ITEM 1. BUSINESS
Corporate History
The Company was organized September 11, 2003 under the laws of the State of Nevada, as GPP Diversified, Inc. The business of the Company was to sell pet products via the Internet. We were initially authorized to issue 25,000,000 shares of no par value common stock. On November 9, 2005, we amended our articles of incorporation to increase our authorized capital to 100,000,000 shares with a par value of $0.001. Concurrently, we changed our name from GPP Diversified, Inc. to Pet Express Supply, Inc. On July 28, 2008, Pet Express Supply, Inc. entered into an Exchange Agreement with each of the shareholders of CJ Vision Enterprises, Inc., a Delaware corporation doing business as Woozyfly.com, pursuant to which we changed our corporate name to Woozyfly, Inc. , authorized the issuance of 10,000,000 blank check preferred shares and effectuated a 6:1 stock split. On January 15, 2009, we ceased operations.
On May 12, 2009, the Company filed a voluntary petition in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) seeking reorganization relief under the provisions of Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). The Chapter 11 case was being administered under the caption In re Woozyfly, Inc. Case No. 09-13022 (JMP) (the “Chapter 11 Case”). The Company continued to operate its business as debtor in possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. In connection with the Chapter 11 Case, the Bankruptcy Court approved the arrangement pursuant to which MKM Opportunity Master Fund Ltd agreed to provide a DIP loan in the amount up to $100,000 (the “DIP Loan”).
The filing of the Chapter 11 Case constituted an event of default or otherwise triggered repayment obligations under the Company's 6% Secured Convertible Notes due June 30, 2011 ("Convertible Notes"). As a result, all indebtedness outstanding under these facilities and the notes became automatically due and payable, subject to an automatic stay of any action to collect, assert, or recover a claim against the Company and the application of applicable bankruptcy law.
On January 17, 2010, we entered into an Agreement and Plan of Merger (“Merger Agreement”) with STW Acquisition, Inc. (“Acquisition Sub”), a wholly owned subsidiary of STW Resources, Inc. (“STWR” ) and certain shareholders of STWR controlling a majority of the issued and outstanding shares of STWR. Pursuant to the Merger Agreement, STWR merged into the Acquisition Sub resulting in an exchange of all of the issued and outstanding shares of STWR for shares of the Company on a one for one basis. At such time, STWR became a wholly owned subsidiary of the Company.
On February 9, 2010, the Court entered an order confirming the Second Amended Plan of Reorganization (the “Plan”) pursuant to which the Plan and the Merger Agreement were approved. The Plan was effective February 19, 2010 (the “Effective Date”). The principal provisions of the Plan were as follows:
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MKM, the DIP Lender, received 400,000 shares of common stock and 2,140,000 shares of preferred stock;
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the holders of the Convertible Notes received 1,760,000 shares of common stock;
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general unsecured claims received 100,000 shares of common stock; and
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the Company’s equity interest was extinguished and cancelled.
On February 12, 2010, pursuant to the terms of the Merger Agreement, STWR merged with and into Acquisition Sub, which became a wholly-owned subsidiary of the Company (the “Merger”). In consideration for the Merger and STWR becoming a wholly-owned subsidiary of the Company, the Company issued an aggregate of 31,780,004 (the “STW Acquisition Shares”) shares of common stock to the shareholders of STWR at the closing of the Merger and all derivative securities of STWR as of the Merger became derivative securities of the Company including options and warrants to acquire 12,613,002 shares of common stock at an exercise price ranging from $3.00 to $8.00 with an exercise period ranging from July 31, 2011 through November 12, 2014 and convertible debentures in the principal amount of $1,467,903 with a conversion price of $0.25 and maturity dates ranging from April 24, 2010 through November 12, 2010.
The par value of the exchanged shares changed from $0.00001 to $0.001. All share amounts presented throughout this document reflect this change in par value.
Considering that, following the Merger, the shareholders of STWR control the majority of our outstanding voting common stock, and effectively succeeded our otherwise minimal operations to those that are theirs, STWR is considered the accounting acquirer in this reverse-merger transaction. Accordingly the Company has not recognized any goodwill or other intangible assets in connection with this reverse merger transaction.
Effective March 1, 2010, the Company changed its name to STW Global, Inc. in accordance with the Bankruptcy proceeding. On March 3, 2010, the Company changed its name to STW Resources Holding Corp. The name change was accomplished by merging a wholly owned subsidiary of the Company into the Company resulting in the Company being the surviving Company and changing the name of the Company.
The Company was the surviving and continuing entity of the Merger and the historical financials following the Merger are those of STWR. The Company was a "shell company" (as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) immediately prior to its acquisition of STWR pursuant to the terms of the Merger Agreement. As a result of such acquisition, the Company’s operations are now focused on the provision of customized water reclamation services. Consequently, management believes that the Merger has caused the Company to cease to be a shell company as it no longer has nominal operations.
Overview
The Company, based in Midland, Texas, provides customized water reclamation services. STW’s core expertise is an understanding of water chemistry and its application to the analysis and remediation of complex water reclamation issues. STW provides a complete solution throughout all phases of a water reclamation project including analysis, design, evaluation, implementation and operations.
STW’s expertise is applicable to several market segments including:
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Gas shale hydro-fracturing flowback;
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Oil and gas produced water;
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Acid mine drainage (“AMD”);
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Desalination;
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Brackish water; and
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Municipal wastewater.
Understanding water chemistry is the foundation of STW’s expertise. STW will provide detailed chemical analysis of the input stream and of the process output that conforms to the various environmental and legal requirements and the needs of the customer. STW becomes an integral part of the water management process and provides a customized solution that encompasses analysis, design, and operations including pretreatment and transportation. Simultaneously, STW evaluates the economic impact of this process to the customer. These processes will use technologies that fit our customer’s needs: fixed, mobile or portable; reverse-osmosis, membrane technology, chemical, other technologies, and any necessary pre-treatment, post-treatment. STW will also supervise construction, testing, and operation of these systems. Our keystone is determining and optimizing the most appropriate technology to effectively and economically address our customers’ particular requirements. As an independent solutions provider STW is manufacturer-agnostic and is committed to the use of the right technology demanded by the design process.
Market Opportunities
Gas shale fracturing flowback water
STW is actively pursuing opportunities in all the major shale formations in the United States. The initial focus, in this sector, is the shale activity in the Permian and Delaware basins of west Texas.
Unconventional tight oil and gas shales such as the Wolfcamp Shale in West Texas require millions of gallons of fresh water to drill and stimulate a new well. The water returns during the fracture flowback (“frac”) and production (“production”) with salts or total dissolved solids (“TDS”) at levels unfit for human consumption. This flowback or produced water is typically disposed of through various means such as controlled injection into disposal wells. STW will target the frac water market in the tight oil and gas formations first, and approach the produced water market for oil and gas production subsequently.
Oil and gas reservoirs are usually found in porous rocks, which also contain saltwater. Cross linked gel fracture fluids with high “proppant” loading (additives that prop open fissures in the geological formation caused by hydraulic fracturing) have been utilized to fracture these zones in order to gain permeability, allowing the oil and gas to flow to the well bore. The unconventional shale formations have been common knowledge for decades, but the cost of gas production was always considered to be uneconomical. The wells were drilled and fractured with the same crossed linked system as discussed above.
All of the wells were vertical and required stimulation about every three years with a new fracture. Around 2001, the “slick water fracture” technique was developed. This change required larger volumes of fresh water (1.2 million gallons per fracture on a well) to be used in the fracturing process, a friction reducing polymer additive, and low concentrations of a proppant in the hydraulic fracture fluid. Wells using this modified technique now can economically produce oil and gas for over eight years without re-stimulation. The fresh water is believed to dissolve salts from the shale over time and open up the natural fractures and fissures in the rock, allowing more oil and gas to be produced. In 2003, horizontal drilling rigs were brought into the Barnett Shale and the slick water fracture volume increased from one to eight plus million gallons per well. The slick water fracture technique has become the standard for most of the shale formations for stimulation of the wells.
This map illustrates the location of the major shale formations that are discussed below:
The Permian and Delaware Basins in West Texas
Producers in West Texas are facing the same water related problems as other producers are nationwide - a shortage of fresh water due to drought and municipality expansion. There are over 450 drilling rigs working in West Texas using approximately 8+ million gallons of fresh water monthly. The formations are shale and the discovery of several new shale formations, West Texas is considered to be one of the largest and most active oil and gas areas in the United States.
Eagle Ford Shale Formation
The Eagle Ford Shale is a recently discovered formation located in South Texas. The development stage of the field is being done with thousands of wells to be drilled and completed annually. This area has limited supplies of fresh water, leading the Company to believe water reclamation will be a required solution in order for producers to access a sufficient supply of frac water in this market. Production of natural gas has been reported at levels in excess of 10 million cubic feet (“Mcf”) per day, and hundreds of barrels of condensate at some of the wells. The Company expects to intensify its efforts to address this market opportunity.
Produced Water
Shale zones are typically dry geological formations devoid of any formation or connate water, and hence the fracture flowback water comprises most of water that returns following gas production. Outside of shale formations, where most gas and oil production occurs, there is typically a reservoir of connate water in the production zone that generates “produced” water. Produced water is primarily salty water trapped in the reservoir rock and brought up along with oil and/or gas during production, and is the most common oil field waste. The quality of produced water varies significantly in different parts of the world depending on the geology of the underlying formation.
In a large number of the oil fields in the USA, secondary or tertiary means of handling produced water storage, such as water floods and steam floods, are typically utilized. These are operations where the produced water is used to maintain reservoir pressure, prevent subsidence, and sweep the zone to remove the oil. Most of these water floods utilize a fresh water source as a supply so that sufficient volumes are available. As these fields age, less water is required for the flood, so excess contaminated brines concentrate and require disposal. As this water could be reclaimed with STW proprietary systems believes that the market for reclaiming produced water outside the shale reclamation projects represents a considerable opportunity for the Company.
Texas is the largest oil and gas production state in the nation and the produced water is unfit for use, poses a threat to the environment and is typically injected into deep injection wells. In accordance with Texas Railroad Commission regulations, water placed in these disposal wells is rendered permanently unavailable for re-use or consumption. The reclaimed water would available for many beneficial uses, including agricultural and environmental applications, as well as re-use in hydraulic fracturing operations. Deep injection well practices in every gas and oil producing region in the world pose the same detrimental environmental and resource conservation issues. The water reclamation products and services offered by the Company could provide a significant part of the solution to all constituencies concerned.
In the steam floods of California, a large portion of the water is recycled through the water treatment facility and converted back to steam. There are some fields that there is excess water in the millions of gallons per day that is low in TDS and could very economically be converted back to environmentally usable water.
Brackish Water
World-wide, there are brackish water zones that contain large volumes of water. The water contains dissolved salts in the 0.5 to 2% (5,000 to 20,000 mg/l TDS) range and hence unfit for human use. This water can be treated to reduce the TDS below 500 mg/l or 0.05% TDS making the water fit for human consumption. Factors such as decreasing supplies of fresh ground and surface water, increased competition for surface water resources, and changes in population/demand centers are driving the need for brackish water for water supply. STW’s potential customers are private companies and municipalities serving fast growing metropolitan areas where demand for water is outpacing the available supply. For example, aquifers in the Texas Gulf Coast contain a large volume of brackish water (less than 10,000 ppm TDS) that, with desalinization, will help meet increasing demand in the region.
There are more than 450 drilling rigs operating in West Texas and each one will use approximately 8+ millions gallons of fresh water per month for drilling and fracking wells. In its current form, brackish water is unsuitable for oilfield use. By cleaning it in an economical way with STW technology, it may be used in the oilfield, thus reducing the strain on current fresh water supplies.
STW is also involved in several projects that will be cleaning brackish water for municipal and golf course use. This helps in the conservation of our fresh water resources.
With one of the worst droughts in our history, the use of treated brackish water is extremely popular and STW has successfully designed and engineered a system capable of processing this water very economically.
Legislative and Regulatory:
Progressively tighter regulations are demanding a thorough review of the entire water-use cycle in industrial applications with the ultimate goal of encouraging and/or mandating reclamation and re-use of water. STW works closely with Federal, State and local regulators and environmental agencies to share our expertise and knowledge on this complex issue and discuss our views on potential solutions. The Company’s intimate knowledge of this process is a key tool to assist their customers to better understand the legislative and regulatory elements related to water management and advise them of various alternatives.
Process
STW’s proprietary systems and processes are predicated upon a thorough understanding of the customer’s water needs and related issues. This understanding is developed through a series of interactive discussions with the customer. The next phase is data gathering and analysis. STW collects samples at various locations and at different time intervals which are then tested at independent laboratories and analyzed by STW. Based upon this analysis, STW would recommend a solution using the most appropriate technologies and negotiate the acquisition and financing of these technologies as well as contracts with engineering procurement construction (“EPC”). Finally, STW oversees the EPC process and operates the facility.
STW’s processes are based upon a fundamental understanding of the core issue and developing an appropriate solution using our experience and expertise. It includes sampling and testing, analysis, design and as required by customers, implementation and operation. Some of the steps involved are described below:
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The inlet water quality must be determined and measurement of Total Dissolved Solids (TDS), hardness, barium, strontium, bromine, sulfate and hydrocarbon concentrations are critical.
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Multiple samples over time are taken to ensure consistency and accuracy of inlet water quality measurement.
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An understanding and analysis of potential uses for the reclaimed water.
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A site inspection to determine the various vessels needed such as tanks, pumps, pits, truck off loading racks, and engineering testing of the land.
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An analysis of fluid volumes and their variability over time.
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Length of time the water needs to be reclaimed at this site.
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Determination of appropriate technology: fixed or mobile, evaporation, reverse osmosis or other.
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Permitting as needed
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An investigation of the handling of the concentrated brines and any other residue from the reclamation process.
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Disposal options on the residue including potential use of the by-products.
Technology
STW has developed relationships with a number of manufacturers that offer best-of-class technologies applicable to its customer base. These technologies include thermal evaporation, membrane technology and reverse osmosis and are available as fixed or mobile units with varying capacities. Various pre and post-treatment options are available as necessary including crystallizers that process very high TDS (>150,000 mg/l).
Thermal Evaporation: This process is capable of handling waters that contain up to 150,000 mg/l TDS, with fresh water recovery rates from 50 to 90% or greater depending on inlet water quality. The recovered fresh water, or “distillate”, is highly purified water from the evaporative process and has multiple re-use applications. It is particularly applicable in the gas shale and oil production facilities for reclaiming frac and produced waters.
The technology is scalable and can be deployed as mobile units that can process 72,000 gallons per day (“gpd”), or as portable units that can process 216,000 gpd, or as fixed central units capable of processing up to 2,880,000 gpd.
Residual brine concentrate can, depending on local conditions and producer’s priorities, either be disposed off in deep injection wells or be treated further through a Crystallizer that reduces it into distillate and commercially valuable salt residuals.
Reverse Osmosis: Waters that are below 34,000 mg/l of total dissolved solids and contain low levels of barium, strontium, bromine, and sulfate can be reclaimed through a reverse osmosis unit (RO). Reverse osmosis is the process of forcing a solvent from a region of high solute concentration through a semi-permeable membrane to a region of low solute concentration by applying a pressure in excess of the osmotic pressure. The membranes used for reverse osmosis are generally designed to allow only water to pass through while preventing the passage of solutes (such as salt ions). This process is best known for its use in desalination (removing the salt from sea water to get fresh water), but it has also been used to purify fresh water for medical, industrial and domestic applications. Recovery rates for seawater to drinking water are about 50%.
A stream of concentrated brine or higher TDS is the by-product. This brine can be properly disposed of or utilized as a feed solution to a brine concentrator or crystallizer. The latter ensures higher quality water with lower TDS levels for industrial Uses.
Most oilfield waters cannot be processed through an RO membrane since they contain barium, strontium, or bromine. The barium and strontium are very large molecules and they plug the membrane and create damage or permanent fouling of the membrane. Bromine and other such halogens react with the membrane and destroy its integrity. There are few oil field waters that could be processed through this technology but a thorough study is required to ensure success. STW Resources will utilize this technology where the water chemistry can be processed through RO membranes.
Membrane Bioreactor: A Membrane BioReactor (“MBR”) is a combination of biological and ultrafiltration technologies. The biological area provides the same process utilized in all sewage treatment facilities. Bacteria are maintained in an aerobic condition which cause decay in all of the organic materials contained in the water, and oxidizing these organic materials into low molecular weight acids, usually acetic acid. Maintaining the bacteria in an oxygen rich environment prevents mutatation or growth of any anaerobic bacteria, which would produce inorganic acids such as hydrogen sulfide.
A filter membrane removes the water fraction from the unit. The membrane provides filtration in the 0.01 microns or lower range which is sufficient enough to remove viruses, bacteria, and other colloidal materials. The water exiting the units is potable water and safe for human consumption.
Marketing & Sales
STW’s business proposition is to provide comprehensive, necessary water treatment solutions. We work closely with our customers to evaluate their water treatment needs, understand how these may change over time, assess the regulatory and economic factors and then design an optimal solution. STW offers a broad array of technical solutions coupled with a service suite and financial structuring options that provide our customers with the ability to obtain a turnkey solution to their waste water disposal challenges.
Oil and Gas Shales: Most of the oil and gas producers in each of the shale formations are already well known to the Company. STW personnel have developed many, and in some cases, long standing relationships with key personnel responsible for well completion and remedial operations at each gas producer. STW monitors production plans at the producer level, the acreage acquisitions at the shale formations and trends that relate to the demand for water reclamation by region. In addition, the Company maintains detailed databases that monitor drilling permits, rig counts and other key statistics that forecast gas production rates by geography. These activities allow the Company to anticipate demand for its services and to prioritize its sales calling effort on those producers for whom fresh water supply is an issue or where shale water disposal pose the greatest challenges.
The foundation of the Company’s sales strategy is to become an integral part of its customer’s water management function. This involves identifying and finding solutions to customer needs through a multi-step, consultative approach:
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Evaluate drilling program and production expansion plans.
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Identify and define fracture water supply needs and waste brine generation levels.
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Study the flowback water volumes and chemistry over time.
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Generate economic models jointly with producers, with full consideration of all costs of obtaining, utilizing, and disposing of the water.
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Evaluate various water reclamation options, from equipment to logistics, and develop financial models for all the options.
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Provide a customized presentation comparing present practices to all of the options of water reclamation available to the customer, for buy-in to the best scenarios.
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Jointly develop a presentation of the best scenarios for water management (present and future) for use by upper management. Support the presentation as required.
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Review and determine optimal system design, location and financial structure.
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Develop a time line for water reclamation implementation.
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Execute definitive off-take and/or other agreements satisfactory to all parties.
STW is able to facilitate this part of the sales process through its detailed knowledge of the oil and gas drilling, fracking and production process and economics, shale formation geology, frac water chemistry, well completion techniques and logistics and regional regulatory landscapes. This expertise reduces the time required during the evaluative stage of the sales process and fosters a positive working relationship with our customers. STW then works together with its engineering and manufacturing partners to complete the technical solution, develop ancillary system requirements (balance of plant) evaluate cost and operating data, model the financial performance of the system and define remaining project parameters and an installation timeline.
Water reclamation is a new paradigm for oil and gas producers. Educating them about the economic, environmental and political benefits is key to long-term adoption.
Competition
In the oil and gas industry, current fracturing and produced water disposal methods - deep injection wells and surface water disposal - represent the Company’s greatest source of competition.
Brine Discharge / Deep Injection Wells
In many gas shale fields, disposal through a deep injection well offers a cost-effective (though environmentally questionable) alternative to water reclamation. If suitable geology exists, high TDS flowback waters can be disposed by injection into a deep discharge well. There are operative brine discharge wells in each of the major shale formations.
Number of Employees
As of October 10, 2012, other than our one executive officer, presently we do not have any full time employees.
Our Website
Our website address is www.stwresources.com. Information found on our website is not incorporated by reference into this report.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the following risk factors and the other information included in this annual report on Form 10-K, as well as the information included in other reports and filings made with the SEC, before investing in our common stock. If any of the following risks actually occur, our business, financial condition or results of operations could be harmed. The trading price of our common stock could decline due to any of these risks, and you may lose part or all of your investment.
Our limited operating history makes it difficult for us to evaluate our future business prospects and make decisions based on those estimates of our future performance.
We did not begin operations of our business until February 2008. We have a limited operating history and have generated limited revenue. As a consequence, it is difficult, if not impossible, to forecast our future results based upon our historical data. Reliance on the historical results may not be representative of the results we will achieve, particularly in our combined form. Because of the uncertainties related to our lack of historical operations, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in revenues or expenses. If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, which may result in a decline in our stock price.
The report of our independent registered public accounting firm on our 2011 consolidated financial statements contains a going concern modification, and we will need additional financing to execute our business plan, fund our operations and to continue as a going concern, which additional financing may not be available on a timely basis, or at all.
We have limited remaining funds to support our operations. We have prepared our consolidated financial statements in this Form 10-K on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We will not be able to execute our current business plan, fund our business operations or continue as a going concern long enough to achieve profitability unless we are able to secure additional funds. The Report of Independent Registered Public Accounting Firm on our December 31, 2011 consolidated financial statements includes an explanatory paragraph stating that the recurring losses incurred from operations and a working capital deficiency raise substantial doubt about our ability to continue as a going concern. However, in order to sustain and improve operations, we will need to secure additional funds. If adequate financing is not available, we will not be able to sustain operations. In addition, if one or more of the risks discussed in these risk factors occur or our expenses exceed our expectations, we may be required to raise further additional funds sooner than anticipated.
We will be required to pursue sources of additional capital to fund our operations through various means, including equity or debt financing, funding from a corporate partnership or licensing arrangement or any similar financing. However, we may be unable to obtain such financings on reasonable terms, or at all. Future financings through equity investments are likely to be dilutive to existing stockholders. Also, the terms of securities we may issue in future capital transactions may be more favorable for our new investors. Newly issued securities may include preferences, superior voting rights and the issuance of warrants or other derivative securities, which may have additional dilutive effects. In addition, if we raise additional funds through collaboration and licensing arrangements, we may be required to relinquish potentially valuable rights to our product candidates or proprietary technologies, or grant licenses on terms that are not favorable to us. Further, we may incur substantial costs in pursuing future capital and/or financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which will adversely impact our financial results. As a result, there can be no assurance that additional funds will be available when needed from any source or, if available, will be available on terms that are acceptable to us. If we are unable to raise funds to satisfy our capital needs prior to the end of 2013, we may be required to cease operations.
STW’s results of operations have not resulted in profitability and we may not be able to achieve profitability going forward.
STW has a deficit accumulated since January 28, 2008 (Inception) through December 31, 2011 of $13,723,704. In addition, as of December 31, 2011, STW had total liabilities of $7,937,569 and total assets of $34,007.
Our management is developing plans to alleviate the negative trends and conditions described above. Our business plan is speculative and unproven. There is no assurance that we will be successful in executing our business plan or that even if we successfully implement our business plan, that we will be able to curtail our losses now or in the future. Further, as we are a new enterprise, we expect that net losses will continue and our working capital deficiency will exacerbate.
We depend upon key personnel and need additional personnel.
Our success depends on the continuing services of Stanley Weiner, our chief executive officer and director. The loss of Mr. Weiner could have a material and adverse effect on our business operations. Additionally, the success of the Company’s operations will largely depend upon its ability to successfully attract and maintain competent and qualified key management personnel. As with any company with limited resources, there can be no guaranty that the Company will be able to attract such individuals or that the presence of such individuals will necessarily translate into profitability for the Company. Our inability to attract and retain key personnel may materially and adversely affect our business operations.
We must effectively manage the growth of our operations, or our company will suffer.
To manage our growth, we believe we must continue to implement and improve our operational and marketing departments. We may not have adequately evaluated the costs and risks associated with this expansion, and our systems, procedures, and controls may not be adequate to support our operations. In addition, our management may not be able to achieve the rapid execution necessary to successfully offer our products and services and implement our business plan on a profitable basis. The success of our future operating activities will also depend upon our ability to expand our support system to meet the demands of our growing business. Any failure by our management to effectively anticipate, implement, and manage changes required to sustain our growth would have a material adverse effect on our business, financial condition, and results of operations.
Our business requires substantial capital, and if we are unable to maintain adequate financing sources our profitability and financial condition will suffer and jeopardize our ability to continue operations.
We require substantial capital to support our operations. If we are unable to maintain adequate financing or other sources of capital are not available, we could be forced to suspend, curtail or reduce our operations, which could harm our revenues, profitability, financial condition and business prospects.
Our operations are subject to comprehensive regulation which may cause substantial delays or require capital outlays in excess of those anticipated causing an adverse effect on us.
Our operations are subject to federal, state, and local laws relating to the protection of the environment, including laws regulating removal of natural resources from the ground and the discharge of materials into the environment. Various permits from government bodies are required for our operations to be conducted; no assurance can be given that such permits will be received. Environmental standards imposed by federal, provincial, or local authorities may be changed and any such changes may have material adverse effects on our activities. Moreover, compliance with such laws may cause substantial delays or require capital outlays in excess of those anticipated, thus causing an adverse effect on us. Additionally, we may be subject to liability for pollution or other environmental damages. We generally maintain insurance coverage customary to the industry; however, we are not fully insured against all possible environmental risks. To date, we have not been required to spend any material amount on compliance with environmental regulations. However, we may be required to do so in future and this may affect our ability to expand or maintain our operations.
Risks associated with the collection, treatment and disposal of wastewater may impose significant costs.
Our wastewater collection, treatment and disposal operations of our subsidiaries are subject to substantial regulation and involve significant environmental risks. If collection systems fail, overflow or do not operate properly, untreated wastewater or other contaminants could spill onto nearby properties or into nearby streams and rivers, causing damage to persons or property, injury to aquatic life and economic damages, which may not be recoverable in rates. Liabilities resulting from such damage could adversely and materially affect our business, results of operations and financial condition. Moreover, in the event that we are deemed liable for any damage caused by overflow, our losses might not be covered by insurance policies, and such losses may make it difficult for us to secure insurance in the future at acceptable rates.
We will require significant capital requirements for equipment, commercialization and overall success.
We will require additional financing for our operations, to purchase equipment and to establish a customer base. We anticipate that we will require a minimum of $3.0 to $5.0 million in additional capital over the next six months to pursue our business plan. We cannot assure you that we will obtain any additional financing through any other means. Additional financing may not be available to us on acceptable terms, if at all. Unless we raise additional financing, we will not have sufficient funds to complete the purchase of equipment and commercialization of our services. As of the date of the Annual Report, we have no firm commitments for additional capital.
Our additional financing requirements could result in dilution to existing stockholders.
We will require additional financings obtained through one or more transactions which effectively dilute the ownership interests of holders of our Common Stock. We have the authority to issue additional shares of Common Stock and Preferred Stock as well as additional classes or series of ownership interests or debt obligations which may be convertible into any class or series of ownership interests in the Company. The Company is authorized to issue 100,000,000 shares of Common Stock and 10,000,000 shares of Preferred Stock. Such securities may be issued without the approval or other consent of the holders of the Common Stock.
A small number of existing shareholders own a significant amount of our Common Stock, which could limit your ability to influence the outcome of any shareholder vote.
Our executive officers, directors and shareholders holding in excess of 5% of our issued and outstanding shares, beneficially own over 80.7% of our common stock as of October 10, 2012. Under our Articles of Incorporation and Nevada law, the vote of a majority of the shares outstanding is generally required to approve most shareholder action. As a result, these individuals will be able to significantly influence the outcome of shareholder votes for the foreseeable future, including votes concerning the election of directors, amendments to our Articles of Incorporation or proposed mergers or other significant corporate transactions.
We face competition.
We face competition from existing companies in reclamation of oil and gas waste water space that provide similar services to the Company’s. Our competitors may have longer operating histories, greater name recognition, broader customer relationships and industry alliances and substantially greater financial, technical and marketing resources than we do. Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements.
We rely on confidentiality agreements that could be breached and may be difficult to enforce.
Although we believe that we take reasonable steps to protect our intellectual property, including the use of agreements relating to the non-disclosure of our confidential information to third parties, as well as agreements that provide for disclosure and assignment to us of all rights to the ideas, developments, discoveries and inventions of our employees and consultants while we employ them, such agreements can be difficult and costly to enforce. Although we generally seek to enter into these types of agreements with our consultants, advisors and research collaborators, to the extent that such parties apply or independently develop intellectual property in connection with any of our projects, disputes may arise concerning allocation of the related proprietary rights. If a dispute were to arise enforcement of our rights could be costly and the result unpredictable. In addition, we also rely on trade secrets and proprietary know-how that we seek to protect, in part, through confidentiality agreements with our employees, consultants, advisors or others.
Despite the protective measures we employ, we still face the risk that: agreements may be breached; agreements may not provide adequate remedies for the applicable type of breach; our trade secrets or proprietary know-how may otherwise become known; our competitors may independently develop similar technology; or our competitors may independently discover our proprietary information and trade secrets.
There has not been an active public market for our common stock so the price of our common stock could be volatile and could decline at a time when you want to sell your holdings.
Our common stock is traded on the OTC Pink under the symbol STWS. Our common stock is not actively traded and the price of our common stock may be volatile. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include:
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expiration of lock-up agreements;
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our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
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changes in financial estimates by us or by any securities analysts who might cover our stock;
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speculation about our business in the press or the investment community;
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significant developments relating to our relationships with our customers or suppliers;
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stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the oil and gas industry;
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customer demand for our products;
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investor perceptions of the oil and gas industry in general and our company in particular;
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the operating and stock performance of comparable companies;
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general economic conditions and trends;
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major catastrophic events;
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announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
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changes in accounting standards, policies, guidance, interpretation or principles;
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sales of our common stock, including sales by our directors, officers or significant stockholders; and
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additions or departures of key personnel.
Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources.
Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.
Our Common Stock is subject to the “penny stock” rules of the Securities and Exchange Commission.
The Securities and Exchange Commission has adopted Rule 15g-9 which establishes the definition of a "penny stock," for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require:
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that a broker or dealer approve a person's account for transactions in penny stocks; and
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the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the broker or dealer must:
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obtain financial information and investment experience objectives of the person; and
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make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the Commission relating to the penny stock market, which, in highlight form:
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sets forth the basis on which the broker or dealer made the suitability determination; and
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that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and about the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.
Because certain of our stockholders control a significant number of shares of our common stock, they may have effective control over actions requiring stockholder approval.
Our directors, executive officers and principal stockholders, and their respective affiliates, will beneficially own approximately 80.7% of our outstanding shares of common stock as of October 10, 2012. As a result, these stockholders, acting together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might harm the market price of our common stock by:
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delaying, deferring or preventing a change in corporate control;
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impeding a merger, consolidation, takeover or other business combination involving us; or
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discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us.
Any adjustment in the conversion price of our convertible notes or the exercise price of our warrants could have a depressive effect on our stock price and the market for our stock.
If we are required to adjust the warrant exercise price pursuant to any of the adjustment provisions of the agreements relating to any of our prior financing transaction, the adjustment or the perception that an adjustment may be required, may have a depressive effect on both our stock price and the market for our common stock.
Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and operating results and stockholders could lose confidence in our financial reporting.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our operating results could be harmed. Failure to achieve and maintain an effective internal control environment, regardless of whether we are required to maintain such controls, could also cause investors to lose confidence in our reported financial information, which could have a material adverse effect on our stock price.
The Company’s management assessed the design and operating effectiveness of internal control over financial reporting as of December 31, 2011 based on the framework set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. In connection with the assessment described above, management identified the control deficiencies that represent material weaknesses at December 31, 2011. See "Item 9 Controls and Procedures" for more detailed discussion.
We have not paid dividends on our common stock in the past and do not expect to pay dividends on our common stock for the foreseeable future. Any return on investment may be limited to the value of our common stock.
No cash dividends have been paid on our common stock. We expect that any income received from operations will be devoted to our future operations and growth. We do not expect to pay cash dividends on our common stock in the near future. Payment of dividends would depend upon our profitability at the time, cash available for those dividends, and other factors as our board of directors may consider relevant. If we do not pay dividends, our common stock may be less valuable because a return on an investor’s investment will only occur if our stock price appreciates.
The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members.
We recently became a public company and subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Sarbanes-Oxley Act. Prior to February 2010, we had not operated as a public company and the requirements of these rules and regulations will likely increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition. Prior to the date of this annual report, we had not filed our annual report for the fiscal year ended December 31, 2012 and we have not filed a quarterly report for the first and second quarters ended March 31, and June 30, 2012. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls for financial reporting. For example, Section 404 of the Sarbanes-Oxley Act of 2002 requires that our management report on, the effectiveness of our internal controls structure and procedures for financial reporting. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. If we fail to do so, or if in the future our chief executive officer and chief financial officer determines that our internal controls over financial reporting are not effective as defined under Section 404, we could be subject to sanctions or investigations by the SEC or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our common stock. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results. The Company’s management assessed the design and operating effectiveness of internal control over financial reporting as of December 31, 2011 based on the framework set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. In connection with the assessment described above, management identified the control deficiencies that represent material weaknesses at December 31, 2011. See "Item 9. Controls and Procedures" for more detailed discussion. Notwithstanding the foregoing, management reviewed the financial statements and underlying information included in this annual report on Form 10-K and believes the procedures performed are adequate to fairly present our financial position, results of operations and cash flows for the periods presented in all material respects.
In order to achieve effective internal controls, we may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company, which will increase costs. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives and to meeting the obligations that are associated with being a public company, which may divert attention from other business concerns, which could have a material adverse effect on our business, financial condition and results of operations.
If securities or industry analysts do not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.
The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. We do not currently have and may never obtain research coverage by industry or financial analysts. If no or few analysts commence coverage of us, the trading price of our stock would likely decrease. Even if we do obtain analyst coverage, if one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
ITEM 2.
ITEM 2. PROPERTIES
Our principal offices are located at 619 West Texas Avenue, Suite 126, Midland, Texas 79701, which includes 1,250 square feet in office space. We pay $1,200 per month in rent and our lease is month to month.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company may become a party to litigation or other legal proceedings that it considers to be a part of the ordinary course of its business. The Company is not involved currently in legal proceedings that could reasonably be expected to have a material adverse affect on its business, prospects, financial condition or results of operations. The Company may become involved in material legal proceedings in the future.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUERS PURCHASES OF EQUITY SECURITES
Our common stock qualified for quotation on the Over-the-Counter Bulletin Board under the symbol “STWS” on November 19, 2010. The stock currently trades on the OTC Pink under the symbol “STWS”. The quotations reflect inter-dealer prices, without retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions.
The closing price of our common stock on the OTC Pink on October 10, 2012, was $0.05 per share.
The following table sets forth the range of high and low bid quotations as reported on the OTC Bulletin Board and the OTC Pink for the periods indicated.
Holders of Common Stock
As of October 10, 2012, we had 221 holders of record of our common stock.
Dividends
We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. There are no restrictions in our certificate of incorporation or by-laws on declaring dividends.
Recent Sales of Unregistered Securities
On September 1, 2011, the Company entered into a note modification (see Note 4 in the accompanying consolidated financial statements) with a holder of $100,000 of the 2010 12% Convertible Notes that had previously matured. The agreement called for issuance of 2,000,000 shares of the Company's common stock to the note holder who will sell these shares for which the proceeds will reduce the Company's liability to the Holder. On March 20, 2012, the Company issued an additional 3,000,000 shares of its common stock to the note holder.
On March 23, 2012, the Board of Directors agreed to exchange their accrued compensation for shares of the Company’s common stock. Total accrued compensation as of that date was $1,473,900 which was converted at a price per share of $0.05, and 29,478,000 shares were issued. Furthermore, for consulting services to the Company, the Board authorized the issuance of 16,950,000 shares of common stock to various consultants, of which, 5,000,000 shares have been issued to Mr. Stan Weiner, the Company’s Chief Executive Officer. On March 23, 2012, the Board authorized the issuance of 425,000 shares of the Company’s common stock to its Advisory Board members and an additional 18,750 shares to a consultant.
Between June and September 2012, the Company issued to certain accredited investors, new 14% Convertible Notes with a principal amount of $200,000. These notes have the same terms as the 14% Notes issued in 2011 (see Note 4 in the accompanying consolidated financial statements). In addition, the investors also received warrants to purchase 500,000 shares of the Company’s common stock at an exercise price of $0.20 and exercisable for a period of two years from the date of issuance. The Company incurred cash fees of $20,000 and issued 50,000 warrants under the same terms.
All other sales of unregistered securities have been previously reported in a Form 8-K.
Equity Compensation Information
The following table summarizes information about our equity compensation plans as of December 31, 2011.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not Applicable.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with STW Resources Holding Corp. (f/k/a/ Woozyfly, Inc.) (the “Company”) consolidated audited financial statements and the notes thereto contained elsewhere in this report. Information in this Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Form 10-K that does not consist of historical facts, are "forward-looking statements." Statements accompanied or qualified by, or containing words such as "may," "will," "should," "believes," "expects," "intends," "plans," "projects," "estimates," "predicts," "potential," "outlook," "forecast," "anticipates," "presume," and "assume" constitute forward-looking statements, and as such, are not a guarantee of future performance. The statements involve factors, risks and uncertainties including those discussed in the “Risk Factors” section included herein, the impact or occurrence of which can cause actual results to differ materially from the expected results described in such statements. Risks and uncertainties can include, among others, fluctuations in general business cycles and changing economic conditions; changing product demand and industry capacity; increased competition and pricing pressures; advances in technology that can reduce the demand for the Company's products, as well as other factors, many or all of which may be beyond the Company's control. Consequently, investors should not place undue reliance on forward-looking statements as predictive of future results. The Company disclaims any obligation to update the forward-looking statements in this report.
Overview
The Company is a development stage corporation formed to utilize state of the art water reclamation technologies to reclaim fresh water from highly contaminated oil and gas hydraulic fracture flow-back salt water that is produced in conjunction with the production of oil and gas. The Company has been working to establish contracts with oil and gas operators for the deployment of multiple water reclamation systems throughout Texas, Arkansas, Louisiana and the Appalachian Basin of Pennsylvania and West Virginia. The Company, in conjunction with energy producers, operators, various state agencies and legislators, is working to create an efficient and economical solution to this complex problem. The Company is also evaluating the deployment of similar technology in the municipal wastewater industry.
The Company’s operations are located at 619 W. Texas Ave Ste 126, Midland, TX 79701.
