Energy Recovery, Inc.

Greetings and welcome to the Energy Recovery 2Q24 earnings call. At this time, all participants are in listen-only mode. A question and answer session will follow the 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. I would now like to turn the conference over to your host, James Cicardi, Vice President of Investor Relations.

Hello, everyone. Welcome to Energy Recovery's 2024 2Q24 earnings conference call. My name is James Cicardi, Vice President of Investor Relations at Energy Recovery. I'm here today with our President and Chief Executive Officer, David Moon, and Brandon Young, our Controller and Interim Chief Accounting Officer. 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, 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, 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, July 31, 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 Chief Executive Officer and President, David Mn.

Thanks, Jim, and thank you all for joining us today. I am joined today by Brandon Young, our Controller and Interim Chief Accounting Officer. Brandon has been an integral part of our financial leadership team for many years. Before I get into the second quarter results, I want to update you on our CFO search and our strategic planning process, or what we call playbook process. First, I want to call your attention to the press release that went out earlier today regarding our new Chief Financial Officer. I am pleased to announce that Michael Mancini will become our new CFO effective August 5th. Michael brings experience leading high-growth engineering and technology-focused startup companies, two of which he served as CFO. He has extensive financial, operational, and capital markets experience from a diverse career including banking, private equity, and hedge funds. Michael's experience will serve as well as we expand into new wastewater and CO2 markets and work to further strengthen our relationships with our shareholders. Regarding our playbook process, we have moved from the where to play phase to the how to play phase. This how to play phase will include critical milestones and financial targets that will form the foundation for how we communicate our progress with all of you in the years to come. While we still intend to share a high-level summary of our playbook during the third quarter earnings call, I've decided that a more appropriate forum would be to host a webinar in the fourth quarter to share the details. We will be providing the details for this webinar by the end of the third quarter. Now let us move to the second quarter update. Beginning with water, we are maintaining revenue guidance of $140 to $150 million for the year. There are four reasons why I remain confident in this guidance. First, we achieved second quarter water revenue of $26.9 million, which was $6.4 million better than the same quarter last year thanks in large part to strong megaproject and OEM performance in MEA in Europe. Now there were several shipments worth noting that we've discussed in previous calls. We are pleased to report that we've completed shipment of the Puroor project in Chennai, India. As a reminder, this was the project that slipped out of December last year. As is the case with large-scale infrastructure projects, there are execution risks that are controlled that can cause delays. It is important to note that while our position remains strong in the megaproject space, we are not immune to these risks. We delivered the first shipment in the second quarter worth $4.2 million and the second shipment this month worth $4.1 million. Once constructed, this will be the largest desalination plant in India, delivering $400,000 cubic meters per day. We also shipped the first phase of three phases, the Hasean IPP project in Dubai, UAE, worth $5.2 million. Once constructed, this 820,000 cubic meter per day plant will be the largest desal plant in Dubai. This serves as another example of large-scale project slippage. In this case, the project was re-tendered and timing was adjusted, but our position to execute this project remains strong throughout the entire process. We expect the remaining two phases to shift within this calendar year. Second, we announced in July the signing of $15 million in contracts to supply pressure exchangers to several SWRO desal plants in India, which included the Perura project. The remaining four projects are expected to ship in 2024. Altogether these plants will provide over 670,000 cubic meters of clean drinking water to communities in India each day. As one of the most water-stressed countries in the world, India continues to invest in desalination projects to supplement its freshwater supply. We continue to observe a growing divergence between the world's freshwater supply and demand and this trend can be observed in countries like India, where it's home to 18% of the world's freshwater resources. Third, our current 2024 total revenue, which includes revenue recognized in the first half of the year and signed projects under contract yet to be delivered, totals approximately $107 million or 74% of the midpoint of our guided range for the year. This compares to roughly $118 million or 89% of the guided range at the same time in 2023. This reflects a 9% decrease year over year. The decrease is driven by the timing of the closure of several large-scale project contracts. We currently have approximately $25 million of megaproject draft contracts that we are anticipating finalizing over the next several weeks that we plan to deliver this year. Our strong performance of contracted activity and the draft contracts under finalization underpins our confidence in reaffirming our guidance for this year. And fourth, our wastewater pipeline continues to grow and we've increased our signed wastewater contracts by almost 5% as compared to last year at this time. As