Item 1A.Risk Factors
RISKS RELATED TO OUR BUSINESS AND OPERATIONS
There is substantial doubt about our ability to continue as a going concern, which may hinder our ability to obtain future financing.
Our consolidated financial statements as of December 31, 2022 have been prepared under the assumption that we will continue as a going concern for the next twelve months. As of December 31, 2022, we had cash and cash equivalents of $16.6 million and an accumulated deficit of $67.3 million. There is substantial doubt that our cash and cash equivalents will not be sufficient for the next twelve months. As a result of our financial condition and other factors described herein, there is substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern will depend on our ability to obtain additional funding, as to which no assurances can be given. We continue to analyze various alternatives, including potentially obtaining debt or equity financings or other arrangements. Our future success depends on our ability to raise capital. We cannot be certain that raising additional capital, whether through selling additional debt or equity securities or obtaining a line of credit or other loan, will be available to us or, if available, will be on terms acceptable to us. If we issue additional securities to raise funds, these securities may have rights, preferences, or privileges senior to those of our common stock, and our current shareholders may experience dilution. If we are unable to obtain funds when needed or on acceptable terms, we may be required to curtail our current development programs, cut operating costs, forego future development and other opportunities, or even terminate our operations.
The adverse effect to our business operations from the Ukraine & Russia conflict or similar political, social, regulatory, or economic tension may challenge our operational flexibility and financial performance.
The continuation of the war between Ukraine and Russia fuels uncertainty and risk to our business as we rely on the ability to manufacture, ship, service, and operate across multiple jurisdictions. The war may result in sanctions and increased uncertainties, thus restricting our ability to service our clients and execute orders globally due to supply chain risk, import/export restrictions, and increased demand uncertainty. Additionally, if customers are not successful in generating sufficient revenue or are precluded from securing financing the ongoing war, they may not be able to pay, or may delay payment of, owed amounts to the Company for the provision of products and services. Any inability of current or new potential customers to purchase or pay for our products may adversely affect our sales, earnings, and cash flow.
Sales and earnings could also be affected by our ability to manage the risks and uncertainties associated with changes in local legal requirements or the enforceability of laws and contractual obligations, trade protection measures, changes in tax laws, regional political instability, war, terrorist activities, severe or prolonged adverse weather conditions, natural disasters, and health epidemics or pandemics.
Prolonged period of inflationary pressure including risk of energy shortages and elevated electricity and energy prices in Europe.
The European energy crisis escalated in 2022 amid the Russia and Ukraine war with the rising cost of gas and electricity, fueling supply uncertainties and risk of energy shortage across Europe due to the lack of gas from Russia. This resulted in decisive measures implemented by the European Union to help manage security of supply and establish new sources of gas. Our business is heavily exposed to both gas and electricity prices, used to power our operating equipment and high-temperature kilns as well as heat the office and manufacturing buildings across Denmark. Consequently, this rising energy cost inflation has negatively impacted our profitability and reduced our competitive position compared to competitors operating outside Europe where the energy crisis has been less pronounced.
The inflationary pressure on energy and gas prices may continue to negatively impact our business as prevailing core inflationary indicators remain above policy targets.
Increased macro-economic uncertainty and its effects on our business operations and financial condition.
The uncertain macroeconomic environment caused by the ongoing war in Ukraine, European energy crisis, and general uncertainty related to the global economy may adversely affect our results and could have a negative impact on timing, delivery and demand for our products and services. Customers, suppliers, and partners may experience business disruptions due to unplanned market volatility, supply chain restrictions, or lack of funding due to increased cost of capital. As a result, our customers may modify, delay or cancel plans to purchase our products and services to help mitigate the impact from the prevailing macro-economic uncertainty.
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Our business has been rightsized to help protect our profitability and cashflow, however we remain exposed to near term market fundamentals as we rely on short lead time products and orders that may be cancelled if customers are facing weakened end-market demand or increased uncertainty.
The resurgence of COVID-19 or similar pandemics could have a material adverse effect on our business, results of operations and financial condition in the future.
Our business could be adversely affected by a resurgence of COVID-19 or similar pandemics as evidenced by the global ramifications of the novel coronavirus first identified in Wuhan, Hubei Province, China (COVID-19). The COVID-19 pandemic resulted in authorities worldwide implementing numerous measures to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, border controls, limitations on business activity, social distancing requirements, quarantines, and shelter-in-place orders. These measures caused business slowdowns or shutdowns in affected areas, both regionally and worldwide.
Since 2020, management has initiated several precautionary initiatives across our business in accordance with local regulations and guidelines to mitigate the spread of COVID-19 and to prepare for future pandemics. These precautions have impacted the way we carry out our business, including additional sanitation and cleaning procedures in our production and other facilities, temperature and symptom confirmations, and remote working when required.
As evidenced during the COVID-19 pandemic, the effects of a prolonged pandemic could result in an extended negative impact on investment across industries. In addition, COVID-19 or similar pandemics could negatively impact the financial position of our customers or those of our collaboration partners, making it difficult to collect receivables or milestone payments. Moreover, our business and results of operations could be exposed to risks associated with uncollectible amounts or defaults on contractual payment obligations. If we are unable to generate sufficient cash from operations due to the impacts of future pandemics, we may need to raise additional funds. The duration and severity of any future pandemics remains uncertain as exemplified by the rapid increase in the COVID-19 pandemic in late 2021, thus there can be no assurance that it will not have an adverse effect on our liquidity and capital resources, including our ability to access capital markets, in the future, on terms that are favorable to us, or at all.
Historically, we have been dependent on a few major customers for a significant portion of the Company’s revenue. Our revenue could decline if we are unable to maintain or develop relationships with additional customers and our results of operations could be adversely affected if any one of these customers is unable to meet their financial obligations to us.
For the year ended December 31, 2022, our four largest customers accounted for approximately 13%, 9%, 6%, and 4% of our net sales (approximately 31% in total). For the year ended December 31, 2021, our four largest customers accounted for approximately 12%, 10%, 9%, and 6% of our net sales (approximately 37% in total). If we are unable to diversify our customer base, our future results will be heavily dependent on these customers. Our dependence on a limited number of customers means that the loss of a major customer or any reduction in orders by a major customer would materially reduce our net sales and adversely affect our results of operations. We expect that sales to relatively few customers will continue to account for a significant percentage of our net sales for the foreseeable future; however, these customers or our other customers may not use our products at current levels in the future, if at all. We have no firm, long-term volume commitments from any of our major customers, and we generally enter into individual purchase orders with our customers, in certain cases under master agreements that govern the terms and conditions of the relationship. We have experienced delays or cancellations of orders and fluctuations in order levels from period to period and expect that we will continue to experience such delays, cancellations, and fluctuations in the future. Customer purchase orders may be delayed or cancelled, and order volume levels can be changed with limited or no penalties. We may not be able to replace cancelled, delayed, or reduced purchase orders with new orders. If any one of these customers reduces its demand for our products, it will likely have a material adverse effect on our financial results.
Furthermore, a significant portion of our accounts receivable is concentrated with a few major customers, who may not be able to meet their financial obligations to us. The failure of any such customer to pay amounts owed to us in a timely fashion or at all could have an adverse effect on our results of operations. The Company is also exposed to credit risk on its accounts receivable, and this risk is heightened during periods when economic conditions worsen. The Company’s outstanding receivables are not covered by collateral or potential credit insurance. The Company's exposure to credit and collection risk on its receivables may also be higher in certain international markets, and its ability to mitigate such risks may be limited. While the Company has procedures to monitor and limit exposure to credit risk on its receivables, there can be no assurance such procedures will effectively limit our credit risk and avoid losses.
The impact on our business operations and financial condition if we fail to restore financial stability through improved profitability and access to adequate liquidity.
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Our business has undergone significant changes in 2022 to help restore financial flexibility to the Company through an enhanced capital structure, improved profitability, and reduced investments. Our ability to achieve financial beak-even is heavily dependent on external macroeconomic and competitive industry dynamics that are outside of our control; therefore, our business may not achieve its financial objectives in a period with increased competition or weakening market fundamentals.
Furthermore, future growth and possibly future strategic acquisitions may require public or private equity offerings or debt financings. Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available, we may be required to delay, or reduce the scope of our plans to grow our revenues, to pass on one or more strategic acquisitions,or to scale back our business plans. In addition, we could be forced to reduce or forgo attractive business opportunities. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience significant dilution. In addition, debt financing, if available, may involve restrictive covenants. We may seek to access the public or private capital markets whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Our access to the financial markets and the pricing and terms we receive in the financial markets could be adversely impacted by various factors, including changes in financial markets and interest rates.
The potential interruption or failure to obtain raw materials and components at affordable prices caused by continued global and regional supply chain constraints could negatively affect our ability to supply products to our customers and negatively affect our profit and delay revenue.
We use silicon carbide, steel, plastic, platinum, and palladium in the manufacturing process. As other industries develop products utilizing silicon carbide, we may not be able to obtain adequate supplies of silicon carbide required for the manufacture of our existing and future products that would prevent us from supplying products to our customers and materially affect our business. Furthermore, any increased demand for, the raising of tariff rates on, or an increase of non-tariff trade barriers that apply to silicon carbide, steel, plastic, platinum, or palladium could increase the price we must pay to obtain it and could adversely affect our profitability, which would have an adverse effect on our financial results. Furthermore, fluctuation in demand for ceramics or global bottlenecks in shipping may result in supply chain constrains and longer lead time on key components which may result in delayed order shipments or risk of cancellation from clients demanding short lead times.
We may rely on subcontractors to meet current demand for our products, and we may need to obtain additional manufacturing capacity to increase production of our existing products or to produce our proposed new products, the failure of which could have a material adverse effect on our operations.
We may not have sufficient internal manufacturing capacity to meet the current demand for our products, and we may need to rely on subcontractors to enable us to meet this demand. Since we may rely on our subcontractors for part of our production capacity, the loss of the services from our subcontractors would have a material adverse effect on our business. Our plans for the growth of our business rely upon increasing sales of our existing products and systems and developing and marketing new products. We may not have adequate internal manufacturing facilities to substantially increase production of our products, and obtaining additional manufacturing capacity in-house could require substantial capital expenditures. We may not have the capital resources to obtain or expand manufacturing capacity and meet increasing demand for our products, which could have a material adverse effect on our operations. Conversely, any significant decrease in demand for our products could create idle plant capacity and an inability to cover fixed costs, which could adversely impact our results of operations and financial condition.
If we are unable to manage our expected growth, our business may be materially and adversely affected.
We expect to expand our operations by increasing our production capacity and penetrating new markets. The growth of our business could place significant strain on our management, operational, and financial resources. To manage our future growth, we could be required to improve existing or implement new operational or financial systems, procedures, and controls as well as to expand, train, and manage a growing employee base. Our failure to accomplish any of these tasks could materially and adversely affect our business. We also may not recognize the anticipated benefits of completed dispositions or other divestitures we may pursue in the future.
Our success will depend, to a large degree, on the expertise and experience of the members of our management team, the loss of whom could have a material adverse effect on our business.
Our success is, to a large degree, dependent upon the expertise and experience of the management team and its ability to attract and retain qualified personnel who are technically proficient. The loss of the services of one or more of such personnel could have a material adverse effect on our business. Our business may be adversely affected if we are unable to continue to attract and retain such personnel.
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We will need to add qualified additional personnel as we expand our business, and we may not be able to employ such persons, which could affect our ability to expand and have a material adverse effect on our business.
To expand our product offerings and customer base, we will need to hire additional qualified personnel. We may not be able to identify such persons, and even if we identify them in periods with low unemployment and increased wage inflation, we may not have the funds or ability to employ them, which could have a material adverse effect on our business expansion.
Adverse conditions, regulatory challenges, or lack of funding for emission control programs may delay or negatively affect our future growth and market potential within the transportation and marine industries.
Global health crises such as the COVID-19 or significant macro-economic uncertainty exacerbated by the current Ukraine and Russia war and high inflationary environment can significantly impact our company, customers, and suppliers. For example, the global shipping industry has been negatively impacted by the coronavirus outbreak and may be further adversely affected by an extended shutdown of various businesses or delayed implementation of regulatory frameworks and environmental policies. This, in turn, could adversely affect the demand for our marine scrubbers as ship owners delay or even cancel their orders for new closed-loop scrubber systems.
Future growth of our business depends in part on the availability of funding for emissions control programs, which can be affected by economic as well as political reasons that are beyond our control. If such funding is not available, or delayed, it can negatively affect our future growth prospects. In addition to funding, we also expect that our future business growth will be driven, in part, by the enforcement of existing emissions-related environmental regulations and tightening of emissions standards worldwide, where regulations and standards are frequently contested in litigation. For example, our ability to expand our business in the marine industry is dependent on the effective implementation of IMO 2020, which requires the burning of low-sulfur oil for marine vessels or the inclusion of marine scrubber technology. During the IMO meeting in November 2021, a number of proposals for further mid-term GHG reduction measures were discussed, including market-based measures, to address GHG emissions from shipping, as well as a proposal to establish an International Maritime Research and Development Board; however, no immediate regulation was imposed. If existing regulations and emissions standards do not continue to become stricter, are loosened, or are not enforced by governmental authorities due to commercial and business pressure, economic conditions, or otherwise, it could have a material adverse effect on our business, operating results, financial condition, and long-term prospects.
We face constant changes in governmental standards by which our products are evaluated, and if we cannot meet any such changes, some of our products could become obsolete, which could have a material adverse effect on our business.
We believe that, due to the intensifying focus on the environment and clean air and water standards throughout the world, new requirements to adhere to more stringent regulations are possible in the future as governmental agencies seek to promote clean air and water along with new product certifications. In the event that our products fail to meet these evolving standards, some or all of our products may become obsolete, which could have an adverse effect on our business, operating results, financial condition, and long-term prospects.
Our international operations are exposed to potential adverse tax consequence.
Our international operations create a risk of potential adverse tax consequences. Taxes on income in future internationally-based operations are dependent upon acceptance of our operational practices and intercompany transfer pricing by local tax authorities as being on an arm's length basis. Due to inconsistencies among taxing authorities in application of the arm's length standard, transfer pricing challenges by tax authorities could, if successful, materially increase our consolidated income tax expense. We will be subject to tax audits, and an audit could result in the assessment of additional income tax against us. This could have a material adverse effect on our operating results or cash flows in the period or periods for which that determination is made and could result in increases to our overall tax expense in subsequent periods.
Adverse impact on our business due to increased interest rates, tightening debt capital markets, and market volatility.
Our business and capital structure are dependent upon our ability to raise financing and optimize our cash management activities through timely access to credit and loan markets at attractive terms. The prevailing uncertainty and increased interest rates, represent a significant risk to our business as we are relying upon our ability to refinance our capital structure and maintain access to relevant financing. Furthermore, increased interest rates may entail increased uncertainty and cash flow constraints including the inability to company with existing debt service commitment. Increased market and interest rate uncertainty may also elevate execution risk and ultimately restrict the ability for our company to refinance our debt obligations.
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Foreign currency fluctuations could adversely impact financial performance.
Our reporting currency is the United States Dollar ($). Because of our activities in Denmark, the European Continent, Middle East, U.S., and other countries, we are exposed to fluctuations in foreign currency rates. Most income and expense-related transactions are denominated in currencies other than the reporting currency and a certain portion of the excess cash balances may be held in other currencies or in bank accounts outside of the United States, causing risks of currency fluctuations when translating balances to the reporting currency at the end of the reporting period. We may manage the risk to such exposure through active cash flow management, and in some cases, by entering into foreign currency futures and option contracts; however, we can make no assurance that such actions will be sufficient to offset a material adverse effect on our operations in the future. As of December 31, 2022, we have not entered into any derivate contracts to hedge our currency exposure.
Our inability to protect our intellectual property rights could negatively affect our business and results of operations.
Our ability to compete effectively depends in part upon developing, maintaining, and/or protecting intellectual property rights relevant to our re-crystallized silicon carbide product forms, applications, and manufacturing processes. We rely principally on a combination of patent protection, trade secrets, confidentiality and non-disclosure agreements, and trusted business relationships to establish, maintain, and protect the intellectual property rights relevant to our business. These measures, however, may not be adequate in every given case to permit us to gain or retain any competitive advantage, particularly in those countries where the laws do not protect our proprietary rights as fully as those in the United States. In particular, because silicon carbide is a well-known material (developed over 100 years ago), and there has been extensive research, development, and publication related to this material and its wide range of applications, obtaining intellectual property rights to key elements of silicon carbide technology can be challenging. Accordingly, at least some of the technology employed in our manufacture of re-crystallized silicon carbide products is not protected by patents.
Where we consider it appropriate, we seek patent protection in the United States and other countries for technologies used in, or relating to, our re-crystallized silicon carbide product forms, applications, and manufacturing processes. The issuance of a patent is not conclusive as to its scope, validity, and enforceability. Thus, any patent or patent application which may issue into a patent held by us could be challenged, invalidated, or held unenforceable in litigation or proceedings before the U.S. Patent and Trademark Office and/or other patent tribunals, or they may be circumvented by others. No consistent policy regarding the breadth of patent claims has emerged to date in the United States, and the landscape could become more uncertain in view of future rule changes by the United States Patent and Trademark Office and the introduction of patent reform legislation and decisions in patent law cases by United States federal courts. The patent landscape outside of the United States is even less predictable. As a result, the validity and enforceability of patents cannot be predicted with certainty. In addition, we may fail to apply for patents on important technologies or product candidates in a timely fashion, if at all, and our existing and future patents may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products or technologies, especially given the long history of silicon carbide development.
Our patent strategy involves complex legal and factual questions. Our ability to maintain and solidify our proprietary technology may depend in part upon our success in obtaining patent rights and enforcing those rights once granted or licensed. We do not know whether any of our pending patent applications will result in the issuance of any patents. Our issued patents and those that may be issued in the future may be challenged, invalidated, rendered unenforceable, or circumvented, which could limit our ability to prevent competitors from marketing similar or related products, or shorten the term of patent protection that we may have for our products, processes, and enabling technologies. In addition, the rights granted under any issued patents may not provide us with competitive advantages against competitors with similar technology. Furthermore, our competitors may independently develop similar technologies, duplicate technology developed by us, or otherwise possess intellectual property rights that could limit our ability to manufacture our products and operate our business.
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We also rely on trade secret protection for our confidential and proprietary information. Trade secrets, however, can be difficult to protect. We may not be able to maintain our technology or know-how as trade secrets, and competitors may develop or acquire equally valuable or more valuable technology or know-how related to the manufacture of comparable silicon carbide products. We also seek to protect our confidential and proprietary information, in part, by requiring all employees, consultants, and business partners to execute confidentiality and/or nondisclosure agreements upon the commencement of any employment, consulting arrangement, or engagement with us. These agreements generally require that all confidential and proprietary information developed by the employee, consultant, or business partner, or made known to the employee, consultant, or business partner by us, during the relationship with us, be kept confidential and not disclosed to third parties. These agreements may be breached and may not provide adequate remedies in the event of breach. To the extent that our employees, consultants, or business partners use intellectual property owned by others in their work for and/or with us, disputes could arise as to the rights in related or resulting technologies, know-how, or inventions. Moreover, while we also require customers and vendors to execute agreements containing confidentiality and/or nondisclosure provisions, we may not have obtained such agreements from all of our customers and vendors. In addition, our trade secrets may otherwise become known or be independently discovered by competitors, customers, or vendors. Such customers or vendors may also be subject to laws and regulations that require them to disclose information that we would otherwise seek to keep confidential.
Moreover, others may independently develop and obtain patents covering technologies that are similar or superior to the product forms, applications, or manufacturing processes that we employ. If that happens, we may need to obtain licenses for these technologies and may not be able to obtain licenses on reasonable terms, if at all, which could limit our ability to manufacture our future products and operate our business. In addition, third parties could utilize our intellectual property rights in territories where we do not have intellectual property protection. Such third parties may then try to import products made using our intellectual property rights into the United States or other countries, which could have a material adverse effect on our business.
Our contracts with third parties could negatively affect our intellectual property rights.
To further strengthen our product development efforts, we continue to work closely with customers and other third parties to research and develop advancements in silicon carbide product forms, applications, manufacturing processes, and related products and technologies. In some instances, the research and development activities that we conduct with customers and other third parties may produce intellectual property to which we may not have ownership or exclusive rights and will be unable to protect or monetize. Furthermore, there could be disputes between us and a private third party as to the ownership rights to any inventions that we develop in collaboration with such third party. Any such dispute may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management from our core business, or harm our reputation.
We could become subject to intellectual property litigation that could be costly, limit or cancel our intellectual property rights, divert time and efforts away from business operations, require us to pay damages, and/or otherwise have an adverse material impact on our business.
The success of our business is highly dependent on protecting our intellectual property rights. Unauthorized parties may attempt to copy or otherwise obtain and use our products and/or enabling technologies. Policing the unauthorized use of our intellectual property rights is difficult and expensive, as is enforcing these rights against unauthorized use by others. Identifying unauthorized use of our intellectual property rights is difficult because we may be unable to monitor the processes and/or materials being employed by other parties. The steps we have taken may not prevent unauthorized use of our intellectual property rights, particularly in foreign countries where enforcement of intellectual property rights may be more difficult than in the United States.
Our continued commercial success will also depend in part upon not infringing the patents or violating the intellectual property rights of third parties. We are aware of patents and patent applications generally relating to aspects of our technologies filed by, and issued to, third parties. Nevertheless, we cannot determine with certainty whether such patents or patent applications of other parties may materially affect our ability to conduct our business. There may be existing patents of which we are unaware that we may inadvertently infringe, resulting in claims against us or our customers. In the event that the manufacture, use, and/or sale of our products or processes is challenged, or if our product forms or processes conflict with the patent rights of others, third parties could bring legal actions against us or our customers in the United States, Europe, or other countries, claiming damages and seeking to enjoin the manufacturing and/or marketing of our products. Additionally, it is not possible to predict with certainty what patent claims may issue from any relevant third-party pending patent applications. Third parties may be able to obtain patents with claims relating to our product forms, applications, and/or manufacturing processes which they could attempt to assert against us or our customers.
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In any case, litigation may be necessary to enforce, protect or defend our intellectual property rights or to determine the validity and scope of the intellectual property rights of others. Any litigation could be unsuccessful, cause us to incur substantial costs, divert resources and the efforts of our personnel away from daily operations, harm our reputation, and/or result in the impairment of our intellectual property rights. In some cases, litigation may be threatened or brought by a patent-holding company or other adverse patent owner who has no relevant product revenues and against which our patents may provide little or no deterrence. If we are found to infringe any patents, we could be required to (1) pay substantial monetary damages, including lost profits, reasonable royalties, and/or treble damages if an infringement is found to be willful and/or (2) totally discontinue or substantially modify any products or processes that are found to be in violation of another party’s intellectual property rights. If our competitors are able to use our technology without payment to us, our ability to compete effectively could be harmed.
We face competition and technological advances by competitors, which could adversely affect the sales of our products.
The growth of our Company depends in part on maintaining and growing the sales of our current products in existing and new markets, but also in developing new products and technologies. There is significant competition among companies that provide solutions for pollutant emissions from diesel engines and liquids purification. Several companies market products that compete directly with our products. Other companies offer products that potential customers may consider to be acceptable or superior alternatives to our products and services, including products that are verified by the Environmental Protection Agency or other environmental authorities. We face direct competition from companies with greater financial, technological, manufacturing, and personnel resources. Newly developed products could be more effective and cost-efficient than our current or future products.
Any liability for environmental harm or damages resulting from technical faults or failures of our products could be substantial and could materially adversely affect our business and results of operations.
Customers rely upon our products to meet emissions control standards imposed upon them by regulatory bodies. Failure of our products to meet such standards could expose us to claims from customers. Our products are also integrated into goods used by consumers, and therefore a malfunction or the inadequate design of our products could result in product liability claims. Any liability for environmental harm or damages resulting from technical faults or failures could be substantial and could materially adversely affect our business and results of operations. In addition, a well-publicized actual or perceived problem could adversely affect the market’s perception of our products, which would materially impact our financial condition and operating results.
We could become liable for damages resulting from our manufacturing activities, which could have a material adverse effect on our business or cause us to cease operations.
The nature of our manufacturing operations exposes us to potential claims and liability for environmental damage, personal injury, loss of life and damage to, or destruction of, property. Our manufacturing operations are subject to numerous laws and regulations that govern environmental protection and human health and safety. These laws and regulations have changed frequently in the past, and it is reasonable to expect additional and more stringent changes in the future. Our manufacturing operations may not comply with future laws and regulations, and we may be required to make significant unanticipated capital and operating expenditures to bring our operations within compliance with such evolving regulations. If we fail to comply with applicable environmental laws and regulations, manufacturing guidelines, and workplace safety requirements, governmental authorities may seek to impose fines and penalties on us or to revoke or deny the issuance or renewal of operating permits, and private parties may seek damages from us. Under such circumstances, we could be required to curtail or cease operations, conduct site remediation or other corrective action, or pay substantial damage claims for which we may not have sufficient or any insurance coverage for claims.
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A significant portion of our assets and some of our officers and directors may be located outside of the United States; therefore, it may be difficult for an investor to enforce within the United States any judgments obtained against us or such officers and directors.
A significant portion of our assets are located outside of the United States. In addition, the majority of our officers and some of our directors are nationals and/or residents of countries other than the United States, and all or a substantial portion of such persons’ assets are located outside of the United States. As a result, it may be difficult for an investor to affect service of process or enforce within the United States any judgments obtained against us or such officers or directors, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state thereof. In addition, there is uncertainty as to whether the courts of other jurisdictions would recognize or enforce judgments of United States courts obtained against us or our directors and officers predicated upon the civil liability provisions of the securities laws of the United States or any state thereof, or be competent to hear original actions brought in other jurisdictions against us or such officers and directors predicated upon the securities laws of the United States or any state thereof.
We have signed partnership, distribution, and joint venture agreements and may engage in additional collaborations, joint ventures, or strategic alliances in the future, and we may not realize the benefits of such arrangements.
From time to time, we may enter into partnership, exclusivity, distribution, or joint venture agreements. Establishment of these agreements involves significant risks and uncertainties, including (i) our inability to cooperate with our local partner, (ii) our local partner having economic, business, or legal interests or goals that are inconsistent with ours, and (iii) the potential that our local partner may be unable to meet its economic or other obligations, which may require us to fulfill those obligations alone. In any joint venture in which we engage, we will rely on our local partner for the implementation of much of any such joint venture operation, and the success of any such operation is thus not entirely within our control. Any failure or perceived failure of a joint venture may have a material impact on our operations and financial condition.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to assess the effectiveness of our internal control over financial reporting and to disclose in our filing if such controls were unable to provide assurance that a material error would be prevented or detected in a timely manner. We have an ongoing program to review the design of our internal controls framework in keeping with changes in business needs, implement necessary changes to our controls design, and test the system and process controls necessary to comply with these requirements. If our internal controls over financial reporting are determined to be ineffective, resulting in material weaknesses and/or significant deficiencies, investor perceptions regarding the reliability of our financial statements may be adversely affected, which could cause a decline in the market price of our stock and otherwise negatively affect our liquidity and financial condition.
In Item 9A, we disclose that, with respect to the standards of Sarbanes-Oxley Section 404 and the internal controls standard to which we are subjected, we reported material weaknesses in our internal controls over financial reporting. For additional information on this item, please see Item 9A. Controls and Procedures.
Although we believe our historical efforts have strengthened our internal control over financial reporting (and we concluded that our financial statements were reliable, notwithstanding the material weakness we reported), we cannot be certain that our revised internal control practices will ensure that we will have or maintain adequate internal control over financial reporting in future periods. Any failure to have or maintain such internal controls could adversely impact our ability to report our financial results accurately and on a timely basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations.
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We may have risks associated with security of our information technology systems.
We make significant efforts to maintain the security and integrity of our information technology systems and data. Despite significant efforts to create security barriers to such systems, it is virtually impossible for us to entirely mitigate this risk. There is a risk of industrial espionage, cyber-attacks, misuse or theft of information or assets, or damage to assets by people who may gain unauthorized access to our facilities, systems, or information. Such cybersecurity breaches, misuse, or other disruptions could lead to the disclosure of confidential information; improper usage and distribution of our intellectual property; theft, manipulation, and destruction of private and proprietary data; and production downtimes. Although we actively employ measures to prevent unauthorized access to our information systems, preventing unauthorized use or infringement of our rights is inherently difficult. These events could adversely affect our financial results, and any legal action in connection with any such cybersecurity breach could be costly and time-consuming, may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, we must frequently expand our internal information system to meet increasing demand in storage, computing, and communication, which may result in increased costs. Our internal information system is expensive to expand and must be highly secure due to the sensitive nature of our customers’ information that we transmit. Building and managing the support necessary for our growth places significant demands on our management and resources. These demands may divert such resources from the continued growth of our business and implementation of our business strategy.
RISKS RELATED TO OUR COMMON STOCK
Future equity financings or convertible debt would dilute your ownership and could adversely affect your common stock ownership rights in comparison with those of other security holders.
Our Board of Directors has the power to issue additional shares of common or preferred stock without stockholder approval. In general, stockholders do not have preemptive rights to any common stock issued by us in the future; therefore, stockholders may experience additional dilution of their equity investment if we issue additional shares of common stock in the future, including shares issuable under equity incentive plans, or if we issue securities that are convertible into shares of our common stock.
If additional funds are raised through the issuance of equity or convertible debt securities, the percentage of ownership of our existing stockholders will be reduced, and such newly issued securities may have rights, preferences, or privileges senior to those of existing stockholders. If we issue additional common stock or securities convertible into common stock, such issuance will reduce the proportionate ownership and voting power of each other stockholder. In addition, such stock issuances might result in a reduction of the market value of our common stock, which could make our stock unattractive to existing stockholders.
We will not receive a significant amount, or potentially any, additional funds upon the exercise of our pre-funded warrants; however, any exercise would increase the number of shares eligible for future resale in the public market and result in substantial dilution to our stockholders.
As of December 31, 2022, we have issued pre-funded warrants to purchase a total of 31,440,000 shares of our common stock, of which none have been exercised. Each pre-funded warrant is exercisable for $0.001 per share of common stock underlying such pre-funded warrant, which may be paid by way of a cashless exercise, meaning that the holder may not pay a cash purchase price upon exercise, but instead would receive upon such exercise the net number of shares of common stock determined according to the formula set forth in the pre-funded warrant. Accordingly, we will not receive a significant amount, or potentially any, additional funds upon the exercise of the pre-funded warrants. To the extent such pre-funded warrants are exercised, additional shares of common stock will be issued for nominal or no additional consideration, which will result in substantial dilution to the then existing holders of our common stock and will increase the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of the common stock, causing our stock price to decline.
Provisions in our articles of incorporation and bylaws could discourage a change in control, or an acquisition of us by a third party, even if the acquisition would be favorable to you, thereby adversely affecting existing stockholders.
Our articles of incorporation and bylaws contain provisions that may have the effect of making it more difficult or delaying attempts by others to obtain control of our Company, even when these attempts may be in the best interests of stockholders. For example, our articles of incorporation authorize our Board of Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices. These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests.
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There is limited trading volume of our common stock, which could make it difficult for you to liquidate an investment in our common stock in a timely manner.
Since April 16, 2019, our common stock has been traded on Nasdaq Capital Market under the ticker LIQT. Because there is limited volume in our common stock, investors may not be able to liquidate their investments when they desire to do so.
In addition, if we fail to meet the criteria set forth in SEC and Nasdaq Capital Market rules and regulations, various requirements would be imposed by law on broker-dealers who sell our securities to persons other than established customers and accredited investors. Consequently, such regulations may deter broker-dealers from recommending or selling our common stock, which may further affect its liquidity.
If securities analysts do not publish research or reports about our business or if they downgrade us or our sector, the price of our common stock could decline.
The trading market for our common stock will depend in part on research and reports that industry or financial analysts publish about us or our business. Furthermore, if one or more of the analysts who cover us downgrades us, the industry in which we operate, or the stock of any of our competitors, the price of our common stock may decline. If one or more of these analysts ceases coverage altogether, we could lose visibility, which could also lead to a decline in the price of our common stock.
The market price of our common stock has been and may continue to be volatile.
The market price of our common stock has been volatile and fluctuates widely in response to various factors that are beyond our control. The price of our common stock is not necessarily indicative of our operating performance or long-term business prospects. In addition, the securities markets have from time-to-time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock. Factors such as the following could cause the market price of our common stock to fluctuate substantially:
● announcements of capital budget changes by major customers;
● the introduction of new products by our competitors;
● announcements of technology advances by us or our competitors;
● additions or departures of our key personnel;
● government regulation of our industry;
● seasonal, economic, or financial conditions;
● our quarterly operating and financial results;
● litigation or public concern about the safety of our products; or
● the effect of macro-economic uncertainty, COVID-19, or other pandemics.
The realization of any of these risks and other factors beyond our control could cause the market price of our common stock to decline significantly. In particular, the market price of our common stock may be influenced by changes in governmental regulations regarding diesel particle emissions and marine wastewater because demand for our products and services is closely related to those regulations. The stock market in general experiences, from time-to-time, extreme price and volume fluctuations. Periodic and/or continuous market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility may be worse if the trading volume of our common stock is low.
Future sales of our common stock, or the perception that future sales may occur, may cause the market price of our common stock to decline.
If any significant number of our outstanding shares are sold, such sales could have a depressive effect on the market price of our stock. We are unable to predict the effect, if any, that the sale of shares, or the availability of shares for future sale, will have on the market price of the shares prevailing from time to time. Sales of substantial amounts of shares in the public market, or the perception that such sales could occur, could depress prevailing market prices for the shares. Such sales may also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we deem appropriate.
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The Company is considered a “smaller reporting company” and is exempt from certain disclosure requirements, which could make our common stock less attractive to potential investors.
As a “smaller reporting company” (as defined in Rule 12b-2 of the Securities Exchange Act of 1934 (the “Exchange Act”), we are not required and may not include a Compensation Discussion and Analysis section in our proxy statements; we provide only three years of business information; provide fewer years of selected financial data; and have other “scaled” disclosure requirements that are less comprehensive than issuers that are not “smaller reporting companies,” which could make our stock less attractive to potential investors and could make it more difficult for shareholders to sell their shares.
We have no current plan to pay dividends on our common stock, and investors may lose the entire amount of their investment.
We have no current plans to pay dividends on our common stock; therefore, investors will not receive any funds absent a sale of their shares. We cannot assure investors of a positive return on their investment when they sell their shares, nor can we assure investors will not lose the entire amount of their investment.
PUBLIC COMPANY RISK FACTORS
We have not continued to satisfy the continued listing requirements of the Nasdaq Capital Market, and failure to regain compliance with the listing standards by could result in the suspension or delisting of our Common Stock, which could, among other things, limit demand for our Common Stock, substantially impair our ability to raise additional capital and have an adverse effect on the market price of, and the efficiency of the trading market for, our Common Stock.
Our Common Stock is listed on the Nasdaq Capital Market. To maintain our listing we are required to satisfy continued listing requirements, including the requirements commonly referred to as the minimum bid price rule. The minimum bid price rule requires that the closing bid price of our common stock be at least $1.00 per share. We currently do not meet these criteria. There can be no assurance we will continue to satisfy applicable continued listing requirements.
The suspension or delisting of our common stock, or the commencement of delisting proceedings, for whatever reason could, among other things, substantially impair our ability to raise additional capital; result in the loss of interest from institutional investors, the loss of confidence in our company by investors and employees, and in fewer financing, strategic and business development opportunities; and result in potential breaches of agreements under which we made representations or covenants relating to our compliance with applicable listing requirements. Claims related to any such breaches, with or without merit, could result in costly litigation, significant liabilities and diversion of our management’s time and attention and could have a material adverse effect on our financial condition, business, and results of operations.
On June 24, 2022, we received a deficiency notification letter from the Listing Qualifications Staff of Nasdaq indicating that the Company was not in compliance with Nasdaq Listing Rule 5550(a)(2) because the bid price for the Company’s common stock had closed below $1.00 per share for the previous 30 consecutive business days.
In accordance with Nasdaq Listing Rule 5810(c)(3)(A), the Company had 180 calendar days from the date of such notice, or until December 21, 2022, to regain compliance with the minimum bid price requirement. However, on December 22, 2022. We received a notice from the Listing Qualifications Staff of Nasdaq that the Company had been granted an additional 180 days to regain compliance with the minimum bid price requirement, or until June 20, 2023. To regain compliance, the bid price for the Company’s common stock must close at $1.00 per share or more for a minimum of 10 consecutive business days. As of March 22, 2023, we had not regained compliance with the $1.00 bid price requirement. There can be no assurance that we will regain compliance with this requirement.
We will continue to incur significant costs from operating as a public company, and our management may be required to devote substantial time to compliance initiatives that ultimately could have a material adverse effect on our financial condition and results of operations.
As a public company, we expect to continue to incur significant legal, accounting, and other expenses. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC, have imposed various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls as well as mandating certain corporate governance practices. Our management and other personnel will continue to devote a substantial amount of time and financial resources to these compliance initiatives.
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As a “smaller reporting company,” we are still able to take advantage of certain exceptions available to both emerging growth companies and smaller reporting companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and the exemption from providing a “Compensation Discussion and Analysis” section in our proxy statements; providing only three years of business information; and other “scaled” disclosure requirements that are less comprehensive than issuers that are not smaller reporting companies.
If we fail to staff our accounting and finance function adequately or maintain internal control systems adequate to meet the demands that are placed upon us as a public company, we may be unable to report our financial results accurately or in a timely manner and our business and stock price may suffer. The costs of being a public company, as well as the diversion of management’s time and attention, may have a material adverse effect on our future business, financial condition, and results of operations.
Our actual or perceived failure to adequately protect personal data could adversely affect our business, financial condition, and results of operations.
A wide variety of provincial, state, national, foreign, and international laws and regulations apply to the collection, use, retention, protection, disclosure, transfer, and other processing of personal data. These privacy- and data protection-related laws and regulations are evolving, with new or modified laws and regulations proposed and implemented frequently and existing laws and regulations subject to new or different interpretations. Further, our legal and regulatory obligations in foreign jurisdictions are subject to unexpected changes, including the potential for regulatory or other governmental entities to enact new or additional laws or regulations, to issues rulings that invalidate prior laws or regulations, or to increase penalties significantly. Compliance with these laws and regulations can be costly and can delay or impede the development and offering of new products and services.
For example, the General Data Protection Regulation, which became effective in May 2018, imposes more stringent data protection requirements, and provides for significantly greater penalties for noncompliance, than the European Union laws that previously applied. Additionally, California recently enacted legislation, the California Consumer Privacy Act, which became effective January 1, 2020. We may also be subject to additional obligations relating to personal data by contract that industry standards apply to our practices. Our actual or perceived failure to comply with applicable laws and regulations or other obligations to which we may be subject relating to personal data, or to protect personal data from unauthorized access, use, or other processing, could result in enforcement actions and regulatory investigations against us, claims for damages by customers and other affected individuals, fines, damage to our reputation, and loss of goodwill, any of which could have a material adverse effect on our operations, financial performance, and business. Further, evolving and changing definitions of personal data and personal information, including the classification of IP addresses, machine identification information, location data, and other information, may limit or inhibit our ability to operate or expand our business, including limiting business relationships and partnerships that may involve the sharing or uses of data, and may require significant costs, resources, and efforts to comply.
Changes in U.S. Generally Accepted Accounting Principles (“GAAP”) could adversely affect our financial results and may require significant changes to our internal accounting systems and processes.
We prepare our consolidated financial statements in conformity with GAAP. These principles are subject to interpretation by the Financial Accounting Standards Board (“FASB”), the SEC, and various bodies formed to interpret and create appropriate accounting principles and guidance. The FASB periodically issues new accounting standards on a variety of topics. For information regarding new accounting standards, please refer to Note 1, “Description of Business and Significant Accounting Policies – Recent Accounting Pronouncements,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K. These and other such standards generally result in different accounting principles, which may significantly impact our reported results or could result in variability of our financial results.
In preparing our financial statements, we make certain assumptions, judgments and estimates that affect amounts reported in our consolidated financial statements, which, if not accurate, may significantly impact our financial results.
We make assumptions, judgments, and estimates for a number of items, including the fair value of financial instruments, goodwill, long-lived assets and other intangible assets; the realizability of deferred tax assets; the recognition of revenue; the fair value of stock awards; and others. We also make assumptions, judgments, and estimates in determining the accruals for employee-related liabilities, including commissions and variable compensation, and in determining the allowance or provisions for uncertain tax positions, doubtful accounts, excess or obsolete inventory, and legal contingencies. These assumptions, judgments, and estimates are drawn from historical experience and various other factors that we believe are reasonable under the circumstances as of the date of the consolidated financial statements. Actual results could differ materially from our estimates, and such differences could significantly impact our financial results.
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Our business could be negatively impacted the by surge in geopolitical unrest and associated market turmoil negatively impacting financial markets.
Increased geopolitical tensions and prolonged inflationary pressure, combined with increased commodity prices and general volatility across financial markets, could negatively impact demand for our products and services due to reductions in investments across the global transportation, shipping, and energy industries. The relevance and economic benefits of our systems may also be undermined by the delayed introduction of, or compliance with, both environmental and regulatory efforts. Furthermore, potential sanctions imposed on select countries could adversely affect our supply chain and overall demand, thus reducing our ability to timely source raw materials and deliver finished goods and services to our clients.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
Our corporate headquarters are located at Industriparken 22C, 2750 Ballerup, Denmark. We lease approximately 67,000 square feet at our Ballerup location, of which approximately 10,000 square feet is used for office space and 57,000 square feet is used for production. The lease will expire on August 31, 2028. We also conduct operations at Benshøj Industrivej 24, 9500 Hobro, Denmark, where we lease approximately 45,750 square feet, of which approximately 10,750 square feet is used for office space and 35,000 square feet is used for production. The lease will expire on November 30, 2034. Other operations are located at Sindalsvej 38-40, Risskov, Denmark, where we lease approximately 19,500 square feet, of which approximately 2,200 square feet is used for office space and 17,300 square feet is used for production. The lease will expire on August 31, 2024.
Item 3. Legal Proceedings
From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. Please reference Note 10 - Agreements, Commitments and Contingencies for details on such litigation.
Item 4. Mine Safety Disclosures.
Not applicable.
Our common stock is quoted on the Nasdaq Capital Market under the symbol LIQT.
As of December 31, 2022, there were approximately 31 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:
● 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, 2022, 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, 2022, we have not repurchased any of our equity securities.
Item 6. Selected Financial Data
Not applicable.
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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.
2022 Developments
On March 18, 2022 the Company announced that Sune Mathiesen, Chief Executive Officer, had taken a medical leave of absence. Alexander J. Buehler, a member of the Board of Directors, was appointed to serve as Interim Chief Executive Officer, effective immediately.
In May 2022, the Company issued 22,535,850 shares of Common Stock and 30,425,000 prefunded warrants in a public offering to fund working capital, general corporate purposes, and partial repayment of its Senior Convertible Note. The total net proceeds from the offering and exercise of the over-allotment option was $24,453,528, which includes $1,996,472 in discounts, commissions and offering expenses paid by the Company.
On June 23, 2022, the Company completed a private placement of Senior Notes in an aggregate principal amount of $6,000,000 and warrants to purchase 4,250,000 shares of common stock of the Company to affiliates of Bleichroeder L.P., 21 April Fund, L.P., and 21 April Fund, Ltd. (together, the "Purchasers"), pursuant to a note and warrant purchase agreement. Additionally, as part of the transaction, the Company issued 230,000 warrants to the placement agent. All warrants issued in this transaction have an exercise price of $0.65 per share, a term of five years, and are exercisable for cash at any time.
On July 29, 2022, the Company announced the appointment of Fei Chen as President & Chief Executive Officer, and a member of the Company’s Board of Directors.
On November 17, 2022, the Company entered into a new distribution agreement with NESR for commercialization of produced water treatment solution for re-injection.
On December 20, 2022, the Company entered into a cooperation agreement with Ecolotron Wasterwater Solutions on a combined solution for Phosporic acid purification
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Results of Operations
Results of Operations for the Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021
The following table sets forth our revenues, expenses, and net income for the years ended December 31, 2022 and 2021 in U.S. dollars, except for percentages.
For the Year Ending December 31,
Period to Period Change
2022 As a % of Sales 2021 As a % of Sales $ Percent %
Operating Expenses
Other Income (Expense)
Revenues
Revenue for the year ended December 31, 2022 was $15,982,438 compared to $18,273,442 for the same period in 2021, representing a decrease of $2,291,004, or 13%. The decline in revenue was primarily due to lower system sales and currency headwinds due to weakening of the EUR and DKK compared to the USD, partly offset by growth in sales of DPFs and plastics products measured in local currency.
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The decrease in sales of systems and related services of $1,899,179, reflecting a year on year decline of 26%, was a result of the negative impact of the uncertain macroeconomic environment and prolonged inflationary pressure, but also increased supply chain restrictions and general market volatility, which has resulted in significant restrictions and business limitations including a substantial decline in the demand and delivery of water treatment systems for the global marine scrubber industry.
The demand for our ceramic membranes and DPFs reflects continued interest in advanced environmental filtration solutions with a focus on the reduction of global CO2 emissions amid increased political and regulatory efforts, resulting in a year-on-year constant currency increase of 7%, offset by the negative impact of the currency headwinds from the weakening of the EUR compared to the USD, resulting a year-on-year decline of 5% to $6,844,861.
The sale of plastic products benefitted from a year-on-year increase of 10% measured in local currency predominantly in the first half of the year underpinned by a diversified customer base, stable order intake, and delivery of large orders for the Asia Pacific marked, followed by increased uncertainty and reduced activity levels amid the European energy crisis in the second half of the year. In addition, the adverse impact of the USD appreciation against the DKK-denominated revenue base resulted in the year-on-year decline of 2% to $3,528,606.
For the years ended December 31, 2022 and 2021, revenue from R&D projects was $311,685 and $277,428, respectively, an increase of 12%.
Gross Profit
Gross profit for the year ended December 31, 2022 was $567,144 compared to $1,576,146 for the same period in 2021, representing a decrease of $1,009,002, or approximately 64%. The decrease in gross profit was largely the result of lower overall market activity and a lower relative mix of filtration system sales in our product mix, which typically command higher average gross margins. Gross profit was further negatively impacted by the European energy crisis amid the Russia and Ukraine conflict and corresponding high electricity costs that also negatively impacted our competitive positioning as compared to companies operating outside of Europe, where the energy crisis has been less pronounced. Proactive measures such as the reduction in capacity and the implementation of electricity price surcharges were implemented by the company to defend profitability to the extent possible. Furthermore, gross profit also included higher provisions for obsolescence and certain non-recurring costs associated with a strategic review of inventories. Included in the gross profit for the year ended December 31, 2022 is depreciation of $1,822,402 compared to $1,957,357 for the same period in 2021.
Expenses
Total operating expenses for the year ended December 31, 2022 were $13,100,898, representing an increase of $837,428, or approximately 7%, compared to $12,263,470 for the same period in 2021. Excluding restructuring charges of approximately $1.9 million, 2022 operating expenses were 9% lower than 2021. More importantly the fourth quarter operating expenses were approximately 34% lower compared to the same period in 2021.
Selling expenses for the year ended December 31, 2022, were $3,669,887 compared to $4,564,188 for the same period in 2021, representing a decrease of $894,301 or approximately 20%. The decrease is explained by the cost reduction and reorganization efforts initiated in 2022, including headcount reductions and organizational streamlining, partly offset by increased costs associated with increasing direct sales efforts, consulting service engagements, direct marketing activities, and bad debt provisions.
General and administrative expenses for the year ended December 31, 2022, were $5,701,955 compared to $5,836,629 for the same period in 2021, representing a decrease of $134,674, or 2%. The decrease for the year ended December 31, 2022, reflects the benefits of the cost reduction and restructuring efforts implemented in the first half of 2022 and fully implemented by the end of the year with favorable currency tailwinds from the weakening of the DKK compared to USD. However, these savings were partly offset by non-recurring costs related to the CEO transition (increased non-cash compensation and recruitment expense) and consultancy costs associated with the now closed Chinese factory.
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Included in general and administrative expenses is non-cash compensation expense of $934,423 and $481,105 for the years ended December 31, 2022 and December 31, 2021, respectively, representing an increase of $453,318, or 94%, attributable to stock grants to management in the context of the CEO transition.
The following is a summary of our non-cash compensation:
Research and development expense for the year ended December 31, 2022 was $1,835,890 compared to $1,862,653 for the same period in 2021, representing a decrease of $26,763, or 1%. The change is attributable to increased spending on materials used for ongoing development projects and patent applications, offset by the benefit of the USD appreciation and a decrease in the average number of employees engaged in research and development activities, as the Company streamlined and centralized the R&D function.
Restructuring costs for the year ended December 31, 2022, were $1,893,166 compared to $0 for the same period in 2021 fully attributable to the restructuring program that was executed in the second quarter (See Note 3).
Other income (expenses)
Total Other income (expense) for the year ended December 31, 2022 was $(1,872,763) compared to $(502,672) for the comparable period in 2021, representing an increase of $(1,370,091), or 273%. The change is mainly related to the lower gain on currency transactions and the early repayment of the Convertible Note issued in April 2021, reflecting the full recognition of the repayment premium and amortization cost in the second quarter. Other income for the year benefited from the decrease in interest expenses due the repayment of the Convertible Note, receipt of COVID-19 grants to the Danish entities, and a gain associated with lease terminations.
Income taxes provision
The income tax benefit for the year ended December 31, 2022 was $237,410 compared to a benefit of $63,036 for the comparable period in 2021, representing an increase of $174,374, or 277%, mainly driven by an increase in tax credits associated with research and development activities in Denmark.
Net Income/Loss
Net income/loss for the year ended December 31, 2022 was $(14,169,107) compared to $(11,126,960) for the comparable period in 2021, representing an increased loss of $3,042,147.
The change was primarily attributable to non-recurring restructuring costs, early repayment of the Convertible Note issued in April 2021, the increase in non-cash compensation, the closure of the production facility in China, and the CEO transition. Furthermore, the change was also impacted by a decline in gross margin, caused largely by inflationary cost pressures on raw materials and electricity, lower overall sales activity levels and an unfavorable revenue mix with a lower share of higher margin systems sales. Increased costs were partly offset by the benefits from the USD appreciation against the EUR/DKK-denominated cost base, general cost reductions and reorganization activities.
Liquidity and Capital Resources
Based on the continued market volatility and geopolitical unrest pertaining to the Russia and Ukraine conflict, European energy crisis, and macro-economic uncertainty, the Company is unable to predict the full impact this will have on our long-term financial condition, results of operations, liquidity, and cash flows. The Company has planned and executed on decisive measures in 2022 to help safeguard the business and its financial position by reducing cost, headcount, and overall capex commitments, which together with the successful completion of the $26.5 million public offering of common stock and pre-funded warrants, substantially improved the near-term liquidity position of the Company.
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Furthermore, in June 2022, the Company completed the refinancing of its $15 million Convertible Note due in 2023, partly funded by the issuance of the new $6 million Senior Promissory Notes due in June 2024 along with the proceeds from the public offering. The Senior Promissory Notes are interest-free, with full redemption after 24 months.
Based on current projections, which are subject to significant uncertainties, including the duration and severity of global macroeconomic issues, commodity volatility, and continued global supply chain disruptions, the Company believes 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.
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, 2022, the Company had net working capital of $21,581,287, including cash of $16,597,371, and on December 31, 2021, the Company had net working capital of $11,199,258, including cash of $17,489,380. The increase in net working capital of $10,382,029 compared to December 31, 2021 is mainly a result of the capital raise and repayment of the Convertible Note.
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 1,350,000 (approximately $1,440,000), which is secured by a cash deposit.
Going Concern and Management’s Plans
The financial statements included elsewhere herein for the year ended December 31, 2022, 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, 2022, we had cash and cash equivalents of $16,597,371, an accumulated deficit of $67,351,035, and total liabilities of $16,816,283. We have incurred losses from continuing operations, have used cash in our continuing operations, and are dependent on additional 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 in order to right size the business and develop a clear and sustainable path to profitability, further underpinned by an updated strategy and onboarding of key management resources. However, there can be no assurance 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 will 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 in us.
Funding that we may receive during fiscal 2023 is expected to be used to satisfy existing and future obligations and liabilities and working capital needs, as well as future operating losses.
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Cash Flows
Year Ended December 31, 2022 Compared to Year Ended December 31, 2021
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, 2022 was $12,039,020 compared to cash used by operating activities of $7,203,843 for the year ended December 31, 2021, representing an increase of $4,835,177. The cash used by operating activities for the year ended December 31, 2022 consists mainly of the net loss for the year of $(14,169,107) adjusted by depreciation and other non-cash items of $5,705,351. Further, changes in assets and liabilities include an increase of Accounts receivables of $460,837, an increase in Contract assets/liabilities of $695,616, and a decrease in Accrued expenses of $1,632,896, offset by a decrease in Inventory of $984,130.
Net cash used in investing activities was $1,689,986 for the year ended December 31, 2022 as compared to $1,450,139 for the year ended December 31, 2021, representing an increase of $239,847, or 17%. 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 $13,696,551 for the year ended December 31, 2022 as compared to $13,902,999 for the year ended December 31, 2021. For the year ended December 31, 2022, the change is mainly explained by the equity capital raise in the second quarter, generating net proceeds of $24,418,612 from the issuance of common stock and prefunded warrants, combined with the $6,000,000 proceeds from the issuance of the new Senior Promissory Notes, and offset by the full repayment of the Convertible Note issued in April 2021 of $16,800,000. For the year ended December 31, 2021, the change was mainly attributable to the net cash proceeds of $14,283,333 related to the Convertible bond issuance in March 2021.
Off-Balance Sheet Arrangements
As of December 31, 2022, 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. 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 valuation of inventory, which impacts cost of sales; and
We discuss these policies further below as well as the estimates and judgments involved.
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Accounts Receivable / Long Term Receivable / Allowance for Doubtful Accounts / Bad Debt
We assess the collectability of accounts receivable and long-term receivables on an ongoing basis and establish an allowance for doubtful accounts when collection is no longer reasonably assured. In establishing the allowance, we consider factors such as known troubled accounts, historical experience, age of receivables, financial and liquidity information that is publicly accessible, and other currently available evidence.
The roll-forward of the allowance for doubtful accounts for the year ended December 31, 2022 and December 31, 2021 was as follows:
Receivables written off during the periods (295,778 ) (24,415 )
Allowance for doubtful accounts at the end of the period $ 59,559 $ 409,076
The receivables written off during the period 2022 mainly relates to legacy marine scrubber contracts and partnerships, renegotiated and terminated amid the COVID disruptions and general slowdown in the marine scrubber market.
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 intangible assets with estimable useful lives 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, 2022 and 2021, as management's estimated fair value of the reporting unit exceeded its carrying value determined during impairment testing in the fourth quarters of 2022 and 2021.
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, 2022 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, 2022 and 2021, no impairment charge of long-lived assets has been recorded.
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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
The Company’s sales by product and service are as follows for the years ended December 31, 2022 and 2021:
% Distribution For the Year Ended December 31
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, 2022 and December 31, 2021 is as follows:
Distributed as follows:
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, 2022, we had total furnace parts and supplies of $66,495, raw materials of $2,474,227, work-in-process inventory of $982,973, total finished goods inventory of $1,201,533, and a reserve for excess and obsolescence of $663,227. 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, as well as 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, 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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Item 8. Financial Statements and Supplementary Data.
Index to Consolidated Financial Statements
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID NO: 3627) 36
Notes to the Consolidated Financial Statements 46
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of LiqTech International, Inc.:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of LiqTech International, Inc. (“the Company”) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2022 and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
Explanatory Paragraph Regarding Going Concern
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) related to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgements. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Inventory Costing
Critical Audit Matter Description
As described in Notes 1 and 4 to the consolidated financial statements, the Company uses a standard costing method to value inventory produced. Management reviews and assesses the standard costing estimates annually or more frequently in the event circumstances indicate a change in cost structure or material variance from actual has occurred. In addition to raw materials, labor and energy usage charges, the Company applies production overhead allocations to each item.
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We identified the auditing of inventory costing as a critical audit matter because of the significant estimates and assumptions management used in the determination of the standard costing allocation and related overhead allocations. Performing audit procedures to evaluate the reasonableness of these estimates and assumptions required a high degree of auditor judgment and an increased extent of effort.
How the Critical Audit Matter was Addressed in the Audit
Our audit procedures consisted of the following:
Revenue Recognition – Contracts with Multiple Performance Obligations
Critical Audit Matter Description
As described in Note 1 to the consolidated financial statements, the Company has some contracts with customers that contain multiple performance obligations. For these contracts, management accounts for individual performance obligations separately if they are distinct. As described by management, management exercises judgment and uses estimates in order to (1) determine whether performance obligations are distinct and should be accounted for separately; (2) determine the standalone selling price of each performance obligation; (3) allocate the transaction price among the various performance obligations on a relative standalone selling price basis; and (4) determine whether revenue for each performance obligation should be recognized at a point in time or over time. Revenue recognized in 2022 related to contracts with multiple performance obligations was approximately $5.3 million.
We identified the auditing of revenue from contracts with multiple performance obligations as a critical audit matter because there was significant judgments by management in identifying, evaluating and accounting for performance obligations in contracts with multiple performance obligations, which led to significant auditor judgment and effort in performing procedures to evaluate whether contracts with multiple performance obligations were appropriately identified, evaluated and accounted for by management.
How the Critical Audit Matter was Addressed in the Audit
Our audit procedures consisted of the following:
/s/ Sadler, Gibb & Associates, LLC
We have served as the Company’s auditor since 2018.
Draper, UT
March 22, 2023
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of As of
December 31, December 31,
Current Assets:
Long-Term Assets:
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of As of
December 31, December 31,
Current Liabilities:
Current portion of operating lease liabilities 561,182 846,544
Current portion of convertible note payable - 8,400,000
Other liabilities, net of current portion - 346,939
Convertible note payable, less current portion - 6,186,936
Senior promissory notes payable, less current portion 5,480,314 -
Stockholders' Equity:
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended
December 31,
Operating Expenses:
Other Income (Expense)
Amortization of discount on convertible note (2,389,128 ) (835,331 )
Gain on on lease termination 147,452 -
Gain on sale of fixed assets 635 1,113
Basic and Diluted Loss Per Share $ (0.40 ) $ (0.52 )
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
For the Years Ended
December 31,
Other Comprehensive Loss - Currency Translation, net (1,345,168 ) (1,929,329 )
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2022and 2021
Common Stock Additional Paid-in Accumulated Accumulated Other Compre- hensive
Shares Amount Capital Deficit Income (Loss) TOTAL
Common stock issued in settlement of RSUs 164,523 165 (165 ) -
Warrants issued in connection with Senior Promissory Notes 660,836 660,836
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2022and 2021
Common Stock Additional Paid-in Accumulated Accumulated Other Compre- hensive
Shares Amount Capital Deficit Income (Loss) TOTAL
Common stock issued in settlement of RSUs 50,245 50 (50 ) -
Exchange of common stock to prefunded warrants (500,000 ) (500 ) 500 -
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended
December 31,
Cash Flows from Operating Activities:
Amortization of discount on convertible notes payable 2,389,128 835,331
Change in deferred tax asset / liability (55,994 ) (63,036 )
Loss (Gain) on lease termination (147,452 ) -
Loss (Gain) on sale of equipment (635 ) (1,113 )
Changes in assets and liabilities:
Assets Held for Sale (712,549 ) -
Cash Flows from Investing Activities:
Proceeds from sale of property and equipment 635 1,113
Net cash paid for acquisition - (317,874 )
Cash Flows from Financing Activities:
Proceeds from issuance of common stock and prefunded warrants 24,418,612 -
Proceeds from issuance of Senior Promissory Notes 6,000,000 -
Effect of foreign currency exchange on cash (859,554 ) (1,024,086 )
Net Change in Cash, Cash Equivalents and Restricted Cash (892,009 ) 4,224,931
The accompanying notes are an integral part of these consolidated financial statements.
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LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Non-cash financing activities
Original issue discount on convertible note - 1,800,000
Convertible Note debt conversion feature - 3,048,396
Debt issuance costs on convertible note - 716,667
Common Stock issued in conjunction with convertible note financing - 531,729
Debt discount on Senior Promissory Notes 695,749 -
The accompanying notes are an integral part of these consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business and Basis of Presentation
The consolidated financial statements include the accounts of LiqTech International, Inc. and its subsidiaries (the “Company”). The terms "Company", “us", "we" and "our" as used in this report refer to the Company and its subsidiaries, which are set forth below. The Company engages in the development, design, production, marketing, and sale of automated filtering systems, ceramic silicon carbide liquid applications, and diesel particulate air filters in the United States, Canada, Europe, Asia, and South America. Set forth below is a description of the Company and each of its subsidiaries:
LiqTech International, Inc., a Nevada corporation organized in July 2004, formerly known as Blue Moose Media, Inc.
LiqTech USA, a Delaware corporation and a 100% owned subsidiary of the Company formed in May 2011.
LiqTech Holding A/S (formerly known as LiqTech International A/S), a Danish corporation, incorporated on January 15, 2000 (“LiqTech Holding”), a 100% owned subsidiary of LiqTech USA, handling all joint group activities such as management, marketing, finance, IT, etc.
LiqTech NA, Inc. (“LiqTech NA”), incorporated in Delaware on July 1, 2005, a 100% owned subsidiary of LiqTech USA, engaged in the production, marketing, and sale of ceramic diesel particulate and liquid filters in the United States and Canada. LiqTech NA closed operations in January 2021, and all activity in this company has ceased.
LiqTech Water A/S (formerly known as LiqTech Systems A/S), a Danish Corporation (“LiqTech Water”), incorporated on September 1, 2009, engaged in the manufacture of fully automated filtering systems for use within marine applications, municipal pool and spa applications, and other industrial applications within Denmark and international markets.
LiqTech Plastics A/S (formerly known as BS Plastic A/S), a Danish Corporation (“LiqTech Plastics”), acquired on September 1, 2019, engaged in the manufacture of specialized machined and welded plastic parts within Denmark and international markets.
LiqTech Ceramics A/S, a Danish corporation (“LiqTech Ceramics”), incorporated on December 20, 2019, engaged in the development, design, application, marketing, and sales of membranes, ceramic diesel particulate and liquid filters, and catalytic converters in Europe, Asia, and South America.
LiqTech Water Projects A/S, a Danish corporation (“LiqTech Water Projects”), incorporated on July 28, 2020, that is a dormant company without activity. This company was formed to include the investments for our joint venture in the Middle East.
LiqTech Emission Control A/S, a Danish corporation (“LiqTech Emission Control”), incorporated on March 1, 2021, that is a dormant company without activity. This company was formed to include the investments for our joint venture in China.
LiqTech Environment Technologies (China) Co. Ltd. (“LiqTech China”), incorporated on September 23, 2021, to be engaged in the development, design, application, marketing, and sales of ceramic diesel particulate, liquid filters, and catalytic converters in Asia.
LiqTech PTE Ltd (“LiqTech Singapore”), a 95% owned subsidiary of LiqTech Holding, incorporated in Singapore on January 19, 2012. This company is in the process of closing operations, and all activity in this company has ceased.
Consolidation-- The consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, and its majority-owned subsidiary. All material intercompany transactions and accounts have been eliminated in the consolidation.
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Functional Currency / Foreign currency translation-- The functional currency of LiqTech International, Inc. and LiqTech USA, Inc. is the U.S. Dollar. The functional currency of LiqTech Holding, LiqTech Water, LiqTech Plastics, LiqTech Ceramics, LiqTech Water Projects, and LiqTech Emission Control is the Danish Krone (“DKK”); the functional currency of LiqTech China is the Renminbi (“RMB”); the functional currency of LiqTech Germany is the Euro; and the functional currency of LiqTech Singapore is the Singapore Dollar. The Company’s reporting currency is the U.S. Dollar for the purpose of these consolidated financial statements. The balance sheet accounts of the foreign subsidiaries are translated into U.S. Dollars at the period-end exchange rates, and all revenue and expenses are translated into U.S. Dollars at the average exchange rates prevailing during the twelve months ended December 31, 2022 and 2021. Translation gains and losses are deferred and accumulated as a component of other comprehensive income (loss) in stockholders’ equity. Transaction gains and losses that arose from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the statement of operations as incurred.
Cash, Cash Equivalents, and Restricted Cash-- The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. As of December 31, 2022, and 2021, the Company held $1,440,394 and $2,125,695, respectively, of restricted cash. The restricted cash is held as security by a local financial institution for ensuring a leasing facility and for payment guarantees issued for the benefit of customers in connection with prepayments of sales orders and for warranties after the delivery of sales orders.
Accounts held in each U.S. institution are insured by the Federal Deposit Insurance Company (“FDIC”) up to $250,000. At December 31, 2022 and December 31, 2021, the Company had $12,999,271 and $11,346,826 in excess of the FDIC insured limit, respectively.
Accounts Receivable-- Accounts receivable consist of trade receivables arising in the normal course of business. The Company establishes an allowance for doubtful accounts that reflects the Company’s best estimate of probable losses inherent in the accounts receivable balance. The Company determines the allowance based on known troubled accounts, historical experience, age, financial information that is publicly accessible, and other currently available evidence.
The roll-forward of the allowance for doubtful accounts as of December 31, 2022 and December 31, 2021 is as follows:
Receivables written off during the periods (295,778 ) (24,415 )
Allowance for doubtful accounts at the end of the period $ 59,559 $ 409,076
The receivables written off during the period 2022 mainly relates to legacy marine scrubber contracts and partnerships, renegotiated and terminated amid the COVID disruptions and general slowdown in the marine scrubber market.
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Inventory -- Inventory directly purchased is carried at the lower of cost or net realizable value, as determined on the first-in, first-out method.
For inventory produced, standard costs that approximate actual cost on the FIFO method are used to value inventory. Standard costs are reviewed at least annually by management, or more often in the event that circumstances indicate a change in cost has occurred.
Work in process and finished goods include material, labor, and production overhead costs. The Company adjusts the value of its inventory to the extent management determines that the cost cannot be recovered due to obsolescence or other factors.
Inventory valuation adjustments for excess and obsolete inventory are calculated based on current inventory levels, movement, expected useful lives, and estimated future demand for our products.
Contracts Assets / Liabilities -- Contract assets are the Company’s rights to consideration in exchange for goods or services and are recognized when a performance obligation has been satisfied but has not yet been billed. When the Company issues invoices to the customer, and the billing is higher than the capitalized Contract assets, the net amount is transferred to Contract liabilities. Contract assets/liabilities are transferred to revenue and cost of goods sold when the right to consideration is unconditional and billed per the terms of the contractual agreement.
Contract assets also include unbilled receivables, which usually comprise the last invoice remaining after the delivery of the water treatment unit, where revenue is recognized at the transfer of control based upon signed acceptance of the unit by the customer. Most commonly, this invoice is sent to the customer at commissioning of the product or no later than 12 months after delivery. Further included in Contract Assets are short-term receivables such as VAT and other receivables.
Assets Held for Sale -- Assets are classified as held for sale when all of the following criteria for a plan of sale have been met: (1) management, having the authority to approve the action, commits to a plan to sell the assets; (2) the assets are available for immediate sale, in their present condition, subject only to terms that are usual and customary for sales of such assets; (3) an active program to locate a buyer and other actions required to complete the plan to sell the assets have been initiated; (4) the sale of the assets is probable and is expected to be completed within one year; (5) the assets are being actively marketed for a price that is reasonable in relation to their current fair value; and (6) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or the plan will be withdrawn. When all of these criteria have been met, the assets are classified as held for sale on the balance sheet. Assets classified as held for sale are reported at the lower of their carrying value or fair value less costs to sell. Depreciation and amortization of assets ceases upon designation as held for sale.
Leases-- The Company has elected to not recognize lease assets and liabilities with an initial term of 12 months or less and to not separate lease and non-lease components. The Company’s accounting for finance leases (formerly called capital lease obligations) remains substantially unchanged. Operating lease right-of-use (“ROU”) assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, an incremental borrowing rate based on the information available at the commencement date is used in determining the present value. The Company will use the implicit rate when readily determinable. The operating lease ROU asset also included prepaid lease payments and reduced by accrued lease payments. The Company’s lease terms may include options to extend or terminate the lease, recognized when it is reasonably certain that those options will be exercised. Operating lease cost for lease payments will be recognized on a straight-line basis over the lease term.
Property and Equipment-- Property and equipment are stated at cost. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized upon being placed in service. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed for financial statement purposes on a straight-line basis over the estimated useful lives of the assets, which range from three to ten years.
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Goodwill and Intangible Assets-- The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business, with the residual purchase price recorded as goodwill. The determination of the value of the intangible assets acquired involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital.
Acquired intangible assets with determinable useful lives are amortized on a straight-line or accelerated basis over the estimated periods benefited, ranging from one to ten years. Customer relationships and other non-contractual intangible assets with determinable lives are amortized over periods of five years.
The Company evaluates the recoverability of long-lived assets by comparing the carrying amount of an asset to estimated future net undiscounted cash flows generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying value of the assets exceeds the fair value of the assets. The evaluation of recoverability involves estimates of future operating cash flows based upon certain forecasted assumptions, including, but not limited to, revenue growth rates, gross profit margins, and operating expenses over the expected remaining useful life of the related asset. A shortfall in these estimated operating cash flows could result in an impairment charge in the future.
Goodwill is not amortized but is evaluated annually for impairment at the reporting unit level or when indicators of a potential impairment are present. The Company estimates the fair value of the reporting unit using the discounted cash flow and market approaches. Forecasts of future cash flows are based on the Company’s best estimate of future net sales and operating expenses, using primarily expected category expansion, pricing, market segment fundamentals, and general economic conditions.
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 for the year ended December 31, 2022 and 2021:
% Distribution For the Year Ended December 31
The Company’s sales by product line are as follows for the years ended December 31, 2022 and 2021:
% Distribution For the Year Ended December 31
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.
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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 margin. 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.
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 filtration systems. We measure the 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 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.
The roll-forward of Contract Assets/Liabilities for the year ended December 31, 2022 and December 31, 2021 is:
Distributed as follows:
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Advertising Cost-- Costs incurred in connection with advertising of the Company’s products is expensed as incurred. Advertising cost is included in sales expenses, and total advertising costs amounted to $144,043 and $308,880 for the years ended December 31, 2022 and 2021, respectively.
Research and Development Cost-- The Company expenses research and development costs for the development of new products as incurred. Included in operating expense for the years ended December 31, 2022 and 2021 were $1,835,890 and $1,862,653, respectively, of research and development costs.
Income Taxes-- The Company accounts for income taxes in accordance with FASB ASC Topic 740: Accounting for Income Taxes. This statement requires an asset and liability approach for accounting for income taxes.
Income/(Loss)Per Share-- The Company calculates earnings (loss) per share in accordance with FASB ASC 260, Earnings Per Share. Basic earnings per common share (EPS) are based on the weighted average number of common shares outstanding during each period. Diluted earnings per common share are based on shares outstanding (computed as under basic EPS) and potentially dilutive common shares. Potential common shares included in the diluted earnings per share calculation include in-the-money stock options and warrants that have been granted but have not been exercised.
Stock Awards-- During the years presented in the accompanying consolidated financial statements, the Company has granted stock awards. The Company accounts for stock awards in accordance with the provisions of FASB ASC Topic 718, Compensation – Stock Compensation. Stock-based compensation costs of $934,423 and $481,105 have been recognized for the vesting of options and stock awards granted to directors, management, and certain key employees for the years ended December 31, 2022 and 2021, respectively.
Fair Value of Financial Instruments-- The Company accounts for fair value measurements for financial assets and liabilities in accordance with FASB ASC Topic 820. The authoritative guidance, which, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as the exit price, representing the amount that would either be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
Unless otherwise disclosed, the fair value of the Company’s financial instruments including cash, accounts receivable, other receivables, prepaid expenses, accounts payable, and accrued expenses approximate their recorded values due to their short-term maturities.
Accounting Estimates-- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, including accounts receivable; allowance for doubtful accounts; reserve for excess and obsolete inventory; depreciation and impairment of property, plant and equipment; goodwill and intangible assets; liabilities including contingencies; the disclosures of contingent assets and liabilities at the date of the financial statements; warrant liability; and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimated.
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Recent Accounting Pronouncements – In March 2022, the FASB issued ASU 2022-02, Troubled Debt Restructurings (“TDRs”) and Vintage Disclosures (Topic 326): Financial Instruments – Credit Losses. This amended guidance will eliminate the accounting designation of a loan modification as a TDR, including eliminating the measurement guidance for TDRs. The amendments also enhance existing disclosure requirements and introduce new requirements related to modifications of receivables made to borrowers experiencing financial difficulty. Additionally, this guidance requires entities to disclose gross write-offs by year of origination for financing receivables, such as loans and interest receivable. The ASU is effective January 1, 2023, and is required to be applied prospectively, except for the recognition and measurement of TDRs which can be applied on a modified retrospective basis. We do not expect the adoption of this ASU to have a material impact on our consolidated financial statements and related disclosures.
In November 2021, the FASB issued ASU 2021-10, Disclosures by Business Entities about Government Assistance. The FASB is issuing this Update to increase the transparency of government assistance including the disclosure of (1) the types of assistance, (2) an entity’s accounting for the assistance, and (3) the effect of the assistance on an entity’s financial statements. The ASU was effective for annual reporting periods after January 1, 2022. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.
In August 2020, the FASB issued ASU 2020-06 Accounting for Convertible Instruments and Contracts in An Entity’s Own Equity. ASU 2020-06 simplifies the accounting for certain convertible instruments by removing the separation models for convertible debt with a cash conversion feature and for convertible instruments with a beneficial conversion feature. As a result, more convertible debt instruments will be reported as a single liability instrument with no separate accounting for embedded conversion features. Additionally, ASU 2020-06 amends the diluted earnings per share calculation for convertible instruments by requiring the use of the if-converted method. The treasury stock method is no longer available. For SEC filers, excluding smaller reporting companies, ASU 2020-06 is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, ASU 2020-06 is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company early adopted ASU 2020-06 on January 1, 2022, using a modified retrospective approach.
In March 2020, the FASB issued ASU 2020-4 Reference Rate Reform (Topic 848). This ASU provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The new guidance provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The new standard was effective upon issuance and upon adoption can be applied prospectively to applicable contract modifications made on or before December 31, 2022. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this update, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. As a smaller reporting company, the guidance is effective for our fiscal years beginning after December 15, 2022. We do not expect the adoption of this ASU to have a material impact on our consolidated financial statements and related disclosures.
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NOTE 2– GOING CONCERN
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles of the United States of America, which contemplate continuation of the Company as a going concern; however, the Company has incurred significant recent losses, which raises substantial doubt about the ability of the Company to continue as a going concern for a period of one year from the issuance of these financial statements. There is no assurance that the Company will be successful in executing the proposed cost reductions and profitability improvement measures, thus achieving profitable operations. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.
NOTE 3– RESTRUCTURING COSTS
During the second quarter of 2022, the Company completed a restructuring program to reduce costs, decrease operating losses and improve cash flow. Total restructuring and restructuring-related net charges pursuant to this program were $1,893,166, which were recorded separately in the income statement as “restructuring costs”, and allocated as follows:
CEO separation -- On May 10, 2022, the Board of Directors accepted the resignation of Sune Mathiesen as Chief Executive Officer and a director of the Company, effective on May 12, 2022. As previously announced, Mr. Mathiesen had been on a medical leave of absence since March 17, 2022. In connection with Mr. Mathiesen’s resignation, Mr. Mathiesen and the Company entered into a Separation Agreement and Release (the “Separation Agreement”). Under the provisions of the Separation Agreement, Mr. Mathiesen received DKK1,605,000 ($228,975), which is the equivalent of six months of salary, car allowance and pension contributions, paid in a lump-sum payment, less applicable deductions and withholdings.
Terminated employees – In the second quarter of 2022, the Company re-aligned its corporate management structure, which involved a reduction in headcount and labor costs of approximately 25%. The new organization reflects a focused effort to align key leaders with strategic imperatives, inspire greater accountability and performance management, eliminate silos and layers of middle management, and operate a leaner, more efficient business. Provisions for salary obligations to employees amounted to $158,199, reflecting the costs related to select employees released from duties with immediate effect. No provisions were made for the employees working during the notice period.
China close-down – In the second quarter of 2022, the Company reduced and suspended planned capital investments, including the Company’s program to build a manufacturing and service center in China. Pursuant to the suspended plans, the Company terminated and settled agreements with consultants, select project employees, and property development providers, resulting in a net payment of termination and cancellation charges of $275,445.
Capex commitments -- As part of efforts to balance future investments with expected demands and cash flow, the Company commenced the renegotiation of all material Capex commitments during the quarter, with the ambition to reduce, cancel, or delay deliveries under the contracts, which initially amounted to approximately $10,300,000. As part of the renegotiation, a provision was made during the second quarter of $668,606 regarding expected cancellation charges and contractual termination costs. During the third and fourth quarter the amount of paid cancellation charges exceeded the provision by $145,388, which explains the total amount regarding capex commitments of $813,994.
Write-downs -- The re-routing of production equipment and machinery to Denmark (originally planned for China), resulted in a write-down of $240,576 on legacy installed equipment and machinery that was decommissioned as part of the arrival and implementation of new and more efficient equipment. Furthermore, review of obsolete inventory and existing product demand resulted in a write-down of $175,977.
The Company’s restructuring costs are as follows for the year ended December 31, 2022, which have all been settled as of December 31, 2022:
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The following table displays a roll-forward of the restructuring accruals, presented within “accrued expenses”, for the year ended December 31, 2022 and 2021:
Restructuring accruals, January 1 $ - $ -
Restructuring costs, net 1,893,166 -
Restructuring accruals, December 31 $ - $ -
NOTE 4 - INVENTORY
Inventory consisted of the following at December 31, 2022 and December 31, 2021:
Inventory valuation adjustments for excess and obsolete inventory are calculated based on current inventory levels, movements, expected useful lives, and estimated future demand for the products. The increase in the reserve for excess and obsolescence is mainly explained by changes in product and sales mix, due to both market driven and strategic changes implemented during the year, and furthermore new and more conservative processes implemented as part of the ERP implementation.
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NOTE 5-PROPERTY AND EQUIPMENT
Property and equipment consisted of the following on December 31, 2022 and December 31, 2021:
Less Accumulated Depreciation - finance lease (544,653 ) (336,338 )
Depreciation expense amounted to $2,007,112 and $1,945,489 for the year ended December 31, 2022 and 2021, respectively. Of the $2,007,112 for the year ended December 31, 2022, $1,414,514 is allocated as cost of goods sold and $592,598 is allocated as operating expenses.
NOTE 6- LEASES
The Company leases certain vehicles, real property, production equipment, and office equipment under lease agreements. The Company evaluates each lease to determine its appropriate classification as an operating lease or finance lease for financial reporting purposes. The majority of our operating leases are non-cancelable operating leases for production and office space in Hobro, Aarhus, and Copenhagen, Denmark. The lease agreements expire on November 30, 2034, August 31, 2024, and August 31, 2028, respectively. During the second quarter of 2022, the Company terminated the lease agreement for the office and production space in Taicang, China.
During the year ended December 31, 2022, cash paid for amounts included for the measurement of operating lease liabilities was $906,373, and the Company recorded operating lease expenses included in operating expenses of $984,236.
During the year ended December 31, 2022, cash paid for amounts included for the measurement of finance lease liabilities was $427,113, and the Company recorded finance lease expenses included in other income (expenses) of $323,081.
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Supplemental balance sheet information related to leases as of December 31, 2022 and 2021 was as follows:
Operating leases:
Finance leases:
Weighted average remaining lease term: