Notes to Unaudited Condensed Consolidated Financial Statements
Note 1. Description of Business and Basis of Presentation
Description of Business
American DG Energy Inc., or the Company, we, our or us, distributes, owns, operates and maintains clean, on-site energy systems that produce electricity, hot water, heat and cooling. The Company's business model is to own the equipment that it installs at customers' facilities and to sell the energy produced by these systems to its customers on a long-term contractual basis at prices guaranteed to the customer to be below conventional utility rates. The Company calls this business the American DG Energy “On-Site Utility”.
The Company was incorporated as a Delaware corporation on July 24, 2001 to install, own, operate and maintain complete DG systems, or energy systems, and other complementary systems at customer sites and sell electricity, hot water, heat and cooling energy under long-term contracts at prices guaranteed to the customer to be below conventional utility rates.
The Company derives revenues from selling energy in the form of electricity, heat, hot water and cooling to its customers under long-term energy sales agreements (with a typical term of
10
to
15
years). The energy systems are generally owned by the Company and are installed in its customers’ buildings. Each month the Company obtains readings from energy meters to determine the amount of energy produced for each customer. The Company multiplies these readings by the appropriate published price of energy (electricity, natural gas or oil) from its customers’ local energy utility, to derive the value of its monthly energy sale, less the applicable negotiated discount. The Company’s revenues per customer on a monthly basis vary based on the amount of energy produced by its energy systems and the published price of energy (electricity, natural gas or oil) from its customers’ local energy utility that month. The Company’s revenues commence as new energy systems become operational. As of
March 31, 2017
, the Company had
92
energy systems operational. In some cases the customer may choose to own the system rather than have it owned by American DG Energy.
The Company has experienced total net losses since inception of approximately
$42 million
. For the next twelve months, the Company expects to experience continuing net losses as its management executes the current business plan. The Company believes that its existing resources, including cash and cash equivalents and future cash flow from operations, plus cash provided by the sale of certain inventory are sufficient to meet the working capital requirements of its existing business for the next twelve months; however, as the Company continues to grow its business by adding more energy systems, the cash requirements will increase, and the Company may need to raise additional capital through debt financings or equity offerings to meet its operating and capital needs. There can be no assurance, however, that the Company will be successful in its fundraising efforts or that additional funds will be available on acceptable terms, if at all.
In 2015, the Company began executing the "Initiative". The Initiative is focused on effectively investing the Company’s capital by increasing the performance of its existing sites. The goal of the Initiative is to make strategic capital improvements aimed at increasing productivity of the existing portfolio while optimizing the Company’s margins and increasing cash flow. The Company continues to expect that the Initiative will provide a strong foundation of high performing assets that may be used to fund future growth.
Stock-for-Stock Merger
On November 1, 2016, the Company's Board of Directors approved a definitive agreement whereby Tecogen Inc would acquire all of the outstanding shares of American DG in a stock-for-stock merger. Under the agreement, each share of American DG common stock will be exchanged for
0.092
shares of Tecogen common stock, valuing American DG at an approximately
27%
premium to the Company's closing share price on that day. This agreement is subject to a vote of security holders of both companies. The transaction is expected to close in the second quarter of 2017.
On April 12, 2017, the Securities and Exchange Commission ("SEC") declared the registration statement on SEC Form S-4 filed with the SEC in connection with its merger with Tecogen Inc. effective. Notice of the Special Meeting and a definitive proxy statement/prospectus was mailed on or about April 27, 2017, to stockholders of the Company as of April 24, 2017. The Special Meeting will be held at the Company's principal executive offices at 45 First Avenue, Waltham, Massachusetts 02451, on Thursday, May 18, 2017, at 1 p.m., Eastern Time.
Exchange of Shares of Subsidiary in Satisfaction of Indebtedness
During the second and third quarters of 2016, the Company settled approximately
$16 million
of its
$19.4 million
6%
convertible debentures due May 2018, reducing future debt service requirements of the Company (see Note 5 "Convertible Debentures and Other Debt") by transferring ownership to the holders of the debt, shares of EuroSite Power, reducing the Company's ownership in EuroSite from
48%
to just over
2%
(see Note 4 "Investment in EuroSite Power and Discontinued Operations").
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the
three months ended
March 31, 2017
are not necessarily indicative of the results that may be expected for the year ending
December 31, 2017
.
The condensed consolidated balance sheet at
December 31, 2016
has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and footnotes thereto included in American DG Energy Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2016
.
There have been no significant changes in accounting principles, practices or methods for making estimates.
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and entities in which it has a controlling financial interest. Those entities include the Company's
51.0%
owned joint venture, American DG New York, LLC, or ADGNY.
