Q3 2019 Earnings Call

Greetings and welcome to the energy recovery third quarter 2019 earnings call.

At this time, all participants are in listen only mode.

Question answer session will follow the formal presentation.

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Please note this conference is being recorded.

I'll now turn the conference over to your host Mr., James Carty, Vice President Investor Relations.

Began.

Good afternoon, everyone and welcome to energy Recoverys earnings Conference call for the third quarter 2019.

My name is jumps to Carty, Vice President Investor Relations energy recovery.

I'm here today, with our President and Chief Executive Officer, Mr., Chris Gannon in our Chief Financial Officer, Mr., Josh will dollar.

During today's call may make projections and other forward looking statements under the Safe Harbor provisions contained in the private Securities Litigation Reform Act 1995 regarding future events.

The future financial performance of the company.

These statements may discuss our business economic and market outlook.

The company's ability to achieve the milestones and commercialization of sports <unk> licensing agreement.

Growth expectations, new products, and the performance cost structure and business strategy.

Forward looking statements are based on information currently available to us and our 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, but the FCC, specifically the company's Form 10-K and Form 10-Q .

These documents identifies 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 31st 2019.

The company expressly disclaims any intention or obligation to update any forward looking statements made during this call to reflect subsequent events or circumstances.

Yes, otherwise required but wall.

In addition, we may make some references to non-GAAP financial measures during this call.

You will find supplemental data in the Companys earnings press release, which was released to newswires and first of the FCC earlier today.

Press release includes reconciliations of the non-GAAP measures to comparable GAAP results.

At this point I'd like to turn the call over to our Chief Financial Officer, Mr., Josh will dollar.

Josh the floor is yours.

Thank you Jim.

The third quarter ending September Thirtyth continued energy recovery strong plenty 19 results.

We generated total revenue of $24.9 million, representing 12% growth year over year.

Year to date, we've achieved revenues of $67.4 million, 19% growth over the same period in 2018.

Reported GAAP net income for the quarter of 5.1 million or nine cents per diluted share.

Note that our GAAP net income includes a one time tax benefit of $1 million related to federal research tax credits.

Our adjusted net income excluding that one time benefit is $4.2 million or seven cents per diluted share.

Our product gross margin grew 210 basis points year on year to 75.1%.

Overall gross margin grew 80% basis points so 78.2%.

Well product gross margin was especially strong this quarter, we have achieved 72% year to date.

We expect it to settle around 71% to 72% for the full fiscal year.

Note that we do see some weakening of our product margin in 2020 2021, as we began to experience a combination of pressure on sales prices due to the growing size of projects in the middle East as well as an overhang from tariffs.

That said, we still expect margins remain strong averaging between 68% to 70% next year.

Our water business generated $21.8 million and revenue during the third quarter representing growth of 18% year.

Year to date, we have achieved revenues of 57 million a 22% increase over the same period last year.

As I've mentioned in previous quarters, there will be a softening of growth in the fourth quarter related to the timing of shipments of our larger Mega project orders.

Ever we should end the fiscal year with water sales growth between 15% to 17% an increase from our expectations last quarter.

Our oil and gas business generated total revenue of 3.1 million for the third quarter, a slight decline from the second quarter revenue of 3.6 million.

This decrease is entirely related to the A.S.C. six so six recognition of Vorteq license revenue.

Overall operating expenditures grew 28% year on year to 14.9 billion for the quarter and have increased 19% year to date.

As in prior quarters. This growth in spend was largely related to investments in R&D in both the water and oil and gas businesses.

We should see a 20% to 22% year over year increase for the full fiscal year I ended the fourth quarter right within the guidance from the last two earnings calls.

As we looked at 2020, you can expect annual growth in operating expenditures to slow to 10% to 12%.

Sales and marketing expenses are expected to grow close to the rate of 2020 revenue growth, which Chris will reference in his remarks.

And administrative and R&D spend is expected to grow 10% to 12%.

The fifth fixed expense of our oil and gas R&D operations has largely reached its cap.

However, we do have the potential for significant growth in variable testing expenses throughout 2020.

These variable testing expenses, that's the Santa diesel for example are difficult to project today, and we will communicate the spend as it occurs.

Our cash and securities balance remained relatively flat at 97.3 million at the end of the quarter, an increase of about $500000 from June Thirtyth.

Our overall 2019 Capex investment is still expected to end the fiscal year between eight to 10 million.

2020, we'll likely see a slightly increase investment roughly 10.

We remain in a strong cash position debt free with that I'll hand, it over to our president and CEO Chris.

Thank you, Josh and thank everyone for joining us today.

I will now begin with our base water business, which is growing rapidly our focus here remains on one executing against our increasing backlog and pipeline to expanding capacity to meet our growing demand and three further developing and executing our water initiatives.

