Energy Recovery Inc (ERII) 2022 Q2 法說會逐字稿

Greetings, and welcome to Energy Recovery's Second Quarter 2020 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, James Siccardi, Vice President, Investor Relations. Please go ahead, sir.

Hello, everyone, and welcome to Energy Recovery's 2022 Second Quarter Earnings Conference Call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery, and I'm here today with our Chairman, President and Chief Executive Officer, Bob Mao; and our Chief Financial Officer, Joshua Ballard.

During today's call, we may make projections and other forward-looking statements under the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995 regarding future events or the future financial performance of the company. These statements may discuss our business, economic and market outlook, growth expectations, new products and the performance, cost structure and business strategy. Forward-looking statements are based on information currently available to us and/or management's beliefs, assumptions, estimates or projections. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors.

We refer you to documents the company files from time to time with the SEC, specifically, the company's Form 10-K and Form 10-Q. These documents identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. All statements made during this call are made only as of today, August 3, 2022, and the company expressly disclaims any intent or obligation to update any forward-looking statements made during this call to reflect subsequent events or circumstances, unless otherwise required by law.

At this point, I will turn the call over to our Chairman, President and Chief Executive Officer, Bob Mao.

Thank you, Jim, and thank you, everyone, for joining us. We are all hearing a lot of negative global and domestic economic views. Inflation is high. There is war in Europe and we may already be in a recession. Equity moves, though, a little better recently, have followed swifter than any time in decades. Yet here at Energy Recovery, we continue to make substantial progress in all 3 of our business markets despite this noise around us. Our growth targets remain intact and our optimism resilient.

I'll remind you that regardless of the domestic economic headwinds, more than 98% of our business is overseas. Despite high inflation, our profitability remains robust, owing to the strength of our margins reflected by the reputation and the value creation of our PX technology. Despite supply chain disruptions, we continue manufacturing without pause because our team's foresight to build inventories well before supply chains were issued. Despite turmoil in the financial markets, we maintain ample cash reserves. And despite the rise in interest rates, our business, which currently has no reliance on debt, has not been directly impacted.

Our core market is desalination. We help provide water to millions of people worldwide. We believe this basic human need will largely weather current global economic uncertainties as it has in past years. The need for water in an increasingly water-scarce world remains a strong motivator for investments in this sector. As of today, we believe we remain on track in our desalination and the industrial wastewater market to meet our guidance of 25% revenue growth for 2022. Our mega project channel remains strong, and we are seeing a resurgence in our smaller OEM desalination projects from the COVID-related pent-up demand. In addition, the increased global water scarcity is leading to a regulatory environment that is pushing filtration requirements of industrial wastewater. In short, we feel we are well positioned today and poised to execute on the strategy we have laid out ahead of us.

Today, I will focus our discussion on industrial wastewater and CO2, and Josh will provide you with some more specific updates about how the desalination business is evolving this year.

With that, let me move on to industrial wastewater. At the end of the second quarter, we had already exceeded 2021 revenue by 60% and are well on our way to meet our forecast of $3 million in industrial wastewater revenue for fiscal 2022. I mentioned in our last call that we were collecting performance data from our first commission in industrial wastewater plants. Results from the field show that our new Ultra PX achieving efficiencies of at least 93%, and we are generating the savings for our customers that we promised.

For example, at one lithium battery plant, our technology is saving the facility roughly $150,000 in electricity cost per year based on 2021 electricity cost levels with an estimated 1-year payback. At a textile plant in India, a $500,000 investment in our technology is netting an estimated $500,000 per year in savings, again, based on 2021, electricity costs. This translates into value creation of 10 to 15x the initial investment over the life of this wastewater plant. We expect to see similar savings results in other wastewater verticals as well.

With rising energy costs, we expect these savings to increase and accelerate in the coming years. We believe these real-world savings will help further improve the value proposition of reverse osmosis processes in industrial wastewater which, of course, are driven by the energy savings provided by our products.

We are now able to use this data to educate and further penetrate the markets where we have a presence. For example, we received our first award with the lithium battery recycling market in China during the second quarter. This installation will give us our first reference site in this lithium subvertical. We have now penetrated 3 subverticals of the lithium ion battery value chain, namely lithium mining, battery manufacturing and now recycling. This is a significant milestone for us as we continue to build volume in this space, especially given the significant position China place in this global market.

We have previously spoken about the potential of the overall lithium market and our estimated total addressable market of likely more than $200 million this decade because of the global urgency to expand lithium this capacity, our teams will continue to prioritize this market and have already identified numerous projects in various stages of planning between now and 2030.

Another industry where we have early success is textiles. Water is used in multiple stages of the textile manufacturing process. And the industry overall generates nearly 5 billion tons of wastewater per year. Textile is one of the top 3 water-wasting industries in both China and India. Combined, these 2 countries discharge over 2.5 billion tons of wastewater every year. Today, the textile industry is looking for ways to reduce water deference and to reuse as much wastewater as possible for a variety of reasons, including regulatory pressures, rising costs and limited availability of freshwater in the increasingly more water-scarce world and the fact that many chemicals in the textile process can be recycled and reused or so.

We have had the initial success in textiles, with approximately 15% of our sales occurring within this industry. We currently estimate a potential TAM, in China and India alone, of about $75 million today, growing to over $100 million by 2026 and $140 million by the end of the decade. Importantly, India has announced intentions to double the size of their textile output by 2026, is investing in textile hubs with centralized wastewater treatment centers. The centralized treatment model which will keep process larger flows of wastewater should provide an exciting opportunity for energy recovery.

All told, the lithium battery and textile markets could reach a total TAM for this decade of more than $340 million. In summary, we believe these 2 verticals represent critical market opportunity to serve as the core revenue-generating focus for our industrial wastewater unit. We will keep you updated on our progress we see in these 2 verticals in the coming quarters as we continue to drill down within them and will highlight additional wastewater verticals in future calls as we continue to push for increased volume sales in this business.

Now let us discuss our CO2 business where again global regulations are forcing a transition from HFC refrigerants to more climate-friendly natural refrigerants due to more global warming, providing tailwinds that drive future potential growth in CO2. While this transition will occur with or without us, the response we have received thus far seems to indicate the industry's desire to ease the OpEx challenge natural refrigerants pose.

First, we're pleased to announce that our first PXG was commissioned in a new grocery store in Southern Europe, and the initial results are exceeding expectations. Installation and commissioning went smoothly, and we have been consistently reducing the energy load of the rack by over 20% during days were temperature ranges from 30 to 35 degrees Celsius or 86 to 95 degrees Fahrenheit. It is important to note this first name was not a PXG-centric system. The unit was fully integrated into rack control systems, but mechanical is separated. Almost like the bolt-on, we will be deploying at Vallarta in California.

Our European partners initial priority was the reliability of our technology in the field and this architecture provides our partners with the ability to isolate the PX should any issue arise. Therefore, in this first installation, energy efficiency was actually a secondary consideration. However, despite these less-than-optimal architectural conditions, the PXG efficiency has provided pleasantly surprising upside to our partner. We believe that with a fully integrated PXG-centric build, we can achieve even greater efficiency for our customers. Our initial success with this customer has already led to preliminary discussions for additional PXG-centric deployment at new sites possibly later this year.

In addition to our successful commissioning, I am pleased to announce we entered into a second joint development agreement with a large U.S.-based refrigeration manufacturer. Our new partner has indicated that they intend to deploy our PXG later this year or early next year. We're also engaged in advanced discussions with additional refrigeration manufacturers and hope to sign and deploy our technology in the coming months.

We have also received a strong response from the G PXG reference designs we published on our website this summer. These reference designs provide manufacturers a number of PXG architectures to consider as they design their own next-generation PXG-centric CO2 refrigeration brand. This move has further gained market acceptance and the expedited relations with additional OEMs. We hope to see further deployment with these OEMs as well.

Finally, an update on our installation of Vallarta Supermarkets. While we had hoped to have commissioned our unit during the second quarter, we are now on track to commission in September. Much of the construction work has been completed and our testing of the scale has been ongoing. Vallarta remains excited about the technology and has begun preliminary discussions about additional future PXG-centric deployments.

In summary, we made material progress this quarter. We believe that our technology is being viewed by the refrigeration industry as the sought-after solution to the OpEx challenge of transitioning away from climate-harmful HFCs and toward more climate-friendly natural refrigerants. Our strategy to leverage distribution efforts established by existing manufacturers is beginning to show promise. Now we are gathering data from the field installation that is proving to the industry the value of our technology in real-world situations, while more and more industry participants are taking notice.

We expect to begin in earnest discussions with our partners regarding volumetric orders so that we can commence the necessary planning needed to meet their delivery requirements for 2023 and beyond. We will provide further updates on our progress in CO2 and our next earnings call in November, including how we see volume ramping up in 2023. With that, I'll hand it over to Josh.

Good afternoon, everyone. We generated $20 million in revenue this quarter, as guided during the Q1 call, relatively flat against Q2 2021. Results for this quarter's revenue were driven by the timing of mega project shipments which, this year, are weighted to the third and fourth quarters as communicated in May. For example, while year-to-date mega project revenues are down 9%, based on our contracted backlog, we are anticipating a strong second half highlighted by a very robust fourth quarter. By year-end, we expect full year mega project growth in the 10% to 15% range.

Notably, OEM revenues are up 75% year-to-date. Total OEM revenue for the year includes $1.6 million in industrial wastewater sales which, as Bob mentioned, is on pace to achieve our full year guidance. OEM desalination revenue has grown closer to 50% year-to-date, which we currently expect to hold through the end of the fiscal year. Overall, we continue to finally see our post-COVID return of desalination OEM and aftermarket revenues due to pent-up demand which, as of today, is expected to continue through the end of the year. We have no change to our revenue forecast for the year, although we continue to keep an eye on end-of-year shipments in our very large fourth quarter.

As I mentioned last quarter, we expect gross margin to moderate this year and we have begun to see this in the second quarter. There are 2 things at play here: first, our product mix changed in the second quarter, reflecting an increase in sales of non-PXG products, which naturally puts pressure on our top line blended margin. We've seen this occur several times over the years. Second, while we are not yet reflecting inflationary increases in our pressure exchanger costs this year, we are experiencing some inflationary pressure on raw materials for pumps and turbochargers which has weighed on margins. While we are working to mitigate these increases, we do not expect to see our margin improve considerably in 2022. Again, we maintain our guidance of 66% to 68% gross margin for the year.

Note that we do expect to see additional increases in costs in 2022, particularly for labor and other inputs such as energy and shipping. The majority of these increases will not be reflected in 2022 margins, in part owing to our overall inventory build that has already occurred, but we cannot delay inflation forever. We do not anticipate that the overall effect of these increases will be large however, and we will be prepared to discuss them in more detail during our Q3 call.

Our OpEx grew about 24% year-over-year in the quarter. However, keep in mind that this includes a $1.3 million onetime expense due to the cessation of our VorTeq activities. About $1 million of this is reflected in R&D spend and the remaining $300,000 in G&A. Therefore, on an adjusted and recurring basis, OpEx grew 15% year-on-year, largely driven by sales and marketing as we naturally grow spend from our COVID lows and focus on building our industrial wastewater and CO2 businesses.

For example, we have greatly increased the number and frequency of trade shows and conferences as we work to reengage with customers in desalination after COVID as well as to expand our messaging and industrial wastewater and refrigeration. R&D remained relatively flat year-over-year, and G&A grew about 8%.

Importantly, overall adjusted operating expenses showed a nominal increase of only 1% over first quarter this year. We are still targeting around 50% OpEx as a percent of revenue by year-end, excluding these onetime VorTeq-related expenses, as increased revenues in the second half of the year should begin to balance out our spend.

We closed the quarter with a cash and securities balance of $87 million. This $10 million reduction from last quarter is entirely due to the share repurchase program. Our free cash flow has actually increased by $12 million for the quarter, due mostly to increased collections but were offset by nearly $19 million of buybacks. We completed the repurchase program on July 1. All told, we repurchased $50 million of stock at an average price of $18.57 for a total of 2.7 million shares. As of today, we have not put a new buyback program in place but, of course, we'll let you know if it changes.

With regards to our operating cash flow, as I discussed last quarter, we continue to see increased inventory levels due to the lower shipments this quarter. Despite these lower shipments, we continue to produce at a level loaded pace to satisfy demand for the much larger planned third and fourth quarters, which increased inventory levels up to about $28 million.

Finally, I'll give you a brief update on VorTeq. We have not been successful in signing a partner to date. Although we continue discussions with a couple of potential interested parties, activities have been reduced to the point where we made the decision to shut down operations. This resulted in a $1.3 million onetime expense driven by severance and accelerated depreciation. All told, the cash component of this onetime expense was only about $200,000.

With that, we can now move to Q&A.

(Operator Instructions) Our first question comes from Nils Thommesen with Fearnley Securities.

I was just hoping to get some additional color on capital allocation going forward. If you could share anything on, for example, CapEx requirements for more capacity and what potentially you need to build in working capital so we can have our own thoughts around future potential shareholder resolutions.

Sure. This is Josh. I'll take a hill take. This year, our CapEx spend is pretty much in line with last year, not any major changes. As we look forward, what is going to drive increases in CapEx or working capital will, any large degree a material degree would be CO2 refrigeration. And so as we start to talk about that potential ramp up in future quarters, we'll be able to define that a little better, right?

So depending how far CO2 refrigerant, how quickly and how far we go will really push our CapEx. We have to build in a facility or increase capacity in existing facilities, that's what will drive that in the coming future, if that makes sense, as well as working capital. Otherwise, our current cash flows can easily cover our operating cash flow we're spending in order to grow desalination and industrial wastewater.

And at this point, is there any reason to believe that a new CO2 refrigeration construction site would be more expensive than the last one you constructed for desal?

No. I think the open questions will be where we build it. So if we don't expand in existing facilities, for example, if we decided to build closer to where other refrigeration manufacturers are or if we had customers in Europe who want to go close to whatever that may be, that could entail a little more cost or because volumes will be increasing so much if we look at more automation and so forth in our manufacturing process. Those things could define up or down. But either way, I don't think it's going to be dramatically higher than what you've seen in the past and what we've talked about.

(Operator Instructions) Our next question comes from Wally Walker with Hana Road Capital.

Just spend one more time on your CO2 business and testing it. Do you have any updates as you think about it on the TAM for that business? And also, as you are spending the time in testing, any adjacencies that have come forward that you hadn't considered just as you're starting to look at that new business?

Thank you, Wally. In terms of TAM, quite a few earnings calls ago, we had said that the refrigeration TAM, by the end of the decade, could be [1 million]. That's probably still is a good number to work with. But of course, you're going to say tell me closer than at the end of today. We think it's quite large, Wally. And in November, we have more explicit quantitative numbers for you. The TAM in part, also depend on how much and how good, which we consider pretty good, is our value proposition. And the temperature range that we can serve very effectively both with our testing results and early results from the actual real-world test are very encouraging. So Wally, next time, we'll give you very specific numbers. I can say from ERI's perspective, the TAM is large.

In terms of adjacencies, Again, we'll talk next time. The flip side refrigeration is heat. And in the first degree of approximation, it is the mirror image of refrigeration, and we are evaluating that. In fact, we are discussing with some OEMs on this other side. Again, more specifics to come next time, Wally.

(Operator Instructions) As there are no further questions, I would now like to hand the call back to Mr. James Siccardi for closing remarks.

Thank you, Peter. As a reminder, our prepared remarks can be found on the Investors section of our website. With that, I'd like to thank everyone for joining us this evening. We look forward to talking to you again in early November. Thank you.

Thank you. You may disconnect your lines at this time. Thank you for your participation.