Energy Recovery, Inc.

Thank you, Mr. Sicardi. You may begin.

Good afternoon, everyone, and welcome to Energy Recovery's 2020 Second Quarter Earnings Conference Call. My name is Jim Sicardi, Vice President of Investor Relations at Energy Recovery. 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, the company's ability to commercialize Vortec, growth expectations, new products and their performance, cost structure, and business strategy. Forelooking statements are based on information currently available to us and on management's beliefs, assumptions, estimates, or projections. Forelooking statements are not guarantees of future performance and are subject to certain risks 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, July 30, 2020, and the company expressly disclaims any intent or obligations 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-GAAP 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 non-GAAP measures to comparable GAAP results. At this point, I'd like to turn the call over to our Chairman, President, and Chief Executive Officer, Bob Mao. Bob, the floor is yours.

Thank you, Jim, and thank you everyone for joining us today. I want to start today's call, as I did last quarter, with the sincere hope that everyone listening and your families are safe and healthy. I am happy to report that the Energy Recovery team and our business remains healthy, well, and strong. The COVID-19 pandemic has not abated as hoped, and it has changed how the world and we at Energy Recovery must operate. Today, both the water industry as a whole and the Energy Recovery have managed well through this pandemic. We are optimistic on the future. We remain focused on balancing first the health and safety of all our employees, but also on protecting our employees' livelihoods and shareholders' investments. Energy recovery is at a key inflection point. First, like everyone, we are working through the challenges of our new normal during this pandemic and adjusting accordingly. Second, our base water business continues to grow and show long-term resilience. And we continue to support the industry and the millions of people who rely on the freshwater created with the help of our technology. Third, the vortex is at a point where we must, in the near term, deliver value to our shareholders, either by monetizing the technology All by bringing an end to our span. Finally, in addition to those clear challenges before us, we must think about the future. When I look at energy recovery, I do not see a water company, nor do I see an oil and gas company. What I see is a PX company. In fact, energy recovery is the PX company. Over the years, including the time spent on VORTEX, significant investment has been made to build our PX technology platform. Let's turn to our water business, which remains strong and dynamic despite the economic and operational challenges presented by the coronavirus. As evidenced by our recent water awards, our megaproject channel continues to show strength and has been largely unaffected by events today. We're seeing a circular shift in desalination demand as water needs continue to grow globally owing to climate change, population growth and industrialization. The need for more fresh water has not weakened during these tough times. That shows not only in our results this year today, but also in our backlog and pipeline. It is for this reason that we again affirm our guidance of 20 to 25% growth for the year. COVID-19 continues to create uncertainties for our 2021 forecast. While we are confident that our mega project business will remain strong, the OEM channel has been more affected by the global economic downturn. Our current overall water backlog and pipeline supports a flat 2021 up to modest growth of 5%. The relative near-term stability we are seeing underscores the strengths of the overall water market. The fact is, despite economic uncertainties, access to fresh water is a real and pressing need all around the world. Our pipeline and industry forecast suggests that over the longer term, the circular shift in desalination demand remains intact, and we expect a rebound once the economic risk that exists today passes. Additionally, we continue to see proof of the thermal to reverse osmosis technology conversion occurring in the industry. Recently evidenced by our El Jebel II announcement, that project is a thermal replacement and one of the largest projects in our company's history. As a reminder, from 1980 through 2018, thermal plant capacity of roughly 23 million cubic meters of produced water per day was commissioned. These plans will eventually transition to seawater reverse osmosis, either as plants approach the end of their useful life or before owing to the significant efficiencies and cost savings offered by reverse osmosis operations. This translates into approximately half a billion dollars in additional addressable market to energy recovery. Just to maintain existing capacity. As I turn to our oil and gas business, I would like to repeat what I said at our general shareholders meeting two weeks ago. The Vortec is in a fundamentally stronger position than it was when I was named interim CEO in November. We have cleared every technical hurdle we have faced. Our late June simulated FRAC test with Liberty has proved to others what we have long believed. We are ready for live whale testing. Let me restate exactly what that test done and was important. We did not look at this test as indication that the VORTEX worked because we had long ago proven that fact. This test One proved to us that the VORTEX should not impede FRAC operations nor cause failure to a job, which will satisfy end customer safety and quality concerns. Two proved to us that the VORTEX can integrate with another team's software, equipment, and FRAC crews. These are important accomplishments when introducing a new technology to a vastly competitive mature industry. We're proud of our success during this test. The vortex skid we tested with Liberty will be our production model 1.0. It is an elegant, simple, single PX skid solution, which takes advantage of the higher sand concentrations we can now handle. The more and many others. In addition, this model allows operators the freedom to scale the vortex up or down to configure their jobs depending on their flow rate, pressure and overall job configuration needs. For all our shareholders now is, what's next? As we mentioned at the AGM, three hurdles remain. We must pass each hurdle or we will cease investment in Vortec. First, we must successfully complete at least two or three life wealth fracks. As we have mentioned, we are working actively with Liberty together to do so. I think all of us understand the current challenges in North America pressure pumping. Our preference is to achieve this with our partner Liberty. However, now that we are free to approach the whole market, we will also explore opportunities with other operators to expand our search if needed. We cannot wait for the frag market to return to accomplish these live well beta tests. Second and related is that we must prove to our customer the value proposition with data from the live well fracks. We must validate whether we can achieve our calculated savings of up to $6 million per frack fleet per year. While we have vetted this data with industry experts, live data will validate our assumptions and calculations. We should note that the value to our customers extends beyond the direct OPEC savings on the FRAC side