Xeros Technology : Year end results

Year end results

Released : 30 Apr 2019 07:00

RNS Number : 4768X

Xeros Technology Group plc 30 April 2019

30 April 2019

Xeros Technology Group plc

Year end results - good progress towards licensing model

Xeros Technology Group plc (AIM: XSG, 'the Group', 'Xeros'), the developer and provider of water saving technologies with multiple commercial applications, today publishes its final results for the 12 months ended 31 December 2018.

Highlights

∙Domestic Laundry

oExclusive development and licensing agreement signed with the leading Indian appliance manufacturer

oDevelopment agreement signed with largest Chinese washing machine OEM

∙High Performance Workwear

∙Commercial Laundry

oRSA, Dubai, and North America markets now served by channel partners

∙Tanning - 10 year contract signed with tannery to use Xeros' technology

∙Textile - successful tests with major Chinese manufacturers in texturing and colouration of garments

∙Financial

oRevenue increased by 62% to £3.5m (2017: £2.2m)

oAdjusted EBITDA1 loss reduced by 27.3% to £20.9m (2017: loss £28.7m)

oAdministration expenses, after exceptional items and FX, down 9.2% - expected to further reduce in 2019

oPost-taxearnings loss reduced to £29.4m (2017: loss £30.6m)

oRapidly reducing cost base as development phase nears completion

oExpect to raise equity from investors in 2019 to further strengthen balance sheet

Mark Nichols, Chief Executive of Xeros, said:

"Having completed the lion's share of our development our disruptive water saving technologies are now firmly on a path to commercialisation under an IP rich and asset light business model in global scale industries.

"We see the demand for our technology increasing as environmental and societal pressures continue to put intense strain on finite water resources - both in terms of pricing and consumption. Manufacturers, consumers and regulators are increasingly demanding that supply chains improve their sustainability credentials with a particular focus on reducing water usage.

Demands that we can help meet.

"We have achieved a number of major inflection points with others expected to follow in 2019, each of which have the capacity to generate significant value. As we end the development phase, our cost base will continue to decline ahead of the implementation of the contracts we have won which are expected to generate high margin royalty revenues."

[1] Adjusted EBITDA is defined as loss on ordinary activities before interest, tax, share-based payment expense, exceptional costs, depreciation and amortisation

Xeros Technology Group plc (LN: XSG) is a platform technology company that is reinventing water intensive industrial and commercial processes.

Xeros' uses its patented XOrbTM technologies to significantly reduce the amount of water used in a number of major applications with the remaining water becoming far more efficient in either affixing or removing molecules from substrates such as fabrics and garments. The result being significant improvements in economic, operational and sustainability outcomes.

Xeros has three divisions working in the garment finishing (Textile Technologies), tanning (Tanning Technologies, branded Qualus) and cleaning/laundry (Cleaning Technologies) markets. In cleaning/laundry, the company has three applications covering domestic laundry, commercial laundry (branded "Hydrofinity") and the cleaning of high-performance workwear (branded "Marken").

For more information, please visit - http://www.xerostech.com/

Strategy execution

Xeros' technologies drastically increase the effectiveness of water in affixing or removing molecules in large scale industrial and domestic processes. The results are radical improvements in the sustainability, performance and economics of water intensive processes, dramatically reducing the consumption of water, chemistry and energy, so reducing effluent, whilst either meeting or exceeding the conventional quality standards for the materials being processed.

Xeros has made significant progress through 2018, meeting a number of critical milestones, having spent many years developing our technologies and applications. We are now entering the key commercialisation phase with our focus on pursuing each technology application, progressing Xeros' IP rich, asset-light licensing and royalty business model and accelerating the winning of license contracts.

There is increasing evidence that accelerating changes in our climate, global population growth and increasingly affluent, urban communities are putting finite water resources under extreme stress. Xeros technology seeks to drive significant reductions in the volume of water and chemicals used in a number of highly water-intensive global scale industries.

Results achieved in tests, trials and commercial operations conducted during 2018 have reaffirmed that Xeros' technologies reduce water consumption and effluent production by up to 80%, reduce chemistry used in processes by up to 50% whilst also cutting energy consumption in cleaning applications by up to 50%.

Xeros is currently commercialising its technologies in three divisions:

∙Cleaning Technologies with applications in domestic laundry, commercial laundry (branded "Hydrofinity") and the cleaning and restoration of high-performance workwear (branded "Marken");

∙Tanning Technologies (branded "Qualus") with applications in leather production;

∙Textile Technologies in the field of garment colouration and finishing including denim. With the addition of applications of our technology in the field of garment manufacture, Xeros' technologies offer the opportunity to improve the sustainability, cost and the life of garments for manufacturers, brands, retailers and consumers.

Xeros' strategy remains that of licensing its technologies to market incumbents and to receive a proportion of the value created by means of royalties.

Our progress in our Cleaning and Textile Technology applications has been enabled by the completion of our new XDrum™ design during 2018. The design is an effective solution for applying Xeros' XOrb™ technology in rotating drums.

The new XDrum design allows OEMs to produce hybrid machines, at a low marginal cost, to dispense and retrieve our patented XOrb technologies into and from process cycles. The XDrum represents an important simplification for our application technology, substantially reducing the cost of incorporating our technology into existing proprietary machine designs, reducing complexity and thereby shortening the 'test' to 'production' cycle time.

In order to prove out and de-risk its technology ahead of licensing to market incumbents, Xeros has historically had to enter markets in its own

right on a selective basis and has had to invest in operations and working capital to do so. With these ventures now proving out market acceptance and customer demand, Xeros is now reducing its physical presence in markets with associated costs also planned to reduce rapidly. Similarly, technology development expenditure will continue to reduce having completed the vast majority of the work needed to license our technologies.

In the future, the majority of Xeros' revenue will be derived from high margin licensing agreements. During 2018, our revenue was derived from those businesses where we currently have a physical operational presence.

Total revenue from these businesses increased 61.8% to £3.5m (2017: £2.2m) with our adjusted EBITDA loss reduced by 27.3% to £20.9m

(2017: loss £28.7m). In a trend which will continue as the Group migrates to its licensing model, underlying administrative expenses, after

adjusting for exceptional items and the impact of foreign exchange, reduced during the year by 9.2% to £25.9m (2017: £28.5m).

2017 and 2018 represented a period of significant investment in the development of new applications with expenditure levels now reducing having materially completed this work.

Following the invention and patenting of our new XDrum design due to be launched this year to serve our Cleaning and Textile markets, we wrote down the value of our inventory of earlier design commercial washing machines and those on operating leases to customers. This resulted in a non-cash exceptional charge of £7.8m. Net cash outflow from operations reduced by 18.4% to £22.1m (2017: £27.1m).

Outlook

In December 2018, Xeros raised £15.8m before expenses in order to continue to execute its licensing strategy and to deliver further major value inflection points through 2019.

With development completed for the majority of our applications and the net cost of our business ventures reducing, we anticipate a continued reduction in our cash burn rate with our current funding sufficient to deliver these milestones through early 2020. However, during 2019 we expect to raise further equity to finish the year with a strong balance sheet as our commercialisation gathers momentum.

Overall, the Group is trading in line with the Board's expectations.

Operational Review

Cleaning Technologies

Domestic Laundry

Following the demonstration of our proprietary XDrum domestic washing machine design at the Consumer Electronics Show in Las Vegas in January 2018 and the cleaning, fabric care and sustainability benefits created by our patented XOrb technologies, Xeros conducted a structured due diligence process with a number of global appliance brands for them to study the potential adoption and commercialisation of our technologies in their machines.

In January 2019, Xeros signed a non-exclusive Joint Development Agreement with Wuxi Little Swan Company Limited, a subsidiary of Midea Group, the Chinese manufacturer of home appliances. The scope of the agreement is to develop and design a prototype washing machine including Xeros' technologies which, if successful, allows for both parties to enter into commercial discussions under a separate agreement and timetable. In 2017 Wuxi Little Swan Company sold 12.4m washing machines in China giving it a 28% share of the retail market. It also exported 3.9 million washing machines.

In April 2019, the Group signed an exclusive 10-year Licensing, Development and Commercialisation agreement with IFB Limited, a major manufacturer, distributor and retailer of washing machines in India, which included an up-front payment for the use of Xeros' technology.

Once machine designs are completed and tested, the agreement provides for fixed royalty percentages on net sales prices, to be paid to Xeros with agreed minimum unit sales volumes. IFB is the market leader in front loading washing machine sales in India, a market currently estimated at 1 million front loading machine sales per annum and growing at between 15% and 20% per annum.

Assuming product development and testing milestones are successfully achieved, we expect first royalty revenues from this application in 2021.

During 2018, Xeros continued the development of its proprietary XFiltra™ filtration device which is designed to prevent micro-plastics generated by washing cycles from being released into the aqua-cycle. Plastics released from clothing during washing cycles is the single largest source of primary micro-plastic pollution.

XFiltra's unique design is capable of filtering and dewatering in excess of 99% of micro-particulate matter found in domestic washing machine effluent. Our design solution to address this global problem was featured in the BBC series 'Blue Planet UK' broadcast in March 2019. The proposed business model for the commercialisation of this technology is licensing with either domestic washing machine OEMs or the pump manufacturers who supply them.

High Performance Workwear

Xeros entered the Firefighter PPE segment of this market in July 2017 with the acquisition of Marken Inc, a US market leader in the cleaning and restoration of firefighter uniforms. The acquisition has demonstrated that our technologies decontaminate PPE from substances harmful to health, whilst simultaneously increasing the life of these expensive garments.

With the objective of creating a broadly accepted platform of evidence and creating a valuable asset in its own right, Xeros subsequently purchased the specialist cleaning business of Gloves Inc in March 2018 with sites in Miami and Atlanta and also converted a Hydrofinity facility in Corona, South California which was commissioned in July 2018.

In July and September 2018, we received independent verification of the cleaning efficacy and garment life extension capabilities of our technologies from SCS Engineers Inc and Intertek Group plc respectively. Testing demonstrated the ability of Xeros' technology to remove heavy metal contamination, remove asbestos contamination to non-detectable levels and preserve the integrity of high-tech fabrics used in the manufacture of firefighter turn-out gear - meaning ensembles last longer.

This evidence has been key to orders received and to build a strong pipeline of prospective orders for our West Coast and Atlanta sites. Xeros strategy is to develop its network of sites to the degree necessary to prove its technology and in locations with the strongest and best quality demand for Xeros' cleaning performance.

In the French transportation sector, we increased to eight the fleet of Xeros machines with a garment fleet provider for the cleaning the PPE of SNCF and Air France workwear. Our technology being selected based on its cleaning efficacy and garment life extension.

The segments of the PPE market that can be addressed with Xeros' technologies goes beyond firefighting and transportation and includes petrochemicals, mining and military markets, many of which are becoming increasingly aware of the adverse and potentially dangerous effects of incorrectly or insufficiently cleaned workwear.

In terms of market opportunity for the US firefighter PPE market, the cleaning, inspection and repair of uniforms is valued at approximately $330m p.a. With 1.1m firefighters in the US, there are 350,000 professional firefighters based in approximately 8,000 fire crews. Nearly 40% of these professional firefighters are based within 100 miles of one of the top 10 major US metropolitan areas.

We expect the Marken business to be cash generative by the end of 2019 and whilst we plan for it to be a valuable asset in its own right, it will be the learning and evidence base which Xeros will leverage to create licensing propositions for PPE garment fleet owners on a global basis.

Commercial Laundry

During 2018, Xeros' Hydrofinity business which addresses the Commercial Laundry market, made significant progress towards its objective of becoming a licensor of Xeros' technologies to industry incumbents.

In July 2018, the business signed an exclusive 10-year licensing agreement with Jiangsu SeaLion Technology Development Company, a subsidiary of one of the largest commercial laundry equipment companies in China, with sales and service offices in each of China's 30 provinces. The first royalty revenues are expected in 2019.

In April 2019, the division signed a similar agreement with IFB limited, one of the largest commercial laundry equipment companies in India with approximately 5,000 machine installations. First revenues are expected in 2020. These agreements will commercialise Xeros' technologies using the XDrum design and provide for the deployment of Xeros' telematics system, XConnect, with all data being recorded and stored by Xeros.

In aggregate, the Chinese and Indian markets comprise 38% of the world's population with both countries experiencing increasing water stress. We continue to develop relationships with OEMs to license and serve key markets outside of these two countries.

The Hydrofinity business has also taken major steps to reduce its physical presence in forward channels in countries around the world. In December 2018, it completed the transfer of all installation and service to its Channel Partners in the US, reducing costs whilst simultaneously improving the customer experience. These partners are also increasingly taking on the sales role including multi-year subscription packages for the use of XOrbs.

Sales, installation and servicing agreements were also established with fanute in South Africa and ElectroRak in Dubai with commercial machines shipped to these partners in late 2018, a number of which have now been commissioned. Local water-stress is one of the key drivers for these partners in selecting Xeros technology.

In November 2018, our commercial laundry technology was certified as an "Environmentally Preferred Product" following an independently conducted Life Cycle Analysis by SCS Global Services. The certification is the only one yet afforded to this industry and was based upon 20,000 wash cycles with testing criteria including water use, energy demand and carbon emissions among other environmental impacts.

The licensing agreements signed to date, and preparations for similar arrangements in the Americas and EMEA, have enabled a significant reduction in the operating costs of the Hydrofinity business. Once implemented, these license agreements also have the benefit of significantly reducing Xeros' working capital.

Tanning Technologies

In 2016, our strategic review to determine which applications we should pursue, identified retanning and dyeing of bovine hides as a viable opportunity. There being no identifiable, willing licensee at the time, we took the decision to enter the market directly to prove out and de-risk the technology. The business, once sufficiently developed, would present commercial options for Xeros including the potential for outside investment. This division is branded Qualus.

Multiple scale trials conducted with tanneries in Europe and Latin America covering the retanning and dyeing phases of the tanning process have proven that our technology works for all hide applications, including auto, fashion and shoe leather, regardless of the different drum types used in the industry. In addition, we have established that the water and chemistry savings and the resultant value created are consistent with our business case for this market.

Following the development of engineering solutions to introduce XOrbs into tannery operations, which comprise some 40 separate operations in a continuous process, Qualus entered into a 10-year contract in September 2018 with Le Farc SA de CV in Leon, Mexico. Le Farc will convert its re-tanning operations in order to use Xeros' technologies. Commissioning of the first drums to process hides with XOrbs under the agreement is expected around the middle of 2019 with conversion completed by the end of the year. Le Farc supplies major footwear and auto brands.

Trials and commercial discussions have also taken place with multiple large-scale tanners and it is our expectation that additional contracts will be signed once Xeros' technologies are demonstrated in the operational environment of Le Farc.

Future developments in this business include applying Xeros' technologies into the up-stream tanning phases of leather production which are significant in their consumption of water and bulk chemicals, including chrome.

We estimate that 300 million bovine hides are tanned globally per annum and the estimated added value created by Xeros technologies from water and chemistry savings in the retanning and dyeing process to be in the range of £0.80 per hide.

Xeros continues to consider opportunities to attract third party finance into the Qualus business with the ultimate objective of being a licensor of its technology into this industry rather than being itself a market incumbent.

Textile Technologies

During 2018, we successfully developed XDrum machines to apply our XOrb technology to wool, cotton and denim garment finishing. These processes are applied to almost every garment that is made in order to remove contaminants introduced during manufacture and to change the texture and colour of raw fabrics to meet the specifications required by clothing designers, brands, retailers and consumers.

The Xeros process significantly reduces the amount of water and chemistry used and effluent produced and, in the case of denim, also has the capacity to reduce process steps and capital costs.

Xeros has now successfully completed tests at its technology centre in Sheffield for three major Chinese garment manufacturers during which we have successfully matched product outcomes in multiple garment types using significantly less water and chemistry. Discussions are ongoing with a number of manufacturers, with the objective of moving to scale trials later in 2019 ahead of commercialisation.

Our solutions in these applications offer manufacturers the resource and pollution reductions that consumers and governments are demanding. One example being the plan for "Zero Discharge of Hazardous Chemicals by 2020" which has 23 global clothing brands as signatories. We have also begun a process of engaging with major retailers to create demand for Xeros' technologies in the forward supply chain.

We believe our strategic decision in 2016 to address this market has now been validated given the benefits that Xeros technology delivers and the proof points we have now achieved in tests. The opportunity is very significant, with 22.7 million tonnes of natural fibres processed annually for the clothing and textiles industries, a third of those in China.

Intellectual Property

Xeros' IP rich and asset light commercialisation model requires that we have a strong and defendable patent portfolio which provides freedom to operate for our businesses and license partners. Xeros now has in excess of 40 patent families in application or granted. The Group files its patents in countries with large potential markets and where it believes it can successfully defend its Intellectual Property.

Our core patents are filed in countries which represent 90% of global GDP. In order to have the financial capacity, should it need to defend its patent portfolio, Xeros has significant levels of patent defense and litigation insurance. We have not identified any infringements which have the capacity to materially impair the validity and enforcement of our patent and trademark portfolio.

During 2018, seven new patent families were filed to protect our inventions with the majority in the fields of the XDrum and XFiltra. Xeros does not expect historical levels of new patent filings to continue as we believe the inventions for our current portfolio are sufficient for their commercialisation. We will continue to make filings based upon their ability to secure future revenues.

Financial review

Group revenue was generated as follows:

Group revenue was up 61.8% to £3.5m in the year ended 31 December 2018 (2017: £2.2m). Of this growth, 42.2% represents organic growth and growth of 19.6% is attributable to the acquisition by Marken of the specialist firefighter cleaning business of Gloves Inc in March 2018.

Machine sales revenue represents revenue from the sale of commercial washing machines by Hydrofinity. Machine sales revenue grew by 45.7% reflecting both the increase in the number of machines placed with customers and the full year impact of the successful conversion of installed machines to fully commissioned revenue-earning machines during 2017. Machine sales revenue is 30% of Group revenue (2017: 33%).

As at 31 December 2018 Hydrofinity's total revenue generating estate of commercial washing machines increased by a net 16 machines to 397 machines. This net figure is the result of a significant focus on improving the quality of the customer portfolio as machines have been moved from poor to good credit quality customers. Whilst such a move does not increase the number of revenue-earning machines it does result in improved financial performance from the estate.

Service revenue increased by 70.5% to £2.5m. Hydrofinity's service revenue increased by 34.4% to £1.6m from (2017: £1.2m). Marken's

revenue jumped by 244% to £0.9m (2017: £0.2m) reflecting the combined impact of a full year of the original Marken business, acquired in July

2017 and the contribution of the Gloves Inc business acquired in March 2018. Service revenue is 70% of Group revenue (2017: 66%).

The Group reduced its adjusted EBITDA loss by 27.3% to £20.9m (2017: loss £28.7m).

Adjusted gross profit was £0.1m (2017: loss £0.4m). Adjusted gross profit comprises a profit of £0.2m from Hydrofinity and a loss of £0.1m from Marken. The move to a gross profit for Hydrofinity reflects the reduced cost of direct sales as Hydrofinity moves sales and customer servicing activities to third party channel partners.

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