Q3 2020 Energy Recovery Inc Earnings Call
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Good afternoon, ladies and gentlemen, thank you for standing by welcome to the energy recovery third quarter 2020 earnings call. At this time all participants are in a listen only mode. A question and answer session will follow the whole presentation.
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I will now turn the conference over to your host James The Carty, Vice President of Investor Relations for energy recovery. Thank you you may begin good afternoon, everyone and welcome to energy Recoverys 2023rd quarter Earnings Conference call My.
My name is Jim Sorry, Vice President of Investor Relations at energy recovery I'm here today, with our chairman President and Chief Executive Officer, Bob now and our Chief Financial Officer, Josh about.
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 their business economic and market outlook, the companys ability to commercialize boards that growth expectations, new products nickel warm its cost structure and business strategy.
<unk> looking statements are based on information currently available to us and 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 the documents the company files from time to time with the FCC, specifically the company's form 10-K and form 10-Q. These.
These documents identify important factors that could cause actual results to differ materially from those contained in our projections or forward looking statements also.
All statements made during this call are made only as of today October 29, 2020, and the company expressively disclaim 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.
This point I would like to turn the call over to our chairman President and Chief Executive Officer, Bob now Bob the floor is yours.
Thank you Jim and thank you everyone for joining us today.
I want to start today's call as I did last quarter.
Sure hope that everyone listening and your families are safe and healthy balance.
Into commercialization with the receipt of the first purchase order.
Let's begin with our water business.
Which continues to be healthy and strong.
Writing up incredibly strong global desalination grows even and newts decoder and dynamic.
This third quarter was in your eyes biggest water revenue generating quarter.
We clips same last years prior quarter record by 26%.
At this time, we feel competent increasing our previously projected 20% to 25% water revenue gross profit.
For fiscal year Twentytwenty.
Up to 25%.
We also feel confident increasing our 2021 gross outlook to 10%.
From the flat to 5% grocery we communicated last quarter.
Finally existing desalination industry trends allows us to.
Optimistically anticipate whether revenue grows in 2020 two similar to what we are achieving in 2020.
This strong global seawater reverse osmosis desalination growth trend.
Is anchored.
In the critical need to provide access to clean water in many parts of the world needs.
In addition to the basic need three.
Three other trends are helping to grow the seawater reverse osmosis.
First.
The technological shift from efficiency thermal desalination plants to reverse osmosis this becoming a growing portion of our pipeline.
Second.
Acceptance of private financing into desalination construction in places like.
So the Arabia, Dubai, Egypt and India.
Increasingly decoupling desalination capital projects.
National fiscal budgets, which may be susceptible to oil price means and COVID-19.
And finally geopolitical ships.
Creating and urging the strategic growth need for desalination in countries like Egypt.
Let me the construction of the mile River Dam in.
NPDC Lps.
Veterans Ejup's water independence.
In addition to our fundamentally strong.
Baseline seawater reverse osmosis outlook power.
Our first incubation initiative.
Real liquid discharge or Zeke LP.
His focus on our water business.
Specifically the wastewater industry.
In fact, we are excited to announce that we received our first commercial purchase order.
For our new water wastewater product.
From a customer in India, just this last week, which is very encouraging.
Hey, Global regulatory push is currently being led by China and India.
To implement more environmentally friendly practices.
Industrial waste water treatment.
Those countries are struggling is maintaining clearly.
Water sources, and they are seeking to maximize the recovery of clean water and minimize.
Okay wastewater disposal polluting the waterways.
[noise] identified existing waste water application.
Our ultra WPX.
Is it potential.
Total addressable market in China.
And as high as 100 million us dollars.
Which would not include further and new growth as the market expands.
We see a similar opportunity in India.
Where we recently received our first purchase order.
And we believe that markets globally.
We'll move further towards those few and minimal.
Discharge technology.
Over time.
As clean water becomes more critical resource.
Nowadays.
It has achieved commercialization.
They will move out of liquidation and into our water business unit.
We're proud of our R&D and commercial teams and their ability to commercialize our new ultra PX.
In several months from initial incubation.
Well below our two year project commitments.
The L.D. should achieve and return on investment far exceed 20%.
And we anticipate ultimately.
Achieving margins at levels comparable to our base water business.
Finally, we anticipate positive operating cash flow.
From the outset.
Our first purchase order in hand.
We are truly confident in the potential of our worst quarter business as we look forward.
Business.
Our baseline seawater desalination business continues to enjoy a cyclical upswing is.
No end in sight over the next few years.
And were excited about the potential of our new wastewater business trips.
We look forward to update you.
Gross in the future.
Yeah.
Next we turn to our oil and gas business and vortex.
Where I continue to view the progress we made was great pride.
We have developed our production model one battle.
Which was utilized fueling our previously reported its feels simulation crack was liberty oilfield services.
However.
The three hurdles, we outline must still be cleared before we commercialized.
While successfully completing 235 fracs.
To validate our customer value proposition.
And three.
Maximize the amount of sand.
That can be.
Push through the contractors before repair or replacement.
As I said, beginning his life fracs and by extension our value proposition we.
We are aggressively seeking to get out in life Frac before year end.
As like Frac that bearish occasion is critical to establishing the vorteq value proposition.
Our customer.
And to verify our forecasts cartridge service space.
In addition to our ongoing dialogue as Liberty.
We have taken cost from and hosted Układ, but.
Additional oil field service companies interested in the potential use of low tech.
We are pleased with the response companies are getting less and the willingness niche.
They have introduced forecast.
Their own customers.
We remain confident in our ability to achieve the life well requirements as outlined last quarter.
When quantifying our value proposition.
As soon as we have achieved our trish lifestyle.
And we will let you know.
With regard to the final hurdle.
Were making solid progress new cartridge life extension.
And manufacturing and finance.
We believe we identified the solution to achieve our cartridge life.
Or some minimal.
A solution that will give us a material step forward.
To this end goal.
And that will be testing the solution as.
We end the year.
We continue to remain.
Remind ourselves.
The need to commercialize flotek by midyear, Twentytwenty, one or else stop investing.
Our committed timeline has not changed.
Next we'll report on innovation.
I discussed earlier, our Zio the initiative.
The first incubation efforts to.
Gradually tooling.
Tooling Ics siding business unit.
In addition to the yield the market.
They are a month or two or potential applications for our ultra high pressure PX in a variety of industries within and outside of the water.
We see significant future potential.
For our ultra high pressure PX technology.
And believe it could become a significant percentage of our revenue in the coming years.
We're also making progress on.
On the second PX incubation initiative pop.
Copied it very large global industry.
Currently undergoing regulatory driven transformation.
While this product has the potential of being transformative.
In much the same manner, the PX transferring the desalination industry.
Where the technology feasibility stage.
And so we'll all.
Paul goes deeper discussion at this point.
We expect to report on the progress of utilization effort.
We speak to you again in March.
At which time, we will have either.
Our technical feasibility overseas investors.
Finally, we mentioned last quarter that.
We are working on a project.
Well, it's banned the aperture of RPX technology Apple.
Thereby creating new pdx applications new industries.
This project is in zero mixing PX.
You are mixing simply means.
There is no co mingling of fluids as column, so fluid transfer there is pressure regime the PX.
That's mixing DASL occurred in our current applications in desalination and in oil and gas.
Barack mixing.
Mixing how are their slide exclude the PX found be applied.
Many applications, such as gas processing or chemicals among others.
Where our technology could potentially help.
Reduce energy consumption and thereby cost.
Existing systems.
We have already approved and the technical feasibility of this extension of our technology and we are now working on longer.
Longer life and reliable.
As we begin to apply this technology to new applications.
We will update you know.
Our progress and the potential of these.
New markets.
With that let's turn to EPS cheap.
As you know, we released our inaugural Estes important to September.
Where our business has always seen alignment is sustainability issues, such as addressing global water scarcity.
And improve access to affordable and clean energy.
Our EPS to report reflects our commitment to become a more sustainable and that leasing business.
The initial drive to build out our EPS gene program.
We based on our business grows as well as inputs from key stakeholders.
The pursue of more efficient sustainable customer solutions as being the core of our DNA.
These are finding more than 20 years ago.
We're proud of the impact our technology lets be making desalination more efficient.
And sustainable.
Particularly.
Our World conference growing water scarcity.
Our new ventures will continue to focus our energy efficiency and the endowment.
As we use our.
Phone pressure exchange technology to drive new growth opportunities.
We desire to do so while providing new efficient and sustainable solutions.
Two industrial needs.
This is an exciting time at energy recovery.
Our water team is focused on maintaining the momentum.
Moreover, our desalination business as well as expanding.
Our reach.
Is the lunch hour to use the product.
Our oil and gas team is focus on finding.
And.
And finally, rising and the commercial lines in port.
And finally, our integration efforts are focused on achieving technically verification.
On one product.
That could prove transformative and another that could further expand the aperture of RPX.
Based platform.
Were transitioning energy recovery into a growth company.
On the basis of our very versatile pressure exchanger.
We are giving you the incise seats.
Through this transition.
By reporting our progress.
Our wins and our failures.
Were investing are harder and cash and you should know.
Oh and why we are investing.
We will continue to tell you what.
What to expect we view updates on our progress and provide.
Details on the outcomes.
If we fail you in those line, but when we succeed we should not be surprised.
In short.
You will see every punch we land.
And every shift will take.
And we do not plan to take when it hits.
With that I will hand, it over to Josh.
Thank you Bob as we saw last quarter each channel in the water business continues to experience different dynamics.
Mega projects remain dominant growing 70% year on year in the quarter and an impressive 48% year to date.
As expected both the OEM and aftermarket channels remain weak as compared to 2019, falling 22, and 40% respectively in the quarter from a year ago.
Based on Bob's affirmation of at least 25% growth in our water business. This year, you should expect a very strong fourth quarter.
I've mentioned in past calls that it's hard to pinpoint quarterly trends in our business.
So 2018 and 19, we experienced a drop off in sales in the fourth quarter.
This year, our fourth quarter sales should be comparable to that of the third quarter.
As we look to 21 and 22, we do expect to see our OEM and aftermarket channels recover.
However, the extent of that recovery will largely depend on the global affects the cobot over this winter and next spring.
While some industries will remain weak within these channels, regardless, most notably travel and hospitality at.
At this time, we believe pent up demand in other industries may help return the OEM and aftermarket channels to more normalized levels, which is lending to our increased confidence and projections for next year.
I should also note that revenue from our new DLP market has not yet included in these projections.
As we build our pipeline and grow more comfortable we will provide more clarity.
That being said, it's probably fair to assume that our initial revenue will be in the single digit millions. The first couple of years with considerably more growth in the future.
Also note that these projects will be of a different nature of the large megaproject desalination plants driving our water growth today thats.
A typical deal the project will be in the range of 50 to $150000 in revenue, but there are potentially a much larger number of these projects than we have seen in desalination. For example, if we assume 100 billion dollar market in China as Bob outlined this will imply roughly 100 projects, whereas in desalination it could be as low as Tim.
Our product gross margin decreased by 360 basis points as compared to Q3 2019, but showed a healthy 550 basis point increase from our low mark in the second quarter of this year and somewhat exceeded our expectations this quarter.
Our margins strengthening over last quarters, largely due to our return to normal production levels at the end of Q2.
While we did have a small effect from co. The due to the delay in the commissioning of our new ceramic plant and Tracy, California that effect was muted compared to prior quarters.
We're pleased with how well our manufacturing team is operating within the restrictions of coated.
We continue to work under strict protocols to ensure the safety of our employees as well as the continuity of our business.
In addition, our decreased OEM sales led to lower than expected sales of Turbochargers and pumps, which proved accretive to margins as these products are less profitable that RPX sales in this channel.
Last year, we mentioned some margin pressure owing to lower Asps as a result of bigger order sizes as we serve ever larger desalination project.
We expect this trend to continue in Q4 and to round out the fiscal year with roughly 68% to 69% gross margin despite a reduced effect from coated.
As we look to 2021, the fundamentals of our gross margin will remain largely the same.
Excluding the potential of any temporary code 19 related effects.
At this time, we don't expect to see a shift in our water business outside of the 68% to 70% range.
Let's now turn to our operating expenditures, where we have reported a decrease of 9% compared to Q3 2019.
While our Opex is somewhat lower than planned today due to coated the real story is an R&D, where you will see a 23% decrease compared to Q3 last year and a similar decrease as compared to the first half of 2020.
While our R&D expenses may increase somewhat in Q4, we expect it to remain roughly 15% to 20% lower than the first half of 2020.
If there is a single theme up on I want you to hear it as that of discipline discipline in our R&D efforts as well as our operations and by extension our expenses.
For example, this year, we terminated some projects altogether that would not have achieved our commercial capesize in expenses from these projects Ses.
And as we look at our Opex going forward, while we expect capex to grow we are focused on reducing our spend as a percentage of revenue over the next two to three years to a more normalized level as related to our peers in the market.
Over the past decade, we have reported annual opex higher than 60% to 65% of revenue every year. There would have been in a similar range. This year, if not for the second quarter termination of the Schlumberger contract and subsequent GAAP recognition of the remaining license and development revenue.
We are targeting our opex to drop to a range of 35% to 40% of revenue by 2022. The subsequently to reduce it to the low thirtys, which will be more in line with our peers in the market.
This taming of Opex will be done in two ways first we will be tapping our R&D as a percent of revenue in our baseline budget.
Our R&D expenses averaged over 20% of revenue the past few years due to our elevated spend on the vorteq.
In 2021, we'll be targeting a range closer to 15% to 20%.
With the goal of lower lawyer lowering it further in 2022 towards the 10% to 15% range.
Keep in mind that this percentage will be decreasing despite the fact that we are guiding total revenues lower next year due to this year's increase in revenue from the termination of the slumbering contract.
You can expect a clear reduction in R&D by the second half of next year as we reduced spend on the Vorteq and wind down those R&D activities.
In addition base R&D spend on our incubation projects is expected to remain in the single digit millions a far cry from the level of spend we saw with the board.
Second we will continue to leverage our existing infrastructure, which will slow GDP growth in the coming years, we have invested significantly in the new system past 18 months to better modernize our operations and leverage our back office as we grow we should see the fruits of this labor as we expect DNA spending growth to continue to lag that.
Revenue.
This year DNA spend is somewhat lower than planned due to COVID-19 next year, we expect more normalized DNA spend in growth will generally occur from inflation and a reversion to the norm rather than increasing resources EPS.
Spec total DNA to grow more than 10% and 2021 and further decrease in growth in subsequent years as like R&D, we aim to reduce DNA as a percent of revenue to the mid to high teens over the medium to long term.
Sales and marketing spend is expected to stay roughly where it is today around 10% to 12% of revenue.
Lastly, as a concern as opex. Please keep in mind that our current levels them assuming success with the Vorteq.
With the Vorteq does not commercializing 2021, our overall opex spend would declined considerably as we reduced activities in our oil and gas business unit and cease R&D.
It's a modeling you keep similar levels of Opex you should then assume revenue from the commercialization of the Vorteq.
If we commercialized commercialize the Vorteq, we expect up to a 40% to 50% reduction in oil and gas opex spend overall with about half of that reduction due to shifting spend and the cost of goods sold once we begin to generate revenue.
And the other half due to decreased R&D also.
All told this will will result in an overall reduction in total R&D spend of at least 20%, 25% next year.
Total reductions will depend on how quickly we commercialize or cease operations.
Finally, a few words on our cash and investments position, which ended at $106 million for the quarter. We continue to see no effect on cash from a global economic uncertainty in fact, our accounts receivable is the cleanest it has ever been.
Which is reflective of the strong position the desalination industry finds itself and despite these strange times.
For now we continue to shift our corporate bond portfolio into cash and securities mature as the future becomes more certain we will revisit our longer term plans.
Capex investments look to finish the year in the mid to lower end of the $8 million to $10 million I guided this time last year, our baseline Capex for 2021 as planned at $5 million to $7 million now this baseline excludes any capex related to the potential commercialization of the vorteq, which will become clear if and when we commercialize.
And we will provide more clarity.
With that let's move to the question and answer portion of our call. Thank you.
Thank you.
This time, we will be conducting a question and answer session. We would like to ask a question. Please press star one on your telephone keypad.
The confirmation tone will indicate your line is in the question queue.
At a time you wish to remove your question from the queue. Please press star two for participants using speaker equipment and may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Our first question is from Pavel Molchanov with Raymond James.
Thanks for taking the question.
I want to just review the guidance targets that you gave to make sure. We all heard them right following 25% water revenue growth this year.
It should slow to 10% growth next year, but then re accelerate to 25% and 22 is that correct.
Correct, yes.
Yes.
So what gives you the confidence that 22 will drop will see this acceleration in the growth rate is that specific project specific geography.
To the customers.
Actually all the above specific projects this year, he will specific geographies and.
In fact, we already have some backlog going into 2022.
So its not depending on the macro.
Market trends only it is on the ground.
Actually project by project customer by customer.
Okay, and then putting food.
For retrofits of legacy plan or rate that or are you only looking at.
Greenfield new belt.
Both.
Okay. My final question wise about your comment about an industry that is being transformed.
By government regulation and I'm sorry, if this is a.
A silly question by are you, referring to the oil and gas industry or something else.
We will go.
Clarified that next call as we are in the.
Technically is technical feasibility phase.
Okay.
Fair enough, we'll we'll look forward to that thank you bye.
Thank you.
Our next question is from Ryan Thanks, with B. Riley Securities.
Hey, good evening guys.
And.
In terms of your inventory of Vorteq equipment for the new single cartridge Skid design.
The opportunity presented itself could you simultaneously execute one well with liberty and another with a different pressure pumper.
If not the are you prioritizing the first attempt to well with liberty above all other options or if another interested party wanted to conduct a live well test before liberty customers ready would you move forward with that opportunity.
We have you had roughly enough inventories to do both.
Should that pleasant opportunity otherwise.
Okay. That's helpful and then for hurdle number three on the path to commercialization the buying the frac sand that the carpet can process before it needs to be repaired or replaced how far along are you now towards your target I know that by year end you aim to be at 50%.
With clear visibility.
On raising 100% could you give some insight on maybe what percentage you're at now or where you exited the third quarter.
We are on track to reach those targets.
Okay. So on track for a 100% visibility by year end.
Yes.
Great and then turning to the new PX derivative.
Product development's could you give some other examples of potential end users that that you're investigating now.
Hi, Lisa.
Good, particularly with zero relaxing.
And the Packaway opening up additional end user into chemical.
Industry.
Industry were in no mixing is out loud at all.
All right. Thank you and then maybe just one last one for Josh could could you. Please provide the.
Third quarter breakdown for water revenue by segment.
Sure, it's up 76% for the Mega projects 15.
15% for OEM.
And about 10% for aftermarket.
Alright, guys I appreciate there's pockets.
You bet.
As a reminder, its star one to enter the question queue.
Our next question is from Ken Hershberg private investor.
Congratulations on the excellent quarter on all the progress you're making.
Could you please give us an update on the commercialization.
Isogen and Isoboost. Thank you.
On that one we are in discussions with potential customers.
Tools deployed our standard product.
And of course, you know our first project is truly you operation and a very happily accepted by our customers. So what we look for here.
As for the standard product applicable to a large larger base of customers rather doing.
David you almost cut.
Customer delayed projects.
So we're making progress we expect to report more data to yet.
Lexington.
Yes, your next Friday surgeon and Isoboost.
Yes, Bose actually John Kneisel boost.
Did I answer your question, yes. It did thank you very much I appreciate that.
Thank you.
Ladies and gentlemen, we have reached the end of the question and answer session I like to turn the call back to James to Carty for closing remarks.
I want to thank everyone for joining us today for your.
Convenience, we've decided to put our prepared remarks up on our website you can access that reach.
Any chance you have being thank you very much for joining us and we look forward to speaking with you again in March.
You say.
This concludes today's conference.
Hi, good recovery. Thanks, you for your participation you may disconnect your lines at this time.
Good bye.
[laughter].