374Water Inc

For the Years Ended December 31, 202****3 and 2022

Notes to Consolidated Financial Statements

Note 1 – Nature of Business and Presentation of Financial Statements

Description of the Company

374Water Inc. (the “Company”, “374Water”, “We”, or “Our”) is a Delaware corporation which was formed in September 2005 as PowerVerde, Inc. At that time, the Company was focused on developing, commercializing and marketing a series of unique electric generating power systems designed to produce electrical power with zero emissions or waste byproducts, based on a pressure-driven expander motor and related organic rankine cycle technology.

On April 16, 2021, the Company entered into an Agreement and Plan of Merger (the “Merger”) with 374Water Inc., a privately held company based in Durham, North Carolina, (“374Water Private Company”) and 374Water Acquisition Corp., a newly-formed wholly-owned subsidiary of PowerVerde.

Following the Merger, 374Water offers a disruptive technology that transforms all wet wastes such as sewage sludge, biosolids, food waste, hazardous and non-hazardous waste, and forever chemicals (e.g., PFAS) into recoverable resources by focusing on waste as a valuable resource for water, energy, and minerals. We are pioneers in a new era of waste management that supports a circular economy and enables organizations to achieve their environment, social, and governance (ESG) goals. Our vision is a world without waste and our mission is to help create and preserve a clean and healthy environment that sustains life.

Presentation of Financial Statements

The accompanying consolidated financial statements are presented in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The accompanying consolidated financial statements include the accounts and operations of the Company and all adjustments which are necessary for a fair presentation of the results of its operations, financial position, and cash flows. The consolidated financial statements include the accounts of 374Water Inc., 374Water Systems Inc., and 374Water Sustainability Israel LTD, each a wholly-owned subsidiary of 374Water. Intercompany balances and transactions have been eliminated in consolidation.

Note 2 – Summary of Significant Accounting Policies

Cash and Cash Equivalents and Investment Securities

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company held $10,445,404 and $4,046,937 in cash and cash equivalents as of December 31, 2023 and 2022, respectively.

During 2023, the Company reassessed classification of certain investment securities and the Company transferred $1,963,432 of investment securities from available-for-sale (“AFS”) to held-to-maturity (“HTM”) investment securities. At the time of transfer, the Company reversed the allowance for credit losses associated with the AFS investment securities through credit loss expense. The securities were transferred at their amortized cost basis, net of any unrealized gain or loss reported in accumulated other comprehensive income. The related unrealized loss of $18,968 included in accumulated other comprehensive loss was amortized out of other comprehensive income with an offsetting entry to interest income as a yield adjustment through earnings over the remaining term of the investment securities which matured in May 2023. Subsequent to transfer, the allowance for credit losses on these investment securities was evaluated under the accounting policy for HTM debt securities. The Company held no AFS investment securities as of December 31, 2023.

The Company held AFS investment securities as of December 31, 2022 as noted in the following table:

Accounting Standards Codification (ASC) Topic 820 “Fair Value Measurements” establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 Inputs - Fair value estimates are based on observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is determined on a first-in, first-out basis. Our inventory is raw materials and work in progress. Net realizable value is the value of an asset that can be realized upon the sale of the asset, less a reasonable estimate of the costs associated with either the eventual sale or the disposal of the asset in question. We utilize third-party suppliers to produce our products. Costs associated with fabrication, and other costs associated with the manufacturing of products, are recorded as inventory. We periodically evaluate the carrying value of our inventories in relation to estimated forecasts of product demand, which takes into consideration the life cycle of product releases. When quantities on hand exceed estimated sales forecasts, we perform an analysis to determine if a write-down for such excess inventories is required. Once inventory has been written down, it creates a new cost basis for inventory. Inventories are classified as current assets in accordance with recognized industry practice.

Reclassifications

Certain reclassifications of prior year amounts including the effect of exchange rates on cash of $328 on the consolidated statements of cash flows have been made to conform to the 2023 presentation. These reclassifications had no effect on net loss or loss per share as previously reported.

