LiqTech International, Inc. (LIQT) Q4 2021 Earnings Report, Transcript and Summary

Good morning and welcome to the LiqTech International reports fourth quarter and fiscal year 2021 financial results conference call. [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.

All right. Thank you very much, Anthony. Good morning, everyone, and thank you all for joining us today for today's conference call to discuss LiqTech International's fourth quarter and year-end financial results for 2021. I'm Robert Blum with Lytham Partners. I'll be the moderator for today's call. And joining us on today's call from the company is Alex Buehler, the company's Interim Chief Executive Officer; and Simon Stadil, company's Chief Financial Officer. Before I turn the call over to Alex and Simon, let me remind listeners that there will be an open Q&A session at the end of the call. 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 condition, 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, encourages all listeners not to place undue reliance on these forward-looking statements, which pertain 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 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 Alex Buehler, Interim CEO, LiqTech International. Alex, please proceed.

Thank you, Robert, and good morning to all of you and thank you for joining us on today's conference call. Please note that I sincerely appreciate your continued interest in and support of the company and its prospects. I know that today's call is unique, occurring shortly after last week's announcement about Sune and his medical leave of absence. So let me start by conveying my very best wishes to Sune and his family for which we hope and pray for a speedy recovery. While I cannot provide any further details related to his condition or time line, we will work diligently to ensure for a seamless transition. I will ask in advance for your patience as clearly I lack Sune's command of the many details of the business, its markets and its technologies. But rest assured that I am a fast learner, and I will climb the learning curve as quickly as possible. I'm honored to lead the company at this time with the full support of the Board of Directors. I am currently in Denmark at our headquarters and manufacturing facility in Greater Copenhagen, and I'm very pleased to observe a team that is welcoming of interim leadership, rising to the occasion of the moment, adapting to the transition and meeting head-on the market challenges that we are facing as a business. I think that it is fair to say that we all embrace the bright and exciting future at LiqTech. Importantly, our investors should know that you have my full commitment, my undivided attention. And I will work tirelessly to provide strong leadership, strategic clarity, commercial intensity and execution discipline during this transitional time. So with that said, let's dive into the business with further detail. I thought it would be important to frame an agenda upfront for today's call. I will kick off by providing some context regarding our addressable markets, including marine scrubbers, oil and gas, black carbon and other segments. I will layer into each category the visibility that we possess or lack in certain instances and how that impacts our outlook for the rest of the year. I will then ask Simon to provide some added color on key financial items affecting the fourth quarter and full year of 2021. After Simon's remarks, we will be happy to open the call to your questions, after which I will conclude with some closing remarks. So let's begin with marine scrubbers. As the company has discussed over the past year, in 2021, we faced a variety of challenges, particularly those stemming from the global pandemic and its associated economic repercussions. In late 2021, we began to discern improving market conditions for scrubber systems as the price spread between high- and low-sulfur fuels stabilized above $100 per metric ton and now widening to more than $200 per metric ton since the beginning of March. Likewise, we observed a strong increase in inquiries and orders in late 2021 and into early 2022 that correlated with the widening fuel price spread. Despite commodity pricing that was more conducive to investment in marine scrubbers for shipowners, the industry experienced a new set of dynamics comprised of highly elevated shipping volumes and unique pricing power to overcome the supply chain disruption that occurred during the height of the pandemic. In this environment, our customers indicated a strong desire to keep their ships on the water and operational to exploit such favorable dynamics. So to reiterate, while the price spreads have improved and indicate very favorable economics for scrubber investments, ship owners remain reluctant to dry dock their assets for the installation of a marine scrubber system amid such frenzied activity and pricing power. Consequently, this has led to delays in customer order acceptance and limited visibility as to when the industry dynamics might return to normalcy. Simon will add some further details here, but it is important to note that we have observed orders originally expected to deliver in Q1 pushed to the right on account of delays imposed by our customers. On a positive note, however, quotation activity in the past months exceeds the pace and levels reported by the company throughout 2021, highlighting pent-up demand for our solutions in the future after the prolonged lull during the pandemic. We believe that trends in the marine scrubber market continue to favor increased adoption of closed-loop scrubbers that employ the company's differentiated filtration technology. However, the timing is more uncertain today than it was a few months ago. At any rate, our enthusiasm for marine scrubbers has not waned, and