Energy Recovery Inc (ERII) 2008 Q4 法說會逐字稿

Good afternoon, my name is Angelia and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 2008 Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.

(Operator Instructions)

At this time I would like to turn the call over to Mr. Willardson, Chief Financial Officer.

Good afternoon, and welcome to Energy Recovery, Incorporated's Fourth Quarter Earnings Conference Call. Joining me today on the call is GG Pique, President and CEO, and Carolyn Bostick, our General Counsel. Today we will discuss the financial results of our fourth quarter, as well as for the full year 2008, the outlook for 2009, and an update of our various strategic initiatives.

In the press release today, we provided guidance on our upcoming first quarter and our projected results for revenue and earnings for the full year 2009. Before we begin I would like Carolyn Bostick, our General Counsel, to make a brief statement about the forward-looking remarks you may hear on today's call. Carolyn?

Thank you, Tom. Please note that our discussion today will include forward-looking statements, which are subject to the Safe Harbor Provisions of the US Federal Securities laws. We caution you that forward-looking statements about future revenue, growth expectations, market trends, business strategy and new products are predictions based on the Company's current expectations about future events and are subject to certain risks, uncertainties and other factors that could cause actual results to differ materially.

A detailed discussion of these factors and uncertainties is contained in the report the Company files with the US Securities and Exchange Commission. The Company assumes no obligation to update any forward-looking statements made during this call, except as required by law. Back to Tom now.

All right. Thank you, Carolyn. Turning now to our fourth quarter results, ERI achieved net revenue of $22 million and earnings of $5.3 million. For the full year 2008, we generated $52.1 million in revenue and net income of $8.7 million. I will discuss these results in more detail after GG's remarks. I would now like to turn the call over to GG Pique, our President and CEO.

Thank you, Tom. Good afternoon. In the call today, I will discuss the near-term outlook of our business and the continued momentum in the global desalination markets. I will also comment on the market shifts we are starting to see as a result of the turmoil in the credit markets and how it affects our 2009 prospects. I will also update you on our strategic initiatives. Following my remarks, Tom will reveal the financial results for the fourth quarter and the fiscal year in more detail, and then I will make some concluding comments. Afterwards, we will open up the line to take questions from research professionals.

ERI had the strongest fourth quarter ever, and we had very good results for the fiscal 2008. We keep managing and growing the business and controlling costs as we have done for the last 27 quarters. We are sure all of you are most interested on what is going on out there in the markets and our take on how it affects ERI.

In preparation for this call, I went to Spain last week to meet with leading desalination contractors, officials with the Ministry of Public Works in Madrid, and with other equipment suppliers to get a fresh reality check on the global desalination markets. The near-term outlook for desalination plan is that it continues to be strong. This is partly because for most of the last two years, the industry has been operating on a sold-out mode. Contracts like Israel, Spain and Australia have been suffering from a severe lack of drinking and irrigation water and the Governor of California just declared a water emergency four days ago.

The capacity of the desalination industry to meet the demand has been constrained by a shortage of people and critical equipment, resulting in long project lead times. The result has been a backload of large funded projects, which will now keep capital equipment suppliers like ERI busy and growing through 2009.

Financing for these large projects being built today were secure before the meltdown in the credit markets. Based on the information available to us today, we believe that these projects remain on track for their scheduled completion dates and planned commissioning. Since the market is driven by water scarcity, we have not seen any projects being cancelled or going away. However, some projects like Carlsbad California, and the [Rasazor] power hybrid desalination plant through Saudi Arabia have been forced to restructure financing at a higher rate.

We see several trends emerging out of the financial crunch we would like to share with you as follows. Although the business of some of our customers has been affected, some clients like Acciona and Befesa in Spain, [Hutchinson Water] in Hong Kong are taking this as an opportunity to expand their business and are forming new ventures to execute water projects.

So mega-projects have been downsized and broken down into phases, instead of building the whole project; the developer builds one-half or one-third now and the rest later. An example of this is the Lima South project in Peru, [Minaris Condia] in Chile, the [Boust fields] China project and the [Keishnopotan] project in India.

The other trend we are starting to see is the reemergence of expansion retro-fits. If you run into a water crisis situation and you have existing desalination plants with the intake and outflow structures already in place, the cheapest and quickest way to get more water is to expand those plants. Once specific example of dissolution is the state of Israel, where substantially all of the existing plans, as well as those under construction, have been expanded by 30%.

Keep in mind that when you retrofit a plant by replacing older energy recovery devices such as a [Pelton] wheel, with ERI PX, you usually can get double to triple the capacity using the already installed high-pressure pumps. These plans can expand capacity by adding membranes, racks and filters. The ERI PX [erase] handle the expanded brine flows. This is a major event of EPX expansion retrofits as we learned during our discussions in Spain that the delivery time for high-pressure pumps is still close to one year.

The biggest new trend we see is that what we call quick water. When you run into a shortage situation and need water in a hurry, solving the problem with multiple small portable emergency units in trailers or skip gets you to a solution a lot quicker than building a big plant from scratch. Also the mobile plants can be relocated in case of shifts in the weather or politics. This is the approach that California took in 1992 when I was working for Ionics and I was involved with the design and start-up of an emergency desalination plant for the city of Santa Barbara in California.

What we see now is a lot of emergency trailers and skips being built by our OEMs, which are ending up in Australia, Israel and the Far East. An extension of this concept is the shift-mounted desalination plant being built by Water Standard in the Middle East. This shift is helping our OEM growth a lot in 2009.

Our OEM division, which covers projects under 50,000 cubic meters per day had a stronger-than-anticipated 2008 and continues to see a steady flow of business coming from Israel, UAE, Turkey and up in Europe. We see stronger flow of business coming from China because of the [garments] investment and infrastructure. The OEM group will also benefit from some newly arrived products being launched in the first half of 2009, which will expand the available market.

However, as we mentioned during our last conference call, we see high-end hotel and resort projects in the Caribbean, Egypt and the [Maldives] being delayed for quite a while. We are expecting the overall market for the small OEM desalination plans to shrink in 2009 from last year. However, despite this decline in demand, we are projecting that due to the new products in available markets the projected 2009 revenue for the OEM group will be the same $4 million-per-quarter range [that we've seen] in 2008.

For our large projects over 50,000 cubic meters per day, we have signed contracts and firm orders are on the pending guidance we provided today. We are still tracking over 160 large projects and several hundred small ones, which are planned to be executed over the next two, are three years, with a total potential revenue to ERI over $500 million range.

Since our last call, we have added to this list some new projects in Lybia, some retrofits in Israel, and some massive projects coming in China. Most of these mega projects are from municipal supplies, largely sponsor-funded and backed by governments. As I mentioned earlier in the call, as part as getting ready for this conference, we met last week with some of the large clients including [Indian] companies, [ABC] contractors in Spain. I can confirm that all of these companies are still very busy designing new desalination plans with our PX technology. This critical water supply projects are all very high priority and what we see is another increase in project at work as soon as the current [uncertainties] in the financial markets clear.

Also, as part of this new expansion wave in desalination projects, we see China emerging as the top desalination market in the world. While the majority of these projects are being built on schedule, some may be subject to delays beyond our control due to funding delays and temporary shortages of high-pressure pumps, qualified plan designers and construction and operating personnel. Projects such as [Scalflat] are being delayed by local concerns and environmental permits. We realize that these are unprecedented times and we are monitoring the funding programs over major customers.

In our press release today we provided guidance on a range of net revenue and earnings for the first quarter and the full 2009 year. We already have a commitment and are negotiating for approximately half of the projected 2009 revenue for the mega-projects group. For these large projects we have good visibility of approximately six to nine months from award to shipment of product due to the longer sales cycle. For the smaller project, the sales cycle is more shorter, but there's less [viability] between quarters.

As we discussed in the last conference call, the fourth quarter tends to be our largest quarter for the year due to the desire of our large customers to take ownership of our energy recovery devices to recognize for [Queman] feast before December 31st. As was the case in 2008, we expect the fourth quarter 2009 to be the largest quarter for the year.

We continue to see the acceptance and shift to our new large [flagship] product, the PX260, which yields 18% improvement in flow through over the PX220. Sales of the PX260 represented roughly half of the large project revenues in the fourth quarter. We expect the percentage of PX260 to exceed 70% in 2009 large project revenues, as most of our large order shipped from the PX220.

Meanwhile, we are hard at work developing the next generation of pressure exchangers. ERI has been developing a new PX which has been referred to in our public filings as the [Com-PX]. The Com-PX will allow PX technology to compete better in markets where the customer electricity is either subsidized or relatively low. The Com-PX also has built-in features that provide hydraulic protection should the plant be run improperly. Field testing of the Com-PX began in Egypt in October and we're expecting to start offering this product commercially in the first half of 2009 competing in price and performance with the turbine energy recovery devices.

We continue testing the PX Titan 1200 device, including ongoing better testing in Mexico. The Titan can do the work of five PX220s and this will be tested for at least another year before we decide on the commercial strategy.

You have all been introduced to Carolyn Bostick, our new in-house General Counsel and Corporate Secretary who read us the forward-looking statement disclaimer at the beginning of this session. She's already doing some impressive work around the IP of ceramic technology and PX technology.

As mentioned previously, we have hired [Doug Iceberg] to promote the use of PX technology and [brackish] water desalination projects, as well as other new PX applications. Some of the markets he's targeting include high-pressure processes in the food industry, gas processing industry and hydrometallurgy. Finally, as we have been doing for many years we continue to evolve our core PX technology to offer increased efficiency, flow-through put, and other improvements. We will start field testing some of these new devices within 90 days, which incorporates somewhat of this new exciting technology.

With the ever-increasing pipeline of projects we see, we realize the need to grow both in terms of facilities and talent. However, in view of the [sudden] precious value of cash, we have decided to undertake all of our needed expenses as frugally as possible. We have entered into a lease agreement covering a refurbished building, which will be used as our new integrated manufacturing facility that will expand our production capacity three-fold. This building will also serve as our corporate headquarters and will be used for inventory storage.

We plan to start phasing our production to this building, to its new facility in the fall of 2009. This will allow us to consolidate our California operations into a single headquarters and have room to grow the Company. We have some of the best people in the industry and continue to build on this very talented team by strengthening our HR and IT functions.

As we have mentioned in the previous call, we feel fortunate that Paul Cook has joined our Board. Paul is the founder and former CEO of Raychem and he's recognized as a pioneer in material sciences. We have been working with Paul regarding our plans to develop and strengthen our material science expertise in ceramics.

As a result of this focus, ERI has implemented a strategic initiative to build a brand-new integrated new ceramics facility in the San Francisco Bay area. This initiative calls for investing some $12 million to $15 million over the next 18 months, which we expect to fund primarily from operating cash flow.

Paul Cook has had many meetings with myself and our CPO, Dr. Rick Stover, and the rest of our team regarding the potential obligations of PX technology as part of the seawater desalination including osmotic power.

We are also excited to mention our Board members, Elizabeth Pate-Cornell, who is the head of Stanford University Department of Management Science and Engineering, and Jackalyne Pfannenstiel, who is the former chair of the California Energy Commission. Both of these people have valuable experience and will bring new perspectives to our Board and help us guide the Company into the future.

We continue to be approached with new business ideas in the water and energy space. As we look at these opportunities, we are finding that as cash becomes scarce and multiples are marked down by the market, business expectations of [after] sellers are becoming more realistic; hence, the purchasing power of our $80 million in cash keeps multiplying over time. Our advisor, [David Levy] tells us that this cash will become even more valuable as outside economic events unfold. I would now like to turn the call over to Tom to discuss fourth quarter results in more detail. Tom?

All right. Thank you, GG Before I discuss our results for the fourth quarter, I will review again our revenue recognition policy and the effect that policy has on our quarterly performance. Sales to large projects exceeding 50,000 cubic meters per day make up the majority of our annual net revenue. Our policy is to recognize revenue when there is evidence of an arrangement, transfer of title and the risks associated with ownership occurs, pricing is determinable and collection is probable.

Transfer of title usually occurs when the order is shipped from our manufacturing facility in California, but may also occur when the order is received at the project site. The timing of product shipment is dictated by our customers and is a function of the construction schedule of a project. Our quarterly results can vary significantly when these large orders are recognized in one lump-sum shipment and are concentrated in one particular quarter. This can result in choppy quarterly performance where year-over-year comparisons or annualizing any single quarter, particularly the fourth quarter, which is seasonally our largest quarter of the year, may not be particularly useful in determining a trend in our business.

For that reason, we have provided annual guidance for 2009 in today's press release. For the fourth quarter ended December 31, 2008, we achieved net revenue of $22 million, a 59% increase over the same period last year and at the top of the Company's previous guidance range of $20 million to $22 million. This was a record quarter for ERI and exceeds the total net revenue and earnings we achieved for all of 2006.

For the full-year, we generated $52.1 million of net revenue, a 47% increase over the previous year. The percentage of net revenue derived from mega-projects customers was 86% in the fourth quarter of 2008. Our mega-projects customers represented 66% of total net revenue for the full-year 2008. Our OEM division contributed $3.1 million in net revenue in the fourth quarter or 14% of the total. For the year, the OEM group contributed approximately 33% of total net revenue.

Approximately 99% of our net revenue in the fourth quarter was generated from sales of our PX devices, with circulation or booster pumps and spare parts contributing the remaining 1% of revenue. For the full-year 2008 approximately 95% of the net revenue was derived from the sales of our PX devices with pumps contributing 3% and other revenue making up the remaining 2%. Sales to foreign customers accounted for 93% of our net revenue for the year, with shipments to Algeria, Spain and China making up 24%, 16% and 11% of the total respectively.

Revenue from customers representing 10% or more of total revenue varies from year-to-year. For the year ended December 31, 2008, two customers, Hyflux Limited based in Singapore and Befesa, a large Spanish EPC company accounted for approximately 16% and 11% of our net revenue respectively. No other customer accounted for more than 10% of net revenue during the year.

Gross profit as a percentage of net revenue was 64% for the fourth quarter compared to 54% for the fourth quarter of last year. For the full year, the gross margin was also 64% compared to 58% a year earlier. The improvement in gross margin is attributable to the increased sales of the PX260, which provides 18% more flow-through and commands a premium over the PX220, as well as the price increase across the other PX models that was effective at the beginning of 2008. For our mega-projects, we expect a percentage of PX260 sales to total PX sales for 2009 to exceed 70%.

Sales and marketing expense, which includes sales commissions and marketing programs, was 10% of net revenue for the fourth quarter of 2008, equal to the percentage of net revenue for the same quarter in the previous year. For the full year, sales and marketing expense decreased to 13% of net revenue in 2008 from 15% in 2007.

As commissions are a function of revenue, we expect sales and marketing expense in the future to increase in absolute dollars as we grow our business. General and administrative expenses consist primarily of personnel in our executive, finance and accounting, information technology and human resource organizations, as well as fees for professional services including outside legal, tax and audit services.

General and administrative expenses increased as a percentage of net revenue to 14% in the fourth quarter of 2008, from 11% in the fourth quarter last year. For the full year, general administrative expenses were 22% of net revenue versus 12%. The primary reasons for the increase in general and administrative expenses relates to the costs associated with our growth in operations, and cost-related to the transition from a private to a public company.

We incurred significant accounting-related consulting expenses in the second and third quarter and are pleased to report that these accounting-related consulting expenses were substantially eliminated in the fourth quarter. We do expect to incur a third-party consulting expenses in 2009 as we implement, document and test Sarbanes Oxley policies and procedures.

Research and development expenses include costs associated with the design, development, testing and enhancement of our products. As a percentage of our net revenue for the fourth quarter of 2008, research and development remained constant, at approximately 3% of sales compared to the fourth quarter of 2007, but increased in absolute dollars by $208,000.

For the full year, research and development expense was 5% of revenue equal to the same percentage a year earlier. In absolute dollars, we increase research and development expenses by $710,000 for the full year. We believe that continued spending on research and development to develop new PX devices and other products is critical to our success and consequently, we expect to increase research and development expenses in absolute dollars in future periods.

Non-cash stock-based compensation expense for the year was $1 million and is included in the cost of revenue, sales and marketing, general and administrative, and research and development expense lines on the income statement. Other net income increased by $382,000 to $794,000 for the year ended December 31, 2008, from $412,000 for the year ended December 31, 2007.

The increase from 2007 to 2008 was primarily due to an increase in interest earnings of $487,000 resulting from interest earned on our IPO net proceeds of $76.7 million received in July 2008, and by a decrease in net interest expense of $26,000 resulting from the reduction of equipment loans outstanding. The increase in other net income was in part offset by a decrease of $131,000 in net foreign exchange gains related primarily to accounts receivable denominated in foreign currencies. Most of our contracts are denominated in US dollars, and a few contracts are denominated in Euros.

Capital preservation is of paramount importance and substantially all of our IPO proceeds are invested in a short-term US Treasury-only money market fund. Net income was $5.3 million for the quarter or $0.10 per fully diluted share compared to net income of approximately $2.7 million or $0.06 per diluted share in the fourth quarter of last year. Net income for the full year 2008 was $8.7 million or $0.18 per fully diluted share, compared to $5.8 million or $0.14 per fully diluted share for 2007.

Turning now to the balance sheet, we ended the fourth quarter with approximately $80 million in cash and no outstanding debt under our revolving credit facility. Inventories were $8.5 million, or 7% of total assets, compared to $4.8 million or 17% of total assets at the end of 2007. Our DSOs, or Days Sales Outstanding, were 120 days, which is a significant improvement over last year and the first two quarters of this year.

Our lock-up agreement with our underwriters expired on December 28, 2008, which was a Sunday. Since the expiration of the lock-up, we have not observed any unusual heavy selling of ERI shares. Prior to the IPO, the Company was financed by group of Norwegian investors who today hold the majority of ERI shares. These Norwegian shareholders have been investors in ERI for an average of 14 years.

We've had discussions with these investors regarding the possible sale of some of their shares through a secondary offering or blocked trades. ERI management will support a secondary or follow-on offering in the future should there be sufficient interest among our pre-IPO shareholders and provided that market conditions permit.

In our press release today, we provided guidance for our expected first quarter revenue and earnings results. For the first quarter, we are projected net revenue in the range of $12 million to $13 million and net earnings between $1.1 million and $1.3 million. For the full year of 2009, we provided guidance of $60 million to $65 million in net revenue or an increase of approximately 20% over fiscal 2008 assuming the mid-point of that guidance. We projected net income in the range of $9.5 million to $11.5 million or $0.18 to $0.22 per fully diluted share for the full year.

For the reasons GG mentioned previously, we expect the OEM group's revenue in 2009 to be equal to its strong performance in 2008. We expect most of our revenue growth in 2009 to come from our sales to large projects, where in most cases; their project financing was secured prior to the credit meltdown. At the end of each quarter, we intend to issue guidance for the next upcoming quarter, as well as update the guidance for the full year. That concludes my review of the fourth quarter and full year 2008 financial results. I would now like to turn the call back over to GG for some concluding remarks.

Thank you, Tom. As you have heard today our industry continues to grow at a rapid pace and we are solidifying our leadership position as the premier energy recovery technology provider in the desalination industry. The factors driving the construction of new desalination plants, including population growth, climate change and increasing demand for water for food and power production continues to intensify. While the worldwide turmoil in the debt markets is affecting almost every industrial sector, the need for water is basic and is a national imperative for most countries.

Energy recovery devices like our pressure exchanger have made desalination affordable. It is a good feeling to have healthy margins, strong operating cash flows and $80 million of cash in the bank and zero debt. We are seeing a continual flow of acquisition opportunities, which could potentially enhance shareholder value. We feel we have developed the best team in the business to manage ERI as well as evaluating, integrating, managing and growing related businesses and technologies on a global basis.

We are also fortunate to have the financial flexibility to move quickly. And I can assure investors that they are represented by highly experienced and dedicated group of outside directors who are challenging us to optimize our leadership position in the industry. I would now like to turn the call back over to Angelia, the operator, and open up the line for questions for research analysts.

(Operator Instructions)

Our first question comes from the line of Michael Cox with Piper Jaffrey.

Good afternoon. Congratulation on the quarter, guys.

Thanks very much.

(inaudible), Michael.

My first question; you talked about 160 or so projects that your large-scale projects that you're looking at now. Could you give us a sense of magnitude of how many of those projects you would expect to deliver in 2009?

Probably it's a number around 15, plus or minus two. It's a -- we're talking about 25 funded projects right now, but we expect about 15 of those close in the year.

Okay, that's helpful. And then you noted that the '09, that these are funded projects, which gives good visibility. I'd be curious what the impact of the current credit crisis has on, say, the 2010 outlook. How quickly can projects come back if the credit market does improve at some point later this year?

The surprising thing that I learned in Spain; I got to met with the Ministry, I met with the people who are engineering these projects, the people who are working with the banks, validating the projects; and the surprising thing is that 2010 promises to be very, very strong. Because what you're seeing here is a lot of these projects that need to be executed, a lot of them are slipping, but we see them, a lot of them happening in 2010. So again, 2010 should be a very, very strong year. And when it comes back, it's going to be a -- we see a big surge in activity as soon as the banking system comes back to normal.

Okay, that's very helpful. And then one question on the cost side; you called out the SOX cost in '09. I was wondering if you could quantify those, and then also looking at total SG&A expenses in 2009, what are your expectations there as a percentage of sales, again maybe relative to '08's performance?

Okay, the SOX costs were budgeting and estimating at around $250,000 and we're beginning that work in the first quarter. With respect to sort of the run rate, I think it's going to be fairly close to what you would see in the fourth quarter. We're not planning to add any personnel to our accounting group, we're basically just staying flat with respect to personnel and so the only additional expense we have this year would be to SOX-related expenses.

Okay, great. Thank you very much.

Our next question is from the line of Greg McKinley with Dougherty and Co.

Thank you. Guys, could you talk a little bit about your intended use of cash this year. I know during your prepared remarks you talked about that balance sheet flexibility enabling you to take a look at potential acquisition opportunities, and yet on the other hand you really referenced how much more valuable that cash could become in a difficult economic backdrop. So can you help us better understand; is your bias toward maintaining a very strong balance sheet or is it toward investing that cash? And then, please share with us your CapEx outlook and what type of specific investments you intend on making with that.

-- go first. Yes, we are looking at a couple -- we have a couple of companies come through the building every week bringing ideas and projects and potential acquisitions. We're being very, very careful with the cash, and one of the reasons I mentioned is the fact that the expectations of these potential acquisitions, they're still priced a little bit too high. But they are coming down. And response to that, I repeat that our advisor, who is David Levy up in New York is suggesting that we hang onto the cash because it's going to be a lot more valuable a few months down the road. Tom will tell you what we're doing with the cash.

Well, we're -- as I mentioned in the call, we're very conservative investors with the cash just because of the turmoil with the banks out there, so all of our discretionary cash right now is in a US Treasury-only account. It's not earning a very high interest rate, but our main concern is preservation of capital. Our maintenance CapEx is somewhere around $1 million, maybe to $1.2 million.

We certainly generate enough operating cash flow every year to handle our maintenance CapEx. In addition to that, GG had mentioned in the call the ceramics facility that could -- the capital costs might range from $12 million to $15 million, we believe we have sufficient operating cash flow to actually fund that without having to dip into the IPO proceeds.

You have -- I'm sorry I want to make sure I understood that, the ceramics facility you would have sufficient operating cash flow to acquire that without dipping into your --

Actually, the plan right now -- we're working on a dual-track. We have a potential acquisition, but we're also proceeding with building our own facility right now. But if something comes along that is the right acquisition, we'll do that -- that's always quicker.

Okay. So, Tom, just as clarification then, what would your anticipated CapEx be for 2009 in total?

The CapEx will be somewhere around $1 million, plus or minus 10% or 15%.

Okay, so you're not anticipating a large capital investment in terms of building out ceramic facilities; that's included in the $1.2 million?

