with the issuance of the Company’s senior secured term note, described in Note 6, the Company has agreed with the Purchaser of the Note and the holder of the Preferred Stock (the “Holder”) not to declare, authorize or pay any cash dividends on the Preferred Stock until the earlier of (i) March 22, 2018, or (ii) the date the obligations under the Note Purchase Agreement have been paid in full (the “Standstill Period”), without the prior written consent of the Purchaser. Following the expiration of the Standstill Period, for so long as the obligations under the Note remain outstanding, the Company may, at its sole discretion, declare, authorize or pay dividends in cash on the Preferred Stock so long as no event of default exists under the Term Note or would result therefrom. The Holder also agreed that it shall not exercise its rights to require the Company to redeem any of the Preferred Stock during the Standstill Period. Following the expiration of the Standstill Period, so long as the obligations under the Note remain outstanding, the Holder may compel the Company to redeem shares of Preferred Stock provided no event of default exists under the Note or would result from such redemption. In consideration for the Holder’s consent to the foregoing restrictions on the payment of cash dividends and redemption of the Preferred Stock, the Company entered into an agreement with the Holder (the “Repricing Agreement”) on August 1, 2017. Pursuant to the Repricing Agreement, each share of Series A Preferred Stock will be initially convertible, at the option of the holder, into one (1) share of common stock at a conversion price of $2.26 per share of common stock, so that the Series A Preferred Stock sold to the Holder are currently convertible into an aggregate of 2,212,389 shares of common stock. In addition, pursuant to the Repricing Agreement, the Series A Warrants sold to the Holder will be exercisable for 125,000 shares of common stock at an initial exercise price of $2.72 per share and the Series B Warrants sold to the Holder will be exercisable for 200,000 shares of common stock at an initial exercise price of $3.17 per share. As a result of the payoff of the secured term loan, there are no longer any restrictions on the Company’s payment of dividends on the Series A Convertible Preferred Stock or the ability of the holders to exercise their right of redemption.    

This agreement was approved by a committee of the Board of Directors comprised solely of independent directors.   

Common Stock

For the nine months ended September 30, 2018, the Company issued a total of 312,880 shares of common stock. The Company issued 182,025 shares of common stock as payment of accrued preferred dividends, as noted above, with the remaining 130,855 shares issued in connection with the Company’s Employee Stock Purchase Plan and upon vesting of restricted stock units.

11. Discontinued Operations

On August 6, 2018, the Company announced it had agreed to sell its U.S. business operated by its wholly owned subsidiary, M&I Electric Industries, Inc. to an affiliate of Myers Power Products, Inc. pursuant to an Asset Purchase Agreement (the “Transaction”).  The Transaction closed on August 12, 2018 for a total cash purchase price of $12.4M plus the value of assumed indebtedness of approximately $12.8M.  In addition, the Company was required to provide $740,000 into escrow in order to secure certain of the Company’s indemnification obligations within a six month period following closing.  A portion of the funds provided by the Transaction were required to be used to pay off the Senior Secured Term Note and related interest totaling approximately $6.5 million.  

The contractual terms of the aforementioned sale include a provision to true-up the net working capital, estimated as of the date of closing, to the actual working capital as calculated by the Buyer and agreed to by the Seller. Any difference in actual (conclusive) net working capital in relation to the estimated working capital at closing could result in an adjustment to the purchase price.   Subsequent to September 30, 2018, the Company received notification from the Buyer of their actual working capital calculation.  In the notification, the Buyer has communicated a decrease of approximately $4.3 million dollars in net working capital, in comparison to the estimated working capital used at the contract closing.  The Company has until November 28, 2018 to review the documentation from the Buyer and respond.  In the event the Buyer and Seller cannot agree to a conclusive net working capital adjustment, then all items remaining in dispute shall be submitted by either one of the parties within thirty (30) calendar days after the expiration of the resolution period to a national or regional independent accounting firm mutually acceptable to Buyer and Seller (the "Neutral Arbitrator"). The Neutral Arbitrator shall act as an arbitrator to determine the conclusive net working capital.  The conclusive net working capital, once finally determined, may result in a purchase price adjustment due to the Buyer or to the Company as Seller.

