Joel Gay - CFO Hans Peter Michelet - Chairman.

Patrick Jobin - Credit Suisse JinMing Liu - Ardour Capital David Rose - Wedbush Securities.

Good day and welcome to the Energy Recovery 2014 Year End Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Joel Gay. Please go ahead..

Good afternoon everyone. Welcome to Energy Recovery's earnings conference call for the fourth quarter and full year of 2014. My name is Joel Gay, CFO of Energy Recovery and I'm here today with our Chairman of the Board of Directors Mr. Hans Peter Michelet.

To begin, some of our comments and responses to questions may contain forward-looking statements about market trends, future revenue, growth expectations, cost structure, gross profit margins, new products and business strategy.

Such forward-looking statements are based on current expectations about future events and are subject to the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act.

Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors that could cause actual results to differ materially from those discussed. A detailed discussion of these factors and uncertainties is contained in the reports that the company files with the U.S.

Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statements made during this call, except as required by law. At this point, I will turn the call over to our Chairman Hans Peter Michelet to provide some opening remarks. HP, please go ahead..

Good afternoon everyone. My name is Hans Peter Michelet. I am the Chairman of the Board of Directors. And I am joined by Joel Gay, our Chief Financial Officer. Some brief opening remarks. Energy Recovery finds itself at one of the most exciting points since the Company’s IPO, something that Joel will elaborate further upon during his remarks.

I am pleased to state that through the guidance of the executive committee established by the Board of Directors of which I am a part, and through Joel’s leadership throughout this transition, the company is well positioned for a sustainable growth.

I will now turn the call over to Joel who will provide strategic and commercial update and discuss the 2014 fiscal year financial results. Joel, please go ahead. .

desalination. We have often discussed the inherent volatility of the market, specifically within the megaprojects segment. 2014 was an exceptionally lumpy year as evidenced by our depressed revenues of $30 million.

While we can examine specific reasons for this volatility based on economic trends, political unrest and the like, the dialogue is better served by restating our belief in the long-term fundamentals of water scarcity, the resulting demand for desalination plants and the strength of our position in the marketplace.

As and when growth normalizes, Energy Recovery is best positioned to capitalize on this growth. We are sensitive to our investors’ desire for clarity on the near-term outlook for desalination.

As a result, we have resumed the policy of announcing material contract awards and will characterize that awards in such a way to increase visibility while at the same time protecting sensitive information around pricing. Let's recap. 2014’s results were unacceptable and the company has responded quickly and decisively.

We rationalized our market and geographic focus to increase the rate and probability of penetration. We designed and are executing against an actionable go-to-market strategy. We right-sized our cost structure while still allocating resources towards product commercialization.

We are on track to schedule -- we are on schedule to begin the VorTeq field trials prior to the month end. In summary, the company has reloaded its strategy, transitioned from ideation to execution and is moving forward at an informed yet aggressive pace.

And while the financial results were lackluster and unacceptable, the innovation accomplishments were significant and very promising. With the reloaded strategy and a revitalized culture, I'm excited to steer this company into the new year and look forward to relaying future results accordingly. Now a brief examination of our financial results.

Beginning with the fourth quarter as compared to the prior year period, revenue of $14.8 million represented a 36% decrease from $23.2 million. Primary drivers were lower MPD shipments offset by increased OEM and aftermarket revenues, as well as oil and gas revenues attributed to an operating lease and subsequent buy-out.

Similarly, gross profit margin decreased by 200 basis points ending at 61% as compared to 63% in the fourth quarter of 2013. In descending order of impact, lower production levels and a shift in mix away from PXes towards pumps and turbochargers resulted in the margin decline. Further examining the shift in mix.

Not only did PX-derived revenues decrease as a function of lower MPD revenues but we've witnessed a mix shift towards pumps and turbochargers within the OEM sales channel.

Primarily a result of increased R&D expenses associated with the development of the VorTeq as well as increase in nonrecurring legal and administrative expenses, OpEx increased by 78% to $13.8 million from $7.8 million in 2013.

On lower revenues, decreased margins and increased OpEx, the company generated a net loss of $4.9 million or $0.09 per share as compared to net income of $6.7 million or $0.13 per share in the prior year. The full-year results for 2014 were very much a macrocosm of the fourth quarter with lower revenues, decreased profitability and higher OpEx.

Specifically revenue declined to $30.4 million from $43 million in 2013 or by 29%, both MPD and OEM pretty significantly less revenue than the prior year offset by higher aftermarket revenue and oil and gas revenue attributed to an operating lease and subsequent buyout.

On lower revenues, gross profit margins declined 500 basis points to 55% from 60% in the prior year. Lower production levels in response to lower revenue coupled with a shift in mix away from PXes, towards pumps and turbochargers drove the decline in gross margins.

As compared to 2013, PX revenue as a percent of total revenue declined by 11% to 69% primarily due to a decrease in MPD revenue of $13.2 million.

Driven by increased R&D expenses, primarily attributed to the development of the VorTeq solution and nonrecurring legal and administrative expenses, OpEx increased by $6.6 million to $35.2 million from $28.6 million in 2013.

