Energy Recovery, Inc.

Greetings and welcome to the Energy Recovery Quarter 1 Fiscal Year 2020 Earnings Call. At this time, all participants are in a listen-only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on the telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to James Sicardi, Vice President of Investor Relations. Thank you. Please begin.

Good afternoon, everyone, and welcome to Energy Recovery's first quarter 2020 earnings conference call. My name is Jim Sicardi, Vice President of Investor Relations at Energy Recovery. I am here remotely today with our Chairman and Interim 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, the company's ability to achieve the milestones and commercialization under the Vortec licensing agreement, 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, uncertainty, 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, April 30, 2020, 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. In addition, we may make some references to non-GAF financial measures during this call. You will find supplemental data in the company's earnings press release, which was released to Newswires and furnished to the SEC earlier today. The press release includes reconciliations of the non-GAAP measures to the comparable GAAP results. At this point, I would like to turn the call over to our Chairman and Interim President and Chief Executive Officer, Bob Nau.

Bob, the floor is yours. Thank you, Jim, and thank you everyone for joining us today. I want to start today's call with the sincere hope that everyone listening and their respective families are safe and well. I'm happy to report that the energy recovery team remains healthy and well. The COVID-19 pandemic has turned our personal and professional lives upside down. All any of us can do in response is rise to the challenge that is presented. To that end, I am tremendously proud of our team's response. Our employees have displayed a remarkable calm and determination that has allowed us to navigate these uncertain times. Two considerations have guided our response. How do we protect the lives of our employees while protecting our business, and by extension, the livelihood of our employees? It is with great pride that I can report We have not laid off or furloughed any employee due to COVID-19. We're also in the fortunate position of being able to give back, including donating personal protective equipment from our manufacturing facilities to health care providers. The safety of our employees has been our primary focus from the beginning. Prior to the implementation of the state and local shelter-in-place orders, we had already determined that all employees who could work remotely should do so. As a result, with the exception of our manufacturing activities, nearly all of our functional business areas continue to operate fully and efficiently, though remotely in most cases. On March 19, when the Bay Area's shelter-in-place was announced, we elected to temporarily suspend manufacturing activities at our San Leandro headquarters to assess the impact of those orders, review additional local, state, and federal guidance, and to implement health and safety measures recommended by health officials to protect our employees. that are required to be present at our facilities. We have since partially reopened our San Leandro manufacturing facility in full accordance with federal, state, and local regulations and guidance. We have also implemented the enhanced safety measures at each of our manufacturing facilities. Those measures include Smaller staggered shifts to ensure social distancing between employees. Personal safety equipment for each worker, including masks and gloves. And most importantly, cleaning between shifts. Fortunately for us, those measures did not have a material impact on the company in the first quarter. As a critical supplier to the domestic and global desalination industry, I am happy to report that we have not missed a single contractual PX delivery since the introduction of the Bay Area orders. We had ample product inventory on hand. We continued shipping customer orders on time. In fact, based on what we know today, I expect that we will be able to fulfill most, if not all, of our existing delivery obligations for the remainder of this year. We're also continuing to take new orders for all of our products, including newly awarded mega projects in Egypt and China, which makes me hopeful that there is an economic light at the end of the tunnel. In short, we're attempting to conduct our business as close to usual as we can in this new normal. We expect this new normal to be here for a while, so we are adjusting and planning for the long term. The strength of our balance sheet gives us some flexibility and confidence in that effort. Energy recovery, like everyone else, is facing more uncertainties. But I do believe we can safely navigate these events. Now turning to our water segment. With so many lives depending on the water produced by these large plants, operators turn to the name they trust. Our flagship PX, with its strong reputation and the lifetime value proposition, remains the technology of choice for operators. who demand proven quality, efficiency, and unmatched reliability. The first quarter of 2020 was the highest revenue generating first quarter in the company's history. Our mega project channel continues to drive this growth. Despite COVID-19 and the recent volatility in the oil markets, we have not seen a significant impact This could still change, but if history is a guide, in today's environment, impacts to our sales tend to lack market downturns. We realize that we are only a phone call away from a project delay in these uncertain times, but remain encouraged. that mega project customers have not yet communicated significant project delays or suspensions because projects in our backlog have already been financed and we typically ship later in the schedule of a construction project. There is a greater potential for negative impacts to pipeline projects in 2021 and beyond. For example, despite the recent volatility in the oil markets, according to recent industry publications, megaprojects in oil-dependent countries such as Saudi Arabia appear stable in the near term, which represent a significant source of our future revenue. Of our other business channel OEM, our smaller project channel which caters to a diverse source of industries including tourism may see the largest relative impact from COVID-19. The degree of impact is likely dependent on the duration of the pandemic and subsequent economic downturn. However, we believe any effect of OEM on our overall guidance should be minor. Overall, I remain cautiously optimistic. As of today, the desalination industry is showing some stability in 2020, and we are therefore maintaining our 2020 outlook as guided last quarter. Finally, I want to follow up on my comments on our water growth initiatives from last quarter. Despite the uncertainties from COVID-19, we are continuing to prepare for product launches later this year, and our water segment continues to move forward despite today's challenges. I would like now to turn to our oil and gas segment, where we are focused on delivering two proof points for the VORTEX. First, a life well frack was our product partner. And second, achieving milestone one. As you know, the oil market has changed dramatically since we last spoke. In late March, we identified a well in Texas with Liberty to conduct a life well frack. Unfortunately, sudden negative changes in the oil market led to the cancellation of that frack mere hours before the scheduled commencement. In mid-April, a second opportunity to conduct a live well was canceled as a result of the oversupply of oil. Admittedly, we were disappointed by these cancellations, but continued to work with Liberty to identify other opportunities to test our vortex system in life real-world conditions, which is critical to our step toward commercialization. Due to the state of the oil market, our opportunities to deploy our technology at a live well may remain limited for the near term, but we will be ready when the opportunity arises. In parallel, were focused on passing Milestone 1. As we mentioned during our last earning call, we believe the technical hurdles of M1 have been cleared and our confidence in achieving certification is high. While we have not had recent discussions with our product licensee regarding M1, our goal is to attempt and document M1 during the second quarter whether at our product licensee site, on our own, or with a third party. We look forward to updating you with the results of that test. A documented M1 will also provide a basis for a substantive review with our product licensee on our respective near and longer term commercial and operational plans. In the meantime, We continue to manufacture and test at our KT facility in accordance with government health and safety guidance. Our focus is on improving our fuel operation, further enhancing vortex reliability, and extending the useful life of the cartridges. As mentioned during our last call, we have settled on a more simplified and effective production model and expect The eventual life well will support those decisions. Our confidence is at an all-time high today. While we do face headwinds in today's oversupplied environment, oil and gas is cyclical in nature. We believe the vortex can ultimately deliver potentially more value during a down cycle than an up cycle, as it may allow our customers to realize meaningful cost of savings relative to their peers. With that, I would like to comment on our incubation initiatives, which we touched upon last quarter, while outlining the technical boundaries within which our PX technology platform can successfully address new market verticals. We have identified two or three potential verticals that appear promising from a technological and commercial perspective. While our priorities remain protecting our base business in water during these uncertain times and commercializing the vortex, we are also devoting resources to expand our market reach with financial discipline and transparency. We look forward to providing more color on these efforts in subsequent quarters. In summary, our employees are safe, our business is successfully adjusting to our new normal, our finances are secure, and our plan toward evolution of our core As Bob mentioned, this was a very good quarter. We generated a total revenue of $21.5 million, representing 9% year-over-year growth. Our water business generated $19 million in revenue, or 19% year-over-year growth.