Accounts Receivable

Accounts receivables consist of balances due from sales, service revenues, and unbilled accounts receivables (revenues earned but not yet billed). The Company monitors accounts receivable and provides allowances for expected credit losses when considered necessary. At December 31, 2023 and 2022, accounts receivable were considered to be fully collectible but in accordance with the allowance for credit losses, the Company recorded an allowance for credit losses based on a reserve of current and aged receivables. Accordingly, an allowance for credit losses of $2,909 and $0 was recorded as of December 31, 2023 and 2022, respectively.

Accounts Receivable

Accounts receivables consist of balances due from customers for equipment sales and service revenues.

Other Receivables

Other receivables consist of accrued interest income from the cash held in interest bearing money market account with a financial institution. We typically receive payment for accrued interest one month in arrears.

Unbilled Accounts Receivables

Unbilled accounts receivables consist of balances due from revenues earned but not yet billed related to one customer contract for an equipment sale and services.

Accounts receivable allowance for credit loss

The activity related to the accounts receivable allowance for credit losses was as follows:

Property and Equipment

Property and Equipment is recorded at cost. Depreciation is computed using the straight-line method and an estimated useful life of three to five years. Expenses for maintenance and repairs are charged to expenses as incurred.

The following table presents property and equipment as of December 31, 2023 and 2022:

Depreciation expense related to property and equipment was as follows:

Intangible Assets

Intangible assets are subject to amortization, and any impairment is determined in accordance with ASC 350, “Intangibles - Goodwill and Other.” Intangible assets are stated at historical cost and amortized over their estimated useful lives. The Company uses a straight-line method of amortization, unless a method that better reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up can be reliably determined. As of December 31, 2023 and 2022, there was no impairment.

Long-Lived Assets

The Company reviews long-lived assets, including property and equipment and intangible assets with finite lives, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company uses an estimate of the undiscounted cash flows over the remaining life of its long-lived assets, or related group of assets where applicable, in measuring whether the assets to be held and used will be realizable. Recoverability of assets held and used is measured by a comparison of the carrying amount to the future undiscounted expected net cash flows to be generated by the asset. As of December 31, 2023 and 2022, there were no impairments.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to credit risk consist of cash and cash equivalents, and marketable securities. Deposits with financial institutions are insured, up to certain limits, by the Federal Deposit Insurance Corporation (“FDIC”). The Company’s cash deposits often exceed the FDIC insurance limit; however, all deposits are maintained with high credit quality institutions and the Company has not experienced any losses in such accounts. The financial condition of financial institutions is periodically reassessed, and the Company believes the risk of any loss is minimal. The Company believes the risk of any loss on cash due to credit risk is minimal. Furthermore, we perform ongoing credit evaluations of our customers and generally do not require collateral.

Significant customers and suppliers are those that account for greater than 10% of the Company’s revenues, purchases, accounts receivables, and accounts payables. One customer made up approximately 88% and 98% of revenue for the year ended December 31, 2023 and 2022, respectively. As of December 31, 2023, one customer accounted for 51% of our outstanding accounts receivable. As of December 31, 2022, we did not have any accounts receivable outstanding.

As of December 31, 2023 and 2022, our unbilled receivables of $1,485,803 and $918,164, respectively, were due from one customer and the same customer that comprises the majority of our revenue. The loss of this significant customer could adversely affect the results of our operations.

In 2023 and 2022, the Company purchased a substantial portion of manufacturing services from one third party vendor, Merrell Bros.

Refer to Note 9 for a license agreement we have with Duke University for the SCWO technology used in our systems.

Revenue Recognition

The Company follows the revenue standards of Codification (ASC) Topic 606: “Revenue from Contracts with Customers (Topic 606).” The core principle of this Topic is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Revenue is recognized in accordance with that core principle by applying the following five steps: 1) identify the contracts with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations; and 5) recognize revenue when (or as) we satisfy a performance obligation using the input method.

The Company generates revenue from the sale of equipment (AirSCWO units) and services, specifically the completion of treatability studies. In the case of equipment revenues, the Company’s performance obligations are satisfied over time over the life of the contract which are typically fixed price contracts. Revenue is recognized over time by measuring the progress toward complete satisfaction of the performance obligation using specific milestones. These milestones within the contract are assigned revenue recognition percentages, based on overall expected cost-plus margin estimates of those milestones compared to the total cost of the contract. Equipment sale related contract revenues are recognized in the proportion that contract costs incurred bear to total estimated costs. This method is used because management considers the input method to be the best available measure of progress on these contracts.

Changes in our overall expected cost estimates are recognized as a cumulative adjustment for the inception-to-date effective of such change. If these changes in estimates result in a possible loss being incurred on the contract, we accrue for such a loss in the period such an outcome becomes probable.

Services revenues are recognized when all five revenue recognition criteria have been completed which is generally when we deliver a completed report to the customer.

Contract costs include all direct material, labor and subcontractor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, and depreciation. General, selling, and administrative costs are charged to expenses as incurred.

We also record as revenue all amounts billed to customers for shipping and handling costs and record the actual shipping costs as a component of cost of revenues. Reimbursements received from customers for out-of-pocket expenses are recorded as revenues, with related costs recorded as cost of revenues. We present revenues net of any taxes collected from customers and remitted to government authorities.

Revenues for the year ended December 31, 2023 in the amount of $655,818 was generated from the manufacturing of the AirSCWO equipment system and $88,134 was generated from the completion of treatability study services. Revenues for the year ended December 31, 2022 in the amount of $2,952,020 was generated from the manufacturing of the AirSCWO equipment system and $63,501 was generated from the completion of treatability study services.

Accrued Contract Loss Provision and Onerous Contracts

Onerous contracts are those where the costs to fulfill a contract exceed the consideration expected to be received under the contract. The revenue standard does not provide guidance on the accounting for onerous contracts or onerous performance obligations. US GAAP contains other applicable guidance on the accounting for onerous contracts, and those requirements should be used to identify and measure onerous contracts.

Our equipment manufacturing contract is a fixed price contract. Due to the nature of the contract, including customer specific equipment design, we applied ASC 605-35,*Revenue Recognition—Provision for Losses on Construction-Type and Production-Type Contract (ASC 605-35).*ASC 605-35 requires the recognition of a liability for anticipated losses on contracts prior to those losses being incurred when a loss is probable and can be estimated.

As of December 31, 2023, we evaluated the total costs incurred on this contract to date and the estimated costs we anticipate incurring to complete the contract. Based on this analysis, we accrued a contract loss provision of $500,000 which has been presented on the accompanying consolidated balance sheets and is recorded within cost of revenues on the accompanying consolidated statements of operations.

Stock-Based Compensation

The Company has accounted for stock-based compensation under the provisions of ASC Topic 718 – “Stock Compensation” which requires the use of the fair-value based method to determine compensation for all arrangements under which employees and others receive shares of stock or equity instruments (stock options and common stock purchase warrants). The fair value of each stock option award is estimated on the date of grant using the Black-Scholes valuation model that uses assumptions for expected volatility, expected dividends, expected term, and the risk-free interest rate. Expected volatilities are based on historical volatility of peer companies and other factors estimated over the expected term of the stock options. The expected term of options granted is derived using the “simplified method” which computes expected term as the average of the sum of the vesting term plus the contract term. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the period of the expected term.

The Company has elected to estimate and account for options granted for which the requisite service period will not be rendered, due to the option being forfeited or expiring. The forfeiture rate estimated is based on the percentage of cumulative forfeitures to the total award grants. During the quarter ended December 31, 2023, we compared our actual forfeiture rate to our estimated forfeiture rate and made acumulative adjustment of approximately $55,000 in the quarter ended December 31, 2023 to reduce our forfeiture rate estimate to approximately 5% of the total stock-based compensation recognized during the year.

Income Tax Policy

The Company accounts for income taxes using the liability method prescribed by ASC 740 - Income Taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the year in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if, based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized as income or loss in the period that includes the enactment date.

Accounting for Uncertainty in Income Taxes

The Company follows the provisions of ASC Topic 740-10, “Accounting for Uncertainty in Income Taxes” which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This topic also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. There were no uncertain tax positions as of December 31, 2023 and 2022.

Research and Development Costs

The Company’s research and development costs are expensed in the period in which they are incurred. Such expenditures amounted to $1,496,129 and $1,113,500 for the years ended December 31, 2023 and 2022, respectively.

Earnings (Loss) Per Share

Earnings (loss) per share is computed in accordance with ASC Topic 260, “Earnings per Share” Basic weighted-average number of shares of common stock outstanding for the years ended December 31, 2023 and 2022 include the shares of the Company issued and outstanding during such periods, each on a weighted average basis. The basic weighted average number of shares of common stock outstanding excludes common stock equivalent incremental shares, while diluted weighted average number of shares outstanding includes such incremental shares. However, as the Company was in a loss position for all periods presented, basic and diluted weighted average shares outstanding are the same, as the inclusion of the incremental shares would be anti-dilutive. As of December 31, 2023, there were the following potentially dilutive securities that were excluded from diluted net loss per share because their effect would be antidilutive: options for 10,828,174 shares of common stock and 1,235,000 warrants. As of December 31, 2022, there were the following potentially dilutive securities that were excluded from diluted net loss per share because their effect would be antidilutive: options for 12,752,000 shares of common stock and 1,250,000 warrants.

Financial Instruments

The Company carries cash, accounts receivable, accounts payable and accrued expenses, at historical costs. The respective estimated fair values of these assets and liabilities approximate carrying values. The Company applies the guidance related to fair value for certain non-financial assets and liabilities. The non-financial assets and liabilities include items such as finite lived intangibles and property and equipment.

Foreign Currency Translation

The Company’s reporting currency is the United States (“U.S.”) dollar while the functional currency of the Company’s insignificant non-U.S. subsidiary 374Water Sustainability Israel LTD is the Israeli Shekel. Translation adjustments resulting from translating the functional currency financial statements into U.S. dollar equivalents are reported separately in accumulated other comprehensive income (loss) in equity. Gains (loss) arising from transactions denominated in a currency other than the functional currency of the entity that is party to the transaction are included in net income (loss) on the Company’s consolidated statements of operations.

All assets and liabilities of the 374Water Sustainability Israel LTD wholly-owned subsidiary whose accounts are denominated in foreign currency are translated into United States dollars at appropriate year-end current exchange rates. All income and expense accounts of those locations are translated at the average exchange rate for each period. The foreign currency translation amounts for the years ended December 31, 2023 and 2022 are included in accumulated comprehensive income on the consolidated statement of changes in equity.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in the accompanying financial statements include the fair value of equity-based compensation, revenue recognition and accrued loss provisions on onerous contracts, fair value of intangible assets, useful lives of long-lived assets, and valuation allowance against deferred tax assets.

Recent Accounting Pronouncements - Adopted

In June 2016, the FASB issued ASU No. 2016-13,Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however Topic 326 will require that credit losses be presented as an allowance rather than as a write-down. This ASU affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Effective January 1, 2023, the Company adopted this ASU. The adoption resulted in an immaterial credit loss allowance against our outstanding accounts receivable as of December 31, 2023.

Recent Accounting Pronouncements - Not Yet Adopted

In December 2023 FASB issued Accounting Standards Update (ASU) 2023-09,Income Taxes (Topic 740): Improvements to Income Tax Disclosures(ASU 2023-09). The ASU focuses on income tax disclosures around effective tax rates and cash income taxes paid. ASU 2023-09 requires public business entities to disclose, on an annual basis, a rate reconciliation presented in both dollars and percentages. The guidance requires the rate reconciliation to include specific categories and provides further guidance on disaggregation of those categories based on a quantitative threshold equal to 5% or more of the amount determined by multiplying pretax income (loss) from continuing operations by the applicable statutory rate. For entities reconciling to the US statutory rate of 21%, this would generally require disclosing any reconciling items that impact the rate by 1.05% or more. ASU 2023-09 is effective for public business entities for annual periods beginning after Dec. 15, 2024 (generally, calendar year 2025) and effective for all other business entities one year later. Entities should adopt this guidance on a prospective basis, though retrospective application is permitted. The adoption of ASU 2023-09 is expected to have a financial statement disclosure impact only and is not expected to have a material impact on the Company’s financial statements.

In November 2023 the FASB issued ASU 2023-07,*Segment Reporting – Improvements to Reportable Segment Disclosures.*The ASU will now require public entities to disclose its significant segment expenses categories and amounts for each reportable segment. Under the ASU, a significant segment expense is an expense that is:

The ASU is effective for public entities for fiscal years beginning after December 15, 2023 and interim periods in fiscal years beginning after December 15, 2024 (calendar year public entity will adopt the ASU in its 2024 Form 10 K). The ASU should be adopted retrospectively unless it’s impracticable to do so. Early adoption of the ASU is permitted, including in an interim period. The adoption of ASU 2023-07 is expected to have a financial statement disclosure impact only and is not expected to have a material impact on the Company’s financial statements.

The Company considers the applicability and impact of all recently issued accounting pronouncements. Recent accounting pronouncements not specifically identified in our disclosures are either not applicable to the Company or are not expected to have a material effect on our financial condition or results of operations.

Note 3 – Liquidity, Capital Resources

As of December 31, 2023, the Company had working capital of $13,528,176 compared to working capital of $7,060,511 at December 31, 2022. As of December 31, 2023, the Company had an accumulated deficit of $15,953,504 compared to an accumulated deficit of $7,849,982 at December 31, 2022. During the year ended December 31, 2023, the Company had a net loss of $8,103,522 and used $9,034,987 of net cash in operations. During the year ended December 31, 2022, the Company had a net loss of $4,689,967 and used $4,948,668 of net cash in operations for the period.

The Company believes it has sufficient cash-on-hand for the Company to meet its financial obligations as they come due at least the next 12 months from the date of the report.

To the extent that the Company raises additional funds by issuing shares of its common stock or other securities convertible or exchangeable for shares of common stock, stockholders will experience dilution, which may be significant. Any or all of the foregoing may have a material adverse effect on the Company’s business and financial performance.

Note****4 – Inventory

Inventory consists of:

As of December 31, 2023 and 2022, the Company noted no inventory impairment and there were no inventory write downs recorded.

Note****5 – Intangible Assets

Intangible assets are recorded at cost and consist of the license agreement with Duke University and other patents. The Company issued Duke University a small block of shares of common stock estimated to have a fair value of $1,073,529 as consideration for granting the Company the license based on the Company’s common stock market price on the date the license agreement was executed (see Note 8). Intangible assets are comprised of the following as of December 31, 2023 and 2022:

Amortization expense for the year ended December 31, 2023 and December 31, 2022 was $67,718 and $65,126, respectively.

Estimated future amortization expense as of December 31, 2023:

Note 6 – Revenue, Unearned Revenue and Unbilled Accounts Receivable

Revenue

The following is a summary of our revenues by type for the years ended December 31, 2023 and 2022:

Unearned Revenue

The following is a summary of our unearned revenue activity for the years ended December 31, 2023 and 2022:

Note 7 – Stockholder’ Equity

The Company is authorized to issue 50,000,000 preferred stock shares and 200,000,000 common stock shares both with a par value of $.0001.

Preferred Stock

On October 30, 2020, the Company designated 1,000,000 shares as Series D Convertible Preferred Stock with a par value of $0.0001.

On April 16, 2021, the Company closed on a private placement of 440,125 shares of Series D Convertible Preferred Stock (the “Preferred Stock'') with a par value of $0.0001, yielding gross proceeds of $6,551,691 (the “Private Placement”) and settlement of a $50,000 liability for Preferred Stock shares. The Private Placement proceeds will be used for working capital, primarily for the development, manufacturing and commercialization of 374Water’s Air SCWO systems. The Preferred Stock has a stated value of $15 per share, is convertible into common stock at $0.30 per share and has voting rights based on the underlying shares of common stock. Upon liquidation of the Company, the Preferred Stockholders have a liquidation preference before any assets can be distributed to common stockholders. All of the Preferred Stock were sold pursuant to an exemption from registration requirements under Regulation D and/or Section 4(2) of the Securities Act of 1933, as amended. On September 29, 2021,412,853 shares of Preferred Stock were converted into 20,642,667 shares of common stock. On January 12, 2022, the Company converted the remaining 27,272 shares of Preferred Stock to 1,363,149 shares of common stock. As of December 31, 2023, there are 50,000,000 shares of “blank check” preferred stock, but there were no shares of Preferred Stock issued and outstanding.

Common Stock

The holders of common stock are entitled to one vote per share on all matters submitted to a vote of shareholders, including the directors’ election. There is no right to cumulative voting in the election of directors. The holders of common stock are entitled to any dividends that may be declared by the board of directors out of funds legally available for payment of dividends subject to the prior rights of holders of preferred stock and any contractual restrictions the Company has against the payment of dividends on common stock. In the event of our liquidation or dissolution, holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preferences of any outstanding shares of preferred stock. Holders of common stock have no preemptive rights and have no right to convert their common stock into any other securities. As of December 31, 2023, there were 132,667,107 shares of common stock issued and outstanding.

In December 2022, the Company entered into an equity distribution agreement with an underwriter pursuant to which the Company may offer and sell shares of its common stock from time to time through the underwriter as its sales agent. Sales of common stock, if any, will be made at market prices by any method permitted by law deemed to be an “at-the-market” offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended. The Company has no obligation to sell any shares of common stock under the open market sale agreement and may at any time suspend offers under the open market sale agreement, in whole or in part, or terminate the equity distribution agreement.

During the year ended December 31, 2023, a total of 3,766,422 shares of common stock have been sold pursuant to the open market sale agreement resulting in a total of $13,441,438 in proceeds, net of $230,000 commission fees and $110,000 of accounting and legal fees. As of December 31, 2023, approximately $86,560,000 remained available under the Company’s at-the-market public facility, subject to various limitations.

Stock-Based Compensation

Stock Options issued are part of the 2021 Equity Incentive Plan (the “2021 Plan”) which reserved a total of 10,000,000 shares. The Company has issued a total of 4,052,000 stock options with 5,948,000 reserved options remaining for issuance as of December 31, 2023. The Company recorded stock-based compensation of $925,181 and $610,741, respectively, related to vested options and options expected to vest granted to employees and various consultants of the Company, of which $796,881 and $549,435 was charged as general and administrative expenses and $128,300 and $61,306 as research and development expenses in the accompanying consolidated statements of operations during the years ended December 31, 2023 and 2022, respectively. During the year ended December 31, 2023 and 2022, the stock-based compensation expense recognized is net of estimated forfeitures of $50,000 and $41,851, respectively.

Stock Options

Stock option activity for the year ended December 31, 2023 and 2022 is summarized as follows:

*Includes 8,700,000 options granted in connection with the Merger (see Note 1) and were not granted under the 2021 Plan. As of December 31, 2023,6,700,000 of these options remain outstanding.

During the year ended December 31, 2023, the options exercised consisted of 2,283,800 of cashless option exercises which resulted in the issuance of 2,067,902 shares of common stock shares and the exercise of 95,238 common stock options with an exercise price of $1.05 which resulted in gross proceeds of $100,000 and the issuance of 95,238 common stock shares.