we are prepared to meet the prospect of increasing demand for our products in the future caused by environmental awareness, increasing regulation and a compelling value proposition in the context of widening fuel spreads. Let's now transition to a discussion on oil and gas. As Sune mentioned last quarter, we have received orders for several oil and gas projects from industry leaders such as Baker Hughes, Chevron and ONGC. These orders span global geographies and feature advanced applications in produced water treatment and deep-sea oil drilling. By way of example, the order from Baker Hughes for the Middle East was a significant milestone for the company as it allows entry into a very large end market for water filtration applications. Expanding on our other oil and gas opportunities outside of the Middle East, we remain excited about applications for ethylene glycol recovery, particularly our agreement with Chevron as well as our order with Oil and Natural Gas Corporation, or ONGC, which is an oil and gas producer owned by the Indian government. There, our technology will be integrated for another produced water application. While our prospects remain intact, it is a fact that we are experiencing delays imposed by our customers due to various logistical challenges in a commodity environment disrupted by geopolitical tensions. Specifically, 2 large orders that were scheduled for delivery in the first quarter of 2022 are now expected to deliver in the second quarter of '22. Overall, this equated to about $2 million in sales that shifted out of the first quarter. Additionally, owing to the uncertainty resulting from the conflict in Ukraine and the overall geopolitical environment, we are experiencing further delays in the release of orders by certain oil and gas customers that we initially anticipated in the first half of 2022. At this point, we now believe that they will push out into the second half of the year. I wish that we were in a position to provide further clarity with respect to the exact timing of the many opportunities that we have developed over the past couple of years. But unfortunately, the environment is very dynamic, evolving quickly, changing daily. We will, however, do our level best to keep everyone apprised of new developments as further clarity manifests, and we hope to paint a better picture during our next conference call in May. Let's now transition to the black carbon market, where our focus remains on marine vessels within China. As we have stated in the past, China has taken a lead in reducing black carbon emissions from inland and ocean-going vessels. The new mandates in China have created a large opportunity for diesel particulate filters, where we have proven our technology leadership over the last 20 years to remove particulate matter from the exhaust gas of internal combustion engines. Consequently, China and black carbon remain key focus areas for the company, and we are progressing to expand our manufacturing capability to serve these strategic markets globally. Over the past couple of years, LiqTech has focused intently to diversify its revenue base, to penetrate new end markets of large size, high growth and regulatory tailwinds and to complement our existing market position in marine scrubbers. We have made notable progress in oil and gas and other industrial applications. And as I mentioned a moment ago, we believe that the black carbon market in China clearly presents some large, imminent opportunities for the company. Beyond marine scrubbers, oil and gas and black carbon, another area of meaningful progress encompasses the supply of our membranes for use in non-LiqTech-developed applications or those through OEM agreements. In January of this year, for example, we announced a 3-year membrane supply agreement with an estimated total value of $23 million over the life of the contract to supply a large European customer for drinking water treatment. We anticipate first deliveries to begin in the third quarter of this year with regularly scheduled deliveries thereafter over the final 2 years of the agreement. Clean water demand continues to grow rapidly due to increasing population, urbanization, industrialization, social mobility, a growing middle class with enhanced living standards and climate change. And I believe that LiqTech's unique, differentiated technology is ideally suited to a variety of OEM applications in this burgeoning market. Importantly, clean water applications represent relatively high-margin opportunities that better leverage the investment and advancements made in our core technologies over the last several years. While we remain optimistic about our prospects in 2022 and beyond, we must also cautiously acknowledge the reality of the current business environment, where geopolitical tensions, supply chain disruptions and sustained inflation create inevitable market uncertainty. Given the first quarter is nearly complete and considering the previously noted revenue that has shifted to the right for marine scrubbers and oil and gas customers, we are revising guidance for the first quarter for which we now anticipate revenue in the range of $3.5 million to $4 million. Assessing the rest of the year as best as we can right now, we are also revising full year guidance to allow for the general shift to the right, forecasting revenue in a range of $25 million to $30 million. While we remain bullish about our long-term prospects and future revenue associated with buoyant end markets, we are conscious of the aforementioned delays and wish to calibrate expectations accordingly. With that said, let me now turn the call over to Simon, who will add some context on financial performance for the fourth quarter and full year of 2021. After Simon's narrative, we will open the line for questions. Simon, please proceed.

Thank you, Alex. Let me talk through some of the financial results and add some further clarity. Revenue in 2021 was $18.3 million compared to $22.5 million in 2020, this representing a decrease of 19% year-on-year. Revenue for the fourth quarter of $6.1 million was in line with the range of expectations that we provided back in November. On the full year, results were negatively impacted by a decrease in sales of our water treatment systems, the marine scrubber industry, impacted by the global pandemic, continued supply chain disruptions and general market volatility, all of which we have previously discussed. The decrease in marine scrubbers was partly offset by an increase in sales of our DPF filters and our engineered plastic products, this reflecting a robustness of our business and a continued interest in our environmental solutions. As Alex mentioned, we are now expecting a Q1 revenue of $3.5 million to $4 million compared to the $4 million recorded in the same period last year. This is below the expectations conveyed during our Q3 earnings call, reflecting delayed oil and gas orders caused by disruptions to the global supply chain, general market volatility as well as the absence of marine scrubber deliveries due to the unwillingness of ship owners to dry dock vessels during periods with elevated freight rates. In the context of the decreased revenue, gross margins were also adversely impacted by an unfavorable shift in our product mix with lower membrane and system sales, reduced utilization across our manufacturing facilities and, finally, rising input cost inflation associated with raw materials, labor and utilities. Additionally, we experienced increased costs related to our upscaling projects in both Denmark and China, more specifically project management costs and depreciation expenses on new machinery. In summary, this resulted in a gross profit margin of 8.6% in 2021 compared to 9.5% in 2020. Moving on to OpEx. Total operating expenses in 2021 amounted to $12.3 million compared to $10.4 million in 2020. This was representing an increase of 18%. The increase was mainly driven by the strategic decisions made in prior years to increase sales and R&D efforts to help underpin revenue growth. However, we also continued our dedicated focus on running a cost-efficient business with a year-on-year decrease in general and administrative expenses of $0.4 million. Furthermore, operating expenses in the fourth quarter reflect intensified sales and marketing efforts, continued investments into our new ERP platform and business intelligence but also increased legal provisions and administrative expenses related to our activities in China. Net other expenses in 2021 was $0.5 million compared to $2 million in 2020. On that note, I would like to highlight that included in the 2020 number was $0.9 million of expenses resulting from the fair value remeasurement of the prefunded warrants that were issued in May 2020. Also this year, the gain on currency translation from U.S. dollar to Danish kroner favorably benefited other income by $0.7 million compared to a loss of $1.5 million in 2020. Finally, this year, we incurred increased interest expenses and amortization discount of a combined $1.5 million related to the issuance of the convertible note in the first half of the year. Overall, net loss for the year amounted to $11.1 million compared to $9.8 million in 2020. Moving on to our cash flow and balance sheet. Cash used in operating activities was negative $7.2 million mainly due to the net loss for the period adjusted for noncash activities. Cash flow from investment activities amounted to $1.5 million, reflecting continued and focused investments across our Danish manufacturing facilities. Furthermore, in Q2, we secured and issued a $15 million senior unsecured convertible note to support the company's liquidity and future growth plans. The net proceeds from the transaction was $14.3 million, which, combined with the payments on our capital lease obligations related to the high-temp furnaces in Denmark, resulted in a cash flow from financing activities of $13.9 million. In summary, this results in a healthy year-end cash position of $17.5 million compared to $13.3 million at year-end 2020, with both numbers including restricted cash. Finally, I would like to echo Alex's opening remarks on our desire and strong focus on navigating our business through the period of seamless actions. I admire the tenacity of the LiqTech employees, and I'm fully committed to establishing a closed aisle of investors and external stakeholders to help facilitate transparency and comfort around our future financial performance and capital structure. I'll also work closely with Alex and the management team to develop a clear path to establishing a more robust and sustainable business model, with focus applied to profitability, cash flow and, equally important, return on invested capital. At this point, I would like to turn the call over to the operator to address any questions from the audience. Thank you. Operator?

[Operator Instructions] Our first question comes from Rob Brown with Lake Street Capital Markets.

I just wanted to get a little more detail on the oil -- or, sorry, on the marine market. How many units are sort of in backlog right now that have been ordered, but you can't ship? And then maybe, how has the order rates come in? How is that backlog build? And then how much visibility do you have in Q1 '22?

Yes. Look, as you know, we don't really give specific backlog guidance, right? Generally, as we look at our business, it's pretty short-cycle, small-order, flow-through business across a diversified set of customers. As you said, kind of the marine scrubber market is a little bit different with a little bit longer lead times. Having said that, however, we're not in the business of publishing our backlog on an ongoing basis. We will continue to announce large orders that are long cycle and outside the ordinary course of business. We'll keep up with that practice and honor historical precedent. But when it gets into kind of backlog, what's shipped, what's not shipped, I just don't want to go into that level of disclosure. Hopefully, you can understand that.

Oh, yes. Yes, I definitely understand. And just really trying to get kind of a sense of visibility for '22. I know you said there was a number of moving pieces, but I'm just trying to get a sense of the revenue number you gave for '22. What's the visibility there? And what needs to come in, I guess, to kind of [ compensate ] [indiscernible]?

Look, I know it's probably a large downgrade or revision from the last quarterly guidance. But look, from my perspective, I just arrived. I'm new to the business. I can't say that it's changed in the last week or so, right? This revised guidance was probably coming. And we just got our arms around this thing and brought it to the surface. That does not undermine the fact that we strongly believe in these core end markets: marine, oil and gas, black carbon, NOx reduction, drinking water and otherwise. I think the current forecast, considering limited time on the ground, is a middle-of-the-road one, right? I have an adequate level of confidence. I do not believe it's unduly conservative. I think there is adequate and responsible stretch in that number. We kind of got there on a bottoms-up basis with Simon engaging with our sales team pretty evenly. So I think we feel good about the forecast as it currently exists. Obviously, as things change, we will do our very best to keep all stakeholders updated and apprised of recent developments and changes in the forecast. But I think in summary, it's probably a middle-of-the-road approach.

And Rob, if I may add one thing here. It's Simon. I think it's -- order backlog for marine scrubbers is a one thing. But for us right now, it's all about getting clarity on the overall diversification, the opportunity pipeline, reassessing all corners of the business. I think that's one of the robust positive elements that we're looking at right now, but it's more the marine scrubbers. So please bear that in mind that when you raise your questions on backlog, gross backlog and opportunity pipeline is more than just the marine scrubbers, giving us more comfort and the ability to execute on proposed numbers because we have a more diversified end market and opportunity pipeline than previously.

Okay. Yes. Great. And then just to clarify the oil and gas comments you made. I think you said there was some order release delay. That was sort of the -- that was the new expected orders? Or was that shipments from the orders you've already received?

These were the new orders that we specified in prior releases. So the orders still stand intact. But yes, the shipment on those orders and the recognition of revenue for those shipments is delayed.

Okay. Okay, great. And then just lastly on the marine -- oh, sorry, the membrane supply agreement. You have made specificity on that ramping. Is that -- maybe just clarify. You're seeing a regular order cadence there. Is that part of a -- is that a membrane that goes into a product that has an existing kind of flow-through? And will that become kind of a regular monthly shipment-type business then at the...

Yes, that is the nature of the agreement we executed with this European customer. It entails the provision of membranes. We are not integrating a system around those membranes. The customer in this case will integrate that system more for modular drinking water applications. But by virtue of a framework agreement over several years, yes, we want to get into a position where we are consistently supplying membranes over the term of that agreement.

Our next question come -- oh, pardon me. [Operator Instructions] Our next question will come from Cole Couzens with Stephens.

