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Edited Transcript of LIQT earnings conference call or presentation 14-Aug-19 1:00pm GMT

Q2 2019 LiqTech International Inc Earnings Call

BALLERUP Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of LiqTech International Inc earnings conference call or presentation Wednesday, August 14, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* 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

* Liam Dalton Burke

B. Riley FBR, Inc., Research Division - Analyst

* Robert Duncan Brown

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

* Robert Paul McCarthy

Stephens Inc., Research Division - MD & Analyst

* Robert A. Blum

Lytham Partners, LLC - Managing Partner

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Presentation

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Operator [1]

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Good morning, and welcome to the LiqTech Second Quarter of Fiscal Year 2019 Financial Results Conference Call. (Operator Instructions) Please note, today's event is being recorded.

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

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

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Thanks so much, Rocco. Good morning, everyone, and thank you for joining us today to -- as LiqTech discusses its second quarter 2019 financial results. I am 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 today's call will be available shortly following the conclusion of the live event, and that a transcript of the call will be available on the Investor Relations section of the company website shortly there afterwards.

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 this release and conference call.

Now 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 very much, Robert, and good morning to all of you. Thank you for joining us today to discuss our second quarter 2019 results. I believe that we're reporting a strong quarter, and I'm excited to be speaking with you today.

The second quarter financial results continue to highlight the strong demand for our proprietary ceramic silicon carbide water filtration systems as the leading solution for closed loop marine scrubber applications. The second quarter was, again, a new record for the company. The revenue was $9.3 million and exceeded the expectations we shared back in May when we also accelerated on profitability. The revenue of $9.3 million was up 258% from the same period in 2018 and up 25% sequentially from the first quarter of 2019. We are clearly gaining significant market traction, and our market share continues to grow.

In addition to the significant growth in revenue, we also improved profitability with income from operations of $393,000 compared to an income from operations loss of $563,000 in the second quarter last year. On a sequential basis, we significantly improved profitability as well. We continued to make progress on leveraging our cost infrastructure, and our contribution margins for our marine scrubber products improved more than 500 basis points in the second quarter. I'll go more into details on our margin optimization program shortly.

Our overall gross margins in the quarter was positively impacted by the 500 basis points improvement in contribution margins from our marine scrubber products, but it was also partly offset by low sales of DPF products in the quarter, resulting in low overhead absorption. We do expect DPF sales to normalize in the coming quarters, and we expect further improvement in contribution margins from our marine scrubber products.

Finally, due to the increases in profitability and proceeds from an oversubscribed public offering in May 2019, our balance sheet is in the best position it has ever been. We are certainly very appreciative of the support we have received from investors.

While we have even yet to hit the January 1, 2020 date for IMO2020, the market is quickly evolving. A number of new scrubber manufacturers have entered the space. However, we have not seen any significant new entrants in the filtration component of this market, the area in which LiqTech operates.

We designed LiqTech's marine scrubber filtration technology as a plug-and-play solution, allowing it -- for it easily to be integrated into a variety of scrubber systems sold in the market. As the scrubber market has expanded and an increasing number of scrubber manufacturers have entered the space, we have successfully increased our customer base and diversified our geographic footprint to drive growth and maintain and grow market share.

The biggest new entrants to the scrubber manufacturer side has come from Asia. We are in very good relationships with the Asian manufacturers. And today, a large proportion of our current backlog is from Asian players compared to just a small percentage a year ago. Overall, we are now supplying filtration systems to a large number of scrubber manufacturers with 2 new customers added in just the last quarter.

We know there has been news in the market about certain companies highlighting headwinds for their products. We believe this is a function more of the increased competition as opposed to a pullback in demand for scrubber solutions. While we continue to see increasing demand for scrubbers as a whole, we are also seeing increasing movement towards closed loop systems which include filtration components. Enhancing this demand is continued tightening of global legislations to ban discharge from open loop scrubbers in many of the world's most important ports, including recent movements by China to further implement new discharge limits on PAH and oils, which our silicon carbide filtration systems helps to address.

We believe the installation and conversion to closed loop systems will continue to increase as a percentage of overall installations in the future, representing a large and increasing market for our solutions. By the end of this year, we estimate that more than 4,000 open loop scrubbers will be installed or on order, representing a large potential upgrade market for us for open loop conversions.

In our opinion, the current economic argument still strongly supports marine scrubbers. The current spread between heavy fuel oil and low-sulfur diesel continues to offer very attractive return on investment on scrubber installations. Analysts following the industry believes that the current spread is likely to widen, as they understand it seeing them.

We know that backlog and customer order commitments are important factors that many of you are looking at. As we continue to grow and are now in the process of delivering systems to the market while at the same time diversifying our product offerings, we have discussed with many of our investors the best ways for us to communicate key metrics on the progress in the business. The consensus was for us to provide a book-to-bill ratio. Our book-to-bill ratio in the second quarter was 1.6. And again, this highlights improvements from our most recent conference call in securing new customers and building our backlog.

The company's margin optimization program remains on target. As most of you that were at our Analyst Day and listened online heard, efforts to eliminate costs, streamline processes, in-source certain manufacturing, benefit from economies of scale and implement LEAN manufacturing are all advancing. As earlier mentioned, contribution margins from our marine scrubber products improved more than 500 basis points in the second quarter. We are very pleased with this progress, and we expect further significant improvements in the second half of 2019, especially from certain design changes to our products and in-sourcing of currently outsourced manufacturing.

Additionally, the planned expansion in manufacturing operations remains on track with the first of the new furnaces for the extension of our Ballerup facility set to be delivered in the third quarter of 2019, and the planned expansion in Hobro also set to be completed in the third quarter of 2019. Overall, we are on target to triple our manufacturing capacity by July 2020.

Again, as many of you heard during our Analyst Day a few months ago, while we are remaining highly focused on the scrubber market, there are a number of opportunities to expand our proprietary technologies to adjacent technologies and applications. We continue to progress the adoption of our ceramic silicon carbide filtration technology to the power plant market. We have already booked several orders in 2019 and have been specified for a number of projects into 2020. Again, tightening legislation within many countries is driving the need for water treatment systems for power plants. We expect meaningful revenue in 2020 from this area.

Additionally, our silicon carbide diesel particulate filters, a product we have been manufacturing for nearly 20 years, is ideally suited to address NOx reduction within the marine industry. I highlighted this point during our Analyst Day. But to reiterate, the NOx emissions from 1 large cruise ship is equivalent to 421,000 passenger cars. As a result, we, along with many others in the industry, anticipate tightening legislation for NOx in the near future. We remain on target to launch the product in 2020.

Finally, we are also anticipating introducing other products adjacent to the marine scrubber market on a stand-alone basis, including an in-port water treatment system that will allow shipowners with an open loop scrubber to operate auxiliary engines while in port, and a filter press that is also a component of our existing systems, further enhancing our reach within the market.

We are also advancing OEM membrane sales. Originally, that is what LiqTech was focused on. However, a lack of interest from water treatment OEMs originally forced us to become a systems integrator in 2014. However, following the current success in the marine scrubber industry and successful large-scale references in other industries, we are now experiencing great interest from water treatment OEMs. We expect membrane sales and licensing agreements to be a significant part of our business in the future. And don't forget that membrane sales carry attractive gross margins that will further improve our overall margin structure.

So while we are highly focused on marine scrubber filtration systems, we are also focused on diversifying and expanding our addressable market opportunities. I mentioned this earlier, but I think it bears repeating: transitioning the business from concept to product development to full commercialization is never easy. However, the team at LiqTech has done an extraordinary job in meeting the increasing demand for our products. I appreciate the hard work and dedication from everyone in LiqTech.

To turn the call over to your questions, let me just say that we're extremely pleased with the progress made to position LiqTech as the market leader in the marine scrubber filtration business. We believe the addressable market opportunity will continue to increase driven by evolving legislation and simply better business growth economics.

From a manufacturing standpoint, we are on track with respect to our margin optimization program, which should continue to yield incremental sequential gains in the quarters to come. Lastly, we have a number of new products set to hit the market in 2020 that should drive continued growth and diversification of our business going forward.

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)

Today's first question comes from Eric Stine of Craig-Hallum.

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

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Maybe I'll start with just a market question. I know it's not widespread, but you're starting to see -- I guess, Singapore would be the best example, saying that they're going to be purposely lax in enforcement early in 2020. Just curious if you think that's a one-off? If that has any teeth? And are you seeing any pause in the market as a result?

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

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We are not. We see continued growth in the market. I think the book-to-bill ratio of 1.6 really proves that. Even though we had a record revenue quarter, we put 60% more orders than we shipped. So we are not seeing any pauses. We, on the contrary, will see a continued growth in the market, and it looks like that will continue in the second half of this year as well.

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

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Got it. Maybe just turning to the 2 new scrubber customers. I'm wondering -- I mean, given your commentary, is it fair to say that those are Asian customers? And maybe if you could just characterize them? And just curious if they were a component of your Q2 order strength.

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

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Yes. They were a component of our order strength. They were not Asian, however. They were actually European players. We saw a lot of new Asian players come into the market in the second half of 2018, and we've seen a lot of players coming in the first half of 2019 as well. But in this specific quarter, it was actually 2 new European players.

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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 I know in the past, you've said that you count 7 of the top 10 as customers. I mean, how would you characterize these customers? I mean, are they on that top 10 list? Or are they more in the up-and-comer category?

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

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They are more in the around 10 spots, so pushing to get into the top 10 but not in the top 10.

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

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Got it. Okay. Last one for me. Just as we think about this going forward, I mean, I would think especially in light of your backlog, is it fair to think -- I know in the past, you've talked about sequential growth throughout the year and obviously strength heading into 2020. Is that still the expectation that there should be a step-up here in revenue for 3Q?

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

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Yes, we definitely feel we had a very strong start to the year. We had a record first quarter, record second quarter, a record first 6 months. But we think definitely that the second half of 2019 will be stronger than the first half.

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Operator [10]

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Our next question today comes from Robert McCarthy of Stephens.

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

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So let's just talk about book-to-bill first. I mean, on the suggestion of, I think, your average content on a scrubber is in that $500,000 range, one could surmise that the shipments in the quarter on the marine vessel side could be as high as the 17 or 18 range, which would imply a book-to-bill order strength of about high 20s. I think that would indicate backlog growth for you, probably mid-single digits for the second quarter. Is that a fair characterization or am I doing the math wrong?

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

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Yes. So we shipped about -- our marine scrubber business in the first quarter was about $8.3 million, $8.4 million of revenue. So we booked 60% more than that.

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

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Understood. Okay. Well, I will pursue that line of questioning offline.

Then I guess the next thing is just maybe in terms of following up with some of Eric's solid questioning. Could you characterize how -- what you're seeing that's different in the market? And I guess it would be around the increased adoption of closed loop scrubbers and the related technology. But obviously, Wärtsilä, Alfa Laval, others did talk about a precipitous drop in orders. But obviously, that was due to some compares and also the fact that as we get closer to compliance and longer-lead times, there could be kind of a strategic pause for open loop scrubbers. Could you just take this opportunity to kind of expand on your comments why you think you're going to just grow a lot better and you're more disconnected from what their comments

are?

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

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Yes. I think if we take those 2 -- and it's correct, that (inaudible) said that they have seen a softening in scrubber demand. And I think it relates to 2 things. One fact is that they used to have a very, very high market share. If you go 12, 24 months back, it was a limited number of players in the industry, and these 2 guys probably had 25%, 30% market share each. What we've seen over the last 12 months is it's a huge number of new players in the industry. We've seen products from South Korean players, a lot of Chinese players coming into the industry. We've seen new European players come into the industry. And I think what they are experiencing is that they are losing market share. So we actually think the overall scrubber market is unchanged or still growing. You are -- and what we're also seeing is a larger proportion of closed loop scrubbers. We think the market is moving slowly but safely from open loop systems to high [proven] closed loop systems, obviously benefiting our business.

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

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Yes. And your core profitability was very strong as were your contribution margins. Obviously, I think FX moved against you, and I think -- we think that will reverse in the second half. Maybe if you could talk about in that context the margin enhancement, some of the initiatives there? And I think one thing that was suggested in the past was obviously more in-sourcing occurring. So I wanted to get any kind of qualitative update on that ability to in-source because obviously, that's going to have very -- potentially very profound impacts on your gross margin.

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

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That's correct. So we made a good improvement in the second quarter. We improved more than 500 basis points on our marine scrubber margins, and that was really due to optimizations in-house. What we will see in the third and fourth quarters is in-sourcing of currently outsourced manufacturing -- is one component, and that will be a big driver for margin optimization. And we are doing certain design changes as well that we're implementing in this current quarter that would also improve our margins. So even though we made significant improvements in the second quarter, we are expecting significant improvements again in the third and fourth quarters.

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

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Finally, if you'll indulge me, the diesel particulate sales in the quarter, I don't know if you called out how much that was on an asset dollar basis. And then obviously, power plant -- excuse me, revenues in association with diesel particulate and then any of the power revenues. I don't know if you disclosed that or not.

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

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We do not disclose that yet, and I think it will be meaningful to start disclosing that when we get into 2020. We're doing very well on booking orders on the top end side, and we think it will be a meaningful part of our revenue stream in 2020.

Coming back to the diesel particulate filters, it's correct that we had a very weak quarter for diesel particulate filters, and we have revenues -- let me check if I'm accurate. We have revenue of about $700,000 in the second quarter of diesel particulate filters, which is exceptionally low. If we take the first half of the year, and -- it's altogether about $3 million of revenue, which is a normal level for us. And we're expecting to see a normal level or normalized level but again in the third and fourth quarters. So it was an exceptional quarter for diesel particulate filters, which will normalize in this quarter. But unfortunately, it also means that we had lower absorption of overhead, and it kind of hit the overall gross margin. So we are pleased with the improvements on the marine scrubber business, and we'll know that diesel particulate filter sales will normalize in the first -- third quarter.

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

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And conversely, obviously, the implied revenues in association with the marine, at least by my expectation, are going up on the basis of that, right? So that's probably a net positive in terms of the growth case. So with that, I'll leave it and get back into queue. And I look forward to seeing you soon.

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Operator [20]

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And our next question today comes from Rob Brown of Lake Street Capital Markets.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [21]

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On the closed loop scrubber market, what's sort of the penetration rate of new orders at this point? And how do you see that playing out into 2020?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [22]

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So what we're missing at this stage is feedback from the scrubber manufacturers. Our sense of what is going on is that we see a larger part of scrubber installations being closed loop now. We have seen -- especially China has been very aggressive in legislation. They have come out and said they want to implement further legislation and ban open loop discharge but also implement new legislation and discharge limits on PAH, on oils and so forth. We think this is a trend. We think we will see more and more ports around the world banning open loop discharge, and we think eventually we will see a global ban against open loop discharge. And I think a lot of shipowners are seeing this right now, and our sense right now is that the larger proportion of the scrubber installations and especially plain scrubber installations are closed loop versus open loop.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [23]

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Okay. Great. And then in the power plant market, you talked about a couple of projects you've won and some activity this year that leads into next year. But what's sort of the average kind of revenue per project? And what markets are you seeing activity in?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [24]

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So we started back home in Denmark a few years back on power plants, and it was really good to see that we got traction. We did a number of power plants in Denmark so far, and we kind of expanded our view into Europe. We recently completed a $1.1 million installation in Finland, and we plan to expand into Germany, Sweden, Finland, Norway. So let's say, countries near to Denmark will be the first countries we're targeting. We're booking orders right now. And again, we think it would be a more meaningful part of our revenue in 2020 numbers.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [25]

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And then lastly, on the framework agreement, the third framework agreement that you're working on, where are you at in terms of order flow there and thinking on how that ramps?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [26]

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Still early stages. We said for a while that we think this will turn into meaningful revenue from beginning of 2020, and that should still be true.

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Operator [27]

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(Operator Instructions)

And today's next question comes from Liam Burke of B. Riley FBR.

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Liam Dalton Burke, B. Riley FBR, Inc., Research Division - Analyst [28]

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You talked about the scrubber market. You talked about legislation. Do you view -- and you don't have to give me a specific number, but do you view the overall demand for scrubbers changing either upward or downward to the original base case you made when you entered the filtration market?

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

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Really, really unchanged. We had high expectations for scrubber adoption. We predicted about 20% uptake in scrubbers by 2025. And so far, that prediction has been pretty accurate. So we had high ambitions. And so far, they proved correct.

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Liam Dalton Burke, B. Riley FBR, Inc., Research Division - Analyst [30]

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Okay. And you mentioned orders getting back to the power plant. You did mention countries, different countries. But in terms of order expected -- or orders you have in the pipeline now, have you gone beyond Denmark and into other countries in Europe? Or are you still just in Denmark on the order backlog?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [31]

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No. We are looking to expand into Europe and have expanded into Europe. And we're kind of working in the countries close to home, which makes a lot of sense for us right now. As we expand our presence in the power plant business, we will add further countries further away from home.

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Operator [32]

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And our next question today is a follow-up from Robert McCarthy of Stephens.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [33]

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But I guess the question I would have is, obviously, you've highlighted this some import opportunity. Has that been driven by just maybe a change in how people are thinking about the market with compliance? How do you think about that opportunity? Is there any way to size it in terms of content per port? And how you would think about doing that in the context of kind of your thesis around the propensity for closed loop adoption overall?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [34]

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Yes. Thank you very much for that question, and it's actually a very exciting opportunity for us. It is -- so by the end of this year, we will have 4,000 open loop scrubbers either installed or in order, which is obviously a huge potential market for us for open loop conversions or to sell them an in-port solution. And what we will be selling is a small filtration system that they can run while in port, and it would allow them to run the auxiliary engines while in port and provide power for the ship. So that is a sizable opportunity.

In terms of dollars, we estimate around $200,000 to $250,000 per installation, and you have about 4,000 of them of the; potential. So there is huge potential.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [35]

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Great. And then as a follow-up on the power plant opportunity, have you seen, in terms of revenue trends, even more sequential strength 1Q versus 2Q? Or anything you can give us about what you've seen in terms of the near-term revenue trends at power.

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [36]

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Yes. Again, we -- it's early stages, and we're booking orders within our order book. We're pleased with our progress. We've been doing it for a couple of years. We know we have a well-functioning product for the power plant market, and now we are expanding beyond Denmark. So it's still not, let's say, a big part of our business. But as we move into 2020, we think it will be a meaningful part of our business.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [37]

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And finally, on NOx, I mean, could you just paint the catalyst scenario around that, no pun intended? Will we expect to see IMO coming out with a similar kind of ban there? Would you expect local jurisdictions or local governments to put in effect that ban? How should that -- how should the regulatory wave kind of occurs so that we'll be on the balls of our feet waiting for kind of -- give the commercial response to the regulation? How do you think about that?

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [38]

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Yes. We think that NOx reduction is the next big mandate in the marine business. We have seen this mandate for sulfur reduction, SOx reduction, which is IMO2020. And I think there will be a mandate for NOx reduction as well sometime in the future. In the meantime, there is environmental protection zones in place. And there, you already have to install NOx reduction product. So there is an existing market for NOx reduction in the marine business. And we think that in the near future, we will see a global mandate for that as well.

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Operator [39]

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And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Sune Mathiesen for any closing remarks.

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Sune Mathiesen, LiqTech International, Inc. - CEO & Director [40]

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Thank you very much, and thanks to everyone joining us today on the call. And we look forward to speaking with you again on our next conference call that is live. It should be in November. And thank you again, and I wish you all a good day.

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Operator [41]

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And thank you, sir. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.