As of the date of the filing of the 10-Q for the period ended September 30, 2018, the Company disagrees with the buyers working capital calculation and has not received documentation sufficient to support the buyers position. As such, no adjustments have been considered in determining the gain on the sale of assets reported as of September 30, 2018.  The resulting purchase price adjustment based on the conclusive net working capital adjustment, if any, would be reflected in the fourth quarter of 2018.

As of June 30, 2018, the assets and liabilities sold in the Transaction were reflected as held for sale in the Company’s Consolidated Balance Sheets, and the related operating results and cash flows of the assets sold and liabilities assumed were reflected as discontinued operations in the Company’s Consolidated Statements of Operations, Consolidated Statements of Comprehensive Income (Loss), and Consolidated Statements of Cash Flows for all periods presented.

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The following tables summarize the M&I Electric Industries Inc. United States assets and liabilities held for sale and operating results.

M&I Electric Industries Inc. in the United States

Assets and Liabilities held for sale

(in thousands)

M&I Electric Industries Inc. in the United States

Statements of Operations (Discontinued)

Unaudited

(in thousands)

Cash provided by operating activities of discontinued operations for the nine months ended September 30, 2018 was $0.8 million. Cash provided by operating activities of discontinued operations for the nine months ended September 30, 2017 was $0.8

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million. Cash provided in investing activities of discontinued operations for the nine months ended September 30, 2018 was $11.6 million. Cash used in investing activities of discontinued operations for the nine months ended September 30, 2017 was $0.1 million. The general and administrative costs represent severance payments that coincided with the discontinued operations.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in the Form 10-Q and the consolidated financial statements included in the 2017 Annual Report on Form 10-K filed on March 29, 2018. Historical results and percentage relationships set forth in the condensed consolidated statements of operations and cash flows, including trends that might appear, are not necessarily indicative of future operations or cash flows.  

FORWARD-LOOKING STATEMENTS

Except for historical and factual information, this document contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate will or may occur in the future, such as predictions of business outlook and future financial performance. All forward-looking statements are based on assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances.

These statements, including statements regarding our capital needs, business strategy, expectations and intentions, are subject to numerous risks and uncertainties, many of which are beyond our control, including our ability to maintain key products’ sales or effectively react to other risks including those discussed in Part I, Item 1A, Risk Factors, of our 2017 Annual Report on Form 10-K filed on March 29, 2018. We urge you to consider that statements that use the terms “believe,” “do not believe,” “anticipate,” “expect,” “plan,” “estimate,” “intend” and similar expressions are intended to identify forward-looking statements. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

BUSINESS

The Company was incorporated on October 21, 1996 as a Florida corporation. On May 15, 2007, we completed a business combination (the “M&I Merger”) with M&I Electric Industries, Inc. (“M&I”), a Texas corporation, and changed our name to American Electric Technologies, Inc. (“AETI”). M&I Electric was originally founded in 1946. Our principal executive offices are located at 6575 West Loop South, Suite 500, Bellaire, Texas 77401 and our telephone number is 832-241-6330.

Our corporate structure currently consists of American Electric Technologies, Inc., which owns 100% of M&I Electric Industries, Inc. including its wholly-owned subsidiaries, South Coast Electric Systems, LLC (“SCES”) and M&I Electric Brazil Sistemas e Servicios em Energia LTDA (“M&I Brazil”).

On August 14, 2018 the Company’s wholly-owned subsidiary, M&I Electric Industries, Inc. (the “Seller”) completed its previously announced sale of its U.S. based assets to M&I Electric, LLC, an unrelated party. The purchase price for the assets was $17.3 million resulting in cash proceeds at closing of approximately $12.4 million after working capital and other closing adjustments. The Buyer also assumed approximately $12.8 million of liabilities related to the assets sold.  In connection with the closing of the asset sale, the Company paid off its long term debt of $6.5 million and paid certain other expenses, including professional fees and other closing costs in connection with the sale, resulting in additional working capital of approximately $2.5 million upon completion of the transaction.