that we have calculated, but also encompasses areas more difficult to quantify but nevertheless extremely valuable to a customer. For example, Significant operational and organizational efficiencies could be obtained as maintenance and logistic challenges become more manageable and breakdowns become more predictable. In addition, with the potential reduced downtime for a FRAC plea using the FORTAC, the number of FRAC stages a plea can complete each day may increase, which in turn would further lower costs and increase revenue over time. Also, by minimizing pump redundancy and increasing equipment lifespan, the VORTEX can lower costs and reduce the resources required for well-completion operations. This, in turn, can indirectly lower emissions associated with oil and gas production as longer testing equipment means fewer truck trips to replace broken pumps and less energy expended on manufacturing redundant equipment. Increasing equipment lifespan can also help to promote safety on the job site by reducing the exposure of repair personnel. The third and final hurdle relates to the pressure exchangers themselves. We must maximize the amount of sand that can be processed through the cartridges before wear requires repair or replacement. These cartridges are the single largest cost driver for the vortex. Increasing the amount of sand processed by each pressure exchanger will both reduce the frequency of resurfacing needed and the number of cartridges a single FRAC fleet would use per year. This is crucial to meeting our own profit targets and we are not there yet. I want to be very clear. If we do not pass any one of these three hurdles, we do not have a commercial product. We also do not have much time. While it is not possible to give an exact timeline to each of these activities, I can tell you that all this must happen in less than a year and we must show significant progress in the life of the cartridges before the end of this year. We are in a good place, but we are not at finish line yet. We will only commercialize if we have a product that is technically ready and will achieve our profit and ROI targets in a reasonable amount of time. I would also like to discuss our go-to-market strategies now that we have the entire FRAC market as our potential addressable market. We're in the early stages of this analysis and do not expect to make any firm decisions on potential partnership or license arrangements until we have sufficiently achieved our remaining hurdles. However, we will be approaching the larger, well-established pressure pumping companies in the coming months. The basic economics of our go-to-market strategy will not change. We're planning a leasing model as we launch, much as we have described previously, centered around our new single PX system. Now to turn My discussion to the future. What does it mean to be a PX company and how will we grow and diversify? The truth is we know the PX better than anyone in the world. The underlying strengths of our business and by extension our financials stems from this unique technological platform. Because our technology is so focused on delivering tangible value to our customers in the form of reduced waste and tremendous savings, it in turn creates tangible value in our financials in the form of a growing top line and high margins. We believe we have the potential to achieve additional high margin growth by focusing our incubation efforts on applications to our PX technology platform. For over two decades, the pressure exchanger has proven the ability to effortlessly handle pressure of roughly 1,000 psi and relatively clean seawater. We have pushed the envelope of the PX with our work on the VORTEX, and we are now able to handle harsh hydraulic fluid at pressures of 10,000 pounds per square inch or more. There are many applications in many industries within the sandbox that we can explore. This year, we began work on three projects at pressures under 3,000 psi. Two of these projects addressed new industrial applications of the PX, and at least one of these will not only allow us to expand our water business into new channels, but will also be an enabling technology for a variety of other potential adjacent industries. The third project aims to further expand the aperture of the PX technology platform itself. This, in turn, will allow us to tackle more applications within our PX sandbox. You can see in our financials that these projects require modest investment, but they can create a value that our investors have come to expect. We plan to confirm technical feasibility over the next several months and hope to explicitly discuss our first commercial launch during the third quarter call in late October. We must be disciplined in our investments, maintaining a focus on increasing shareholder value and delivering within a reasonable timeframe. This includes taking a rigorous approach to new product introduction that begins and ends with direct commercial involvement to ensure we keep our eye on costs and ROI. Incubation efforts must be challenged and we will not hesitate to shelf or stop spending on efforts that do not meet the cost objective and return profile that we have set. We're also focused on delivering commercial results quickly. This means proving our technical and commercial feasibility within 12 months. and achieving the first commercial order was in 24. If we do not believe we can achieve that as we begin a new project, we will shelf it. So we will not pursue another vortex in terms of expected timing. We do not believe that limits our potential. And some of the applications we pursue can be transformative to both ERI and to the industry they serve. At the end of each incubation project, four possible outcomes will be achieved. One is that the products will move into an existing business unit, or two, the products will move into a newly formed business unit, or three, we will form a joint venture or other partnership. or four, we cease investment and close down the project. We'll continue to keep you updated as we launch these future products in the coming quarters. Before I hand off to Josh, I want to discuss one last item. For more than 20 years, we have sought to help our customers achieve more efficient, sustainable operations. Our flagship PX pressure exchanger delivers up to 60% energy saving in seawater reverse osmosis. We have played a major part in transforming desalination from a historically energy intensive industry to one more sustainable and energy efficient. While water scarcity remains a significant global concern, We take pride in providing a solution that reduces both costs and carbon emissions. Our new incubation efforts are finding new ways to continue that good work. In addition to focus on how our products can help the world, we also need to look at how we can build a better energy recovery for our shareholders, our employees, and the world. Given our focus on growing our business, now seems the ideal time to provide our first ESG report, which we will issue in the third quarter. Taking this step reflects our commitment toward continuous improvement as we strive to become a more sustainable and resilient business. We look forward to your input once our report is public. With a stable and growing water business during this economic turmoil, real proof points with a vortex, exciting incubation projects, and embarking on our new ESG journey, it could not be a more interesting time at energy recovery. And with that, I hand it over to Josh.