LIQTECH INTERNATIONAL INC - Annual Report: 2019 (Form 10-K)

PART I

Forward Looking Statements

Certain statements made in this Annual Report on Form 10-K 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 Annual 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.   

Overview

LiqTech International, Inc. is a clean technology company that provides state-of-the-art products 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. Using nanotechnology, we develop proprietary products using patented silicon carbide technology. Our products are based on unique silicon carbide membranes that facilitate new applications and improve existing technologies. We market our products from our offices in the United States and Denmark, and through local representatives and distributors. 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 subsidiaries LiqTech Systems A/S (“LiqTech Systems”) and BS Plastic A/S (“BS Plastic”), two Danish limited companies, organized under the Danish Act on Limited Companies of the Kingdom of Denmark and LiqTech NA, Inc., a Delaware corporation (“LiqTech Delaware”). Collectively, LiqTech USA, LiqTech Int. DK, LiqTech Systems, BS Plastic 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, in Hobro and in Aarhus, and our U.S. operations are conducted in White Bear Lake, Minnesota.

Our Products

We manufacture and sell ceramic membranes and systems for the filtration of liquids and diesel particulate filters for the control of soot exhaust particles from diesel engines. We also provide plastics parts through the recently acquired BS Plastics A/S for a variety of internal and external industrial applications. 

Ceramic Silicon Carbide Membranes for Liquid Filtration

Under the “LiqTech”, “Cometas” and “Provital” brand names, we manufacture and sell ceramic silicon carbide membranes and systems for liquid filtration using our patented silicon carbide technology (sometimes also referred to herein as our “SiC Filters”). Our currently focus is on marine scrubber wash water, hydrocarbon production-derived contaminated water, which we refer to herein as “produced water”, removal of heavy metals in mining and energy applications, pre-filtration for reverse osmosis in drinking water and other industrial applications.

Our SiC Filters have been used in the following applications by our clients:

Our products are based on the following silicon carbide membrane technologies:

Our SiC Filters are manufactured with a silicon carbide ceramic membrane based on patented technology. We are not aware of other companies that makes both the substrate (honeycomb) and the membrane (the part that accomplishes the filtering) solely from silicon carbide.

The advantages of our SiC Filters compared to other pre-filtration systems for reverse osmosis are:

Our SiC Filters offer consistent removal of oil and suspended solids at high throughput rates regardless of feed conditions. Our membranes are ideal for the treatment of scrubber wash water; produced water for discharge and re-injection, pre-reverse osmosis ("RO") as well as polymer flooded streams. We offer on shore and offshore solutions and have extensive experience with produced water streams for fracking, gas condensate, and oil emulsions. We believe our SiC filters are the best alternative to micro-flotation and walnut shell filters due to their cost savings, reduced installation cost, robustness and reduced downtime. Our chemically inert, plug-and-play filters are extremely hard, chemically resistant and durable ceramics with high flux (flow) to increase membrane life and reduce downtime for cleaning. SiC filters are stronger, harder, longer-lasting, more temperature-resistant and recover faster than conventional ceramic or polymeric membranes.

Our flat sheet membranes (“FSM”) offer low energy consumption, maximum permeation, innovative rack design and high flux. These membranes are used in drinking water, pre-RO, and industrial wastewater reuse applications. The FSM carrier and the selective layer are also made of silicon carbide, which gives the product unique advantages such as high flux, total chemical resistance (pH 0-14), long life and the lowest fouling tendency of any polymeric or ceramic membrane material. Our tubular membranes offer robust and high yield membrane solutions for produced water in the Oil & Gas market and industrial wastewater for removing suspended solids as well as oil droplets and oil emulsions from solutions. Our dynamic, high-flux membrane disks are designed for the removal of high suspended solids. The filtration path direction is outside-in, with internal permeation channels that facilitate removal of the solids. A crossflow effect is generated through the rotation of the discs at high velocities that enables flow cleaning of the filter membrane surface. This principle offers energy savings that can exceed 80% compared to conventional cross flow.

For the years ended December 31, 2019 and 2018, we received grants from governmental entities of $624,981 and $431,340, respectively.

For the years ended December 31, 2019 and 2018, our sales of liquid filters, services and systems were $25,464,614 and $5,264,663, respectively, and accounted for 78% and 43% of our total sales, respectively. 

Diesel Particulate Filters (DPFs)

We offer diesel particulate filters for exhaust emission control solutions to the verified retrofit and original equipment manufacturer (OEM) market through our direct sales force. DPF sales are generally made to distributors specializing in sales to end users. We use a proprietary “nano washcoat” to provide catalytic coating for anything from diesel particulate filters to catalytic converters. Our DPF products are sold worldwide under the LiqTech brand.

We have developed a robust silicon carbide diesel particulate filter that is especially effective for vehicles that produce a high soot load, and, if properly maintained, should last as long as the vehicle’s engine. Our DPFs are ideal for off-road vehicles because of their strength, chemical non-reactive nature, temperature resilience and thermal conductivity. 

Our DPF Filters can handle higher soot loads than filters that do not use a silicon carbide membrane, which makes them ideal for situations in which engines infrequently reach high enough temperatures to burn off soot. Examples include:

For the years ended December 31, 2019 and 2018, our sales of DPFs were $5,652,685 and $6,536,085, respectively, and accounted for 17% and 53% of our total sales, respectively.

Plastics

Plastics has been part of our offering since the acquisition of the Danish Company BS Plastic A/S on September 4, 2019. Plastics is providing machined and welded plastic parts used for the prepress, UV and aquaculture market segments.

For the year ended December 31, 2019 (4 months), our plastics revenues were $895,203 and accounted for 3% of our total sales.

Our Competitive Strengths

We believe the following strengths position us to increase our revenue and profitability:

Our Strategy 

Our strategy is to create stockholder value by leveraging our competitive strengths in silicon carbide filters and membranes through our focus on discrete applications in key end markets. Essential features of our strategy include:

Our Industry 

Overview

We serve primarily two industries: the liquid filtration system market and the diesel particle filter (DPF) market. Our goal is to leverage our products and technology into industrial liquid filtration applications that offer significant growth opportunity and to take advantage of favorable market trends.

Liquid Filtration Market

The market for marine water filtration systems is rapidly developing due to new regulations for sulphur and ballast water emissions. Industry experts estimate that 8,000-10,000 ships will be retrofitted with a scrubber water treatment system over the next five years. At the end of 2019, the industry statistics note that nearly 4,000 ships have installed or ordered scrubbers (according to DNV GL report March 2020), with most installations being open loop scrubbers.  Open loop scrubbers discharge the wash water directly into the sea.  The addressable market for LiqTech is focused on closed loop scrubbers, where the scrubber wash water is routed through the LiqTech filtration system to remove sulphur and other particulates, and the clean water is then recycled as wash water.

 As noted above, the use of open loop scrubbers to clean the exhaust from marine engines that use high sulphur residual oil and diesel fuels may lead to the discharge of high concentrations of harmful compounds in the waters from vessels using such scrubbers. Several trials have been conducted onboard vessels by scrubber suppliers to define the constituent concentrations in wash water discharge. The trials find that scrubber wash water also contains suspended solids, heavy metals, hydrocarbons and polycyclic aromatic hydrocarbons (PAHs). Before the scrubber wash water is discharged, it must be treated to remove solids. LiqTech’s water treatment systems can be used to remove the solids from wet scrubber wash water. The treatment process includes a pre-filtration step followed by a LiqTech SiC membrane filtration. Treated water quality is monitored (NTU, PAH and pH) before discharge. We believe that many of the open loop scrubbers already installed will eventually be converted to closed loop (where the LiqTech filtration system is employed), thus resulting in a significantly larger market for LiqTech. The Company is globally engaging with scrubber equipment suppliers, ship owner/operators and shipyards. Furthermore, we are presenting our water treatment and filtration solutions at marine conferences and trade shows.

In addition to our marine scrubbers, LiqTech offers packaged filtration systems consisting of ceramic SiC and conventional reverse-osmosis (RO) membranes for industrial and municipal customers. We anticipate that global demand will increase for robust and low operating expense products such as ours that are well-suited for mobile and modular systems. RO membranes are increasingly used for the production of drinking water (desalination of sea water or brackish water), demineralized water in industrial processes (boiler feed water, microelectronics production), as well as in food processing and pharmaceuticals production. In addition, many laboratories rely on pure water for which demineralization is an essential step. LiqTech is differentiated by what we believe is our superior SiC membrane technology and by being able to provide a complete water treatment system. According to Lux Research, an industry expert, the market size for membrane technologies in the water industry and the adoption of next-generation separations in municipal and industrial applications is expected to grow at a compound annual growth rate (CAGR) of 7.5%, from $8.1 billion in 2018 to $11.7 billion 2021.

We also see a general trend worldwide of increasing demand for higher-quality re-injection water in connection with unconventional oil and gas production. In addition, we see tightening water discharge legislation, increasing water usage (more water produced per barrel oil) and the introduction of Enhanced Oil Recovery (“EOR”) techniques. The tightening of produced water specifications is a problem for conventional treatment and filtration technologies; however, our SiC Filters have been shown to mitigate these challenges, and we believe the increasing demand represents a favorable market trend for our business.

Water is essential to life on earth, and clean water shortages are expected to affect half of the human population by 2025 (Worldwildlife). 29% of the human population is living today without clean water, and this is expected to increase to half of the population by 2025 due to the growing population (United Nations). According to the World Health Organization, approximately 2,200 children die every day due to unsafe water and the lack of basic sanitation. Due to the growing need for pure water for drinking and industrial purposes, the market for water filtration is growing rapidly, with more and larger plants being commissioned all over the world.