On January 17, 2010, the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) with STW Acquisition, Inc. (“Acquisition Sub”), a wholly owned subsidiary of STW Resources, Inc. (“STWR”) and certain shareholders of STWR controlling a majority of the issued and outstanding shares of STWR. Pursuant to the Merger Agreement, STWR merged into Acquisition Sub resulting in an exchange of all of the issued and outstanding shares of STWR for shares of the Company on a one for one basis. At such time, STWR became a wholly owned subsidiary of the Company.
On February 9, 2010, the Court entered an order confirming the Second Amended Plan of Reorganization (the “Plan”) pursuant to which the Plan and the Merger Agreement were approved. The Plan was effective February 19, 2010 (the “Effective Date”). The principal provisions of the Plan were as follows:
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MKM, the DIP Lender, received 400,000 shares of common stock and 2,140,000 shares of preferred stock;
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the holders of the Convertible Notes received 1,760,000 shares of common stock;
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general unsecured claims received 100,000 shares of common stock; and
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the Company’s equity interest was extinguished and cancelled.
On February 12, 2010, pursuant to the terms of the Merger Agreement, STWR merged with and into Acquisition Sub, which became a wholly-owned subsidiary of the Company (the “Merger”). In consideration for the Merger and STWR becoming a wholly-owned subsidiary of the Company, the Company issued an aggregate of 31,780,004 shares of common stock ("the STW Acquisition Shares") to the shareholders of STWR at the closing of the merger and all derivative securities of STWR as of the Merger became derivative securities of the Company including options and warrants to acquire 12,613,002 shares of common stock at an exercise price ranging from $3.00 to $8.00 with an exercise period ranging from July 31, 2011 through November 12, 2014 and convertible debentures in the principal amount of $1,467,903 with a conversion price of $0.25 and maturity dates ranging from April 24, 2010 through November 12, 2010.
Considering that, following the Merger, the shareholders of STWR control the majority of our outstanding voting common stock and we effectively succeeded our otherwise minimal operations to those that are theirs, STWR is considered the accounting acquirer in this reverse-merger transaction. Accordingly, we have not recognized any goodwill or other intangible assets in connection with this Merger. STW is the surviving and continuing entities and the historical financials following the reverse merger transaction will be those of STWR. We were a "shell company" (as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) immediately prior to our acquisition of STW pursuant to the terms of the Merger Agreement. As a result of such acquisition, our operations our now focused on the provision of customized water reclamation services. Consequently, we believe that acquisition has caused us to cease to be a shell company as we no longer have nominal operations.
The Report of Independent Registered Public Accounting Firm to our December 31, 2011 consolidated financial statements includes an explanatory paragraph stating that the recurring losses and negative cash flows from operations since inception and our working capital deficiency at December 31, 2011 raise substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Recent Developments
On or about May 22, 2008, STWR, a predecessor company of the Company entered into a Teaming Agreement, as amended, with GE Ionics, Inc., a Massachusetts corporation (“GE”) (STWR and GE are collectively referred to as the “Parties”). On or about April 4, 2008 STWR and GE entered into a Purchase Order (the “Purchase Order”), pursuant to which there was due and unpaid a debt by STWR to GE in the amount of $11,239,437 as of August 31 2010, (the “Original Debt”).
On August 31, 2010, the Parties entered into a Settlement Agreement pursuant to which GE permitted the Company to substitute for STWR as to all rights and obligations under the Purchase Order (including the Original Debt) and Teaming Agreement, and such that to fully discharge STWR’s financial obligations to GE under the Purchase Order, the Company shall pay GE $1,400,000 pursuant to a senior promissory note (the “Note”). The Note bears interest at a rate of the WSJ Prime Rate (as published daily in the Wall Street Journal) plus two percent (2%) per annum. Under the terms of the Note, the Company has thirteen months to pay off the Note plus all accrued interest thereon. In addition, upon the consummation of a debt or equity financing following the execution of the Note, the Company shall pay GE thirty percent (30%) of the gross proceeds of any equity investments in or loans to the Company or any affiliated entity until the Note is paid in full, including all accrued interest thereon.
On September 29, 2011, the Parties agreed to extend the maturity date of the Note from September 30, 2011 to October 30, 2011.
On October 30, 2011, the Parties entered into an amendment to the settlement agreement, effective October 1, 2011, pursuant to which, among other things, the Parties agreed as follows: (i) the Company will have until September 1, 2013 to pay GE $2,100,000 plus interest accrued after October 1, 2011 under the Note in accordance with its terms, (ii) upon the consummation and closing of a debt or equity financing following the execution of the Note, the Company shall pay GE thirty percent (30%) of any and all tranches (“Tranches” being defined as the cash receipts of the proceeds of any equity investments in or loans to the Company or any affiliated entity by third parties, but excluding any conversions of pre-existing debt to equity by any of the Company’s then current convertible note holders or creditors) until the Note is paid in full, including all accrued interest, provided the Company shall not be obligated to pay GE upon, among other things, the following: (a) short term commercial paper of $200,000 or less, up to a cumulative maximum of $500,000 through December 31, 2012, (b) commercial equipment leasing whereby GE is taking a secured interest in the purchased equipment, (c) proceeds from project, lease and equipment funding to any subsidiary of the Company provided the Company does not receive any proceeds of such funding and (d) a one-time general exception for $1,500,000 of new equity financing of the Company, (iii) the Company shall begin making a regular series of installment payments as follows: (a) $10,000 per month beginning on January 1, 2012, and (b) $15,000 per month beginning on June 1, 2012 through the maturity date of the note and (iv) the Company shall be able to prepay the Note, without interest, on or before the maturity date. As of the date of this filing, no payments have been made, the Company is in default and GE has the right to accelerate the maturity of the note and demand immediate payment.
In November 2011, the Company commenced an offer to exchange the outstanding principal and accrued interest on the 12% Convertible Notes with new 14% Convertible Notes (the “2011 14% Convertible Notes”). The holders of the 12% Convertible Notes were also offered an opportunity to purchase additional 2011 14% Convertible Notes for cash. Each 2011 14% Convertible Note is convertible, at any time at the option of the holder, into shares of the Company’s common stock, at an initial conversion price of $0.08 per share (the “14% Note Conversion Price”). The 2011 14% Convertible Notes bear interest at 14% per annum (6% cash interest and 8% paid-in-kind “PIK” interest) and mature 24 months from the date of issuance. Warrants associated with the 12% Convertible Notes (the “12% Warrants”) were exchanged for new warrants to purchase three times the number of common shares of the Company that could be purchased with the 12% Warrants. The new warrants are exercisable for a period of two years from the date of issuance at an exercise price of $0.20 per share. Through December 31, 2011, the Company had issued a total of $2,481,235 face value of its 14% Convertible Notes in exchange for $235,000 cash, $1,657,903 of principal of the 12% Notes, $125,000 of short-term notes payable, $463,332 of accrued interest and other expenses.
During February 2012, the Company issued to certain accredited investors (the “Investors”) revenue participation interest notes with a principal amount of $165,000 (the “March 2012 Notes”). These March 2012 Notes mature on January 21, 2017 and carry an interest rate of 12%. Principal and interest payments shall come solely from the Investors share of the revenue participation fees from water processing contracts related to brackish and/or produced water. The Investors shall receive 50% of the net revenues from such contracts until such time as they have received 2 times their investment amount, 10% of the net revenues thereafter until such time as they have received an additional $295,000 at which time the March 2012 Notes are retired in full. The Investors received warrants to purchase 165,000 shares of the Company’s common stock. These warrants have an exercise price of $0.20 and a two year maturity. The Company incurred cash fees of $16,500 and issued 16,500 warrants under the same terms as those received by the Investors.
On March 20, 2012, pursuant to a debt settlement agreement (see Note 4 in the accompanying consolidated financial statements), the Company issued 3,000,000 shares of its common stock to a note holder who will sell these shares, and the net proceeds will reduce the Company's liability to the note holder.
On March 23, 2012, the Board of Directors agreed to exchange their accrued compensation for shares of the Company’s common stock. Total accrued compensation as of that date was $1,473,900 which was converted at a price per share of $0.05, and 29,478,000 shares were issued. Furthermore, for consulting services to the Company, the Board authorized the issuance of 16,950,000 shares of common stock to various consultants, of which, 5,000,000 shares have been issued to Mr. Stan Weiner, the Company’s Chief Executive Officer. On March 23, 2012, the Board authorized the issuance of 425,000 shares of the Company’s common stock to its Advisory Board members and an additional 18,750 shares to a consultant.
In May 2012, the Company entered into a subscription agreement with accredited investors pursuant to which the Company sold 1,000,000 Units, each Unit consisting of one share of the Company’s common stock par value $0.001 and a warrant to purchase 0.375 shares of the Company’s common stock (the “Warrants”) for aggregate consideration of $50,000. The Warrants shall be exercisable for a period of two years from the date of issuance at an initial exercise price of $0.20. The Company incurred cash fees of $5,000 and issued 150,000 warrants under the same terms.
Between June and September 2012, the Company issued to certain accredited investors, new 14% Convertible Notes with a principal amount of $200,000. These notes have the same terms as the 14% Notes issued in 2011 (see Note 4 in the accompanying consolidated financial statements). In addition, the investors also received warrants to purchase 500,000 shares of the Company’s common stock at an exercise price of $0.20 and exercisable for a period of two years from the date of issuance. The Company incurred cash fees of $20,000 and issued 50,000 warrants under the same terms.
On September 6, 2012, the Company announced that it had signed a contract with Ranchland Hills Golf Club, Midland, TX, to design, build and deliver a proprietary water desalinization facility to produce 700,000 gallons of water a day by converting brackish well water into the equivalent of rain water to maintain the greens and fairways of the golf course. Under terms of the agreement, STW has received a down payment and will collect additional manufacturing milestone payments to engineer and install customized equipment that adds proprietary technology and chemicals to a desalinization membrane technology to increase the amount of fresh water recovered and lower the cost of operation. The equipment is to be delivered in 10-12 weeks.
Plan of Operations
For the next twelve months, our current operating plan is focused on providing water reclamation services to oil & gas producers and other commercial ventures in Texas. Water reclamation services include treating brackish water for use in fracking operations, landscaping and other commercial applications and reclaiming produced water.
As is discussed further in the Liquidity and Capital Resources section below, we have limited funds to support our operations. Our continuation as a going concern subsequent to the year ended of 2011 is dependent on our ability to obtain additional financing to fund the continued operation of our business model for a long enough period to achieve profitable operations. Based on our current business plan, we currently estimate we will need up to an additional $3 million of new capital to execute our business plan through the year ended 2012. There can be no assurance, however, that such financing will be available or, if it is available, that we will be able to structure such financing on terms acceptable to us and that it will be sufficient to fund our cash requirements until we can reach a level of profitable operations and positive cash flows. If we are unable to obtain the financing necessary to support our operations, we may be unable to continue as a going concern. We currently have no firm commitments for any additional capital.
The downturn in the United States stock and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our shares of common stock or the debt securities may cause us to be subject to restrictive covenants. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek additional financing. If additional financing is not available or is not available on acceptable terms, we will have to curtail our operations.
Results of Operations
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Revenues
For the years ended December 31, 2011 and 2010, the Company generated no revenues.
Operating Expenses
Our operating expenses for the year ended December 31, 2011 were $1,951,797 and consisted of salaries and benefits ($11,317), legal and professional fees ($544,429), board compensation ($1,196,150), share-based compensation expense ($52,000) and other administrative expenses including travel to the prospective sites ($147,901). Our expenses for the year ended December 31, 2010 were $2,689,699, and consisted of salaries and benefits ($81,337), legal and professional fees ($2,134,123), share-based compensation ($312,500) and $(161,739) in other administrative expenses including travel to the prospective sites. The reason for the decrease in comparing the year ended December 31, 2011 to the same period for 2010 was due to the fact that the Company refocused operations on water reclamation opportunities in Texas. Once the Company obtains contracts for water reclamation, of which there is no guarantee, the Company expects to hire additional employees to commence its operations.
Other Income / Expense
For the year ended December 31, 2011, we had a loss on extinguishment of liabilities, net of $(823,573), loss on disposition of assets of $(60,749), interest expense of $(572,421) and change in fair value of derivative liabilities of $606,293. For the year ended December 31, 2010, we had a loss on disposition of assets of $(5,329,624), interest expense of ($1,923,176) and change in fair value of derivative liabilities of $546,041. The loss on extinguishment of liabilities in 2011 was primarily due to the modification of the GE Note. The decrease in interest expense in 2011 when compared to 2010 is because of a reduction in the amortization of debt discount and because of a reclassification of capitalized interest in 2010 to interest expense. In 2010, the Company canceled an order for equipment and recorded a loss on disposition of the asset.
Net Loss
Net loss for the years ended December 31, 2011 and 2010 was $2,819,743 and $9,396,458, respectively.
Liquidity and Capital Resources
As of December 31, 2011, we had current assets of $34,007 including cash of $7,187, and current liabilities of $5,500,199. As of December 31, 2010, we had current assets of $93,655 including cash of $6,696 and current liabilities of $5,286,542.
Operating Activities
Our operating activities resulted in net cash used in operations of $359,509 for the year ended December 31, 2011 compared to net cash used in operations of $811,325 for the year ended December 31, 2010. The net cash used in operations for the year ended December 31, 2011 reflects a net loss of $2,819,743 offset by depreciation of $3,962, amortization of debt discount and debt issuance costs of $185,970, loss on extinguishment of liabilities, net of $823,573, change in fair value of derivative instruments of $(606,293), accounts payables and other accrued expenses of $1,882,396 and other minor factors. The net cash used in operations of $811,325 for the year ended December 31, 2010 reflects a net loss of $9,396,458 offset by depreciation of $2,622, amortization of debt discount & issuance costs of $901,714, share based compensation of $312,500, the estimated fair value of equity issued for services of $1,617,188, a loss on disposition of assets of $5,329,624, change in fair value of derivative instruments of $(546,041), account payables and other accrued expenses of $1,005,767 and other minor factors. The reason for the decrease in comparing the year ended December 31, 2011 to the same period for 2010 was due to the fact that the Company refocused operations on water reclamation opportunities in Texas.
Investing Activities
Our investing activities did not generate any cash flows for the years ended December 31, 2011 and 2010.
Financing Activities
Our financing activities resulted in a cash inflow of $360,000 for the year ended December 31, 2011 and $806,400 for the year ended December 31, 2010, which represents both issuances of convertible notes payable and sales of equity by the Company, offset by repayment of notes payable and the payment of debt issuance costs.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Revenue
Revenue generated for the year ended December 31, 2010 and 2009 was $0 and $34,000, respectively. Revenues for 2009 were generated in conjunction with a test of our technology for a potential customer.
Cost of Sales
Cost of sales for the year ended December 31, 2010 and 2009 was $0 and $35,355, respectively.
Expenses
Our expenses for the year ended December 31, 2010 were $2,689,699 and consisted of salaries and benefits ($81,337), legal and professional fees ($2,134,123), share-based compensation ($312,500) and $(161,739) in other administrative expenses including travel to the prospective sites. Our expenses for the year ended December 31, 2009 were $3,532,041, and consisted of salaries and benefits ($1,654,659), legal and professional fees ($873,050), share-based compensation ($600,300) and ($404,032) in other administrative expenses including travel to prospective sites. The reason for the decrease comparing the year ended December 31, 2010 to the same period for 2009 was due to the fact that the Company refocused operations on the process for permitting sites in Pennsylvania. The Company decreased its operations from six employees to one employee during this process.
Other Income / Expense
For the year ended December 31, 2010, we had a loss on disposition of the assets of $(5,329,624), interest expense of ($1,923,176) and change in fair value of derivative liabilities of $546,041. For the year ended December 31, 2009, we had interest expense of $(895,161) and change in fair value of derivative liabilities of $5,029,533. The increase in interest expense in 2010 when compared to 2011 is primarily because of a reclassification of capitalized interest in 2010 to interest expense pursuant to the cancellation of the equipment purchase order with GE. In 2010, the Company canceled an order for equipment and recorded a loss on disposition of the asset.
Net (Loss) Income
Net (loss) income for the year ended December 31, 2010 and 2009 was $(9,396,458) and $600,976 respectively.
Liquidity and Capital Resources
As of December 31, 2010, we had current assets of $93,655 including cash of $6,696 and current liabilities of $5,286,542. As of December 31, 2009, we had current assets of $112,480 including cash of $11,621 and current liabilities of $11,988,860.
Operating Activities
Our operating activities from continuing operations resulted in a net cash used by operations of $811,325 for the year ended December 31, 2010 compared to net cash used by operations of $995,940 for the year ended December 31, 2009. The net cash used by operations for the year ended December 31, 2010 reflects a net loss of $9,396,458 offset by depreciation of $2,622, amortization of debt discount & issuance costs of $901,714, share-based compensation of $312,500, the estimated fair value of equity issued for services of $1,617,188, a loss on disposition of assets of $5,329,624, change in fair value of derivative instruments of $(546,041), account payables and other accrued expenses of $1,005,767 and other minor factors. The net cash used by operations for the year ended December 31, 2009 reflects a net income of $600,976 offset by depreciation of $21,633, amortization of debt discount & issuance costs of $720,023, shares issued for deferred compensation of $1,123,851, share-based compensation of $600,300, the estimated fair value of equity issued for services of $402,151, change in fair value of derivative instruments of $(5,029,533), account payables and other accrued expenses of $432,930 and other minor factors.
Investing Activities
Our net cash used in investing activities were $0 for the year ended December 31, 2010 and $3,387 for the year ended December 31, 2009. Cash used in investing activities for the year ended December 31, 2009 principally represents acquisition of property and equipment offset by proceeds from the sale of assets.
Financing Activities
Our financing activities resulted in a cash inflow of $806,400 for the year ended December 31, 2010 and $993,309 for the year ended December 31, 2009, which represents both issuances of notes payable and sales of equity by the Company.
Going Concern
Our consolidated financial statements (included elsewhere in this report) have been prepared on a going concern basis. The Company from Inception (January 28, 2008) through December 31, 2011, has not had any significant revenues. The Company has no significant operating history as of December 31, 2011, has accumulated losses of $13.7 million and negative cash flow from operations of $3.9 million since inception. From Inception (January 28, 2008) through December 31, 2011, management has raised net equity and debt financing of $8.8 million to fund operations and to provide working capital. However, there is no assurance that in the future such financing will be available to meet the Company’s needs.
Management has undertaken steps as part of a plan to improve operations with the goal of sustaining our operations for the next twelve months and beyond. These steps include (a) raising additional capital and/or obtaining financing; (b) executing contracts with oil and gas operators and municipal utility districts; and (c) controlling overhead and expenses. There can be no assurance that the Company can successfully accomplish these steps and it is uncertain that the Company will achieve a profitable level of operations and obtain additional financing. There can be no assurance that any additional financing will be available to the Company on satisfactory terms and conditions, if at all.
In the event the Company is unable to continue as a going concern, the Company may elect or be required to seek protection from its creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. To date, management has not considered this alternative, nor does management view it as a likely occurrence.
The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the possible inability of the Company to continue as a going concern.
