Energy Recovery Inc (ERII) 2014 Q4 法說會逐字稿

Good day, and welcome to the Energy Recovery 2014 year-end earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Joel Gay. Please go ahead.

Good afternoon, everyone, and welcome to Energy Recovery's earnings conference call for the fourth quarter and full year of 2014. My name is Joel Gay, CFO of Energy Recovery, and I'm here today with our Chairman of the Board of Directors, Mr. Hans Peter Mitchelet.

To begin, some of our comments and responses to questions may contain forward-looking statements about market trends, future revenue, growth expectations, cost structure, gross profit margins, new products, and business strategy. Such forward-looking statements are 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, uncertainties, and other factors that could cause actual results to differ materially from those discussed. A detailed discussion of these factors and uncertainties is contained in the reports that the Company files with the US Securities and Exchange Commission. The Company assumes no obligation to update any forward-looking statements made during this call except as required by law.

At this point, I will turn the call over to our Chairman, Hans Peter Michelet, to provide some opening remarks. HP, please go ahead.

Good afternoon, everyone. My name is Hans Peter Michelet. I'm the Chairman of the Board of Directors, and I am joined by Joel Gay, our Chief Financial Officer. Some brief opening remarks.

Energy Recovery finds itself at one of the most exciting points since the Company's IPO, something that Joel will elaborate further upon during his remarks. I'm pleased to state that to the guidance of the executive committee established by the Board of Directors of which I'm a part, and through Joel's leadership throughout this transition, the Company is well positioned for sustainable growth.

I will now turn the call over to Joel, who will provide a strategic and commercial update and discuss the 2014 fiscal year financial results. Joel, please go ahead.

Thank you, HP. Before we begin, allow me to characterize how I will be executing these calls such that we can engage in an informative and productive dialogue. The Company is in the midst of transition, and as such will take this opportunity to discern a new path forward. What can you expect from me? You can expect candor and openness. I will clearly articulate our strategy and characterize our performance accordingly. You can expect an execution bias with a singular goal over time of delivering results. You can expect a management-by-the-numbers approach, with a focus on optimal resource allocation.

Now, let me preempt questions around the several key issues facing the Company. Let's begin with the class-action litigation filed earlier this year.

The Company does not comment on active litigation matters, and this will be no exception. As for the CEO search, here's what I can tell you. The Board created an executive committee to execute a comprehensive search to evaluate and identify Energy Recovery's next CEO. That process is underway. As for desired qualifications and attributes, the Company simply seeks to identify the best person for the job, an individual who can generate results across all market opportunities of interest.

Lastly, the interim leadership structure. I am running the day-to-day operations of the business with direct oversight from the executive committee mentioned earlier. Now, let us get into the substance of this call.

Beginning with an assessment of our financial performance in 2014, while not a surprise given our understanding of the global desalination in the oil and gas markets, as well as our financial performance reported through the third quarter, 2014 was nonetheless disappointing and, frankly, unacceptable. To characterize it as anything less would be equally unacceptable. While we continue to identify fertile markets where pressure energy recovery is possible, and develop strategies and solutions to penetrate these markets, we are cognizant that our investors seek and deserve quantifiable financial results that drive value creation.

In this, I will not dedicate time to discern the silver lining in our financial performance or provide speculative commentary on the several growth initiatives underway. Rather, I will provide an update on the Company's evolving strategy, operating tactics and culture, and the actions taken to demonstrate improved performance. Later in this call, I will deconstruct the fourth-quarter and fiscal-year financial results.

Over the last three years, the Company's strategy was to leverage its core competencies of advanced material science and fluid dynamics to identify and unlock new industrial fluid flow markets. Here, the Company sought to deploy technology to either recover and recycle wasted pressure energy or, more recently, to act as an extreme pump in hostile fluid environments. The latter, of course, resulted in the development of the VorTeq hydraulic pumping solution, which I will provide an update on later in this call.

The rationale supporting diversification then remains valid today. Here, Energy Recovery is committed to and capitalized for staying the course, which is to say, we will continue to preserve the strength of our position in desalination and pursue the commercialization of our products in oil and gas and chemical processing. The tactics by which we achieve diversification are a core central to our success. Energy Recovery is at a critical point of inflection, namely the transition from ideation to execution. Allow me to use a metaphor to better unpack this concept.

