Energy Recovery, Inc. (ERII) Earnings Call Transcript & Summary

Hello, and welcome to the VorTeq Progress Update Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to James Siccardi, Vice President of Investor Relations. James, please go ahead.

Good morning, everyone, and welcome to the Energy Recovery's VorTeq Progress Update Call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery. With me today remotely is our Chairman, President and CEO, Bob Mao; and our CFO, Joshua Ballard. Bob will be providing some brief remarks, and then we'll be opening up the call to Q&A. I would now like to welcome our Chairman, President and CEO, Bob Mao. Bob, the line is yours.

Thank you, Jim. Good morning, everyone, and thank you for joining us. We are here to report on our recent progress in moving our VorTeq technology toward commercialization, both in terms of product and field operation readiness. We will also answer any questions you may have following our report. We completed our VorTeq product and field operation readiness testing in a simulated live frac environment earlier in June at a third-party location. Although that location was not a live frac well, we did test VorTeq in an actual frac spread and worked directly with an experienced third-party full frac crew. We're thankful to our VorTeq partner, Liberty Oil Services, who helped us in setting up the frac test site and provided us one of their crews and equipment to run the simulated live frac operation. From our own observations of the test results and from constructive and positive feedback from the frac crew on-site, we are satisfied and encouraged by the live frac readiness of the VorTeq. The most important result of the June test is that we demonstrated that the VorTeq can be integrated seamlessly into existing frac spreads and will not interrupt live frac operations, more cost savings to a job even if upset occurrences were to occur with the VorTeq or other equipment during the live frac. The upset conditions we deliberately introduced in the simulation tests, it should satisfy any customers' safety and quality concerns. The VorTeq is ready for live frac, which will contribute beta tests and our major step in commercialization. We continue to search for live frac opportunity with our partner, Liberty, and we'll also field inquiries from all potential new customers. Particularly notable was that we successfully processed sand concentration of 5.5 pounds per gallon through the VorTeq, which is more than twice the original equipment for the system. The implication of that capability is that we can reduce the VorTeq size and the number of cartridges, which reduces both its footprint and -- footprint on the frac side and potential rate costs for our customers. This capability also potentially has an important positive impacts on the profitability of the technology for Energy Recovery. Due to these positive changes, a large 12-cartridge VorTeq model is no longer necessary. The current version of the VorTeq, which will be our initial production model for commercialization, is now a simplified single-PX VorTeq. The size and flow rate of a job, which will define how many single-PX skips are needed on each frac spread. Feedback from the June field simulation will help further refine the VorTeq product itself and enhance its field operability. Experience and data from future live frac data tests will help update the VorTeq value proposition for both our customers as well as for Energy Recovery ourselves. We recognize we have challenges ahead, but we are excited by the opportunity to approach the entire frac market as we continue our go-to-market plan. We will report on our VorTeq commercialization progress in the future in other investor updates and calls. Finally, our -- sorry, finally, in connection with the previous Schlumberger license agreement, you can expect a GAAP recognition of about $24 million of the unrecognized license and the development revenue in Q2. With that, I'll open the line to questions.

Yes. We'll now take questions and answers. Kevin?

[Operator Instructions] Our first question today is coming from Joseph Osha from JMP Securities.

Three questions for you, and I'll just put them all out there now. First, some color, please, as to why, given this progress, the Schlumberger relationship ended? Second, may we assume, for the intermediate term, that most of the activity we see around the testing of VorTeq is going to be with Liberty? And third, what does the development signal in terms of the level of R&D investment that you are making in VorTeq?

Thank you, Joe. I cannot add more to your first question other than what we said in the press release that into a strategic perspective which is that we decided to pull this operation. Okay. Yes, in the near term, going to a live frac for our beta test is the thing that we have to do. We are searching together with Liberty. And as I said just now, we will also field questions -- field inquiries from all potential new customers. As far as R&D, we continue to refine the product, both for the product itself and for a more efficient field operation. And we will address that more in our next earnings call, which is about 4 weeks away from June.

Okay. Just to amplify your first question, you said we. So may I assume at least that this was a mutual decision between yourselves and Schlumberger?

Yes, sure. It is. This can only happen mutually. Okay.

[Operator Instructions] Our next question today is coming from Pavel Molchanov from Raymond James.

Historically, you have been recognizing approximately $3 million of quarterly revenue for the upfront license payment that you received 5 years ago. How will that line item work now that the collaboration with Schlumberger is ending?

Pavel, this is Josh.

Josh will answer.

Yes. Yes, I can answer that, Bob. So that line item will go away, Pavel. So we're going to recognize all the remaining license and development revenue that we still had deferred on our balance sheet. That's about $24 million that Bob mentioned in his prepared remarks. We'll fully recognize that this quarter. And then you will no longer see that being recognized quarterly on a go-forward basis. It will be fully recognized at that point.

Okay. Understood. And another kind of -- sorry, for the housekeeping. But will there be any headcount reductions or decreases in R&D expense as a result of Schlumberger no longer being a partner?

Yes.

No. I mean, do you want to answer? Do you want to start, Bob?

Yes. Josh will answer.

Okay. The -- nothing has fundamentally changed, Pavel, right? So I wouldn't expect any massive changes suddenly. This doesn't change our strategy going forward. It doesn't change what our plans were with our investments in the VorTeq in the short term by any means.

Okay. And just one last question. With the ending of that -- the Schlumberger relationship, is Energy Recovery able to sign future partnerships or licensing deals with anyone you want?

The short answer is yes. Good question. We can structure any relationship with any potential new partners or customers.

Our next question today is coming from Paul Sonz from Sonz Partners.

I wondered -- I have a few questions, all revolving around the cost structure of the company going forward. What do you expect to spend on R&D on the VorTeq before it goes commercial? Is there a lot of money to be still be spent on R&D? Or is the R&D phase pretty much over?

We will continue to do product refining based on the experience we just had in this simulation, and we expect some more refinement as we go through the beta tests. And also in field operation, it's the first time actually we went to a "field." And field operation needs to be more efficient. Since I said we will have a further discussion on that in our quarterly call, which is about 4 weeks from now. As far as spending, last week and the announcement today and this week, Josh and I don't expect there's drastic change. Josh, do you want to add some color to it?

Yes. No drastic changes. Most of our spend now is really related to ongoing testing and people and facility in Houston. So that's not going to dramatically change. We don't have any changes in our short-term plans. Certainly, any big investments that you've seen in the past, those are all over, right? It was invested in the Houston facility and all that. And so any big investments that would incur -- would occur would be at commercialization from that standpoint.

Okay. Do you expect now that with Schlumberger not there as a customer, are you going to now have to start adding salespeople? Will there be an additional burden as you build up the sales staff?

In the near term, we'll be going into, hopefully, live fracs and beta tests and plan out our go-to-market setup. But we don't really expect to build out any sales force, large one or small one, in the remaining of this year. Of course, we will do our marketing outreach.

Okay. Is there -- at this point, is there any -- will there be switching of money from R&D on the VorTeq to now redirecting funds towards the incubation part of the business?

As we reported on -- in my last earnings call, the incubation activities we have 2 or 3 initiatives which are down, and we are moving on that. Again, we will add color at the next earning call. There is no drastic change that's not already planned.

Our next question today is coming from Nils Olav Thommesen from Fearnley Securities.

Just a quick question on pricing. Your last licensing agreement with Schlumberger was $1.5 million per missile deployed. Just what should we think about sales price going forward? Is -- are you thinking you're going to achieve somewhere around the same per missile? Or what's your thoughts on that? And can you talk a bit about the dynamics you have when potentially discussing prices with the customers?

For starters, we just reported, and you see on our website, the new single-PX skip, which means the costing of our VorTeq has changed. And we are now learning the field operation and plan out costs there. So on the cost side, we are doing an update. On the pricing side, that's another matter that we can address. You mentioned about our previous agreements, those were basically leasing. Would we do only leasing or would we also do some sales? All these are at the active planning stages. And also a very important part of the whole pricing, it depends on the update of our value proposition. So therefore, there's not more I can say at this very moment, but they will come.

[Operator Instructions] Our next question today is coming from Tom Curran from B. Riley FBR.

Bob or Josh, where are you at just conceptually in hammering out the commercial structure with Liberty? Is it more likely to be a lease or a purchase model? And when would you expect to have that commercialization model for Liberty finalized?

We do have understanding with Liberty. And again, I think the final model is for the pricing needs to be finalized based on the number of factors that I just mentioned. At the end of day, we must have value for our partners involved and all parties, including us, need to make a profit.

Fair enough. Is -- are there any versions of the model you've discussed with Liberty where they've made it contingent upon or pushed for exclusivity in any way?

No. There is not any discussion on that at all, Liberty and us. Liberty actually has been a partner. They are our very first partner going back to 2014, and they continue to be a partner. And we jointly agree that the most pressing thing to do is to go to the beta tests then we can talk about commercial on the [indiscernible].

