ClearSign Technologies Corp 10-K

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 has been proven in full scale industrial test furnaces and boilers, and first customer installations are currently operating in normal commercial applications. We have generated nominal revenues from operations to date to meet operating expenses. We have incurred losses since inception totaling $88.5 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 $91.0 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. 22 ​ Table of Contents 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 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. With respect to our China operations, we have a satellite office located in Beijing, China to support our commercialization efforts. At this time, these operations in China are immaterial compared to total company operations. As of December 31, 2022, our China asset balance totaled $172 thousand, or approximately 1.6%, compared to our total asset balance of $10,925 thousand. During the year ended December 31, 2022, our China operations reported zero revenues. During the same period in 2021, revenues attributable to our China operations were $21 thousand, or approximately 3.4% compared to our total revenues of $607 thousand. ​ 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. We currently have 16 full-time employees. Because using third party expertise and resources is more efficient than maintaining full time resources, we also expect to incur ongoing consulting expenses related to technology development and some administrative, sales and legal functions commensurate with our current level of activities. 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 sufficient 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 or other 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 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. These policies and estimates require the application of significant judgment by management. These estimates can be materially affected by changes from period to period as economic factors and conditions outside of our control change. 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. 23 ​ Table of Contents 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 documents 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 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 are offset by any funds received from strategic partners in cost sharing, collaborative projects. During the year ended December 31, 2022, the Company received no monies from strategic partners. During the year ended December 31, 2021, the Company received $44 thousand from such arrangements. 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. 24 ​ Table of Contents Fair Value of Financial Instruments The Company's financial instruments primarily consist of 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 consolidated balance sheets. This is primarily attributed to the short maturities of these instruments. Results of Operations Comparison of the Years Ended December 31, 2022 and 2021 Highlights of our annual financial performance are as follows: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the Year Ended ​ ​ ​ ​ ​ ​ (in thousands, except per share data) ​ December 31, ​ ​ ​ ​ ​ ​ ​ 2022 2021 $ Change % Change Revenues ​ $ 374 ​ $ 607 ​ $ (233) ​ (38.4) % Cost of goods sold ​ ​ 258 ​ ​ 1,059 ​ $ (801) ​ (75.6) % Gross profit (loss) ​ ​ 116 ​ ​ (452) ​ $ 568 ​ NM Research and development ​ ​ 505 ​ ​ 2,680 ​ $ (2,175) ​ (81.2) % General and administrative ​ ​ 5,728 ​ ​ 5,013 ​ $ 715 ​ 14.3 % Operating Expenses ​ ​ 6,233 ​ ​ 7,693 ​ $ (1,460) ​ (19.0) % Other income, net ​ ​ 359 ​ ​ 253 ​ $ 106 ​ 41.9 % Net loss ​ $ (5,758) ​ $ (7,892) ​ $ 2,134 ​ 27.0 % Basic and diluted net income per common share ​ $ (0.16) ​ $ (0.25) ​ $ 0.09 ​ 36.0 % NM = Not meaningful ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Sales and Gross Loss Consolidated revenues for the year ended December 31, 2022 totaled $374 thousand compared to $607 thousand reported for the year ended December 31, 2021, mainly due to the timing of performance obligations associated with certain projects during the period. Because our contracts generally include progress payments from customers upon completion of defined milestones, the timing of these performance obligations can affect our recognition of revenue per ASC 606. Revenues recognized in 2022 were related to the closeout of our ExxonMobil technology validation project, and the sale of our ClearSign Core TM enclosed oxidizer product for a hydrogen production plant. ExxonMobil revenues were recognized upon receipt of cash to close out the contract. This cash receipt eliminated collectability concerns, thus allowing recognition of revenue per ASC 606. During the year 2021, we recognized $499 thousand from contracts related to process burners, boiler burners and installation services. Additionally, $108 thousand in revenues related to 2020 projects where collectability constraints were eliminated in 2021, thus allowing the recognition of revenues per ASC 606. Product and service revenues in 2021 came from a range of customers and locations, such as a United States infrastructure company, a European refinery owned by a global energy company, and a Chinese boiler burner rental company. Gross profit for the year end December 31, 2022 increased $568 thousand compared to gross profit reported for the year end December 31, 2021, mainly due to recognizing revenues from our ExxonMobil technology validation project. During 2021, a gross loss occurred primarily due to project losses amounting to $762 thousand. These contract losses were incurred by refinery projects with the majority of the loss generated by our ExxonMobil project. The ExxonMobil loss was caused by rigorous product testing and product development costs. Operating Expenses Operating expenses consist of research and development (“R&D”) and general and administrative (“G&A”) expenses, which are addressed separately below. 