|9 Months Ended|
Sep. 30, 2018
On January 1, 2018, we adopted Topic 606. We elected to use the modified retrospective approach for contracts that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented in accordance with Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting method under Topic 605. As a result of applying the new standard, there were no changes to any financial statement line item.
Our performance obligations include delivery of product, installation of product, and servicing of product as well as technology transfer licensing and royalty-based licensing for subsequent sales of units under license. We recognize product revenue performance obligations when the product is delivered to the customer and commissioned for use by the customer. Upon commissioning and at that point in time, the control of the product is transferred to the customer. We recognize technology transfer licensing upon successful integration of the technology into usable products. Our royalty-based licenses are calculated as a percentage of the value of the units sold under license. We recognize royalty-based licensing upon subsequent unit orders, represented by purchase orders from our licensing partners with specified unit values. We expect to satisfy our current and future performance obligations within a few months of entering into the contract. Depending on the size of the project, the performance obligations could be satisfied sooner or later.
Our customers have a limited right to return our products which is not expected to be material and would further result in cancellation penalties. We provide a warranty on some of our products ranging from nine months to one year, depending on the contract with an option to purchase extended warranties. The amount accrued for expected returns and warranty claims was immaterial as of September 30, 2018.
All of the current contracts are expected to be completed within one year. We have elected to use the practical expedient in 340-40-25-4 (regarding the incremental costs of obtaining a contract) for costs related to contracts that are estimated to be complete within one year and as a result, we have not recognized a contract asset account. If we had chosen not to use this practical expedient, we would not expect a material difference in the contract balances. For our product sales where amounts received or expected to be received are less than the expected costs of a contract, we record contract loss provisions and contract loss liabilities. Anticipated losses on contracts are recognized in full in the period in which losses become probable and estimable. Changes in estimate of profit or loss on contracts are included in earnings on a cumulative basis in the period the estimate is changed. As of September 30, 2018 and December 31, 2017, we had provisions for contract losses of $391,000 and $617,000, respectively.
Patent and technology licensing arrangements result in fixed payments received over time, with guaranteed minimum payments on occasion, variable payments calculated based on the licensee’s sale or use of the intellectual property (“IP”), or a mix of fixed and variable payments.
Under our existing licensing arrangements, Dresser-Rand has a worldwide perpetual license (the “License”) to manufacture, market, commercialize and sell Power Oxidizers as part of a Dresser-Rand KG2-3GEF 2 MW gas turbine coupled with our Power Oxidizer (a “Combined System”) within the 1 MW to 4 MW range of power capacity. Initially, the License will be exclusive within this power capacity range, for so long as Dresser-Rand sells a minimum number of units of the Combined System in each annual sales threshold (the “Sales Threshold”), subject to certain conditions and exceptions. If Dresser-Rand does not meet either the initial or any subsequent annual Sales Thresholds, and the Sales Threshold is not otherwise waived, Dresser-Rand may maintain exclusivity of the License by making a true-up payment to us for each unit that is in deficit of the Sales Threshold (a “True-Up Payment”); provided, however, that Dresser-Rand may not maintain an exclusive License by making a True-Up Payment for more than two consecutive Sales Threshold periods. In the event Dresser-Rand does not meet the Sales Threshold, does not qualify for a waiver and elects not to make the True-Up Payment, the License will convert to a non-exclusive License.
These arrangements do not typically grant the licensee the right to terminate for convenience and where such rights exist, termination is prospective, with no refund of fees already paid by the licensee.
The Company’s per-unit royalty agreement contains a provision which sets forth minimum amounts to be received by the Company in order for Dresser-Rand to maintain exclusivity of its License as a True-Up Payment. Under ASC 606, we would consider any such True-Up Payments as minimum royalties at a fixed transaction price to which the Company will have an unconditional right once all other performance obligations, if any, are satisfied. Therefore, if the Company receives any True-Up Payments for exclusivity in the future, such receipts would be recorded as revenues in the period in which all remaining revenue recognition criteria have been met.
For license or royalty based revenue contracts, we invoice the customer when the performance obligation is satisfied and payment is due. For our royalty-based contract with Dresser-Rand, we invoice 50% of the order upon license order placement and the second 50% on the earlier of subsequent unit delivery or 12 months, whichever occurs first. For our products sold under contract, terms such as progress billings or longer terms are agreed to on a case-by-case basis. We do not have significant financing components, non-cash consideration, or variable consideration except that our royalty-based unit licenses vary by the value of the unit sold, which is established at order placement. As of September 30, 2018, we had $4.2 million allocated to performance obligations that were unsatisfied and we expect those obligations to be satisfied within one year.
Disaggregation of Revenue
All revenue recognized in the condensed consolidated statement of operations is considered to be revenue from contracts with customers. For the three and nine months ended September 30, 2018, all revenues were associated with technology transfer licenses under fixed-fee arrangements.