Energy Recovery Inc

NASDAQ:ERII

Earnings Call Analysis

Strong quarterly performance amidst growth and challenges

In the second quarter, our company reported a significant increase in Water revenue to $26.9 million, up $6.4 million from last year, driven by megaprojects in MEA and Europe. We completed crucial shipments for India's largest desalination plant and secured $15 million in new contracts. Despite a yearly 9% revenue drop due to project timing, we reaffirm our annual guidance of $140-$150 million. The Wastewater pipeline grew by 5%, with an active second half expected. Gross margins are projected at 64-67%, although operating expenses rose 21% due to one-time costs. Cash reserves grew to $138 million, and positive operating income is anticipated by year-end.

Strong Performance in Water Revenue

In the second quarter of 2024, Energy Recovery reported a remarkable water revenue of $26.9 million, an increase of $6.4 million compared to the same period last year. This growth was largely driven by robust performance in mega projects and original equipment manufacturer (OEM) contracts, especially in the Middle East and Africa (MEA) and Europe. Notably, the completion of significant shipments, such as the Perur project in India—projected to be the largest desalination plant in the country—signifies noteworthy contract execution. Additionally, the Hassyan IPP project in Dubai is on track for completion in upcoming phases, further adding to optimistic revenue forecasts.

Revenue Guidance and Backlog

Energy Recovery is maintaining its revenue guidance for 2024 at between $140 million and $150 million. As of now, the company has recognized approximately $107 million in revenue, representing 74% of the midpoint of this guidance, although this figure reflects a 9% decline from last year due to timing issues with contract closures. Encouragingly, there is a backlog of draft contracts worth approximately $25 million that are expected to be finalized soon, underscoring continued confidence in achieving the annual revenue goals.

Challenges and Market Dynamics

The company has faced operational challenges, including onetime costs of $4 million in the second quarter, arising from consulting and executive transition expenses. This has led to a slight net income loss for the quarter, although significant sequential improvement indicates a trend towards breakeven. Despite these hurdles, Energy Recovery has witnessed a growth in wastewater contracts by nearly 5%, indicating resilience even as they navigate current economic challenges, particularly in China.

Gross Margins and Operational Expenses

Gross margins rebounded to approximately 65% in the second quarter, with expectations for the next quarter ranging between 62% to 64%. Energy Recovery anticipates managing production ramp-up challenges effectively, with confidence in achieving gross margins between 64% and 67% for the full year. Operating expenses are projected to be stable at $78 million to $80 million, which includes anticipated onetime costs.

Technological Advancements in CO2 Business

The company is making significant strides in its CO2 business, with plans to install between 30 and 50 units of the second-generation PX G by the end of 2024. Currently, nine sites are operating successfully, with a focus on capturing data that will support a white paper for future marketing and sales efforts. Positive initial reports regarding the performance of these units indicate both reduced noise and vibration compared to the first generation, positioning Energy Recovery as an innovative leader in refrigeration technology.

Future Prospects and Strategic Initiatives

Looking ahead, Energy Recovery anticipates that 2024 will mark its tenth consecutive year of revenue growth, with trends suggesting that 2025 will continue this positive trajectory. The company is actively refining its strategic roadmap—referred to as the 'Playbook'—with a focus on revenue and operational targets to enhance communication with stakeholders. This forthcoming strategy will soon be detailed in an upcoming webinar.

Conclusion

Overall, Energy Recovery showcases a solid position despite facing operational hurdles and external economic pressures. The expected revenue guidance, coupled with improvements in gross margins and an expanding backlog, presents a promising outlook for the company. Furthermore, the advancements in its CO2 solutions highlight its innovative edge, while strategic planning efforts are aimed at sustaining long-term growth. Investors should keep an eye on further developments in both revenue generation and strategic execution as the year progresses.

Earnings Call Transcript 2024-Q2

[Operator]

Greetings, and welcome to the Energy Recovery 2Q '24 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, James Siccardi, Vice President of Investor Relations.

[James Siccardi, executive]

Hello, everyone, and welcome to Energy Recovery's 2024 Second Quarter Earnings Conference Call. My name is Jim Siccardi, 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 Moon.