Share Based Compensation
Since Inception (January 28, 2008), the Company issued 8.4 million shares of the Company’s common stock to directors, employees and certain consultants. As of December 31, 2011, 400,000 of these shares have been forfeited. During the period from Inception (January 28, 2008) through December 31, 2008, the Company recognized $233,493 in compensation cost associated with the issuance of these shares. For the years ended December 31, 2011, 2010 and 2009 the Company recognized compensation expense of $52,000, $312,500 and $600,300 respectively. At December 31, 2011, the Company had no remaining compensation cost to be recognized related to these issuances.
Warrants
As of December 31, 2011, the Company had 29,803,434 warrants outstanding to acquire the Company’s common stock.
Presently, due to the lack of revenue we are not able to meet our operating and capital expenses. The success of our ability to continue as a going concern is dependent upon successful permitting of our sites obtaining customers for water reclamation services, and maintaining a break even or profitable level of operations. We have incurred operating losses since inception, and this is likely to continue through the fourth quarter of 2012.
The financial requirements of our Company will be dependent upon the financial support through credit facilities and additional sales of our equity securities. . There can be no assurance, however, that such financing will be available or, if it is available, that we will be able to structure such financing on terms acceptable to us and that it will be sufficient to fund our cash requirements until we can reach a level of profitable operations and positive cash flows. If we are unable to obtain the financing necessary to support our operations, we may be unable to continue as a going concern. We currently have no firm commitments for any additional capital.
The downturn in the United States stock and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our shares of common stock or the debt securities may cause us to be subject to restrictive covenants. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek additional financing. If additional financing is not available or is not available on acceptable terms, we will have to curtail our operations.
Credit Facility
Presently we have no revolving credit facility established. If needed, it will be necessary to establish a line of credit and it will need to be on favorable terms.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Contractual Obligations and Commitments
The following table is a summary of contractual cash obligations for the periods indicated that existed as of December 31, 2011, and is based on information appearing in the notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K:
Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations, as well as disclosures included elsewhere in this Annual Report, are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are described in the notes to the audited consolidated financial statements contained elsewhere in this Annual Report. Included within these policies are our “critical accounting policies.” Critical accounting policies are those policies that are most important to the preparation of our consolidated financial statements and require management’s most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Although we believe that our estimates and assumptions are reasonable, actual results may differ significantly from these estimates. Changes in estimates and assumptions based upon actual results may have a material impact on our results of operations and/or financial condition.
We believe that the critical accounting policies that most impact the consolidated financial statements are as described below.
Principles of Consolidation
Our consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany balances and transactions.
Share Based Compensation
The Financial Accounting Standards Board Accounting Standard Codification (ASC) Topic 718 “Stock Compensation” requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. The effective date for the Company’s application of ASC Topic 718 was January 28, 2008 (date of inception).
There were no grants of employee options during the period from January 28, 2008 (date of inception) through December 31, 2011. There were no unvested options outstanding as of the date of the Company’s adoption of ASC Topic 718.
Property and Equipment
Property and equipment are recorded at cost and depreciation is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are capitalized and amortized over the lesser of the life of the lease or the estimated useful life of the asset.
Expenditures for major additions or improvements, which extend the useful lives of assets, are capitalized. Minor replacements, maintenance and repairs, which do not improve or extend the lives of the assets, are charged to operations as incurred. Disposals are removed at cost less accumulated depreciation, and any resulting gain or loss is reflected in current operations.
Impairment of Long-Lived Assets
The Company follows ASC Topic 360, “Property, Plant and Equipment”, which requires that long-lived assets held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses, or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon undiscounted cash flows. Should impairment in value be indicated, the carrying value of the long-lived assets will be adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset. ASC Topic 360 also requires assets to be disposed of be reported at the lower of the carrying amount or the fair value less disposal costs.
Beneficial Conversion Features and Debt Discounts
If a conversion feature of conventional convertible debt is not accounted for as a derivative instrument and provides for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF”). A BCF is recorded by the Company as a debt discount. The convertible debt is recorded net of the discount related to the BCF. The Company amortizes the discount to interest expense over the life of the debt using the effective interest rate method.
Derivative Liabilities
Certain of the Company’s embedded conversion features on debt and issued and outstanding common stock purchase warrants, which have exercise price reset features, are treated as derivatives for accounting purposes. The common stock purchase warrants were not issued with the intent of effectively hedging any future cash flow, fair value of any asset, liability or any net investment in a foreign operation. The warrants do not qualify for hedge accounting, and as such, all future changes in the fair value of these warrants are recognized currently in earnings until such time as the warrants are exercised, expire or the related rights have been waived. These common stock purchase warrants do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants and embedded conversion features using Black-Scholes.
Equity Instruments Issued to Non-Employees for Acquiring Goods or Services
Issuances of the Company’s common stock for acquiring goods or services are measured at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The measurement date for the fair value of the equity instruments issued to consultants or vendors is determined at the earlier of (i) the date at which a commitment for performance to earn the equity instruments is reached (a “performance commitment” which would include a penalty considered to be of a magnitude that is a sufficiently large disincentive for nonperformance) or (ii) the date at which performance is complete. When it is appropriate for the Company to recognize the cost of a transaction during financial reporting periods prior to the measurement date, for purposes of recognition of costs during those periods, the equity instrument is measured at the then-current fair values at each of those interim financial reporting dates.
Segment reporting
The Company operates as a single segment and will evaluate additional segment disclosure requirements as it expands its operations.
Income taxes
The Company follows ASC Topic 740, “Income Taxes” for recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability during each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change. Deferred income taxes may arise from temporary differences resulting from income and expense items reported for financial accounting and tax purposes in different periods. Deferred taxes are classified as current or non-current, depending on the classification of assets and liabilities to which they relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.
At Inception (January 28, 2008), the Company implemented the accounting guidance for uncertainty in income taxes using the provisions of ASC Topic 740 ,which is intended to clarify the accounting for income taxes prescribing a minimum recognition threshold for a tax provision before being recognized in the consolidated financial statements. This guidance also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result, the Company has concluded that it does not have any unrecognized tax benefits or any additional tax liabilities after applying this guidance. The adoption of this guidance therefore had no impact on the Company’s consolidated financial statements.
New Accounting Pronouncements
In June 2011, the FASB updated the accounting guidance on alignment of disclosures for U.S. GAAP and the International Financial Reporting Standards (“IFRS”) by updating ASC Topic 820 entitled “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”, relating to presentation of fair value measurements reported in financial statements. The updated guidance requires companies to align fair value measurement and disclosure requirements between U.S. GAAP and IFRS. The updated guidance is effective beginning in our fiscal 2012 year and earlier adoption is not permitted. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The full text of our audited consolidated financial statements as of December 31, 2011, 2010 and 2009, begins on page of this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On January 17, 2010, the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) with STW Acquisition, Inc. (“Acquisition Sub”), a wholly owned subsidiary of the Company, STW Resources, Inc. (“Acquiree”) and certain shareholders of Acquiree controlling a majority of the issued and outstanding shares of STW. On February 12, 2010, pursuant to the Merger Agreement, Acquiree merged into the Acquisition Sub resulting in an exchange of all of the issued and outstanding shares of Acquiree for shares of the Company on a one for one basis (the “Reverse Merger”). As a result of the Reverse Merger, Acquiree is now a wholly owned subsidiary of the Company and the former shareholders of STW now hold a majority of the outstanding stock of the Company.
At the time of the Reverse Merger, Weaver & Tidwell L.L.P. (the “Weaver Tidwell”) was the independent auditor of record for Acquiree. Accordingly, on February 12, 2010 (the “Engagement Date”), by reason of the Reverse Merger, Weaver Tidwell became the principal independent accountant for the Company. Therefore, on April 2, 2010, the Board of Directors of the Company dismissed Weaver & Martin LLC (the “Former Auditor”) from its position as the principal independent accountant for the Company.
On April 2, 2010 (the “Dismissal Date”), the Company advised the Former Auditor that it was dismissed as the Company’s independent registered public accounting firm. The decision to dismiss the Former Auditor as the Company’s independent registered public accounting firm was approved by the Company’s Board of Directors on April 2, 2010. Except as noted in the paragraph immediately below, the reports of the Former Auditor on the Company’s consolidated financial statements for the years ended December 31, 2009 and 2008 did not contain an adverse opinion or disclaimer of opinion, and such reports were not qualified or modified as to uncertainty, audit scope, or accounting principle.
The reports of the Former Auditor on the Company’s consolidated financial statements for the years ended December 31, 2009 and 2008 contained an explanatory paragraph which noted that there was substantial doubt as to the Company’s ability to continue as a going concern as the Company had recurring losses from operations.
During the years ended December 31, 2009 and 2008 and through the Dismissal Date, the Company has not had any disagreements with the Former Auditor on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the Former Auditor’s satisfaction, would have caused them to make reference thereto in their reports on the Company’s consolidated financial statements for such years.
During the years ended December 31, 2009 and 2008 and through the Dismissal Date, there were no reportable events, as defined in Item 304(a)(1)(v) of Regulation S-K.
The Company has requested that Former Auditor furnish it with a letter addressed to the SEC stating whether it agrees with the above statements. A copy of this letter is incorporated by reference to Exhibit 16.1.
As explained above, on the Engagement Date, Weaver Tidwell assumed the position of the principal independent accountant for the Company. During the 2010, 2009 and 2008 fiscal years and through the Engagement Date, the Company has not consulted with Weaver Tidwell regarding either:
1.
application of accounting principles to any specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s financial statements, and neither a written report was provided to the Company nor oral advice was provided that Weaver Tidwell concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue; or
2.
any matter that was either the subject of a disagreement (as defined in Regulation S-K, Item 304(a)(1)(iv) and the related instructions) or reportable event (as defined in Regulation S-K, Item 304(a)(1)(v)).
On January 25, 2012, the Company was notified that its principal independent accountant, Weaver Tidwell, had resigned as the independent auditors for the Company and its subsidiaries, effective immediately.
Weaver Tidwell’s reports on the Company's financial statements for the fiscal year ended December 31, 2010 and 2009 contained an explanatory paragraph indicating that there was substantial doubt as to the Company’s ability to continue as a going concern. Other than such statement, no reports of Weaver Tidwell on the financial statements of the Company for either of the past two years and through January 25, 2012 contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles.
During the Company’s 2010 and 2009 fiscal years and through January 25, 2012: (i) there have been no disagreements with Weaver Tidwell on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Weaver Tidwell, would have caused it to make reference to the subject matter of the disagreement in connection with its reports and (ii) Weaver Tidwell did not advise the Company of any of the events requiring reporting in this Current Report on Form 8-K under Item 304(a)(1) of Regulation S-K.
The Company provided to Weaver Tidwell the disclosure contained herein and requested Weaver Tidwell to furnish a letter addressed to the SEC stating whether it agrees with the statements made by the Company herein and, if not, stating the respects in which it does not agree. A copy of such letter is attached hereto as Exhibit 16.2.
On April 4, 2012, the Audit Committee of the Board of Directors authorized the engagement of KMJ Corbin & Company LLP ("KMJ"), a California CPA firm, with offices at 555 Anton Blvd, Suite 1000, Costa Mesa, CA, as the Company’s new independent registered public accounting firm for the 2012 and 2011 fiscal years. The decision to change accountants was recommended and approved by the Company's Board of Directors, effective March 30, 2012. During the two most recent fiscal years ended December 31, 2010 and 2009 and for the subsequent interim period through April 4, 2012, KMJ has not been engaged as independent accountants to audit the consolidated financial statements of the Company, nor has it been consulted regarding the application of accounting principles to any specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s consolidated financial statements, or any matter that was the subject of a disagreement or reportable event as defined in Items 304(a)(2)(i) and (ii) of Regulation S-K.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
We carried out an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2011, the end of the period covered by this report. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses discussed below.
Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, our principal executive officer and principal financial officer and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of us;
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures of are being made only in accordance with authorizations of our management and directors; and
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of our inherent limitations, our internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework.
The Company restated its consolidated financial statements and other financial information for the years ended December 31, 2010 and 2009, and the quarters ended March 31, 2009, June 30, 2009, September 30, 2009, March 31, 2010, June 30, 2010, September 30, 2010, March 31, 2011, June 30, 2011 and September 30, 2011, as a result of the Company’s determination that the original accounting for certain of its unit and convertible note offerings failed to appropriately record separate derivative treatment for the conversion option and the warrants issued. See the accompanying Notes to the 2011 consolidated financial statements for more information.
In connection with the restatement our Principal Executive Officer and Principal Financial Officer considered the effect of the error on the adequacy of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K for the year ended December 31, 2011. A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (“PCAOB”) Auditing Standard No. 5), or combination of control deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following six material weaknesses which have caused management to conclude that, as of December 31, 2011, our disclosure controls and procedures were not effective at the reasonable assurance level:
1.
We do not have written documentation of our internal control policies and procedures. Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and had concluded that the control deficiency that resulted represented a material weakness.
2.
We do not have sufficient segregation of duties within accounting functions, which is a basic internal control. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.
3.
We had not effectively implemented comprehensive entity-level internal controls.
4.
We did not have a sufficient complement of personnel with appropriate training and experience in accounting principles generally accepted in the United States of America, or GAAP.
5.
We did not implement financial controls that were properly designed to meet the control objectives or address all risks of the processes or the applicable assertions of the significant accounts.
6.
Due to material weaknesses identified at our entity level controls we did not test whether our financial activity level controls or our information technology general controls were operating sufficiently to identify a deficiency, or combination of deficiencies, that may result in a reasonable possibility that a material misstatement of the consolidated financial statements would not be prevented or detected on a timely basis.
Remediation of Material Weaknesses. While management believes that the Company’s financial statements previously filed in the Company’s SEC reports have been properly recorded and disclosed in accordance with US GAAP, based on the control deficiencies identified above, we have designed and plan to implement, or in some cases have already implemented, the specific remediation initiatives described below:
·
We are in the process of further enhancing our internal finance and accounting organizational structure, which includes hiring additional resources.
·
We are in the process of further enhancing the supervisory procedures to include additional levels of analysis and quality control reviews within the accounting and financial reporting functions.
·
We are in the process of strengthening our internal policies and enhancing our processes for ensuring consistent treatment and recording of reserve estimates and that validation of our conclusions regarding significant accounting policies and their application to our business transactions are carried out by personnel with an appropriate level of accounting knowledge, experience and training.
We do not expect to have fully remediated these material weaknesses until management has tested those internal controls and found them to have been remediated. We expect to complete this process during our annual testing for fiscal 2012.
Management has reviewed the consolidated financial statements and underlying information included herein in detail and believes the procedures performed are adequate to fairly present our financial position, results of operations and cash flows for the periods presented in all material respects.
This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to such attestation pursuant to rules of the Securities and Exchange Commission that permits us to provide only management’s report in this Annual Report.
Changes in Internal Control over Financial Reporting
No changes in the Company's internal control over financial reporting have come to management's attention during the Company's last fiscal quarter that have materially affected, or are likely to materially affect, the Company's internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The names, ages and positions of our directors and executive officers as of October 10, 2012, are as follows:
All directors hold office until the next annual meeting of stockholders and the election and qualification of their successors. Officers are elected annually by the board of directors and serve at the discretion of the board.
The principal occupations for the past five years (and, in some instances, for prior years) of each of our directors and executive officers are as follows:
Stanley Weiner, Director, Chief Executive Officer and Principal Accounting Officer
Stanley T. Weiner, a 30 year veteran of the oil and gas industry, has explored, drilled and operated oil and gas properties in the United States and in South America. Previously, Mr. Weiner served as president and CEO of Molecular Solutions, LLC, and was founder and CEO of Weiner Investments Inc, and American Crude Oil, Inc.
Joseph O’Neill, Director
Joseph I. O’Neill III has close to 40 years of experience in the oil and gas industry. He currently serves as Managing Partner of O’Neill Properties, a highly regarded Midland, Texas oil and gas producer. Mr. O’Neill is the Chairman of the Board of Texas Oil & Gas Association and is a Director of the Petroleum Club of Midland. He has served on the boards of numerous industries, civic, academic, political and charitable institutions. He is a graduate of Notre Dame University and formerly on the Board of Directors and a past President of the Notre Dame Alumni Association.
The Hon. Bill Carter, Director
The Hon. Bill Carter is a former Member of the Texas House of Representatives (1984-2003) and is former Chairman of the Texas Public Safety Committee. In addition to receiving the 1997 American Legislative Exchange Council Legislator of the Year Award, Mr. Carter has received numerous state and national awards, including Outstanding Legislator Award from the Texas Chiropractic Association, the Legislative Excellence Award from the Texas Head Injury Association, the Greater Dallas Crime Commission Crime Fighter of the Year, the Outstanding Legislator in Texas from the Texas Association of Regional Councils, and the Presidential Achievement Award from President Ronald Reagan.
Manfred Birnbaum, Director
Manfred Birnbaum’s career spans 30 years in power generation and industrial business. His experience ranges from Senior Management positions at Westinghouse Electric Corporation to high tech start-up operations, power plant control, and electronic manufacturing services in both domestic and international markets. He currently serves on the Board of ZBB Energy Corp., a public company engaged in the design and manufacture of energy storage solutions to the renewable energy and electric utility markets.
Paul DiFrancesco, Director
Paul C. DiFrancesco has over twenty years of experience in the financial sector. Mr. DiFrancesco is currently a Managing Director at Ascendiant Capital, a registered broker-dealer that provides investment banking services to emerging growth companies. Prior to joining Ascendiant Capital, Mr. DiFrancesco was a Partner at Viewpoint Securities. In 2001, Mr. DiFrancesco co-founded and was the President of Decision Capital Management, LLC. Prior to co-founding Decision, Mr. DiFrancesco was Senior Managing Director of Preferred Capital Markets in San Francisco. During Mr. DiFrancesco's tenure, Preferred Capital Markets was named by Fortune Magazine several years running, as one of the top 100 fastest growing private companies. In 1995, Mr. DiFrancesco joined Apodaca-Johnston Investment Group as Managing Director and as a member of the Investment Committee. In 1990, Mr. DiFrancesco joined Torrey Pines Securities, where he built and managed the trading desk.
Dale F. Dorn, Director
Mr. Dorn brings more than 40 years of experience in the oil & gas industry. Most recently, he founded and serves as CEO of Dale F. Dorn Oil & Gas Minerals, a privately held company that acquires and trades minerals, which he has been with for aver 10 years. Previous oil & gas experience includes 30 years in roles of increasing responsibility with the Forest Oil Corporation, rising from Landman to Vice President to Director and ultimately spending six years as the President of Flare, Inc., Forest’s frontier exploration subsidiary. For two years, Mr. Dorn worked in Oil & Gas Investment Banking, under Jim Glanville, with Lehman Brothers. He also founded Bradford Natural Gas Corp., a company that exported natural gas to Mexico.
D. Grant Seabolt, Jr., Director
Mr. Seabolt is an "AV" Preeminent® rated, 33-year law practitioner with the Dallas, Texas based Seabolt Law Group, where he advises entrepreneurs, start-up companies and mature companies in business transactions, including mergers and acquisitions, capital raising, securities law and corporate finance. He also represents U.S.A. clients in foreign business transactions and foreign clients in the U.S.A. He is retired from the Marine Corps Reserves (attaining rank of Colonel in the Reserves as an International Law Specialist for Europe and Africa). He holds an LL.M (International Law, with highest honors ) from the National Law Center of the George Washington University, 1984; a J.D. from the Univ. of Alabama School of Law, 1979; and a B.A. (Accounting) from Birmingham-Southern College, 1976. Mr. Seabolt currently serves as the Company’s Outside General Counsel and Corporate Secretary, and serves on the Company’s Audit, Compliance and Compensation Committees.