The contractual terms of the aforementioned sale include a provision to true-up the net working capital, estimated as of the date of closing, to the actual working capital as calculated by the Buyer and agreed to by the Seller. Any difference in actual (conclusive) net working capital in relation to the estimated working capital at closing could result in an adjustment to the purchase price.   Subsequent to September 30, 2018, the Company received notification from the Buyer of their actual working capital calculation.  In the notification, the Buyer has communicated a decrease of approximately $4.3 million dollars in net working capital, in comparison to the estimated working capital used at the contract closing.  The Company has until November 28, 2018 to review the documentation from the Buyer and respond.  In the event the Buyer and Seller cannot agree to a conclusive net working capital adjustment, then all items remaining in dispute shall be submitted by either one of the parties within thirty (30) calendar days after the expiration of the resolution period to a national or regional independent accounting firm mutually acceptable to Buyer and Seller (the "Neutral Arbitrator"). The Neutral Arbitrator shall act as an arbitrator to determine the conclusive net working capital.  The conclusive net working capital, once finally determined, may result in a purchase price adjustment due to the Buyer or to the Company as Seller.

As of the date of the filing of the 10-Q for the period ended September 30, 2018, the Company disagrees with the buyers working capital calculation and has not received documentation sufficient to support the buyers position. As such, no adjustments have been considered in determining the gain on the sale of assets reported as of September 30, 2018.  The resulting purchase price adjustment based on the conclusive net working capital adjustment, if any, would be reflected in the fourth quarter of 2018.        

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The current and historical operating results associated with these assets and liabilities have been reclassified to give effect to these changes and are reported as discontinued operations in the Condensed Consolidated Statement of Operations for all periods presented.  

Overview

With the  sale of the U.S. operations of its wholly owned subsidiary, M&I Electric Industries Inc., now complete, the Company conducts only its foreign operations.    

Foreign Operations

Brazil

M&I Electric Brazil has offices in Rio de Janeiro, Macaé and Belo Horizonte to serve this market and focuses primarily on services and products for the oil and gas, marine vessel, power generation and broad industrial market segments in Brazil.

China

BOMAY Electric Industries Company, Ltd. (“BOMAY”), in which the Company holds a 40% interest, Baoji Oilfield Machinery Co., Ltd. (a subsidiary of China National Petroleum Corporation) holds a 51% interest, and AA Energies, Inc., holds a 9% interest. We account for our interest in BOMAY under the equity method.

Locations

Our Company headquarters are located in Bellaire, Texas.

M&I Electric Brazil has three locations (Macaé, Rio de Janiero and Belo Horizonte) in Brazil which provides services to the Brazil oil and gas, marine vessel, power generation and broad industrial markets.

Our BOMAY foreign joint venture has facilities in Xian, China.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We have adopted various critical accounting policies that govern the application of accounting principles generally accepted in the United States of America (“U.S. GAAP”) in the preparation of our condensed consolidated financial statements. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although these estimates are based on management’s knowledge of current events and actions it may undertake in the future, they may ultimately differ from actual results.

Certain accounting policies involve significant estimates and assumptions by us that have a material impact on our condensed consolidated financial condition or operating performance. Management believes the following critical accounting policies reflect its most significant estimates and assumptions used in the preparation of our condensed consolidated financial statements. We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities”, nor do we have any “variable interest entities”.

Allowance for Doubtful Accounts – The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The estimate is based on management’s assessment of the collectability of specific customer accounts and includes consideration for credit worthiness and the financial condition of those specific customers. The Company also reviews historical experience with the customer, the general economic environment and the aging of receivables. The Company records an allowance to reduce receivables to the amount that is reasonably believed to be collectible. Based on this assessment at September 30, 2018 and December 31, 2017, management believes the allowance for doubtful accounts is adequate.

Revenue Recognition – See Note 2 for new accounting policy on revenue recognition.

