1. The Company, Description of Business, and Future Liquidity Needs

The accompanying condensed consolidated financial statements include the accounts of Quest Resource Holding Corporation (“QRHC”) and its subsidiaries, Earth911, Inc. (“Earth911”), Quest Resource Management Group, LLC (“Quest”), Landfill Diversion Innovations, LLC, and Youchange, Inc. (“YouChange”) (collectively, “we,” “us,” or “our company”).

Operations – We are an environmental solutions company that serves as a single-source provider of full service recycling and waste stream management solutions, as well as an environmental program services and information provider. We offer innovative, cost-effective, one-stop reuse, recycling, and waste disposal management programs designed to provide regional and national customers with a single point of contact for managing a variety of recyclables and disposables. Two customers accounted for 59.3% and 75.7% of revenue for the three months ended June 30, 2015 and 2014, respectively.  Two customers accounted for 60.3% and 75.9% of revenue for the six months ended June 30, 2015 and 2014, respectively.  We also own the Earth911.com website, offering original online environmental related content about reuse, recycling, and disposal of waste and recyclables, and we own a comprehensive online database of local recycling and proper disposal options. Our principal offices are located in Frisco, Texas.

Liquidity – As of June 30, 2015 and December 31, 2014, our working capital balance was $7,480,722 and $1,316,319, respectively.   

2. Summary of Significant Accounting Policies

Principals of Presentation, Consolidation, and Reclassifications

The condensed consolidated financial statements included herein have been prepared by us without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with our audited financial statements for the year ended December 31, 2014. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted, as permitted by the SEC, although we believe the disclosures that are made are adequate to make the information presented herein not misleading.

The accompanying condensed consolidated financial statements reflect, in our opinion, all normal recurring adjustments necessary to present fairly our financial position at June 30, 2015 and the results of our operations and cash flows for the periods presented. We derived the December 31, 2014 condensed consolidated balance sheet data from audited financial statements, but did not include all disclosures required by GAAP. As Quest, Earth911, and YouChange each operate as ecology based green service companies, we did not deem segment reporting necessary.

All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year balances to conform to the current year presentation that did not have an effect on our net loss or net loss per share. Interim results are subject to seasonal variations, and the results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year.

Revenue Recognition

We recognize revenue only when all of the following criteria have been met:

Persuasive Evidence of an Arrangement Exists – We document all terms of an arrangement in a service agreement or quote signed or confirmed by the customer prior to recognizing revenue.

Delivery Has Occurred or Services Have Been Rendered – We perform all services or deliver all products prior to recognizing revenue. Services are deemed to be performed when the services are complete.

The Fee for the Arrangement is Fixed or Determinable – Prior to recognizing revenue, a customer’s fee is either fixed or determinable under the terms of the quote, service agreement, or accepted customer purchase order.

Collectability Is Reasonably Assured – We assess collectability on a customer by customer basis based on criteria outlined by management.

We provide businesses with management programs to reuse, recycle, and dispose of a wide variety of waste streams and recyclables generated by their business. We utilize third-party subcontractors to execute the collection, transport, and recycling or disposal of used motor oil, oil filters, scrap tires, cooking oil, and expired food products. We evaluate the criteria outlined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 605-45, Revenue Recognition—Principal Agent Considerations, in determining whether it is appropriate to record the gross amount of service revenue and related costs or the net amount earned as management fees. Generally, when we are primarily obligated in a transaction, have latitude in establishing prices and selecting suppliers, have credit risk, or have several but not all of these indicators, we record revenue gross and record amounts collected from customers for sales tax on a net basis. In situations in which we are not primarily obligated, we do not have credit risk, or we determine amounts earned using fixed percentage or fixed payment schedules, we record the net amounts as management fees earned. Currently, we have no contracts accounted for as management fees.

Earth911 revenue primarily represents licensing fees that we recognize ratably over the term of the license. We derive some revenue from advertising contracts, which we recognize ratably over the term that the advertisement appears on our website.

