LiqTech International, Inc. (LIQT) Q1 2022 Earnings Report, Transcript and Summary

Good morning, and welcome to LiqTech International First Quarter 2022 Earnings Event. [Operator Instructions] Please note that this event is being recorded. I'd like to turn the conference over to Mr. Robert Blum, Lytham Partners. Please go ahead.

All right. Thank you very much, Nick. Good morning, everyone, and thank you for joining us in today's conference call to discuss LiqTech International's First Quarter 2022 Financial Results. Joining us on the call today from the company is Alex Buehler, Interim Chief Executive Officer; and Simon Stadil, 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 the prepared remarks, we submit for the record the following statement. 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 Chief Executive Officer of 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. As you know, this is my second conference call as Interim CEO of LiqTech. But I know that today, I am in a far better position to communicate a more informed update of the business, along with its recent developments, of which there are many. Said differently, there is much to discuss as we assess an intense and elevated activity over the last several weeks. As always, we will commence with prepared remarks, making a deliberate attempt to anticipate your areas of interest, but also leave adequate time to address your questions at the end. But let me first start off by saying what an incredible opportunity that I believe LiqTech represents. We possess technology that is highly differentiated, confirming a position of product leadership. We are focused on large, attractive end markets with favorable regulatory tailwinds and significant ESG dimensions. To connect our products to these existing end markets, we deliver a value proposition that in many instances is uniquely compelling. So with such attributes in mind, I believe the company benefits from strong backable investment themes, and I am increasingly excited about the business and its prospects. As you noted in the press release, we have entered into a separation and release agreement with our former CEO, Sune Mathiesen. I want to thank Sune for his service to the company over the last many years, and we wish him well in his future endeavors. To assist the company in a search for a new CEO, we have retained Heidrick & Struggles, a leading international executive search firm. While it is difficult to estimate timing, the process is proceeding as planned, and I have committed to a full transition and proper handover as Interim CEO. For as long as I occupy this position, I am fully committed to the success of LiqTech and will work tirelessly to provide engage leadership, strategic clarity, commercial intensity and execution discipline during this transitional time. I am taking today's call from our ceramics manufacturing facility in Ballerup located in the Greater Copenhagen area. Since our last conference call, I have spent most of my time in Denmark, and I can confidently observe that there exists a talented team of professionals who are equally committed to the success of the company. Critical to our building momentum is Simon Stadil, our CFO. Please remember that Simon only joined LiqTech in late November of last year. And since that time, he has planned and executed with remarkable pace and intensity. We are very fortunate to have him on the team. While we will note some of our actions and achievements over the last 2 months, clearly, there is much more heavy lifting to do. But please know that we are all up to the challenge and rising to the occasion. It was clear to all of us during the last call that in the context of operating losses, cash burn, and a convertible note that started amortizing, the balance sheet was weak, and the company was poorly capitalized. Consequently, we surged immediately to shore up the balance sheet. You will note from our press release that we have entered into an interim agreement to raise $23 million in gross proceeds through a public equity offering. Additionally, we have negotiated an agreement to amend our existing convertible notes. I will ask Simon to provide specifics on both the equity raise and the convertible note amendment in a moment. What is fairly obvious is that these 2 agreements transform our balance sheet while providing us with the necessary capital to execute on our business plan going forward. Clearly, this was a highly dilutive event, and we do not take such moves lightly, but rest assured that it was necessary, even in these challenging market conditions, to secure the financial future of the business and allow us the flexibility to execute our strategic growth and operating plans. Admittedly, we cannot rely on capital raises to fund operating losses as such as not a sound catalyst to investment. Instead, we must create an efficient business that is self-sufficient. Consequently, we are taking proactive and decisive measures to protect and rightsize our business. Specifically in April, we implemented an organizational realignment and related downsizing, reducing headcount and labor costs by about 25% or roughly 30 employees, the overwhelming population of whom were classified as overhead and indirect. This will provide us with an expected annual run rate savings of approximately $2.5 million to $3 million with full realization expected toward the end of 2022. By virtue of this downsizing, we expect to record restructuring costs in the second quarter of this year including costs related to the suspension of investment activities, which I will discuss in a few moments. Having identified labor cost savings, we are applying a similar focus for nonlabor expenses, both of which will help to reduce our breakeven level for operating income and cash flow to a revenue run rate of approximately $7 million to $8 million per quarter. Clearly, this will depend on attainment of certain contribution and gross margins through optimization of volume, price and mix, a constructive analysis and program for which is already underway. Also in the spirit of self-help, we have made the decision to suspend our planned investments in China and rationalize our CapEx plans. To this point, we are actively negotiating with our equipment suppliers to reduce open CapEx commitments by up to $4 million while redirecting certain items of equipment that were originally destined for China to our ceramics manufacturing facility in Copenhagen to relieve existing production bottlenecks. Thus we are balancing 2 competing imperatives, reduction of capital commitments on one hand with value realization upon cash already spent on the other. Beyond cost and capital reductions, we are laser-focused on shaping an efficient business that fully embraces the discipline of execution, again, with pace and intensity. We are moving quickly to elevate a culture of accountability, performance management and continuous improvement. Concurrent with the realignment and headcount reduction described earlier, we have implemented a new organizational design, moving toward 1 LiqTech and eliminating a divisional structure that resulted in operating silos, layers of middle management strained communication and poor sharing of resources. As part of this new organizational design, we have centralized the sales and marketing and R&D functions, which had previously resided in the divisions. We removed managing directors who led the divisions and appointed plant managers for each manufacturing site. Moreover, we have created functional leadership to align with critical imperatives for the business and elevate accountability for key initiatives. From a manufacturing standpoint, we are working diligently to craft an optimization plan to unlock capacity, reduce equipment downtime, increase manufacturing yields, reduce scrap and decrease average unit costs. In combination with those drivers of revenue previously mentioned, including volume, price and mix, we are confident in our ability to achieve margin accretion to support the new breakeven level of the business. Many investors have asked me, do we have a real business here? Or is this simply a science project? My answer is yes to the first and no to the second. There is a business here. This is more than a science project. LiqTech benefits from real core competencies that are difficult to replicate and possible to scale and leverage. These core competencies include material science, fluid dynamics and systems integration. LiqTech has positioned itself as a world leader in silicon carbide ceramics technology since 1999. Our flagship silicon carbide membranes are chemically inert, temperature-resistant, high flux and extremely durable. Additionally, we have robust in-house engineering capabilities for process design, 3D modeling and control systems. We have supplied a diverse set of applications across multiple end markets, including marine scrubber wash water, industrial wastewater, drinking water, oil with emulsion separation and many more. We have established production and sales capacity in Europe, coupled with distributors and agents in China, Korea, Spain, U.K., France and the Middle East, which allow for planned expansion in key geographic markets. And we have a highly seasoned team of professionals who bring deep experience in the clean technology and advanced filtration industries. So yes, this is a real business with core competencies. These core competencies have translated into differentiated technology and a premium product position that is facing large, attractive end markets with regulatory tailwinds and important ESG dimensions and that is connecting these products to end markets through value propositions that are uniquely compelling across many applications. I sincerely hope the takeaway here that is that, in fact, in the last 6 weeks, we have taken bold steps and decisive actions to reposition the business. We have initiated a leadership transition, redesigned and stabilized the organization, short up the balance sheet and reduced costs and investments. Operational improvements are manifested so let's now transition to a commercial and market update, discussing some of the saline activity over the last several weeks. On the oil and gas front, we have shipped our systems to a strategic customer in the Middle East through Baker Hughes and our local partner. The systems are currently en route to the customer with planned delivery anticipated next week. Based on the import terms for custody transfer, we will recognize revenue for the upfront portion upon equipment received at its final destination, which will occur in the second quarter. We will then recognize commissioning and service revenue over the term of the contract as we step through the validation process. As noted in the past, this project represents our first foray into the Middle East oil and gas market at commercial scale, and we are truly excited to demonstrate the unique benefits of our systems. Importantly, under the terms of the contract, the customer will be deploying our water filtration systems on 4 sites for 3 different applications. And if or when we could validate performance along with the associated value proposition, there are other opportunities in the current pipeline that should accelerate. I believe that this is a significant milestone for the company, opening new applications in a new end market and 1 from which we can convert new opportunities with this existing customer and activate new customers based on a referenced case study and validated value proposition. I know that this has been a long time in the making and technology adoption in the oil and gas market is painfully slow due to its reliance on manual labor, and the associated need to provide a bullet-proof solution with high reliability. Some have remarked that they heard about this for many years. But I honestly believe that we are now on the doorstep of validation for our first commercial proof point in the oil and gas market. And as we commission these systems and accumulate run time, we will work to validate our value proposition and elevate customer engagement. Meanwhile, we are actively working to commission our first systems for the asset filtration market in the U.S. As a reminder, these systems were originally shipped in the fourth quarter of 2021, during which we recognized revenue of about $2.2 million. With the successful commissioning of these highly specialized systems, which should conclude in the next few days, we are optimistic that this will generate additional opportunities for deployment of LiqTech's unique filtration technology within this market segment for this customer at other sites and for new customers. Recently, we announced an order for a European OEM customer valued at about $23 million over a term of 3 years. Upon full evaluation of this contract, we have determined that the commercial terms are not conducive to meet our margin expectations in the context of notable inflation. Accordingly, we are actively negotiating with this customer to better frame price, volume and timing commitments. Based on secular trends such as population growth, water scarcity, social mobility and a growing middle class, regulatory oversight and climate change, clean water demand continues to grow rapidly. And I believe that LiqTech's unique differentiated technology is ideally suited to a variety of OEM applications in this burgeoning market. And as I stated last quarter, 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. From a marine scrubber perspective, we are in a similar position as that expressed during our last call. Price spreads are strong and resilient, indicating favorable economics for closed loop scrubber investments. But on the other hand, supply chains remain disrupted with the marine industry still in scramble mode amid frenzied activity and strong pricing power. We are, however, seeing proof of life in this market where our quotation activity is elevated, and hopefully, orders are imminent. As you read in the press release, the Q1 revenue of $3.6 million fell within our guidance for the quarter communicated in late March. As we look towards the second quarter, we are expecting revenue of $5 million to $5.5 million, underpinned by our ongoing system deliveries for our clients in the Middle East. Furthermore, we maintain our view on the full year with a revenue range of $25 million to $30 million. And as I mentioned, and Simon will expand upon this momentarily, we have significantly reduced our go-forward operating cost structure to decrease our breakeven point, which we expect to realize by the end of the year. With that said, let me now turn the call over to Simon, who will add some context on financial performance for the first quarter and provide some additional details on the balance sheet and operating initiatives that I highlighted a moment ago. Simon, please proceed.