Total unrecognized compensation associated with these unvested options is approximately $1,912,257 which will be recognized over a period of approximately three years.

Intrinsic value is based on the difference between the option exercise price and the quoted market price as of December 31, 2023.

The fair value of these options granted were estimated on the date of grant, using the Black-Scholes option-pricing model with the following assumptions:

Stock Warrants

During the year ended December 31, 2022, there were no new warrants issued or exercised. During the year ended December 31, 2023, there were no new warrants issued and 15,000 warrants exercised with an exercise price of $2.50 resulting in gross proceeds of $37,500 and the issuance of 15,000 shares of common stock. The intrinsic value of all outstanding warrants as of December 31, 2023 was $0 based on the market price of our common stock of $1.42 per share.

A summary of warrant activity as of December 31, 2023, is as follows:

Note 8 – Related Party Transactions

In 2021, the Company entered into a manufacturing and service agreement to fabricate and manufacture the AirSCWO systems (the “Original M&S Agreement”) with Merrell Bros. Fabrication, LLC, a division of Merrell Bros. Inc (“Merrell Bros.”). The initial term of the Original M&A Agreement ends July 7, 2024 with a one-year automatic renewal unless terminated by either party with at least a sixty-day notice prior to expiration (see Note 11 – Subsequent Events).

As part of the agreement, the Company appointed Terry Merrell to its board of directors. As of December 31, 2023, Merrell Bros. or their affiliates own stock below 5% of the outstanding common stock. As of December 31, 2022, Merrell Bros. or their affiliates own stock in excess of 5% of the outstanding common stock.

As of December 31, 2023, the Company incurred $1,210,826 in related party expenses related to the manufacturing of the AirSCWO systems. As of December 31, 2023, accounts payable and accrued expenses includes $125,282 of amounts owed to Merrell Bros. for the manufacturing services provided.

Note 9 – Commitments and Contingencies

License Agreement

The patented technology underlying 374Water’s supercritical water oxidation (SCWO) units, which was developed principally through the efforts of Messrs. Nagar and Deshusses at the facilities of Duke University, Durham, North Carolina (“Duke”), where Dr. Deshusses is a professor. The SCWO technology is licensed to 374Water pursuant to a worldwide license agreement with Duke executed on April 16, 2021 (the “License Agreement”). In connection with the License Agreement, 374Water also executed an equity transfer Agreement with Duke pursuant to which Duke received a small number of common stock in the Company (See Note 5). Under the terms of the License Agreement, the Company is required to make royalty payments based on a percentage of licensed product sales, as defined in the License Agreement which is triggered by the sale of licensed products. Further, the Company is also required to pay royalties on a percentage of sublicensing fees. The Company will reimburse Duke for any ongoing patent expenses incurred. As of December 31, 2023, the Company has not incurred any expenses in connection with this License Agreement. The Company may terminate the license agreement anytime by providing Duke 60 days’ written notice.

Legal Settlement

In 2023, the Company was named in a lawsuit filed against our former stock transfer agent (“Former TA”) by certain unrelated individuals asserting claims for negligence, conversion, and various breaches. Our Former TA issued 175,000 shares of our common stock to the State of Delaware in accordance with escheat laws after the Former TA was unable to issue the shares of common stock to the individuals. While the Company was not at fault in the matter, due to certain indemnification clauses between the Company and the Former TA, we are in the process of settling the matter with the individuals.

Based on the settlement discussions currently in process, we believe this matter will be settled with 275,000 common stock options with an exercise price equal to the market price when granted and an exercise period of five years. As of December 31, 2023, we have $135,000 as an accrued legal settlement, as presented on the accompanying consolidated balance sheet, for this pending settlement based on the estimated grant-date fair value of these options using a Black-Scholes valuation model and the following assumptions: stock price and exercise price of $1.33, risk free rate 4.43%, expected term five years, and volatility of 26.36%. This estimated legal settlement has been included in general and administrative expenses on the accompanying consolidated statements of operations for the year ended December 31, 2023.

We note that in the ordinary course of business that we may be the subject of, or party to, various pending or threatened legal actions which could result in a material adverse outcome for which the related damages may not be estimable. We do not believe any legal action would have a significant impact on the financials other than the matter disclosed above. However, there is inherent uncertainty regarding such matters.

Note 10 – Income****Taxes

Deferred income taxes are provided based on the provisions of ASC Topic 740, “Accounting for Income Taxes”, to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Significant components of the Company’s net deferred income taxes are as follows:

A reconciliation of the U.S. statutory federal income tax rate to the effective income tax rate (benefit) follows:

Rate Reconciliation

The Company has gross net operating loss carryforwards for federal tax purposes totaling approximately $13.3 million and $4.4 million at December 31, 2023 and 2022 respectively, which will carry forward indefinitely. The Company has gross net operating loss carryforwards for state tax purposes totaling approximately $11.0 million and $1.45 million at December 31, 2023 and 2022 respectively, which will carry forward indefinitely.

NOLs that were acquired with the acquisition of businesses are excluded from the amount of available NOLs to the extent their use is limited by the provisions of Section 382 of the Internal Revenue Code. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company's ownership may result in further limitation on the amount of net operating loss carryforwards which can be utilized in future years.

In evaluating the amount of the valuation allowance against its deferred tax assets as of December 31, 2023 and 2022, the Company considered all available positive and negative evidence and concluded that it is more likely than not that a portion of its deferred tax assets would not be realized. Accordingly, the Company has recorded a valuation allowance against its net deferred tax assets due to the uncertainty surrounding the realization of such assets.

The Company had no unrecognized tax benefits as of December 31, 2023 and 2022. The Company does not anticipate a significant change in total unrecognized tax benefits within the next 12 months. Tax years 2020-2022 remain open to examination by the major taxing jurisdictions to which the Company is subject.

Note 11 – Subsequent Events

On March 27, 2024, we executed a supplemental manufacturing and services agreement (the “Supplemental M&S Agreement”) with Merrell Bros. as Merrell Bros. has indicated to us their intent to not renew the Original M&S Agreement and we have indicated our desire to relocate to a larger manufacturer facility with more square footage dedicated to expanding our manufacturing operations. Simultaneous to executing the Supplement M&S Agreement, Merrell Bros. provided us with a written non-renewal notice. Accordingly, the manufacturing and service agreement will terminate on its original expiration date of July 7, 2024 and will not be renewed.

The Supplemental M&S Agreement will become effective on July 7, 2024 and will replace the Original M&S Agreement. Under the Supplemental M&S Agreement, our relationship and the manufacturing services provided by Merrell Bros. will continue on an as needed basis based on statements of work to be agreed upon by both parties to fulfill future and current manufacturing orders. The term of the Supplemental M&S Agreement is one year from July 7, 2024 with a one-year renewal upon a mutually executed written extension. Either party may terminate this Supplement M&S Agreement upon written notice of such a termination, specifying the extent to which performance of work is terminated and the effective date of termination.

The Supplemental M&S Agreement will become effective on July 7, 2024 and will replace the Original M&S Agreement. Under the Supplemental M&S Agreement, our relationship and the manufacturing services provided by Merrell Bros. will continue on an as needed basis based on statements of work to be agreed upon by both parties to fulfill future and current manufacturing orders. The term of the Supplemental M&S Agreement is one year from July 7, 2024 with a one-year renewal upon a mutually executed written extension. Either party may terminate this Supplement M&S Agreement upon written notice of such a termination, specifying the extent to which performance of work is terminated and the effective date of termination.

EXHIBIT INDEX

• Filed herewith.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

In accordance with the Exchange Act, this Report has beensignedby the following persons on behalf of the Registrant and in the capacities and on the dates indicated.