Item 5. Market for Registrant’s Common Equity
Item 5.
Market for Registrant ’ s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is quoted on the Nasdaq Capital Market under the symbol LIQT.
As of December 31, 2023, there were approximately 33 stockholders of record of our common stock as reported by our transfer agent, one of which is Cede & Co., a nominee for Depository Trust Company (“DTC”). All of the shares of common stock held by brokerage firms, banks, and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC and are therefore considered to be held of record by Cede & Co. as one stockholder.
We have not paid any cash dividends on our common stock and have no intention of paying any dividends on the shares of our common stock in the future. Subject to Nevada law, our Board of Directors will determine the payment of future dividends on our common stock, if any, and the amount of any dividends subject to:
●
any contractual restrictions limiting our ability to pay dividends that may be applicable at such time;
●
our earnings and cash flow;
●
our capital requirements;
●
our financial condition; and
●
other factors that our Board of Directors deems relevant.
Since the beginning of our fiscal year ended December 31, 2023, we have not sold any equity securities that were not registered under the Securities Act of 1933 that were not previously reported in a quarterly report on Form 10-Q or in a current report on Form 8-K.
Since the beginning of our fiscal year ended December 31, 2023, we have not repurchased any of our equity securities.
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Item 6.
[Reserved]
Item 7.
Management ’ s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a Nevada corporation, formerly named Blue Moose Media, Inc. In October 2011, we changed our name to LiqTech International, Inc. For more than two decades, we have developed and provided state-of-the-art technologies for gas and liquid purification using silicon carbide ceramic filters, particularly highly specialized filters for the control of soot exhaust particles from diesel engines and for liquid filtration. Using nanotechnology, LiqTech develops products using proprietary silicon carbide technology. LiqTech's products are based on unique silicon carbide membranes that facilitate new applications and improve existing technologies. In particular, the Company has developed a new standard of water filtration technology to meet the ever-increasing demand for higher water quality. By incorporating LiqTech's SiC liquid membrane technology with its long-standing systems design experience and capabilities, the Company offers solutions to the most difficult water pollution problems.
2023 Developments
On February 15, 2023, the Company entered into a distribution agreement with Liquinex regarding the supply of silicon carbide ceramic membranes.
On April 25, 2023, the Company entered into a distribution agreement with Silicon Filter for Phosphoric Acid Purification Applications in China.
On May 26, 2023, the Company completed a 1-for-8 reverse split of its issued and outstanding shares of Common Stock.
On June 27, 2023, the Company announced that Chairman Mark Vernon would retire from the Board with immediate effect. Alexander J. Buehler, a member of the Board of Directors, was appointed as the new Chairman of the Board. Further, the Company announced that Martin Kunz was appointed to the Company’s Board of Directors, also with immediate effect.
On October 13, 2023, the Company and the Purchasers entered into an amendment to the Note and Warrant Purchase Agreement (the “ Amendment ”) and Allonge No. 1 to each of the Notes (collectively, the “ Allonges ”), each as more fully described in the current report on Form 8-K filed with the SEC on October 19, 2023, effective as of September 30, 2023, pursuant to which the Company and the Purchasers extended the maturity date of the Notes from June 20, 2024, to January 1, 2026 (the “ Extension ”).
On October 30, 2023, the Company entered into a distribution agreement with Barr + Wray for Aqua Solution® swimming pool water filtration systems covering the Middle East.
On November 2, 2023, the Company entered into a distribution agreement with Waterco for Aqua Solution® swimming pool water filtration systems covering Australia, New Zealand, Papua New Guinea, and the Pacific Islands.
On November 13, 2023, the Company filed an amendment to its Articles of Incorporation to increase the number of authorized shares of the Company’s common stock from 12,500,000 shares to 50,000,000 shares, which was approved by the Company’s stockholders at the Company’s on November 9, 2023.
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Results of Operations
Results of Operations for the Year Ended December 31, 2023 Compared to the Year Ended December 31, 2022
The following table sets forth our revenues, expenses, and net income for the years ended December 31, 2023 and 2022 in U.S. dollars, except for percentages.
For the Year Ending December 31,
Period to Period
Change
2023
As a %
of Sales
2022
As a %
of Sales
$
Percent %
Revenue
18,001,652
100.0
%
15,982,438
100.0
%
2,019,214
12.6
%
Cost of Goods Sold
15,226,176
84.6
15,415,294
96.5
(189,118
)
(1.2
)
Gross Profit
2,775,476
15.4
567,144
3.5
2,208,332
389.4
Operating Expenses
Selling expenses
4,298,905
23.9
3,669,887
23.0
629,018
17.1
General and administrative expenses
4,856,779
27.0
5,701,955
35.7
(845,176
)
(14.8
)
Research and development expenses
1,418,842
7.9
1,835,890
11.5
(417,048
)
(22.7
)
Restructuring costs
-
-
1,893,166
11.8
(1,893,166
)
(100.0
)
Total Operating Expenses
10,574,526
58.7
13,100,898
82.0
(2,526,372
)
(19.3
)
Loss from Operations
(7,799,050
)
(43.3
)
(12,533,754
)
(78.4
)
4,734,704
(37.8
)
Other Income (Expense)
Interest and other income
366,365
2.0
384,058
2.4
(17,693
)
(4.6
)
Interest expense
(151,670
)
(0.8
)
(419,942
)
(2.6
)
268,272
(63.9
)
Amortization discount on Convertible Note
(400,903
)
(2.2
)
(2,389,128
)
(14.9
)
1,988,225
(83.2
)
Gain (Loss) on currency transactions
(359,960
)
(2.0
)
404,162
2.5
(764,121
)
(189.1
)
Gain (Loss) on lease termination
-
-
147,452
0.9
(147,452
)
(100.0
)
Gain (Loss) on assets held for sale
(439,388
)
(2.4
)
-
-
(439,388
)
-
Gain (Loss) on sale of property and equipment
7,254
0.0
635
0.0
6,619
1,042.4
Total Other Income (Expense)
(978,302
)
(5.4
)
(1,872,763
)
(11.7
)
894,462
(47.8
)
Loss Before Income Taxes
(8,777,352
)
(48.8
)
(14,406,517
)
(90.1
)
5,629,166
(39.1
)
Income Taxes Provision (Benefit)
(206,207
)
(1.1
)
(237,410
)
(1.5
)
31,203
(13.1
)
Net Loss
(8,571,145
)
(47.6
)
(14,169,107
)
(88.7
)
5,597,963
(39.5
)
Revenues
Revenue for the year ended December 31, 2023 was $18,001,652 compared to $15,982,438 for the same period in 2022, representing an increase of $2,019,214, or 13%. The increase in revenue was underpinned by an uptick in system sales, general spare parts and related services, and plastic component sales, partly offset by a decline in sales of DPFs and ceramic membranes.
●
For the years ended December 31, 2023 and 2022, sales of systems, spare parts and related services were $7,705,080 and $5,297,286, respectively, and accounted for 42% and 33% of our total sales.
●
For the years ended December 31, 2023 and 2022, sales of DPFs and ceramic membranes were $6,232,628 and $6,844,861, respectively, and accounted for 35% and 43% of our total sales.
●
For the years ended December 31, 2023 and 2022, plastics revenues were $3,736,529 and $3,528,606, respectively, and accounted for 21% and 22% of our total sales.
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The increase in system sales and related services of $2,407,794, reflecting a year-on-year increase of 46%, is a result of the increased focus on aftermarket activities through the establishment of a new dedicated aftermarket organization that generated an uptick in spare parts and membrane housing orders, , coupled with continued traction within our system business related to pool and marine system deliveries as well as oil & gas and industrial system applications.
