Item 7. Management’s Discussion and Analysis
ITEM 7: 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 audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion and analysis here and throughout this Form 10-K contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements due to a number of factors, including but not limited to, the risks described in the section titled “Risk Factors”.
OVERVIEW
We design and develop technologies for the purpose of improving key performance characteristics of combustion systems, including emission and operational performance, energy efficiency and overall cost-effectiveness. Our ClearSign Core technology is currently installed in limited commercial applications. We have generated nominal revenues from operations to date to meet operating expenses.
We have incurred losses since inception totaling $82.8 million and we expect to experience operating losses and negative cash flow for the foreseeable future. We have historically financed our operations primarily through issuances of equity securities. Since inception, we have raised approximately $84.0 million in gross proceeds through the sale of our equity securities. We may need to raise additional capital in the future, however, the significant volatility in the capital markets may negatively affect our ability to raise this additional capital.
It is not possible at this time to estimate the full impact that the coronavirus pandemic will have on our business or on our potential customers, suppliers or other business partners. However, the continued spread of the coronavirus, the measures taken by the governments of affected countries, actions taken to protect employees, the limitations placed on travel and border crossings, and the impact of the pandemic on various business activities in affected countries could adversely impact our operational results and financial condition.
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In order to generate meaningful revenues, our technologies must gain market recognition and acceptance to develop sufficient recurring sales. In addition, management believes that the successful growth and operation of our business is dependent upon our ability to obtain adequate sources of funding through co-development agreements, strategic partnering agreements, or equity or debt financing to adequately support commercialization of our research and development efforts, protect intellectual property, form relationships with strategic partners and provide for working capital and general corporate purposes. There can be no assurance that we will be successful in achieving our long-term plans, or that such plans, if consummated, will result in profitable operations or enable us to continue in the long-term as a going concern .
Our costs include employee salaries and benefits, compensation paid to consultants, materials and supplies for prototype development and manufacture, costs associated with development activities including materials, sub-contractors, travel and administration, legal and accounting expenses, sales and marketing costs, general and administrative expenses, and other costs associated with an early stage, publicly-traded technology company. As of December 31, 2021, we have 12 full-time employees. Because using third party expertise and resources is more efficient than maintaining full time resources, we also expect to incur consulting expenses related to technology development and some administrative, sales and legal functions commensurate with our current levels.
The amount that we spend for any specific purpose may vary significantly, and could depend on a number of factors including, but not limited to, the pace of progress of our commercialization and development efforts, actual needs with respect to product testing, development and research, market conditions, and changes in or revisions to our sales and marketing strategies.
Research, development, and commercial acceptance of new technologies are, by their nature, unpredictable. Although we undertake development and commercialization efforts with reasonable diligence, there can be no assurance that the net proceeds from our securities offerings will be sufficient to enable us to develop our technology to the extent needed to create future sales to sustain operations. If the net proceeds from these offerings are insufficient for this purpose, we will consider other options to continue our path to commercialization, including, but not limited to, additional financing through follow-on equity offerings, debt financing, co-development agreements, sale or licensing of developed intellectual property, or other alternatives.
We cannot assure that our technologies will be accepted, that we will ever earn revenues sufficient to support our operations, or that we will ever be profitable. Furthermore, we have no committed source of financing and we cannot assure that we will be able to raise money as and when we need it to continue our operations. If we cannot raise funds as and when we need them, we may be required to scale back our development and deployment plans by reducing expenditures for employees, consultants, business development and marketing efforts or to otherwise severely curtail, or even to cease, our operations.
Critical Accounting Policies
The following discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Certain accounting policies and estimates are particularly important to the understanding of our financial position and results of operations and require the application of significant judgment by our management or can be materially affected by changes from period to period in economic factors or conditions that are outside of our control. As a result, they are subject to an inherent degree of uncertainty. In applying these policies, our management uses their judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical operations, our future business plans and projected financial results, the terms of existing contracts, our observance of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. See Note 2 to our audited consolidated financial statements included elsewhere in this report for a more complete description of our significant accounting policies.
Revenue Recognition and Cost of Goods Sold. The Company recognizes revenue and related cost of goods sold in accordance with FASB ASC 606 Revenue from Contracts with Customers (ASC 606). Revenues and cost of goods sold are recognized once the goods or services are delivered to the customer’s control or non-refundable performance obligations are satisfied. The Company’s contracts with customers generally have performance obligations and a schedule of non-refundable cancellation obligations. The contracts generally will be fully performed upon delivery of certain drawings or equipment. Revenue related to the contracts is recognized following the completion of non-refundable performance obligations as defined in the contract.
The Company’s contracts generally include progress payments from customers upon completion of defined milestones. As these payments are received, they are offset against accumulated project costs and recorded as either contract assets or contract
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liabilities. Upon completion of the performance obligations and collectability is determined, revenue can be recorded. For any contract in connection with which the Company is expected to incur costs in excess of the contact price, the Company accrues the estimated loss in full in the period such determination is made.
Impairment of Long-Lived Assets
The Company tests long-lived assets, consisting of fixed assets, patents, and other intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected from the use and eventual disposition of the assets. In the event an asset in not fully recoverable a loss is recognized based on the amount by which the carrying amount exceeds the fair value of the long-lived assets. Fair value is determined based on the present value of estimated expected cash flows using a discount rate commensurate with the risks involved, quoted market prices, or appraised values depending upon the nature of the assets. Losses on long-lived assets to be disposed of is determined in a similar manner, except those fair values are reduced for the cost of disposal.
Product Warranties
The Company warrants all installed products against defects in materials and workmanship, and shortcomings in performance compared to contractual guarantees for a period specified in each contract. Accruals for product warranties are based on expected warranty experience and current product performance trends which are recorded as a component of cost of sales at the time revenue is recognized. The warranty liabilities are reduced by material and labor costs during the warranty period in the periods in which the costs are incurred. The Company periodically assesses the adequacy of our recorded warranty liabilities and adjusts the amounts as necessary, and such adjustments could be material if estimates differ significantly from actual warranty expense. The warranty liabilities are included in accounts payable and accrued liabilities in the unaudited condensed consolidated balance sheets.
Research and Development
The cost of research and development is expensed as incurred. Research and development costs consist of salaries, benefits, share based compensation, consumables, and consulting fees, including costs to develop and test prototype equipment and parts. Research and Development costs have been offset by funds received from strategic partners in cost sharing, collaborative projects. During the year ended December 31, 2021, the Company received $50 thousand from such arrangements and during the year ended December 31, 2020, the Company received $40 thousand to partially fund specific engineering activity relating to the development of burners for a Super Major and $50 thousand to partially fund the engineering and installation of a product for an air quality demonstration project. Since these funds were provided without expectation of reciprocation, other than the notification of research results, the funds received were offset against the related research and development costs incurred.
Stock-Based Compensation
The costs of all employee stock options, as well as other equity-based compensation arrangements, are reflected in the condensed consolidated financial statements based on the estimated fair value of the awards on the grant date. That cost is recognized over the period during which an employee is required to provide service in exchange for the award, or in the case of performance options, expense is recognized upon completion of a milestone as defined in the grant agreement. Stock-based compensation for stock grants to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.
Fair Value of Financial Instruments
The Company's financial instruments primarily consist of cash and cash equivalents, accounts payable, accrued expenses and short-term investments in government securities. As of the balance sheet date, the estimated fair values of the financial instruments were not materially different from their carrying values as presented on the balance sheets. This is primarily attributed to the short maturities of these instruments.