The Company is in a reload versus rebuild situation. While macroeconomic factors and systematic risk contributed to our revenue performance in 2014, and general industry risk aversion affected our ability to generate sales orders within the oil and gas and chemical processing markets, we cannot decouple operating results -- or rather operating tactics -- from results. Our focus is therefore tier. To reload and generate results, the Company has rationalized its focus, both from a geographic and a market perspective, and implemented austerity measures to realign our cost structure with the economic conditions and organizational priorities. Let's first address the aperture of our focus.

On our December 8 capital markets day, we quantified the global recurrent total adjustable market as being around $4 billion. This addressable market presented three segments: water, oil and gas, and chemical processing. While we are confident that this market opportunity can be monetized over time, we will not attempt a wholesale penetration effort for a number of reasons, not the least of which are relative size and resources. Our market priorities from a diversification perspective are therefore gas processing, ammonia, and fracking, with a specific focus on North America. In all of these markets, the lion's share of the opportunity resides in North America. We will continue to evaluate opportunities beyond North America. However, such will be done on an opportunistic basis only.

While the risk aversion to new technology has contributed to our slow pace of adoption, it is not the only factor. While we deployed a dedicated global sales force and hired a seasoned oil and gas executive as our Chief Sales Officer, we did not create an execution framework that allows for rival shop business development and accounts for the complexity of achieving the technical qualification of our solutions. To this end, we have recalibrated the sales process, derived an actionable go-to-market strategy, and launched a technical sales consultancy solely dedicated to achieving the specification of our offerings into either retrofit or greenfield oil and gas or chemical processing opportunities.

To provide more color as to the intensity of the go-to-market effort, we implemented a strategic account management program and identified, profiled, and triaged the top 25 gas processors in North America. We have assigned account directors and executive sponsors to all strategic accounts to ensure adequate coverage. We are running existing leads and new leads through a classic stage-gate sales process. We are developing rifle-shot marketing programs specific to each account, targeting decision makers at both the corporate and plant levels. The deployment of this operational framework will not guarantee but rather increase the probability of quantifiable results and allow for optimal resource allocation.

What does this mean in the context of sales order generation and our pipeline generally? We have, in the past, quantified the pipeline as a means of conveying progress. We will abandon this approach as such does not meet the criteria of being meaningfully quantifiable. I can, however, say that after a comprehensive examination, we are pursuing opportunities within a pipeline, the integrity of which continues to improve, and will only announce actual contract awards. Again, we seek to generate and communicate quantifiable results. Let us now discuss the austerity measures implemented in January 2015, namely this year.

Even excluding a number of non-recurring expenses and accounting for significant R&D investment, the majority of which related to the VorTeq, our cost structure did not align with market realities. An OpEx of $35 million is not acceptable. In response, we executed a reduction of force of nearly 10% of total headcount, significantly cut discretionary spending, and reallocated resources to support the sales process within oil and gas and chemical processing, and to support the forthcoming field trials for the VorTeq. While our operating leverage is significant, and an impediment to profitability given depressed revenues, we will continue to right-size our cost structure as market conditions change. Let us now segue to a discussion on the VorTeq.

Consistent with our announcement during the capital markets day, the Company is in the final stages of preparation for field trials with our strategic partner Liberty Oilfield Services. These field trials are on track to commence prior to the end of this month, namely the end of the first quarter of 2015, and are expected to last at least six months. We are excited about the months ahead and will approach the process with the utmost diligence. To set expectations, we will not provide updates on the status of the field trials until we can, with certainty, conclude that the solution is fit to progress to the next stage of commercialization.

I can, however, characterize the industry's response since we unveiled the VorTeq back in December. Simply put, we are encouraged by the level of inbound interest and, to this end, are at varying levels of engagement with a broad sample of the industry across all sizes of service providers. We are keenly aware of the challenging market environment due to crude oil prices. And while rig counts and completion activity have fallen, we believe the economic power of the VorTeq value proposition will still allow for an appreciable rate of commercialization within a wide band of oil and natural gas prices.

Prior to the financial discussion, let us end with an update on our core market, desalination. We have often discussed the inherent volatility of the market specifically within the megaprojects segment. 2014 was an exceptionally lumpy year, as evidenced by our depressed revenues of $30 million. While we can examine region-specific reasons for this volatility based on economic trends, political unrest, and the like, the dialogue is better served by restating our belief in the long-term fundamentals of water scarcity, the resulting demand for desalination plants, and the strength of our position in the marketplace. As and when growth normalizes, Energy Recovery is best positioned to capitalize on this growth.