For the past several quarters, we have spoken of a surge of growth and global water infrastructure spend that is coming today as they look out on our water business I can tell you that this growth is no longer expected. It is here.

As indicated by our recent press releases the size in the flow of projects continues to increase.

Since our last earnings call, we have further strengthen or backlog and pipeline for the remainder of 2019, 2020, and even 2021 and.

And we're continuing to successfully execute against this backlog as evidenced by the growth estimates Josh provided earlier.

Given what we see ahead of us.

We now have the confidence that enhance our outlook.

Based on current 2019 consensus estimates for water revenue of $69 million, we expect our water business to experienced growth of at least 20% to 25% in 2020.

And then an additional 10% to 15% 2021.

We've talked previously about the drivers of our industry in the macro state of global water supply.

As a reminder, more than 2 billion people are roughly one quarter of the world's population already live in a high water stress territories. According to the United Nations half of the countries worldwide to face water shortages or stress by 2025.

These numbers are significant but they can sometimes seen intangible.

Take one look at the headlines and it's clear that water scarcity is a reality in many places around the world.

With that in mind, we want to provide a view of what we see happening on the ground.

In the Middle East water availability has long been a concern in the region continues to invest heavily in desalination when shirt continued growth.

In Australia dozens of cities are facing day zero, an estimated date when they could run out of war eight town South Africa face the same threat last year and is now considering additional desalination capacity to address shortages.

In addition, two thirds of global population growth is expected to occur in Asia between now and 2030.

Representing an increase of 500 million people get this region already has less freshwater per person than any other cotton in the world.

More than 40% of India's population suffering from work order just.

Pakistan is dependent on other countries for more than 70% of its water resources.

Bangladesh, 90% and bodie up more than 70% he's being just a few examples of severely water star economies.

However, north and South America are not immune.

Route persists in the United States, most notably in the West in southwest and in South America, who are availability in countries, such as Peru, and Chile are creating challenges for the mining industry are the primary contributors to local economic growth.

In short global water scarcity is a real impressing issue that their need for desalination, along with other water treatment solutions is very clear.

Further the conversion of thermal desalination to reverse osmosis is beginning to emerge and will likely continue throughout the coming decade.

We first highlighted this trend in the first quarter now thermal replacement projects are starting to move from our pipeline into our backlog long term. This thermal capacity conversion of more than 20 million cubic meters per day creates an additional layers sales potential for energy recovery.

Our confidence in the strength of our water revenue over the next few years is reflected previously announced you get back Sherri capacity expansion.

Phase one of this expansion is complete and contributing to current production.

Phase two is underway.

By the end of next summer, we expect to have doubled our capacity.

This capacity expansion as necessary to meet growing demand from our customers many of whom I saw last week at a large industry about the idea of World Congress in Dubai.

My conversations there reinforced my optimism about our base business.

They also further validated our focus on expanding our water solutions.

Which I mentioned in previous quarters.

We're looking at several near term initiatives, both organic and inorganic designed to deliver more value to our customers.

We expect to announce some of these initiatives early next year with sales potential beginning in late 2020.

We are confident in our ability to aggressively grow our business based on the strength of or an engineering.

Manufacturing and sales teams.

We intend to leverage these strengths to one broaden our share of the war wallet in our existing market seawater reverse osmosis desalination.

To expand our market presence in the OEM and minded Mega project channels by these products.

And three increase the revenue potential our aftermarket service sales channels.

Lastly, I want to emphasize that our current revenue out with only reflects our base business does not include any impact from these growth initiatives.

I'm excited to share more when we speak again I believe the call for more powerful water around the world in the bigger on which this call is being made has placed us at an inflection point of growth in the SW Aro desalination industry.

The surgeon industrial growth expectations, which historically was always projected to occur a year or two out is now a cost.

There was a swell in activity Andrew recovery is ready for it.

Now, let's turn to oil and gas, where our focus remains one commercializing the vorte Q2 building out our Houston operations.

And three preparing the organization for commercialization and beyond.

It's important to remember the vorteq as an entirely new especially game changing technology to be deployed in the mature and vastly competitive industry.

The successful commercialization of the Vorteq is dependent on our ability to prove the systems durability in a feel.

That proved comps from consistent and repeated testing.

Our decision last year to secure experienced frac crews equipment and attesting site has significantly increased our ability to repeatedly task the vorteq in real world conditions.

We are seeing the pay off of these decisions every day now that we are fully operational 80.

There are increased runtime, we're gaining insight and advancing the technology.

Our work today is focused on failure modes of this system, where we essentially look for any possible means by which we can force the PS cartridges to stall break or otherwise fail to perform.

Throughout the quarter, we have had a number of visitors to our second Katie getting investors and analysts.

These visitors have seen firsthand how significantly the technology has advanced.

Let's see how seriously we are taking our responsibility to commercialize this technology.

During these visits people expressed interest in our test ash.

Last year and a move designed to speed our development process, we looked closely at our testing operations and made the decision to bridge. The gap between testing is single pressure exchangers, Knowhow and testing at both scale with the Vorteq missile, which contains 12 cartridges.

As such we commissioned a smaller more modular vortex, which is for pressure exchanger cartridges are one third of that have a full scale cortech missile.

The modular test system is representative of the full scale Vorteq, however, because of its smaller size implement changes to the system at an accelerated pace.

Our testing protocol is as follows we design and execute test to focus on specific operating conditions and or failure us.

We gather information I, how this system performed during these tests.

And then we designed and implemented solutions on the modular Vorteq and test the gap.

This is an iterative process, which is sometimes take mall, let's house.

Once we find a robust and reliable solution. We then implement the solution on the Fullscale Vorteq missile.

And begin again.

You can imagine how much slower this testing process was on the Bulls Guild War attack, we're making changes across the system three times as large.

This smaller more agile system allows us to development test solutions must faster.

Using the smaller system as the test Dash you can accelerate the research and development process.

We continue to tested an unprecedented right now in addition toward advances in testing we've made significant progress on our facility in Katy, Texas and are close to commissioning our manufacturing operations further we continue to make progress and developing our supply chain.

In summary, our technology and manufacturing readiness programs are more robust than ever before and I'm extremely proud of the work our team is doing to advance the system.

Commercialization is the priority and we are executing against our plan.

In closing.

Our base water business is growing rapidly as trends, we have track for years, a conversion to drive demand.

Which is reflected in the largest third quarter in the company's history.

The optimism for the future of our water business is stronger than ever as evidenced in our robust growth outlook through 2021.

In oil and gas, we continue to methodically execute our technology and manufacturing readiness programs and preparation for commercialization.

I'm extremely pleased that where we are today.

As we approach the start of a new decade, I can say with great pride that I truly believe the best has yet to come for energy recovery.

Happy Halloween to everyone and I look forward to your questions.

Thank you.

This time, we will be conducting a question answer session.

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The first question comes from Avella, well channels with Raymond James. Please go ahead.

Thanks for taking my question.

I.

Wanting to ask about the international.

D cell opportunities you referenced the lower margin.

On a some of the middle Eastern business that you recently wine. If you work to yeah hypothetically got opportunities in places like South Africa, or or India, I'm curious, whether it's a those would continue to be had a lower margin structure. Then what you have.

Traditionally been accustomed to north of 70%.

Hey, Bill this is Josh I'm.

No what we're seeing today is especially in the middle East. These these massive projects that are being award is what's really driving that we're not seeing it across the board by any means and a lot of the margin.

Predation and we're seeing you know I mean, it's not a lot on a couple percentage points, but also due to tariffs and some other cost increases. So the overall effective is not is not too big as you can see.

Understood capital spending this past quarter, what's close to zero.

Do I take that can mean that you have.

Concluded the build out of the facility near Houston.

Not quite we had we did have a small amount this quarter, but you're going to see that go back up in the fourth quarter.

Well, we bought we had been all the equipment last year, we've been working on the building this year and we still have you probably see a couple of million dollars going into Houston give or take here in the fourth quarter.

Okay. Appreciate it guys.

[laughter].

Thank you. The next question comes from Joseph All Shaw with JMP Securities. Please go ahead.

Hi, there yeah, a couple of questions and I'm wondering if you might be able to step through again that math on the D cell growth into 2020, Oh I thought I've heard a.

2019 base number of 68 million I mean, maybe I was wrong I'm wondering if you can clarify that and then I have another one.

Yeah, Hey, Joe how you doing thanks for the question. So we're we're really looking at the six 9 million from the standpoint of the consensus estimate that's out there.

And so off of that base I'm, assuming that that's the number.

Right, we're looking at a growth of 20% to 25% for water into its carrying out this morning.

It does I mean understanding of course that you've just done 57 million in the first three quarters are you still saying that that.

That would either imply that Q4 drops off water that 69 million isn't to reasonable number I mean, I'm just curious about that in the context at this very strong first three quarters.

Yes, so it's really based off of the consensus estimates I'm not going to comment specifically about the Q4, but we'd given some guidance to that asked Josh Yes, I mean, I did get guidance and.

In the prepared remarks, Joe that we're gonna do between 15% to 17%.

So how that fits obviously going to show a lower Q4 much like last year last year was also lower Q4, and it's just all based on the timing of our Mega project shipments is all that really is.

Okay, sorry, but I I get not to belabor. The point you would be happy with our supplying that 15% to 17% a kind of whatever whatever outcome for 2019 ends up recurring that what you're saying.

Yeah, that's why we get you.

Okay. Thank you and then on Oh and by the way. Thank you for hosting is down a kt that was great. As regards the I know, we're not going to ask about Oh, Schlumberger timing, but I'm wondering if you can just talk a little bit about how you're thinking about the go to market strategy at this point and weather.

You would tend to prioritize that testing regime versus perhaps fracking, a well with with liberty or any any insight you could give us into the thought process if not the timing.

Well our priority right now is to test in our own Youre right. We invested heavily there as you know I made that decision last year, we've made tremendous progress there and we're executing against that specific plans and so when you look at what we're focusing on we're focusing on extending them.

In time to failure and the inherent reliability of our specific system. What that means is that we want to ensure that our system isn't the cause of unplanned downtime in the field right. We don't want to getting the way of our customers operations and so we're focusing on those activities and.

Focusing on testing as much as possible in our yard to two again caused failures to figure out what will cause failures in the fixed.

It's all about reliability until we get to that point, where we're confident there.

And now with that that will be the deciding factor when we go before.

Okay and as I gathered then from your your comments that.

We really shouldn't expect any more specific.

Comments is as regards commercialization timeline.

For the intermediate term.

Yeah, I think that's fair.

Okay. Thank you very much.

Thank you.

Thank you once again, if you wish to ask a question. Please press star one on your telephone keypad.

The next question comes from Ryan Thanks, with B. Riley. Please go ahead.

Hey, guys happy Halloween.

I will go away right.

At summer Jay since the CEO transition that became effective August 1st have there been any new appointments for summer days for tech team or any changes to their approach to or communications around the timing of am one or the path to commercialization.

Hi, the simple answer is no there's no changes.

Okay great.

And along those same line at the new CEO said that there now conducting conducting a deeper view of their entire north American business, what implications could emerge or partial sale or significant rationalization of.

Summerhayes wants them fragmented business have on the licensing agreement and commercialization path.

Well, that's a and that's a big question I mean, right now we have to see where they are where they decide to go with with that business I'm not going to no comment specifically on on where they're headed that they're still I think in into the process of deciding that.

At the end of the day, what we're focused on his commercializing our technology period.

Fair enough, Chris when it comes to your strategic objective of expanding the water come a companys border Tam have you reached the point now or when might you decide to move forward with trying to organically developing offering rather than waiting for the right acquisition to materialize.

Well interestingly a great question interestingly enough, we're doing a lot of internal development right. Now. So we have a two pronged strategy inorganic growth strategy meeting developing technology in house and so we've been working on that for better part of a year.

We're also all out there talking to our various parties.

From an inorganic standpoint, but that's principally related to our partnerships and supply agreements versus.

Acquisitions at this point.

Cool thanks for the color I'll turn it back.

All right. Thanks, so much.

Thank you. The next question is a follow up question from Joseph Asha. Please go ahead.

Well I didn't think I do I get back on this quickly.

I wanted to understand some of the comments you made about adding capacity for do you sell pxs, because I know that you'd had or some for tax capacity and some silicon carbide <unk> tungsten carbide excuse me in family and grow is the audio basic we did all of for Tech.

Oh has been pulled out in and that you were able to ramp you were able to accomplish this additional expansion just with the Stanley Edra for space or is some of that going to be in Texas are just wondering if you can explain how that'll works.

Yeah, Great question. So we really have to approaches right I'll comment on water on the oil and gas part of your your question. So we we completed phase one of our water production increases this year.

So that was in the middle of the or in June we are now on what we're calling internally phase two capacity expansion again for our water business and that's going to be completed mid next year that will effectively double our capacity on the water side and based on my earlier comments, we have a very very robust backlog unfilled.

Well there.

We are also that's all in California by the way.

In terms of oil and gas, yes, we established our Katy facility I, specifically odd to two manufacturer our pressure exchangers. The courts that award technology in Katy, Texas. So that's that's the facility I think when you saw when you were there you were seeing it being built.

We're very very far along there and we're going to turn that on on terms of manufacturing very shortly.

Okay. So the idea would be you'd have some ceramic PX capacity and Kt is wells, what you're saying.

No no no no no no so all.

Ceramic.

Manufacturing capacity for the water business is in California, Oh, sorry, I misunderstood.

All of our oil and gas more tech related manufacturing is in <unk> is down in Texas and that does not impact our manufacturing here in ER in California.

Okay. Thank you.

Absolutely.

Thank you we have reached the end of the question and answer session.

Now ill turn the call over to Mr. Gannon for closing remark.

Great well. Thank you for joining us. This afternoon. We appreciate your continued support our company and we're looking forward to talking to you. The next earnings call I mean with that I have a great rest of your day and once again happy Halloween.

This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation you may now disconnect.

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