Energy Recovery Q3 2024 Earnings Call Transcript

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October 30, 2024

There are 8 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Energy Recovery Third Quarter Earnings Call. Our host for today's call is Lionel McBee. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer I would like to now turn the call over to your host, Mr. McD.

Speaker 1

Good afternoon, everyone. Welcome to Energy Recovery's 2024 Q3 earnings conference call. We appreciate you joining us. I'm Lionel McD, Director of Investor Relations at Energy Recovery, and I'm joined here today by our President and Chief Executive Officer, David Moon and our Chief Financial Officer, Mike Mancini. The prerecorded remarks from today's call are available on the Investors section of our website and are meant to accompany the Q3 earnings news release, which is posted in the same location.

Speaker 1

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 their performance, cost structure and business strategy. Forward looking statements are based on information currently available to us on management's beliefs, assumptions, estimates and 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 ks and Form 10 Q.

Speaker 1

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, October 30, 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. And lastly, for your planning purposes, please note that our Q4 and full year earnings conference call is scheduled for Wednesday, February 26, 2025. And with that, I will turn the call over to David.

Speaker 2

Thanks, Lionel, and thank you for joining us today. As Lionel mentioned, we are joined today for the first time on our quarterly earnings call by Energy Recovery's new CFO, Mike Mancini, who started on August 5. I want to say how grateful I am for Mike's partnership and the work he has already done. As I mentioned last quarter, Mike brings a wealth of experience in high growth engineering and technology companies. He has had executive leadership roles in finance, where he demonstrated his ability to drive financial strategy and performance across the entire enterprise.

Speaker 2

Additionally, his background with the institutional investment community provides him with a deep understanding of capital markets, which makes him a valuable asset to our leadership team. Now before I get into the Q3 financial results, I will make a brief comment on our strategic planning process or the playbook as we call it. Although we won't be getting into any of the specifics of the playbook on this call, we are hosting a live investor webinar on November 18, where members of my senior leadership team will present our playbook, including growth plans for desalination, wastewater and CO2. We will also provide guidance for 20252026 as well as provide long term 2029 financial targets. The webinar will take place at 10 am Eastern Time and will last approximately 2 hours, including the live Q and A session.

Speaker 2

The event will be accessible virtually via the link located on the IR calendar section of Energy Recovery's IR website and a replay of the event will also be archived there. Additional details can be found in our press release issued on October 21st. Now let's move into the 3rd quarter update. First, let me start by saying thank you to our employees for helping deliver another very solid quarter. With total revenue of $38,600,000 we achieved the upper end of our guidance for the quarter and set another quarterly revenue record.

Speaker 2

Now while we still have considerable work to do to deliver what stands to be the largest quarter in the company's history in the Q4,

Speaker 3

our Q3 performance did create a line of sight to achievement of our full year guidance of $140,000,000

Speaker 2

to $150,000,000 As I've said the last couple of quarters, the demands on the team to deliver on these mega projects are only increasing. With that said, I remain confident in our ability deliver what will be the biggest quarter in Energy Recovery's history, capping off what will be the 11th consecutive year of revenue growth and another year of strong market share in our mega projects channel. Let me talk briefly about our high level segment results before turning it over to Mike for the financial results. Let's start with water. Water revenue came in at $38,300,000 an increase of 4% compared to the Q3 of 2023 and up 42% compared to the Q2 of 2024.

Speaker 2

This reflects the high end of our guidance for the Q3 of $35,000,000 to $39,000,000 and continues the prior quarter's solid growth in mega projects. Results were driven by continued strong demand in the Middle East and North Africa as well as demand from India. I'd like to highlight several notable desal shipments made during the quarter. First, we completed the 2nd and final shipment of the Purura project in Chennai, India worth $4,100,000 as we mentioned previously during our July earnings call. Once constructed, this will be the largest desalination plant in India, delivering 400,000 cubic meters per day.

Speaker 2

Also as a reminder, the Perur project was just one of the projects included in the $15,000,000 in contracts that we announced in July for several SWRO desalination plants in India. For the remaining 4 projects under these contracts, we shipped $8,300,000 and expect to complete the additional $2,600,000 of shipments in the 4th quarter. Altogether, these plants will provide over 600 and 70,000 cubic meters of clean drinking water to communities in India each day. We also made progress on the Hacienda IPP project in Dubai, UAE during the Q3, which was construct which once constructed will be the largest desalination plant in Dubai, providing 820,000 cubic meters per day. As of our last call in July, we had shipped the first phase.

Speaker 2

As of today, I'm pleased to report that we shipped a total of $10,500,000 year to date and expect to ship the final $5,300,000 in Q4. In addition to these shipments, we also continue to secure major desalination contracts in recent months. In August, we signed contracts totaling $27,500,000 for SWRO desalination projects in Morocco. These projects will supply over 1,000,000 cubic meters per day of potable water for municipal and agricultural use, which represents enough water for more than 600,000 Moroccans. As of today, we have shipped $12,300,000 of that total order.

Speaker 2

The balance of the order is currently expected to be filled in 2024. However, we are closely monitoring this timing given an end of December target shipping day. North Africa continues to be an important driver of growth for our water business with secular trends such as ongoing drought, industrial growth and population growth continuing to generate strong demand for SWRO desalination

Speaker 3

plants.

Speaker 2

Earlier this month, we announced contract awards totaling over $12,000,000 for 3 SWRO desalination projects in the United Arab Emirates. The plans include capacity totaling close to 1,000,000 cubics per day cubic meters per day. And as a proof point as to the manufacturing improvements we have made, our intent is to ship nearly all of these orders in the 4th quarter. Both contract awards and their shipment dates were on our radar and therefore included in our 2024 financial guidance. Based on our strong third quarter results and our expectations for additional shipments in the 4th quarter, we are maintaining our revenue guidance of $140,000,000 to $150,000,000 for the year.

Speaker 2

Now as we provided in previous quarters, our current 2024 total water revenue as of the end of the Q3, which includes revenue recognized in the 1st 9 months of the year and signed projects under contract yet to be delivered totals approximately $137,000,000 or 94% of the midpoint of our guided range for 2024. This compares to roughly $136,000,000 or 100 percent of the guided range at the same time in 2023. With this substantial progress towards our full year guidance underpins our confidence in reaffirming our guided range for the full year. We cannot control customer driven delays or slippage. With that said, we continue to collaborate closely with our customers and we remain focused on strong execution in the Q4 to complete our remaining shipments and to deliver our full year guidance.

Speaker 2

In the event unforeseen circumstances caused slippage towards the end of the year, I'd like to reiterate that the associated revenue would not be at risk, but would simply be recognized in 2025 rather than in the Q4 2024. Now turning to wastewater. Our wastewater pipeline continues to grow and we've increased our signed wastewater contracts by almost 46% as compared to last year during the same period. Our strategic diversification strategy for water is underway and we are making progress in our product portfolio expansion. For the year, we expect to generate revenue towards the lower end of our previous provided guided range of $12,000,000 to $15,000,000 This is primarily the result of a wastewater mega project, the NEOM project in Saudi Arabia that's transitioned to a longer term phased project over multiple years.

Speaker 2

However, we expect to offset this impact through continued outperformance that we are seeing in the OEM channel. We will share more details on our progress and our strategy for wastewater during our investor webinar on November 18. Overall, we feel that the air pocket created by rapidly rising interest rates, inflationary effects and concerns around the global economic activity have begun to moderate. Clearly, there are still economic and geopolitical concerns around the globe, but the long term trend for freshwater demand remain intact and we continue to see solid growth ahead. Now let's move to our CO2 business.

Speaker 2

We continue to make progress in the development and commercialization of our 2nd generation PXG. As I stated during our last call, in the Q2, we completed our first gating item for 2024, which was the successful completion of lab testing. During the Q3, we turned our focus to our 2nd guiding item, which is the installation of 30 to 50 sites by the end of Q4 2024. I am pleased to report that we reached our initial goal of having at least 10 sites installed and operating across the U. S.

Speaker 2

And Europe. In fact, we've now completed the installation of a total of 11 sites year to date. With that site goal reached, we were able to complete the collection of critical summer data. As I discussed during our last call, we partnered with DC Engineering, a highly respected third party engineering firm to measure and verify energy savings provided by our 2nd generation PXG at 6 of the 10 initial sites. I'm pleased to report that in that collaboration with DC Engineering, we recently published a white paper on these results, which we believe will be the catalyst for our OEM partners and for us to accelerate PXG adoption with end users in the near term.

Speaker 2

The white paper can be found on our website. The results were better than expected, showing that the PXG reduces energy consumption, increases cooling capacity and improves system stability. The findings show that the PXG improved the leading metric of energy efficiency or the coefficient of performance by piece up to 30% with as much as 15% in projected annual energy savings. In addition to energy efficiency, findings providing operational flexibility to safeguard against heat waves. Providing operational flexibility to safeguard against heat waves.

Speaker 2

Based on the success of the ongoing measurement and verification processes, during the Q3, multiple OEMs began to process began the process of integrating the PXG into their CO2 transcritical racks. This is a necessary and important step towards full commercialization of the PXG. We are highly encouraged by the test results and the resulting integration by our OEM partners. Adding to our momentum, we currently have 19 additional sites to be commissioned for installation in the coming months. Including the 11 sites already installed and operating, we're on a clear path towards meeting the low end of our target of 30 to 50 sites installed by the end of this year.

Speaker 2

Additionally, our pipeline of additional sites has grown meaningfully as the industry has gained awareness of the PXG technology. We're Momentum for the PXG is clearly accelerating. Momentum for the PXG is clearly accelerating. I look forward to sharing additional details on our progress and strategy for CO2 and wastewater during our upcoming webinar. With that, I'd like to hand it over to Mike to discuss our financial results for the quarter.

Speaker 3

Thank you, David. And let me start by saying thanks to you and to the Board for your trust and confidence in me to lead the finance function here at Energy Recovery. Before arriving, I was excited about the company's core business prospects, the exciting opportunities to grow and expand the reach of the PX technology and the opportunity to drive profitability and cash flow. After almost 3 months on the job, I am now confident in the company's ability to create value for shareholders and I look forward to working with the team on driving financial results. I would like to begin by discussing our revenue, gross margin and product mix.

Speaker 3

Then I'll discuss our operating expense, net income and cash position as well as our expectations for the full year 2024. As David mentioned, we had a solid quarter of revenue generating $38,600,000 at the upper end of our guidance. The project driven lumpy nature of our mega project channel has become quite evident to me even in the short time I have been here. Q4 revenue is expected to be between $62,000,000 $72,000,000 which will represent over 45% of our full year revenue at the midpoint. In the 4th quarter alone, 5 projects represent approximately 50% of the revenue with a single project representing over 20%.

Speaker 3

Any delays in shipment dates on those projects could have an impact on our full year revenue, although there would be a minimal impact to the intrinsic value of the business of such delays. Moving to margins, our gross margin improved 50 basis points when compared to the Q2 of the year with the Q3 coming in at 65.1 percent above our previously guided range of 62% to 64% for the Q3. We believe we have turned the corner in our efforts to manage and resolve challenges related to our ramp up in production of the Q400 and our gross margin expectation for the Q4 is 64% to 68%, which should put our full year gross margin guidance within our guided range of 64% 67%. Regarding product mix, on our last call, we stated that the Q400 was trending towards 50% of our WaterPX demand for 2024, up from our original expectation of 25%. During the Q3, the Q400 comprised approximately 45% of our WaterPX demand, reinforcing our expectation for 50% product mix for the full year.

Speaker 3

This faster than expected adoption of the Q400 highlights our product leadership position in the megaproject desalination space and underscores our ability to align our solutions with customers' evolving needs. Our operating expenses for the Q3 were $18,100,000 which came in below our previously guided range of $21,000,000 to $22,000,000 for the quarter. One time costs for the quarter were $1,100,000 As a result, base OpEx for the quarter was $17,000,000 a 1% increase from the same period last year. So while our focus on cost and capital efficiency are working, we do expect to continue to experience some one time costs associated with the work in support of our long term growth strategy and some added employee count to support our growth. Still, we will be able to capture the benefit of our cost efforts and are reducing our full year operating expense guidance to $76,000,000 to $78,000,000 from the previous $78,000,000 to $80,000,000 which still includes the estimated $7,000,000 in one time costs we have indicated before.

Speaker 3

This implies expected operating expense for the Q4 of approximately $20,000,000 to $22,000,000 and full year 2024 base OpEx of $69,000,000 to $71,000,000 Additionally, we reported income from operations for the Q3 of $7,100,000 in line with our expectation provided on our last call to move to a positive operating income as the year progresses. We also reported net income for the quarter of $8,500,000 reflecting a substantial increase compared to the 2nd quarter. Lastly, we maintained our cash balance during the quarter with cash and investments of $140,000,000 as of the end of the 3rd quarter, compared to $138,000,000 at the end of the 2nd quarter. We remain in a very strong financial position and we expect to end the year at between $140,000,000 $150,000,000 of cash depending on collections. With that, I'd like to turn it back over to David for a few closing remarks.

Speaker 2

Thank you, Mike. To sum up, we delivered a record Q3. And while there is still work ahead of us to execute the Q4, we remain confident in our full year revenue guidance of $140,000,000 to $150,000,000 We remain on track to generate $12,000,000 to $15,000,000 in revenue from our wastewater business, although we anticipate this will come in towards the lower end of that range. We are on track to deliver the low end of 30 to 50 sites with our 2nd generation PXG installed by the end of the year. We are maintaining our gross margin guidance of 64% to 67% and we are reducing our operating expense guidance from $76,000,000 to $78,000,000 With that, now let's move to Q and A.

Operator

Your first question comes from Ryan Fink with B. Riley. Your line is open.

Speaker 4

Hey, guys. Thanks for taking my questions.

Speaker 2

Hey Brian.

Speaker 4

Not to get ahead of the webinar, but I was wondering if you could talk about the competitive landscape in CO2. Is anyone else attempting to do what you guys are doing with the PXG?

Speaker 2

No, no other pressure exchanger competition that we see today. Now as you know, we compete against other technologies for applications in the space, but no one with a pressure exchange.

Speaker 4

Got it. It's helpful, David. And then I guess for my second question on your capital allocation strategy, Wondering how you're thinking about the potential for share repurchases with the strong cash balance you have now. And maybe if you could remind us of the capital requirements needed for this TiO2 opportunity? I know it's still early stage, but is there any meaningful cash needed as that opportunity ramps?

Speaker 3

Hey, Ryan, this is Mike. So I think we're going to get into that on the webinar. We'll lay out all of our growth strategy plans, capital needs and roll out a capital allocation policy. So, we will be talking about that on November 18.

Speaker 4

Understood. Thanks for taking my questions.

Speaker 2

Thanks, Brian.

Operator

Your next question comes from Pavel Molchanov with Raymond James. Your line is open.

Speaker 5

Yes. Thanks for taking the question. Let me start with kind of a high level one about decel. Are you observing any geographic diversification of your customer mix away from the Middle East and towards newer desal markets?

Speaker 2

Hi, Pavel, this is David. Nice to talk to you. No, still the concentration still is favoring Middle East, Africa. And then in the Q3 as it's done really all of this year, we're up over 70% of our revenue for the quarter came from the EMEA and then about 60% came from for the 1st 9 months of the year came from EMEA. So we're still very reliant on that part of the world and we'll look to continue to be that.

Speaker 2

As you'll hear in the webinar, the Middle East and Africa will continue to play a very important part of our mix over the next 5 years.

Speaker 5

On the refrigeration side, I remember this is now a couple of years ago you signed a strategic partnership in the Netherlands with a few people technique and Italy

Speaker 2

Yes. Still going strong.

Speaker 5

Yes. And in Italy with Aetna Group, have there been any other European partners that you've signed up?

Speaker 2

No, that's we've got a number of new faces that we're talking to Pavel at the moment. But in terms of official sort of partnerships, it's EBITDA and it's few at the moment in Europe.

Speaker 5

And is the I guess the go to market strategy for Refrigeration, I'm sure you'll touch on that in a few weeks, Peter, but is it going to remain kind of centered around a select list of partners or is there a better approach to getting the word out about this product?

Speaker 2

Ultimately, to get to the end users. It doesn't mean we're not talking to end users directly, but ultimately the OEMs is where we have to get our PXG integrated into their systems and thus get ourselves spec'd officially spec within a supermarket. And so to do that, we've got to go through the OEMs.

Speaker 6

All

Speaker 5

right. We'll save the rest until November 18. Looking forward to it.

Speaker 2

Thank you. Thanks Pavel.

Operator

Your next question comes from Jason Bandel with Evercore ISI. Your line is open.

Speaker 7

Great. Thanks for taking my question. My first one is for Mike. You've been the CFO seat now for almost 3 months like you said. And in the prepared remarks, you touched on what attracted you to the company.

Speaker 7

Just curious, what were some of your initial impressions being inside the company so far? And what are some of the initiatives that you've been focusing on, of course, in addition to the playbook work?

Speaker 3

Yes. Thanks for the question, Jason. So you've been here almost 3 months now. And I think largely what I expected coming in has been true. And that really is I think the key word for me is opportunity.

Speaker 3

There is opportunity for efficiency in manufacturing. There's opportunity for efficiency in cost. There's opportunity for growth, there's opportunity for capital and how we allocate it and just a lot of things where we can bring my expertise in finance to the team along with the other new executives here to really focus on profitable growth going forward.

Speaker 7

Got it. Makes sense. I'm looking forward to working with you. You as well. Next in Refrigeration, David, I'm just curious, in the white paper, was the performance of the PXG consistent across the 6 sites that were monitored by DC Engineering?

Speaker 2

Yes, consistent depending on temperature variation, right, whether Canada versus Southern California. So there's a bit of that variation. But what was consistent was the energy savings and the capacity increase. Now it differed the amount of energy savings and capacity increase differ depending on location, but we got we got both of those out of all the locations that we've been tracking.

Speaker 7

And in terms of the remaining sites for the year, now that you have the performance data in hand in this white paper, how are you prioritizing the deployment there for the remaining sites?

Speaker 2

Yes. So the remaining sites are going to be a combination of Europe, U. S, existing OEM customers versus new OEM customers. And so we've got a site selection tool that we use to ensure that we optimize the sites that we work with the OEMs on selecting. And so we're ensuring that we're using that site selection tool for optimization to make sure we get the right sites early on.

Speaker 2

So we'll continue to use that process. But otherwise, it's we've got capacity to do these other 20 sites or so for the remainder of the year.

Speaker 7

Understood. And just one last quick one for me here on OpEx, good cost control there. Was there anything in particular that kind of drove the performance in the Q3? And how much is left to spend at this point of the one time costs?

Speaker 3

Yes. This is Mike. So I'd say the largest driver of costs coming in was more of a cost avoidance of not growing in certain non core growth areas that was planned for. So some cost cutting, but also just cost avoidance. And then the one time costs, we expect to do $7,000,000 in total for the year.

Speaker 3

And we have about $6,000,000 of that in cash and non cash already done, so about $1,000,000 left.

Speaker 7

Perfect. Sounds good. Looking forward to the webinar. Thanks guys.

Speaker 2

Thank you.

Operator

Your next question comes from Jeffrey Campbell with Seaport Research Partners. Your line is open.

Speaker 6

Thanks and thank you for taking my questions. My first one is a white paper question. Your recent white paper noted that the PXG-thirteen hundred transcritical system energy savings and increased cooling capacity did not require any water cooling. So I was wondering if this suggested that a system using the PXG might be able to avoid an adiabatic cooler and choose a dry cooler instead?

Speaker 2

Yes, it's a good so, hey, this is David. That's a good question. So there are a number of sites across what that refers to is there are a number of sites across Europe and even in certain parts of the U. S, especially Southern California that require adiabatic cooling or for high heat load days. And so what the PXG does is that given its increased cooling capacity, depending on the location replace the adiabatic cooler as a best case or as a work or worst case can reduce the amount of adiabatic cooling that goes on during high heat load days thus reducing water usage, thus reducing energy savings and so on.

Speaker 2

And so what this means is that if you're putting in a greenfield site where you've got an adiabatic, if you would have put an adiabatic cooler before, you no longer if you're going to put in the PXG, you no longer require that. You don't have to go through the expense of putting in the $20,000 to $60,000 of putting in the adiabatic cooler nor do you have to you can for sale the $5,000 to $10,000 a year of operating costs as well. So we're a nice replacement for that adiabatic cooling system.

Speaker 6

Yes, that stuck out as a pretty good argument for the PXG from what I

Speaker 2

We hope so. We hope that's the case as others read it, especially end user. So let's hope that

Speaker 6

And we can get rid of the standard at the same time. So that's or the ejector, excuse me, at the same time. So it's a pretty good argument.

Speaker 2

That's right.

Speaker 6

I want to ask you one other kind of think a roo question. The recent EPA SNAP decision in June allows continued use of HFO and HFO, HFC blends in new equipment designed for these refrigerants in the U. S. Just wondering what are your thoughts or maybe what you're hearing or what are the animal spirits on continuing competition between HFO and CO2 refrigeration, particularly with the PXG's ability to strengthen the CO2 case as we just discussed?

Speaker 2

Yes. I think CO2 is still the outright winner. You might have some outliers that will choose the HFO blends and maybe even as in standalone cases that you can move around the store freely. But everything that we're hearing in the U. S.

Speaker 2

From our OEMs, our OEM customers we've been working with is that it's full speed ahead on CO2, full speed

Speaker 6

ahead. Okay, great. Thank you. I appreciate that.

Speaker 2

You're welcome.

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