Family Relationships
None.
Board Qualifications
The Board believes that each of our directors is highly qualified to serve as a member of the Board. Each of the directors has contributed to the mix of skills, core competencies and qualifications of the Board. When evaluating candidates for election to the Board, the Company seeks candidates with certain qualities that it believes are important, including integrity, an objective perspective, good judgment, leadership skills. Our directors are highly educated and have diverse backgrounds and talents and extensive track records of success in what we believe are highly relevant positions.
To our knowledge, during the last ten years, none of our directors and executive officers (including those of our subsidiaries) has:
● Had a bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time.
●
Been convicted in a criminal proceeding or been subject to a pending criminal proceeding, excluding traffic violations and other minor offenses.
●
Been subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities.
●
Been found by a court of competent jurisdiction (in a civil action), the SEC, or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
●
Been the subject to, or a party to, any sanction or order, not subsequently reverse, suspended or vacated, of any self-regulatory organization, any registered entity, or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
Our business, property and affairs are managed by or under the direction of the board of directors. Members of the board are kept informed of our business through discussion with the chief executive and financial officers and other officers, by reviewing materials provided to them and by participating at meetings of the board and its committees.
Audit Committee
The Board of Directors acts as the audit committee. The Company does not have a qualified financial expert at this time because it has not been able to hire a qualified candidate. Further, the Company believes that it has inadequate financial resources at this time to hire such an expert. The Company intends to continue to search for a qualified individual for hire.
Compensation Committee
The Board of Directors acts as the compensation committee.
Director Compensation
Directors are expected to timely and fully participate in all regular and special board meetings, and all meetings of committees that they serve on. We compensate directors through the grant of 200,000 shares of common stock and the payment of a cash fee equal to $1,000 plus travel expenses for each board meeting attended, and $75,000 per year as compensation for serving on our board of directors.
The following table sets forth summary information concerning the total compensation paid or payable to our directors for services to our company.
Code of Ethics
We have not adopted a Code of Business Conduct and Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions because of the small number of persons involved in the management of the Company.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than 10 percent of a registered class of our equity securities, to file reports of ownership and changes in ownership with the SEC. During the fiscal year ended December 31, 2011, all Section 16(a) filing requirements applicable to our officers, directors and greater than 10% beneficial owners were complied with.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The table below sets forth, for the last two fiscal years, the compensation earned by (i) each individual who served as our principal executive officer or principal financial officer during the last fiscal year and (ii) our most highly compensated executive officer, other than those listed in clause (i) above, who were serving as executive officers at the end of the last fiscal year (together, the “Named Executive Officers”). No other executive officer had annual compensation in excess of $100,000 during the last fiscal year.
Outstanding Equity Awards at Fiscal Year-End
There were no outstanding unexercised options, unvested stock, and/or equity incentive plan awards issued to our named executive officers as of December 31, 2011.
Employment Agreements
None.
Indemnification Agreements
We entered into indemnification agreements with each of our directors pursuant to which we have agreed to indemnify such party to the full extent permitted by law, subject to certain exceptions, if such party becomes subject to an action because such party is our director.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information, as of October 10, 2012 with respect to the beneficial ownership of the outstanding common stock by (i) any holder of more than five (5%) percent; (ii) each of the Company’s executive officers and directors; and (iii) the Company’s directors and executive officers as a group. Except as otherwise indicated, each of the stockholders listed below has sole voting and investment power over the shares beneficially owned.
(1)
Except as otherwise indicated, the address of each beneficial owner is c/o STW Resources Holding Corp. 619 West Texas Avenue, Suite 126, Midland, Texas 79701.
(2)
Applicable percentage ownership is based on 85,558,598 shares of common stock outstanding as of October 10, 2012, together with securities exercisable or convertible into shares of common stock within 60 days of October 10, 2012 for each stockholder. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of common stock that are currently exercisable or exercisable within 60 days of October 10, 2012 are deemed to be beneficially owned by the person holding such securities for the purpose of computing the percentage of ownership of such person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person.
(3)
Mr. Weiner is the beneficial owner of 19,554,003 shares of common stock, warrants to purchase 2,196,378 shares of common stock and $102,219 face value and accrued PIK interest, convertible at $0.08.
(4)
Mr. Dorn is the beneficial owner of 3,345,000 shares of common stock, warrants to purchase 517,500 shares of common stock and $109,995 face value and accrued PIK interest, convertible at $0.08.
(5)
MKM Opportunity Master Fund (“MKM”) is the beneficial owner of 1,006,250 shares of common stock, warrants to purchase 4,633,500 shares of common stock and $823,932 face value of notes and accrued PIK interest, convertible at $0.08. Pursuant to an agreement between the Company and MKM, the beneficial ownership of MKM is capped at 9.99%.
(6)
Calibre Fund SPC (“Calibre”) is the beneficial owner of 745,000 shares of common stock, warrants to purchase 4,080,000 shares of common stock and $548,056 face value of notes and accrued PIK interest, convertible at $0.08. Pursuant to an agreement between the Company and Calibre, the beneficial ownership of Calibre is capped at 9.99%.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
In connection with the Company’s capital raising activities, the Company had incurred, as of December 31, 2009, a total of $982,787 in fees and expenses payable to Viewpoint Securities, LLC (“Viewpoint”), the Company’s financial and capital markets advisor at that time, and of which one of its partners is a member of the Company’s Board of Directors and issued, pursuant to the terms of its arrangement with Viewpoint, 1,200,000 shares of common stock and 549,900 warrants to purchase one and one-half shares of the Company’s common stock on the same terms as the warrants issued in the $2.00 Unit Offering. The exercise price of these warrants is subject to anti-dilution adjustments and hence are considered derivative instruments and accounted for as such. In addition, the Company issued a warrant to purchase 352,296 shares of the Company’s common stock on the same terms as the warrants issued with the 2009 12% Convertible Notes, except that these warrants did not have any anti-dilution rights.
During the year ended December 31, 2010, the Company incurred $123,823 in fees and expenses payable to Viewpoint and issued, pursuant to the terms of its arrangement with Viewpoint, 2,000,000 shares of common stock and 169,200 warrants to purchase one and one-half shares of the Company’s common stock on the same terms as the warrants issued with the 2010 12% Convertible Notes, and 130,000 warrants to purchase shares of the Company’s common stock on the same terms as the warrants issued with the December 2010 Unit offering. The warrants did not have any anti-dilution rights.
During the year ended December 31, 2011, the Company incurred $73,500 in fees and expenses payable to Viewpoint, and a warrant to purchase 566,667 shares of the Company’s common stock with an exercise price of $0.20 per share and exercisable for a period of two years from the date of issuance.
At December 31, 2011, 2010, and 2009, the Company had a balance due Viewpoint of $202,728, $139,227 and $142,787 respectively, recorded in accounts payable.
At December 31 2011, 2010 and 2009, the Company had accrued compensation for amounts due to the officers of the Company, of $249,480, $37,630 and $0 respectively.
Director Independence
Four of our directors, Joseph O’Neill, Hon. Bill Carter, Manfred Birnbaum, and Dale F. Dorn are independent directors, using the Nasdaq definition of independence.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table represents aggregate fees billed to us for fiscal years ended December 31, 2011 and 2010, by KMJ Corbin and Company LLP our principal accountant for 2011, and Weaver & Tidwell, L.L.P., our principal accountant for 2010.
1)
Audit Fees -This category includes the audit of our annual financial statements, review of financial statements included in our Quarterly Reports on Form 10-Q, and services that are normally provided by independent auditors in connection with the engagement for fiscal years.
* Includes $42,300 billed by Weaver & Tidwell, L.L.P. for the review of financial statements in our Quarterly Reports on Form 10-Q during the year ended December 31, 2011
2)
Audit-Related Fees - This category consists of fees reasonably related to the performance of the audit or review of our financial statements, including assurance and related services rendered by our principal accountants related to the performance of the audit or review of our financial statements, that are not reported as “Audit Fees.”
3)
Tax Fees - This category consists of tax compliance, tax advice and tax planning work.
4)
All Other Fees - This category consists of fees for other miscellaneous items.
Consistent with SEC policies and guidelines regarding audit independence, the Audit Committee is responsible for the pre-approval of all audit and permissible non-audit services provided by our principal accountants on a case-by-case basis. Our Audit Committee has established a policy regarding approval of all audit and permissible non-audit services provided by our principal accountants. Our Audit Committee pre-approves these services by category and service. Our Audit Committee has pre-approved all of the services provided by our principal accountants.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1) Incorporated by reference to the Registration Statement on Form SB-2, previously filed with the Securities and Exchange Commission on September 26, 2006.
(2) Incorporated by reference to Registrant’s Definitive Information Statement on Schedule 14C filed with the Securities and Exchange Commission on September 4, 2008.
(3) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on January 26, 2010.
(4) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on February 19, 2010.
(5) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on March 2, 2010.
(6) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on March 9, 2010.
(7) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on April 5, 2010.
(8) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on September 16, 2010.
(9) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on September 22, 2010.
(10) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on December 10, 2010.
(11) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on November 3, 2011.
(12) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on April 26, 2011.
(13) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on November 23, 2011.
(14) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on February 2, 2012.
(15) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on April 10, 2012.
(16) Incorporated by reference to the Form 8-K Current Report filed with the Securities and Exchange Commission on May 11, 2012.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE
TITLE
DATE
/s/ Stanley Weiner
Chief Executive Officer, President and Director
(Principal Executive Officer, Principal Financial and Accounting Officer)
October 22, 2012
Stanley Weiner
Director
Joseph O’Neill
/s/ Hon. Bill Carter
Director
October 14, 2012
Hon. Bill Carter
/s/ D. Grant Seabolt, Jr.
Director
October 22, 2012
D. Grant Seabolt, Jr.
Director
Dale F. Dorn
/s/ Paul DiFrancesco
Director
October 18, 2012
Paul DiFrancesco
Director
Manny Birnbaum
STW RESOURCES HOLDING CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of STW Resources Holding Corp.
We have audited the accompanying consolidated balance sheet of STW Resources Holding Corp. (a development stage company) (the “Company”) as of December 31, 2011, and the related consolidated statements of operations, shareholders’ equity (deficit) and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We did not audit the cumulative data from January 28, 2008 (date of inception) to December 31, 2010 in the consolidated statements of operations, shareholders' equity (deficit) and cash flows, which was audited by other auditors whose report, dated April 15, 2011, except for Note 12 as to which the date is October 19, 2012, expressing an unqualified opinion (which report includes an explanatory paragraph related to the uncertainty of the Company's ability to continue as a going concern and an explanatory paragraph regarding the Company’s restatement of its 2010 and 2009 consolidated financial statements) has been furnished to us. The consolidated financial statements for the period from January 28, 2008 (date of inception) to December 31, 2010 reflect total revenues and net loss of $34,000 and $10,903,961, respectively, of the related totals. Our opinion, insofar as it relates to the amounts included for the cumulative data from January 28, 2008 (date of inception) to December 31, 2010 is based solely on the report of other auditors.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit on its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of STW Resources Holding Corp. as of December 31, 2011, and the consolidated results of their operations and their cash flows for the year then ended and for the cumulative period from January 28, 2008 (date of inception) to December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As more fully described in Note 1 to the consolidated financial statements, the Company has incurred significant operating losses and has had negative cash flows from operations since inception, and at December 31, 2011, has a deficit accumulated during the development stage of $13,723,704. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments to reflect possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
October 23, 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of STW Resources Holding Corp.
(A Development Stage Company)
We have audited the accompanying consolidated balance sheets of STW Resources Holding Corp. (the Company) (a Development Stage Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended and for the period from inception (January 28, 2008) to December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 12, subsequent to the issuance of its 2010 financial statements the Company discovered an error in its accounting for certain anti-dilution provisions that adjust the exercise price of the related warrants based on the exercise price of future issuances. Therefore, the 2010 and 2009 financial statements have been restated.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of STW Resources Holding Corp. as of December 31, 2010 and 2009 and the results of its operations and cash flows for the years then ended and for the period from inception (January 28, 2008) to December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company is in the development stage, has not attained profitable operations and is dependent upon obtaining adequate financing to fulfill its business activities. These factors raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Houston, Texas
/s/ Weaver and Tidwell LLP
WEAVER AND TIDWELL, LLP
Houston, Texas
April 15, 2011, except for Note 12, as to which the date is October 19, 2012.
STW RESOURCES HOLDING CORP.
(A Development Stage Company)
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
STW RESOURCES HOLDING CORP.
(A Development Stage Company)
Consolidated Statements of Operations
The accompanying notes are an integral part of these consolidated financial statements.
STW RESOURCES HOLDING CORP.
(A Development Stage Company)
Consolidated Statements of Shareholders' Equity (Deficit)
For the years ended December 31, 2011, 2010 and 2009 and for the period from January 28, 2008 (Inception) through December 31, 2011
The accompanying notes are an integral part of these consolidated financial statements.
STW RESOURCES HOLDING CORP.
(A Development Stage Company)
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
STW RESOURCES HOLDING CORP.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 2011, 2010 and 2009 and for the period from January 28, 2008 (Inception) through December 31, 2011
1. Organization, Nature of Activities and Summary of Significant Accounting Policies
STW Resources Holding Corp., (“STW” or the “Company”, f/k/a Woozyfly Inc. and STW Global Inc.) is a development stage corporation formed to utilize state of the art water reclamation technologies to reclaim fresh water from highly contaminated oil and gas hydraulic fracture flow-back salt water that is produced in conjunction with the production of oil and gas. STW has been working to establish contracts with oil and gas operators for the deployment of multiple water reclamation systems throughout Texas, Arkansas, Louisiana and the Appalachian Basin of Pennsylvania and West Virginia. STW, in conjunction with energy producers, operators, various state agencies and legislators, is working to create an efficient and economical solution to this complex problem. The Company is also evaluating the deployment of similar technology in the municipal wastewater industry.
The Company’s operations are located in the United States of America and the principal executive offices are located at 619 W. Texas Ave. Ste. 126, Midland, TX 79701.
On January 17, 2010, the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) with STW Acquisition, Inc. (“Acquisition Sub”), a wholly owned subsidiary of STW Resources, Inc. (“STWR” ) and certain shareholders of STWR controlling a majority of the issued and outstanding shares of STWR. Pursuant to the Merger Agreement, STWR merged into the Acquisition Sub resulting in an exchange of all of the issued and outstanding shares of STWR for shares of the Company on a one for one basis. At such time, STWR became a wholly owned subsidiary of the Company.
On February 9, 2010, the Court entered an order confirming the Second Amended Plan of Reorganization (the “Plan”) pursuant to which the Plan and the Merger Agreement were approved. The Plan was effective February 19, 2010 (the “Effective Date”). The principal provisions of the Plan were as follows:
●
MKM, the DIP Lender, received 400,000 shares of common stock and 2,140,000 shares of preferred stock;
●
the holders of the Convertible Notes received 1,760,000 shares of common stock;
●
general unsecured claims received 100,000 shares of common stock; and
●
the Company’s equity interest was extinguished and cancelled.
On February 12, 2010, pursuant to the terms of the Merger Agreement, STWR merged with and into Acquisition Sub, which became a wholly-owned subsidiary of the Company (the “Merger”). In consideration for the Merger and STWR becoming a wholly-owned subsidiary of the Company, the Company issued an aggregate of 31,780,004 (the “STW Acquisition Shares”) shares of common stock to the shareholders of STWR at the closing of the Merger and all derivative securities of STWR as of the Merger became derivative securities of the Company including options and warrants to acquire 12,613,002 shares of common stock at an exercise price ranging from $3.00 to $8.00 with an exercise period ranging from July 31, 2011 through November 12, 2014 and convertible debentures in the principal amount of $1,467,903 with a conversion price of $0.25 and maturity dates ranging from April 24, 2010 through November 12, 2010.
The par value of the exchanged shares changed from $0.00001 to $0.001. All share amounts presented throughout this document reflect this change in par value.
Considering that, following the Merger, the shareholders of the Company control the majority of our outstanding voting common stock and effectively succeeded our otherwise minimal operations to those that are theirs, the Company is considered the accounting acquirer in this reverse-merger transaction. A reverse-merger transaction is considered, and accounted for as, a capital transaction in substance; it is equivalent to the issuance of the Company’s securities for our net monetary assets, which are deminimus, accompanied by a recapitalization. Accordingly, the Company has not recognized any goodwill or other intangible assets in connection with this reverse merger transaction.
Effective March 1, 2010, Woozyfly, Inc. changed its name to STW Global, Inc. in accordance with the Bankruptcy proceeding. On March 3, 2010, the Company changed its name to STW Resources Holding Corp. The name change was accomplished by merging a wholly owned subsidiary of the Company into the Company resulting in the Company being the surviving Company and changing the name of the Company.
STW Resources Holding Corp. is the surviving and continuing entity and the historical financial statements following the reverse merger transaction are those of STW. WoozyFly was a "shell company" (as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) immediately prior to its acquisition of STW pursuant to the terms of the Merger Agreement. As a result of such acquisition, WoozyFly’s operations are now focused on the provision of customized water reclamation services. Consequently, management believes that the acquisition has caused WoozyFly to cease to be a shell company as it no longer has nominal operations.
Status of Relationship with GE Water & Process Technologies
On August 31, 2010, the Company entered into a settlement agreement with GE Water & Process Technologies (“GE Water”) to terminate the purchase order and related teaming agreements to construct a water reclamation unit. The terms of the settlement agreement include GE Water retaining the water reclamation unit, forgiveness of the Company’s liability to GE Water associated with the water reclamation unit, and established a $1,400,000 note payable (“GE Note”) to GE Water.
Pursuant to the terms of the settlement agreement, the Company recorded a $5,329,624 loss on disposition of asset as a result of the write off of $13,992,988 of work in process and capitalized interest on the evaporator system from GE Water, $10,063,364 of accounts payable and accrued interest, as well as recording $1,400,000 of notes payable (see Note 4).
Going Concern
These consolidated financial statements have been prepared on a going-concern basis which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The Company from January 28, 2008 (Inception) through December 31, 2011, has not had any significant revenues. The Company has no significant operating history as of December 31, 2011, has a deficit accumulated during the development stage of $13.7 million and negative cash flow from operations of $3.9 million since inception. These factors raise substantial doubt about our ability to continue as a going concern. From Inception through December 31, 2011, management has raised net equity and debt financing of $8.8 million to fund operations and to provide working capital. However, there is no assurance that in the future such financing will be available to meet the Company’s needs.
Management has undertaken steps as part of a plan to improve operations with the goal of sustaining our operations for the next twelve months and beyond. These steps include (a) raising additional capital and/or obtaining financing; (b) executing contracts with oil and gas operators and municipal utility districts; and (c) controlling overhead and expenses. There can be no assurance that the Company can successfully accomplish these steps and it is uncertain that the Company will achieve a profitable level of operations and obtain additional financing. There can be no assurance that any additional financing will be available to the Company on satisfactory terms and conditions, if at all.
The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the possible inability of the Company to continue as a going concern.
Basis of Presentation
The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S”)(“GAAP”). Certain reclassifications have been made to prior periods presented to conform with current period presentation.
Principles of Consolidation
These consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, STW Resources, Inc. All intercompany transactions and balances have been eliminated upon consolidation.
Subsequent Events
The Company has evaluated subsequent events through the filing date of this Form 10-K, and determined that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes thereto other than as disclosed in the accompanying notes.
Development Stage Enterprise
The Company is a development stage company as defined by the Financial Accounting Standards Board (the “FASB”). The Company is devoting substantially all of its present efforts to establish a new business, and its planned principal operations have not yet commenced. All losses accumulated since inception have been considered as part of the Company’s development stage activities.
These consolidated financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. The Company is a development stage enterprise and has sustained significant losses since inception and expects to continue to incur losses through 2012.
Revenue Recognition
The Company will recognize revenues in accordance with FASB guidance, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) will be based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments will be provided for in the same period the related sales are recorded. The Company will defer any revenue for which the product has not been delivered or for which services have not been rendered or are subject to refund until such time that the Company and the customer jointly determine that the product has been delivered or services have been rendered or no refund will be required.
As of December 31, 2011, the Company had not generated significant revenues and the Company does not anticipate that it will generate any significant revenues until the fourth quarter of 2012.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make 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 and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s significant estimates include recoverability of long-lived assets, valuation of deferred tax assets and the valuation of derivative liabilities, conversion options, and share-based transactions.
Concentration of Credit Risk
A financial instrument that potentially subjects the Company to concentration of credit risk is cash. The Company places its cash with financial institutions deemed by management to be of high credit quality. The Federal Deposit Insurance Corporation (“FDIC”) provides basic deposit coverage with limits to $250,000 per owner. In addition to the basic insurance deposit coverage, the FDIC is providing temporary unlimited coverage for noninterest-bearing transaction accounts from December 31, 2010 to December 31, 2012. At December 31, 2011, there were no uninsured deposits.
The Company anticipates entering into long-term, fixed-price contracts for its services with select oil and gas producers and municipal utilities. The Company will control credit risk related to accounts receivable through credit approvals, credit limits and monitoring procedures.
As of December 31, 2011, 2010 and 2009, three vendors accounted for 77% of total accounts payable, three vendors accounted for 71% of total accounts payable and one vendor accounted for 93% of total accounts payable, respectively. Two vendors, three vendors and one vendor accounted for 48%, 69% and 37% of purchases for the years ended December 31, 2011, 2010 and 2009, respectively.
Property and Equipment
Property and equipment are recorded at cost and depreciation is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are capitalized and amortized over the lesser of the life of the lease or the estimated useful life of the asset.
Expenditures for major additions or improvements, which extend the useful lives of assets, are capitalized. Minor replacements, maintenance and repairs, which do not improve or extend the lives of the assets, are charged to operations as incurred. Disposals are removed at cost less accumulated depreciation or amortization, and any resulting gain or loss is reflected in current operations.
Impairment of Long-Lived Assets
The Company accounts for its long-lived assets in accordance with FASB Accounting Standards Codification (“ASC”) Topic 360, “Property, Plant and Equipment”, which requires that long-lived assets held and used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses, or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon undiscounted cash flows. If the future net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying value and fair value or disposable value. As of December 31, 2011, 2010 and 2009, we do not believe there has been any impairment of our long-lived assets other than the write-off of $13,992,988 of work in process and capitalized interest on the evaporator system from GE Water during the year ended December 31, 2010 (see Note 1). There can be no assurance, however, that market conditions will not change or demand for our products will continue, which could result in impairment of long-lived assets in the future.
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash, notes payable, convertible notes payable, accounts payable, accrued expenses and derivative liabilities. The carrying value for all such instruments except convertible notes payable and derivative liabilities approximates fair value due to the short-term nature of the instruments. The Company cannot determine the estimated fair value of its convertible notes payable as instruments similar to the convertible notes payable could not be found. Our derivative liabilities are recorded at fair value (see Note 5).
We determine the fair value of our financial instruments based on a three-level hierarchy for fair value measurements under which these assets and liabilities must be grouped, based on significant levels of observable or unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect management’s market assumptions. This hierarchy requires the use of observable market data when available. These two types of inputs have created the following fair-value hierarchy:
Level 1 - Valuations based on unadjusted quoted market prices in active markets for identical securities. Currently, we do not have any items classified as Level 1.
Level 2 - Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. Currently, we do not have any items classified as Level 2.
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment. We use the Black-Scholes-Merton option pricing model (“Black-Scholes”) to determine the fair value of the financial instruments.
If the inputs used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy level is based upon the lowest level of input that is significant to the fair value measurement.
Our derivative liabilities consist of embedded conversion features on debt and price protection features on warrants which are carried at fair value, and are classified as Level 3 liabilities. We use Black-Scholes to determine the fair value of these instruments (see Note 5).
Beneficial Conversion Features and Debt Discounts
If a conversion feature of conventional convertible debt is not accounted for as a derivative instrument and provides for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF”). A BCF is recorded by the Company as a debt discount. The convertible debt is recorded net of the discount related to the BCF. The Company amortizes the discount to interest expense over the life of the debt using the effective interest rate method.
Derivative Liabilities
Certain of the Company’s embedded conversion features on debt and issued and outstanding common stock purchase warrants, which have exercise price reset features, are treated as derivatives for accounting purposes. The common stock purchase warrants were not issued with the intent of effectively hedging any future cash flow, fair value of any asset, liability or any net investment in a foreign operation. The warrants do not qualify for hedge accounting, and as such, all future changes in the fair value of these warrants are recognized currently in earnings until such time as the warrants are exercised, expire or the related rights have been waived. These common stock purchase warrants do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants and embedded conversion features using Black-Scholes (see Note 5).
Share-Based Compensation
The Company accounts for share-based compensation under the fair value recognition provisions of ASC Topic 718, “Stock Compensation.”
There were no grants of employee options during the period from January 28, 2008 (Inception) through December 31, 2011.
Equity Instruments Issued to Non-Employees for Acquiring Goods or Services
Issuances of the Company’s common stock for acquiring goods or services are measured at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The measurement date for the fair value of the equity instruments issued to consultants or vendors is determined at the earlier of (i) the date at which a commitment for performance to earn the equity instruments is reached (a “performance commitment” which would include a penalty considered to be of a magnitude that is a sufficiently large disincentive for nonperformance) or (ii) the date at which performance is complete. When it is appropriate for the Company to recognize the cost of a transaction during financial reporting periods prior to the measurement date, for purposes of recognition of costs during those periods, the equity instrument is measured at the then-current fair values at each of those interim financial reporting dates (see Note 6).
Basic and Diluted Loss per Share
The Company’s basic earnings (loss) per share (“EPS”) amounts have been computed based on the weighted-average number of shares of common stock outstanding for the period. Diluted EPS reflects the potential dilution, using the treasury stock method and as-if-converted method for convertible debt, which could occur if all potentially dilutive securities were exercised. As the Company realized a net loss for the years ended December 31, 2011 and 2010, no potentially dilutive securities were included in the calculation of diluted earnings per share as their impact would have been anti-dilutive. See Note 6 for a list of all dilutive securities as of December 31, 2011, 2010 and 2009.
The following presents the basic and diluted earnings (loss) per share for the years ended December 31, 2011, 2010 and 2009.
Diluted net income per share for the year ended December 31, 2009, excludes the impact of 10.7 million warrants because the exercise price per share for those warrants exceeds the average market price of the Company’s common stock during the period.
The conversion price of the Company’s debt assumed in the calculation of diluted earnings per share for the year ended December 31, 2009 is $0.25 per share, based on the conversion price that would have been in effect.
Segment Reporting
The Company operates as a single segment and will evaluate additional segment disclosure requirements as it expands its operations.
Income Taxes
The Company accounts for its income taxes in accordance with ASC Topic 740, “Income Taxes”. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability during each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change. Deferred income taxes may arise from temporary differences resulting from income and expense items reported for financial accounting and tax purposes in different periods. Deferred taxes are classified as current or non-current, depending on the classification of assets and liabilities to which they relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.
ASC Topic 740, which clarifies the accounting for uncertainty in income taxes recognized in the financial statements, provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more likely than not recognition threshold. As of December 31, 2011, 2010 and 2009, there were no unrecognized tax benefits included in the accompanying consolidated balance sheets that would, if recognized, affect the effective tax rates. It is not anticipated that there will be a significant change in the unrecognized tax benefits over the next twelve months.
The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties on its consolidated balance sheets at December 31, 2011, 2010 and 2009, respectively, and has not recognized interest and/or penalties in the consolidated statements of operations for the years ended December 31, 2011, 2010 and 2009.
New Accounting Pronouncements
In June 2011, the FASB updated the accounting guidance on alignment of disclosures for U.S. GAAP and the International Financial Reporting Standards (“IFRS”) by updating ASC Topic 820 entitled “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”, relating to presentation of fair value measurements reported in financial statements. The updated guidance requires companies to align fair value measurement and disclosure requirements between U.S. GAAP and IFRS. The updated guidance is effective beginning in our fiscal 2012 year and earlier adoption is not permitted. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.
2. Property and Equipment
The Company recognized total depreciation expense of $3,962, $2,622 and $21,633 during the years ended December 31, 2011, 2010 and 2009, respectively. Property and equipment consists of computer equipment, vehicles and furniture and fixtures which carry useful lives ranging from three to five years.
As discussed in Note 1, on August 31, 2010, the Company entered into a settlement agreement with GE Water to terminate the purchase order and related teaming agreement to construct a water reclamation unit. As a result, the Company recorded a $5,329,624 loss on disposition of asset. As of December 31, 2011 and 2010 the only balance recorded related to the water reclamation unit was the note payable to GE Water, see Note 4.
3. Joint Ventures and Acquisitions
On August 5, 2010, the Company entered into a Joint Venture Agreement (the “JV Agreement”) with Aqua Verde, LLC (“AV”). Pursuant to the JV Agreement, STW and AV agreed to collectively work together through the joint venture to procure water reclamation contracts with natural gas drilling companies in the states of Colorado and Texas. In addition, AV would assign all of its existing master services agreements and master services contracts to the joint venture. The joint venture was to be named Water Reclamation Partners, LLC, and owned 51% by the Company and 49% by AV, with the Company having exclusive control and management of the business of the joint venture. The term of the JV Agreement was one year, unless extended by mutual agreement. During the term, there were no operations within the joint venture, and AV had not contributed the master services contracts to the joint venture, and the JV Agreement expired. There was no impact on the accompanying consolidated financial statements as a result of this transaction.
On April 17, 2011, the Company entered into a binding letter of intent (the “LOI”) to purchase a group of three privately held limited liability companies (the “Transaction”). The Transaction contemplated that the acquisition would be comprised of two different parts: (a) an asset purchase of JNC Energy Systems, LLC, a Texas limited liability company (“JNC”) and (b) a purchase of membership interests of Green Line Power LLC, a Texas limited liability company (“GLP”) and TexRep7, LLC, a Delaware limited liability company, d/b/a/ Saturn Power (“REP” and together with JNC and GLP, the “Power Co”). In connection with the acquisition of JNC, the Company agreed to pay, at closing of the Transaction, JNC’s outstanding loan with West Texas State Bank.
The purchase price to be paid by the Company for Power Co would be paid as follows: $450,000 in cash, 3,000,000 shares of the Company’s common stock, and a note in the aggregate principal amount of $90,000, payable 13 months from the date of issuance, accruing simple interest at 12 month LIBOR at closing plus 2%, and payable at maturity.
The Transaction was subject to the execution of definitive agreements and contingent on a number of customary closing conditions, including the Company’s securing adequate financing of at least $1.3 million, completion of satisfactory due diligence and financial audits, and securing various required consents and approvals. The closing conditions were not satisfied, no definitive agreements were signed and the LOI expired. There was no impact on the accompanying consolidated financial statements as a result of this transaction.
4. Debt
The Company’s notes payable at December 31, 2011, 2010 and 2009, consisted of the following:
September 2008 Bridge Note and March 2009 Bridge Note
On September 29, 2008, the Company entered into a securities purchase agreement with an accredited investor (the “September 2008 Bridge Investor”) providing for the issuance by the Company to the September 2008 Bridge Investor of its 12% promissory note in the principal amount of $125,000 (the "September 2008 Bridge Note"). In addition to the September 2008 Bridge Note, the September 2008 Bridge Investor also received 62,500 shares of common stock of the Company. These shares of common stock were valued at an aggregate of $16,875, based on the estimated fair value of the Company’s common stock at that date. This amount was recorded as a discount to the September 2008 Bridge Note and was amortized to interest expense using the effective interest rate method over the term of the note. The September 2008 Bridge Note matured on December 28, 2008. Interest associated with this note was 12% per annum, payable on the maturity date. In the event that all amounts due under the note were not paid by the maturity date, the Company was required to issue an additional 31,250 shares to the September 2008 Bridge Investor every 30 days that any amounts remain outstanding on the note.
On March 24, 2009, the Company entered into a securities purchase agreement with the September 2008 Bridge Investor providing for the rollover of the $125,000 principal amount outstanding under the September 2008 Bridge Note and the advancing of an additional $50,000 (the “March 2009 Bridge Note”). Pursuant to the terms of the September 2008 Bridge Note, the Company issued penalty shares, totaling 93,750 additional shares of the Company’s common stock, to the September 2008 Bridge Investor. These shares of common stock were valued at an aggregate of $25,314, based on the estimated fair value of the Company’s common stock at that date. This amount was recorded as a discount to the September 2008 Bridge Note and was amortized to interest expense using the effective interest rate method over the term of the note. In addition to the March 2009 Bridge Note, the September 2008 Bridge Investor also received an additional 200,000 shares of common stock of the Company. These shares of common stock were valued at an aggregate of $54,000, based on the estimated fair value of the Company’s common stock at that date. This amount was recorded as a discount to the March 2009 Bridge Note and was amortized to interest expense using the effective interest rate method over the term of the note. The September 2008 Bridge Investor was also entitled to a $15,000 financing fee payable at maturity. This fee was accrued as a discount to the March 2009 Bridge Note and was amortized to interest expense using the effective interest rate method over the term of the note. The March 2009 Bridge Note matured on the earlier of 90 days from closing or upon closing of a private placement by the Company, with net proceeds to the Company of at least $1.0 million. Interest associated with this note was 12% per annum, payable on the maturity date. See the 2009 12% Convertible Notes disclosure for the conversion of this note.
CEO Bridge Note
On December 29, 2008, the Company entered into a securities purchase agreement with the Company’s then Chairman and Chief Executive Officer for the issuance by the Company of its 10% promissory note in the principal amount of $75,000 (the "CEO Bridge Note"). In addition to the CEO Bridge Note, the CEO also received 37,500 shares of common stock of the Company. These shares of common stock were valued at an aggregate of $10,125, based on the estimated fair value of the Company’s common stock at that date. This amount was recorded as a discount to the CEO Bridge Note and was amortized to interest expense using the effective interest rate method over the term of the note. The CEO Bridge Note matured on March 29, 2009. Interest associated with the CEO Bridge Note was 10% per annum, payable on the maturity date. See the 2009 12% Convertible Notes disclosure for the conversion of these notes.
January 2009 Bridge Notes
On January 2, 2009, and January 6, 2009, the Company entered into securities purchase agreements with two accredited investors (the “January 2009 Bridge Investors”) for the issuance by the Company of a 10% promissory note in the principal amount of $25,000 to each of the January 2009 Bridge Investors (the "January 2009 Bridge Notes"). In addition to the January 2009 Bridge Notes, the January 2009 Bridge Investors also each received 12,500 shares of common stock of the Company. These shares of common stock were valued at an aggregate of $6,750, based on the estimated fair value of the Company’s common stock at that date. This amount was recorded as a discount to the January 2009 Bridge Notes and was amortized to interest expense using the effective interest rate method over the term of the notes. The January 2009 Bridge Notes matured on the earlier of 90 days from closing or upon closing of a private placement by the Company. Interest associated with the January 2009 Bridge Notes was 10% per annum, payable on the maturity date. See the 2009 12% Convertible Notes disclosure for the conversion of these notes.
January 14, 2009 Bridge Note
On January 14, 2009, the Company entered into a bridge loan letter agreement and a securities purchase agreement with an accredited investor (the “January 14, 2009 Bridge Investor”) for the issuance by the Company of a 15% promissory note in the principal amount of $400,000 to the January 14, 2009 Bridge Investors (the "January 14, 2009 Bridge Note"). In addition to the January 14, 2009 Bridge Notes, the January 14, 2009 Bridge Investors also received 50,000 shares of common stock of the Company. These shares of common stock were valued at $13,500, based on the estimated fair value of the Company’s common stock at that date. This amount was recorded as a discount to the January 14, 2009 Bridge Note and was amortized to interest expense using the effective interest rate method over the term of the notes. In connection with entering into the bridge loan letter agreement, the Company also issued warrants to acquire 480,000 shares of the Company’s common stock and paid $40,000 in fees. The warrants are exercisable for a period of five years at an exercise price of $3.00 per share. Using Black-Scholes, with volatility of 100%, a risk-free interest rate of 1.5% and a 0% dividend yield, the warrants were determined to have a fair value of $48,168, with such value recorded as a discount to the January 14, 2009 Bridge Note and to additional paid-in capital. This discount, along with the $40,000 in fees, was amortized using the effective interest rate method over the term of the note. The January 14, 2009 Bridge Note matured 90 days from closing. Interest associated with the January 14, 2009 Bridge Note was 15% per annum, payable on the maturity date. See the 2009 12% Convertible Notes disclosure for the conversion of this note.
2009 12% Convertible Notes
In April 2009, the Company commenced an offering of its 12% Convertible Notes (the “2009 12% Convertible Notes”). Each 2009 12% Convertible Note is convertible, at any time at the option of the holder, into shares of the Company’s common stock, at an initial conversion price of $0.25 per share (the “Conversion Price”). The 2009 12% Convertible Notes bear interest at 12% per annum and mature 12 months from the date of issuance. For each 2009 12% Convertible Note purchased, each investor received a warrant to purchase up to such number of shares of the Company’s common stock equal to one-half of the face amount of the 2009 12% Convertible Note divided by the Conversion Price. The warrants are exercisable for a period of five years from the date of issuance at an exercise price of $3.00 per share. Through December 31, 2009, the Company had issued a total of $740,000 face value of its 12% Convertible Notes for cash.
In connection with the issuance of the 2009 12% Convertible Notes, the Company had issued 2,935,805 warrants to acquire the Company’s common stock to investors and an additional 352,296 warrants to acquire the Company’s common stock to the placement agent.
The conversion price of the 2009 12% Convertible Notes and the exercise price of the warrants issued in connection with the 2009 12% Convertible Notes, except those warrants issued to the placement agent, are subject to adjustment pursuant to anti-dilution provisions and are considered to be derivative instruments and accounted for as such (see Note 5).
The warrants issued to the agent were valued using Black-Scholes, with a volatility of 100%, a risk-free interest rate of 1.5% and 0% dividend yield, and were determined to have a fair value of $31,670 and recorded as a deferred financing cost which was amortized over the term of the note.
In April 2009, the holders of the CEO Bridge Note, the January 2009 Bridge Notes, the January 14, 2009 Bridge Note and the March 2009 Bridge Note agreed to convert the $700,000 total of their outstanding notes, plus accrued interest of $12,903 and deferred fees of $15,000, into the 2009 12% Convertible Notes.
These notes were scheduled to mature at various dates during the year ended December 31, 2010. In 2010, the Company received extensions of the maturity dates for these notes and granted an additional 1,389,152 warrants in consideration for these extensions. The warrants are exercisable for a period of five years from the date of issuance at an exercise price of $3.00 per share. These warrants had the same derivative features as the initial warrants, and as such, the Company calculated the full fair value of the warrants and recorded a debt discount that is amortized over the remaining life of the note. Using Black-Scholes, with a volatility of 100%, a risk-free rate of 1.27% - 1.79%, and 0% dividend yield, these extensions warrants were determined to have a fair value of $92,335.
On November 30, 2011, principal of $1,277,903 and related accrued interest on the 2009 12% Convertible Notes were exchanged for new 14% convertible notes (see 2011 14% Convertible Note below). At December 31, 2011, outstanding 2009 12% Convertible Notes amounted to $90,000. These notes are due on demand, the notes are in default, and are thus classified as current. The conversion features in these notes as well as the associated warrants continue to be subject to adjustment pursuant to anti-dilution provisions and are considered derivative instruments (see Note 5).
2010 12% Convertible Notes
In January 2010, the Company commenced an offering of its 12% Convertible Notes (the “2010 12% Convertible Notes”). Each 2010 12% Convertible Note is convertible, at any time at the option of the holder, into shares of the Company’s common stock, at an initial conversion price of $0.25 per share (the “Conversion Price”). The 2010 12% Convertible Notes bear interest at 12% per annum and mature 12 months from the date of issuance. For each 2010 12% Convertible Note purchased, each investor received a warrant to purchase up to such number of shares of the Company’s common stock equal to one-half of the face amount of the 2010 12% Convertible Note divided by the Conversion Price. The warrants are exercisable for a period of five years from the date of issuance at an exercise price of $3.00 per share. Through December 31, 2010, the Company had issued a total of $705,000 face value of its 2010 12% Convertible Notes for cash.
In connection with the issuance of the 2010 12% Convertible Notes, the Company had issued 1,410,000 warrants to acquire the Company’s common stock to investors and an additional 169,200 warrants to acquire the Company’s common stock to the agent, all on the terms set forth above , except as described below.
The conversion price of 2010 12% Convertible Notes and the exercise price of the warrants issued in connection with the 2010 12% Convertible Notes, except those warrants issued to the placement agent, are subject to adjustment pursuant to anti-dilution provisions and are considered to be derivative instruments and accounted for as such (see Note 5).
The warrants issued to the agent were valued using Black-Scholes, with a volatility of 100%, a risk-free interest rate of 1.15% and 0% dividend yield, and were determined to have a fair value of $10,701, and recorded as a deferred financing cost which was amortized over the term of the note to interest expense.
The 2010 12% Convertible Notes were originally scheduled to mature at various dates in 2011. During 2010, the Company received six month extensions for certain of these notes in advance of the scheduled maturity dates and granted an additional 112,500 warrants in consideration for the extensions on these notes. These warrants had the same derivative features as the initial warrants, and as such, the Company calculated the full fair value of the warrants and recorded a debt discount that is amortized over the life of the note. Using Black-Scholes, with a volatility of 100%, a risk-free rate of 1.27% and 0% dividend yield, these extensions warrants were determined to have a fair value of $13,025.
On November 30, 2011, principal of $380,000 and related accrued interest on the 2010 12% Convertible Notes were exchanged for new 14% convertible notes (see 2011 14% Convertible Note below). At December 31, 2011, outstanding 2010 12% Convertible Notes amounted to $325,000. These notes are due on demand, the notes are in default, and are thus classified as current. The conversion features in these notes as well as the associated warrants continue to be subject to adjustment pursuant to anti-dilution provisions and are considered derivative instruments (see Note 5).
During the years ended December 31, 2011, 2010 and 2009, the Company amortized $146,683, $757,980 (as restated) and $432,302 (as restated), respectively, of the debt discounts related to 2009 12% Convertible Notes and 2010 12% Convertible Notes (collectively, the “12% Convertible Notes”) as interest expense.
Debt Settlement Agreement
On September 1, 2011, the Company entered into a note modification with a holder (the "Holder") of $100,000 of the 2010 12% Convertible Notes that had previously matured. The agreement called for a $45,000 extension fee payable to the Holder in consideration for not calling the debt, plus $15,900 of accrued interest, and resulted in total consideration payable to the holder of $160,900 that bears interest at 12% per annum on the original principal amount of $100,000. Additionally, the Company issued 2,000,000 shares (the "Shares") of the Company's common stock to the Holder who will sell these shares for which the proceeds will reduce the Company's liability to the Holder. The Company has the right to settle the $160,900 liability in cash at any time and reclaim any remaining Shares provided to the Holder. The modified note does not have a conversion feature. The Company may be required to issue additional shares of its common stock to the Holder if the Holder's sales proceeds from selling the Shares is less than the $160,900 liability plus accrued interest payable. The Company accounted for this transaction by recording a current liability of $160,900 and recognizing $45,000 as a loss on extinguishment of liabilities, net since the conversion feature was removed. Further, the shares issued were recorded at the then fair market value on the date of issuance of $40,000 as an other current asset as the shares are forfeitable and can be reclaimed at any time. The fair value of the common shares not sold by the Holder is revalued at the end of each reporting period based upon the then fair market price and any changes are recognized as income or expense in other income (expense), net. As of December 31, 2011, the Holder had not notified the Company of any shares sold, thus the liability to shareholder was $164,693 (including interest accrued from September 1, 2011 through December 31, 2011 of $3,793) and the fair value of the common shares unsold by the Holder was $20,000, which is included in other current assets.
2011 14% Convertible Notes
In November 2011, the Company commenced an offer to exchange the outstanding principal and accrued interest on the 12% Convertible Notes with new 14% Convertible Notes (the “2011 14% Convertible Notes”). The holders of the 12% Convertible Notes were also offered an opportunity to purchase additional 2011 14% Convertible Notes for cash. Each 2011 14% Convertible Note is convertible, at any time at the option of the holder, into shares of the Company’s common stock, at an initial conversion price of $0.08 per share (the “14% Note Conversion Price”). The 2011 14% Convertible Notes bear interest at 14% per annum (6% cash interest and 8% paid-in-kind “PIK” interest) and mature 24 months from the date of issuance. Warrants associated with the 12% Convertible Notes (the “12% Warrants”) were exchanged for new warrants to purchase three times the number of common shares of the Company that could be purchased with the 12% Warrants. The new warrants are exercisable for a period of two years from the date of issuance at an exercise price of $0.20 per share.
On November 30, 2011, principal of $1,657,903 and accrued interest of $458,332 related to the 12% Convertible Notes were exchanged for new 14% Convertible Notes. In connection with this transaction, the derivative liability associated with the conversion feature of the 12% Convertible Notes and warrants exchanged were written off and a gain of $21,587 was recognized and is included in loss on extinguishment of liabilities, net. Through December 31, 2011, the Company had issued a total of $2,481,235 face value of its 14% Convertible Notes in exchange for $235,000 cash, $1,657,903 of principal of the 12% Notes, $125,000 of short-term notes payable (see Other Financings), $463,332 of accrued interest and other expenses, of which $5,000 has been classified as a loss on extinguishment of liabilities, net. The conversion features of the 2011 14% Note and the associated warrants were not subject to any anti-dilution adjustment and are not considered derivative instruments.
The Company calculated the relative fair value of the warrants and recorded a debt discount of $63,005 (calculated using Black-Scholes with a volatility of 100%, a risk-free interest rate of 0.25% and 0% dividend yield). The debt discount will be amortized over the life of the notes. For the year ended December 31, 2011, $2,625 of the debt discount was amortized as interest expense.
Deferred Compensation Notes
Beginning in February 2009, the Company had been unable to meet its contractual employment related obligations and has been accruing, as a component of accrued expenses, past due salaries to its employees and, as a component of accounts payable, severance payments payable to its former Chief Executive Officer and fees due its in-house counsel. Through December 31, 2009, the Company, in partial satisfaction of these past due amounts, had issued $1,071,333 principal amount of 12% convertible notes (the “Deferred Compensation Convertible Notes”) on the basis of $2.00 of Deferred Compensation Convertible Note face value for each $1.00 of compensation deferred. Each Deferred Compensation Convertible Note was convertible, at any time at the option of the holder, into shares of the Company’s common stock, at an initial conversion price of $0.25 per share (the “Conversion Price”). On December 31, 2009, there was $1,071,333 of the Deferred Compensation Convertible Notes outstanding plus related accrued interest of $48,540 under these notes, in addition to accrued salaries of $327,713 recorded (collectively the “Deferred Compensation Liabilities”).
On December 31, 2009, the Company entered into a new agreement (the “Deferred Compensation Note Agreement”) with holders of the Deferred Compensation Convertible Notes, who were also owed the accrued salaries of $327,713. Pursuant to the terms of the Deferred Compensation Note Agreement and in settlement of the Deferred Compensation Liabilities, liabilities of $323,735 were forgiven, the Company converted liabilities of $844,756 to 3,379,024 shares of the Company’s common stock, using a conversion price of $0.25, which approximated the fair value of the Company’s common stock at that date, and $279,095 principal amount of 10% notes maturing in 36 months were issued (the “Deferred Compensation Notes”). The forgiveness of the $323,735 was recorded as a reduction of salary expense. Pursuant to the note agreements monthly installment payments were to begin on January 1, 2011. No payments have been made and the Company is in default. As per the terms of the agreement, the interest rate payable on the notes increased to 15% per annum and the amount is now current.
Other Financings
On March 17, 2011, the Company issued a 10% promissory note payable to an unaccredited investor for $75,000. The note matured 90 days after issuance, but continued to accrue interest at 10% per annum.
On May 11, 2011, the Company issued a promissory note payable to an unaccredited investor for $50,000. The note matured in 60 days and the Company was charged interest of $600 and financing fees of $4,400.
All of the outstanding principal and accrued interest on the March 17, 2011 and May 11,, 2011 notes were exchanged for 2011 14% Convertible Notes as described above.
GE Note
On August 31, 2010, the Company entered into a Settlement Agreement pursuant to which GE Water permitted the Company to substitute for STW Resources as to all rights and obligations under the purchase order between STW Resources and GE Water (the “Purchase Order”) (including the original debt amounts) and teaming agreement between STW Resources and GE Water, and such that to fully discharge STW Resources’ financial obligations to GE Water under the Purchase Order, the Company shall pay GE Water $1,400,000 pursuant to the GE Note. The note bears interest at a rate of the WSJ Prime Rate (as published daily in the Wall Street Journal) plus two percent (2%) per annum (5.25% as of December 31, 2011). Under the terms of the GE Note, the Company had thirteen months to pay off the GE Note plus all accrued interest thereon. In addition, upon the consummation of a debt or equity financing following the execution of the GE Note, the Company was obliged to pay GE Water thirty percent (30%) of the gross proceeds of any equity investments in or loans to the Company or any affiliated entity until the GE Note was paid in full, including all accrued interest thereon. In December 2010, the Company made a principal payment in the amount of $97,500.
On September 29, 2011, the parties agreed to extend the maturity date of the Note from September 30, 2011 to October 30, 2011.
On October 30, 2011, the parties entered into an amendment to the settlement agreement, effective October 1, 2011, pursuant to which, among other things, the parties agreed as follows: (i) the Company will have until September 1, 2013 to pay GE $2,100,000 plus interest accrued after October 1, 2011 under the GE Note in accordance with its terms, (ii) upon the consummation and closing of a debt or equity financing following the execution of the GE Note, the Company shall pay GE thirty percent (30%) of any and all tranches (“Tranches” being defined as the cash receipts of the proceeds of any equity investments in or loans to the Company or any affiliated entity by third parties, but excluding any conversions of pre-existing debt to equity by any of the Company’s then current convertible note holders or creditors) until the GE Note is paid in full, including all accrued interest, provided the Company shall not be obligated to pay GE upon, among other things, the following: (a) short term commercial paper of $200,000 or less, up to a cumulative maximum of $500,000 through December 31, 2012, (b) commercial equipment leasing whereby GE is taking a secured interest in the purchased equipment, (c) proceeds from project, lease and equipment funding to any subsidiary of the Company provided the Company does not receive any proceeds of such funding and (d) a one-time general exception for $1,500,000 of new equity financing of the Company, (iii) the Company shall begin making a regular series of installment payments as follows: (a) $10,000 per month beginning on January 1, 2012, and (b) $15,000 per month beginning on June 1, 2012 through the maturity date of the note; and (iv) the Company shall be able to prepay the GE Note, without interest, on or before the maturity date. Pursuant to this amendment, the Company recognized a loss on extinguishment of liabilities, net of $797,500. As of the date of this filing, no payments have been made, the Company is in default, the note has been classified as current and GE has the right to accelerate the maturity of the GE Note and demand the immediate payment thereof.
For the years ended December 31, 2011, 2010 and 2009, total interest expense incurred related to the convertible notes payable and other notes payable were $572,421, $1,923,176 (as restated) and $895,161 (as restated), respectively, which included $149,308, $757,980 (as restated) and $432,302 (as restated), respectively, of amortization of debt discount and $36,662, $143,734 and $287,721, respectively, of amortization of debt issuance costs. There was no interest capitalized in 2011 and 2010. The 2009 balance sheet includes $1.2 million in capitalized interest.
5. Derivative Liabilities
We apply the accounting standard that provides guidance for determining whether an equity-linked financial instrument, or embedded feature, is indexed to an entity’s own stock. The standard applies to any freestanding financial instrument or embedded features that have the characteristics of a derivative, and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.
From time to time, the Company has issued notes with embedded conversion features and warrants to purchase common stock. Certain of the embedded conversion features and warrants contain price protection or anti-dilution features that result in these instruments being treated as derivatives. The Company estimates the fair value of these embedded conversion features and warrants using Black-Scholes with the following assumptions:
Expected volatility is based primarily on historical volatility. Historical volatility was computed using weekly pricing observations for recent periods. We believe this method produces an estimate that is representative of our expectations of future volatility over the expected term of these warrants and embedded conversion features.
We currently have no reason to believe that future volatility over the expected remaining life of these warrants and embedded conversion features is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants and embedded conversion features. The risk-free interest rate is based on one-year to five-year U.S. Treasury securities consistent with the remaining term of the warrants and embedded conversion features.
On April 14, 2008, the Company commenced a unit offering (the “$2.00 Unit Offering”) whereby each unit consisted of one share of the Company’s common stock and a warrant to acquire one and one-half shares of the Company’s Common Stock (see Note 6). The exercise price of the warrants is subject to adjustment pursuant to anti-dilution provisions and are considered to be derivative instruments and accounted for as such. Under derivative accounting, the Company calculates the full fair value of the warrants and records a derivative liability against additional paid-in capital. The derivative liability is revalued on each reporting period. Using Black-Scholes, with 100% volatility, a risk-free interest rate of 1.13-3.10%, 0% dividend yield, the estimated fair value of the warrants was $5,408,408 (as restated) and recorded as derivative liabilities and netted with the proceeds from the unit offering in additional paid-in capital.
In connection with the issuance of the 2009 12% Convertible Notes (see Note 4), the Company issued 2,935,805 warrants to acquire the Company’s common stock. The conversion price of the notes and the exercise price of the warrants are subject to adjustment pursuant to anti-dilution provisions and are considered to be derivative instruments. Under derivative accounting, the Company calculates the full fair value of the embedded conversion feature derivative and the full fair value of the warrants and records a debt discount that is amortized over the life the note. The initial estimated fair value of the embedded conversion feature and warrants was $832,113 (as restated) and was recorded as derivative liabilities and debt discount.
The 2009 12% Convertible Notes were scheduled to mature at various times throughout 2010. In 2010, the Company received extensions of the maturity dates for these notes and granted an additional 1,389,152 warrants in consideration for extensions. The warrants are exercisable for a period of five years from the date of issuance at an exercise price of $3.00 per share. These warrants had the same derivative features as the initial warrants, and as such, the Company calculated the full fair value of the warrants and recorded a debt discount that is amortized over the remaining life of these notes. Using Black-Scholes, with a volatility of 100%, a risk-free rate of 1.27% - 1.79%, and 0% dividend yield, these extensions warrants were determined to have an estimated fair value of $92,335 (as restated).
In connection with the issuance of the 2010 12% Convertible Notes (see Note 4), the Company issued 1,410,000 warrants to acquire the Company’s common stock. The conversion price of the notes and the exercise price of these warrants are subject to adjustment pursuant to anti-dilution provisions and are considered to be derivative instruments. Under derivative accounting, the Company calculates the full fair value of the embedded conversion feature derivative and the full fair value of the warrants and records a debt discount that is amortized over the remaining life of the 2010 12% Convertible Notes. The initial estimated fair value of the embedded conversion feature and warrants was calculated as $399,493 (as restated) and was recorded to derivative liabilities and debt discount.
The 2010 12% Convertible Notes were originally scheduled to mature at various dates in 2011. During 2010, the Company received six month extensions for certain of these notes in advance of the scheduled maturity dates and granted an additional 112,500 warrants in consideration for the extensions on these notes. These warrants had the same derivative features as the initial warrants, and as such, the Company calculated the full fair value of the warrants and recorded a debt discount that is amortized over the remaining life of the note. Using Black-Scholes, with a volatility of 100%, a risk-free rate of 1.27% and 0% dividend yield, these extensions warrants were determined to have an estimated fair value of $13,025 (as restated).
On November 30, 2011, $1,657,903 of principal of the 12% Convertible Notes (see Note 4) plus accrued interest and warrants were exchanged for the 2011 14% Convertible Notes and warrants (see above). The derivative liability associated with the 12% Convertible Notes and warrants exchanged were extinguished and a gain of $21,587 was recognized and is included in loss on extinguishment of liabilities, net.
In connection with the debt settlement agreement (see Note 4 above), the embedded conversion feature of the related 2010 12% Convertible Note was extinguished and the Company recognized a loss on extinguishment of liabilities of $2,340.
During the years ended December 31 2011, 2010 and 2009, we recorded other income of $606,293, $546,041 (as restated) and $5,029,533 (as restated), respectively, related to the change in fair value of the warrants and embedded conversion options which is included in change in fair value of derivative liabilities in the accompanying consolidated statements of operations.
The following table presents our warrants and embedded conversion options which have no observable market data and are derived using Black-Scholes measured at fair value on a recurring basis, using Level 3 inputs, as of December 31:
The following table presents the changes in fair value of our warrants and embedded conversion options measured at fair value on a recurring basis for the years ended December 31:
6. Capital Stock
Preferred Stock
The Company has authorized 10,000,000 shares of preferred stock with a par value of $0.001 per share.
In April 2008, the Company designated the Series A Preferred Stock, with a par value of $0.001 per share, and authorized the issuance of 100 shares to the Company’s Chairman and Chief Executive Officer. The Series A Preferred Stock provides voting rights as if each share of Series A Preferred Stock is equal to 80,000 shares of the Company’s common stock. The holder of Series A Preferred Stock is entitled to vote together with the holders of the common stock on all matters that the common stock is entitled to vote on.
Effective February 24, 2009, the Company acquired, and retired, from its former Chairman and Chief Executive Officer, the 100 shares of Series A preferred stock then outstanding, in exchange for a commitment by the Company to issue its former Chairman and Chief Executive Officer a warrant to purchase 1,500,000 shares of the Company’s common stock at $8.00 per share, with a five-year exercise period.
