Q3 2022 Energy Recovery Inc Earnings Call
Any supply chain issues, we are not immune to these macro events. However by the nature of our business and the strength of our balance sheet.
We are in a better position to navigate these headwinds. Despite these macro economic headwinds, we achieved our second highest revenue quarter to date.
$35 million in the third quarter.
We continue to anticipate a record Q4, which will mark our sixth consecutive record revenue year.
While we anticipate signing.
Roughly $130 million in contracts to ship this year.
Are experiencing some America project customer related delays.
Which could result in revenue lending between 121 and $125 million.
2022.
Meanwhile, we're on track to exceed our industrial wastewater guidance of $3 million.
For this year.
We will discuss these risks as well as our successes to date.
Josh will then also take you through our guidance for next year and outlook for 2024.
The takeaway is that we believe we're well positioned with the right technology and strategy even for December omen, despite any headwinds globally.
And feel confident about our long term prospects.
As usual.
We will start with our water business.
In 2022.
It seems a water scarcity issue are increasing at a heightened pace across the globe.
There is this.
This is evident was news headlines.
Highlighting record low water levels in places as desperate.
Disparate as.
Western United States, along the Mississippi in the U S. The Rhine of.
Europe .
The times, new England throughout Italy and across the world.
Growing water scarcity highlights the need for solutions that created more sustainable and stable sources of freshwater.
Our water business, including both desalination and industrial wastewater are part of that solution.
This reason and to remain the dominant market leader in this growing market, we continue to invest in.
Innovative new products to remain at the forefront of these industries.
In October we launched our newest pressure exchanger, the PX Q4 hundred.
Q4 hundred is our most efficient and highest capacity PX available as.
<unk> generally is substantial industry interest, including our first purchase orders.
The Q4 hundred is targeted at larger scale desalination plants as well as potential industrial wastewater applications.
The Q4 hundred can handle 33% more water flow then that Q3 hundred model.
It offers industry, leading mixing rate of less than 3%.
And provides a nearly 1% increase in efficiency at maximum PX flow capacity.
Which translates into significant additional dollars savings for our customers over the Q3 hundred.
We also recently announced a new pressure exchanger for low pressure water applications.
An example of this is brackish water desalination such as underground aquifers.
Which typically requires much lower pressures than seawater desalination.
Our new low pressure PX should help us expand our presence in brackish water desalination.
We're also.
Innovating in industrial wastewater our team has worked with our customers.
The proof is collected from these initial deployments are providing.
Proving instrumental in helping us to grow our product leadership position.
And our backlog in these key verticals.
While heightening our value proposition through efficiency gains and market leading reliability.
We continue to see the results of these efforts in the lithium market where.
Where we have secured 15 separate contracts.
From lithium refining recycling and mining markets in China.
According to benchmark mineral intelligence.
Current global leasing volumes will need to increase by 24 to meet demand by the middle of this century by.
By 2014, nearly 20% of leasing will be sourced from.
Recycled batteries.
The lithium market is important segment of our growing industrial wastewater backlog.
Are more customer focused marketing approach, we're seeking to extract additional market share in this market.
We're also actively investing into developing our brand name and build a market leadership role.
<unk>, the Asian, industrial wastewater industry verticals, such as Tech stop.
We expect to see significant growth in the coming years.
We are committed to building the teams and presence we need to be successful in this market.
We have set aggressive targets for our team and we will hold ourselves responsible for.
We're delivering on these targets.
We will continue to strengthen our competitive position in desalination through 2023 and beyond.
To meet our 2026th target of $200 million in revenue.
In addition.
We will continue to invest in our industrial wastewater business to build our volume sales by investing in new product innovation personnel in key markets, including China and India.
And the increased local marketing efforts.
He will stay on track of our.
$30 million to $70 million revenue goal for 2026.
We must significantly grow industrial wastewater revenue in 2023 and 2024.
Given our backlog, we feel comfortable in our ability to double our revenue in 2023.
For 2024, we are targeting a range of $12 million to $20 million.
Now, let's turn to our Cotwo business.
As we have previously stated we are focused on achieving volume sales in 2023.
We're comfortable with the technology and the results in the field and continue to see growing interest.
On the refrigeration market as evidenced by new sales orders and increased activity by our OEM partners and others.
It is an exciting times for energy recovery.
I will start with an update of our partner related activities.
First.
We successfully commission RPX Biochar supermarkets here in California.
<unk> been from performing reliably as expected.
The past few weeks.
But it is too early to provide data because we are now entering the cooler months, we expect efficiency gains will be less than those we initially experienced at our first installation in Europe .
As a reminder, our technology improves efficiency is outside temperature rise.
Continuing the momentum from the successful commissioning.
Working was by.
Potential future deployments of <unk> enabled systems in 2023.
RPX G installation in southern Europe continues to perform optimally.
Which have frankly exceeded expectations. However, we have not incur as much experience in these early weeks as we would have liked.
Due to commissioning issues relating to ancillary equivalent which resulted in some delays in running the PX cheap.
But when running the PSG has delivery efficiency gains up to 25% during the hottest days of the summer.
We're also discussing with our partner on potential deployment for next year.
We hope to have more of an update on those locations in early 2023.
Our U S based partner, whom we announced in our call in August .
Has been working with our technical team to optimize their system architecture was the intention of deploying their first PSG enabled the <unk> system.
At the supermarket here in the U S, which will likely occur in early 2023.
In addition.
We expect to ship multiple units to other customers through the end of this year and early 2023.
In fact, we will recognize our first revenue in the fourth quarter of this year.
While this revenue may not be very material and marks a major milestone are pass through volume sales.
Importantly, these sales also include our first four units.
Industrial partner in Europe for two locations in Europe .
These sites will be the first locations to utilize multiple phds and we are already discussing future installations for 2023 will.
We will be able to update you on these upcoming shipments.
Our year end earnings call in February .
Finally, we will have begun to see an uptick of interest from European heat pump manufacturers.
This is in part a response to our recently published.
The pump reference design.
But also follows our participation in the largest refrigeration and heating technology trade show.
Annually in Germany.
We were one of the only disruptive technologies at the conference and the interest in our capabilities.
Hi from both refrigeration and the heat Oems at the conference and these discussions have led to increased activities in the weeks since.
Our early partner success are significant milestones.
For our business, we're showing that one the refrigeration and heating industries are hungry for new technologies to help address their challenges.
C O two systems.
To that <unk> is the future of.
Both refrigeration and heat pump applications.
And three that our products can provide concrete out by reducing energy consumption just as we have consistently done over 20 years in desalination.
As we look forward to 2023, we must begin to deliver on volume sales and <unk> business as a startup.
And just beginning to enter the market. Therefore, it is too early to provide explicit guidance.
However.
What I can tell you is that any volume sales in 2073 would be weight.
Through the second half of the year and likely remain in the single digit millions.
My goal is to exit 2023, with a backlog or pipeline that points to double digit millions in sales in 2024.
<unk> that were on our way to our $100 million to $300 million targeted revenue for 2026.
We clearly have a lot of work to do.
To achieve these markets however.
We believe market interest is strong and that the potential pipeline volume is there as we further gaining acceptance of our technology in the industry.
In 2023, we'll be increasing investments in sales and account management talent as.
As well as technical service resources to provide after sales commissioning and product support as we launch and expand marketing to further build our brand name in the industry.
Drive demand from the end customers of our technology supermarkets.
And industrial users, we will continue to invest in engineering and technology through one partner closely.
Closely with OEM and supermarkets on the most efficient architectures used.
Or.
RPX and.
And provide further improvements to our technology.
And the three.
Our heat pump applications.
We believe we are providing the versatile nature.
The of our PX technology platform, while meeting the targets required by the disciplined growth strategy metrics. We have put in place we continue to execute on this strategy.
Have laid out for you over the last several quarters and despite the global economic headwinds. This year as we are making significant progress in continuing to grow our business with.
With that let me hand, this call over to Josh good.
Good afternoon, everyone.
I'll start first with providing a few more details on our topline growth.
Revenue grew 47% in the third quarter year on year and that has grown 18% year to date.
The real story within these results is the strength in OEM and aftermarket sales, which have finally broken through our COVID-19 lows in 2020 in 2021.
OEM sales, excluding industrial wastewater have grown over 60% year to date and aftermarket has exceeded 30%.
Our strong results reflect in part a backlog of projects that were delayed in the past couple of years. It is likely that 2000, 22022 will be our largest year ever in both OEM and aftermarket sales.
As I mentioned in prior calls our Mega project revenue started out slower in the first half of the year, but it is picking up in the second half as expected.
While Q3 was a strong quarter, our fourth quarter should be our strongest ever led by Mega project shipments.
However, as Bob mentioned, there are some risks in our fourth quarter I wanted to clear that this risk is simply due to temporary project specific delays, while we are seeing some changes in the timing of a few individual projects. We are not yet seeing a shift in our longer term outlook related to global economic events.
There were two key project related shifts this year.
First about $4 million of our 2022 backlog of shipping the Egypt, where local capital controls have been put in place to slow hard currency payments due to a weakening Egyptian pounds.
This has slowed our ability to ship and recognize this revenue.
While the timing of influx as of today. We are confident these projects will ship either this year or next.
Second another $6 million project in the UAE was delayed due to the replacement of the EPC itself. This project is being rebid and revenues likely delayed until 2024.
We're working hard to solve these challenges, but there does seem to be more risk to the timing of our 2022 revenue, which is why we have adjusted to a range.
In 2023, and the dynamics of our desalination revenue will likely change somewhat.
First after a COVID-19 rebound in OEM and aftermarket sales. We expect these channels to remain relatively flat to slightly down in 2023.
However, our Mega project channel should exhibit growth of 6% to 12%, which shows continued strength in our most important channel for desalination growth.
Therefore in 2023, we are currently projecting overall desalination revenue growth of between 3% to 7%.
However, the actual growth rate in 2023 will much depend on our final 2022 results.
So I will update you again at the next earnings call.
This may be slower growth in 2022, however, we often talk about the lumpy nature of our desalination revenue.
As a slight shift in the timing of one or two mega projects can have an outsized effect on growth in a given year.
This is in part what we're seeing in 2023.
You should also note that this growth is overweighted to the latter half of next year due to the timing of these megaproject shipments our first quarter will likely be our lowest quarter of the year at between $10 million to $15 million in revenue in our second quarter could fall to between 20% to $25 million with the remaining balance split between Q3 and Q.
Four.
We anticipate 2024 to be another strong year for desalination, where revenue growth could again exceed 20%.
This growth in 2024 and put us back on an average 15% growth trends and put us well on the path to achieving our $200 million target in desalination revenue by 2026.
We believe the secular strength of desalination remains strong.
And industrial wastewater, we are targeting $6 million to $8 million in revenue in 2023, which would mean doubling from this year.
At least the doubling again, our revenue and industrial wastewater in 2024 will keep us on track to hit our target of 30% to $70 million in 2026.
Despite our bullishness.
Our watching global events and in particular three main risks in the short to medium term inflation, the strengthening dollar and a potential global economic downturn.
The biggest risk to our outlook is and our desalination OEM and aftermarket channels, where we have visibility on average of only about six months.
These two channels could be more negatively affected by a strengthening dollar or a potential global economic slowdown because 40% to 50% of their revenue is made up of a variety of industries and as many countries.
We are already experiencing a negative effect related to the dollar with our sales to Egypt as I described earlier.
About 60% to 70% of our revenue is currently in the Middle East, where there is little fear of the rising dollar or an economic downturn.
It could affect customers in other parts of the world such as North Africa, Asia, and Latin America.
We are less concerned as to how these economic events could affect our launch in the <unk> business. This is a new business and whether there is a slowdown in the overall industry is largely irrelevant to us.
As the transition to <unk> means that the Cotwo kit will continue to grow at a very fast clip regardless.
In addition, our product helps supermarket save money, which only becomes more valuable in a challenging inflationary environment.
Now, let's turn to gross margin, we remain on target to achieve our guidance of 66% to 68% gross margin in 2022 and will likely end the year at the higher end of this range.
We still expect to see some softening of our water margin in 2023, as we experienced growing wages hospital increased tariffs and other inflationary pressures.
In addition, we are expecting a growing shift in product mix, whereas we are providing more integrated packages, including racks and manifolds, which have grown to as high as 4% of revenue this past year.
Vaccine manifolds are an added service to our customers, but largely a pass through cost for us at a much reduced margin.
Of course as every company is today, we're looking at pricing and methods to increase manufacturing efficiencies to mitigate the effect of increasing costs.
Altogether, we are currently estimating a water gross margin of between 64% to 66% in 2023.
Our blended topline gross margin will depend on the level of <unk> sales next year.
<unk> of our volume sales in a startup business begin to take shape in 2023, I will be sure to update.
Let's now turn to operating expenses, our opex, excluding the onetime expenses associated with seasoning vortec operations.
<unk> to evolve in line with what I have described in past calls.
This year, we're trending to roughly 48% to 49% of revenue based on our original revenue guidance or approximately 63% to $64 million in opex when excluding those onetime expenses.
This opex range translates in the $50 to 52% of revenue based on our adjusted guidance for this year.
You will note that sales and marketing spend represents up to 80% of growth in recurring Opex in 2022, as we ramp up our cotwo industrial wastewater teams.
Also included as opposed to Covid bouncing standard our desalination sales team returned to traveling trade shows picked up and so.
We expect this dynamic will remain much the same in 2023 was slower digital.
With slower single digit growth in G&A spend largely driven by wage inflation and head count added in 2022, along with inflationary increases in insurance and professional services spend such as audit.
We expect growth of high 30% to 40% and sales and marketing spend as we accelerate investments in <unk> and industrial wastewater and flat to a possible slight decrease in R&D spend due to the lack of <unk> investments in 2023.
Overall, we expect Opex as a percent of revenue to come in at 52% to 53% next year. This will be a slight increase over 2022.
We remain steadfast in maintaining our disciplined approach to spend as we grow.
Inflation and our need to invest in sales and marketing ahead of future sales is simply caused a bit of a bump.
However, I remain confident that by 2026, we can still reduce our operating spend to a lower percent of revenue likely in the 30% to 35% range.
In 2024, assuming we achieve the growth we are targeting we will see the trend of opex decreasing as a percent of revenue begin to accelerate.
As we look forward to 'twenty four through 26.
G&A spend should continue to grow at a much slower pace than revenue and therefore normalize over this period.
Sales and marketing spend will likely remain elevated over the next year or two but should begin to fall.
For a more normalized range of 5% to 10% of revenue as we realize revenue for new business lines.
And finally based on our current strategy R&D spend should continue to grow slowly and therefore fall below 10% of revenue in the coming years.
So what does all this mean for our Bottomline profitability in.
In 2023, we are currently projecting a somewhat weaker operating margin compared to 2022 between 10% to 14% and adjusted EBITDA margin of 19% to 23%.
We should see our operating margins begin to grow again in 2024 through 2026, the simple math of this if we assume an average blended gross margin of 60% by 2026 within our three business lines and reduce our opex to 30% to 35%. This implies an operating margin over the long run of 25% to 30% and therefore in adjusted EBITDA.
EBITDA margin of roughly 35% to 40%.
And our projections of net profit, we are assuming a 15% to 20% tax range, which I would use for projections going forward.
Let's now turn to cash.
Our current cash and security balance remained at a healthy $87 million in Q3, we believe we will end the year between 90% to $100 million.
Where we end of that range depends solely on the timing of customer receipts at this point.
We have clearly made a significant investment in inventory. This year. However, this pace Lamont continue first we will ship out a lot of pressure exchanges in the fourth quarter.
Second while you continue to see growth in our raw material inventory levels that will begin to reduce by early 2023.
We had two goals. This year, we have targeted to end the year with four to five months of pressure exchanger inventory, which is roughly where we ended last year with.
Also we continued to build up raw material inventory in light of production and supply chain issues in both China, and Europe , which we believe we can begin to moderate as we head into 2023.
As we look forward and we should begin to see a reduction in inventory levels in Q4, which will likely continue throughout the first half of 2023.
We will need to be careful to balance our finished good inventory levels with the changing product mix, which includes our new Q4 hundred our industrial wastewater products and the <unk>.
In addition, we must keep an eye on our capacity needs as we gauge how quickly the <unk> business will ramp up in the latter half of 2023 and into 2024.
Increased finished good levels of our stable water products for example could help to free up capacity in 2024, if it's needed for COPD.
In short we will keep you updated as these businesses evolve next year.
We are expecting to invest $40 million to $45 million in total capex by the end of this year and likely a similar level in 2023 as we continue to upgrade our manufacturing equipment in San Leandro and in the overall facilities. We do not expect a large increase in capex to occur until we begin to see growth in Q2 at which time, we will need to invest in.
Capacity to manage future growth at this time.
At this time there is no plan for additional share buybacks.
With that we can move into Q&A.
Thank you, Sir ladies and gentlemen, we will now be conducting a question and answer session.
I'll ask a question. Please press star one on your telephone keypad.
A confirmation tone will indicate that your I understand the question queue.
You May please talk to leave the question queue.
All participants using speaker equipment, it may be necessary to pick up a handset before pressing the talkies.
We oppose the amendment will be ready for the question <unk>.
The first question comes from Pavel <unk>.
Raymond James.
Thanks for taking the question.
Let me start with the near term desalination outlook.
We typically think of diesel at something that has really no.
Phenom X sensitivity, we thought with enduring Colgate in 2020 for example.
To the extent that you mentioned projects being being pushed out.
Is that driven by macroeconomic conditions or is that just no physical construction delays.
Hey, Pablo this is Josh these are.
Very specific project delay that's not related to the overall economy at all at this point well I mean with the exception I guess, you could say with Egypt with their their currency, having a little bit of trouble, obviously, that's causing some specific delays, but otherwise it's really unrelated to the economy at this time.
And to your point on <unk> being decoupled I think that is true with the Mega projects and Thats. What we saw in 2020, when Covid began its less true with OEM projects that are much more where the roughly 60% of our smaller OEM projects our munis.
Capacities, which are probably less affected but the other 40% give or take.
Or a variety of industries, which can be affected so during COVID-19 hospitality and.
And travel industries got hit really hard for example, so it just really depends on where the economic effect is happening in a given country.
Okay.
Following up on diesel.
You touched on water scarcity being kind of a worldwide story not limited to the middle East.
As we hear more headline for example from California and parts of Europe .
<unk> new builds are you seeing that in incoming.
Orders or at least your prospective customer engagements.
We are not seeing it yet and in incoming orders in Europe or the U S.
At this time that we are seeing it for example in Asia.
The Asia this year is growing about 30%.
Versus closer to 10% for the Middle East for example, so we're definitely seeing it in Asia.
But not yet quite in the U S or Europe .
Okay.
My third question is on.
The margin profile between.
The wastewater solution and the T cell solution.
Wastewater, becoming a bit more needle moving in the revenue mix next year.
Does that.
Lower your kind of blended.
Margin profile in other words is it for you averaging in.
Our lower margin product as you grow the wastewater business.
We are not when we started out. So for example, we talked about at our last earnings call. We have a one year payback.
That is an example, where we had our initial sales with lower margin, but we're already getting them.
Well over 60% and starting to near the.
Desalination margins at this point.
Okay, and lastly, I think.
Three months ago, there was still some.
Yeah.
Potential for finding a <unk> partner.
That still remotely possibility.
I suppose remotely anything's possible prevail.
Assuming a high chance of success there.
Hey, Bob.
Understood. Thank you guys.
You bet. Thanks, Bill Thank you.
Okay.
Thank you ladies and gentlemen, just a reminder is a call for question.
And then one or two places in the question queue.
We have a falloff from Pavel.
Now <unk> of Raymond James.
But I did not want to monopolize, but.
Maybe maybe I'll ask it.
On the on the refrigeration solution.
I think the target that you.
Indicated maybe six months ago was for that business to be at breakeven.
So kind of first half of 2023.
Is it fair to say that.
It will be take a little longer than that maybe another year or so.
Yes.
Probably.
So the latter part of 2020.
Yeah.
Right, Okay, and where are you.
You mentioned the kind of backlog in refrigeration to expect by the end of next year.
Geographically where is the demand.
Visible is it is essentially a European story because of the regulatory landscape.
We see Europe and now in recent weeks, we start seeing movement at the end user level.
In the U S as well.
And.
What drive.
That demand in other words is that.
Is that cost savings at simple is that for the end user.
Or is there.
Or is there a regulatory angle to it.
The mandate of some sort.
The regulatory mandate is for the industry to a shift out of HFC.
And into therefore into natural refrigerants.
At the end of natural refrigerants, Seo tools seems to becoming really dominant.
So from a regulatory push point of view.
The customer goes with <unk> they are compliant.
As we have said that the onset.
Couple or several.
Quarters ago.
That's <unk> more energy.
So for the end user regulatory push.
<unk> was a financial pain.
And that's where we come in.
We can reduce the energy burden.
Our results are also showing.
That when properly.
Design that dimension the whole refrigeration.
System cost truck.
There need not be additional capex incurred due to the addition of our equivalent.
That's what we mean by Capex neutrality, why because our PX.
Does have compressor air cooler functions in the vital functions.
The incorporation of our PX.
Clearly designed constructed.
We'll reduce the need for the other components, which pays for the PX.
And if we truly reach.
Capex in <unk> and Pablo.
The payback become instantaneous.
That is the energy savings.
And of course energy saving <unk> <unk>.
Christy use too.
To run these systems are not 100% renewable energy and energy saving also translates to a smaller emission footprint.
And then <unk>.
Finally on guidance for next year.
When we add the third.
7% growth rate for T cell.
With $6 8 million wastewater.
I want to make sure I'm doing the arithmetic right I get to somewhere.
Kind of.
130 $235 million.
Total topline as reported that that accurate.
Yes, probably a little higher probably more like <unk>.
133 to 137 somewhere in there.
One of them.
It will really depend on what the top by next earnings call.
On how we end at.
At the end of this year with that range, because even at $4 million range for US is a few percentage points right.
So we will see how that ends and where those when those projects shift and I come update.
Okay. Okay.
That's very helpful. Thank you and thanks as always for posting the.
The script online.
You bet.
Thank you.
Ladies and gentlemen, just a final reminder, you can ask the question Youre welcome to brace stall and then one.
Ladies and gentlemen, we have no further questions from the lines. This concludes our question and answer.
I would now like turn the conference back to Mr. James <unk> for closing remarks.
Thank you everyone for joining us today, we look forward to speaking to you again in February have a grade.
Goodbye.