Net Loss Per Share

We compute basic net loss per share by dividing net loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. We have other potentially dilutive securities outstanding that are not shown in a diluted net loss per share calculation because their effect in both 2015 and 2014 would be anti-dilutive. These potentially dilutive securities include options, restricted stock units, warrants, and convertible promissory notes, and totaled 16,908,173 and 19,287,215 shares at June 30, 2015 and 2014, respectively.

The following table sets forth the computation of basic and diluted loss per share:  

The following table sets forth the anti-dilutive securities excluded from diluted loss per share:

Inventories

We record inventories within “Prepaid expenses and other current assets” in our condensed consolidated balance sheets.  As of June 30, 2015 and December 31, 2014, all inventories were finished goods with a balance of $13,827 and $30,759, respectively, and consisted of waste disposal equipment, with no reserve for inventory obsolescence at either date.

3. Property and Equipment, Net, and Other Assets

At June 30, 2015 and December 31, 2014, property and equipment, net, and other assets consisted of the following:

We compute depreciation using the straight-line method over the estimated useful lives of the property and equipment. The depreciation expense related to property and equipment was $70,335 and $72,894 for the three months ended June 30, 2015 and 2014, respectively.  The depreciation expense related to property and equipment was $146,381 and $142,461 for the six months ended June 30, 2015 and 2014, respectively.

4. Goodwill and Other Intangible Assets

The components of goodwill and other intangible assets were as follows:

We compute amortization using the straight-line method over the estimated useful lives of the finite lived intangible assets. The amortization expense related to finite lived intangible assets was $901,998 and $880,605 for the three months ended June 30, 2015 and 2014, respectively. The amortization expense related to finite lived intangible assets was $1,805,090 and $1,762,701 for the six months ended June 30, 2015 and 2014, respectively.  We have no indefinite-lived intangible assets other than goodwill. The goodwill is not deductible for tax purposes.

5. Line of Credit

On December 15, 2010, Quest entered into a Revolving Credit Note and Loan Agreement with Regions Bank (“Regions”), a national banking association. This agreement, as amended, provides Quest with a loan facility up to $10,000,000 for working capital with advances generally limited to 80% of eligible accounts receivable from Quest’s largest customer and 85% of all other eligible accounts receivable. The interest on the outstanding principal amount accrues daily and is payable monthly based on a fluctuating interest rate per annum, which is the base rate plus 1.50% (2.44% as of June 30, 2015). The base rate for any day is the greater of (a) the federal funds rate plus one-half of 1%, (b) Region’s published effective prime rate, or (c) the Eurodollar rate for such day based on an interest period of one month. To secure the amounts due under the agreement, Quest granted Regions a security interest in all of its assets. Quest had $7,250,000 outstanding and $2,750,000 available to be borrowed as of June 30, 2015, excluding the $5,000,000 accordion. The amount of interest expense related to the Regions line of credit for the three months ended June 30, 2015 and 2014 was $53,479 and $49,304, respectively.  The amount of interest expense related to the Regions line of credit for the six months ended June 30, 2015 and 2014 was $88,529 and $92,384, respectively.  

On May 9, 2014, Quest entered into a Sixth Amendment to Loan Agreement with Regions. The loan agreement was amended to, among other things, (i) add a $5.0 million accordion feature, (ii) increase the borrowing base, (iii) reduce the applicable margin for eurodollar rate loans by 1.0% per annum, (iv) add an unused fee of 0.25% per annum, (v) extend the maturity date to May 31, 2015, (vi) release the guaranty of our Chief Executive Officer previously executed in favor of Regions, (vii) add our company and our wholly owned subsidiary, Earth911, as guarantors (collectively, the “Guarantors”), (viii) allow for permitted acquisitions, and (ix) delete two of the financial covenants and modify the other financial covenants in certain respects.  As of June 30, 2015, we were in compliance with the financial covenants.

In connection with the Sixth Amendment, on May 9, 2014, the “Guarantors” entered into a Guaranty (the “Guaranty”) for the benefit of Regions to guarantee the obligations of Quest under the loan agreement and other loan documents. In addition, on May 9, 2014, Earth911 entered into a Pledge Agreement with Regions, pursuant to which Earth911 pledged to Regions 50% of the membership interests in Quest held by Earth911 to secure the prompt and complete payment and performance of the obligations of Quest and the Guarantors under the loan agreement and other loan documents.

