Greetings, ladies and gentlemen, and welcome to Energy Recovery Third Quarter of 2022 Conference Call. At this time, all participants are in 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, Mr. Jim Siccardi, Vice President of Investor Relations. Please go ahead.

Hello, everyone, and welcome to Energy Recovery's 2022 third 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 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 of forward-looking statements. All statements made during this call are made only as of today, November 2, 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 will turn the call over to our Chairman, President and Chief Executive Officer, Bob Mao.

Thank you, Jim, and thank you everyone for joining us. We recognize today's challenging economic environment with a potential global recession, rising interest rates, inflation, a strengthening dollar and lingering supply chain issues. We are not immune to these macro events. However, by the nature of our business and the strength of our balance sheet, we are in a better position to navigate these headwinds. Despite these macroeconomic headwinds, we achieved our second highest revenue quarter to-date of $30.5 million in the third quarter. We continue to anticipate a record Q4, which will mark our sixth consecutive record revenue year. While we anticipate signing roughly $130 million in contracts to ship this year, we are experiencing some markup project customer-related delays, which could result in revenue landing between $121 million and $125 million for 2022. Meanwhile, we are on track to exceed our industrial wastewater guidance of $3 million for this year. We will discuss these risks as well as our successes today. Josh will then also take you through our guidance for next year and outlook for 2024. The takeaway is that, we believe we are well positioned with the right technology and strategy, even for this environment, despite any headwinds globally and feel confident about our long-term prospects. As usual, we will start with our water business. In 2022, it seems that water scarcity issue are increasing at a heightened pace across the globe. There is -- this is evident with new headlines, highlighting record low water levels in places a step desperate as Western United States, around the Mississippi, in the U.S., a ring of Europe, LATAM and in England, throughout Italy and across the world. Growing water scarcity highlights the need for solutions that created more sustainable and stable sources of freshwater. Our water business, including…

Good afternoon, everyone. I'll start first with providing a few more details on our top line growth. Revenue grew 47% in the third quarter year-on-year, and that has grown 18% year-to-date. The real story within these results is the strength in OEM and aftermarket sales, which are finally broken through our COVID lows in 2020 and 2021. OEM sales, excluding industrial wastewater, have grown over 60% year-to-date and aftermarket has exceeded 30%. These strong results reflect, in part, a backlog of projects that were delayed in the past couple of years. It is likely that 2022 will be our largest year ever in both OEM and aftermarket sales. As I mentioned in prior calls, our mega project revenue started out slow in the first half of the year but is picking up in the second half as expected. While Q3 was a strong quarter, our fourth quarter should be our strongest ever led by mega-project shipments. However, as Bob mentioned, there is some risk in our fourth quarter. I want to be clear that, this risk is simply due to temporary project-specific delays. While we are seeing some changes in the timing of a few individual projects, we are not yet seeing a shift in our longer-term outlook related to global economic events. There were two key project-related shifts this year. First, about $4 million of our 2022 backlog is shifting to Egypt, where local capital controls have been put in place to slow hard currency payments due to a weakening Egyptian pound. This has slowed our ability to ship and recognize this revenue. While the timing is in flux, as of today, we are confident these projects will shift either this year or next. Second, another $6 million project in the UAE was delayed due to the replacement of…

Thank you, sir. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator instructions] The first question comes from Pavel Molchanov of Raymond James.

Thanks for taking the questions. Let me start with the near-term desalination outlook. We typically think of desal as something that has really no economic sensitivity. We saw this with -- during COVID in 2020, for example, to the extent that you mentioned projects being pushed out. Is that driven by macroeconomic conditions, or is it just now physical construction delays.

Hey, Pavel, this is Josh. These are very specific project delays. It's not related to the overall economy at all at this point. Well, I mean, with the exception, I guess, you could say, with Egypt, with their currency having a little bit of trouble, obviously, that causing some specific delays. But otherwise, it's really unrelated to the economy at this time. And to your point on desal being decoupled, I think that is true with the mega projects, and that's what we saw in 2020 when COVID began. It's less true with OEM projects that are much more where roughly 60% of our smaller OEM projects are municipalities, which are probably less effective, but the other 40%, give or take, are a variety of industries, which could be affected. So during COVID, hospitality and travel industry got hit really hard, for example. So it just really depends on where the economic effect is happening in a given country.

Okay. Following up on desal, you touched on water scarcity being kind of a worldwide story, may not limited to the Middle East. As we hear more headlines, for example, from California and parts of Europe on desal new builds. Are you seeing that in incoming orders or at least perspective customer engagements?

We are not seeing it yet in the incoming orders in Europe or the US at this time. Now, we are seeing it, for example, in Asia. Asia this year is growing about 30% versus closer to 10% for the Middle East, for example. So we're definitely seeing it in Asia, but not yet quite in the US or Europe.

Okay. My third question is on the margin profile between the wastewater solution and the desal solution, with wastewater becoming a bit more needle moving in the revenue mix next year, does that lower your kind of blended margin profile. In other words, are you averaging in a lower-margin product as you grow the wastewater business?

We are not -- when we started out -- so, for example, we talked about at our last earnings call we had that one year payback. That is an example where we had some -- our initial sales were lower margin, but we're already getting them well over 60% and starting to near the desalination margins at this point.

Okay. And lastly, I think three months ago, there was still some potential for finding a VorTeq partner, is that still remotely possibility?

I suppose remotely anything is possible, Pavel. I'm not assuming a high chance of success there, no.

Okay.

Probably.

Understood. Thank you, guys.

You bet. Thanks, Pavel.

Thank you.

Thank you. [Operator Instructions] We have a follow-up from Pavel Molchanov of Raymond James.

Well, I did not want to monopolize, but maybe I'll ask a few. On the refrigeration solution, I think the target that you indicated maybe six months ago was for that business to be at breakeven kind of first half of 2023. Is it fair to say that it will be -- take a little longer than that, maybe another year or so

Probably to the latter part of 2022

Right. Okay. And where are you -- you mentioned the kind of backlog in refrigeration to expect by the end of next year. Geographically, where is the demand visible? Is it potentially a European story because of the regulatory landscape?

We see Europe and now in recent weeks, we start seeing movement at the end user level in the US as well.

And what drives that demand? In other words, is it a cost savings as simple as that for the end user, or is there -- or is there a regulatory angle to it, like the mandate of some sort?

The regulatory mandate is for the industry to shift out of HFC and into -- therefore, into natural refrigerants. And in the natural refrigerants, CO2 seems becoming really dominant. So from a regulatory push point of view, you got the customer go to CO2, they are compliant. But as we have said at the outset, a couple or several quarters ago. that CO2 burns more energy. So for the end user, regulator push comes with a financial pain, and that's where we're coming. We can reduce the energy burn. And our results are also showing that when properly designed and dimension, the whole refrigeration system construct, there need not be additional CapEx incurred due to the addition of our equipment. That's what we mean by CapEx neutrality. Why? Because our PX does have compressor, air cooler functions, and valve function. So the incorporation of our PX properly designed, constructed will reduce the need for the other components, which pays for the PX. And if we truly reach CapEx neutrality then Pavel, the payback becoming instantaneous. That is energy saving. And of course, energy savings as well as the electricity used to run these systems are not 100% renewable energy, then energy saving also translates to a smaller emission footprint. Q – Pavel Molchanov: And then finally, on guidance for next year, when we add the 3% to 7% growth rate for diesel with 6 million to 8 million of wastewater. I want to make sure I'm doing the arithmetic right, I get to somewhere in kind of 130 million to 135 million of total top line as reported, is that – that accurate? A – Bob Mao: Yes, probably a little higher, probably more like 133 137, somewhere in there. That's right, Pavel. And it will really depend on we'll have to talk about next earnings call on how we end at the end of this year with that range because even that $4 million range for us is a few percentage points, right? So we'll see how that ends and where the -- when those projects shift, and then I can update Q – Pavel Molchanov: Okay. Okay. That's very helpful. And thanks as always for posting the script online. A – Bob Mao: You bet. A – Joshua Ballard: Thank you.

[Operator Instructions] Ladies and gentlemen as we have no further questions on the lines. This concludes our question-and-answer session. I would now like to turn the conference over back to Mr. Jim Siccardi for closing remarks. End of Q&A:

Thank you, everyone, for joining us today. We look forward to speaking to you again in February. Have a great evening.

Goodbye.