Liqtech International Inc Q1 FY2020 Earnings Call

Good morning. Welcome to the LiqTech Reports First Quarter 2020 Financial Results Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Robert Blum with Lytham Partners. Please go ahead.

Thank you very much, Kate. Hello, everyone, and thank you for joining us today to discuss LiqTech International's first quarter 2020 financial results. I’m Robert Blum of Lytham Partners. I will be your moderator for today's call. Joining us on today's call from the company is Sune Mathiesen, the company's Chief Executive Officer. Before I turn the call over to Sune, let me remind listeners that following the conference call, there will be an open Q&A session. You should also note that a replay of this call will be available shortly following the conclusion of the live call, and that a transcript of the call will be available on the Investor Relations section of the company website. Before we begin with prepared remarks, we submit for the record the following statements. This conference call may contain forward-looking statements. Although the forward-looking statements reflect the good faith and judgment of management, forward-looking statements are inherently subject to known and unknown risks and uncertainties that may cause actual results to be materially different from those discussed during the conference call. The company, therefore, urges all listeners to carefully review and consider the various disclosures made in the reports filed with the Securities and Exchange Commission, including risk factors that attempt to advise interested parties of the risks that may affect our business, financial conditions, and sales of operations and cash flows. If one or more of these risks or uncertainties materialize or if the underlying assumptions prove incorrect, the company’s actual results may vary materially from those expected or projected. The company, therefore, urges all listeners not to place undue reliance on these forward-looking statements, which speak only as of this date and the date of the release and conference call. The company assumes no obligation to update any forward-looking statements in order to reflect any events or circumstances that may arise after the date of this release and conference call. With that said, I would like to turn the call over to Sune Mathiesen, Chief Executive Officer of LiqTech International. Sune, please proceed.

Thank you, Robert, and good morning to all of you. Thank you for joining us today to discuss our first quarter 2020 financial results. We hope everyone on the call and your families are safe and healthy. COVID-19 has certainly made the past months challenging. The situation in Denmark is now slowly, but safely normalizing, and we are seeing the first signs of activity in the market. I will get back to this a little bit later. Our first quarter results were below the preliminary expectations we discussed with you during our March 26 conference call, with yet another record revenue quarter for the business of $10.3 million despite the negative impact from COVID-19, which affected deliveries in the final weeks of the quarter. As we discussed, we were on track to deliver approximately $12 million for the first quarter when COVID-19 began to disrupt operations. The $10.3 million we achieved represents a 39% increase from the first quarter a year ago and was due to the highest sales of our proprietary ceramic silicon carbide water filtration systems for the marine scrubber market, while we continue to achieve a significant commercial breakthrough. We also remain profitable, although not at the level that we might normally expect as our cost structure for the first quarter was designed to meet both the higher revenue expectations we originally had prior to COVID-19, but also our expectations for continued growth in the business going into the second quarter. I will talk about our outlook for the second quarter and beyond shortly. We also made very good operational progress since the start of the year. We successfully installed the first of the brand new customized furnaces around the start of the year and recently completed installation of the second new customized furnace for use in the manufacture of the company’s proprietary silicon carbide membrane filters. Each of the furnaces has throughputs that are approximately four times higher than the older furnaces due to size and efficiency. We are planning to install two additional new furnaces by the third quarter 2020, which upon successful installation of all four, will increase the company's total capacity to between $150 million to $200 million on an annualized basis by mid-2020. As we mentioned in the press release, we incurred approximately $200,000 of incremental costs during the first quarter due to the need to reign in manufacturing. As the additional furnaces come online, these amounts will decrease as our know-how improves. We improved our overall gross margins to 25.7% in the first quarter. The improvement was primarily driven by deliveries of our Mark 6.1 system, which we launched in the third quarter last year. The Mark 6.1 system is a lower-cost and more efficient system. When you break out the contribution margin by systems, the Mark 6.1 had contribution margins of more than 40% during the quarter, compared to the older Mark 6 systems, which had contribution margins of approximately 4% to 5%. Of the $7.9 million of marine revenue during the first quarter, about two-thirds was from the older lower margin systems and one-third was from the newer higher margin systems. We have now worked through all orders for the old lower margin Mark 6 systems and all future deliveries will be Mark 6.1 systems or higher, which should further drive improvement in gross margins overall going forward. When the impact from COVID-19 first began to occur, we implemented several measures to ensure manufacturing continuity and adhere to the strict state guidelines regarding the number of personnel that can work in proximity. We divided the workforce into multiple shifts and had certain office staff work remotely. Since the end of the first quarter, the end markets have relaxed their guidelines and employees have now returned to more normalized operating procedures. We were also proactive in restructuring our overall cost base, given the expected near-term impact to the business. Overall, we have a process in place to reduce our annual cost base by approximately $1.9 million, which will be phased in over the next several months. Our hope is that we are able to quickly ramp back up to full capacity, but given the current uncertainty, these moves have allowed us to create a cost structure whereby we can be profitable at about $7 million per quarter in revenue. We continue to monitor the current situation and are prepared to implement further plans to reduce costs if necessary. As I mentioned back at the end of March during our year-end call, due to the impact of COVID-19, the rate of incoming orders for the marine scrubber industry has slowed and will likely impact the second and third quarter revenues. We are currently working through and delivering orders received earlier in the year, but with the slowdown in orders and difficulties in delivering and commissioning systems, this will translate into a slowdown in deliveries this quarter and the next. What I can share with you is the following: We are now back to full manufacturing in Denmark. Unfortunately, this is not the same case in many other countries around the world, and I want to emphasize that our lack of visibility for the next two quarters is not due to our inability to manufacture products, but based on customers' ability to receive products. We are currently in discussions on more than 17 marine system orders, which represent roughly $30 million in sales, and based on our historical conversion cycles, I expect us to receive the vast majority of these system orders. While there has certainly been a slowdown in orders that started in Asia and gradually worked their way to Europe, customers around the world seem to be slowly coming back, and the recent improvement gives us reason to believe that our business will soon return to normal levels. I want to provide you with an update on our progress in the oil and gas markets before I turn it back over to your questions. At a high level, the capabilities we have developed using our proprietary silicon carbide filters in our unique system design are applicable to a number of applications. We had our first commercial breakthrough of the technology in the marine scrubber segment and we believe this will be a significant growth area for our business. We have also made inroads in the power plant market, particularly in parts of Europe where similar regulations are limiting the discharge capabilities from these plants. The next application we are commercializing is in the oil and gas market, which we believe will significantly surpass both of the other markets in terms of overall size in the years to come. What makes LiqTech's solution unique for this market is our ability to treat difficult water and reuse it in the process. We have tested our technology together with some of the largest oil and gas companies, and we have proven that our technology offers a better solution in terms of both quality and cost compared to existing alternatives in the market. As previously discussed, we have matured our efforts in the Middle East for some time. These projects are focused on water reuse in oil production, related to water scarcity in the region. So despite the varying price of oil in any given period, these projects are focused on long-term solutions to long-term issues. This is why we think our technology is ideally positioned to address the need for water treatment solutions in areas of the Middle East facing local water scarcity. We look forward to finalizing contracts in the months and years to come, with an expectation that the oil and gas market will be the largest contributor of revenue in 2021. And once again, to note that this is not because the marine scrubber business will see a drop-off, but because the oil and gas opportunity is simply that large. So, just to wrap things up before we turn it over to your questions, I want to say that I'm pleased with the operational performance by the team over the last several months. We finished the first quarter with record revenues despite the impact from COVID-19 midway through Q1 and maintain profitability in the business. The management team has quickly navigated the COVID-19 disruptions, ensuring manufacturing continuity while at the same time ensuring our cost structure matches our revenue levels in the near-term, lowering our overall breakeven point. We continue to make progress in the oil and gas market, following successful pilot programs with key customers in the region, and we believe we are on track to announce significant orders for this industry in the near-term. Despite the impacts of COVID-19, we remain the leader in the marine scrubber industry for filtration. Our market share remains in the 50% range. And while there have been a number of orders, given the global disruptions, activities are once again picking up with us contemplating more than 70 orders, which we believe will translate to a return to our historical levels of growth later this year. One final note: I will be participating in a virtual investor conference presentation next week, Wednesday, May 20, with the team at Lytham Partners. Details on the webcast will be sent out later this week, and I will also be participating in virtual one-on-one meetings on Thursday, May 21. Please contact Robert Blum for additional information. And with that said, let me now turn the call over to any questions you might have. Operator, please.

We will now begin the question-and-answer session. Our first question is from Eric Stine with Craig-Hallum. Go ahead.

Morning, Eric.

Morning. So you've kind of touched on it and obviously, things have slowed down, but I'd love to hear your thoughts just on the overall market and obviously there's been, at least here near-term because of the spread, a pretty widening or lengthening out of paybacks for scrubbers. What are you hearing from customers, whether you or they are saying they think that's a little bit more of a long-term situation, or is that truly a couple of quarters?

So, what we hear from our customers is that they are not really focused on, let's say, the spread in any given time. They're more focused on the long-term spread between low sulfur and high sulfur. We see that now it has truly been quiet for some months. In the beginning of the COVID-19 situation, I'm very pleased to see that in the last, I'll say, two or three weeks, we have seen a significant take-off in activity from the scrubber manufacturers and from the ship owners. So, it looks like things are now normalizing. We see the oil price coming off a little bit again, the price spread is coming up, and it looks like they are now continuing with the scrubber installation plans that they had before the COVID-19 situation. So, we think it is a couple of months of disruption. Especially what we've seen in the last couple of weeks leads us to believe that the situation is now normalizing. We're not completely back to normal, but as I mentioned, we are negotiating a significant number of new contracts. That is a very positive sign for us.

Yeah. And when you talk about those new contracts, I mean, is it still a similar dynamic as what was happening a month and a half ago when it was more activity out of China rather than Europe, or is some of that renewed activity happening in Europe?

In the past couple of weeks, we have now seen more activity again from Europe. Two weeks ago or three weeks ago, it was completely quiet from Europe; it was driven by the Asia players who had been back to work for a while. But now we see the European players are coming back, which is a great sign. Again, things are normalizing in Europe and I think there are still a lot of challenges in the southern part of Europe, but in northern Europe, things are slowly but safely normalizing and we see activities picking up.

Got it. Thanks for that. And then maybe just the backlog, I know you don't quote the backlog. But maybe if you could just talk about the health of that a little bit. Are you seeing or have there been any cancellations, or is it more a case of what you've got in backlog just being pushed to the right in terms of timing?

We have actually not seen a single cancellation. We have seen issues in delivering a product and issues in commissioning systems that were delivered, but we have not seen any cancellations. So, again, that is a great sign. It leads us to believe that this is more of a timing issue more than anything, and that things will come back. Obviously, we are encouraged to see that there have been no cancellations at all.

Yeah. Absolutely. Maybe the last one for me, just on the OpEx, could you just give some of the specific actions that you're taking there? And then I'm just curious, you mentioned last quarter that there might be some assistance from the Danish government. I think it was something like $400,000 a quarter. Whether that is something that you have chosen to access?

Yeah, there are a number of initiatives from the Danish government. You can send people home and have salaries pre-funded or partly pre-funded. There’s also an initiative to delay tax payments for four months. We have chosen to use the delay of the tax payments, which will help liquidity over the next four months. We have not chosen to reimburse part of the salaries for employees because for our employees, the percentage was too low. So, the cost savings that we have now implemented is that we have laid off a number of people to reduce our overall costs. We have tried to be careful in the layoffs; so they are mainly in manufacturing and project management roles. We have not made any reductions in R&D or other long-term important functions. The Danish situation is a little bit different. It's not like in the U.S. where when you lay off people, they go home the next day. We often have three to five months termination periods. So, these employees are currently working through their termination periods, which is why the cost reductions will reinforce by August this year.

Okay. Thanks a lot.

Thanks, Eric.

Our next question is from Robert McCarthy from Stephens. Go ahead.

Morning Robert. Good. How are you?

Good. So, appreciate all the color. Definitely a lot to consider. I guess, asking around the cash burn, it looks like, obviously, working capital, it's a good news story and the fact that you're expanding working capital to meet demand. But how do we think about your cash balance right now and your cash burn going forward? And would you anticipate any needs for additional funding, or do you think, just given the fact that you're going to have these cost savings and ramping up production, that cash generation is going to take care of itself? Because obviously, I think, last time we spoke on the quarterly call, you suggested that obviously if activity picks up more, you definitely have a long runway here. But given the fact that you're going to have some fits and starts with your working capital and your supply chain, how do we assess what your cash position could be going into 2021 and beyond?

Yeah. So, the steps we've taken right now to reduce our overall cost base means that we should be profitable on approximately $7 million of revenue per quarter. So, we are definitely cautious here. We have taken light steps to reduce our overall cost base, which means that we shouldn't burn too much cash due to this COVID-19 situation. Secondly, we saw our cash balance come down in the first quarter, but that was really a result of the increased level of business—the record revenues in the first quarter—which required more working capital. After the quarter ended, we have started collecting some of these payments on goods delivered in the first quarter, and our cash balance today is somewhat higher than it was at the end of the quarter. So, I think we are in good shape here. We have no debt; we have our cash balance. We have taken steps to reduce our overall cost base to match revenues in this difficult COVID-19 situation. We are now seeing signs of the business improving, more products being used, and receiving more orders again, leading us to believe that by the end of this year, hopefully, we will be back to where we were before this COVID-19 situation.

In terms of your backlog, I think you suggested, obviously, with the mix shift to the better Mark 6, in terms of product profitability, you expect a 40% contribution versus your historical 25% for your existing product lines. So, we should expect, all else being equal, a pretty nice lift in gross margins in the back half of the year or into 2021, correct?

That is correct. So, it’s very encouraging to see the development in the first quarter, about one-third of the deliveries were the higher margin Mark 6.1 product. Two-thirds were the old lower margin Mark 6 product. We have now worked through all the Mark 6 orders we had in our pipeline; all future deliveries will be Mark 6.1 or higher. That also means that we will see further improvement in the gross margins, which I am very pleased about.

And then how is your tax credit right now in terms of what’s going on? Remind us how much of a tax advance you get over the next couple of years?

Yeah, we have—I think it's all together about $6 million tax advance. We're now starting this next week. We were nicely profitable in the Danish entities last year, and we used some of that tax asset, so we're not paying tax.

So, final question. The third quarter, I think, is traditionally a period where you'd start to see some easing in production just given the seasonal activity of production in Europe and Scandinavia, right? Do you expect, just given the disruptions we've seen, whether you'll be full strength in the third quarter, or do you think you'll see the same kind of seasonal production patterns?

The technical challenge with the COVID-19 situation is that we have burned through a lot of the holiday allowances for the employees. In theory, if we see activity pick up in the market and customers being able to accept deliveries, then we will be able to have more workers than normal during the holiday season. Now seeing the first signs of the market recovering after COVID-19, it is still challenging, and I believe that our revenues will be impacted for the second and third quarters. To which extent is still difficult to predict. We are back to full manufacturing, so it all comes down to our customers' ability to accept products. In theory, we will be able to have more people working through the holiday season because they have already taken some of their holidays at this point.

I'm sorry. Just one more. Diesel particulate sales in your business—what's your expectation for the full year? Just so we can level set expectations.

Yeah, for DPF, we have not really any changes to our expectations. We still think it will be between $6 million to $8 million for the year, and for the quarter, it was pretty stable. I believe it was around $1.5 million.

$1.5 million? Okay. Thank you, Sune.

Yes. Thank you.

Next question is from Rob Brown with Lake Street Capital Markets. Go ahead.

Just on timing of shipments and recovery and things recovering, how many units do you have built, ready-to-go at this point, or what is your sense of how quickly things can turn back on?

We have not discussed that, but we have stated full manufacturing. So, we do have a fair amount of systems ready. When things pick up again, we will be able to ship products very quickly.

Okay. The oil and gas market, you talked about a significant ramp into next year. When do you sort of need to see order activity start to hit your goal of being a larger part of the business next year?

We think that the second and third quarters will see first orders from the oil and gas industry. In fact, we have great confidence in that. We have been working on it for a long time now. We talked about it over the last six months. There are no changes. The projects in the Middle East are related to water scarcity, and so they are moving forward. Despite the swings in oil prices that we have seen in the last couple of months, we are encouraged to see that we are still making progress in that area. We expect to see first orders in the next few months.

Okay. Great. Thank you so much. We'll turn it over.

This concludes our question-and-answer session. I would now like to turn the conference back over to Sune Mathiesen for closing remarks. Go ahead.

Thank you, operator, and thanks for everyone joining us on the call today. I look forward to speaking with many of you again during our virtual presentation and one-on-one, and hope that we can all meet face-to-face again in the near future. Have a good day and stay safe.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.