[David Moon, executive]

Thanks, Jim, and thank you all for joining us today. I'm 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 5. Michael brings experience leading high-growth engineering and technology-focused start-up companies, 2 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 us well as we expand into the 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 form 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 million to $150 million for the year. There are 4 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. There were several shipments worth noting that we've discussed in previous calls.

We are pleased to report that we completed shipment of the Perur 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 could 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 3 phases: the Hassyan IPP project in Dubai, UAE worth $5.2 million. Once constructed this 820,000 cubic meter per day plant will be the largest desalination plant in Dubai. This serves as another example of large-scale project slippage. In this case, the project was retendered and timing was adjusted, but our position to execute this project remains strong throughout the entire process. We expect the remaining 2 phases to ship within this calendar year.

Second, we announced in July the signing of $15 million in contracts to supply Pressure Exchangers to several SWRO desalination plants in India, which included the Perur project. The remaining 4 projects are expected to ship in 2024. All together, 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 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 mega project 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 million to $39 million in the fourth quarter at $66 million 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 PX G 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 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 9 second-generation PX G sites operating in the U.S. and Europe as of July 15 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 PX G at 6 of the 10 sites. They will also assist us in the white paper development. These 6 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. 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 a respected third-party or university to independently verify your claims in a field setting. This is exactly what we are 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 Greenchill 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 PX G adoption with the end users. DC Engineering is currently in the measuring phase. Additionally, our OEM partners, Hillphoenix and Epta, will be collecting data on our behalf at 2 of the 10 sites located in Canada, which is Loblaws and Hungary, which is Auchan, respectively. We will be collecting data at the remaining 2 sites. And finally, we have 40 sites in our pipeline for 2024, including the 9 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 Q4 under 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 full year gross margin guidance remains at 64% to 67%. Our operating expenses increased 21% over the second quarter of last year, primarily due to onetime expenses. Now as mentioned last quarter and as expected, we continue to experience onetime 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 onetime expenses totaled $4 million in the second quarter.

To recap onetime cost and operating expense to date, 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 million to $80 million, which includes the estimated $7 million in onetime costs. We expect operating expense to come in at $21 million to $22 million for the third quarter.

Of the remaining approximately $2.2 million of onetime costs, we expect 75% to be spent in the third quarter and 25% in the fourth quarter. As a result of these onetime 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 million and $150 million. So to sum up, we delivered a strong quarter supported by a growing backlog, which gives us confidence in our full year revenue guidance of $140 million to $150 million. We anticipate our Wastewater business to generate $12 million to $15 million in revenue. We expect to have 30 to 50 sites with our PX second-generation PX G installed by the end of the year. And we are maintaining our gross margin guidance of 64% to 67% and operating expense to $78 million to $80 million.

With that, now let's move to Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of Pavel Molchanov with Raymond James.

[Pavel Molchanov, analyst]

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?

[David Moon, executive]

Pavel, this is David Moon. Nice to hear your voice today. So the guidance that will -- so we'll break out, as I said on -- just a few minutes ago, we're going to break out the release of the Playbook into -- we'll have -- 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 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 will be a 5-year look, but we'll also provide not just revenue but also earnings and also a look by business unit as well.

[Pavel Molchanov, analyst]

Okay. That's something for us to look forward too. 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?

[David Moon, executive]

Yes. So there's 2 specific -- so there's 2 specific metrics that were -- that are being validated or measured by DC engineering. One is just purely energy segments. And then the second is capacity extension. And I think we've talked in previous calls well about how the PX G provides capacity extension and high heat load dates. And so DC engineering is measuring and confirming both of those.

[Pavel Molchanov, analyst]

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?

[David Moon, executive]

I think so. Largely, the feedback has been around -- it's a very first cost conscious industry. And so largely, the feedback has been around pay that period. And anything from 2 to 3 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 saving as part of that. But that's the primary feedback we get or what end users supermarkets way you'd be looking for. And that's a very, very short payback period.

[Pavel Molchanov, analyst]

Okay. Last question, a little bit more macro. Is there any evidence that interest rate -- high interest rates, currency, oil price or anything else is structurally hindering the development of desalination in the Middle East?