Diesel Particulate Filter (DPF) Market

The increase in global regulation of diesel engine exhaust particles is expected to drive growth in the DPF market. We expect jurisdictions in the United States to begin requiring DPF filters. In Europe, for example, cities in Germany are setting requirements for off-road machinery to include DPF filters. According to an industry publication (Diesel Particulate Filter – Global Market Outlook (2017-2026), the global market for new DPF filters manufactured by OEMs is expected to increase approximately 13% per year from 2017 to 2026. Diesel emissions consist of several toxic gases and particles: particulate matter (soot), carbon monoxide and hydrocarbons. Soot has been linked to a variety of health problems in humans. Reducing diesel emissions will have both health and social benefits, along with reduced costs.

In response to these health impacts, governments have been implementing legislation to regulate emissions from diesel engines. California implemented the Diesel Risk Reduction Plan, and New York City implemented binding directives for the retrofitting of buses, garbage trucks and construction machines. In the European Union, Directive EC 715/2007 of June 20, 2007 defined particle count limits for certain cars and light utility vehicles. Also in Europe, low emission zones have been implemented locally, creating a patchwork of regulation.

The Asian markets have shown economic growth and an improved standard of living that has led to increased sales of vehicles in the region. At the same time, pollution in major cities has reached high PM levels. As a result, the Chinese government have introduced additional regulations, including new emissions standards faster than previously anticipated. We also believe the high pollution levels will result in an increase in the need for the retrofitting of existing vehicles.

Manufacturing

We currently manufacture our DPF and membrane products in facilities located in Ballerup, Denmark and White Bear Lake, Minnesota. We assemble our water treatment systems in Hobro, Denmark. In 2019 we acquired BS Plastic A/S that manufactures its plastic products in facilities located in Aarhus, Denmark. We are planning to expand our production capacity, primarily through investment in additional equipment for our liquid filtration products.

Raw Materials

The main raw materials that we use in our manufacturing processes are silicon carbide, steel, plastic, platinum and palladium. We purchase these commodities from various sources generally based upon availability and price. There is a limited supply of silicon carbide available to us. As other industries develop products utilizing silicon carbide, we may not be able to obtain adequate supplies of silicon carbide required for the manufacture of our existing and planned future water filtration products. Any increased demand for silicon carbide, platinum or palladium could increase the price we must pay to obtain it and could adversely affect our profitability; however, management believes that we could obtain satisfactory substitutes for these materials should traditional sources become unavailable.

Sales, Marketing and Distribution 

Our products are sold primarily to large industrial customers for gas and liquid filtration. The Company sells through direct sale, systems integrators, distributors, agents and partners. 

The Company initially focused on selling its DPF filters to the automotive industry. In 2014, we acquired LiqTech Systems, a Danish filtration system manufacturing company, which enabled us to shift our focus to providing complete, modular liquid filtration systems. The Company’s liquid filtration systems business is now rapidly expanding, focusing on the marine industry and other industrial applications in mining, power generation, aquaculture, oil and gas, and other applications within the pool industry, water reclamation and drinking water. 

For the year ended December 31, 2019, our four largest customers accounted for approximately 29%, 18%, 15% and 7%of our net sales (approximately 68% in total). For the year ended December 31, 2018, our four largest customers accounted for approximately 10%, 9%, 6% and 5% of our net sales (approximately 31% in total). If we are unable to diversify our customer base, our future results will be heavily dependent on these same customers. 

We plan to actively market our existing products to new customers as we increase our production capacity. As of March 2020, we employed eleven (11) full time salespeople in addition to distribution agents. We promote our products through direct sales to potential customers and marketing activities such as participation in tradeshows and exhibitions.

In certain instances, our products are delivered to the end customer through systems integrators. These systems integrators use our filtration products in larger filtration systems, which eventually are installed in products used by the end customer. Due to legislative regulation, systems integrators are often required by end customers to receive approval for their systems, including the components used in such systems, which requires significant time and expense. As a result, we believe that certain of the systems integrators that use our products will not replace our filters with competitive products unless there are compelling reasons.

Intellectual Property

We have one issued patent in the United States that we co-own with a third party, two issued patents in Denmark, three issued foreign patents (Germany, China and South Korea) that we co-own with a third party and one pending European patent application that we co-own with a third party. The United States patent that we co-own is generally effective for 20 years from the filing date (July 8, 2004) of the earliest U.S. or international application to which it claims priority. The scope and duration of each of our foreign patents varies in accordance with local law. On July 7, 2014, we obtained a new Danish patent application related to the silicon carbide membrane technology in Denmark.

We also rely on trade secret protection for our confidential and proprietary information. Trade secrets, however, can be difficult to protect. We may not be able to maintain our technology or know-how as trade secrets, and competitors may develop or acquire equally valuable or more valuable technology or know-how related to the manufacture of comparable silicon carbide products. We also seek to protect our confidential and proprietary information, in part, by requiring all employees, consultants and business partners to execute confidentiality and/or nondisclosure agreements upon the commencement of any employment, consulting arrangement or engagement with us. These agreements generally require that all confidential and proprietary information developed by the employee, consultant or business partner, or made known to the employee, consultant or business partner by us, during the course of the relationship with us, be kept confidential and not disclosed to third parties.

We also believe that having distinctive names is an important factor in marketing our products and therefore use trademarks to brand some of our products. As of March 2020, we had one trademark registration in the United States (LiqTech NA) and four trademark registrations in the European Union (AQUA SOLUTION, CoMem, CDPX and FUTURE FILTRATION).

Government Regulation

We do not believe that we are subject to any special governmental regulations affecting our products in the countries in which we have operations, except that in Minnesota, we are required to comply with the Minnesota Air Pollution standards related to the use of our incinerators located in our Minnesota facility. We are subject to numerous health and safety laws and regulations. In the United States, these laws and regulations include the Federal Occupation Safety and Health Act and comparable state legislation. We are also subject to similar requirements in other countries in which we have extensive operations, including Denmark. We actively seek to maintain a safe, healthy and environmentally friendly workplace for all of our employees and those who work with us.

Environmental Matters

We are subject to a broad range of federal, state, local and foreign environmental laws and regulations that govern, among other things, air emissions, wastewater discharges and the handling, storage, disposal and release of waste and hazardous substances. It is our policy to comply with all applicable environmental requirements at each of our facilities. We are also subject to laws such as the Comprehensive Environmental Response, Compensation and Liability Act, which may impose liability retroactively and without fault for releases or threatened releases of hazardous substances at on-site or off-site locations. We are subject to similar requirements in Denmark and other European countries. From time to time, we have identified minor environmental compliance issues at our facilities. To date, compliance with environmental matters has not had a material effect upon the Company’s capital expenditures, results of operations or competitive position.

We believe that, due to the constant focus on the environment and clean air and clean water standards throughout the world, a requirement in the future to adhere to new and more stringent regulations both in the U.S. and abroad is likely as governmental agencies seek to improve standards required for certification of products intended to promote clean air and water. In the event our products fail to meet these changing standards, some or all of our products may become obsolete, which could have an adverse effect on our business, operating results, financial condition and long term prospects.

Research and Development

We have fifteen (15) full-time employees that spend a majority of their time on research and development. For the years ended December 31, 2019 and 2018, we spent $749,249 and $661,014, respectively, on research and development.

Competition 

Our products compete with other filters that are made using both ceramic and plastic membranes. Most of our competitors are large industrial companies; however, we believe our patented technology allows us to produce high-quality products that provide an advantage over many of our competitors, many of which that have greater financial, technological, manufacturing and personnel resources. We intend to continue to devote resources to developing new technologies and improving our products to retain our existing customers and to acquire new customers.

Employees

At December 31, 2019 we had 147 employees, 142 of whom were full-time employees. We have 133 employees at our operations in Denmark, including 85 in production, 20 in administration, 13 in research and development, 13 in sales and engineering and two in executive management. We also have 14 sales, accounting and production employees in the United States.

Certain employees in Denmark are represented by workers’ councils that have collective bargaining agreements. With the exception of such Danish employees, no other employees are members of a labor union or are represented by workers’ councils that have collective bargaining agreements. We believe that we have good relations with our employees.

Corporate Information

We filed our Articles of Incorporation on July 1, 2004 and are incorporated under the laws of the State of Nevada. Our principal executive office is located at Industriparken 22C, 2750 Ballerup, Denmark, and our telephone number is +45 4498 6000. We maintain an Internet website at www.liqtech.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reason-ably practicable after we electronically file with or furnish them to the SEC and are available in print to any stockholder who requests a copy.  The information contained in, or accessible from, our website is not a part of this Annual Report. 

Additionally, the SEC maintains a website that contains reports, proxy statements, information statements and other information regarding issuers, including us, that file electronically with the SEC at www.sec.gov.

Item 1A.   Risk Factors

RISKS RELATED TO OUR BUSINESS 

Historically, we have been dependent on a few major customers for a significant portion of our Company's revenue. Our revenue could decline if we are unable to maintain or develop relationships with additional customers and our results of operations could be adversely affected if any one of these customers is unable to meet their financial obligations to us.

