Greetings and welcome to Energy Recovery Fourth Quarter and Yearend 2021 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. I'd now like to turn the conference over to your host, James Siccardi, Vice President of Investor Relations. Thank you and over to you, Sir.

Hello everyone and welcome to Energy Recovery's 2021 yearend and fourth quarter earnings conference call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery. I am here today with our Chairman, President and Chief Executive Officer, Bob Mao and 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 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, growth expectations, new products and their performance, cost structure and business strategy. Forward-looking statements are based on information currently available to us and on management's beliefs, assumptions, estimates and 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, February 24, 2022 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'd like to turn the call over to our Chairman, President and Chief Executive Officer, Bob Mao. Bob, the floor is yours.

Thank you, Jim and thank you everyone for joining us. We finished 2021 in a strong fashion. It was a record fourth quarter. Despite the continued pandemic and global supply chains constraints, we exceeded our originally stated 10% top line guidance for 2021 by 3% achieving 13% growth or $104 million in revenue. This marks our first consecutive year of record revenues led by our core desalination business and supported by $1 million of sales from industrial wastewater, which we launched just a year ago. We also made concrete progress with our new PX G1300 for refrigeration with our first contract in Q3. This April will mark energy recovery's 30th anniversary breaking the $100 million revenue threshold is a fitting end to our third decade and yet, we believe energy recovery is fundamentally stronger than ever and strategically cost positioned to have our best days ahead of us. Soon after becoming CEO, I laid out the following fixed technical, commercial and financial timelines for all new products and technologies to drive internal accountability. Year one proved the technology viable. Year two, commercialize, and by end of year three, achieve a cash flow breakeven win rate. As we continue to evolve, these are the characteristics of the new ERII, disciplined, focused and accountable growth in new industries. This discipline extends to our finances as we focused on increased profitability, which Josh will describe. We will highlight this discipline in each of our industries today, starting with desalination. In desalination last quarter, I discussed the growing global water supply gap, which is the macroeconomic basis behind a secular demand shift that continues to provide dependable double digit revenue growth. We have set an ambitious target of doubling our desalination business by 2026. However, we are not complacent and as the overall desalination…

Thank you, Bob. Let me start by providing some transparency behind our revenue numbers. Each of our desalination channels saw double digit growth in the teens during 2021. During 2019 and '20, our revenue growth was predominantly generated from our mega project channel. However, 2021 exhibited a reemergence of our OEM and aftermarket channels following the 2020 COVID lows. Most notable was nearly 50% higher OEM growth than the second half of 2021 compared to the first half. This accelerating OEM growth throughout the year is providing some confidence that we will see a return to pre-pandemic highs in that segment in 2022 or 2023. Also have noted the geographic breakdown of our sales, while we saw healthy 6% growth in the Middle East and Africa in 2021, our Asia sales grew 2.5 times over 2020 and exceeded average trends from pre pandemic years by about 40%. This reflects a noticeable shift in Asia that should continue into 2022, where we expect material double growth in the region driven by both our desalination and industrial wastewater businesses. We expect this trend to continue as Asia grows in importance over the decade. Product gross margin remains strong ending the year just shy of 69%, which is roughly in the mid range of the guidance we provided for the year. The slight decrease in product margin year over year was mainly driven by increased sales of lower margin products. While we are experiencing higher tariffs and freight expenses, as well as increased labor costs, these were mostly offset by increased operating leverage as we boosted production. Our 2021 operating expenditures came in line with guidance as we continued our intentional dual focus on both the bottom and top lines. First, our OpEX decreased to 55% of product revenue from more than 60%…

[Operator instructions] The first question comes from the line of Ray Deacon with Petro Lotus. Please go ahead.

My question was about the G&A expense for sales and marketing. I know you've talked about having to ramp up your sales force as you enter new product lines, I guess, where do you think that number could go in the next year?

So specifically the G&A expense as Joshua.

Yeah exactly because I noticed although a year ago, I think it was 930,000 versus $1.2 million. I was just wondering.

No, what you're really seeing there, Ray is we did a recast of how we how we allocate our expenses to the various business segments meaning either water or emerging technologies or to corporate. So you're seeing a shuffling of that as we tried to. Our goal this last year in 2021 was to better allocate our expenses to reflect where they're being used in the business is really our goal there. We don't expect specifically for water. I would not expect that number to increase very much year on year except for perhaps additional allocations as the business grows depending how that balances out with the growth in refrigeration and especially with refrigeration in the next couple of years because we're not going to add a lot of resources to support that business on the backend, if that makes sense.

Okay. Got it. And do you have any early idea what your gross margins might look like in the lithium ion in the waste quarter business that you're targeting and maybe…

Yeah, we're certainly targeting over the long-term gross margins, more in-line with what we've shown in desalination. However, in these first couple of years they're going to be a little lower, but we are exceeding our 50% marker that we've put for our -- ourselves, but they're not as high as where we like them to be as we start out, but as costs come down and so forth, we'll be able to get those up. We can cover time.

Okay, great and just the last quick one, given the shift and focus away from the oil and gas segment that would suggest the composition of the board potentially changes. Do, do you feel that's likely or?

Well, thank you, Ray. Thank you for joining us for the first time and I hope we get to see you every time. Our board continuously evolved to reflect and to lead the strategic transformation of ERII, as you may agree, we believe our company is on an exciting transformation and growth path. Thank you.

[Operator Instructions] Thank you. The next question comes from Neil Thompsons with Family Securities. Please go ahead.

Good afternoon. Just a quick question on the [indiscernible] partner. I was wondering if you could elaborate if this is a Company that has global operations or if it's limited to specific markets. And also if you could touch upon how the gross margin looks like if you would do a delivery with the PX standalone, bolt-on into the existing systems and what the gross margin looks like. When it's by of a PX centric system?

Going forward, actually we do not expect much of any pure bolt-ons. Going forward, we will be concentrating and we think the market will accept the PX centric solution even going into the installations that's already in place. Certain extent of the PX centric benefits will be reflected. For example if we, as we fully expect, PX centric means less compressor capacity is needed in CO2 systems without PX. So that you could say for example take out one of the tools number of compressors current use. So we don't really fully expect to really push the so-called Bolt-ons.

Okay, and just another one for me as well. I know it's early days, but can you imagine that there's any impact from the, in Ukraine on your business in terms of either sourcing or raw materials or any supply chain related issues there?

We do not expect the disruption in the sourcing and the supply chain. And anything else on Ukraine is geopolitical will be this conversation

Neils, I, I would add as well.

Thank you.

Just a reminder that we did build up, you know, inventory quite a bit. So even if there were some kind of supply chain disruptions for a short period of time globally. We're pretty well covered for a while, so.

All right, good. Thank you.

Thank you. The next question comes from Wally Walker with Hana Road Capital, please go ahead.

Thank you. Congratulations guys on a great quarter. I'm going to ask the operating leverage question, which Joshua was some -- somewhat preemptive in talking about operating income could go by as much as 40% in '22. I, I would love for some elaboration on the puts and takes about how that, that might happen.

Yeah, well, in 2022, what you're going to see, what's really driving. It is going to be less operating leverage additional operating leverage. It's going to be more because of the way we're managing our expenses and, and holding our margins, what you're really going to see be driving up that operating income, if that makes sense. So if we're able to continue to reduce our OpEx as a percent of revenue, which is our plan this year and get that closer to that 50% marker as well as manage our margin and keep it within the, that we've provided, you know, that gets us into that roughly 40% range for the year that that's, what'll really be driving it this year while.

Okay. And, and Josh, I'm not sure I heard correctly. You mentioned something was going to, you're going to realize cash from a source that that would mostly end up in Q1. What, was that source please?

Yeah. In Q4, Q4 was a, was a monster quarter for us. And a lot of the sales in Q4 happened actually in the latter half of the quarter, so in a lot of, in December, in fact, and in November, probably after the holidays. So that's the cash that we're going to be realizing Q1. We haven't realized a lot of the receivables cash from our customers from the Q4, those Q4 sales.

Okay. So it's going to come from [indiscernible] then and, and realizing cash. You haven't typically had the inventory balance that you currently have, and the reasons for that makes sense to me, you know, what will be the cadence of realizing the cash and sales from the current elevated inventory?

Inventory this year? You're not going to, does the inventory grow in the same manner this year, as you did last year? We're pretty, fairly comfortable where we're at today and we've got enough safety stock and finished goods and so forth for, you know, to, to really carry us. I think you may see it go down a little bit by the end of the year. But I think it'll be fairly stable for this year. So I, I wouldn't expect that to, to be having a, a large effect on working capital this year as it did last year. And then

[Operator Instructions] Thank you, ladies and gentlemen, we have reached the end of question and answer session, and I would like to turn the call back to Jim Siccardi for closing remarks.

Thank you everyone for joining us this evening. We look forward to speaking with you again early may until then stay safe and have a great

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