Joel Gay - President and Chief Executive Officer Hans Peter Michelet - Chairman of the Board of Directors Sharon Smith Lenox - Corporate Controller and Chief Accounting Officer.

David Rose - Wedbush Securities Jennifer Ky - Credit Suisse JinMing Liu - Ardour Capital Ken Hershberg - Hershberg Capital Arthur Bechhoefer - Independent Investors Forum.

Good day and welcome to Energy Recovery's first quarter 2015 earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Joel Gay. Please go ahead..

Good afternoon, everyone, and welcome to Energy Recovery's earnings conference call for the first quarter of 2015. My name is Joel Gay, President and CEO of Energy Recovery. And I'm here today with our Chairman of the Board of Directors Mr. Hans Peter Michelet; and Corporate Controller and Chief Accounting Officer, Ms. Sharon Smith-Lenox.

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 opening remarks. HP, please go ahead..

Thank you, Joel. Good afternoon, everyone. My name is Hans Peter Michelet, Chairman of the Board of Directors. And I am joined by Mr. Joel Gay, our newly appointed President and Chief Executive Officer. I am pleased to say that we are fortunate to have Joel now taking the role of leading Energy Recovery forward.

We have searched high and low for the best CEO candidate possible. After careful considerations and multiple rounds of interviews with external candidates, it gives me great pleasure to know that we have been able to develop our next leader from within the organization itself.

As stated in our previous earnings call, Energy Recovery finds itself at one of the most exciting inflection points since the company's IPO. Years of elaborate research and development work is expected to start to yield financial results, something that Joel will elaborate further upon during his remarks.

Our continuous transformation from one-product company in seawater reverse osmosis to now selling multiple solutions in the oil and gas industry as well as specialty chemical industry is finally positioning the company for a long-term sustainable growth. I'll now turn the call over to Joel, who will provide a strategic and commercial update.

Joel, please go ahead..

Thank you, HP. I would first like to thank the Board of Directors and its Chairman for affording me the opportunity to continue my leadership of Energy Recovery, now as its CEO, through its next phase of evolution and growth. I'll begin with a brief analysis of our financial results.

The company generated healthy revenue and gross profit margins of $5.9 million and 57%, respectively, when considering the seasonality of our business, specifically desalination.

While the lion's share of revenue was generated through desalination sales, the company did recognize oil and gas revenue through the commissioning of an IsoGen turbo-generator system for a Saudi Aramco gas processing plant.

As compared to the first quarter of 2014, while revenue increased by $2 million, gross profit margins fell by 100 basis points on lower levels of production. The impact of operating leverage, however, was offset by a favorable shift in mix towards PXes, specifically within the OEM sales channel.

In the aggregate, product mix was 70%, 28% and 2% for PXes, pumps and turbos and oil and gas sales, respectively. The shift in mix coupled with the projected increase in OEM average transaction size for 2015 are indicators of a strengthening market, a subject that I will fully explore later in this call.

The impact of seasonally strong revenue and gross profitability was offset by OpEx, which ended at $11.4 million, representing a $5.4 million increase as compared to the first quarter of 2014. It is important to note that OpEx in the first quarter of 2014 benefited by $850,000 due to the booking of a Spanish-backed refund.

I will now unpack the current quarter's OpEx to provide greater clarity as to a normalized run rate as well as the impact of the austerity measures implemented in January of this year.

The company experienced approximately $3.4 million of non-recurring expenses relating to legal expenses, the CEO transition and the severance associated with the reduction in force executed in January.

In addition, R&D of approximately $700,000 was expensed in the first quarter relating to the completion of the VorTeq missile, expenses that were originally expected to have manifested in 2014.

Excluding non-recurring and delayed R&D expenses, the company's run rate of approximately $7 million per quarter reflects the impact of austerity and is the targeted level of investment.

In summary, on increased revenues, healthy gross margins and elevated OpEx due to non-recurring expenses, the company generated a net loss of $8.3 million or $0.16 per share as compared to a net loss of $3.7 million or $0.07 per share in the prior-year period.

Net cash flow generated of $4.9 million reflects the favorable impact of working capital, given the monetization of receivables capitalized in prior periods, as well as a conservative treasury strategy allowing for the maturation of marketable securities.

Excluding current and non-current restricted cash of $4.4 million, the company reported unrestricted cash of $20.4 million, short-term investments of $8.3 million and long-term investments of $0.3 million, all of which represent a combined total of $29 million.

Now, a commercial and strategic update on the company, beginning with an organizational update. To increase the rate of early adoption of our solutions into new markets such as oil and gas and chemical processing, I restructured the sales, marketing and engineering functions.

The first step here was the creation of a technical sales consultancy to act as the primary liaison for the commercial and technical constituents between the customer and Energy Recovery. This group was activated in January of this year and is executing accordingly.

Additionally, marketing and engineering have been combined into a single discipline to ensure that our positioning, product development, product management and pricing strategies align with the realities of the target markets.

To this end, we are well into the search process to identify a Vice President of Marketing and Technology to lead this new group. The selected individual will presents significant domain expertise and experience in the markets we seek to penetrate.

The sales operations have also been realigned by segment, ensuring peak focus on our core market, desalination, and emerging markets oil and gas and chemical processing.

Given the breadth of the market landscape, the nuances of the various verticals and the distinct go-to-market approaches required, I have formalized the corporate strategy practice, and will staff such with a Vice President of Corporate Strategy, reporting directly to me.

As with the Vice President of Marketing and Technology role, we are at an advanced stage of the search process, and the chosen individual will similarly present domain expertise and experience in our emerging market segments.

Lastly, the vacant CFO post, we are in the latter phases of the search process, and the company will select the best person for the job. One with whom I will partner in leading Energy Recovery forward.

While we will be diligent in our approach to filling all such vacancies, we are confident that we can move quickly and achieve a steady state staffing level of the executive leadership team. Now, progressing to a market segment update, beginning with desalination. In the fourth quarter of 2014, we observe signs of recovery in various geographies.

This trend has continued in the current year, resulting in strong order intake and an overall improvement in the current year and future period pipelines. This applicable to both the OEM and mega project sales channels.

While in the current quarter, we again experienced mega project shipment delays, against orders booked in 2014, totaling approximately $4 million, we expect these delayed revenues to be recognized in the second quarter of this year.

Furthermore, we anticipate announcing material mega project awards that are currently at a Letter of Intent status in the coming months, and a significant portion of these pending contracts are expected to ship this year. Desalination in 2014 was defined by uncertainty throughout nearly all of our key markets.

Given the overall strengthening of the pipeline, increasing order intake and the pending mega project contract awards, we are cautiously optimistic about desalination in 2015. Regarding our efforts in oil and gas, more specifically gas processing.

The fallout of the deflationary pricing environment has been well chronicled, and we face the same headwinds as all market participants. As a function of CapEx and OpEx reductions implemented by ConocoPhillips, the IsoBoost contract award announced in December of last year was recently canceled.

While disappointing, we were able to offset this setback with a major milestone. You will recall that during the 2014 yearend earnings call, I detailed a reloaded strategy through which we rationalized our markets and geographic focus, all to facilitate a bias towards execution and demonstrating results.

Gas processing remains our top market priority in 2015. And to this end, earlier this quarter, we were pleased to announce the commissioning of our first Energy Recovery device into oil and gas, an IsoGen turbo-generation system into a Saudi Aramco gas processing plant.

While the revenue associated with this installation was recognized in 2014, as both lease income and revenue attributed to the buyout of the lease, this was nonetheless a major milestone for our company.

It is evidence that we successfully developed, designed, delivered and installed nascent technology into a risk-averse industry throughout an elongated sales cycle, the sum of which is project execution, a prerequisite to commercial success in the oil and gas market.

We are optimistic that this proof point will bode well in terms of future opportunities with Saudi Aramco and beyond, as they emerge as a blue-chip customer reference. Our market penetration strategy of targeting both plants and strategic accounts, and running set opportunities through a stage-gate sales process continues.

And as and when quantifiably meaningful results are evident, they will be communicated to our investors. Chemical processing, specifically ammonia production is increasingly attractive and remains our second commercial priority in 2015.

While we only began a penetration effort earlier this year, the deflationary crude and natural gas pricing environment has resulted in increased demand for ammonia derivatives, such as fertilizer. And operators are beginning to enjoy CapEx and OpEx surpluses that could be allocated to cost efficiency solution, such as our IsoBoost.

Additionally, as compared to gas processing, a significant portion of the existing installed base of ammonia plants present pressure recovery technology in the form of power recovery turbines or more commonly reverse running pumps.

This is a key distinction, as we are not in the unenviable position of having to educate a large market as to merits of pressure energy recycling.

Similar to gas processing, we are focused on the Americas, triaging and profiling strategic accounts, and importantly identifying additional distribution channels beyond our own to include targeting the engineering or licensing firms that design the plants on behalf of the end-user.

We are early stage in our efforts and our structure to deliver results, potentially through a compressed timeline as compared to other verticals and markets of interest. On to our fracking initiatives, the VorTeq. Last month, we announced the initiation of field trials with our strategic partner Liberty Oilfield Services.

We expect these field trials to last six months and are fully prepared for a longer trial period to maximize the probability of success.

To provide some color, as to how we define success, we conducted hundreds of actual and simulative tests on prototype cartridges at our R&D facility, and achieved proof of concept as it relates to a single unit within a broad technical envelope for slick water applications.

The VorTeq missile is a complex aggregation of multiple cartridges that needs to be integrated into an equally complex process. Our objective is therefore to achieve proof of concept in the field with the VorTeq as an integrated component to a frac spread. Success will begin with the fracking of one well with our VorTeq solution.

The second generation design effort is underway and will be informed by our learnings in the field trials. Upon the completion of field trials, I would advise as to the commercialization timeline. We have and will continue to approach this process with the utmost diligence and meticulous attention to detail.

The development and introduction of the VorTeq represents not only a near-term opportunity in fracking, but an expansion of the utility of the PX to that of a pump versus solely an Energy Recovery device.

While the current market landscape presents ample opportunities for Energy Recovery, adding to such, the multiple applications, where the PX can be used as a pump in challenging processing of pumping environments suggest an even larger addressable market that can be monetized over time.

A major corporate objective for 2015 is to create a product development roadmap for the PX as pump, specifically within oil and gas applications. The various verticals will be identified.

They will sized and prioritized for future period development to ensure that we maintained a balance between executing against existing opportunities and developing potentially disruptive solutions for future commercialization. In summary, I am energized by the opportunities and challenges ahead.

I am pleased with the strategic and organizational changes made thus far, and I'm ever more confident in our strategy. That's concluded our prepared remarks. And we'll now open it up for questions..

[Operator Instructions] And we'll take our first question from David Rose with Wedbush Securities..

I had just a couple of items, so if we can go through them quickly. One is you referenced backlog and orders.

Can you give us a sense of whether backlog is up or down versus last year?.

Yes. We don't report on backlog, but I can tell you that it's up significantly..

And you don't call out awards, but you started to talk about awards.

So can you give us an idea of geography and science, just trying to understand where we should expect them?.

So David, there is a handful of mega project, desalination projects, that were here Q4 in future periods. For a number of reasons specific to each geography those projects had been accelerated. And we're noticing that trend in multiple locales. So we believe that that's a sign of the strengthening of the desalination market. You can look at mix.

You can look at average transaction side. It all bodes well for the company and the market in 2015. With respect to the projects that I mentioned, they are currently at a Letter of Intent status, only [technical difficulty] announce them we expect to convert those in the contracts in the coming months.

Let's give you a range anywhere from $10 million to $13 million of mega project contracts that we expect to announce..

So given what you see in the pipeline would you expect your desal revenues to be comparable or greater to the 2013 level?.

I won't speak to that directly, David, it's still early days. There is certainly that potential. What I can tell you is that we will be materially better than we were last year, which isn't saying much, I acknowledge that, but as to pegging the $42 million, $43 million mark, I think it's too early to say that.

