10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2017

or

☐ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number 0-29185

QS ENERGY, INC.

(Exact name of registrant as specified in its charter)

Nevada	52-2088326
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

23902 FM 2978

Tomball, TX 77375

(Address, including zip code, of principal executive offices)

(805)-845-3561

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act: None.

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $0.001 par value.

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

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

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

Large accelerated filer  ☐	Accelerated filer ☐
Non-accelerated filer ☐	Smaller reporting company ☒
Emerging growth company ☐

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

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

The number of shares of the Registrant’s Common Stock outstanding as of August 7, 2017 was 230,914,605.

QS ENERGY, INC.
FORM 10-Q

INDEX

PART I – FINANCIAL INFORMATION	3
Item 1.   Unaudited Condensed Consolidated Financial Statements	3
Condensed Consolidated Balance Sheet	3
Condensed Consolidated Statement of Operations, Unaudited	4
Condensed Consolidated Statement of Stockholders’ Deficit, Unaudited	5
Condensed Consolidated Statements of Cash Flows, Unaudited	6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.   Quantitative and Qualitative Disclosure about Market Risk	22
Item 4.   Controls and Procedures	23
PART II – OTHER INFORMATION
Item 1.   Legal Proceedings	24
Item 1A.   Risk Factors	24
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.   Defaults Upon Senior Securities	24
Item 4.   Mine Safety Disclosures	24
Item 5.   Other Information	24
Item 6.   Exhibits	25
SIGNATURES	26
EXHIBITS	27
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

2

PART I – FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

QS ENERGY, INC.

Condensed Consolidated Balance Sheet

	June 30,
	2017			December 31,
	(unaudited)			2016
ASSETS
Current assets:
Cash	$	880,000		$	136,000
Prepaid expenses and other current assets		40,000			26,000
Total current assets		920,000			162,000
Property and equipment, net of accumulated depreciation of $36,000 and $32,000 at June 30, 2017 and December 31, 2016, respectively		34,000			17,000
Other assets		1,000			7,000
Total assets	$	955,000		$	186,000
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable-license agreements	$	918,000		$	805,000
Accounts payable and accrued expenses		891,000			251,000
Accrued expenses and accounts payable-related parties		19,000			135,000
Deposit and other current liabilities		–			5,000
Convertible debentures, net of discounts of $327,000 and $92,000 at June 30, 2017 and December 31, 2016, respectively		503,000			348,000
Total current liabilities		2,331,000			1,544,000
Commitments and contingencies
Stockholders’ deficit
Common stock, $.001 par value: 300,000,000 shares authorized, 224,508,406 and 199,045,026 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively		224,508			199,045
Additional paid-in capital		107,003,492			103,716,955
Accumulated deficit		(108,604,000	)		(105,274,000	)
Total stockholders’ deficit		(1,376,000	)		(1,358,000	)
Total liabilities and stockholders’ deficit	$	955,000		$	186,000

See notes to condensed consolidated financial statements.

3

QS ENERGY, INC.

Condensed Consolidated Statement of Operations, Unaudited

	Three months ended						Six months ended
	June 30,						June 30,
	2017			2016			2017			2016
Revenues	$	–		$	–		$	50,000		$	–
Costs and Expenses
Operating expenses		580,000			626,000			1,838,000			1,261,000
Research and development expenses		56,000			73,000			120,000			148,000
Loss before other income (expense)		(636,000	)		(699,000	)		(1,908,000	)		(1,409,000	)
Other income (expense)
Interest and financing expense		(1,210,000	)		(439,000	)		(1,422,000	)		(933,000	)
Loss on disposition of equipment		–			–			–			(3,000	)
Net Loss		(1,846,000	)		(1,138,000	)		(3,330,000	)		(2,345,000	)
Net loss per common share, basic and diluted	$	(0.01	)	$	(0.01	)	$	(0.02	)	$	(0.01	)
Weighted average common shares outstanding, basic and diluted		207,419,243			192,010,704			203,362,641			188,616,394

See notes to condensed consolidated financial statements.

4

QS ENERGY, INC.

Condensed Consolidated Statement of Stockholders’ Deficit, Unaudited

For the SIX months Ended JUNE 30, 2017

	Common Stock				Additional Paid-in		Accumulated			Total Stockholders’
	Shares		Amount		Capital		Deficit			Deficit
Balance, January 1, 2017		199,045,026	$	199,045	$	103,716,955	$	(105,274,000	)	$	(1,358,000	)
Common stock issued on exercise of warrants		605,000		605		60,395		–			61,000
Common stock issued on conversion of notes payable		24,858,380		24,858		1,222,142		–			1,247,000
Fair value of warrants and beneficial conversion feature of issued convertible notes		–		–		1,469,000		–			1,469,000
Fair value of options and warrants issued as compensation		–		–		535,000		–			535,000
Net loss		–		–		–		(3,330,000	)		(3,330,000	)
Balance, June 30, 2017		224,508,406	$	224,508	$	107,003,492	$	(108,604,000	)	$	(1,376,000	)

See notes to condensed consolidated financial statements.

5

QS ENERGY, INC.

Condensed Consolidated Statements of Cash Flows, Unaudited

	Six months ended
	June 30
	2017			2016
Cash flows from Operating Activities
Net loss	$	(3,330,000	)	$	(2,345,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock based compensation expense		535,000			267,000
Issuance of common stock for services		–			33,000
Amortization of debt discount		1,381,000			922,000
Accrued interest expense		21,000			–
Loss on disposition of assets		–			3,000
Depreciation and amortization		4,000			4,000
Changes in operating assets and liabilities:
Prepaid expenses and other assets		(8,000	)		3,000
Accounts payable and accrued expenses		640,000			49,000
Accounts payable – license agreements		113,000			94,000
Accounts payable and accrued expenses – related parties		(116,000	)		(32,000	)
Deposits and other current liabilities		(5,000	)		81,000
Net cash used in operating activities		(765,000	)		(921,000	)
Cash flows from investing activities
Purchase of equipment		(21,000	)		(5,000	)
Net cash used in investing activities		(21,000	)		(5,000	)
Cash flows from financing activities
Net proceeds from issuance of convertible notes and warrants		1,469,000			905,000
Net proceeds from exercise of warrants		61,000			–
Net cash provided by financing activities		1,530,000			905,000
Net increase (decrease) in cash		744,000			(21,000	)
Cash, beginning of period		136,000			349,000
Cash, end of period	$	880,000		$	328,000
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest	$	–		$	–
Income Taxes	$	1,600		$	–
Non-cash investing and financing activities
Conversion of convertible debentures to common stock	$	1,247,000		$	905,000
Fair value of warrants and beneficial conversion feature associated with issued convertible notes		1,469,000			905,000

See notes to condensed consolidated financial statements.

6

QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited

SIX MONTHS ENDED JUNE 30, 2017 AND 2016

1. Description of Business 

QS Energy, Inc. (“QS Energy”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.

QS Energy develops and commercializes energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic and international patents and patents pending, a substantial portion of which have been developed in conjunction with and exclusively licensed from Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology™ (AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. Engineered specifically to reduce pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity by applying a high intensity electrical field to crude oil feedstock while in transit. The AOT product has transitioned from the research and development stage to initial production for continued testing in advance of our goal of seeking acceptance and adoption by the midstream pipeline marketplace.

The Company also began commercial development of a suite of products based around the Joule Heat technology. The Company began fabrication of prototype equipment to be operated under a joint development agreement with a commercial entity in the fourth quarter of 2014. The Company’s first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. In addition, the Company filed two additional provisional patents related to the technology’s method and apparatus. In December 2015, we temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the AOT Midstream. We currently plan to resume Joule Heat development in 2018 depending on the availability of sufficient capital and other resources.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the SEC. The condensed consolidated balance sheet as of December 31, 2016 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures, including notes, required by GAAP.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the Company's financial position and results of operations for the interim periods reflected. Except as noted, all adjustments contained herein are of a normal recurring nature. Results of operations for the fiscal periods presented herein are not necessarily indicative of fiscal year-end results.

2. Summary of Significant Accounting Policies

Consolidation Policy

The accompanying consolidated financial statements of QS Energy Inc. include the accounts of QS Energy Inc. (the Parent) and its wholly owned subsidiaries, QS Energy Pool, Inc. and STWA Asia Pte. Limited. Intercompany transactions and balances have been eliminated in consolidation.

7

Going Concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the six-months ended June 30, 2017, the Company incurred a net loss of $3,330,000, used cash in operations of $765,000 and had a stockholders’ deficit of $1,376,000 as of that date. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. In addition, the Company's independent registered public accounting firm, in its report on the Company's December 31, 2016 financial statements, has raised substantial doubt about the Company's ability to continue as a going concern.

At June 30, 2017, the Company had cash on hand in the amount of $880,000. Management estimates that the current funds on hand will be sufficient to continue operations through September 2017. Management is currently seeking additional funds, primarily through the issuance of debt and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with the license and research and development agreements with Temple; costs associated with product development and commercialization of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by, among other things, filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain payments to a former officer, and consulting fees, during the remainder of 2017 and beyond.

No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or cause substantial dilution for our stockholders in case of equity financing.

Basic and Diluted Income (loss) per share

Our computation of earnings per share (“EPS”) includes basic and diluted EPS. Basic EPS is measured as the income (loss) available to common stockholders divided by the weighted average common shares outstanding for the period. Diluted income (loss) per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income (loss) of the Company as if they had been converted at the beginning of the periods presented, or issuance date, if later. In computing diluted income (loss) per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. Potential common shares that have an antidilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

Income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the respective periods. Basic and diluted (loss) per common share is the same for periods in which the Company reported an operating loss because all warrants and stock options outstanding are anti-dilutive. At June 30, 2017 and 2016, we excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock as their effect would have been anti-dilutive.

	June 30, 2017		June 30, 2016
Options		35,313,541		23,724,256
Warrants		21,507,270		9,342,892
Common stock issuable upon conversion of notes payable		9,968,933		2,401,667
Total		66,789,744		35,468,815

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include those related to assumptions used in valuing equity instruments issued for financing and for services, and reduction of deferred tax assets. Actual results could differ from those estimates.

8

Revenue Recognition Policy

The Company recognizes lease revenue upon commencement of the lease. Revenue on future product sales will be recognized upon meeting the following criteria: persuasive evidence of an arrangement exists; delivery has occurred or services rendered; the seller's price to the buyer is fixed or determinable; and collectability is reasonably assured.

In the fourth quarter 2016, the Company entered a contract to provide onsite testing services to a Canadian oil producer and pipeline operator at a fixed price of $50,000. The testing service was performed in January 2017 and was completed in March 2017.

Research and Development Costs

Costs incurred for research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed. Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial uses are also expensed.

For the six-month periods ended June 30, 2017 and 2016 research and development costs were $120,000 and $148,000, respectively.

Patent Costs

Patent costs consist of patent-related legal and filing fees. Due to the uncertainty associated with the successful development of our AOT and Joule Heat products, all patent costs are expensed as incurred. During the six-month periods ended June 30, 2017 and 2016, patent costs were $24,000 and $30,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations. During the three-month periods ended June 30, 2017 and 2016, patent costs were $7,000 and $17,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein. Entities will be able to transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures. In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

9

In July 2017, the FASB issued Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The guidance in ASU 2017-11 is to be applied using a full or modified retrospective approach. The adoption of ASU 2017-11 is not currently expected to have any impact on the Company’s financial statement presentation or disclosures.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statement presentation or disclosures.

3. Accrued Expenses and Accounts Payable – Related Parties

Accrued expense – related parties consists of accrued salaries of officers and fees due to members of the Board of Directors.

As of June 30, 2017 and December 31, 2016, accrued expenses and accounts payable to related parties amounted to $19,000 and $135,000, respectively.

4. Property and Equipment

At June 30, 2017 and December 31, 2016, property and equipment consists of the following:

	June 30, 2017			December 31, 2016
	(unaudited)
Office equipment	$	30,000		$	28,000
Furniture and fixtures		3,000			3,000
Testing Equipment		37,000			18,000
Subtotal		70,000			49,000
Less accumulated depreciation		(36,000	)		(32,000	)
Total	$	34,000		$	17,000

Depreciation expense for the six-month periods ended June 30, 2017 and 2016 was $4,000 for each period. Depreciation expense for the three-month periods ended June 30, 2017 and 2016 was $2,000 for each period.

