Q4 2021 Energy Recovery Inc Earnings Call
[music].
Greetings and welcome to energy recovery fourth quarter and year end 2021 earnings conference call.
At this time all participants are in a listen only mode.
A question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference.
Please press Star zero on your telephone keypad as a reminder, this conference is being recorded.
I would now like to turn the conference over to your host James Zaccardi wife's president of Investor Relations.
Thank you.
Over to you Sir.
Hello, everyone and welcome to energy Recovery's, 2021 year end and fourth quarter earnings Conference call.
My name is Jim <unk>, Vice President of Investor Relations at energy recovery I am here today, with our chairman President and Chief Executive Officer, Bob Mao 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 with 1995 regarding future events for 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.
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 the documents the company files from time to time with the SEC.
Specifically, the Companys 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 February 24th 2022, 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 would like to turn the call over to our chairman President and Chief Executive Officer, Bob Mao.
Bob the floor is yours.
Thank you Jim and thank you everyone for joining US we finished 2021 and strong fashion.
Was it a record fourth quarter.
<unk> continued to panic and global supply chains constraints, we have.
Ceded to our originally stated 10% topline guidance for 2020 one.
3%.
Leaving 13% gross or $104 million revenue.
This marks our fifth consecutive.
Record revenues led by our core desalination business.
Supported by a $1 million of sales from industrial wastewater.
We launched just a year ago.
We also made concrete progress with our new <unk> hundred <unk>.
Our refrigeration, which our first contract in Q3.
This April one Mach energy recovery's 40th anniversary.
They can be $100 million revenue threshold is a fitting N two hour for decades.
And yet we believe energy recovery is fundamentally stronger than ever and strategically positioned to have our best days are ahead of us.
So after becoming CEO I laid out the following fixed technical commercial and financial timelines for all new products and technologies.
Drive internal accountability.
Year, one prove the technology viable.
Here to commercialize and by end of year suite achieve cash flow breakeven run rate.
As we continue to evolve.
These are the characteristics of the U a E.
Our.
Disciplined focused and accountable gross new industries.
This discipline extends to how finances.
As we focus on increased profitability, which Josh will describe.
We will highlight this discipline in each of our industries today, starting with desalination.
In desalination last quarter I discussed the growing global water supply gap.
She is the macroeconomic basis behind the secular demand shift that continues to provide dependable double digit revenue growth.
We have set of ambitious target of doubling our desalination business by 2026.
We're not complacent.
It's the overall desalination industry expense Burger, we continue to anticipate new competitive entrance and products.
Therefore like elsewhere in this company, we must continually evolving our products.
We've been enhancing while enhancing our customers' experience to maintain our position in the market.
Discipline and focus remain key in delivering on this commitment.
While we believe the reputation earned over the past 30 years.
Driving the most reliable and low.
Cause energy recovery devices.
It will help us remain the industry leader.
We must always strive for improvement.
We are actively investing today to improve our nearly perfect.
Hum.
High quality PX.
We are modernizing our manufacturing to ensure continued high quality production.
Even greater efficiency as always we must continue to focus on creating the best customer experience every day.
While we work on the future we continue to deliver today.
Stand by our guidance from October of 25% topline growth in 2022 and 15% in 2023.
And have already started booking backlog for delivery in 2024.
Let's now turn to the industrial wastewater.
Industrial wastewater not only did we achieve our goal of $1 million in sales from our first year.
But our sales pipeline has grown from single to well into double digit millions.
We set guidance for the first time.
$3 million.
2022.
We have a twofold focus in 2022 first.
In accordance with our own public stated milestones, we must reach cash flow breakeven run rate in this business by March 'twenty.
Which we believe we're well underway towards.
We can.
We are to achieve our five year target of $30 million or $70 million.
We must now turn to boot and volume business to do so we need to deepen our understanding of and expand further into these markets.
The goal of driving demand.
That's again use the lithium ion battery industry vertical as an example, where we are already building volume.
Growth in the global electric vehicle market continues to surge.
In turn driving lithium battery demand.
Forecast it grows from 500 Gigawatts of global capacity in 2020.
To 2500 Gigawatts in 2030, we.
Referenced may 2021 is now a five year forecast.
Those levels are now expected to be achieved by 2025.
According to the U S Department of energy.
For every ton of battery materials produced.
The 20 points of the wastewater as January but really.
English further CRO, we have identified three applications, which wastewater treatment is needed.
One lithium mining to lithium battery manufacturing and eventually three.
Battery recycling.
We're tackling.
Battery manufacturing for us not only in China, where over 75% of current world capacity. Besides.
Global.
The top battery manufacturers I will now.
LG Panasonic.
T O.
Further capacity expansions are publicly announced.
As we commission RPX in the plans.
In the coming months the data collected should support further sales.
We must now educate the overall lithium battery market together with our partners and so into it.
This approach will be replicated in other vertical markets.
To ensure success, we are investing in resources, including sales and marketing teams in Asia, Europe , and Latin America.
Customer support personnel in Asia.
While developing a network of resellers and distributors.
We are also extending our product.
Product portfolio later this year to further align our products with the needs of this industry.
With that let's turn to refrigeration.
We continue to build off the momentum generated from our first commercial order.
Yeah refrigeration since we announced our first <unk> contract with.
Supermarkets last November <unk>.
Interestingly, our technology continues to grow.
The industry response was immediate.
Multiple refrigeration manufacturers in North America, and Europe approaching us to learn more about the cost savings potential of our PX T centric next generation refrigeration systems.
In fact, we're.
We just signed our first joint development agreement with a leading refrigeration rack manufacturer.
Which is an example of this response.
This manufacturer.
Understood the potential of RPX to certain countries.
I agree to join to design build and commercially installed a Phd centric system. This year.
He will help their customers reduce both their environmental footprint and operating expense.
This will likely simplify our go to market strategy away from trying to prove our technology with additional bolt on products for existing systems.
We immediately focused on developing TXT centric systems that more fully leverage the pea its potential.
Let's discuss a bit more in detail what this could mean for energy recovery.
As a reminder, the galley amendment to the Montreal protocol requires a 40% reduction in the production and the implementation of Patriot F ceased for developed countries by 2024 and.
85% reduction by 2036.
This amendment has been ratified by over 120 countries.
The EU and UK, leading the way.
Europe has accelerated these timeline.
Targeting nearly 80% reduction in HSE by 2030.
Europe's timeline provides us a roadmap for how other markets could evolve in the coming decade.
The transition in Europe began in the early twenties two thousands.
What is the regulation initially enacted.
2006.
Total C O two installation all industries, including supermarkets subsequently grew from nearly 3520.
13, two roughly 40000 in 2021.
While the U S has not yet ratified that cut value for medicine.
Mental protection agency has begun and that the news who regularly harmful HFC pursuant to the American innovation and manufacturing Act of 2020.
A 10% reduction in the production and importation of HFC was implemented for <unk>.
<unk>.
'twenty two.
Is the goal of achieving an 85% reduction of HFC by 2035.
Which is in line with the cargo in May.
England pockets.
States, such as California, or accelerate these timelines matching.
National supermarket channel, such as Audi and Walmart among others.
I've already started.
Or are beginning to discuss transition.
It was around 40000 supermarkets in the U S.
But only close to 1000 total E C O. Two installations today, there is clearly significant upside growth and just the supermarket industry itself, even if we simply assume 50% of the market is our potential tenant.
They are roughly 55000 supermarkets in Europe .
And between 30% to 40% have been installed.
Two systems today.
Many of which.
We will have to be removed and replaced in the coming decade.
Is there a looming 2035 deadlines and the cost of HFC increasing supplies decline.
We can only assume an acceleration of C O two installation.
As the deadline approaches these.
These estimates are only supermarkets do not yet include industrial refrigeration, HV AC or other markets.
Which are new PX T may be comparable.
Nor does it include other regions in the world.
Other countries, such as China, and Japan have announced similar regulatory intentions.
It is needless environment, a favorable regulatory pressure and market opportunity.
Or is that would speak to achieve the 100 million to 300 million contract by 2026.
We have a long last quarter.
Lower end target of 100 million in revenue would only equate to the lower single digit thousand units themselves.
The question button remain in crew what portion of this market. These ph.
The P. A L P S T.
Can effectively address and how fast regulations around the world will catch up with Europe .
We're working hard on defining and answering the first question no. We have made solid progress to date and.
In this new business segment.
Our focus this year you can create in a volume business to achieve a breakeven milestone by March 20 countries.
We will continue to update you as we further penetrate this market.
Now, let me briefly talked about the water.
We both had we have now passed my second year as CEO and a corresponding to your timing.
The commercialization.
Although we have made nice progress.
Pending the cartridge life continues to challenge us and as of today.
No additional progress for now.
We must hold ourselves accountable visible attack as we are in other businesses.
Therefore as of the end of last year, we began to reduce activity onboard pad development.
In late January we began to focus our efforts on.
Seeking a partner to bring brought back to completion and to market.
Yeah.
They partner, who can more fully benefit from the ESG benefits offered by the technology.
One of our clear preference is to seek out and find a way to monetize this investment as a partner.
If we cannot really shut down the project.
Josh will discuss the financial implications of this decision.
Bottom line is we will not commercialized will attack all of them.
In conclusion.
As we begin a new year energy recovery and solid financial footing.
Are we growing our desalination business, making significant progress in our flooring into industrial wastewater treatment and commercial refrigeration.
1022 looks to be an exciting year of growth a new milestone with the pass for energy recovery.
We work to provide energy saving sustainable product offering will continue to create value for our shareholders.
With that I will turn the call over to Josh to discuss the financial results and expectations for the year Yeah.
Thank you Bob let.
Let me start by providing some transparency behind our revenue numbers.
Each of our desalination channels saw double digit growth in the teens during 2021.
During 2019 and 20 are revenue growth was predominantly generated from our Mega project channel.
For 2021 exhibited a reemergence of our OEM and aftermarket channels. Following the 2020 COVID-19 loans.
Most notable was nearly 50% higher OEM growth in the second half of 2021 compared to the first half.
This accelerating OEM growth throughout the year as providing some confidence that we will see a return to pre pandemic highs in that segment in 2022 or 2023.
Also of note is the geographic breakdown of our sales, while we saw healthy 6% growth in the Middle East and Africa in 2021, our Asia sales grew two five times over 2020 and exceeded average trends from pre pandemic years by about 40%.
This reflects a noticeable shift in Asia that should continue into 2022, where we expect material double digit growth in the region driven by both our desalination and industrial wastewater business we.
We expect this trend to continue as Asia grows in importance over the decade.
Product gross margin remained strong ending the year, just shy of 69%, which is roughly in the mid range of the guidance we provided for the year.
Slight decrease in product margin year over year was mainly driven by increased sales of lower margin products.
While we are experiencing higher tariffs and freight expenses as well as increased labor costs. These were mostly offset by increased operating leverage as we boosted production.
Our 2021 operating expenditures came in line with guidance as we continued our intentional dual focus on both the bottom and top lines.
First our opex decreased to 55% of product revenue for more than 60% in 2020.
Note that I'm, excluding the gap license and development revenue related to the Schlumberger contract in that calculation.
No two other key points first our 2021 Opex includes a write off of approximately $1 $2 million.
Related to accelerated depreciation and a small reduction in force at the end of the year both related to reduce activities at <unk>.
Second depreciation and stock based compensation grew a combined $1 $9 million in 2021.
If you look at the past few years, our GAAP financials show operating profit of $10 million in 2019 and $31 million in 2020. However.
However, these numbers include license and development revenue as well as the related impairment 2020, following the termination of the Schlumberger contract, none of which have real economic value.
If you adjust operating income to remove these items, we grew profitability from an adjusted $3 $7 million operating loss in 2019 to a $6 $7 million operating profit in 2020, and then more than doubled that process to nearly $14 million in 2021.
If we achieve our guidance of Opex of 50% of revenue in 2022, you may potentially grow operating income as high as 40% this year.
However, while improving profitability, we also increased our sales and marketing investments by 50% to support all three of our businesses. The key messages, we are not holding back investments, where we need it.
I've talked about the fact that over the next five years, we should be able to reduce opex levels to be more in line with our peers in the Russell 2000, Industrials index, while more typically in the range of 20% to 30% of revenue.
I would like to give you a bit more color into my assumptions driving that target.
If we assume we can increase asps in line with inflation and maintain R&D spend at roughly 10% of revenue over the long term.
We could maintain healthy double digit growth in our non R&D spend and still achieve the lower end of my 30% to 40% target range provided last quarter.
The key is to manage R&D spend over the long term, while maintaining the levels of spend necessary to support our expansion in the refrigeration industrial wastewater markets.
I'll also rational and growing our back office and sales functions.
Whether or not we see higher R&D spend in future years will depend on our focus on markets for the PX outside of desalination industrial wastewater and commercial refrigeration today, which would also imply potentially higher future revenues and currently targeted.
Overall, I feel very confident in our ability to achieve our opex target, regardless of whether we achieve lower or higher revenue target extremes.
Regarding vortex, we are down to one or two scenarios partnership or shut down.
If we are successful with the partnership how this will affect our financials will be entirely dependent on the nature of that partnership however.
However, we would be looking to contribute certain assets to the partnership and support of the future business.
In the case of a full shutdown you should expect a onetime expense of roughly 1% to 2% of total assets.
Currently our spend is limited to some minimal testing and maintaining personnel such as manufacturing and field staff that will be important for any partnership.
We closed the year with a cash and securities balance of $108 million essentially unchanged from the third quarter slightly down from the end of 2020.
Our operating cash was about $3 million lower year on year. This occurred chiefly for two reasons first we nearly doubled our inventory to protect ourselves from any potential pandemic related disruptions.
As well as to build finished good inventory reserves for the growth we're seeing in 2022.
Second our historic fourth quarter revenues were weighted to the latter half of the quarter, meaning that we will realize most of this cash in Q1 this year.
Despite these significant pressures on operating cash flow operating cash held strong due to our disciplined management of opex and increasing profitability.
As Bob mentioned, we are targeting to achieve a cash flow breakeven run rate by the end of 36 months in both our industrial wastewater and refrigeration businesses, which is our next milestone to achieve with this disciplined approach I will now briefly explain what we mean by that.
As we ramp up our emerging businesses, we may invest in additional working capital to build inventory for the sales and marketing to further build a volume business clearly, we will need to invest to support growth and are prepared to do so and these investments could well increase cash outflows in the initial years.
What we're really looking for by the end of the third years to see that operating cash flow on a normalized basis is covering our normal operating cost of the business, meaning specifically that we need to show we have a viable business.
We believe we are on the path to achieve that goal and our industrial wastewater business. This year already ahead of schedule.
We will look to strengthen our relationships with refrigeration manufacturers this year to achieve the same in refrigeration in 2023.
Throughout 2021, we executed buybacks valued at $23 million in to date through February we've repurchased accumulative $27 million or $1 5 million shares at an average price of about $18 56.
Which represents 54% of the $50 million approved the program, we will continue to execute as opportunities arise throughout this year.
In addition to our cash reserves on our balance sheet, we recently announced a working capital agreement for $50 million signed with J P. Morgan Chase at the end of last year.
The purpose of this agreement is to provide us more flexibility in our management of working capital as we grow we do not expect explicit cash drawdown in the near term, but note that we are utilizing this line to support our issuance of standby letters of credit in support of sales.
Overall, we are in great financial condition as we enter 2022.
Like everyone. We're feeling some effects of inflation. So far we have been able to keep those at a minimum due to our advanced inventory build.
Additionally, the bay area as a whole to date has experienced somewhat lower inflation in other areas of the country.
Additionally, we neither see inflation, nor potentially higher interest rates to be a risk to the growth. We are fostering over the next 12 to 24 months. This growth is organic in nature. Our balance sheet is strong and helps to insulate us from potential increased cost of capital a higher interest rate environment presents for many growth companies our size.
Of course, we are watching trends carefully for how inflation could affect us as we move closer to 2023.
As well as how it could affect our employees during this time of transition and our global workforce.
To date, our turnover rates have not significantly increase from prior years.
We remain more or less in line with our rates in 2019 and 2020.
With that we can now move to Q&A.
Thank you.
At this time, we will be conducting a question and answer session.
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One moment, please while we poll for questions.
The first question comes from the line of Ray Deacon with petrol Lucas. Please go ahead.
Yes, Hi, good afternoon. My question was about the.
Okay.
G&A expense for sales and marketing I know you've talked about having to pump.
Your sales force.
These new product lines I guess.
Where do you think that number could go.
And the next year.
So specifically the G&A expenses, Josh Hey rates, yes, that's true.
Exactly.
I noticed it was below a year ago I think it was.
<unk> thousand versus $1 2 million.
Just wondering.
Yes.
No what you're really seeing there ray as we did a a recast of how we are.
How we allocate our expenses to the various business segments, meaning either water or emerging technologies or corporate so youre seeing a shuffling of that as we try to our goal of this last year in 2021 was too.
Better allocate our expenses to reflect where they're being used in the business is really our goal. There. We don't expect specifically for water I would not expect that number to increase very much year on year, except for perhaps additional allocations of the business grows depending how that balances out with the growth in refrigeration and such.
With refrigeration in the next couple of years.
We're not going to add a lot of resources to support that business on the backend if that makes sense.
Okay got it got it.
If you have any early idea of what your gross margins might look like in the.
Lithium ion in the wastewater business that you're targeting.
Yes.
Yes.
Yes, we're certainly targeting over the long term gross margins more in line with what we've shown in desalination.
However in these first couple of years now, they're going to be a little lower but we are exceeding our 50%.
Marker that we put for ourselves, but theyre not as high as where we'd like them to be as we start out but as costs come down and so forth will now we'll be able to get those up we think over time.
Okay great.
Just one last quick one.
The shift in focus away from the oil and gas segment.
Would suggest.
The composition of the board potentially changes.
Feel better.
Well. Thank you all right. Thank you for joining us for the first time and I hope we.
We get to see you every time.
Our board continuously evolve to reflect and to lead the strategic transformation.
As you May agree we believe our company is on an exciting transformation and growth past. Thank you.
Great. Thank you.
Yeah.
Ladies and gentlemen.
Again, if you wish to ask a question. Please press star one on your telephone keypad.
Thank you.
The next question comes from Neil.
Tom since <unk> with Fearnley Securities. Please go ahead.
Good afternoon.
A quick question on the do refrigeration partner I was wondering if you could elaborate if this is a company that has global operations or if it's limited to specific markets and also if you could touch upon how the gross margin looks like if you would do you a delay.
Terry.
With the PX as a standalone bolt on into the existing systems and what the gross margin looks like and when it's part of a PX centric system.
Going forward actually we do not expect much or.
Any pure bolt ons.
Going forward, we are we.
We will be concentrating in and we think the market will accept.
The PX centric solution even going into.
The installations that's already in place.
A certain extent of the PX centric benefits will be reflected as for example.
If we as we fully expect PX centric means less.
Compression capacity as needed.
Oh, two systems without PX, so that you could say for example.
Take out one of them to us via a number of compressors and people in the us so.
We don't really fully expect.
To really push these so called photo.
Okay.
And just another one for me as well I know, it's early days, but can you imagine that there's any impact from the situation in Ukraine on your business in terms of either sourcing of raw materials or any supply chain related issues there.
Yeah.
We do not expect the disruption.
In the sourcing and the supply chain.
And anything else, how clean is a geopolitical it wouldn't be a conversation.
Neil I would add as well thank you.
Just a reminder, that we did build up inventory quite a bit.
So even if there were some kind of supply chain disruption for a short period of time globally, we're pretty well covered for awhile. So.
Yeah.
Alright. Thank.
Thank you.
Okay.
Thank you. The next question comes from.
Walker with panel real capital.
Please go ahead.
Thank you and congratulations guys had a great quarter.
I'm going to ask the operating leverage question with Josh.
Somewhat preemptive and talking about operating income could drop by as much as 40% and 22 I would love portion of elaboration on the puts and takes about how about that might happen.
Yeah, well in.
2022, what youre going to see what's really driving it is going to be less operating leverage.
Additional operating leverage is going to be more.
Because of the way, we're managing our expenses.
And holding our margins when you're really going to CB driving up that operating income if that makes sense. So if we're able to.
Continue to reduce our opex as a percent of revenue, which is our plan this year and get that closer to that 50% marker.
As well as manage our margin and keeping within the range that we provided now that gets us into that roughly 40% range for the year, that's what will really be driving it this year.
And Josh I'm not sure I heard correctly, you mentioned, something we're going to realize cash from a source.
They were mostly ended up in Q1, but what was that short squeeze.
Yes in Q4, Q4 was a monster quarter for us and a lot of the sales in Q4 happened actually in the latter half of the quarter. So.
A lot of it in December in fact.
November prior to the holidays. So that's the cash that we're going to be realized in Q1, we haven't realized a lot of the receivables cash from our customers from the Q4. The Q4 sales. Okay. So it is going to come from <unk> and <unk>.
I realize.
You haven't typically had inventory balance that you currently have in the regions, where it makes sense to me.
What would be the cadence of realizing cash and sales from the current elevated inventory.
Inventory this year youre not going to see inventory grow in the same manner. This year as you did last year, and we're pretty fairly comfortable where we're at today and we've got enough safety stock of finished goods and so forth.
Sure.
Curious.
I think you may see it go down a little bit by the end of the year, but I think it will be fairly stable for this year. So I wouldn't expect that to be having a large effect on working capital. This year as it did last year.
Okay Alright.
Okay. Thank you.
Right.
Thank you.
Yes.
Thank you.
Again, if you wish to ask a question. Please press star one on your telephone keypad.
Ladies and gentlemen, if you wish to ask a question. Please press star one on your telephone keypad.
Okay.
Yes.
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Yeah.
Thank you ladies and gentlemen, we have reached the end of question and answer session.
And I would like to turn the call back to James <unk> for closing remarks.
Thank you everyone for joining us this evening and we look forward to speaking with you again in early may sell them stay safe while integrating.
Thank you. This concludes today's conference you may disconnect. Your lines at this time Goodbye you for your participation.
Okay.