Energy Recovery Inc (ERII) 2009 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Fourth Quarter 2009 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. And following the presentation, the conference will be open for questions. (Operator Instructions). As a reminder, this conference is being recorded today, Thursday, March 4th, 2010.

I would now like to turn the conference over to CFO, Tom Willardson. Please go ahead, sir.

Good afternoon and welcome to Energy Recovery Incorporated's Fourth Quarter Earnings Conference Call. Joining me today on the call is G.G. Pique, President and CEO. Today, we will discuss the unaudited financial results of our fourth quarter as well as our full year 2009, the outlook for 2010 and an update of our various strategic initiatives, including the progress on our ceramics production facility and the integration of pump engineering.

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 2010. The press release also contains certain financial measurements for both our 2009 performance and 2010 projections that exclude certain non-cash charges that we view as either one-time or non-operating in nature and are considered non-GAAP for reporting purposes.

We provide these non-GAAP measurements as we believe they provide investors and management with additional insight into the underlying core operating performance. The press release contains a reconciliation to GAAP of these non-GAAP measurements. I will discuss them in more detail during my portion of this call.

Before we begin, I will make a brief statement about the forward-looking remarks you may hear on today's call. The primary purpose of today's call is to provide you with information about our fourth quarter and fiscal year 2009 performance. However, some of our comments and responses to questions may contain forward-looking statements about market trends, future revenue, growth expectations, new products and business strategies. Such statements are predictions based on our current expectations about future events and are subject to the Safe Harbor provisions of the US 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. A detailed discussion of these factors and uncertainties is contained in the reports 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.

Turning now to our fourth quarter results, ERI achieved net revenue of $15.7 million and earnings of $1.7 million. For the full year 2009, we generated $47 million in net revenue and net income of $3.7 million. Our revenues and net come for the fourth quarter and fiscal year 2009 were all within the guidance ranges that we provided in early November. I will discuss these results as well as the non-GAAP measurements in more detail after G.G.'s remarks.

I would now like to turn the call over to G.G. Pique, our President and CEO.

Good afternoon. In the call today, I will discuss the outlook for our business and the recent increase in procurement activity in the global desalination market. I will also comment on the improving market conditions we continue to see as credit markets start to function in new malls and how this affects our prospects for the next few quarters and beyond.

In addition, I will also update you on new product developments and strategic initiatives. Following my remarks, Tom will review the financial results of the fourth quarter and our full year 2009 in more detail and then, I will make some concluding comments. Afterwards, I will open up the line to take questions from research professionals.

During 2009, we generated $13.1 million in cash from operations. During the year, we spent about $20 million in cash by pump engineering. We also issue 1 million shares to close the PEI acquisition. We have also been steadily investing cash in our ceramics initiative. We ended the year with $64 million in cash, including restricted cash as Tom will define later. We're substantially enhancing our core business without burning a lot of the $77 million we raised at the IPO.

In Q4, we had net revenue in our guidance range and met our guidance on the earnings per diluted share by generating $0.03 per share for the quarter and $0.07 per share for the year. However, despite record bookings for the year and a strong fourth quarter in 2009, we ended up the year slightly below 2008 because assertion bookings happen too late for us to ship and recognize revenue in 2009.

In 2009, ERI has the strongest bookings in the history of the company with an increase of more than 40% in terms of contracted capacity in our mega projects division compared to 2008. This compares to pump companies like Flowserve which recently announced a 24% decrease in year-to-year bookings and Sulzer's Pump Group, which just reported bookings down 26%, in both cases reflecting the downturn in the energy markets.

In retrospect, procurement and contracting activity for large desalination projects slow down significantly following the collapse of the Lehman Brothers and remain at a low ebb for the subsequent three quarters. However, we saw a strong upsurge in procurement during the last half of the year, particularly during the Q4 in which, among others, we secured a largest order ever for our PX-260 for the 400,000 cubic meter per day plant located in Melbourne, Australia. This gave us the record bookings for 2009, but the surge came too late in the year to allow us to ship and record match revenue before year-end.

