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 Sicardi, Vice President of Investor Relations.

Hello, everyone, and welcome to Energy Recovery's 2024 Second Quarter 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 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 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 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 Moon.

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'm 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 mega project 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 Parur 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 out of our control that can cause delays. It is important to note that while our position remains strong in the mega project 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 Hacian 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 remained 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 Perora project. The remaining four projects were 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 fresh water supply. We continue to observe a growing divergence between the world's fresh water supply and demand, and this trend can be observed in countries like India, where it's home to 18% of the world's population, but only has 4% of the world's fresh water 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 Vallarta and Grocery Outlet, Ohio, which is Kroger, Belgium, which is Delhaize, 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. And 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. It's 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, Hill Phoenix and APTA, will be collecting data on our behalf at two of the 10 sites located in Canada, which is Loblaws, and Hungary, which is Auchan, 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 ramp-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% for the 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 cost. 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 breakeven. 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 second-generation PXG installed by the end of the year. And we are maintaining our gross margin guidance 64 to 67% and operating expense to $78 to $80 million. With that, now let's move to Q&A.