For the year ended December 31, 2019, our four largest customers accounted for approximately 29%, 18%, 15% and 7% of our net sales (approximately 68% in total). For the year ended December 31, 2018, our four largest customers accounted for approximately 10%, 9%, 6% and 5% of our net sales (approximately 31% in total). If we are unable to diversify our customer base, our future results will be heavily dependent on these customers. Our dependence on a limited number of customers means that the loss of a major customer or any reduction in orders by a major customer would materially reduce our net sales and adversely affect our results of operations. We expect that sales to relatively few customers will continue to account for a significant percentage of our net sales for the foreseeable future; however, these customers or our other customers may not use our products at current levels in the future, if at all. We have no firm, long-term volume commitments from any of our major customers and we generally enter into individual purchase orders with our customers, in certain cases under master agreements that govern the terms and conditions of the relationship. We have experienced delays or cancellations of orders and fluctuations in order levels from period to period and expect that we will continue to experience such delays, cancellations and fluctuations in the future. Customer purchase orders may be delayed or cancelled, and order volume levels can be changed with limited or no penalties. We may not be able to replace cancelled, delayed or reduced purchase orders with new orders. If any one of these customers reduces its demand for our products, it will likely have a material adverse effect on our operations.

Furthermore, a significant portion of our accounts receivables is concentrated with a few major customers, who may not be able to meet their financial obligations to us. The failure of any such customers to pay amounts owed to us in a timely fashion or at all could have an adverse effect on our results of operations. The Company is also exposed to credit risk on its accounts receivable, and this risk is heightened during periods when economic conditions worsen. The Company's outstanding receivables are not covered by collateral or credit insurance. The Company's exposure to credit and collectability risk on its receivables may also be higher in certain international markets, and its ability to mitigate such risks may be limited. While the Company has procedures to monitor and limit exposure to credit risk on its receivables as well as long-term prepayments, there can be no assurance such procedures will effectively limit our credit risk and avoid losses.

We have global operations and face risks related to health epidemics that could impact our results of operations.

Our business could be adversely affected by the effects of a widespread outbreak of contagious disease, including the recent outbreak of respiratory illness caused by a novel coronavirus first identified in Wuhan, Hubei Province, China (COVID-19). Any outbreak of contagious diseases and other adverse public health developments could have a material and adverse effect on our business operations. These could include disruptions or restrictions on our ability to travel or to distribute our products, as well as temporary closures of our facilities or the facilities of our suppliers or customers. Any disruption of our suppliers or customers would likely impact our sales and operating results. In addition, a significant outbreak of contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could impact our operating results.

Adverse conditions or events affecting the marine transportation industries may have a material adverse effect on our business.

Global health crises, such as the outbreak of COVID-19, can significantly impact us and our customers and suppliers. For example, the global shipping industries have been negatively impacted by the coronavirus outbreak due to increased travel restrictions and may be further adversely affected by an extended shutdown of various businesses in the affected regions. In light of this operating environment, shipping companies that carry goods may begin to significantly reduce the number of seaborne vessels as measures to stop the spread of the coronavirus negatively impacts the demand for seaborne transport of goods. This in turn can adversely affect the demand for our marine scrubbers to these shipping customers if many vessels sit idle or are taken out of service during the outbreak.

Further, after OPEC and Russia failed to agree recent oil production cuts, Saudi Arabia sharply cut its oil production, causing the price of oil to significantly drop, which has corresponded with a drop of the price of fuel oil used by our marine customers, including low-sulfur fuel oil. The corresponding reduction in the price of low-sulfur fuel oil could negatively affect the demand for our marine scrubber systems, which allow our marine customers to use fuels with higher sulfer content that has historically been cheaper than low-sulfer fuel oil. A decrease in the demand for marine scrubbers to allow the use of heavy fuel oil under IMO 2020 could impact our sales of marine scrubbers and our operating results.

We may be adversely affected by global and regional economic conditions and legislative, regulatory and political developments.

We sell our products around the world, and we expect to continue to derive a substantial portion of sales from outside the U.S. The uncertain macroeconomic environment due to the outbreak of COVID-19 and other factors in the U.S. and other countries around the globe from which we derive significant sales may adversely affect our results and could have a negative impact on demand for our products. Customers or suppliers may experience cash flow problems and as a result, may modify, delay or cancel plans to purchase our products, and suppliers may significantly and quickly increase their prices or reduce their output. Additionally, if customers are not successful in generating sufficient revenue or are precluded from securing financing, they may not be able to pay, or may delay payment of, amounts owed to us. Any inability of current and/or potential customers to purchase our products and/or to pay us for our products may adversely affect our sales, earnings and cash flow. Sales and earnings could also be affected by our ability to manage the risks and uncertainties associated with the application of local legal requirements or the enforceability of laws and contractual obligations, trade protection measures, changes in tax laws, regional political instability, war, terrorist activities, severe or prolonged adverse weather conditions and natural disasters as well as health epidemics or pandemics.

Our success will depend, to a large degree, on the expertise and experience of the members of our management team, the loss of whom could have a material adverse effect on our business.

Our success is, to a large degree, dependent upon the expertise and experience of the management team and its ability to attract and retain qualified personnel who are technically proficient. The loss of the services of one or more of such personnel could have a material adverse effect on our business. Our business may be adversely affected if we are unable to continue to attract and retain such personnel.

We will need to add qualified additional personnel as we expand our business, and we may not be able to employ such persons, which could affect our ability to expand and have a material adverse effect on our business.

In order to expand our product offerings and customer base, we will need to hire additional qualified personnel. We may not be able to identify such persons, and even if we identify them, we may not have the funds or ability to employ them, which could have a material adverse effect on our business.

Future growth of our business depends in part, on the availability of funding for emissions control programs as well as the enforcement of existing emissions-related environmental regulations and further tightening of emission standards worldwide, all of which are beyond our control and the lack of which could negatively affect our future growth.

Future growth of our business depends in part on the availability of funding for emissions control programs, which can be affected by economic as well as political reasons that are beyond our control. For example, in light of a past budget crisis in California, funding was not available for a state-funded emissions control project and its start date was delayed. Funding for these types of emissions control projects drives the demand for our diesel particulate filters. If such funding is not available, or delayed, it can negatively affect our future growth prospects. In addition to funding, we also expect that our future business growth will be driven, in part, by the enforcement of existing emissions-related environmental regulations and tightening of emissions standards worldwide, where regulations and standards are frequently contested in litigation. For example, the Alliance for California Business filed suit against the California Air Resources Board in an effort to cease the California Air Resources Board’s mandate that a DPF be retrofitted on certain older diesel trucks. Likewise, our ability to expand our business in the marine industry is dependent on the effective implementation of IMO 2020, which requires the burning of low-sulfur oil for marine vessels or the inclusion of marine scrubber technology. If existing regulations and emissions standards do not continue to become stricter, are loosened or are not enforced by governmental authorities due to commercial and business pressure, economic conditions or otherwise, it could have a material adverse effect on our business, operating results, financial condition and long-term prospects.

If we are unable to manage our expected growth, our business may be materially and adversely affected.

We expect to expand our operations. The growth of our business could place significant strain on our management, operational and financial resources. To manage our future growth, we could be required to improve existing or implement new operational or financial systems, procedures and controls or expand, train and manage a growing employee base. Our failure to accomplish any of these tasks could materially and adversely affect our business.

We face constant changes in governmental standards by which our products are evaluated, and if we cannot meet any such changes, some of our products could become obsolete, which could have a material adverse effect on our business.

We believe that, due to the constant focus on the environment and clean air and water standards throughout the world, a requirement in the future to adhere to new and more stringent regulations both in the U.S. and abroad is possible as governmental agencies seek to improve standards required for certification of products intended to promote clean air and water. In the event our products fail to meet these ever-changing standards, some or all of our products may become obsolete, which could have an adverse effect on our business, operating results, financial condition and long-term prospects.

Our inability to protect our intellectual property rights could negatively affect our business and results of operations.

Our ability to compete effectively depends in part upon developing, maintaining and/or protecting intellectual property rights relevant to our re-crystallized silicon carbide product forms, applications and manufacturing processes. We rely principally on a combination of patent protection, trade secret laws, confidentiality and non-disclosure agreements, and trusted business relationships to establish, maintain and protect the intellectual property rights relevant to our business. These measures, however, may not be adequate in every given case to permit us to gain or keep any competitive advantage, particularly in those countries where the laws do not protect our proprietary rights as fully as in the United States. In particular, because silicon carbide is a well-known material (developed over 100 years ago), and there has been extensive research, development and publication related to this material and its wide range of applications, obtaining intellectual property rights to key elements of silicon carbide technology can be challenging. Accordingly, at least some of the technology employed in our manufacture of re-crystallized silicon carbide products is not protected by patents.

Where we consider it appropriate, we seek patent protection in the United States and other countries on technologies used in, or relating to, our re-crystallized silicon carbide product forms, applications and manufacturing processes. The issuance of a patent is not conclusive as to its scope, validity and enforceability. Thus, any patent or patent application which may issue into a patent held by us could be challenged, invalidated or held unenforceable in litigation or proceedings before the U.S. Patent and Trademark Office and/or other patent tribunals or circumvented by others. No consistent policy regarding the breadth of patent claims has emerged to date in the United States, and the landscape could become more uncertain in view of future rule changes by the United States Patent and Trademark Office, the introduction of patent reform legislation and decisions in patent law cases by United States federal courts. The patent landscape outside the United States is even less predictable. As a result, the validity and enforceability of patents cannot be predicted with certainty. In addition, we may fail to apply for patents on important technologies or product candidates in a timely fashion, if at all, and our existing and future patents may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products or technologies, especially given the long history of silicon carbide development. 