During the six months ended June 30, 2015, Quest entered into a Seventh Amendment to Loan Agreement with Regions. The loan agreement was amended to, among other things, (i) reduce the applicable margin for eurodollar rate loans by 0.25% per annum, (ii) extend the maturity date to May 13, 2018, and (iii) modify the permitted acquisitions in certain respects.

On July 7, 2015, Quest entered into an Eighth Amendment to Loan Agreement with Regions as discussed in Note 11 — Material Subsequent Events.

6. Capital Lease Obligations

At June 30, 2015 and December 31, 2014, total capital lease obligations outstanding consisted of the following:

Our capital lease obligations are included within “Deferred revenue and other current liabilities” and “other long-term liabilities” in our condensed consolidated balance sheets.  The amount of interest expense related to our capital leases for the three months ended June 30, 2015 and 2014 was $426 and $452, respectively.  The amount of interest expense related to our capital leases for the six months ended June 30, 2015 and 2014 was $913 and $1,090, respectively.  

7. Income Taxes

We compute income taxes using the asset and liability method in accordance with FASB ASC Topic 740, Income Taxes. Under the asset and liability method, we determine deferred income tax assets and liabilities based on the differences between the financial reporting and tax bases of assets and liabilities and measure them using currently enacted tax rates and laws. We provide a valuation allowance for the amount of deferred tax assets that, based on available evidence, are more likely than not expected to be realized. Realization of our net operating loss carryforward was not reasonably assured as of June 30, 2015 and December 31, 2014, and we have recorded a valuation allowance of $10,308,000 and $9,108,000, respectively, against deferred tax assets in excess of deferred tax liabilities in the accompanying condensed consolidated financial statements. As of June 30, 2015 and December 31, 2014, we had federal income tax net operating loss carryforwards of approximately $17,100,000 and $14,800,000, respectively, which expire at various dates beginning in 2031.

8. Fair Value of Financial Instruments

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, line of credit, capital lease obligations, and warrant liability. We do not believe that we are exposed to significant interest, currency, or credit risks arising from these financial instruments. With the exception of the warrant liability, the fair values of these financial instruments approximate their carrying values using Level 3 inputs, based on their short maturities or, for long-term portions of capital lease obligations and line of credit, based on borrowing rates currently available to us for loans with similar terms and maturities.

On May 7, 2014, we issued an aggregate of 200,000 warrants to purchase shares of our common stock to a consultant in exchange for services rendered during 2014.  Of these warrants, 100,000 vested immediately and resulted in no expense recorded for the three months ended June 30, 2015.  The remaining 100,000 warrants, which we had classified as a liability, vested on May 7, 2015, subject to performance conditions.  We measured the warrants at fair value by applying the Black-Scholes-Merton valuation model, which utilizes Level 3 inputs. As of May 7, 2015, the assumptions used in the Black-Scholes-Merton valuation for the 100,000 warrants that vested on May 7, 2015 were as follows: volatility of 88.5%; risk free interest rate of 0.63%; expected term of two years; and expected dividend yield of 0%. The grant date fair value of the warrant valuation described above was $0.35 per warrant. We based the risk free interest rate on U.S. Treasury rates with maturity dates approximating the expected term of the warrants. We determined the historical volatility using the historical changes in the market price of our common stock and applicable comparable companies.  We report the warrant liability in “Accounts payable and accrued liabilities” within our balance sheets.  Our warrant liability was nil and $34,857 at June 30, 2015 and December 31, 2014, respectively. On the May 7, 2015 vesting date, we reclassified the $35,001 estimated fair value of the warrants to stockholders’ equity.

9. Stockholders’ Equity

Preferred Stock – Our authorized preferred stock includes 10,000,000 shares of preferred stock with a par value of $0.001, of which no shares have been issued or are outstanding.