5. Convertible Notes

	June 30, 2017			December 31, 2016
	(unaudited)
Convertible notes outstanding	$	787,000		$	417,000
Accrued interest		43,000			23,000
Subtotal		830,000			440,000
Unamortized note discounts		(327,000	)		(92,000	)
Balance on convertible notes, net of note discounts	$	503,000		$	348,000

10

The Company issues convertible notes in exchange for cash. The notes typically do not bear any interest, however, there is an implied interest rate of 10% since the notes are typically issued at a price 10% less than its face value. The notes are unsecured, and usually mature twelve months from issuance.

The notes are convertible at the option of the note holder into the Company’s common stock at a conversion price stipulated in the conversion agreement. In addition, the note holders received warrants to purchase shares of common stock that are fully vested and will expire in one year from the date of issuance.

As a result, the Company records a note discount to account for the relative fair value of the warrants, the notes’ beneficial conversion feature or BCF, and original issue discount of 10% (OID). The note discounts are amortized over the term of the notes or amortized in full upon its conversion to common stock. At December 31, 2016, total outstanding notes payable amounted to $417,000, accrued penalty interest of $23,000 and unamortized note discount of $92,000, or a net balance of $348,000.

During the six-month period ending June 30, 2017, the Company issued similar convertible promissory notes in the aggregate of $1,616,000 for cash of $1,469,000 or a discount of $147,000. The notes do not bear any interest, however, the implied interest rate used was 10% since the notes were issued at a price 10% less than its face value. The notes are unsecured, mature in twelve months from issuance and convertible at $0.05 per share. In addition, the Company also granted these note holders warrants to purchase 16,160,770 shares of the Company’ common stock. The warrants are fully vested, exercisable at $0.05 per share and will expire in one year. As a result, the Company recorded a note discount of $1,616,000 to account for the relative fair value of the warrants, the notes’ BCF, and OID. The note discounts are being amortized over the term of the note or amortized in full upon the conversion to common stock.

During the period ended June 30, 2017, a total of $1,247,000 notes payable was converted to 24,858,380 shares of common stock. In addition, the note discount of $1,381,000 was amortized to interest expense, and interest of $21,000 was accrued.

As of June 30, 2017, total outstanding notes payable amounted to $787,000, accrued interest of $43,000 and unamortized note discount of $326,000 for a net balance of $503,000. In addition, a total of five notes amounting to $295,000 reached maturity and are past due. The Company is currently in negotiations with the noteholders to settle the matured notes payable.

6. Research and Development

The Company constructs, develops and tests the AOT and Joule Heat technologies with internal resources and through the assistance of various third-party entities. Costs incurred and expensed include fees such as license fees, purchase of test equipment, pipeline pumping equipment, crude oil tank batteries, viscometers, SCADA systems, computer equipment, payroll and other related equipment and various logistical expenses for the purposes of evaluating and testing the Company’s AOT prototypes and Joule Heat prototypes.

For the six-month periods ended June 30, 2017 and 2016, our research and development expenses were $120,000 and $148,000 respectively. For the three-month periods ended June 30, 2017 and 2016, our research and development expenses were $56,000 and $73,000, respectively.

AOT Product Development and Testing 

During the six-month periods ended June 30, 2017 and 2016, the Company incurred total expenses of $26,000 and $54,000, respectively, in the manufacture, delivery and testing of the AOT prototype equipment. During the three-month periods ended June 30, 2017 and 2016, the Company incurred total expenses of $9,000 and $26,000, respectively. These expenses have been reflected as part of Research and Development expenses on the accompanying consolidated statements of operations.

Temple University Licensing Agreement

On August 1, 2011, the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive and the territory licensed to the Company is worldwide and replace previously issued License Agreements.

11

Pursuant to the two licensing agreements, the Company agreed to pay Temple the following: (i) non-refundable license maintenance fee of $300,000; (ii) annual maintenance fees of $187,500; (iii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing agreements; and (iv) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon. Temple also agreed to defer $37,500 of the amount due if the Company agreed to fund at least $250,000 in research or development of Temple’s patent rights licensed to the Company. The term of the licenses commenced in August 2011 and will expire upon the expiration of the patents. The agreement can also be terminated by either party upon notification under terms of the licensing agreements or if the Company ceases the development of the patent or failure to commercialize the patent rights.

Total expenses recognized during each six-month period ended June 30, 2017 and 2016 pursuant to these two agreements amounted to $94,000. Total expenses recognized during each three-month period ended June 30, 2017 and 2016 pursuant to these two agreements amounted to $47,000 These expenses have been reflected in Research and Development expenses on the accompanying consolidated statements of operations.

As of June 30, 2017 and December 31, 2016, total unpaid fees due to Temple pursuant to these agreements amounted to $840,000 and $727,000, respectively, which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As of June 30, 2017, $222,000 of the $840,000 payable has been deferred until the licensing agreements are terminated and $581,000 is deemed past due.

The Company generated $50,000 in revenue from the viscosity reduction license during the six-month period ended June 30, 2017. This amount is not sufficient to be subject to additional license fees under the license agreement. No revenues were earned from the two license agreements during the six-month period ended June 2016.

In July 2017, the Company and Temple amended the license agreement related to the Company’s AOT viscosity reduction technology. Under this amendment, Temple agreed to defer amounts currently due under the viscosity reduction license in the amount of $135,000, bringing the Company current under the viscosity reduction technology license agreement. The Company is currently in negotiations with Temple to settle amounts due under the second license agreement related to a fuel injector technology.

Temple University Sponsored Research Agreement

On March 19, 2012, the Company entered into a Sponsored Research Agreement (“Research Agreement”) with Temple University (“Temple”), whereby Temple, under the direction of Dr. Rongjia Tao, performed research related to the Company’s AOT device (the “Project”), for the period April 1, 2012, through April 1, 2014. All rights and title to intellectual property resulting from Temple’s work related to the Project were subjected to the Exclusive License Agreements between Temple and the Company, dated August 1, 2011.  In exchange for Temple’s research efforts on the Project, the Company has agreed to pay Temple $500,000, payable in quarterly installments of $62,500. The agreement expired in August 2015. As of June 30, 2017 and December 31, 2016, total unpaid fees due to Temple pursuant to this agreement amounted to $78,000, which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As of June 30, 2017, the entire $78,000 is deemed past due.

On July 14, 2017, the Company and Temple reached agreement to settle these past due amounts under a payment plan, paying the amount before the end of December 2017.

In addition, Temple University continues to provide laboratory testing and support related to the Company’s commercialization efforts. This continuing work is provided on at a fixed price, on an ad hoc basis depending upon the scope of work. During the six-month period ending June 30, 2017, the Company incurred a total of $3,000 in ad hoc testing with Temple University. No ad hoc testing was performed during the three-month period ending June 30, 2017. Temple ad hoc testing expense is reported as part of Research and development expenses in the accompanying consolidated statements of operations.

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7. Common Stock

During the six months ended June 30, 2017, the Company issued 24,858,380 shares of its common stock upon the conversion of $1,247,000 in convertible notes at conversion rates ranging from $0.05 and $0.10 per share.

8. Stock Options and Warrants

The Company periodically issues stock options and warrants to directors, employees, and non-employees in capital raising transactions, for services and for financing costs. Options vest and expire according to terms established at the grant date.

Options

Options vest according to the terms of the specific grant and expire from 2 to 10 years from date of grant. The weighted-average, remaining contractual life of employee and non-employee options outstanding at June 30, 2017 was 6.1 years. Stock option activity for the period January 1, 2017 up to June 30, 2017, was as follows:

	Options		Weighted Avg. Exercise Price
January 1, 2017		23,474,256	$	0.28
Granted		11,839,285		0.12
Exercised		–		–
Forfeited		–		–
June 30, 2017		35,313,541	$	0.23

The weighted average exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of June 30, 2017 were as follows:

	Outstanding Options				Exercisable Options
Option Exercise Price Per Share	Shares	Life (Years)		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
$ 0.05 - $ 0.99	35,163,095	6.1	$	0.22	29,017,262	$	0.23
$ 1.00 - $ 1.99	150,446	6.1	$	1.18	150,446	$	1.18
	35,313,541	6.1	$	0.23	29,167,708	$	0.23

During the six-month period ending June 30, 2017, the Company granted options to purchase 8,339,285 shares of common stock to members of the Company’s Board of Directors. The options are exercisable at $0.05 to $0.13 per share, vest monthly over a twelve-month period, and expire ten years from the date granted. Total fair value of these options at grant date was $379,000 using the Black-Scholes Option Pricing model with the following assumptions: life of 5 years; risk free interest rate of 1.94%; volatility of 123% to 144%, and dividend yield of 0%.

During the six-month period ending June 30, 2017, the Company granted two officers and an employee of the Company stock options to purchase a total of 3,500,000 shares of common stock. The stock options vest over a two-year period, exercisable at a price range of $0.07 through $0.40 per share and will expire in 10 years. Total fair value of the stock options amounted to $182,000 which will be expensed over the vesting period. In addition, as a result of the resignation of the Company’s CEO and three members of the Board of Directors, the Company agreed to modify the vesting term of 4.5 million options granted to them in January 2017 and fully vested those options resulting in a charge of $308,000 to account for the fair value of these options. There were no other changes in the remaining terms of the original grant.

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During the six-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs based on the fair value of options that vested of $535,000 and $181,000 respectively, which is included in Operating expenses in the Company’s statement of operations. During the three-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs based on the fair value of options that vested of $300,000 and $100,000 respectively, which is included in Operating expenses in the Company’s statement of operations.

At June 30, 2017, the Company’s closing stock price was $0.22 per share. The aggregate intrinsic value of the options outstanding at June 30, 2017 was $1,574,000. Future unamortized compensation expense on the unvested outstanding options at June 30, 2017 is $438,000 to be recognized through December 2017.

Warrants

The following table summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2017 up to June 30, 2017.

	Warrants			Weighted Avg. Exercise Price
January 1, 2017		11,446,892		$	0.15
Granted		16,160,770			0.05
Exercised		(605,000	)		–
Cancelled		(5,495,392	)		0.13
June 30, 2017		21,507,270		$	0.08

The weighted average exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of June 30, 2017 were as follows:

	Outstanding Warrants				Exercisable Warrants
Warrant Exercise Price Per Share	Shares	Life (Years)		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
$ 0.05 - $ 0.99	21,507,270	1.1	$	0.08	21,407,270	$	0.08
$ 1.00 - $ 1.99	–	–		–	–		–
	21,507,270	1.1	$	0.08	21,407,270	$	0.08

In the six-month period ending June 30, 2017, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 16,160,770 shares of common stock with an exercise price of $0.05 per share, vesting immediately upon grant and expiring one year from the date of grant (see Note 5).

During the six-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs of $1,000 and $86,000, respectively, based on the fair value of warrants previously issued for services that vested during the period, which is included in Operating expenses in the Company’s statement of operations. During the three-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs of $1,000 and $58,000, respectively, based on the fair value of warrants that vested, which is included in Operating expenses in the Company’s statement of operations.

At June 30, 2017, the aggregate intrinsic value of the warrants outstanding was $3,114,000. Future unamortized compensation expense on the unvested outstanding warrants at June 30, 2017 is approximately $3,000 to be recognized through July 2018. 

9. Commitments and Contingencies

There is no current or pending litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the normal course of business.

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On April 1, 2017, the Company executed a separation agreement and release effective with the Company’s Chief Executive Officer (CEO). As part of the agreement, the Company agreed to pay the CEO $580,000 in severance, payable in equal installment over 24 months. In addition, the Company also agreed to pay the CEO’s medical insurance for 24 months and provide use of a cell phone for 12 months with an estimated cost of $44,000. As a result, the Company accrued the entire amount of $624,000 which was also reported as part of Operating Expenses in the accompanying consolidated statements of operations. As of June 30, 2017, the outstanding balance amounted to $546,000 which was reported as part of Accounts Payable and Accrued Expenses in the accompanying consolidated balance sheets.

10. Subsequent Events

Grant of Stock Options

In July 2017, the Company’ shareholders elected a new member to the Board of Directors. Upon this election, in accordance with the Company’s Board of Directors compensation policy, the Company granted the new director stock options to purchase a total of 122,567 shares of common stock. The stock options vest monthly through December 31, 2017, are exercisable at $0.19 per share and will expire 10 years from the date of issuance. Total fair value of the stock options amounted to $20,000 which will be expensed over the vesting period.

Agreements

On July 13, 2017, the Company and Temple University entered into an amendment to the exclusive license agreement related to the Company’s AOT viscosity reduction technology. The amendment defers those outstanding fees in the amount of $135,000 owed by the Company to Temple University under the license agreement, until such time as the Company either receives sales receipts exceeding $835,000 or sublicenses the agreement. Further, the amendment established interest rates for outstanding fees and terms of payment for an annual license fee between the Company and Temple University.

Additionally, on July 13, 2017, the Company and Temple University entered into a payment agreement related to the sponsored research agreement of March 19, 2012 between the parties, as amended on March 19, 2013. Under the terms of the payment agreement, the Company and Temple University agreed to a payment schedule for outstanding fees in the amount of $78,314, owed by the Company to the Temple under the research agreement. Under the terms of the payment agreement, these fees are payable $20,000 upon the effective date of the Agreement, and the balance payable in six equal monthly installments of $9,719.

Conversion of Convertible Notes

From July 1, 2017 up to August 7, 2017, Company issued 3,453,092 shares of restricted common stock upon conversion of previously issued convertible notes in aggregate value of $174,000.

Exercise of Warrants

From July 1, 2017 up to August 7, 2017, the Company issued 2,500,000 shares of restricted common stock on the exercise of warrants in aggregate value of $203,250.

Exercise of Options

In July 2017, the Company issued 271,752 shares of restricted common stock on the exercise of options by a member of the Company’s Board of Directors.

Private Sale of Unregistered Securities

In July, 2017, the Company issued 181,355 shares of restricted common stock at a price of $0.21 per share, total proceeds of $38,000 by a member of the Company’s board of directors in private offerings exempt from registration.

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and supplementary data referred to in this Form 10-Q.

This discussion contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration, selling, general and administrative expenses, research and development expenses, capital resources, additional financings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed elsewhere in this Form 10-Q, particularly in “Risk Factors,” that could cause actual results to differ materially from those projected. Unless otherwise expressly indicated, the information set forth in this Form 10-Q is as of June 30, 2017, and we undertake no duty to update this information.

Overview

QS Energy, Inc. (“QS Energy” or “Company” or “we” or “us” or “our”) develops and commercializes energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic and international patents and patents pending, a substantial portion of which have been developed in conjunction with and exclusively licensed from Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology™ (AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. Engineered specifically to reduce pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity by applying a high intensity electrical field to crude oil feedstock while in transit. AOT technology delivers reductions in crude oil viscosity and pipeline pressure loss as demonstrated in independent third-party tests performed by the U.S. Department of Energy, the PetroChina Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™, at full-scale test facilities in the U.S. and China, and under commercial operating conditions on one of North America’s largest high-volume crude oil pipelines. Recent testing on a commercial crude oil condensate pipeline demonstrated high correlation between laboratory analysis and full-scale AOT operations under commercial operating conditions with onsite measurements and data collected by the pipeline operator on its supervisory control and data acquisition (“SCADA”) system. The AOT product has transitioned from laboratory testing and ongoing research and development to initial production and continued testing in advance of our goal of seeking acceptance and adoption by the midstream pipeline marketplace. We continue to devote the bulk of our efforts to the promotion, design, testing and the commercial manufacturing and operations of our crude oil pipeline products in the upstream and midstream energy sector. We anticipate that these efforts will continue during 2017 and 2018.

Our Company was incorporated on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The name change was effected through a short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Additionally, QS Energy Pool, Inc., a California corporation, was formed as a wholly-owned subsidiary of the Company on July 6, 2015 to serve as a vehicle for the Company to explore, review and consider acquisition opportunities. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.

Between 2011 and 2012, the Company transitioned from prototype testing of its AOT technology at the U.S. Department of Energy Rocky Mountain Oilfield Testing Center, Midwest, Wyoming (“RMOTC”), to the design and production of full-scale commercial prototype units. The Company worked in a collaborative engineering environment with multiple energy industry companies to refine the AOT Midstream commercial design to comply with the stringent standards and qualification processes as dictated by independent engineering audit groups and North American industry regulatory bodies. In May 2013, the Company’s first commercial prototype unit known as AOT Midstream, was completed.

In 2013, the Company entered into an Equipment Lease/Option to Purchase Agreement (“TransCanada Lease”) with TransCanada Keystone Pipeline, L.P. by its agent TC Oil Pipeline Operations, Inc. ("TransCanada") which agreed to lease and test the effectiveness of the Company’s AOT technology and equipment on one of TransCanada’s operating pipelines. As previously reported in our 10-K report filed with the SEC on March 16, 2015, in June 2014, the equipment was accepted by TransCanada and the lease commenced and the first full test of the AOT equipment on the Keystone pipeline was performed in July 2014 by Dr. Rongjia Tao of Temple University, with subsequent testing performed by an independent laboratory, ATS RheoSystems, a division of CANNON™ (“ATS”) in September 2014. Upon review of the July 2014 test results and preliminary report by Dr. Tao, QS Energy and TransCanada mutually agreed that this initial test was flawed due to, among other factors, the short-term nature of the test, the inability to isolate certain independent pipeline operating factors such as fluctuations in upstream pump station pressures, and limitations of the AOT device to produce a sufficient electric field to optimize viscosity reduction. Subsequent testing by ATS in September 2014 demonstrated viscosity reductions of 8% to 23% depending on flow rates and crude oil types in transit. In its summary report, ATS concluded that i) data indicated a decrease in viscosity of crude oil flowing through the TransCanada pipeline due to AOT treatment of the crude oil; and ii) the power supply installed on our equipment would need to be increased to maximize reduction in viscosity and take full advantage of the AOT technology. While more testing is required to establish the commercial efficacy of our AOT technology, we are encouraged by the findings of these field tests performed under commercial operating conditions. The TransCanada Lease was terminated by TransCanada, effective October 15, 2014. Upon termination of the TransCanada Lease, all equipment was uninstalled, returned, inspected and configured for re-deployment.

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On July 15, 2014, the Company entered into an Equipment Lease/Option to Purchase Agreement (“Kinder Morgan Lease”) with Kinder Morgan Crude & Condensate, LLC (“Kinder Morgan”) under which Kinder Morgan agreed to lease and test the effectiveness of the Company’s AOT technology and equipment on one of Kinder Morgan’s operating pipelines. Equipment provided under the Lease includes a single AOT Midstream pressure vessel with a maximum flow capacity of 5,000 gallons per minute. The equipment was delivered to Kinder Morgan in December 2014 and installed in March 2015. In April 2015, during pre-start testing, low electrical impedance was measured in the unit, indicating an electrical short. A replacement unit was installed May 2015. The second unit also presented with low impedance when flooded with crude condensate from Kinder Morgan’s pipeline. Subsequent to design modifications, a remanufactured AOT unit was installed and tested at Kinder Morgan’s pipeline facility in August 2015. Initial results were promising, with the unit operating generally as expected. However, voltage dropped as preliminary tests continued, indicating decreased impedance within the AOT pressure vessel. QS Energy personnel and outside consultants performed a series of troubleshooting assessments and determined that, despite modifications made to the AOT, conductive materials present in the crude oil condensate continued to be the root cause of the decreased impedance. Based on these results, QS Energy and Kinder Morgan personnel mutually agreed to put a hold on final acceptance of equipment under the lease and temporarily suspend in-field testing to provide time to re-test crude oil condensate in a laboratory setting, and thoroughly review and test selected AOT component design and fabrication. Subsequent analysis and testing led to changes in electrical insulation, inlet flow improvements and other component modifications. These design changes were implemented and tested by Industrial Screen and Maintenance (ISM), one of QS Energy's supply chain partners in Casper, Wyoming. Tests performed by ISM at its Wyoming facility indicated significant improvements to system impedance and efficiency of electric field generation.

In February 2016, the modified AOT equipment was installed at Kinder Morgan’s facility. Pre-acceptance testing was performed in April 2016, culminating in more than 24 hours of continuous operations. In-field viscosity measurements and pipeline data collected during this test indicated the AOT equipment operated as expected, resulting in viscosity reductions equivalent to those measured under laboratory conditions. Supervisory Control And Data Acquisition (“SCADA”) pipeline operating data collected by Kinder Morgan during this test indicated a pipeline pressure drop reduction consistent with expectations. Kinder Morgan provided the Company with a number of additional crude oil samples which were tested in the laboratory for future test correlation and operational planning purposes. Based on final analysis of in-field test results, SCADA operating data and subsequent analysis of crude oil samples at Temple University, Kinder Morgan and QS Energy are considering moving the AOT test facility to a different, higher-volume pipeline location. In the meantime, the Kinder Morgan Lease is in suspension and lease payments have not yet commenced.

Southern Research Institute (SRI) was engaged by QS Energy in 2015 to investigate the root cause of the crude oil condensate impedance issue by replicating conditions experienced in the field utilizing a laboratory-scaled version of the AOT and crude oil condensate samples provided by Kinder Morgan. In addition, QS Energy retained an industry expert petroleum pipeline engineer to review the AOT design and suggest design modifications to resolve the crude oil condensate impedance issue. This engineer has studied design details, staff reports and forensic photographs of each relevant AOT installation and test. Based on these investigations, specific modifications were proposed to resolve the impedance issue, and improve the overall efficiency of the AOT device, resulting in a new value-engineered design of certain AOT internal components.

The Company is actively seeking new deployments of its AOT technology. In August, 2015, QS Energy was invited to an offshore oil transfer platform in the Gulf of Mexico. This offshore platform was assessed by QS Energy personnel for a potential deployment of the AOT viscosity reduction technology as a solution for super-heavy crude oil flow assurance issues. Following the site visit, subject to non-disclosure agreements executed by all parties, laboratory testing was performed on crude oil samples provided by the operator, which demonstrated significant AOT viscosity reductions. Detailed hydraulic analysis based on laboratory results and pipeline operating parameters was presented to the operator demonstrating potential benefits of AOT technology within the operator’s specified infrastructure. Based on this analysis, the Company was directed by the operator to prepare a preliminary configuration for AOT units optimized for the operator’s high-volume, space-constrained operations. Company engineers and supply chain partners have prepared an optimized configuration and production budget. Based on this optimized configuration, the operator is considering an onsite pilot test with full scale AOT equipment for deployment in 2018 or 2019.

The Company is in discussions with a large Middle Eastern oil company regarding AOT technology in the Middle East, having tested multiple oil samples provided by this oil company at Temple University in 2015 and 2016. The most recent round of testing on Middle Eastern oil company samples was completed early 2017, demonstrating AOT viscosity reductions of 20% to 50% in a laboratory setting.

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During the third quarter 2016, the Company developed a new onsite testing program designed to accelerate the AOT sales cycle. This program utilizes a fully functional laboratory-scale AOT device designed and developed by the Company in 2015, and tested at the Southern Research Institute. Under this new program, Company engineers will set up a temporary lab at the customer’s site to test a full range of crude oils. Fees charged for providing this service will be dependent on scope of services, crude oil sample to be tested, and onsite time requirements. This program has received a positive response from potential customers. In the fourth quarter 2016, the Company entered a contract to provide these onsite testing services to a Canadian oil producer and pipeline operator over a one-week period in early 2017 at a fixed price of $50,000. This initial test was performed in January 2017; data analysis and final report was completed in March 2017.

In 2014, the Company began development of a new suite of products based around the new electrical heat system which reduces oil viscosity through a process known as joule heat (“Joule Heat”). The Company is designing and optimizing the Joule Heat technology for the upstream oil transportation market. The Company filed two provisional patents related to the technology’s method and apparatus in the second quarter and fourth quarter of 2013, respectively. The first of the two provisional patents was finalized and submitted to non-provisional status on April 29, 2014. The second of the two provisional patents was finalized and submitted to non-provisional status at the end of the third quarter 2014.

In October 2014, QS Energy entered into a Joint Development Agreement with Newfield Exploration Company (“Newfield”) to test a prototype of QS Energy Joule Heat equipment, and combined Joule Heat and AOT technology, on a crude oil pipeline serving the Greater Monument Butte oilfield located in the Uintah Basin of Utah. This test of the Joule Heat technology provides ideal conditions to demonstrate efficiency and efficacy. The Uintah Basin is 5,000 to 10,000 feet above sea level with average low winter temperatures of 16ºF. Crude oil pumped from the region is highly paraffinic with the consistency of shoe polish at room temperature. Uintah's black wax crude must remain at a minimum of 95ºF and yellow wax above 115ºF and therefore requires a substantial amount of heat to keep it above its high pour point. Operators in the upstream market often run at temperatures of 140ºF to 160ºF. Newfield, like many other companies in the region, incurs significant operating expense in the form of fuel and power used to heat the waxy crude and counter the cold climate conditions characteristic of Utah. The Company’s first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. During the third and fourth quarters of 2015, we worked with Newfield and Dr. Carl Meinhart to modify the prototype configuration based on observed pipeline and Joule Heat operating factors. In addition, QS Energy provided a scaled-down version of the Joule Heat unit for static and flow-through testing at SRI. Testing performed by SRI in September 2015 on a laboratory-scale Joule Heat unit demonstrated the ability of the Joule Heat technology to deliver temperature increases in the laboratory setting.

In 2015, the Company worked in collaboration with Newfield, SRI, Dr. Carl Meinhart, and our manufacturing partner to design and build an AOT prototype unit, for operations in the upstream crude oil pipeline market (“AOT Upstream”), specifically configured for pipeline operating factors observed at Newfield’s Utah site. Our original plan was to retrofit an earlier prototype device previously tested at RMOTC; however, after multiple site visits and discussions with Newfield, it was determined a new, smaller unit, specifically optimized for Newfield operations would be more appropriate for this field test opportunity. We plan to jointly test the AOT Upstream prototype unit under typical upstream commercial pipeline conditions on Newfield’s pipeline in conjunction with the previously installed Joule Heat unit.

In December 2015, we temporarily suspended Joule Heat and AOT Upstream development activities to focus Company resources on finalizing commercial development of the AOT Midstream. Testing terminated at SRI and all prototype equipment was returned to the Company. We currently plan to resume Joule Heat and AOT Upstream development in 2017 depending on the availability of sufficient capital and other resources.

In July 2015, the Company formed QS Energy Pool, Inc., a wholly owned subsidiary of QS Energy, Inc., for the sole purpose of taking advantage of asset acquisition opportunities in the oil and gas operations market. QS Energy Pool is specifically targeting the acquisition of one or more operating companies or properties with proven positive cash flow, providing operating income and bottom line revenue which are both accretive to and synergistic with QS Energy, Inc.’s current operations. QS Energy has identified multiple attractive opportunities to acquire producing oil and gas field operations. Our strategy is to acquire producing oil and gas fields with production profiles of at least ten years, proven long-term development rights, and demonstrated positive cash flow at commodity prices as low as $25/barrel of oil and $2.00/MCF of gas. Any such acquisitions would be subject on our ability to obtain acquisition financing under acceptable terms and conditions. To date, we have not acquired any oil and gas properties, and there can be no assurances that we will do so in the future. We can provide no assurances that acquisition financing would be available to us.

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Our expenses to date have been funded primarily through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise of stock purchase warrants and options. We will need to raise substantial additional capital through 2017, and beyond, to fund our sales and marketing efforts, continuing research and development, and certain other expenses, until our revenue base grows sufficiently.

There are significant risks associated with our business, our Company and our stock. See “Risk Factors” in Part II, Item 1A below.

Results of Operation for Six and Three-month periods ended June 30, 2017 and 2016

I. Six months ended June 30, 2017 and 2016

	Six months ended
	June 30
	2017			2016			Change
Revenues	$	50,000		$	–		$	–
Costs and expenses
Operating expenses		1,838,000			1,261,000			577,000
Research and development expenses		120,000			148,000			(28,000	)
Loss before other income (expense)		(1,908,000	)		(1,409,000	)		(499,000	)
Other income (expense)
Interest and financing expense		(1,422,000	)		(933,000	)		(489	)
Loss on disposition of equipment		–			(3,000	)		3,000
Net Loss	$	(3,330,000	)	$	(2,345,000	)	$	(2,345,000	)

During the six-month period ended June 30, 2017, the Company recognized revenues of $50,000 pursuant to the completion of lease and testing agreement of the Company’s AOT equipment. There was no similar transaction during the period ended June 30, 2016.

Operating expenses were $1,838,000 for the six-month period ended June 30, 2017, compared to $1,261,000 for the six-month period ended June 30, 2016, an increase of $577,000. This is due to increases in non-cash expenses of $237,000, and in cash expenses of $337,000. Specifically, the increase in non-cash expenses are attributable to increases in depreciation of $1,000 and stock compensation expenses attributable to the fair value of options granted to directors and employees of $355,000, offset by decreases in stock compensation expenses attributable to the fair value of warrants granted to consultants of $119,000. The increase in cash expense is attributable to severance package expense of $671,000 with our Chief Executive Officer, and an increase in legal and accounting of $21,000, offset by decreases in consulting fees of $160,000, corporate expenses of $52,000, insurance of $23,000, rent of 51,000, salaries and benefits of $25,000, and other expenses of $41,000.

Research and development expenses were $120,000 for the six-month period ended June 30, 2017, compared to $148,000 for the six-month period ended June 30, 2016, a decrease of $28,000. This decrease is attributable to a decrease in prototype product development costs of $30,000, off-set by an increase in product testing, research, patents and other costs of $2,000.

Other income and expense were $1,422,000 expense for the six-month period ended June 30, 2017, compared to $933,000 expense for the six-month period ended June 30, 2016, a net increase in other expenses of $489,000. This increase is attributable to an increase in non-cash other expenses of $489,000. The increase in non-cash other expense is due to increases in expense attributable to interest, beneficial conversion factors and warrants associated with convertible notes issued in the amount of $469,000 and other non-cash interest of $20,000.

The Company had a net loss of $3,330,000, or $0.02 per share, for the six-month period ended June 30, 2017, compared to a net loss of $2,345,000, or $0.01 per share, for the six-month period ended June 30, 2016.

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II. Three months ended June 30, 2017 and 2016

	Three months ended
	June 30
	2017			2016			Change
Revenues	$	–		$	–		$	–
Costs and expenses
Operating expenses		580,000			626,000			(46,000	)
Research and development expenses		56,000			73,000			(17,000	)
Loss before other income (expense)		(636,000	)		(699,000	)		63,000
Other income (expense)
Interest and financing expense		(1,210,000	)		(439,000	)		(771,000	)
Net Loss	$	(1,846,000	)	$	(1,138,000	)	$	(708	)

The Company had no revenues in the three month-periods ended June 30, 2017 and 2016.

Operating expenses were $580,000 for the three-month period ended June 30, 2016, compared to $626,000 for the three-month period ended June 30, 2016, a decrease of $46,000. This is due to an increase in non-cash expenses of $142,000, and a decrease in cash expenses of $188,000. Specifically, the increase in non-cash expenses are attributable to decreases in depreciation of $1,000 and stock compensation expenses attributable to the fair value of warrants granted to consultants and others of $76,000, offset by an increase in stock compensation expenses attributable to the fair value of options granted to directors and employees of $219,000. The decrease in cash expense is attributable to decreases in consulting fees of $56,000, corporate expenses of $43,000, insurance of $13,000, legal and accounting fees of $13,000, rent of $37,000, salaries and benefits of $24,000, and other expenses of $2,000.

Research and development expenses were $56,000 for the three-month period ended June 30, 2017, compared to $73,000 for the three-month period ended June 30, 2016, a decrease of $17,000. This decrease is attributable to decreases in prototype product development costs of $17,000.

Other income and expense were $1,210,000 expense for the three-month period ended June 30, 2017, compared to $439,000 expense for the three-month period ended June 30, 2016, a net increase in other expenses of $771,000. This increase is attributable to an increase in non-cash other expenses of $771,000. The increase in non-cash other expense is due to an increase in expense attributable to interest, beneficial conversion features and warrants associated with convertible notes issued in the amount of $771,000.

The Company had a net loss of $1,846,000, or $0.01 per share, for the three-month period ended June 30, 2017, compared to a net loss of $1,138,000, or $0.01 per share, for the three-month period ended June 30, 2016.

Liquidity and Capital Resources

General

As reflected in the accompanying condensed consolidated financial statements, the Company has not yet generated significant revenues and has incurred recurring net losses. We have incurred negative cash flow from operations since our inception in 1998 and a stockholders’ deficit of $1,376,000 as of June 30, 2017. Our negative operating cash flow for the periods ended June 30, 2017 was funded primarily through issuance of convertible notes.

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying condensed consolidated financial statements, the Company had a net loss of $3,330,000 and a negative cash flow from operations of $765,000 for the six-month period ended June 30, 2017 and stockholders’ deficit of $1,376,000. These factors raise substantial doubt about our ability to continue as a going concern. In addition, the Company’s independent registered public accounting firm, in its report on the Company’s December 31, 2016 financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to raise additional funds and implement our business plan. The consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

20

Summary

During the period ended June 30, 2017, we received cash totaling $1,530,000 from issuance of our convertible notes payable and exercise of warrants, and used cash in operations of $765,000. At June 30, 2017, we had cash on hand in the amount of $880,000. We will need additional funds to operate our business, including without limitation the expenses we will incur in connection with the license and research and development agreements with Temple University, as amended; costs associated with product development and commercialization of the AOT and related technologies; costs to manufacture and ship our products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed above, we have substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain severance payments to a former officer and consulting fees, during the remainder of 2017 and beyond.

No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.

Licensing Fees to Temple University

For details of the licensing agreements with Temple University, see Financial Statements included in this report, Note 6 (Research and Development).

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going basis, our estimates and judgments, including those related to the useful life of the assets. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies that are both most important to the portrayal of a company’s financial condition and results of operations and those that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain at the time of estimation. For a more detailed discussion of the accounting policies of the Company, see Note 1 of the Notes to the Condensed Consolidated Financial Statements, “Summary of Significant Accounting Policies”.

We believe the following critical accounting policies, among others, require significant judgments and estimates used in the preparation of our consolidated financial statements.

Estimates

The preparation of consolidated financial statements in conformity with generally accepted accounting principles 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. Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note 1 to Notes to the Condensed Consolidated Financial Statements. Actual results could differ from those estimates.

21

Stock-Based Compensation

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

The fair value of the Company's common stock option grants is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual experience. The assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded in future periods.

Going Concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the six-months ended June 30, 2017, the Company incurred a net loss of $3,330,000, used cash in operations of $765,000 and had a stockholders’ deficit of $1,376,000 as of that date. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

At June 30, 2017, the Company had cash on hand in the amount of $880,000. Management estimates that the current funds on hand will be sufficient to continue operations through November 2017. Management is currently seeking additional funds, primarily through the issuance of debt and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with the license and research and development agreements with Temple; costs associated with product development and commercialization of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain payments to a former officer and consulting fees, during the remainder of 2017 and beyond.

No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or cause substantial dilution for our stockholders in case of equity financing.

Recent Accounting Polices

See Footnote 2 in the accompanying financial statements for a discussion of recent accounting policies.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

We issue from time to time fixed rate discounted convertible notes. Our convertible notes and our equity securities are exposed to risk as set forth below, in Part II Item 1A, “Risk Factors.” Please also see Item 2, above, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

22

Item 4. Controls and Procedures

1. Disclosure Controls and Procedures

The Company's management, with the participation of the Company's chief executive officer and chief financial officer, evaluated, as of June 30, 2017, the effectiveness of the Company's disclosure controls and procedures, which were designed to be effective at the reasonable assurance level. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of the Company's disclosure controls and procedures as of June 30, 2017, management, the chief executive officer and the chief financial officer concluded that the Company's disclosure controls and procedures were effective at the reasonable assurance level at that date.

(a)       Changes in Internal Control over Financial Reporting

No change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the six-month period ended June 30, 2017 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

23

PART II – OTHER INFORMATION

Item 1.  Legal Proceedings

There is no litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the normal course of business.

Item 1A.  Risk Factors

There have been no material changes in the risk factors previously disclosed in Form 10-K for the period ended December 31, 2016, which we filed with the SEC on March 15, 2017.

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

Issuances

In private offerings exempt from registration, during the six months ended June 30, 2017, the Company issued 24,858,380 shares of its common stock upon the conversion of $ 1,247,226 in convertible notes at $0.05 to $0.10 per share, and issued 605,000 shares of its common stock upon the exercise of warrants at an exercise price of $0.10 per share. In connection with the issuances of the foregoing securities, the Company relied on the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended, for transactions not involving a public offering.

The proceeds received by the Company in connection with the above issuances of shares were used for general corporate purposes.

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

24

Item 6. Exhibits

Exhibit No.	Description
31.1	Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
31.2	Certification of Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
32	Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C.  Section 1350
101.INS	XBRL Instance Document
101.SCH	XBRL Schema Document
101.CAL	XBRL Calculation Linkbase Document
101.LAB	XBRL Label Linkbase Document
101.PRE	XBRL Presentation Linkbase Document
101.DEF	XBRL Definition Linkbase Document

25

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this Report to be signed on its behalf by the undersigned, hereunto duly authorized.

	QS ENERGY, INC.
Date: August 14, 2017	By:	/s/ Michael McMullen
		Michael McMullen
		Chief Financial Officer

26

EXHIBITS

Exhibit No.	Description
31.1	Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
31.2	Certification of Chief Financial Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
32	Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C.  Section 1350
101.INS	XBRL Instance Document
101.SCH	XBRL Schema Document
101.CAL	XBRL Calculation Linkbase Document
101.LAB	XBRL Label Linkbase Document
101.PRE	XBRL Presentation Linkbase Document
101.DEF	XBRL Definition Linkbase Document

27

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

AND RULES 13A-14 AND 15D-14 UNDER THE SECURITIES EXCHANGE ACT OF 1934

I, Jason Lane, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of QS Energy, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e)  and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(d)-15(f) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its condensed consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting  principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 

2. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 14, 2017	/s/ Jason Lane
	Jason Lane
	Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

AND RULES 13A-14 AND 15D-14 UNDER THE SECURITIES EXCHANGE ACT OF 1934

I, Michael McMullen, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of QS Energy, Inc.; 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(d)-15(f) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its condensed consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and 

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 14, 2017	/s/ Michael McMullen
	Michael McMullen
	Chief Financial Officer

EX-32

EXHIBIT 32

CERTIFICATION OF PERIODIC FINANCIAL REPORT BY THE CHIEF EXECUTIVE

OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Solely for the purposes of complying with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, we, the undersigned Acting Chief Executive Officer and the Chief Financial Officer of QS Energy, Inc. (the “Company”), hereby certify, based on our knowledge, that the Quarterly Report on Form 10-Q of the Company for the quarter ended June 30, 2017 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 14, 2017	/s/ Jason Lane
	Jason Lane
	Chief Executive Officer
Date: August 14, 2017	/s/ Michael McMullen
	Michael McMullen
	Chief Financial Officer

XML

Document and Entity Information - shares	6 Months Ended
	Jun. 30, 2017	Aug. 07, 2017
Document And Entity Information
Entity Registrant Name	QS ENERGY, INC.
Entity Central Index Key	0001103795
Document Type	10-Q
Document Period End Date	Jun. 30, 2017
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		230,914,605
Document Fiscal Period Focus	Q2
Document Fiscal Year Focus	2017

XML

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) - USD ($)	Jun. 30, 2017	Dec. 31, 2016
Current assets:
Cash	$ 880,000	$ 136,000
Prepaid expenses and other current assets	40,000	26,000
Total current assets	920,000	162,000
Property and equipment, net of accumulated depreciation of $36,000 and $32,000 at June 30, 2017 and December 31, 2016, respectively	34,000	17,000
Other assets	1,000	7,000
Total assets	955,000	186,000
Current liabilities:
Accounts payable-license agreements	918,000	805,000
Accounts payable and accrued expenses	891,000	251,000
Accrued expenses and accounts payable-related parties	19,000	135,000
Deposits and other current liabilities	0	5,000
Convertible debentures, net of discounts of $327,000 and $92,000 at June 30, 2017 and December 31, 2016, respectively	503,000	348,000
Total current liabilities	2,331,000	1,544,000
Stockholders' deficit
Common stock, $.001 par value: 300,000,000 shares authorized, 224,508,406 and 199,045,026 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively	224,508	199,045
Additional paid-in capital	107,003,492	103,716,955
Accumulated deficit	(108,604,000)	(105,274,000)
Total stockholders' deficit	(1,376,000)	(1,358,000)
Total liabilities and stockholders' deficit	$ 955,000	$ 186,000

XML

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Parenthetical) - USD ($)	Jun. 30, 2017	Dec. 31, 2016
Statement of Financial Position [Abstract]
Accumulated depreciation	$ 36,000	$ 32,000
Discounts on convertible debentures	$ 327,000	$ 92,000
Common stock, par value	$ .001	$ 0.001
Common stock, shares authorized	300,000,000	300,000,000
Common stock, shares issued	224,508,406	199,045,026
Common stock, shares outstanding	224,508,406	199,045,026

XML

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) - USD ($)	3 Months Ended		6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016	Jun. 30, 2017	Jun. 30, 2016
Income Statement [Abstract]
Revenues	$ 0	$ 0	$ 50,000	$ 0
Costs and Expenses
Operating expenses	580,000	626,000	1,838,000	1,261,000
Research and development expenses	56,000	73,000	120,000	148,000
Loss before other income (expense)	(636,000)	(699,000)	(1,908,000)	(1,409,000)
Other income (expense)
Interest and financing expense	(1,210,000)	(439,000)	(1,422,000)	(933,000)
Loss on disposition of equipment	0	0	0	(3,000)
Net loss	$ (1,846,000)	$ (1,138,000)	$ (3,330,000)	$ (2,345,000)
Net loss per common share, basic and diluted	$ (.01)	$ (.01)	$ (.02)	$ (.01)
Weighted average common shares outstanding, basic and diluted	207,419,243	192,010,704	203,362,641	188,616,394

XML

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (Unaudited) - 6 months ended Jun. 30, 2017 - USD ($)	Common Stock [Member]	Additional Paid-in Capital [Member]	Deficit Accumulated [Member]	Total
Beginning balance, shares at Dec. 31, 2016	199,045,026
Beginning balance, value at Dec. 31, 2016	$ 199,045	$ 103,716,955	$ (105,274,000)	$ (1,358,000)
Common stock issued on exercise of warrants, shares	605,000
Common stock issued on exercise of warrants, value	$ 605	60,395		61,000
Common stock issued on conversion of notes payable, shares issued	24,858,380
Common stock issued on conversion of notes payable, value	$ 24,858	1,222,142		1,247,000
Fair value of warrants and beneficial conversion feature of issued convertible notes		1,469,000		1,469,000
Fair value of options and warrants issued as compensation		535,000		535,000
Net loss			(3,330,000)	(3,330,000)
Ending balance, shares at Jun. 30, 2017	224,508,406
Ending balance, value at Jun. 30, 2017	$ 224,508	$ 107,003,492	$ (108,604,000)	$ (1,376,000)

XML

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) - USD ($)	6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016
Cash flows from operating activities
Net Loss	$ (3,330,000)	$ (2,345,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock based compensation expense	535,000	267,000
Issuance of common stock for services	0	33,000
Amortization of debt discount	1,381,000	922,000
Accrued interest expense	21,000	0
Loss on disposition of assets	0	3,000
Depreciation and amortization	4,000	4,000
Changes in operating assets and liabilities:
Prepaid expenses and other assets	(8,000)	3,000
Accounts payable and accrued expenses	640,000	49,000
Accounts payable - license agreements	113,000	94,000
Accounts payable and accrued expenses - related parties	(116,000)	(32,000)
Deposits and other current liabiilities	(5,000)	81,000
Net cash used in operating activities	(765,000)	(921,000)
Cash flows from investing activities
Purchase of equipment	(21,000)	(5,000)
Net cash used in investing activities	(21,000)	(5,000)
Cash flows from financing activities
Net proceeds from issuance of convertible notes and warrants	1,469,000	905,000
Net proceeds from exercise of warrants	61,000	0
Net cash provided by financing activities	1,530,000	905,000
Net increase (decrease) in cash	744,000	(21,000)
Cash, beginning of period	136,000	349,000
Cash, end of period	880,000	328,000
Supplemental disclosures of cash flow information
Cash paid during the year for: Interest	0	0
Cash paid during the year for: Income taxes	1,600	0
Non-cash investing and financing activities
Conversion of convertible debentures to common stock	1,247,000	905,000
Fair value of warrants and beneficial conversion feature associated with issued convertible notes	$ 1,469,000	$ 905,000

XML

1. Description of Business

6 Months Ended

Jun. 30, 2017

Organization, Consolidation and Presentation of Financial Statements [Abstract]

Description of Business

QS Energy, Inc. (“QS Energy”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.

QS Energy develops and commercializes energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic and international patents and patents pending, a substantial portion of which have been developed in conjunction with and exclusively licensed from Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology™ (AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. Engineered specifically to reduce pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity by applying a high intensity electrical field to crude oil feedstock while in transit. The AOT product has transitioned from the research and development stage to initial production for continued testing in advance of our goal of seeking acceptance and adoption by the midstream pipeline marketplace.

The Company also began commercial development of a suite of products based around the Joule Heat technology. The Company began fabrication of prototype equipment to be operated under a joint development agreement with a commercial entity in the fourth quarter of 2014. The Company’s first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. In addition, the Company filed two additional provisional patents related to the technology’s method and apparatus. In December 2015, we temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the AOT Midstream. We currently plan to resume Joule Heat development in 2018 depending on the availability of sufficient capital and other resources.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the SEC. The condensed consolidated balance sheet as of December 31, 2016 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures, including notes, required by GAAP.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the Company's financial position and results of operations for the interim periods reflected. Except as noted, all adjustments contained herein are of a normal recurring nature. Results of operations for the fiscal periods presented herein are not necessarily indicative of fiscal year-end results.

XML

2. Summary of Significant Accounting Policies

6 Months Ended

Jun. 30, 2017

Accounting Policies [Abstract]

Summary of Significant Accounting Policies

Consolidation Policy

The accompanying consolidated financial statements of QS Energy Inc. include the accounts of QS Energy Inc. (the Parent) and its wholly owned subsidiaries, QS Energy Pool, Inc. and STWA Asia Pte. Limited. Intercompany transactions and balances have been eliminated in consolidation.

Going Concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the six-months ended June 30, 2017, the Company incurred a net loss of $3,330,000, used cash in operations of $765,000 and had a stockholders’ deficit of $1,376,000 as of that date. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. In addition, the Company's independent registered public accounting firm, in its report on the Company's December 31, 2016 financial statements, has raised substantial doubt about the Company's ability to continue as a going concern.

At June 30, 2017, the Company had cash on hand in the amount of $880,000. Management estimates that the current funds on hand will be sufficient to continue operations through September 2017. Management is currently seeking additional funds, primarily through the issuance of debt and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with the license and research and development agreements with Temple; costs associated with product development and commercialization of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by, among other things, filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain payments to a former officer, and consulting fees, during the remainder of 2017 and beyond.

No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or cause substantial dilution for our stockholders in case of equity financing.

Basic and Diluted Income (loss) per share

Our computation of earnings per share (“EPS”) includes basic and diluted EPS. Basic EPS is measured as the income (loss) available to common stockholders divided by the weighted average common shares outstanding for the period. Diluted income (loss) per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income (loss) of the Company as if they had been converted at the beginning of the periods presented, or issuance date, if later. In computing diluted income (loss) per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. Potential common shares that have an antidilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

Income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the respective periods. Basic and diluted (loss) per common share is the same for periods in which the Company reported an operating loss because all warrants and stock options outstanding are anti-dilutive. At June 30, 2017 and 2016, we excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock as their effect would have been anti-dilutive.

	June 30, 2017		June 30, 2016
Options		35,313,541		23,724,256
Warrants		21,507,270		9,342,892
Common stock issuable upon conversion of notes payable		9,968,933		2,401,667
Total		66,789,744		35,468,815

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include those related to assumptions used in valuing equity instruments issued for financing and for services, and reduction of deferred tax assets. Actual results could differ from those estimates.

Revenue Recognition Policy

The Company recognizes lease revenue upon commencement of the lease. Revenue on future product sales will be recognized upon meeting the following criteria: persuasive evidence of an arrangement exists; delivery has occurred or services rendered; the seller's price to the buyer is fixed or determinable; and collectability is reasonably assured.

In the fourth quarter 2016, the Company entered a contract to provide onsite testing services to a Canadian oil producer and pipeline operator at a fixed price of $50,000. The testing service was performed in January 2017 and was completed in March 2017.

Research and Development Costs

Costs incurred for research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed. Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial uses are also expensed.

For the six-month periods ended June 30, 2017 and 2016 research and development costs were $120,000 and $148,000, respectively.

Patent Costs

Patent costs consist of patent-related legal and filing fees. Due to the uncertainty associated with the successful development of our AOT and Joule Heat products, all patent costs are expensed as incurred. During the six-month periods ended June 30, 2017 and 2016, patent costs were $24,000 and $30,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations. During the three-month periods ended June 30, 2017 and 2016, patent costs were $7,000 and $17,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein. Entities will be able to transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures. In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

In July 2017, the FASB issued Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The guidance in ASU 2017-11 is to be applied using a full or modified retrospective approach. The adoption of ASU 2017-11 is not currently expected to have any impact on the Company’s financial statement presentation or disclosures.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statement presentation or disclosures.

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3. Accrued Expenses and Accounts Payable - Related Parties

6 Months Ended

Jun. 30, 2017

Related Party Transactions [Abstract]

Accrued Expenses and Accounts Payable - Related Parties

Accrued expense – related parties consists of accrued salaries of officers and fees due to members of the Board of Directors.

As of June 30, 2017 and December 31, 2016, accrued expenses and accounts payable to related parties amounted to $19,000 and $135,000, respectively.

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4. Property and Equipment

6 Months Ended

Jun. 30, 2017

Property, Plant and Equipment [Abstract]

Property and Equipment

At June 30, 2017 and December 31, 2016, property and equipment consists of the following:

	June 30, 2017			December 31, 2016
	(unaudited)
Office equipment	$	30,000		$	28,000
Furniture and fixtures		3,000			3,000
Testing Equipment		37,000			18,000
Subtotal		70,000			49,000
Less accumulated depreciation		(36,000	)		(32,000	)
Total	$	34,000		$	17,000

Depreciation expense for the six-month periods ended June 30, 2017 and 2016 was $4,000 for each period. Depreciation expense for the three-month periods ended June 30, 2017 and 2016 was $2,000 for each period.

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5. Convertible Notes

6 Months Ended

Jun. 30, 2017

Debt Disclosure [Abstract]

Convertible Notes

	June 30, 2017			December 31, 2016
	(unaudited)
Convertible notes outstanding	$	787,000		$	417,000
Accrued interest		43,000			23,000
Subtotal		830,000			440,000
Unamortized note discounts		(327,000	)		(92,000	)
Balance on convertible notes, net of note discounts	$	503,000		$	348,000

The Company issues convertible notes in exchange for cash. The notes typically do not bear any interest, however, there is an implied interest rate of 10% since the notes are typically issued at a price 10% less than its face value. The notes are unsecured, and usually mature twelve months from issuance.

The notes are convertible at the option of the note holder into the Company’s common stock at a conversion price stipulated in the conversion agreement. In addition, the note holders received warrants to purchase shares of common stock that are fully vested and will expire in one year from the date of issuance.

As a result, the Company records a note discount to account for the relative fair value of the warrants, the notes’ beneficial conversion feature or BCF, and original issue discount of 10% (OID). The note discounts are amortized over the term of the notes or amortized in full upon its conversion to common stock. At December 31, 2016, total outstanding notes payable amounted to $417,000, accrued penalty interest of $23,000 and unamortized note discount of $92,000, or a net balance of $348,000.

During the six-month period ending June 30, 2017, the Company issued similar convertible promissory notes in the aggregate of $1,616,000 for cash of $1,469,000 or a discount of $147,000. The notes do not bear any interest, however, the implied interest rate used was 10% since the notes were issued at a price 10% less than its face value. The notes are unsecured, mature in twelve months from issuance and convertible at $0.05 per share. In addition, the Company also granted these note holders warrants to purchase 16,160,770 shares of the Company’ common stock. The warrants are fully vested, exercisable at $0.05 per share and will expire in one year. As a result, the Company recorded a note discount of $1,616,000 to account for the relative fair value of the warrants, the notes’ BCF, and OID. The note discounts are being amortized over the term of the note or amortized in full upon the conversion to common stock.

During the period ended June 30, 2017, a total of $1,247,000 notes payable was converted to 24,858,380 shares of common stock. In addition, the note discount of $1,381,000 was amortized to interest expense, and interest of $21,000 was accrued.

As of June 30, 2017, total outstanding notes payable amounted to $787,000, accrued interest of $43,000 and unamortized note discount of $326,000 for a net balance of $503,000. In addition, a total of five notes amounting to $295,000 reached maturity and are past due. The Company is currently in negotiations with the noteholders to settle the matured notes payable.

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6. Research and Development

6 Months Ended

Jun. 30, 2017

Research and Development [Abstract]

Research and Development

The Company constructs, develops and tests the AOT and Joule Heat technologies with internal resources and through the assistance of various third-party entities. Costs incurred and expensed include fees such as license fees, purchase of test equipment, pipeline pumping equipment, crude oil tank batteries, viscometers, SCADA systems, computer equipment, payroll and other related equipment and various logistical expenses for the purposes of evaluating and testing the Company’s AOT prototypes and Joule Heat prototypes.

For the six-month periods ended June 30, 2017 and 2016, our research and development expenses were $120,000 and $148,000 respectively. For the three-month periods ended June 30, 2017 and 2016, our research and development expenses were $56,000 and $73,000, respectively.

AOT Product Development and Testing 

During the six-month periods ended June 30, 2017 and 2016, the Company incurred total expenses of $26,000 and $54,000, respectively, in the manufacture, delivery and testing of the AOT prototype equipment. During the three-month periods ended June 30, 2017 and 2016, the Company incurred total expenses of $9,000 and $26,000, respectively. These expenses have been reflected as part of Research and Development expenses on the accompanying consolidated statements of operations.

Temple University Licensing Agreement

On August 1, 2011, the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive and the territory licensed to the Company is worldwide and replace previously issued License Agreements.

Pursuant to the two licensing agreements, the Company agreed to pay Temple the following: (i) non-refundable license maintenance fee of $300,000; (ii) annual maintenance fees of $187,500; (iii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing agreements; and (iv) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon. Temple also agreed to defer $37,500 of the amount due if the Company agreed to fund at least $250,000 in research or development of Temple’s patent rights licensed to the Company. The term of the licenses commenced in August 2011 and will expire upon the expiration of the patents. The agreement can also be terminated by either party upon notification under terms of the licensing agreements or if the Company ceases the development of the patent or failure to commercialize the patent rights.

Total expenses recognized during each six-month period ended June 30, 2017 and 2016 pursuant to these two agreements amounted to $94,000. Total expenses recognized during each three-month period ended June 30, 2017 and 2016 pursuant to these two agreements amounted to $47,000 These expenses have been reflected in Research and Development expenses on the accompanying consolidated statements of operations.

As of June 30, 2017 and December 31, 2016, total unpaid fees due to Temple pursuant to these agreements amounted to $840,000 and $727,000, respectively, which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As of June 30, 2017, $222,000 of the $840,000 payable has been deferred until the licensing agreements are terminated and $581,000 is deemed past due.

The Company generated $50,000 in revenue from the viscosity reduction license during the six-month period ended June 30, 2017. This amount is not sufficient to be subject to additional license fees under the license agreement. No revenues were earned from the two license agreements during the six-month period ended June 2016.

In July 2017, the Company and Temple amended the license agreement related to the Company’s AOT viscosity reduction technology. Under this amendment, Temple agreed to defer amounts currently due under the viscosity reduction license in the amount of $135,000, bringing the Company current under the viscosity reduction technology license agreement. The Company is currently in negotiations with Temple to settle amounts due under the second license agreement related to a fuel injector technology.

Temple University Sponsored Research Agreement

On March 19, 2012, the Company entered into a Sponsored Research Agreement (“Research Agreement”) with Temple University (“Temple”), whereby Temple, under the direction of Dr. Rongjia Tao, performed research related to the Company’s AOT device (the “Project”), for the period April 1, 2012, through April 1, 2014. All rights and title to intellectual property resulting from Temple’s work related to the Project were subjected to the Exclusive License Agreements between Temple and the Company, dated August 1, 2011.  In exchange for Temple’s research efforts on the Project, the Company has agreed to pay Temple $500,000, payable in quarterly installments of $62,500. The agreement expired in August 2015. As of June 30, 2017 and December 31, 2016, total unpaid fees due to Temple pursuant to this agreement amounted to $78,000, which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As of June 30, 2017, the entire $78,000 is deemed past due.

On July 14, 2017, the Company and Temple reached agreement to settle these past due amounts under a payment plan, paying the amount before the end of December 2017.

In addition, Temple University continues to provide laboratory testing and support related to the Company’s commercialization efforts. This continuing work is provided on at a fixed price, on an ad hoc basis depending upon the scope of work. During the six-month period ending June 30, 2017, the Company incurred a total of $3,000 in ad hoc testing with Temple University. No ad hoc testing was performed during the three-month period ending June 30, 2017. Temple ad hoc testing expense is reported as part of Research and development expenses in the accompanying consolidated statements of operations.

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7. Common Stock

6 Months Ended

Jun. 30, 2017

Stockholders' Equity Note [Abstract]

Common Stock

During the six months ended June 30, 2017, the Company issued 24,858,380 shares of its common stock upon the conversion of $1,247,000 in convertible notes at conversion rates ranging from $0.05 and $0.10 per share.

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8. Stock Options and Warrants

6 Months Ended

Jun. 30, 2017

Share-based Compensation Arrangement by Share-based Payment Award, Options, Additional Disclosures [Abstract]

Stock Options and Warrants

The Company periodically issues stock options and warrants to directors, employees, and non-employees in capital raising transactions, for services and for financing costs. Options vest and expire according to terms established at the grant date.

Options

Options vest according to the terms of the specific grant and expire from 2 to 10 years from date of grant. The weighted-average, remaining contractual life of employee and non-employee options outstanding at June 30, 2017 was 6.1 years. Stock option activity for the period January 1, 2017 up to June 30, 2017, was as follows:

	Options		Weighted Avg. Exercise Price
January 1, 2017		23,474,256	$	0.28
Granted		11,839,285		0.12
Exercised		–		–
Forfeited		–		–
June 30, 2017		35,313,541	$	0.23

The weighted average exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of June 30, 2017 were as follows:

	Outstanding Options				Exercisable Options
Option Exercise Price Per Share	Shares	Life (Years)		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
$ 0.05 - $ 0.99	35,163,095	6.1	$	0.22	29,017,262	$	0.23
$ 1.00 - $ 1.99	150,446	6.1	$	1.18	150,446	$	1.18
	35,313,541	6.1	$	0.23	29,167,708	$	0.23

During the six-month period ending June 30, 2017, the Company granted options to purchase 8,339,285 shares of common stock to members of the Company’s Board of Directors. The options are exercisable at $0.05 to $0.13 per share, vest monthly over a twelve-month period, and expire ten years from the date granted. Total fair value of these options at grant date was $379,000 using the Black-Scholes Option Pricing model with the following assumptions: life of 5 years; risk free interest rate of 1.94%; volatility of 123% to 144%, and dividend yield of 0%.

During the six-month period ending June 30, 2017, the Company granted two officers and an employee of the Company stock options to purchase a total of 3,500,000 shares of common stock. The stock options vest over a two-year period, exercisable at a price range of $0.07 through $0.40 per share and will expire in 10 years. Total fair value of the stock options amounted to $182,000 which will be expensed over the vesting period. In addition, as a result of the resignation of the Company’s CEO and three members of the Board of Directors, the Company agreed to modify the vesting term of 4.5 million options granted to them in January 2017 and fully vested those options resulting in a charge of $308,000 to account for the fair value of these options. There were no other changes in the remaining terms of the original grant.

During the six-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs based on the fair value of options that vested of $535,000 and $181,000 respectively, which is included in Operating expenses in the Company’s statement of operations. During the three-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs based on the fair value of options that vested of $300,000 and $100,000 respectively, which is included in Operating expenses in the Company’s statement of operations.

At June 30, 2017, the Company’s closing stock price was $0.22 per share. The aggregate intrinsic value of the options outstanding at June 30, 2017 was $1,574,000. Future unamortized compensation expense on the unvested outstanding options at June 30, 2017 is $438,000 to be recognized through December 2017.

Warrants

The following table summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2017 up to June 30, 2017.

	Warrants			Weighted Avg. Exercise Price
January 1, 2017		11,446,892		$	0.15
Granted		16,160,770			0.05
Exercised		–			–
Cancelled		(5,495,392	)		0.13
June 30, 2017		21,507,270		$	0.08

The weighted average exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of June 30, 2017 were as follows:

	Outstanding Warrants				Exercisable Warrants
Warrant Exercise Price Per Share	Shares	Life (Years)		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
$ 0.05 - $ 0.99	21,507,270	1.1	$	0.08	21,407,270	$	0.08
$ 1.00 - $ 1.99	–	–		–	–		–
	21,507,270	1.1	$	0.08	21,407,270	$	0.08

In the six-month period ending June 30, 2017, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 16,160,770 shares of common stock with an exercise price of $0.05 per share, vesting immediately upon grant and expiring one year from the date of grant (see Note 5).

During the six-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs of $1,000 and $86,000, respectively, based on the fair value of warrants previously issued for services that vested during the period, which is included in Operating expenses in the Company’s statement of operations. During the three-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs of $1,000 and $58,000, respectively, based on the fair value of warrants that vested, which is included in Operating expenses in the Company’s statement of operations.

At June 30, 2017, the aggregate intrinsic value of the warrants outstanding was $3,114,000. Future unamortized compensation expense on the unvested outstanding warrants at June 30, 2017 is approximately $3,000 to be recognized through July 2018.

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9. Commitments and Contingencies

6 Months Ended

Jun. 30, 2017

Commitments and Contingencies Disclosure [Abstract]

Commitments and Contingencies

There is no current or pending litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the normal course of business.

On April 1, 2017, the Company executed a separation agreement and release effective with the Company’s Chief Executive Officer (CEO). As part of the agreement, the Company agreed to pay the CEO $580,000 in severance, payable in equal installment over 24 months. In addition, the Company also agreed to pay the CEO’s medical insurance for 24 months and provide use of a cell phone for 12 months with an estimated cost of $44,000. As a result, the Company accrued the entire amount of $624,000 which was also reported as part of Operating Expenses in the accompanying consolidated statements of operations. As of June 30, 2017, the outstanding balance amounted to $546,000 which was reported as part of Accounts Payable and Accrued Expenses in the accompanying consolidated balance sheets.

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10. Subsequent Events

6 Months Ended

Jun. 30, 2017

Subsequent Events [Abstract]

Subsequent Events

Grant of Stock Options

In July 2017, the Company’ shareholders elected a new member to the Board of Directors. Upon this election, in accordance with the Company’s Board of Directors compensation policy, the Company granted the new director stock options to purchase a total of 122,567 shares of common stock. The stock options vest monthly through December 31, 2017, are exercisable at $0.19 per share and will expire 10 years from the date of issuance. Total fair value of the stock options amounted to $20,000 which will be expensed over the vesting period.

Agreements

On July 13, 2017, the Company and Temple University entered into an amendment to the exclusive license agreement related to the Company’s AOT viscosity reduction technology. The amendment defers those outstanding fees in the amount of $135,000 owed by the Company to Temple University under the license agreement, until such time as the Company either receives sales receipts exceeding $835,000 or sublicenses the agreement. Further, the amendment established interest rates for outstanding fees and terms of payment for an annual license fee between the Company and Temple University.

Additionally, on July 13, 2017, the Company and Temple University entered into a payment agreement related to the sponsored research agreement of March 19, 2012 between the parties, as amended on March 19, 2013. Under the terms of the payment agreement, the Company and Temple University agreed to a payment schedule for outstanding fees in the amount of $78,314, owed by the Company to the Temple under the research agreement. Under the terms of the payment agreement, these fees are payable $20,000 upon the effective date of the Agreement, and the balance payable in six equal monthly installments of $9,719.

Conversion of Convertible Notes

From July 1, 2017 up to August 7, 2017, Company issued 3,453,092 shares of restricted common stock upon conversion of previously issued convertible notes in aggregate value of $174,000.

Exercise of Warrants

From July 1, 2017 up to August 7, 2017, the Company issued 2,500,000 shares of restricted common stock on the exercise of warrants in aggregate value of $203,250.

Exercise of Options

In July 2017, the Company issued 271,752 shares of restricted common stock on the exercise of options by a member of the Company’s Board of Directors.

Private Sale of Unregistered Securities

In July, 2017, the Company issued 181,355 shares of restricted common stock at a price of $0.21 per share, total proceeds of $38,000 by a member of the Company’s board of directors in private offerings exempt from registration.

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2. Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2017

Accounting Policies [Abstract]

Description of business

QS Energy, Inc. (“QS Energy”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.

QS Energy develops and commercializes energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic and international patents and patents pending, a substantial portion of which have been developed in conjunction with and exclusively licensed from Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology™ (AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. Engineered specifically to reduce pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity by applying a high intensity electrical field to crude oil feedstock while in transit. The AOT product has transitioned from the research and development stage to initial production for continued testing in advance of our goal of seeking acceptance and adoption by the midstream pipeline marketplace.

The Company also began commercial development of a suite of products based around the Joule Heat technology. The Company began fabrication of prototype equipment to be operated under a joint development agreement with a commercial entity in the fourth quarter of 2014. The Company’s first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. In addition, the Company filed two additional provisional patents related to the technology’s method and apparatus. In December 2015, we temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the AOT Midstream. We currently plan to resume Joule Heat development in 2018 depending on the availability of sufficient capital and other resources.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the SEC. The condensed consolidated balance sheet as of December 31, 2016 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures, including notes, required by GAAP.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the Company's financial position and results of operations for the interim periods reflected. Except as noted, all adjustments contained herein are of a normal recurring nature. Results of operations for the fiscal periods presented herein are not necessarily indicative of fiscal year-end results.

Consolidation policy

Consolidation Policy

The accompanying consolidated financial statements of QS Energy Inc. include the accounts of QS Energy Inc. (the Parent) and its wholly owned subsidiaries, QS Energy Pool, Inc. and STWA Asia Pte. Limited. Intercompany transactions and balances have been eliminated in consolidation.

Going concern

Going Concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the six-months ended June 30, 2017, the Company incurred a net loss of $3,330,000, used cash in operations of $765,000 and had a stockholders’ deficit of $1,376,000 as of that date. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. In addition, the Company's independent registered public accounting firm, in its report on the Company's December 31, 2016 financial statements, has raised substantial doubt about the Company's ability to continue as a going concern.

At June 30, 2017, the Company had cash on hand in the amount of $880,000. Management estimates that the current funds on hand will be sufficient to continue operations through September 2017. Management is currently seeking additional funds, primarily through the issuance of debt and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with the license and research and development agreements with Temple; costs associated with product development and commercialization of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by, among other things, filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain payments to a former officer, and consulting fees, during the remainder of 2017 and beyond.

No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or cause substantial dilution for our stockholders in case of equity financing.

Basic and Diluted Income (loss) per share

Basic and Diluted Income (loss) per share

Our computation of earnings per share (“EPS”) includes basic and diluted EPS. Basic EPS is measured as the income (loss) available to common stockholders divided by the weighted average common shares outstanding for the period. Diluted income (loss) per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income (loss) of the Company as if they had been converted at the beginning of the periods presented, or issuance date, if later. In computing diluted income (loss) per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. Potential common shares that have an antidilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

Income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the respective periods. Basic and diluted (loss) per common share is the same for periods in which the Company reported an operating loss because all warrants and stock options outstanding are anti-dilutive. At June 30, 2017 and 2016, we excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock as their effect would have been anti-dilutive.

	June 30, 2017		June 30, 2016
Options		35,313,541		23,724,256
Warrants		21,507,270		9,342,892
Common stock issuable upon conversion of notes payable		9,968,933		2,401,667
Total		66,789,744		35,468,815

Estimates

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include those related to assumptions used in valuing equity instruments issued for financing and for services, and reduction of deferred tax assets. Actual results could differ from those estimates.

Revenue Recognition Policy

Revenue Recognition Policy

The Company recognizes lease revenue upon commencement of the lease. Revenue on future product sales will be recognized upon meeting the following criteria: persuasive evidence of an arrangement exists; delivery has occurred or services rendered; the seller's price to the buyer is fixed or determinable; and collectability is reasonably assured.

In the fourth quarter 2016, the Company entered a contract to provide onsite testing services to a Canadian oil producer and pipeline operator at a fixed price of $50,000. The testing service was performed in January 2017 and was completed in March 2017.

Research and Development Costs

Research and Development Costs

Costs incurred for research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed. Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial uses are also expensed.

For the six-month periods ended June 30, 2017 and 2016 research and development costs were $120,000 and $148,000, respectively.

Patent costs

Patent Costs

Patent costs consist of patent-related legal and filing fees. Due to the uncertainty associated with the successful development of our AOT and Joule Heat products, all patent costs are expensed as incurred. During the six-month periods ended June 30, 2017 and 2016, patent costs were $24,000 and $30,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations. During the three-month periods ended June 30, 2017 and 2016, patent costs were $7,000 and $17,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations.

Recent Accounting Pronouncements

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein. Entities will be able to transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures. In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

In July 2017, the FASB issued Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The guidance in ASU 2017-11 is to be applied using a full or modified retrospective approach. The adoption of ASU 2017-11 is not currently expected to have any impact on the Company’s financial statement presentation or disclosures.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statement presentation or disclosures.

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2. Summary of Significant Accounting Policies (Tables)

6 Months Ended

Jun. 30, 2017

Accounting Policies [Abstract]

Antidilutive shares

	June 30, 2017		June 30, 2016
Options		35,581,398		23,724,256
Warrants		35,313,541		9,342,892
Common stock issuable upon conversion of notes payable		9,968,933		2,401,667
Total		66,789,744		35,468,815

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4. Property and Equipment (Tables)

6 Months Ended

Jun. 30, 2017

Property, Plant and Equipment [Abstract]

Property and equipment

	June 30, 2017			December 31, 2016
	(unaudited)
Office equipment	$	30,000		$	28,000
Furniture and fixtures		3,000			3,000
Testing Equipment		37,000			18,000
Subtotal		70,000			49,000
Less accumulated depreciation		(36,000	)		(32,000	)
Total	$	34,000		$	17,000

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5. Convertible Notes (Tables)

6 Months Ended

Jun. 30, 2017

Debt Disclosure [Abstract]

Convertible Notes and Warrants

	June 30, 2017			December 31, 2016
	(unaudited)
Convertible notes outstanding	$	787,000		$	417,000
Accrued interest		43,000			23,000
Subtotal		830,000			440,000
Unamortized note discounts		(327,000	)		(92,000	)
Balance on convertible notes, net of note discounts	$	503,000		$	348,000

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8. Stock Options and Warrants (Tables)

6 Months Ended

Jun. 30, 2017

Share-based Compensation Arrangement by Share-based Payment Award, Options, Additional Disclosures [Abstract]

Stock options outstanding

	Options		Weighted Avg. Exercise Price
January 1, 2017		23,474,256	$	0.28
Granted		11,839,285		0.12
Exercised		–		–
Forfeited		–		–
June 30, 2017		35,313,541	$	0.23

Options outstanding by Per Share Price

	Outstanding Options				Exercisable Options
Option Exercise Price Per Share	Shares	Life (Years)		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
$ 0.05 - $ 0.99	35,163,095	6.1	$	0.22	29,017,262	$	0.23
$ 1.00 - $ 1.99	150,446	6.1	$	1.18	150,446	$	1.18
	35,313,541	6.1	$	0.23	29,167,708	$	0.23

Warrants outstanding

	Warrants			Weighted Avg. Exercise Price
January 1, 2017		11,446,892		$	0.15
Granted		16,160,770			0.05
Exercised		–			–
Cancelled		(5,495,392	)		0.13
June 30, 2017		21,507,270		$	0.08

Warrants outstanding by Per Share Price

	Outstanding Warrants				Exercisable Warrants
Warrant Exercise Price Per Share	Shares	Life (Years)		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
$ 0.05 - $ 0.99	21,507,270	1.1	$	0.08	21,407,270	$	0.08
$ 1.00 - $ 1.99	–	–		–	–		–
	21,507,270	1.1	$	0.08	21,407,270	$	0.08

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2. Summary of Significant Accounting Policies (Details) - shares	6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016
Antidilutive shares excluded from EPS	66,789,744	35,468,815
Options [Member]
Antidilutive shares excluded from EPS	35,313,541	23,724,256
Warrants [Member]
Antidilutive shares excluded from EPS	21,507,270	9,342,892
Convertible Notes [Member]
Antidilutive shares excluded from EPS	9,968,933	2,401,667

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2. Summary of Significant Accounting Policies (Details Narrative) - USD ($)	3 Months Ended		6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016	Jun. 30, 2017	Jun. 30, 2016	Dec. 31, 2016	Dec. 31, 2015
Accounting Policies [Abstract]
Net loss	$ (1,846,000)	$ (1,138,000)	$ (3,330,000)	$ (2,345,000)
Cash flow from operations			(765,000)	(921,000)
Stockholders' deficit	(1,376,000)		(1,376,000)		$ (1,358,000)
Cash on Hand	880,000	328,000	880,000	328,000	$ 136,000	$ 349,000
Research and development costs	56,000	73,000	120,000	148,000
Patent costs	$ 7,000	$ 17,000	$ 24,000	$ 30,000

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3. Accrued Expenses and Accounts Payable - Related Parties (Details Narrative) - USD ($)	Jun. 30, 2017	Dec. 31, 2016
Related Party Transactions [Abstract]
Accrued expenses and accounts payable-related parties	$ 19,000	$ 135,000

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4. Property and Equipment (Details) - USD ($)	Jun. 30, 2017	Dec. 31, 2016
Property and equipment, gross	$ 70,000	$ 49,000
Less: accumulated depreciation	(36,000)	(32,000)
Property and equipment, net	34,000	17,000
Office equipment [Member]
Property and equipment, gross	30,000	28,000
Furniture and fixtures [Member]
Property and equipment, gross	3,000	3,000
Testing equipment [Member]
Property and equipment, gross	$ 37,000	$ 18,000

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4. Property and Equipment (Details Narrative) - USD ($)	3 Months Ended		6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016	Jun. 30, 2017	Jun. 30, 2016
Property, Plant and Equipment [Abstract]
Depreciation expense	$ 2,000	$ 2,000	$ 4,000	$ 4,000

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5. Convertible Notes (Details) - USD ($)	Jun. 30, 2017	Dec. 31, 2016
Debt Disclosure [Abstract]
Balance due on convertible notes	$ 787,000	$ 417,000
Accrued Interest	43,000	23,000
Subtotal	830,000	440,000
Unamortized note discount	(327,000)	(92,000)
Balance on convertible notes, net of note discount	$ 503,000	$ 348,000

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5. Convertible Notes (Details Narrative) - USD ($)	6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016	Dec. 31, 2016
Debt Disclosure [Abstract]
Convertible notes issued	$ 1,616,000
Proceeds from convertible notes	1,469,000	$ 905,000
Discount on notes issued	$ 147,000
Warrants issued with notes	16,160,770
Discount on fair value of warrants, BCF and OID	$ 1,616,000
Notes payable balance	787,000		$ 417,000
Unamortized discount	327,000		92,000
Debt converted during year	$ 1,247,000
Debt converted, shares issued	24,858,380
Interest expense	$ 1,381,000
Accrued interest payable	43,000		23,000
Convertible debentures outstanding	503,000		$ 348,000
Debt in default	$ 295,000

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6. Research and Development (Details Narrative) - USD ($)	3 Months Ended		6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016	Jun. 30, 2017	Jun. 30, 2016	Dec. 31, 2016
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Research and development expenses incurred	$ 56,000	$ 73,000	$ 120,000	$ 148,000
Accounts payable - licensing agreement	918,000		918,000		$ 805,000
License revenue generated	0	0	50,000	0
AOT Prototypes [Member]
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Research and development expenses incurred	9,000	26,000	26,000	54,000
Temple University License Agreements [Member]
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Research and development expenses incurred	47,000	$ 47,000	94,000	94,000
Accounts payable - licensing agreement	840,000		840,000		727,000
License revenue generated			0	0
Temple University License Agreements [Member] | Accounts payable deferred [Member]
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Accounts payable - licensing agreement	222,000		222,000
Temple University License Agreements [Member] | Accounts payable past due [Member]
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Accounts payable - licensing agreement	581,000		581,000
Temple University Sponsored Research Agreement [Member]
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Research and development expenses incurred				$ 78,000
Accounts payable - licensing agreement	78,000		78,000		$ 78,000
Temple University Sponsored Research Agreement [Member] | Accounts payable past due [Member]
Research and Development Arrangement, Contract to Perform for Others [Line Items]
Accounts payable - licensing agreement	$ 78,000		$ 78,000

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7. Common Stock (Details Narrative)	6 Months Ended
	Jun. 30, 2017 USD ($) shares
Value of notes converted	$ 1,247,000
Convertible Notes Payable [Member]
Common stock issued on conversion of notes, shares | shares	24,858,380
Value of notes converted	$ 1,247,000

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8. Stock Options and Warrants (Details-Options Outstanding) - Options [Member]	6 Months Ended
	Jun. 30, 2017 $ / shares shares
Beginning Balance | shares	23,474,256
Granted | shares	11,839,285
Exercised | shares	0
Forfeited | shares	0
Ending Balance | shares	35,313,541
Weighted Average Exercise Price, Outstanding Beginning Balance | $ / shares	$ .28
Weighted Average Exercise Price, Granted | $ / shares	.12
Weighted Average Exercise Price, Exercised | $ / shares
Weighted Average Exercise Price, Forfeited | $ / shares
Weighted Average Exercise Price, Outstanding Ending Balance | $ / shares	$ .23

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8. Stock Options and Warrants (Details-Options by Exercise Price Per Share) - Options [Member] - $ / shares	6 Months Ended
	Jun. 30, 2017	Dec. 31, 2016
Outstanding Options
Options outstanding	35,313,541	23,474,256
Life (Years), options outstanding	6 years 1 month 6 days
Weighted Average Exercise Price, options outstanding	$ .23	$ .28
Exercisable Options
Options exercisable	29,167,708
Weighted Average Exercise Price, options exercisable	$ .23
$0.05 - $0.99 [Member]
Outstanding Options
Options outstanding	35,163,095
Life (Years), options outstanding	6 years 1 month 6 days
Weighted Average Exercise Price, options outstanding	$ .22
Exercisable Options
Options exercisable	29,017,262
Weighted Average Exercise Price, options exercisable	$ .23
$1.00 - $1.99 [Member]
Outstanding Options
Options outstanding	150,446
Life (Years), options outstanding	6 years 1 month 6 days
Weighted Average Exercise Price, options outstanding	$ 1.18
Exercisable Options
Options exercisable	150,446
Weighted Average Exercise Price, options exercisable	$ 1.18

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8. Stock Options and Warrants (Details-Warrants Outstanding) - Warrants [Member]	6 Months Ended
	Jun. 30, 2017 $ / shares shares
Warrants outstanding, beginning balance | shares	11,446,892
Warrants granted | shares	16,160,770
Warrants exercised | shares	(605,000)
Warrants cancelled | shares	(5,495,392)
Warrants outstanding, ending balance | shares	21,507,270
Weighted Average Exercise Price, Outstanding Beginning Balance | $ / shares	$ .15
Weighted Average Exercise Price, Granted | $ / shares	0.05
Weighted Average Exercise Price, Exercised | $ / shares
Weighted Average Exercise Price, Cancelled | $ / shares	.13
Weighted Average Exercise Price, Outstanding Ending Balance | $ / shares	$ 0.08

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8. Stock Options and Warrants (Details-Warrant Exercise Price per Share) - Warrants [Member] - $ / shares	6 Months Ended
	Jun. 30, 2017	Dec. 31, 2016
Outstanding Warrants
Warrants outstanding	21,507,270	11,446,892
Life (Years), warrants outstanding	1 year 1 month 6 days
Weighted Average Exercise Price, warrants outstanding	$ .08
Exercisable Warrants
Warrants exercisable	21,407,270
Weighted Average Exercise Price, warrants exercisable	$ .08
$0.05 - $0.99 [Member]
Outstanding Warrants
Warrants outstanding	21,507,270
Life (Years), warrants outstanding	1 year 1 month 6 days
Weighted Average Exercise Price, warrants outstanding	$ .08
Exercisable Warrants
Warrants exercisable	21,407,270
Weighted Average Exercise Price, warrants exercisable	$ .08
$1.00 - $1.99 [Member]
Outstanding Warrants
Warrants outstanding	0
Weighted Average Exercise Price, warrants outstanding	$ 0
Exercisable Warrants
Warrants exercisable	0
Weighted Average Exercise Price, warrants exercisable	$ 0

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8. Stock options and Warrants (Details Narrative) - USD ($)	3 Months Ended		6 Months Ended
	Jun. 30, 2017	Jun. 30, 2016	Jun. 30, 2017	Jun. 30, 2016
Valuation assumptions
Share-based compensation			$ 535,000	$ 267,000
Options [Member]
Options granted, shares			11,839,285
Valuation assumptions
Options vested, share based compensation expense	$ 300,000	$ 100,000	$ 535,000	181,000
Share-based compensation			265,448
Aggregate intrinsic value of options outstanding	1,574,000		1,574,000
Future unamortized compensation expense on unvested outstanding options	438,000		$ 438,000
Options [Member] | Board of Directors [Member]
Options granted, shares			8,339,285
Fair value of options at grant date			$ 379,000
Valuation assumptions
Expected life			5 years
Risk free interest rate			1.94%
Volatility, minimum			123.00%
Volatility, maximum			144.00%
Expected dividend yield			0.00%
Options [Member] | Two Officers [Member]
Options granted, shares			3,500,000
Fair value of options at grant date			$ 182,000
Valuation assumptions
Options vested, share based compensation expense			308,000
Warrants [Member]
Valuation assumptions
Share-based compensation	1,000	$ 58,000	$ 1,000	$ 86,000
Warrants granted			16,160,770
Warrant exercise price			$ 0.05
Aggregate intrinsic value of warrants outstanding	3,114,000		$ 3,114,000
Future unamortized compensation expense on unvested outstanding warrants	$ 3,000		$ 3,000

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9. Commitments and Contingencies (Details Narrative) - USD ($)	Jun. 30, 2017	Dec. 31, 2016
Total severance accrued	$ 624,000
Accounts payable and accrued expenses	891,000	$ 251,000
Severance payable [Member]
Accounts payable and accrued expenses	$ 546,000