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

Thanks, everyone, for joining us this morning. Our next presenting company is actually a client of Three Part Advisors. If you guys have any interest in them, we're happy to arrange a meeting. Presenting next is Energy Recovery. They're traded on the Nasdaq Exchange under the ticker symbol ERII and presenting with the company today is James Siccardi, Investor Relations. James?

Thank you, Bill, and thanks to Three Part Advisors. I really appreciate you all having us speak here today. Thank for all of you to come here and see us. And with me today is Lionel McBee, our Director of Investor Relations. My name is Jim Siccardi, I'm Vice President of Investor Relations at Energy Recovery. So let tell me you a story about a small cap company that's doing a lot of big things. Our core business for the last 30 years has been a desalination and our little device, which is called Pressure Exchanger, has revolutionized global desalination market. In fact, it helped antiquate the prior technology of thermal desalination and is the reason now why seawater reverse osmosis is the dominant desalination process around the world. We're in essentially every large-scale desal plant around the world. We're also now using the same technology to get into other areas, most importantly, industrial wastewater treatment, largely in India and in China, where the regulations have forced companies to go to a 0 or minimal liquid discharge method and then CO2 refrigeration. CO2 refrigeration is going to be a topic you're going to hear about for the next probably a decade or 2. The entire world is transitioning away from hydrofluorocarbons or HFCs to CO2. There's a problem there, and I'll get to that later, but we're the ones that are solving that problem. Over the last several years, our desal business has been extremely strong. We've generated a 20% CAGR in our top line for the last 6 years. We've done that with extremely high gross margins. Our margins have come down a little bit, but they're now in the 65% to 75% -- 65% to 70% range. And it's an indication of our dominant position in desalination and the demand for our pressure exchange market. We also have a very strong balance sheet. Right now, it's about the lowest I've seen in the last 4 years with only $87 million of cash and securities in the balance sheet. We expect that to increase significantly in the second half of the year based on the orders that we have coming. We have no debt. And this has been told to us that we've had an inefficient balance sheet at times. But when COVID hit, we were told that we were very ahead of the ball in terms of making sure that we had the cash available. We like to make sure there's always a little cushion. $87 million maybe a little bit more than we need, but it's helped us so far, and we'll see what we do going forward. Over the last several years, we've done very well in the stock market. Our stock has done very well in up markets and in down markets. And given the fact that the majority of our shareholders' are long-term, long-only investors, we've been helping them in up and down markets. Going into Friday, I think we were up 11% year-to-date. Prior to this year, our 3-year CAGR was 47%. That compares to a CAGR for the Nasdaq and the Russell about 18% to 22% over the same timeframe. This is an indication of the relationships that we develop with our investors. Over the last several years, we've engaged in several follow-up calls after each earnings call. This quarter, we had close to 60. What we try to do is provide long-term sustainable solutions for our clients with the products that we provide, help generate affordable water, affordable drinking water for millions of people. We also help millions of people treat wastewater, and we're taking the toxins out of wastewater. But most importantly, I think, is the new business we have in CO2 refrigeration where we're helping transition away from HFCs by making it more affordable. We're addressing the problem that CO2 brings in terms of handling pressure when temperatures rise. All of our solutions reduce waste and energy consumption. This is very important in the current environment. Where in Europe, we were told over and over again that they like the last part of our name, the recovery because we help recover wasted energy. And in this environment with prices going up, every little bit of energy you can save is beneficial. We've revolutionized seawater reverse osmosis, as I mentioned before. Our little device, which is about 1% of the overall desal CapEx cost saves the desal plant 60% of their energy consumption. This is significant as the plants get larger and larger, with the one device they really can't do without. And now that we're expanding this pressure exchanger is saving companies money, making our clients or our customers more sustainable in industrial wastewater and CO2 refrigeration. As I said, over the last couple of years, we've done well on the revenue side. This year, we're anticipating growth of about 25%. Next year, we expect to see that in this another 15% in our desal business with $8 million to $10 million coming from industrial wastewater. But as we look through the next 5 years, what we anticipate is a 3 to 5x our 2021 revenue base. In desal alone, we expect to double our revenue, going from roughly $100 million to $200 million. In industrial wastewater, we generated $1 million last year. This year, we're expecting to generate $3 million. Next year, as I said, $8 million to $12 million. And by 2026, our target is for $30 million to $70 million. But in CO2 refrigeration, we're expecting to see -- we're targeting rather, that business to generate between $100 million and $300 million by 2026. What we're really excited about is how we are benefiting the environment and our customers with our product. The work that we've been doing on the ESG side has been showing up in terms of the demand for our products and demand for our stock by a lot of sustainable investors but also by MSCI and some other magazines