As we have discussed in previous calls, our quarterly performance can vary significantly depending on the timing of when our customers want us to ship products and the shipping terms which dictate transfer of title. In our OEM business, we continue to see improvement in desalination projects planning connection with resort and tourist development, particularly in the Mediterranean Canary Islands.

The major exception continues to be Dubai where projects related to real estate development has stalled. Tourists bookings in hotels and resorts in Egypt continues to improve and we just booked one of the first set of PX-300 orders in that market. Many of these projects are expansion retrofit opportunities and involve replacing Pelton Turbines in existing plants with PX devices.

Beginning in 2010, we started to see an increase compared to last year in the level of new plants construction from US based OEMC Mexico and the Caribbean. We continue to see India an emerging market, especially in projects related to power plants. Our OEM Group has historically not seen a lot of variation quarter-to-quarter, however OEM projects are getting bigger and their revenue per quarter is getting lumpier.

It is important to note that projects representing the majority of our business are driven by order scarcity. We are still -- are not seeing project cancellations but rather delays in timing of equipment procurement while the credit market continues to stabilize. It is also important to emphasize that we're not losing projects to competitors that we expected to win.

EPC contractors using PX technology are more successfully winning projects, as was the case in the large Melbourne and other late plants in Australia and the Tenes plant in Algeria. Given the trend towards larger and larger plant capacities and the fact that even after the PEI acquisition, mega projects will still comprise roughly 70% of our annual revenue stream; a shift of a few large projects can cause significant variations in our quarterly numbers.

As we mentioned last November, when we look at the total picture for our business over the near-term, we continue to see the drivers of desalination growth intact and our competitive position improving with new product offerings for Seawater RO like the PX-300, the hydraulic turbocharger options for low power cost areas, and larger range of booster pumps and the BEI MSRO high pressure pumps.

Turbocharger technology also allow us to aggressively go after the brackish water and gas processing markets. Longer-term, the outlook for the desalination plant business and the ERI continues to be very strong. Countries and regions like Israel, Spain, Cyprus, Australia, India and North Africa have been suffering from severe lack of drinking and irrigation water. In North Africa, we see Libya developing as a potentially large market by 2011 as they emulate the Algerian model.

Population growth, industrialization and improvements in the standard of living are driving water stress in emerging countries like China and India. The retrofit bid activity continues to be very strong. Other plants in places like Tampa, Trinidad, Cyprus, Malta, Chile, Spain are considering expanding their capacity or saving energy by replacing legacy energy recovery devices with our PX units.

As I mentioned earlier, our OEM division which cover projects on the 50,000 cubic meters per day had a good quarter and there is still a steady flow of business coming from Spain, Egypt, Israel, China and parts of Europe. For our large projects over 50,000 cubic meters per day, we have signed contracts and firm orders under pending guidance we provided today. Our sales pipeline of desalination projects over the next three to four years is still very strong. New projects in Mexico, Chile, North Africa continue to be added to our tracking list as formerly list of projects have turned into purchase orders.

Here in California, we continued to see significant water supply and demand challenges. Although we are not in a drought emergency as was the case when I was involved with the Santa Barbara desalination plant 18 years ago, the bureau reclamation database shows that Lake Mead is a 120 feet below its level a decade ago. In fact, despite of a couple of El Ninos, including the one just ending, Lake Mead reservoir levels have suddenly dropped at a rate of one foot per month since the year 2000. This depletion is a result of 20 million additional people throughout California, Nevada, Arizona, Mexico and Utah, draining the Colorado Basin dry.

As I sat on a water panel in Los Angeles a few weeks ago, I realized the policymakers understand this increasingly critical water situation in the western US. A couple of weeks ago, the developer, the cost of desalination project overcame what is hopefully the last legal hurdle and is now seeking to raise California tax-free bonds to fund the cost of desalination project.

Closer to home, in the Monterey area, where we have four competing desalination projects is starting this February, local residents have been given a small water allocation with pricey penalties that could double or triple their water rates up to $7.00 per cubic meters. As part of a permanent solution, California American Water is running a 4,000 cubic meter per day desalination plant in Sun City with PX technology. Tomorrow afternoon, I plan to help host a group of regional municipal authorities to demonstrate how efficient, modern desalination plants operate.

In our press release today, we provided guidance in a range of net revenue and earnings for the first quarter of 2010 full year. As we discussed in our previous conference call, the fourth quarter tends to be our largest quarter of the year. As CPC contractors prefer to take ownership of energy, recovery devices to recognize procurement fees before December 31st. We expect the fourth quarter of 2010 to follow this cycle which we have now observed for eight years.

When the acquisition of Calder DWEER by Flowserve was announced a year ago, there was a little concern regarding ERI's competitive position. Let me confirm that Flowserve has been very aggressive in the market. However, the only win they have announced is the acquisition is the [Campo del Dalio's] project in Spain, which was actually awarded to Calder DWEER pre-acquisition. Flowserve recently filed their 10-K confirming that the earn-out contingency covering this acquisition has been reduced to zero.

Our PX devices continue to have significant advantages with the DWEER devices including simplicity, reliability, endurance and cost of manufacturer. In 2005, all the mega projects awarded using isobaric technology, ERI has won over 33 projects and DWEER has won five, with four of those from a single EPC company [Baolia].

With the ongoing evolution and improvements in our technology as evidenced with the recent announcement of the PX-300 devices, we believe we can continue to solidify our market leadership position. Because of their low upfront cost, turbine technology devices like the Pelton Wheels and turbochargers are still a factor in places where power subsidized and the client is looking for a lower CapEx solution.

As you have seen lately, turbochargers are now being used in large projects like Jeddah, Saudi Arabia. For the last 15 years or so, Pelton Wheels were the almost exclusive solution. This is bad news from Flowserve's Calder DWEER division after Pelton Wheels also continue to lose share to these newer technologies.

This summer, we also announced the introduction of the PX-300 device. Like the Titan PX-400 device, the PX-300 features our most advanced design engineering and what we are calling [quadrobaric] technology. Similar to the PX-220 and the PX-260 devices, the new PX-300 device operates at up to 98% efficiency, however, in addition, quadrobaric technology provides a cleaner transfer of energy and better mixing performance of full flow.

As we mentioned, we are starting to sell PX-300 units for smaller projects and we start offering it for big projects soon. ERI expects to be more competitive and to maintain our improved market share with affordable solutions. We continue testing the PX Titan 200 device, including ongoing beta testing in Mexico for at least another year before we defined the commercial strategy. We also making very encouraging progress with integration of the ERI and PEI sales forces and see clear examples of how our customers perceive us already as one company.

Our team can now meet the energy recovery needs of our projects with the best permanent solutions in the market or the best isobaric technology to meet specific customer needs regardless of size. More important, we have expanded the addressable market as we can add high pressure and circulation pumps to the isobaric PX solution offering.

Our recent acquisition of PEI has added products to our market, an entire new market for our products such as gas processing, while we continue to enhance our control over ceramic material science in search for better products and new market opportunities. PEI has more than seven years of development experience with the hydraulic turbocharger in the treatment of sour gas using ME processes, which is one of the promising developments for the near future.

In addition, PEI has a full offering of single stage pumps for brackish and foresee water applications. These pumps are uniquely and specifically designed for reverse osmosis. Now, we can also offer multi-stage high pressure pumps to be utilized with the PX systems for medium-size drains. We have near-term plans to expand our multi-stage pump line for larger PX solution in power plants. Furthermore, we are evaluating several other markets where these pump line could be utilized.

We are pleased to report our brackish PX device is also being used by Statkraft, Europe's largest renewable energy company, as an integral component in the world's first osmotic power plant inaugurated this last November near Oslo, Norway. As we mentioned last time, Statkraft is projecting substantial global potential for osmotic power.

We continue to investigate new business ideas and company acquisitions in the water and clean energy space. The criteria has been defined in previous calls and we made some change. We are also in various stages of discussions on several opportunities which we believe satisfy most if not all of the ERI's investment criteria. We can share more details with you if and when we enter into anything definitive.

I would now like to turn the call over to Tom to discuss our fourth quarter results in more detail. Tom?

For the fourth quarter ended December 31st, 2009, we achieved net revenue of $15.7 million, a 28% decrease over the same period last year and within the company's guidance range of $14.5 million to $16.5 million. For the full year, we generated $47 million of net revenue, a 10% decrease over the previous year. As G.G. mentioned earlier, while we had a record year for new contract bookings, the bookings came too late in the year to recognize the revenue before year-end.

The percentage of net revenue derived from our mega projects sales division was 67% in the fourth quarter and was generated from sales to the 200,000 cubic meter per day Tenes project in Algeria, and the 150,000 cubic meter per day Adelaide project, and 137,000 cubic meter per day Perth II project, both located in Australia. For the full year, net revenue generated by our mega projects sales division represented 67% of total net revenue compared to 66% in 2008. Our OEM division contributed $4.3 million in net revenue in the fourth quarter or 27% of the total. For the year, our OEM group contributed 28% of the total net revenue.

Approximately 94% of our net revenue in the fourth quarter was generated from the sales of our PX devices with circulation of booster pumps comprising 1%, service and aftermarket spare parts contributing 4% of revenue and PEI contributing the remaining 1%. For the full year, approximately 91% of our net revenue was generated from the sales of our PX devices with circulation of booster pumps comprising 4% and service and aftermarket spare parts contributing the remaining 5% of revenue.

Sales to foreign customers accounted for 92% of our net revenue for the quarter with shipments to Algeria and Australia making up 22% and 45% of the total respectively. Sales to foreign customers for the full year accounted for 94% of our net revenue with shipments to Algeria, Israel, and Australia, making up 24%, 21% and 19% respectively.

Revenue from customers representing 10% or more of total revenue varies from period to period. For the fourth quarter, a joint venture led by [Bethesa Agua] based in Spain, a joint venture of [Valariza] and [Sadeeth] headquartered in Spain and Acciona Agua based in Spain accounted for approximately 22%, 26% and 20% of the Company's net revenue respectively. No other customer accounted for more than 10% of net revenue during the quarter.

For the year ended December 31st, 2009, IDE Technologies Limited, Acciona Agua and UTE Mostaganem, a consortium of Inima and Aqualia accounted for approximately 20%, 11% and 11% of our net revenue respectively. We purchased pump engineering on December 21st, 2009 and included 10 days of pump engineering's net revenue of approximately $234,000 in our fourth quarter results.

Gross profit as a percentage of net revenue was 60% for the fourth quarter compared to 64% for the fourth quarter last year. For the full year, gross margin was 63%, which was 1% higher than last year's 62% gross margin percentage after adjusting for a one-time reversal of a warranty provision. The decline in gross margin in the fourth quarter is due to several factors, including higher overhead costs from our new expanded production facility, a modest increase in our cost to purchase ceramic parts, volume discounts and meeting aggressive pricing from our competitors.

For 2010, we expect a gross margin for our pressure exchange of product line to decline to 60% to 61% due to a modest decline in the average sales price as a result of competitive pressures, a small increase in the price of ceramics we paid to our outside vendors, but mainly due to the gradual ramp up of our ceramics production facility, which is beginning in the second quarter.

As we ramp up production throughput during the course of the year and are able to absorb more of the fixed cost of our ceramics production facility, we expect to see the benefits from this vertical integration. Bear in mind that the ceramic components make up approximately 60% of the cost of a PX device. The single largest cost of the ceramic production process is yield out of the kiln and our ceramic vendors average yield is approximately 60% overall. Our goal for our own ceramic production is to achieve yields in the high 80s to low 90s once we are in full production by the first half of 2011.

Due to the average length of the sales cycle for large projects, we expect modest sales in 2010 of our newest most efficient pressure exchanger, the PX-300 which provides our customers with a 15% improvement in production capacity over the PX-260 device. While we are consolidating the financial results, the pump engineering in our financial statements, we will provide segment information on pump engineering in our financial disclosures during 2010 as required by GAAP.

As we indicated during our conference call last December, PEI's product line of turbochargers and pumps are primarily aimed at a different segment of the market than our pressure exchangers. Further, PEI's products are designed, manufactured and composed of non-ceramic materials that are very different than those used for the pressure exchanger device. As a result, they do not have the same margins as our pressure exchangers.

We expect a blended gross margin for the two companies to average 55% to 56% for the full year. This assumption is built into the earnings guidance we provided today. In 2011, we expect the gross margin to improve due to the full utilization of our ceramics production facility and increased sales of the PX-300.

One last comment on gross margin relates to the purchase accounting for the acquisition of pump engineering. The accounting rules require us to write up the inventory at PEI to its current fair market value at the time of acquisition. This step up of inventory is non-cash and non-recurring in nature and serves to reduce the gross profit for PEI by approximately $870,000 for the year. We will report our results this year, both including the step-up charge on a GAAP basis and excluding this non-cash charge on a non-GAAP basis to reflect our operating performance.

Sales and marketing expense, which includes sales, commissions and marketing programs was 11% of net revenue for the fourth quarter of 2009 compared to 10% for the same quarter in the previous year. For the full year, sales and marketing expenses increased to 14% of net revenue in 2009 from 13% in 2008. The increase as a percentage of revenues was due to the fixed nature of our base salaries for our sales personnel and lower revenues in 2009 compared to 2008.

General and administrative expenses consist primarily of personnel on our executives, finance and accounting, information technology and human resources organizations as well as fees for professional services, including outside legal, tax and audit services.

General and administrative expenses for the fourth quarter increased by $938,000 over the previous year. Almost all of that increase was attributable to expenses that we consider either non-recurring or non-cash in nature, including approximately $185,000 for a tax study to reduce our taxes, $216,000 of intangible amortization from the acquisition of PEI, $229,000 increase in non-cash stock-based compensation expense and $292,000 of legal and other professional fees related to the acquisition of PEI.

For the full year, general and administrative expenses were 29% of revenue versus 22%. The primary reasons for the increase in general and administrative expenses for the year relates to costs associated with our growth in operations and cost related to the transition from a private to a public company and the lower revenues in 2009 compared to 2008. When comparing the G&A expense for 2009 versus 2008, please note that we were only a public company for six months in 2008, so we are picking up the full year burden of public related expense for 2009 compared to the previous year.

Stock-based compensation expense included in general and administrative expense was $1.5 million for the year ended December 31st, 2009 against $512,000 for the year ended December 31st, 2008. We also incurred approximately $250,000 of offsite consulting services in 2009 in conjunction with preparing for SOX compliance.

As part of the purchase accounting for pump engineering, a third-party valuation was performed to determine the level of intangible assets that will be amortized and included under general and administrative expense. For 2010, we estimate the amortization of intangible assets to be approximately $2.5 million. When we report the non-GAAP measurement of adjusted EBITDA, we will be adding back the amortization of intangible expense to earnings as it is non-cash in nature.

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 2009, research and development expense increased to 4% of sales compared to 3% in the fourth quarter 2008. For the full year, research and development expense was 6% of revenue compared to 5% in the previous year, an increase in absolute dollars by $626,000 principally due to costs associated with our ceramics initiative.

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 fourth quarter and the full year was $594,000 and $2.4 million, respectively, and is included in the cost of revenue, sales and marketing, general and administrative, and research and development expense lines on the income statement. For 2010, we expect our non-cash stock based compensation expense to total approximately $3.2 million. When we report the non-GAAP measurement of adjusted EBITDA, we will be adding back the stock based compensation to earnings as it is non-cash in nature.

Other net income or expense decreased by $786,000 to $8,000 for the year ended December 31st, 2009 from $794,000 for the year ended December 31st, 2008. The reduction in 2009 versus 2008 was primarily due to a decrease in interest earnings of $552,000, resulting from dramatically lower interest rates in 2009 versus 2008 and investing our cash in a US Treasury only money market instrument to ensure capital preservation.

Net income was $1.7 million for the quarter or $0.03 per fully diluted share compared to net income of approximately $5.3 million or $0.02 per diluted share in the fourth quarter of last year. Net income for the full year 2009 was $3.7 million or $0.07 per fully diluted share compared to $8.7 million or $0.18 per fully diluted share for 2008.

