Good day, everyone, and welcome to the Energy Recovery's Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. And at this time I would like to turn the conference over to Chris Gannon, CFO. Please go ahead, sir.

Thank you. Good morning, everyone, and welcome to Energy Recovery's earnings conference call for the second quarter of 2016. My name is Chris Gannon, Chief Financial Officer, Energy Recovery, and I'm here today with our President and Chief Executive Officer, Mr. Joel Gay. To begin, some of our comments and responses to questions may contain forward-looking statements about market trends. The Company’s ability to achieve the milestones under the Schlumberger licensing agreement, future revenues under the Schlumberger licensing agreement, the Middle East IsoBoost purchase order, centrifugal product line licensing, growth expectations, cost structure, gross profit margins, new products and their performance, and business strategy, including strategic partnerships. 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 risks factors and uncertainties is contained in the reports that the Company files with the U.S. Securities and Exchange Commission, including our most recent Form 10-K filed on March 3, 2016. The Company assumes no obligation to update any forward-looking statements made during this call except as required by law. In addition some of our comments include certain non-GAAP financial measures, which do not reflect a comprehensive system of accounting. Generally a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either exclude or include amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP. Non-GAAP measures should be considered as a supplement to and not a substitute for or superior to financial…

Thank you, Chris. Consistent with the imperative of delivering quantifiably meaningful results across all operating segments. The second quarter’s performance was in line with management's expectations and further buttresses what we expect to be a landmark year financially and strategically. With total revenues of $13.2 million at a 68% gross margin, this quarter produced the most efficient financial performance of all second quarters in the company's history as it relates to gross margin and the second best second quarter in absolute gross profit dollars. That the first quarter of 2016 was similarly the most efficient first quarter in the company's history supports the observation of increasing momentum through disciplined execution. While total gross margins are listed to the recognition of the quarterly amortization of the $75 million exclusivity fee paid in conjunction with the VorTeq licensing agreement, product gross margins alone of 65% again confirm that was sufficient volume, gross margins in the low 60’s are consistently sustainable. Importantly the quarter’s performance is an encouraging microcosm of the profit potential of the enterprise and its notable progress toward our goal of first breakeven probability and ultimately profit levels that support premium risk adjusted returns for our shareholders. Now for an update on our progress against the four imperatives that comprise our long-term corporate strategy namely, one, to establish and drive growth in the PX as a pump market beginning with the commercialization of our VorTeq technology. Two, to create a rapid-fire innovation machine, resulting in the achievement of proof-of-concept of one derivative of the pressure exchanger every 24 months annually. Three, to enhance our market position in desalination, through the expansion of our product and service offering. And four, to monetize our centrifugal product line, IsoBoost and IsoGen, through alternative commercial vehicles. Let's begin with an update on our VorTeq…

Thank you. [Operator Instructions] We'll take our first question from Brian Uhlmer with GMP Securities.

Good morning, gentlemen. How are you?

Good morning, Brian.

Very eloquent and thoughtful monologue. Joel I appreciate that.

Thank you, Brian.

I was curious after running through this battery of tests which Schlumberger. Can you walk us through the machinations of the process for commercialization and so much as how you go from Sugarland to Oklahoma? And then back to Sugarland or how you identify the tough subject there, the second milestone. And then from there how we go to commercialization will the original VorTeq be unit one out in the field operational and kind of just walk through the steps.

Okay. So let me provide some more context as to exactly what we've been doing over the last 100 days obviously without disclosing anything that would be considered confidential. Both teams designed a set of tests that were to ensure that the functionality of the VorTeq in practice matched the theoretical design. Now the first thing that needs to be understood and appreciated is we are dealing with an entirely new product as compared to that which we utilized during the field testing with liberty namely the Gen-2 cartridge which of course is powered by an electrical motor. That introduces a level of complexity that requires diligent design and diligent testing to ensure that of course again it operates in a manner that it was originally designed to. That’s number one. Number two, we've been working with Schlumberger to further improve the mixing performance of the VorTeq. And as you know within our pressure exchangers the way that hydraulic energy is transferred is on a fluid to fluid basis. So the two fluids actually come into contact and there is a de minimis amount of mixing within desalination that’s typically anywhere 4% to 5%, sometimes less. What we've managed to do with Schlumberger is drive that down to less than one-tenth of 1%, which is to say 10 basis points. So in addition to shaking down the system and getting the electrical componentry and the entire system to work, we've also worked toward further optimizing the performance of the VorTeq to a level that was previously thought to be unachievable. Now with respect to what's on the critical path. Clearly, we're still in Sugarland. And there are number of tests that we have yet to perform. Once those tests are completed, we will mobilize for the Oklahoma test. The mobilization…

No, no. That was great. Would you foresee them beginning to start manufacturing more trailers and getting ready for your product after milestone one. So it can be prepared to take on more or would you think that they’d wait till after the field trial and how would that ramp occur.

I am loath to what speak on what their supply chain plans are. All I can tell you is they are very encouraged by the progress we've made and they are equally committed to seeing this thing through. Obviously a successful milestone one test, begets higher levels of confidence and obviously a successful milestone two test would signify the earliest phases of commercialization and their supply chain would have to respond in kind, but I don't want to speculate on what they're thinking right now.

Okay. Second thing obviously there's been some negative commentary about some suits and your ability to sell into the energy market and without bringing those you're going to detail on those. I was curious how the – I guess I'm not supposed to say Aramco the contract with this big hydrocarbon producer. How the sales process shifted and how that arrangement came to pass and also how that benefits you in disproving your critics.

Yes, okay. Well, I can’t remember the name of that movie. I believe it was signs and there was a color that we do not speak of. So we – yes, there is certainly a lot of detractors. I mean Brian, if this management team had $1 for every road scholar who thought it was a good idea to sort the stock then we would be a lot wealthier than we are. With respect to the sales order, the purchase order with this large producer of hydrocarbons in the GCC. What we're focused on right now is mobilizing to deliver that product. I stated in my prepared remarks that we could recognize revenue against that purchase order as early as the fourth quarter of this year. And the scope of work that we've taken on there is much more expensive than what we have in the past certainly within our limited experience in oil and gas and then even in desalination which is to say its an EPC styled scope of work. So we are actually delivering the solution [indiscernible] Eric Siebert, our VP of Corporate Strategy and emerging market sales is leading that effort. So we're first and foremost focused on that with respect to other prospects our opportunities for purchase order generation in 2016, of course, we have an active pipeline of opportunities in leads and we're working diligently to convert those in to purchase orders. What we're not going to do and the history here Brian what we're not going to do is speculate on the timing of those purchase orders. When they manifest in a letter of award, we will announce and when we convert that letter of award into our purchase order similarly we will announce.

Okay, perfect. Well, I'll turn it over and see if anyone else is in the queue. Thanks a lot, Joel.

Hi, thanks.

Our next question comes from Patrick Jobin with Credit Suisse.

Hey, good morning. Thanks for taking the question.

Good morning, Patrick.

Let me ask the questions maybe a little bit different way. So on the milestone achievement, can you delineate what's different between the tests that you've done in the last 100 days and what you have to satisfy from milestone one.

Yes, well, that the main delineation between what we're doing in Sugarland and what we'll do in Oklahoma is the rate of flow. We can't run any more than let's say 20 to 25 barrels a minute in Sugarland and then that’s a tremendous amount of fluid. And of course associated prop and if in fact you're running a dirty test. That you have to cool, cleanse, filter, dispose of, et cetera. So from a volumetric throughput there are real limitation as to what we can do in Sugarland. So Sugarland you can consider it Patrick to be a microcosm of what will do in Kellyville, where we will be pushing anywhere from 60 to 66 barrels a minute throughout the five stages.

And a few more small questions here. Thanks for entertaining them. Is the less than one-tenth of 1% of mixing satisfactory within the commercial agreement for milestone one and milestone two.

Yes, it exceeds that.

Great. And then the other question is related to the minimum adoption curve. If you successfully complete milestone one and milestone two this year which it seems like you're pretty confident you can and the first commercial unit is up and running by the end of June 2017. From a 12-month standpoint after that, can you walk us through what the minimum adoption curve calls for in the contract?

Yes. Patrick, we have not disclosed what those adoption rates are per annum. I can tell you that upon achieving milestone two not only what we disclosed the minimum adoption rates, but we will also disclose the step up in royalty once we transition over to the new pumping model, but as we have guided in the past for the purposes of building out your models a linear assumption of 20% per year over five years to get to 100% penetration will not skew your model. But again, we will disclose the precise adoption rate once we have achieved milestone two. Because I think it's not a speculative if you will.

That's helpful. Sorry two last questions, one the IsoBoost contract. Can you talk about the payback that is envision from the customer you've given some energy metrics that we found interesting. And then separately on the core water desalination market, can you talk about your current revenue or growth expectations in 2016 or 2017.

Sure, Patrick. So yes, the economics around the IsoBoost order that we recently announced you're looking at a payback period conservatively of 1.5 years. And that has everything to do with the level of energy or degree of energy density that will exist in the plant. This is going to be a massive plant therefore you're going to have high flows within the mean loop which is the cleansing mechanism as such that allows you to sweet and sour gas so you could have really, really high flows relatively high pressure differential the combination of which is energy density which means that in essence we are recycling more energy than that would be otherwise wasted and it allows us to get to a very attractive payback of 1.5 years. Now with respect to our prospects, our outlook for desalination in 2015, let's start there, in my prepared comments I described that market as a bull market climbing to peak. And I think Patrick that the market will peak in 2017 as you know desal has gone anywhere from a three to five year cycle and there are myriad factors that ultimately dictate how, why and when there is growth at the big table within global desalination and you have to look at it on a regional basis. But certainly for 2016 as evidenced by the – gosh, $14 million, $15 million in announcements that we’ve made in 2016. We're very bullish on desal specifically within the large scale capital projects segment of the market. Our OEM channel is also doing exceptionally well as you know we don't measure market share within OEM rather win rate, our win rate is on the rise as compared to let's just say the last couple of years. And then our aftermarket rather sales in aftermarket sales channel is doing very, very well. I would submit that both OEM and aftermarket aren't paced to have record years and then NPD will have one of the stronger years that we've had in the past. With respect to 2017, while we do not report backlog we have issued press releases on a few very large orders where we indicated that the shipment would occur in 2017 and therefore the revenue would be recognized in 2017. And we continue to see that level of bid activity and sales order, purchase order acquisition activity as a very positive indicator. In addition to the continued shift toward pressure exchangers away from pumps and turbos both as a function of mix within each channel and more importantly as a function towards channel mix which is to say a greater degree of megaprojects as opposed to OEM opportunities and of course an increasing average sales order size. So yes, I mean we're bullish on the these opportunities for 2016 and 2017 is looking pretty good, as well.

Okay, so you're still comfortable revenue level within and do you sell comparable to 2015 if not perhaps a little bit higher for 2016 and then growth into 2017?

That's correct.

Right. Thanks very much, guys.

Thanks, Patrick.

Our next question comes from Tom Curran with FBR Capital Markets.

Good morning, guys.

Good morning Tom, welcome.

Thank you. Thank you. Good to be on board. Sticking with our desal market, Chris hopefully this will be a relatively straightforward housekeeping one for you. Could you share with us what OEM and aftermarket where as a percentage of water revenues for both 2Q in the first half of 2016?

We sure will. In terms of OEM as a percentage, it was for the – so far in general it was in Q1, it was roughly 75% was OEM.

Okay.

And the other was roughly say, 20%.

So 1Q was 75% OEM, 20% aftermarket.

Well, it was roughly 10% aftermarket.

Okay.

And then in Q2, you had roughly let’s see roughly 60% was OEM and roughly 30% was aftermarket.

And so it sounded as if you've become even more confident on the NPD award flow we should see from now through when this up cycle crests. Could you speak to where specifically you’re starting to see some of those projects move forward and had there been any surprises with regards to the award flow that starting materialized either in terms of the regions or the nature of the projects involved?

No. So in terms of the regions where we see the greatest amount of velocity, it would be Middle East, North Africa, which has traditionally been one of our stronger regions. A couple of factors there: number one, they are the most water-starved economies despite the fact having maybe the greatest investment in desalination technology and infrastructure over the last 15 years. And then number two, those economies, specifically the Middle East, have enjoyed very or let’s just say comparably or comparatively healthy GDP by virtue of hydrocarbon exports. So that region continues to be very strong for us. There has been a slight uptick in India and China in particular as the Indian political or let’s just call it political economy has stabilized and municipal contracting has become a bit more efficient and fluid. And then we are beginning to actually see some interesting activity in South America, which has been somewhat dormant for the last three to four years but we’re starting to see some activity in South America, as well in particular as we think about projects that will come to the bid table in 2017, as well as 2018. So no surprises as to where demand is manifesting and how it’s how coming to form.

Okay. Thank you for that. And then shifting gears back to oil and gas, Joel, with the effort underway in the other focal geographic market, North America, given where you’re at this point in the exploratory discussions you’re having with potential strategic partners for both gas processing and pipelines. What type of commercial vehicle at this point seems as if it – it's most likely to be the first form of monetization. And then based on where talks are at this point, what’s the earliest we might see the first letter of award or some other form of early indication of a potential monetization in North America.

Okay. So let's start with our business model of preference that would of course be licensing and I've spoken to that on prior calls given that I do see this Company's business model evolving much more into a hybrid leaning more toward a licenser of technology as opposed to a direct seller of technology. So our first choice would always be a licensing agreement. Moreover one that would mirror what we did with Schlumberger, now that’s probably not in the cards for that product portfolio but we are evaluating whether it's a licensing agreement exclusive, non-exclusive, it could be a joint venture. There are a number of different forms that the agreement could take. So that's number one. Number two in terms of timing that I'm not going to speak to you, I never do. When we have something in hand when an agreement has been consummated, we will announce that agreement and we will market that agreement accordingly. But an agreement would predate depending upon the business model employed, an agreement would predate any purchase order. Let us say so, as you think about the linear sequence, we'll conclude our due diligence and negotiations if you will at some point. We will then consummate an agreement of some sort, we will announce that agreement and then the two parties will set forth to monetize the technology through whatever the operating plan maybe.

Okay. Look forward to it. I'll get back into queue. Thanks guys.

All right, thanks.

[Operator Instructions] Our next question comes from Laurence Alexander with Jefferies.

Good morning. Couple of things, for the chemical and related industry applications that you are looking to expand into. Are you going to be here to take the data from the first trial and share towards your customer, is your trial partner going to view that data to some degree proprietary?

Okay. How is it going Lawrence? Its great to talk to you again. Let me try and answer that question. So when we think about chemical processing we're currently developing one vertical and that would be ammonia. It just so happens that the CO2 removal process that you find within gas prophecy is identical to that, which you find within the production of ammonia. And so to the extent that we utilize the IsoBoost installation that we expect to again begin recognizing revenue again as early as the fourth quarter of this year and into 2017. To the extent that we utilize that massive installation of multiple units as a reference point then yes we should be able to leverage that immediately into chemical processing most specifically ammonia because they are almost a perfect analog as you think about the actual process by which gas is sweetened and ammonia is produced.

And then I guess in a similar way can you elaborate a little bit on what you need to get in place to start a trial project on a pipeline application?

Yes. We're working on that. I believe as I stated in previous calls Laurence the pipeline market from an engineering perspective and from a pressure energy arbitrage perspective its probably the most fascinating of all the verticals that we're attempting to develop. Concurrently it is also the most regulated and there are some – there are very, very high hurdles in particular as you think about North America to – in essence base load power generating and tapping into someone's pipeline to do so. So we are focused on the pipeline of opportunities in the GCC, we are focused on pipeline opportunities within Saudi Aramco frankly. And I would submit that whenever the initial pilot installation occurs it will be in the Middle East.

And probably a little bit of far afield, I mean I'm probably wrong on this but is there a potential application in marine and what I'm thinking if there is either LPG, LNG those kinds of applications?

Yes – as you think about our product development roadmap potential areas for development. Do contemplate LNG applications.

Okay, thank you.

Our next question comes from Robert Smith with Center for Performance Investing.

