Energy Recovery, Inc.

Greetings, and welcome to Energy Recovery's second quarter 2021 earnings call. At this time, all participants are on a listen-only mode. A question-and-answer session will follow the form of presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, James McCarty, Vice President of Investor Relations. Please proceed.

Good afternoon, everyone, and welcome to Energy Recovery's 2021 Second Quarter Conference Call. My name is Jim Sicardi, 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, the company's ability to commercialize Vortec, growth expectations, new products and their performance, cost structure, and business strategy. Poor-looking statements are based on information currently available to us and on management's beliefs, assumptions, estimates, or projections. Poor-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 SBC, specifically the company's Form 10-K and Form 10-Q. These documents identify important factors that could cause actual results that 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 5, 2021, 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'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. During the second quarter, our evolution as a PX-based platform company continued to gain steam. We're seeing momentum for our new water solutions outside of seawater desalination, and we made progress with Vortec and substantial strides in refrigeration. Today, I will describe to you in greater detail our activities in each of our new lines of business, including technical challenges as well as new insights into our go-to-market strategies. Each new industry will present its own unique challenges, but we're ready. Let me start with desalination. Our desalination business is performing in line with expectations. The dumbbell shape of our water revenue that Josh mentioned last quarter is playing out as expected, while our second quarter revenue of $21 million was lower than the first quarter. We expect strong annual product revenue results. Our backlog is strong. Our growth outlook remains robust at 10% this year and 25% in 2022. The Middle East remains our most active region, and we do not foresee that changing in the near term. We are encouraged by other regions that are appearing in our pipeline, most notably Asia, where we have been generating only nominal revenues the past few years. China's recent action plan, which calls for a 75% increase in desalination capacity, could lead to desalination on a far greater scale in the region. We remain very bullish on the potential of desalination, not only for the next two years, but for many years to come. Let's now turn to our growing industrial wastewater business. As we announced earlier this week, we recently secured additional three awards, all in China, related to landfill, chemical, and lithium battery industries. Over the past nine months, we have secured five awards in four industries, including those just mentioned, as well as natural gas. These initial awards will allow us to accumulate the real-life data we need to show the benefits reverse osmosis methods provide, together with our PX and UltraPX. as we have shown in seawater desalination. Our next focus will be to expand our brand recognition within these new markets. We will work with our reverse osmosis partners to educate these markets as to why our pressure exchanger together with other RO technologies is the most cost-effective, sustainable solution to meet growing industrial wastewater treatment requirements. I would like to take a little time to dive into one of these markets today, lithium batteries. In 2020, there were roughly 450 gigawatt hours of global lithium battery capacity, with 60% of this in China. which is expected to grow to nearly 2,500 gigawatt hour by 2030. If we conservatively assume the average battery capacity of a vehicle is 90 kilowatt hour, which is the capacity of a Tesla Model S, then this overall market capacity equates to roughly 5 million electric vehicles. Growing to nearly 30 million vehicles over that period. While we cannot yet know the exact size of this market based on these capacity assumptions, we estimate up to a 20 million one-time total addressable market, TAM, for our PXs in the lithium battery market today. We expect this market to grow on average by at least $10 million per year. through the next decade for a total time of up to $120 million. This is in addition to each of the $100 million one-time times we previously mentioned in both China and India. This is an example of the potential of a single industry, but the concept can be extended to other industries as well. We may not know exactly when an industry may shift to more sustainable methods of wastewater treatment. However, judging by the increasingly dire freshwater concerns we have cited many times in our calls, we believe that this will become an issue outside of just China and India sooner rather than later. We're now digging deeper into these issues. New Verticals to increase our knowledge of the best strategy to expand sales in China, India, and the rest of the world. However, not all industrial water is the same. It can vary by amounts and types of solids, viscosity, and other parameters that need to be addressed by our technology. Therefore, we are also laying out a product roadmap to approach this wider industrial wastewater market. Next quarter, we plan to share our thoughts on how industrial wastewater could potentially impact our revenue outlook over the next five years. Now we turn to VORTEX. At our annual shareholders meeting in June, we highlighted the progress made during multiple light well field trials. where the VORTAG was deployed. Year to date, we have participated in four field trials and completed 40 FRAC stages. These trials clearly demonstrated that the VORTAG can perform as envisioned without interrupting or impeding normal FRAC operations. In addition, we are encouraged by the positive feedback we received from Liberty Oil Services, and their customers. We have repeatedly stated that the key to achieve profitable commercialization is cartridge life extension. Today, I will describe in a little more detail what we are trying to achieve. Our cartridges are made from the second hardest material known to man, tungsten carbide. But even tungsten carbide wearers under the abrasiveness of sand at pressures as high as 10,000 pounds per square inch. And over time, we must refurbish the cartridges as this occurred. To extend cartridge life in between refurbishments, we designed and are testing solutions to protect portions of our cartridge with industrial diamonds. We're looking at a variety of production methods to apply diamond to our tungsten carbide cartridges that we believe hold great promise. Our challenge is to attach a diamond to the tungsten to withstand high pressures and at the size we need. This has not previously been done at such extremes. The process is iterative. entails work at both our suppliers' facilities and our own. We then test, analyze, identify new issues, again, work with our suppliers on a new iteration of the PX. While we await results of our cartridge life enhancement efforts, we continue to move forward on our go-to-market strategy. To maximize its potential, it is critical that the Vortec becomes a standard piece of equipment on the frack side, that our customers take ownership and ultimately operate the Vortec themselves. Therefore, we are prepared to offer the design of our skid to our customers without charge to build themselves while we provide an maintain the cartridges needed to run the vortex. In essence, we are providing them with a reference design of our system. This will ease our supply chain, create ownership over the system with our customers, and ultimately enable us to focus on what we do best, design and manufacture pressure exchanger cartridges. We will continue to update You are on this front. Now let us turn to our new product, the PXG 1300 energy recovery device for refrigeration or PXG. Global regulations are accelerating a shift away from refrigerants such as hydrofluorocarbons or HFC. to more natural ones such as CO2. Most developed countries are making this transition within the next 15 years. Phasing out HFCs has the potential to help avoid a half a degree Celsius increase in temperature globally. This is significant. For energy recovery, this transition could translate into a roughly $1 billion annual TAM by the end of this decade in commercial and industrial refrigeration alone. Current CO2 systems operate at pressures four to five times higher than the more efficient HFC-based ones. This means that a CO2 system without energy recovery device Thank you very much. Moreover, the efficiency of these technologies actually degrades as temperatures increase. Our PXG is designed to resolve these challenges. The warmer it gets, the better PXG performs. In fact, the PXG can potentially increase the breadth of the market for CO2 systems globally by approaching hotter regions that have been an economically insurmountable hurdle for the industry today. Owing to the rapid transition happening within the refrigeration industry and the weakness of existing energy recovery technologies, we feel a real sense of urgency to bring our product to market as quickly as possible. Our strategy for this involves a two-pronged approach. First, we offer a system that can bolt on to existing CO2 systems, allowing customers to begin to achieve real energy savings with our PXG. This approach will allow our system to be decoupled from operations. In the event of failure, the system will simply bypass our PXG automatically and operate as if it was not present. This is a streamlined approach for customers with existing CO2 systems already installed, providing them assurance that our new technology will not melt their ice cream, while giving them the firsthand evidence of the benefits it can offer. While this retrofit approach will allow customers to achieve material cost savings, it will not show the full potential of our technology. To achieve this, our second approach is to provide a PXG-centric reference design to the industry at no cost to accelerate the adoption of our technology. This PXG-centric system will fully leverage the power of our PXG with the goal of dramatically decreasing energy consumption and operating costs for our customers, thereby making their shift to sustainable CO2 systems as financially painless as possible. Refrigeration technologies have changed very little over the past 100 years. We believe that PXG has the potential to disrupt the global refrigeration industry, much as the PX did in desalination. And if successful, we could not only accelerate the sale of our PXGs, but also help accelerate the adoption of CO2 systems and significantly contribute to the reduction of global warming gases. To achieve this, we must educate the refrigeration market on our PXG and make it as easy as possible for customers to try and ultimately adopt our technology. We have come far with the PXG over the past 15 months. We have tested it. across a range of temperatures in our full refrigeration test loop in California, build a control system to manage it in operations, and are building our first commercial-ready system as we speak. We truly believe this could be a game changer for the refrigeration industry. To wrap up, as you can see, we continue to make solid progress In each of our verticals of focus and are adjusting our go-to-market strategy based on the needs of the specific industry we approach. As we look to next quarter's update, we plan to provide deeper insight into how we view the economics of these initiatives playing out through the first half of this decade Thank you, Bob.