Results of Operations
Comparison of the Years Ended December 31, 2021 and 2020
Highlights of our annual financial performance are as follows:
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For the Year Ended
December 31,
(in thousands, except per share data)
2021
2020
$ Change
% Change
Revenues
$
607
$
—
$
607
N/A
Cost of goods sold
1,059
279
$
780
(279.6)
%
Gross Loss
(452)
(279)
$
(173)
(62.0)
%
Operating Expenses
7,693
6,653
$
1,040
(15.6)
%
Other income
253
46
$
207
450.0
%
Net loss
$
(7,892)
$
(6,886)
$
(1,006)
(14.6)
%
Basic and diluted net income per common share
$
(0.25)
$
(0.25)
$
—
—
%
Sales and Gross Loss
Consolidated revenues for the 2021 year totaled $607 thousand, whereas no sales were reported in 2020. Revenues in 2021 include $499 thousand from contracts related to process burners, boiler burners and installation services. Current year demand for our products and services came from a range of customers and geographies, such as a United States infrastructure company, a European refinery owned by a global energy company, and a Chinese boiler burner rental company. An additional $108 thousand in sales were recorded from two prior year projects where constraints relating to collectability were eliminated in the current year.
Gross loss increased by $173 thousand, or 62.0% compared with 2020. In 2021, gross loss was unfavorably impacted by contract losses reported in costs of goods sold, which amounted to $762 thousand. These contract losses were incurred by refinery projects with most of the loss derived from our ExxonMobil project. The ExxonMobil loss was caused by rigorous product testing and product development costs. In contrast, gross loss was favorably impacted by expired product warranties reducing costs of goods sold by $86 thousand. During the year ended December 31, 2020, gross loss was unfavorably impacted by contract losses of $450 thousand, offset by favorable warranty expirations of $171 thousand.
In September of 2021, the Company received verbal notification from ExxonMobil that our project at their Baytown, Texas refinery would be placed on hold. At that time, we were fully prepared for a formal witness acceptance test by ExxonMobil, which would have allowed their staff to move into the final phases of the project. ExxonMobil noted their engineers had insufficient time to meet their targeted 2022 refinery turnaround. ClearSign and ExxonMobil are continuing to discuss contractual obligations related to the Baytown project.
Operating Expenses
Operating expenses consist of research and development (R&D) and general and administrative (G&A) expenses, which are addressed separately below.
R&D expenses increased by $651 thousand or approximately 32.1% to $2,680 thousand for the year ended December 31, 2021, as compared to $2,029 thousand during the year ended December 31, 2020. In 2021, we incurred additional costs year over year of approximately $315 thousand for product development. A majority of this spend related to boiler burner product lines that were developed in collaboration with our strategic partners California Boiler and Zeeco. As a result, ClearSign developed a 125 horsepower (hp) and 500hp fire tube boiler burner along with a 2400hp water tube boiler burner. Furthermore, we assessed our patent and trademark intangible assets to ensure that our ongoing intellectual property investments protect future anticipated cash returns. The assessment was a two-phased approach with the first phase focused on product alignment, and the second phase focused on a risk, reward cost benefit analysis. As a result of these assessments, we recognized a $385 thousand non-cash impairment charges, and an additional $50 thousand in accelerated amortization. These R&D cost increases were offset by approximately $50 thousand for year over year net savings in human capital costs.
R&D expenditures were lower in the year ended December 31, 2020, due to reduced laboratory and customer fieldwork costs, coupled with zero costs for non-cash impairment charges.
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G&A expenses increased by $389 thousand or approximately 8.4% to $5,013 thousand during the year ended December 31, 2021, as compared to $4,624 thousand during the year ended December 31, 2020. In 2021, we incurred additional costs year over year of approximately $380 thousand for accounting and audit costs. Most of these costs related to temporary professional staff and recruitment, to reinforce the finance and accounting function after the death of our CFO in July 2021. The Company accrued $32 thousand for an estimated renovation liability to exit the Seattle lease at the end of its term. These G&A cost increases were offset by approximately $45 thousand for year over year net savings in human capital costs.
