Liqtech International Inc: Form 10-Q for the period ended Mar 31, 2024

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 22, 2024 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 and membranes as well as developing industry-leading and fully automated filtration solutions and systems. For more than two decades, we have developed and manufactured products of re-crystallized silicon carbide. We specialize in three business areas: ceramic membranes for liquid filtration systems, ceramic diesel particulate filters (DPFs) to control soot exhaust particles and black carbon emission from diesel engines, and plastic components for usage 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 offices 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, advanced filtration, 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 commercial pool owners, scrubber technology providers, shipowners, and ship operators as well as tailored filtration systems for oil & gas operators and services companies. We are expanding our range of products to better leverage existing customer relationships and develop new relationships within the oil & gas, marine, chemical, and other industries.
• Better penetrate existing end markets where our value proposition is strong. We have successfully sold products and installed systems into several end market segments--including automotive/transportation, clean water and pool filtration, marine, industrial wastewater, chemicals/petrochemicals, and oil & gas applications. We are focused on targeting and developing 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 develop strategic partners 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, 2024 and 2023:

Revenue

Revenue for the three months ended March 31, 2024 was $4,235,344 compared to $4,011,519 for the same period in 2023, representing an increase of $223,825 or 6%. The favorable change was attributable to an increase in sales of DPFs and ceramic membranes of $396,964 and an increase in deliveries of liquid filtrations systems and aftermarket sales of $113,747, partly offset by a decline in plastics products of $286,886. The uptick in DPFs and ceramic membranes sales was attributed to focused sales efforts beginning from late 2023 that generated elevated activity in the current year. The increase in liquid filtration system sales was mainly attributed to the delivery of an oil & gas pilot system to North America, albeit offset by reduced deliveries of marine orders. The decline in plastic products relates solely to a large one-off sale that was recorded in 2023, without recurrence in the current year.

Gross Profit

Gross profit for the three months ended March 31, 2024 was $271,102 (or 6.4% gross margin) compared to gross profit of $391,342 (or 9.8% gross margin) for the same period in 2023, representing a decrease of $120,240, or 31%, and a decrease in gross margin of 3.4 percentage points. This decline in gross profit can be attributed to the revenue mix. Specifically, the deployment of the containerized oil & gas pilot system contributed to lower-than-usual margins, reflecting a strategic decision aimed at demonstrating and documenting the efficiency of our technology. Furthermore, both efforts to strengthen the workforce to accommodate growth and the hedge against the cost of energy and critical raw materials contributed to the decline. The decline in gross profit was partly offset by decreased depreciation as well as continued initiatives aimed at optimizing manufacturing processes which have improved profitability within DPF and ceramic membrane production. Included in the gross profit was depreciation of $451,644 and $614,592 for the three months ended March 31, 2024, and 2023, respectively.

Expenses

Total operating expenses for the three months ended March 31, 2024 were $2,317,122, representing a decrease of $266,881, or 10%, compared to $2,584,003 for the same period in 2023.

Selling expenses for the three months ended March 31, 2024 were $517,579 compared to $1,182,435 for the same period in 2023, representing a decrease of $664,856, or 56%. The decrease in selling expenses is mainly explained by the release of bonus provisions for 2023, as well as reductions in travel costs, marketing expenses, and expenses related to external sales consultancy services. Furthermore, the comparable period in 2023 was affected by bonus payouts, which was partially offset by the release of bonus provisions classified as general and administrative expenses.

General and administrative expenses for the three months ended March 31, 2024 were $1,544,731 compared to $1,058,949 for the same period in 2023, representing an increase of $485,782, or 46%. The comparable period in 2023 was affected by the release of bonus provisions, whereas the actual bonus payouts were classified as selling expenses. Furthermore, the change was attributable to increased legal expenses, insurance costs, and recruitment expenses associated with the CFO transition for the three months ended March 31, 2024. Included in general and administrative expenses were non-cash compensation of $193,321 and $157,173 for the three months ended March 31, 2024 and 2023, respectively.

The following is a summary of non-cash compensation:

Research and development expenses for the three months ended March 31, 2024 were $254,812 compared to $342,619 for the same period in 2023, representing a decrease of $87,807, or 26%. 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, as the Company streamlined and centralized the R&D function.

Other Income (Expenses)

Other Income (Expenses) for the three months ended March 31, 2024 was $(356,714) compared to $(211,134) for the comparable period in 2023, representing a decrease of $145,580, or 69%. The decrease was attributable to the non-cash loss associated with the sale of fixed assets and increased interest expenses incurred due to the acquisition of leased equipment throughout the remaining financial year of 2023. Additionally, we incurred increased amortization cost due to the extension of the maturity date for the senior promissory notes, with additional warrants issued as consideration for the extension. The decrease in Other Income (Expenses) was offset by a gain on currency transactions due to the EUR/DKK depreciation against the USD during the period.

Net Loss

Net loss for the three months ended March 31, 2024 was $(2,388,295) compared to $(2,389,503) for the comparable period in 2023, representing a reduction in net loss of $1,208.

The change was primarily attributable to savings in operation expenses of $266,881, offset by a decrease in gross profit of $120,240, the non-cash loss on sale of fixed assets, and increased interest expenses and amortization costs.

Liquidity and Capital Resources

On September 30, 2023, the Company proactively addressed the maturity of the $6 million senior promissory notes, extending the original maturity from June 2024 to January 2026 with terms and conditions that are generally aligned with the original agreement dated on June 22, 2022.

Based on current projections, which are subject to significant uncertainties--including the duration and severity of global macroeconomic issues, geopolitical instability, commodity price volatility, and continued global supply chain disruptions--the Company believes that 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.

The Company has historically satisfied its capital and liquidity requirements through offerings of equity instruments, internally generated cash from operations and our available lines of credit. On March 31, 2024, we had cash of $7,726,213 and net working capital of $12,777,940, and on December 31, 2023, we had cash of $10,442,181 and net working capital of $14,590,432. On March 31, 2024, our net working capital had decreased by $1,812,492 compared to December 31, 2023, 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 EUR 850,000 (approximately $905,000). The credit line is secured by a cash deposit.

Going Concern and Management’s Plans

The financial statements included herein for the period ended March 31, 2024, 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, 2024, we had cash and cash equivalents of $7,726,213, net working capital of $12,777,940, an accumulated deficit of $78,310,475, and total assets and liabilities of $31,366,068 and $16,828,606, respectively. We have incurred losses from continuing operations, used cash in our continuing operations, and remain dependent on external 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 to help right-size the business and develop a clear and sustainable path to profitability, further underpinned by an updated strategy and onboarding of key executives. There can be no assurance, however, 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 could 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.

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 531,250 shares of Common Stock 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 “Note and Warrant Purchase Agreement”). The warrants issued in this transaction have an exercise price of $5.20 per share, a term of five years and are exercisable for cash at any time.

The Notes originally had 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.

Additionally, as part of the transaction, the Company issued 28,846 warrants to the placement agent. The warrants issued in this transaction have an exercise price of $5.20 per share, a term of five years and are exercisable for cash at any time.

As a result, the Company recorded an initial debt discount of $695,749, based on the relative fair value of the warrants and Notes issued. The Company determined the fair value of the warrants by using the Black-Scholes Option Pricing Model, with the following assumptions: expected term of 2.5 years, stock price of $3.44, exercise price of $5.20, volatility of 80.8%, risk-free rate of 3.13%, and no forfeiture rate. The debt discount will be accreted according to the effective interest method over the contractual term of the Notes. The warrants qualified for equity classification and were reported within Additional Paid-In Capital.

On October 13, 2023, the Company and the Purchasers entered into an amendment to the Note and Warrant Purchase Agreement (the “Amendment”) and Allonge No. 1 to each of the Notes (collectively, the “Allonges”) effective as of September 30, 2023, pursuant to which the Company and the Purchasers extended the maturity date of the Notes from June 20, 2024, to January 1, 2026 (the “Extension”). As consideration for the Extension, simultaneously with the entry into the Amendment and Allonges, the Company issued to the Purchasers additional warrants to purchase an aggregate of 531,250 shares of Common Stock at an exercise price of $5.20 per share, subject to adjustment as provided therein (the “2023 Warrants”). The 2023 Warrants are exercisable at any time prior to the five-year anniversary of the initial exercise date of September 30, 2023. The Amendment qualifies as a modification and entitles the Purchasers to registration rights with respect to the shares of Common Stock issuable upon exercise of the 2023 Warrants pursuant to the existing Registration Rights Agreement, dated June 22, 2022, by and between the Company and the Purchasers.

As a result of the amendment, the Company recorded an initial debt discount of $1,193,206, based on fair value of the warrants issued. The Company determined the fair value of the warrants by using the Black-Scholes Option Pricing Model, with the following assumptions: expected term of 5.0 years, stock price of $3.89, exercise price of $5.20, volatility of 73.66%, risk-free rate of 4.60%, and no forfeiture rate. The debt discount will be accreted according to the effective interest method over the contractual term of the Notes. The warrants qualified for equity classification and were reported within Additional Paid-In Capital.

Cash Flows

Three months ended March 31, 2024 compared to three months ended March 31, 2023

Cash flows from operating activities for the period ending March 31, 2024 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, 2024 were $(1,956,701), representing an improvement of $328,600 compared to cash flows from operating activities of $(2,285,301) for the three months ended March 31, 2023. The cash flows from operating activities for the period consists mainly of the net loss of $(2,388,295) adjusted for depreciation and other non-cash-related items of $1,465,256 as well as a reduction in accrued expenses of $513,197 due to a reduction in accrued payroll, partly offset by a decrease in accounts receivable of $396,168 as a result of effective collection efforts.

Cash flows from investing activities were $551,787 for the three months ended March 31, 2024 as compared to $(87,470) for the three months ended March 31, 2023, representing an improvement of $639,257. The investing activities include proceeds from the sales of production equipment in Ballerup, offset by general purchases of production equipment to continue optimizing production throughput.

Cash flows from financing activities were $(1,009,437) for the three months ended March 31, 2024 compared to $(98,945) for the three months ended March 31, 2023, representing a decrease of $910,492. The decrease was mainly driven by the repayment of lease agreements in connection with the sales of production equipment in Ballerup as mentioned above.

Off Balance Sheet Arrangements

As of March 31, 2024, 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, 2024, 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 22, 2024, for the year ended December 31, 2023.

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, our 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 in 2023 hired additional employees into the finance department, and the Company implemented a new ERP system along with other IT programs to help reinforce its controls and processes, and these investments are an important step in the remediation of the material weaknesses. During 2022, the Company introduced an updated Delegation of Authority, with the overall purpose to provide clarity for all employees on the extent to which they can commit the Company and at the same time provide the Company with assurance that decisions about agreements are made by the appropriate functions and employees. Lastly, the Company has started the process of redesigning and ensuring documentation of all processes and procedures related to the financial reporting process 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.