Earnings Call Transcript - LIQT Q4 2022

Operator, Operator

Good morning, everyone, and welcome to the LiqTech International Reports Fourth Quarter and Fiscal Year 2022 Financial Results Conference Call. All participants will be in a listen-only mode. Also note, today's event is being recorded. And at this time, I'd like to turn the floor over to Robert Blum with Lytham Partners. Sir, please go ahead.

Robert Blum, Moderator

All right. Thank you very much. Good morning, everyone. And as Jamie mentioned, thanks for joining us on today's conference call to discuss LiqTech International's Fourth Quarter and Fiscal Year 2022 financial results for the period ending December 31, 2022. Joining us on today's call from the company is: Fei Chen, Chief Executive Officer; 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 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, 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 and 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 and conference call. Now I'd like to turn the call over to Fei Chen, CEO of LiqTech International. Fei, please proceed.

Fei Chen, CEO

Thank you, Robert. Good morning or good afternoon to everyone on the call, depending on where you may be. I am excited to get the opportunity to speak with you all today. As those of you that have followed the company closely, I took over as CEO in mid-September, following a long career across a variety of global industry companies with an emphasis on water treatment, chemicals, and clean energy technologies. As I mentioned briefly last quarter, I have been connected to LiqTech since 2012, and it was when I was first introduced to LiqTech's technology that I saw the uniqueness of the company's silicon carbide membrane technologies and the close opportunity that I believe the technology enabled. Today, with six months under my belt, that feeling is only amplified. We have a tremendous opportunity ahead 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. So the big question is, how do we get there and what is different today versus a few months ago? Following my appointment, we moved quickly to define our corporate vision and commercial strategy with a clear focus on recurring revenues and large system opportunities. My initial actions included the hiring and appointment of a senior leadership team and the staffing of key sales personnel to accelerate revenue growth. These actions have already resulted in the expansion of recurring revenue prospects as we now have a much larger and more reliable pipeline of swimming pool, DPF, membrane sales, and plastic business opportunities. To that point, just last week, we received a large order for full commercial swimming pool water filtration systems in New Zealand, which deploys a complete filtration system solution, leveraging our enhanced Aqua Solution membrane. This project is an extension of three commercial swimming pool systems supplied to the same customer in 2020. This type of repeat sale illustrates our strategy to focus on recurring business. From a membrane element standpoint, at the end of September, we closed a large order consisting of nearly 1,200 membrane elements and have since closed orders for an additional 265 membrane elements over the past few months. Membranes represent a significant opportunity for us. On the DPF side, where we don't expect tremendous growth, our objective has been to stem the tide from the most recent few years. Last year showed a 9.8% decrease in our DPF business. In the fourth quarter, we are expecting a 3.8% increase from the quarter 4 2022 as the sales team has reengaged with existing and past accounts to drive incremental order flow. Finally, on the plastic side, in the first quarter, we are expecting a 70% increase from the quarter 4 2022. This is mainly driven by a large order we received at the end of last year in the area of biological-based material development. To give some perspective, last year our products and services to swimming pool, DPF, and plastics were around $11 million in total. We will look to make strong increases on those numbers in 2023, improving the flexibility of the business, increasing our manufacturing throughput and gross margins, and ultimately reducing our breakeven point. However, we are not ignoring our systems business. Our team has done an excellent job in identifying areas where our solutions can offer superior performance and add value to our customers. As evidence of this, in the last few months, we received new system orders for monoethylene glycol or MEG recovering solutions in the oil and gas industry as well as systems for wastewater treatment in the metro processing industry, two key end markets that can play a significant role in our future growth. This MEG order is the first of a two-part order for an offshore project from a major U.S. oil company operating in Europe where we have already demonstrated the silicon carbide membrane technology performance in pilot and have verified significant performance improvements to the MEG regeneration process. When compared to other membrane technologies, our MEG system has completed the Fed accent test, and we expect that this improvement will be validated on site in the coming years. For those not familiar, MEG is widely used by oil and gas producers in wellheads and pipelines to reduce the risk of hydrate formation, which can cause a blockage. In deepwater offshore gas production facilities, we have exposure to lower temperatures in subsea pipelines, so MEG is used for hydrate inhibition. The wastewater treatment system order for the metro processing industry is for an application in Denmark, but worldwide it represents a potentially large addressable market for the company. Diluted water influence from major processing has been a long-standing challenge for the industry. By leveraging our preparatory silicon carbide membranes that can handle heavy metals and other demanding substances and toxins, customers can now overcome challenges they have historically faced. Beyond these new agreements, I think it is also important to note our agreement in the Middle East addressing produced water treatment for oil and gas production where our technology in cooperation with our partners continues to provide tremendous results. Not only does this help to drive revenue growth for our company due to the recurring components of the agreement and aftermarket activity, but it also creates a tremendous case study for this market. Our team is aggressively pursuing opportunities in the Middle East, which is a longer lead cycle solution, and I believe progress is being made. Beyond direct selling efforts, another important component of our commercial strategy will be the creation of distribution partnerships. Since our call in November, we have signed three new agreements that will expand our geographic reach and access to key market verticals. First, in November, we entered an agreement with National Energy Services Reunited or NESR, a publicly traded international provider of integrated energy services in the Middle East and North African region. The agreement will focus on leveraging our capabilities in produced water treatment filtration solutions for reinjection. NESR has close customer relationships and a strong service organization within the Middle East and North Africa oil and gas industry. As the industry-leading provider of solutions across its drilling, evaluation, and production service segments, NESR is looking to incorporate new technologies into the region. Additionally, through its ESG impact segment, NESR's goal is to import and jointly develop technological solutions, specifically to help customers enhance resource use efficiency and decarbonization, within which the water treatment sub-segment is a primary focus. LiqTech's solution fits perfectly into their objectives. We both look forward to a mutually beneficial relationship going forward. In December, we entered a cooperation agreement with Ecolotron Wastewater Solution, a U.S.-based firm specializing in electronic water treatment for the commercialization of a combined solution for phosphoric acid purification. A unique solution offered by both LiqTech and Ecolotron is based on a combination of electronic technology, which is an electrochemical preception and oxidation reduction system, and our silicon carbide ceramic petrification system for the purification of crude phosphoric acid streams. We have filed a joint patent application for this combined solution and should have more updates throughout the year on this program. Lastly, we entered into a distribution agreement to supply membranes to Liquinex water treatment solutions for Singapore. Liquinex specializes in the design, fabrication, and system integration of compact water and wastewater treatment platforms using next-generation technologies such as ceramic, biometric, and graphic membranes. Liquinex collaborates with Singapore Water agencies as well as other public and private entities in Singapore, Malaysia, the Philippines, and Indonesia. In the past, Liquinex has used our silicon carbide ceramic membranes for their cooling tower systems, industrial water recycling, aquaculture, and human drinking water supply applications. By entering into this distribution agreement, our two companies will expand our relationships and become more closely aligned in providing efficient technology solutions to mitigate water scarcity and the effects of climate change in Southeast Asia. I believe we will see increased performance in these countries from this agreement in 2023. While our primary focus is to further develop and commercialize our co-filtration technology to drive profitable revenue growth, we have also successfully improved cash flow, having reduced both fixed costs and discretionary operating expenses during 2022. Importantly, operating expenses in the fourth quarter of 2022 continued to trend sequentially lower to $2.3 million, excluding any restructuring expenses, compared to $2.4 million reported in the third quarter of 2022, and we reduced annual operating expenses by 37% from the prior year period, hoping to substantially reduce our revenue breakeven point. Compared to the third quarter of 2022, our sequential quarter-end cash balance decreased by $1 million. Simon will hit on the numbers a bit more, but I can confirm that we are on track to deliver a profitable business based on quarterly revenue breakeven around $7 million, which is a significant improvement from where we were a few quarters ago. While the operating backdrop is still not ideal, with energy-related concerns still impacting us along with higher interest rates and inflation, I believe we are making significant progress. As we look through the first quarter, we are expecting revenue of about $4 million, which represents an 11% increase from the year-ago first quarter and is about flat with the fourth quarter. Much of the revenue is attributable to recurring components, with most of the recently booked systems set for delivery later in the year. 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.

Simon Stadil, CFO

Thank you, Fei, and good morning, everyone. Let me add some color on the financial highlights for the fourth quarter and full year. For the full year, revenue was $16 million compared to $18.3 million in 2021, representing a decrease of 13%. Breakdown by vertical sales were as follows: system sales and related services were $5.3 million compared to $7.2 million last year, a decline of 26%. EPS and ceramic membrane sales were $6.8 million versus $7.2 million in 2021, a decline of 5%. Finally, plastic revenues were $3.5 million compared to $3.6 million, a year-on-year decline of 2%. The largest decline was in our Systems business, primarily due to a reduction in sales of water treatment systems to the global marine scrubber industry as well as lower commissioning activity. This was partly offset by increased activity pertaining to our successful oil and gas commissioning in the Middle East and the start-up of the next project in the Mediterranean. The more modest decline in our Plastics and ceramics businesses reflects increased underlying activity, offset by currency headwinds due to euro and DKK denominated revenue streams converted to U.S. dollars at a less favorable rate compared to the prior year. Looking more specifically at the fourth quarter, revenue was $4 million compared to $3.3 million in the sequential third quarter, an increase of 22%. So as Fei alluded to, we are seeing a positive trend going into the New Year. In terms of outlook for the first quarter, I echo the remarks made by Fei, indicating a Q1 revenue of approximately $4 million, an improvement of about 11% compared to Q1 last year and flat compared to the fourth quarter of 2022. Looking at our gross profit for the full year, we reported $0.6 million with an implied gross profit margin of 3.5% compared to $1.6 million and 8.6% in the prior year. The decrease was predominantly explained by the overall reduction in revenue, coupled with the lower relative share of system sales, which typically command a higher average gross margin compared to our legacy ETF and plastic businesses. Gross profit was further impacted by the European energy crisis, rising input cost inflation, and increased provision for inventory obsolescence. During the year, we continued to adjust capacity, cut costs, and implement price surcharges to defend profitability, which we expect to benefit from going into 2023. Turning to OpEx, total operating expenses for the year were $13.1 million compared to $12.3 million in 2021, with the year-on-year increase explained by the restructuring cost of $1.9 million and non-recurring costs related to the CEO transition and China closure. Adjusting for this, OpEx was down 16% year-on-year despite the elevated OpEx levels recorded in the early part of 2022. As Fei mentioned, fourth quarter OpEx came in at $2.3 million, excluding restructuring expenses, compared to $3.7 million in the fourth quarter of 2021, which is a reduction of 37%, evidencing the benefits of our cost reduction efforts. Again, we remain diligent in managing the business, reflecting our determination to defend profitability through organizational rightsizing, mix improvements, and capacity optimization. Looking into 2023, we have strengthened our commercial capabilities and invested in improved business intelligence resources, which combined with the recent depreciation of the dollar against our euro-denominated cost base is likely to increase our OpEx run rate compared to Q4. However, we maintain our commitment to deliver a quarterly breakeven at around $7 million, measured on an adjusted EBITDA basis. Net other expenses during the year were $1.9 million compared to $0.5 million in 2021. This was due to lower gains on currency transactions and, more importantly, the repayment of the convertible note in the second quarter with $1.8 million in early repayment premium and additional amortization costs. Conversely, other income benefited from the decrease in interest expenses due to the improved capital structure, receipt of COVID-19 aid in the Danish entities, and finally, a gain on lease termination due to the closure in China. Conclusively, net loss was $14.2 million for the year compared to a loss of $11.1 million in 2021, with the increase explained by the non-recurring restructuring costs, China closure, early repayment of convertible note, and CEO transition. For the fourth quarter, the net loss was $2.2 million compared to a loss of $2.7 million in the fourth quarter of 2021, hence, a meaningful improvement despite lower revenue and a review of our inventories conducted during the quarter. Finally, let me briefly comment on our cash flow and balance sheet before summarizing and handing over to Fei. We ended the year with $16.6 million in cash, down $1 million compared to the third quarter, evidencing a significantly lower cash burn compared to the same period last year. Development in Q4 represents net cash used in operating activities of $0.6 million. Cash flow from investing activities of $0.9 million offset by new lease financing secured for debinding kilns in Ballerup and gain on currency translation. Balancing our cash flow remains a key KPI for our business as we are determined to preserve cash to maintain our strategic and financial flexibility in what is clearly a very volatile and uncertain market environment. Furthermore, we continue to benefit from excess capacity across our Danish manufacturing site. Hence, near to medium-term CapEx will be confined to maintenance CapEx and select strategic investments in machinery that can help us improve quality and operational efficiencies. Additionally, our capital structure remains robust, with no debt servicing in 2023, except for ordinary lease payments. In summary, 2022 was a difficult year for LiqTech, however, we have together stabilized our business, strengthened our balance sheet, and with new leadership defining a new strategic direction for our company with an immediate focus on defending profitability, and importantly, creating a sustainable and credible path to profitable growth step by step. Thank you for your continued support and interest in LiqTech, and over to you, Fei.

Fei Chen, CEO

Thank you, Simon. Before I turn it over to your questions, let me quickly summarize. First, we are moving quickly to accelerate the commercial and business development processes here at the company. We are simultaneously working to develop markets where we can create more predictable recurring revenue opportunities, leveraging our differentiated technology. We're also focusing on opportunities where we can deploy larger systems. We made nice progress on both fronts over the past few months. Second, we will continue to drive opportunities through our traditional direct go-to-market sales pathway, but also look to create new distributor relationships to address certain end markets. We have signed three new agreements since our last call, and we expect to leverage my industry relationships to bring more agreements to fruition. Third, we have brought in highly accomplished commercial sales individuals that can help to develop and execute market strategies. I believe we have a great team in place now. Finally, everything we are doing is set against the backdrop of achieving profitability. The organizational transition we are undertaking has proceeded with emphasis on utilizing our existing core competencies. We've seen the company recalibrated with our renewed strategic focus and the market dynamics. As Simon and I both mentioned, we remain on track to deliver breakeven at the $7 million in revenue, a number we think is achievable in the near term. I am extremely optimistic about our future and I look forward to taking any questions.

Operator, Operator

Our first question today comes from Rob Brown from Lake Street Capital Markets. Please go ahead with your question.

Robert Brown, Analyst

Hi, Simon, hi, Fei. Just first question is on the kind of time to maturity of these distribution agreements that you put in place. How long do they typically take to mature? And how do you see them sort of ramping in the next year or so?

Fei Chen, CEO

The distribution agreements we signed, if we take each of them, Liquinex has already been working with us for some years, so this is actually accelerating what they've already done. So we definitely think it's a very mature relationship; we have high expectations on that. The agreement with NESR is also progressing well because we have close dialogue and activity together with them. So we also hope we can very soon get some results on that, even though the oil and gas industry has a longer project cycle, as I mentioned and you also understand. The third one with Ecolotron technology is something we're already working on. So we just need to focus on scaling up commercialization. All distribution agreements we signed have clear expectations of near-term impact, not long term.

Robert Brown, Analyst

Okay. Thank you. Then in the systems market, can you just give an update on the pipeline in the major markets? How is that pipeline developing? And how does it look at this point, I guess? And then maybe also an update on the marine market as well.

Fei Chen, CEO

Yes. According to our commercial strategy, we actually have two different pipelines: one for recurring business and another for larger systems because the larger systems have much longer sales cycles. For the larger systems, we have a quite strong pipeline, and we expect to have some projects this year. However, it takes longer to materialize compared to swimming pools. We are quite confident we have a very reliable and strong pipeline, and we expect to deliver something this year, definitely.

Robert Brown, Analyst

How long does it take to start seeing revenue from orders in that business? Should we expect revenue to begin ramping up in that business in the third and fourth quarters?

Simon Stadil, CFO

So Rob, Simon here. The key focus has been on building stronger and more predictable business models. With our pool marine scrubbers, aftermarket, EPS plastics, and membrane business – that's our recurrent business. This is showing solid progress. You'll see this reflected in our Q1 disclosures in about 45 days. It's about creating predictability and improvement in revenue from our recurring business for sustainable operations. We also have some uncertainty regarding timing for larger projects, so we won't guide specific quarters yet. However, we have increased confidence in our ability to deliver on these large growth projects later this year.

Robert Brown, Analyst

Last question is on pricing actions you've taken. Have those started yet? Or are those more for 2023 impact?

Simon Stadil, CFO

The key thing to note is that 2022 had numerous non-recurring items. We are reaping the benefits of both our cost reductions and our profitability improvement measures on the pricing side. Importantly, having our ERP system fully functional in the latter part of the year has provided us some visibility on costs for individual orders. Our pricing has become sharper, and we have improved insights into our profitability. In summary, we expect to see significant improvements in 2023 due to reduced non-recurring items and both pricing and cost reductions positively impacting our business.

Robert Brown, Analyst

Thank you. I’ll turn it over.

Operator, Operator

And ladies and gentlemen, at this time, I'm showing no additional questions, so I'd like to turn the floor back over to the management team for any closing remarks.

Fei Chen, CEO

Thank you. I would just like to say thank you all very much for being with us today. We look forward to communicating with you very soon again. Thank you.

Operator, Operator

And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.