We are sensitive to our investors' desire for clarity on the near-term outlook for desalination. As a result, we have resumed a policy of announcing material contract awards and will characterize said awards in such a way to increase visibility while at the same time protecting sensitive information around pricing.

Let's recap. 2014's results were unacceptable, and the Company has responded quickly and decisively. We rationalized our market and geographic focus to increase the rate and probability of penetration. We designed and are executing against an actionable go-to-market strategy. We right-sized our cost structure while still allocating resources towards product commercialization. We are on track to schedule -- we are on schedule to begin the VorTeq field trials prior to the month end.

In summary, the Company has reloaded its strategy, transitioned from ideation to execution, and is moving forward at an informed yet aggressive pace. And while the financial results were lackluster and unacceptable, the innovation accomplishments were significant and very promising. With a reloaded strategy and a revitalized culture, I am excited to steer this Company into the new year and look forward to relaying future results accordingly.

Now, a brief examination of our financial results. Beginning with the fourth quarter, as compared to the prior-year period, revenue of $14.8 million represented a 36% decrease from $23.2 million. Primary drivers were lower MPD shipments offset by increased OEM and aftermarket revenues as well as oil and gas revenues attributed to an operating lease and subsequent buyout.

Similarly, gross profit margin decreased by 200 basis points, ending at 61% as compared to 63% in the fourth quarter of 2013. In descending order of impacts, lower production levels and a shift in mix away from PXs towards pumps and TurboChargers resulted in the margin decline. Further examining the shift in mix, not only did PX-derived revenues decrease as a function of lower MPD revenues, but we witnessed a mix shift towards pumps and TurboChargers within the OEM sales channel. Primarily a result of increased R&D expenses associated with the development of the VorTeq, as well as increased and non-recurring legal and administrative expenses, OpEx increased by 78% to $13.8 million from $7.8 million in 2013. On lower revenues, decreased margins, and increased OpEx, the Company generated a net loss of $4.9 million, or $0.09 per share, as compared to net income of $6.7 million, or $0.13 per share, in the prior year.

The full-year results for 2014 were very much a macrocosm of the fourth quarter, with lower revenues, decreased profitability, and higher OpEx. Specifically, revenue declined to $30.4 million from $43 million in 2013, or by 29%. Both MPD and OEM produced significantly less revenue than the prior year, offset by higher aftermarket revenue and oil and gas revenue attributed to an operating lease and subsequent buyout.

On lower revenues, gross profit margins decline 500 basis points to 55% from 60% in the prior year. Lower production levels in response to lower revenue, coupled with the shift in mix away from PXs towards pumps and TurboChargers, drove the decline in gross margins. As compared to 2013, PX revenue as a percent of total revenue declined by 11% to 69%, primarily due to a decrease in MPD revenue of $13.2 million. Driven by increased R&D expenses primarily attributed to the development of the vortex solution and non-recurring legal and administrative expenses, OpEx increased by $6.6 million to $35.2 million from $28.6 million in 2013.

On summary -- in summary, on lower revenues, decreased margins, and increased OpEx, the Company generated a net loss of $18.7 million, or $0.36 per share, as compared to a net loss of $3.1 million, or $0.06 per share, in the prior year. For the full year of 2014, the Company generated net cash flow of $1.1 million. Contributing to cash used by operating activities of $3.7 million was the continued monetization of receivables on lower revenue as compared to the prior year, offset by increased inventory given lower levels of demand and the delay of project shipments into 2015.

Cash generated from investing activities of $6.5 million was chiefly the result of the maturation of marketable securities offset by capital expenditures of $2.6 million. Cash used by financing activities of $1.8 million reflects the repurchase of $2.8 million worth of common stock, or approximately 700,000 shares, offset by proceeds resulting from exercising of options and warrants. Excluding current and non-current restricted cash of $5.5 million, the Company reported unrestricted cash of $15.5 million, short-term investments of $13.1 million, and long-term investments of $300,000, all of which represent a combined total of $28.9 million.

This concludes our prepared remarks, and we will now take questions.

(Operator Instructions) Patrick Jobin, Credit Suisse.

How should we think about growth prospects looking out to next year with field trials starting? Any way we can kind of put it in context what growth could we expect for new markets?

Specific to fracking, Patrick?

Yes. Sorry, to be more precise, to fracking.

Sure, sure. As I stated, we are on schedule to begin field trials prior to the end of this month. It's our expectation that those field trials will last at least six months. It could last three months; it could last nine months; could last a year. The point is that we are committed to staying the course, and we're not going to submit to any explosive deadlines. So from a 2015 standpoint, expectations should be that this is a year of field validation. And depending upon the success and pace of that field validation process, we will segue into commercialization to 2016.

Got it. And then I appreciate resuming the policy of disclosing contract awards on the desalination business. I guess to bring this up to speed perhaps with -- I guess perhaps contracts that might have been won that weren't announced, how should we be thinking about megaproject desalination in 2015? Is there any way you can quantify the backlog? Any help on visibility in that market would be much appreciated.

Sure, sure. So I will give you a bit of a mixed bag, Patrick. Desalination -- the level of uncertainty and volatility that we witnessed in 2014, there are no clear signs that that growth will -- rather, that that market will resume a normalized growth rate in the near future. Okay? So specifically within the MPD division, we have witnessed a number of delays, just call it the bid table shifting into the outer years, and, of course, that's what drives growth in that industry are the large greenfield opportunities.

Now having said that, we did witness the bid table strengthening a bit in the fourth quarter of 2014. Now, is that an indication that revenue generation will benefit from that slight increase in the strength of the bid table in 2014? I can't answer that. But fundamentally, obviously we are committed to that market. The long-term fundamentals are strong, our market position is commanding, and we will continue to evaluate opportunities and react as quickly as we can.

Got it. And I apologize if I missed this in the first few minutes. It was a late flight here; I had to hop on late. Can you maybe update us on the management changes that have been announced and the current status and, I guess, search process?

Yes, I believe that's under my compartment here. And we currently have a CEO search underway. We are evaluating a number of candidates, and this is where we are. So our mission here is really to find the best suitable candidate to lead ERI going forward.

Great. Thank you.

JinMing Liu, Ardour Capital.

At this juncture, my question is about what direction Energy Recovery will take in terms of the (inaudible) of desal and oil and gas.

Could you clarify that a bit for me, JinMing?

Yes. Just say which -- when Tom was in the office, ERI was almost 100% emphasizing oil and gas opportunities. And the ways -- what the Board thinks at this moment for your direction of your (inaudible), whether (multiple speakers) -- yes.

Sure, sure. Okay. So there are three primary segments where we have identified attractive fluid flow markets. Clearly, desalination or water, oil and gas, and chemical processing. So the direction of the Company -- it's not an either/or, which is to say you are a water company or you are an oil and gas company. Our concern is, of course, in the fluid flow applications.

From a focus standpoint, as a detailed in my opening remarks, we have rationalized our strategic end-market focus, JinMing. On December 8, we unveiled about a $4 billion opportunity, and we're confident that we can monetize that opportunity over time. But frankly, that is an order of magnitude larger than what a Company of our size can effectively penetrate in very short order. So as a result, we have distilled that market opportunity down from $4 billion to what we consider to be an actionable $1 billion to $1.5 billion focusing on gas processing, ammonia in North America. Okay? And then, of course, the other focus that we have this year is on supporting the fracking initiative.

So the strategy of the Company to leverage its core competencies in advanced material science and fluid dynamics and to utilize those core competencies to identify pressure energy cycles where energy is being wasted, we will continue. And currently, again, the three segments are water, oil and gas, and chemicals.

Okay. Regarding your focus on the oil and gas and the chemical industries, I think my -- at the current three (inaudible) of those three, two are based on the turbo technology, if I'm not mistaken. So my question there, whether you see a threat from the technology point of view, other companies could copy your early success (technical difficulty) sense.

Yes, so that is correct. Both gas processing and ammonia are opportunities that are served for IsoBoost, which is a TurboCharger-based technology. We are comfortable with the level of IP that we have around that solution. But at the same time, we are cognizant of the fact that we are not the only ones who produce TurboChargers for either water, industrial water, or oil and gas applications. And so, differentiation is key for us, as is first-mover advantage. And we are -- we are attempting to maximize both of those advantages as we step through these early and, at times, painful phases of commercialization.

Okay. Got that. Thanks a lot.

Kenneth Hershberg, Hershberg Capital.

Could you tell us a little bit more about the ConocoPhillips contract? What vertical was that for, how much was it for, and when do you expect to ship it?

Good afternoon, Ken. Sure, I will provide some color on the ConocoPhillips -- so first of all, it was a capital sale. By virtue of the contract, we cannot disclose the price. It is a IsoBoost for gas processing that will be installed sometime between the second and third quarter of this year within one of their plants. Now, this is a plant that has lower mean flow and therefore lower levels of throughput or nat gas production.

So as you examine the market analysis that we put forth on December 8, we had a global ASP of around $1 million for the IsoBoost for gas processing. This capital sale was materially lower than that by virtue of the size of the plant as well as -- we understand that technical -- the hurdle of technical adoption is very high. Okay? So we have to incent customers to take on the technology risk.

But what's most important to the Company, Ken, is that ConocoPhillips is a blue-chip E&P. And we look forward to establishing them as a reference and getting that unit online such that it can propel future sales in gas processing.

Okay, another question is about the IsoGen use in the pipeline transport. Are you still pursuing that? And has Alex Buehler been helpful in that area?

Yes, yes. We are pursuing it. However, our priorities for this year -- P1 gas processing, P2 ammonia, and then, of course, franking is a bit different. That's a field trial support. We are evaluating pipeline opportunities with the IsoGen technology. However, we are doing that on an opportunistic basis. We believe that we will gain the greatest traction through gas processing and ammonia penetration tactics.

Okay. And then at your December 8 conference, you said you expect the -- VorTeq to be installed and tested in January or February. And now we're talking about the end of March. What were the delays?

I don't recall saying that, Ken. I think we had always communicated somewhere prior to the end of the first quarter. So as far as we're concerned, we are on track; we are on schedule to do that. I'm not aware of any delays.

Okay. Thank you very much.

(Operator Instructions) David Rose, Wedbush Securities.

I do appreciate the candor. I think it's really helpful. A couple quick ones if I may. First is, how much were legal expenses in the quarter? And do you see them going up, flat, or down sequentially?

I don't have the exact number on the legal expenses as a single item. I did characterize the increase as being attributed to some non-recurring expenses, the subject matter of which is privileged. So I think -- I don't think -- you will see a resumption of steady-state OpEx spend in 2015.

So what sort of OpEx spend should we expect starting in Q1?

David, as you know, it is our policy not to provide guidance, whether it be top line, gross profitability, or OpEx. What I can tell you is that the austerity measures that we implemented early in January were very broad, and they were immediately done such that we could benefit from those reductions in 2015. Rather than provide to you a number, because, again, we don't provide guidance, what I can tell you is that we believe that we are properly right-sized given the market realities and the commercial priorities of the Company.

Maybe I can back into the non-recurring items all in. Give me a ballpark approximately? $2 million, $3 million, $4 million?

Yes, I would say non-recurring items were around $6 million.

Okay. And if I look at the payment consideration of $1.4 million on the cash flow statement, what was that for?

Yes, so that -- we actually re-classed that, David. In prior disclosures, it was captured in cash flow from operations. That relates to a settlement on the Ratacovic litigation matter or the litigation matter with the former shareholders of Pump Engineering Inc.

And then if I look at the -- I know you don't provide any guidance, but maybe I can better understand the inventory levels were fairly high in Q1. Does that relate to some shipments in Q4 that you were expecting, or is that just trying to level-load the factory?

Yes, so let's talk about that, David, because I know you have had questions about our inventory levels in the past. We endeavor to level-load production as a way of managing demand volatility or variability. Midway through the year, when we realized that the bid table was shifting out, of course we recalibrated our production activity and decreased it. However, we had still accumulated a fair amount of inventory up to that point. So that's one factor. The demand equation changed in the middle of the year, if you will.

Number two, as you pointed out, there were a few shipments, relatively large ones, that were scheduled to ship in the fourth quarter of 2014 and have shifted into 2015. So we are carrying inventory that is discreetly tied to shipments that are under contract.

Okay. So timing of which is still uncertain. You probably don't want to nail down the quarter, Q1 or Q2, but sometime in 2015 (multiple speakers).

Yes. Exactly, exactly. The timing is forever uncertain. This is -- I can tell you it is an MPD shipment, and we will be making an announcement here on that.

Okay. And then last question and I'll get back into the queue. The share repurchase that took place in Q4, was that just a function of offsetting the options?

No, no. So the Company -- we've been very active in repurchasing our common stock over the last three years. The Company does not trade on an arbitrary basis, rather through a 10B51. So we had a trading formula and, at certain price points, trades were triggered. But that Board-approved repurchase plan expired on December 31 of 2014, so the Company at this point does not have any plans on continuing to repurchase common stock.

Okay, great. Thank you very much. I'm all done.

And there are no further questions at this time. I would like to turn the conference back over to Mr. Joel Gay for any additional and/or closing remarks.

None here. Thank you all for participating. Look forward to talking to you in May.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.