Thanks for taking my question. Can you hear me?

Can, Robert, good morning.

All right. So first the $11 million IsoBoost order is that all in, I mean is that the amount of revenue that you would expect to take in from the shipment in late this year and into 2017?

No. So the range on the purchase order is $7 million to $11 million and we will begin recognizing the revenue. Chris you want to talk about how we expect to recognize the revenue?

Yes, we're doing a percentage of completion revenue recognition over time. Joel mentioned that we'll start recognizing that revenue in Q4 of this year. And then it will proceed through the remainder of next year. When and which will deliver the units and have them installed. The key there is that right now we're focused on $7 million to $11 million. The $11 million will be based on change orders or additional equipment that may be necessary as we move forward.

Okay. Joe you mentioned in 2017 there’d be at least one new area – derivative area if could you give some ideas to the market size of that area?

No, to be so blunt. As you know our one of – the imperative that I was providing an update on was the objective of taking a product from a concept to proof-of-concept at a 24 month cycle. We began that process in earnest January and we do appear to be ahead of schedule as it relates to a few of the concepts that are currently being funded. And so what I said was we now believe that we will be in a position to announce a new technology in 2017. And when we announce that technology we will provide the appropriate market sizing segmentation technology characterization and what not. For me to speculate on that right now would be imprudent.

I wouldn't want it being imprudent. What is the temper of the present publicity about Carlsbad at this points, the Carlsbad Desal Project?

From what I've been able to ascertain at least within the industry and I guess that’s more or less preaching to the choir Carlsbad has been a smashing success ever since it was brought online. Now the assault from the environmental last in California will never stop. They will continue to assail that product – that project and they'll continue to assail desalination as a means of providing potable and usable water. So technologically the plant is producing wealth based on my understanding and certainly our pressure exchangers are performing to spec.

Finally, so I haven’t heard China or the or the Chinese potential you mentioned today and I was wondering what is the opportunity in China in both areas and what about IP protection?

So across all segments, China is one of the few ascendant economies globally and everyone understands that. The water prospects are very bright part and parcel to their five and 10 year plans, programs, there are specific mandates or dictates whereby they have to let's say increase total desalination capacity by 400% by a certain date. The timing of all of that is always suspect but we're certainly long on China as it relates to desalination opportunities in particular if you think about the water energy nexus and the rate of population growth that China has experienced. Within oil and gas in the long run you will find that China is in fact for hydraulic fracturing remains as the pre-eminent profits whereby you extract hydrocarbons from shale formations. You will find that China has some of the largest or the greatest reserves of hydrocarbons caught in shale in the world. They’re just not currently being produced at this point in time but over the let’s just say the next seven to 15 years, I think you’ll see a real shift in the demand curve in China with respect to pressure pumping and hydraulic fracturing. With respect to petrochem as relates to our company specifically the production of ammonia, China ironically is not a good market for us. Simply because the way they produce ammonia is through a process known as gasification versus CO2 removal which is utilizing a liquid where you’re pressurizing and then you are depressurizing it. So there’s an opportunity for arbitrage for us. Gasification does not provide that opportunity. And so until – gasification utilizes coal as the feedstock to produce ammonia versus natural gas. So within ammonia China does not appear to be a target rich environment for us again just based on that technical distinction.

And as far as viability of working in that market with IP do you feel you could be comfortable?

Yes, we feel very comfortable. Our IP is robust and we prosecute our patents vigorously and we protect our intellectual property vigorously. As we stated in the past above and beyond the claims enumerated in our portfolio of patents what’s most prohibitive as it relates to the pressure exchangers and derivatives of the pressure exchanger Robert are our trade secrets namely our ability to achieve very, very finite manufacturing tolerances plus or minus five micron. And so the wealth of knowledge that we’ve amassed here over the last 20 years in concert with the aforementioned claims in the IP position us well to compete in any market whether it’s China, Russia, Middle East or what have you.

Wonderful thanks so much for your great progress and the clarity in which you make your presentation.

You welcome, Robert. We appreciate your investments.

And there are no further questions at this time. So that does conclude today’s presentation. Thank you for your participation. And you may now disconnect.