In summary, on lower revenues, decreased margins and increased OpEx, the company generated a net loss of $18.7 million or $0.36 per share as compared to a net loss of $3.1 million or $0.06 per share in the prior year. For the full year of 2014, the company generated net cash flow of $1.1 million.

Contributing to cash used by operating activities of $3.7 million was the continued monetization of receivables on lower revenue as compared to the prior year, offset by increased inventory given lower levels of demand and the delay of project shipments into 2015.

Cash generated from investing activities of $6.5 million was chiefly the result of the maturation of marketable securities, offset by capital expenditures of $2.6 million.

Cash used by financing activities of $1.8 million reflects the repurchase of $2.8 million worth of common stock or approximately 700,000 shares, offset by proceeds resulting from the exercising of options and warrants.

Excluding current and non-current restricted cash of $5.5 million, the company reported unrestricted cash of $15.5 million, short-term investments of $13.1 million and long-term investments of $300,000 all of which represent a combined total of $28.9 million. This concludes our prepared remarks and we will now take questions. .

[Operator Instructions] And we will take our first question from Patrick Jobin with Credit Suisse..

Hey Joel, thanks for taking the question here.

How should we think about kind of growth prospects, looking out to next year, kind of as field trials starting, in any way we can kind of put in context what growth could we expect for new markets?.

Specific to fracking, Patrick?.

Yes. Sorry, to be more precise, the fracking..

Sure, sure. As I stated, we are on schedule, we will begin field trials prior to the end of this month. It’s our expectation that those field trials will last at least six months, it could last three months, it could last nine months, could last a year.

The point is that we are committed to staying the course and we’re not going to submit to any explosive deadlines. So from a 2015 standpoint, expectation should be that this is a year of field validation. And depending upon the success and pace of that field validation process, we will segue into commercialization, 2016..

And then I appreciate resuming the policy of disclosing contract awards on the desalination business.

I guess to bring us up to speed, perhaps, with I guess perhaps contracts that might have been won, that weren’t announced, how should we be thinking about megaproject desalination in 2015? Is there any way you can quantify the backlog or any help on visibility in that market would be much appreciated?.

Sure, sure. So I’ll give you bit of a mixed bag, Patrick. Desalination, the level of uncertainty and volatility that we witnessed in 2014, there are no clear signs that that growth will -- rather that, that market will resume a normalized growth rate in the near future.

Okay, so it’s specifically within the MPD division, we have witnessed a number of delays, just call it the bid table shifting into the outer years and of course that's what drives growth in that industry are the large greenfield opportunities. Now having said that, we didn't witness the bid table strengthening a bit in the fourth quarter of 2014.

Now, is that an indication that revenue generation will benefit from that slight increase in the strength of the bid table in 2014? I can't answer that. But fundamentally, obviously we’re committed to that market. The long-term fundamentals are strong.

Our market position is commanding and we will continue to evaluate opportunities and react as quickly as we can..

Got it and I apologize if I missed this in the first few minutes – I had to hop on late.

Can you maybe update us on management changes that have been announced and kind of the current status on I guess search process?.

Yes, I believe that’s under my compartment here and we currently have the CEO search underway. We are evaluating a number of candidates. And this is why we are so -- and our mission here is really to find the best suitable candidate to lead the ERII going forward. .

We’ll go next to JinMing Liu with Ardour Capital..

At this juncture, my question is about what direction Energy Recovery will take to balance out desal and oil and gas?.

Could you clarify that a bit for me, JimMing?.

Yes, which just say – when Tom was in the office, ERII was almost 100% emphasizing oil and gas opportunities. And which was the board thinks at this moment for direction of your company, whether you go –.

So there are three primary segments where we have identified attractive fluid flow markets, clearly desalination or water, oil and gas and chemical processing. So the direction of the company is not an either or which is to say you are a water company or you are an oil and gas company. Our concern is of course in the fluid flow applications.

From a focus standpoint, as I detailed in my opening remarks, we have rationalized our strategic and market focus, JinMing. On December 8 we unveiled about a $4 billion opportunity and we’re confident that we can monetize that opportunity over time.

But frankly that is an order of magnitude larger than what a company of our size can effectively penetrate in very short order. So as a result, we’ve distilled that market opportunity down from $4 billion to what we consider to be an actionable $1 billion to $1.5 billion focusing on gas processing, ammonia in North America.

And then of course the other focus that we have this year is on supporting the fracking initiative. So the strategy of the company to leverage its core competencies in advanced material science and fluid dynamics and to utilize those core competencies to identify pressure energy cycles where energy is being wasted, we will continue.

And currently again the three segments are water, oil and gas and chemicals..

Okay. Regarding your focus on the oil and gas and chemical industries, I think the current three product lines, of those three, two are based on the turbo technology if I am not mistaken.

So my question there, whether you see a threat from a technology point of view other companies, to copy your early success to such an extent?.

Yes. That is correct. Both gas processing and ammonia are our opportunities that are served with our IsoBoost, which is a turbocharger-based technology, we are comfortable with the level of IP that we have around that solution.

But at the same time we’re cognizant of the fact that we are not the only ones who produce turbochargers for either water, industrial water or oil and gas applications.

And so differentiation is key for us as is first mover advantage and we are attempting to maximize both of those advantages as we step through these early and at times painful phases of commercialization. .

We will go next to Kenneth Forsberg with Forsberg Capital [ph]. .

Good afternoon.

Could you tell us a little bit more about the Conoco Phillips contract? What vertical was that for, how much was it for and when do you expect to ship it?.

Good afternoon, Ken. Sure. I will provide some color on the Conoco Phillips. So first of all, it was a capital sale. By virtue of the contract, we cannot disclose the price. It is a IsoBoost for gas processing, that will be installed sometime between the second and third quarter of this year within one of their plants.

Now this is a plant that has lower amine flow and therefore lower levels of throughput or net gas production. So as you examine the market analysis that we put forth on December 8, we had a global ASP of around $1 million for the IsoBoost for gas processing.

This capital sale was materially lower than that by virtue of the size of the plant, as well as we’ve got to understand that technical – the hurdle of technical adoption is very high. Okay, so we have to incent customers to take on the technology risk.

But what's most important to the company, Ken, is that Conoco Phillips is a blue-chip E&P and we look forward to establishing them as a reference and in getting that unit online such that it can propel future sales in gas processing. .

Okay. Another question is about the IsoGen use in pipeline transport.

Are you still pursuing that and has Alex Phillips [ph] been helpful in that area?.

Yes. We are pursuing it. However our priorities for this year, P1, gas processing; P2, ammonia and then of course fracking a bit different. That's a field trial support. We are evaluating pipeline opportunities with the IsoGen technology. However we’re doing that on an opportunistic basis.

We believe that we will gain the greatest traction through gas processing and ammonia penetration tactics. .

And then on your December 8 conference, you set to expect the VorTeq to be installed or tested in January, or February and now we are talking about the end of March.

What was the delays?.

I don't recall saying that, Ken. I think we’d always communicated somewhere prior to the end of the first quarter. So as far as we’re concerned we are on track. We’re on schedule to do that. I'm not aware of any delays. .

[Operator Instructions] We’ll go next to David Rose with Wedbush Securities. .

A couple of quick ones if I may.

First is how much were legal expenses in the quarter and do you see them going up flat or down sequentially?.

I don't have the exact number on the legal expenses as a single item. I did characterize the increase as being attributed to some non-recurring expenses, the subject matter of which is privileged. Okay. So I think -- I don't think you'll see a resumption of steady state OpEx spend in 2015. .

So what sort of OpEx spend should we expect starting in Q1?.

Yes, David, as you know, it is our policy not to provide guidance whether it’d be top line, gross profitability, or OpEx.

What I can tell you is that the austerity measures that we implemented early in January were very broad and they were immediately done such that we could benefit from those reductions in 2015, rather than provide you a number, because again we don't provide guidance, what I can tell you is that we believe that we are properly right- sized given the market realities and the commercial priorities of the company.

.

And maybe I can back into the nonrecurring items, all in give me a ballpark, approximately 2 million, 3 million, 4 million?.

Yeah. I would say non-recurring items were around $6 million. .

And if I look at the payment consideration of $1.4 million in the cash flow statement, what was that for?.

Yes. So that we actually re-classed that, David, in prior disclosures, it was captured in cash flow from operations, that relates to a settlement on the Radakovich litigation matter or the litigation matter with the former shareholders of Pump Engineering Inc. .

And then if I look at the – and I know you don’t provide any guidance but maybe I can better understand the inventory levels are fairly high in Q1, does that relate to some shipments in Q4 that you were expecting or is that just find a level load factory?.

Yes, let's talk about that, David, because I know, if you had questions about our inventory levels in the past, we endeavored a level load production as a way of managing the demand volatility or variability.

Midway through the year, when we realized that the bid table was shifting out, of course, we recalibrated our production activity and decreased it, right? However we had still accumulated a fair amount of inventory up to that point. So that's one factor, that the demand equation changed in the middle of the year if you will.

Number two, as you pointed out, there were a few shipments, relatively large ones, that were scheduled to ship in the fourth quarter of 2014 and that shifted into 2015. So we are carrying inventory that is discreetly tied to shipments that are under contract. .

So timing on which is still uncertain, you probably don’t want to nail on a quarter Q1 or Q2, that’s some time in –.

Yes, exactly, exactly. The timing is forever uncertain. This is –I can tell you like it’s an MPD shipment and we will be making an announcement here on that..

And then last question, I will get back into the queue.

The share repurchase that took place in Q4, was that just a function of offsetting the options?.

No, no, so the company – if you know we’ve had – we’ve been very active in repurchasing our common stock over the last three years. The company does not trade on a arbitrary basis rather through a 10b5-1. So we had no a trading formula and at certain price points trades were triggered.

But that board approved repurchase plan expired on December 31 of 2014. So the company at this point does not have any plans on continuing to repurchase common stock. End of Q&A.

And there are no further questions at this time. I’d like to turn the conference back over to Mr. Joel Gay for any additional and/or closing remarks..

None here. Thank you all for participating. Look forward to talking to you in May. .

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation..