LIQTECH INTERNATIONAL INC - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.20549

FORM 10-Q

(Mark One) 

For the nine months period ended September 30, 2017

or

For the transition period from _______________________ to _______________________

Commission File Number:001-36210

LiqTech International, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: +4544986000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No ☒

The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, at November 14, 2017, was 44,229,264 shares. 

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

Quarterly Report on Form 10-Q

For the Period Ended September 30, 2017

TABLE OF CONTENTS

FORWARD-LOOKING STATEMENTS

Certain statements made in this Quarterly Report on Form 10-Q are “forward-looking statements” regarding the plans and objectives of management for future operations and market trends and expectations.  Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties.  Our plans and objectives are based, in part, on assumptions involving the continued expansion of our business. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control.  Although we believe that our assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.  We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Continued) 

The accompanying notes are an integral part of these unaudited financial statements.

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these unaudited financial statements. 

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

(UNAUDITED) CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these financial statements.

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

 (UNAUDITED) CONSOLIDATED STATEMENTS OF OTHER

COMPREHENSIVE INCOME

The accompanying notes are an integral part of these financial statements.

 LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

(UNAUDITED) CONSOLIDATED STATEMENTS OF CASH FLOWS

Increase (Decrease) in Cash and Cash Equivalents

The accompanying notes are an integral part of these financial statements.

 LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

(UNAUDITED) CONSOLIDATED STATEMENTS OF CASH FLOWS

Increase (Decrease) in Cash and Cash Equivalents

The accompanying notes are an integral part of these financial statements.

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business and Basis of Presentation

The consolidated financial statements include the accounts of LiqTech International, Inc. (“Parent”) and its subsidiaries. The terms "Company", “us", "we" and "our" as used in this report refer to Parent and its subsidiaries, which are set forth below. The Company engages in the development, design, production, marketing and sale of automated filtering systems, liquid filters, diesel particulate air filters and kiln furniture in United States, Canada, Europe, Asia and South America. Set forth below is a description of Parent and each of its subsidiaries:

LiqTech International, Inc., a Nevada corporation (Parent) organized in July 2004, formerly known as Blue Moose Media, Inc.

LiqTech USA, a Delaware corporation and a wholly owned subsidiary of Parent formed in May 2011.

LiqTech International AS, a Danish corporation, incorporated on January 15, 2000 (“LiqTech Int. DK”), a 100% owned subsidiary of LiqTech USA, engages in development, design, application, marketing and sales of membranes on ceramic diesel particulate and liquid filters and catalytic converters in Europe, Asia and South America.

LiqTech NA, Inc. (“LiqTech NA”), incorporated in Delaware on July 1, 2005, a 100% owned subsidiary of LiqTech USA. LiqTech NA, Inc. engages in the production, marketing and sale of ceramic diesel particulate and liquid filters and kiln furniture in United States and Canada.

LiqTech Germany (“LiqTech Germany”) a 100% owned subsidiary of LiqTech Int. DK, incorporated in Germany on December 9, 2011, engages in marketing and sale of liquid filters in Germany. The Company has no operation and is in the process of closing down, which is expected to be completed during 2017.

LiqTech PTE Ltd. (“LiqTech Sing”) a 95% owned subsidiary of LiqTech Int. DK, incorporated in Singapore on January 19, 2012, engages in marketing and sale of liquid filters in Singapore and other countries in the area. The Company has no operation and is in the process of closing down, which is expected to be completed during 2017.

LiqTech Systems A/S ("LiqTech Systems"), a Danish corporation (formerly Provital Solutions A/S) was incorporated on September 1, 2009 and engages in the manufacture of fully automated filtering systems for application within the pool and spa markets, marine applications, and a number of industrial applications within Denmark and international markets. The financial statements include the accounts of LiqTech Systems from the date of acquisition on July 31, 2014.

Consolidation -- The consolidated financial statements include the accounts and operations of the Company. The non-controlling interests in the net assets of the subsidiaries are recorded in equity. The non-controlling interests of the results of operations of the subsidiaries are included in the results of operations and recorded as the non-controlling interest in subsidiaries. All material inter-company transactions and accounts have been eliminated in the consolidation.

Functional Currency / Foreign Currency Translation -- The functional currency of LiqTech International, Inc., LiqTech USA, Inc. and LiqTech NA is the U.S. Dollar. The Functional Currency of LiqTech Int. DK and LiqTech Systems is the Danish Krone (“DKK”), 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 U.S. Dollar for the purpose of these financial statements. The foreign subsidiaries balance sheet accounts 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 three and nine months ended September 30, 2017 and 2016. Translation gains and losses are deferred and accumulated as a component of other comprehensive income 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.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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. The Company had no balances held in a financial institution in the United States in excess of federally insured amounts at September 30, 2017 and December 31, 2016.

Accounts Receivable -- Accounts receivables consist of trade receivables arising in the normal course of business. The Company establishes an allowance for doubtful accounts, which 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, and other currently available evidence. 

The roll forward of the allowance for doubtful accounts for the nine months ended September 30, 2017 and the year ended December 31, 2016 is as follows:

Inventory -- Inventory is carried at the lower of cost or market, as determined on the first-in, first-out method.

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 (See Note 4).

Long-Term Investments -- Investments in non-consolidated companies are included in long-term investments in the consolidated balance sheet and are accounted for under the cost method and equity method. For these non-quoted investments, we regularly review the assumptions underlying the operating performance and cash flow forecasts based on information requested from these privately held companies. Generally, this information may be more limited, may not be as timely as and may be less accurate than information available from publicly traded companies. Assessing each investment's carrying value requires significant judgment by management. If it is determined that there is another-than-temporary decline in the fair value of a non-public equity security, we write-down the investment to its fair value and record the related write-down as an investment loss in the consolidated statement of operations.

Intangible Assets -- Definite life intangible assets include patents. The Company accounts for definite life intangible assets in accordance with Financial Accounting Standards Board, (“FASB”) Accounting Standards Codification, (“ASC”) Topic 350, “Goodwill and Other Intangible Assets” and amortized the patents on a straight line basis over the estimated useful life of two to ten years. 

Goodwill -- Goodwill is evaluated for impairment annually, and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Triggering events that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of goodwill or a significant decrease in expected cash flows.

Revenue Recognition and Sales Incentives -- The Company accounts for revenue recognition in accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (SAB 101), FASB ASC 605 Revenue Recognition. The Company recognizes revenue when rights and risk of ownership have passed to the customer, when there is persuasive evidence of an arrangement, product has been shipped or delivered to the customer, the price and terms are finalized, and collections of resulting receivable is reasonably assured. Products are primarily shipped FOB shipping point at which time title passes to the customer. In some instances, the Company uses common carriers for the delivery of products. In these arrangements, sales are recognized upon delivery to the customer. The Company's revenue arrangements with its customers often include early payment discounts and such sales incentives are recorded against sales.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The Company has received long-term contracts for the installation of various water filtrations systems and grants from government entities for development and use of silicon carbide membranes in various water filtration and treatment applications. Revenues from long-term contracts and grants are recognized on the percentage-of-completion method, measured by the percentage of project costs incurred to date to estimated total project costs for each long-term contract or grant multiplied by the long-term contract or grant income on a project-by-project basis. This method is used because management considers costs incurred to be the best available measure of progress on contracts in process.

Project costs of the long-term contracts and grants include all direct material and labor costs and those indirect costs related to the project. Project costs are capitalized and accreted into cost of sales based on the percentage of the project completed. Should a loss be estimated on an incomplete project it would be recorded in the period in which such a loss is determined. Changes in estimated profitability of a project are recognized in the period in which the revisions are determined. The aggregate of costs incurred and income recognized on incomplete projects are recorded as costs in excess of billings and are shown as a current asset. 

The aggregate of billings in excess of related costs incurred and income recognized on projects is shown as a current liability.  

In Denmark, Value Added Tax (“VAT”) of 25% of the invoice amount is collected in respect of the sales of goods on behalf of tax authorities. The VAT collected is not revenue of the Company; instead, the amount is recorded as a liability on the balance sheet until such VAT is paid to the authorities. 

Advertising Cost -- Cost incurred in connection with advertising of the Company’s products is expensed as incurred. Such costs amounted to $9,270 and $21,307 for the nine months ended September 30, 2017 and 2016, respectively.

Research and Development Cost -- The Company expenses research and development costs for the development of new products and systems as incurred. Included in operating expense for the nine months ended September 30, 2017 and 2016 were $375,026 and $476,734, 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 Options and Awards -- The Company has granted stock options and awards to certain key employees and directors. See Note 14. The Company accounts for options in accordance with the provisions of FASB ASC Topic 718, Compensation – Stock Compensation. Non-cash compensation costs of $150,013 and $377,140 have been recognized for the vesting of options granted to employees and restricted stock awards issued to the board of directors with an associated recognized tax benefit of $26,775 and $18,445 for the nine months ended September 30, 2017 and 2016, respectively.

Fair Value of Financial Instruments --The Company accounts for fair value measurements for financial assets and financial 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:

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Unless otherwise disclosed, the fair value of the Company’s financial instruments including cash, accounts receivable, prepaid expenses, investments, accounts payable, accrued expenses, capital lease obligations and notes payable approximates 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 allowance for doubtful accounts receivable, cost in excess of billings, reserve for obsolete inventory, depreciation and impairment of property plant and equipment and impairment of goodwill and liabilities billings in excess of cost commitment and contingencies, the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimated.

Recent Accounting Pronouncements -- In May 2014, the Financial Accounting Standards Board (FASB) issued a new standard to achieve a consistent application of revenue recognition within the U.S., resulting in a single revenue model to be applied by reporting companies under U.S. generally accepted accounting principles. Under the new model, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. On July 9 2015, the FASB agreed to delay the effective date by one year; accordingly, the new standard is effective for us beginning in the first quarter of 2018 and we expect to adopt it at that time. The new standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. We have not yet selected a transition method, nor have we determined the impact of the new standard on our consolidated financial statements.

In February 2016, the FASB issued changes to the accounting for leases that primarily affect presentation and disclosure requirements. The new standard will require the recognition of a right to use asset and underlying lease liability for operating leases with an initial life in excess of one year. This standard is effective for us beginning in the first quarter of 2019. We have not yet determined the impact of the new standard on our consolidated financial statements.

Other recent accounting pronouncements issued by the FASB did not or are not believed by management to have a material impact on the Company’s present or future financial statements. 

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 limited cash and incurred significant recent losses. These factors raise substantial doubt about the ability of the Company to continue as a going concern. There is no assurance that the Company will be successful in raising additional cash through the issuance of debt or equity instruments or return to achieving profitable operations. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. 

NOTE 3 - INVENTORY

Inventory consisted of the following at September 30, 2017 and December 31, 2016:

NOTE 4 - PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at September 30, 2017 and December 31, 2016:

Depreciation expense amounted to $731,312 and $992,418 for the nine months ended September 30, 2017 and 2016, respectively. The property and equipment is held as collateral on lines of credit and guarantees with financial institutions. See Note 9.  

NOTE 5 - INVESTMENTS AT COSTS

The following tables summarize Level 1, 2 and 3 financial assets and financial (liabilities) by their classification in the Statement of Financial Position:

At September 30, 2017 and 2016, our total investments consisted of an investment of $5,909 and $5,282 in LEA Technology in France to strengthen our sales channels in the French market.

