Liqtech International Inc: Form 10-Q for the period ended Mar 31, 2023

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this quarterly report. In addition, the following discussion should be read in conjunction with our annual report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 31, 2023 and the financial statements and notes thereto. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Overview

LiqTech International, Inc. is a clean technology company that provides state-of-the-art gas and liquid purification products by manufacturing ceramic silicon carbide filters, membranes and providing engineered systems. For more than two decades, we have developed and manufactured products of re-crystallized silicon carbide. We specialize in the following business areas: water treatment systems and services, ceramic membranes for liquid filtration, diesel particulate filters (DPFs) to control soot exhaust particles from diesel engines, and plastic components for applications across various industries. Using nanotechnology, we develop proprietary products using patented silicon carbide technology. Our products are based on unique silicon carbide membranes that facilitate new applications and improve existing technologies. We market our products from our office in Denmark and through local representatives and distributors. The products are shipped directly to customers from our production facilities in Denmark.

The terms “LiqTech”, “we”, “our”, “us”, the “Company” or any derivative thereof, as used herein, refer to LiqTech International, Inc., a Nevada corporation, together with its direct and indirect wholly owned subsidiaries, which we collectively refer to herein as our “Subsidiaries”.

At present, we conduct our operations in the Kingdom of Denmark. Our Danish operations are located in the Copenhagen area, Hobro, and Aarhus.

Our Strategy

Our strategy is to leverage our core competencies in material science, fluid dynamics, and systems integration, creating differentiated products with compelling value propositions to penetrate attractive end markets with regulatory and ESG tailwinds. Essential imperatives associated with our strategy include the following:

• Develop and reinforce new products and applications to provide clean water and reduce pollution We currently provide water filtration systems for scrubber technology providers, shipowners, and ship operators as well as tailored filtration systems for oil & gas clients, industrial wastewater applications, and integrated services companies. We are expanding our range of products to better leverage existing customer relationships and develop new relationships within the oil & gas, marine, global manufacturing, and chemical industries.
• Better penetrate existing end markets where our value proposition is strong We have successfully sold products and installed systems into several end markets--including automotive/transportation, clean water and pool filtration, marine, industrial wastewater, and oil & gas. We are focused on targeting and activating new customers in these end markets while working with distributors, agents, and partners to access other important geographic markets.
• Develop new end markets for our core products and applications. Our existing products and systems are relevant for and valuable to other end markets, and we regularly evaluate opportunities to partner with strategic customers to perfect new applications and validate associated value propositions.

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Results of Operations

The financial information below is derived from our unaudited condensed consolidated financial statements included elsewhere in this report.

The following table sets forth our revenues, expenses and net loss for the three months ended March 31, 2023 and 2022:

Revenue

Revenue for the three months ended March 31, 2023 was $4,011,519 compared to $3,637,236 for the same period in 2022, representing an increase of $374,283, or 10%. The positive development was attributable to an increase in sales of liquid filtration systems of $613,337, aftermarket sales of $229,658 and plastics products of $28,035, partly offset by a decline in sales of DPFs and ceramic membranes. The increase in liquid filtration systems pertains to deliveries of pool and marine orders in Europe and Asia, increased sales of spare parts and associated services related to legacy installations. The offsetting decline in DPF sales was caused by large deliveries of legacy orders in the first quarter of 2022 combined with a strategic decision to focus on improved product mix and higher profit orders that are better suited for Ceramic manufacturing . The decline in ceramic membranes revenue was largely driven by slow order intake due to reduced sales activity.

Gross Profit

Gross profit for the three months ended March 31, 2023 was $391,342 compared to gross profit of $245,541 for the same period in 2022, representing an increase of $145,801, or 60%. The increase in gross profit was primarily driven by revenue growth, improvements in product mix, and improved pricing discipline underpinned by the enhanced insights gained from the newly implemented ERP platform. The efforts resulted in improved profitability from our recurring business activities, despite ongoing remediation costs associated with legacy liquid filtration systems and ongoing manufacturing optimization initiatives seeking to improve kiln utilization and manufacturing throughput. Furthermore, profitability within our ceramics business continues to benefit from the proactive measures implemented in the second half of 2022 to help offset the negative impact from the inflationary cost pressures on raw materials and labor. Included in the gross profit was depreciation of $614,592 and $496,049 for the three months ended March 31, 2023, and 2022, respectively.

Expenses

Total operating expenses for the three months ended March 31, 2023 were $2,584,003, representing a decrease of $995,199, or 28%, compared to $3,579,202 for the same period in 2022.

Selling expenses for the three months ended March 31, 2023 were $1,182,435 compared to $1,059,948 for the same period in 2022, representing an increase of $122,487, or 12%, due to increased costs associated with direct sales efforts, onboarding of new sales leadership, interim consulting services, and intensified travel and marketing activities.

General and administrative expenses for the three months ended March 31, 2023 were $1,058,949 compared to $1,916,517 for the same period in 2022, representing a decrease of $857,568, or 45%. The decrease was attributable to the cost reduction and reorganization efforts initiated in 2022 as well as elevated spend in the same period last year due to the implementation of the new corporate ERP platform and China expansion. Included in general and administrative expenses were non-cash compensation of $157,173 and $178,778 for the three months ended March 31, 2023 and 2022, respectively.

The following is a summary of non-cash compensation:

Research and development expenses for the three months ended March 31, 2023 were $342,619 compared to $602,737 for the same period in 2022, representing a decrease of $260,118, or 43%. The change is attributable to more focused R&D efforts with fewer ongoing projects combined with a decrease in the average number of employees engaged in research and development activities from 17 as of March 31, 2022 to 8 as of March 31, 2023, as the Company streamlined and centralized the R&D function.

Other Income (Expenses)

Other Income (Expenses) for the three months ended March 31, 2023 was $(211,134) compared to $(427,707) for the comparable period in 2022, representing a decrease in other expenses of $216,573, or 51%. The change reflects the improved capital structure with reduced interest expense and amortization cost due to the early repayment and refinancing of the Convertible Note in the second quarter of 2022, offset by the loss on currency transactions of $242,271 due to the USD depreciation against the EUR/DKK during the period.

Net Loss

Net loss for the three months ended March 31, 2023 was $(2,389,503) compared to $(3,746,424) for the comparable period in 2022, representing a reduction in net loss of $1,356,921.

The change was primarily attributable to the improved gross profit of $145,801, savings in operating expenses of $995,199, reduced interesting expense and amortization costs, and higher interest income on excess cash, partly offset by the loss on currency transactions due to the USD depreciation against the EUR/DKK.

Liquidity and Capital Resources

Based on the continued market volatility and geopolitical unrest pertaining to the Russia and Ukraine conflict, European energy crisis, and macro-economic uncertainty, the Company is unable to predict the full impact this will have on our long-term financial condition, results of operations, liquidity, and cash flows. The Company has planned and executed on decisive measures in 2022 to help safeguard the business and its financial position by reducing cost, headcount, and overall capex commitments, which together with the successful completion of the $26.5 million public offering of common stock and pre-funded warrants, substantially improved the near-term liquidity position of the Company.

Furthermore, in June 2022, the Company completed the refinancing of its $15 million Convertible Note due in 2023, partly funded by the issuance of the new $6 million Senior Promissory Notes due in June 2024 along with the proceeds from the public offering. The Senior Promissory Notes are interest-free, with full redemption after 24 months.

Based on current projections, which are subject to significant uncertainties, including the duration and severity of global macroeconomic issues, commodity volatility, and continued global supply chain disruptions, the Company believes the cash on hand, as well as ongoing cash generated from operations, will be sufficient to cover its capital requirements and committed investments for the next 12 months.

Continued market uncertainty and reduced order intake caused by weakening global macroeconomic conditions, recession, or a resurgence of the COVID-19 pandemic, however, could unfavorably impact the Company’s ability to generate positive cash flow and thereby significantly reduce its profitability and liquidity position.

While the Company anticipates that its proactive measures will be sufficient to protect the business over the coming 12 months, the Company cannot predict the specific duration and severity of the unfavorable market dynamics that may adversely affect the business. In the future, the Company may experience reduced or changed demand for its products and services, especially if there is a global recession, structural shift in regulation, or the continuation of escalating interest rates that adversely impacts the investment decisions of our customers.

We have historically satisfied our capital and liquidity requirements through offerings of equity instruments, internally generated cash from operations and our available lines of credit. On March 31, 2023, we had cash of $14,309,933 and net working capital of $20,123,957, and on December 31, 2022, we had cash of $16,597,371 and net working capital of $21,581,287. On March 31, 2023, our net working capital had decreased by $1,457,330 compared to December 31, 2022, mainly as a result of a reduction in cash and cash equivalents.

In connection with certain orders, we provide the customer a working guarantee, a prepayment guarantee or a security bond. For that purpose, we maintain a guaranteed credit line of EUR1,350,000 (approximately $1,470,000). The credit line is secured by a cash deposit.

Going Concern and Management’s Plans

The financial statements included elsewhere herein for the period ended March 31, 2023, were prepared under the assumption that we would continue our operations as a going concern, which contemplates the realization of assets and the satisfaction of liabilities during the normal course of business. As of March 31, 2023, we had cash and cash equivalents of $14,309,933, an accumulated deficit of $69,740,538, and total liabilities of $17,256,096. We have incurred losses from continuing operations, have used cash in our continuing operations, and are dependent on additional financing to fund operations. These conditions raise substantial doubt about our ability to continue as a going concern for one year after the date the financial statements are issued. The financial statements included elsewhere herein do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

The Company has initiated substantial cost reductions and profitability improvement measures in order to right size the business and develop a clear and sustainable path to profitability, further underpinned by an updated strategy and onboarding of key management resources. However, there can be no assurance that the Company will be able to obtain any sources of funding. Such additional funding may not be available or may not be available on reasonable terms, and, in the case of equity financing transactions, could result in significant additional dilution to our stockholders. If we do not obtain required additional equity or debt funding, our cash resources will be depleted and we could be required to materially reduce or suspend operations, which would likely have a material adverse effect on our business, stock price and our relationships with third parties with whom we have business relationships, at least until additional funding is obtained. If we do not have sufficient funds to continue operations, we could be required to seek bankruptcy protection or other alternatives that could result in our stockholders losing some or all of their investment in us.

Funding that we may receive during fiscal 2023 is expected to be used to satisfy existing and future obligations and liabilities and working capital needs, as well as future operating losses.

Convertible Note

On March 24, 2021, the Company entered into a Securities Purchase Agreement with an institutional investor pursuant to which the Company agreed to issue and sell a $15.0 million principal amount senior convertible note (the “Convertible Note”) maturing on October 1, 2023 and 80,000 shares of our common stock, $0.001 par value (“Common Stock”), for an aggregate purchase price of $15.0 million upon the satisfaction of the closing conditions set forth in the Securities Purchase Agreement. The Closing occurred on April 8, 2021, and the Company issued to the Investor the securities in connection with the Closing.

The Convertible Note was a senior, unsecured obligation of the Company, payable at 112% of the principal amount at maturity (October 1, 2023), or earlier upon redemption or repurchase as set forth in the Convertible Note. The Convertible Note was convertible into shares of Common Stock pursuant to the terms of the Convertible Note, in part or in whole, from time to time, at the election of the Investor. The initial conversion rate was 100.6749 shares of Common Stock per $1,000 of principal amount of the Convertible Note. The conversion rate was subject to anti-dilution adjustments, including for stock dividends, splits, and combinations; issuances of options, warrants, or similar rights; spin-offs and distributions of property; cash dividends or distributions; and tender or exchange offers, in each case as further described in and pursuant to the terms of the Convertible Note.

Beginning on March 1, 2022, and on the first day of each calendar month thereafter, at the election of the Investor or Holder, if applicable, the Company was required to redeem $840,000 of the amounts due under the Convertible Note in cash or Common Stock at 90% of the lesser of (i) the volume-weighted average price (“VWAP”) of the Common Stock on the trading day immediately preceding the payment date and (ii) the average of the lowest three (3) VWAPs over the 10 trading days immediately preceding the payment date, which shall in no case be less than the floor price of $1.75 per share. Beginning on March 1, 2022, the Company paid the first monthly installment of $840,000 in cash.

As of June 22, 2022, the Note, including accrued interest and all relevant obligations, was repaid in full, amounting to $13,446,875, allocated between a principal repayment of $11,640,000 and contractual repayment premium of $1,806,875.

Senior Promissory Notes

On June 22, 2022, the Company issued and sold Senior Promissory Notes in an aggregate principal amount of $6.0 million (the “Notes”) and issued warrants to purchase 4,250,000 shares of common stock of the Company to affiliates of Bleichroeder L.P., 21 April Fund, L.P., and 21 April Fund, Ltd. (together, the “Purchasers”), pursuant to a note and warrant purchase agreement entered into with the Purchasers.

The Notes have a term of 24 months and do not bear interest during this period. If the notes are not repaid on or before the second anniversary of issuance, however, the Notes will thereafter bear interest of 10% per annum, which will increase by 1% each month the Notes remain unpaid, up to a maximum of 16% per annum, payable monthly.

Cash Flows

Three months ended March 31, 2023 compared to three months ended March 31, 2022

Cash flows from operating activities for the period ending March 31, 2023 derived from the net loss for the period, adjusted for non-cash items and changes in assets and liabilities. Cash flows from operating activities for the three months ended March 31, 2023 was $(2,285,301), representing an improvement of $2,749,643 compared to cash flows from operating activities of $(5,034,944) for the three months ended March 31, 2022. The cash flows from operating activities for the period consists mainly of the net loss of $(2,389,503) adjusted for depreciation and other non-cash-related items of $984,040, partly offset by a reduction in accrued expenses of $433,045 due to this quarter’s utilization charges against the warranty reserve and a decrease in salary provisions, and increased accounts receivable of $379,330 due to back-end loaded revenue recognition.

Cash flows from investing activities was $(87,470) for the three months ended March 31, 2023 as compared to $(183,031) for the three months ended March 31, 2022, representing a decrease of $95,561. The investing activities include the purchase of production equipment in Ballerup to help optimize production throughput.

Cash flows from financing activities was $(98,945) for the three months ended March 31, 2023 compared to $(931,807) for the three months ended March 31, 2022, representing a decrease of $832,862. The decrease was mainly driven by the repayment of $840,000 regarding the Convertible Note in the second quarter of 2022.

Off Balance Sheet Arrangements

As of March 31, 2023, we had no off-balance sheet arrangements. We are not aware of any material transactions that are not disclosed in our consolidated financial statements.

Significant Accounting Policies and Critical Accounting Estimates

The methods, estimates, and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our consolidated financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include:

• The assessment of revenue recognition, which impacts revenue and cost of sales;
• the assessment of allowance for product warranties, which impacts gross profit;
• the assessment of collectability of Accounts receivable, which impacts operating expenses when and if we record bad debt or adjust the allowance for doubtful accounts;
• the assessment of recoverability of long-lived assets, which impacts gross profit or operating expenses when and if we record asset impairments or accelerate their depreciation;
• the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions), which impact our provision for taxes;
• the valuation of inventory, which impacts gross profit; and
• the recognition and measurement of loss contingencies, which impact gross profit or operating expenses when we recognize a loss contingency, revise the estimate for a loss contingency, or record an asset impairment.

Recently Enacted Accounting Standards

For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see “Note 1: Recently Enacted Accounting Standards” in the accompanying Financial Statements.

We are not required to provide quantitative and qualitative disclosures about market risk because we are a smaller reporting company.

Evaluation of Disclosure Controls and Procedures

Management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the design and effectiveness of our internal controls over financial reporting and disclosure controls and procedures (pursuant to Rule 13a-15(b) and (c) under the Exchange Act) as of the end of the period covered by this Quarterly Report. A weakness is a control deficiency, or combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a misstatement of the registrant's financial statements will not be prevented or detected on a timely basis.

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures as of March 31, 2023 were not effective as of the period covered by this Quarterly Report due to material weaknesses in internal controls over financial reporting. For more information on material weaknesses identified by management, please reference our Form 10-K filed on March 31, 2023 for the year ended December 31, 2022.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management's Remediation Initiatives

In response to the identified material weaknesses, Company management, with oversight from the Company’s Audit Committee, has been and will continue to dedicate necessary resources to enhance the Company’s internal control over financial reporting and remediate the identified material weaknesses. As an example of such remediation, the Company has hired additional employees into the finance department, and we plan to continue to work on remediating the material weaknesses during 2023 by improving competencies and work processes. Further, an investment in a new ERP system has been made along with other supporting IT systems to support the controls and processes of the Company. These investments are an important part of our remediation plan. Lastly, the Company has started the process of redesigning and ensuring documentation of all processes and procedures related to financial reporting to ensure the effective design and operation of process-level controls.

While management believes that the steps that have been taken and plan to take will improve the overall system of internal control over financial reporting and will remediate the identified material weaknesses, these material weaknesses cannot be considered fully remediated until the applicable relevant controls operate for a sufficient period of time.

Limitations on the Effectiveness of Internal Controls

An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

While management believes that the steps that we have taken and plan to take will improve the overall system of internal control over financial reporting and will remediate identified material weaknesses, the material weaknesses cannot be considered remediated until the applicable relevant controls operate for a sufficient period of time.