Foreign Currency Gains and Losses – Foreign currency translations are included as a separate component of comprehensive income. The Company has determined the local currency of its foreign joint venture and foreign subsidiary, M&I Brazil, to be the functional currency. In accordance with ASC 830, the assets and liabilities of the foreign equity investees and M&I Brazil, denominated in foreign currency, are translated into United States dollars at exchange rates in effect at the consolidated balance sheet date and net sales and expenses are translated at the average exchange rate for the period. Related translation adjustments are reported as comprehensive income, net of deferred income taxes, which is a separate component of stockholders’ equity, whereas gains and losses resulting from foreign currency transactions are included in results of operations.

Federal Income Taxes – The liability method is used in accounting for federal income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Our ability to realize the deferred tax assets are evaluated annually and a valuation allowance is provided if it is more likely than not that the deferred tax assets will not give rise to future benefits in the Company’s tax returns.

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Contingencies – The Company records an estimated loss from a loss contingency when information indicates that it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. Contingencies are often resolved over long time periods, are based on unique facts and circumstances, and are inherently uncertain. The Company regularly evaluates the current information that is available to determine whether such accruals should be adjusted or other disclosures related to contingencies are required. The ultimate resolution of these matters, individually or in the aggregate, is not likely to have a material impact on the Company’s consolidated financial position or results of operations.

Equity Income from Foreign Joint Ventures’ Operations – The Company accounts for its investments in foreign joint venture using the equity method. Under the equity method, the Company records its pro-rata share of foreign joint venture income or losses and adjusts the basis of its investment accordingly. Dividends received from the joint venture, if any, are recorded as reductions to the investment balance.

Carrying Value of Joint Venture Investment – The Company reviews its equity method investment for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment may not be recoverable or the inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. Based on the most recent review at September 30, 2018 and December 31, 2017, management believes the carrying value of the investment in its foreign joint venture is recoverable.

Business Outlook

Through the third quarter of 2018, the Company saw increasing signs of a rebound in its traditional international drilling customers.

In Brazil, the Company is forecasting global energy market growth due to stabilization of oil prices and the return of major oil and gas companies to the Brazilian market. The rebound in investments in some of the key Brazilian industrial markets could result in growth opportunities for the Company as well.

In China, the Company’s joint venture BOMAY, is anticipating market growth for the remainder of 2018 as the Chinese government is trying to move away from coal-fired power generation to natural gas which would increase Chinese shale drilling opportunities for the remainder of 2018 and beyond.

The Company is currently evaluating various investment opportunities in the U.S.

OVERALL RESULTS OF CONTINUING OPERATIONS

The following table represents revenue and income (loss) from continuing operations and net equity income from foreign joint ventures’ operations, for the periods indicated (in thousands):

Non-U.S GAAP Financial Measures

A non-U.S. GAAP financial measure is generally defined as one that purports to measure historical or future financial performance, financial position or cash flows, but excludes or includes amounts that would not be so adjusted in the most comparable

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U.S. GAAP measure. Please see the Company’s Annual Report on Form 10-K for 2017 filed on March 29, 2018 for a more in-depth discussion of this indicator, earnings before interest, taxes, depreciation and amortization (“EBITDA”). Management believes it is useful in evaluating operating performance.

Non-U.S. GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for our financial results prepared in accordance with U.S. GAAP.

 The table below shows the reconciliation of net loss attributable to common stockholders to “EBITDA” for the three and nine months ended September 30, 2018 and 2017 (dollars in thousands):

Backlog

The order backlog at September 30, 2018  and December 31, 2017 was $1.0 million and $2.2 million, respectively. This backlog is for work primarily in Brazil and is expected to be recognized in revenue during the remainder of 2018 and 2019.

Continuing Operations Business Sector Disclosures

Our financial results are reported in our three major market sectors. These sectors are Oil & Gas; Power Generation & Distribution and Marine & Other Industrial. The products we manufacture and the services we provide are consistent in application within all the sectors. This information is supplemental and provided to allow investors to follow our future trends in marketing to various customer groups.