On February 21, 2010, pursuant to the Merger Agreement, the Company issued 2,140,000 shares of convertible preferred stock. On December 17, 2010 the preferred stock was converted to 2,140,000 shares of common stock.
Common Stock
The Company has authorized 100,000,000 shares of common stock with a par value of $0.001.
On January 28, 2008, the Company issued 8,100,000 shares of common stock at $0.00001 per share for total consideration of $81.
In April 2008, the Company issued 5,980,000 shares of common stock at $0.0445 per share for total consideration of $266,110. On April 14, 2008, the Company commenced a unit offering (the “$2.00 Unit Offering) whereby each unit consisted of one share of the Company’s common stock and a warrant to acquire one and one-half shares of the Company’s common stock as follows: (i) 0.5 shares at an exercise price equal to $3.00 per share, (ii) 0.5 shares at an exercise price equal to $4.00 per share, and (iii) 0.5 shares at an exercise price equal to $8.00 per share. Each warrant is exercisable for three years from the date of issuance. As of December 31, 2008, the Company had sold an aggregate of 3,467,500 units for gross proceeds of $6.9 million, net of offering costs of $0.8 million. The Company also issued 700,000 common shares for investment banking compensation associated with this offering. These shares were valued at an aggregate of $98,800, based on the estimated fair value of the Company’s common stock at that date. In January 2009, the Company issued an additional 508,000 shares of common stock for investment banking compensation and 62,500 units under its $2.00 Unit Offering, for gross proceeds of $125,000. The Company incurred costs of $31,944 resulting in net proceeds of $93,056. The exercise price of the warrants is subject to adjustment pursuant to anti-dilution provisions and are considered to be derivative instruments (see Note 5).
In connection with the April 2008 notes, the Company issued a total of 275,000 shares of common stock which were valued at an aggregate of $12,238, based upon the price of the Company’s shares of common stock issued under the most recent private placement offering prior to the issuance of the April 2008 notes. Upon the extension of the April 2008 notes in June 2008, the Company issued a total of 41,325 additional shares of common stock. These additional shares of common stock were valued at an aggregate of $11,157, based on the estimated fair value of the Company’s common stock at that date.
On January 14, 2009, the Company issued 1,500,000 for consulting services. Using Black-Scholes, with a volatility of 100%, a risk-free interest rate of 1.36% and 0% dividend yield, these warrants were valued at $180,651.
On September 30, 2009, the Company issued 200,000 shares of common stock as a donation to a private foundation, which was valued at an aggregated $50,000 based upon the estimated fair market value of the Company’s common stock at that date.
For the year ended December 31, 2009, the Company issued 886,000 shares of common stock, which were valued at an aggregate of $221,500, based upon the estimated fair value of the Company’s common stock on the date of valuation, for consulting services rendered to the Company.
On February 12, 2010, pursuant to the terms of the Merger Agreement, STW Resources, Inc. merged with and into STW Acquisition, Inc. (“Acquisition Sub”), which became a wholly-owned subsidiary of the Company (the “Merger”). In consideration for the Merger and STW becoming a wholly-owned subsidiary of the Company, the Company issued an aggregate of 31,780,004 (the “STW Acquisition Shares”) shares of $0.001 par value common stock to the shareholders of STW at the closing of the merger and all derivative securities of STW as of the Merger became derivative securities of Woozyfly, including options and warrants to acquire 12,613,002 shares of common stock at an exercise price ranging from $3.00 to $8.00, with an exercise period ranging from July 31, 2011 through November 12, 2014 and convertible debentures in the principal amount of $1,467,903 with a conversion price of $0.25 and maturity dates ranging from April 24, 2010 through November 12, 2010.
Additionally, MKM, the DIP Lender, received 400,000 shares of common stock and 2,140,000 shares of convertible preferred stock, the holders of the Convertible Notes received 1,760,000 shares of common stock, and general unsecured claims received 100,000 shares of common stock. An adjustment was made through additional paid in capital to reflect the issuance of these shares as the Merger was treated as a reverse merger and a capitalization transaction for accounting purposes.
For the year ended December 31, 2010, the Company issued 6,468,750 shares of common stock which were valued at an aggregate of $1,617,188 based upon the estimated fair value of the Company’s common stock on the date of valuation of $0.25 per share, for consulting services rendered to the Company.
On December 8, 2010, the Company entered into a subscription agreement with accredited investors pursuant to which the Company sold 1,300,000 units (each a “Unit” and collectively, the “Units”), each Unit consisting of one share of our common stock, par value $0.001 per share (the “Common Stock”) and a warrant to purchase one share of our Common Stock (each a “Warrant” and collectively, the “Warrants”) for total aggregate consideration of $325,000. The warrants shall be exercisable for a period of two years from the date of issuance at an initial exercise price of $0.50 per share. In connection with this offering, the Company incurred cash fees of $41,500 as well as issued 130,000 warrants exercisable for a period of two years from the date of issuance at an initial exercise price of $0.50 per share.
In May 2011, the Company issued 400,000 shares of common stock valued at $52,000 based upon the fair market value of the Company’s common stock at the issuance date of $0.13 per share, to a consultant for services performed (see Note 7).
In June 2011, the Company issued 400,000 shares of common stock valued at $32,000 based upon the fair market value of the Company’s common stock at the issuance date of $0.08 per share, to a vendor in exchange for certain accounts payable owed to such vendor. The outstanding accounts payable on the date of issuance was $34,500 and the difference of $2,500 was recorded as other income.
In September 2011, pursuant to the terms of the Debt Settlement Agreement (see Note 4) with an investor, the Company issued 2,000,000 shares of common stock valued at $40,000 based upon the fair market value of the Company’s common stock at the issuance date of $0.02 per share.
During the year ended December 31, 2011, the Company issued 566,667 warrants to its placement agent. Using Black-Scholes, with a volatility of 100%, a risk-free interest rate of 0.25% and 0% dividend yield, these warrants were valued at $2,186 and expensed as professional fees.
Total Dilutive Securities
As of December 31, 2011, the Company had the following dilutive securities to acquire the Company’s common stock outstanding:
Warrants
A summary of the Company’s warrant activity and related information during the year ended December 31, 2011 follows:
7. Share-Based Compensation
Since Inception (January 28, 2008), the Company issued 8.4 million shares of the Company’s common stock to directors, employees and certain consultants. As of December 31, 2010, 400,000 of these shares have been forfeited. There were no shares forfeited in 2011. The following table sets forth the number of shares outstanding, the fair value at date of issue and the period over which the shares vest:
a) These shares vested upon the earlier of (i) the initial public offering of the Company’s common shares, or (ii) the involuntary termination of the employee after December 31, 2008, or (iii) upon consent of the Board of Directors.
During the years ended December 31, 2011, 2010 and 2009, the Company recognized $52,000, $312,500 and $600,300 in compensation cost associated with the issuance of these shares. At December 31, 2011, the Company had no remaining compensation cost to be recognized related to the issuances set forth above.
8. Related Party Transactions
In connection with the Company’s capital raising activities, the Company had incurred, as of December 31, 2009, a total of $982,787 in fees and expenses payable to Viewpoint Securities, LLC (“Viewpoint”), the Company’s financial and capital markets advisor at that time, and of which one of its partners is a member of the Company’s Board of Directors, and issued, pursuant to the terms of its arrangement with Viewpoint, 1,200,000 shares of common stock and 549,900 warrants to purchase one and one-half shares of the Company’s common stock on the same terms as the warrants issued in the $2.00 Unit Offering. The exercise price of these warrants is subject to anti-dilution adjustments and are considered derivative instruments (see Note 5). In addition, the Company issued a warrant to purchase 352,296 shares of the Company’s common stock on the same terms as the warrants issued with the 2009 12% Convertible Notes, except that these warrants did not have any anti-dilution rights (see Note 4).
During the year ended December 31, 2010, the Company incurred $123,823 in fees and expenses payable to Viewpoint and issued, pursuant to the terms of its arrangement with Viewpoint, 2,000,000 shares of common stock and 169,200 warrants to purchase one and one-half shares of the Company’s common stock on the same terms as the warrants issued with the 2010 12% Convertible Notes, and 130,000 warrants to purchase shares of the Company’s common stock on the same terms as the warrants issued with the December 2010 Unit offering. The warrants did not have any anti-dilution rights.
During the year ended December 31, 2011, the Company incurred $73,500 in fees and expenses payable to Viewpoint, and granted a warrant to purchase 566,667 shares of the Company’s common stock with an exercise price of $0.20 per share and exercisable for a period of two years from the date of issuance.
At December 31, 2011, 2010, and 2009, the Company had a balance due to Viewpoint of $202,728, $139,227 and $142,787 respectively, recorded in accounts payable.
At December 31 2011, 2010 and 2009, the Company had accrued compensation for amounts due to the officers of the Company, of $249,480, $37,630 and $0 respectively.
9. Board of Directors and Advisory Board compensation
Directors are expected to timely and fully participate in all regular and special board meetings, and all meetings of committees that they serve on. In December 2011, the Board voted to authorize the issuance of shares in lieu of cash compensation for past services.
Per the Director Agreements, the Company compensates each of the directors through the grant of 200,000 shares of common stock and the payment of a cash fee equal to $1,000 plus travel expenses for each board meeting attended, and $75,000 per year as compensation for serving on our board of directors. As of December 31, 2011, the Company had total cash compensation due to its directors (both current and former) of $1,173,900 which is calculated based upon time of service and the number of Board meetings attended and is included in accrued compensation in the accompanying consolidated balance sheet.
The Company’s advisory board is comprised of three members. Each advisory board member is granted 56,250 shares upon joining the board and 75,000 shares annually thereafter. As of December 31, 2011, the Company was obligated to issue 225,000 shares to the advisory board members and has recorded the fair market value of these shares as an accrued liability totaling $2,250 in accrued compensation in the accompanying consolidated balance sheet.
10. Income Taxes
The Company’s net (loss) income before income taxes totaled $(2,819,743), $(9,396,458) and $600,976 for the years ended December 31, 2011, 2010, and 2009, respectively.
The total provision for income taxes, which consist solely of U.S. Federal taxes, consist of the following:
A reconciliation of the tax on the Company’s loss for the year before income taxes and total tax expense is shown below:
Based on the weight of available evidence, the Company’s management has determined that it is more likely than not that the net deferred tax assets will not be realized. Therefore, the Company has recorded a full valuation allowance against the net deferred tax assets.
The components of net deferred tax assets recognized are as follows:
At December 31, 2011, the Company had net U.S. deferred tax assets of $5,770,097. Due to uncertainties surrounding the Company’s ability to generate future U.S. taxable income to realize these assets, a full valuation allowance has been established to offset the net U.S. deferred tax asset. Additionally, the future utilization of the Company’s Federal net operating loss credit carry forwards (“NOLs”) to offset future taxable income maybe subject to an annual limitation, pursuant to Internal Revenue Code Sections 382 and 383, as a result of ownership changes that may have occurred previously or that could occur in the future. The Company has not formally analyzed any NOLs to determine the maximum potential future tax benefit that might be available, nor has it performed a Section 382 analysis to determine the limitation of the NOLs. When a formal analysis is finalized, the Company plans to update its unrecognized tax benefits. Due to the existence of the valuation allowance, future changes in the Company’s unrecognized tax benefits will not impact the Company’s tax provision.
At December 31, 2011, the Company had Federal income tax NOLs of approximately $5.4 million. The Federal NOLs expire at various dates through 2031, unless previously utilized. The tax years from 2008 through 2011 remain open for examination.
11. Commitments and Contingencies
Commitments
The Company leased its office facilities under a month-to-month lease for a monthly rental expense of $1,174. Rent expense for the years ended December 31, 2011, 2010, 2009 and the period from Inception through December 31, 2011 was $16,815, $11,462, $42,952 and $94,924, respectively.
Indemnities and Guarantees
In addition to the indemnification provisions contained in the Company’s charter documents, the Company will generally enter into separate indemnification agreements with the Company’s directors and officers. These agreements require the Company, among other things, to indemnify the director or officer against specified expenses and liabilities, such as attorneys’ fees, judgments, fines and settlements, paid by the individual in connection with any action, suit or proceeding arising out of the individual’s status or service as the Company’s director or officer, other than liabilities arising from willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest, and to advance expenses incurred by the individual in connection with any proceeding against the individual with respect to which the individual may be entitled to indemnification by the Company. These guarantees and indemnities do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. Historically, the Company has not been obligated nor incurred any payments for these obligations and, therefore, no liabilities have been recorded for these indemnities and guarantees in the accompanying consolidated balance sheets.
12. Restatement of Prior Period Financials
In 2008, the Company completed an offering of units, each unit comprised of a share of common stock of the Company and a warrant to purchase 1.5 shares of the common stock under the following terms: (i) Exercisable any time prior to the third anniversary of the closing of this financing; (ii) 0.5 shares at an exercise price of $3.00; 0.5 shares at an exercise price of $4.00 and 0.5 shares at an exercise price of $8.00 (the “2008 Unit Offering”). The warrants issued in the Unit Offering have anti-dilution provisions that adjust the exercise prices proportionately in the event of any future issuances of warrants at an exercise price below $5.00 per share.
In April 2009, the Company completed an offering of 12% convertible notes, convertible into shares of the Company’s common stock at an initial conversion price of $0.25 per share. In addition, each investor received warrants to purchase shares of Common Stock at an exercise price of $3.00 per share and exercisable for five years (the “2009 Note Offering”). The conversion price of the 12% Convertible Note and the exercise price of the attached warrants are subject to adjustment pursuant to anti-dilution provisions.
In connection with the audit of the Company’s financial statements for the fiscal year ended December 31, 2011, management of the Company conducted an analysis of the Company’s various financial instruments and agreements involving the 2008 Unit Offering and 2009 Note Offering, with a particular focus on the accounting treatment of derivative financial instruments under ASC Topic 815 “Derivatives and Hedging” (the “Derivative Accounting Pronouncement”).
Historically, the Company accounted for the warrants associated with the 2008 Unit Offering and 2009 Note Offering as equity instruments in the consolidated financial statements for the quarterly and annual periods through September 30, 2011. For the 2009 Note Offering, using Black Scholes, the value of the warrants were calculated and the relative fair value was recorded as a discount to the 2009 12% Notes and to additional paid-in capital. The discount was amortized over the term of the note. In July 2011, when the Company reset the exercise prices for the warrants associated with the 2008 Unit Offering, the value of warrants associated with this offering was recalculated using Black Scholes, which resulted in an additional estimated fair value of $218,064, which was recorded to additional paid-in capital and charged to general and administrative expenses.
After review, the Company determined that the original accounting for the 2008 Unit Offering and the 2009 Note Offering failed to appropriately record separate derivative treatment for the conversion option and the warrants issued. Under derivative accounting, the Company calculates the full fair value of the warrants and the full fair value of the embedded conversion feature derivative and records a debt discount that is amortized over the life of the note. The fair value of the embedded conversion feature and warrants are recorded to a derivative liability account and revalued each reporting period (see Note 5).
On June 29, 2012, as a result of this analysis, management, along with Company’s Board of Directors, concluded that it was necessary to restate its previously filed consolidated financial statements in the annual report for the years ended December 31, 2010 and December 31, 2009, each filed on Form 10-K, together with the quarterly reports on Form 10-Q for the quarters ended March 31, 2009, June 30, 2009, September 30, 2009, March 31, 2010, June 30, 2010, September 30, 2010, March 31, 2011, June 30, 2011 and September 30, 2011 (collectively, the “Reports”). The need to restate the Company’s consolidated financial statements is primarily due to the incorrect application of GAAP. The restatements are required to properly reflect the Company’s consolidated financial results for the periods set forth in the Reports noted above. As a result, such consolidated financial statements included within the Reports noted above should no longer be relied upon.
As a result of the restatement, the tables below set forth the changes to be made in the consolidated financial statements included in the Reports noted above. The effect on the consolidated balance sheets for the periods described in the Reports noted above is due to the recording of the embedded conversion feature and warrant liabilities and the effect on the consolidated statements of operations for the periods described in the Reports noted above is due to the gains and losses from the mark-to-market adjustments and an increase in interest expense. Accordingly, the consolidated balance sheets and statements of operations for the periods described in the Reports noted above have been retroactively adjusted as summarized below:
13. Subsequent Events
During February 2012, the Company issued to certain accredited investors (the “Investors”) revenue participation interest notes with a principal amount of $165,000 (the “March 2012 Notes”). These March 2012 Notes mature on January 21, 2017 and carry an interest rate of 12%. Principal and interest payments shall come solely from the Investors share of the revenue participation fees from water processing contracts related to brackish and/or produced water. The Investors shall receive 50% of the net revenues from such contracts until such time as they have received 2 times their investment amount, 10% of the net revenues thereafter until such time as they have received an additional $295,000 at which time the March 2012 Notes are retired in full. The Investors received warrants to purchase 165,000 shares of the Company’s common stock. These warrants have an exercise price of $0.20 and a two year maturity. The Company incurred cash fees of $16,500 and issued 16,500 warrants under the same terms as those received by the Investors.
On March 20, 2012, pursuant to a debt settlement agreement (see Note 4), the Company issued 3,000,000 shares of its common stock to a note holder who will sell these shares, and the net proceeds will reduce the Company's liability to the note holder.
On March 23, 2012, the Board of Directors agreed to exchange their accrued compensation for shares of the Company’s common stock. Total accrued compensation as of that date was $1,473,900 which was converted at a price per share of $0.05, and 29,478,000 shares were issued. Furthermore, for consulting services to the Company, the Board authorized the issuance of 16,950,000 shares of common stock to various consultants, of which, 5,000,000 shares have been issued to Mr. Stan Weiner, the Company’s Chief Executive Officer. On March 23, 2012, the Board authorized the issuance of 425,000 shares of the Company’s common stock to its Advisory Board members and an additional 18,750 shares to a consultant.
In May 2012, the Company entered into a subscription agreement with accredited investors pursuant to which the Company sold 1,000,000 Units, each Unit consisting of one share of the Company’s common stock par value $0.001 and a warrant to purchase 0.375 shares of the Company’s common stock (the “Warrants”) for aggregate consideration of $50,000. The Warrants shall be exercisable for a period of two years from the date of issuance at an initial exercise price of $0.20. The Company incurred cash fees of $5,000 and issued 150,000 warrants under the same terms.
Between June and September 2012, the Company issued to certain accredited investors, new 14% Convertible Notes with a principal amount of $200,000. These notes have the same terms as the 14% Notes issued in 2011 (see Note 4). In addition, the investors also received warrants to purchase 500,000 shares of the Company’s common stock at an exercise price of $0.20 and exercisable for a period of two years from the date of issuance. The Company incurred cash fees of $20,000 and issued 50,000 warrants under the same terms.
On September 6, 2012, the Company announced that it had signed a contract with Ranchland Hills Golf Club, Midland, TX, to design, build and deliver a proprietary water desalinization facility to produce 700,000 gallons of water a day by converting brackish well water into the equivalent of rain water to maintain the greens and fairways of the golf course. Under terms of the agreement, STW has received a down payment of $400,500 and will collect additional manufacturing milestone payments to engineer and install customized equipment that adds proprietary technology and chemicals to a desalinization membrane technology to increase the amount of fresh water recovered and lower the cost of operation. The equipment is to be delivered in 10-12 weeks.