LiqTech International, Inc. (LIQT) Q2 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to LiqTech International Reports Second Quarter Fiscal Year 2018 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] 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, Chad, good day everyone and thank you for joining us to discuss LiqTech International's financial results for the quarter ended June 30, 2018. I'm Robert Blum of Lytham Partners and I will be your moderator for today's call. Earlier LiqTech issued their second quarter 2018 results in a press release to be available on a number of different outlets. Joining us on today's call to discuss these results is Sune Mathiesen, CEO of LiqTech. Before I turn the call over, let me remind listeners that following the conference call, there will be an open Q&A session. You should also note that the replay of this call will be available shortly following the conclusion of the live call. Before we begin with prepared remarks, we submit for the record the following statements. The press release and conference call contains 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 in the press release and 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 advice interested parties of the risks that may affect the company's business, financial condition 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 the 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. Now, I'd like to turn the call over to Sune Mathiesen, CEO, LiqTech International. Please proceed.

Thank you, Robert. Good morning to all of you. Thank you for joining us today on this call to discuss our financial results for the second quarter. In the second quarter, we continue to solidify our leadership position in the marine scrubber water filtration space. During the quarter, total revenues increased 23% year-over-year driven by 100% growth in our marine products. I'll speak more in detail about the marine opportunity in just a moment. We also continue to make progress towards our stated goal of turning the company profitable. In the second quarter we reported a net loss of approximately $300,000 which included more than $300,000 of investment related to the development of our recently launched Mark 6 filtration system. Excluding this increased spending, we would actually have been slightly profitable and during the quarter. Based on our results to-date and the outlook for the remainder of the year which includes a strong demand within the marine segment, we expect to reach our goal of turning the company profitable in 2018. During the second quarter, we also made a significant improvement through our balance sheet and cash position through a successful secondary offering in April. Our improved operating results along with our solid balance sheet, efficient working capital structure, improving gross margins, and increased order visibility provide us confidence that we can execute on our growth plans. I would like to take a step back for a moment for the many new investors we have on the call to provide a little bit of an overview of the very exciting returns in the asset in the marine scrubber industry. In November 2016, the International Maritime Organization or IMO made the decision to implement a new lower cap console for emissions from international shipping. This new lower cap believes that ship owners will come into -- the lower capital come into force from January 1, 2020 and released the ship owners with a couple of limited choices; either to install scrubbers to the vessels, a system whereby the emissions from the ship are captured by washing it with seawater, or they can switch to significantly more expensive [indiscernible]. Where LiqTech fits into the equation is our ability to filter the polluted water from the scrubber process allowing the now clean water to be disposed off back into the ocean. This is a process that requires a very robust filter technology, and our unique silicon carbide filter has proven very well suited for this challenging application. With the current price gap between the low sulfur fume and the bong oil [ph] used today, the return-on-investment for our scrubber installation is approximately two years [ph]. This price gap is expected to widen as more than main ships away from the bong oil to the low sulfur fume. Therefore, the installation of scrubbers becomes highly attractive business case. Analysts believe that by 2025 roughly 14,000 vessels are roughly 20% of the global fleet with have a scrubber. At revenues of LiqTech of about $450,000 per vessel this puts the total addressable revenue opportunity for LiqTech at more than $6 billion. Importantly, we believe that the market will not only be defined by richer fits but also by new vessel installation which comes on top of the before mentioned revenue opportunity. We have been working in the marine scrubber industry for several years now. We're one of the first companies to work in the industry and we've been able to secure a very healthy market share. As discussed last quarter, during March and April of 2018 we announced the signing of framework agreements with over 130 units expected to be delivered in the next two years. We have also announced a let-off intent with one of the world's largest scrubber manufacturers. In addition to this, we're working with an increasing number of ship owners, shipyard operators, and scrubber manufacturers; and based on our conversations with these partners we're expecting to receive a substantial amount of new orders in 2018. We are also expecting to see a further strong growth for 2019. As you can hear, the 2016 IMO ruling is affecting the shipping industry at an accelerating rate. Ship owners and operators are deliberating about the limiting options they have to comply with the IMO decision. And an ever increasing number of them are choosing to have scrubbers with their filtration technology. It is still early in the marine scrubber adoption cycle but we are excited about the activity that should ultimately drive the sensation [ph] off our water filtration technology. Now I would like to turn to our legacy DPF business. We have traditionally focused on retrofits of trucks and buses. In the past this market has been driven by mandates throughout the world and had growth opportunities due to subsidies and other trends but that has some swings [ph]. However, we are now seeing demand in growth areas such as luxury yachts, off-road vehicles, and power generators. We are seeing order flow in several European, as well as international markets. We expect revenues within our legacy operations to stabilize in 2018. As I mentioned before, we are making great strides to turn the company profitable. We remain very confident in our forecast to achieve profitability in 2018 based on revenues of approximately $16 million to $18 million. In the second quarter, we achieved gross margins of 18.3%, a strong increase of almost 1200 basis points versus the second quarter of 2017. We improved margins where due to an increase in sales of all marine products which carry higher margins as well as fixed costs leverage. Despite our 23% sales growth in the second quarter, operating expenses remained relatively flat. As many of you know, we have spent considerable time and a lot of money developing our filtration applications. It is taking longer and more money than originally anticipated that. With that said, we believe that we are now on the cost of significantly leveraging that investment to drive profitability going forward. One important investment that has come to fruition is the launch of our Mark 6 system. This new state-of-the-art system can be manufactured more efficiently than any we have developed in the past. This will allow for significantly improved contribution margins going forward. So while our gross margins have improved the opportunity for leverage is significant going forward. As part of our long-term strategy moving forward, the company recently announced Mark Raymond as our new Chairman of the Board of Directors replacing Aldo Petersen. Mark has been a board member since May 2013 and has been serving as the Chairman of the Compensation, Nominating and Governance committees, as well as a member of the audit committee. Let me offer my congratulations to Mark and thank Aldo for his many years of service to LiqTech. Additionally, effective tomorrow, Soren Degn will be retiring as LiqTech's Chief Financial Officer. I would like to thank Soren for his seven years of service to the company and wish him well on his rich endeavors. I would also like to welcome Claus Toftegaard as our new Chief Financial Officer. Claus joins us with many years of experience, and most recently as the CFO of Gabriel Holding, a publicly traded fabric supply company in Denmark. I look forward to working with Mark and Claus as we face the many exciting prospects for LiqTech. To that same thought, we believe that we have the right products to club operating structure, the balance sheet, the market traders [ph] should drive strong growth in 2018 and beyond. And we also believe that we have the visibility to change the company [indiscernible]. We thank our shareholders for the support over the years and look forward to repaying that support in the years to come. With that said, let me now turn the company over to any questions that might be. Thank you.

[Operator Instructions] The first question today will come from Eric Stine with Craig-Hallum.

Maybe we could just start with the Mark 6, you mentioned that it will enable you to manufacture more efficiently, and I also know that you've outsourced a lot of the non-core manufacturing. So maybe, just -- I guess one, maybe an update on what that might mean for your annual capacity? And then I'd also love to hear beyond what it means for you what this new product means for the main applications that will be for marine scrubber and power plant?

Yes. As you correctly said, we have been outsourcing a large part of our manufacturing process over the last six to nine months. We obviously still have the manufacturing of the silicon carbide membranes in-house that's the heart of our systems and this is our unique technology but we have outsourced welding of pipes, welding off skits [ph], assembly of the systems and so forth. That has been an ongoing process for some time now and this has been a successful process which enables us to ramp up capacity much more efficiently, and we have been able to do with in-house manufacturing. And that's very important going forward, we've seen very cost just development right now in the marine scrubber industry, we see a very rapid development, and I think it was absolutely right choice for us to outsource a large part of the manufacturing and it will allow us to ramp up to follow the general ramp up in the industry. As to the Mark 6 system, this is a very important step for us, we have been working on that system for a while now. It is more -- there is a card system that we have before, it means that we can use it for a lot of different applications predominantly and for scrubber applications in -- of course, marine scrubber applications but also in power plants, but it will also be used for several other applications. It is truly a standardized system which has been important for us as well, it allows us to have much shorter lead times and more importantly, we have been able to cut cost of about 30% to 35% which obviously will improve our gross margins.

Absolutely. So I'm interested in the commentary that you had about substantial orders expected in 2018. I mean, obviously in 2019 I'm just curious -- I mean is there any way that you can provide some color or more specifics around that whether your two framework customers have started to receive orders? And that's what's giving you the confidence or maybe just a visibility into that statement?

I think our confidence comes from several things. One, yes, we have these two framework agreements, we have seen these customers starting to receive orders and that gives us confidence that there will actually still be amount of business coming out of the framework agreements than we anticipated but as I also mentioned, we are continuing to form partnerships with ship owners, with shipyard operators and scrubber manufacturers; and in general we see that this market is developing very rapidly. I think this general perception that the uptake in scrubbers will actually be higher than first anticipated and to support that we have seen a lot of announcements from scrubber manufacturers over the past one or two months, and that they have been filling their order books for 2018 and 2019, even 2020 which is a very very positive side for LiqTech as well. We are currently in discussions for orders for very very high two-digit [ph] number. So I think we have a lot of confidence that this is actually developing the way we thought it would, and I would even say that it's developing more positively than we thought it would. And the long-term relationships and the agreements that we have in place with ship owners, shipyards and scrubber manufacturers gives us with ability now to say that we worked for this growth rate, we worked to make the company profitable in 2018, and we will see the growth for 2019 that we always anticipated.

And, so some of the order activity or confidence that you have is outside these framework agreements, I mean these are people that you don't have anything official right now but I would assume it sounds like you do anticipate that you will at some point?

Yes, we are continuing to widen our customer base in this industry. And as I mentioned, we're working directly with ship owners, we're working directly with shipyard operators, and we're working with larger and larger number of scrubber manufacturers. We have these two framework agreements in place, we have the latest intent and announced earlier with one of the world's largest scrubber manufacturers in place, and besides that we have a handful of established relationships with scrubber manufacturing and all of this combined leads us to believe that we'll see the growth that we have been talking about.

Maybe just lastly for me, just on the topic of the letter of intent; would that prospective customer I know that you had been targeting system integration, and also that that company was trying to put together their go-to-market strategy, maybe just talk about your understanding of where that company stands in the process of both of those two?

Yes, that relationship is progressing according to plan. We're very happy to announce the extension of the latter's [ph] intent. And we are working diligently to complete the process at both companies and all the basic stuff is already clear, we have tested our technology very successfully, and now it's more a matter of taking the newer product to market. And of this is progressing according to plan.

[Operator Instructions] The next question comes from Morgan Frank [ph] with Manchester Management.

I had a quick question for you on contribution margins and how to think about gross margin going forward. Looks like incremental revenue drops to the gross profit line at about 55% from last quarter but if we compare it to Q4, it actually looks like it was something like 100% contribution margin. So I'm guessing that that's probably too high to use going forward. Can you give us some sense of kind of what the next couple of million incremental revenue would look like on the gross profit line?

Yes, we can do that. Good morning, Morgan. Well, with the new Mark 6 system, we will see higher contribution margins moving forward. We actually think there it will be to realize large concentration margins of around 70% to 75%. Of course not all of that will dropdown but a significant part of it will. As we increased volume, more and more off that will drop down to the bottom line, and probably it's going to be in the region of 55% to 60%.

So, as I look at your cost of goods sold now what would be a good number to use just as an estimate of fixed costs?

We are very -- the level where we are right now is a good level for the future estimates. We have made significant investments in our organization which means that there will not be a lot of investments going forward, we have prepared for this ramp up in the business that we are already experiencing, and we have also prepared for future ramp up of business. So we're not looking to significantly increase our costs.

And so we'll start to see the actual unit margins on the systems drop through pretty fully?

Yes. As we progress, as we see volumes increase, we will see that drop down, that's correct.

[Operator Instructions] The next question will be from Bill Chapman [ph], a private investor.

On your scrubber manufacturing partnerships that we're hoping to have three once this third one closes. Do you anticipate more formal contracts with other scrubber firms or is it going to be more case-by-case orders in a less formal range?

Yes, that's a good question and it's actually going to be both. So some of the largest scrubber manufacturers when you will probably see a few more framework agreements just laying out -- just say, how we're working together. But we're also seeing case to case ordnance [ph], we see a slight change in the way this market is working right now. We see then -- you can tell it's a new industry, so it's already becoming a commodity, and we believe that we see a lot of the orders in the future come directly from the shipyard operators. It doesn't necessarily mean that -- or it doesn't mean that we'll not see orders coming from scrubber manufacturers, it just means that I have told to several sources for orders in the future.

Going forward, do you anticipate being able to announce an order flow or is it going to be on a quarter-to-quarter basis when we see the actual recognized revenues?

As we see this market firm up, we will see less announcements, probably for competitive reasons we are not that keen on making announcements all the time, and there is -- this industry is becoming very attractive for a lot of players, and what we want to avoid is to announce small amount of orders, we'll of course announce any -- very large orders but more and more we will update the market on a quarterly basis.

Let me ask you also on the financing; I saw Goldman Sachs and some Wall Street firms getting involved offering financing. Is that really picking up quite a bit?

Yes, we have seen Goldman Sachs, for example, being out there offering to finance scrubber installations. We even see shipyard operators financing this for the ship owners; so we think there are a lot of findings and opportunities available for ship owners which obviously supports the business case for scrubbers even more which is good news for LiqTech.

As you know, there is quite a bit of discussion in the trade magazines about what's going on with this 2020 mandate; and I just saw one last week that commented that according to the industry sources at least 60% of the current ships are expected to opt-in for scrubbers by 2022. Now I've never seen the number that high, I've seen upto 20%, is this an outlier or is this just really a mass wave of interest in converting to scrubbers in a material way than what we've seen?

What we have been working with, it is the 20% uptake of scrubbers by 2025 and what we have seen recently is that it looks like there will be an even higher uptake in scrubbers. Trying to be conservative, we think the 20% number is a good number, that is a huge opportunity for LiqTech, it's a $6 billion addressable market for us over the next seven years. Of course, we would love to see a high uptake in that than that but we think with the 20% number it's a great opportunity for us. But as you rightfully said, it looks like the adoption of scrubbers will be in demand [ph].

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Thank you very much. And thank you to everyone for joining us today on the call. We look forward to speaking with you again very soon. Have a great day.

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