Energy Recovery, Inc.

and welcome to the Energy Recovery fourth quarter and full year 2023 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow a formal 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. It is now my pleasure to introduce your host, James Sicardi, Vice President of Investor Relations. Thank you. You may begin.

Hello, everyone, and welcome to Energy Recovery's 2023 Fourth Quarter and Full Year Earnings Conference Call. My name is Jim Sicardi, Vice President of Investor Relations at Energy Recovery, and I'm here today with our President and Chief Executive Officer, David Noon, 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 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 and on management's beliefs, assumptions, estimates, or projections. forward-looking statements or 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-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 21, 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. At this point, I will turn the call over to our President and Chief Executive Officer, David Noon.

Thank you, Jim. First off, I want to thank my fellow board members for appointing me the permanent CEO. I look forward to working with our shareholders, the board, my leadership team, and our employees as we enter this phase of energy recovery's growth. I also want to thank Bob Mao for his grace, assistance, and advice these past four months. As we announced today, Josh Ballard has decided to step down at the end of June as our CFO. He and I are working together with Korn Ferry to conduct our CFO search. I want to thank Josh for his commitment to an orderly CFO transition and for his continued leadership throughout this transition. He and the Energy Recovery Leadership Team have given me a great foundation to build on, which is a healthy business with nine years of consecutive revenue growth, a strong balance sheet, and a technology that is showing promise outside of our core desal business. I'm excited to be here. and I look forward to our future at Energy Recovery. I've now been in the seat for approximately four months. Over this period, I've taken a deeper dive into our technology and products, our diversification strategy around our pressure exchanger and wastewater technology, and where we are executing on that strategy. I have a better understanding of our markets and customers, where we sit in the product development cycle and commercialization of these new products, as well as the challenges ahead of us. I'd like to start with a few observations in how I will approach this role. First, to be very clear, my number one focus is to rebuild the shareholder value that we've seen decline in recent months, and then to grow it further. There is nothing more important than creating stability, rebuilding trust with shareholders, and showing that we can deliver on a full potential of our pressure exchanger technology. We will start with delivering on an orderly CFO transition. We must also execute and therefore deliver on our 2024 financial targets, or walk the talk as I like to say. Now we have challenges, but I believe we can create true value for our shareholders in the coming years. I've had extensive discussions with many of you and heard your opinions regarding the CEO transition. I assure you that your voices have been heard loud and clear, and your concerns have been communicated directly to the board. Third, this is a strong team, and I could not be more excited to lead it. Everyone has rolled up their sleeves and jumped in to make the transition as smooth as possible, have been consummate professionals throughout, have kept the company moving forward, have signed numerous water customer contracts, continued to produce industry-leading products, and showed what good teams do during moments of transition, adapt, and come together. Fourth, the company's strategy of PX diversification and growth is the right strategy in my and the Board's opinion. It is critical to Energy Recovery's future. as well as to our ability to rebuild and grow shareholder value, that we continue to grow and diversify our business around our incredible pressure exchanger and intellectual property that creates value for our customers by recovering otherwise wasted energy and decile wastewater and now CO2 refrigeration. We must now do the deep work to develop our 2025 to 2029 strategic plan, or what I call our playbook. With this playbook, I'll be able to clearly communicate what and where our growth targets will be in the desal, wastewater, and CO2 verticals, as well as the critical actions and milestones needed to achieve these targets. This playbook will also clearly identify what our cash requirements will be to fund our growth going forward. Rest assured, though, we will continue to spend wisely and be mindful of the need to generate strong returns on investments. Our playbook will focus on maintaining our market leadership in desal, as well as on executing in the wastewater verticals where we see the most potential growth, including wastewater treatment for lithium battery manufacturing, chemicals, municipal water, as well as CO2 commercial refrigeration. I also see derivative verticals where I believe our wastewater and CO2 refrigeration products could be applicable. However, more work needs to be done here to understand and prioritize these many other verticals. Fifth, I remain committed to sustainability and the products we develop and produce as well as in our internal operations and how we produce those products. Sustainability is a critical piece of our DNA. and will remain part of our strategy going forward. And finally, energy recovery remains in a very enviable position financially. We continue to generate cash, and we expect our cash position to grow in 2024, even while we invest in growth, which Josh will describe to you. We will need to make decisions on how to deploy this growing cash position with the same financial and commercial focus that we've instilled in energy recovery for the past few years. Rest assured, though, I share Josh's vision of expanding our EBITDA margin as we grow into these new verticals. So where I sit today, I believe the fundamental pieces of energy recovery's overall vision and diversification strategy will remain in place. We must continue to defend and strengthen our position in desal. We must accelerate growth in wastewater. And where my experience and strengths come to bear, we must define in more detail what the best market and distribution strategy is to deliver our PXG to supermarkets. Successful execution here has the potential to open doors to other vertical opportunities in the coming years, but we must first be laser focused on the task at hand. In short, I think you can see that while we certainly see changes in energy recovery, the fundamental principles that have attracted so many of you to our company for these past years remain in place. Now, with that, let's get into our update. And as usual, we will start with water. We delivered growth in our desal business for the ninth consecutive year in 2023. Now, this growth was slower than we would have liked. due to a delay in a single $8 million project in India, which Josh highlighted as a specific risk last quarter. That project is now slated to ship in 2024. Due to this slippage, we came in at approximately $128 million in revenue. Now, despite the shipment moving into this year, we're holding our revenue water guidance of $140 to $150 million for 2024. While this India project will increase our revenue for the year since our last earnings call, we've had two projects in Saudi Arabia shift to 2025 that together offset this increase by India. In addition, we have several projects shipping in December that based on our experience in 2023 post some timing risks. And although my team has identified some potential mitigation approaches for this risk, I'm still getting my hands around our project-based water business and prefer to remain conservative. We will tighten up this guidance throughout the year as more is known. Now note that our wastewater guidance of $12 to $15 million remains unchanged, which means our overall guidance points to between roughly 10% to 17% growth for the whole of our water business this year. We also have some great things happening underneath the hood. First, roughly 50% of our desal megaproject revenue will come from our Q400, our newest and most efficient energy recovery device. We are extremely proud of this fact, as our initial projections were to achieve only 25% of revenue this year for the Q400. Not only should we achieve 50% this year, but we believe the Q400 could be as much as 75% of our revenue in 2025. The resounding success of the Q400, which was only introduced to the market in late 2022, is proof that we are continuing to innovate and show leadership in the desal space. Second, if we hit our guidance in wastewater, This implies wastewater could double in 2024 and be up to 10% of our overall water revenue after only our third year pursuing diversification into wastewater. Today, we've generated revenue from 16 different industry verticals in wastewater. We have 12 industries in our pipeline, exceeding $1 million each in potential revenue. We are tracking projects in over 30 countries, and importantly, More than a quarter of our pipeline years away for us. We consider our wastewater business a resounding success that highlights the versatility of the PX, as well as the acceptance of our value proposition outside of desal. Now, you might expect to tackle 16 different wastewater industry verticals takes resources and products that potentially can be unique to each vertical. Our playbook will prioritize those verticals to ensure greater probabilities of success, financial return, and customer satisfaction. More to come here. Our water business remains firmly entrenched in a global secular upward trend in water demand, and our competence in this business has not changed. We continue to innovate and to provide a compelling argument for our product offering in the marketplace. As you all know, there's simply not enough fresh water in the world today. The world is beginning to understand that to address these freshwater challenges, we must reuse the water that we have, which our wastewater products address, and that desal is critical to providing new freshwater capacity at scale, which our desal products address. Now let's move on to our CO2 business. This year, our focus for the CO2 business unit is to gain market penetration in OEMs and supermarkets through increased site validations. This will allow us to continue stress testing a greater number of PXGs in the field in varied climates and operating conditions while validating and fine-tuning our value proposition. One thing we learned during PXG field testing in 2023 was that we were seeing some operating issues that needed to be addressed. I temporarily slowed our PXG rollout in late Q4 2023 to allow our engineering team sufficient time to apply these learnings to upgrade the PXG to address these issues. Our second generation PXG is now being tested in our lab with very positive results and will be deployed to field validation sites in Europe and the U.S. in the second quarter. This second-generation PXG is a drop-in replacement for the first generation and also makes for a more reliable and quieter PXG. In addition, we've designed a more streamlined and cost-effective skid for retrofits in the field. We have two critical milestones to achieve in 2024 with this next with the second-generation PXG to move forward with a broader commercialization in 2025. The first milestone is the successful completion of testing in our internal labs in Q2 2024. We are encouraged by the results thus far. The second milestone is successful installation, operations, and third-party validation of the 30 to 50 additional validation sites by Q4 2024. Now, as a reminder, supermarkets are very conservative when it comes to adopting disruptive technology, especially large chains with billions of dollars of existing refrigeration infrastructure. We must take the time and pay our dues to perform extensive field validation while continuing to work with end-users OEMs and engineering firms. However, we have several things on our side. Number one, growing relationships with new influential supermarket customers in the U.S. and Europe who are marking national and international change. Repeat orders with existing supermarkets, such as Vallarta and Carrefour. Recent EPA legislation in the U.S., the AMAC and the EU F-gas regulations, have accelerated the phase-out of HFCs, thereby putting the pressure on supermarkets and its supply chain to begin serious planning to convert refrigeration infrastructure to natural refrigerants like CO2. Number four, a historical track record of successful supermarket industry adoption past disruptive technologies, such as aluminum-aluminum coils, ejectors, and others. And number five, two years of PXG field testing in extreme operating conditions, which has led to the second-generation PXG and provided the prioritized list of upgrades and improvements for future generations of PXGs. Now, my experience in this industry has taught me that when introducing a disruptive technology like the PXG into this market on a broader scale, reliability is of the utmost importance to end users. And that's why we must be more deliberate and conservative, spending the necessary time to validate the product in the lab and the field while developing relationships with the industry stakeholders such as supermarkets, OEMs, major contractors, and engineering firms. A new product introduction must provide a seamless installation experience, must be operationally reliable and repeatable across varied regions and contractors. If we've done our job successfully, we will be invisible to the supermarket site manager, especially in the summer months. As part of our playbook development, we're moving towards a more standardized PXG that will allow future generation PXGs to be a drop-in or plug-and-play of the refrigeration rack. We believe this more standardized version, which is closer to what supermarkets and OEMs are more comfortable with, will provide a more seamless option to further accelerate the rate so we can penetrate the market. Our initial step to this plug and play element is with the second generation PXG. Looking forward, our focus for 2024 is to deploy at least 30 to 50 PXGs between North America and Europe. However, because I intentionally slowed our PXG progress to allow for the second generation PXG to be launched, we're more likely to be closer to 30 validation sites. When it comes to selecting validation sites, we're focusing on quality versus quantity. This will provide us the critical mass we need for validation purposes and puts us in a good position to achieve the second critical milestone in Q4. And by the time we get to our first quarter earnings call, I'll be able to better define the number of validation sites for 2024. So, to sum up, The operational deliverables that I put in place for 2024 are as follows. Maintain and grow our dominant position in desal. Grow our wastewater business to $12 to $15 million in revenue. Install 30 to 50 second gen PXG units across North America and Europe. And deliver on our full year revenue guidance of $140 to $150 million. With that, let me hand the call over to Josh to update you on the financials.