Energy Recovery Inc (ERII) 2012 Q1 法說會逐字稿

Ladies and gentlemen thank you for standing by, I will now hand the conference over to Alex Buehler, our CFO, please go ahead sir.

Good morning and welcome to Energy Recovery's First Quarter 2012 Earnings Conference Call. Joining me on today's call is Tom Rooney, ERI's President and Chief Executive Officer. Before we begin, I will like to make a brief statement about forward looking remarks.

The primary purpose of today's call is to provide you with information about our financial performance in the first quarter of 2012. However, some of our comments and responses to questions may contain forward looking statement about market trends, future revenue, growth expectations, cost structure, gross profit margins, new products and business strategy.

Such statements are predictions based on current expectations about future events and are subject to the safe harbor provisions of the US private securities litigation reform act. Forward looking statements are not guarantees of future performance and are subject to certain risks and uncertainties and other factors that could cause results to differ materially.

A detailed discussion of these factors and uncertainties is contained in a report of the Company files with the US Securities and Exchange Commission. The Company assumes no obligations to update any forward looking statement made during this call excerpt as required by law.

Let's turn now to our financial performance. At anticipated, revenue was down to the fourth consecutive quarter without mega project shipments. What is important to note however, is that we believe the current period represents the last quarter without MPD revenue. As we expect substantial shipment to commence in the current month and continue to the balance of the year.

Such forecasted activity is largely reinforced through existing backlog and to a lesser extent through an ongoing sales activity. Specifically, we generated $4.8 million in net revenue. Reflecting a decrease of $5.6 million or 54% as compared to the same quarter of the prior year. Net revenue in the first quarter of 2011 included MPD sales of $6.5 million comprised a four large projects all of which carried over from the fourth quarter of 2010.

Again in comparison, we recognize no revenue in the first quarter of 2012 or mega project shipments. Excluding the effects of MPD sales OEM shipment increased from the first quarter of 2011 to the current quarter. A trend that we believe is indicative of the market rebound as we work beyond the macroeconomic and geopolitical events that weighed down OEM market activity in 2011.

Not unlike the trend for OEM sales. After market activity also increased in the current period over prior year. Of the $10.4 million in net revenue recognized in the first quarter of 2011, the PX devices and related products and services represented 85%. In comparison, PX devices and related products and services represented only 65% of net revenue in the first quarter of 2012. Representing an unfavorable make shift caused again b the absence of MPD revenue which is almost always comprised wholly of PX devices.

Consequently, the complete lack of MPD shipment in the current period affected not only our top line revenue but also our gross profit margin in the current period. Considering that pumps and turbo chargers such lower margins than do PX devices. Our revenue forecast remains as previously conveyed, that is we expect 40% annual revenue growth as compared to 2011 with the second and third quarters representing the highest proportion of total revenue due to specific and planned MPD shipments.

In short, the revenue story in the first quarter is all about MPD shipment or rather the lack thereof and importantly, these are forthcoming. With OEM and aftermarket demonstrating growth over prior year and forecasted to increase and with significant MPD shipment pending, we remain confident in this revenue forecast. Our market is growing, driving by large mega projects around the world and our market share based on non sales activity has increased significantly over the last nine months. The latter of which was not achieved through decreased pricing.

On diminished revenue of $4.8 million we achieved a gross profit margin of 26% in the first quarter of 2012. This compared to 45% gross margin in the same quarter of the prior year. Considering the difference between gross margin profits between PX devices on one hand and pumps and turbo chargers on the other, the heavy mix of PX devices as a percent of total revenue cost the higher gross profit margin in 2011.

Conversely, make shifted substantially towards pumps and turbo charger in the current period causing a much lower margin in comparison. Average sales prices remains stable and in certain cases even increased. Beyond changes in product mix, under applied overhead cost and notable margin drag in the first quarter of 2012. We ramped up production methodically over the first three months of the year.

With few units manufactured in January due to ongoing plans and integration issues. Now we are happy to report that production levels for PX devices have normalized. We are consistently achieving yields beyond our internal goals and the plant is staffed and equipped to achieve targeted production levels for the year. While admittedly we still have room for improvement, strong production levels, efficient operations and increased yields should cause much higher absorption of fixed manufacturing cost and a corresponding increase in gross profit margins in future periods.

In the context of vertical integration and increased utilization unit production cost decreased in the current period. However, first quarter shipment included units produced in prior periods in higher cost. As more units are produced under the lower cost structure due to the vertical integration and consolidation, we expect to realize the full benefit of decreased cost of revenue in future periods.

So let's summarize the margin drivers. Price is stable and in some cases increasing. Mix is shifting back in our favor through increased MPD shipment comprised only of PX devices. Absorption is stepping up to a strong production levels and the full benefit of vertical integration manifesting in lower unit cost is expected in the near future. In short, we see ample opportunities for margin expansion in 2012 and beyond.

As planned through restructuring activities and other cost reduction initiatives, G&A decreased by $0.6 million or 15% to $3.5 million in the first quarter of 2012. The decrease was due primarily to CEO transition cost recognized in the first quarter of 2011. Similar to the trend in GNA cost sales and marketing expenses declined from $2.1 million in the first quarter of 2011 to $1.5 million in the first quarter of 2012, demonstrating a decrease of $0.6 million or 28%, this decrease was largely attributable to lower sales commissions in the context of reduced sales and cost savings associated with the downsizing of our sales office in Spain.

Research and development expenses were $0.7 million in the first quarter of 2012 in comparison to $1 million in the prior year. A decline of $0.3 million or 33% was caused principally by reduced compensation and employee related benefits. Regarding R&D expenses we expect increased spending in subsequent periods as we continue to strengthen existing products and develop new products for energy recovery applications in market outside of desalination. With the continued and intense focus on application in the oil and gas industry.

Also included in the operating expenses was the amortization of intangible assets. Which decreased from $346,000 in the first quarter of 2011 to $262,000 in the current quarter, reflecting a decline of 24% caused by the full amortization of certain non (inaudible - background noise) agreements in connection with the purchase of pomp engineering.

Finally, the income statement showed minimal trailing cost of $31,000 associated with restructuring activities that were substantially completed in 2011. As conveyed in previous earnings calls, these included the consolidation of manufacturing operations in California and the closure of our production facility in Michigan along with the downsizing of our sales of in Spain.

With restructuring activities now complete, we expect to enjoy the full benefit of cost savings as initially forecasted. In totally, with declining expenses for nearly all categories, total operating expenses decreased by $1.6 million or 21% from the first quarter of 2011 to the current period. The favorable variance was due largely to the planning and execution of certain cost reduction initiatives in 2011 which caused non reoccurring expenses in the prior year and generated cost savings in the current year.

Notably, the Company has better aligned its cost structure with the available revenue opportunity which incidentally is forecasted to grow and we believe that the existing level of OPEX is right sized and scalable in the context of decreasing revenue. To be sure, through the planned closure in Michigan, the office downsizing in Spain and other specific efforts, we believe that we have better calibrated our cost structure to generate meaningful APEX savings in 2012.

Even with deep loses in 2011, our cash position remains strong. Worth noting is the fact that our income statement includes many expenses that are non cash in nature. Specifically, share base compensation expense for the fourth quarter was $0.8 million with depreciation and amortization totaled $1.0 million. In total, non cash expenses amounted to nearly $2.0 million in the first quarter of 2012.

Operating activities used $3.7 million in the current period, most of which related to operating losses and to a lesser extent a decrease in accrued expenses. Capital expenditure used $1.0 million as the Company paid for the plant integration that was planned as part of the restructuring initiative.

Finally, specific to financing activities, the Company used $800,000 as of March 31, 2012 to repurchase common stock on the open market in accordance with our plans and authorized by the board of directors, which allows for the purchase of up to 5 million shares. As of May 1 the Company has purchased 1.2 million shares at weighted average market price of $2.17, demonstrating a total cash use of 2.6 million that is inclusive of broker commissions.

We expect to continue our share repurchases to the extent that our share price remains below our perception of value calibrated through our long range plan. Also on the topic of liquidity, we entered the first quarter with $15.8 million in cash and cash equivalents along with $12.5 million of short term investments and $6.8 million of long term investments. Additionally, the total restricted cash balance including current and noncurrent portions amounted to $11.5 million of which $3.5 million related to contingent and other consideration pertaining to the acquisition of pump engineering.

$7.9 million for pledge collateral backing outstanding letters of credit and $0.1 million associated with collateral for an equipment promissory note. As revenue increases in accordance with our forecast, we expect to use cash and funding working capital, making moderate capital investments to facilitate new market diversification and repurchasing shares.

Irrespective of the upcoming uses of cash however, we believe that we have sufficient liquidity to fund our strategic initiatives along with the impending growth of our core business and as mentioned before, our cash balance remains strong. With low due to no MPD shipments, moderate gross profit margins affected by mix absorption and legacy unit cost, savings and operating expenses forged through initiatives executed last year and know benefits for income taxes in the current period.

Our net loss in the first quarter was $4.7 million, compared to a net loss of $1.8 million in the same period of the prior year. Likewise, we generated a loss of $0.09 per share compared to a loss of $0.03 per share in the same period of 2011. In summary, the financial results in the first quarter of 2012 reflects what we consider to be the fourth and final quarter lacking in MPD revenue.

We have amass significant backlog for MPD shipments that should commence in the current month and our OEM business is experiencing increased activity through resisting markets and emerging markets like China and India. With such imminent revenue opportunity forecasted we believe that our gross profit margin will demonstrate instinct improvement in the second quarter that is commensurate with increased volume and a favorable shift in mixed of PX devices.

Consequently , increase in revenue and margins coupled with savings and operating expenses achieved through restructuring and other cost reduction initiatives give us confidence in reaching our internal forecast, which should reflect significant financial progress.

In closing, the business trends are these, the market is growing, evidence by increased backlog through recent mega project awards and current OEM activity. We have significantly increased our market share in a rebounding market not through price reductions but rather through a refined value preposition. Closed profit margins are increasing due to product mix, volume and reduced cost and operating expenses will remain at decreased levels due to savings achieved to restructuring and other cost reduction initiatives.

Accordingly, we see profitability improving substantially in the current year. Representative of the first step in a multiyear evolution. We on the management team remain intensely focused, executing our strategic plan diligently even relentlessly to achieve the imminent turnaround in our core business and for a successful diversification into new markets including oil and gas.

Recent share repurchases convey our strong sentiment and sense of confidence in the Company and the strategic direction. That concludes my financial remarks. I would now like to open the call for questions. Operator you want to open the call for

Thank you sir.

(Operator Instructions)

Our first question comes from Laurence Alexander of Jefferies, please go ahead with your question.

Good morning.

Good morning.

On the market share gain, can you give any characterization on type of project that you are winning more on or is there a type of competitive situation where you find your taking share or it's just across the board?

Sure, that's a good question. You know the Company -- to give you a full answer, I have to suggest that the Company really from 2000 to 2008 went from an interesting new entrant in the market to being quite a dominant player in terms of market share, you know, the peak in 2008, there arguably the Company had something like 80% market share. Fairly well across the board, certainly large projects and so on.

The sort of international collapse of the desalination market caused a frenzy of competitive forces from 2008 on and the Company lost market share from 2008 through 2011. When I came in early 2011, we made a strategic decision to do a global study in terms of what people thought about our products, what was our -- what we called value proposition, why did people buy from us and so on.

At the time we were having to chase price down and a sought of face to face price competition. So based on a very extensive and frankly very extensive study that we performed last spring, we launched a completely new value preposition -- not new but a very refined value preposition over the summer most notably the industry conference in September, since that point in time, to our knowledge, we haven't lost a single MPD project in a competitive environment and we won something like seven consecutive MPV projects.

People ask me so you must be really sharpening your pencil on price and the answer is quite to the contrary. We are enunciating a very clear value preposition to our clients which is around a total value preposition or total cost and so here before we've been asked -- prior to that we've been asked to fight a battle around first cost or first price, but the total economics of energy recovery device revolve around the 25 year life and 25 year energy savings and so on and we really started to get our clients to focus on the total cost of ownership of an energy recovery that we devised, which is the first cost and typically by the way, our devices are 15% to 20% more expensive than the next competitor.

But we except the fact that we are more expensive, we have our clients then focused on what it takes to operate a plant. Given the fact that the energy recovery device is only about 2% of the plant. If an energy recovery device cause this plant down time, the magnification of the cost is substantial and so our clients are really resonate or the message is really resonating with clients that they need to yes, look at the first cost, yes, look at the energy cost, yes, look at the maintenance cost, but now also, look at the notion that when you buy a PX device from an energy recovery, you plant is up and running all the time and the economic power of that is tremendous.

So the simple answer to your question is we've been fortunate that the last seven or so mega projects that we've won all of them, we were not aware that we were competing with others and we won every one of them. We've not had to chase prices down the rabbit hole. Similarly, we are doing quite well on the OEM side, although I will tell you that if and when a client is choosing between two turbo chargers or two high pressure pumps, there is less differentiatiors between ourselves and others, so at the low end of the market, the very low end of the market which represents about 10% to 15% of all energy recovery devices, we are not hyper competitive but we are working to get to that point as well.

So most of the great success that we are enjoying and huge market share gains is coming from a very strong value preposition that resonates with our clients. By the way, will we keep going forever? Winning every mega projects? No, not at all. Clients will choose to make decisions themselves but so far we like the dynamic in the marketplace.

Secondly if you look out a few years for the adjacency market, sought of the industrial market, can you give us a sense for what you need to do to see a reflection point in growth rate there?

Are you referring to like oil and gas and chemical processing and so on?

Exactly.

Okay, so where we are right now is we're most focused on the adjacent market in oil and gas and we're currently working with three very high profiled oil and gas companies on three different continents and we will be shipping devices onto three continents before this year is over. As I said, three very high profiled clients and that is anticipated, the demand is very high, the payback period is good and so the demand appears to be very high, so the schedule in effect is we deliver devices this year, de minimis revenue for us as a company although definitely revenues, they go through instate trial periods of three to six months, then that is followed by significant demand thereafter.

So we are fully expecting to have material revenue coming from oil and gas in 2013, the total addressable market just in the oil and gas industry will suggest that over five year period the demand for energy recovery devices in the oil and gas space could be just as large as we see in the desalination industry over the next five years.

Thank you.

By the way beyond that we would also and we will soon start to look at the chemical processing industry, the food processing industry, any industrial application where fluid is found on the pressure or put under pressure we see as prime opportunity, needless to say in this economy right now, giving the fluid flows the pressures and the profits being generated the most appealing industry for us is oil and gas so we are going there first.

Okay, great.

Thank you. Our next question comes from Dale Pfau from Cantor Fitzgerald please go ahead with your question.

Yes good morning gentlemen. Several questions here. Where do you calculate your breakeven level? Either on a cash flow or on a bottom line number and then if you could give me an idea of how your commission are going to track as revenue go up and then I've got a follow up.

So we see EBITDA positives around $42 million in revenue and we see income positives around $52 million.

Quarterly or annual?

$42 million annually.

Okay.

And that's how we -- that's what we see in terms of cash flow positives and income positives. What was the second question?

How are commission is going to track as revenue growth so we can try and model that, it's not going to be linear but it's some commission rate as (inaudible) low base here.

So our sales commissions are in effect earned when deals are done and contracts are signed but they are paid when shipments commence, so the reason we have low to no commissions paid in the first quarter is because we have low revenue, so the commissions should come concurrent with the revenue that you would see.

And so what is that relationship? What -- can you give me a percentage or how should I model --

How much do we pay in commission you are saying?

Yes.

it's going to be very difficult to model because it is very lumping and it's very dependent on which project in what geography, so I mean generally we are about 1% of gross profit on sale but we also had outside commissions that we pay and those are highly variable.

Okay, so I can't -- they is no way for me to adequately model it.

Okay, let me think about it and we then we can talk about it.

Okay. And then we've seen some of the project winds, could you give us any kind of indication of what your current backlog is and how long that stretches? Is it an 18 month or two year kind of thing?

So we don't report backlog but it is in fact the backlog that gives us very high level of confidence that we are going to achieve 40% year over year revenue growth. I can only think of $250,000 worth of our backlog that is scheduled to track into next year. So I'm sure you can refer that we have sufficient backlog to generate close to $40 million of revenue this year.

Okay, so your $40 million this year is coming all from backlog and we don't need to book anything more to meet that number?

Well we book day to day coming out of this small project but it tends to regular and consistent, which gives us huge fluctuations in our revenue year to year in some mega projects. You know, we have one mega project in the order of $7 million, we have several in the $3 million to $4 million range, so getting or not getting one of those has a massive impact on our revenues but the smaller OEM business and the recurring aftermarket business, we typically have backlog, I think in the OEM business at any giving time we have three to four months of backlog and so we have all of the backlog from MPD that we need for the year as we sit today and we likely have about four or five months of backlog in the OEM business right now.

And short of calamity in world markets, we will fully expect the OEM business which is very consistent and steady just to play itself out to the balance of the year. At this stage right now with our MPD business we are seeking to build that backlog for next year. Of course we would take it if it occur this year but the mantra now is really building up backlog for next year.

Because in fact if we previously guided that we expect 40% year over year growth from last year to this year and we fully anticipate compounding on top of that 20% cumulative growth for each of the next five years and so our backlog build up is likely going to contribute to 2013 growth.

And on your OEM business, you say nice and consistent. Are you going to see a 40% year over year growth in that business or is that more likely a 20% growth?

Yes, it's probably more on the 20%. The big 40% rebound is predominantly coming from the rebound in the mega projects.

Great, thank you very much, good luck.

Thank you.

Also for the purposes of modeling, you might think of commissions at about 2% of revenues but it's going to be lumpy, it's going to be higher in heavy quarters with a lot of MPD shipments and low and light quarters such as the first quarter of this year.

Great, that is very helpful.

Thank you. Our next question comes from Patrick Jobin from Credit Suisse, please go ahead with your question.

Great, thanks for taking my question and coming morning. It sounds like a great batting average (inaudible - multiple speakers) project wins.

Thank you.

Two quick questions. First on the backlog, I just want to understand some of the comments there. Can you quantify some of the number of mega projects that you expect in '12 and am I correct assuming all of them are in backlog today?

So we -- first of all we classify a mega project based on sheer size which is more or less a project graded in about $1.25 million and we anticipate that we will have 11 of those projects this year. So when we report that we've got seven, we actually have three I think, we are in final contract negotiations with clients and we have an issued press release on.

So pre-significant change into year over year which by the way first and foremost is a reflection on the fact that the industry has rebounded with or without our company but we are also quite fortunate to have peer point of pretty strong batting average right now

Great, and just the second question is on the diversification efforts, you mentioned three very high profiled oil and gas company you are working with. Is there any way to quantify the opportunity from either a revenue standpoint with just those three companies or how should we look at kind of immediate market size for customers you are already into discussions with?

Well, first of all I guess I would say -- and by the way I've been corrected on something, I just said we likely have 11 mega project deal this year but only seven or eight of them lastly shipped this yea. Roughly three of them will transfer till next year so I've been corrected on that one.

But on the mega client that we're dealing with is at Middle East in North America. The signs of the market is substantial; we are intensely focused in working with these three very high profile companies. We could in fact and we'd been approach by a number of other ruling gas companies. We could -- we could be working with others but we seek to be successful very successful with those.

I think it will probably be border line records for me to try to gage for you, powers the address of the market is with those clients in the next one, two or three years. But I will say this -- we've been very presently surprised at the degree to which there is high demand for this technology in this industry.

And so I think we pick up from those clients in particular in the industry in general. Is going to be very rapid but for us the most pressing issue is to refined and develop our technologies into usable solutions this year. Towards the end of this year I could give you pretty good clarity to those but I think it's going to be very surprising pick up and revenue of coming credited on the steep demand that we're hearing from those clients.

Okay, and you feel like the technology is progressing well and have field trials be gone and what's the status of the project.

Yes, there are absolutely field trials around their way and more field trials will be started. We typically will try the -- test the product in the house people will send them out for field trials. The field trial at that stage are really for the clients benefit and for them and then in couple of cases we actually have some very large international load companies beginning to map out very internal flows so that they will be able to enunciate to us what their total demands are.

So but all of that triggers on the successful field trials up their locations of these devices. But the technology development is moving along, we -- it does take time, it took years and years for us to perfect the PX device but we celebrate I would say years and years in the development here.

We've been working on these energy recovery devices for several years anyway. A major breakthrough for us still is we now believe that we're going to be able to use a pressure exchanger or a PX device for which we hold numerous patents to be the premier products in the oil and gas industry.

And that's probably the most exciting part for us because what that suggests is a point entering the oil and gas space. We enter with the whole platform of electoral property which will create significant barriers.

Thank you.

Sure thank you.

Thank you, another question is coming from JinMing Liu from Ardour Capital please go ahead with your question.

Good morning gentlemen.

Good morning.

Yes, first one need to straight to -- could you give more or clarity on your PX application in the oil and gas industry, like the writer of the application will be in the E&P site of their business or this will be more in the refining part of the business.

I preferred to hold off on that if the stage were compare to the reasons if you don't mind that we're -- we have model that and we're beginning to construct the pressure exchangers, the core energy recovery device inside of a larger solution package.

Okay.

But for competitive purposes If you don't mind, I would rather not answer that specific question.

Okay, in terms of your effort to diversify your revenue stream, is there any progress we put on your effort to diversify into the general water applications?

Yes we work -- we are working down that part but I don't have an update for you on them.

Okay, lastly just for the first quarter revenue could you give us a break up between your PX devices and the regular turbo charger and the high pressure pumps, what's the break out there?

Sure, in the first quarter of 2012, we had about $3.1 million related to PX devices and about $1.7 million related to turbos and pumps.

This related to that question, historical lead the pump and drill nearing group made roughly about $10 million in revenue this year. Should we expect similar run rate for a new run rate for that group going forward?

Yes.

Okay, thanks.

Thanks very much, your next question is coming from David Rose from Wedbush Securities, please go ahead.

Hi, this is Michelle in for Dave. so my first question is, if you plan to maintain the prior practice of extending very long payment terms, the customers for mega projects.

Yes that industry trend really hasn't changed much, I'd love to think we had more control over that thing we do and we don't. There seems to be an industry practice for a very long payment terms that I guess that the bad news for the good news is the, we have very low credit risk with those clients. But yes we do have pretty long payment term of course it's only on a small portion of the overall contract.

So you're talking 5% to 15% generally hold back which could have long terms but then it's fast terms and even some of its prepaid before shipment.

Okay, and then my next question is what do you expect your working capital requirements will be as you win these mega projects? You have traditionally financed these projects over a year so do we expect receivable to jump up meaningfully?

Yes, as revenue increases you will see inventory and trade they are increase commence where with the level of revenue. And we do expect that networking capital will consume temporally quite a bit of cash and the current this people here because of the increase and NPD shipments. But of course we'll get that back and monetize it in the next year.

Okay, thank you.

You welcome.

(Operator Instructions)

Okay, so if we have no further questions, I will thank everybody for joining the call today. I would say that the management team feels particularly good about where we are for the year. And we right on track right on plan, we have made tremendous strives in our clause structure because of operating leverage in growth across the good soul has drop dramatically between a significant jumping our market share without having to give our price.

We're growing very strongly in our co business; we have a strong cash position. All of that explains why we are so bullish about buying back our shares and we will continue to do so until we see or believe that share price equals our value proposition of the Company. We continue to invest diligently and diversifying into the oil and gas and other sectors.

We currently expect 40% growth this year in our co business we expect 20% growth over the next five years on top of that 40% growth. And that is before we begin the calibrate growth that would come from the oil and gas and other diversified industries.

So in summery we feel particularly good, the first quarter of 2012 is the turning point quarter for us. We have a manufacturing plan down stairs with this chat full of devices getting ready to be shipped this month which we get very strong revenues in Q2 and in Q3. So the year 2012 is devolving exactly how we had hoped it would and we are very optimistic about having a very strong year this year. So thank you to everybody for being on the call today.

Thank you ladies and gentlemen, that concludes today's conference call, thanks for participation you may now disconnect.