Greetings and welcome to Energy Recovery First Quarter 2022 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. Please go ahead.

Hello everyone and welcome to Energy Recovery’s 2022 first quarter earnings conference call. My name is Jim Siccardi, Vice President of Investor Relations at Energy Recovery. I am here today 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 the 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 or forward-looking statements. All statements made during this call are made only as of today, May 4, 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.

Thank you, Jim, and thank you everyone for joining us. We delivered a strong first quarter with revenue of $32.5 million, a 12% increase over the first quarter of 2021. Importantly, we also delivered over $8 million in operating income, a 34% increase over Q1 last year. The fact that our operating income grew almost 3 times our revenue underlines our continued focus on profitability as we grow. Today, I am going to focus our discussion on the industrial wastewater and CO2 businesses. Our core desalination business remains strong, and we are maintaining our outlook for this year and next of 25% and 15% growth, respectively. Let’s start with our industrial wastewater business, where we achieved revenues in the first quarter equal to nearly 50% of 2021’s full-year industrial wastewater revenue. The growth we are seeing in our backlog and sales pipeline is encouraging, providing us confidence in the $3 million top-line guidance we set for industrial wastewater in 2022. Our first Ultra PXs were commissioned at a lithium battery manufacturing facility in China in Q1 and have been running for more than a month now. We are collecting performance data which we will use to further educate and penetrate this market. In our third quarter earnings call last year, we talked about the overall potential of this market, with a current one-time TAM of roughly $1 billion today based on industrial water treatment statistics. This market has the potential to grow up to $4 billion to $5 billion, depending on how the regulatory environment develops during this decade. We have already identified specific TAMs of $300 million $400 million in just a few industries, such as the lithium battery market. In preparation to seize this opportunity, we have increased our boots on the ground in China and India, where…

Thank you, Bob. Our 12% year-over-year revenue growth this quarter was largely driven by our OEM and aftermarket channels, both of which exceeded Q1 2021 by 67%, while our mega project channel remained flat against last year. However, as we have discussed before, a quarter-to-quarter comparison does not point to a trend for the year. The first quarter of 2021 was still affected by COVID slowdowns, however we saw growth in both the OEM and aftermarket channels throughout the final three quarters of the year. In particular, if you look closer at OEM sales, you can see that revenue this quarter is very much in line with the past three quarters. While aftermarket is high compared to any quarter last year, I do not expect it to remain this elevated throughout 2022. While we are maintaining our guidance of roughly $130 million for the fiscal year, we have seen some shifting between quarters. We originally expected our quarterly revenue to be fairly evenly distributed in 2022. It now appears our second and third quarters will be lighter than our first and fourth again this year. Our second quarter will be our lightest quarter, likely around $20 million. Fourth quarter revenue is shaping up to land in the low- to mid-$40 million range, and Q3 will make up the balance. We generated a 71% product gross margin during the quarter but anticipate this range to moderate as the year progresses. We are benefiting from our inventory build during 2021 but will begin to experience some effects from inflation and tariffs in the latter half of this year, which will moderate our margin to bring it within our guidance of 66% to 68%. Our OpEx grew about 3% over our average 2021 quarterly rate. Our R&D spend should remain fairly stable for…

[Operator Instructions] We have a question from Pavel Molchanov of Raymond James. Please go ahead.

Thanks for taking the question. Let me start with VorTeq. Stating the obvious, since the last time we spoke the war, $100 a barrel oil, has kind of accelerated attention on everything related to oil field service technology. I’m curious if you are seeing in the last 60 days, any increase in interest from prospective partners, anything along those lines that you can talk about?

This is Josh. I wouldn’t say, we’ve seen any specific change. No, just we are continuing the conversation that we started a couple months ago.

Okay. And given that historically you tested VorTeq with the few partners specifically in the Permian basin, is there any appetite from prospective partners to engage in testing somewhere outside of the Permian, maybe even outside of North America?

Well, if we move forward with a partnership, I’m sure that partnership would look at all areas that made sense for the VorTeq. It’s truly the same. Also, as far as we are concerned, we have no need to do further test for VorTeq.

Okay. Fair enough. And then, back to desalination, California, yet again, in a severe drought, the whole western half of North America. You obviously, desal business has always been very mid-east-centric. Are you hearing any discussion in Sacramento or other parts of the Western U.S. about a prospective desal build out domestically?

Well, Pavel, the long running Huntington Beach project is coming up for another decision point on May 12th. So, we will listen to that.

[Operator Instructions] We have a question from Ray Deacon of Petro Lotus. Please go ahead.

Yes. Hi. Bob, I was wondering if you could elaborate a little bit more on the design institute in China and what that could mean to the wastewater business. And is there much competition at this point?

The design institute is like a standards committee, that we on the Western part of the world, in deploying new technology or new products. So, they define what would be the new -- how a new product is to be deployed, in what way the new systems look like and what metrics they are measuring. So, you can think of them as a standard spot, but they go deeper than the American industry standard. They actually review detailed designs of a specific wastewater, whole setup.

So, it helps with marketing the product and customer recognition, I suppose?

Yes.

Our next question is from Wally Walker of Hana Road.

That was close. Thank you. And congratulations, guys on the improving operating leverage and profitability. Bob, you talked about leadership challenges with the growth, and these are good challenges to have. And if my memory serves me correctly, you agreed to serve as CEO through the end of ‘23. Maybe could you elaborate on your current feelings about your tenure as CEO?

Okay. Wally, I don’t remember I said I’d only serve till the end of ‘23, okay? I don’t know in what context you remember that. But let’s say this, I think it was two earnings calls ago, I sketched out a vision for ERI based on proof points that we aim to grow 5 times by 2026 with 2021 as the baseline. We’re now on that mission to achieve $500 million in revenue by 2026 with basically organic growth in a disciplined, profitable manner. Always investors continue the confidence and confirmation, which is always based on our performance. I expect to be personally here in 2026 to deliver that profitable $500 million vision to you, the investors and all our stakeholders. By the way, if you remind me that just 10 minutes ago, I said, 550, okay, 550. Of course, CEOs serve at the pleasure of the Board. And ultimately the Board serves the pleasure of the investors actually. We’re doing well, and we aim to do well, and we will deliver our 2026 vision.

Bob, if I miss-remembered any comment you made about your tenure, I apologize. The context for me was hoping you would stay in place, the Company has clearly gotten more efficient and focused and profitable, which evidenced again today. So please -- and thank you for that answer.

Thank you.

We have a follow-up question from Pavel Molchanov. Please go ahead.

Yes. On the CO2 refrigeration opportunity. When you think about breakeven for that product line, by the, I think you said first half of next year, so only a year from now. What’s the assumed revenue contribution? In other words, what -- how much sales do you need to achieve for that product for you to break even on that?

I don’t have exact figures here but while you remember that we aim any new project under my tenure is minimum 50% gross margin. And we are a very lean operation. It doesn’t take that much to reach breakeven. In other words, the business no longer burns cash. And we are very confident that we will reach that goal in the first half of 2023. In fact, Pavel, you will remember, this is part of that 3 to 12 months regime we’re on. Any project I start will clear all technical hurdles in the first 12 months. And it will commercialize was at least minimum one bona fide commercial order. Then by the third 12 months, it will break even on a cash basis. We’re well on their -- on our way, not only in CO2, but also industrial wastewater. As we go into the further earning calls from here onward, I will brief you exactly where we are on the road to breakeven and where we’re on the road to 559.

[Operator Instructions] Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to James Siccardi for closing remarks.

Thank you for joining us this evening. For reference the prepared remarks can be found on the Investors section of our website. With that I’d like to wish everyone a nice evening, and we look forward to speaking with you at our second quarter call on August 3rd. Thank you. And have a good night.

This concludes today’s conference. Thank you for joining us. You may now disconnect your lines.