NOTE 6 - DEFINITE-LIFE INTANGIBLE ASSETS

At September 30, 2017 and December 31, 2016, definite-life intangible assets, net of accumulated amortization, consisted of patents on the Company’s products of $3,963 and $5,614, respectively. The patents are recorded at cost and amortized over two to ten years. Amortization expense for the nine months ended September 30, 2017 and 2016 was $1,651 and $3,269, respectively. Expected future amortization expense for the years ended are as follows: 

NOTE 7 - GOODWILL

The Company recorded Goodwill in connection with the acquisition of LiqTech Systems. Goodwill is evaluated for impairment annually in the fourth quarter of the Company’s fiscal year, and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Triggering events that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of goodwill or a significant decrease in expected cash flows. Key variables included in evaluating goodwill for impairment include the pipeline of proposed potential customer sales, budgeted reoccurring sales, risk free interest rate and risk premium rate and future budgeted operating results. The Company recorded an impairment charge of $7,343,208 during the year ended December 31, 2016, as management's estimated fair value of the reporting unit did not exceed the carrying value during 2016 fourth quarter testing. 

NOTE 8 - NOTES PAYABLE

The Company had a 4.02% note payable used to purchase a vehicle with $48,582 and $54,929 balance outstanding as of September 30, 2017 and December 31, 2016. The note calls for monthly payments of $1,477, matures August 1, 2020 and is secured by the vehicle purchased.

The following represents the future maturities of long-term debt as of September 30, 2017:

NOTE 9 - LINES OF CREDIT

In connection with certain orders, we have to give the customer a working guarantee or a prepayment guarantee or security bond. For that purpose, we have a guarantee credit line of DKK 94,620 (approximately $15,000 at September 30, 2017) with a bank, subject to certain base limitations. As of September 30, 2017, we had DKK 94,620 (approximately $15,000) in working guarantee against the line. This line of credit is guaranteed by Vækstfonden (the Danish state's investments fund) and is secured by certain assets of LiqTech Systems such as receivables, inventory and equipment.

NOTE 10 - LEASES

Operating Leases -- The Company leases office and production facilities under operating lease agreements expiring in March 2021, August 2018, and May 2018. In some of these lease agreements, the Company has the right to extend.

The future minimum lease payments for non-cancelable operating leases having remaining terms in excess of one year as of September 30, 2017 are as follows:

Lease expense charged to operations was $481,001 and $559,755 for the nine months ended September 30, 2017 and 2016, respectively.

Capital Leases -- The Company leases equipment on various variable rate capital leases currently calling for monthly payments of approximately $661 and $595 expiring through July 2018. Included in property and equipment, at September 30, 2017 and December 31, 2016, the Company had recorded equipment on capital lease at $1,267,773 and $1,240,358, respectively, with related accumulated depreciation of $1,230,832 and $1,126,550, respectively. 

During the nine months ended September 30, 2017 and 2016 depreciation expense for equipment on capital leases amounted to $39,445, and $103,219, respectively, and has been included in depreciation expense. During the nine months ended September 30, 2017 and 2016, interest expense on a capital lease obligation amounted to $6,216 and $13,770, respectively. 

The following represents future minimum capital lease payments as of September 30, 2017: 

NOTE 11 - AGREEMENTS AND COMMITMENTS

401(K) Profit Sharing Plan -- LiqTech NA has a 401(k) profit sharing plan and trust covering certain eligible employees. The amount LiqTech NA contributes is discretionary. For the nine months ended September 30, 2017 and 2016, matching contributions were expensed and totaled $8,636 and $9,291, respectively.

Contingencies -- From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business.

On September 9, 2014, Mr. Raffaele Bruno Tronchetti Provera (“Plaintiff”), the 60% owner of LiqTech Italy s.r.l. (the “Venture”), sued LiqTech International A/S, the 40% owner of the Venture (“Defendant”), 750,000 Euros before the Court of Como, Italy alleging, among other things, that certain products provided by Defendant to the Venture were defective.  As of August 14, 2017, the case is in the preliminary stages where the court has appointed an expert in order to verify the quality of the products in order to determine whether there is sufficient evidence to proceed.  An evaluation of the outcome will only be possible after the results of the court appointment expert are known. This outcome of the court appointment expert is expected to be reported during 2017. Defendant believes that the claims are without merit and intends to vigorously defend any litigation.

In connection with certain orders, we have to give the customer a working guarantee or a prepayment guarantee or security bond. For that purpose, we have a guarantee line of DKK 94,620 (approximately $15,000 at September 30, 2017) with a bank, subject to certain base limitations. As of September 30, 2017, we had DKK 94,620 (approximately $15,000 at September 30, 2017) in working guarantee against the line. 

NOTE 12 - INCOME TAXES

The Company accounts for income taxes in accordance with FASB ASC Topic 740, Accounting for Income Taxes, which requires the Company to provide a net deferred tax asset or liability equal to the expected future tax benefit or expense of temporary reporting differences between book and tax accounting and any available operating loss or tax credit carry forwards. The amount of and ultimate realization of the benefits from the deferred tax assets for income tax purposes is dependent, in part, upon the tax laws in effect, the Company’s future earnings, and other future events, the effects of which cannot be determined. In accordance with prevailing accounting guidance, the Company is required to recognize and disclose any income tax uncertainties. The guidance provides a two-step approach to recognizing and measuring tax benefits and liabilities when realization of the tax position is uncertain. The first step is to determine whether the tax position meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. Actual results could differ from these estimates.

As of September 30, 2017, the Company had net operating loss carryovers of approximately $10,857,383 for U.S. federal tax purposes expiring through 2036; approximately $8,645,417 for Danish tax purposes, which do not expire; approximately $491,212 for German tax purposes, which do not expire and approximately $637,307 for Singapore tax purposes which do not expire.

As of September 30, 2017 and December 31, 2016, the Company established a valuation allowance of $3,491,779 and $3,542,000 for the tax components of LiqTech International Inc. and Liqtech NA, respectively, $2,116,505 and $1,095,000 for the tax components of LiqTech International AS and LiqTech Systems, respectively, $137,000 and $122,000 for the tax component of LiqTech Germany and $108,000 and $97,000 for the tax component of LiqTech Singapore as management could not determine that it was more than likely not that sufficient income could be generated by these components to realize the resulting net operating loss carry forwards and other deferred tax assets of these components.

The Company is not relying on the reversal of deferred tax liabilities to realize the deferred tax assets. The same variable used by the Company in evaluating goodwill for impairment was used in assessing the realization of deferred tax assets (See Note 7).

The temporary differences, tax credits and carry forwards gave rise to the following deferred tax asset (liabilities) at September 30, 2017 and December 31, 2016:  

A reconciliation of income tax expense at the federal statutory rate to income tax expense at the Company’s effective rate is as follows for the nine months ended September 30, 2017 and 2016: 

The components of income tax expense (benefit) from continuing operations for the nine months ended September 30, 2017 and 2016 consisted of the following:

Deferred income tax expense / (benefit) results primarily from the reversal of temporary timing differences between tax and financial statement income. 

The Company files Danish, U.S. federal and Minnesota state income tax returns. LiqTech International AS is generally no longer subject to tax examinations for years prior to 2012 for their Danish tax returns. LiqTech NA is generally no longer subject to tax examinations for years prior to 2013 for U.S. federal and U.S. states tax returns. 

NOTE 13 - INCOME (LOSS) PER SHARE

The following data shows the amounts used in computing earnings per share and the effect on income and the weighted average number of shares of potential dilutive common stock for the nine months ended September 30, 2017 and 2016:

For the nine months ended September 30, 2017, Parent had 455,000 options outstanding to purchase shares of common stock of Parent at $0.74 to $1.01 per share and Parent had 700,000 warrants outstanding to purchase shares of common stock of Parent at $0.81 to $1.65 per share, which were not included in the loss per share computation because their effect would be anti-dilutive.

For the nine months ended September 30, 2016, Parent had 1,046,000 options outstanding to purchase shares of common stock of Parent at $0.74 to $1.90 per share and Parent had 7,325,575 warrants outstanding to purchase shares of common stock of Parent at $0.81 to $4.06 per share, which were not included in the loss per share computation because their effect would be anti-dilutive.

NOTE 14 - STOCKHOLDERS' EQUITY

Common Stock -- Parent has 100,000,000 authorized shares of common stock, $0.001 par value. As of September 30, 2017 and December 31, 2016, respectively, there were 44,229,264 and 36,835,514 common shares issued and outstanding.      

Voting -- Holders of Parent common stock are entitled to one vote for each share held of record on each matter submitted to a vote of stockholders, including the election of directors, and do not have any right to cumulate votes in the election of directors. 

Dividends -- Subject to the rights and preferences of the holders of any series of preferred stock which may at the time be outstanding, holders of Parent common stock are entitled to receive ratably such dividends as our Board of Directors from time to time may declare out of funds legally available.  

Liquidation Rights -- In the event of any liquidation, dissolution or winding-up of affairs of Parent, after payment of all of our debts and liabilities and subject to the rights and preferences of the holders of any outstanding shares of any series of our preferred stock, the holders of Parent common stock will be entitled to share ratably in the distribution of any of our remaining assets.   

Other Matters -- Holders of Parent common stock have no conversion, preemptive or other subscription rights, and there are no redemption rights or sinking fund provisions with respect to the common stock. All of the issued and outstanding shares of common stock on the date of this report are validly issued, fully paid and non-assessable. 

Preferred Stock -- Our Board of Directors has the authority to issue Parent preferred stock in one or more classes or series and to fix the designations, powers, preferences and rights, the qualifications, limitations or restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any class or series, without further vote or action by the stockholders. The issuance of Parent preferred stock may have the effect of delaying, deferring or preventing a change in control of us without further action by the stockholders and may adversely affect the voting and other rights of the holders of common stock.

Common Stock Cancelation 

On December 31, 2016, the Company canceled 2,696,521 common shares of the previously issued common shares held in escrow issued in connection with the acquisition of all of the issued and outstanding capital stock of LiqTech Systems (formerly Provital Solutions A/S), as LiqTech Systems failed to meet 2014, 2015 and 2016 catchup gross revenue and EBITDA thresholds.

Common Stock Issuance  

On April 13, 2015, Parent issued an additional 100,000 shares of restricted stock valued at $75,000 for services provided and to be provided to a member of the Board of Directors. The Company will recognize the non-cash compensation of the award over the requisite service period, of which 33,333 shares vested on January 1, 2016, 33,333 shares will vest on January 1, 2017 and 33,334 shares will vest on January 1, 2018.

On January 2, 2016, Parent issued an additional 27,253 shares of restricted stock valued at $20,167 for services provided by the Board of Directors. The Company will recognize the non-cash compensation of the award over the requisite service period. The shares vested immediately.

On January 2, 2017, Parent issued an additional 93,750 shares of restricted stock valued at $60,000 for services provided by the Board of Directors. The Company will recognize the non-cash compensation of the award over the requisite service period. The shares vested immediately.

On May 19, 2017, Parent completed a private placement of its common stock. The Company issued 7,300,000 new shares at a price of $0.25 per share. The private placement was made directly by LiqTech and the Company plans to use the net proceeds of $1,825,000 for acceleration of its business in the marine scrubber industry.

For the nine months ended September 30, 2017 and 2016, the Company has recorded non-cash compensation expense of $78,750 and $58,250, respectively, relating to the vesting of restricted stock awards issued to the board of directors.   

Common Stock Purchase Warrants 

A summary of the status of the warrants outstanding at September 30, 2017 is presented below:

At September 30, 2017, the Company had zero non-vested warrants. We have recorded non-cash compensation expense of $13,225 for the nine months ended September 30, 2017 related to the warrants issued.

The exercise price of the warrants and the number of shares underlying the warrants are subject to adjustment for stock dividends, subdivisions of the outstanding shares of common stock and combinations of the outstanding shares of common stock. For so long as the warrants remain outstanding, we are required to keep reserved from our authorized and unissued shares of common stock a sufficient number of shares to provide for the issuance of the shares of common stock underlying the warrants.

On February 15, 2016, the Company issued to LCL Finance Limited warrants to purchase 100,000 shares of common stock at an exercise price of $0.81 per share. The warrants are exercisable immediately and will remain exercisable until December 31, 2017.

Stock Options  

In August 2011, Parent’s Board of Directors adopted a Stock Option Plan (the “Plan”). Under the terms and conditions of the Plan, the Board of Directors is empowered to grant stock options to employees, officers, and directors of the Company. At September 30, 2017, 455,000 options were granted and outstanding under the Plan. 

The Company recognizes compensation costs for stock option awards to employees, during 2016, based on their grant-date fair value. The value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average assumptions used to estimate the fair values of the stock options granted using the Black-Scholes option-pricing model are as follows:

The Company recognized stock based compensation expense related to the options of $58,038 and $272,665 for the nine months ended September 30, 2017 and 2016, respectively. At September 30, 2017, the Company had approximately $28,206 of unrecognized compensation cost related to non-vested options expected to be recognized through December 31, 2025. 

A summary of the status of the options outstanding under the Plan at September 30, 2017 is presented below: 

A summary of the status of the options at September 30, 2017, and changes during the period are presented below:

At September 30, 2017, Parent had 216,667 non-vested options to purchase shares of Parent common stock with a weighted average exercise price of $0.74 and with a weighted average grant date fair value of $0.46, resulting in unrecognized compensation expense of $18,804, which is expected to be expensed over a weighted-average period of 0.5 years.

The total intrinsic value of options at September 30, 2017 was $0. Intrinsic value is measured using the fair market value at the date of exercise (for shares exercised) or at September 30, 2017 (for outstanding options), less the applicable exercise price.  

NOTE 15 - SIGNIFICANT CUSTOMERS / CONCENTRATION

For the nine months ended September 30, 2017, our four largest customers accounted for approximately 13%, 12%, 9% and 5%, respectively, of our net sales (approximately 39% in total).

For the nine months ended September 30, 2016, the Company had two customers who account for 30% and 19%, respectively, of our net sales (approximately 49% in total).

The Company sells products throughout the world. Sales by geographical region are as follows for the three and nine months ended September 30, 2017 and 2016:

The Company’s sales by product line are as follows for the three and nine months ended September 30, 2017 and 2016:

NOTE 16 – SUBSEQUENT EVENTS

On November 14, 2017, the Parent effected a private placement of 1,617,503 shares of preferred stock (1 to 4 conversion rate) or 6,470,012 ordinary shares of its common stock at a per share price of $1.20 per preferred share for aggregate proceeds to Parent of $1,941,203.60. Immediately prior to the closing of the private placement, Parent had 44,229,264 of its common stock issued and outstanding, and after the issuance of the 1,617,503 shares of preferred stock in the private placement, or 14.63% equivalent shares of the total shares of common stock issued and outstanding immediately prior to effecting the private placement, Parent has 1,617,503 preferred shares and 44,229,264 common shares issued and outstanding as of the date of this Report. The private placement was completed pursuant to Rule 506 of Regulation D and/or Regulation S of the Securities Act. In connection with the private placement, each investor executed a subscription agreement, which contains customary representations and warranties of Parent and of each investor. The private placement was made directly by Parent and no underwriter or placement agent was engaged by Parent.

Except as set forth above, the Company's management reviewed material events through November 14, 2017 and there were no other subsequent events. 

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this quarterly report. In addition, the following discussion should be read in conjunction with our annual report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 30, 2017, and the financial statements and notes thereto. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Overview

We are a clean technology company that provides state-of-the-art technologies for gas and liquid purification by manufacturing ceramic silicon carbide filters. For more than a decade, we have developed and manufactured products of re-crystallized silicon carbide. We specialize in two business areas: ceramic membranes for liquid filtration and diesel particulate filters (DPFs) for the control of soot exhaust particles from diesel engines. We are phasing out the fabrication of kiln furniture for the refractory industry. Using nanotechnology, we develop proprietary products using patented silicon carbide technology. Our products are based on unique silicon carbide membranes which facilitate new applications and improve existing technologies. We market our products from our offices in the United States and Denmark, and through local representatives. The products are shipped directly to customers from our production facilities in the United States and Denmark.

The terms “LiqTech”, “we”, “our”, “us”, the “Company” or any derivative thereof, as used herein refer to LiqTech International, Inc., a Nevada corporation, together with its direct and indirect wholly owned subsidiaries, including LiqTech USA, Inc., a Delaware corporation (“LiqTech USA”), which owns all of the outstanding equity interest in LiqTech International A/S, a Danish limited company, organized under the Danish Act on Limited Companies of the Kingdom of Denmark (“LiqTech Int. DK”), together with its direct wholly owned subsidiary LiqTech Systems A/S, a Danish limited company, organized under the Danish Act on Limited Companies of the Kingdom of Denmark (“LiqTech Systems”) and LiqTech NA, Inc., a Delaware corporation (“LiqTech Delaware”). Collectively, LiqTech USA, LiqTech Int. DK, LiqTech Systems and LiqTech Delaware are referred to herein as our “Subsidiaries”.  

We conduct operations in the Kingdom of Denmark and the United States. Our Danish operations are located in the Copenhagen area and in Hobro in Jutland, Denmark, and our U.S. operations are conducted by LiqTech Delaware located in White Bear Lake, Minnesota.

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 limited cash and incurred significant recent losses raising substantial doubt about the ability of the Company to continue as a going concern. 

Our Strategy

Our strategy is to create stockholder value by leveraging our competitive and strengths and focusing on the opportunities in the end-markets we serve. Key features of our strategy include:

Developments

Signed Contracts

On January 5, 2017, we announced that we and Grundfos Biobooster A/S (Grundfos) have signed a framework agreement for the delivery of silicon carbide ceramic discs. The agreement has a minimum value of $450,000 and an initial term of 2 years. The ceramic discs will be used in Grundfos´s Ultra Filtration systems for water re-use.

On January 17, 2017, we announced that we had received a $120,000 order for the Company´s water treatment systems for flue gas condensate. The order was received from Tjæreborg Industri A/S, a Danish company who specializes in the development and manufacturing of equipment for power plants. The system has been installed at Uldum Varmeværk, Denmark in 2017.

On March 1, 2017, we announced that due to regulatory issues it has not been feasible for Hunan Yonker Investment Group (Yonker) to complete the agreed investment in LiqTech before the deadline of February 28, 2017. The parties amended the Investment Agreement and the deadline for completion of the US$4,000,000 investment in LiqTech was extended to April 15, 2017, however Yonker subsequently informed the Company that the National Development and Reform Commission (NDRC) was still reviewing and verifying the submitted documents.

On April 17, 2017, we announced that we had received a $480,000 order for the Company´s standardized systems for treatment of waste water from marine scrubbers.

On April 17, 2017, we announced that we had been informed by Hunan Yonker Investment Group (Yonker) that they had completed the mandatory due diligence process related to earlier announced USD 4 million investment in LiqTech.

Yonker further confirmed that the final application has been submitted to the National Development and Reform Commission (NDRC) and now awaits the formal approval.

On May 15, 2017, we announced that we had received a $380,000 order for the Company´s system for treatment of waste water from marine scrubbers. The order is from a new customer and includes an option for further two systems.

On May 19, 2017, we announced that we had received subscription agreements for 7,300,000 new shares at a price of $0.25 per share. The private placement was made directly by LiqTech and the Company plans to use the net proceeds of $1,825,000 million for acceleration of its business in the marine scrubber industry.

On June 8, 2017, we announced that we had been informed by Hunan Yonker Investment Group (Yonker) that its application for a USD 4 million investment in LiqTech has been declined by the National Development and Reform Commission (NDRC).

On June 14, 2017, we announced that we had received a $290,000 order for the Company´s system for treatment of waste water from marine scrubbers.

On August 28, 2017, we announced that we had received two new orders for the Company's systems for treatment of waste water from marine scrubbers.

Results of Operations

The financial information below is derived from our unaudited condensed consolidated financial statements included elsewhere in this report. 

The following table sets forth our revenues, expenses and net income for the three months ended September 30, 2017 and 2016:  

Comparison of the Three Months Ended September 30, 2017 and September 30, 2016
 

Revenues 

Net sales for the three months ended September 30, 2017 were $2,456,484 compared to $3,689,511 for the same period in 2016, representing a decrease of $1,233,027 or 33.4%. The decrease in sales consisted of a decrease in sales of liquid filters and systems of $826,103, a decrease in sales of DPFs of $230,005 and a decrease in sales of kiln furniture of $176,919. The decrease in demand for our liquid filters and systems is mainly due to a delay in certain business opportunities compared to the same period last year where various projects were realized. The decrease in demand for our DPFs is mainly due to a decrease in market activity in general compared to the same period last year. The decrease in demand for our kiln furniture is due to the decision that we will not focus on this product line anymore and expect very limited activity going forward.

Gross Profit

Gross loss for the three months ended September 30, 2017 was $315,967 compared to a gross profit of $386,469 for same period in 2016, representing a decrease of $702,436 or 181.8%. The decrease in gross profit was due to low sales activity compared to our fixed cost of goods sold. Included in gross profit is depreciation of $268,872 and $325,990 for the three months ended September 30, 2017 and 2016, respectively.

Expenses

Total operating expenses for the three months ended September 30, 2017 were $1,100,730 representing a decrease of $184,314 or 14.3%, compared to $1,285,044 for the same period in 2016. This decrease in operating expenses is attributable to an decrease in selling and marketing expenses of $36,478, or 6.5%, a decrease in general and administrative expenses of $64,990, or 13.0%, a decrease in non-cash compensation expenses of $80,361, or 77.0% and a decrease in research and development expenses of $2,485, or 2.0%, compared to the same period in 2016.   

Selling expenses for the three months ended September 30, 2017 were $521,627 compared to $558,105 for the same period in 2016, representing a decrease of $36,478, or 6.5%. This decrease is attributable to a cost reduction in selling expenses in general and a centralization of the sales structure for the three months ending September 30, 2017 compared to the same period in 2016.

General and administrative expenses for the three months ended September 30, 2017 were $433,368 compared to $498,358 for the same period in 2016, representing a decrease of $64,990, or 13.0%. This decrease is attributable to a general cost reduction in general and administrative expenses for the three months ending September 30, 2017 compared to the same period in 2016.

Non-cash compensation expenses for the three months ended September 30, 2017 were $24,055 compared to $104,416 for the same period in 2016, representing a decrease of $80,361, or 77.0%. This decrease is attributable to decreased non-cash compensation expense for options, shares and warrants for services performed granted to directors, employees and management compared to the same period in 2016.

The following is a summary of our non-cash compensation: 

Research and development expenses for the three months ended September 30, 2017 were $121,680 compared to $124,165 for the same period in 2016, representing a decrease of $2,485, or 2.0%. This decrease is attributable to a cost reduction in research and development expenditures in general for the three months ending September 30, 2017 compared to the same period in 2016.

Net Income

Net loss for the three months ended September 30, 2017 was a loss of $1,479,425 compared to a loss of $937,628 for the comparable period in 2016, representing an increase of $541,797, or 57.8%. This increase was primarily attributable to lower gross profit for the three months ending September 30, 2017 compared to the same period in 2016. This was partially offset by a decrease in total operating expenses for the three months ending September 30, 2017 compared to the same period in 2016.

Comparison of the Nine Months Ended September 30, 2017 and September 30, 2016
 

Revenues 

Net sales for the nine months ended September 30, 2017 were $8,350,758 compared to $11,338,817 for the same period in 2016, representing a decrease of 2,988,059 or 26.4%. The decrease in sales consisted of a decrease in sales of liquid filters and systems of $4,195,253, a decrease in sales of kiln furniture of $151,609 offset by an increase in sales of DPFs of $1,358,803. The decrease in demand for our liquid filters and systems is mainly due to a delay in certain business opportunities compared to the same period last year where various projects were realized. The increase in demand for our DPFs is mainly due to an increase in market activities compared to the same period last year. The decrease in demand for our kiln furniture is due to the decision that we will not focus on this product line anymore and expect very limited activity going forward.

Gross Profit

Gross profit for the nine months ended September 30, 2017 was $148,124 compared to a gross profit of $2,260,781 for same period in 2016, representing a decrease of $2,112,657 or 93.4%. The decrease in gross profit was due to lower sales activity in general, lower gross margin and due to lower sales activity for our liquid filters and systems, which historically have a higher gross margin, compared to the same period in 2016. Included in gross profit is depreciation of $732,963 and $995,687 for the nine months ended September 30, 2017 and 2016, respectively.

Expenses

Total operating expenses for the nine months ended September 30, 2017 were $3,550,343 representing a decrease of $795,143 or 18.3%, compared to $4,345,486 for the same period in 2016. This decrease in operating expenses is attributable to a decrease in selling and marketing expenses of $154,983, or 9.3%, a decrease in general and administrative expenses of $311.325, or 17.0%, a decrease in non-cash compensation expenses of $227,127, or 60.2% and a decrease in research and development expenses of $101,708, or 21.3%, compared to the same period in 2016.   

Selling expenses for the nine months ended September 30, 2017 were $1,506,369 compared to $1,661,352 for the same period in 2016, representing a decrease of $154,983, or 9.3%. This decrease is attributable to a cost reduction in selling expenses in general and a centralization of the sales structure for the nine months ending September 30, 2017 compared to the same period in 2016.

General and administrative expenses for the nine months ended September 30, 2017 were $1,518,935 compared to $1,830,260 for the same period in 2016, representing a decrease of $311,325, or 17.0%. This decrease is attributable to a general cost reduction in general and administrative expenses for the nine months ending September 30, 2017 compared to the same period in 2016. 

Non-cash compensation expenses for the nine months ended September 30, 2017 were $150,013 compared to $377,140 for the same period in 2016, representing a decrease of $227,127, or 60.2%. This decrease is attributable to decreased non-cash compensation expense for options, shares and warrants for services performed granted to directors, employees and management compared to the same period in 2016.

The following is a summary of our non-cash compensation: 

Research and development expenses for the nine months ended September 30, 2017 were $375,026 compared to $476,734 for the same period in 2016, representing a decrease of $101,708, or 21.3%. This decrease is attributable to a cost reduction in research and development expenditures in general for the nine months ending September 30, 2017 compared to the same period in 2016. 

Net Income

Net loss for the nine months ended September 30, 2017 was a loss of $3,505,090 compared to a loss of $5,020,699 for the comparable period in 2016, representing a decrease in net loss of $1,515,609, or 30.2%. This decrease in net loss was primarily attributable to a tax expense of $2,868,286 in 2016 and a decrease in total operating expenses offset by a decrease in gross profit compared to same period in 2016.

Liquidity and Capital Resources 

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 limited cash and incurred significant recent losses raising substantial doubt about the ability of the Company to continue as a going concern.   

We have historically satisfied our capital and liquidity requirements through offerings of equity instruments, internally generated cash from operations and our available lines of credit. At September 30, 2017, the Company did not have any available lines of credit with any lender. At September 30, 2017, we had cash of $528,566 and working capital of $2,816,713 and at December 31, 2016, we had cash of $1,208,650 and working capital of $3,497,578. At September 30, 2017, our working capital decreased by $680,865 compared to December 31, 2016. Total current assets were $8,065,285 and $8,506,321 at September 30, 2017 and at December 31, 2016, respectively, and total current liabilities were $5,248,572 and $5,008,743 at September 30, 2017 and at December 31, 2016, respectively. 

On May 19, 2017, the Parent completed a private placement of 7,300,000 shares of its common stock at a per share price of $0.25 for aggregate proceeds to Parent of $1,825,000. Immediately prior to the closing of the private placement, Parent had 36,929,264 of its common stock issued and outstanding, and after the issuance of the 7,300,000 shares of common stock in the private placement, or 19.8% of the total shares of common stock issued and outstanding immediately prior to the closing of the private placement, Parent has 44,229,264 shares issued and outstanding as of the date of this Report. The private placement was completed pursuant to Section 4(a)(2) of the Securities Act and/or Regulation S promulgated under the Securities Act. In connection with the private placement, each investor executed a subscription agreement, which contains customary representations and warranties of Parent and of each investor. The private placement was made directly by Parent and no underwriter or placement agent was engaged by Parent.

On November 14, 2017, the Parent effected a private placement of 1,617,503 shares of preferred stock (1 to 4 conversion rate) or 6,470,012 ordinary shares of its common stock at a per share price of $1.20 per preferred share for aggregate proceeds to Parent of $1,941,203.60. Immediately prior to the closing of the private placement, Parent had 44,229,264 of its common stock issued and outstanding, and after the issuance of the 1,617,503 shares of preferred stock in the private placement, or 14.63% equivalent shares of the total shares of common stock issued and outstanding immediately prior to effecting the private placement, Parent has 1,617,503 preferred shares and 44,229,264 common shares issued and outstanding as of the date of this Report. The private placement was completed pursuant to Rule 506 of Regulation D and/or Regulation S of the Securities Act. In connection with the private placement, each investor executed a subscription agreement, which contains customary representations and warranties of Parent and of each investor. The private placement was made directly by Parent and no underwriter or placement agent was engaged by Parent.

In connection with certain orders, we have to give the customer a working guarantee or a prepayment guarantee or security bond. For that purpose, we have a guarantee credit line of DKK 94,620 (approximately $15,000 at September 30, 2017) with a bank, subject to certain base limitations. As of September 30, 2017, we had DKK 94,620 (approximately $15,000) in working guarantee against the line. This line of credit is guaranteed by Vækstfonden (the Danish state's investments fund) and is secured by certain assets of LiqTech Systems such as receivables, inventory and equipment.

We will need additional funds to sustain our business. We may raise such funds from time to time through public or private sales of equity or debt securities. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could materially adversely impact our financial condition and results of operations. Additional equity financing may be dilutive to holders of our common stock, and debt financing, if available, may involve significant cash payment obligations and covenants that restrict our ability to operate our business. In the event that the Company is unable to raise funds, there is substantial doubt about the ability of the Company to continue as a going concern.

Cash Flows 

Nine months ended September 30, 2017 Compared to nine months ended September 30, 2016

Cash provided (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 nine months ended September 30, 2017 was $2,700,581, representing an increase of $1,597,902 compared to cash used by operating activities of $1,102,679 for the nine months ended September 30, 2016. The $1,597,902 increase in cash used by operating activities for the nine months ended September 30, 2017 was mainly due to a loss of $3,505,090 adjusted for no cash items, an increase of $478,879 in accounts receivable and a decrease of $202,066 in long-term contracts. This was partially offset by a decrease of $238,986 in inventory, an increase of $27,657 in accounts payable and an increase of $340,371 in accrued expenses.

The increase in in accounts receivable, the increase in accrued expenses, the increase in accounts payable, the decrease in inventory and the decrease in long-term, were all due to normal variations in the ordinary course of business.

Cash used in investing activities was $82,123 for the nine months ended September 30, 2017, as compared to cash used in investing activities of $129,411 for the nine months ended September 30, 2016. Cash used in investing activities decreased by $47,288 for the nine months ended September 30, 2017, compared to the nine months ended September 30, 2016. This decrease was due to a period over period decrease of $34,461 in the purchase of property and proceeds from sale of property and equipment of $12,827.

Cash provided by financing activities was $1,707,690 for the nine months ended September 30, 2017, as compared to cash used by financing activities of $133,776 for the nine months ended September 30, 2016. This change of $1,841,466 in cash provided by financing activities for the nine months ended September 30, 2017, compared to 2016, was mainly due to cash received in connection with the private placement on May 19, 2017 where the Company raised $1,825,000 with no offering costs issuing 7,300,000 shares of common stock.

Off Balance Sheet Arrangements

As of September 30, 2017, we had no off-balance sheet arrangements other than normal operating leases. We are not aware of any material transactions, which are not disclosed in our consolidated financial statements. 

Operating Leases -- The Company leases office and production facilities under operating lease agreements expiring in March 2021, August 2018, May 2018, and September 2017, In some of these lease agreements, the Company has the right to extend.

The future minimum lease payments for non-cancelable operating leases having remaining terms in excess of one year as of September 30, 2017 are as follows:

Significant Accounting Policies and Critical Accounting Estimates

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:

Recently Enacted Accounting Standards

For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see “Note 1: Recently Enacted Accounting Standards” in the accompanying Financial Statements.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable. 

ITEM 4.  CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

Our management, under supervision and with the participation of both of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) and 15-d-15(e)) as of the end of the period covered by this report (the “Evaluation Date”). Based upon that evaluation, both of our Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

We do not expect that our disclosure controls and procedures will prevent all errors and all instances of fraud. Disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Further, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and the benefits must be considered relative to their costs. Because of the inherent limitations in all disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that we have detected all our control deficiencies and instances of fraud, if any. The design of disclosure controls and procedures also is based partly on 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.　

(b) Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 1A. RISK FACTORS

Not required for a “smaller reporting company.”  

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 

None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

 None.

ITEM 4.    MINE SAFETY DISCLOSURES

 None.  

ITEM 5.    OTHER INFORMATION

On November 14, 2017, the Parent effected a private placement of 1,617,503 shares of preferred stock (1 to 4 conversion rate) or 6,470,012 ordinary shares of its common stock at a per share price of $1.20 per preferred share for aggregate proceeds to Parent of $1,941,203.60. Immediately prior to the closing of the private placement, Parent had 44,229,264 of its common stock issued and outstanding, and after the issuance of the 1,617,503 shares of preferred stock in the private placement, or 14.63% equivalent shares of the total shares of common stock issued and outstanding immediately prior to effecting the private placement, Parent has 1,617,503 preferred shares and 44,229,264 common shares issued and outstanding as of the date of this Report. The private placement was completed pursuant to Rule 506 of Regulation D and/or Regulation S of the Securities Act. In connection with the private placement, each investor executed a subscription agreement, which contains customary representations and warranties of Parent and of each investor. The private placement was made directly by Parent and no underwriter or placement agent was engaged by Parent.