On a non-GAAP basis, we generated adjusted EBITDA in 2009 of $9.7 million or 21% of revenue compared to $14.7 million or 28% of revenue in 2008. As described in our press release today, adjusted EBITDA adjust earnings by adding back interest, taxes depreciation, amortization and stock based compensation; our net cash provided by operating activities for the year was $13.1 million compared to $1.4 million in 2008.

The $13.1 million cash generated from operations was more than sufficient to fund the $7.7 million of capital expenditures, including the tenant improvements of our new headquarters building, the first phase of our ceramics production initiative, and other equipment.

Turning now to the balance sheet, we ended the fourth quarter with approximately $59 million in cash and $5 million in restricted cash supporting letters of credit for a total of $64 million. This figure does not include the $5.5 million of cash in contingent escrow funds related to the purchase of pump engineering. We made significant strides in 2009 in reducing our accounts receivable. Our accounts receivable balance as a percentage of revenue was reduced to 27% at the end of 2009 compared to 40% at the end of 2008.

Despite this difficult global economic credit market, our bad debt as a percentage of accounts receivable improved from 3% in 2008 to just 2% in 2009. Inventories were $10.4 million or 7% of total assets compared to $8.5 million or 7% of total assets at the end of 2008. We increased our net intangibles from $321,000 last year to $23.8 million at year end 2009 as a result of the acquisition of pump engineering. Included in that intangible figure is approximately $12.8 million of goodwill that will be subject to an impairment analysis towards the end of the year.

As I mentioned earlier, our general and administrative fees in 2010 will include approximately $2.5 million of non-cash amortization expense related to our intangibles. We had no outstanding debt under our revolving credit facility. We picked up a small amount of equipment related debt from PEI acquisition. Most of the increase in other long term liabilities relates to a portion of the purchase proceeds for pump engineering that was put in escrow amounts.

In our press release today, we provided guidance for our expected revenue and earnings results for the first quarter and full year of 2010. For the first quarter, we are projecting net revenue in the range of $11 million to $12 million and GAAP net loss between $500,000 and $1 million. On a non-GAAP basis, adjusting for the purchase accounting related to our acquisition of pump engineering, we are projecting net earnings as zero to a loss of $400,000.

For the full year of 2010, we provided guidance of $70 million to $75 million in net revenue or an increase of approximately 54% over fiscal 2009, assuming the midpoint of that guidance range. We projected GAAP net income in the range of $4 million to $6 million or $0.07 to $0.11 per fully diluted share for the full year. On a non-GAAP basis, adjusting for the non-cash purchase accounting, we projected net income in the range of $6 million to $8 million or $0.11 to $0.15 per fully diluted share for the full year.

Lastly, we projected adjusted EBITDA to be in the range of $100,000 to $600,000 for the first quarter and $15 million to $18 million for the full year. As a reminder, the adjusted EBITDA for 2009 was $9.7 million. A full reconciliation of the adjusted EBITDA to GAAP is contained in today's press release.

That concludes my review of the fourth quarter and full year 2009 financial results. I would now like to turn the call over to G.G. for some concluding remarks.

Thank you, Tom. As you have heard today, our industry continues to enjoy strong growth and we continue to solidify our leadership position as a provider of energy recovery solutions in the desalination industry. The factors driving the construction of new desalination plants including population growth, climate change, and increasing demand for water and food and power production have not changed and continue to intensify.

Energy Recovery devices like our PX pressure exchanger and hydraulic turbocharger products have made desalination affordable and we expect to see rapid growth in our core businesses. We will continue to drive applications of our core technologies into other markets. While it is difficult for anyone to predict when the volatility of the bank inserter will stabilize, we see encouraging signs for 2010 including the rapid state of development and financial closings of the Melbourne project, one of the largest desal plants ever built.

We see accelerated activity in Israel, as evidenced by the large Hadera shipment in Q1 followed by an expansion of the same plant in Q3. Last fall, we moved into a new integrated manufacturing facility that will streamline our manufacturing and logistics workflow, and will expand our production potential threefold. This building will also serve as our corporate headquarters, integrated ceramics production facility and ceramics material science laboratory.

Let me tell you a little bit about the ceramics material science. Taking control of our material science is transformational for ERI. Our ceramic components set us apart from our competition. Since 1995, we have built off a tremendous knowledge base of machining ceramics to precise tolerances. We have also centered most of our prototypes like the Titan and the PX-300 in-house.

Now, we are broadening into the material science of ceramics beginning with high purity metal oxide powders. We work diligently through the summer and fall in our new ceramics facility lab to optimize the properties of our aluminum oxide ceramics formulation. This will help us to improve our deals as we ramp up production and help us make better PX products.

This summer, we will continue development work centering other intriguing metal oxides which have unique properties. We are investing $12 million to $15 million in this new ceramics operations which will have the capacity to eventually produce half of our ceramics needs. We are planning a graduated ramp up in ceramics production starting this summer with full production in 2011.

This should have a positive impact in our cost of goods sold and cash flow as we get the yields up. We believe this investment will lead to other innovative ceramics based solutions even outside of the desalination market. This is very exciting for us and we expect our ceramics initiative will have a broad and long-term benefit to our shareholders.

I would now like to turn the call back over to the operator and hope I will open up the line for questions with research analysts. Given the number of analysts presently covering the Company, we ask that you limit your questions to one and rejoin the queue for additional questions.

Operator, please proceed. Josh?

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions).

And our first question comes from the line of Laurence Alexander with Jefferies & Company. Please go ahead

Hi, this is actually Amanda Sigouin on for Laurence. I was wondering -- you mentioned in your comments that the pipeline is really robust for the next three to four years. Could you give a little bit of color around the size of the pipeline or the number of projects and what your expectations are around timing?

Yes. Interesting in office, it's still holding up at 160 projects and $500 million in revenue, and where we see is new projects coming in, we mentioned Libya in the PX and projects in Morocco. Projects -- this -- a lot of projects in Mexico related to -- along the borders, related to the water scarcity in the western states. We see a lot of activity coming in Chile and other places.

So, we see -- this is where we see -- we mentioned this twice before but it's happening as we speak. Israel is accelerating, all of their water projects in Israel are accelerating very fast. So, we see Israel's accelerating, we see Australia very, very active, and then we see all these projects coming in. And then, as we go a little bit longer term, we see India and China becoming big factors here.

Thank you.

Thank you. And our next question comes from the line of Alex Potter with Piper Jaffray. Please go ahead

Hi guys.

Hi.

Hi, Alex.

Question here in terms of how many projects you have, how many mega projects you have underlying the guidance for 2010? And then, if you could go into this amount of detail, it would be interesting. I would be interested just if you could follow up on this last geography question. Of those however many projects there are in 2010, what geographies are they in?

Yes. Actually, the numbers is very similar to last year's. The number is about 14 or so, but the projects are getting a lot bigger. What we see -- the projects tend to be -- we used to do 100,000 cubic meter per projects in Algeria a couple of years ago. Now, we are seeing a lot of 400,000 and up. So, we're dealing with similar numbers of much bigger, much bigger projects. And then, as we mentioned, Israel is very active. The entire Eastern part of the Mediterranean, including Cyprus is tremendously active. India, a little bit of Spain, a couple of projects in China and -- three of that -- we mentioned three of that retrofit.

There is a lot of activity -- this -- even though if you are in the East Coast, you have been getting a lot of rain, it hasn't rained in Venezuela and the Caribbean for a while now, so clearly that is accelerating the retrofit, so they can expand some of the plants that they have and build some new ones. And then, a couple of projects in Algeria and Morocco, so that's roughly where the activity is coming from in the next 18 months or so.

Okay.

And we also -- I mentioned California. I think what you are going to see is you are going to see California accelerate, especially the -- we believe that the Monterey project will get a head on the [Carlstadt].

Okay, interesting. Yes, I was wondering how many last and final hurdles there are left for the Carlstadt plant. It seems like every week there is a last hurdle that's been cleared. So, I guess just in summary, 2010, you have about 14 project underlying guidance and they should be coming or the Company should be booking revenue from projects in the mega projects division from Israel, Cyprus, Algeria, India, Spain, China, and Trinidad. Is that correct?

Yes. But a big chunk of that and we're not going to tell you precisely, but a big chunk of that is already booked.

Okay.