Investments in partnerships and companies in which the Company does not have a controlling financial interest but where we have significant influence are accounted for under the equity method.
The Company’s operations are comprised of
one
business segment. The Company’s business is selling energy in the form of electricity, heat, hot water and cooling to its customers under long-term sales agreements.
Reclassification
Certain prior year amounts have been reclassified to conform with current year presentation.
Note 2. Income (Loss) Per Common Share
The Company computes basic income (loss) per share by dividing net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period. The Company computes diluted earnings per common share using the treasury stock method. For purposes of calculating diluted earnings per share, the Company considers its shares issuable in connection with convertible debentures, stock options and warrants to be dilutive common stock equivalents when the exercise price is less than the average market price of its common stock for the period. For the
three months ended
March 31, 2017
, the Company excluded
4,739,270
potentially dilutive shares because such shares would be anti-dilutive. For the
three months ended
March 31, 2016
, the Company excluded
14,428,583
potentially dilutive shares because such shares would be anti-dilutive as a result of the reported net loss.
Note 3. Income Taxes
The provision for income taxes in the accompanying unaudited condensed consolidated statements of operations for the
three months ended
March 31, 2017
and
2016
differ from that which would be expected by applying the federal statutory tax rate primarily due to losses and nontaxable income for which no benefit is recognized.
Note 4. Investment in EuroSite Power and Discontinued Operations
During the second and third quarters of 2016, the Company settled approximately
$16 million
of the
$19.4 million
of its
6%
convertible debentures due May 2018 (see Note 5 "Convertible Debentures and Other Debt") by transferring ownership of shares it owned of EuroSite Power Inc to the holders of the debt. As a result, the Company's ownership in EuroSite decreased from
48.04%
to just over
2%
. Prior to the foregoing exchanges, the Company consolidated the results of EuroSite under the variable interest model as it was determined to be the primary beneficiary of EuroSite.
The exchanges were undertaken primarily as a plan to reduce future debt service requirements of the Company, however they also resulted in a disposition of all foreign operations of the Company, representing a strategic shift that will have a major effect on the Company's operations and financial results. Accordingly, amounts related to this component have been reported in discontinued operations in the accompanying condensed consolidated financial statements.
As of June 30, 2016, the Company owned a
20.5%
interest in the common stock of EuroSite Power which it accounted for using the equity method. Prior to June 28, 2016, the Company accounted for its investment in EuroSite Power as a consolidated subsidiary as it determined it was the primary beneficiary of EuroSite under the variable interest model. That determination included consideration of an implicit variable interest held by the Company in the form of a guarantee of the long-term convertible indebtedness of EuroSite Power. On June 28, 2016, substantially all of that convertible indebtedness was converted by the holders into shares of EuroSite Power, rendering the Company’s guarantee inconsequential in the determination. As a result, the Company concluded it no longer held a variable interest in EuroSite Power. The Company deconsolidated EuroSite Power in its consolidated financial statements. This required recording the remaining shares held at fair value as an equity method investment, which resulted in a gain of approximately
$3.9 million
. The Company utilized a market approach in determining the fair value of the shares retained which incorporated the quoted market price of the shares at the date of deconsolidation adjusted for volatility.
As of September 30, 2016, the Company owned a
2.03%
interest in the common stock of EuroSite Power. As such, the equity method of accounting was no longer appropriate in that the ability to exercise significant influence over EuroSite no longer exists at this level of ownership. The investment, since September 30, 2016 is accounted for as an available-for-sale security (see Note 7 "Fair Value Measurements").
The following is a reconciliation of the major line items comprising loss from discontinued operations for the
three months ended
March 31, 2016
:
|
|
|
|
|
|
Revenue
|
|
$
|
687,032
|
|
Cost of sales
|
|
$
|
544,392
|
|
Operating expenses
|
|
$
|
521,511
|
|
Other expenses, net
|
|
$
|
12,590
|
|
Pretax loss from discontinued operations
|
|
$
|
391,461
|
|
Income tax benefit
|
|
$
|
—
|
|
Loss from discontinued operations
|
|
$
|
391,461
|
|
Loss from discontinued operations attributable to noncontrolling interest
|
|
$
|
203,403
|
|
Loss from discontinued operations attributable to American DG Energy Inc.
|
|
$
|
188,058
|
|
The total operating and investing cash flows of the discontinued operation for the
three months ended
March 31, 2016
is as follows:
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
62,576
|
|
Net cash used in investing activities
|
|
$
|
(211,453
|
)
|
Note 5. Convertible Debentures and Other Debt
Convertible debenture 2016 transactions
On May 4, 2016, the Company settled
$9.3 million
of its
$19.4 million
outstanding
6%
convertible debentures due May 2018 (“convertible debentures” or “debt”) by transferring ownership of approximately
14.72 million
shares it owned of EuroSite Power to the holders of the debt.
As the shares used to extinguish the debt are considered nonmonetary assets, the overall gain realized of approximately
$7.2 million
is composed of two elements: (1) the gain resulting from the difference between the carrying value and the fair value of the shares transferred, of approximately
$7.7 million
and (2) the loss from the debt extinguishment of approximately
$500,000
.
As the Company retained its controlling financial interest in EuroSite Power following the transaction,
no
gain was recognized on the transaction, rather the gain was credited to additional paid-in capital in accordance with ASC 810-10-45-23.
On September 30, 2016, the Company settled
$6.7 million
of its
$10.1 million
outstanding
6%
convertible debentures due May 2018 by transferring ownership of
15.2 million
shares it owned of EuroSite Power in exchange for the debt. A new note evidencing the remaining balance of the debt outstanding of
$3,418,681
was issued, replacing the previous note. Interest on the debt was previously prepaid through maturity and the prepayment is reflected as a discount against the debt which is amortized to interest expense over the life of the debt. (see Note 4 "Investment in EuroSite Power and Discontinued Operations").
As the shares used to extinguish the debt are considered nonmonetary assets, the overall gain realized of
$182,887
is composed of two elements: (1) the gain resulting from the difference between the carrying value and the fair value of the shares transferred, of
$107,688
and, (2) the gain from the debt extinguishment of
$75,199
. The total gain is recorded as a gain on extinguishment of debt in the consolidated statement of operations.
On December 23, 2016, the Company repaid the remaining outstanding balance of its 2014 Convertible Debentures for
$3,058,943
, representing payment in full of the remaining
$3,418,681
net of remaining interest through maturity which had been previously prepaid.
Loan due to related party
On December 22, 2016, the Company entered into a Revolving Line of Credit Agreement ("Agreement") with John Hatsopoulos, the Company's co-Chief Executive Officer and member of the Company's board of directors. Under the terms of the Agreement, Mr. Hatsopoulos had agreed to lend the Company up to an aggregate of
$3,000,000
, upon written request.
On February 27, 2017, Mr. Hatsopoulos terminated the Revolving Line of Credit Agreement, allowing for payment of the outstanding balance of
$850,000
to be made on the Maturity date. The borrowing bears interest at
6%
, payable quarterly and matures on May 25, 2018. The Company may prepay any amount of the borrowing at any time without penalty. See Note 5 "Convertible Debentures and Other Debt".
Note 6. Related Parties
EuroSite Power, Tecogen, Ilios Inc., or Ilios are affiliated companies by virtue of common ownership and/or common leadership.
The Company purchases the majority of its cogeneration units from Tecogen, a related party sharing similar management. In addition, Tecogen pays certain operating expenses, including benefits and payroll, on behalf of the Company, and the Company leases office space from Tecogen. These costs were reimbursed by the Company. As of
March 31, 2017
, the Company owed Tecogen
$183,030
, and Tecogen owed the Company
$52,067
.
On December 22, 2016, the Company entered into a Revolving Line of Credit Agreement ("Agreement") with John Hatsopoulos, the Company's co-Chief Executive Officer and member of the Company's board of directors. Under the terms of the Agreement, Mr. Hatsopoulos had agreed to lend the Company up to an aggregate of
$3,000,000
, upon written request.
On February 27, 2017, Mr. Hatsopoulos terminated the Revolving Line of Credit Agreement, allowing for payment of the outstanding balance of
$850,000
to be made on the Maturity date. The borrowing bears interest at
6%
, payable quarterly and matures on May 25, 2018. The Company may prepay any amount of the borrowing at any time without penalty. See Note 5 "Convertible Debentures and Other Debt".
On January 13, 2017, the Company sold certain items of equipment and a substantial portion of its parts inventory to Tecogen, which is a major supplier to the Company, at Tecogen's cost, which is generally manufacturer or wholesale cost rather than a retail cost. The sale was prompted out of a need for funds to retire existing long-term indebtedness of the Company. As a result, the Company has classified these items as assets held for sale at December 31, 2016 at fair value (see Note 7 "Fair Value Measurements").
For further description of certain related party transactions see Note 4 "Investment in EuroSite Power and Discontinued Operations" and Note 5 "Convertible Debentures and Other Debt".
Note 7. Fair Value Measurements
The fair value topic of the FASB Accounting Standards Codification defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The accounting guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
Level 1
- Unadjusted quoted prices in active markets for identical assets or liabilities. The Company currently does not have any Level 1 financial assets or liabilities.
Level 2 -
Observable inputs other than quoted prices included in Level 1. Level 2 inputs include quoted prices for identical assets or liabilities in non-active markets, quoted prices for similar assets or liabilities in active markets and inputs other than quoted prices that are observable for substantially the full term of the asset or liability.
Level 3
- Unobservable inputs reflecting management’s own assumptions about the input used in pricing the asset or liability.
The following table presents the assets reported on the consolidated balance sheets measured at their fair value on both a recurring basis and a nonrecurring basis as of
March 31, 2017
and
December 31, 2016
by level within the fair value hierarchy.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2017
|
|
|
Quoted prices in active markets for identical assets
|
|
Significant other observable inputs
|
|
Significant unobservable inputs
|
|
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total gains (losses)
|
Description
|
|
|
|
|
|
|
|
|
|
Recurring fair value measurements
|
|
|
|
|
|
|
|
|
|
Available-for-sale equity securities
|
|
|
|
|
|
|
|
|
|
EuroSite Power Inc.
|
$
|
519,568
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
519,568
|
|
|
$
|
(118,083
|
)
|
Total recurring fair value measurements
|
$
|
519,568
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
519,568
|
|
|
$
|
(118,083
|
)
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
|
Quoted prices in active markets for identical assets
|
|
Significant other observable inputs
|
|
Significant unobservable inputs
|
|
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total gains (losses)
|
Description
|
|
|
|
|
|
|
|
|
|
Recurring fair value measurements
|
|
|
|
|
|
|
|
|
|
Available-for-sale equity securities
|
|
|
|
|
|
|
|
|
|
EuroSite Power Inc.
|
$
|
637,651
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
637,651
|
|
|
$
|
(136,848
|
)
|
Total recurring fair value measurements
|
$
|
637,651
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
637,651
|
|
|
$
|
(136,848
|
)
|
Nonrecurring fair value measurements
|
|
|
|
|
|
|
|
|
|
Long-lived assets held and used(a)
|
$
|
681,577
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
681,577
|
|
|
$
|
(503,072
|
)
|
Assets held for sale(b)
|
946,883
|
|
|
—
|
|
|
—
|
|
|
946,883
|
|
|
(743,770
|
)
|
Total nonrecurring fair value measurements
|
$
|
1,628,460
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,628,460
|
|
|
$
|
(1,246,842
|
)
|
(a) Long-lived assets held and used with a carrying amount of
$1,184,649
were written down to their fair value of
$681,577
, resulting in an impairment charge of
$503,072
, which was included in earnings for the year ended December 31, 2016.
(b) Assets held for sale with a carrying amount of
$1,690,653
were written down to their fair value of
$946,883
, resulting in a loss of
$743,770
, which was included in earnings for the year ended December 31, 2016.
In connection with the sale of certain equipment and inventory to Tecogen (see Note 6 "Related Parties"), the Company utilized a Level 3 category fair value measurement to value the assets classified as held for sale at December 31, 2016. That measurement was based on the manufactured or wholesale cost of such assets as this is the level at which the Company determined such assets could be sold in the market given the level of both functional and economic obsolescence, which results from the existence of newer, less expensive and more effective and efficient replacements.
The Company utilizes a Level 3 category fair value measurement to value its investment in EuroSite Power as an available-for-sale security at period end (see Note 4 "Investment in EuroSite Power and Discontinued Operations"). That measurement is determined by management based on the average closing sales price in a
24
day trading period within quarter end, which is discounted by
10%
to account for volatility.
The following table summarizes changes in level 3 assets which are comprised of available-for-sale securities for the period:
|
|
|
|
|
Initial establishment of fair value at September 30, 2016 -
|
|
Carryover basis from equity method investment
|
$
|
624,499
|
|
Purchase of 300,000 shares at $0.50 per share
|
150,000
|
|
Unrealized loss recognized in other comprehensive income
|
(136,848
|
)
|
Fair value at December 31, 2016
|
637,651
|
|
Unrealized loss recognized in other comprehensive income
|
(118,083
|
)
|
Fair value at March 31, 2017
|
$
|
519,568
|
|
Note 8. Commitments and Contingencies
The Company guarantees certain obligations of its former subsidiary EuroSite Power Inc. These guarantees include certain long term unsecured convertible indebtedness, with a remaining principal amount outstanding subject to the guarantee at
March 31, 2017
of
$300,000
with a maturity date of June 17, 2017; a payment performance guarantee in respect of collateralized equipment financing loans, with a remaining principal amount outstanding subject to the guarantee at
March 31, 2017
is approximately
$313,000
due ratably in equal installments through September 2021; and certain guarantees of performance in respect of certain customer contracts. Based on current conditions, the Company does not believe there to be any amounts probable of payment by the Company under any of the guarantees and has determined that the value associated with the non-contingent aspect of the guarantees is not significant.
At this time the Company believes these guarantees are not material to its financial statements.
In the ordinary course of its business, ADGE is involved in various legal proceedings involving a variety of matters.
On or about February 6, 2017, ADGE, John Hatsopoulos, George N. Hatsopoulos, Charles T. Maxwell, Deanna M. Petersen, Christine Klaskin, John Rowe, Joan Giacinti, Elias Samaras, Tecogen, and ADGE.Acquisition Corp., were served with a Verified Complaint by William C. May ("May"), individually and on behalf of the other shareholders of ADGE as a class. The action was commenced in the Business Litigation Session of the Superior Court of the Commonwealth of Massachusetts, Civil Action No. 17-0390. The complaint alleges the proposed Merger is subject to certain conflicts of interest; that ADGE's board failed to protect our stockholders by failing to conduct an auction or market check; that the Exchange Ratio undervalues ADGE's outstanding shares; that ADGE's directors breached their fiduciary duties in approving the Merger proposal; that Tecogen’s registration statement on Form S-4 contained material omissions; that Tecogen aided and abetted ADGE's board’s breaches of its fiduciary duties; and other claims. The plaintiff is seeking preliminary and permanent injunctions related to the Merger, rescissory damages, compensatory damages, accounting, and other relief.
The May action is in its earliest stages. The state court denied plaintiff’s motion for expedited discovery. The defendants have not yet answered or otherwise responded to the complaint, and plaintiff has not yet filed a motion for injunctive relief.
On or about February 15, 2017, a lawsuit was filed in the United States District Court for the District of Massachusetts by Lee Vardakas (“Vardakas”), individually and on behalf of other shareholders of ADGE, naming ADGE, John N. Hatsopoulos, George N. Hatsopoulos, Benjamin Locke, Charles T. Maxwell, Deanne M. Petersen, Christine M. Klaskin, John Rowe, Joan Giacinti, Elias Samaras, Tecogen Inc., Tecogen.ADGE Acquisition Corp., and Cassel Salpeter & Co., LLC, as defendants. Among other things, the complaint alleges (1) the merger is the result of a flawed and conflicted sales process and that the Exchange Ratio undervalues ADGE’s outstanding shares and (2) the registration statement on Form S-4 contains materially incomplete and misleading information concerning: (a) the financial analyses performed by ADGE’s financial advisor, (b) financial projections for ADGE and Tecogen, and (c) conflicts of interest in the sales process. The complaint asserts that defendants violated Section 14(a)(1) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), and Rule 14a-9 thereunder, as a result of the alleged materially incomplete and misleading information; that the directors and officers of ADGE have control person liability for the alleged material misstatements and omissions pursuant to Section 20(a) of the Exchange Act; that the directors of ADGE breached their fiduciary duties to ADGE’s stockholders related to the merger, including that they failed to take steps to obtain the highest possible consideration for ADGE shareholders in the transaction; that Mr. John Hatsopoulos and Mr. George Hatsopoulos, acting in concert and as a group, as controlling shareholders of ADGE, violated their fiduciary duties to the shareholders of ADGE; and that Mr. George Hatsopoulos, Tecogen.ADGE Acquisition Corp., and ADGE’s financial advisor aided and abetted breaches of fiduciary duties by the directors and officers of ADGE. Vardakas is seeking to
certify a class action, a preliminary injunction, damages, costs and disbursements, including reasonable attorneys’ fees, and such other relief as the court deems just and proper.
The Vardakas action is in its earliest phase. The defendants have not yet answered or otherwise responded to the complaint, and plaintiff has not yet filed a motion for injunctive relief.
Note 9. Subsequent Events
On April 12, 2017, the Securities and Exchange Commission ("SEC") declared the registration statement on Form S-4 filed with the SEC in connection with its merger with Tecogen Inc. effective. Notice of the Special Meeting and a definitive proxy statement/prospectus was mailed on or about April 27, 2017, to stockholders of the Company as of April 24, 2017. The Special Meeting will be held at the Company's principal executive offices at 45 First Avenue, Waltham, Massachusetts 02451, on Thursday, May 18, 2017, at 1 p.m., Eastern Time.
The Company has evaluated subsequent events through the date of this filing and determined that no other subsequent events occurred that would require recognition in the condensed consolidated financial statements or disclosure in the notes thereto other than those disclosed in the notes to these condensed consolidated financial statements.