Greetings, and welcome to Energy Recovery Fourth Quarter and Full year 2022 Conference Call. At this time, all participants are in listen-only mode. A brief 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, Jim Siccardi, Vice President of Investor Relations. Thank you, Jim. You may begin.

Hello, everyone, and welcome to Energy Recovery's 2022 fourth quarter earnings conference call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery. And 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, February 22, 2023 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 had one of the best years in Energy Recovery’s history in 2022. Let’s recap for a moment. 21% organic topline growth, while winning 100% of the mega projects tendered and awarded in 2022. Industrial wastewater exceeded guidance and almost quadrupled 2021 revenue. We generated some of the best profit metrics in Energy Recovery’s history. Gross margin of 69.6%, exceeded 2021 full year by 100 basis points; OpEx as a percentage of revenue, when adjusted for one-time costs, was 48%, its lowest level in nearly 14 years. During the past three years, this adjusted OpEx has grown only 8% despite revenue growing 73% in the same period. In our adjusted EBITDA exceeded $30 million for the first time and increased earnings per share by 75%. We also positioned each of our businesses for future growth. We launched the Q400 for seawater desalination, a low pressure PX for brackish and wastewater applications, along with new industrial wastewater products. We commissioned our first PX G1300s in Europe and the U.S. and have generated field performance that has surprised even our partners. In short, I couldn’t be more pleased with our progress in 2022. As we all look to 2023, there remains macroeconomic uncertainty, and this is nothing particular to Energy Recovery. We will have to navigate these short-term uncertainties together in the coming months, and we will continue to keep you informed. But what I will say is that here, at the beginning of 2023, we are cautiously optimistic about the current year, seeing solid single-digit revenue growth, and remain bullish on our long-term prospects. As usual, I’ll start with our Water business, where we are actively investing to both strengthen our position in the desalination market, as well as to seek…

Good afternoon, everyone. I’ll start with revenue. We generated $121.6 million in desalination revenue and nearly $4 million in industrial wastewater in 2022, for a combined total growth of 21% for the year. Mega projects continued to pick up pace as expected, growing nearly 9% in 2022, and OEM and Aftermarket achieved 64% and 36% growth respectively. Desalination OEM revenue, excluding industrial wastewater, grew nearly 50% to $25 million, exceeding our previous annual high in desalination OEM sales by 9%. The geographic dynamics of our 2022 revenue are also important. We continued to see steady growth in the Middle East and Africa of 10% for the year, an acceleration from 2021’s increase of only 6%. However, Asia is where the real story lies. We achieved over 30% growth in 2022 on the heels of over 150% growth in 2021. This rapid increase over the past few years highlights major freshwater issues in Asia. Countries such as China and India are turning to desalination and filtration of wastewater to help alleviate their water problems. In addition, we are beginning to see sales in other countries outside of China and India, which made up 16% of industrial wastewater sales last year. Finally, last quarter I had referenced $4 million of at risk backlog in Egypt that was delayed due to local hard currency capital controls. We were able to realize about half of that at risk backlog, with the balance expected to be shipped this year. We will retain our desalination revenue growth guidance for 2023 of 3% to 7%, or $125 to $130 million. We continue to expect desalination revenue to be heavily weighted to the third and fourth quarters, with up to 70% to 80% of revenue occurring in the second half of the year. We are currently anticipating revenue…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from Graham Price with Raymond James. Please proceed with your question.

Hi. Good afternoon, and thanks for taking the questions. I guess from my first one, you talked about the refrigeration distribution agreement in the Benelux region. I was wondering if you could just give a little more detail on how big that revenue opportunity is, and how you see that playing out over the coming years?

So, first, Graham, just to highlight, this is Josh. And hope you're doing well. I want to note that we did just release a press release here this afternoon, that we did sign that agreement with few today. So that that agreements live in the Benelux and the Benelux obviously, with the population count that it has is going to be a smaller amount of revenue that we're going to be able to realize in Europe. But it's a very important and key milestone for us signing this agreement as it shows an important proof point and confidence in the ability of our technology to reduce costs for these supermarkets and industrial sites and so forth.

Got it. And I guess as you sign additional agreements, do you think those will be exclusive in nature as well?

Definitely, yes. Would all are them will be exclusive? We don't know at this point.

Got it. Understood. Maybe switching gears a little bit. It's been roughly six months since Gavin Newsom talks about ramping up the diesel in California. Just wondering if you've seen any evidence that anything is changing in a large sense in that area?

The short answer is no. California and diesel, you know the story.

Got it. Okay. Understood. And then, I guess final one for me. Just on the cash balance, obviously, ended the year at a very healthy level and didn't see any buybacks this quarter. So I was just wondering, and I know, I'm guessing kind of the inventory build and the backend weighted revenue plays into it. But how are you thinking about buybacks for the rest of the year?

Well, right now, Graham, we're really looking at how our markets could evolve over this year. So for example, we have more confidence, and where waters headed. And we built a lot of capacity for that, as well as inventory at this stage. But CO2 is still a bit of unknown and we could have pretty substantial investments in CO2, if it accelerates in the latter half of the year, as well as, as we've talked about before potential additional fixed assets investments in order to build up capacity for that business. So at this stage, we're watching that because we're going to need cash for that build both working capital and fixed assets. Not to say nothing of the kind of the low cash flow we're going to have in the first couple of quarters just because of sales. So I wouldn't expect anything in the near term. But it's something we keep obviously discussing with the Board.

Okay. Perfect. That's it for me. So I'll pass it along. Thank you very much.

Thanks. Graham.

Thank you.

Thank you. Our next question is from Nils Thommesen with Fearnley Securities. Please proceed with your question.

Good afternoon. Just wondering, given that you're now sitting out to a couple of these PX G units to Europe and other markets, do you have sort of a lower range in terms of revenue to communicate for 2023 or is it still too early?

It’s still too early. That's why we're highlighting that our emphasis is breaking through into the new supermarket chains, what we call confirmed addressable market, and that's what we're following. Actually this has been we find out that this has been very conservative industry in adopting new things. But our value proposition is such we are very confident once we break into a new chain, the whole chain becomes a pipeline, then we can meaningfully discuss timing and volume.

Right. And at what point do you expect that you can make a decision on potentially building another plant or facility to add capacity to CO2, that's sort of a 2023 event?

Right now we have excess capacity using vacuum, as you know, it's the same aluminum oxide material. So we think probably is toward the end of the year, fourth quarter, we have to look at capacity increase.

Right. Thank you.

To be clear, those estimates would occur next year, most likely, right, even if we started the process this year, we'll get more updates in the latter half of the year in terms of how that cash outflow would look like.

All right. Great. Thanks.

Thank you. Our next question is from Ryan Pfingst with B. Riley Securities. Please proceed with your question.

Hey, guys, thanks for taking my question here. Now, the last time we spoke, we talked about exiting this year with a backlog allowing for sales in the double digit million range for 2024 for CO2 refrigeration. And Josh on the 3Q call, you spoke about the potential for diesel growth to once again reach 20% again, in 2024. Is that still how you guys are still thinking about those two items?

Yes, as of today, those are how we're still looking. And with CO2 in particular, we'll see how this year plays out. But that's certainly the targets we're pushing for. And then on as I mentioned today, and my prepared remarks on the diesel side, we're just very closely watching the market in terms of these major risks that we're seeing globally and we'll certainly keep you guys apprised as well as this year progresses. But where we stand today Energy.

Got it. And we've touched on California a little bit but with the Colorado River, running low and getting more attention and just the growing problem of less available water here in the US or are you guys seeing talks around domestic desalination demand picking up steam recently?

Recently, I glanced at a very interesting top line says that, the Arizona maybe considering building diesel for Mexico to trade for Mexico's Colorado quota. I don't know how to true is that. And if that's true and that's doable maybe just pure speculation was California has retired some diesel maybe California would also trade Colorado quota was Mexico diesel.

Got it. And maybe just one more for me. Obviously, your market share and the core business has been really impressive for a long time, but can you maybe talk about the competitive landscape a little bit and anything you're keeping an eye on that could potentially down?

We always keep an eye on competition. But there is nothing new to report from what we report in the last quarter and if they're out there, and we're watching.

Excellent.

Our Q400 is being received very, very well, in some ways competition was gearing up targeting Q300. Now we have Q400.

Got it. Good to know. Thank you.

[Operator Instructions] Our next question is from Wally Walker with Hana Road Capital. Please proceed with your question.

Hey, guys, congratulations on the quarter and the year. After market growth was impressive and accelerated the year end, whoever a little bit on rate of change? And if that's a trend, and is it fair to think of that as recurring revenue going forward?

Yes. Hey, Wally, hope you are doing well. We saw some great growth and aftermarket this year as well as OEM. But we are expecting it. Some of this was a – was a kind of a post COVID bounce in 2022. So we are expecting it to temper a bit this year, at least in terms of growth. And this could mean it either flattening with aftermarket, I'd expect it to flatten or low growth this year, compared to what we saw in 2022. Aftermarket is really a function of our installed base, right. And so as we grow, it grows with us. And it's been a pretty stable, call it 8% to 10%ish typically a revenue. And that's kind of what we still anchor on, although it's a bit higher this year. OEM as well and of course, we saw this big COVID bounce, and OEM, I think, this year, we think could pretty much the same story, it's going to revert back to its normal growth rate. We're kind of above that curve right now. Which is why we're one reason why we talked about last quarter we're seeing somewhat lower growth this year is because OEM is going to flatten or perhaps even be a little lower than this year, just as it returns to its normal growth curve, if that makes sense.

Yes. One other for me, please. Expected tax rates in 2023, how should we model for those?

That's good question. At something, what I probably should have included in my script because I think last quarter I talked about a 10% to 15% expected tax rate. But as we've been looking at we came in at about 8% this year. And what we're finding is we have a lot of changes last year, we've utilized all of our cumulative net operating losses, which is great because we're making that means we're making money. We also because we utilize those losses, we're starting to get a new benefit, starting last year called the foreign derived intangible income tax benefit, which is really, it's a tax benefit, you get exporting, right. And it's pretty big for us this year, it was almost 7% for 2022. We also get a pretty healthy R&D tax credit. So because of the fact that we used all of those NOLs and they're now gone, it's actually going to boost our foreign derived intangible income tax benefit, which means it's going bigger this year. It could be. So I think we probably revise our estimate down from 10% to 15%, to more like 8% to 12%. As we look forward, at least for the next few years. That's excluding any effect we may get from -- from our share base comp, tax benefits that we get, because that's pretty, pretty volatile and not dependent on us. That makes sense, mostly driven by this FDII benefit, which is -- which is pretty new.

Okay. Thank you,

Thanks. Wally.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Jim Siccardi for any closing comments.

Thank you, everyone for joining us today. As a reminder, our prepared remarks and the most recent press releases can be found on the website. We look forward to speaking with you again in early May. I guess it's the 3rd of May. Other than that, have a great weekend. Have a great rest of your week and we will be participating in follow-up calls over the next couple days. Thank you.

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