Energy Recovery, Inc. (NASDAQ:ERII) Q1 2024 Earnings Call Transcript

Energy Recovery, Inc. (NASDAQ:ERII) Q1 2024 Earnings Call Transcript May 1, 2024

Energy Recovery, Inc. misses on earnings expectations. Reported EPS is $-0.14 EPS, expectations were $-0.11. ERII isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the Energy Recovery First Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, James Siccardi, Vice President of Investor Relations. Thank you, Mr. Siccardi. You may begin.

James Siccardi: Hello, everyone and welcome to Energy Recovery’s 2024 first quarter earnings conference call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery. And I’m here today with our President and Chief Executive Officer, David Moon; and our Chief Financial Officer, Joshua Ballard. During today’s call, we may make projections and other forward-looking statements under the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995 regarding future events or the future financial performance of the company. These statements may discuss our business, economic and market outlooks, 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, May 1, 2024 and the company expressly disclaims any intent or obligation to update any forward-looking statements made during this call to reflect subsequent events or circumstances, unless otherwise required by law.

At this point, I will turn the call over to our President and Chief Executive Officer, David Moon.

David Moon: Thank you, Jim and thank you all for joining us today. The first quarter was a busy one for us and played out as anticipated. Revenue at $12.1 million was in line with our guidance for the quarter of $10 million to $13 million. With regards to the CFO transition, we’ve been actively interviewing some promising candidates and are making real progress. We believe we will have our candidate in place prior to Josh’s last date of June 30. I stated on our last call that I, as well as the Board, strongly believe Energy Recovery’s strategy of PX diversification to drive growth is the right strategy and is critical to our future. While continuing to recognize the importance of maintaining our foundational market leadership in desalination, it is critical that we also continue to look for ways to accelerate our penetration into the wastewater and the CO2 refrigeration markets, as this is from where the lion’s share of potential revenue growth will originate.

We anticipate our strategic future will build off this perspective. We have now formally kicked off work on our strategic planning cycle and have enlisted the assistance of industry experts to provide us additional guidance, specifically in wastewater and refrigeration. These industry experts will play integral roles in providing intelligence and hard data, while challenging us on our product development and market strategy and contributing to the development of our strategic Playbook. This will add significant expense in the second quarter especially but I believe it is critically important work to establish a strong strategic foundation from which to grow in the coming years. Now let’s get into our update, starting with water. First, we are maintaining our revenue guidance of $140 million to $150 million for the year.

Our current 2024 contracted projects, including the revenue recognized in the first quarter, totals roughly $87 million, or 60% of the mid-point of our guided range for the year. This compares to $69 million, or 50% of the guided range, at the same time in 2023. This reflects a 26% increase over year and underpins our confidence in our guidance for the year. In addition, we also just signed our first mega project deal in Brazil for shipment in 2025. In our second quarter call last August, we discussed in some detail the growing wastewater challenges in South America. This project is a clear example of how growing water challenges outside of the Middle East, desal’s historic growth area are being reflected in our pipeline in new ways. The cadence of this year’s revenue guidance is unchanged.

We remain heavily weighted towards the second half of the year. We are seeing real strength in both our desal OEM and aftermarket sales as we start the year and have signed most of the mega project deals for the year. Our focus today in water is to close the handful of megaproject deals remaining in the coming months, as well as maintaining our momentum in our OEM and aftermarket channels to end the year as strongly as possible. Our wastewater business is also developing well this year and we remain confident in our range of $12 million to $15 million for the year. Our pipeline continues to grow and we’ve increased our signed wastewater contracts by almost 40% as compared to last year at this time. We’ve also seen positive news here locally in the U.S. as it relates to the municipal wastewater market.

United States government on April 10th announced newly adopted rules to address PFAS contamination, or forever chemicals, in our drinking water. The Biden Administration has allocated $9 billion to help communities with drinking water impacted by PFAS. Now one valuable tool for filtering out existing PFAS from drinking water is reverse osmosis filtration. While it’s not the only solution to this problem, we believe reverse osmosis can play a key role in the coming years as the world tackles this growing challenge and we will be exploring these opportunities and the timing of them in our Playbook. The global attention on PFAS continues to underscore the growing focus on water quality and scarcity that is happening around the world today. Now let’s move to our CO2 business.

The past few months, the most important activity I engaged in was to meet with the major OEMs in the U.S. and Europe. I have a few key takeaways from these meetings, all of which support the approach we are taking this year. First and foremost, the interest in and the feedback on the PX G was positive. OEMs can see the potential value of the PX G in their systems and remain very interested in our success. Second, OEMs are looking for more quality, uninterrupted runtime data during the summer months which is the goal of our activities this year. This data will provide reliable performance data in the field which is critical to OEMs and end customers to fully accept our product in the marketplace, to fine-tune our value proposition and to be a catalyst to allow Energy Recovery to take a substantial step forward to building commercial relationships with the OEMs. Third, once the OEMs have comfort in our data, it is clear that our best path forward will be to integrate the PX G directly into the rack architecture of the OEMs’ CO2 systems.

This will mean that OEMs will need to commit engineering resources to adjust their existing architectures to incorporate the PX G. This is a commitment of time and money and therefore another reason why field data is so key to creating broader market acceptance for the PX G. At the last earnings call, we discussed 2 gates to better position ourselves for future market penetration and revenue growth. These gates directly support the feedback we received from the OEMs in the first quarter. The first gate is the successful completion of testing of our second generation PX G in our internal labs by the end of Q2, 2024. I am pleased to announce that we’ve achieved this milestone. Lab performance has shown an order of magnitude increase in reliability and performance which is critical to providing the uninterrupted runtime data we need this year.

The second-generation PX G has now been installed as part of a beta test in supermarkets in California and Belgium. Both installations have been operating successfully since the beginning of March. The second gate is the successful installation, operations and third-party validation of 30 to 50 additional field validation sites by the end of this year. Our first step is to install roughly 10 sites this summer which are the most critical sites for this year and will provide the key performance data that we need. As of today, we currently have 3 sites currently running. We expect 4 additional sites to be commissioned by the end of June in Canada, Belgium, Hungary and the U.S. The remaining 3 sites are scheduled for Europe and the U.S. by the end of August.

I will continue to update you on our progress in August but we are off to a strong start to the year. Outside of these critical activities, I have 2 other updates from the market. First, our PX G was awarded the Refrigeration Product of the Year by ACR News London. This award is a recognition of excellence and innovation from across the air conditioning and refrigeration sector. The PX G was selected for its ability to improve year-round transcritical CO2 systems performance by reducing energy costs which is perhaps the single biggest hurdle faced by supermarkets in adjusting to stringent global requirements. This is the third award we’ve received since the start of 2023 as the PX G continues to gain attention across the globe and should serve as further proof that technology is catching up to the changing regulatory environment.

Second, I have a quick update on the regulatory environment. The EU came out with new, more stringent regulations on the reduction in HFCs that became effective March 11th. Whereas previous regulations reduced HFC usage from 31% of the 2025 baseline in 2024 to 21% by 2030, the EU has now accelerated this reduction. As of March 11th, the EU must reduce usage to 24% of their baseline by 2025, 12% in 2027, to 5% in 2030. This is good news for CO2. So to sum up, the operational deliverables that I’ve put in place for 2024 are as follows: maintain and grow our dominant position in desalination, grow our wastewater business to $12 million to $15 million in revenue, install at least 30 to 50 sites in North America and Europe by the end of the year and deliver our full revenue guidance for the year of $140 million to $150 million.

The work we do over the next several months will position us to deliver on our future in water and CO2 growth. In the interim, we remain 1 of the purest means to invest in the growing global water scarcity story. And with that, let me hand over the call to Josh to update you on the financials.

Joshua Ballard: Good afternoon, everyone. First quarter revenue fell comfortably within expectations, with no real surprises and within the midpoint of our guidance from our last earnings call. Unlike the first quarter last year, our water channel mix was more balanced, with roughly half our revenue coming from mega projects and the remaining split between OEM and aftermarket sales. Although our OEM channel shows a significant decline as compared to Q1 last year, this is simply due to the timing of projects shipping. We currently expect to show healthy double-digit growth in our OEM channel in 2024. We are reporting no material emerging technology revenue this quarter which is in line with David’s comments in February with regards to our short pause to make and test the enhancements to the PX G and now launch the second generation here in the second quarter.

We are maintaining our estimated range for water revenue in the second quarter at $20 million to $25 million. This means that we are still heavily weighted to the second half of the year. Where we sit today, we are assuming that the last 2 quarters will show 40% of the second half revenue falling into Q3 and 60% in Q4. However, we will be better prepared to update you more precisely in our August call as the third quarter comes into focus. Note that our target water revenue range of $140 million to $150 million this year includes a buffer against possible movements of up to a couple of mega projects. David mentioned the status of our signed and shipped contracts year-to-date. We have been getting a lot of questions on the status of our pipeline from all of you to get a sense as to how the year is progressing.

Our plan is to continue to update you on this cumulative number as we move forward through the year to give you a sense as to how we are tracking to the current full-year guidance. We will then reset in Q1 next year for 2025. Therefore, note that the $87 million cited for this year is explicitly for signed water projects, in both our desalination and wastewater markets, forecasted to ship out in 2024, inclusive of those shipped in the first quarter. Our gross margin in the first quarter was 59%. Much like last year, we are seeing a product mix more heavily weighted to pumps and turbochargers in a low revenue quarter which is lowering our margin on a blended basis. You will also note that our margin is 190 basis points below Q1 2023, despite a similar product mix.

This is because of the inflation and growing manufacturing costs that we have been describing over the past year. We also experienced slightly higher scrap in the first quarter which, combined with a lower revenue denominator, had an outsized effect on margin but will not be material for the full year. We fully expect to recover to our guided range as the year progresses and pressure exchangers take a larger percentage of sales. For now, we have no change to our guided range of 64% to 67% and the year-on-year variance from Q1 2023 roughly falls in line with our expectations for 2024. Let’s now turn to operating expenses. Our OpEx grew 11% over the first quarter of last year. However, we are reporting a decrease of 4% against Q4 2023 which is a more relevant comparison.

There are 2 things at play here. First, Q1 OpEx is inclusive of nearly $500,000 of, what we call, onetime executive transition costs which you will note in our non-GAAP calculations in our press release. In addition, this quarter includes another $300,000 of short-term retention grants provided to some executives at the end of last year. Adjusted for these temporary charges of roughly $800,000, our base recurring OpEx grew closer to 7% year-on-year. Second, our investments in people and the organization grew throughout the year in 2023 as we increased our sales and marketing spend and added headcount in support of both our water and CO2 businesses. Therefore, what we are seeing now is the effect of increased headcount and other spend in the first quarter for investments made in 2023.

Now that we are further into the year and our onetime costs related to the ongoing transition are becoming clearer, I also wanted to go a little deeper into our OpEx forecast to provide some additional clarity. In the second quarter, we expect our base recurring OpEx to remain fairly flat. However, we will have material onetime expenses related to executive transition and a significant portion associated with work in support of our long-term growth strategy as mentioned by David in his opening remarks. These overall costs which will include a mix of cash and noncash items, could be as high as $5 million in Q2, meaning our OpEx will likely land between $22 million to $23 million. We are expecting an additional roughly $1.5 million of these onetime expenses by the end of the year.

When you add in the $800,000 of onetime expenses described earlier, this brings these charges to a total of about $7 million for 2024. In light of some of these onetime expenses, we have made the decision to reduce our base recurring OpEx to around $71 million to $73 million versus my guidance from last quarter of $73 million to $75 million. Note that these reductions are in softer nonpersonnel discretionary spend and will not be in areas that could get in the way of our growth plans. If you add our estimated $7 million of onetime costs, this puts our total forecasted OpEx for the year at roughly $78 million to $80 million. I realize that 2024 is a bit of an anomaly compared to prior years but we should normalize again in 2025. We will be sure to clearly outline this onetime spend each quarter so you can differentiate between our recurring operating spend and any onetime charges that we do not expect to repeat next year.

Now let’s turn to our bottom line. We experienced a loss in Q1, as forecasted and largely in line with public estimates. Like the first quarter last year, this should be expected based on our level of revenue and fixed OpEx. We expect our second quarter to remain negative, moving back into positive territory in the third and fourth quarters to end the year strong. We continued to grow cash in the first quarter, increasing our cash and investments from $122 million to $129 million. We expect these balances to pause at this level in the second quarter as we continue to build inventory levels to support planned shipments in Q3 and Q4. We are already seeing an uptick in inventory levels driven by WIP and finished goods related to this. Like last year, inventory will continue to build until dipping back down to normalized levels in the third and fourth quarters as I’ve described in previous calls.

And with that, let’s move to Q&A.

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Q&A Session

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

Pavel Molchanov: Three months ago, you talked about a desal project in India that was pushed into the first half of ’24 versus last year. What’s the status on that? Is that still on track to be recognized before June 30th?

Joshua Ballard: Pavel, it’s Josh. It has not shipped out yet. Technically, we’re moving along pretty well. We got an update today. We’ll see whether it’s by June 30th but still expected this year.

Pavel Molchanov: Okay. So maybe in the second half, correct?

Joshua Ballard: Could be in the second half, yes.

Pavel Molchanov: Okay. Understood. Also, three months ago — there was a comment that deployments of the — how is that effort progressing?

Joshua Ballard: You broke up there, Pavel. Can you repeat that question, please?

Pavel Molchanov: Three months ago, there was also a comment about deployments of the refrigeration product being deliberately slowed to improve its reliability. How is that effort progressing?

David Moon: Yes. Pavel, this is David Moon. So, the second generation is progressing well. So we just passed through the first gate or milestone which was internal testing in the lab, got really good results in terms of reliability and performance. And so, since the end of March — or since beginning of March, we’ve now been doing beta testing in the field in the U.S. and Europe with very good results. And so, we are now moving on to pushing it out to the 10 summer sites that I’ve talked about in the script. And getting through the summer testing season would be our next milestone but so far, very pleased with the results.

Pavel Molchanov: Okay. And David, another question for you, kind of big picture strategy. When you came in, as you know, there were some targets for 2026 which, as you acknowledged 3 months ago, were kind of on the aggressive side. When do you think you will be ready to put out some updated targets?

David Moon: So, we’re in the middle of our strategy work now, what we’re calling our Playbook and I expect latest that we’ll be talking about the outyears ’25, ’26, ’27 by the time we get to the third quarter earnings call.

Pavel Molchanov: Okay. That’s helpful. Last 1 for me. You mentioned a minute ago, desal customer in Brazil which sounds interesting because we really do not think of Brazil as a particularly kind of water scarce geography. Can you talk about how big that project is and how it came about?

David Moon: Yes. So it’s a part of Brazil’s — the government’s initiative to increase the portable water supply by 12%. And so, this is our first desal megaproject. It’s in Fortaleza which is in the Northeast part of Brazil. It’s the fourth biggest city in Brazil. It’s going to be roughly, I think, 86,000 cubic meters per day. It’s planned to be online by the end of 2026. And this will be all Q400s which will be our newer product. And so, we’re very excited about our first large desal project in South America and given the government’s initiative, hopefully more to follow.

Operator: [Operator Instructions] Our next question will come from the line of Ryan Pfingst with B. Riley Securities.

Ryan Pfingst: For the PX Gs getting deployed ahead of this summer, if all goes well, would you expect these customers to place meaningful additional orders later this year? Potentially that could translate into some significant revenue in ’25, or is the focus here really on getting that data in the hands of the OEMs?

David Moon: It’s the latter first. And that’s getting at least 3 months’ worth of data which will turn into a white paper sometime in Q4, into the hands of OEMs first. So that’s — my trip over the last few months to visit OEMs in the U.S. and Europe, I mean, that’s what they pounded the table for, was with summer data, summer data. And once that’s in the hands of the OEMs and they feel good about it, then they’ll start going to their end users and start talking up the PX G more so than what they’re doing today. So, first steps first, let’s get through the summer. Let’s get our white paper done, prove the fact that we’re getting good energy savings and then I think we’ll start to see some momentum build in the last half of the year for 2025. What that revenue stream looks like at this point? Too soon to tell.

Ryan Pfingst: Okay. That’s helpful. And then, for water, you guys have signed the $87 million in contracts for shipments this year. Curious if you have a number handy of what that might look like for ’25, just to try to get some visibility early on, on how next year is shaping up?

Joshua Ballard: I don’t have that number on top of my head but it wouldn’t be very big yet, Ryan. It’d still be fairly small. I mean, we’re still a year out, right? So, it wouldn’t be a large number anyway.

Ryan Pfingst: Okay. What about more general visibility, Josh, about next year? Just what you’re seeing in terms of projects out there? Are things getting delayed kind of what you’ve expected, given we only spoke about 2.5 months ago? Any changes since then?