Liqtech International Inc Q3 FY2022 Earnings Call

Good day and welcome to the LiqTech International Reports' Third Quarter of Fiscal Year 2022 Financial Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference call over to Mr. Robert Blum of Lytham Partners. Mr. Blum, the floor is yours, sir.

Great, thank you so much. Good morning everyone and thank you for joining us on today's conference call to discuss LiqTech International's third quarter 2022 financial results. Joining us on today's call from the company are Fei Chen, Chief Executive Officer; Alex Buehler, Former Interim Chief Executive Officer and Member of the Board of Directors; and Simon Stadil, Chief Financial Officer. Before I turn the call over to management, let me remind listeners that there will be an open Q&A session at the end of the call. Before we begin with prepared remarks, we submit for the record the following statement. 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 differ materially 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 other risks that may affect our business, financial condition, 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 encourages all listeners not to place undue reliance on these forward-looking statements which pertain only as of this date and the date of the release in the conference call. The company assumes no obligation to update any forward-looking statements to reflect any events or circumstances that may arise after the date of this release in the conference call. Now, I'd like to turn the call over to Fei Chen, CEO of LiqTech International. Fei, please proceed.

Thank you, Robert. Let me start out by saying what an honor it is to be the CEO of LiqTech at this important stage of the company's development and how grateful I am for the strong support. I have now been at LiqTech for eight weeks and the response from the entire organization has been overwhelmingly warm, including many of you, our investors, with whom I have had the opportunity to speak. I believe we all understand the tremendous opportunity that is in front of us to leverage our highly unique technological advantages, brand competencies, and sustainability value to build a growing and profitable business in the years to come. I need more than eight weeks to provide you with step-by-step details on our going-forward strategic plan, but let me provide some high-level observations and initial thoughts on how we are accelerating our commercial and business development processes. First, it is of great interest that we have tremendous technologies. For those not familiar, I was the international innovation platform director responsible for establishing Grundfos' water treatment division. Grundfos is one of the world leaders in the development, manufacturing, and distribution of water and liquid pumps. While at Grundfos in 2012, I was introduced to LiqTech's technology. At that time, I saw the uniqueness of LiqTech's silicon carbide membrane technology and reached out to the company for potential collaboration to accelerate the commercialization of this membrane technology. Unfortunately, LiqTech rejected the idea, electing instead to go it alone. It is therefore very interesting for me all of these years later to assume the responsibility to accelerate the commercialization of LiqTech membrane technology, which is even stronger today. Strategically, it's rather obvious that we are currently too reliant on large silicon sales to generate revenues. To balance this reliance, we are moving quickly to maintain and grow our markets where we have increasing potential for recurring revenue, such as pool and spa systems, diesel particulate filters, membranes, plastics, and aftermarkets. For instance, just last week we launched our new Aqua Solution membrane that demonstrates notable improvements to our existing membrane solutions, both in production process stability and final product robustness. You likely have not heard us talk much about the pool and spa market, but from my experience, this brings an imminent opportunity for recurring revenue similar to what we had preserved for many years with DPS. As a point of reference, we have five pool system deliveries planned for the fourth quarter, so we are very excited about this market and intend to aggressively pursue it in the years to come. Furthermore, our agreement in the Middle East addressing produced water treatment for oil and gas production, where we are operating in a build, own, and operate model, has similar recurring revenue characteristics. The commercial test unit for this produced water, initially deployed in May 2022, has been up and running for the past three months, demonstrating tremendous results. Our 99% of the feed water passing through the system is being delivered back as clean permit for reinjection. The quality of the clean water permit is better than the performance requirements originally defined by the end user. Furthermore, the system operates with a low amount of water and chemicals and has proven to be energy efficient. We are extremely pleased with this commercial test result as we believe it can serve as a gaining factor for our expansion in the region. Importantly with these results in hand, we are working intensely on a go-to-market plan for produced water in the Middle East region. I am excited to disclose more on this in the near future. Another dimension of recurring revenue is membrane sales. We have applied an intensified strategic focus on membrane sales and achieved good results in sales orders. Specifically at the end of September, we closed a large order consisting of nearly 1,200 membrane elements. I will provide more details in the future, but please understand that expanding our commercial activities where we can achieve more recurring business is a team strategic focus going forward. Another area of focus is the establishment of distribution agreements within key market verticals. I have a long history of developing mutually beneficial relationships with distributors across the world within the water treatment market, and I will look to leverage these relationships to extend our sales reach within selected end markets. I look forward to sharing more with you in the coming quarters on this front. Where we work to expand our focus on recurring revenue opportunities and develop distributor relationships, we will maintain our current efforts to further develop system projects to our target markets, including marine, scrubbers, black carbon, oil and gas, acid purification, and others where we have a number of systems set to be delivered that will drive near-term revenue growth. Within marine scrubbers, we are in the process of manufacturing 12 water treatment systems with delivery expected by the end of the year. We also have the planned delivery of the industry-with-the-water system that we announced earlier this week, along with the five pool systems I mentioned a moment ago—the delivery in quarter four. On top of that, following the successful commissioning of our first system for the acid purification market in the U.S., we are in active discussions with this customer regarding a second system deployment at another site. This project is expected to ship in the first half of next year. I will let Simon provide details on the outlook for the fourth quarter, but generally, based on our existing recurring revenue covered with system delivery planned for quarter four, we expect the revenue to land at the lower end of the revenue range in the company guidance that was provided in September. As you saw in two separate press releases issued recently, we are making some significant organizational changes to accelerate the commercial strategies that I have mentioned. In late September, we announced the appointments of Ms. Janne Pedersen as Vice President of Sales and Mr. Kim Hansen as Managing Director of LiqTech Plastics. Kim has many years of leadership experience with international companies such as Mercuri International Group and Grundfos and was recently Managing Director of Flexiket, Intertek, and Bording Link, where he achieved successful turnarounds and transformations. Janne has extensive industry knowledge in water treatment, membrane filtration, and instrumentation. Having had a successful career in sales, business development, and product management from firms such as Hach Lange, Grundfos, Diatom, FOSS Analytical, and Alfa Laval, Janne joined us formally on November 1st and has provided immediate value to the organization. Additionally, this week we announced the appointment of Tobias Baldrian Madsen as our new Head of Strategy and Business Intelligence as we work on advancing LiqTech to the next stage of commercial development. It is crucial that we define our market and customer focus based on sound business intelligence and formulate our strategy accordingly to ensure fast execution. I believe Tobias will make a significant contribution given his business development experience and relevant industry knowledge. As we rapidly move forward with our plans, it is clearly important to note the operating backdrop. Since summer, Europe has experienced energy prices the likes of which we have not seen in decades. Electricity spot prices in September increased 240% compared to January, and natural gas prices in September increased 167% compared to January. The extraordinarily high electricity prices have negatively impacted our cost and margin since our production for membranes and DPFs utilizes high-temperature furnaces that are heated by electricity. For some of our product categories, the production costs have increased by 30% to 40%. We are working intensely to communicate with our customers regarding the elevated prices to define margins. The results are mixed at this point as we try to balance customer expectations with the margins we need to maintain while competing in a global market. For future new sales, we will ensure the price increases are reflected in our sales prices. Nevertheless, we have indeed experienced a slowdown in order closure in quarter three due to the energy crisis, macroeconomic uncertainty, high inflation, and rising interest rates—factors that combined have resulted in a lower second half outlook than what we expected before the summer. We communicated this to everyone on September 13. Generally, we expect that situation will slowly stabilize, although we might land at a higher plateau of energy prices. I will now turn the call over to Simon to review the numbers in more detail. Let me quickly summarize. Firstly, we are moving quickly to accelerate the commercial and business development processes here at the company. We are continuously working to develop markets where we can create more predictable recurring revenue opportunities, leveraging our differentiated technology, working to overcome challenging sectors that have impacted certain end markets where we see opportunities for numerous large system deployments. Secondly, we will continue to drive opportunities through our traditional direct go-to-market sales pathways, but also look to create new distributor relationships to address certain end markets. I have a strong history of creating successful agreements within the water treatment industry and I believe I can apply this experience to LiqTech. Currently, we have brought in highly accomplished commercial sales individuals that can help develop end market strategies but, more importantly, can execute on those strategies. I believe the additions of Janne, Kim, Tobias, and others will make significant contributions with their professional leadership skills and rich industry knowledge. Finally, Simon will touch on this in a moment, but I want to confirm that everything we are doing is in the context of achieving profitability. The organizational transition we are undertaking is proceeding with an emphasis on utilizing our existing core competencies within the company aligned with our renewed strategic focus and market dynamics. Similar to what Alex and Simon mentioned last quarter, we remain on track to achieve breakeven at around $7 million to $8 million per quarter in revenue, moving closer to $7 million per quarter. With that, let me turn the call over to Simon to review the financials in more detail, after which I will wrap up with a few comments and then open the call to your questions. Simon, please proceed.

Thank you, Fei. Let me add some color on the financial highlights for the third quarter and full year outlook. Revenue for the quarter was $3.3 million compared to $4.1 million in the same period last year, representing a $0.8 million or 20% decrease. This development reflects a quarter with stable contributions from our plastics, ceramics, and aftermarket businesses, underpinned by increased share of membrane and spare part sales. However, the quarter was also impacted by a slowdown in water system deliveries due to reduced order intake and delayed shipments, owing to general supply chain issues and longer lead times on our core EQS membrane production. The quarter also reflects a period of unprecedented volatility in Europe, due to geopolitical unrest stemming from the Ukraine-Russia conflict, with a significant surge in both gas and electricity prices across Europe, combined with increased macroeconomic uncertainty and rising inflation. For our business, this uncertainty resulted in reduced order intake for our ceramic DPF and plastic products, which was partly offset by the delivery of large marine and on-road DPF orders for the Asian market secured earlier in the year. Looking closely at the numbers for each of our segments, ceramics reported $1.9 million in revenue, underpinned by a couple of large membrane and DPF orders, followed by water and plastic revenue of $0.8 million and $0.7 million respectively. The reduction in plastics revenue of 22% compared to the same period last year generally reflects a slow start to the quarter with lower than expected order intake during the European summer holiday amidst the escalating energy crisis. Turning to the water systems business, the revenue of $0.8 million represented a 47% reduction compared to Q3 last year, with the lack of system deliveries explaining the reduction, which was partly offset by increased aftermarket activities, more specifically commissioning and general spare part sales. Looking at the currency development, the U.S. dollar appreciation against the Euro did continue into the third quarter, with the year-to-date September FX rate 12% higher than the same period last year. On that note, I can confirm that approximately 70% of our year-to-date revenue has been denominated in non-U.S. dollar currency, predominantly Euro and DKK. In terms of the outlook for the fourth quarter, I echo the remarks made by Fei indicating a Q4 and full year outlook at the low end of the previously communicated guidance. This reflects the challenging market environment and overall delays in incoming orders. Before diving further into the numbers, I would like to highlight that we, despite the challenging market backdrop, have been working thoroughly and with clear and decisive measures to right-size our business and restore financial stability. On that note, I’m pleased to report substantial improvements in both cash flow and fixed costs as well as operating expense reduction efforts. To be specific, our operating cash flow in the third quarter ended at negative $0.5 million, representing a significant improvement compared to the previous quarter’s run rate. Fixed costs and operating expenses came down 19% sequentially and are now more than 30% less compared to the beginning of the year, reflecting our commitment to substantially reduce our breakeven point of the business, measured on an adjusted EBITDA basis. In the same context, I can confirm that we are on track to deliver a profitable business based on quarterly revenue breakeven around $7 million, on the low end of the previously communicated target of $7 million to $8 million. With regards to cash flow outlook, I can confirm that the company continues to benefit from reduced CapEx commitments and the successful refinancing of the convertible note earlier this year. The company had, as of September 30, less than $1 million of outstanding cash CapEx commitments and no interest payments due on the senior notes. Furthermore, following the delivery and installation of the new production equipment in early 2023, our company will have ample capacity to significantly grow our water systems, aftermarket, and ceramic membrane business without further investments over the near to medium term. Now let me comment on the quarterly financials in more detail. The gross margin in the third quarter of 3% reflects low activity levels within our water systems business, but also the adverse impact from the escalating energy crisis in a highly inflationary environment across Europe, which has reduced our profitability across our core ceramics and plastic businesses. The quarter was further challenged by non-recurring inventory adjustments and write-downs within our ceramics business, reflecting a proactive review of our ceramics inventory for dated and slow-moving products in a period of reduced activity and increased uncertainty. On a more positive note, we successfully secured and delivered high-margin membrane and marine DPF orders during the quarter, as well as large aftermarket orders, allowing for stable sequential development in the reported gross margin despite the lower top line. Furthermore, our increased focus on pricing discipline continues to support our underlying profitability, which combined with a sequential reduction in fixed cost of $0.2 million did allow for significant improvements in both gross and contribution margin when excluding the non-recurring inventory adjustments previously mentioned. Turning to OpEx, our total operating expenses for the quarter of $2.4 million represent a sequential reduction of 19% when adjusting for the second quarter restructuring costs. The continued reduction is a direct result of the planned cost reduction efforts and organizational right-sizing announced earlier this year. The cost savings represent a mix of reduced employee costs as well as increased focus on reducing run rate travel, marketing, legal, and IT costs. Moving to the next item, net other income in the third quarter was $0.5 million compared to a net other expense of $0.3 million in the same period of 2021, with the improvement explained by reduced interest expense and amortization costs related to the new and improved capital structure. Concluding on the P&L, net loss for the period was $1.7 million compared to $2.9 million in the same period last year, indicating a vital step in the right direction, with cost reductions and improved capital structure being the main drivers. Moving to our cash flow and balance sheet, we ended the quarter with $17.6 million in cash, down $2.1 million from last year—from the second quarter, sorry—with net cash used in operating and investing activities accounting for approximately $1 million and the remaining being lost in currency translation. To summarize and reaffirm, we are committed to further improving our financial performance through incremental cost reductions, which together with the improved product mix and pricing discipline will pave the way for a business imbalance over the coming quarters from both a profitability, cash flow, and capital structure perspective. We are, during the course of 2022, stabilizing and right-sizing our business, and it is evident that we are now positioned to take the next step on our commercial and strategic journey. Thanks for your continuous support and interest in LiqTech, and over to you, Fei.

Thank you, Simon. Looking into quarter four, we have a busy quarter ahead of us as we focus on executing the various initiatives I mentioned today and delivering a number of systems that are currently in production. In the coming weeks, we will further define the growth strategy and substantiate our sales forecast and the budget for 2023. We will translate this into guidance and communicate with everyone at the appropriate time. One final comment that I would like to make is to thank Alex for his leadership over the past six months. This transition and the guidance have helped to position the company for the future. It’s never an easy task to assume the role of interim CEO, but by all accounts, he handled it well. I am extremely excited to be leading this company as I believe the best days are ahead of us. I thank you all for your time today. At this point, I would like to turn the call over to the operator to address any questions from the audience. Mike, please proceed.

Yes, ma’am. Thank you. We will now begin the question-and-answer session. And the first question we have will come from Robert Brown of Lake Street Capital. Please go ahead.

Hi, good morning. Just quickly, I'm kind of wondering about the pricing environment. I know you've taken some pricing actions. How has that impacted the different pipelines in different markets? I presume it depends on the market, but how's the pricing impact been able to be flowed through?

Hi, Rob. It's Simon here. I'll start out and then Fei can comment further. So, clearly, when it comes to our products—plastics, DPFs, membranes—we haven't seen price erosion. We have, on the other side, seen pricing being fairly stable in a very inflationary environment. Clearly, we have worked to increase our pricing to offset the cost inflation we have seen. And obviously, that's always a balancing act, but in terms of price competition and pricing situation, that's not on the agenda. On the system side, there is obviously a more complex picture where we are trying to leverage the value proposition and the value we are creating for our clients to basically increase our pricing and achieve a high contribution margin in the process going forward. But at this point in time, I would say it is a fairly robust picture on pricing and no price erosion.

Yes, I think I would like to add that on top of that, the new end markets, which we mentioned, we really believe, because of our solution having unique properties, we might achieve much better pricing in the future.

Okay, thank you. And then I am just wondering if you can elaborate a little bit on your efforts to expand the distribution channels in water. Maybe what sort of is the distribution environment there and how have you seen that kind of develop historically and what sort of the opportunity in the water market comes from adding distribution relationships?

I mean we have different end markets. I'll give you a concrete example. For the pool and spa market, this market is very distributor-driven already. So we just need to choose the right distributor, build close relationships, and really get commitments from them, delivering what we need. So this is what we're already doing today. We just want to further strengthen our distribution side. The produced water market I mentioned today is a new area because we have the systems in the Middle East region that are now operational. With this data in hand, we will be able to find the right partner to enter this region and effectively push out our product in this application. You will hear more from us. We are looking at different market segments and choosing the right partners to push out our distribution channels.

Okay, thank you. I'll turn it over.

Thanks, Rob.

Hi, good morning. Thanks for your time. Can you hear me?

Yes. Hi, John.

Hi, great, thank you. Just a couple of questions on the $7 million to $8 million breakeven. Are we estimating that to get to that level, we need to get back into the marine scrubber business? Or do you believe the current businesses that are generating revenue in this quarter are substantial enough to get to that breakeven point?

As I mentioned earlier, we have a two-step strategy. We would really like to emphasize our recurring business, and that means the pool and spa membranes, and plastics, and also DPFs areas—we want to grow there. On top of that, we have the different end markets where marine scrubber will be one of the end markets. So with both of these combinations together, we believe we can achieve the $7 million to $8 million breakeven. We believe that our recurring business will provide a solid foundation, and we will build additional system deliveries on top of that. So the marine scrubber will be contributing, but due to the delay of the legislation, we do not expect significant growth in that segment.

Thank you, Fei. And just another question with the $17.6 million or so in cash on the balance sheet. Do you think that it is no small task for you to more than double your current sales to get to breakeven. Do you think that you have the ample liquidity to reach that breakeven level with the balance sheet you have today?

Yes. Yes, we have. I think it is a bigger picture here, John. First of all, you need to look at what we have achieved this year. The capital structure is obviously a vital step, getting the convertible note off our balance sheet, reducing our CapEx commitments, and really utilizing the CapEx spend this year to invest in the right machinery. We have significant capacity at our facilities in Denmark, so we don't need CapEx over the coming years to grow our business significantly. This gives us a lot of comfort. Finally, with the cost reductions we have achieved thus far—down 30% on OpEx and fixed costs since Q1—we don't have a long runway to reach cash flow breakeven. With $17.6 million in the bank, I am very confident—we are very confident that we have enough runway to get this company to where it should be.

That's fantastic. One last question for some of the not-so-sophisticated investors, including myself out there. If you do get to breakeven, the incremental revenue generated, Fei, from these new applications, I'm not as familiar with, within the pool space and some of these other verticals. What is the incremental contribution margin from these recurring revenues or new revenue applications? I'd assume it's pretty high margin and high contribution once you pass that chasm of getting to breakeven.

Yes, you're absolutely correct. One of the key mechanisms to achieve stability is obviously growing your top line or, even better, also improving your contribution margin at the same time. That's a strategic focus of ours. I think a minimum of 40% is what we need to deliver, and we are striving higher than that. In Q1 this year, when you look at our Q3 numbers and adjust for some non-recurring items, we are above 40%. For every million dollars of implemented revenue, we should see at least 40% falling through to Q2 EBITDA and help us achieve cash flow stability faster than what we've guided in the past. We now guide to $7 million, and if we achieve better pricing, it might even go lower than that. But again, I'm very cautious about that in an environment where we have inflationary pressures on our costs. We'll see how the world looks in early next year, and I'll provide more guidance then.

It sounds like we've got the right team there now. Thanks a lot, folks. We'll look forward to connecting in the coming quarters.

Thank you.

Thank you, John.

At this time, we're showing no further questions. We will go ahead and conclude today's question-and-answer session. I would like to turn the conference back over to the management team for any closing remarks.

Thank you, Mike. I would like to close this conference call by saying thank you all very much for being with us today. We look forward to continuing to communicate with you soon in the New Year. Thank you.

And we thank you, ma'am, and to the rest of the management team for your time today. Again, the conference call is now concluded. At this time, you may disconnect your lines. Thank you, everyone. Take care and have a wonderful and blessed day.