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Edited Transcript of LIQT earnings conference call or presentation 11-May-20 1:00pm GMT

Q1 2020 LiqTech International Inc Earnings Call

BALLERUP Jun 26, 2020 (Thomson StreetEvents) -- Edited Transcript of LiqTech International Inc earnings conference call or presentation Monday, May 11, 2020 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Robert A. Blum

Lytham Partners, LLC - Managing Partner

* Sune Mathiesen

LiqTech International, Inc. - CEO & Director

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Conference Call Participants

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* Eric Andrew Stine

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Robert Duncan Brown

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Robert Paul McCarthy

Stephens Inc., Research Division - MD & Analyst

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Presentation

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Operator [1]

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Good morning. Welcome to the LiqTech Reports First Quarter 2020 Financial Results Conference Call. (Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to Robert Blum with Lytham Partners. Please go ahead.

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Robert A. Blum, Lytham Partners, LLC - Managing Partner [2]

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Thank you very much, Kate. Hello, everyone, and thank you for joining us today to discuss LiqTech International's First Quarter 2020 Financial Results. I'm Robert Blum of Lytham Partners. I'll be your moderator for today's call.

Joining us on today's call from the company is Sune Mathiesen, the company's Chief Executive Officer.

Before I turn the call over to Sune, let me remind listeners that following the conference call, there will be an open Q&A session. You should also note that a replay of this call will be available shortly following the conclusion of the live call and that a transcript to the call will be available on the Investor Relations section of the company's website.

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 and sales of operations and cash flows. If one or more of these risks or uncertainties materialize or if the underlying assumptions prove incorrect, the company's actual results may vary materially from those expected or projected. The company, therefore, urges all listeners not to place undue reliance on these forward-looking statements which speak only as of this date and the date of the release and conference call. The company assumes no obligation to update any forward-looking statements in order to reflect any events or circumstances that may arise after the date of the release and conference call.

With that said, I'd like to turn the call over to Sune Mathiesen, Chief Executive Officer of LiqTech International. Sune, please proceed.

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [3]

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Thank you, Robert. And good morning to all of you. Thank you for joining us today to discuss our first-quarter 2020 financial results. We hope everyone on the call and your families are safe and healthy.

The COVID-19 pandemic has certainly made the past months challenging. Our situation in Denmark is now slowly, but safely, normalizing, and we are seeing the first signs of activity improving in the market. I will get back to this a little bit later.

The first quarter results were in line with the preliminary expectations we discussed with you during our March 26 conference call, with yet another record revenue quarter for the business of $10.3 million despite the negative impact from COVID-19, which impacted deliveries in the final weeks of the quarter. As we discussed, we were on track to deliver approximately $12 million for the first quarter, when COVID-19 began to disrupt operations.

The $10.3 million we achieved represents a 39% increase from the first quarter a year ago and was due to the higher sales of our proprietary ceramic silicon carbide water filtration systems for the marine scrubber market, where we continue to achieve a significant commercial breakthrough.

We also remain profitable, although not at the level that we might normally expect, as our cost structure for the first quarter was designed to meet both the higher revenue expectations we originally had prior to COVID-19, but also our expectations for continued ramp in the business going into the second quarter. I will talk about our outlook for the second quarter and beyond momentarily.

We also made very good operational progress since the first of the year. We successfully installed the first of the brand-new customized furnaces around the first of the year and recently completed installation of the second new customized furnace for use in the manufacture of the company's proprietary silicon carbide membrane filters. Each of the furnaces have throughputs that are approximately 4x higher than the older furnaces due to size and efficiency. We are planning to install 2 additional new furnaces by the third quarter 2020 which, upon successful installation of all 4, increases the company's total capacity to be between $150 million up to $200 million on an annualized basis by mid-2020.

As we mentioned in the press release, we incurred approximately $200,000 of incremental costs during the first quarter related to the ramp in manufacturing. As the additional furnaces come on board, these amounts will decrease as our know-how improves.

We improved our overall gross margin to 25.7% in the first quarter. The improvement was primarily driven by deliveries of our Mark 6.1 system, which we launched in the third quarter last year. The Mark 6.1 system is a lower cost and more efficient system. When you break out the contribution margin by systems, the Mark 6.1 had contribution margins of more than 40% during the quarter. This compared to the older Mark 6 systems which had contribution margins of approximately 25%.

Of the $7.9 million of Marine revenue during the first quarter, about 2/3 was on the older, lower-margin systems and 1/3 was under new, higher-margin systems. We have now worked through all orders for the old lower-margin Mark 6 systems, and all future systems set for delivery will be Mark 6.1 systems or higher, which should further drive improvement in gross margins overall going forward.

When the impact from COVID-19 first began to occur, we implemented several measures to ensure manufacturing continuity and adhered to strict state guidelines on the number of personnel that can work in proximity. We divided the workforce into multiple shifts and had certain office people work remotely from home. Since the end of April, Denmark has now relaxed its guidelines and employees have now returned to more normalized operating procedures.

We were also proactive in restructuring our overall cost base given the expected near-term impact to the business. Overall, we have a path in place to reduce our annual cost base by approximately $1.9 million, which will be phased in over the next several months. Our hope is that we are able to quickly ramp back up to full capacity. But given the current uncertainty, these moves allow us to create a cost structure whereby we can be profitable at about $7 million per quarter in revenue.

We continue to monitor the current situation, and we are prepared to implement further plans to reduce costs, if necessary.

As I mentioned back at the end of the March during our year-end call, due to the impact from COVID-19, the rate of incoming orders for the marine scrubber industry has slowed and will likely impact the second and third quarter revenues. We are currently working through and delivering orders received earlier in the year. But with the slowdown in orders and difficulties in delivering and commissioning systems, this will translate into a slowdown in deliveries this and next quarter.

What I can share with you is the following: We are now back in full manufacturing in Denmark. Unfortunately, this is not the same case in many other countries around the world, and I want to emphasize that our lack of visibility for the next 2 quarters is not due to our inability to manufacture product, but based on customers being able to receive products.

We are currently in discussion on more than 70 marine system orders which will be delivered commencing later this year and beyond. This is a strong number that represents roughly $30 million in sales. And based on our historical conversion cycles, I expect us to receive the vast majority of these orders. While there has certainly been a slowdown in orders that started in Asia and gradually worked their way to Europe, customers around the world seem to be slowly coming back and the recent improvement in activity gives us reason to believe that our business will soon return to normal levels.

I want to give you an update on our progress in oil and gas market before I turn it back over to your questions. At a high level, the capabilities we have developed using our proprietary silicon carbide filters and our unique system design are applicable to a number of applications. We had our first commercial breakthrough of the technology in the marine scrubber segment, and we continue to believe this will be a significant growth driver for our business. We have also made inroads in the power plant market, particularly in parts of Europe, where similar regulations are limiting the discharge capabilities from these plants.

The next application we are commercializing is the oil and gas market, one we believe -- one that we believe will significantly surpass both of the other markets in terms of their overall size for LiqTech in the years to come. What makes LiqTech solution unique for this market is our ability to treat difficult water and reuse it in the process. We have tested our technology together with some of the largest oil and gas companies, and we have proven that our technology offers a better solution in terms of both quality and cost compared to existing alternatives in the market.

As earlier discussed, we have been maturing several projects in the Middle East for some time. These projects are for water reuse in the oil production and related to water scarcity in the region. So despite of the varying price of oil in any given period, these projects are focused on long-term solutions to long-term issues. This is why we think that our technology is ideally positioned to address the need for water treatment solutions to areas in the Middle East where there is local water scarcity. We look forward to finalizing contracts in the months and years to come with an expectation that the oil and gas market will be the largest contributor of revenue in 2021. I want to again -- to once again note that this is not because the marine scrubber business will see a drop-off, but because the oil and gas opportunity is simply that large.

So just to wrap things up before we turn it over to your questions, I want to say that I'm pleased with the operational performance by the team over the last number of months. We finished the first quarter with record revenues despite the impact from COVID-19 midway through Q1 and maintained profitability in the business. The management team has quickly navigated the COVID-19 disruptions, ensuring manufacturing continuity, while at the same time ensuring our cost structure matches our revenue levels in the near-term, and lowering our overall breakeven point. We continue to make progress in the oil and gas market, which follows successful pilot programs with key customers in the region, and we believe that we are on track to announce significant orders for this industry in the near term.

And despite the impact from COVID-19, we remain the leader in the marine scrubber industry for filtration. We believe our market share remains in the 50% range. And while there was a loss of orders given the global disruptions, activity's once again picking up with us, currently bidding on more than 70 orders, which we believe will translate to a return to our historical levels of growth later this year.

One final note: I will be participating in a virtual investor conference presentation next week, Wednesday, May 20, with the team at Lytham Partners. Details on the webcast will be sent out later this week, and I will also be participating in virtual one-on-one meetings on Thursday, May 21. Please contact Robert Blum for additional information.

And with that said, let me now turn the call over to any questions you might have. Operator, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Eric Stine from Craig-Hallum.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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So you've kind of touched on, and obviously things have slowed down but I'd love to hear your thoughts just on the overall market. And obviously, there's been, at least, to near-term because of the spread, a pretty widening or lengthening out of paybacks for scrubbers. What you're hearing from customers? Whether you or they are saying they think that that's a little bit more of a long-term situation? Or is that truly a couple of quarters?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [3]

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So what we hear from our customers is that they are not really focused on, let's say, the spread in any given time. They are more focused on the long-term spread between low-sulfur and the bunker fuel. We see that now. It has truly been quiet for some months in the beginning of the COVID-19 situation. I'm very pleased to see that in the last, let's say 2 or 3 weeks, we have seen a significant pick up in activity from the scrubber manufacturers and from the ship owners. So it looks like things are now normalizing. We see the oil is coming up a little bit again. The price spread is coming up, and it looks like they are now continuing with, let's say, the scrubber installation plans that they had already before the COVID-19 situation. So we think it is a couple of months of disruption. And especially what we have seen in the last couple of weeks, leads us to believe that the situation is now normalizing. We're not completely back to normal. But as I mentioned, we are negotiating a significant number of new contracts. So that is a very positive sign for us.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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Yes. And when you talk about those new contracts, I mean, is it still a similar dynamic as, what, 1.5 months ago when it was more activity out of China rather than Europe? Or, I mean, is some of that renewed activity in Europe?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [5]

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In the past couple of weeks, we now see more activity again from Europe. Two weeks ago or 3 weeks ago, it was completely dead from Europe, and it was driven by the Asia players, who have been back to work for a while now. But now we see the European players are coming back, which is a great sign. So again, things are normalizing in Europe. I think there are still a lot of challenges in southern part of Europe. But in Northern Europe, things are slowly but safely normalizing, and we see activities picking up.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

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Got it. And then maybe just on the backlog, and I know you don't quote the backlog. But maybe if you could just talk about the health of that a little bit. Are you seeing -- or have there been any cancellations? Or is it more a case of what you've got in backlog just being pushed to the right in terms of timing?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [7]

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We have actually not seen a single cancellation. We have seen issues in delivering product, issues in commissioning systems already delivered, but we have not seen any cancellations. So again, a great sign. And it leads us to believe that this is more a timing issue more than anything and that that things will come back. And obviously, we're encouraged to see that, right, that there has been no cancellations at all.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [8]

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Yes, absolutely. Maybe last one for me, just on the OpEx. Could you just give some of the specific actions that you're taking there? And then just curious, you mentioned last quarter that there might be some help from the Danish government -- I think it was something like $400,000 a quarter -- whether that is something that you have chosen to or are able to access?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [9]

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Yes. There are a number of initiatives from the Danish government. You can send people home and have salaries refunded or partly refunded. And there's also an initiative that you can delay tax payments for 4 months. We have chosen to use the delay of the tax payments, which will help liquidity in the next 4 months. We have not chosen to use the initiatives to reimburse part of the salaries for employees because for our employees, the percentage was too low. So the cost savings that we have now put place is that we have laid off a number of people to reduce our overall cost. We have tried to be careful in the layoffs. So they are people in the manufacturing; they are people working with project management. We have not made any reductions in R&D and, let's say, longer-term important functions.

The Danish situation is a little bit different. It's not like in the U.S. when you lay off people, they go home the next day. We often have 3, 4, 5 months of termination periods. So these employees are currently working through their termination periods, which is why the cost reductions will come into real force by August this year.

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Operator [10]

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Our next question is from Robert McCarthy from Stephens.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [11]

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So appreciate all the color, definitely a lot to noodle on. I guess, asking around the cash burn, it looks like, obviously, working capital, it's a good news story and the fact that you're expending working capital to kind of meet demand. But how do we think about kind of your cash balance right now and your cash burn going forward? And would you anticipate any needs for additional funding? Or do you think just given the fact that you're going to have these cost saves and ramping up production that cash generation is going to kind of take care of itself? Because obviously, I think last time we spoke on the quarterly call, you suggested that, obviously, if activity went moribund, you definitely had a long runway here. But given the fact that you're going to have some fits and starts with your working capital and your supply chain, your productive chain, how do we think about, kind of, what your cash position could be going into '21 and beyond?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [12]

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Yes. So the steps we have taken right now to reduce our overall cost base means that we should be profitable on approximately $7 million of revenue per quarter. So we are definitely cautious here. We have taken, I think, the right steps to reduce our overall cost base. And it means that we shouldn't burn too much cash due to this COVID-19 situation.

Secondly, we saw our cash balance come down in the first quarter, but that was really a result of the increased level of business, the record revenues in the first quarter, which required more working capital. After the quarter ended, we have started collecting some of these payments on goods delivered in the first quarter, and our cash balance today is somewhat higher than it was ending the quarter.

So I think we're in good shape here. We have no debt. We have a fair cash balance. We have taken steps to reduce our overall cost base to match revenues in this difficult COVID-19 situation. And we are now seeing signs of the business improving. We're seeing more RFQs. We see more orders again, and that leads us to believe that by the end of this year, hopefully we will be back, let's say, where we were before this COVID-19 situation.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [13]

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In terms of your backlog, I think you suggested, obviously, given the mix shift to the better Mark 6, I believe, in terms of the product profitability, you expect 40% contribution margins versus kind of your historical 25% for your existing product line. So we should expect, all things being equal, a pretty nice lift in gross margins in the back half of the year going into 2021, correct?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [14]

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That is correct. So very encouraging to see the development in the first quarter. About 1/3 of the deliveries was the higher-margin Mark 6.1 product, 2/3 was the old lower-margin Mark 6 product. We have now worked through all the Mark 6 orders we had in our pipeline. All future deliveries will be Mark 6.1 or higher. And that also means that we'll see further improvement in the gross margins, which I'm very pleased to see.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [15]

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And then how -- what's the state of your tax credit right now in terms of what's going on? Remind us how that's going to work, particularly as you start to ramp and start to make some money here? How much of a tax advance that you get over the next couple of years?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [16]

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Yes. We have -- I think it's all together about $6 million tax advance that we are now starting to actuate. We were nicely profitable in the Danish entities last year. And we kind of used that -- some of that tax asset. So we're not paying tax, and that will continue in the years to come.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [17]

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Final question. The third quarter, I think, is traditionally a period where you would start to see some kind of just easing of production just given the seasonal activity of production in Europe and Scandinavia, right? Do you expect, just given the disruptions we've seen, whether you'll be full bore in the third quarter? Or do you think you'll see the same kind of seasonal production patterns?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [18]

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So one of the good things that came out of the COVID-19 situation is that we burn through a lot of the holiday allowance for the employees. So in theory, if we see activity pick up in the market and the customers being able to accept deliveries, then we will be able to be more active than normal in the holiday season. But again, we are now seeing the first signs of the market recovering after COVID-19. It is still challenging. And I believe that our revenues will be impacted for the second quarter and the third quarter. To which extent, is still difficult to predict. We are back in full manufacturing. So it more comes down to our customers' ability to actually accept product.

So yes, in theory, we will be able to have more people working through the holiday season because they already took out some of their holidays at this point.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [19]

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I'm sorry; I had just one more. Diesel particulate sales in your business for the quarter and for the -- what's your expectation for the full year, just so we kind of level set expectations?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [20]

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Yes. DPF, we have not really any changes to our expectations. We still think it will be between $6 million to $8 million for the year. And for the quarter, it was pretty stable. I believe it was around $1.5 million.

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Operator [21]

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(Operator Instructions) Our next question is from Rob Brown from Lake Street Capital Markets.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [22]

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Just on kind of timing of shipments and recovery into things recovering, how many units do you have sort of built, ready-to-go at this point? Or a sense of how quickly things can turn back on?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [23]

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We have not disclosed that, but we have stayed at full manufacturing. So we do have a fair amount of systems that are ready-to-go. And it also means that when things pick up again, we will be able to ship product very quickly.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [24]

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Okay, good. And then on the oil and gas market, you talked about a significant ramp into next year. When do you sort of need to see order activity start to hit your goal of being a larger part of the business next year?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [25]

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We think that the second and third quarters, we'll see first orders from the oil and gas industry. In fact, we have great confidence in that. We have been working on it for a long time now. We talked about it for the last 6 months now. And there are no changes. The projects in the Middle East are related to water scarcity. And so they are moving forward despite of, let's say, the out swings in oil prices that we have seen in the last couple of months. So we are encouraged to see that we're still making progress in that, and we would expect to see first orders in the next few months.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [26]

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Okay. And it's, I guess, a little surprising that at the oil and gas business, given the CapEx cuts in that world that they're still moving forward with sort of a capital project, I guess. Have you gotten sort of recent checks there that are saying that things are moving forward? Or is this a case of the customer base that you're talking about maybe isn't delaying CapEx as much? Just give us a sense of why those projects can still move forward in the tough commodity environment?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [27]

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Yes. We are in contact with these customers almost on a daily basis. Things are moving forward. And you could say, yes, it is surprising in the current environment in the oil and gas business. But again, these projects are not related to anything other than water scarcity. So they simply do not have any water. And if they want to continue to manufacture oil, they need to do something; otherwise, there will be in need of water. What they're doing today is trucking desalinated water, which obviously comes with a huge cost. So even despite of the oil prices that we have today, this really represents a great opportunity for the operators to cut their costs on water used in the process.

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Operator [28]

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This concludes our question-and-answer session. There's no more questions. I would now like to turn the conference back over to Sune Mathiesen for closing remarks. Go ahead.

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [29]

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Thank you, operator, and thanks for everyone joining us on the call today. I look forward to speaking with many of you again next during our virtual presentation and one-on-ones, and hope that we can all visit face-to-face again in the near future. Have a good day, and stay safe.

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Operator [30]

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