Our patent strategy involves complex legal and factual questions. Our ability to maintain and solidify our proprietary technology may depend in part upon our success in obtaining patent rights and enforcing those rights once granted or licensed. We do not know whether any of our pending patent applications will result in the issuance of any patents. Our issued patents and those that may be issued in the future may be challenged, invalidated, rendered unenforceable or circumvented, which could limit our ability to prevent competitors from marketing similar or related products, or shorten the term of patent protection that we may have for our products, processes and enabling technologies. In addition, the rights granted under any issued patents may not provide us with competitive advantages against competitors with similar technology. Furthermore, our competitors may independently develop similar technologies, duplicate technology developed by us or otherwise possess intellectual property rights that could limit our ability to manufacture our products and operate our business. 

We also rely on trade secret protection for our confidential and proprietary information. Trade secrets, however, can be difficult to protect. We may not be able to maintain our technology or know-how as trade secrets, and competitors may develop or acquire equally valuable or more valuable technology or know-how related to the manufacture of comparable silicon carbide products. We also seek to protect our confidential and proprietary information, in part, by requiring all employees, consultants and business partners to execute confidentiality and/or nondisclosure agreements upon the commencement of any employment, consulting arrangement or engagement with us. These agreements generally require that all confidential and proprietary information developed by the employee, consultant or business partner, or made known to the employee, consultant or business partner by us, during the course of the relationship with us, be kept confidential and not disclosed to third parties. These agreements may be breached and may not provide adequate remedies in the event of breach. To the extent that our employees, consultants or business partners use intellectual property owned by others in their work for and/or with us, disputes could arise as to the rights in related or resulting technologies, know-how or inventions. Moreover, while we also require customers and vendors to execute agreements containing confidentiality and/or nondisclosure provisions, we may not have obtained such agreements from all of our customers and vendors. In addition, our trade secrets may otherwise become known or be independently discovered by competitors, customers or vendors. Such customers or vendors may also be subject to laws and regulations that require them to disclose information that we would otherwise seek to keep confidential.

Moreover, others may independently develop and obtain patents covering technologies that are similar or superior to the product forms, applications or manufacturing processes that we employ. If that happens, we may need to obtain licenses for these technologies and may not be able to obtain licenses on reasonable terms, if at all, which could limit our ability to manufacture our future products and operate our business. In addition, third parties could utilize our intellectual property rights in territories where we do not have intellectual property protection. Such third parties may then try to import products made using our intellectual property rights into the United States or other countries, which could have a material adverse effect on our business.

Our contracts with third parties could negatively affect our intellectual property rights.

To further our product development efforts, we continue to work closely with customers, the Danish government and other third parties to research and develop advancements in silicon carbide product forms, applications, manufacturing processes and related products and technologies. We have entered into agreements with private third parties and have been awarded a research and development contract with the Danish government to independently and jointly research, design and develop new devices and systems that incorporate our silicon carbide technologies. We expect to enter into similar private agreements and be awarded similar government contracts in the future. In some instances, the research and development activities that we conduct under these contracts may produce intellectual property to which we may not have ownership or exclusive rights and will be unable to protect or monetize. Furthermore, there could be disputes between us and a private third party as to the ownership rights to any inventions that we develop in collaboration with such third party. Any such dispute may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management from our core business or harm our reputation. 

We could become subject to intellectual property litigation that could be costly, limit or cancel our intellectual property rights, divert time and efforts away from business operations, require us to pay damages and/or otherwise have an adverse material impact on our business.

The success of our business is highly dependent on protecting our intellectual property rights. Unauthorized parties may attempt to copy or otherwise obtain and use our products and/or enabling technology. Policing the unauthorized use of our intellectual property rights is difficult and expensive, as is enforcing these rights against unauthorized use by others. Identifying unauthorized use of our intellectual property rights is difficult because we may be unable to monitor the processes and/or materials being employed by other parties. The steps we have taken may not prevent unauthorized use of our intellectual property rights, particularly in foreign countries where enforcement of intellectual property rights may be more difficult than in the United States.

Our continued commercial success will also depend in part upon not infringing the patents or violating the intellectual property rights of third parties. We are aware of patents and patent applications generally relating to aspects of our technologies filed by, and issued to, third parties. Nevertheless, we cannot determine with certainty whether such patents or patent applications of other parties may materially affect our ability to conduct our business. There may be existing patents of which we are unaware that we may inadvertently infringe, resulting in claims against us or our customers. In the event that the manufacture, use and/or sale of our products or processes is challenged, or if our product forms or processes conflict with the patent rights of others, third parties could bring legal actions against us or our customers in the United States, Europe or other countries, claiming damages and seeking to enjoin the manufacturing and/or marketing of our products. Additionally, it is not possible to predict with certainty what patent claims may issue from any relevant third-party pending patent applications. Third parties may be able to obtain patents with claims relating to our product forms, applications and/or manufacturing processes which they could attempt to assert against us or our customers.

In either case, litigation may be necessary to enforce, protect or defend our intellectual property rights or to determine the validity and scope of the intellectual property rights of others. Any litigation could be unsuccessful, cause us to incur substantial costs, divert resources and the efforts of our personnel away from daily operations, harm our reputation and/or result in the impairment of our intellectual property rights. In some cases, litigation may be threatened or brought by a patent holding company or other adverse patent owner who has no relevant product revenues and against which our patents may provide little or no deterrence. If we are found to infringe any patents, we could be required to (1) pay substantial monetary damages, including lost profits, reasonable royalties and/or treble damages if an infringement is found to be willful and/or (2) totally discontinue or substantially modify any products or processes that are found to be in violation of another party’s intellectual property rights. If our competitors are able to use our technology without payment to us, our ability to compete effectively could be harmed.

We face competition and technological advances by competitors, which could adversely affect the sales of our products.

The growth of our Company depends in part on maintaining and growing the sales of our current products in existing and new markets, but also in developing new products and technologies. There is significant competition among companies that provide solutions for pollutant emissions from diesel engines and water purification solutions. Several companies market products that compete directly with our products. Other companies offer products that potential customers may consider to be acceptable or superior alternatives to our products and services, including products that are verified by the Environmental Protection Agency or other environmental authorities. We face direct competition from companies with greater financial, technological, manufacturing and personnel resources. Newly developed products could be more effective and cost-efficient than our current or future products.

Failure to obtain adequate supplies of raw materials or failure to obtain raw materials at affordable prices could negatively affect our ability to supply products to our customers and negatively affect our profit margins.

We use silicon carbide, steel, plastic, platinum and palladium in the manufacture of our products. As other industries develop products utilizing silicon carbide, we may not be able to obtain adequate supplies of silicon carbide required for the manufacture of our existing and planned water filtration products that would prevent us from supplying products to our customers and materially affect our business. Furthermore, any increased demand for, the raising of tariff rates on, or an increase of non-tariff trade barriers that apply to silicon carbide, steel, plastic, platinum or palladium could increase the price we must pay to obtain it and could adversely affect our profitability, which would have an adverse effect on our financial results.

We may rely on sub-contractors to meet current demand for our products and we may need to obtain additional manufacturing capacity in order to increase production of our existing products or to produce our proposed new products, the failure of which could have a material adverse effect on our operations.

We may not have sufficient internal manufacturing capacity to meet the current demand for our products, and we may need to rely on subcontractors to enable us to meet this demand. Since we may rely on our subcontractors for a significant amount of our production capacity, the loss of the services of our subcontractors would have a material adverse effect on our business. Our plans for the growth of our business rely upon increasing sales of our existing products and systems and developing and marketing new products. We may not have adequate internal manufacturing facilities to substantially increase production of our products and obtaining additional manufacturing capacity in-house could require substantial capital expenditures. We may not be able to locate such additional facilities, and, if located, we may not have the capital resources to obtain or construct them, which could have a material adverse effect on our operations.

Our results may fluctuate due to certain regulatory, marketing and competitive factors over which we have little or no control.

The factors listed below, some of which we cannot control, may cause our revenue and results of operations to fluctuate significantly:

Any significant fluctuations in our revenue or results of operations could negatively impact investor confidence and shares of our common stock may trade at prices significantly below the price paid to acquire them. Furthermore, declines in the price of our common stock may adversely affect our ability to conduct future offerings or to recruit and retain key employees, including our management team and other key professional employees.

Foreign currency fluctuations could adversely impact financial performance.

Our reporting currency is the United States Dollar ($). Because of our activities in Denmark, the European Continent and other countries, we are exposed to fluctuations in foreign currency rates. We may manage the risk to such exposure by entering foreign currency futures and option contracts; however, we can make no assurance that such actions will be sufficient to offset a material adverse effect on our operations in the future. As at December 31, 2019 and 2018 we have not entered into any derivate contracts to hedge our currency exposure.

Any liability for environmental harm or damages resulting from technical faults or failures of our products could be substantial and could materially adversely affect our business and results of operations.

Customers rely upon our products to meet emissions control standards imposed upon them by the government. Failure of our products to meet such standards could expose us to claims from customers. Our products are also integrated into goods used by consumers, and therefore a malfunction or the inadequate design of our products could result in product liability claims. Any liability for environmental harm or damages resulting from technical faults or failures could be substantial and could materially adversely affect our business and results of operations. In addition, a well-publicized actual or perceived problem could adversely affect the market’s perception of our products, which would materially impact our financial condition and operating results.

We could become liable for damages resulting from our manufacturing activities, which could have a material adverse effect on our business or cause us to cease operations.

The nature of our manufacturing operations exposes us to potential claims and liability for environmental damage, personal injury, loss of life and damage to, or destruction of, property. Our manufacturing operations are subject to numerous laws and regulations that govern environmental protection and human health and safety. These laws and regulations have changed frequently in the past and it is reasonable to expect additional and more stringent changes in the future. Our manufacturing operations may not comply with future laws and regulations, and we may be required to make significant unanticipated capital and operating expenditures to bring our operations within compliance with such evolving regulations. If we fail to comply with applicable environmental laws and regulations, manufacturing guidelines, and workplace safety requirements, governmental authorities may seek to impose fines and penalties on us or to revoke or deny the issuance or renewal of operating permits, and private parties may seek damages from us. Under such circumstances, we could be required to curtail or cease operations, conduct site remediation or other corrective action, or pay substantial damage claims for which may not have sufficient or any insurance coverage for claims.

A significant portion of our assets and the majority of our officers and some of our directors are located outside of the United States, and therefore it may be difficult for an investor to enforce within the United States any judgments obtained against us or such officers and directors.

A significant portion of our assets are located outside of the United States. In addition, the majority of our officers and some of our directors are nationals and/or residents of countries other than the United States, and all or a substantial portion of such persons’ assets are located outside the United States. As a result, it may be difficult for an investor to affect service of process or enforce within the United States any judgments obtained against us or such officers or directors, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state thereof. In addition, there is uncertainty as to whether the courts of other jurisdictions would recognize or enforce judgments of United States courts obtained against us or our directors and officers predicated upon the civil liability provisions of the securities laws of the United States or any state thereof, or be competent to hear original actions brought in other jurisdictions against us, or such officers and directors predicated upon the securities laws of the United States or any state thereof. 

We will continue to incur significant costs as a result of operating as a public company, and our management may be required to devote substantial time to compliance initiatives that ultimately could have a material adverse effect on our financial condition and results of operations.   

As a public company, we expect to continue to incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC, have imposed various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls as well as mandating certain corporate governance practices. Our management and other personnel will continue to devote a substantial amount of time and financial resources to these compliance initiatives.

Effective January 1, 2018, we are no longer an “emerging growth company” as defined in the Jumpstart our Business Startups Act of 2012, and as such we may no longer take advantage of certain exemptions from various reporting requirements that are applicable to other public companies, such as exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. This increased burden will further increase our compliance burden. As a “smaller reporting company” we are still able to take advantage of certain exceptions available to both emerging growth companies and smaller reporting companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and the exemption from providing a “Compensation Discussion and Analysis” section in our proxy statements; providing only three years of business information; and other “scaled” disclosure requirements that are less comprehensive than issuers that are not smaller reporting companies. 

 We previously elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(1) of the JOBS Act, which allowed us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. We are no longer entitled to this extended transition period, and as a result we may incur additional expenses and our management and other personnel may have to devote additional resources to compliance with such new or revised standards.

If we fail to staff our accounting and finance function adequately or maintain internal control systems adequate to meet the demands that are placed upon us as a public company, we may be unable to report our financial results accurately or in a timely manner and our business and stock price may suffer. The costs of being a public company, as well as diversion of management’s time and attention, may have a material adverse effect on our future business, financial condition and results of operations.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting.

We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. We are likewise required, on a quarterly basis, to evaluate the effectiveness of our internal controls and to disclose any changes and material weaknesses in those internal controls. In Item 9A, we disclose that with respect to the standards of Sarbanes-Oxley Section 404, the internal controls standard to which we were subjected, we reported material weaknesses in our internal controls over financial reporting. For additional information on this item, please see Item 9A. Controls and Procedures.

Although we believe our historical efforts have strengthened our internal control over financial reporting (and we concluded that our financial statements were reliable, notwithstanding the material weakness we reported), we cannot be certain that our revised internal control practices will ensure that we will have or maintain adequate internal control over financial reporting in future periods. Any failure to have or maintain such internal controls could adversely impact our ability to report our financial results accurately and on a timely basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations.

We may have risks associated with security of our information technology systems.

We make significant efforts to maintain the security and integrity of our information technology systems and data. Despite significant efforts to create security barriers to such systems, it is virtually impossible for us to entirely mitigate this risk. There is a risk of industrial espionage, cyber-attacks, misuse or theft of information or assets, or damage to assets by people who may gain unauthorized access to our facilities, systems, or information. Such cybersecurity breaches, misuse, or other disruptions could lead to the disclosure of confidential information, improper usage and distribution of our intellectual property, theft, manipulation and destruction of private and proprietary data, and production downtimes. Although we actively employ measures to prevent unauthorized access to our information systems, preventing unauthorized use or infringement of our rights is inherently difficult. These events could adversely affect our financial results and any legal action in connection with any such cybersecurity breach could be costly and time-consuming and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, we must frequently expand our internal information system to meet increasing demand in storage, computing and communication, which may result in increased costs. Our internal information system is expensive to expand and must be highly secure due to the sensitive nature of our customers’ information that we transmit. Building and managing the support necessary for our growth places significant demands on our management and resources. These demands may divert such resources from the continued growth of our business and implementation of our business strategy.

Our actual or perceived failure to adequately protect personal data could adversely affect our business, financial condition and results of operations.

A wide variety of provincial, state, national, foreign, and international laws and regulations apply to the collection, use, retention, protection, disclosure, transfer, and other processing of personal data. These privacy- and data protection-related laws and regulations are evolving, with new or modified laws and regulations proposed and implemented frequently and existing laws and regulations subject to new or different interpretations. Further, our legal and regulatory obligations in foreign jurisdictions are subject to unexpected changes, including the potential for regulatory or other governmental entities to enact new or additional laws or regulations, to issues rulings that invalidate prior laws or regulations, or to increase penalties significantly. Compliance with these laws and regulations can be costly and can delay or impede the development and offering of new products and services. 

For example, the General Data Protection Regulation, which became effective in May 2018, imposes more stringent data protection requirements, and provides for significantly greater penalties for noncompliance, than the European Union laws that previously applied. Additionally, California recently enacted legislation, the California Consumer Privacy Act, which became effective January 1, 2020. We may also be subject to additional obligations relating to personal data by contract that industry standards apply to our practices. Our actual or perceived failure to comply with applicable laws and regulations or other obligations to which we may be subject relating to personal data, or to protect personal data from unauthorized access, use, or other processing, could result in enforcement actions and regulatory investigations against us, claims for damages by customers and other affected individuals, fines, damage to our reputation, and loss of goodwill, any of which could have a material adverse effect on our operations, financial performance, and business. Further, evolving and changing definitions of personal data and personal information, including the classification of IP addresses, machine identification information, location data, and other information, may limit or inhibit our ability to operate or expand our business, including limiting business relationships and partnerships that may involve the sharing or uses of data, and may require significant costs, resources, and efforts in order to comply.

Changes in United States Generally Accepted Accounting Principles (“GAAP”) could adversely affect our financial results and may require significant changes to our internal accounting systems and processes.

We prepare our consolidated financial statements in conformity with GAAP. These principles are subject to interpretation by the Financial Accounting Standards Board (“FASB”), the SEC and various bodies formed to interpret and create appropriate accounting principles and guidance. The FASB periodically issues new accounting standards on a variety of topics. For information regarding new accounting standards, please refer to Note 1, “Description of Business and Significant Accounting Policies – Recent Accounting Pronouncements,” of the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K. These and other such standards generally result in different accounting principles, which may significantly impact our reported results or could result in variability of our financial results.

We are required to evaluate the effectiveness of our internal control over financial reporting and publicly disclose material weaknesses in our controls. Any adverse results from such evaluation may adversely affect investor perception, and our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to assess the effectiveness of our internal control over financial reporting and to disclose in our filing if such controls were unable to provide assurance that a material error would be prevented or detected in a timely manner. We have an ongoing program to review the design of our internal controls framework in keeping with changes in business needs, implement necessary changes to our controls design and test the system and process controls necessary to comply with these requirements. If in the future, our internal controls over financial reporting are determined to be not effective resulting in a material weakness or significant deficiency, investor perceptions regarding the reliability of our financial statements may be adversely affected which could cause a decline in the market price of our stock and otherwise negatively affect our liquidity and financial condition.

In preparing our financial statements we make certain assumptions, judgments and estimates that affect amounts reported in our consolidated financial statements, which, if not accurate, may significantly impact our financial results.

We make assumptions, judgments and estimates for a number of items, including the fair value of financial instruments, goodwill, long-lived assets and other intangible assets, the realizability of deferred tax assets, the recognition of revenue and the fair value of stock awards. We also make assumptions, judgments and estimates in determining the accruals for employee-related liabilities, including commissions and variable compensation, and in determining the accruals for uncertain tax positions, valuation allowances on deferred tax assets, allowances for doubtful accounts, and legal contingencies. These assumptions, judgments and estimates are drawn from historical experience and various other factors that we believe are reasonable under the circumstances as of the date of the consolidated financial statements. Actual results could differ materially from our estimates, and such differences could significantly impact our financial results.

Our business could be negatively affected as a result of actions of activist shareholders, and such activism could impact the trading value of our securities.

In recent years, shareholder activists have become involved in numerous public companies. Shareholder activists frequently propose to involve themselves in the governance, strategic direction and operations of the Company. Such proposals may disrupt our business and divert the attention of our Board of Directors, management and employees, and any perceived uncertainties as to our future direction resulting from such a situation could result in the loss of potential business opportunities, interfere with our ability to execute our strategic plan, be exploited by our competitors, cause concern to our current or potential customers, and make it more difficult to attract and retain qualified personnel and business partners, all of which could adversely affect our business. A proxy contest for the election of directors at our annual meeting could also require us to incur significant legal fees and proxy solicitation expenses. In addition, actions of activist shareholders may cause significant fluctuations in our stock price based on temporary or speculative market perceptions or other factors that do not necessarily reflect the underlying fundamentals and prospects of our business.

RISKS RELATED TO OUR COMMON STOCK

Future equity financings or convertible debt would dilute your ownership and could adversely affect your common stock ownership rights in comparison with those of other security holders.

Our board of directors has the power to issue additional shares of common or preferred stock without stockholder approval. In general, stockholders do not have preemptive rights to any common stock issued by us in the future; therefore, stockholders may experience additional dilution of their equity investment if we issue additional shares of common stock in the future, including shares issuable under equity incentive plans, or if we issue securities that are convertible into shares of our common stock. 

If additional funds are raised through the issuance of equity or convertible debt securities, the percentage of ownership of our existing stockholders will be reduced, and such newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we issue additional common stock or securities convertible into common stock, such issuance will reduce the proportionate ownership and voting power of each other stockholder. In addition, such stock issuances might result in a reduction of the market value of our common stock, which could make our stock unattractive to existing stockholders.

Provisions in our articles of incorporation and bylaws could discourage a change in control, or an acquisition of us by a third party, even if the acquisition would be favorable to you, thereby adversely affecting existing stockholders.

Our articles of incorporation and bylaws contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of our Company, even when these attempts may be in the best interests of stockholders. For example, our articles of incorporation authorize our Board of Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices. These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests.

There is limited trading volume of our common stock, which could make it difficult for you to liquidate an investment in our common stock in a timely manner.

Since April 16, 2019, our common stock has been traded on Nasdaq Capital Market under the symbol LIQT. Because there is limited volume of our common stock, investors may not be able to liquidate their investments when they desire to do so.

In addition, if we fail to meet the criteria set forth in SEC and Nasdaq Capital Market rules and regulations, various requirements would be imposed by law on broker-dealers who sell our securities to persons other than established customers and accredited investors. Consequently, such regulations may deter broker-dealers from recommending or selling our common stock, which may further affect its liquidity.

If securities analysts do not publish research or reports about our business or if they downgrade us or our sector, the price of our common stock could decline.

The trading market for our common stock will depend in part on research and reports that industry or financial analysts publish about us or our business. Furthermore, if one or more of the analysts who cover us downgrades us, the industry in which we operate, or the stock of any of our competitors, the price of our common stock will probably decline. If one or more of these analysts ceases coverage altogether, we could lose visibility, which could also lead to a decline in the price of our common stock. 

The market price of our common stock has been and may continue to be volatile.

The market price of our common stock has been volatile and fluctuates widely in price in response to various factors that are beyond our control. The price of our common stock is not necessarily indicative of our operating performance or long-term business prospects. In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock. Factors such as the following could cause the market price of our common stock to fluctuate substantially:

• the underlying price of the commodities in the industrial water filtration, marine, and oil and gas industries;

• announcements of capital budget changes by major customers;

• the introduction of new products by our competitors;

• announcements of technology advances by us or our competitors;

• current events affecting the political and economic environment in the United States, Europe or Asia;

• conditions or industry trends, including demand for our products, services and technological advances;

• changes to financial estimates by us or by any securities analysts who might cover our stock;

• additions or departures of our key personnel;

• government regulation of our industry;

• seasonal, economic, or financial conditions;

• our quarterly operating and financial results; or

• litigation or public concern about the safety of our products.

The realization of any of these risks and other factors beyond our control could cause the market price of our common stock to decline significantly. In particular, the market price of our common stock may be influenced by changes in governmental regulations regarding diesel particles emissions and marine wastewater because demand for our products and services is closely related to those products. The stock market in general experiences, from time to time, extreme price and volume fluctuations. Periodic and/or continuous market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility may be worse if the trading volume of our common stock is low.

Our existing shareholders could experience further dilution if we elect to raise equity capital to meet our liquidity needs or to finance strategic transactions.

As part of our strategy, we may desire to raise capital, issue stock to employees, and/or utilize our preferred or common stock to effect strategic business transactions, any of which will likely require that we issue equity (or debt) securities which would result in dilution to our existing stockholders. Although we anticipate attempting to minimize the dilutive impact of any future capital-raising activities or business transactions, we cannot offer any assurance that we will be effectively able to do so.

Future sales of our common stock, or the perception that future sales may occur, may cause the market price of our common stock to decline.

If any significant number of our outstanding shares are sold, such sales could have a depressive effect on the market price of our stock. We are unable to predict the effect, if any, that the sale of shares, or the availability of shares for future sale, will have on the market price of the shares prevailing from time to time. Sales of substantial amounts of shares in the public market, or the perception that such sales could occur, could depress prevailing market prices for the shares. Such sales may also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we deem appropriate.

The Company is considered a “smaller reporting company” and is exempt from certain disclosure requirements, which could make our common stock less attractive to potential investors.

Rule 12b-2 of the Securities Exchange Act of 1934 ("Exchange Act") defines a “smaller reporting company” as an issuer that is not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent, that is not a smaller reporting company, and that:

As a “smaller reporting company” we are not required and may not include a Compensation Discussion and Analysis section in our proxy statements; we provide only three years of business information; provide fewer years of selected financial data; and have other “scaled” disclosure requirements that are less comprehensive than issuers that are not “smaller reporting companies” which could make our stock less attractive to potential investors and could make it more difficult for shareholders to sell their shares.

 We have no current plan to pay dividends on our common stock, and investors may lose the entire amount of their investment.

We have no current plans to pay dividends on our common stock; therefore, investors will not receive any funds absent a sale of their shares. We cannot assure investors of a positive return on their investment when they sell their shares, nor can we assure that investors will not lose the entire amount of their investment.

None.

Our corporate headquarters are located at Industriparken 22C, 2750 Ballerup, Denmark. We lease approximately 67,000 square feet at our Ballerup location, of which approximately 10,000 square feet is used for office space and 57,000 square feet is used for production. The lease will expire on August 31, 2024. Our LiqTech Systems operations are located at Benshøj Industrivej 24, 9500 Hobro, Denmark. We lease approximately 45,750 square feet at our Hobro location, of which approximately 10,750 square feet is used for office space and 35,000 square feet is used for production. The lease will expire on November 30, 2034. Our BS Plastic operations are located at Sindalsvej 38-40, Risskov, Denmark. We lease approximately 19,500 square feet at our Risskov location, of which approximately 2,200 square feet is used for office space and 17,300 square feet is used for production. The leases will expire on August 31, 2024. Our U.S. operations are located at 1800 - 1808 Buerkle Road, White Bear Lake, Minnesota 55110 where we lease approximately 25,700 square feet, of which 6,000 square feet is used for office space and 19,700 square feet is used for production. The lease will expire on March 1, 2021.

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 December 31, 2019, we were not a party to any legal proceeding that we believe would have a material adverse effect on our business, financial condition or operating results.

The legal proceedings reported on December 31, 2018, has not been concluded in 2019.

Not applicable. 

Our common stock is currently quoted on the Nasdaq Capital Market under the symbol LIQT.

As of December 31, 2019, there were approximately 32 stockholders of record of our common stock as reported by our transfer agent, one of which is Cede & Co., a nominee for Depository Trust Company (“DTC”). All of the shares of common stock held by brokerage firms, banks, and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC and are therefore considered to be held of record by Cede & Co. as one stockholder.

We have not declared or paid any dividends and do not intend to declare or pay dividends on our common stock in the foreseeable future. Instead, we intend to invest any future earnings in our business. Subject to Nevada law, our Board of Directors will determine the payment of future dividends on our common stock, if any, and the amount of any dividends in light of:

We are not required to provide selected financial data disclosures because we are a smaller reporting company.

Overview

We are a Nevada corporation, formerly named Blue Moose Media, Inc. In October 2011, we changed our name to LiqTech International, Inc. For more than a decade we have developed and provided state-of-the-art technologies for gas and liquid purification using ceramic silicon carbide filters, particularly highly specialized filters for the control of soot exhaust particles from diesel engines and for liquid filtration. Using nanotechnology, LiqTech develops products using proprietary silicon carbide technology. LiqTech's products are based on unique silicon carbide membranes that facilitate new applications and improve existing technologies. In particular, LiqTech Systems A/S, the Company's subsidiary, has developed a new standard of water filtration technology to meet the ever-increasing demand for higher water quality. By incorporating LiqTech's SiC liquid membrane technology with its long-standing systems design experience and capabilities, the Company offers solutions to the most difficult water pollution problem.

Acquisition of LiqTech Systems

On July 29, 2014, the Company, through its subsidiary, LiqTech Int. DK, completed the acquisition of all of the issued and outstanding capital stock (the "Shares") of Provital Solutions A/S, a Danish company (now known as LiqTech Systems) from Masu A/S, a Danish company ("MASU") controlled by Sune Mathiesen. In consideration for the Shares, MASU received cash consideration in the amount of DKK12,600,000, or approximately $2,300,000 (at the exchange rate on July 28, 2014), and 4,044,782 shares of the Company's common stock (the "Payment Shares"). Two-thirds (2/3) of the Payment Shares were held in escrow and subject to achievement of certain milestones. The milestones were not achieved, and such Payment Shares were forfeited and returned to treasury on December 31, 2016.

Acquisition of BS Plastic

On August 31, 2019, the Company, through its subsidiary, LiqTech Int. DK, completed the acquisition of all of the issued and outstanding capital stock (the "Shares") of BS Plastic A/S, a Danish company (now known as BS Plastic) from JS Holding Risskov A/S, a Danish company ("JS Holding") controlled by Steen Simonsen. In consideration for the Shares, JS Holding received cash consideration in the amount of DKK9,000,000, or approximately $1,332,090 (at the exchange rate on August 31, 2019). Further JS Holding is entitled to an additional DKK6,000,000 or $888,060 (at the exchange rate on August 31, 2019) if certain financial targets are met with DKK2,000,000 ($296,020) for the period July 2019 to June 2020, DKK2,000,000 ($296,020) for the period July 2029 to June 2021 and DKK2,000,000 ($296,020) for the period July 2021 to June 2022.

2019 Developments

On January 14, 2019, we provided an update to the market that we currently had confirmed orders for more than 110 of our standardized water filtration systems. In addition to the confirmed orders, we expected to deliver a significant amount of systems in 2019 under the Framework Agreement announced on October 1, 2018. Positive visibility to order flow delivery affirmed expectations for the second quarter of 2019 revenue to surpass the first quarter of 2019, setting another new record for the Company.

On March 28, 2019 the Company preannounced a record quarter with revenue of $7 million and profitability for the first quarter of 2019. Further, the Company announced that the current order backlog continued to grow, increasing from the 110 standardized systems reported on January 14, 2019. The Company also announced its intention to move the trading of its common stock to the Nasdaq Capital Market.

On May 21, 2019 the Company announced that it had commenced an underwritten registered public offering of its common stock. The Company intended to use the net proceeds from the offering to fund the growth of the business, including adding manufacturing capacity through equipment purchases, funding continued research and development efforts, for general corporate purposes, and the potential insourcing of currently outsourced manufacturing.

On May 22, 2019 the Company announced the upsizing and pricing of the previously announced underwritten public offering of 1,931,035 shares of its common stock at a public offering price of $7.25 per share. As part of the offering, LiqTech granted the underwriters a 30-day option to purchase at the public offering price up to an additional 284,827 shares of its common stock to cover over-allotments, if any. All shares of common stock to be sold in the offering were offered by LiqTech. The offering was closed on May 24, 2019 with the sale of 2,215,862 shares of $7.25 granting a total gross proceeds of $16,065,000.

On August 20, 2019, the Company announced the signing of a Share Purchase Agreement (SPA) to acquire BS Plastic A/S, a specialized plastics manufacturer based in Denmark.

On August 26, 2019, the Company announced the receipt of the largest single order to date ($8.4 million) for its proprietary ceramic silicon carbide water filtration systems for marine scrubber applications.

On September 4, 2019 the Company announced the closure of the announced agreement to acquire BS Plastic A/S.

2020 Developments

On January 2, 2020 the Company announced the successful installation of a brand-new customized furnace for use in the manufacture of the Company’s proprietary silicon carbide membrane filters. The new furnace has throughputs that is more than triple the Company’s existing furnaces due to its size and efficiency.

Results of Operations

Results of Operations for the Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018 

The following table sets forth our revenues, expenses and net income for the year ended December 31, 2019 and 2018 in U.S. dollars, except for percentages. 

Revenues

Revenue for the year ended December 31, 2019 were $32,637,484 compared to $12,232,088 for the same period in 2018, representing an increase of $20,405,396, or 166.8%. The change in sales consists of an increase in liquid filters of $20,199,951, an increase in plastics of $895,203, an increase in development projects of $193,641 and a decrease in DPFs of $883,400. The increase in demand for our liquid filters and systems is due to the ramp-up in delivery of water treatment systems for the marine scrubber industry. The decrease in demand for our DPFs is mainly due to the diminished market activity globally compared to the same period of last year. The increase in sales of plastic components is related to the newly acquired business in 2019. 

Gross Profit

Gross profit for the year ended December 31, 2019 was $7,162,314 compared to $1,066,144 for the same period in 2018, representing an increase of $6,096,170, or 571.8%. The increase in gross profit is due to a positive mix shift toward liquid filters and systems, where sales command a higher gross margin. Included in the gross profit is depreciation of $1,131,008 and $819,070 for the years ended December 31, 2019 and 2018, respectively.

Expenses

Total operating expenses for the year ended December 31, 2019 were $7,554,664, representing an increase of $2,003,012 or 36.1%, compared to $5,551,652 for the same period in 2018.

Selling expenses for the year ended December 31, 2019 were $2,426,971 compared to $1,703,327 for the same period in 2018, representing an increase of $723,644 or 42.5%. This change is attributable to an increase in sales activities and the addition of new sales employees from an average of seven in 2018 to an average of nine in 2019. Further the participation in tradeshows and exhibitions increased in 2019 compared to the same period in 2018.

General and administrative expenses for the year ended December 31, 2019 were $4,378,444 compared to $3,187,311 for the same period in 2018, representing an increase of $1,191,133, or 37.4%. This change is attributable to the addition of administrative employees, where the number of employees increased from 11 in 2018 to 16 in 2019. The increase in the number of employees also created additional IT-expenses and office costs. Included in general and administrative expenses is Non-cash compensation expenses, that were $197,945 and $116,434 for the years ended December 31, 2019 and December 31, 2018, representing an increase of $81,511 or 70.0%, attributable to increased non-cash compensation expense for stock options granted to employees. 

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

Research and development expenses for the year ended December 31, 2019 were $749,249 compared to $661,014 for the same period in 2018, representing an increase of $88,235, or 13.3%. This change is attributable to an increase in the number of employees in the Research and Development area as the Company focuses on the further development of existing and new products for the marine industry.

Other income/(expense)

Total Other income/(expenses) for the year ended December 31, 2019 was $134,714 compared to $305,550 for the comparable period in 2018, representing a decrease of $170,836. This change is attributable to increased interest expenses as a consequence of the adoption of Leases (Topic 842) and ASU 2016-19 which resulted in an increase in interest expenses and decrease in Operating expenses.

Net Income taxes

Net income taxes for the year ended December 31, 2019 was a benefit of $297,252 compared to $365,430 for the comparable period in 2018, representing a decrease in benefit of $68,178.

Net Income/(Loss)

Net income/(loss) attributable to the Company for the year ended December 31, 2019 was $39,616 compared to a loss of $3,814,528 for the comparable period in 2018, representing a change of $3,854,144.

This improvement was primarily attributable to increased Revenue that drove a similar increase in Gross Profit and higher gross profit margin caused by a favorable mix shift toward marine scrubber systems, offset by higher operating expenses caused primarily by the growth in headcount to support additional sales and production.

Liquidity and Capital Resources

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company 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 the filing date, the Company had an available line of credit from the bank amounting to DKK20,000,000 ($3,000,000) which is used for a leasing arrangement and guarantees issued to customers for prepayments and for warranties after delivery. At December 31, 2019, we had cash of $9,783,932 and net working capital of $17,155,126, and at December 31, 2018, we had cash of $3,776,111 and net working capital of $6,753,593. At December 31, 2019, our net working capital had increased by $10,401,533 compared to December 31, 2018. Total current assets were $27,487,257 and $11,373,206 at December 31, 2019 and December 31, 2018, respectively, and total current liabilities were $10,332,131 and $4,619,613 at December 31, 2019 and December 31, 2018, respectively.

In connection with certain orders, we provide the customer a working guarantee, a prepayment guarantee or a security bond. For that purpose, we maintain a guarantee credit line of DKK10,000,000 (approximately $1,500,000). The credit line is secured by a cash deposit of $2,700,000. Further, we have a guarantee for a specific project delivered in 2016 of DKK 94,620 (approximately $14,186 at December 31, 2019) with a bank, subject to certain base limitations. 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.

Cash Flows

Year Ended December 31, 2019 Compared to Year Ended December 31, 2018

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 year ended December 31, 2019 was $4,546,761, representing an increase of $632,587 compared to cash used by operating activities of $3,914,174 for the year ended December 31, 2018. The change in cash used by operating activities for the year ended December 31, 2019 was mainly due to an increase in accounts receivables of $4,180,917, increase in other receivables of $2,098,896, and increase in inventory of $683,405, off-set by an increase in accounts payable of $1,769,852 and an increase in accrued expenses of $2,164,358.

Net cash used in investing activities was $3,700,675 for the year ended December 31, 2019 as compared to net cash used in investing activities of $170,890 for the year ended December 31, 2018, representing an increase of $3,529,785. This increase was due to the initial payment for the acquisition of BS Plastic A/S of $1,154,902 and a period-over-period increase of $2,363,885 for the purchase of property and equipment especially related to the installation of new furnaces in Ballerup to increase production capacity in the context of a growing demand.

Cash provided by financing activities was $14,627,470 for the year ended December 31, 2019, as compared to cash provided by financing activities of $6,017,280 for the year ended December 31, 2018. This change of $8,610,190 was mainly due to cash received in connection with a registered public offering in May 2019 that generated net proceeds of $14,650,039, which was greater than cash received in connection with a registered public offering in April 2018.

Off Balance Sheet Arrangements

As of December 31, 2019, we had no off-balance sheet arrangements. We are not aware of any material transactions that are not disclosed in our consolidated financial statements.

Operating Leases 

The Company leases office and production facilities under operating lease agreements.

The future minimum lease payments for non-cancelable operating leases having remaining terms in excess of one year as of December 31, 2019 is reflected in Note 4.

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:

We discuss these policies further below, as well as the estimates and judgments involved. 

Accounts Receivable / Long Term Receivable / Allowance for Doubtful Accounts / Bad Debt

We assess the collectability of accounts receivable and long-term receivable on an ongoing basis and establish an allowance for doubtful accounts when collection is no longer reasonably assured. In establishing the allowance, we consider factors such as known troubled accounts, historical experience, age of receivables, financial and liquidity information that is publicly accessible, and other currently available evidence.

The roll forward of the allowance for doubtful accounts for the year ended December 31, 2019 and December 31, 2018 was as follows:

Goodwill and Definite-life intangible assets

The Company accounts for Goodwill and definite-life intangible assets in accordance with provisions of the Statement of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles, Goodwill and Other. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of Topic 350. Impairment losses arising from this impairment test, if any, are included in operating expenses in the period of impairment. Topic 350 requires that definite intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with Topic 360, criteria for recognition of an impairment of Long-Lived Assets.

Goodwill

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. The Company recorded an impairment charge of $0 on goodwill during the years ended December 31, 2019 and 2018, as management's estimated fair value of the reporting unit exceeded its carrying value determined during impairment testing in the fourth quarters of 2019 or 2018.

Long-Lived Assets

We assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in our use of the assets. We measure the recoverability of assets that will continue to be used in our operations by comparing the carrying value of the asset grouping to our estimate of the related total future undiscounted net cash flows. If an asset grouping’s carrying value is not recoverable through the related undiscounted cash flows, the asset grouping is considered to be impaired. The impairment is measured by comparing the difference between the asset grouping’s carrying value and its fair value. Long-lived assets such as goodwill, intangible assets, and property, plant and equipment are considered non-financial assets and are recorded at fair value only if an impairment charge is recognized.

Impairments of long-lived assets are determined for groups of assets related to the lowest level of identifiable independent cash flows. Due to our asset usage model and the interchangeable nature of our ceramic filter manufacturing capacity, we must make subjective judgments in determining the independent cash flows that can be related to specific asset groupings. In addition, as we make manufacturing process conversions and other factory planning decisions, we must make subjective judgments regarding the remaining useful lives of assets, primarily process-specific filter manufacturing tools and building improvements. If we determine that the useful lives of assets are shorter than we had originally estimated, we accelerate the rate of depreciation over the assets’ new, shorter useful lives. During the years ended December 31, 2019 and 2018, no impairment charge of long-lived assets has been recorded. 

Revenue Recognition

On January 1, 2018, the Company adopted Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers,” which includes clarifying ASUs issued in 2015, 2016 and 2017 (“new revenue standard”). The new revenue standard was applied to all open revenue contracts using the modified-retrospective method as of January 1, 2018. The new revenue standard did not have a material impact on revenue recognition. The Company does not expect the impact of the adoption of the new standard to be material to sales or net income on an ongoing basis.

For membrane, DPF and plastic product sales, revenue is recognized when performance obligations under the terms of a contract with the customer are satisfied which occurs when control of the membrane, DPF or plastic product is transferred to the customer. The majority of the Company's sales contracts contain performance obligations satisfied at a point in time when title and the risks and rewards of ownership have transferred to the customer. This generally occurs when the product is shipped or accepted by the customer.  Revenue for service contracts are recognized as the services are provided. Revenue is measured as the amount of consideration expected to be received in exchange for transferring the goods or providing services. The satisfaction of performance obligations under the terms of a revenue contract generally gives rise to the right of payment from the customer. The Company's standard payment terms vary by the type and location of the customer and the products or services offered. Generally, the time between when revenue is recognized and when payment is due is not significant. Pre-Payments received prior to satisfaction of performance obligations are recorded as contract liabilities. Given the insignificant days between revenue recognition and receipt of payment, financing arrangements do not exist between the Company and its customers.

For contracts with customers that include multiple performance obligations, judgment is required to determine whether performance obligations specified in these contracts are distinct and should be accounted for as separate revenue transactions for recognition purposes. For such arrangements, revenue is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are generally determined based on the prices charged to customers or using expected cost-plus margin.

System sales are recognized when the Company transfers control based upon signed acceptance of the system by the customer upon shipment of the system in accordance with the terms of the contract. For the majority of Systems, the Company transfers control and recognizes revenue when products are shipped to the customer according to the terms of the contract or purchase order. In connection with the system it is normal procedure to issue a FAT (Factory Acceptance Test) stating that the customer has accepted the performance of the system as it is being shipped from the production facility in Hobro. As part of the delivery performance, the customer is normally offered a commissioning (a final assembly and configuration at a place designated by the customer) and this commission is therefore considered a second performance obligation and is valued at cost plus a standard margin based on the contractual performance. This second performance obligation is recognized as revenue at the time of delivery of the commissioning together with the cost incurred. The portion of the invoicing that is attributable to commissioning is recognized as Non-invoiced as part of Unbilled receivable while the revenue related to the commissioning is recognized as Deferred Income.

Aftermarket sales represent part sales, extended warranties and maintenance services. For the sale of aftermarket parts, the Company transfers control and recognizes revenue when parts are shipped to the customer or services are provided. When customers are given the right to return eligible parts and accessories, the Company estimates the expected returns based on an analysis of historical experience. The Company adjusts estimated revenues at the earlier of when the most likely amount of consideration expected to be received changes or when the consideration becomes fixed. The Company recognizes revenue for extended warranty and maintenance agreements based on the standalone selling price over the life of the contract, which reflects the costs to perform under these contracts and corresponds with, and thereby depicts the transfer of control to the customer. For invoicing to customers where the transfer of control has not occurred (prepayments), the invoiced amount is recognized as Contract assets / Contracts liabilities.

The Company has received long-term contracts for grants from government entities for development and use of silicon carbide membranes in various water filtration and treatment applications and historically in the installation of various water filtrations systems. We measure transfer of control of the performance obligation on long-term contracts utilizing the cost-to-cost measure of progress, with cost of revenue including direct costs such as labor and materials. Under the cost-to-cost approach, the use of estimated costs to complete each performance obligation is a significant variable in the process of determining recognized revenue and a significant factor in the accounting for such performance obligations. The timing of when we bill our customers is generally dependent upon advance billings terms, milestone billings based on completion of certain phases of the work or when services are provided or products are shipped. Projects with performance obligations recognized over time that have costs and estimated earnings recognized to date in excess of cumulative billings are reported on our Balance Sheets as Contract assets. Projects with performance obligations recognized over time that have cumulative billings in excess of costs and estimated earnings recognized to date are reported on our Balance Sheets as Contract liabilities.

Income Taxes

We must make estimates and judgments in determining the provision for taxes for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions and in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes in these estimates may result in an increase or decrease to our tax provision in a subsequent period.

We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover the deferred tax assets recorded on our consolidated balance sheets. Should there be a change in our ability to recover our deferred tax assets, however, our tax provision would increase in the period in which we determined that the recovery was not likely. Recovery of a portion of our deferred tax assets is impacted by management's plans and methods of allocating research and development costs to the underlying reporting units.

The calculation of our tax liabilities involves uncertainties in the application of complex tax regulations in Denmark and the United States. When a tax position is determined uncertain, we recognize liabilities based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will more likely than not be sustained on audit, the second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as we must determine the probability of various possible outcomes. If uncertainties arise, we re-evaluate the tax positions on a quarterly basis. This evaluation is based on factors such as changes in facts or circumstances, changes in tax law, new audit activity, and effectively settled issues. Determining whether an uncertain tax position is effectively settled requires judgment. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.

Inventory

The valuation of inventory requires us to estimate excess or obsolete inventory as well as inventory that is not of saleable quality. The determination of excess or obsolete inventory requires us to estimate the future demand for our products. The estimate of future demand is compared to work-in-process and finished goods inventory levels to determine the amount, if any, of excess or obsolete inventory. As of December 31, 2019, we had total furnace parts and supplies of $631,865, raw materials of $2,087,020, work-in-process inventory of $1,624,499, total finished goods inventory of $1,521,161 and a reserve for obsolescence of $665,307. The estimated future demand is included in the development of our short-term manufacturing plans to enable consistency between inventory valuation and production decisions. Product-specific facts and circumstances reviewed in the inventory valuation process include a review of the customer base, acceptance of the product by the customer and the various environmental authorities, competitor’s products, as well as an assessment of the selling price in relation to the product cost. If our demand forecast for specific products is greater than actual demand, and we fail to reduce manufacturing output accordingly, we could be required to write off inventory, which would negatively impact our gross profit.

In order to determine what costs can be included in the valuation of inventory, we must determine normal capacity at our manufacturing, assembly and test facilities, based on historical production, compared to total available capacity. If the factory production is below the established normal capacity level, a portion of our manufacturing overhead costs would not be included in the cost of inventory, and therefore would be recognized as cost of sales in that period, which would negatively impact our gross profit. We refer to these costs as excess capacity charges. The Company has been operating below capacity and excess capacity charges have been recognized as cost of sales.

Loss Contingencies

We are subject to various legal and administrative proceedings along with asserted and potential claims, accruals related to product warranties and potential asset impairments (loss contingencies) that arise in the ordinary course of business. An estimated loss from such contingencies is recognized as a charge to income if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a loss contingency is required if there is at least a reasonable possibility that a loss has been incurred. The outcomes of legal and administrative proceedings and claims, and the estimation of product warranties and asset impairments, are subject to significant uncertainty. Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. To estimate the losses associated with repairing and replacing parts in connection with product warranty, we make judgments with respect to customer claim rates. At least quarterly, we review the status of each significant matter, and we may revise our estimates. These revisions could have a material impact on our results of operations and financial position. 

We are not required to provide quantitative and qualitative disclosures about market risk because we are a smaller reporting company.

Index to Consolidated Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of LiqTech International, Inc.:

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of LiqTech International, Inc. (“the Company”) as of December 31, 2019 and December 31, 2018, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the years in the two-year period ended December 31, 2019 and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for the years in the two-year period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 30, 2020 expressed an adverse opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Sadler, Gibb & Associates, LLC

We have served as the Company’s auditor since July 2018

Salt Lake City, UT

March 30, 2020 

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

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

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

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

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

For the Years Ended December 31, 2019 and 2018

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

For the Years Ended December 31, 2019 and 2018

LiqTech International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

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

LIQTECH INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Increase (Decrease) in Cash and Cash Equivalents

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS