LiqTech International, Inc. (LIQT) Earnings Call Transcript & Summary

Good day, and welcome to the LiqTech International reports its third quarter of fiscal year 2022 financial results conference call. [Operator Instructions] Note this event is being recorded. I would now like to turn the conference over to Mr. Robert Blum of Lytham Partners. Mr. Blum, the floor is here, 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 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.

Thank you, Robert. Let me start out by saying what a honor it is be the CEO of LiqTech at this important stage of the company's development and how grateful I am for the Board's strong support. I have now been at LiqTech for 8 weeks, and the response from the entire organization has been overwhelming warm, including from 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. While I need more than 8 weeks to provide you with state-by-state details on our going-forward strategic plan, let me provide some high-level observations and the initial thoughts on how we are accelerating our commercial and business development processes. First, it needs to be reinforced that we have tremendous technology. 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 the distribution of water and liquid pumps. Where 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 then reached out to the company for a 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 the years, these years later to assume the responsibility to accelerate the commercialization of LiqTech's membrane technology, which is even stronger today. Strategically, it's rather obvious that we are currently too reliant on large system sales to generate revenue. 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 demonstrate notable improvements to our existing membrane solution, both in production process stability as well as final product robustness. You likely have not heard us talk much about the pool and the spa market. But from my experience, this brings an imminent opportunity for recurring revenue that we had pursued for many years with DTFs. As a point of reference, we have 5 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. Further, 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 as similar recurring revenue characteristics. The commercial type unit for this produced water initially deployed in May 2022, has been up and around for the past 3 months, demonstrating tremendous results. Our 99% of the feedwater passing through the system is being delivered back as clean permeate for reinjection. The quality of the clean water permeate 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 assumed to be energy efficient. We are extremely pleased by this commercial scale results as we believe they are a gating factor to our expansion in the region. Importantly, with these results in hand, we are working intensively on go-to-market plans for produced water in 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 order. 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 key strategic focus going forward. Another area of focus is establishment of distribution agreements within key market verticals. I have a long history of developing mutual 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 4 water treatment systems, with deliveries 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 5 pool system I mentioned a moment ago, delivered in quarter 4. On top of that, following the successful commissioning of our first system for acid purification market in the U.S., we are acting with this customer regarding a second system deployment at another site. Most likely, this project is expected to ship in the first half of next year. I will ask Simon to provide details on the outlook for the fourth quarter, but in general, based on our existing recurring revenue coupled with system deliveries planned for quarter 4, we expect the revenue to land at the lower end of the revenue range in company guidance that was provided in September. As you saw in 2 separate press release issued recently, we are making some significant organizational changes to accelerate the commercial strategies that I have mentioned. In late September, we announced the appointment 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 turnaround and transformation. Janne has wide industry knowledge in water treatment, membrane situation and instrumentation, has included a successful career in sales, business development and product management from firms such as Hach Lange, Grundfos, Diatom, FOSS Analytical and Alfa Laval. Janne joins us formally on November 1 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 the customer focus based on sound business intelligence and formulate our strategy accordingly to ensue fast execution. I believe Tobias will make significant contribution given his business development experience and relevant industry knowledge. While we like to be forward with our plans, it is clearly important to note the operating backdrop. Since summer, Europe has experienced an energy price, the likes of which we have not experienced in decades. Electricity spot prices in September has increased 240% compared to January and the natural gas prices in September have increased 167% compared to January. The extraordinarily high electricity price has negatively impacted us with respect to cost and the margin. Since our production for membranes and DPFs utilize high-temperature furnaces that are heated by electricity. For some of our product category, the production cost has increased 30% to 40%. We are working intensely to communicate with our customers and the elevated price to define margins. The results are mixed at this point. As we try to balance customer retention and the margin we are competing in a global market. For future new sales, we will ensure the price increase are reflected in our sales price. Nevertheless, we indeed experienced some slowdown in order closures in quarter 3 due to the energy crisis, macroeconomic uncertainty, high inflation and rising interest rates. The combination of which has caused a lower second half outlook than what we expected before the summer. We communicated this to everyone on September 13. Generally, we do expect that situation will slowly stabilize, although we might land at a higher plateau of energy price. And I will 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 simultaneously working to develop markets where we can create more predictable recurring revenue opportunities, leveraging our differentiated technology, working to overcome engaging sectors that have hinted certain end markets, where we see opportunity for numerous large system deployment. Secondly, 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. I have a strong history of creating successful agreements within the water treatment industry and believe I can apply this to this stage. Thirdly, we have bought in highly accomplished commercial sales individuals that continue to develop end market strategy, but more importantly, can execute on those strategies. I believe the addition of Janne, Kim, Tobias and others will make significant contributions with their professional leadership skills and the rich industry knowledge. And finally, Simon will touch on this in a moment, but I want to confirm that everything we are doing will be against the backdrop of achieving profitability. The organizational transition we are undertaking is proceeding with the emphasis on utilizing our existing core competencies within the company and to calibrate with our renewed strategic focus and market dynamics. Similar to what Alex and Simon mentioned in the last quarter, we remain on track to achieve breakeven at around USD 7 million to USD 8 million per quarter in revenue, moving more towards USD 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 contribution from our Plastics, Ceramics and our Aftermarket businesses underpinned by increased share of membrane and spare parts sales. However, the quarter was also impacted by a slowdown in water system deliveries due to reduced order intake and delayed shipments due to general supply chain issues and longer lead time on our core AQS membrane production. The quarter also reflects a period with unprecedented volatility in Europe. This is due to the political unrest related to the Ukraine Russia conflict with a significant surge in both gas and electricity prices across Europe and also paired with increased macroeconomic uncertainty and rising inflation. For our business, the uncertainty did result 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 closer 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 same period last year generally reflects a slow start to the quarter with more than expected order intake during the European summer holiday amidst the escalating energy crisis. Turning to the Water Systems business. Revenue of $0.8 million represented a 47% reduction compared to Q3 last year with the lack of system deliveries explaining the reduction, 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 outlook for the fourth quarter, I echo the remarks made by Fei, indicating a Q4 and full year outlook at the lower end of the previously communicated guidance. This negatively impacted by the challenging market environment and overall delays in incoming orders and FX. 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 rightsize our business and restore financial stability. On that note, I'm pleased to see substantial improvements in both cash flow, fixed costs and OpEx 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 previous quarter's run rate. Fixed cost and OpEx came down 19% sequentially and down more than 30% compared to the beginning of the year, which reflects 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, hence at the lower end of the previously communicated target of $7 million to $8 million. With regard to cash flow outlook, I can confirm that the company continues to benefit from reduced CapEx commitments and a 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 '23, 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 lower activity levels within our Water Systems business, but also the adverse impact from the escalating energy crisis and highly inflationary environment across Europe, thus reducing our profitability across our core Ceramics and Plastics businesses. The quarter was further challenged by nonrecurring inventory adjustments and write-downs within our Ceramics business, reflecting a proactive and prudent review of our Ceramics inventory for dated and slow-moving products in the period with 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 a stable sequential development in the reported gross margin, this despite the lower top line. Furthermore, our increased focus on pricing discipline is continuing to support our underlying profitability, which combined with a sequential reduction in fixed costs of $0.2 million did allow for significant improvement in both gross and contribution margin when excluding the nonrecurring inventory adjustments previously mentioned. Turning to OpEx. Our total operating expenses for the quarter of $2.4 million represents 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 rightsizing 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 -- or from the second quarter, sorry. With net cash used in operating and investing activities accounted for approximately $1 million and the remaining being loss on currency translation. To summarize and reaffirm, we are committed to further improve our financial performance through incremental cost reductions, which together with the improved product mix and pricing discipline will pave the way for our business imbalance over the coming quarters from both a profitability, cash flow and capital structure perspective. We have during the course of 2022 stabilized and rightsized our business and is evident that we're now well positioned to take the next step on our commercial and strategic journey. Thanks for your continued support and interest in LiqTech and over to you, Fei.

Thank you, Simon. Looking into quarter 4, we had 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 as the appropriate time. One final comment that I would like to make, and that is to thank Alex for his leadership over the past 6 months. His steady hand and the guidance has helped to position the company going forward. It's never an easy task to assume the role as the interim CEO. But by all accounts, he handled it to perfection. 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 audience. Mike, please proceed.

[Operator Instructions] And the first question we have will come from Robert Brown of Lake Street Capital.

Just quickly 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's -- it depends on the market, but how is the pricing impact been able to be flowed through?

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

Yes. I think I would like to add on top of that, the new end markets, which were mentioned today, we really believe because our solution has a unique property there. So we might have much better price in the future.

And then 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's sort of the opportunity in the Water market with adding distribution relationships?

And we -- I mean, we have a different end market. I just give you a concrete example, for example, for the pool and the spa market definitely is a very much distributor driven market already -- beforehand. So we just need to choose the right distributor and go close to them and really get commitment from them and deliver what we need. So this is what we've already been doing today. We just want to do further strength on the distribution side. And the produced water I mentioned today is a new area because we had a system in Middle East region is up running now. With this data in hand, we will be able to find the right partner to go into this region and really pushing out in these applications. So you will hear more from us. We are looking at the different market segments and choosing the right partners and really pushing out distribution channel.

The next question we have will come from [ John Littman, ] Investor.

Just a couple of questions on the $7 million to $8 million through breakeven, are we estimating that to get to that level, we need to get back into the marine scrubber business? Or are you in the belief that the current businesses that we're generating revenue from in this quarter are substantial enough to get to that breakeven point [Technical Difficulty] of the membrane to get to that?

As we -- as I mentioned earlier, we have a strategy in 2 steps. We would like to really emphasize our recurring business, and that means the pool and the space membrane and plastics and also DPF areas we want to grow there. And on top of that, we have the different demand. We have marine scrubber will be out in the market. So these are the 2 combinations we do together in order to achieve this $7 million to $8 million. And we believe with the recurring business, will give us a very solid foundation and build on top system delivery. So this is 2-legged strategy we are working on. And the marine scrubber will be contributing. But because of the delay of the registration, we do not expect big growth in that segment.

And just another question. With the $17.6 million or so in cash on the balance sheet, do you think that -- I mean, it's 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 get to that breakeven level with the balance sheet you have today?

Yes. Yes, we have. I think it's a bigger picture here, John. First of all, you need to look at what we have achieved this year. I think the capital structure, obviously, is an important vital step, getting the convertible note of our balance sheet, reducing our CapEx commitments and really using the CapEx we expend this year to invest into 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 even significant growth. So that gives us a lot of comfort. And finally, with the cost reductions that we have achieved so far this year, down 30% on OpEx and fixed costs since Q1. We don't have a long run rate to get to cash flow breakeven. And with $17.6 million in the bank account, I'm very confident -- we are very confident that we have enough runway to get this company up to where it belongs.

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

Yes, you're absolutely correct. I think one of the key mechanisms to achieve stability is obviously growing a top line or even better also improving your contribution margin at the same time. And that's obviously a strategic focus of ours. I think a minimum of 40% we need to deliver on. We are striving higher than that. And even in Q1 this year and if you look into our Q3 numbers and adjust some of the nonrecurring items, we are above 40%, and that's basically a focus of ours. So you can say for every $1 million of incremental revenue, we should have at least 40% fall through to EBITDA and help us achieve that cash flow stability faster than what we've guided to you in the past. And as also mentioned today, we guided to $7 million to $8 million, we're now confident in saying, it's more $7 million. And if we shoot higher and better pricing, maybe it could go lower than that. But again, I'm very cautious about that in an environment where we have inflationary pressure on our costs. So let's see how the world looks like in early next year, and I'll provide more guidance on that.

[Operator Instructions] At this time, we're showing no further questions. We will go ahead and conclude today's question-answer session. I would now 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 communicating 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 also today. Again, the conference call has now concluded. At this time, you may disconnect your lines. Thank you, everyone. Take care, and have a wonderful rest of the day.