What I can say is that backlog, as we measure it, is a positive indicator of things to come this year as are the forthcoming contracts. And so again, there is a high potential for significant out performance as compared to last year. Now, where it benchmarks with respect to some of the better years we've had, time will tell..

And then lastly, if I may now, then I'll jump back-in in the queue. Is on the operating expense line item, last quarter there were a number of similar non-recurring items relating to legal management transition. I believe some of that might have been Marketing Executive versus CEO.

Should we expect that again in the second quarter these, non-recurring items? And then aside from that, the second part of the question on the OpEx line item is, the implication on one end is your cutting significantly, which I applaud. The other side is that you're bringing more people on.

So how should we think about the balance between cost cutting and adding additional personnel?.

So I'll take the first part of it, David. At some point, expenses are no-longer non-recurring, because they keep hitting you every quarter. But we do consider these to be non-recurring expenses. The legal expenses that we incurred relate to the termination of our former SVP of Sales, the subject matter of which is privileged.

We booked about $1 million in the first quarter relating to the CEO transition, the accounting for the expenses with respect to the employment agreement. We do expect to book about another $1 million associated with that CEO transition in the second quarter.

And then the transition cost associated with the elimination of the CMO position, the marketing executive, those will similarly hit in the second quarter. Now, to your second question. There are two components to that. First of all, let's talk about our investment, our resource allocation strategy.

Indeed, we have created one new position, which is to say the Vice President of Corporate Strategy, but I view it as a zero-sum gain, David. We have offset those cost elsewhere, which is to say we are not adding cost to the detriment of our bottomline.

With respect to the Vice President of Marketing and Technology role, those functions were lead by two individuals. Now, that function is being led by a single individual. So there are some cost synergies there.

In terms of switching costs, you should expect some switching in recruitment costs to hit in the second quarter, assuming we can hire all such individuals, including the CFO, the VP of Marketing and Technology, as well as the VP of Corporate Strategy. So there will be some non-recurring expenses in the second quarter, as I outlined.

And just to recap that again, you're going to have about another $1 million associated with the CEO transition, about $300,000 associated with the CMO position elimination, and then haven't really quantified the impact of bringing on these new hires, but yes.

Does that answer your question David?.

Yes, that's a great answer.

So then just to really kind of round it up, so you were looking at $7 million run rate, then you would tack on those items that you mentioned to probably be kind of closer to the run rate you were in the first quarter?.

Yes, David. Exactly, that's a right way to think about it. That's how we see it today. As you know, we are in the field trials, and so far the costs that we're incurring in those field trials are right in line with our expectations.

So to the extent that we are targeting $28 million to $28.5 million, all of those expenses would be subsumed in that number. The other thing I will tell you, David, one of obviously our objectives is to at some point in the near future get to a breakeven point of profitability.

And here's how we think about that, and a lot of it depends upon the health of the desal market. And certainly, the extent to which we can bring forward purchase orders in new markets and generate revenue.

But we think about breakeven from the standpoint of $45 million in revenue, at a 62% gross margin and then that's how we arrive at that $28 million target in OpEx. So put it another way, to the extent that we exceed $28 million in OpEx, we would have to generate an incremental $1.6 million in revenue to generate $1 million in gross profit.

So that's the financial goal post, if you will that we've set up and that's what we're endeavoring towards..

We'll go next to Patrick Jobin with Credit Suisse..

This is Jennifer Ky on the line for Patrick.

I was just wondering if you could talk little bit more about the VorTeq, what are some of the announcements we should expect in line with the field trials? And are you guys talking to other pumpers, much interest like in the product?.

So I'll start with announcement on the VorTeq field trials. The simple answer is that there will not be any, until we conclude the field trials. The last thing we wan to do is create speculation without substance. And so the only substantive announcement that I can think of would be mission accomplished.

Meaning, we have proven the concept in the field, and we're therefore prepared to step in the commercialization. Now, from a industry interest standpoint as we expressed or communicated on our yearend earnings call, the response of the industry has been fantastic. I don't want to over-hyper, oversell it, but it's been great.

We are at varying levels of engagement with a broad sample of the industry, call it 70% to 80% of the global frac capacity has reached out to us at some point, since December 8. And we are taking them through the, call it, presale or presale familiarization process. I think the industry views this as potentially disruptive.

All of the orders of value creation, whether it'd would be reduced repair and maintenance, reduced excess capacity or certainly the potential to rethink how pumping or how fracking is done today.

But until we prove that this thing works in the field, it would be imperative for us to speculate too much as to what sort of a ramp up or take up we could expect upon commercialization..

And on the ammonia market, I think you mentioned that it's your second commercial priority for the -- what are you guys expecting for a ramp up in ammonia? And what's the interest like?.

So the interest in ammonia has been very, very strong. And as I stated in my prepared remarks, here is the key differentiation between ammonia and gas processing.

While the two processes, specifically the high pressure loops that you find within an ammonia plant or gas processing plant, while they are identical, the difference between gas processors and ammonia processors is that ammonia processors already are using pressure energy recovery technology in the form of a reverse running pump.

And so you can imagine that a pump running conventionally, which is to say, forward, is unreliable running forward. I mean pumps breakdown. There is a no meantime to failure. So when you run a pump in reverse that meantime to failure is even shorter, if you will.

So when you juxtapose the existing pumps with our IsoBoost technology, which has one rotating assembly, which is a turbocharger, the operators immediately understand that okay, first of all, this is a higher efficiency offering, okay.

A reverse running pump might operate at 50% efficiency, whereas a turbocharger has a theoretical efficiency of 81%, but practically closer to 70% to 75%. And so you have a gain in efficiency between the incumbent technology and our IsoBoost, but then you also have the added simplicity, and the increased reliability that could come about.

But again, I want to make sure its well known that we are still very, very early days in our commercialization effort, our penetration effort into ammonia, but it does appear that the tactical adoption timeline could be more compressed than what we've experienced in gas processing. So we're encouraged by that..

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

Firstly, just a clarification of the oil and gas revenue recognized during the quarter. I remember you [recalled the offering lease revenue from the same unit last year.

So what caused you to call on those revenue for the first quarter and whether you will have more revenue going forward?.

So the revenue recognized against that unit related to commissioning. So basically the bringing online of the units, so there is a daily commissioning rate that we embedded in all of our contracts. And so as part of the installation and commissioning process, we were able to generate some revenue..

But that unit was in service last year?.

No, that unit was not in service. That unit was only brought online in the first quarter of this year..

Regarding the MPD project delayed into second quarter, what exactly caused the delay? It has been delayed from fourth quarter last year into second quarter.

Is there any problem with that project?.

I wouldn't say there are problems with the project. The end user has experienced scheduling delays. Believe that is a project -- there are actually two projects, one for about $3.1 million and the other for about $900,000.

The larger project, I believe the plant is being built in India and the end user and the E&P have just not been able to synchronize their scheduling in project management, and so that's resulted in the delays. Obviously, it's frustrating to us, JinMing, but we do have line of sight visibility to a Q2 shipment.

Obviously, nothing is guaranteed, but I would assign a 90% probability to that shipping in the second quarter, both of the shipments, this $900,000 one as well as the $3.1 million..

Lastly, from me just regarding your build OpEx. Specifically, the legal expense happened during the last two quarters.

I mean, why it took so long in terms of expense and the -- just the way I've traveled on this, make sure I another big ticket for that item next quarter?.

All of the expenses that you're speaking to, the subject matter is privileged, JinMing, I can't speak to that. I can however, say that for the second quarter and third quarter we do expect a significant decrease in those non-recurring expenses that are legal related.

I can't tell you that we won't have any in the second quarter, but they will not be nearly as exorbitant as they have been in the past two quarters..

We'll go to Ken Hershberg with Hershberg Capital..

With the changes that are happening structurally last fall you hired David Barnes as Chief Sales Officer.

With all these changes, has his responsibilities changed?.

No, David remains focused with laser light precision on commercializing our products into oil and gas and chemical processing.

When I spoke to the sales force realignment that was to ensure that rather than having a shared service platform sort of approach to BD, we created a siloed very segment specific sales force and I think that's absolutely requisite. We don't want to take our eye off the ball in terms of desal.

We started as a water company, we remain a water company despite the fact that we have aspirations of becoming much more. And in terms of oil and gas and chemical processing, the challenges that we've experienced in achieving early adoption are well-known. And I want to ensure that our effort is as concentrated and as potent as possible.

And so by refocusing and realigning the sales force we believe that that puts us in a better position to play offense this year..

Let me ask you a question about the VorTeq too. You took receipt of the VorTeq last November. And the R&D date we were told was ready to roll, but its not like there has been some more testing and delays before it was put into the field.

What was the nature of the delays between when you took receipt between the time it went into the field?.

I wouldn't characterize them as delays, Ken. We're learning everyday that we're in the field. Just like we commissioned IsoGen turbogenerator over I think it was a six week period, the commissioning effort for the VorTeq was intensive. We are not shy about admitting that this is uncharted territory for us.

This is a new single technology, that again, we've proven the -- we've achieved proof of concept for a single cartridge in our lab, but when you aggregate 10 to 12 of these pressure exchangers on a 100,000 pound behemoth of a trailer and your began running up to 85, 90 barrels per minute at high pressure, the level of calibration required to ensure a successful test is very high.

And so I characterize our attention to detail is being meticulous and that's precisely what it was and what it remains. We were not going to and we will not succumb to artificial or expulsive deadlines. We initiated the field trials when we were comfortable with initiating the field trials..

So when you told us initially it was ready to roll, it wasn't really quite ready to roll, was it?.

No, it certainly was. It certainly was. The R&D process is iterative, so as we began working on the VorTeq and commissioning it, we may call inaudible and change a certain design feature, and we will continue to do that throughout the process, but if in fact it was ready to role..

Now, you talked about using the pressure exchangers as pumping devices.

This is the way its always been with the VorTeq? That's not a new thought, is it?.

Yes, of course. The VorTeq is our first foray into utilizing the PX as a pump. And when we first conceived that concept it only related to fracking.

The landscape of opportunities really didn't go beyond fracking, but now that we have a better appreciation for the aperture of the PX as a pump, it has identified or allowed us to identify a number of other very, very attractive market opportunities that we are going to begin to wet, flush out and size this year.

And as and when we're confident that those opportunities are viable for future product development, we will communicate that accordingly..

And those are totally different verticals right?.

Yes. They are totally different, and at a glance can very exciting, but if were early days in chemical processing then I don't know how to even describe how early stage we are in terms of identifying those markets, but it's part of our continual R&D mantra..

We'll go next to Arthur Bechhoefer with Independent Investors Forum..

My only question regards the desalination equipment and whether you're getting any additional interest, drought places like California, other than Carlsbad which I assume is moving along.

Are there any other projects that you know that might be interested in your stuff because I noticed in your recent announcements thee new orders were all to country and overseas?.

Yes, Arthur, first of all thanks for the question. The subject of desalination in the United States, more specifically, California requires a lot more time and we have here today, but I think everyone's aware of the height and level of sensitivity around the drought in Southwest United States.

There has been a inundation of articles, and just what is called the press on the matter, generally. We have been tracking over the last, call it, five to 10 years, 15 to 20 large scale desalination plants in California. Each year they are pushed out a year. And the regulatory and environmental lobby issues are very, very complex.

However, if we hearken back to some of our early experience and I'm thinking of the Perth plant in Australia, while not as politicize of an issue in Australia as it is here in California, the commissioning of that plant did resulted in immediate opening of the floodgate.

So while we do not anticipate a rash of demand in the context of new capital projects being led in California, after calls back comes online, we do believe that is a positive indicator and it will have a positive impact on desalination as a readily accepted solution to balancing out the supply issue that you have with fresh water here in the U.S.

and specifically in the Southwest..

And ladies and gentlemen, that does conclude our question-and-answer session. I'd now like to turn the call back over to management for any additional or closing remarks. End of Q&A.

No additional remarks. Thank you everyone for your attendance. Look forward to speaking to you in a quarter's time..

And ladies and gentlemen, once again that does conclude today's call. We do appreciate everyone's participation..