Makes sense. Last one for me, Bob. Among the recent inquiries you fielded from other pumpers, have there been any expressions of an interest in simply acquiring the technology?

No, we have not had any leasing inquiries. In fact, we only announced this a few hours ago.

[Operator Instructions] Our next question today is coming from Jan Martínek from Central European Capital Partners.

I have 3, if I may. The first one is, would you please be able to estimate what cost saving will VorTeq offer to frackers? Would you be able to say per barrel or whatever way it's calculated?

I would not venture to guess at this point what is the cost estimate to frackers, that's our customers, simply because we have -- there has been a long involvement of the product. And we are -- only really recently, we settled on the single-PX skip as our production model 1.0 field well. And we are learning the field operation experience, which is also part of the cost. And the further beta test portfolio also refine our estimates. Until then, I will not venture to say what is the cost estimate.

Yes. And I would add, in our presentation, we do have gross rough estimations of the overall savings. This is before the cost of what the VorTeq may be to a customer. So I'd refer you to that as well in terms of gross savings.

Perfect. I think it was on Page 26 of the previous version, if I'm not mistaken.

Yes, it's still there, if I remember.

On both -- they were…

I think this is going back quite some time ago. They were estimations, if you use the word, for lack of a better word. But I will say that's not very relevant going forward, simply because we have not reexamined that. And that estimation was also based on a multi-PX missile, which we are not going to deploy. So our target now has a smaller footprint and should offer a much more efficient field operation.

On Q1 call, you mentioned that during Q2, you would have a third-party certifying meeting of M1 milestone and that you would inform on Q2 call about the outcome. Would you be able to give us some light today? Or would that be covered on the Q2 call?

That was all in relation to -- if we were continuing with Schlumberger, and if we were continuing with M1, then that will be a supporting evidence that we are ready to do M1, but M1 no longer is relevant.

Understand. And on the Q1 call, you also mentioned that on Q2, you will announce new VorTeq products, and you will also talk about new verticals. Can you confirm that this is still the plan?

Yes. We were -- as I remember the exact words I've said is that we will add color to that, and we will make the initial reports. And you will also -- after that, you will hear us continue to report. We seek to be more transparent and offer continuous reporting. We look forward to updating you on our next Q2 call.

Next question today is coming from [ Bob Kareem ], a private investor.

Yes. So was there no obligation on Schlumberger's part to compensate you if you volunteer to do the M1 test? And secondly, why is there no news about MTeq, which was alleged to be more cost-effective and easier to commercialize than VorTeq?

No. Our relationship with Schlumberger has separated for that announcement. So therefore, going forward, there is no more relationship. On the MTeq, it was a product we were developing concurrently with VorTeq. And we made the decision that we will focus on VorTeq and put the MTeq aside for the time being, and we have not changed that position.

My question to you is, was Schlumberger under no obligation to continue with M1 test as per the original contract that I came across on SEC?

Going forward, we have no obligation toward each other. None at all.

I understand. I understand there is no obligation going forward. My question is, was there no obligation on Schlumberger's part to carry out the test as per the original contract?

The original contract no longer exists. And since M1 did not happen while there was a contract, there is, going forward, no contractual basis to do M1 or anything else between our 2 parties.

Well, I'm sorry. With all due respect, you're not answering my question, sir.

My answer to your question is very direct. While we had a contract with Schlumberger, we will mutually do not do M1. And today, we don't have a contract. We do not have obligation to each other. And so, therefore, M1 is not relevant anymore.

It -- was there no…

M1 did not happen while there was a contract.

Was there no ongoing discussion between the 2 companies? This seems…

There is no ongoing obligation of whatever between the 2 companies as of this moment, and there is no ongoing discussions.

Our next question is coming from Paul Sonz from Sonz Partners.

This will be a little bit easier question. In terms of the -- it sounds like that the VorTeq is working at levels better than previously anticipated. And if that is true, is there a possibility that you can upgrade the pumps so that you're using smaller but larger pumps? I think, originally, there was talk that if it works, you could move to centrifugal pumps and have fewer larger pumps. Would that be the case?

Not immediately. Because immediately, we're trying to fit the VorTeq seamlessly into existing frac pad. But I think only after our customers have enough experience with it, feel comfortable and then jointly, we can talk about modifications.

[Operator Instructions] If there are no further questions, I'll turn the floor back over to management for any further or closing comments.

Okay. Thank you again for joining today, and I look forward to speaking with you at our next earnings call in 2 weeks. Have a good day. Thank you.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.