Our continuing operations constitute the electric distribution, conversion, automation and control systems manufactured and sold by our wholly own Brazilian subsidiary. Our interest in our Chinese joint venture is accounted for by the equity method.

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Three Months Ended September 30, 2018 as Compared with the Three Months Ended September 30, 2017

Revenue and Gross Margin

Revenues increased 33%, or $0.48 million, to $1.93 million for the three months ended September 30, 2018, compared to the three months ended September 30, 2017. This growth was driven by the Company’s continued sales progress in penetrating the industrial market and increased orders from a repeat customers.

Gross margin increased 89%, or $0.26 million, to $0.56 million for the three months ended September 30, 2018, compared to the three months ended September 30, 2017. Gross margin as a percentage of revenues increased to 29% in the three months ended September 30, 2018, compared to 20% in the three months ended September 30, 2017. The increase was primarily attributable to an increase in demand for services across all three sectors.

Selling and Marketing Expenses

Selling and marketing costs were unchanged at $0.01 million for the three months ended September 30, 2018, compared to the three months ended September 30, 2017.   

General and Administrative Expenses

General and administrative expenses increased by 24%, or $0.27 million, to $1.39 million during the three months ended September 30, 2018, when compared to the three months ended September 30, 2017. The increase included $0.14 million in a retention bonus and $0.20 million of payroll and benefit vesting.   

Foreign Joint Venture Equity Income

Net equity income from foreign joint venture operations increased by $0.19 million, to $0.22 million during the three months ended September 30, 2018, when compared to the three months ended September 30, 2017. The increase is primarily due to an increase in performance by our BOMAY joint venture in China.

Other Income (Expense)

Interest expense and other income (expense) remained at $0.01 million during the three months ended September 30, 2018 when compared to the three months ended September 30, 2017.  

Income Tax Provision

The provision from income taxes for the three months ended September 30, 2018 was $0.13 million which reflects the provision of taxes on our earnings from our Brazilian subsidiary and the tax on the BOMAY dividend.    

Nine Months Ended September 30, 2018 as Compared with the Nine Months Ended September 30, 2017

Revenue and Gross Margin

Revenues increased 47%, or $1.88 million, to $5.88 million for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. This growth was driven by the Company’s continued sales progress in penetrating the power generation market and increased orders for field services.

Gross margin increased 75%, or $0.60 million, to $1.40 million for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. Gross margin as a percentage of revenues increased to 24% in the nine months ended September 30, 2018, compared to 20% in the nine months ended September 30, 2017. This increase was primarily attributable to the increase in revenue.

Selling and Marketing Expenses

Selling and marketing costs decreased by 26%, or $0.10 million, to $0.29 million for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. This decrease was primarily attributable to a layoff of sales employee not replaced. Selling and marketing expenses, as a percentage of revenues, decreased to 5% during the nine months ended September 30, 2018 compared to 10% during the nine months ended September 30, 2017.

General and Administrative Expenses

General and administrative expenses increased by 15%, or $0.48 million, to $3.60 million during the nine months ended September 30, 2018, when compared to the nine months ended September 30, 2017. The increase included $0.14 million in a retention bonus and $0.20 million of payroll and benefit vesting.   

Foreign Joint Venture Equity Income

Net equity income from foreign joint venture operations increased by $0.48 million, to $0.56 million during the nine months ended September 30, 2018, when compared to the nine months ended September 30, 2017. The increase is primarily due to an increase in performance by our BOMAY joint venture in China.

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Other Income (Expense)

Interest expense and other income (expense) increased $0.06 million to $0.09 million during the nine months ended September 30, 2018, when compared to the nine months ended September 30, 2017. Interest expense and other income (expense), as a percentage of revenues, remained at 1% during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017.   

Income Tax Provision

The provision for income taxes for the nine months ended September 30, 2018 was $0.32 million which reflects the provision of taxes on our earnings from our Brazilian subsidiary and the tax on the BOMAY dividend.

LIQUIDITY AND CAPITAL RESOURCES