25 ​ Table of Contents R&D expenses decreased by $2,175 thousand, or approximately 81.2%, to $505 thousand for the year ended December 31, 2022, as compared to $2,680 thousand during the same period in 2021. During 2022, R&D expenses decreased due to an organizational restructure that occurred at the beginning of 2022. We restructured our organization such that some employees previously performing R&D functions were reassigned to business development functions, which shifted salaries of approximately $527 thousand to G&A expense (as discussed below). This reassignment was executed as part of our transition from focusing on research to focusing on the commercialization of our technologies. Decreases in human capital costs also favorably impacted R&D expenses by $438 thousand for the year ended December 31, 2022, when compared to the same period in 2021. In addition, product development costs trended down by $645 thousand for the for the year ended December 31, 2022, as compared to the same period in 2021, due in large part to costs incurred during 2021 for the development of our water-tube and fire-tube boiler burner product lines. G&A expenses increased by $715 thousand, or approximately 14.3%, to $5,728 thousand during the year ended December 31, 2022, as compared to $5,013 thousand during the year ended December 31, 2021. Our organizational restructure referenced in the R&D explanation above increased expenses by approximately $527 thousand for the year ended December 31, 2022, compared to the same period in 2021. Increases in human capital costs also unfavorably impacted G&A expenses by $127 thousand for the year ended December 31, 2022, when compared to the same period in 2021. Expense increases were offset by year-over-year decreases in board compensation expenses of approximately $147 thousand, for the year ended December 31, 2022, compared to the same period in 2021. This compensation decrease was attributed to two key factors: (i) changing payment of director compensation from stock options to restricted stock units, and (ii) deferring compensation expense as required by accounting standard ASC 718 Stock Compensation. Refer to Note 8 - Equity for further details. Other income Other income increased by $106 thousand, or approximately 41.9%, to $359 thousand for the year ended December 31, 2022, as compared to $253 thousand during the same period in 2021. During 2022, we received $232 thousand in government assistance which consisted of two government programs: (i) Small Business Innovative Research (SBIR) grant from the Department of Energy (“DOE”) and (ii) Oklahoma 21 st Century Jobs Act. Refer to financial statement Note 12 – Government Assistance for more details about these programs. In addition, during 2022 we earned $83 thousand in interest from our money market account and short-term U.S. Treasury investments. Other income during 2021 reflects a $251 thousand gain on forgiveness of a Paycheck Protection Program ("PPP") loan and accrued interest under the 2020 CARES Act. Net Loss Net loss for the year ended December 31, 2022, was $5,758 thousand compared to $7,892 thousand for the year ended December 31, 2021, or an approximate 27.0% decrease. The $2,134 thousand decrease in net loss during the year ended December 31, 2022, is primarily attributable to the reduced R&D costs throughout the year, as further explained in the above discussion. Liquidity and Capital Resources At December 31, 2022, our cash and cash equivalent balance totaled $6,451 thousand compared to $7,607 thousand at December 31, 2021, a decrease of $1,156 thousand. During 2022, we invested in short-term held-to-maturity U.S. treasuries of which we had $2,606 thousand outstanding as of December 31, 2022. At December 31, 2022, our current assets were in excess of current liabilities resulting in working capital of $8,586 thousand as compared to $7,293 thousand at December 31, 2021. We have no contractual debt obligations, and the Company has sufficient working capital to fund current operating expenses for over twelve months. To the extent the Company requires additional funds more than 12 months from the date hereof, and customer cash collections cannot fund our needs, the Company may utilize equity offerings to raise these funds. Historically, the Company has funded operations predominately through equity offerings. Currently, the Company can sell shares of common stock through its ATM program. As noted in Note 8 – Equity, the remaining aggregate offering price on the ATM is approximately $8.7 million. During 2022, working capital was funded with approximately $6,539 thousand in net cash proceeds from our equity offerings during the year. Refer to financial statement Note 8 – Equity for further details about our equity offerings. We filed a Form S-3 shelf registration statement with the SEC on July 1, 2022 that was declared effective on August 12, 2022. The registration statement on Form S-3 allows us to offer common stock, preferred stock, warrants, subscription rights, debt 26 ​ Table of Contents securities and units from time to time, as market conditions permit to fund, to the extent required beyond the 12 months from the date hereof, the ongoing operations of the Company. Until the growth of revenue increases to a level that covers operating expenses, the Company intends to continue to fund operations in this manner, although, the volatility in the capital markets and potential upcoming recession may negatively our ability to do so. ​ Operating activities for the year ended December 30, 2022, resulted in cash outflows of $4,992 thousand, primarily due to the loss for the period of $5,758 thousand, offset with non-cash expenses of $627 thousand. Operating activities for the year ended December 31, 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 $1,394 thousand. ​ Investing activities for the year ended December 31, 2022, resulted in cash outflows of $2,686 thousand, which is primarily attributable to $2,561 thousand of net investments in short-term held-to-maturity US treasuries, and $154 thousand of disbursements for patents and other intangibles. December 31, 2021, resulted in cash outflows of $213 thousand, primarily due to $140 thousand of disbursements for patents and other intangibles. Financing activities for the year ended December 31, 2022, included $6,539 thousand in net proceeds from the sale of 501 thousand shares of our common stock through our ATM program at an average price of $1.24 per share, sale of 4.2 million shares of our common stock through a public offering at a price of $1.11 per share, and sale of 1.6 million shares of our common stock at a price of $1.11 per share pursuant to the Participant Right with clirSPV LLC. Financing activities for the year ended December 31, 2021 resulted in $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. Off-Balance Sheet Transactions We do not have any off-balance sheet transactions.