G&A expenditures were lower in the year ended December 31, 2020, due to lower costs related to professional services and travel expenses due in large part to the impact of the COVID 19 pandemic.
Other income
Other income for the year ended December 31, 2021 reflects a $251 thousand gain on forgiveness of a Paycheck Protection Program ("PPP") loan and accrued interest under the 2020 CARES Act. We received notification of the loan forgiveness during the second quarter of 2021. Other income of $44 thousand for the year ended December 31, 2020 resulted from a non-recurring sale of spare materials and parts for an installation site on a previously completed contract.
Net Loss
Net loss for the year ended December 31, 2021, was $7,892 thousand compared to $6,886 thousand for the year ended December 31, 2020, or an approximate 14.6% increase. The $1,006 thousand increase in net loss during the year ended December 31, 2021 is primarily attributable to the testing and engineering costs incurred during extensive development of the process burner technology under the initiative of the ExxonMobil technology validation project, as well as costs attributable to product development and commercialization efforts for our fire tube and water boiler burners. These cost increases were offset by year over year revenue increases for product deliveries and installation services.
Liquidity and Capital Resources
At December 31, 2021, our cash and cash equivalent balance totaled $7,607 thousand compared to $8,824 thousand at December 31, 2020, a decrease of $1,217 thousand.
At December 31, 2021, our current assets were in excess of current liabilities resulting in working capital of $7,293 thousand as compared to $8,302 thousand at December 31, 2020.
Based on our current plans, we have sufficient funds to continue operating our business at current levels for at least 12 months from the date of issuance of this report. In order to continue business operations beyond that point, we currently anticipate that we will need to raise additional capital. Our development and general administrative costs are ongoing, and we expect to require additional funding to meet these expenses. To that end we may undertake offerings of our securities, debt financing, selling or licensing intellectual property, or other alternatives. We filed a Form S-3 shelf registration statement with the Securities and Exchange Commission on June 27, 2019 that was declared effective on July 12, 2019. The registration statement allows us to offer common stock, preferred stock, warrants, subscription rights, debt securities and units from time to time as market conditions permit to fund the ongoing operations of the Company. Until the growth of revenue increases to a level that covers operating expenses it is the Company’s plan to continue to fund operations in this manner, although, as noted above, the significant volatility in the capital markets may negatively affect our ability to do so.
During the year ended December 31, 2021, working capital has been funded with approximately $5,309 thousand in net proceeds from the ATM offering of 1,093 thousand shares of our common stock, offset with operating expenses. Additionally, we received $385 thousand from the exercise of option awards and warrants. Subsequent to the year ended December 31, 2021, the Company raised an additional $602 thousand in net proceeds from the ATM by issuing 496 thousand shares, prior to the close of business on March 29, 2022.
During the year ended December 31, 2020, we raised $6,053 thousand in net proceeds from the sale of our equity securities and received $126 thousand from the exercise of option awards.
Operating activities for the year ended December 30, 2021, resulted in cash outflows of $6,707 thousand, primarily due to the loss for the period of $7,892 thousand, offset with non-cash expenses of $1,206 thousand.
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Operating activities for the year ended December 31, 2020, resulted in cash outflows of $ 5,964 thousand primarily due to the loss for the period of $6,886 thousand, offset with non-cash expenses of $1,027 thousand.
Investing activities for the year ended December 31, 2021, resulted in cash outflows of $213 thousand in disbursements for fixed and intangible assets, compared to cash outflows of $194 thousand for the year ended December 31, 2020.
Financing activities for the year ended December 31, 2021, include $5,309 thousand in net proceeds from the sale of 1,093 thousand shares of our common stock through our ATM program at an average price of $5.03 per share and $385 thousand from the exercise of option awards and warrants.
Financing activities for the year ended December 31, 2020, include proceeds from a $6,053 thousand private equity offering, $251 thousand from a PPP loan funding and $126 thousand in proceeds from the exercise of stock options.
Off-Balance Sheet Transactions
We do not have any off-balance sheet transactions.