Right, well the ceramics facility we're speaking about that as a separate discreet project. So the cost for that would be somewhere in the range of $12 million to $15 million whether we buy an existing plant in that range, or whether we build a plant (inaudible) from scratch and we buy the equipment, we believe over the next 18 months it will be about that much capital expenditure. Absent the ceramics initiative then, our maintenance CapEx is a little over $1 million a year.

Okay, perfect. And then just one other question; with your balance having that much cash on it, does that impact how we should think about normalized effective tax rate? Or what -- how should we think about your tax rate outlook for '09?

Well, our tax rate right now, we're still in the process of doing our projections. We have -- we're actually consulting with some folks on the outside, trying to be -- trying to minimize that tax rate as best we can. And so we'll have more to talk about when we get the results of various studies that are going on --

Okay.

So that -- there's more to follow as far as our normalized tax rate.

Okay. All right, thank you.

Yes.

Our next question is from the line of Debra Coy with Janney.

Thanks. Hi, GG Hi, Tom.

Hi, Debra.

GG, just to follow-up on the demand side. It sounds like from what you're saying that you're seeing both see the credit market having an impact on demand but also still some capacity constraints? You mentioned, I think, that there's still a 12-month wait for high-pressure pumps, is that correct?

Yes, absolutely. I asked the very specific question to two major pump companies, David Brown Union Pump and Sulzer. If there was an earthquake in California tomorrow morning and we needed some emergency pumps to build a desalination plant, what is your delivery time? How many pumps can you deliver this year? And the answer was maybe one pump this year. So if -- they moves things around. So that gives you an idea how impacted the industry still is.

That really gets fixed by early next year and the capacity constraint on pumps goes away. The capacity constraint on people is actually bigger than the capacity constraint on pump. And what we see is a lot of reshuffling of people, we see Befesa buying engineering companies in Texas. We see Befesa opening engineering offices in the US and in India. So the companies are doing a lot of these projects like Acciona and Befesa are scrambling to do alliances and acquisitions to bring more people into the industry in a hurry.

So I'm having a hard time reconciling the slowdown plus the tight capacity and where we are in terms of growth, because certainly we had seen a period of pretty rapid growth in the industry and certainly we had been talking about growth rates for ERI that were potentially higher than this 20% top line we're talking about now. What I'm trying to understand is kind of where you're seeing some moderation that it sounds like some of the plants that you were tracking say three to six months ago have been delayed?

Yes. You take Carlsbad, Carlsbad is pushed back --

Yes, Carlsbad, definitely. But that's political.

Yes, political and also refinancing and keep in mind Citibank is one of the paper holders there. Also the other project I mentioned in Saudi Arabia, that one also has Citibank as one of the funders, so now the government of Saudi Arabia has to step in and all those processes are ongoing and they will happen, but they take time. Basically it's a change of structure, a change of ownership and that pushes things into 2010. So we're -- what we're projecting is a huge 2010, or 2011 once all of these things clear and get going again.

Okay. And you're not seeing any change related to, say, energy demand? One of the things that I've been reading a little bit about is that some of the combined water and power projects in the Middle East are being set aside or delayed because energy demand with the overall economy has come down.

Yes. It seems to be hitting the thermal folks more than it's hitting us. Because usually those are big, huge 2,000, 4,000 megawatt power plants with associated thermal plants. Those are big chunks of cash, in the billions of dollars. So it seems to be hitting them more than it's hitting the seawater RO plants, which are in some cases down -- happening in a downsized mode.

Okay, that's helpful. And then just finally on that subject; you talked about 25 plants that you're most closely tracking. Can you talk a little bit about geographies, you mentioned China earlier -- obviously you talked about --

Yes, Algeria continues to be very strong area for us, the Barcelona area. Australia is very big right now; the drought is still going compounded by fires and China's coming very, very strong. Those are the key areas for us.

Okay. And then finally on margins; very strong end to the year on margins, obviously it was a big shipment quarter. As you're looking at your -- I haven't had a chance to run the numbers down through the model, but it sounds like you're expecting margins to stay stable in 2009 on the gross line?