predicted, we had a slow start to the year, primarily driven by the economic conditions in China. We are monitoring the situation closely, but have already seen an uptick in bid activity and plan to have a very active second half of the year in this sector. Based on current projected delivery schedules, we expect that 35% of the second half water revenue will fall into Q3 and 65% in Q4. This would put the third quarter water revenue at $35 to $39 million and the fourth quarter at $66 to $72 million. Now let's move to our CO2 business. As I stated during our last call, after the successful completion of lab testing, our second generation PXG in the second quarter, our first gate for 2024, we have now moved towards our second gate, which is the installation of 30 to 50 sites by the end of Q4 2024. We have planned to have 10 of these sites installed by the end of August to capture critical summer data that would then form the foundation for a white paper we will publish in the fourth quarter. I am pleased to report that we now have nine second generation PXG sites operating in the US and Europe as of July 15th, with the 10th site to start up in August. Additionally, we have contracted with a highly respected third party engineering firm, DC Engineering, to measure and verify energy savings provided by our second generation PXG at six of the 10 sites. They will also assist us in the white paper development. These six sites are in California, which are Variata and Grocery Outlet, Ohio, which is Kroger, Belgium, which is Del Haze, and Spain, which is Elda Foods. The site in Spain will be a large food processing plant. DC Engineering is an industry leader in commercial and industrial refrigeration design, management, and compliance services. In fact, many of their engineers have worked for large retailers. In such a conservative industry as food retail, third party verification of a new technology is paramount. In fact, if you have faith in your technology as we do, you will proactively engage your respected third party or university to independently verify your claims in a field setting. This is exactly what we were doing with DC Engineering. The last time I worked with them was on a new ammonia carbon dioxide cascade refrigeration system for a supermarket chain in the southeast. In fact, our results were so well received, we and our supermarket customer were awarded the EPA's Green Chill Platinum Certification for environmentally advanced refrigeration systems. Such an exercise becomes table stakes when sitting in front of end users. With DC Engineering's assistance, our white paper will become the catalyst for our OEM partners and us to accelerate PXG adoption with the end users. DC Engineering is currently in the measuring phase. Additionally, our OEM partners, Health Phoenix and Epta, will be collecting data on our behalf at two of the ten sites located in Canada, which is Loblaws, and Hungary, which is Ashan, respectively. We will be collecting data at the remaining two sites. And finally, we have 40 sites in our pipeline for 2024, including the nine sites already operating. Now let's move to the financial update. Our gross margin rebounded from the first quarter of the year, with the second quarter coming in at approximately 65%. Our gross margin expectation for the third quarter is 62 to 64% as we continue to manage Q400 wrap-up production challenges. We are confident we will have most of these challenges, which are largely material handling in nature, behind us by the end of the third quarter, including adding additional Q400 capacity by the end of the year. We had expected the Q400 would only comprise about 25% of our water PX demand for 2024, but have been pleasantly surprised that it's trending towards 50% per year. Our four-year gross margin guidance remains at 64 to 67%. Our operating expenses increased 21% over the second quarter of last year, primarily due to one-time expenses. Now, as mentioned last quarter and as expected, we continue to experience one-time costs associated with the work in support of our long-term growth strategy, our playbook, as well as some executive transition costs. The combined impact of these one-time expenses totaled $4 million in the second quarter. To recap, one-time costs and operating expense today, we incurred $800,000 in the first quarter and $4 million in the second quarter. The second quarter breakdown is as follows. $2.6 million for playbook consulting and $1.4 million for recruiting and executive transition costs. We are maintaining our operating expense guidance for the year of 78 to $80 million, which includes the estimated $7 million in one-time costs. We expect operating expense to come in at $21 to $22 million for the third quarter. Of the remaining approximately $2.2 million of one-time costs, we expect 75% to be spent in the third quarter and 25% in the fourth quarter. As a result of these one-time items, we experienced a small net income loss in the quarter, though with a large sequential improvement from the previous quarter and putting us very close to break even. We are on track to moving to positive operating income as the remainder of the year progresses. And lastly, we continue to grow cash in the second quarter, increasing our cash and investment position in the second quarter from $129 million to $138 million. We currently expect to end the year between $140 and $150 million. So to sum up, we delivered a strong quarter supported by a growing backlog, which gives us confidence in our four-year revenue guidance of $140 to $150 million. We anticipate our wastewater business to generate $12 to $15 million in revenue. We expect to have 30 to 50 sites with our PX second-generation PXG installed by the end of the year. And we are maintaining our gross margin guidance of 64 to 67% and operating expense to $78 to $80 million. With that, now let's move to Q&A.

