Energy Recovery Inc

NASDAQ:ERII

Earnings Call Transcript 2024-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Energy Recovery Third Quarter Earnings Call. Our host for today's call is Lionel McBee. [Operator Instructions]

I would like to now turn the call over to your host, Mr. McBee.

[Lionel McBee, executive]

Good afternoon, everyone. Welcome to Energy Recovery's 2024 third quarter earnings conference call. We appreciate you joining us. I'm Lionel McBee, Director of Investor Relations at Energy Recovery, and I'm joined here today by our President and Chief Executive Officer, David Moon; and our Chief Financial Officer, Mike Mancini.

The prerecorded remarks from today's call are available on the Investors section of our website and are meant to accompany the third quarter earnings news release, which is posted in the same location.

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 and 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, October 30th, 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. And lastly, for your planning purposes, please note that our fourth quarter and full year earnings conference call is scheduled for Wednesday, February 26, 2025.

And with that, I will turn the call over to David.

[David Moon, executive]

Thanks, Lionel, and thank you for joining us today. As Lionel mentioned, we are joined today for the first time on our quarterly earnings call by Energy Recovery's new CFO, Mike Mancini, who started on August 5th. I want to say how grateful I am for Mike's partnership and the work he has already done. As I mentioned last quarter, Mike brings a wealth of experience in high-growth engineering and technology companies. He has had executive leadership roles in finance, where he demonstrated his ability to drive financial strategy and performance across the entire enterprise. Additionally, his background with the institutional investment community provides him with a deep understanding of capital markets, which makes him a valuable asset to our leadership team.

Now before I get into the third quarter financial results, I will make a brief comment on our strategic planning process, or the Playbook as we call it. Although we won't be getting into any of the specifics of the playbook on this call, we are hosting a live investor webinar on November 18th, where members of my senior leadership team will present our Playbook, including growth plans for desalination, wastewater and CO2.

We will also provide guidance for 2025 and 2026, as well as provide long-term 2029 financial targets. The webinar will take place at 10 a.m. Eastern Time and will last approximately 2 hours, including a live Q&A session. The event will be accessible virtually via the link located on the IR calendar section of Energy Recovery's IR website, and a replay of the event will also be archived there. Additional details can be found in our press release issued on October 21st.

Now, let's move into the third quarter update. First, let me start by saying thank you to our employees for helping deliver another very solid quarter. With total revenue of $38.6 million, we achieved the upper end of our guidance for the quarter and set another quarterly revenue record. Now while we still have considerable work to do to deliver what stands to be the largest quarter in the company's history in the fourth quarter, our third quarter performance did create a line of sight to achievement of our full year guidance of $140 million to $150 million.

As I've said the last couple of quarters, the demands on the team to deliver on these mega projects are only increasing. With that said, I remain confident in our ability to deliver what will be the biggest quarter in Energy Recovery's history, capping off what will be the 11th consecutive year of revenue growth and another year of strong market share in our mega projects channel.

Let me talk briefly about our high-level segment results before turning it over to Mike for the financial results. Let's start with water. Water revenue came in at $38.3 million, an increase of 4% compared to the third quarter of 2023 and up 42% compared to the second quarter of 2024. This reflects the high end of our guidance for the third quarter of $35 million to $39 million and continues the prior quarter's solid growth in mega projects. Results were driven by continued strong demand in the Middle East and North Africa, as well as demand from India.

I'd like to highlight several notable desal shipments made during the quarter. First, we completed the second and final shipment of the Perur project in Chennai, India worth $4.1 million, as we mentioned previously during our July earnings call. Once constructed, this will be the largest desalination plant in India, delivering 400,000 cubic meters per day. Also, as a reminder, the Perur project was just one of the projects included in the $15 million in contracts that we announced in July for several SWRO desalination plants in India.

For the remaining 4 projects under these contracts, we shipped $8.3 million and expect to complete the additional $2.6 million of shipments in the fourth quarter. Altogether, these plants will provide over 670,000 cubic meters of clean drinking water to communities in India each day. We also made progress on the Hassyan IPP project in Dubai, UAE during the third quarter, which was -- which once constructed will be the largest desalination plant in Dubai, providing 820,000 cubic meters per day.

As of our last call in July, we had shipped the first phase. As of today, I'm pleased to report that we shipped a total of $10.5 million year-to-date and expect to ship the final $5.3 million in Q4. In addition to these shipments, we also continue to secure major desalination contracts in recent months. In August, we signed contracts totaling $27.5 million for SWRO desalination projects in Morocco. These projects will supply over 1 million cubic meters per day of potable water for municipal and agricultural use, which represents enough water for more than 600,000 Moroccans.

As of today, we have shipped $12.3 million of that total order. The balance of the order is currently expected to be filled in 2024. However, we are closely monitoring this timing given an end-of-December target shipping date. North Africa continues to be an important driver of growth for our water business with secular trends such as ongoing drought, industrial growth, and population growth continuing to generate strong demand for SWRO desalination plants.

Earlier this month, we announced contract awards totaling over $12 million for 3 SWRO desalination projects in the United Arab Emirates. The plans include capacity totaling close to 1 million cubics per day -- cubic meters per day, and as a proof point as to the manufacturing improvements we have made, our intent is to ship nearly all of these orders in the fourth quarter. Both contract awards and their shipment dates were on our radar and therefore, included in our 2024 financial guidance. Based on our strong third quarter results and our expectations for additional shipments in the fourth quarter, we are maintaining our revenue guidance of $140 million to $150 million for the year.

Now as we provided in previous quarters, our current 2024 total water revenue as of the end of the third quarter, which includes revenue recognized in the first 9 months of the year and signed projects under contract yet to be delivered, totals approximately $137 million or 94% of the midpoint of our guided range for 2024. This compares to roughly $136 million or 100% of the guided range at the same time in 2023. With this substantial progress towards our full year guidance underpins our confidence in reaffirming our guided range for the full year. We cannot control customer-driven delays or slippage.

With that said, we continue to collaborate closely with our customers, and we remain focused on strong execution in the fourth quarter to complete our remaining shipments and to deliver our full year guidance. In the event unforeseen circumstances cause slippage towards the end of the year, I'd like to reiterate that the associated revenue would not be at risk, but would simply be recognized in 2025 rather than in the fourth quarter of 2024.

Now turning to wastewater. Our wastewater pipeline continues to grow, and we've increased our signed wastewater contracts by almost 46% as compared to last year during the same period. Our strategic diversification strategy for water is underway, and we are making progress in our product portfolio expansion. For the year, we expect to generate revenue towards the lower end of our previous provided guided range of $12 million to $15 million. This is primarily the result of a wastewater mega project, the NEOM project in Saudi Arabia that's transitioned to a longer-term phased project over multiple years.

However, we expect to offset this impact through continued outperformance that we are seeing in the OEM channel. We will share more details on our progress and our strategy for wastewater during our investor webinar on November 18th. Overall, we feel that the air pocket created by rapidly rising interest rates, inflationary effects and concerns around the global economic activity have begun to moderate. Clearly, there are still economic and geopolitical concerns around the globe, but the long-term trends for fresh water demand remain intact, and we continue to see solid growth ahead.

Now let's move to our CO2 business. We continue to make progress in the development and commercialization of our second generation PX G. As I stated during our last call, in the second quarter, we completed our first gating item for 2024, which was the successful completion of lab testing. During the third quarter, we turned our focus to our second gating item, which is the installation of 30 to 50 sites by the end of Q4 2024.

I am pleased to report that we reached our initial goal of having at least 10 sites installed and operating across the U.S. and Europe. In fact, we've now completed the installation of a total of 11 sites year-to-date. With that site goal reached, we were able to complete the collection of critical summer data. As I discussed during our last call, we partnered with DC Engineering, a highly respected third-party engineering firm, to measure and verify energy savings provided by our second generation PX G at 6 of the 10 initial sites.

I'm pleased to report that in that collaboration with DC Engineering, we recently published a white paper on these results, which we believe will be the catalyst for our OEM partners and for us to accelerate PX G adoption with end users in the near-term. The white paper can be found on our website, the results were better than expected, showing that the PX G reduces energy consumption, increases cooling capacity and improves system stability.

The findings showed that the PX G improved the leading metric of energy efficiency or the coefficient of performance by peaks up to 30% with as much as 15% in projected annual energy savings. In addition to energy efficiency, findings estimate that the PX G increased its cooling capacity for CO2 refrigeration systems by up to 15% in 95 degrees Fahrenheit or 35 degrees centigrade, providing operational flexibility to safeguard against heat waves.