Common Stock – Our authorized common stock includes 200,000,000 shares of common stock with a par value of $0.001, of which 111,714,938 and 111,601,304 shares were issued and outstanding as of June 30, 2015 and December 31, 2014, respectively.

During the six months ended June 30, 2015, we issued shares of common stock as follows:

During the six months ended June 30, 2014, we issued shares of common stock as follows:

Warrants – During the six months ended June 30, 2015 and 2014, we did not issue any warrants and no holders exercised warrants.  During the six months ended June 30, 2015, a third party forfeited 1,200,000 contingent warrants, with no corresponding expirations during the six months ended June 30, 2014.  At June 30, 2015, we had outstanding exercisable warrants to purchase 11,791,000 shares of common stock.  

The following table summarizes the warrants issued and outstanding as of June 30, 2015:

Restricted Stock Units – During April 2014, we granted restricted stock units representing 132,600 shares of common stock under our 2012 Incentive Compensation Plan. The restricted stock units vest based on a combination of financial performance factors and continued service. The financial performance factors are based on the revenue generated by new business activity of one of our subsidiaries. All payouts of restricted stock units that vest will be exercisable immediately and will be paid in the form of common stock. While we do not anticipate issuing dividends, the restricted stock unit awards will not participate in any dividends prior to vesting.

We determined the fair value of the restricted stock unit awards granted based on the market value of our common stock on the date of grant, which was $3.75 per share. We assumed a forfeiture rate of 0%. Due to the uncertainty of attaining any of the remaining performance conditions, we recorded no additional stock-based compensation expense for the remaining performance conditions for the six months ended June 30, 2015. We issued 56,500 shares during the six months ended June 30, 2015 for the restricted stock units that vested during 2014.  As of June 30, 2015 and December 31, 2014, outstanding restricted stock units totaled 76,100 and 132,600, respectively.  

Employee Stock Purchase Plan – On September 17, 2014, our stockholders approved the Quest Resource Holding Corporation 2014 Employee Stock Purchase Plan (the “ESPP”). We recorded expense of $25,102 and $36,924 related to the ESPP during the three and six months ended June 30, 2015, respectively.  On May 15, 2015, we issued 57,134 shares to employees for the ESPP options that vested and were exercised.    

Stock Options – The following table summarizes the stock option activity for the six month period ended June 30, 2015:

10. Related Party Transactions

Acquisition of the Quest Interests – On July 16, 2013, we acquired all of the issued and outstanding membership interests of Quest held by Quest Resource Group LLC (“QRG”), comprising 50% of the membership interests of Quest (the “Quest Interests”). The purchase price for the Quest Interests consisted of 22,000,000 shares of our common stock issued at a fair market value of $2.50 per share based on the closing price of the stock on the date of the transaction and convertible secured promissory notes (collectively, the “Sellers’ Notes”) in the aggregate principal amount of $22,000,000. The total purchase price of $77,000,000 was paid to the owners of QRG who at the time of the transaction were related parties: the Chief Executive Officer of Quest and the former President of Quest. After the close of the transaction, the Chief Executive Officer of Quest became the President, Chief Executive Officer, and member of the Board of Directors of our company. On September 24, 2014, we paid $11,000,000 to the holders of the Sellers’ Notes and such holders converted the remaining $11,000,000 of principal, plus accrued interest through September 24, 2014 of $101,260, into 5,550,630 shares of our common stock. For the three and six months ended June 30, 2014, we recognized interest expense of $383,945 and $763,671, respectively. The amount of interest expense related to the amortization of the discount on the Sellers’ Notes for the three and six months ended June 30, 2014 was $456,661 and $908,303, respectively.  We recognized no comparable interest expense or amortization of the discount on the Sellers’ Notes for the three and six months ended June 30, 2015 due to the retirement of the Sellers’ Notes in September 2014.

11. Material Subsequent Events

On July 7, 2015, Quest entered into an Eighth Amendment to Loan Agreement with Regions.   The loan agreement was amended to, among other things, increase the aggregate revolving credit commitment to $15.0 million by exercising the $5.0 million accordion feature in the loan agreement.