I saw the update to the full year 2022 guide. Assuming you're in that range, what's a reasonable operating margin we can expect? Do we think breakeven, positive, negative? Kind of anything to get us in the range.

Look, we're going to stick to revenue guidance. I don't want to get into the business -- and I'm sensitive to the fact that it helps you with your modeling exercises and the value of the business, et cetera. But look, I want to start with revenue. So we had some specific guidance out there in the market as of Q4 of last year kind of getting down into margins, et cetera. I just don't think we're ready for that, so I am going to pull it back a little bit. We will forecast revenue kind of for the current year, and then give a little clarity on the front month quarter. I'm not in a position where we're going to get down into revenue, OpEx and earnings. Perhaps with more time. And maybe that's just me, honestly, being new to the role and the business, although I've observed it from afar as an independent director. It's quite another thing to be an interim CEO and fully engaged in the day-to-day details of the business. So for me, until I'm comfortable, I'm going to stick with annual revenue guidance with some calibration for the front month quarter.

Fair. I guess kind of sticking to that revenue guidance, two quick follow-ups. First, just to support that, how much CapEx will you need? And what are some of the key budget items there? And then second, if you think about working capital across inventories, accounts receivable and accounts payable, how much investment would you need to support the revenue outlook? And is $5 million a reasonable number? .

Well, look, I'll start, and then I'll turn it over to Simon. And I'll kind of start with the first question on CapEx, and he could go into more detail on working capital. Look, obviously, CapEx is something we're evaluating right now, particularly in light of sort of our operating performance, balance sheet, cash flow characteristics, et cetera. So I do think we are evaluating the level and the pace of our investments in light of our current operations and cash flow and balance sheet strength. So we will closely look at CapEx and apply that for future investments with a known return. I'm not prepared to quantify a range of CapEx options just because I personally haven't gotten into that process yet except for looking at sort of the high-level financial statements. But you can expect a little bit more clarity on CapEx during the next conference call in May after I/we've had a full opportunity to assess the planned investments, planned and budgeted investments for the current year. I will say, however, and reiterate that we are reevaluating the level and pace of our investments. We know we need to expand our manufacturing capability and capacity to meet growing demand across our global end markets, but it's a question of how do we -- the how and where do we best do that. So I know that's high level and thematic. It's not providing you the quantification that you were after on CapEx. But with that, let me hand it over to Simon, and he could provide, hopefully, a little bit of color on working capital.

Thanks, Alex. Just one final comment on the CapEx. I think it's important to note that at the moment, we have excess capacity within our Danish manufacturing plants. And as -- again, that's evidenced by the fact that we obviously, a few years back, delivered plus $30 million of revenue. So clearly, for us right now, it's also a matter of understanding where will the growth come from, which part of the business. And obviously, if it's within the system business, then we obviously have capacity that doesn't require more CapEx to service near-term growth. So again, the growth and the spending CapEx, I think, more ties into our views on '23 and '24 which end markets that we're going to service. Finally on CapEx, clearly the European flat sheet membrane order clearly requires some investments in the near term, and that's what we're going to focus on. Turning to your question on working capital and, again, the number that you flagged, I think it's a fair assumption, though I think it's obviously clearly sensitive to the sequence of revenue in terms of the quarterly revenue over the coming 3 quarters in terms of collections and so on and so forth. But I think the level you're referring to here, Cole, I think it's fair. But again, be mindful that we're early in the year. And in terms of revenue sequence, that can impact working capital quite significantly. But let's go with the assumption we make for now.

[Operator Instructions] Our next question will come from Alex Blanton with Clear Harbor Asset Management.

Could you give us a little more color on the shifting of orders in the oil and gas part of the business from the first half to the second half that you mentioned in your opening remarks? You said there were -- it had to do with geopolitical concerns and commodity price changes. Could you give us a little more color on that? What are [indiscernible]?

Yes, I guess that was -- I'd think about it on -- sorry, I didn't mean to interrupt you. I'll let you finish that thought before I answer.

No, just a few more specifics on what those factors are and how they're causing the delays in the orders.

Yes. So let's think about it on two levels. Obviously, there's the strategic and the macro and then the more tactical and the micro. Strategic, yes, we can talk about this commodity price environment, which would generally be helpful to investments in oil and gas. We could talk about the geopolitical tensions, and everybody is kind of looking around saying, okay, what's going to happen here with crude oil flows and what's going to be the impact, right? I think what that has caused is a certain stasis and uncertainty among our major customers. Now on one hand, you would say, well, they should be more likely to invest because commodity prices are at historic levels. But practically speaking, they're not, right? Kind of everybody has stopped waiting around saying, okay, where is this market going and what are we doing at the moment. Beyond that, they don't want to disrupt any operations that could undermine production, right? So you keep production churning at very high levels without interruption, particularly interruption concerning integration of new products and technologies. So that's kind of the macro and the strategic. In terms of the micro and the tactical, I would just point to kind of logistical challenges on the customer site. There are freight challenges to get deliveries and materials in place. There are operational challenges just with their scheduling on the ground. And then some of the orders are just a little bit being recalibrated for very good reasons, by the way. I won't go into specifics, but we think some of these orders might expand, but they're evaluating kind of the size and the need and the timing. So hopefully, that's enough color. But to summarize, that's how we -- I would characterize it. On one hand, you've got the macro and the strategic, and, on the other hand, you kind of have the micro and the tactical, both of which are causing orders to slip out of both the first quarter and the first half of the year. Now having said that, obviously we remain very bullish on the oil and gas market. When you look at produced water or deep-sea drilling or any of these other segments in oil and gas, the need is manifest and potentially very large. So we fundamentally believe in these markets. We believe we have a very strong technology and value proposition. We believe that things like the disposal of produced water even in places like the Middle East, where they have not had much environmental awareness, all that is changing overnight. Because of the increasing awareness, sensitivity, ESG, et cetera, their stakeholders are making them embrace these changes. So long term, the fundamentals are very good. The future is very exciting. However, things are pushing out of the first quarter and first half of the current year. We just can't deny that. Therefore, we've got to recalibrate.

In line with that, I've been reading that the oil price increase is going to lead to more spending on capital goods in Saudi Arabia specifically. So is there a thought that a higher oil price might make these orders larger when they eventually come in than they would have been otherwise? Is that a possibility?

Yes, definitely. Yes. I mean I think slower and bigger is hopefully the mantra here, right? Obviously, Saudi considered a petro state, right, and they have a Vision 2030 that consists of significant investment not only in oil and gas but also across water, desal, infrastructure. By way of example, they're building new mega cities, greenfield projects in the desert, right? So they have very ambitious investment plans in oil and gas and beyond. And elevated commodity prices are only going to accelerate -- I shouldn't say accelerate, deepen their investment plans. I think it will go bigger but slower because, again, they don't want to do anything to disrupt production or interfere at the moment with kind of global trade flows of crude oil, right? So we are sort of hanging in the balance here of sort of one, not -- one more geopolitical event that completely disrupts all oil and gas markets. So everybody is kind of producing outright right now. And even the Saudis are close to maximum capacity. There's almost no spare capacity in the market with the exception of Saudi and maybe, to a lesser extent, the Emirates. But yes, I would agree with your conclusion. They're going to be much richer as a petro state. They're going to have a lot more dollars to invest. So I have to assume in the long run, that's good for our products and technology and good for our business. But I think it'll be slower.

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

I want to thank all of you for your participation in today's call, along with your continued interest in and support of the company. While we face continued uncertainty in our target markets, we are not tempering our growth ambitions or altering our strategy. It remains our intent to continue progressing our sales efforts to fully deploy our water system filtration technology and leverage our deep experience manufacturing silicon carbide ceramic filters into several large, growing end markets. The company is fortunate to benefit from a strong, adaptive organization with market-leading products and technology and stable corporate governance. As I stated at the beginning of the call, please note that I will work tirelessly to provide strong leadership, strategic clarity, commercial intensity and execution discipline during Sune's absence. I look forward to continued dialogue in the future and more specifically revisiting our discussion in May during the Q2 conference call. Thanks again for your attention, and please have a great day.

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