Based on the success of the ongoing measurement and verification processes, during the third quarter multiple OEMs began to process of integrating the PX G into their CO2 transcritical racks. This is a necessary and important step towards full commercialization of the PX G. We are highly encouraged by the test results and the resulting integration by our OEM partners.

Adding to our momentum, we currently have 19 additional sites to be commissioned for installation in the coming months. Including the 11 sites already installed and operating, we're on a clear path towards meeting the low end of our target of 30 to 50 sites installed by the end of this year. Additionally, our pipeline of additional sites has grown meaningfully as the industry has gained awareness of the PX G technology.

We are in discussions with existing customers to expand installed sites and with new OEMs for new sites across the U.S. and Europe. Momentum for the PX G is clearly accelerating. I look forward to sharing additional details on our progress and strategy for CO2 and wastewater during our upcoming webinar.

With that, I'd like to hand it over to Mike to discuss our financial results for the quarter.

[Michael Mancini, executive]

Thank you, David. And let me start by saying thanks to you and to the Board for your trust and confidence in me to lead the finance function here at Energy Recovery. Before arriving, I was excited about the company's core business prospects, the exciting opportunities to grow and expand the reach of the PX technology, and the opportunity to drive profitability and cash flow. After almost 3 months on the job, I'm now confident in the company's ability to create value for its shareholders, and I look forward to working with the team on driving financial results.

I'd like to begin by discussing our revenue, gross margin and product mix. Then I'll discuss our operating expense, net income and cash position, as well as our expectations for the full year 2024. As David mentioned, we had a solid quarter of revenue, generating $38.6 million at the upper end of our guidance. The project-driven lumpy nature of our mega project channel has become quite evident to me even in the short time I have been here.

Q4 revenue is expected to be between $62 million and $72 million, which will represent over 45% of our full year revenue at the midpoint. In the fourth quarter alone, 5 projects represent approximately 50% of the revenue, with a single project representing over 20%. Any delays in shipment dates on those projects would have an impact on our full year revenue, although there would be a minimal impact to the intrinsic value of the business of such delays.

Moving to margins. Our gross margin improved 50 basis points when compared to the second quarter of the year, with the third quarter coming in at 65.1%, above our previously guided range of 62% to 64% for the third quarter. We believe we've turned the corner in our efforts to manage and resolve challenges related to our ramp-up in production of the Q400, and our gross margin expectation for the fourth quarter is 64% to 68%, which would put our full year gross margin guidance within our guided range of 64% and 67%.

Regarding product mix, on our last call, we stated that the Q400 was trending towards 50% of our Water PX demand for 2024, up from our original expectation of 25%. During the third quarter, the Q400 comprised approximately 45% of our Water PX demand, reinforcing our expectation for 50% product mix for the full year. This faster-than-expected adoption of the Q400 highlights our product leadership position in the mega project desalination space and underscores our ability to align our solutions with customers' evolving needs.

Our operating expenses for the third quarter were $18.1 million, which came in below our previously guided range of $21 million to $22 million for the quarter. One-time costs for the quarter were $1.1 million. As a result, base OpEx for the quarter was $17 million, a 1% increase from the same period last year. So while our focus on cost and capital efficiency are working, we do expect to continue to experience some one-time costs associated with the work in support of our long-term growth strategy and some added employee count to support our growth.

Still, we will be able to capture the benefit of our cost efforts and are reducing our full year operating expense guidance to $76 million to $78 million from the previous $78 million to $80 million, which still includes the estimated $7 million in one-time costs we have indicated before. This implies expected operating expense for the fourth quarter of approximately $20 million to $22 million, and full year 2024 base OpEx of $69 million to $71 million.

Additionally, we reported income from operations for the third quarter of $7.1 million, in line with our expectation provided on our last call to move to a positive operating income as the year progresses. We also reported net income for the quarter of $8.5 million, reflecting a substantial increase compared to the second quarter.

Lastly, we maintained our cash balance during the quarter with cash and investments of $140 million as of the end of the third quarter compared to $138 million at the end of the second quarter. We remain in a very strong financial position, and we expect to end the year at between $140 million and $150 million of cash, depending on collections.

With that, I'd like to turn it back over to David for a few closing remarks.

[David Moon, executive]

Thank you, Mike. To sum up, we delivered a record third quarter, and while there is still work ahead of us to execute the fourth quarter, we remain confident in our full year revenue guidance of $140 million to $150. We remain on track to generate $12 million to $15 million in revenue from our wastewater business, although we anticipate this will come in towards the lower end of that range.

We are on track to deliver the low end of 30 to 50 sites with our second generation PX G installed by the end of the year. We are maintaining our gross margin guidance of 64% to 67%, and we are reducing our operating expense guidance from -- to $76 million to $78 million.

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

[Operator]

[Operator Instructions] Your first question comes from Ryan Pfingst with B. Riley.

[Ryan Pfingst, analyst]

Not to get ahead of the webinar, but I was wondering if you could talk about the competitive landscape in CO2. Is anyone else attempting to do what you guys are doing with the PX G?

[David Moon, executive]

No, no other pressure exchanger competition that we see today. Now as you know, we compete against other technologies or applications in the space, but no one with the pressure exchanger.

[Ryan Pfingst, analyst]

Got it. That's helpful, David. And then I guess for my second question, on your capital allocation strategy, wondering how you're thinking about the potential for share repurchases with the strong cash balance you have now? And maybe if you could remind us of the capital requirements needed for the CO2 opportunity. I know it's still early stage, but is there any meaningful cash needed as that opportunity ramps?

[Michael Mancini, executive]

Ryan, this is Mike. So, I think we're going to get into that on the webinar. We'll lay out all of our growth strategy plans, capital needs and roll out a capital allocation policy. So we will be talking about that on November 18.

[Operator]

Your next question comes from Pavel Molchanov with Raymond James.

[Pavel Molchanov, analyst]

Let me start with kind of a high-level one about desal. Are you observing any geographic diversification of your customer mix away from the Middle East and towards newer desal markets?

[David Moon, executive]

Pavel, this is David. Nice to talk to you. No, still -- the concentration still is favoring Middle East, Africa in the third quarter as it's done really all of this year, we're up over 70% of our revenue for the quarter came from the MEA and then about 60% came from -- for the first 9 months of the year came from MEA. So we're still very reliant on that part of the world, and we'll look to continue to be that. As you'll hear in the webinar, the Middle East and Africa will continue to play a very important part of our mix over the next 5 years.

[Pavel Molchanov, analyst]

On the refrigeration side, I remember, this is now a couple of years ago, you signed a strategic partnership in the Netherlands with [indiscernible]

[David Moon, executive]

Still going strong.

[Pavel Molchanov, analyst]

Yes. And in Italy, with [ Aetna Group, ] have there been any other European partners that you've signed up?

[David Moon, executive]

No, that's -- we've got a number of new faces that we're talking to, Pavel, at the moment. But in terms of official sort of partnerships, it's Epta and it's few at the moment in Europe.

[Pavel Molchanov, analyst]

And is the -- I guess, the go-to-market strategy for refrigeration, I'm sure you'll touch on that in a few weeks here, but is it going to remain kind of centered around a select list of partners? Or is there a better approach to getting the word out about this product?

[David Moon, executive]

Ultimately to get to the end users. It doesn't mean we're not talking to end users directly. But ultimately, the OEMs is where we have to get our PX G integrated into their systems and thus get ourselves specked -- officially specked within a supermarket. And so to do that, we've got to go through the OEMs.

[Pavel Molchanov, analyst]

All right. We'll save the rest until November 18. Looking forward to it.

[Operator]

Your next question comes from Jason Bandel with Evercore ISI.

[Jason Bandel, analyst]

My first one is for Mike. You've been in the CFO seat now for almost 3 months, like you said. And in the prepared remarks, you touched on what attracted you to the company. Just curious, what were some of your initial impressions being inside the company so far? And what are some of the initiatives that you've been focusing on, of course, in addition to the Playbook work?

[Michael Mancini, executive]

Yes. Thanks for the question, Jason. So you've been here almost 3 months now. And I think largely what I expected coming in has been true. And that really is -- I think the key word for me is opportunity. There is opportunity for efficiency in manufacturing. There's opportunity for efficiency and cost. There's opportunity for growth. There's opportunity for capital, and how we allocate it, and just a lot of things where we can bring my expertise in finance to the team, along with the other new executives here to really focus on profitable growth going forward.

[Jason Bandel, analyst]

Got it. Makes sense. I'm looking forward to working with you. Next in refrigeration, David, I'm just curious, in the white paper, was the performance of the PX G consistent across the 6 sites that were monitored by DC Engineering?

[David Moon, executive]

Yes, consistent depending on temperature variation, right, whether Canada versus Southern California. So there's a bit of that variation. But what was consistent was the energy savings and the capacity increase. Now it differed the amount of energy savings and capacity increase differed depending on location. But we got both of those out of all the locations that we've been tracking.

[Jason Bandel, analyst]

In terms of the remaining sites for the year, now that you have the performance data in hand in this white paper, how are you prioritizing the deployment there for the remaining sites?

[David Moon, executive]

Yes. So the remaining sites are going to be a combination of Europe, U.S., existing OEM customers versus new OEM customers. And so, we've got a site selection tool that we use to ensure that we optimize the sites that we work with the OEMs on selecting. And so, we're ensuring that we're using that site selection tool for optimization to make sure we get the right sites early on. So we'll continue to use that process. But otherwise, it's -- we've got the capacity to do these other 20 sites or so for the remainder of the year.

[Jason Bandel, analyst]

Understood. And just one last quick one for me here on OpEx, good cost control there. Was there anything in particular that kind of drove the performance in the third quarter? And how much is left to spend at this point of the one-time costs?

[Michael Mancini, executive]

Yes. This is Mike. So I'd say the largest driver of cost coming in was more of a cost avoidance of not growing in certain non-core growth areas that was planned for. So some cost cutting, but also just, I'd say, cost avoidance. And then the one-time costs, we expect to do $7 million in total for the year, and we have about $6 million of that in cash and non-cash already done. So about $1 million left.

[Operator]

Your next question comes from Jeffrey Campbell with Seaport Research Partners.

[Jeffrey Campbell, analyst]

My first one is a white paper question. Your recent white paper noted that the PX G1300 transcritical system energy savings and increased cooling capacity did not require any water cooling. So I was wondering if this suggested that a system using the PX G might be able to avoid an [ adiabatic ] cooler and choose a dry cooler instead.

[David Moon, executive]

Yes, it's a good -- this is David. It's a good question. So there are a number of sites across -- what that refers to is, there are a number of sites across Europe and even in certain parts of the U.S., especially Southern California, that require adiabatic cooling or -- for high heat load days. And so what the PX G does is that given its increased cooling capacity, depending on the location can either replace the adiabatic cooler as a best case or a worst case can reduce the amount of adiabatic cooling that goes on during high heat load days, thus reducing water usage, thus reducing energy savings and so on.

And so what this means is that, if you're putting in a greenfield site where you've got an adiabatic, you would have put an adiabatic cooler before, you no longer -- if you're going to put in the PX G, you no longer require that. You don't have to go through the expense of putting in the $20,000 to [ $50,000 ] of putting in the adiabatic cooler nor do you have to, you can forego the $5,000 to $10,000 a year of operating costs as well. So we're a nice replacement for that adiabatic cooling system.

[Jeffrey Campbell, analyst]

Yes. That stuck out as a pretty good argument for the PX G from...

[David Moon, executive]

We hope so. We hope that's the case as others read it, especially end users. So...

[Jeffrey Campbell, analyst]

And we can get rid of the expander at the same time. So that's -- or the ejector, excuse me, at the same time. So it's a pretty good argument.

[David Moon, executive]

That's right.

[Jeffrey Campbell, analyst]

I wanted to ask you one other kind of [ think a real ] question. The recent EPA's SNAP decision in June allows continued use of HFO and HFO, HFC blends in new equipment designed for these refrigerants in the U.S. Just wondering what are your thoughts or maybe what you're hearing or what are the animal spirits on continued competition between HFO and CO2 refrigeration, particularly with PX G's ability to strengthen the CO2 case as we just discussed.

[David Moon, executive]

Yes. I think CO2 is still the outright winner. You might have some outliers that will choose the HFO blends, and maybe even in stand-alone cases that you can move around the store freely. But everything that we're hearing in the U.S. from our OEMs, our OEM customers that we've been working with is that, it's full speed ahead on CO2, full speed ahead.

[Operator]

[Operator Instructions] Your next question comes from [ Miriam Martin ] with BMO Capital.

It appears there are no further questions at this time. I'd like to turn the call back to our presenters for any further remarks.

[David Moon, executive]

[Technical Difficulty]

[Operator]

This concludes today's Energy Recovery Third Quarter earnings call. Thank you for attending, and have a wonderful rest of your day.