Ladies and gentlemen, if you would like to ask a question, please press star 1 on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you would 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 pull for questions. Our first question comes from the line of Pavel Malkomov with Raymond James. Please proceed.

Thanks for taking the question. No, may I probably start with the playbook. I know you do not want to kind of front run the specific targets that you will unveil towards the end of the year, but just conceptually, will you provide kind of revenue earnings, any other metrics, and will it be by product line?

Hi, Pavel. This is David Moon. Nice to hear your voice today. So, the guidance that we'll break out, as I said on just a few minutes ago, we're going to break out the release of the playbook. We'll provide the 25 and 26 revenue guidance as part of the earnings call for Q3, maybe a few milestones, but it will be pretty high level. And then when we get to the actual webinar that we'll have later in Q4, we'll provide more detail around not only years in terms of years out. It'll be a five year look, but we'll also provide not just revenue, but also earnings and also a look by business unit as well.

Okay, that's something for us to look forward to. When you talk about DC engineering in the measuring phase as it relates to the refrigeration product, what exactly is being measured? Is it the energy savings or something else?

Yeah, so there's two specific metrics that were being validated or measured by DC engineering. One is just purely energy savings. And then the second is capacity extension. And I think we've talked in previous calls, Pavel, about how the PXG provides capacity extension in high heat load days. And so DC engineering is confirming measuring and confirming both of those.

And as you speak with prospective customers, do they have a particular threshold or target that they want to see in terms of the improvement in the refrigeration system?

I think so. Largely the feedback has been around, you know, it's a very first cost conscious industry. And so largely the feedback has been around payback period. And anything from two to three years is acceptable. And so that's been sort of the, and so then you can roll in capacity extension under that. You can roll in certain energy savings as part of that. So that's the primary feedback we get or what end user supermarkets are going to be looking for. And that's a very, very short payback period.

Okay, last question's a little bit more macro. Is there any evidence that interest rate, you know, high interest rates, currency, oil price or anything else is structurally hindering the development of diesel in the Middle East?

None. I'd say nothing that we can see at this point. And, you know, our field team is as good as it gets and as close to customers as any. And, you know, so far full steam ahead.

All right. Thanks very much.

And the next question comes from the line of Ryan thinks with be Riley securities. Please proceed.

Hey, guys, thanks for taking my questions. I know you don't want to get ahead of the three to update and webinar in the fourth quarter around CO2, but maybe can you talk a little bit about the recently deployed PXG and maybe how they've performed compared to what you were seeing from the prior generation?

So I think what's most important about what we've seen out of the second gen is that they're just they're not running nonstop. No vibration. Sound levels are better than the first gen PXG, which were the two issues that we saw wanted to solve for when we developed the second gen. And so field time so far, you know, it's they're running like like clockwork in the field. So very, very pleased thus far with the performance we've seen in the field. And we're starting to get in several areas like Southern California. We're starting to get really some stress test, you know, our PXG stress test, right? I mean, we've had under plus degree days and Southern California for most of the last month or so. And so far so good. So we're happy with the performance.

Great. And then turning over to the water side, the AI theme is obviously super topical today and data centers are huge consumers of water. Are you hearing anything in terms of desalination or RO and wastewater participating there?

So we are we're starting to push that discussion on our side. And so this is something we've been talking about the last three or so months about how we can. You know, we would capture a lot of data. There's a lot of our PXG are data rich in terms of opportunity. And so we're talking to our EPC and O-line operators about how potentially we can go faster. And some ideas we have along the AI fronts. We're not getting pulled. It's we're pushing. We're doing the pushing at this moment.

Okay, interesting. And then maybe just one more. Could you potentially talk a little bit about 2025? I know you just said the macro wasn't really hindering, you know, desal projects moving forward. What are you seeing in terms of the visibility you have on 2025 today and the potential growth for you guys?

Yeah, so I think so. You know, we're confident we're in this 2024 will be the 10th consecutive year of growth that we've had. And I would say looking where sort of where I'm standing today, I would say that 2025 should be no different. I mean, that should be the 11th year of growth that we'll be looking at for ERI. Okay, so more to come when we, you know, when we talk in third quarter, and certainly as part of the webinar, but I see the growth trends can, you know, the macro story continues to look good. So we're going to continue to ride that way. So I think it looks good for 2025.

Great. Thanks for those answers. I'll turn it back.

And

then the next question comes from the line of Jason Bandel with Evercore ISI. Please proceed.

Yeah, thanks. Hey, guys. First question on the refrigeration side. I know you mentioned your repaired remarks about Kroger testing your PXG, and I saw their recent announcement that they're going to start using CO2 refrigeration system starting next year. Just curious, based on your experience so far, what would a typical supermarket rollout look like? Do they typically start with new store openings and distribution centers? Do they kind of wait for the end of the use of life for older systems? Like, how does that transition typically happen?

It's going to really depend. So in this space, there are what we call first movers or first adopters, and then there are followers. And so those sort of supermarkets fall in those two camps, sort of nobody in between really. And I see Kroger as someone that you would call an early adopter, right? And so how this will play out with Kroger is we're doing the one store now in Cincinnati. It's getting a lot of exposure, by the way, because they're headquarters. And that continues to go well. And as Kroger begins to work on their capital plans for rolling out CO2 over the next five years, then I believe we have a real chance to be a part of those capital plans. And they'll go faster. And they'll start with stores that are older, most likely that are older, where there may be some leaks, may be a problem. The system may not be running well, or it's just the equipment is sort of at its expiration date. And so they'll start with the older stores first. And then as the new stores are obviously built, those would be certainly CO2. But I think they'll start from the bottom of their list, and their most problematic stores will be where they start.

Got it. Okay, that makes sense. And then with the white paper, do OEMs, will they feel comfortable with the amount of runtime data in the white paper, or will some want to see even more runtime data in order to get comfortable with the real world performance of the PXG?

Yeah, so it's a very good question. So the runtime that we've laid out as part of this work with DC Engineering has been largely given to us by the OEMs. And so this is what they're mandating. This is what they're comfortable with in order to be able to then be able to sit with end users and have this next discussion. And so we are following their direction when it comes to runtime. And what's critical is this is the summer period. And nothing more, nothing less. And so we come out of this summer period with good results, that'll be enough then to take our discussion to the next level.

Got it. Now switching gears a little bit to the wastewater. I know you reiterated the full year revenue guidance despite the slower start to the year. Just curious if you can provide a little more color, or I'll give you the confidence that the second half revenue will come in to meet your full year guidance.

Yeah, so we did about $600,000 in the wastewater this quarter, which was equal to what we did last year. Our backlog, our backlog as I talked about earlier is growing. We're seeing an uptick over the last four weeks. We've seen a real uptick in quoting that we had seen for a while, largely driven by China. And so we're seeing that China is starting, we're starting to see just an increased level of activity that we haven't seen for the year in China. And so I think that bodes well for the rest of the year. And if we look at the uptick in quoting plus what we've already got on the books in terms of backlog, we're still comfortable with the 12 to 15 of guidance, even though we started slow.

Understood. And one last one for me, just on the CFO search process, I know you went kind of went through Michael's background and the prepared remarks. Just curious if you can share a little more details on how you decided to pick him and if you regret not having an overlap with Josh when he starts.

Oh, look, I think in a perfect world have been great. If we would have had some overlap, but Michael is is an experienced CFO. He he he brings a skill set with his startup work. He knows how to work under pressure. Given his previous background, he knows how to he knows how to work with investors. He'll hit the ground running, I have no doubt. And so, so yes, would have been good. Yes, but we're he'll hit the ground. He you know, he starts next Monday. And so, and Josh has been kind enough to say that he will make himself available if needed. So I'm pretty happy that he'll hit the ground running. I'm not worried about that.

Sounds good. Looking forward to meeting him and thanks for taking my questions.

Thank

you.

Thank you.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star one on your telephone keypad. There are no further questions at this time. I would like to turn the call back to James Sikardi for closing remarks.

Thank you everyone for joining us this evening. We look forward to speaking to you again and the third quarter call and at our webinar. Please take care.

This concludes today's conference. You may disconnect your lines at this time. Enjoy the rest of your day.