Good day ladies and gentlemen and welcome to the Energy Recovery's Year-End 2016 Earnings Conference Call. Please note today's conference is being recorded. At this time, I would like to turn the conference over to Chris Gannon. Please go ahead.

Good morning, everyone, and welcome to Energy Recovery's earnings conference call for the fiscal year and fourth quarter of 2016. My name is Chris Gannon, Chief Financial Officer of Energy Recovery, and I'm here today with our President and Chief Executive Officer, Mr. Joel Gay. During today’s call, we may make projections or other forward-looking statements under the safe harbor provisions contained in the U.S. Private Securities Litigation Reform Act regarding future events of the future financial performance of the company. These statements may discuss our business, economic, and market outlook, the company’s ability to achieve the milestones under the VorTeq licensing agreement, growth expectations, gross profit margins, new products and their performance, cost structure and business strategy. Forward-looking statements are based on information currently available to us and on management's beliefs, assumptions, estimates, or projections. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties, and other factors. We refer you to the company’s documents filed with the Securities and Exchange Commission specifically the company’s Form 10-K and 10-Q. These documents identify important factors that could cause actual results to defer materially from those contained in our projections or forward-looking statements. All statements made during this call are made only as of today 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. We will make references to non-GAAP financial measures during this call. You will find supplemental data in the company’s earnings press release filed with the SEC, which includes reconciliations of the non-GAAP measures to the comparable GAAP results. Now turning to the financials, I will begin with a brief analysis of our financial results on a consolidated basis. I will then turn…

Thank you, Chris. 2016 was the first time in nearly a decade where the company made significant progress towards the achievement and realization of its long-term strategy whilst generating positive net income. In this 2016 was a year of notable record. We generated record total revenues of nearly $55 million, thereby establishing a new high watermark since our IPO In 2008. We generated record revenues in our oil and gas segment thereby creating economic substance to our market diversification strategy. We generated record full-year total gross margins of 67.4%, thereby demonstrating the pricing power that our prohibited shared was in the globally desalination market upwards, as well as the benefit of our manufacturing process that yields pressure exchanger contribution margins in excess of 90%. We’ve produced record gross profit margins for four consecutive quarters thereby demonstrating our performance, as a harbinger of things to come versus an aberration. We produced record full-year gross profit demonstrating the scaling potential of our business model. The company's long-term strategy departed from a comprehensive operational and strategic turnaround effort initiated in January 2015. Two years ago, almost to the date, I led the 2014 year-end call as the then Interim CEO and in doing so reported financial results for one of the worst performances in the company's history. This, a year in which we generated earnings per share and earnings per share loss of $0.36 against $0.30 million in revenue. During that call, I enumerated a multi-faceted turnaround program consisting of the implementation of austerity measure, the rationalization of our market development effort, the reallocation of capital invested in ill-stated demand generation activities, the structured and economic value added in R&D activities, and finally, the rehabilitation and positioning of our desalination business as with CashCall Enterprise upon high-value growth initiatives. I also stated the…

Thank you. [Operator Instructions] Our first question will come from Laurence Alexander with Jefferies.

Hi good morning. This is actually [indiscernible] on for Laurence. How are you?

Good, how are you doing?

Good. So with you going to the third generation of the VorTeq and the second generation missile, and third generation for the pressure exchanges would that just - the milestone payments are probably more likely towards the end of the year or I mean is there any color within the year on how you can tell me about this?

Sure. As you know we stayed clear from providing quarterly guidance on when so-called catalyst events or to occur just based on the many variables that are frankly outside of our control, but given that we are amidst the design process of the missiles and well into the design and testing process of the cartridge and we are already in March, if you examine the lead times associated not only with design, but with manufacturing, a safe bet would be the second half of the year, where we would attempt the first milestone.

Okay. And then - I understand when you are coming with the different - or going to next-generation for VorTeq, but you do have a pretty strong balance sheet, I mean are there other opportunities outside of which are working right here that you are looking at and moving to adjacencies or you are just going to stick to what you are working on now?

No. Well that’s a great question and I had spent some time addressing that in the prepared remarks. We are going to be announcing a new product here in 2017, which is a direct offshoot or a derivative of the VorTeq for an oil and gas application, which is to say, this is a product that will be utilized as a sacrificial barrier between existing pumping infrastructure and a hostile process fluid. We are currently in the process now of refining our marketing plan, finalizing a few points on our go to market strategy and we are well into the corporate development effort as well. And so as and when we check all the boxes that need to be checked both commercially and technically, we will announce that product here in 2017. But that’s only one of several very exciting technology initiatives that we have going on in the company and this frankly harkens back to the commentary that I offered in my prepared remarks around the so-called binary investment thesis. Energy recovery is much more than simply desalination technology provider, much more than a GAAP processing provider, much more than a hydraulic fracturing technology provider. We have solutions and projects that we are currently funding against a number of applications where one finds very high rates of fluid flow, very large pressure differentials and in high spending in the form of pumps. So, from a corporate objective standpoint, our goal is to announce one product each year begetting in 2017, we are certainly on track to do that. We’re excited to do that and then come 2018, 2019 we expect to maintain the same cadence.

With this next product that you are expected to announce this year, will it be more along the lines of VorTeq where some of the licensing agreement with milestone payments or is it more like based on IsoBoost where you get kind of providing in an as you go along and you recognize revenue as it develops?

Yes. Great question. So, one of the primary pivots that we made back in 2015 was to evolve the business model to more of a hybrid of a direct seller of technology in the licensor technology. So, one hand with our establishment indeed, mature desalination business where we have a well grown distribution channel, we are able to take our products to market quite efficiently and generate mediocre gross profit margins as evidence in the financial statements. Conversely what we are looking to penetrate at new industries, markets, and verticals such as oil and gas more over the upstream, midstream, downstream where we don't have brand equity, the most efficient way for us to take our technology is through a channel partnership and the specific business model would be that of a licensing business model. We were able to do that with the VorTeq, a licensing business model is our preferred mode to attack a market and so it is our intention as it relates to this new product based on the success of fuel validation and field trials, it is certainly our intention to license that technology out, but step one and it is like I said to dot all the I’s and cross all the T’s both commercially and technically, which we are doing right now. Step two is to announce the products. Step three is to announce an early stage partnership, namely the vehicle through which we can take this new technology into the oil patch and achieve validation. And then step four would be a later stage partnership that could look like, what we did with [indiscernible] or could look entirely different.

Okay. Thank you for the color.

Thank you. Our next question will come from [indiscernible] with Coker Palmer Institutional.

Hi guys thanks for taking the questions. First off, can you give a little more specific on the timing of the first milestone, exactly what’s the process line in sale, what we can understand a little bit better in the stages getting to that actual first amount of debt?

Okay. I mean I will give you a high level view of the credit compares rate. So back in December when we concluded testing with the prototype missile, we spent about 45 to 60 days analyzing the data, from the entirety of 2016; frankly not just the last is that we did. That data and analysis process leant to or lead to what’s known as a design specification. So, the design specification is simply the parameters through which the new missile need be designed and ultimately manufactured. And obviously we’re focused on reliability and structural integrity as it relates to allowing our pressure exchangers to perform in a manner that’s been keeping with the commercialization standard as enumerated or as detailed in the contract with our product licensee. So, we have rendered that design specification to a third-party manufacturer and we are in the process or we are in the design process. Once the design process is completed, we will then manufacture the missile. Once the missile has been manufactured, we will equip it with the third generation equipment housing and third-generation cartridge. We will then commission and test the entire system and at that point we will, if things are going the way they should, at that point we would schedule the first milestone test.

All right, understood. And then, let's say on the new product side if you are focusing on oil and gas, still here, what about the timing there as far as, I don't know what you can see is the potential new contract and then how much - what kind of runway we have ahead of us, we’d be looking forward in terms of catalyst on our side to stage the development there?

Yes, I mean, I’m certainly, some good lessons learned in 2016 trade with respect to how long things can take to develop and commercialize with new oil patch. So, I'm certainly not going to get over my fees and speculate as to a monetization event for this new technology. As and when we announce it, and as and when we announce it an early-stage partnership, we’ll be in a much better position to guide as to when that next catalyst would be.

Understood. Okay. Also in the oil field we are seeing a lot of tightness in labor that’s impacting in pressure pumping guys, as they are trying to give up with [indiscernible] activity cranking up a little bit, are you all seeing any impact there on labor supply, whether getting it the way on the supply side, or anything that might impact you’re ramping up down the line?

Yes, I mean, obviously, we're quite excited to see the recent ramp up in completions activity, and in particular, in West Texas. And what that could ultimately equate to for us would be some sort of a bottleneck in the supply chain, given that we are outsourcing both the design and manufacturing of the missile. So, obviously, there's a degree of supply chain risk, as it relates to timing, which is why when responding to the questions from Laurence’s colleague, I said, latter half of the year is when we would expect to get back out there and attempt the first milestone, but the supply chain partners that we're working with have assured us that this project will be prioritized. And so based on the facts and circumstances today, I do not see the ramp up or increase in completion of the activity and result in supply chain bottlenecks or crunches as adversely impacting our critical path toward milestone success in 2017.

All right. Thanks. That will do it for me for now.

Hey, thanks.

Thank you. [Operator Instructions] Our next question will come from Mark Kelley with FBR & Company.

Hi, guys. Thanks for taking my question. Can you discuss any further updates on efforts to break into the pipeline markets and either in the Middle East or North America?

Yes. Well, let's start with the easy one, North America. We're not currently developing any leaves either in North America or South America, as it relates to the pipeline market. As I believe, I shared on prior calls, there are too many, let's just say, that there are too many regulatory hurdles and those hurdles are frankly too high as it relates to consummating what I know the cogeneration agreements with the various utilities that adjudicates the provision of power to either industry or the consumer base. We certainly are developing leads within the Middle East for a number of reasons, not the least of which, the lack of regulation or the regulatory environment that you find certainly from an environmental standpoint in the Middle East. And as we've been quite public in instating, the biggest target for us is within the Kingdom of Saudi Arabia, both specifically within Saudi Aramco. They have the largest pipelines. They are conveying the greatest volume of hydrocarbons. And so, when you have a large pipeline that convey great volumes of hydrocarbons across great distances, what that all equates to is energy density and the opportunity for us to convert that otherwise wasted energy density into electricity. So, I don't know when we're going to strike first blood in that market. It could be in 2017, but the sales cycle is much more elongated for that specific application, as compared to our IsoBoost application in the context of other gas processing plant or ammonia facility. Now, having said all of that, let's get back to a few statements that I made in the prepared remarks, it is not our intention to continue to directly sell either IsoBoost or IsoGen indefinitely. We have been working quite diligently to identify a channel partner with whom we could work to more rapidly speed the market with both IsoBoost and IsoGen, specifically we’re seeking to take advantage of the brand equity that they have in the midstream and more importantly the distribution that they have - distribution channel that they have in the midstream in the form of master services agreement, vendor approvals, and so on so forth. And so as I said it in my call, we believe we’re close to consummating a partnership for IsoBoost and IsoGen in both gas processing and pipelines, and as and when that agreement is consummated we’ll announced it accordingly. But generally from a strategy standpoint you should not expect energy recovery to continue to directly sell those products into those markets indefinitely.

Great, thanks so much.

Thank you.

Thank you. Our next question will come from [indiscernible] WDH Capital.

Yes, hi, thanks for the call. I have a follow-up question on the next gen missile for oil and gas. Is the Schlumberger engineers working directly with your people to optimize the missile design or is this an effort 100% in-house, particularly after acquiring Cooper and Cameron I firmly had extensive knowledge and expertise in pump systems that you could take advantage of?

Yes, look great question. So, let's first start with our contractual obligation that it is energy recoveries obligation to furnish and supply a missile through which the milestone test will be pursued and eventually achieved that is not the product licensees responsibility that is our responsibility. Now, so therefore we are funding the design and manufacturing of the second generation system. We are providing the technical leadership that is required to do so, but we will be relying very heavily on the third party manufacturer and that manufacturer is a world class entity that's well known throughout oil and gas we're not going to disclose who that is for, I think quite obvious reasons. Now the larger or the broader question would be to what extent are we cooperating and working with the product licensee. The answer to that is, very closely. We view the relationship as very, very positive and they have been nothing, but supportive.

Okay have hired a number of structural engineers yourself in the six months for mechanical or with expertise in this business or area?

Yes, sure. Yes we've increased our engineering headcount by probably a dozen in the last 14, 15 months; a number of those individuals are of course PhD grade engineers, mechanical engineers, aerodynamicists, astrophysicists all of whom are very well versed in structural dynamics and model dynamics, but again we don't we don't represent the company to be on it - in all aspects of engineering, and so when we need to tap into outside resources to you know validating a given concept or validate a given design modification we do so. And again as it relates to the structural integrity of the missile itself, we will be relying very heavily on our third party manufacturing partner.

Got you. Okay, I appreciate it. Thank you.

Okay. Thank you.

We’ll take a follow-up [indiscernible].

Yes, one other quick one, you mentioned the third gen pressure exchanger or the missile, can you give a more specific on how that’s going to defer, what’s being done to address the issues your thought previous testing how you might understand it from a finance guys perspective?

Okay sure. Well let’s establish a premise or not even a premises let’s establish a fact. The Gen 2 pressure exchanger in certain environments works spectacularly well such as here at our R&D facility, across a number of flows and pressure ranges it works quite well. In the field we've seen it work quite well, as I stated on previous calls the challenges that we encountered where when we attempted to scale up to the required flow rate and to get all of the pressure exchangers to work in unit set. So, on an individual basis or a singular basis, the Gen 2 pressure exchanger is fit for purpose. Now, we could have taken the design across the philosophy that we would sit back and wait for the perfect missile that God himself or God herself would have designed. That would be a bit intellectually lazy in our estimate. So, we're attacking this from both ends. Number one, we are seeking the design, the best missile specifically a missile that can insulate the pressure exchangers to the fullest extent, but at the same time, Tray [ph] we are designing a third generation cartridge that is as impervious to its environment, or is impervious to exogenous forces as possible, all with a central focus on the liability. I don't want to get into the technical specifics, as to how the third generation cartridge differs from the second generation cartridge, but again, we want to make it more reliable and less susceptible to its environment.

Well speaking at a high level then, is it more about the fluid layer, the membrane here addressing how that works with vibrations you are seeing on a missile with several cartridges working at once?

Yes. So at a high level, the objective is to create a design that allows the rotor. There's one rotating element in our design or offering to create a design that ensures that that rotor is always spinning, and that is a function of the bearings, if you will, in our technology.

Is that still fluid [indiscernible]?

Like I said, I don't want to get into the specifics, in particular, as we’re spawning intellectual property. You need a bearing in the technology to allow us to rotate, and that's what we're focused on.

Okay, understood. Thanks.

Thank you, Tray [ph].

Thank you. Our next question will come from Robert Smith with Center for Performance Investing.

Hi, good morning and thanks for taking my questions. Joel, are you dealing with mainly a quick question of - problem of science and physics, or engineering with VorTeq?

Yes, it’s a good question Robert, and great to hear for you. It’s been a few quarters since we spoke. No, we are not up against the laws of physics, right. You cannot defy the laws of physics. Some would argue that you could bend them, but we're not anywhere near the point, where we're trying to litigate an argument with Isaac Newton. This is an engineering challenge. This is an engineering issue, and we feel that we're well-equipped with our supply chain partner, as well as the wealth of expert that we have here in the company to overcome these challenges, okay. And the other thing is just from a - having a bit of perspective, we have demonstrated a lot of progress and promise in this technology. We've already delivered profit to the wellbore, we did so with Liberty. We've executed a number of very successful tests in 2016, both in the field and R&D facility. But there are - there’s a commercialization standards that needs to be met in the contract. And so our design effort and the introduction of this second-generation system seeks to satisfy, if not exceed, that commercialization standard.

And back in 2016, when the discussion was the fulfillment of the milestone - the second milestone following the first milestone was something like a windows six additional months, you foresee the same timeline, so to speak, when you reach the first milestone to get to the second?

Right. So another good question, Robert. So when I estimated a potential four to six-month lag between milestone one and milestone two, that contemplated the lead time or the cycle time to design and manufacture the second-generation system. We have preempted that. And as I stated, we abandoned testing with the prototype in December of 2016 and we progressed immediately into the design process for the second generation system. And so, as and when we achieve the first milestone, I would not expect a four-to-six-month duration to achieve the second milestone. I'm not going to estimate what that duration would be other than it shouldn’t be four to six months, because we would not presumably be executing a new design effort for either the missile or the pressure exchanger.

That’s good to hear. And my last question centers on the new product off shot, when is the market opportunity there?

Robert, we will make all of that known when we announce the product, just like we did with every other product that we have announced. We will come out; we will characterize the technical value proposition, the economic value proposition and of course provide market sizing and segmentation. So, so stay tuned Robert.

I certainly will. Thanks so much, and good luck.

Thank you.

Thank you. And this does conclude our question-and-answer session today and our conference. We thank you for your participation.