[David Moon, executive]

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

[Operator]

The next question comes from the line of Ryan Pfingst with B. Riley Securities.

[Ryan Pfingst, analyst]

I know you don't want to get ahead of the 3Q update and webinar in the fourth quarter around CO2. But maybe can you talk a little bit about the recently deployed PX G's and maybe how they performed compared to what you were seeing from the prior generation?

[David Moon, executive]

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 PX G which were the 2 issues that we saw wanted to solve for when we developed the second gen. And so field time so far, they're running 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, our PX G stress test, right? I mean we've had 100-plus degree days in Southern California for most of the last month or so and so far so good. So we're happy with the performance.

[Ryan Pfingst, analyst]

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?

[David Moon, executive]

So we're starting to push that discussion on our side. And so this is something we've been talking about the last 3 or so months about how we can -- we capture a lot of data. There's a lot of -- our PXs are data-rich in terms of opportunity. And so we're talking to our EPCs and all lines operators about how potentially we can go faster and some ideas we have on the AI front. We're not getting pulled that we're pushing, we're doing and pushing at this moment.

[Ryan Pfingst, analyst]

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 desalination projects moving forward. But what are you seeing in terms of the visibility you have on 2025 today and the potential growth for you guys?

[David Moon, executive]

Yes. So I think -- so we're confident we're -- this 2024 will be the 10th consecutive year of growth that we've had. And I would say, looking where sort of understanding 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. So more to come when we talk in third quarter, certainly as part of the webinar, but I see the growth trends, the macro story continues to look good. So -- and we're going to continue to ride that way. So I think it looks good for 2025.

[Operator]

The next question comes from the line of Jason Bandel with Evercore ISI.

[Jason Bandel, analyst]

First question on the refrigeration side. I know you mentioned in your prepared remarks about Kroger test in our PX G and I saw their recent announcement that they're going to start using the 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 useful life for older systems? Like how is that transition typically happen?

[David Moon, executive]

It's going to really depend. So in this space, there are -- what we call first movers or first adopters and then their followers. And so those sort of supermarkets fall in those 2 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, we're doing the one store announced Cincinnati. It's getting a lot of exposure, by the way, because it's their headquarters.

And that continues to go well and as Kroger begins to work on their capital plans for rolling out CO2 over the next 5 years. And 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 might not be running well or it's just the equipment is sort of at its expiration day. 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.

[Jason Bandel, analyst]

Got it. Okay. That makes sense. And then with the white paper, the OEMs, will they feel comfortable with the amount of run time data in the white paper? Or will some want to see even more run time data in order to get comfortable with the real-world performance of the PX G?

[David Moon, executive]

Yes. So it's a very good question. So the run time 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 sit with end users and have this next discussion. And so we are following their direction when it comes to run time. And what's critical is this is the summer period, and nothing more, nothing less. And so if we come out of the summer period with good results, that will be enough then to take our discussion to the next level.

[Jason Bandel, analyst]

Got it. Now switching gears a little bit to 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. I will give you the confidence that the second half revenue will come in to meet your full year guidance.

[David Moon, executive]

Yes. So we did about $600,000 in wastewater this quarter, which was equal to what we did at this time last year. Our backlog, as I talked about earlier, is growing -- we're seeing an uptick over the last 4 weeks, we've seen a real uptick in quoting that we hadn't seen for a while, largely driven by China. And so we're seeing that China is 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 and quality plus what we've already count on the books in terms of backlog, we're still comfortable with the 12% to $15 million of guidance, even though we started slow.

[Jason Bandel, analyst]

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

[David Moon, executive]

Look, I think in a perfect world, have been great. If we would have had some overlap. But Michael is an experienced CFO. He brings a skill set with his start-up work. He knows how to work under pressure given his previous background. He knows how to work with investors. He'll hit the ground running. I have no doubt. And so yes, would have been good, yes, but where he'll hit the ground he nearly 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 we hit the ground running. I'm not worried about that.

[Operator]

[Operator Instructions] There are no further questions at this time. I would like to turn the call back to James Siccardi for closing remarks.

[James Siccardi, executive]

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

[Operator]

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