Q1 2022 Energy Recovery Inc Earnings Call
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Yeah.
Greetings and welcome to the energy recovery first quarter 2022 conference call.
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I would now like to turn the conference over to your host Jane Mccahon. Please go ahead.
Hello, everyone and welcome to energy Recovery's 2022 first quarter earnings Conference call.
My name is Jim Zaccardi, 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 of 1995 regarding future events or the future financial performance of the company.
These statements may discuss our business economic and market outlook.
Growth expectations, new products and their performance cost structure and business strategy.
We're looking statements are based on information currently available to us.
And on management's beliefs assumptions estimates or projections.
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 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 four 2022.
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'd like to turn the call over to our Chairman President and Chief Executive Officer, Bob Mao.
Thank you Jim and thank you everyone for joining us.
We delivered a strong first quarter with revenue of $32 5 million.
A 12% increase over the first quarter of 2021.
Importantly, we also delivered over $8 million in operating income of 34% increase over Q1 last year. The fact that our operating income grew almost three times our revenue.
Their lines, our continued focus on profitability as we grow.
I'm going to focus our discussion on the.
The industrial wastewater and <unk> are.
Our core desalination business remains strong.
We are maintaining our outlook for this year and next of 25% and 15% growth respectively.
Let's star was our industrial wastewater business, where we are.
<unk> revenues in the first quarter equal to nearly 50% of 2021 full year industrial wastewater revenue.
The growth, we're seeing in our backlog and sales pipeline is encouraging providing us confidence in the $3 million.
Topline guidance, we said for industrial wastewater in 2022.
Our first ultra PX.
Were commissioned at a lithium battery manufacturing facilities in China in Q1.
And have been running for more than a month.
We are collecting performance data.
Which we'll use to further educate and penetrate this market.
In our third quarter earnings call last year, we talked about the overall potential of this market.
Was apparent in one time was occurring on time Tam of roughly.
$1 billion today based on industrial.
Water treatment statistics.
This market has the potential to grow up to $4 5 billion.
Depending on how the regulatory environment develops during this decade we.
We have already identified specific terms of three.
<unk>.
<unk> to $400 million.
And just a few industries such as the lithium battery market.
Preparation to seize this opportunity we have increased our boots on the ground.
In China and India.
The regulations are pushing toward minimal or zero liquid discharge providing potential tailwind.
We've also added technical Christian now here in California to.
To help drive business in the application development within the various market verticals.
To ensure product leadership in the PX and turbo Chargers as the energy recovery.
<unk> a choice just as they are in desalination. We have also partnered with two major equipment suppliers and are in discussions with several process innovators, who joined market to the industry.
Our teams are active.
Actively engaging with government run industrial design institutions.
In China.
<unk> defined the technologies that can be used in various industrial processes Oems and system integrators and end users themselves to educate them on the value proposition.
Our solutions.
Finally, we're now looking at how we can expand our focus in the industries, we know such as lithium battery market to further drive sales outside of Asia.
In short as.
As a first mover, we are positioning ourselves to capitalize on the industry poised for significant expansion in the near term with regulatory tailwind helping.
Helping to drive that expansion and a great need for quality proven reliable energy recovery devices.
During our next earnings call on August 3rd we will provide provide further clarity on.
Additional industry industrial.
The industrial wastewater market.
We will initially focus.
Now, let me turn to the development of our <unk> refrigeration business.
We have made significant progress.
Our initial <unk> developments.
Deployments with our partners and therefore, our first steps to volume sales.
The installation and commissioning of the industry's first <unk> refrigeration units was a an integrated PX in Europe is scheduled to occur early this summer.
We have already shipped RPX due to Europe and will soon be outside with our partner to help wishing installation.
The deployment of our bolt on PSG.
<unk> two <unk> in deal, California grocery store was pushed out a few weeks due to delays in construction.
Installation will now occur during the second quarter.
We will then begin testing and fully commissioning the PX G alongside existing.
Existing <unk> refrigeration wreck this summer.
And begin compiling the energy savings data PSG offers.
We will give further update on both deep deployments during our second quarter earnings call in early August .
We continue to engage with and finding interest from other refrigeration manufacturers as we look to expand our commercial relationships to build our volume business.
We are actively working with two additional refrigeration manufacturers, who have met with our engineers pro forma tests on our refrigeration test flow.
Studied RPX Jeep and the data compiled understand the benefit of the PSG centric design to.
Optimize energy savings.
In short the industry is taking notice of us.
Let's take a moment to remind ourselves as the regulatory force driving the industry to adopt <unk> refrigeration, thereby for the need for our energy saving PX.
<unk> Amendment to the Montreal protocol requires accelerated reductions in <unk>.
The production and consumption of HFC and.
And it was committed to by over 130 countries, including the European Union, China and India.
While the United States has not yet officially ratify Kigali amendment.
U S has already begun implementing the HFC phasedown.
Under the American innovation and manufacturing Act enacted last year.
I'm curious searches are accelerating these reductions such as the use F gas regulation.
Which moved up the timeline by six years.
Europe is also in posting outright bans on new HFC systems as well as <unk>.
On servicing existing HFC systems in the coming years.
In addition here in the U S, California adopted.
<unk> plus to achieve similar timelines as to Europe .
Yes.
The world is already reducing HFC supplies today, the EU has already reduced HFC by 60%.
Their 2015 baseline.
In 2020 to the U S is implementing its first phase down of 10% of its baseline.
This reduction is supplies.
So affect existing systems.
Frigerator systems lose a significant amount of refrigerant each year.
Central supermarket refrigeration systems for which the <unk> currently.
Hello.
Fleet, an average of 17% over their HFC each year.
<unk> HFC production and the ultimate plan of production and the trade in the future.
We will mean supplier will no longer be enough to refill even existing HFC systems in the coming years.
Other industry, yet unaffected by this protocol such as data centers will further pressure.
Dwindling supplies.
Well some HFC refrigerant can be recycled from retire systems to help alleviate the reduction new production. We believe there will be a 25, 20% deficit in available hfcs to satisfy demand, losing roughly the first half.
Of this transition period.
Here in the U S.
Based on the life of 10 to 15 years for typical system.
This translates to a 9% average annual replacement rate of the total installation over 40000 supermarkets and grocery stores. However, this replacement will likely accelerate in the future years.
FC supplies continued tightened and costs to run these systems increase.
The key takeaway here is that these regulations limits and bow HFC refrigerants.
We are equally effect all countries, including those in Europe and in all 50 states in the U S, thereby accelerating the conversion from HFC base too.
<unk> based systems.
This regulatory pressure.
And the evolution of the European market is why we believe we can achieve the $100 million to $300 million targets by 2026, which we outlined last year.
As you can see momentum continues to build both in our ambitions as well as in the overall regulatory environment globally.
This year, we will deploy <unk> centric systems gather proof points improve the reliability of the <unk> in the real world.
These are the next steps to create a volume business and achieving our breakeven milestone by the first half of 2023.
I would like to take a few moments.
We'll talk about all the changes occurring inside eri.
<unk> itself will have to continue to mature is operations to maintain our position in desalination and achieve the growth we have targeted.
On the industrial wastewater as Cotwo refrigeration.
Growing up to $550 million.
The revenue means not only approaching our markets in new ways, which I have described at least during these costs.
It will also mean, adding complexity to our operations as we add.
Substantially.
Abstention Lee to our workforce and expand capacity.
Potentially in new locations to handle the increased volume.
This growth will put new pressure on our leadership employees and systems.
Manage this.
More complex visits.
One of the pillars of our commitment to achieve sustainable growth is our commitment to our ESG program.
The employee aspect of ESG is growing in importance as we look at hiring and retaining the best talent as well as developing our employees and leaders with Zim.
As we seek to scale.
While we are establishing new teams to address our new markets. We're also actively building out and develop our internal capabilities to prepare for this growth and a multiyear effort.
To ensure we can meet increasing demand in a disciplined focused and accountable manner.
We believe we are off to a good start our ESG efforts has been noticed by others.
And our second annual ESG report was recognized by Investor Relations Magazine Award.
For the best ESG reporting for a small and mid cap company in March.
And just last week MSCI upgraded our ESG rating from a single a rating to doubling.
This represents ESG rating increase by MSCI two years in a row and we are proud of this acknowledgment of our commitment to ESG principles.
In addition to these recognitions.
We also recently earned <unk> certification.
As a great place to work.
An early step in our commitment to our employees as we grow.
With that I'll turn the call over to Josh.
Thank you Bob.
Our 12% year over year revenue growth this quarter was largely driven by our OEM and aftermarket channels.
Both of which exceeded Q1 2021 by 67%, while our Mega project channel remained flat against last year. However.
However, as we've discussed before a quarter to quarter comparison does not point to a trend for the year. The first quarter of 2021 was still affected by Covid slowdowns. However, we saw growth in both the OEM and aftermarket channels throughout the final three quarters of the year.
In particular, if you look closer at OEM sales you can see that revenue. This quarter is very much in line with the past three quarters.
While aftermarket is high compared to any quarter last year I do not expect it to remain this elevated throughout 2022.
While we are maintaining our guidance of roughly $130 million for the fiscal year, we have seen some shifting between quarters. We originally expected our quarterly revenue to be fairly evenly distributed in 2022.
It now appears our second and third quarters will be lighter than our first and fourth again this year.
Our second quarter will be our lightest quarter likely around $20 million fourth quarter revenue was shaping up to land in the low to mid $40 million range in Q3, we will make up the balance.
We generated a 71% product gross margin during the quarter, but anticipate this range to moderate as the year progresses, we are benefiting from our inventory build during 2021, and we will begin to experience some effects from inflation and tariffs in the latter half of this year, which will moderate our margin to bring it within our guidance of 66, 68%.
Yes.
Our opex grew about 3% over our average 2021 quarterly rate.
Our R&D spend should remain fairly stable for the remainder of the year, averaging between $4 million to $5 million per quarter. You can expect significant increases in sales and marketing as the year progresses, and moderate 8% to 12% growth to G&A.
We are still targeting opex of roughly 50% of revenue this year.
In order to provide you with a bit more clarity as to the nature of our Opex included non-GAAP measures in our earnings press release to exclude share based compensation nonrecurring and extraordinary items, if they were to occur.
Due to our slightly higher gross margin and decreasing opex as a percent of revenue we saw healthy growth in our operating income $8 2 million or 34% year on year growth and we achieved adjusted EBITDA of $11 million or 23% growth year on year.
And 34% of revenue.
We are also offer greater insight to our tax rate, which has bounced around quite a bit. The last couple of years from a 10% tax benefit in Q1 last year to 5% effective tax rate this quarter.
This change is reflective of two events first last year's rapid share price events led to the exercising of options, resulting in high deductions in the first half of the year, which provided a tax benefit extra.
Exercises a moderated to more typical levels this quarter.
Second we will have access to the new foreign derived intangible income deduction, where STI for the first time. This year <unk> is not an allowable deduction, while accompanies utilizing accrued net operating losses to offset taxable income, but we should use up all of our net operating losses in 2022.
Based on what we know today, we believe this new FDI benefit could reduce our tax rate by up to 7% this year.
This expected deduction together with this significant R&D tax credits, we received should keep our effective tax rate adjusted for share based compensation at roughly 10% as reported this quarter.
We closed the quarter with a cash and securities balance of $97 million somewhat below our end of year balances largely due to share repurchases totaling $8 million in the quarter as well as somewhat negative operating cash flow.
As of the end of April we had repurchased one 9 million shares for a cumulative $35 million at an average share price of $18 77.
That leaves us with about $15 million remaining in our current repurchase program as of last Friday.
With regards to our operating cash flow increased inventory and receivables levels compared to year end drove this dip.
Accounts receivable continued to grow in the first quarter due to record high sales, but remains strong we are seeing no indication of weakness in the ability of our customers pay off of that.
Inventories rose, mostly due to the timing of the receipt of raw materials. Despite the continued negative news regarding the global supply chain, we remain in a fairly strong position from a manufacturing perspective.
First our suppliers have largely avoided port shutdowns.
Due to our inventory program in 2020, one we have a healthy buffer of finished goods and materials, which if the world were to shutdown today will provide us with up to eight months of pressure exchangers for our customers.
Note that you should expect inventory levels to continue to rise in the second and third quarters that sales moderate mid year, we've level loaded production of pressure exchanges. This year to cover shipments for this year as well as to prepare us for continued growth in 2023.
Because of the very large level of shipments anticipated in the fourth quarter by end of year. Our finished goods inventory should be more in line with what we saw at the end of 2021.
We often get questions on capacity and our ability to satisfy not only growth in demand from our detailed customers, but also incremental new demand from industrial wastewater in tier two in the next couple of years.
We are comfortable that we can handle any new production volumes over the next couple of years, we have the footprint to incrementally add new capacity or exist at our existing facilities if needed at fairly low cost to support the initial growth of these businesses.
However, actively reviewing our manufacturing options for 2024, and beyond which will largely be driven by our <unk> business. We will keep you updated any investment and expanding our existing facilities or building a new one will likely not begin until 2023 at the earliest unless sidoti demand upticks much faster than currently expected.
Finally, let me briefly update you on <unk>, we continue to discuss options with potential parties and expect to finalize our plans in the coming weeks, one way or another.
As I mentioned last quarter, our spin on vortec is fairly minimal at this time, we're not testing that are mainly focused on supporting employees that would we would need within any potential partnership.
We should be prepared to discuss our final plans for vortec at the next earnings call, but either way you should not expect much change to our recurring opex.
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 poll for questions.
We have a question from about <unk> of Raymond James. Please go ahead.
Thanks for taking the question, let me start with with Board Tac, stating.
Stating the obvious.
Since the last time, we spoke.
The water.
Hundred dollar a barrel of oil.
Has kind of accelerated attention on everything related to oilfield service technology I'm curious if you're seeing in the last 60 days any.
Increase in interest from prospective partners.
Along those lines that you can talk about.
Well this is Josh I wouldn't say, we've seen any specific change no.
Turning the conversation that we started a couple months ago.
Okay.
And.
Given that.
Storage you tested board cap with a few partners specifically in the Permian Basin.
Is there any.
<unk> died from prospective partners to engage in testing.
Outside of the Permian, maybe even outside of North America.
Both.
As we move forward with our partnership.
I'm sure that partnership would look at all areas that makes sense for the vertex.
I mean, it's too early to say in Alphaville.
Now also as far as we're concerned we have no need to do further tests.
Okay.
Okay fair enough.
And then.
Back to desalination.
California yet.
Yet again in a severe drought in the whole western half of North America.
You obviously your default business has always been very.
<unk>.
Correct.
Are you hearing any.
Discussion in Sacramento or or other.
Parts of the Western U S.
About our perspective T cell build out domestically.
Okay.
The long running Huntington Beach project is coming up for another decision point on May 12. So.
We listened to that.
Alright.
Thank you guys.
Thanks, Laura.
Yeah.
Ladies and gentlemen, just a reminder, if anyone else with laptops quick question Youre welcome today Star and then one.
Of course <unk>.
Further questions.
We have a question from Ray Deacon of Petro niches. Please go ahead.
Yes, hi.
Bob I was wondering if you could elaborate a little bit more on the design Institute in China, and what that could mean to the.
To the wastewater business and.
Hum.
Is there much competition at this point.
So does that answer too is like a standards committee that we on the western part of the world.
Oh in deploying new technology, new products. So they define what would be the new our new product has to be deployed.
In what way the new systems look like and what metrics measuring so you can think of them as a standards file but they go deeper than the.
The American industry standard they actually review detailed designs of our specific wastewater.
Whole setups.
That's what it was such a blessing.
Okay got it so it helps with with marketing the product.
Customer recognition I suppose.
Yes, yes.
Got it thank.
Thank you.
Thank you.
Our next question is from.
Wally Walker.
All right.
Please go ahead.
That was of course, thank you and congratulations guys on the improving operating leverage and profitability.
Bob you talked about.
Challenges with ROIC laser good challenges to have and if my memory serves me correctly, you agreed to serve as CEO through the end of 'twenty three.
Maybe could you elaborate on your current feelings about it.
Sure.
Okay.
Okay.
I don't remember I said only serve till the end of 'twenty three okay.
I don't know what context, you remember that.
But.
Let's say this.
It was two earnings calls ago I sketched out a.
Michigan for Eri based on proof points.
We aim to grow.
Five times by 2026 was a 2021 as the baseline.
We're now on that mission to achieve $500 million in revenue by 2026.
It was basically organic growth.
In a disciplined profitable manner.
Oh as investors continued.
Confidence in.
Confirmation.
Which is always based on our performance.
I expect to be personally here in 2026 to deliver that profitable $500 million revision to you the investors and our stakeholders.
By the way if you can remind me that just 10 minutes ago, I said 550 <unk> five.
550.
Yeah.
Of course CEO serve at the pleasure of the board and ultimately the <unk>.
The pressure of the investors that you.
We're doing well and we aim to do well.
We will deliver our 2026 mission.
Thanks, Bob if I misremembered any comment you made about your tenure I apologize the contracts for me was hoping you would stay in place for the company is clearly got more efficient and focused and profitable evidenced again today. So.
Please.
Thank you for that answer.
Thank you Ariel.
Okay.
We have a follow up question from <unk> <unk>. Please go ahead.
Yeah on the on the C O two refrigeration opportunity.
When you think about breakeven for that product line.
By the I think you said first half of next year or so.
Only a year from now.
What's the assumed revenue contribution in other words what.
How much sales do you need to achieve for that product.
For you to breakeven on that.
I don't have an exact figure here, but why do.
You will remember that.
We aim any new project under my.
Tenure.
Is minimal 50% gross margin.
And we.
We are a very lean operation.
It doesn't take that much.
To reach breakeven in other words, a business no longer burn cash.
And we are very confident that we will reach that goal in the first half of 2023.
In fact.
However, you remember this is part of that $3 12 months regime, where on any.
Any projects I star.
We will clear all technical hurdles in the first 12 months.
And you will commercialize was at least minimum one bonafide commercial order.
Then by the third 12 months it will breakeven on a cash basis.
Were well on their way not only in.
In <unk>, but also.
Industrial wastewater.
As we go into the third or earning cost from here onward.
I will brief you exactly where were on the road to breakeven and where we're on the road to 515 million.
Alright.
Thank you very much.
Okay.
Ladies and gentlemen, just a final reminder, if anyone else with labs asked a question Youre welcome to pay Star and then one.
We will pause a moment for any last question.
Ladies and gentlemen, we have reached the end of the question and answer session and I would like to turn the call back to James Mccarthy for closing remarks.
Thank you for joining us this evening for reference a prepared remarks can be found on the investors section of our website with that I'd like to wish everyone. A nice evening and we look forward to speaking with you at our second quarter call on August 3rd.
Thank you and have a good night.
Goodbye.
This concludes today's conference. Thank you for joining US you may now disconnect your lines.