Energy Recovery, Inc.
Q3 2018 Earnings Call Transcript

Published: 2 Nov 2018

[Operator:]

Greetings, and welcome to the Energy Recovery Third Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] 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. You may begin.

[James Siccardi:]

Good afternoon, everyone, and welcome to Energy Recovery’s earnings conference call for the third quarter of 2018. My name is Jim Siccardi, Vice President of Investor Relations of Energy Recovery. I’m here today with our Chief Financial Officer, Joshua Ballard; and our President and Chief Executive Officer, Chris Gannon. 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, economic, and market outlook, the company’s ability to achieve the milestones and commercialization under the VorTeq licensing agreement, growth expectations, new products, and their performance, including the MTeq system, cost structure, and business strategy. Forward-looking statements are based on the 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 that the company’s 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 today during this call are as of today, November 1, 2018, 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. In addition, we may make some references to non-GAAP financial measures during the call. You will find supplemental data in the company’s earnings press release, which was released to newswires and furnished to the SEC earlier today, which includes reconciliations of the non-GAAP measures to the comparable GAAP results. At this point, I’d like to turn the call over to our Chief Financial Officer, Joshua Ballard.

[Joshua Ballard:]

Good afternoon, everyone, and thank you for joining us today. Before I begin, I would like to first thank Chris and the Board for providing me the opportunity to join Energy Recovery as its Chief Financial Officer. Since 2015, Energy Recovery increased its overall gross margin from 57% to 75%, created sustainable profit in operating cash flow, continue to advance its leadership position in the water desalination business, and made tremendous progress developing its disruptive VorTeq technology. I’m honored to step into this role and work alongside the team who built this company to where it is today. My own background is focused on high-growth companies and markets, and I’m excited to now be collaborating with everyone at Energy Recovery during its exciting time in the company’s growth. The positive momentum we experienced in the first-half of 2018 has continued in the third quarter. For the third quarter ending September 30, 2018, we generated total revenue of $22.2 million, representing 30% top line growth year-over-year. This top line growth translated into a product gross margin of 73% and an overall gross margin of 77%. In addition, we reported GAAP net income for the quarter of $4.7 million, or $0.08 per diluted share. Year-to-date, we have generated $56.8 million in revenue, $11.3 million over the same period in 2017, a 25% increase year-over-year. As in previous quarters, our water business has continued to drive growth at Energy Recovery. Water alone generated $18.5 million in revenue during the third quarter of 2018, growth of 40% over 2017 and $47 million year-to-date, a 38% increase over the same nine-month period last year. This strong growth has been driven largely by mega projects, those generating over 50,000 cubic meters of water or more per day. By their very nature, mega projects are somewhat unpredictable when it comes to the timing of shipments, and this unpredictability has generated a stronger than expected third quarter. As such, we believe our overall year-end growth rate will moderate itself to single-digit percent growth as was communicated earlier this year. Our oil and gas business generated total revenue of $3.8 million for the third quarter of 2018. Of the total oil and gas revenue $3.7 million was related to ASC 606 recognition of VorTeq license revenue, with the remaining associated with lower cost-to-total cost revenue recognition related to the sale of multiple IsoBoost system. As in past quarters, we continue to invest heavily in the commercialization of our VorTeq and advancement of our MTeq solutions. Our third quarter operating cash flow was $11.4 million, especially strong due to the timing of several large customer receipts. We ended the quarter with nearly $102 million in cash and securities. These high customer receipts in the third quarter, however, will not continue into the fourth quarter, and we will end the year with operating cash flow more in line with the past two years. I look forward to talking more with current and potential investors, as well as our sell-side analysts. And with that, I will hand it over to our President and CEO, Chris Gannon.

[Chris Gannon:]

Thank you, Josh, and thank you, everyone, for joining us today. As in past calls, I will begin my commentary by reiterating our strategic objectives, I will then discuss our progress in meeting these objectives. Our near-term strategic priorities and focus remain

[Operator:]

Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is coming from the line of Joseph Osha with JMP Securities. Please proceed with your question.

[Hilary Cauley:]

Hi, guys. This is actually Hilary Cauley on for Joe Osha. My first question for you is, if you could just talk a little bit more about what some of those other water growth opportunities might look like? And that you had previously said that pumps were something you were looking at and just what that timeline might look like?

[Chris Gannon:]

Certainly. Thanks for the the question, Hilary. When we think about our water business, what we’re focused on is really growing our overall product offering. So we have certain, I’ll call it, hose in our pump offering, certain size ranges and whatnot that we need to fill. We took a – an initial step forward on that when we entered our agreement with Düchting Pumpen, a German manufacturer, and we will continue to work with them and look at potentially others to continue to grow that. In addition, as we think about the overall opportunity in the Water segment, there are other system-level enhancements or products we can offer to that, that customer base around the globe for things that they’re actually asking for us to do.

[Hilary Cauley:]

Okay, great. And as you start to bring some of those online, is this going to kind of support that 3% to 5% growth rate, or could we actually see some upside to that?

[Chris Gannon:]

Yes. When we think about maybe next year, we actually are seeing an enhanced growth rate than they kind of, let’s say, the historical guidance I provided or – and we’re really looking at more of a 5% to 8% growth. On top of that, as we think about the other activities with regards to other future growth activities, that would layer on top of that.

[Hilary Cauley:]

Okay, great. Thanks for taking my questions.

[Chris Gannon:]

Thanks, Hilary.

[Operator:]

Thank you. The next question is coming from the line of Mike Urban with Seaport Global. Please proceed with your question.

[Michael Urban:]

Thanks. Good afternoon.

[Chris Gannon:]

How’s it going, Mike?

[Michael Urban:]

Yes, thanks. So last quarter, you had talked about and I think, you referenced it again on – in your prepared comments on this call just, your partners are often busy and focused on field operations and gives you a great difficulty in getting testing opportunities. Have you seen a pretty dramatic slowdown in frac activity over the last quarter and a real acceleration there just in the last month or two and that looks like that’s going to continue for some period of time. Has that given you any opportunities, or have they made equipment or facilities available to you given that they are seeing that pause in their business?

[Chris Gannon:]

Well, so in the – as in the past, I’m not going to comment specifically on our product licensee or product partners activities. We are always looking for opportunities to get runtime on our technology. We are currently at our product partners facilities and have access to other facility and equipment. So both our product licensee and product partner have continued to be supportive of us. And that is – that’s obviously a massive positive for us.

[Michael Urban:]

And as you look to establish your own testing capability, presumably you don’t need to buy a whole frac spread here just going to be a select equipment and the relevant equipment and then this facility itself. What’s the cost of that?

[Chris Gannon:]

So, today, and you’ll see that in our financials, we spent about $3 million and we’re going to continue to add on to that. I think – but going back to your past question, where I think – let me just finish answering, I guess. When you think about why we’re doing this, it’s for us to control our ability to test whenever we want to and not have to schedule it with either our product licensee or product partner, and that is key for us. We need to be able to test anytime we want to, and not be subject to them needing to run their business.

[Michael Urban:]

Okay, that makes sense. So you said, you spent $3 million, yes, I think, you said on it so far as a total estimate for what that ultimately cost to establish that independent testing capability?

[Chris Gannon:]

Yes. When we think about the testing capability, as well as potentially adding in a facility, you’re looking at $6 million to $10 million over time.

[Michael Urban:]

Okay, gotcha. And then the last one for me is – and it may be a difficult question to answer, given that there’s going to be a technology-oriented business inherently and predictable. But how do you recognize you don’t want to give targets publicly? But how do you evaluate it internally in terms of the spend, in terms of the timeline? How you’re evaluating your – the folks who are working on this and are you making – in terms of making adequate progress? And just is this something regardless I get the technology, is that just makes sense in the grand scheme of things and relative to the very stakeholders in the company?

[Chris Gannon:]

Well, yes. I mean, the – when you think about the VorTeq technology, the thing that we’re focusing on is commercialization, because that’s exponentially more important than milestone one, when we think about the value of that technology to our shareholders. So yes, we are always evaluating our spend and where we’re allocating our resources. I made the decision to invest in our testing capability, as an example. So that we could more quickly IDA and test. We are always going to need to continue invest and expand our capabilities as we focus on commercialization.

[Michael Urban:]

Okay, gotcha. That’s all for me. Thank you.

[Chris Gannon:]

Okay.

[Operator:]

Thank you. [Operator Instructions] Our next question is coming from the line of Ryan Pfingst with FBR. Please proceed with your question.

[Ryan Pfingst:]

Hey, good evening, Chris.

[Chris Gannon:]

Good evening. How are you doing?

[Ryan Pfingst:]

Good. Just coming back to growth for water and your M&A effort…

[Chris Gannon:]

Sure.

[Ryan Pfingst:]

…we’re just wondering how the pipeline has evolved for prospects, given the new growth strategy for water? And when the earliest might be we see initial transaction?

[Chris Gannon:]

There are certain things that are in my control and others that are not. We have – we’re going down multiple paths when we think about water growth, both organic and inorganic. As far as the timing of various inorganic initiatives, I’m going to pause on that one and you’ll see that as it plays out.

[Ryan Pfingst:]

Okay, great. And then just on mega projects, wondering if you could share an update on how your visibility is looking to late 2019 into 2020?

[Chris Gannon:]

Yes. So on the mega projects side, we’re seeing really nice growth in – into 2019 into 2020. So, when I think about our business – our base business right now or the water, I’m very bullish on where things are headed for us. I really are. When I think about mega projects, the OEM segment, even aftermarket, the – that business is doing wonderful.

[Ryan Pfingst:]

Okay. And then just one on VorTeq, if I could get anything add here. If you have any further update on discussions with Liberty and how they’re thinking about the technology since moving to Texas?

[Chris Gannon:]

Well, yes, I’m – I certainly, I mean, I guess also – what I’ll tell you is that, I’m not going to comment specifically on our product partner or our product licensee and their positions on it. What I can tell you is that, both are – have been very supportive of us. Obviously, we are in their – one of their facilities right now, so hopefully, that speaks to their support.

[Ryan Pfingst:]

All right. Thanks for taking my questions.

[Chris Gannon:]

Absolutely.

[Operator:]

Thank you. It appears we have no further questions at this time. So I’d like to pass the floor back over to Mr. Gannon for any additional concluding comments.

[Chris Gannon:]

All right. Well, thank you for joining us this afternoon, and we appreciate your continued support of our company. We certainly look forward to providing updates in our next earnings call. And again, thank you again, everyone, and have a great rest of your day.

[Operator:]

Ladies and gentlemen, this does conclude today’s teleconference. Again, we thank you for your participation, and you may disconnect your lines at this time.