Principals of Presentation, Consolidation, and Reclassifications

The condensed consolidated financial statements included herein have been prepared by us without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with our audited financial statements for the year ended December 31, 2014. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted, as permitted by the SEC, although we believe the disclosures that are made are adequate to make the information presented herein not misleading.

The accompanying condensed consolidated financial statements reflect, in our opinion, all normal recurring adjustments necessary to present fairly our financial position at June 30, 2015 and the results of our operations and cash flows for the periods presented. We derived the December 31, 2014 condensed consolidated balance sheet data from audited financial statements, but did not include all disclosures required by GAAP. As Quest, Earth911, and YouChange each operate as ecology based green service companies, we did not deem segment reporting necessary.

All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year balances to conform to the current year presentation that did not have an effect on our net loss or net loss per share. Interim results are subject to seasonal variations, and the results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year.

Revenue Recognition

We recognize revenue only when all of the following criteria have been met:

Persuasive Evidence of an Arrangement Exists – We document all terms of an arrangement in a service agreement or quote signed or confirmed by the customer prior to recognizing revenue.

Delivery Has Occurred or Services Have Been Rendered – We perform all services or deliver all products prior to recognizing revenue. Services are deemed to be performed when the services are complete.

The Fee for the Arrangement is Fixed or Determinable – Prior to recognizing revenue, a customer’s fee is either fixed or determinable under the terms of the quote, service agreement, or accepted customer purchase order.

Collectability Is Reasonably Assured – We assess collectability on a customer by customer basis based on criteria outlined by management.

We provide businesses with management programs to reuse, recycle, and dispose of a wide variety of waste streams and recyclables generated by their business. We utilize third-party subcontractors to execute the collection, transport, and recycling or disposal of used motor oil, oil filters, scrap tires, cooking oil, and expired food products. We evaluate the criteria outlined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 605-45, Revenue Recognition—Principal Agent Considerations, in determining whether it is appropriate to record the gross amount of service revenue and related costs or the net amount earned as management fees. Generally, when we are primarily obligated in a transaction, have latitude in establishing prices and selecting suppliers, have credit risk, or have several but not all of these indicators, we record revenue gross and record amounts collected from customers for sales tax on a net basis. In situations in which we are not primarily obligated, we do not have credit risk, or we determine amounts earned using fixed percentage or fixed payment schedules, we record the net amounts as management fees earned. Currently, we have no contracts accounted for as management fees.

Earth911 revenue primarily represents licensing fees that we recognize ratably over the term of the license. We derive some revenue from advertising contracts, which we recognize ratably over the term that the advertisement appears on our website.

Net Loss Per Share

We compute basic net loss per share by dividing net loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. We have other potentially dilutive securities outstanding that are not shown in a diluted net loss per share calculation because their effect in both 2015 and 2014 would be anti-dilutive. These potentially dilutive securities include options, restricted stock units, warrants, and convertible promissory notes, and totaled 16,908,173 and 19,287,215 shares at June 30, 2015 and 2014, respectively.

The following table sets forth the computation of basic and diluted loss per share:  

The following table sets forth the anti-dilutive securities excluded from diluted loss per share:

Inventories

We record inventories within “Prepaid expenses and other current assets” in our condensed consolidated balance sheets.  As of June 30, 2015 and December 31, 2014, all inventories were finished goods with a balance of $13,827 and $30,759, respectively, and consisted of waste disposal equipment, with no reserve for inventory obsolescence at either date.

The following table sets forth the computation of basic and diluted loss per share:  

The following table sets forth the anti-dilutive securities excluded from diluted loss per share:

At June 30, 2015 and December 31, 2014, property and equipment, net, and other assets consisted of the following:

The components of goodwill and other intangible assets were as follows:

At June 30, 2015 and December 31, 2014, total capital lease obligations outstanding consisted of the following:

During the six months ended June 30, 2015, we issued shares of common stock as follows:

During the six months ended June 30, 2014, we issued shares of common stock as follows:

The following table summarizes the warrants issued and outstanding as of June 30, 2015:

Stock Options – The following table summarizes the stock option activity for the six month period ended June 30, 2015: