Liquidmetal Technologies, Inc.: Emerging From A Period Of Transition

Summary

LQMT has promising technology that could change the materials landscape in the 21st century.

The company has had to transition from an IP holding company to a commercially viable business.

The management team at LQMT has done a good job of steering this company into a positive trajectory and set themselves up well for outsized returns.

LQMT: Emerging from a period of Transition
Strong Buy

Summary

Liquidmetal Technologies, Inc. (OTCPK:LQMT) owns the exclusive intellectual property pertaining to material and manufacturing processes developed in collaboration with NASA and CalTech. The company is a materials technology company that develops and commercializes products made from amorphous alloys. The company designs, develops, and sells products to customers in various industries. The company occasionally enters into agreements with third parties to license out their Liquidmetal intellectual property to help develop and commercialize Liquidmetal products. Third parties include Engel, Visser, Apple, Swatch, and Materion.

Liquidmetal

Liquidmetal, an amorphous metal alloy, exhibits many strengths, including high tensile strength, possibility to achieve post processing effects directly in the manufacturing stage (highly reflective finish), corrosion resistance, ease of manufacturing applications, a much lower heat melting point than other similar metals (720C), and can be used in similar applications to thermoplastics. Additionally, there are cost advantages in many high volume applications as many post processing steps are not necessary when using a LM alloy.

The primary difference between Liquidmetal and other materials is the fact that LM is an amorphous alloy, meaning the way that the atomic structure of the material settles is similar to glass, whereas traditional metals settle into a crystalline atomic structure that has inherent structural weaknesses. According to the company,

"The amorphous atomic structure of the Company's alloys enables them to overcome certain performance limitations caused by inherent weaknesses in crystalline atomic structures, thus facilitating performance and processing characteristics superior in many ways to those of their crystalline counterparts. For example, in laboratory testing, zirconium-titanium Liquidmetal alloys are approximately 250% stronger than commonly used titanium alloys such as Ti-6Al-4V, but they also have some of the beneficial processing characteristics more commonly associated with plastics."

It can also be mold injected which is critical for large volume production. Additionally, there is little shrinkage from the mold, meaning you can easily cast high precision pieces. It outclasses other materials (stainless steel, titanium, aluminum, and magnesium) in strength, strength to weight, hardness, and elasticity. The applications for the material include, but are not limited to: aerospace/defense, sporting equipment, precision metal machined parts, metal die casting parts, medical devices, and oil/gas exploration.

The company has several proprietary alloy blends for a variety of applications, including a beryllium free alloy, LM 105. This is important as it opens a lot of areas of use that might otherwise be ill suited for Liquidmetal. Beryllium can be toxic in powder form and requires special handling in the manufacturing process. Additionally, the presence of beryllium precludes any use in a medical application.

Financials and Performance Metrics

The company has been operating at a loss for some time, and there can be no assurances that they will ever operate on a profitable basis. Due to the unique position that the company is in, transitioning from an IP holding company to a fully commercialized business, the finances of the company are not as useful in determining its future viability and success. No reliable revenue model can be built as the company is only shipping prototypes currently and has no reoccurring stream of revenue. Prices paid for prototypes can be very volatile and determining where the company's margin eventually settles down to will be a function of if and when they can procure steady streams of revenue. We believe they are on the verge of doing this, however it is worth being aware of their somewhat precarious financial picture.

A more worthwhile endeavor is finding other metrics to measure the company's progress in moving towards its goals. We believe there are two metrics that do a good job of this. The first metric worth keeping an eye on is the number of prototypes being shipped in a given quarter and the second metric is the steady rise in SGA expenses that has been continually attributed to increasing marketing resources and making key hires in the same space. Management has clearly stated that they expect both of those trends to continue, with plans to increase spending on marketing headcount and to dramatically ramp up prototype shipments.

Business Model

While the company continues to expand its IP portfolio, which is currently comprised of 63 patents and 56 pending patents, it has very clearly begun commercializing the technology at its disposal. In Q2 2013, the company took advantage of its stock's recent strong performance and paid off a senior convertible note, becoming debt free. The management team was very pleased with this and announced that its liquidity situation had improved, projecting cash on hand lasting until Q1 2014. It also was the first time that the company clearly elucidated its plans to pursue a two pronged approach to its business model, pursuing both (1) developing and manufacturing parts for customers and (2) licensing Liquidmetal's IP portfolio to customers who may prefer to internally develop Liquidmetal solutions. Previous to this point in time, the management team had suggested the main rational behind licensing was that it allowed for continued development of the technology while providing cash that wasn't dilutive to shareholders.

In our opinion, Q3 of 2013 was a key turning point for Liquidmetal. Many moving parts came together, and ultimately resulted with Tom Steipp, Liquidmetal's CEO, announcing that the "technology is stabilizing." This is when the commercial efforts of Liquidmetal kicked into high gear. In the same quarter, Liquidmetal announced in a press release that it was producing canards for missiles in the EAPS system being developed by Lockheed Martin. This was the company's first press release regarding a specific application and partner - a major milestone. This contract could result in a very steady, long term source of revenue as defense contracts tend to last 10-20 years. Additionally, the company announced the availability of a turnkey injection molding solution from Engel, its 3rd Generation Liquidmetal Molding System. This machine will serve as an integral component of the licensing business model, as it can be readily delivered to any licensor around the world. An added benefit of this model is that not only does Liquidmetal capture a license fee from its partner, but it also receives a portion of the net $ sales of the Engel machine.

While there were some interesting developments related to Liquidmetal Golf, which LQMT retains a 79% interest in (two golf related prototypes in the quarter and R&D spending for the quarter was up 59%, mainly attributed to Liquidmetal Golf R&D), the final piece of major news from Q3 was that Liquidmetal had entered into an equity line of credit in which $20,000,000 was made available to it by Kingsbrook Opportunities Master Fund P, Tech Opportunities LLC, and Iroquois Master Fund Ltd. (2013 Selling Stockholders). It is certainly one of the best financing arrangements for the company to date. In congruence with entering into this financing arrangement, the board moved to authorize additional shares, raising total authorized shares of the company to 700,000,000, with roughly 400mm outstanding.

Management has stressed that it is aware of dilution concerns and is working very carefully with working capital to make such financing actions unnecessary. Under the terms of the agreement, LQMT's management has $20,000,000 which it can draw down on over a three year period. There is no obligation to make a drawdown. Under the terms of the agreement, the 2013 Selling Stockholders, per direction by LQMT management, must buy stock from the company's account at a price calculated from a formula using VWAP over a number of days. To date, the aggregate purchase price by the 2013 Selling Stockholders is roughly $.22. Any appreciation of the stock between now and Q3 '06 will make the terms of this arrangement that much more favorable.

Since Q3 of 2014, management has continued to impress and fulfill its goals in regards to increasing its marketing resources, hiring an expert in the industry, Paul Hauck, and expanding its MSR network. It has settled an ongoing dispute with its contract manufacturer, Visser. It has released another press release announcing a joint project with Jet Propulsion Laboratory. Finally, it recently announced that it is opening a Technology Development Center at its location in Rancho Santa Margarita, CA. This is a major step forward as it will allow potential customers to come and rapidly prototype parts in person using Engel's new turnkey solution.

Partnerships

Currently Liquidmetal has several ongoing partnerships. While Visser is currently serving as Liquidmetal's contract manufacturer, it is likely that Liquidmetal will begin working with other manufacturers. Visser and Liquidmetal just exited arbitration and it is unlikely that the relationship will return to its early form. However, there are other partners that Liquidmetal is currently working with that have excellent ongoing relationships.

Materion is currently the exclusive provider of Liquidmetal alloys and have proven that they are able to create Liquidmetal's alloys in large volume.

Engel Provides the turnkey mold injection system. This is sold to licensees of Liquidmetal's intellectual property. Liquidmetal receives a percentage of sales on these machines from Engel.

Apple is currently a partner of Liquidmetal's, however the relationship is widely misunderstood. In 2010, Liquidmetal and Apple entered into an agreement in which Apple paid 20,000,000 to Liquidmetal and in return Apple received exclusive and perpetual rights to Liquidmetal technologies in the consumer electronic space. Additionally, the two companies, through a subsidiary of Liquidmetal, Crucible Technologies, license to each other all new intellectual property related to Liquidmetal during the length of the agreement. This agreement, separate from the initial 2010 agreement, has recently been extended for another year. To be clear, LQMT has the rights to the technology that Apple develops in collaboration with Liquidmetal and vice versa. There will be no royalty payments from Apple if they choose to pursue Liquidmetal in one of their products and there is no guarantee that they will use Liquidmetal to source the alloy. That said, it is possible that Apple will outsource the production of Liquidmetal components to Liquidmetal Technologies and its ecosystem of suppliers.

Risks to equity holders

While we believe there is a compelling opportunity with Liquidmetal, it is important to analyze the potential risks to our optimistic view. First, the company is financially in a very precarious position. While we believe the management team, including CFO Tony Chung (former SolarCity(NASDAQ:SCTY)), is working diligently with the resources available to them to expand their business, the reality of their balance sheet is that this is a very small company with limited assets. The company has continually provided updates as to its liquidity profile and currently believes it has enough cash available for operations extending past 2014.

This logically leads to another area of concern for shareholders, dilution. In the past the company has taken dilutive actions to raise cash for the company's operations, however they have recently been receiving much more favorable terms in securing working capital. The most recent agreement, the $20,000,000 line of credit, being one of the more favorable agreements to date. The company currently has roughly ~400,000,000 shares outstanding with 700,000,000 authorized. There is no guarantee that the board will not seek to authorize additional shares, but we believe the management team continues to increase options available to them in terms of financing larger scale operations.

Another area of concern for the company is the fact that its main asset is its intellectual property portfolio. Intellectual property can be very expensive to defend and rigorous defense of the company's portfolio must be a top priority. While unrelated to their IP, Visser, previously Liquidmetal's exclusive contract manufacturer, entered arbitration with Liquidmetal and the ongoing legal costs of this arbitration showed just how vulnerable the company's balance sheet and income statement is to any legal action.

Additionally, the company has never operated at a profitable level, and there can be no guarantee that they ever will. While we believe that their recent milestones and the growth in prototype shipments indicate future revenue growth, it remains ambiguous how this will translate to the company's bottom line until Liquidmetal's cost of sales settles into a more stable range and more long term, reliable streams of revenue start accruing.

It is important to be aware that this is still relatively early stage technology. The technology, while "stabilizing," is still being developed. There are no guarantees that Liquidmetal's alloys become the amorphous alloy of choice in the future. Many leading academic institutes and major corporations spend a lot of resources on their respective materials science departments and the company could face unforeseen competition. Some of Liquidmetal's R&D efforts are funded and/or supported by their partners, including Apple, Inc. Apple and other partners could chose to abandon these projects in the future.

Finally, it is worth noting that Liquidmetal Technologies trades on OTCBB and is a sub $1.00 stock. Both of these factors can contribute to increased price volatility. This investment is not suited to those who cannot tolerate volatile swings in their portfolio and we advise that you construct your portfolio in such a way that you do not have a high degree of risk associated with any one given position - especially a company that has near term liquidity concerns.

Closing Thoughts

The management team's recent focus on commercializing its technology is extremely encouraging. We believe they are taking the appropriate steps to monetize an incredible opportunity and believe that the platform that they have developed to both pursue direct shipments of products and licensing their portfolio of IP as a package is the best way to leverage their position for strong returns on equity given their financial position.

Disclosure: I am long LQMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.