Q1 2024 Energy Recovery Inc Earnings Call

Participants

James Siccardi; VP of IR; Energy Recovery Inc

David Moon; President, Chief Executive Officer, Director; Energy Recovery Inc

Joshua Ballard; Chief Financial Officer; Energy Recovery Inc

Pavel Molchanov; Analyst; Raymond James

Presentation

Operator

Greetings and welcome to the Energy Recovery First Quarter 2024 earnings 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 Siccardi, Vice President of Investor Relations. Thank you, Mr. Siccardi, you may begin.

James Siccardi

Hello, everyone, and welcome to Energy Recovery's 2024 first quarter earnings conference call. My name is Jim McCarthy, Vice President of Investor Relations at Energy Recovery. And I'm here today with our President and Chief Executive Officer, David Moon, and our Chief Financial Officer, Josh Levine.
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 and economic and market outlooks, growth expectations, new products and the 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. Forward looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. We refer you to 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 first, 2024, and the Company expressly disclaims any intent or obligation to update any forward-looking statements made during this call to reflect subsequent events or circumstances unless otherwise required by law.
At this point, I will turn the call over to our President and Chief Executive Officer, David Moon.

Thank you, Jim, and thank you all for joining us today.

David Moon

The first quarter was a busy one for us and played out as anticipated. Revenue at $12.1 million was in line with our guidance for the quarter of 10 to $13 million.
With regards to the CFO transition, we have been actively interviewing some promising candidates and are making real progress. We believe we will have our candidate in place prior to Josh's last state at June 30th, I stated on our last call that I as well as the Board, strongly believe energy recovery, strategy of PX diversification to drive growth is the right strategy and is critical to our future while continuing to recognize the importance of maintaining our foundational market leadership in desalination, it is critical that we also continue to look for ways to accelerate our penetration into the wastewater and the CO2 refrigeration markets. As this is firm where the lion's share of potential revenue growth will originate, we anticipate our strategic future will build off this perspective, we have now formally kicked off work on our strategic planning cycle and have enlisted the assistance of industry experts to work to provide us additional guidance specifically in wastewater and refrigeration. These industry experts will play integral roles in providing the intelligence and hard data while challenging us on our product development and market strategy. And contributing to the development of our strategic playbook. This will add significant expense in the second quarter, especially, but I believe it is critically important work to establish a strong strategic foundation from which to grow in the coming years.
Now let's get into our update starting with water. First, we are maintaining our revenue guidance of 140 to 150 million for the year. Our current 2024 contracted projects, including the revenue recognized in the first quarter totals roughly $87 million or 60% of the midpoint of our guided range for the year. This compares to $69 million or 50% of the guided range at the same point in 2023. This reflects a 20% to 26% increase over year and underpins our confidence in our guidance for the year. In addition, we also just signed our first mega project deal in Brazil for shipment in 2025.
In our second quarter call last August, we discussed in some detail the growing wastewater challenges in South America. This project is a clear example of our growing water challenges outside of the Middle East, the sales historic growth area are being reflected in our pipeline in new ways. The cadence of this year's revenue guidance is unchanged. We remain heavily weighted towards the second half of the year. We are seeing real strength in both our D-cell OEM and aftermarket sales as we start the year and have signed most of the major product mega-project deals for the year. Our focus today in waters to close a handful of mega-project deals remaining in the coming months as well as maintaining our momentum in our OEM and aftermarket channels to end the year as strongly as possible. Our wastewater business is also developing well this year, and we remain confident in our range of 12 to 15 million for the year. Our pipeline continues to grow and we've increased our signed wastewater contracts by almost 40% as compared to last year. At this time. We've also seen positive news here locally in the U.S. as it relates to the municipal wastewater market. United States Government on April 10th announced newly adopted rules to address PFAS contamination for forever chemicals in our drinking water, the Biden administration has allocated 9 billion to our communities with drinking water impacted by PFAS, one valuable tool for filtering out existing PFAS for drinking water reverse osmosis filtration. While it's not the only solution to this problem, we believe reverse osmosis can play a key role in the coming years as the world tackles this growing challenge, and we will be exploring these opportunities and a timing of them. And our playbook for global attention on PFAS continues to underscore the growing focus on water quality and scarcity that is happening around the world today.
Now let's move on to our CO2 business. The past few months, the most important EBIT activity I engaged in was to meet with major OEMs in the US and Europe have a few key takeaways from these meetings, all of which support the approach we are taking this year. First and foremost, the interest in the feedback on the PHG. was positive. Oems can see the potential value of the PX G in their systems and remain very interested in our success.
Second OEMs are looking for more quality, uninterrupted run-time data during the summer months, which is the goal of our activities this year. This data will provide reliable performance data in the field, which is critical to OEMs and end customers to fully accept our product in the marketplace, fine-tune our value proposition to be a catalyst to allow energy recovery to take a substantial step forward to building commercial relationships with the OEMs.
Third, once the OEM.s have comfort in our data, it is clear that our best path forward will be to integrate the PX G directly into the rack architecture of OEM.'s CO2 systems. This will mean that OEMs will need to commit engineering resources to adjust their existing architectures to incorporate the PX G. This is a commitment of time and money and therefore, another reason why we data is so key to creating broader acceptance for the PXG. at the last earnings call, we discussed two gates to better position ourselves for future market penetration and revenue growth. These gates directly support the feedback received from the OEM.s in the first quarter, the first gated to successful completion of testing of our second-generation PX G in our internal labs by the end of Q2 2024. I am pleased to announce that we've achieved this milestone. Flat performance has shown an order of magnitude increase in reliability of performance, which is critical to providing the uninterrupted run-time data we need this year. Second-generation PX she has now been installed as part of a beta test in supermarkets in California and Belgium. Both installations have been operating successfully since the beginning of March. Second, gate is the successful installation operations and third party validation of 30 to 50 additional field validation sites by the end of this year. Our first steps is to install roughly 10 sites this summer which are the most critical sites for this year and will provide the key performance data that we need. As of today, we currently have three sites running. We expect four additional sites to be commissioned by the end of June in Canada and Belgium, Hungary and the US. The remaining three sites are scheduled for Europe and the U.S. by the end of August and and we'll continue to update you on our progress in August, but we are off to a strong start for the year outside of these critical activities.
Our two other updates from the market. First, our PX G. was awarded the refrigeration Product of the Year by ACR news London. This award is a recognition of excellence and innovation from across the air conditioning and refrigeration sector. PHT. was selected for its ability to improve here around trends, critical CO2 systems performance by reducing energy costs, which is perhaps the single biggest hurdles faced by supermarkets and adjusting to stringent global requirements. This is a third award we've received since the start of 2023 as the PX G continues to gain attention across the globe and should serve as further proof that technology's catching up to the changing regulatory environment.
Second, I have a quick update on the regulatory environment. You came out with new more stringent regulations on the reduction in HFCs that became effective March 11th for as previous regulations, reduced HFC usage from 31% of the 2025 baseline in 2024 to 21% by 2030. The EU has now accelerated this reduction. As of March 11th, the EU must reduce usage to 24% of their baseline by 2025, 12% in 2027 to 5% in 2030. This is good news for CO2.
So to sum up the operational deliverables that I put in place for 2024 are as follows, maintain and grow our dominant position in desalination, grow our wastewater business to 12 to $15 million in revenue install at least 30 to 50 sites in North America and Europe by the end of the year and deliver our full revenue guidance for the year of 140 to 150 million. The work we do over the next several months will position us to deliver on our future in water and CO2 growth in the near term. We remain one of the purest means to invest in the global water scarcity story.
With that, let me hand it over the call to Josh and to update you on the financials.

Joshua Ballard

Good afternoon, everyone. first quarter revenue fell comfortably within expectations with no real surprises and within the midpoint of our guidance from our last earnings call, unlike the first quarter last year, our water channel mix was more balanced with roughly half our revenue coming from megaprojects and the remaining split between OEM and aftermarket sales. Although our OEM channel shows a significant decline as compared to Q1 last year. This is simply due to the timing of project shipping. We currently expect to show healthy double digit growth in our OEM channel in 2024 we are reporting no material emerging technology revenue this quarter, which is in line with David's comments in February.
With regards to our short short pause to make and test the enhancements to the PX G and now launched the second generation here in the second quarter. We are maintaining our estimated range for water revenue in the second quarter at 20 to 25 million. This means that we are still heavily weighted to the second half of the year where we sit today, we are assuming that the last two quarters will show 40% of the second half revenue falling into Q3 and 60% in Q4. However, we will be better prepared to update you more precisely in our August call as the third quarter comes into focus. Note that our target water revenue range of 140 to 100 million this year includes a buffer against possible movements of up to a couple of megaprojects. David mentioned the status of our signed and ship contracts year to date. We have been getting a lot of questions on the status of our pipeline from all of you to get a sense as to how the year is progressing. Our plan is to continue to update you on this cumulative number as we move forward through the year to give you a sense as to how we are tracking into the current full year guidance, we will then reset in Q1 next year for 2025. Therefore, note that the $87 million cited for this year was explicitly for signed water projects in both our desalination and wastewater markets forecasted to ship out in 2024, inclusive of those shipped in the first quarter.
Our gross margin in the first quarter was 59%, much like last year, we are seeing a product mix more heavily weighted to pumps and turbochargers and a low revenue quarter, which is lowering our margin on a blended basis. You will also note that our margin is 190 basis points below Q1 2023 despite a similar product mix. This is because of the inflation and growing manufacturing costs that we have been describing over the past year. We also experienced slightly higher scrap in the first quarter, which combined with a lower revenue denominator, had an outsized effect on margin, but will not be material for the full year. We fully expect to recover to our guided range as the year progresses and Pressure Exchangers take a larger percentage of sales. For now, we have no change to our guided range of 64% to 67% year on year variance from Q1 2023 roughly falls in line with our expectations for 2024.
So let's now turn to operating expenses. Our OpEx grew 11% over the first quarter of last year. However, we are reporting a decrease of 4% against Q4 2023, which is a more relevant comparison. There are two things at play here. First, Q1 OpEx is inclusive of nearly 500,000 of what we call onetime executive transition costs, which you will note our non-GAAP calculations in our press release. In addition, this quarter includes another $300,000 of short-term retention grants provided to some executives at the end of last year. Adjusted for these temporary charges of roughly $800,000. Our base recurring OpEx grew closer to 7% year on year. Second, our investments in people in the organization grew throughout the year in 2023 as we increased our sales and marketing spend and added headcount in support of both our water and CO2 businesses. Therefore, what we are seeing now the effect of increased headcount, other than in the first quarter for investments made in 2023. Now that we're further into the year and are one-time costs related to the ongoing transition of it becoming clear I also want to go a little deeper into our OpEx forecast to provide some additional clarity in the second quarter. We expect our base recurring OpEx to remain fairly flat. However, we will have material one-time expenses related to executive transition and a significant portion associated with work in support of our long-term growth strategy.
As mentioned by David in his opening remarks, these overall costs, which will include a mix of cash and noncash items to be as high as 5 million in Q2, meaning our OpEx will likely land between 20 to 23 million. We are expecting an additional roughly $1.5 million of these one-time expenses by the end of the year. When you add in the $800,000 of one-time expenses described earlier this spring. These charges to a total of about 7 million for 2020. For the light of some of these one-time expenses, we have made the decision to reduce our base recurring OpEx to around 71 to 73 million versus my guidance from last quarter of 73 to $75 million. Note that these reductions are in softer non-personnel discretionary spend and will not be in areas that could get in the way of our growth plans. If you add our estimate of 7 million of one-time costs. This puts our total forecasted OpEx for the year at roughly 78 to 80 million. So I realize the 2024 is a bit of an anomaly compared to prior years, but we should normalize again in 2025. We'll be sure to clearly outline this one-time spend each quarter so you can differentiate between our recurring operating spend and any one-time charges that we do not expect to repeat next year.
So let's turn to our bottom line. We experienced a loss in Q1 as forecasted and largely in line with public estimates by the first quarter last year. This should be expected based on our level of revenue and fixed OpEx. We expect our second quarter to remain negative.
Moving back into positive territory in the third and fourth quarters, the end to end the year strong. We continue to grow cash in the first quarter, increasing our cash and investments from 100,000 to 200, 29 million. We expect these balances to pause at this level in the second quarter as we continue to build inventory levels to support planned shipments for Q3 and Q4. We are already seeing an uptick in inventory levels driven by whip and finished goods related to this like last year. Inventory will continue to build until dipping back down to normalized levels in the third and fourth quarters, as I've described in previous calls.
With that, let's move to Q&A.

David Moon

Thank you.

Question and Answer Session

Operator

(Operator Instructions) Pavel Molchanov, Raymond James.

Pavel Molchanov

Three months ago, you talked about a DSL project in India that was pushed into the our first half of 24 versus versus last year. What's the status on that? Is that still on track to be recognized before June 30th?

Joshua Ballard

It develops, Josh.

David Moon

It has not shipped out yet.

Joshua Ballard

Technically, we're moving along pretty well with an update today, and we'll see whether it's by June 30th, but still expect this year.

Pavel Molchanov

Okay. So may may be in the second half?

Correct?

Joshua Ballard

Could be in the second half?

Yes.

Pavel Molchanov

Okay. And Understood. Also three months ago, the for the comment that deployments of these, how is that effort progressing?

James Siccardi

You broke up there, but can you repeat that question, please?

Pavel Molchanov

Do costs three months ago, there was also a comment about deployments of the refrigeration product being deliberately slowed to improve its reliability. How is that effort progressing?

David Moon

Yeah, hey, Bhavan, this is David Moon of.
Thanks for the question. So part of the second generation is progressing well. So we just passed through the first gate or milestone, which was internal tested in the lab. It got really good results in terms of reliability and performance. And so since the end of March, since beginning of March, we've now been doing beta testing in the field in the US and Europe with very good results. And so we are now moving on to pushing that out to the 1010 summer sites that I talked about in the script and getting through the summer testing season would be our next milestone. But so far, very pleased with the results.

Pavel Molchanov

Okay. And David, another question for you kind of big picture strategy when you came in, as you know, there were some targets for 2026, which, as you acknowledged three months ago, were kind of on the aggressive side. When do you think you will be ready to put out some updated targets?

David Moon

So we're so we're so we're in the middle of our strategy work now what we're calling our playbook and I expect Leidos that we'll be talking about the out years 25, 26, 27 by the time we get to the third quarter earnings call.

Pavel Molchanov

Okay, that's helpful. And last one for me. You mentioned a minute ago a DSL customer in Brazil, which sounds interesting because we really do not think of Brazil as a particularly on kind of a water scarce geography. Can you talk about how big that project is and how it came about?

David Moon

So it's a part of Brazil's the government's initiative to increase potable water potable water supply by 12%. And so this is our first D-cell mega project in Fortaleza, which is in the northeast part of Brazil. It's the fourth biggest city in Brazil. It's going to be roughly, I think 86,000 cubic meters per day. It's planned to be online by the end of 2026. And this will be our Q. four hundreds, which will be our new product, our newer product. And so we're very excited about our first large desal project in South America and and given the government's initiative, hopefully more more to follow.

All right.

Pavel Molchanov

Thanks very much.

James Siccardi

Was Veeva.

David Moon

Thank you.

Operator

(Operator Instructions) Bryan things, B. Riley Securities.

Hey, good afternoon, guys.

Joshua Ballard

For the for.

As for the PX G is getting deployed ahead of this summer, if all goes well, would you expect these customers to place meaningful additional orders later this year, potentially that could translate into some some?
Yes, significant revenue in 25? Or is the focus here really on getting that data in the hands of the OEMs?

You know, it's the latter first and that's getting that, you know, getting at least three months worth of data, which will turn into a white paper sometime in Q4 into the hands of OEMs. First, that's that's, you know, my trip over the last few months to visit OEMs in the US and Europe. I mean, that's what they pound of the title before was with summer data summer data. And once that's in their hands of the OEMs and they feel good about it, then they'll start going to their end users and start talking up the PX G more so than what they're doing today. So first steps first, let's get through the summer, let's get our white paper done, prove the fact that we're getting good energy savings. And then I think we'll start to see some momentum build in the last half of the year for 2025, what that revenue stream looks like at this point too soon to tell.

Pavel Molchanov

Okay, that's helpful.

David Moon

Thank you.

David, and then for water, guys have signed that 87 million in contracts for shipments this year. Curious if you have a number handy of what that might look like for 25. Just to trying to get some visibility early on how next year shifting?

Joshua Ballard

I don't have that number out of my head, but I wouldn't be very big yet, but it's still be fairly small. I mean, we're still a year out, right? So there wouldn't be a large number anyway.

David Moon

Okay.

What about more general visibility, Josh, about next year? Just what you're seeing in terms of projects out there and are things getting delayed kind of what you'd expected given we only spoke about 2.5 months ago, any changes since then no, no real changes since then.

Joshua Ballard

And we're not seeing any new delays or any new strange movement, our pipeline or anything like that. Things are moving on track generally and I would probably point to because we're not we're not ready yet to talk about 2025. Number two, I'd point you to the industry from industry data source for desal which is detailed data coming out of GW either. We've got some good industry data that still showing pretty strong growth over the next few years. And what I'd point you there for now. And then when we get to the November call the Q3 call, we'll be talking more about 2025 in the future more explicitly.

James Siccardi

That's helpful.

Thanks, Josh. And maybe just one more for you on water. In the past, you've talked about an estimated PX TAM of 0.5 billion solely for replacing thermal with SWRO. tech, what does that opportunity look like today?

Joshua Ballard

If we've done, we've already covered about 20% of that. So we're at somewhere around 400 million left, which will play out over the next 10, 15 years, we not coming as plants age out.

Got it. Thank you, guys.

David Moon

I'll turn it back.

Joshua Ballard

Yes, thank you.

Operator

(Operator Instructions)

David Moon

Thank you more level.

Operator

We have reached the end of our question and answer session.
And with that, I would like to turn floor back over to James security for any closing comments.

James Siccardi

Thank you, everyone, for joining us today, and we look forward to speaking with you again in late July.
You bet.

David Moon

Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.