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spk05: Hello, everyone, and welcome to Energy Recovery's 2022 Full Year and Fourth Quarter Earnings 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 for the future financial performance of the company. These statements may discuss our businesses, economic and market outlook, 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 performances 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, February 22, 2023, 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 Chairman, President, and Chief Executive Officer, Bob Mao.
spk06: Thank you, Jim, and thank you, everyone, for joining us. We had one of the best years in energy recovery's history in 2022. Let's recap for a moment. 21% organic top-line growth while winning 100% of the mega projects tendered and awarded in 2022. Industrial wastewater exceeded guideline and almost quadrupled 2021 revenue. We generated some of the best profit metrics in energy recovery's history. Gross margin of 69.6% exceeded 2021 full year by 100 basis points. OPEX's percentage of revenue when adjusted for one-time costs was 48%, its lowest level in 14 years. During the past three years, this adjusted OPEX has grown only 8% despite revenue growing 73% in the same period. In our adjusted EBITDA exceeded 30 million for the first time. and increased earning per share by 75%. We also positioned each of our business for future growth. We launched the Q400 for seawater desalination, a low-pressure PX for brackish and wastewater applications, along with new industrial wastewater products. We commissioned our first PXG 1300s in Europe and in the U.S. and have generated field performance that has surprised even our partners. In short, I couldn't be more pleased with our progress in 2022. As we all look to 2023, there remains macroeconomic uncertainty, and this is nothing particular to energy recovery. We'll have to navigate these short-term uncertainties together in the coming months and we will continue to keep you informed. But what I will say is that here, at the beginning of 2023, we are cautiously optimistic about the current year, seeing solid single-digit revenue growth and remain bullish on our long-term prospects. As usual, I'll start with our water business, where we are actively investing to both strengthen our position in the desalination market as well as to seek out new avenues of growth. We know we cannot sit still and must continue to innovate and grow in new ways despite our commanding position in the market. Last quarter, we announced the new Q400, our most efficient and highest capacity PX available today. We have found strong customer interest in our new high-efficiency PX. The first of these orders will begin to ship in the second half of this year, and we expect that Q400 will make up a material portion of our mega project sales by 2024. In addition, we launched two low-pressure PX at varying flow rates as we seek to unlock portions of the brackish water with our PX. Rackage is very common in the United States and Europe, but has remained out of the reach of the PX until now. We believe we can potentially capture material incremental revenue from this market as we seek to achieve our 230 million to 270 million target in total water revenue by 2026. We will also continue to invest in core engineering research in 2023. This is not an easy task when we are already producing a product with efficiencies near the limits of physics. However, we must think about how to further evolve the PX to expand our opportunity set in desalination, industrial wastewater, and water reuse in the coming years. Now let's turn to wastewater, where we have had a few notable developments. We generated nearly $4 million of wastewater revenue in 2022, nearly 30% over our target for the year. Importantly, we have now increased our gross margin to one much more akin to our desalination business. The Ultra PX continues to prove its value to customers in the field. The recent introduction of our low-pressure product line also expands our reach into wastewater. We're now positioned to actively address some of the largest municipal wastewater projects in the world, including initial projects in the Middle East on the basis of this new line. Municipal wastewater, in particular, portable reuse, potable reuse, is a natural extension of our water business. Many regions are beginning to turn to potable reuse to help address their growing water shortages, including the Middle East and here in the United States. As we learn more about this potential market, we'll keep you updated. Overall, wastewater is already generating a clear profit and paying for itself. This year we're adding to our sales team in China and India, while also continuing investments to improve and expand our line of products. Wastewater is a clear example of how we can successfully apply our existing PX technologies swiftly to new and adjacent industries with minimal investment. Now let's turn to our CO2 business. We have now shipped PX 1300s to six separate OEMs and our zone shipping to a seventh. During our third quarter call, we spoke about the sale of multiple PXs to PXGs to industrial refrigeration manufacturer Europe. This manufacturer fuel kill technique is a leading refrigerant component and service provider for the Benelux region of Belgium, the Netherlands, and Luxembourg. Pew expects to commission the first installation with two PXC units at a Terrafor store in Benelux. Terrafor is one of the largest supermarkets chains in Europe and in the world. Following a visit in January, Pew placed a second order for six additional units to be deployed this year. And we are currently negotiating a distribution agreement with you. But the P X G in the better looks region. This relationship is the first formal step in building a broader pipeline and back wall. And a critical achievement for the energy recovery in the refrigeration space. As we progress through this year we will look for more regional distribution agreement like the one we are discussing with few for the Benelux region. Even more importantly, in 2023, we look to continue initial PXG installation breakthroughs into end-user supermarket chains to verify potential sales pipeline. Our potential pipelines already include Viata stores in California, Carrefour stores, and the large Southern Europe chain in which APTA commissioned a PXG last summer. In 2023, our priority is to turn in as many of the European and the U.S. supermarket chains into what we call the confirmed addressable markets, which will build confidence in growing our refrigeration business and in hitting our revenue targets of $100 million to $300 million by 2026. In support of these actions, we are hiring additional sales account managers for Europe and North America. Our first Europe sales account manager started this January, and we'll also be hiring field technicians to assist our partners as we roll out in the coming months. Additionally, we commissioned our PhD at the NTNU, the Norwegian University of Science and Technology. NTNU is considered the critical research facility to confirm performance data on new technologies in the refrigeration space in Europe. We have been very pleased with our performance on NTNU's refrigeration rack the past months. and we'll be presenting this data at the Euroshop in Germany next week. This performance data should provide objective third-party verification of the strengths of our technology. In addition to exploring additional regional distribution agreements for the PXC at Euroshop 2023, We'll be joining the APTA group, our European joint development partner at that event. APTA is a leading player in the refrigeration market in Europe and in the United States through their subsidiary Kaiser Warren. Together with APTA, we will be showcasing to end users the impressive results of our first deployment in Southern Europe during last summer's record high temperatures This part of after push into new and sustainable products. We have previously discussed how the PXC can help alleviate the stress of ever-increasing temperature highs on refrigeration systems. Today, supermarkets building extra refrigeration capacity to handle the hottest days of the year. The historical high temperature we experienced last year in many parts of the world exceeded the design maximum capacity of many refrigeration systems. This caused some supermarket chains to shut down their stores to avoid losing refrigerator inventory. This is a significant loss of revenue and profit. Our PXG's unique ability to provide additional capacity as temperatures rise means You no longer need to over-build the system if our PXG is installed. In fact, our technology can help handle these unexpected spikes in temperatures where it is needed most at a significantly lower cost than existing technologies protecting their operating margin. We still have much to do to achieve our 100 to 300 million targeted revenue But momentum is clearly building. Market interest is strong and the demand for solutions such as our PXG is there. As we continue to demonstrate the reliability of our PXG, our confidence in hitting our targets will be further solidified. I look forward to provide further updates during our next call in May. With that, I'll turn the call over to Josh. Good afternoon, everyone.
spk07: I'll start with revenue. We generated $121.6 million in desalination revenue and nearly $4 million in industrial wastewater in 2022 for a combined total growth of 21% for the year. Mega projects continue to pick up pace as expected, growing nearly 9% in 2022, and OEM and aftermarket achieved 64% and 36% growth, respectively. Desalination OEM revenue, excluding industrial wastewater, grew nearly 50% to $25 million, exceeding our previous annual high in desalination OEM sales by 9%. The geographic dynamics of our 2022 revenue are also important. We continue to see a steady growth in the Middle East and Africa of 10% for the year, an acceleration from 2021's increase of only 6%. Asia is where the real story lies. We achieved over 30% growth in 2022 on the heels of over 150% growth in 2021. This rapid increase over the past few years highlights major freshwater issues in Asia. Countries such as China and India are turning to desalination and filtration of wastewater to help alleviate their water problems. In addition, we are beginning to see sales in other countries outside of China and India, which made up 16% of industrial wastewater sales last year. Finally, last quarter, I had referenced $4 million of at-risk backlog in Egypt that was delayed due to local hard currency capital controls. We were able to realize about half of that at-risk backlog, with the balance expected to be shipped this year. We will retain our desalination revenue growth guidance for 2023 of 3 to 7 percent, or $125 to $130 million. We continue to expect desalination revenue to be heavily weighted to the third and fourth quarters with up to 70 to 80% of revenue occurring in the second half of the year. We are currently anticipating revenue within the lower to mid-range of our $10 to $15 million guidance for the first quarter. Our range remains the same at $20 to $25 million in the second quarter with the balance occurring in Q3 and Q4. We are also maintaining our industrial wastewater target of $6 to $8 million in revenue in 2023 for a combined water revenue of $131 to $138 million. Last quarter, I mentioned three risks to growth that we are closely monitoring this year. Inflation, the strengthening dollar, and the potential for a global economic downturn. Although these risks remain, two of the three risks have alleviated somewhat over the past few months. The rapid strengthening of the U.S. dollar against many of the local currencies and the countries into which we sell have softened. And we have seen that inflation is beginning to be addressed in many of these same countries. We are continuing to monitor if these risks could affect revenue or our pipeline this year and next, and we'll keep you apprised. Now let's turn to gross margin, where we significantly exceeded the upper end of our target for 2022. Our overall gross margin performance for the year was driven by three factors. One, the success of our sales team and increasing pricing in response to inflation. Two, a product mix that shifted heavily to the PX in the fourth quarter. And three, our outperformance in industrial wastewater and improved pricing in those markets, which helped increase our overall margin by about half percent for the year. We are maintaining our 2023 outlook of 64 to 66 percent average gross margin for the year for water. However, our first and potentially second quarter margin may come in lower than this average, because of our shift in product mix in favor of the PX in the fourth quarter last year. We are currently projecting 60 to 64% gross margin in the first quarter, largely dependent on the final product mix of sales. Note that we have seen lower margins in prior years and quarters more weighted to OEM and aftermarket sales, so this is not a new phenomenon. The second half of 2023 will likely be heavily weighted to megaproject PX shipments, where margins will improve and balance out the year. Now let's turn to operating expenses. We ended the year with OPEX slightly less than 50% of revenue or 48% when adjusted for one-time non-recurring expenses compared to 55% in 2021. While sales and marketing increased by 1% in 2022 to 13% of revenue, we saw declines in G&A from 24 to 22% and R&D from 19 to 13%, excluding any one-time non-recurring expenses. Our OPEX guidance for 2023 remains unchanged at 52 to 53% of revenue this year, excluding any potential upside from CO2 refrigeration revenues. I mentioned during the last call that sales and marketing would increase 30 to 40% this year, pushing this spend to 17 to 18% of revenue. However, I expect G&A to grow only in the low to mid single digits, largely driven by inflation. R&D spend will likely remain flat in 2023. Therefore, both G&A and R&D spend should flatten or fall somewhat as a percentage of revenue this year, which is in line with our longer-term targets. With regards to net income, note that our first and second quarters will show negative income. Keep in mind that sales are significantly lower in the first two quarters, but our OPEX is relatively fixed and growing. This is simply because of the lumpy nature of our quarterly sales due to the timing of megaproject shipments and has happened in past quarters as well. We will see a significant uptick in profitability from our larger sales in Q3 and Q4, which will balance out the year. We ended the year with $93 million in cash and securities falling within our target despite returning $26 million to shareholders last year as we wrapped up our $50 million share buyback program. Our overall operating cash flow was $12.6 million, slightly below the 2021 level. Operating cash was driven by two main factors in 2022. First, inventory grew by $8 million for the year. Second, because revenue was heavily weighted in the fourth quarter last year, our accounts receivable balance is significantly higher than in previous years. This increase in receivables is simply due to the timing of these late year sales. We have seen no delays in collections nor any increase in doubtful accounts. We expect to collect the majority of this receivable balance in the first quarter. As we look forward to 2023, it's important I comment on inventory. As I stated earlier, we expect to ship only 20 to 30% of our 2023 revenue in the first half of this year, with 70 to 80% of revenue to ship in Q3 and Q4. In order to meet this high demand in the second half of the year, we must continue to build product in the first two quarters. Therefore, you should expect substantial growth in finished goods inventory in Q1 and Q2. By the end of the second quarter, we could see an inventory balance as high as $40 million. This balance should subsequently fall in the second half of the year. By the end of the year, based on water demand, we expect inventory levels to end the year roughly in line with 2022. Any additional increase or rise would be driven by our CO2 business, which we will communicate as the year plays out. In addition, based on our first and second quarter shipment expectations, we should see lower than normal cash and investment balances by the end of the second quarter, possibly falling to a range of $70 to $80 million, which should subsequently rebound in the second half of the year. Depending on the timing of shipments in the fourth quarter, we should end the year with between $110 to $120 million in cash and securities, driven by growing operating cash flow.
spk10: Let's move to Q&A.
spk09: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from Graham Price with Raymond James. Please proceed with your question.
spk02: Hi. Good afternoon, and thanks for taking the questions. I guess for my first one, you talked about the refrigeration distribution agreement, the Benelux region. I was wondering if you could just give a little more detail on how big that revenue opportunity is and how you see that playing out over the coming years.
spk10: So first, Graham, just to highlight, this is Josh, and I hope you're doing well.
spk07: I want to note that we did just release a press release here this afternoon that we did sign that agreement with few today. So that agreement's live in the Benelux. And the Benelux, obviously, with the population count that it has, is going to be a smaller amount of revenue that we're going to be able to realize in Europe. But it's a very important and key milestone for us signing this agreement as it shows an important proof point and confidence in the ability of our technology to reduce costs for these supermarkets and industrial sites and so forth.
spk02: Got it. And I guess as you sign additional agreements, do you think those will be exclusive in nature as well?
spk10: Some definitely, yes. Whether all of them will be exclusive, we don't know at this point.
spk02: Got it. Understood. And maybe switching gears a little bit, it's been roughly six months since Gavin Newsom talked about ramping up desal in California. Just wondering if you've seen any evidence that anything is changing in a large sense in that area?
spk06: The short answer is no. California and DeSalle, you know the story.
spk02: Got it. Okay. Understood. And then I guess final one for me, you know, just on the cash balance, obviously ended the year at a very healthy level. and didn't see any buybacks this quarter. So, you know, I was just wondering, and I know I'm guessing kind of the inventory build and the back end weighted revenue plays into it, but how are you thinking about buybacks for the rest of the year?
spk07: Well, right now, Graham, we're really looking at how our Markets could evolve here over this year. So, for example, you know, we have more confidence in where water's headed, and we've built a lot of capacity for that, as well as inventory at this stage. But CO2 is still a bit of unknown, and we could have pretty substantial investments in CO2 if it accelerates in the latter half of the year, as well as, as we talked about before, potential additional fixed assets investments in order to build up capacity for that business. So at this stage, we're watching that because we're going to need cash for that bill, both working capital and fixed assets. To say nothing of the kind of the low cash flow we're going to have in the first couple quarters just because of sales. So I wouldn't expect anything in the near term, but it is something we keep obviously discussing, you know, with the board.
spk02: Okay. Perfect. That's it for me. So I'll pass it along. Thank you very much. Thank you.
spk09: Thank you. Our next question is from Nils Tomlinson with Fearnley Cap Securities. Please proceed with your question.
spk04: Good afternoon. I'm just wondering, given that you're now shipping out a couple of these PXG units to Europe and other markets, do you have sort of a lower range in terms of revenue to communicate for 2023, or is it still too early?
spk06: It's still too early. That's why we're highlighting that our emphasis is breaking through into a new supermarket chance, what we call confirmed addressable market. And that's what we're following. Actually, this has been, we find out that this has been very conservative industry in adopting new things. But our value proposition is such we are very confident once we break into a new chain, that whole chain becomes a pipeline. Then we can meaningfully discuss timing and the volume.
spk04: Right. And at what point do you expect that you can make a decision on potentially building another plant or facility to add capacity to CO2? That's sort of a 2023 event?
spk06: Right now we have excess capacities in our kiln. As you know, it's of the same oxide material. So we think probably is toward the end of the year, fourth quarter, we have to look at capacity increase.
spk07: To be clear, those investments would occur next year, most likely, right, even if we started the process this year. So we'll get more updates in the latter half of the year in terms of how that cash outflow would look like.
spk10: All right. Great. Thanks.
spk09: Thank you. Our next question is from Ryan Finks with B. Reilly Securities. Please proceed with your question.
spk08: Hey, guys. Thanks for taking my question here. I know the last time we spoke, we talked about exiting this year with a backlog allowing for sales in the double-digit million range for 24 for CO2 refrigeration. And Josh, on the 3Q call, you spoke about the potential for desal growth to once again reach 20% again in 2024. Is that still how you guys are still thinking about those two items?
spk07: Yeah, as of today, those are how we're still looking. And, you know, with CO2 in particular, we'll see how this year plays out. But that's certainly the targets we're pushing for. And then on, as I mentioned today in my prepared remarks on the desal side, we're just very closely watching the market in terms of these major risks that we're seeing globally. And we'll certainly keep you guys apprised as well as this year progresses. But where we stand today, yeah, no changes.
spk08: Got it. And we touched on California a little bit, but, you know, with the Colorado River running low and getting more attention and, you know, I think just the growing problem of less available water here in the U.S. Are you guys seeing talks around domestic desalination demand picking up steam, you know, recently?
spk06: Recently, I glanced at a very interesting hotline that says that, you know, The Arizona may be considering building diesel for Mexico to trade for Mexico's Colorado quota. I don't know how true is that. And Gary, if that's true and that's doable, maybe just pure speculation with California's retirements on diesel, maybe California would also trade Colorado quota with Mexico diesel.
spk08: Got it. Maybe just one more for me. Obviously, your market share in the core business has been really impressive for a long time, but could you maybe talk about the competitive landscape a little bit and anything you're keeping an eye on that could potentially challenge this?
spk06: We always keep an eye on competition, but there is nothing new to report from what we reported in the last quarter. Yes, they're out there, and we're watching. Excellent. Q400 is being received very well. In some ways, competition was gearing up, targeting our Q300. Now we have Q400.
spk10: Got it. Good to know. Thank you.
spk09: As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. Our next question is from Wally Walker with Hannah Road Capital. Please proceed with your question.
spk03: Hey, guys. Congratulations on the quarter and the year. Aftermarket growth was impressive and accelerated the year end. Can you elaborate a little bit on rate of change and if that's a trend? And is it fair to think of that as recurring revenue going forward?
spk07: Yeah. Hey, Wally. You're doing well. We saw some great growth in aftermarket this year, as well as OEM. But we are expecting it. Some of this was a kind of a post-COVID bounce in 2022. So we are expecting it to temper a bit this year, at least in terms of growth. And this could mean it either flattening. With aftermarket, I'd expect it to flatten or low growth this year compared to what we saw in 2022. Aftermarket is really a function of our install base, right? And so as we grow, it grows with us. And it's been a pretty stable, call it 8 to 10-ish percent typically of revenue. And that's kind of what we still anchor on, although it's a bit higher this year. OEM as well, of course, we saw this big COVID bounce. And OEM, I think, this year we think could pretty much the same story. It's going to revert back to its normal growth rate. We're kind of above that curve right now. which is one reason why we talked about last quarter. We're seeing somewhat lower growth this year because OEM is going to flatten or perhaps even be a little lower than this year, just as it returns to its normal growth curve, if that makes sense.
spk01: Yeah. One other for me, please. Expected tax rates in 2023, how should we model for those?
spk07: That's a good question. That's something, you know what, I probably should have included in my script, because I think last quarter I talked about a 10% to 15% expected tax rate. But as we've been looking at, we came in at about 8% this year. And what we're finding is we had a lot of changes last year. We've utilized all of our cumulative net operating losses, which is great, because that means we're making money. We also, because we utilize those losses, we're starting to get a new benefit starting last year called the foreign-derived intangible income tax benefit, which is really, it's a tax benefit you get in exporting, right? And it's pretty big for us. This year it was almost 7% for 2022. We also get a pretty healthy R&D tax credit. So because of the fact that we used all of those NOLs and they're now gone, it's actually going to boost our foreign-derived intangible income tax benefits. which means it's going to be bigger this year. It could be, so I think we probably revise our estimate down from 10 to 15 to more like 8 to 12% as we look forward, at least for the next few years. That's excluding any effect we may get from our share-based comp tax benefits that we get, because that's pretty volatile and not dependent on us, if that makes sense. Mostly driven by this FDII benefit, which is pretty new. Thank you. Thanks a lot.
spk09: Thank you. There are no further questions at this time. I'd like to turn the floor back over to James Sicardi for any closing comments.
spk05: Thank you, everyone, for joining us today. As a reminder, our prepared remarks and the most recent press releases can be found on the website. We look forward to speaking with you again in early May. I guess it's the 3rd of May. Other than that, have a great weekend and have a great rest of your week, and we will be participating in follow-up calls over the next couple days. Thank you.
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