Energy Recovery Inc. Q1 2023 Earnings Call
Speaker 1: Oh.
Speaker 2: Hello everyone and welcome to Energy Recovery's 2023 first quarter earnings conference call. My name is Jim Sikarty, Vice President of Investor Relations at Energy Recovery and I am here today with our Chairman, President and Chief Executive Officer Bob Mal in 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 Security's 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 in the performance, cost structure and business strategy.
Speaker 2: For the statements are based on information currently available to us, and on management's beliefs, assumptions, estimates, or projections.
Speaker 2: Good afternoon and thank you everyone for joining us today.
Speaker 2: Let me start with the latest update in our water business. In the deceleration, we continue to be on track for this year. The Middle East remains the foundation of our deceleration sales, but as the water scarcity continue to increase.
Speaker 2: number times, which remains true. However, we have not spoken in much detail about North African countries.
Speaker 2: Morocco, Egypt, and Algeria, who are showing real potential as well. Morocco is increasingly turning to desalination, to ease the impact of its multi-year drought, which is the worst country ever seen in 40 years.
Speaker 2: Reservoir levels in Morocco have fallen by half. From about 62% in 2013 to 32% in 2022. Water supplies in Morocco have fallen below 650 cubic meters per paprika from 2,560. And are expected to decline throughout the decade. Today, Morocco relies on its surface and underground water for nearly all its water needs. But these sources are quickly drying up. They have recently announced aggressive plans.
Speaker 2: to invest in this automation in the coming years.
Speaker 3: We're already seeing growth.
Speaker 3: by 25 to 26. We have previously discussed Egypt's plan to invest in deceleration as a response to the damning of the Brunile by Ethiopia. In December of last year, Egypt announced plans to award 21 additional deceleration plans this year to become a commissioner in the coming four years, totaling 3.3 million cubic meters of data reproduction in the first phase of a program that could ultimately reach 9 million cubic meters.
Speaker 3: In response to its own water crisis, Algeria has a goal of meeting 50% of their water demand with desolination by 2030. Five plants in the coming years could increase capacity by over 1.5 million cubic meters of production per day. We're currently building on each of these projects and they could exceed...
Speaker 3: $20 million in revenue this year. These three countries simply highlight the growing need for the deconination to come by the increasing scarcity of water around the globe.
Speaker 3: Despite all their efforts, shooting dams, working on waste and water reuse,
Speaker 3: reducing water usage as well as other initiatives.
Speaker 3: whether patterns. It is this type of decision being made by countries all over the world that underpins our confidence in deceleration in the coming years. As the interest in deceleration grows, we are actively seeking ways to serve potential new or adjacent markets, as we discuss last core, such as about British deceleration.
Speaker 3: But as we expand into a wider subset of smaller deceleration and wastewater projects, the average size of each project will become smaller compared to our traditional mega project growth trajectory that we have written the past decade.
Speaker 3: Increasing volume across a large number of smaller projects and many new customers means we must look at new ways to serve our customers.
Speaker 3: more efficiently as well as
Speaker 3: efficiently as well as to expand our sales reach.
Speaker 3: As an example of our new focus, we recently launched our Pro Model Pro platform, a powerful and easy to use cloud-based configurator tool that enables the optimization of desalination and industrial wastewater hydraulic pumping systems. This platform allows customers to design and select the optimal energy recovery products, project equipment performance, and
Speaker 3: and to model energy consumption for specific projects.
Speaker 3: We believe this tool will prove very beneficial to our smaller OEM customers and will help enable continued revenue growth in this vertical channel. Now let's turn to wastewater. We are excited about the evolution of our pipeline.
Speaker 3: India remained the top two countries of focus, however.
Speaker 3: The experience and knowledge we gain in these two countries combined with our new product offerings.
Speaker 3: is now allowing us to target other regions.
Speaker 3: We now have a growing pipeline in North America, Europe , and the United States.
Speaker 3: a growing pipeline in North America, Europe , the Middle East and South America.
Speaker 3: The industry is spent from our growing lithium battery market to chemical manufacturing, textile, mining, agriculture and municipal waste water. To respond to the volume of potential projects we are seeing, we are beginning to make significant.
Speaker 3: We must remain on our target growth curve in the coming years and expand that curve if possible, as we continue our aggressive push over the next three years.
Speaker 3: Now, let's turn to CO2.
Speaker 3: The first quarter was a milestone one.
Speaker 3: The first quarter was a milestone one for our CO2 business.
Speaker 3: First, we signed and announced our first distribution agreement with the Belgian company, FU.
Speaker 3: Second, EPSAPU, our initial European partner and the Italian independent global leader in commercial refrigeration, introduced their XTE product line. The XTE line specifically incorporates.
Speaker 3: our PXC-1300 in order to cut energy consumption and enhance the performance of rocket. example.
Speaker 3: after I introduced the XCE at the Euroshop, one of the key industry trade shows that occurs every couple of years in Germany.
Speaker 3: According to the Spanish food distribution publication in Diza, the XG was one of the great attractions for attendees. And it helped.
Speaker 3: lead to a flood of activities from refrigeration manufacturers, contractors, and grocery stores at our booths.
Speaker 3: The validation by both OEMs of our technology is an important one and key step as we evolve this business from an idea to a commercial success. Building on this momentum, we believe we're on track to get deployment into additional supermarket chance this year.
Speaker 3: As our PX becomes better known, we are finding new applications for our products.
Speaker 3: within and outside the supermarket chain.
Speaker 3: As an example, we have spoken on several occasions about how the PX will be applicable for many other cooling applications such as in the industrial market. A new development in Europe of multi-PXGs by our partner FU...
Speaker 3: could be commissioned this summer as a manufacturer facility in the food industry.
Speaker 3: should be commissioned this summer as a manufacturer facility in the food industry. This opens a new channel for us.
Speaker 3: to grow our PXG cells in the coming years. And we are now beginning to evaluate the likely...
Speaker 3: considerable potential of this market. We do not believe this is where the vast majority of the PFC ends.
Speaker 3: Every such move into a new market will allow us
Speaker 3: to further build and collect data and accelerate market adoption of our technology.
Speaker 3: On our last call, I discussed the fact that last summer, some supermarkets actually shut down due to the unexpected and historic high temperature spikes.
Speaker 3: and the strain placed on their cooling systems. The unpredictability of weather and the increasing chance of repeated high temperature spikes means that supermarkets will have an increasingly difficult time building refrigeration systems that are full future proof.
Speaker 3: and the strain placed on their cooling systems. The unpredictability of weather and the increasing chance of repeated high temperature spikes means that supermarkets will have an increasingly difficult time building refrigeration systems that are future proof in our new climate reality.
Speaker 3: RPXC provides one answer to this growing problem.
Speaker 3: helping to ensure that these systems can handle these new unpredictable temperature spikes.
Speaker 3: If the store can avoid closing.
Speaker 3: That provides immediate value on their purchase of a PXC, while also protecting their operating margin and allow them to sleep well at night.
Speaker 3: I connect Canadian supermarkets...
Speaker 3: who was forced to close some of their stores last year.
Speaker 3: showed interest in using PXC as a backstop to protect them against their own system failures on the hottest days.
Speaker 3: Our PXG is scheduled to be installed at one of their locations early this summer.
Speaker 3: Interestingly, many of the locations in which we are installing RPXCs are retrofits of existing systems.
Speaker 3: Some of you may remember that in 2021 we initially began talking about BXG as a retrofit, or bowdown as we termed it then, to existing systems.
Speaker 3: For periods we had to walk away from this concept, this we were not able to incorporate our PXG at a low enough price point on our own.
Speaker 3: We had to walk away from this concept as we were not able to incorporate our PFC at a low enough price point on our own. However,
Speaker 3: With the experience of relationships we have gained over the past 80 months, we may have now found a reasonable pass to...
Speaker 3: potentially turn a previously unreachable market into a low-hanging food opportunity. We are seeing considerable interest by both OEM and contractors.
Speaker 3: in assisting us in tackling this market, which would potentially allow us to address.
Speaker 3: the estimated more than 40,000 CO2 refrigeration systems already installed throughout Europe and North America.
Speaker 3: This retrofit market could be a critical one for us to drive up demand and enter the market quickly. Existing grocery store chairs using these previously restored CO2 refrigeration racks such as.
Speaker 3: Toyota here in California have seen firsthand how the combination of elevated ambient temperatures and high energy costs can significantly erode operating margins.
Speaker 3: This became an even more critical issue in 2022, following the onset of war in Ukraine and the subsequent spiking energy caused in Europe . We believe the time is right to drive PXC deployment when grocery chain can realize the greatest benefits and fastest payback through their investment in our technology.
Speaker 3: However, volume deployment provides an additional challenge.
Speaker 3: provides a additional channel. Product support.
Speaker 3: Any new technology introduced to a large mature industry is likely to face unexpected issues during the adaptation stage. Energy recovery must ensure that the transition occurs as smoothly as possible.
Speaker 3: As such, we're hiring and training the field engineering and technician staff we need.
Speaker 3: to support this roll out. We're also focused on developing...
Speaker 3: training for external service technicians on the PXC in order to bring our contractors and OEM partners up to speed.
Speaker 3: how this PXG as quickly and painlessly as possible. The faster we can avoid any potential bumps in our roads, the quicker we believe the PXG will be perceived to be the answer to the operating expense concern of the groceries store and users.
Speaker 3: In short, we continue to push hard into this new market and remain confident in our ability to deliver. We look forward to providing new updates in our July call. With that, let me hand this call over to Josh.
Speaker 4: Good afternoon everyone. We generated revenue within Guide at $13.4 million.
Speaker 4: For that revenue, $1.4 million came from industrial wastewater and a little over $100,000 from CO2 with the balance from desalination. OEM and aftermarket revenues made up 74% of desalination revenue in the first quarter, which is contrary to a typical quarter, but simply highlights the heavy weight of mega project shipments planned in the second half of the year. We believe we will achieve the upper end of our guidance for the second quarter and our guidance for the year remains unchanged.
Speaker 4: Let's talk briefly about where we stand on our path to our $200 million desalination revenue target in 2026.
Speaker 4: Our long-term growth outlook remains strong despite seeing some short-term fluctuations during this global economic uncertainty as we're seeing this year.
Speaker 4: Based on this year's guidance, we would need to average 16 to 17 percent growth over the three years from 2024 to 2026 to achieve 200 million dollars in 2026.
Speaker 4: This is the summer growth to what we have seen over the past five years.
Speaker 4: Where we sit today, given our pipeline, the fundamentals of the overall market, and the strength of our product set, we believe we can still achieve that target.
Speaker 4: As we look to the near future, we remain comfortable in our 2023 outlook, but are paying close attention to risks in the market that could affect our 2020 full revenue. In particular, rising costs in the current economic uncertainty seem to be delaying the tendering of a few mega projects to the EPC. Any prolonged delays could mean that one or more of those projects may slip into 2020-
Speaker 4: wastewater business.
Speaker 4: Now let's turn back to first quarter results where our water gross margin is 62% in line with guidance from last quarter.
Speaker 4: Gross margin was impacted by the outsized weight of the OEM and aftermarket channels, resulting in fewer pressure exchangers shift as a percentage of overall revenue.
Speaker 4: Of note, racks of manifolds made up about 8% of water sales this quarter, which added to the temporary margin decline. We should see a return to our guided range of 64 to 66% in the second quarter throughout the remainder of the year.
Speaker 4: You may also note a negative gross profit margin in our emerging technology segment, which is temporary as we launch this new business.
Speaker 4: We are incurring higher costs as we transition from an engineering support launch to commercially driven product this year.
Speaker 4: Margin should begin to normalize throughout the year as we begin to purchase and produce a higher volume.
Speaker 4: It's early to guide a march on this business this year, but I will be sure to provide more color as the year progresses. Let's now turn to operating expenses. We are showing a 10% increase in OpEx over Q1 2022 levels.
Speaker 4: but a 6% increase over 2-4 last year.
Speaker 4: As expected and communicated, this quarter-on-quarter sustained growth in OpEx spend is largely happening in sales and marketing, which grew 12% over Q4 last year. We experienced an increase in R&D as compared to the prior quarter, however this increase is more temporary in nature and simply tied to the timing of specific project spend.
Speaker 4: Overall, R&D spend will likely remain flat for the full year as communicated last quarter, while growth in sales and marketing should continue to accelerate throughout the year.
Speaker 4: Prop X is generally moving in line with expectations and we have no changes to our guidance for the year at this time. However, we continue to evaluate spend to ensure that we invest in where needed to keep growth targets on track.
Speaker 4: As expected and as we communicated the preceding two quarters, we did experience a loss in Q1. This is no surprise based on the level of revenue in our generally fixed op-eds.
Speaker 4: Based on our current projections, we now anticipate we should achieve close to a break even second quarter. We expect to see a significant uptick and profitability from increased sales and Q3, and Q4, which has balanced out the year. Despite the loss of this quarter, we showed healthy increases in operating cash flow, and overall cash levels increased by almost $9 million or about 9.5% following better than expected customer receipts in the quarter.
Speaker 4: Additionally, while we saw overall growth in inventory levels, raw material inventory declined in the first quarter. As a reminder, inventory levels should grow in the second quarter and could somewhat exceed $40 million driven by increased finished good balances.
Speaker 4: We anticipate a rapid drop and finish the inventory in a second half of the year, a shipment pick up, which should bring our inventory level more in line with where we ended in 2022. As I mentioned last quarter, the one factor that could change this trajectory could be the PhD inventory needs, which will continue to assess.
Speaker 4: To wrap up, this was a fairly quiet quarter from a financial perspective. We remain on track with our 2023 projections from last year and we'll continue to keep you apprised of our longer revenue outlook as the year progresses. Let's move to Q&A.
Speaker 5: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue.
Speaker 5: For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we pull for questions.
Speaker 5: The first question comes from Ryan Pitts with B. Riley Securities. Please go ahead.
Speaker 5: The first question comes from Ryan Pitts with B. Riley Securities. Please go ahead. Hi. Good afternoon, guys. Good afternoon, guys.
Speaker 2: For the $20 million that you referenced, Bob, potentially coming from those projects in Algeria, would that be upside to guidance for this year, or is that somewhat baked in here?
Speaker 3: Now that's included in our forecast.
Speaker 2: Okay, and to kind of piggyback off that, could you talk a little bit about visibility into the back half? It looks like the year is off to a good start in terms of meeting your expectations, but just wondering if you could provide any color.
Speaker 4: as to how much of the expected 2023 revenue might come from orders that you already have in hand, whether that's some, most, or close to all. I can answer that, Ryan. It's Josh. I mean, as is typical.
Speaker 4: You know, we have good visibility from our mega project perspective, so we haven't necessarily signed all those projects, but everything is either signed or very...
Speaker 4: very progressed in negotiations and so forth.
Speaker 4: So we'll be wrapping that up sooner rather than later for the year. But OEM and aftermarket, you know, we certainly never sign everything this soon. They're a much shorter length in time in terms of, you know, the negotiated project and so forth, you know, six months or less typically. So we'll still be signing those projects. I wouldn't say we have the entire year wrapped up, but.
Speaker 4: In terms of pipeline, our existing backlog and where we see the second quarter and so forth going forward, we feel pretty confident in this year. Great. Thanks, guys. I'll hop in the queue.
Speaker 5: Once again, if you would like to ask a question, please press star 1 on your telephone keypad. Next question comes from Pavel Mouchanov with Raymond James. Please go ahead.
Speaker 6: Thanks for taking the question and interesting comments about the opportunity in Morocco.
Speaker 6: When I look geographically at your desalination business mix, you know, it's...
basically two-thirds Middle East, only 20% Asia. As we're watching these record heat waves in places like China, Thailand, Vietnam, I'm curious if you're getting more incoming interest from.
that part of the world versus the more traditional Middle Eastern market. Not yet seeing any more than we already anticipated.
China, as we talked about last time, this 14th five-year plan is the first time China officially recognized D-SAL as an alternative to
to address the water stress.
whereas China traditionally relied on sending excess water from the south via canal to the north. Of course, this past summer, maybe that's what you're referring to, the drought in Sichuan, the...
It allows the youngster to do it, but it's a planned economy. Changing plans takes a little time.
Okay, let me follow up on the
I think you said break even for this product in the second quarter. Is that faster than what you originally anticipated?
So we didn't say break even for refrigeration. I was for the business overall based on where we're seeing the revenues come in and Q2 on the higher end of our forecast.
Okay, understood. So maybe I guess specific to refrigeration. I think last year you were suggesting that it should reach break even.
sometime in 2023, how likely is that looking?
It's probably challenging due to the fact that
the whole refrigeration industry
is facing a demand far exceed the supply for traditional configurations.
So therefore the OEMs have more than their hands full shipping the CO2 without our energy saving devices. And this is an issue. Which means we have to redouble our sales effort.
to generate greater demand pool so that there will be end users
start demanding having our PX energy saving devices. For example, the...
the Canadian supermarket who is installing this RPX.
to address the heat wave pipes, the spikes, I'm sorry, was an end user generate the map, not a OEM pushed solution.
And of course this increases in the short term or go to market expense.
Thank you very much. Once again, please press star 1 on your telephone keypad to ask a question.
to James for closing remarks.
That concludes today's teleconference. You may disconnect your lines at this time and say goodbye.