Thank you, Alex. Let me add some color to the performance, outlook and current focus areas. On revenue. Revenue for the first quarter was $3.6 million compared to $4 million in the first quarter of last year. This representing a decrease of 9%. The revenue in the quarter reflects a difficult quarter that contained limited activity within our systems business, with revenue confined to general commissioning and spare part sales, but also stable volumes within our legacy DPF and Plastics businesses. The decrease in system sales reflects a continuation of the difficult market environment that we have been navigating over the past quarters, exacerbated by continued supply chain constraints and general market volatility. Turning to outlook. And as Alex mentioned, we are expecting a Q2 revenue of $5 million to $5.5 million compared to $4.7 million recorded in the same period last year. The sequential increase is supported by ongoing deliveries and commissioning activities across the Middle East and the U.S., but also positive momentum within our Pool segment, where we see increased interest and deliveries. The quarter will also benefit from a continued and stable contribution from our Plastics and DPF businesses as well as direct membrane sales. Furthermore, we are reaffirming our view on the full year revenue to be within the range of $25 million to $30 million. While the sales pipeline continues to increase, it's important to note that our forecast is highly weighted towards Q4. So as always, there is a risk of slippage, mainly due to longer lead times and general disruption to the global supply chain. At any rate, we are comfortable to hold this guidance based on a bottom-up sales forecast that includes clear visibility and close engagement with the sales team and our customers. In the context of the decreased revenue, gross margins in Q1 were also adversely impacted by an unfavorable shift in product mix with low activity in our systems business and lower levels within our DPF business. Low utilization across our manufacturing facilities and rising input cost inflation on raw materials, labor and utilities also impacted our gross margin negatively. This is comparable to the trend we saw in the latter part of last year. In summary, the quarter resulted in a gross profit of 6.7% compared to 2.9% in the same quarter last year. As Alex mentioned, we have crafted a manufacturing optimization plan, which when coupled with improved revenue, should result in increased gross margins later this year. Furthermore, as we are still facing inflationary cost pressures going into the second quarter, we are diligently working with our sales team to increase pricing and optimize our product and service mix to maintain and even expand our contribution margin as we progress into the second half. Moving to OpEx. Total operating expenses for the quarter was $3.6 million compared to $2.9 million in Q1 last year. This represents an increase of 22%. The increase was mainly due to project management and leasehold expenses in China related to our ramp-up in China, coupled with the implementation of a new ERP platform, intensified sales and marketing efforts, higher legal expenses as well as increases in ongoing development projects. Again, we have already implemented a number of cost reduction initiatives this quarter to streamline and rightsize our organization. This is expected to result in an annual run rate savings of approximately $2.5 million to $3 million. This was -- this with full realization in late Q2 -- in late 2022, considering an average notice period of approximately 4 months. Furthermore, we are working to identify tangible incremental fixed cost savings to reduce the OpEx run rate even further, achieving a level that will facilitate breakeven on an operating and cash flow basis at a revenue level of roughly $7 million to $8 million per quarter. Finally, please note that associated restructuring costs will be specified and booked later this quarter with the scope and final amounts pending negotiations with both vendors and external stakeholders. Moving to the next item. Net other expenses in the first quarter was negative $0.4 million compared to a positive $0.3 million in the same quarter last year. The change was mainly related to the convertible note issued in April last year with $0.3 million related to amortization discount and $0.2 million tied to interest expenses. Turning to net loss. The net loss for the period was negative $3.7 million compared to negative $2.5 million in the first quarter last year. This is mainly due to the reduced revenue, increased operating expenses and other expenses, including interest and the amortization discount. Moving to our cash flow and balance sheet. We ended the first quarter with $11.2 million in cash compared to $17.5 million at year-end 2021. The decline was mainly driven by cash used in operating activities of negative $5 million, reflecting the operating result for the period but also a tie-up of working capital along with prepayments on CapEx commitments of approximately $1 million for equipment and machine delivery scheduled later this year. Also, please note that based on ongoing and advanced negotiation with other vendors, we are currently expecting a reduction in CapEx commitments of up to $4 million related to the cancellation, postponement and amendments to previously committed equipment purchases. Finally, cash flow from financing activities of $0.9 million was confined to the payment of the first installment on the convertible note in March and recurring payments on our finance leases, leading to a net change in cash for the period of negative $6.2 million in the first quarter. Now taking a step back and concluding on the quarter and commenting on the ongoing initiatives taken to protect our business. The cost reductions and stabilization efforts are centered around a company-wide effort where access to data and involvement from operations, sales and R&D will be paramount to ensure we deliver a leaner, more agile and increasingly profitable business. The immediate must win battles are clear and well defined. This includes improved pricing discipline, better mix, higher capacity utilization, a streamline organization and finally, tangible cost savings to shape a business that will be in balance. Our business imbalance also implies that we need to establish financial flexibility for our company by reducing our CapEx commitments and improving our capital structure with the equity raise of approximately $23 million in gross proceeds and a negotiated term sheet to amend the convertible note serving as critical components. To be specific, the amendment to convertible note, if consummated, will generate 3 main benefits: a payment holiday for the reminder of the year; an extended maturity profile; and finally, a reduced monthly payments. The new agreement is conditioned upon an equity raise of $20 million, partial repayment down to $10 million and certain amendments to the agreement, including a reset of the conversion price and an increased minimum cash covenant. Finally, I would like to echo Alex's opening remarks that we truly appreciate your support and continued interest in our company and that we are committed to maintain a constructive and transparent dialogue with all of you. Over to you, Alex.

So before I turn the call over to the operator, let me just express my excitement at the way the team has worked together over the past 6 weeks. It has been all hands on deck by everyone to secure LiqTech's future success. And I could not be more pleased by the efforts of the entire organization and what were clearly very difficult circumstances. We have accomplished much over the last 6 weeks, but clearly, there is still ample heavy lifting to do. But I know that we are up to the task and the best is yet to come. At this point, I would like to turn the call over to the operator to address any questions from the audience. Operator?

[Operator Instructions] Our first question comes from Mark Collin, private investor.

While I appreciate the efforts you guys are making and the confidence you have in the future, I guess I'm kind of curious, Alex, you've been on the Board for, I want to say, at least 5 years, while Sune, the ex CEO, has been putting out these inflated projections to investors for years. I'm just wondering where was the oversight of the Board? And why should we have any confidence in your projections going forward now?

Well, look, as you know, it's a very different thing to be an executive engaged in the business every day as opposed to an independent director kind of with a quarterly view of the business that's typically filtered through 1 or 2 people. So look, the Board's oversight was intact, and it was -- when it became clear that we had to move, we moved. What should give you confidence in the future? I will tell you that the way we're making these future projections is in a way that the business has not seen before. So when we look at our sales pipeline and revenue projections for the current year, we're doing it on a bottom-up basis. We're doing it salesperson by salesperson and project by project. Obviously, we start with the revenue that's been recognized already. We add on top of that sort of our run rate business that is very predictable and historically validated. We then add on top of that our secured backlog through actual orders. And then on top of that, we had a factor sales pipeline. By factor, I mean, probability weighted. Key inputs into that last feature, our estimated contract value shift date whereon we recognize revenue as well as probability. I will tell you that, that pipeline is very well diversified. It does not have heavy concentration. We're kind of not dependent on 1 or 2 deals without which we be with. So it's a very good pipeline. I think it's the best visibility I've seen from this business. We put the discipline in place with our sales team, interacting also with our customers, and we think we have a really good way to sort of validate that pipeline. Now I mean it is true that it's very much back-end loaded. You can arrive at that when you look at actual revenue in Q1 as well as our projections for Q2 and then subtracting the sum of those from the full year guidance, you can see that H2 and more specifically, by the way, Q4, are going to be very back-end loaded. There is always the probability that something slips out of Q4, particularly in this environment of supply chain disruption, very long lead times, where it's kind of tough to call. But obviously, we're taking any measures we can in the business to secure that pipeline so that we can show that sequential growth throughout the full year. So look, I think the sales pipeline visibility is solid. It's increasing. Since I've been here that the sales pipeline has been growing. But I'm always cognizant of the risk of slippage, particularly when you're staring at a pipeline that is so back-end weighted. But thank you for the question. I appreciate it.

[Operator Instructions] Next question comes from John Chatter, [indiscernible] Wealth Investment.

Maybe I missed this, but what's your commitment in China at this point? Does the $5 million of CapEx include anything for China? Or could the $5 million in CapEx be revised down further if you're able to extricate yourself from commitments in China? If I missed that, I apologize.

Yes. So look, we have suspended our investment in China. Now we have committed capital for that investment historically. So we are working with the vendors to do 1 of 2 things, right, either reduce the capital commitment but we need to negotiate our way out of that. And in certain cases, we pay cash upfront, and we want to get some value realization on what we paid for equipment that we can use in our facilities here in Denmark. So we're balancing those 2 competing imperatives. We want to reduce the capital commitments but at the same time, receive some value realization on capital or on cash that's already been paid. So for the latter, we are redirecting certain equipment items that were originally destined to China back here to Denmark for pieces that are needed to relieve manufacturing bottlenecks and increase our utilization. Hopefully, that answers your question.

Over the years, the prior CEO kept talking about needing to expand productive capacity and putting out large numbers as to what that productive capacity was going to be. So I guess, why would you need any machinery back in Denmark at all given the expansions that you had undertaken in prior years?

Well, I mean, again, the other option is, do we just let it go and not get any value for the cash that's already been paid? I would -- I am choosing to negotiate where we can and get out of it. But in certain cases, for cash that's already been paid, we might as well get something in return. Now this is just not sort of a big pet rock that's going to sit in our manufacturing plant. It's very targeted in terms of where the bottlenecks. Okay, we need an extruder, for example. We need another mixer, for example. So it's very targeted to relieve those bottlenecks. As I look at capacity overall for the business, I think we're having ample capacity, particularly after we incorporate some of these pieces of equipment that we're rerouting from China to Denmark. Now having said that, we're still shaking out our plants here in Copenhagen. We got to get the production yields up. We need to get the scrap down. We need to get the throughput up. But after this year of CapEx, and we gave you some estimates on what that looks like, I think our capacity is sound for the foreseeable future, which means there's not a lot of CapEx after this year. We're sitting on what should be a solidified operation and clear ability to produce and grow our revenue.

You mentioned validation process that needs to take place in the Middle East for the water filtration system. How long do you expect validation to take?

Well, I mean, we'll start accumulating run time immediately, obviously, right? And there are 4 different sites with 3 different applications. Each of those sites are scheduled to run for a period of several months, but that doesn't mean you have to wait for the end of each site to do anything. With 2 weeks, with 4 weeks of run time, we start demonstrating our value proposition and engaging with the customer accordingly, right? Now this is, in fact, a 2-year agreement where it's sort of structured as revenue upfront now with service and commissioning fees over the remaining 2 years, but we'll be engaging with the customer starting from commissioning with run time, validating the value proposition, hopefully using that as a reference point to upsell the existing customer and then activate new customers. We do have other opportunities in the pipeline with this strategic customer in the Middle East. However, you should know we're not including them in the current year forecast. So it's also keeping with what I said a moment ago, right? It's a very well-diversified pipeline that's not relying on any 1 or 2 large deals to hit our nut here. So -- but if these go well, there is an opportunity to accelerate some of those sales opportunities with the customer.

Got it. And back to China with your pulling back on your commitment to China, are you including any inland marine NOx revenue in this year's guide? That was talked up as being such a gigantic market in the past. And I guess I'm just wondering, is that still the case? And if you do intend to supply it you will do it then from Denmark, I guess?

Yes, we will. And to your first question, there is a little bit in the pipeline for black carbon NOx reduction, not huge, but it's a start. Your point is valid. We will work to skin that market from afar outside of Denmark. Obviously, if we ever got into sort of volume-based orders, we would need to revisit that decision or our investment, but we would do so when we had much clearer line of sight on the market. And obviously, we were ready to make that investment accordingly. I think they're going slower than China than we had originally anticipated. Obviously, they came out with a splash in their 5-year plan with their ability to reduce these emissions, but things are on study at the moment in China, especially in the Shanghai area with the lockdown so they are delayed with their implementation of those regulations. So meaning the decision right now to skin that market from afar is clearly the right decision from my perspective.

This concludes our question-and-answer session. I'd like to turn the call back over to Mr. Alex Buehler for closing remarks. Please go ahead.

I want to thank you all for your participation in today's call. Along with your continued interest in and support of the company, I hope that you share my belief that we have accomplished a lot over the last several weeks. We have initiated a CEO transition, stabilized the organization, shored up the balance sheet, reduced headcount and costs, rationalized our investment plans, accelerated sales to drive margin-accretive growth and are now working intensely to solidify operations. To reinforce my earlier position, LiqTech is a real business that possesses core competencies. We are facing attractive end markets with regulatory tailwinds and ESG dimensions. We have differentiated technologies that confirm a position of product leadership, and we have compelling value propositions to connect products and systems to end markets. I am very excited about the business and its prospects, and I look forward to continued dialogue in the future. Thanks again for your participation, and please have a great day.

Conference has now concluded. Thank you for attending today's event. You may now disconnect.