ClearSign Technologies Corp: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited consolidated condensed financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q as well as our audited financial statements and related notes included in our most recent Annual Report on Form 10-K. In addition to historical information, this discussion and analysis here and throughout this Form 10-Q contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements due to a number of factors, including but not limited to, the risks described in the section titled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022.

Overview

We design and develop technologies for the purpose of improving key performance characteristics of combustion systems, including emission and operational performance, energy efficiency and overall cost-effectiveness. Our ClearSign Core™ technology has been proven in full scale industrial test furnaces and boilers and first customer installations are currently operating in normal commercial applications. We have generated nominal revenues from operations to date to meet operating expenses.

We have incurred losses since inception totaling $92.8 million and we expect to experience operating losses and negative cash flow for the foreseeable future. We have historically financed our operations primarily through issuances of equity securities. Since inception, we have raised approximately $91.0 million in gross proceeds through the sale of our equity securities. We may need to raise additional capital in the future, however, the significant volatility in the capital markets may negatively affect our ability to raise this additional capital.

In order to generate meaningful revenues, our technologies must gain market recognition and acceptance to develop sufficient recurring sales. In addition, management believes that the successful growth and operation of our business is dependent upon our ability to obtain adequate sources of funding through co-development agreements, strategic partnering agreements, or equity or debt financing to support commercialization of our research and development efforts, protect intellectual property, form relationships with strategic partners and provide for working capital and general corporate purposes. There can be no assurance that we will be successful in achieving our long-term plans, or that such plans, if consummated, will result in profitable operations or enable us to continue in the long-term as a going concern.

With respect to our China operations, we have a satellite office located in Beijing, China to support our commercialization efforts. At this time, these operations in China are immaterial compared to total company operations. As of September 30, 2023, our China asset balance totaled $261 thousand, or approximately 3%, compared to our total asset balance of $8,998 thousand. During the nine months ended September 30, 2023 and 2022, our China operations reported zero revenues.

Our costs include employee salaries and benefits, compensation paid to consultants, materials and supplies for prototype development and manufacture, costs associated with development activities including materials, sub-contractors, travel and administration, legal and accounting expenses, sales and marketing costs, general and administrative expenses, and other costs associated with an early stage, publicly traded technology company. We currently have 16 full-time employees. Because using third party expertise and resources is more efficient than maintaining full time resources, we also expect to incur ongoing consulting expenses related to technology development and some administrative, sales and legal functions commensurate with our current level of activities.

The amount that we spend for any specific purpose may vary significantly, and could depend on a number of factors including, but not limited to, the pace of progress of our commercialization and development efforts, actual needs with respect to product testing, development and research, market conditions, and changes in or revisions to our sales and marketing strategies.

Research, development, and commercial acceptance of new technologies are, by their nature, unpredictable. Although we undertake development and commercialization efforts with reasonable diligence, there can be no assurance that the net proceeds from our securities offerings will be sufficient to enable us to develop our technology to the extent needed to create sufficient future sales to sustain operations. If the net proceeds from these offerings are insufficient for this purpose, we will consider other options to continue our path to commercialization, including, but not limited to, additional financing through follow-on equity offerings, debt financing, co-development agreements, sale or licensing of developed intellectual or other property, or other alternatives.

We cannot assure that our technologies will be accepted, that we will ever earn revenues sufficient to support our operations, or that we will ever be profitable. Furthermore, we have no committed source of financing, and we cannot assure that we will be able to raise money as and when we need it to continue our operations. If we cannot raise funds as and when we need them, we may be required to scale back our development by reducing expenditures for employees, consultants, business development and marketing efforts or to otherwise severely curtail, or even to cease, our operations.

Critical Accounting Policies

The following discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Certain accounting policies and estimates are particularly important to the understanding of our financial position and results of operations. These policies and estimates require the application of significant judgment by management. These estimates can be materially affected by changes from period to period as economic factors and conditions outside of our control change. As a result, they are subject to an inherent degree of uncertainty. In applying these policies, our management uses their judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical operations, our future business plans and projected financial results, the terms of existing contracts, our observance of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. See Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this report for a more complete description of our significant accounting policies.

Revenue Recognition and Cost of Goods Sold.

The Company recognizes revenue and related cost of goods sold in accordance with FASB ASC 606 Revenue from Contracts with Customers (ASC 606). Revenues and cost of goods sold are recognized once the goods or services are delivered to the customer’s control or non-refundable performance obligations are satisfied. The Company’s contracts with customers generally have performance obligations and a schedule of non-refundable cancellation obligations. The contracts generally will be fully performed upon delivery of certain documents or equipment. Revenue related to the contracts is recognized following the completion of non-refundable performance obligations as defined in the contract.

The Company’s contracts generally include progress payments from customers upon completion of defined milestones. As these payments are received, they are offset against accumulated project costs and recorded as either contract assets or contract liabilities. Upon completion of the performance obligations and collectability is determined, revenue can be recorded. For any contract in connection with which the Company is expected to incur costs in excess of the contact price, the Company accrues the estimated loss in full in the period such determination is made.

Impairment of Long-Lived Assets

The Company tests long-lived assets, consisting of fixed assets, patents, and other intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected from the use and eventual disposition of the assets. In the event an asset in not fully recoverable a loss is recognized based on the amount by which the carrying amount exceeds the fair value of the long-lived assets. Fair value is determined based on the present value of estimated expected cash flows using a discount rate commensurate with the risks involved, quoted market prices, or appraised values depending upon the nature of the assets. Losses on long-lived assets to be disposed of is determined in a similar manner, except those fair values are reduced for the cost of disposal.

Product Warranties

The Company warrants all installed products against defects in materials and workmanship, and shortcomings in performance compared to contractual guarantees for a period specified in each contract. Accruals for product warranties are based on expected warranty experience and current product performance trends which are recorded as a component of cost of sales at the time revenue is recognized. The warranty liabilities are reduced by material and labor costs during the warranty period in the periods in which the costs are incurred. The Company periodically assesses the adequacy of our recorded warranty liabilities and adjusts the amounts as necessary, and such adjustments could be material if estimates differ significantly from actual warranty expense. The warranty liabilities are included in accounts payable and accrued liabilities in the unaudited condensed consolidated balance sheets.

Research and Development

The cost of research and development is expensed as incurred. Research and development costs consist of salaries, benefits, share based compensation, consumables, and consulting fees, including costs to develop and test prototype equipment and parts. Research and development costs are offset by any funds received from strategic partners in cost sharing, collaborative projects.

Stock-Based Compensation

The costs of all employee stock options, as well as other equity-based compensation arrangements, are reflected in the unaudited, condensed consolidated financial statements based on the estimated fair value of the awards on the grant date. That cost is recognized over the period during which an employee is required to provide service in exchange for the award, or in the case of performance options, expense is recognized upon completion of a milestone as defined in the grant agreement. Stock-based compensation for stock grants to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Fair Value of Financial Instruments

The Company's financial instruments primarily consist of cash equivalents, accounts payable, accrued expenses and short-term investments in government securities. As of the balance sheet date, the estimated fair values of the financial instruments were not materially different from their carrying values as presented on the consolidated balance sheets. This is primarily attributed to the short maturities of these instruments.

RESULTS OF OPERATIONS

Comparison of the Three and Nine Months Ended September 30, 2023 and 2022

Highlights of our quarter financial performance are as follows:

(in thousands, except per share data)

(in thousands, except per share data)

Revenues and Gross Profit

Consolidated revenues for the three and nine months ended September 30, 2023, were $85 thousand and $1,129 thousand, respectively, compared to $324 thousand for the same time periods in 2022. Revenues for the three months ended September 30, 2023, were generated from a boiler burner order. Revenues for the nine months ended September 30, 2023, were generated from several orders for spare parts, burner performance testing, engineering feasibility study and boiler burner sale.

The $324 thousand in consolidated revenues for the three and nine months ended September 30, 2022, were predominantly generated from the closeout of our ExxonMobil technology validation project. Additional revenue consisted of the sale of our ClearSign Core™ enclosed oxidizer product for a hydrogen production plant.

Gross profit for the three months ended September 30, 2023, decreased by $99 thousand compared to $123 thousand in profit for the same period in 2022, mostly due to a lower margin profile for the boiler burner sold in the third quarter of 2023 as compared to the margin from the ExxonMobil technology validation project during the 2022 comparable period. The margin profile for the boiler burner order sold in the 2023 quarter was lowered to incentivize the sale and adoption of our technology. Gross profit for the quarter ended September 30, 2023, was approximately 28.2% of revenues, resulting in a decrease of approximately 9.8% compared to the same quarter in 2022.

Gross profit for the nine months ended September 30, 2023, increased by $136 thousand compared to $123 thousand for the same period in 2022. For the nine months ended September 30, 2023, gross profit was approximately 22.9% of revenues, resulting in a decrease of approximately 15.1% compared to the same period in 2022, mainly due to our burner performance testing revenues during 2023, and revenues recognized in connection with the ExxonMobil technology validation project during the 2022 comparable period. The margin profile in the current year was lower predominantly due to the revenue coming from burner performance testing. Burner performance testing typically produces lower margin compared to burner fabrication revenues.

Operating Expenses

Operating expenses consist of research and development (“R&D”) and general and administrative (“G&A”) expenses. These are addressed separately below.

Research and Development

R&D expenses for the three and nine months ended September 30, 2023, remained relatively consistent year-over-year.

General and Administrative

G&A expenses for the 2023 third quarter remained relatively consistent compared to the same quarter in 2022. During the three months ended September 30, 2023, G&A expenses decreased by $33 thousand or 2.3% when compared to the same quarter in 2022.

During the nine months ended September 30, 2023, G&A expenses increased by $307 thousand or 7.1% when compared to the same period in 2022. This year-over-year difference in G&A expenses is primarily comprised of $73 thousand for vesting of restricted stock units triggered by the departure of two board members, one in 2023 and the other in 2022; an increase in project management and refurbishment costs for our Seattle office decommissioning project, which added $134 thousand in expenses as compared to the same period in 2022; and the vesting of $62 thousand in inducement stock options, which were granted to our new Customer Relationships and Business Development Director to incentivize employment (see “Note 6 – Equity – Inducement Options” for more details on the granted inducement options).

Other Income

Other income increased by $42 thousand or 34.1%, and $419 thousand or 243.6% for the three and nine month periods ending on September 30, 2023, respectively, as compared to the same time periods in 2022. During the three months ended September 30, 2023, interest income increased by $51 thousand compared to the same quarter in 2022. Materials sold as a result of our Seattle office decommission project increased other income by $43 thousand compared to the same quarter in 2022. The current third quarter increases were offset by a decrease of $50 thousand in government assistance, which are related to our Oklahoma Quality Jobs rebate agreement and our Department of Energy (“DOE”) ultra-low NOx hydrogen burner development grant. Our Phase 2 DOE grant was awarded late in the current quarter, thus a minimal amount of reimbursement was earned compared to our prior Phase 1 grant reimbursements during the comparable period. During the nine months ended September 30, 2023, interest income increased by $202 thousand, which was driven by rising interest rates. Our Seattle office decommission project increased other income by $197 thousand for the nine months ended September 30, 2023, compared to the same period in 2022.

Net Loss

Net loss for the three months ended September 30, 2023, was $1,332 thousand as compared to $1,312 thousand for the same quarter in 2022, or an approximate 1.5% increase. The $20 thousand increase is primarily attributable to the $99 thousand decrease in gross profit referenced in the above explanation.

Net loss for the nine months ended September 30, 2023, was $4,239 thousand as compared to $4,440 thousand for the same period in 2022, or an approximate 4.5% decrease. The $201 thousand decrease in net loss is primarily attributable to the $136 thousand increase in gross profit referenced in the above explanation.

Liquidity and Capital Resources

At September 30, 2023, our cash and cash equivalent balance totaled $7,235 thousand compared to $6,451 thousand at December 31, 2022, an increase of $784 thousand. The increase in cash and cash equivalent balance is primarily attributable to the change of short-term held-to-maturity investments. At September 30, 2023, our short-term held-to-maturity investments totaled zero, compared to $2,606 thousand at December 31, 2022.

At September 30, 2023, our current assets were in excess of current liabilities resulting in working capital of $4,947 thousand as compared to $8,586 thousand at December 31, 2022. We have no contractual debt obligations, and the Company has sufficient cash and expected cash collections to fund current operating expenses for over twelve months. To the extent the Company requires additional funds more than 12 months from the date hereof, and customer cash collections cannot fund our needs, the Company may utilize equity offerings. Historically, the Company has funded operations predominantly through equity offerings.

Currently, the Company can sell shares of common stock through its ATM program. As of September 30, 2023, the remaining aggregate offering price for future sales of common stock on the ATM is approximately $8.7 million, subject to the SEC’s “baby shelf rules,” which prohibits companies with a public float of less than $75 million from issuing securities under a shelf registration statement in excess of one-third of such company’s public float in a 12-month period (for more details, see “Note 6 – Equity” in the notes to our condensed consolidated financial statements). Future sales of shares of common stock and the price at which we may be able to sell such shares of common stock under the ATM are dependent on factors beyond our control, including, but not limited to, market conditions, and the trading price of our common stock.

We filed a Form S-3 shelf registration statement with the SEC on July 1, 2022 that was declared effective on August 12, 2022.The registration statement on Form S-3 allows us to offer common stock, preferred stock, warrants, subscription rights, debt securities and units from time to time, as market conditions permit to fund, to the extent required beyond the 12 months from the date hereof, the ongoing operations of the Company. Until the growth of revenue increases to a level that covers operating expenses, the Company intends to continue to fund operations in this manner, although the volatility in the capital markets may negatively affect our ability to do so.

Operating activities for the nine months ended September 30, 2023, resulted in cash outflows of $1,783 thousand, primarily due to the loss for the period of $4,239 thousand, offset with non-cash expenses of $678 thousand, and an increase of $1,554 thousand of contract liabilities, which represents payments from customers in advance of future project costs.

Operating activities for the nine months ended September 30, 2022, resulted in cash outflows of $4,264 thousand, primarily due to the loss for the period of $4,440 thousand, offset with non-cash expenses of $520 thousand.

Investing activities for the nine months ended September 30, 2023, resulted in cash inflows of $2,595 thousand, which is primarily attributable to the redemption $4,847 thousand of short-term held-to-maturity U.S. treasuries, offset by $2,162 thousand of purchases for the same type of investments.

Investing activities for the nine months ended September 30, 2022, resulted in cash outflows of $3,982 thousand, which is primarily attributable to $3,900 thousand of investments in short-term held-to-maturity U.S. treasuries, and $114 thousand of disbursements for patents and other intangibles.

Financing activities for the nine months ended September 30, 2023, included $15 thousand in disbursements for taxes paid related to vesting of employee restricted stock units.

Financing activities for the nine months ended September 30, 2022, included $6,539 thousand in net proceeds from the sale of 501 thousand shares of our common stock through our ATM program at an average price of $1.24 per share, sale of 4.2 million shares of our common stock through a public offering at an average price of $1.11 per share, and sales of 1.6 million shares of our common stock at a price of $1.11 per share pursuant to the Participant Right with clirSPV.

Off-Balance Sheet Transactions

We do not have any off-balance sheet transactions.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), that are designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal accounting and financial officer, as appropriate, to allow timely decisions regarding required disclosure.

We carried out an evaluation under the supervision and with the participation of management, including our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal accounting and financial officer), of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2023, the end of the period covered by this Quarterly Report on Form 10-Q. Based upon the evaluation of our disclosure controls and procedures as of September 30, 2023, our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal accounting and financial officer) concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management, including our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal accounting and financial officer), does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

We incorporate herein by reference the risk factors included under “Part I - Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2022 which we filed with the Securities and Exchange Commission on March 31, 2023, and the risk factors included in the reports and other documents we filed with the Securities and Exchange Commission subsequent to that date. There are no material changes from the risk factors set forth in such prior filings.