374Water Inc

Note 1 – Nature of Business and Presentation of Financial Statements

Description of the Company

374Water Inc. (the “Company”, “374Water”, “we”, “us”, 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 is developing a technology that destroys hazardous and non-hazardous waste such as sewage sludge, biosolids, food waste, and forever chemicals (e.g., “per-and polyfluoroalkyl substances” or “PFAS”) and in the process produces safe dischargeable waste streams, safe mineral effluent, safe vent gas and recoverable heat energy. We are in the process of developing AirSCWO, a proprietary waste treatment system based on “supercritical water oxidation.” We continue making progress towards commercializing our AirSCWO systems to provide the market with advanced clean and sustainable organic waste destruction technologies and solutions.

Presentation of Financial Statements and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) for interim financial information. It is management’s opinion that the accompanying unaudited condensed consolidated financial statements are prepared in accordance with instructions for Form 10-Q and include all adjustments (consisting only of normal recurring accruals) which are necessary for a fair presentation of the results for the periods presented. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the Annual Report on Form 10-K of 374Water Inc. as of and for the year ended December 31, 2023 filed with the SEC on March 29, 2024.

The results of operations for the nine months ended September 30, 2024, are not necessarily indicative of the results to be expected for the full year or for future periods. The condensed consolidated financial statements include the accounts of 374Water Inc., 374Water Systems Inc, and 374Water Sustainability Israel LTD (currently inactive), each a wholly-owned subsidiary of 374Water Inc. Intercompany balances and transactions have been eliminated in consolidation.

Note 2 – Summary of Significant Accounting Policies

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company held $1,960,375 and $10,445,404 in cash and cash equivalents at September 30, 2024 and December 31, 2023, respectively.

Accounts Receivable and Unbilled Accounts Receivable

Accounts receivables consist of balances due from equipment and service revenues. Unbilled accounts receivables are from revenues earned but not yet billed and relate to one customer contract. The Company monitors accounts receivable and provides allowances when considered necessary. At September 30, 2024 and December 31, 2023, accounts receivable were considered to be fully collectible but in accordance with the allowance for credit losses, the Company recorded an allowance for bad debt based on a reserve of current and aged receivables which was not significant at September 30, 2024 and December 31, 2023.

Other Accounts Receivable

Other accounts receivable primarily consisted of accrued interest income from the cash held in an interest bearing money market account with a financial institution. We typically receive payment for accrued interest one month in arrears.

Inventory, Net

Inventories are stated at the lower of cost or net realizable value. Cost is determined on a first-in, first-out basis. The majority of 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. 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 or usage 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. Based on our evaluation, we estimated an inventory allowance of $50,000 and $0 at September 30, 2024 and December 31, 2023, respectively.

Property and Equipment, Net

Property and Equipment is recorded at cost. Expenses for maintenance and repairs are charged to expense as incurred.

The following table represents property and equipment at September 30, 2024 and December 31, 2023:

Property and equipment is recorded at cost. Depreciation is computed using the straight-line method and estimated useful lives of three to five years. Expenses for maintenance and repairs are charged to expense as incurred. Depreciation expense for the three months ended September 30, 2024 and 2023, was $10,276 and $2,376, respectively. Depreciation expense for the nine months ended September 30, 2024 and 2023, was $27,185 and $12,793, respectively.

Equipment In-Process

We are in the process of manufacturing and fabricating one of our AirSCWO systems that we plan to use for water treatment demonstration purposes (“Demo System”). We have capitalized the material and labor costs incurred to develop this Demo System, and had previously classified these costs within inventory. In the first quarter of 2024, we executed a contract with the City of Orlando, Florida to deploy the Demo System as part of a full-scale demonstration. We began the set up and commissioning process of this Demo System in the third quarter of 2024. Therefore, at September 30, 2024, we have-presented these costs in long-term assets, equipment-in-process which will be depreciated over an estimated useful life of ten years once the Demo System begins the full-scale demonstration. We will likely continue to develop and enhance this unit as we perform our demonstrations and continue progressing towards commercialization. Expenses incurred deemed to be maintenance and repairs will be expensed as incurred. Upgrades and enhancements that will improve the operational efficiency of the unit itself will be capitalized.

Intangible Assets, Net

Intangible assets are subject to amortization, and any impairment is determined in accordance with ASC 360, “Property, Plant, and Equipment.” 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. At September 30, 2024 and December 31, 2023, there was no impairment.

Long-Lived Assets

The Company reviews long-lived assets, including 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. At September 30, 2024 and December 31, 2023, there were no impairments.

Concentrations of Credit Risk

Financial instruments and other items that potentially subject the Company to credit risk consist of cash and cash equivalents and customer concentrations. 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, the Company performs ongoing credit evaluations of its customers and generally does not require collateral.

Significant customers and suppliers are those that account for greater than 10% of the Company’s revenues and purchases. For the nine months ended September 30, 2024, two customers made up approximately 80% of our consolidated revenues. For the nine months ended September 30, 2023, over 96% of our consolidated revenues were from one customer. At September 30, 2024 and December 31, 2023, our unbilled receivables of $1,721,147 and $1,494,553, respectively, was due from one customer. At September 30, 2024, one customer accounted for 59% of our outstanding consolidated accounts receivable balance of $288,777. At of December 31, 2023, an accounts receivable concentration did not exist.

During the nine months ended September 30, 2024 and 2023, the Company purchased a substantial portion of fabrication and manufacturing services from one related party vendor, Merrell Bros Fabrication, LLC (“Merrell Bros.”) (see Note 8).

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 systems) and services, specifically the completion of treatability and demonstration services of various types of waste streams. In the case of revenues from AirSCWO systems, the Company’s performance obligations are satisfied over time over the life of the contract, which is currently a long-term 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 proportion to the contract costs incurred compared to total estimated costs to complete. 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, from treatability studies, are recognized when all five revenue recognition criteria have been completed which is generally when the Company has delivered a completed treatability study report to the customer.

During the three months ended September 30, 2024, we deployed our Demo System to the City of Orlando’s Iron Bridge Regional Water Reclamation Facility pursuant to a contract executed in March 2024 as part of a full-scale demonstration (the “Demo Contract”). Pursuant to the Demo Contract, the Company is responsible for system design, installation, commissioning and the start-up of the AirSCWO unit at the facility. Further, the Company will operate and maintain the AirSCWO unit for a period of approximately three months and is required to treat no less than 400 metric tons of waste water during the three-month period. Lastly, the Company will decommission, disassemble and demobilize the AirSCWO unit after the contract period. The Company will receive $812,000 as consideration, of which $574,000 is subject to achieving the 400 metric ton performance requirement over the three-month period of operations and maintenance.

In accordance with ASC 606-10-25-21, we have concluded that the Demo Contract includes one performance obligation as the various services required to be performed by the Company are interdependent and highly interrelated. Therefore, the various services are not separate and distinct. We will recognize revenue on this Demo Contract over the three-month period of operations and maintenance which is the point in time that the City of Orlando receives the benefit simultaneous to Company’s performance.

We will invoice the City of Orlando in accordance with the contract terms. Invoices are due within thirty days of receipt. The City of Orlando has the right to cancel the Demo Contract for convenience with a twenty-day written notice but is responsible for paying the Company all amounts owed and outstanding for work performed prior to the effective termination date and costs and expenses incurred by the Company to uninstall, remove, relocate and delivery the AirSCWO unit but limited to $68,000.

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. As of September 30, 2024, we have capitalized $99,245 of costs incurred to date to fulfill the Demo contract which are presented as contract assets. We will expense these costs over the three-month demonstration period. General, selling, and administrative costs are charged to expenses as incurred.

Refer to Note 6 for further disclosures related to our revenue.

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. GAAP contains other applicable guidance on the accounting for onerous contracts, and those requirements should be used to identify and measure onerous contracts.

The Company’s outstanding equipment manufacturing contract on our sold unit is a fixed price contract (“Equipment Sale 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.

At September 30, 2024 and December 31, 2023, the Company evaluated the total costs incurred on this Equipment Sale Contract to date and the estimated costs it anticipates incurring to complete the contract. Based on this analysis, we accrued a total accrued loss provision of $600,000 and $500,000 at September 30, 2024 and December 31, 2023, respectively, which has been presented on the accompanying unaudited condensed consolidated balance sheets and is recorded within cost of revenues on the accompanying unaudited condensed consolidated statements of operations.

Stock-based Compensation and Change in Accounting Policy

The Company accounts 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.

Prior to January 1, 2024, the Company had elected to estimate options granted for which the requisite service period would not be rendered, due to the option being forfeited or expiring. The forfeiture rate estimate was based on the percentage of cumulative forfeitures to the total award grants. During the quarter ended December 31, 2023, the Company compared its actual forfeiture rate to its estimated forfeiture rate and made acumulative adjustment of approximately $55,000 in the quarter ended December 31, 2023 to reduce its forfeiture rate estimate to approximately 5% of the total stock-based compensation recognized during the year.

Effective January 1, 2024, the Company made a change in its accounting policy to recognize forfeitures on service-based stock award instruments as they occur. Due to the lack of history available to adequately estimate its forfeiture rate and the fact that the majority of its serviced based options include a one-year cliff vesting and monthly vesting after, the Company believes recognizing forfeitures as they occur will result in more accurate financial reporting. The change in this accounting policy did not have a significant impact on the current or prior period financial statements.

Leases

The Company accounts for leases under ASC Topic 842,Leases. Operating leases are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities on the consolidated balance sheets. The Company leases an office and warehouse to conduct business. The Company has elected not to recognize right-of-use assets and lease liabilities for short-term leases that have a term of 12 months or less.

Operating lease ROU assets represent the right to use the leased asset for the lease term and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most leases do not provide an implicit rate, the Company uses an incremental borrowing rate based on the information available at the adoption date in determining the present value of future payments. Operating lease expense is recognized on a straight-line basis over the lease term. At September 30, 2024 and December 31, 2023, we did not have any leases with terms that exceed 12 months.

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 at September 30, 2024 and December 31, 2023.

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 $1,526,294 and $945,443 for the nine months ended September 30, 2024, and 2023, respectively, and $424,579 and $317,573, for the three months ended September 30, 2024, and 2023, respectively,

Earnings (Loss) Per Share

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 nine-months ended September 30, 2024 and 2023 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.

At September 30, 2024, there were the following potentially dilutive securities that were excluded from diluted net loss per share because their effect would be antidilutive: options for 17,207,510 shares of common stock,1,235,000 warrants, and unvested restricted stock awards of 3,053,742. At September 30, 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 10,628,000 shares of common stock and 1,235,000 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 / useful lives of equipment and intangible assets due to their current nature.

Use of Estimates

The preparation of financial statements in conformity with GAAP 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, reserve for obsolete inventory, accrued contract loss provisions, total estimated costs to be incurred on long-term contracts, and valuation allowance against deferred tax assets.

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 December 15, 2024 (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, 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.

Note 3 – Liquidity, Capital Resources and Going Concern

In accordance with ASU No. 2014-15 Presentation of Financial Statements – Going Concern (subtopic 205-40), the Company’s management evaluates whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. At September 30, 2024, the Company had working capital of $4,484,164 and cash on hand of $1,960,375. At September 30, 2024, the Company had an accumulated deficit of $23,612,106. For the nine months ended September 30, 2024, the Company had a net loss of $7,658,602 and used $7,497,734 of net cash in operations for the period, respectively. Further, we expect to incur substantial losses until we can successfully commercialize and market our AirSCWO systems, as to which there can be no assurance that this will occur.

These conditions raise substantial doubt regarding our ability to continue as a going concern as the Company will need additional debt or equity financing or a combination of both to continue its operations and meet its financial obligations for twelve months from the date these condensed consolidated financial statements were issued.

Presently, the Company will need additional debt or equity financing or a combination of both to continue its operations and meet its financial obligations for at least the next twelve months from the date these condensed consolidated financial statements were issued and beyond. We may consume available resources more rapidly than currently anticipated, resulting in the need for additional funding. We expect to incur continuing losses and negative cash flows from operations for the foreseeable future.

Since inception, we have financed our operations principally through the sale of debt and equity securities and operating cash flows. We have an at-the-market (ATM) equity offering under which we may issue up to $100 million of common stock, subject to applicable law. During the nine months ended September 30, 2024 and year ended December 31, 2023, we raised approximately $12,000 and $13,400,000 respectively, of net proceeds through this ATM. The Company is evaluating strategies to obtain the required additional funding for future operations.

Any additional debt or equity financing that the Company obtains may substantially dilute the ownership held by our existing stockholders. The economic dilution to our shareholders will be significant if our stock price does not materially increase, or if the effective price of any sale is below the price paid by a particular investor. The Company may be unable to access further equity or debt financing when needed or obtain additional financing under acceptable terms, if at all.

We may decide to raise additional capital through a variety of sources in the short-term and in the long-term, including but not limited to:

If the Company is unable to raise additional capital, there is a risk that the Company could be required to discontinue or significantly reduce the scope of its operations. These condensed consolidated financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Note 4 – Inventory

Inventory consists of:

Note 5 – Intangible Assets

Intangible assets, net, are comprised of the following at September 30, 2024 and December 31, 2023:

Amortization expense for the three months ended September 30, 2024 and 2023, was $17,812 and $16,925, respectively, which is included in general and administrative expenses on the condensed consolidated statements of operations.

Amortization expense for the nine months ended September 30, 2024 and 2023, was $51,855 and $50,789. respectively, which is included in general and administrative expenses on the condensed consolidated statements of operations.

Estimated future amortization expense for the years ended December 31:

Note 6 – Revenue

The following is a summary of our revenues by type for the three and nine-month periods ended September 30, 2024 and 2023:

Unbilled Accounts Receivable

The following is a summary of our unbilled accounts receivable activity for the nine months ended September 30, 2024 and the year ended December 31, 2023:

Unearned Revenue

The following is a summary of our unearned revenue activity for the nine months ended September 30, 2024 and year ended December 31, 2023:

We anticipate recognizing the unearned revenue as of September 30, 2024 within the next twelve months.

Note 7 – Stockholders’ Equity

The Company is authorized to issue 50,000,000 shares of preferred stock and 200,000,000 shares of common stock both with a par value of $0.0001.

Preferred Stock

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

At September 30, 2024, 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 liquidation or dissolution of the Company, 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 pre-emptive rights and have no right to convert their common stock into any other securities. At September 30, 2024, there were 133,168,049 shares of common stock issued and outstanding.

Common Stock Sales

In December 2022, the Company entered into an open market sale agreement with a sales agent pursuant to which the Company may offer and sell shares of its common stock from time to time through the 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 sale market agreement, in whole or in part, or terminate the open market sale agreement.

During the nine months ended September 30, 2024, a total of 50,510 shares of common stock were sold pursuant to the open market sale agreement resulting in gross proceeds of approximately $62,000, and issuance costs consisting of $1,560 in commission fees and approximately $49,100 of accounting and legal fees for net proceeds of approximately $12,000.

During the nine months ended September 30, 2023, a total of 3,766,422 shares of common stock were sold pursuant to the open market sale agreement resulting in net proceeds of $13,441,000 in proceeds, net of $230,000 of commission fees and $110,000 of accounting and legal fees.

At September 30, 2024, a total of 3,816,932 shares of common stock have been sold pursuant to the open market sale agreement. At September 30, 2024, approximately $86,154,000 remains available to be sold in the Company’s at-the-market offerings, subject to various limitations.

Common Stock for Services

During the nine months ended September 30, 2024, we issued 31,672 fully vested shares of common stock to service providers with an aggregate fair value of $39,631 based on the market price of our common stock on date of grant.

During the nine months ended September 30, 2024, we issued an aggregate of 240,000 fully vested shares of restricted common stock to our board of directors with a fair value of $333,600 based on the market price of our common stock on the date of grant.

During the nine months ended September 30, 2024, aggregate expense associated with shares of common stock issued for services was $373,231 which has been included in general and administrative expenses on the condensed unaudited consolidated statements of operations.

During the nine months ended September 30, 2023, we issued 20,000 fully vested shares of restricted common stock to two former employees with a fair value of $71,200 based on the market price of our common stock on date of grant.

Stock-Based Compensation

During the nine months ended September 30, 2024 and 2023, the Company recorded stock-based compensation of $878,993 and $667,950, respectively, for restricted stock units and options granted to employees and various consultants of the Company.

For the nine months ended September 30, 2024, $719,786 of the stock-based compensation was charged as general and administrative expenses and $159,207 as research and development expenses in the accompanying unaudited condensed consolidated statements of operations.

For the nine months ended September 30, 2023, $583,549 was charged as general and administrative expenses and $84,401 as research and development expenses in the accompanying unaudited condensed consolidated statements of operations.

Stock Options

Stock options issued under the Company’s 2021 Equity Incentive Plan, as amended (the “2021 Plan”), initially reserved and authorized a total of 10,000,000 shares of our common stock for issuance under the 2021 Plan. At the 2024 Annual Meeting of Stockholders held on June 13, 2024, the Company’s stockholders approved an amendment to the Company’s 2021 Plan to increase the number of shares of common stock authorized and issuable pursuant to the 2021 Plan by 14,000,000 shares for a total of 24,000,000 shares.

Stock option activity for the nine months ended September 30, 2024 is summarized as follows:

*Includes 7,675,000 options granted outside of our 2021 Plan. In connection with the Merger (see Note 1)7,400,000 were not granted under the 2021 Plan and the 275,000 options granted to settle a legal matter (see Note 9) were granted outside of the 2021 Plan.

During the three months ended September 30, 2024, we made an adjustment to our stock option activity to add back 700,000 fully vested stock options reissued to a consultant that were previously granted that had been presented as forfeited in prior periods. The service agreement with this consultant was terminated on October 15, 2024. These options have an exercise price of $0.12 per share and expire July 15, 2025.

During the nine months ended September 30, 2024, the option grants primarily consisted of 5,250,000 options granted to the Company’s Chief Executive Officer (“CEO”, see Note 9),231,000 options granted to the Company’s Chief Operating Officer (“COO”, see Note 9),481,000 options granted a key employee pursuant to an employment agreement and 376,742 granted to employees and non-employees. Further,275,000 options were granted pursuant to a legal settlement (see Note 9). The average grant-date fair value of the granted options was $0.47.

Of the total options granted during the nine months ended September 30, 2024, 3,151,871 of the options include performance conditions. The performance-based options vest as follows: 50% vest upon the achievement of Operating Profit, as defined in the employment agreements, and 50% upon the achievement of a revenue target of $100 million by the end of fiscal year 2028. The restricted stock units with the revenue target begin vesting once the Company achieves $15 million in revenue for a fiscal year. Vesting will occur on January 31 of each year through January 31, 2029. The number of restricted stock units that vest is based on the proportionate percentage of each fiscal year’s revenue to the $100 million target. For example, if our annual revenue for fiscal year 2026 is $20 million, 20% of the restricted stock units with the revenue performance condition will vest on January 31, 2027.

The aggregate grant-date fair value of these performance-based options is $1,477,251. During the nine months ended September 30, 2024, the Company did not recognize any stock-based compensation associated with these options as the probability of the performance conditions being met was deemed remote.

Total unrecognized compensation associated with unvested time-based options is approximately $2,417,287 which will be recognized based on the options associated vesting schedules over a period of approximately 1.67 years. During the nine months ended September 30, 2024, $696,720 of our stock-based compensation was associated with the time-based stock options.

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. This does not include options related to a settlement which were issued during the year and will be discussed in Footnote 9 - Commitments:

Restricted Stock Units

During the nine months ended September 30, 2024, the Company granted an aggregate of 3,053,742 unvested restricted stock units under the 2021 Plan as follows:2,250,000 our Chief Executive Officer (Note 9),231,000 to our Chief Operating Officer (Note 9), and 572,742 to key employees of the Company. These unvested restricted stock units consist of 1,401,871 units with time-based vesting provisions and 1,651,871 units with performance-based vesting provisions. Theperformance-based units vest as follows: 50% vest upon the achievement of Operating Profit, as defined in the employment agreements, and 50% upon the achievement of revenue targets between $15.0 and $100 million by the end of fiscal year 2028. The restricted stock units with the revenue target begin vesting once the Company achieves $15.0 million in revenue for a fiscal year. Vesting will occur on January 31 of each year through January 31, 2029. The number of restricted stock units that vest is based on the proportionate percentage of each fiscal year’s revenue to the $100 million target. For example, if our annual revenue for fiscal year 2026 is $20 million, 20% of the restricted stock units with the revenue performance condition will vest on January 31, 2027.

The grant-date fair value of the restricted stock units was determined using the market price of our common stock on the date of grant which ranged from $1.09 to $1.30. At September 30, 2024, we have $2,075,299 of unrecognized stock-based compensation associated with the restricted stock units with a performance condition which will be recognized when the performance conditions are probable of being met. At September 30, 2024, the Company had $1,580,526 of unrecognized stock-based compensation associated with the time vesting restricted stock units which will be recognized over a period of approximately 3.75 years. During the nine months ended September 30, 2024, $182,273 of our stock-based compensation was associated with the time-based restricted stock units.

A summary of our outstanding nonvested restricted stock units is as follows:

Warrants

At September 30, 2024, there were 1,235,000 warrants outstanding which relate to a private placement offering consummated in December 2021, where investors were offered a warrant for every two shares of common stock purchased in the offering at an exercise price of $2.50 per share. These warrants will expire in December of 2024. At September 30, 2024, the intrinsic value was nil based on the market price of our common stock.

Note 8 - Related Party Transactions

On July 7, 2021, we entered into a manufacturing and services agreement (the “Original M&S Agreement”) to fabricate and manufacture the AirSCWO systems with Merrell Bros. Fabrication, LLC (“Merrell Bros.”). As part of the agreement, the Company appointed Terry Merrell, one of the owners of Merrell Bros., to its board of directors. At September 30, 2024, Merrell Bros. or their affiliates own stock below 5% of the outstanding common stock.

For the nine-month period ending September 30, 2024 and 2023, the Company incurred $240,559 and $737,775, respectively, in related party expenses, all of which was related to non-recurring labor and other operating costs associated with the manufacturing of our AirSCWO systems. At September 30, 2024 and December 31, 2023, accounts payable and accrued expenses include $33,593 and $125,282, respectively, due to Merrell Bros. for manufacturing related services provided.

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

The Supplemental M&S Agreement became effective on July 7, 2024 and replaced the Original M&S Agreement. Under the Supplemental M&S Agreement, our relationship and the manufacturing services provided by Merrell Bros. will continue 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.

Merrell Bros. agreed to extend the expiration date of the Original M&S Agreement through July 31, 2024, to allow for our transition and move to our own facility. See subsequent events Note 10.

Note 9 - Commitments

License Agreement

The SCWO technology is licensed to 374Water pursuant to a non-exclusive 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 shares of common stock of the Company (See Notes 5 and 7). 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. During the nine-month period ending September 30, 2024, 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 its former stock transfer agent (“Former TA”) by certain unrelated individuals asserting claims for negligence, conversion, and various breaches. The Former TA issued 175,000 shares of Company 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, the Company was part of the settlement with the individuals.

This matter was fully settled on May 31, 2024 with an aggregate of 275,000 fully vested common stock options granted to the unrelated individuals. These stock options were granted outside of the 2021 Plan. The stock options have an exercise price of $1.25, equal to the market price of our common stock on the settlement date, and an exercise period of five years. At December 31, 2023, the Company had accrued $135,000 as an estimated legal settlement for this pending matter 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%. Upon the matter being formally settled on May 31, 2024, we determined the grant-date fair value of the options using a Black-Scholes valuation model to be $112,697 and the following assumptions: stock price and exercise price of $1.25, risk free rate 4.52%, expected term five years, and volatility of 27.43%. The Company recognized a gain of $22,303 upon the settlement of this legal matter which is reflected in professional fees on the unaudited condensed statements of operations.

In the ordinary course of business, the Company 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. The Company does 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.

Employment Agreements

CEO

On April 19, 2024, the Company entered into an employment agreement with Christian Gannon (the “Employment Agreement”), for Mr. Gannon to serve as President and Chief Executive Officer (“CEO”) of the Company effective April 22, 2024 (the “Start Date”). The Employment Agreement provides for an initial annual salary for Mr. Gannon of $450,000. Mr. Gannon is also eligible to earn an annual fiscal year performance bonus for each whole or partial fiscal year of his employment period with the Company; for the initial year under the Employment Agreement in accordance with certain milestones set forth by the Company, and thereafter as determined by the compensation Committee of the Company and the Board of Directors of the Company. Mr. Gannon is eligible to earn a performance bonus up to 125% of Mr. Gannon’s then-current base salary (the “Annual Bonus”) if certain milestones are met as defined in the Employment Agreement.

Under the Employment Agreement and subject to the terms of the Company’s 2021 Plan, Mr. Gannon was granted up to 2,250,000 Restricted Stock Units (as defined in the Plan) under the Plan, vesting as follows: (a) 250,000, on the first annual anniversary of the Start Date; (b) 750,000, in equal increments on the last day of every month thereafter over the following 36 months, subject to Mr. Gannon’s continued employment with the Company on each vesting date; and (c) 1,250,000, pursuant to certain performance related milestones set forth by the Company and defined in the Employment Agreement (collectively, the “Gannon Restricted Stock Units”). Additionally, pursuant to the Employment Agreement and the terms of the 2021 Plan, Mr. Gannon was granted 5,250,000 Options (as defined in the 2021 Plan) under the 2021 Plan vesting as follows: (a) 625,000, on the first annual anniversary of the Start Date; (b) 1,875,000, in equal installments on the last day of every month thereafter over the following 36 months subject to Mr. Gannon’s continued employment with the Company on each vesting date; and (c) 2,750,000, pursuant to certain performance related milestones set forth by the Company and defined in the Employment Agreement (collectively, the “Gannon Options”, and together with the Gannon Restricted Stock Units, the “Gannon Equity Awards”). See Note 7 for further disclosures on the vesting performance related milestones.

If the Employment Agreement is terminated by the Company without “Cause” or by Mr. Gannon for “Good Reason” (each as defined in the Employment Agreement, subject to the Company’s right to cure), he will be entitled to termination benefits, pursuant to which the Company will be obligated to (i) pay Mr. Gannon 100% of his then-current annual base salary in 12 equal installments; (ii) any earned but unpaid Annual Bonus; (iii) coverage to Mr. Gannon and his dependents under the Company’s then current medical, health, and vision insurance plans for 12 months; and (iv) if such separation occurs on or after the first anniversary of the Start Date, (x) a pro-rated Annual Bonus for the fiscal year in which the employment is terminated equal to the pro-rated Annual Bonus that Mr. Gannon would have received based on actual performance for such fiscal year if Mr. Gannon was employed by the Company, and (y) accelerated vesting with respect to the Gannon Equity Awards as if Mr. Gannon had remained employed by the Company through the first anniversary of the date of such separation.

The Employment Agreement contains covenants for the benefit of the Company relating to the protection of the Company’s confidential information and standard Company indemnification obligations.

COO

On May 16, 2024 (the “Meyers Effective Date”), we entered into an employment agreement with Brad Meyers (the “COO Employment Agreement”), for Mr. Meyers to continue to serve as Chief Operating Officer (“COO”) of the Company, a position he has held since November 6, 2023. The COO Employment Agreement provides for an initial annual base salary for Mr. Meyers of $300,000. Mr. Meyers is also eligible to earn an annual fiscal year performance bonus with a target amount equal to 50% of Mr. Meyers’ then base-salary (the “Meyers Annual Bonus”).

Under the COO Employment Agreement and subject to the terms of the 2021 Plan , Mr. Meyers was granted 231,000 Restricted Stock (as defined in the 2021 Plan) and stock options for 231,000 (collectively, the “Meyers Equity Awards”), vesting as follows: (a) with respect to 115,500 Restricted Stock and 115,500 shares subject to stock options (“Options”), 25% vest on the first anniversary of the Effective Date, and the remaining 75% vest in equal increments on the last day of every month thereafter over the following 36 month, subject to Mr. Meyer’s continued employment with the Company on each vesting date: and (b) with respect to the remaining 115,500 Restricted Stock and 115,000 Options, each vest in accordance with a performance based milestones set forth by the Company and defined in the COO Employment Agreement. See Note 7 for further disclosures on the vesting performance-related milestones.

If the COO Employment Agreement is terminated by the Company without “Cause” or by Mr. Meyers for “Good Reason” (each as defined in the COO Employment Agreement, subject to the Company’s right to cure), he will be entitled to termination benefits, pursuant to which the Company will be obligated to (i) pay Mr. Meyers six months of his then-current annual base salary in six equal installments; (ii) any earned but unpaid Meyer’s Annual Bonus; (iii) coverage to Mr. Meyers and his dependents under the Company’s then current medical, health, and vision insurance plans for six months; and (iv) if such separation occurs on the day or after the first year anniversary of employment of the Meyers Effective Date, (x) a pro-rated Annual Bonus for the fiscal year in which the employment is terminated equal to the pro-rated Annual Bonus that Mr. Meyers would have received based on actual performance for such fiscal year if Mr. Meyers was employed by the Company, and (y) accelerated vesting with respect to the Meyers Equity Awards as if Mr. Meyers had remained employed by the Company through the six-month anniversary of the date of such separation.

The Employment Agreement contains covenants for the benefit of the Company relating to protection of the Company’s confidential information and standard Company indemnification obligations.

Note 10 – Subsequent Events

On October 15, 2024, a lease for our new laboratory space located in North Carolina commenced upon substantial completion of all tenant improvements by the landlord. The term of the lease began September 1, 2024 and ends in sixty-one months or October 1, 2029 with one five-year extension period. Monthly rental payments required under the lease are subject to annual increases and range from $14,235 - $16,503 over the initial term of the lease.

This lease will be accounted for under ASC Topic 842,Leasesand will result in an operating lease ROU asset and liability on our consolidated balance sheet based on the net present value of lease payments required over the lease term. The one five-year extension period will not be included in the ROU asset and liability as it was not reasonably certain this option would be exercised at lease commencement.

On November 4, 2024, our former Chief Executive Officer and Chairman of the Board filed a complaint against the Company alleging unpaid wages and a bonus. Management, in consultation with its attorneys, cannot reasonably estimate a loss associated with this complaint, at this time, as the matter is early in the process. If we are unsuccessful in defending this matter, we do not believe it would have a material impact to our financial position or results of operations.

On November 11, 2024, the Company’s board of directors approved a registered offering for the sale of units consisting of common stock and the issuance of warrants. The transaction is expected to close before year-end 2024, subject to customary closing conditions for a transaction of this type.

Cautionary Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q (the “Form 10-Q”) contains certain statements related to future results of 374Water, Inc. (the “Company,” “374Water,” “we,” “our,” or “us”) that are considered “forward-looking statements’’ within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements relate to future events, future financial performance, including statements relating to our ability to continue as a going concern, our strategies, expectations, competitive environment and regulation, our design, development and commercialization goals of our AirSCWO technology, projected timing for demonstration of our various AirSCWO systems, the assessment of market opportunities, our planned focus areas, our assessment of the regulatory landscape and its impact on demand for our products, expansion of our research and development and laboratory facility and its anticipated benefits, our ability to execute on our strategic plan, and other factors that may cause our actual results, levels of activity, performance, or our achievements or those of our industry to be materially different from those expressed or implied by any forward-looking statements. In some cases, forward-looking statements may be identified by the use of words like “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “project,” “consider,” “predict,” “potential,” “feel,” or other comparable terminology. The Company has based these forward-looking statements on its current expectations, assumptions, estimates, beliefs, and projections. While the Company believes these expectations, assumptions, estimates, and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which involve factors or circumstances that are beyond the Company’s control. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties, including, but not limited to:

In addition, many of the foregoing risks and uncertainties are, or could be, exacerbated by any worsening of the global business and economic environment. The forward-looking statements herein are made only as of the date they were first issued, and unless otherwise required by applicable securities laws, the Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

You should read the following discussion in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the SEC on March 29, 2024 (“2023 Form 10-K”). This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed under the caption “Risk Factors” and elsewhere in this Form 10-Q. See also “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this Form 10-Q.

Overview

374Water is a global cleantech company providing innovative solutions addressing wastewater treatment and waste management issues within the municipal, federal and industrial markets. 374Water’s AirSCWO technology is designed to efficiently destroy and mineralize a broad spectrum of organic non-hazardous and hazardous organic wastes producing safe dischargeable water streams, safe mineral effluent, safe vent gas, and recoverable heat energy. 374Water’s AirSCWO technology has the potential to assist its customers to meet discharge requirements, reduce or eliminate disposal costs, remove bottlenecks, and reduce litigation and other risks. 374Water continues to be a leader in innovative waste treatment solutions, dedicated to creating a greener future and eradicating harmful pollutants.

We are in the process of developing a proprietary waste stream treatment system based on supercritical water oxidation (AirSCWO) at a commercial scale. AirSCWO leverages the unique properties of water in its supercritical phase (above 374 o C and 221 Bar) to convert organic matter to energy and safe products that can be recovered and used.

We continue making progress towards commercializing our AirSCWO system to provide the market with advanced clean and sustainable organic waste destruction technologies and solutions. We have deployed our Demo System to the City of Orlando, Florida where we intend to demonstrate AirSCWO’s efficacy in destroying a variety of waste streams at a commercial scale. While the principal focus will be on treating the City of Orlando’s biosolids waste, we also intend to complete previously announced forever chemicals (e.g., “per-and polyfluoroalkyl substances” or “PFAS”) destruction demonstrations for federal agencies. These PFAS waste streams include recalcitrant organic wastes such as spent Granulated Activated Carbon (GAC), spent Ion Exchange (IX) resins, and Aqueous Film Forming Foam (AFFF).

Critical Accounting Estimates

In preparing the condensed consolidated financial statements, we have made estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues, costs, and expenses, and the disclosure of contingent assets and liabilities as in our condensed consolidated financial statements. Actual results may differ from these estimates. A summary of our critical accounting estimates is included in our 2023 Form 10-K under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” During the three months ended September 30, 2024, there have been no significant changes to these estimates and policies previously disclosed in our 2023 Form 10-K. For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, please refer to Note 2 of the condensed consolidated financial statements included in this Form 10-Q.