Energy Recovery Inc (ERII) 2024 Q1 法說會逐字稿

Greetings and welcome to the Energy Recovery first-quarter 2024 earnings call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, James Siccardi, Vice President of Investor Relations. Thank you, Mr. Siccardi.

You may begin. Hello, everyone, and welcome to Energy Recovery's 2024 first-quarter earnings conference call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery, and I'm here today with our President and Chief Executive Officer, David Moon, 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 1995 regarding future events or the future financial performance of the company. These statements may discuss our business and economic and market outlooks, growth expectations, new products and their performance, cost structure, and business strategy. Forward-looking statements are based on information currently available to us and on 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, May 1, 2024, 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 President and Chief Executive Officer, David Moon.

Thank you, Jim, and thank you all for joining us today. The first quarter was a busy one for us and played out as anticipated. Revenue at $12.1 million was in line with our guidance for the quarter of $10 million to $13 million.

With regards to the CFO transition, we have been actively interviewing some promising candidates and are making real progress. We believe we will have our candidate in place prior to Josh's last date of June 30.

I stated on our last call that I, as well as the Board, strongly believe energy recovery strategy of PX diversification to drive growth is the right strategy and is critical to our future. While continuing to recognize the importance of maintaining our foundational market leadership and desalination, it is critical that we also continue to look for ways to accelerate our penetration into the wastewater and the CO2 refrigeration markets, as this is from where the lion's share of potential revenue growth will originate. We anticipate our strategic future will build off this perspective.

We have now formally kicked off work on our strategic planning cycle and have enlisted the assistance of industry experts to provide us additional guidance, specifically in wastewater and refrigeration. These industry experts will play integral roles in providing intelligence and hard data. While challenging us on our product development and market strategy and contributing to the development of our strategic playbook. This will add significant expense in the second quarter especially, but I believe it is critically important work to establish a strong strategic foundation from which to grow in the coming years.

Now, let's get into our update, starting with water. First, we are maintaining our revenue guidance of $140 million to $150 million for the year. Our current 2024 contracted projects, including the revenue recognized in the first quarter, totals roughly $87 million, or 60% of the midpoint of our guided range for the year. This compares to $69 million, or 50% of the guided range, at the same point in 2023. This reflects a 26% increase over year and underpins our confidence in our guidance for the year.

In addition, we also just signed our first megaproject deal in Brazil for shipment in 2025. In our second quarter call last August, we discussed in some detail the growing wastewater challenges in South America. This project is a clear example of how growing water challenges outside of the Middle East, desal's historic growth area, are being reflected in our pipeline in new ways. The cadence of this year's revenue guidance is unchanged. We remain heavily weighted towards the second half of the year.

We are seeing real strength in both our desal OEM and aftermarket sales, as we start the year and have signed most of the megaproject deals for the year. Our focus today in water is to close the handful of megaproject deals remaining in the coming months, as well as maintaining our momentum in our OEM and aftermarket channels to end the year as strongly as possible.

Our wastewater business is also developing well this year, and we remain confident in our range of $12 million to $15 million for the year. Our pipeline continues to grow, and we've increased our signed wastewater contracts by almost 40%, as compared to last year at this time.

We've also seen positive news here locally in the US as it relates to the municipal wastewater market. The United States government on April 10 announced newly adopted rules to address PFAS contamination, or forever chemicals, in our drinking water. The Biden administration has allocated $9 billion to help communities with drinking water impacted by PFAS.

Now, one valuable tool for filtering out existing PFAS from drinking water is reverse osmosis filtration. While it's not the only solution to this problem, we believe reverse osmosis can play a key role in the coming years, as the world tackles this growing challenge, and we will be exploring these opportunities and the timing of them in our playbook. The global attention on PFAS continues to underscore the growing focus on water quality and scarcity that is happening around the world today.

Now, let's move on to our CO2 business. The past few months, the most important activity I engaged in was to meet with major OEMs in the US and Europe. I have a few key takeaways from these meetings, all of which support the approach we are taking this year. First and foremost, the interest in and the feedback on the PX G was positive. OEMs can see the potential value of the PX G in their systems and remain very interested in our success.

Second, OEMs are looking for more quality, uninterrupted run-time data during the summer months, which is the goal of our activities this year. This data will provide reliable performance data in the field, which is critical to OEMs and end customers to fully accept our product in the marketplace, to fine-tune our value proposition, and to be a catalyst to allow energy recovery to take a substantial step forward to building commercial relationships with the OEMs.

Third, once the OEMs have comfort in our data, it is clear that our best path forward will be to integrate the PX G directly into the rack architecture of OEMs' CO2 systems. This will mean that OEMs will need to commit engineering resources to adjust their existing architectures to incorporate the PX G. This is a commitment of time and money, and therefore another reason why field data is so key to creating broader acceptance for the PX G.

At the last earnings call, we discussed two gates to better position ourselves for future market penetration and revenue growth. These gates directly support the feedback we received from the OEMs in the first quarter.

The first gate is the successful completion of testing of our second-generation PX G in our internal labs by the end of Q2 2024. I am pleased to announce that we've achieved this milestone. Lab performance has shown an order of magnitude increase in reliability and performance, which is critical to providing the uninterrupted runtime data we need this year.

The second gate is the successful installation, operations, and third-party validation of 30 to 50 additional field validation sites by the end of Q2 2024. Our first steps is to install roughly 10 sites this summer, which are the most critical sites for this year and will provide the key performance data that we need. As of today, we currently have three sites running. We expect four additional sites to be commissioned by the end of June in Canada, Belgium, Hungary, and the US. The remaining three sites are scheduled for Europe and the US by the end of August. I will continue to update you on our progress in August, but we're off to a strong start to the year.

Outside of these critical activities, I have two other updates from the market. First, our PX G was awarded the Refrigeration Product of the Year by ACR News London. This award is a recognition of excellent innovation from across the air conditioning and refrigeration sector. The PX G was selected for its ability to improve year-round transcritical CO2 systems performance by reducing energy costs, which is perhaps the single biggest hurdle faced by supermarkets in adjusting to stringent global requirements. This is the third award we've received since the start of 2023, as the PX G continues to gain attention across the globe and should serve as further proof that technology is catching up to the changing regulatory environment.

Second, I have a quick update on the regulatory environment. The EU came out with new, more stringent regulations on the reduction in HFCs that became effective March 11. Whereas previous regulations reduced HFC usage from 31% of the 2025 baseline in 2024 to 21% by 2030, the EU has now accelerated this reduction. As of March 11, the EU must reduce usage to 24% of their baseline by 2025, 12% in 2027, to 5% in 2030. This is good news for CO2.

So, to sum up, the operational deliverables that I put in place for 2024 are as follows. Maintain and grow our dominant position in desalination. Grow our wastewater business to $12 million to $15 million in revenue. Install at least 30 to 50 sites in North America and Europe by the end of the year. And deliver our full revenue guidance for the year of $140 million to $150 million.

The work we do over the next several months will position us to deliver on our future in water and CO2 growth. In the interim, we remain one of the purest means to invest in the global water scarcity story.

With that, let me hand it over to the call to Josh to update you on the financials.

Good afternoon, everyone. First quarter revenue fell comfortably within expectations, with no real surprises and within the midpoint of our guidance from our last earnings call. Unlike the first quarter last year, our water channel mix was more balanced, with roughly half our revenue coming from megaprojects and the remaining split between OEM and aftermarket sales. Although our OEM channel shows a significant decline as compared to Q1 last year, this is simply due to the timing of project shipping. We currently expect to show healthy double-digit growth in our OEM channel in 2024.

We are reporting no material emerging technology revenue this quarter, which is in line with David's comment in February with regards with regards to our short pause to make and test the enhancements to the PX G, and now launch the second generation here in the second quarter.

We are maintaining our estimated range for water revenue in the second quarter at $20 million to $25 million. This means that we are still heavily weighted to the second half of the year. Where we sit today, we are assuming that the last two quarters will show 40% of the second-half revenue falling into Q3 and 60% in Q4. However, we will be better prepared to update you more precisely in our August call as the third quarter comes into focus. Note that our target water revenue range of $140 million to $150 million this year includes a buffer against possible movements of up to a couple of megaprojects.

David mentioned the status of our signed and shipped contracts here today. We have been getting a lot of questions on the status of our pipeline from all of you to get a sense as to how the year is progressing. Our plan is to continue to update you on this cumulative number as we move forward through the year to give you a sense as to how we are tracking to the current full year guidance. We will then reset in Q1 next year for 2025. Therefore, note that the $87 million cited for this year is explicitly for signed water projects in both our desalination and wastewater markets forecasted to ship out in 2024, inclusive of those shipped in the first quarter.

Our gross margin in the first quarter is 59%. Much like last year, we are seeing a product mix more heavily weighted to pumps and turbochargers in a low-revenue quarter, which is lowering our margin on a blended basis. You will also note that our margin is 190 basis points below Q1 2023, despite a similar product mix. This is because of the inflation and growing manufacturing costs that we have been describing over the past year.

We also experienced slightly higher scrap in the first quarter, which combined with a lower revenue denominator had an outsized effect on margin but will not be material for the full year. We fully expect to recover to our guided range as the year progresses and pressure exchangers take a larger percentage of sales. For now, we have no change to our guided range of 64% to 67%, and the year-on-year variance from Q1 2023 roughly falls in line with our expectations for 2024.

Let's now turn to operating expenses. Our OpEx grew 11% over the first quarter of last year. However, we are reporting a decrease of 4% against Q4 2023, which is a more relevant comparison. There are two things at play here. First, Q1 OpEx is inclusive of nearly $500,000 of what we call one-time executive transition costs, which you will note in our non-GAAP calculations in our press release. In addition, this quarter includes another $300,000 of short-term retention grants provided to some executives at the end of last year. Adjusted for these temporary charges of roughly $800,000, our base recurring OpEx grew closer to 7% year-on-year.

Second, our investments in people and the organization grew throughout the year in 2023 as we increased our sales and marketing spend and added headcount in support of both our water and CO2 businesses. Therefore, what we are seeing now is the effect of increased headcount and other spend in the first quarter for investments made in 2023.

Now that we are further into the year and our one-time costs related to the ongoing transition are becoming clearer, I also want to go a little deeper into our OpEx forecast to provide some additional clarity. In the second quarter, we expect our base recurring OpEx to remain fairly flat. However, we will have material one-time expenses related to executive transition and a significant portion associated with work in support of our long-term growth strategy, as mentioned by David in his opening remark.

These overall costs, which will include a mix of cash and non-cash items, could be as high as $5 million in Q2, meaning our OpEx will likely land between $22 million and $23 million. We are expecting an additional $1.5 million of these one-time expenses by the end of the year. When you add in the $800,000 of one-time expenses described earlier, this brings these charges to a total of about $7 million for 2024.

In light of some of these one-time expenses, we have made the decision to reduce our base recurring OpEx to around $71 million to $73 million versus my guidance from last quarter of $73 million to $75 million. Note that these reductions are in softer non-personnel discretionary spend and will not be in areas that could get in the way of our growth plan.

If you add our estimated $7 million of one-time costs, this puts our total forecasted OpEx for the year at roughly $78 million to $80 million. I realize that 2024 is a bit of an anomaly compared to prior years, but we should normalize again in 2025. We will be sure to clearly outline in this one-time spend each quarter so you can differentiate between our recurring operating spend and any one-time charges that we do not expect to repeat next year.

Now let's turn to our bottom line. We experienced a loss in Q1 as forecasted and largely in line with public estimates. Like the first quarter last year, this should be expected based on our level of revenue and fixed OpEx. We expect our second quarter to remain negative, moving back into positive territory in the third and fourth quarters to end the year strong.

We continue to grow cash in the first quarter, increasing our cash and investments from $122 million to $129 million. We expect these balances to pause at this level in the second quarter as we continue to build inventory levels to support planned shipments in Q3 and Q4. We are already seeing an uptick in inventory levels driven by WIP and finished goods related to this. Like last year, inventory will continue to build until dipping back down to normalized levels in the third and fourth quarters as I described in previous calls.

With that, let's move to Q&A.

(Operator Instructions) Pavel Molchanov, Raymond James.

Three months ago, you talked about a desal project in India that was pushed into the first half of '24 versus last year. What's the status on that? Is that still on track to be recognized before June 30?

It has not shipped out yet. Technically, we are moving along pretty well. We have an update today. We will see whether it is by June 30, but it is still expected this year.

Okay. So may be in the second half, correct?

It could be in the second half, yes.

Understood. Also, three months ago, there was a comment that deployments of the (technical difficulty) How is that effort progressing?

You broke up there, Pavel. Can you repeat that question, please?

Three months ago, there was also a comment about deployments of the refrigeration product being deliberately slowed to improve its reliability. How is that effort progressing?

Yeah, hi Pavel, this is David Moon. Thanks for the question. So, the second generation is progressing well. So, we just passed through the first [gator] milestone, which was internal testing in the lab. Got really good results in terms of reliability and performance. And so, since the end of March, since beginning of March, we've now been doing beta testing in the field in the US and Europe with very good results. And so, we are now moving on to pushing it out to the 10 summer sites that I've talked about in the script, and getting through the summer testing season would be our next milestone. But so far, very pleased with the results.

Okay. And David, another question for you, kind of big picture strategy. When you came in, as you know, there were some targets for 2026, which, as you acknowledged three months ago, were kind of on the aggressive side. When do you think you will be ready to put out some updated targets?

So, we're in the middle of our strategy work now, what we're calling our playbook. And I expect latest that we'll be talking about the out years 2025, 2026, 2027, by the time we get to the third-quarter earnings goal.

Okay, that's helpful. Last one for me, you mentioned a minute ago, desal customer in Brazil, which sounds interesting, because we really do not think of Brazil as a particularly kind of water scarce geography. Can you talk about how big that project is and how it came about?

Yeah, so it's a part of Brazil's, the government's initiative to increase the potable water supply by 12%. And so this is our first desal mega project. It's in Fortaleza, which is in the northeast part of Brazil. It's the fourth biggest city in Brazil. It's going to be roughly, I think, 86,000 cubic meters per day. It's planned to be online by the end of 2026. And this will be all Q400s, which will be our new product, our newer product. And so we're very excited about our first large desal project in South America and given the government's initiative, hopefully more to follow.

Yep. All right. Thanks very much.

(Operator Instructions) Ryan Pfingst, B. Riley Securities.

For the PX Gs getting deployed ahead of this summer, if all goes well, would you expect these customers to place meaningful additional orders later this year, potentially, that could translate into some significant revenue in '25? Or is the focus here really on getting that data in the hands of the OEMs?

You know, it's the latter first. And that's getting at least three months' worth of data, which will turn into a white paper sometime in Q4, into the hands of OEMs first. So that's my trip over the last few months to visit OEMs in the US and Europe. I mean, that's what they pounded the table for was summer data, summer data.

And once that's in the hands of the OEMs and they feel good about it, then they'll start going to their end users and start talking up the PX G more so than what they're doing today. So first steps first, let's get through the summer. Let's get our white paper done, prove the fact that we're getting good energy savings. And then I think we'll start to see some momentum build in the last half of the year for 2025. What that revenue stream looks like at this point, too soon to tell.

Okay, that's helpful. Thank you, David. And then for water, you guys have signed the $87 million in contracts for shipments this year. Curious if you have a number handy of what that might look like for '25, just to try to get some visibility early on how next year is shaping up.

I don't have that number on top of my head, but it wouldn't be very big yet. It'd still be fairly small. I mean, we're still a year out, right? So it wouldn't be a large number anyway.

Okay, what about more general visibility, Josh, about next year? Just what you're seeing in terms of projects out there? Are things getting delayed? Kind of what you expected, given we only spoke about 2.5 months ago? Any changes since then?

No, no real changes since then. We're not seeing any new delays or any new strange movement in our pipeline or anything like that. Things are moving on track generally. And I would probably point you, because we're not ready to talk about 2025 numbers, but I'd point you to the industry data source for desal, which is desal data coming out of the GWI. They've got some good industry data that still shows pretty strong growth over the next few years. I'd point you there for now. And then when we get to the November call, the Q3 call, we'll be talking more about 2025 in the future, more explicitly.

That's helpful. Thanks, Josh. And maybe just one more for you on water. In the past, you've talked about an estimated PX TAM of $0.5 billion solely for replacing thermal with SWRO tech. What does that opportunity look like today?

We've already covered about 20% of that. So we're at somewhere around $400 million left, which will play out over the next 10, 15 years as plants age out.

Got it. Thank you, guys. I'll turn it back.

(Operator Instructions) Thank you. We have reached the end of our question-and-answer session. And with that, I would like to turn the floor back over to James Siccardi for any closing comments.

Thank you, everyone, for joining us today. We look forward to speaking with you again in late July. Good evening.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.