Yes, we do. It was 64% for the fourth quarter --

Yes.

It was also 64% for the full year, so some of the price increases that we instituted at the beginning of the year and the fact that we're selling more 260s, which sell at a premium to the 220s has been aiding in the increase in the gross margin.

Okay. Thanks, Tom.

Our next question is from the line of Gary Balter with Credit Suisse.

Hi, Gary.

Hi, Tom and GG, this is actually Patrick here with Gary. Just wanted to follow-up with a question, if I may and hopefully you don't have an earthquake in California tomorrow, but just looking back at acquisitions that you mentioned. Obviously, it makes a lot of sense for vertically integrating some of your ceramic needs; are you looking at any other areas that you'd be utilizing that cash for? I mean I understand the ceramic facility and the capital requirements there; I'm trying to get a sense of your interest in other horizontal businesses.

Yes. Most of the things we're looking at in the water space are specifically are things that our sales people could sell to the same desalination clients and we're always interested in the pump area because we are a pump company and we're doing more and more in [booster] pumps every day, so I think that gives you an idea what the things we're looking at. I would encourage you -- we will be calling you after the conferences. We actually have four competitors listening to this call, and go to our website twice every other day, we kind of track that, and they do the marketing by listening to our conference calls. So --

Sure, I understand. I understand.

So we will talk a little bit more specific after the call.

Okay, and if I may follow up with one other quick question; Carlsbad, is that baked into your numbers for '09, or is that still politically intertwined?

No, we don't think that in the California reality of water politics that is anybody can do that, even Arnold, declaring an emergency that is doable in 2009. That's a 2010 project for us.

Okay, good. All right, well I appreciate your time.

(Operator Instructions).

Our next question is from the line of JinMing Liu with Ardour Capital.

Thanks for taking my call. My question is really to (inaudible), actually GG you mentioned there that you saw some expansion of current facilities. What kind of market site are we talking about there?

Yes, we see a tremendous amount of activity in the retrofit -- expansion retrofits. The biggest area in the world right now doing expansion retrofits is Israel, where almost all their plants are being retrofitted and expanded. Simultaneously, for this whole bunch of plants in Spain and the Caribbean, including the Tampa Bay plant in the US that need to be expanded. If you were to quantify the market, there's many ways to put the numbers together and we can talk about it after the call.

Okay, I will do that. Just a (inaudible) question, what is your total headcount right now?

Yes, we were 91 late last year, we kind of had a shrinkage of about 10% at the end of the year to conform with the realities of -- we wanted to be really, really lean going into this thing. So right now we're about 87, and we extend to probably by the end of the year unless we do acquisitions, we'll be about 90.

Okay. My last question is about the location of your ceramic facility; before we were talking about somewhere not in California. I believe you mentioned that it will be in San Francisco?

Yes, that is a change in strategy. Paul Cook is driving the fact that in order for us to do innovations in ceramics, the farther away you put it, the longer the cycle to get things done. So we would like to have it in our backyard, we may or may not get the city of (inaudible) to permit that, but if we don't it will be within probably a 15-mile radius of our facility now.

Okay, thanks.

(Operator Instructions)

Our next question is from the line of Brian Chin with Citi.

Hi, Brian.

Hi, good afternoon. This is actually [Brian Oshenbecken] for Brian Chin. I had a quick question on the net income margin and your guidance. Looking at fiscal year 2009, embedded in there is about 16% to 18%, which is consistent with 2008, but if I look at first quarter 2009, embedded margins between 9% and 10%. Can you give me more color on what looks like a disconnect between those two, please?

Yes, I think those are really just timing differences. What we encourage people to do is not try to annualize any given quarter because it really never tells you the whole story. I think the best thing to look is at a full year 2008 and kind of project off of that, recognizing that we were private for some of 2008 and public for other parts of it and we had some unusual consulting expenses in 2008. So I would caution you against drawing any conclusions off of just one quarter.

Okay, thank you.

Again --

Operator, I think that's -- we appreciate everyone's interest and attendance, and I think we'll conclude the call.

This concludes today's conference call. You may now disconnect.

Okay, thank you.