The sales of DPFs and ceramic membranes experienced a year-on-year decline of 9% to $6,232,628, as the year ended December 31, 2022, benefitted from delivery of a large legacy DPF order. In addition, the Company has applied a deliberate focus to optimize the product mix in favor of higher-margin products, explaining the significant improvement in gross profit for the year.
The sale of plastic products benefitted from a year-on-year increase of 6% to $3,736,529, underpinned by increased customer diversification, stable order intake, and the successful execution of a large new order for the construction industry.
For the years ended December 31, 2023 and 2022, revenue from R&D projects was $327,415 and $311,685, respectively, reflecting an increase of 5%.
Gross Profit
Gross profit for the year ended December 31, 2023, was $2,775,476, or 15.4%, compared to $567,144, or 3.5%, for the same period in 2022, representing an increase of $2,208,332, or approximately 389%. The increase derives from a reduction in cost of goods sold due to an improved product mix and increased pricing discipline within the legacy ceramic DPF business, coupled with continued delivery of profitable system and aftermarket orders within the pool, oil & gas, and phosphoric acid businesses.
These efforts resulted in improved profitability, despite remediation costs related to legacy system deliveries and increased depreciation from recent investments in manufacturing equipment and facilities to improve kiln utilization and manufacturing throughput. Included in the gross profit for the year ended December 31, 2023 is depreciation of $2,575,824 compared to $1,822,402 for the same period in 2022.
Expenses
Total operating expenses for the year ended December 31, 2023, were $10,574,526, representing a decrease of $2,526,372, or approximately 19%, compared to $13,100,898 for the same period in 2022. Adjusting for the reported restructuring costs of $1,893,166 incurred in 2022, total operating expenses decreased by $633,206, or 6%.
Selling expenses for the year ended December 31, 2023, were $4,298,905 compared to $3,669,887 for the same period in 2022, representing an increase of $629,018, or approximately 17%. The increase is explained by the onboarding of new sales and commercial leadership in 2023, partly offset by the ongoing focus on cost reduction and reduced bad debt expenses.
General and administrative expenses for the year ended December 31, 2023, were $4,856,779 compared to $5,701,955 for the same period in 2022, representing a decrease of $845,176, or 15%. The decrease is attributed to reduced legal expenses, the absence of costs associated with the now-closed production facility in China, the CEO transition, and other transition costs related to management changes executed in 2022.
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Table of Contents
Included in general and administrative expenses is non-cash compensation expense of $627,904 and $934,423 for the years ended December 31, 2023 and December 31, 2022, respectively, representing a decrease of $306,519, or 33%, mainly explained by the stock grants awarded to management amid the 2022 CEO transition.
The following is a summary of our non-cash compensation:
2023
2022
Compensation for vesting of restricted stock awards issued to the Board of Directors
$
203,708
$
167,750
Compensation for vesting of restricted stock awards issued to management
424,196
766,673
Total Non-Cash Compensation
$
627,904
$
934,423
Research and development expense for the year ended December 31, 2023, was $1,418,842 compared to $1,835,890 for the same period in 2022, representing a decrease of $417,048, or 23%. The decrease was attributable to the centralization of R&D efforts to streamline R&D spend and allow for better resource allocation and prioritization of projects.
Restructuring costs for the year ended December 31, 2023, were $0 compared to $1,893,166 for the same period in 2022.
Other income (expenses)
Total Other income (expense) for the year ended December 31, 2023, was $(978,302) compared to $(1,872,763) for the comparable period in 2022, representing a decrease of $894,462, or 48%. Total Other income (expense) in 2023 reflects a loss on assets held for sale along with a reduced gain on currency transactions, with the increased levels in the prior period explained by non-recurring transactions related to the now-closed production facility in China, the receipt of COVID-19 grants, and the early repayment of the Convertible Note.
Income taxes provision
The income tax benefit for the year ended December 31, 2023, was $206,207 compared to a benefit of $237,410 for the comparable period in 2022, representing a decrease of $31,203, or 13%, mainly driven by a decrease in tax credits associated with research and development activities in Denmark.
Net Loss
Net loss for the year ended December 31, 2023 was $(8,571,145) compared to $(14,169,107) for the comparable period in 2022, representing an improvement of $5,597,963, or approximately 40%.
The change was primarily attributable to the improved gross profit combined with the notable non-recurring items recorded in 2022, including restructuring costs, early repayment of the Convertible Note, closure of the production facility in China, and the CEO transition.
Liquidity and Capital Resources
In relation to the delivery and installation of new machinery and equipment to facilitate revenue growth, the Company has secured approximately $1.4 million of new finance leases from financial institutions to further strengthen its liquidity. On September 30, 2023, the Company proactively addressed the maturity of the $6 million senior promissory notes, extending the original maturity from June 2024 to January 2026 with terms and conditions that are generally aligned with the original agreement dated on June 22, 2022.
Based on current projections, which are subject to significant uncertainties--including the duration and severity of global macroeconomic issues, geopolitical instability, commodity price volatility, and continued global supply chain disruptions--the Company believes that the cash on hand, as well as ongoing cash generated from operations, will be sufficient to cover its capital requirements and committed investments for the next 12 months.
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Table of Contents
Continued market uncertainty and reduced order intake caused by weakening global macroeconomic conditions, recession, or a resurgence of the COVID-19 pandemic, however, could unfavorably impact the Company’s ability to generate positive cash flow and thereby significantly reduce its profitability and liquidity position.
While the Company anticipates that its proactive measures will be sufficient to protect the business over the coming 12 months, the Company cannot predict the specific duration and severity of the unfavorable market dynamics that may adversely affect the business. In the future, the Company may experience reduced or changed demand for its products and services, especially if there is a global recession, structural shift in regulation, or the continuation of escalating interest rates that adversely impacts the investment decisions of our customers.
The Company has historically satisfied its capital and liquidity requirements through offerings of equity instruments, cash from operations, and our available lines of credit. On December 31, 2023, we had cash of $10,422,181 and net working capital of $14,590,430, and on December 31, 2022, we had cash of $16,597,371 and net working capital of $21,581,287. On December 31, 2023, our net working capital had decreased by $6,990,857 compared to December 31, 2022, mainly due to a reduction in cash and cash equivalents.
In connection with certain orders, we provide the customer a working guarantee, a prepayment guarantee, or a security bond. For that purpose, we maintain a guaranteed credit line of EUR 850,000 (approximately $940,000), which is secured by a cash deposit.
Going Concern and Management ’ s Plans
The financial statements included herein for the period ended December 31, 2023, were prepared under the assumption that we would continue our operations as a going concern, which contemplates the realization of assets and the satisfaction of liabilities during the normal course of business. As of December 31, 2023, we had cash and cash equivalents of $10,422,181, net working capital of $14,590,430, an accumulated deficit of $75,922,180, and total assets and liabilities of $35,971,847 and $18,695,831, respectively. We have incurred losses from continuing operations, used cash in our continuing operations, and remain dependent on external financing to fund operations. These conditions raise substantial doubt about our ability to continue as a going concern for one year after the date the financial statements are issued. The financial statements included elsewhere herein do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
The Company has initiated substantial cost reductions and profitability improvement measures to help right-size the business and develop a clear and sustainable path to profitability, further underpinned by an updated strategy and onboarding of key executives. There can be no assurance, however, that the Company will be able to obtain any sources of funding. Such additional funding may not be available or may not be available on reasonable terms, and in the case of equity financing transactions, could result in significant additional dilution to our stockholders. If we do not obtain required additional equity or debt funding, our cash resources could be depleted and we could be required to materially reduce or suspend operations, which would likely have a material adverse effect on our business, stock price, and our relationships with third parties with whom we have business relationships, at least until additional funding is obtained. If we do not have sufficient funds to continue operations, we could be required to seek bankruptcy protection or other alternatives that could result in our stockholders losing some or all of their investment.
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Table of Contents
Cash Flows
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
Cash used by operating activities is net income (losses) adjusted for certain non-cash items and changes in assets and liabilities. Cash used by operating activities for the year ended December 31, 2023, was $4,183,918 compared to cash used by operating activities of $12,039,020 for the year ended December 31, 2022, representing a decrease of $7,855,102. The cash used by operating activities for the year ended December 31, 2023, consists mainly of the net loss for the year of $(8,571,145) adjusted by depreciation and other non-cash items of $4,544,181. Further, changes in assets and liabilities included an increase of Inventory of $1,045,838, an increase of Accounts receivables of $765,956, and an increase in Contract assets/liabilities of $1,108,589, offset by a decrease in Deposits of $1,403,707 and an increase of Accounts payable of $990,538.
Net cash used in investing activities was $2,886,036 for the year ended December 31, 2023, as compared to $1,689,986 for the year ended December 31, 2022, representing an increase of $1,196,050. The investing activities include the purchase of property and equipment to satisfy earlier commitments made for the production facility in China, with select equipment re-directed to the manufacturing facility in Ballerup as part of the strategic negotiation with vendors.
Cash provided by financing activities was $580,645 for the year ended December 31, 2023, as compared to $13,696,551 for the year ended December 31, 2022, representing a decrease of $13,115,906. The decrease was mainly driven by the equity raise recorded in May 2022, generating net proceeds of $24,418,612 from the issuance of Common Stock and prefunded warrants, coupled with proceeds of $6,000,000 from the issuance of the new Senior Promissory Notes, and partly offset by the full repayment of the Convertible Note issued in April 2021 of $16,800,000.
2023
2022
Net Cash Used in Operating Activities
$
(4,183,918
)
$
(12,039,020
)
Net Cash Used in Investing Activities
(2,886,036
)
(1,689,986
)
Net Cash Provided by Financing Activities
580,645
13,696,551
Net Change in Cash and Cash Equivalents
(6,175,190
)
(892,009
)
Cash and Cash Equivalents at End of Period
$
10,422,181
$
16,597,371
Off-Balance Sheet Arrangements
As of December 31, 2023, we had no off-balance sheet arrangements. We are not aware of any material transactions that are not disclosed in our consolidated financial statements.
Critical Accounting Policies
The methods, estimates, and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include:
●
The assessment of revenue recognition, which impacts revenue and cost of sales;
●
The assessment of allowance for product warranties, which impacts cost of sales;
●
The assessment of collectability of accounts receivable, which impacts operating expenses when and if we record bad debt or adjust the allowance for doubtful accounts;
●
The assessment of recoverability of long-lived assets, which impacts gross margin or operating expenses when and if we record asset impairments or accelerate their depreciation;
●
The recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions), which impact our provision for taxes;
●
The valuation of inventory, which impacts cost of sales; and
●
The recognition and measurement of loss contingencies, which impact cost of sales or operating expenses when we recognize a loss contingency, revise the estimate for a loss contingency, or record an asset impairment.
We discuss these policies further below as well as the estimates and judgments involved.
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Table of Contents
Accounts Receivable / Long-Term Receivable / Allowance for Doubtful Accounts / Bad Debt
Accounts receivable consist of trade receivables arising from credit sales to customers in the normal course of business. These receivables are recorded at the time of sale, net of an allowance for current expected credit losses. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 326, “Financial Instruments – Credit Losses,” the Company estimates expected credit losses based on historical bad debt experience, the aging of accounts receivable, the current creditworthiness of our customers, prevailing economic conditions, and reasonable and supportable forward-looking information.
The roll-forward of the allowance for doubtful accounts for the year ended December 31, 2023 and December 31, 2022 was as follows:
2023
2022
Allowance for doubtful accounts at the beginning of the period
$
59,559
$
409,076
Bad debt expense
82,066
(24,534
)
Receivables written off during the periods
(10,298
)
(295,778
)
Effect of currency translation
3,585
(29,205
)
Allowance for doubtful accounts at the end of the period
$
134,912
$
59,559
Goodwill and Definite-life intangible assets
The Company accounts for Goodwill and definite-life intangible assets in accordance with the provisions of the Statement of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles, Goodwill and Other. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of Topic 350. Impairment losses arising from this impairment test, if any, are included in operating expenses in the period of impairment. Topic 350 requires that definite-life intangible assets be amortized over their respective estimated useful lives and reviewed for impairment in accordance with Topic 360, Criteria for Recognition of an Impairment of Long-Lived Assets.
The Company did not record an impairment charge on goodwill during the years ended December 31, 2023 and 2022, as management's estimated fair value of the reporting unit exceeded its carrying value determined during impairment testing in the fourth quarters of 2023 and 2022.
Long-Lived Assets
We assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in our use of the assets. We measure the recoverability of assets that will continue to be used in our operations by comparing the carrying value of the asset grouping to our estimate of the related total future undiscounted net cash flows. If an asset grouping’s carrying value is not recoverable through the related undiscounted cash flows, the asset grouping is considered to be impaired. The impairment is measured by comparing the difference between the asset grouping’s carrying value and its fair value.
Impairments of long-lived assets are determined for groups of assets related to the lowest level of identifiable independent cash flows. Due to our asset usage model and the interchangeable nature of our ceramic filter manufacturing capacity, we must make subjective judgments in determining the independent cash flows that can be related to specific asset groupings. In addition, as we make manufacturing process changes and other factory planning decisions, we must make subjective judgments regarding the remaining useful lives of assets, primarily process-specific filter manufacturing tools and building improvements. If we determine that the useful lives of assets are shorter than we had originally estimated, we accelerate the rate of depreciation over the assets’ new, shorter useful lives.
Management has analyzed the impact of the current economic climate on its financial statements as of December 31, 2023, and has determined that the changes to its significant judgements and estimates did not have a material impact with respect to goodwill, intangible assets, or long-lived assets. During the years ended December 31, 2023 and 2022, no impairment charge of long-lived assets has been recorded.
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Table of Contents
Revenue Recognition
On January 1, 2018, the Company adopted Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers,” which includes clarifying ASUs issued in 2015, 2016 and 2017 (“new revenue standard”). The new revenue standard was applied to all open revenue contracts using the modified retrospective method as of January 1, 2018.
The Company sells products throughout the world; sales by geographical region are as follows:
% Distribution
For the Year Ended December 31
2023
2022
2023
2022
Americas
12
%
7
%
$
2,125,460
$
1,073,433
Asia-Pacific
14
%
21
%
2,506,215
3,406,420
Europe
65
%
59
%
11,820,674
9,379,337
Middle East & Africa
9
%
13
%
1,549,303
2,123,248
100
%
100
%
$
18,001,652
$
15,982,438
The Company’s sales by product and service are as follows for the years ended December 31, 2023 and 2022:
% Distribution
For the Year Ended December 31
2023
2022
2023
2022
Water
42
%
33
%
$
7,705,080
$
5,297,286
Ceramics
35
%
43
%
6,232,628
6,844,861
Plastics
21
%
22
%
3,736,529
3,528,606
Corporate
2
%
2
%
327,415
311,685
100
%
100
%
$
18,001,652
$
15,982,438
For Water (systems and aftermarket), Ceramics (diesel particulate filters and membranes), and Plastics (components), revenue is recognized when performance obligations specified within the terms of a contract with the customer are satisfied, which occurs when control of the product transfers to the customer or when services are rendered by the Company. The majority of the Company's sales contracts contain performance obligations satisfied at a point in time when title along with risks and rewards of ownership have transferred to the customer. This generally occurs when the product is shipped or accepted by the customer. Revenue for service contracts is recognized as the services are provided. Revenue is measured as the amount of consideration expected to be received in exchange for transferring the goods or providing services. The satisfaction of performance obligations under the terms of a revenue contract generally gives rise to the right to receive payment from the customer. The Company's standard payment terms vary by the type and location of the customer and the products or services offered. Generally, the time between when revenue is recognized and when payment is due is not significant. Pre-payments received prior to satisfaction of performance obligations are recorded as a Contract liability. Considering the relatively short time between revenue recognition and receipt of payment, financing components do not exist between the Company and its customers.
For contracts with customers that include multiple performance obligations, judgment is required to determine whether performance obligations specified in these contracts are distinct and should be accounted for as separate revenue transactions for recognition purposes. For such arrangements, revenue is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are generally determined based on the prices charged to customers or using expected cost-plus margin.
System sales are recognized when the Company transfers control to the customer based upon sales and delivery conditions specified in the sales contract. This typically occurs upon shipment of the system from the production facility but can also occur upon other agreed delivery terms. In connection with the completion of the system, it is normal procedure to issue a FAT (Factory Acceptance Test) asserting that the customer has accepted the performance of the system as it is being shipped from our production facility in Hobro. As part of the performance obligation, the customer is normally offered commissioning services (final assembly and configuration at a place designated by the customer), and this commissioning is therefore considered a second performance obligation and is valued at cost, with the addition of a standard gross profit. This second performance obligation is recognized as revenue at the time of the commissioning services being rendered together with the cost incurred. Part of the invoicing to the customer is also attributed to the commissioning, and at transfer of the control of the system (i.e., the first performance obligation), this portion is recognized as Contract Liabilities.
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Aftermarket sales represent parts, extended warranties, and maintenance services. For the sale of aftermarket parts, the Company transfers control and recognizes revenue when parts are shipped to the customer. When customers are given the right to return eligible parts and accessories, the Company estimates the expected returns based on an analysis of historical experience. The Company adjusts estimated revenues at the earlier of when the most likely amount of consideration expected to be received changes or when the consideration becomes fixed. The Company recognizes revenue for extended warranty and maintenance agreements based on the standalone selling price over the life of the contract.
The Company has received long-term contracts for grants from government entities for the development and use of silicon carbide membranes in various water filtration and treatment applications and historically in the installation of various water filtrations systems. We measure transfer of control of the performance obligation on long-term contracts utilizing the cost-to-cost measure of progress, with cost of revenue including direct costs such as labor and materials. Under the cost-to-cost approach, the use of estimated costs to complete each performance obligation is a significant variable in the process of determining recognized revenue and a significant factor in the accounting for such performance obligations. The timing of when we bill our customers is generally dependent upon advance billings terms, milestone billings based on completion of certain phases of the work or when services are provided, or when products are shipped. Projects with performance obligations recognized over time that have costs and estimated earnings recognized to date in excess of cumulative billings are reported on our balance sheet as Contract assets. Projects with performance obligations recognized over time that have cumulative billings in excess of costs and estimated earnings recognized to date are reported on our balance sheet as Contract liabilities.
Contract assets are the Company’s rights to consideration in exchange for goods or services and is recognized when a performance obligation has been satisfied but has not yet been billed. Contract assets are transferred to receivables when the right to consideration is unconditional and billed per the terms of the contractual agreement. Contract liabilities are payments received from customers prior to satisfaction of performance obligations, and these balances are typically related to prepayments for third-party expenses that are incurred shortly after billing. Contract liabilities also include deferred revenue related to the second performance obligation stated under Revenue Recognition, where the obligation is attributed to the commissioning of the water treatment system.
The roll-forward of Contract assets / liabilities for the periods ended December 31, 2023 and December 31, 2022 is as follows:
December 31,
2023
December 31,
2022
Cost incurred
$
3,225,728
$
3,860,179
Unbilled project deliveries
582,557
950,105
VAT
329,980
229,006
Other receivables
92,619
45,814
Prepayments
(1,688,427
)
(3,363,039
)
Deferred Revenue
(33,360
)
(118,327
)
$
2,509,097
$
1,603,738
Distributed as follows:
Contract assets
$
2,891,744
$
2,253,295
Contract liabilities
(382,647
)
(649,557
)
$
2,509,097
$
1,603,738
Income Taxes
We must make estimates and judgments in determining the provision for income taxes for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions and in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes in these estimates may result in an increase or decrease to our tax provision in a subsequent period.
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover the deferred tax assets recorded on our consolidated balance sheets. Should there be a change in our ability to recover our deferred tax assets, however, our tax provision would increase in the period in which we determined that the recovery was not likely. Recovery of a portion of our deferred tax assets is impacted by management's plans and methods of allocating research and development costs to the underlying reporting units.
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The calculation of our tax liabilities involves uncertainties in the application of complex tax regulations in Denmark and the United States. When a tax position is determined uncertain, we recognize liabilities based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will more likely than not be sustained on audit, the second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as we must determine the probability of various possible outcomes. If uncertainties arise, we re-evaluate the tax positions on a quarterly basis. This evaluation is based on factors such as changes in facts or circumstances, changes in tax law, new audit activity, and effectively settled issues. Determining whether an uncertain tax position is effectively settled requires judgment. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.
Inventory
The valuation of inventory requires us to estimate excess or obsolete inventory as well as inventory that is not of saleable quality. The determination of excess or obsolete inventory requires us to estimate the future demand for our products. The estimate of future demand is compared to work-in-process and finished goods inventory levels to determine the amount, if any, of excess or obsolete inventory. As of December 31, 2023, we had total raw materials of $3,301,526, total finished goods inventory of $1,507,113, work-in-process inventory of $1,271,458, furnace parts and supplies of $55,177, and a reserve for excess and obsolescence of $867,458. The estimated future demand is included in the development of our short-term manufacturing plans to enable consistency between inventory valuation and production decisions. Product-specific facts and circumstances reviewed in the inventory valuation process include a review of the customer base, acceptance of the product by the customer and the various environmental authorities, competitors’ products, and an assessment of the selling price in relation to the product cost. If our demand forecast for specific products is greater than actual demand, and we fail to reduce manufacturing output accordingly, we could be required to write off inventory or increase our allowance, which would negatively impact our gross profit.
To determine what costs can be included in the valuation of inventory, we must determine normal capacity at our manufacturing, assembly, and test facilities based on historical production and compared to total available capacity. If the factory production is below the established normal capacity level, a portion of our manufacturing overhead costs would not be included in the cost of inventory and therefore would be recognized as cost of sales in that period, which would negatively impact our gross profit. We refer to these costs as excess capacity charges. The Company has been operating below capacity, and excess capacity charges have been recognized as cost of sales.
Loss Contingencies
We are subject to various legal and administrative proceedings along with asserted and potential claims, accruals related to product warranties, and potential asset impairments (loss contingencies) that arise in the ordinary course of business. An estimated loss from such contingencies is recognized as a charge to income if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a loss contingency is required if there is at least a reasonable possibility that a loss has been incurred. The outcomes of legal and administrative proceedings and claims, and the estimation of product warranties and asset impairments, are subject to significant uncertainty. Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. To estimate the losses associated with repairing and replacing parts in connection with product warranties, we make judgments with respect to customer claim rates. At least quarterly, we review the status of each significant matter, and we may revise our estimates. These revisions could have a material impact on our results of operations and financial position.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
We are not required to provide quantitative and qualitative disclosures about market risk because we are a smaller reporting company.
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