Q4 2022 Energy Recovery Inc Earnings Call
[music].
Greetings and welcome to the energy recovery fourth quarter and full year 2022 conference call. At this time all participants are in a listen only mode. A brief 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 it is now my pleasure to introduce your host James Mccarty Vice President of Investor Relations. Thank you James you may begin.
Hello, everyone and welcome to energy Recovery's 2022, full year and fourth quarter earnings Conference call. My name is Jim Zaccardi, Vice President of Investor Relations at energy recovery and.
I'm 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.
Statements may discuss our businesses 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 and on management's beliefs assumptions estimates or projections are forward looking statements are not guarantees of future performances and are subject to certain risks uncertainties and other factors.
I 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.
Documents identify important factors that could cause actual results to differ materially.
Those contained in our projections or forward looking statements.
All statements made during this call are made only as of today February 22023.
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 will turn the call over to our Chairman President Chief Executive Officer, Bob Mao.
Thank you again and thank you everyone for joining US we had one of the best years seeing energy Recovery's history in 2022, let's recap for a moment.
21% organic top line growth, while winning 100% of the Mega projects tender and awarded.
22 <unk>.
Industrial wastewater exceeded guideline and almost tripled 2021 grouping.
We generate some of the best profit metrics energy Recovery's history.
Gross margin.
69.
6% exceeded 2021 full year by 100 basis points.
<unk> as a percentage of revenue when adjusted for onetime costs.
Was 48%.
Its lowest level in 14 years.
During the past three years.
This adjusted Opex has grown only 8% despite revenue growing 73% the same period.
Our adjusted EBITDA.
Exceeded 30 million for the first time and increased earnings per share by 75%.
We also positioned each of our business.
For future growth, we launched the Q4 hundred four seawater desalination, a low pressure PX, so brackish and wastewater applications.
With new industrial wastewater products, we commissioned our first <unk> hundred in Europe and in the U S and have generated a field performance.
Has surprised even our partners <unk>.
In short I couldn't be more pleased with our progress in 2022.
Oh look through 2023.
There remains macroeconomic uncertainty and this is nothing particular to them.
Energy recovery, we will have to navigate these short term uncertainties together.
In the coming months and we will continue to keep you informed.
But what I will say is that here at the beginning of 2023, we are cautiously optimistic about the current year.
And solid single digit revenue growth and remain bullish on our long term prospects.
As usual I'll start with our water business we are.
Well, we are actively investing to both strengthen our positioning in the desalination market as well as to seek out new avenues of growth.
We know we cannot sit Stifel and must continue to innovate and grow in new ways.
Spite, our commanding position in the market.
Last quarter, we announced a new Q4 hundred our most efficient and highest capacity P X available today.
Have found strong customer interest in our new high efficiency PX.
The first of these orders will begin to ship in the second half of this year and we expect that Q4 hundred will make up a material portion of our Mega project sales by 2024.
In addition, we launched two low pressure PX.
At very low rates as we seek to unlock portions of the brackish water with RPX Rockies.
Bracket is very common in the United States and Europe , but it has to remain out of the reach of the PX until now we believe we can potentially capturing material incremental revenue from this market as we seek to achieve our 230 million to $200.
70 million target.
In total water revenue by 2026.
We will also continue to invest in core engineer a research in 2023. This is not an easy task. When we are already producing a product with efficiencies near the limits of physics.
Number one we must think about how to further evolve the PX to expand our opportunity set in desalination industrial wastewater and water reuse in the coming years.
Now, let's turn to wastewater, where we have had a few notable development.
We generated nearly $4 million of wastewater revenue in 2022.
Nearly 30% over our target for the year importantly, we have now increased our gross margin to one much more akin to our desalination business.
Altra PX continued to prove its value to customers in the field.
The recent introduction of our low pressure product line.
So expands our reach into wastewater.
We're now positioned to actively address some of the largest municipal wastewater projects in the world, including initial projects in the middle East on the basis of this new line.
Civil wastewater in particular portable reuse.
Potable reuse is a natural extension of our water business. Many regions are beginning to return to potable reuse to help address their growing water shortages.
Including the middle East and here in the United States.
As we learn more about this potential market, we will keep you updated.
Overall wastewater is already generating a clear profit and paying for itself.
This year, we're adding to our sales team in China, and India, where also continued investments to improve and expand our line of products.
Wastewater is a clear example of how we can successfully.
<unk> existing PX technology swiftly to new and adjacent industries with minimal investment.
Now, let's turn to our <unk> business will.
We have now shipped PX <unk> hundreds to six separate Oems and our film shipping to a seven.
During our third quarter call, we spoke about the sale of our multiple PX is too.
Geez, two industrial refrigeration manufacturing in Europe . This manufacturer few pillar technique is a leading refrigerant component and service.
Provider.
Or the Benelux region of Belgium, the Netherlands and Luxembourg.
Do you expect to commission the first installation was two <unk> units.
As a tariff for store.
Panamax Airport is one of the largest supermarket chains in Europe and in the world.
Following a visit in January few places second harder for six additional units to be deployed this year.
And we are currently negotiating a distribution agreement with <unk>.
The PSG independent region.
This relationship is the first formal step in building a broader pipeline and backlog.
And a critical achievement for the energy recovery in the refrigeration space as.
As we progress through this year, we will look for more regional distribution agreement like the one we're discussing with SKU for the bandwidth region.
Even more importantly in 2023, we look to continue.
Initial PFC installation breakthroughs into end user supermarket chains to verify potential sales pipeline.
Our potential pipeline already include <unk> stores in California are four stores and the large southern Europe churn, which.
After commission <unk> last summer.
In 2023, our priority is retiring as many of the European and the U S supermarket change into what we call the confirmed addressable markets.
Which will build confidence in growing our refrigeration business and then hitting our revenue targets of 100 million to 300 million by 2026.
In support of these actions we are hiring additional sales account managers for Europe and North America.
Our first European sales could come manager started this January and we will also be hiring field technicians to assist our partners as we rollout in the coming months.
Additionally, we commissioned our ph D and the NT and U the Norwegian University of Science and technology.
And he and you is considered critical research facility to confirm performance data, our new technologies in the refrigeration space in Europe .
We have been very pleased with our performance.
MTN use refrigeration rack the.
Past months.
And we will be.
Be presenting this data at the Euro shop in Germany next week this performance data.
Should provide objective third party verification of the strengths of our technology in.
In addition to exploring additional regional distribution agreements for the PFC at your shop 2023 will be joining the <unk>, our European joint development partner.
That event.
<unk> is a leading player in the refrigeration market in Europe and in the United States through their subsidiary <unk>.
Sure.
Together with <unk>, we will be showcasing to end users.
The impressive results of our first deployment in southern Europe during last summer's record high temperatures as part of <unk>.
<unk> push into new and sustainable products.
We have previously discussed how <unk> can help alleviate the stress of ever increasing temperatures ice.
Our refrigeration systems.
Today's supermarkets building extra refrigeration capacity to handle the hottest days of the year.
The historical high temperature.
We experienced last year, many parts of the world.
He did the design maximum capacity of many refrigeration systems.
This caused some supermarket sheds to shut down their stores.
Avoid losing refrigerator inventory.
This is a significant loss of revenue and profit are.
<unk> unique ability to provide additional capacity as temperatures rise means you no longer need to overdo the system.
If our <unk> store in fact, our technology can help handle this unexpected spike in.
Temperatures were.
It is needed most at a significantly lower cost than existing technologies protecting their operating margin.
We still have much to do to achieve our 100 to 300 million targeted revenue.
1026.
But momentum is clearly building.
Market interest is strong and the demand for solutions such as our PX G is there as we continue to demonstrate the reliability of RPX Jeep our confidence in hitting our targets will be further solidified I look forward to provide further updates during our next call in may.
With that I will turn the call over to Josh.
Good afternoon, everyone I'll start with revenue, we generated a $121 $6 million in desalination revenue and nearly $4 million in industrial wastewater in 2022 for a combined total growth of 21% for the year.
Mega projects continued to pick up pace as expected ROE and nearly 9% in 2022, and OEM and aftermarket achieved 64% and 36% growth respectively.
Desalination OEM revenue, excluding industrial wastewater grew nearly 50% to $25 million exceeding our previous annual high in desalination OEM sales.
By 9%.
The geographic dynamics of our 2022 revenue are also important we continued to see steady growth in the middle East and Africa, 10% for the year, an acceleration from 2021, an increase of only 6%.
Asia is where the real story lies we achieved over 30% growth in 2022 on the heels of over 150% growth in 2021.
This rapid increase over the past few years highlights major freshwater issues in Asia.
Countries, such as China, and India, turning to desalination and filtration of wastewater to help alleviate their water problems. In addition, we are beginning to see sales in other countries outside of China, and India, which made up 16% of industrial wastewater sales last year.
Finally last.
Quarter, I had referenced $4 million of at risk backlog in Egypt that was delayed due to a local hard currency capital controls.
We were able to realize about half of that backlog with the balance expected to be shipped this year.
We will retain our desalination revenue growth guidance for 2023 of 3% to 7% or 125 million to $130 million.
We continue to expect desalination revenue to be heavily weighted to the third and fourth quarters with up to 70% to 80% of revenue occurring in the second half of the year.
We are currently anticipating revenue within the lower to mid range of our $10 million to $15 million guidance for the first quarter.
Our range remains the same at 20% to $25 million in the second quarter with the balance occurring in Q3 and Q4.
We are also maintaining our industrial wastewater target of $6 million to $8 million in revenue in 2023 for a combined water revenue of 131% to $138 million.
Last quarter I mentioned three risks to growth that we are closely monitoring this year inflation, the strengthening dollar and the potential for a global economic downturn.
Although these risks remain two of the three risks have alleviated somewhat over the past few months.
The rapid strengthening of the U S dollar against many of the local currencies in the countries into which we sell has softened.
And we have seen that inflation is beginning to be addressed in many of these same countries.
We are continuing to monitor these risks could affect revenue or our pipeline this year and next and we'll keep you apprised.
Now, let's turn to gross margin, where we significantly exceeded the upper end of our target for 2022.
Our overall gross margin performance for the year was driven by three factors one the success of our sales team and increasing pricing response to inflation.
To a product mix that shifted heavily to the PX in the fourth quarter.
And three our outperformance in industrial wastewater and improved pricing in those markets, which helped increase our overall margin by about 5% for the year.
We are maintaining our 2023 outlook of 64% to 66% average gross margin for the year for water.
However, our first and potentially second quarter margin may come in lower than this average because of our shift in product mix in favor of the PX in the fourth quarter last year.
We are currently projecting 60% to 64% gross margin in the first quarter largely dependent on the final product mix of sales.
Note that we have seen lower margins in prior years and quarters more weighted to OEM and aftermarket sales. So this is not a new phenomenon.
The second half of 2023 will likely be heavily weighted the megaproject, PX shipments where margins will improve and balance out the year.
Now, let's turn to operating expenses.
We ended the year with opex slightly less than 50% of revenue or 48% when adjusted for one time nonrecurring expenses compared to 55% in 2021, while sales and marketing increased by 1% in 2022% to 13% of revenue.
Declines in G&A from 24% to 22% and R&D from 19% to 13%, excluding any onetime nonrecurring expenses.
Our opex guidance for 2023 remains unchanged at 52% to 53% of revenue this year, excluding any potential upside from Seo to refrigeration revenue.
I mentioned during the last call that sales and marketing will increase 30% to 40% this year pushing the spend to 17% to 18% of revenue.
However, I expect G&A to grow only in the low to mid single digits, largely driven by inflation R&D.
R&D spend will likely remain flat in 2023, therefore, both G&A and R&D spend should flatten or fall somewhat as a percentage of revenue this year, which is in line with our longer term targets.
With regards to net income note that our first and second quarters will show negative income.
Keep in mind that sales are significantly lower than the first two quarters, but our opex is relatively fixed and growing.
This is simply because of the lumpy nature of our quarterly sales due to the timing of Mega project shipments and has happened in past quarters as well.
We will see a significant uptick in profitability from our larger sales in Q3, and Q4, which will balance out the year.
We ended the year with $93 million in cash and securities falling within our target. Despite returning $26 million to shareholders last year as we wrapped up our 50 million share buyback book.
Our overall operating cash flow was $12 6 million slightly below 2021.
Operating cash was driven by two main factors in 2022 first inventory grew by $8 million for the year.
Because revenue was heavily weighted to the fourth quarter last year, our accounts receivable balance is significantly higher than in previous years.
This increase in receivables is simply due to the timing of these late year sales, we have seen no delays in collections, nor any increase in doubtful accounts.
We expect to collect the majority of this receivable balance in the first quarter.
As we look forward to 2023, it's important to comment on the inventory as I stated earlier, we expect to ship only 20% to 30% of our 2023 revenue in the first half of this year with 70% to 80% of revenue just shipped in Q3 and Q4.
In order to meet this high demand in the second half of the year, we must continue to build product in the first two quarters. Therefore, you should expect substantial growth in finished goods inventory in Q1 and Q2.
By the end of the second quarter, we could see an inventory balances highest $40 million. This balance should subsequently fall in the second half of the year.
At the end of the year based on water demand, we expect inventory levels to end the year roughly in line with 2022.
Any additional increase or rise will be driven by our cotwo, which we will communicate as the year plays out.
In addition, based on our first and second quarter shipment expectations, we should see lower than normal cash and investment balances by the end of the second quarter.
Possibly falling to a range of $70 million to $80 million, which should subsequently rebound in the second half of the year.
Depending on the timing of shipments in the fourth quarter, we should end the year with between $110 million to $120 million in cash and securities driven by growing operating cash flow.
Let's move to Q&A.
Thank you we will now be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad.
Confirmation tone will indicate your line is in the question queue.
Press Star two if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Thank you. Our first question is from Graham price with Raymond James. Please proceed with your question.
Hi, good afternoon, and thanks for taking the questions.
I guess for my my first one you talked about the refrigeration distribution agreement in the Benelux region.
Was wondering if you could just give a little more detail on.
How big.
That revenue opportunity is.
And how you see that playing out over the coming years.
So first Greg just to highlight this.
As Josh and hope you're doing well.
We did just release a press release here. This afternoon that we did sign that agreement with few.
Today, So that agreement lies in the Benelux.
In the Benelux obviously.
The population count that it has is going to be a smaller amount of revenue that we're going to be able to realize in Europe .
But it's a very important and key milestone for US signing this agreement as it shows an important proof point.
Our confidence in the ability of our technology to reduce cost for these for supermarkets industrial sites and so forth.
Yes.
Yes.
Got it and I guess as you sign additional agreements.
Agreements do you do you think those will be exclusive in nature as well.
Some definitely yes, what are all of them will be exclusive and we don't know.
At this point.
Got it understood.
And maybe switching gears, a little bit it's been roughly six months.
Gavin Newsome talks about ramping up these all in California.
Just wondering if you've seen any evidence.
That anything is changing.
And in a large sense in that area.
The short answer is no.
California, and DSO you know the story.
Yes.
Got it okay.
Understood and then I guess final one for me.
Yes, just on the cash balance.
Obviously ended the year at a very healthy level.
Didn't see any buybacks this quarter so.
Yes, it was.
Just wondering and I know I'm guessing.
Inventory build in the back end weighted revenue plays into it but how are you thinking about buybacks for the rest of the year.
Well right now Graham of really looking at.
How are markets could evolve here over this year. So for example.
We have more confidence in where water is headed and we built a lot of capacity for that as well as inventory at this stage, but <unk> is still a bit of unknown and we could have pretty substantial investments in <unk> and.
It accelerates in the latter half of the year as well as well.
We've talked about before potential.
Additional fixed assets investments in order to build up capacity for that business.
At this stage, we're watching that because we're going to need.
Going to need cash for that bill, both working capital and fixed assets, but to say nothing of the kind of the low cash flow, we're going to have in the first couple of quarters, just because of sales.
I wouldn't expect anything in the near term, but it is something we keep obviously discussing with the board.
Okay.
Effect.
That's it for me so I'll pass it along thank you very much.
Thanks, Craig thank.
Thank you.
Thank you. Our next question is from Nils Tomlinson with fairly cap Securities. Please proceed with your question.
Good afternoon, I'm, just wondering given that you're now shipping out a couple of these peaks G units to Europe and other markets do you have sort of a lower range in terms of revenue to communicate for 2023 or is it still too early.
It's still too early that's why we're highlighting that.
Our emphasis is.
Taking two into new.
Supermarket change what we call confirmed.
Our addressable market and Thats what.
We are following.
Actually this has been we find out that this has been very conservative industry in adopting new things.
But our valid composition as such we are very confident once we break into a new Chen.
That whole churn becomes a pipeline then we can mean.
Meaningfully discuss the timing and the volume.
Right.
And at what point do you expect that you can make a decision on potentially building another plant or facility to add capacity to two C O two.
That's sort of a 2023 of them.
Right now we have.
Excess capacity easing of June as you know it's the same.
<unk> material.
So we think.
Probably as toward the end of the year fourth quarter, we have to look at.
Capacity increase.
So to be clear those investments would occur next year.
Most likely rate, even though even if we started the process. This year, we'll give more updates in the latter half of the year in terms of how that cash outflow would look like.
Alright, great. Thanks.
Yeah.
Thank you. Our next question is from Ryan <unk> with B Riley Securities. Please proceed with your question.
Hey, guys. Thanks for taking my question here.
I know the last time, we spoke we talked about exiting this year with a backlog, allowing for sales in the double digit million range for 'twenty four for C. O two refrigeration and Josh on the three acute call you spoke about the potential for a detailed growth once again reached 20%.
<unk> and 'twenty 'twenty four is that still how you guys are still thinking about those two items.
Yeah as of today those are how we are still looking and with Cotwo in particular.
We'll see how this year plays out, but that's certainly the targets we're pushing for and then on as I mentioned today in my prepared remarks on the detail side, we're just very closely watching the market in.
In terms of these major risks that we're seeing globally and we will certainly keep you guys apprised as well as this year progresses.
Where we stand today and unchanged.
Got it.
And we touched on California, a little bit, but you know what what the Colorado River.
Running low and getting more attention.
The growing problem of less available water here in the U S or are you guys seeing talks around domestic desalination demand picking up steam recently.
Basically as I glanced at a very interesting.
Top line says that.
The Arizona may be considering.
Building DSO for Mexico to trade for Mexico's Colorado quota.
I don't know how some shows that in <unk>.
If thats true and Thats doable may be just pure speculation was California.
<unk> T cell, maybe California would also trade, Colorado quota was Mexico diesel.
Got it and then maybe just one more for me obviously.
Your market share in the core business has been really impressive for a long time, but could you maybe talk about the competitive landscape, a little bit and anything you're keeping an eye on that could potentially challenge that.
Yeah.
We always keep our eye on.
Titian, but there is nothing new to report on what we reported last quarter.
Yes, they are out there and we're watching.
Excellent.
Yes.
Q4 hundred.
Is being.
Being received very well in some ways competition was gearing up targeting our Q3 hundred now.
Q4 hundred.
Got it thank you.
As a reminder, if you'd like to ask a question. Please press star one on your telephone keypad.
<unk> tone will indicate your line is in the question queue.
Our next question is from Wally Walker with Hana Road capital. Please proceed with your question.
Yeah, Hey, guys congratulations on the quarter in a year.
Aftermarket growth was impressive and accelerated the year end can you elaborate a little bit on rate of change and if that's a trend and is it fair to think of that as recurring revenue going forward.
Yeah.
Well the we saw some great growth in aftermarket this year as well as OEM.
But we are expecting it.
This was a kind of a post COVID-19 balance in 2022. So we are expecting it to temper a bit this year at least in terms of growth.
And this could mean it either flattening with aftermarket I'd expecting flat or low growth this year compared to what we saw in 2022.
Aftermarket is really a function of our installed base right and so as we grow it grows with us and it's been a pretty stable call it 8% to tenants and ish percent typically of revenue.
That's kind of what we still anchor on although it's a bit higher this year.
OEM as well of course, we saw this big told the balance and OEM I think this year, we think could pretty much the same story.
Going to revert back to its normal growth rate and we're kind of above that curve right now.
Which is why were one reason why we talked about last quarter, we're seeing somewhat lower growth. This year is because the Oems got a good plan.
Latin or perhaps you're going to be a little lower than this year just as it returns to its normal growth curve if that makes sense.
Yeah, one of it for me please.
Our expected tax rate.
<unk> three how should we model for those.
Yes, good question.
You know what I probably should have.
Included in my script, because I think last quarter I talked about a <unk>.
10% to 15%.
Expected tax rate, but you know as we've been looking at we came in at about 8% this year.
What we're finding is we have a lot of changes last year, we've utilized all of our cumulative net operating losses, which is great because we're making that means were making money.
We also because we utilize those losses were starting to get a new benefit starting last year called the foreign derived intangible income tax benefit which is really.
It's a tax benefit you get them right and its pretty big for US. This year. It was almost 7% for 2022, we also get a pretty healthy R&D tax credits so.
Because of the fact that we used all of those Nols and they are now gone, it's actually going to boost our <unk>.
Foreign derived intangible income tax benefit which means its been bigger this year it could be.
So.
I think we probably probably revise our estimate down from 10 to 15 to more like 8% to 12%.
As we look forward at least for the next few years, that's excluding any effect we may get from.
From our share based comp tax benefit that we get because thats pretty pretty volatile and not dependent on us that makes sense, mostly driven by this FDI benefit which is which is pretty new.
Okay. Thank you.
Okay. Thanks, a lot.
Thank you there are no further questions at this time I'd like to turn the floor back over to James Mccarthy for any closing comments.
Thank you everyone for joining us today as a reminder, our prepared remarks and the most recent press releases can be found on the website. We look forward to speaking with you again in early May I guess, it's the third of me, although not all have a great weekend. After work great rest of your week and we will be participating in follow up calls over the next couple of days.
Thank you.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Goodbye.