like Investor Relations Magazine, where we've generated several awards on the ESG side. We've saved over $3.9 billion in energy expenses annually for our customers. Our product revenue generated from energy efficiency-related sources have been over 98%. And we save tons of emissions on an annual basis from our PX, basically 1.5 -- I'm sorry, 14.5 million tons on an annual basis. And on an electricity consumption basis, we've saved over 30 terawatts hours for our customers. Also on the ESG side, we've been moving up the rankings from MSCI. We've gone from BBB to AA recently, and we've been included in MSCI Small Cap Global and U.S. ESG Leaders Index. This is the device that we use. This is our core technology, the pressure exchanger. And what it does is it operates under pressure. It transfers columns of energy, basically you're playing pool of billiards and you slam the cue ball against the 8 ball. You hit the 8 ball, the cue ball stops the 8 ball takes off, you're transferring energy there. We do the same thing with columns of fluids and with gases in their liquid state. We're able to generate a lot of savings by doing this. In desalination, what our device does is you put the -- you pressurize the water from the sea that comes in, you use a high-pressure pump and you slam that water against the membranes. When it hits the membranes, what comes out is low-pressure drinkable water. But that pressure that you've generated has to go somewhere, and it comes out in brine. Before our device, that brine was immediately discharged back into ocean. It was costly, but it did save some money compared to thermal. With our devices, we close loop that system and send it back in basically closing it and saving about 60% of the energy use. And we do this with efficiency of 98%, which is almost perfect as far as physics goes. We also have the rotor -- it's a ceramic device that rotates within a sleeve. The clearance is about half the width of a human hair. And that clearance basically runs on the columns of fluids. There's no emissions when it's in operation, and it doesn't break down. It was overengineered. It often lasts as long as the plants themselves. And this is beneficial to our clients because in the large-scale desal plants, unplanned downtime could cost as much as $800,000, $900,000 a day. With our device, where it doesn't break down, it lets these guys go to sleep knowing that our device isn't going to be the reason that the product doesn't work. Over the last several years, this is a bit of an indication of the dominance we have in the market. We've not lost a large-scale desal plant bid in 7 or 8 years now. We've retrofitted basically 50% of the prior competition. And now this blue chart shows you where we are in terms of the industry. The desal market is growing. And it's growing because of the next slide that I show you, which will give you an indication of how scarce the world is on drinkable water. But the technology we use in diesel is very transferable, and we've used that to go into industrial wastewater. We're using the same concept. We just add a little bit more pressure and a little stronger pressure exchanger. Again, the pressure exchanger is ceramic, same manufacturing process, Same people on the floor using it, same kilns. And the addressable market in the industrial wastewater, we believe will help us generate those targets that we put out there before. This next slide gives you an indication of really how scarce the global water market is. Around the world, these red little spots give you an indication of the water scarce areas. And by 2040, roughly 50% of the world is expected to be water scarce. Desalination is not going to solve all the world's problems. What it will do, though, is it will be part of any large-scale solution. This slide here just gives you an indication of some of the highlights that have gone on in terms of the water scarcity. In terms of the industrial wastewater applications, while we're going to China and India initially, the areas that we're focused on most at the beginning is in lithium-ion battery manufacturing and coking and mining for lithium and textile production and in lithium brine mining. Essentially, what we are doing is we're removing the toxins from this waste so that the water, the wastewater is not going back into the rivers or tributaries. And instead, it's being cleaned up and being reused. This means that the industries in China and India will have less of a call for new water sources. The industrial wastewater applied to lithium market has given us opportunities to generate some of the revenue we've gotten already. These so far have been in the lithium battery manufacturing, mining and lithium brine mining operations and then the recycling side of things. Again, for -- on the CO2 refrigeration side, this is one that really excites us. We believe that over the next several years, we'll be generating revenue that could really get into this TAM of $1 billion by 2030. The technology that we use is the same PX technology that we use for seawater reverse osmosis and for industrial wastewater. We've made a little tweaks to it. We've put a little different casings around it. But essentially, it allows CO2 to operate as both a gas and as a liquid. And what we do is we put it in here and we basically close loop the system. The problem with CO2 is it's a natural refrigerant. HFCs were man-made and they're extremely efficient, but they're terrible for the ozone. What it does is HFCs have a GWP or global warming potential of 1,000 to 13,000 depending on its use. CO2's refrigerant, however, has a GWP of 1. What we do is we address the main problem of this transition, which means is in CO2, as temperatures rise, more pressures needed to be able to take the heat away from [ food ] the way that is done in -- with HFCs. However, with CO2, the hotter it is, the more pressures needed. And that leads to an OPEX increase. Our device by close looping the system is able to operate as a compressor and as a valve. By doing that, we're able to eliminate much of that OPEX pressure. We're also able to generate significant savings in the process. As temperatures rise, we actually get better. At temperatures of 75 to 80 degrees, our efficiency is roughly 25%, but as it approaches 100 degrees, our efficiency rises to 50%. And in short, we're better when it's hot, and that's when you need it the most. This slide gives you some quick indication of the global warming potential that the two have. I already went over that. And then over the next couple of slides, we'll talk about like Bob Mao. Bob is a visionary. When we first went into the CO2 market, we were a new technology. We were going into a vastly competitive mature industry. They didn't know who we were. Bob approached the OEMs or the refrigeration manufacturing firms to try to convince them to use our technology, understanding the need of the industry. We were given the [indiscernible]. They basically told us that's an interesting technology. If you sign an exclusive deal with us, well then maybe we'll put you on the approved vendors list within a year or 2. Bob wouldn't take that. Instead, we went to the end users we, went to a grocery store in Southern California near Indio, California, which is right next to Death Valley, where it's extremely hot. And we told them, we'll give you an offer you can't refuse. We'll give you an opportunity to have this device in your store with no cost to you. We will put it in, we'll maintain it, we'll operate it, we'll enhance it. And over the next couple of years, the only payment you have to give us is a breakdown of the savings that you generate. This isn't a long-term business model that we wanted to use, but what it did was it woke up the industry. It showed the industry that we had a device that was solving their biggest problem. The transition from HFC to CO2 is going to happen with or without us. But with us, we provide the cost savings that their customers, the grocery stores need. As soon as Bob made that announcement, everything changed. We were no longer making the outbound calls to the industry, instead the industry is coming to us. In subsequent quarters, we announced a joint development deal with a major manufacturing firm in Europe and in U.S. In July, we deployed our first PX in Europe. It's been running ever since. It's been generating significant cost savings for the firm. The interesting part there though is they were concerned about the reputation. We were a new technology. They didn't know whether it was going to work and they want to protect their reputation. So they told us they were less concerned about the efficiency we could generate, more concern about making sure it was reliable. Interesting enough, though, the reliability was more on us than on them. When their device broke down, we were there to back up them and instead of generating 5% to 6% of efficiency, which is what they were looking for. we generated 20%. And yet this still was not incorporated into their product. What our ultimate goal is, is to be into the refrigeration rack similar to the way Intel is in your laptop. We want the refrigeration rack built around the PX. And as we talk over the next couple of quarters, you're going to see that device is going to be inside these refrigeration racks. And that's when we're going to generate the greatest level of efficiency. Over the next couple of years, we -- in the next quarter, we announced -- I guess it was in the last quarter, we announced another joint development agreement with the North American firm. This firm is going to deploy a PX-centric version in the U.S. in either the late fourth quarter or early first quarter of next year. We're in discussions with 2 other refrigeration firms in terms of deploying new PX centric refrigeration racks in Europe or in the U.S. And we're talking to another one that's talking about a technology that is another derivative from the refrigeration side, mostly on the heat pump side. This is a very interesting opportunity for us. We're not ready to start talking about what the financials could look like. But the fact that large OEMs are coming to us, telling us that the refrigeration reversed is simply a heat pump, and that our device that operates in desal industrial wastewater and CO2 refrigeration can also be a major player in the world transitioning to heat pumps. This picture here is just a quick depiction of the diversity of our Board. But the key point that I want to get across today is that our sustainable growth rests on 3 strategic pillars. We're going to protect the position that we have in seawater reverse osmosis. We're convinced that the world is going through a secular shift in demand for water. There's water scarcity everywhere. It's only getting worse. We believe that we will continue to be a key player in solving part of this problem. In terms of innovating in new industries, we're driving high-margin growth in these as well. All of our growth opportunities must have a 50% gross margin, must generate a 20% return on investment. We have a 3-year process going from incubation to commercialization. In the first 12 months of any new product that we have, and they're all based off the core PX technology, any product has 12 months approved that's technologically viable there's no showstoppers. In the next 12 months or in the first 24 months, we've got to prove that it's commercially viable, that we can generate a commercial contract or purchase order. And then within 36 months from incubation over the next 12 months, we want to prove that we can generate cash flow neutrality for all these new devices. We've done that already in industrial wastewater, and we're well on our way of doing that for CO2 refrigeration. In the next quarter, we will be projecting what our expectations are for 2023 and 2024. But over the last several years, we've not wavered on the projections that we put out. That's one of the reasons that you saw such strong share price growth and how we expect to see things going in the not-too-distant future. And with that, I'll open up the floor to any questions. Yes.

Can you talk a little bit about the potential for any copycat technology or anybody has capability to get a new product on your technology How durable, I guess, PX is in your mind?

The durability is unmatched. We overengineered the product. Our competition in desalination had a business model that is predicated on recurring sales by breaking down every 3 to 5 years. It's a good business model to have unless you've got a competitor that doesn't break down. In desal, most of our patents have run out about 7 or 8 years ago. In fact, we intentionally let them run out. And as we made further enhancements, we kept all those secrets to ourselves. We've never divulge the secret sauce or the composition of the aluminum oxide that makes the ceramics that we use. We've had others try to copy it. We had a Chinese firm trying to copy it 7 years ago, but it didn't have the same clearance I mentioned earlier that we have, the half of width of a human hair. And that additional clearance led the columns of fluids to make it shake and that shaking under the pressure led it to break. It looked like a gorilla had ripped it to pieces. At that point, the Chinese decided that they're going to commoditize any part of the desal process, they could do that with pumps. They could do that with membranes. They could do that with pipes but didn't make sense to spend tens of millions of dollars to replicate a near perfect device that was only 1% of the overall CapEx of the plant but represented 60% of the savings. Now in industrial wastewater and in CO2 refrigeration, our devices there are fully patented inside and out. We filed what was about 30 different patents over the last 2 or 3 years as we progress. Now as we move into other derivative markets such as heat pumps and what can come after that, we're going to fully patent those. But in desal, we've been around 23 years. And at that point, we decided we were going to let the current patents run out, and all of the enhancements we made would keep to ourselves. Yes, sir.

And you kind of mentioned that 1% bill of material is your product that produces almost all the energy savings. Why aren't you pricing -- using pricing power more on your product?

That's a very good question. Our -- the payback in desal is not what you'd be told to do in business school. It's about a 3-month payback. We have the ability to push prices, but we also want to maintain very strong customer relationships. Because we're in every large-scale desal plant around the world, we know that the customers listen to our earnings calls. They look at our financials. They hear the 65%, 70% gross margins. And they ask us, can you give us a bit of a break? So instead of pushing prices harder, what we've done instead is we've given volumetric discounts. As these products, as these plants are getting larger and larger, we give them more discounts. Our ASP ranges from -- roughly 20,000 to 30,000. And the larger the plant, the lower the ASP, but these relationships are important because these are the same customers we're going to be going to as the world continues to rely on desalination. And that's one of the reasons why we anticipate a doubling of our revenue in the next 4 years.

And in terms of the building of the plants [Technical Difficulty]

We -- there's about a dozen or so EPCs that operate in global desalination in the various countries or host countries that build the plants rotate these around. We've got very strong relationships with them. And what it does is that we've got boots on the ground in all the major areas where our plant -- where our product is going to, it gives us very good visibility and good backlog to end pipeline. With our backlog, we have visibility of about 12 to 24 months. So when we give our outlook, that outlook is predicated off the backlog that we have, we ship off that backlog. So we have a very good sense of what we're going to be generating next year and a very good sense of what we're doing this year. The only question is, sometimes these projects get delayed by a month or two. When that happens, you see the revenue get pushed back. It's not canceled, but they get delayed a little bit. That's why it's important for us to have a client base or an investor base that understands the long-term nature of the company. We're not really concerned from a month-to-month or quarter-to-quarter basis. But year-to-year, we feel very confident in generating the revenue that we've anticipated because of those relationships. And anything else? Yes, sir.

The exact status of your first PX integration?