Right. The only thing I would add, Alex, is from PEI obviously, people know about the Magtaa project, which is included for this year and in our guidance. And they've been stronger in the Middle East than we have in the past, so I would add the Middle East and certainly including Algeria for the PEI product line.

Right, absolutely. That allows us to go into places like Saudi Arabia. There's projects coming in Qatar. So, we will have a lot more activity in the Red Sea and the Arabian Gulf.

In mega projects?

Yes, because the turbocharger, it's getting specified in bigger and bigger projects in low power cost countries like Saudi Arabia, Qatar.

Okay, great. I'll jump back in queue. Thanks.

Thank you. And our next question comes from the line of Ben Kallo with Baird. Please go ahead.

Hi, good afternoon. You talked about in your prepared remarks on the retrofit opportunity accelerating. Could you talk a little bit what's driving that? Thank you.

As an operator, the cheapest way to get water is the retrofit -- the cheapest way and the quickest way to get water is the retrofit, something that already has an intake and your high pressure pumps, which we saw that in Israel. We did several large retrofits last year of the Palmachim plant in Israel, the Larnaca plant in Cyprus, and what we're seeing now is that this -- a strong, a very strong drive to retrofit some of these plants that are in the Caribbean, including potentially the Tampa Bay plant in Florida. Just because -- it gives you more water very shortly as opposed to building a new plant and lowers your cost at the same time.

Thank you. And our next question comes from the line of Shawn Severson with ThinkEquity. Please go ahead.

Thank you. Good afternoon, gentlemen. I was wondering if you could elaborate a little bit on the ceramics side of things and obviously for your own internal capacity. But as you go forward, to may be discuss the timing of when you might start exploring other applications in other markets and begin selling your ceramics outside of ERII.

Yes, yes, basically we have a team of people dedicated to the ceramics, ramping up the ceramics facility and as some Tom disclosed, we expect to get the yields up very quickly, and that's crucial. So, part of our mandate from the Board is not to distract this group into new ventures while they're doing that.

Never -- having said that, I already mentioned that we are -- we will be tinkering with new ceramics formulation this summer that will get, that potential will get us into completely new areas, but basically we'll be doing development work in the lab, but we're not going to be distracting our production capacity until probably in October, November. We are accelerating delivery of some of the ceramics furnaces so we can start doing some of these new components.

And just in terms of sales and distribution, how would you bring that product to market if you look out into 2011?

Yes, as you look into the products, that's basically, as we look at the Company and you look -- I think it's on our website, the new investor presentation, the -- one of the last slides. As we look into -- what -- even more, one more year out into 2012, we see ceramics being a separate business unit of the company selling products. Selling ceramic products because we are in the middle of Silicon Valley, that's not, it's not difficult.

We know there is a lot of demand for ceramic products in the semiconductor areas. But we don't want to become merchant producers of parts to other people like Applied Materials. We want to come out with complete solutions and that's what we are looking at, and that's part of building up of separate team of people. We're doing the same thing with the gas group. We have an expert that starts on Monday morning that's going to be looking at the gas market for us.

Right. Thank you.

So, we keep it as separate businesses.

Thank you. And our next question comes from the line of Dale Pfau with Cantor Fitzgerald. Please go ahead.

Hi, Dale.

Mr. Pfau, your line is open. And our next question comes from the line of Patrick Jobin with Credit Suisse. Please go ahead.

Hi, G.G., hi Tom.

Hi, Patrick.

Hi.

Just a quick question here, I want to jump back into gross margins and operating expenses in your outlook for 2010. Did you mention specifically what revenue you expect from PEI? Is it still within that $13 million to $15 million range?

Yes, I can say that it's still within that range and what we'll do, we'll have some segment accounting going forward in each one of those quarters because the fact that the margins are different in the two businesses, I think it's going to be very helpful to explain to analysts and investors what the revenues and the gross margin were for PEI separate.

There's a lot of integration going on between the two companies. I can assure you of that as far as sales and service out in the field and HR and accounting, et cetera. So, even though we'll be reporting the numbers on a consolidated basis, we'll break out what we think is material segment reporting for each of the two business lines.

Great. That will be helpful. And then, so for the gross margin in your outlook, are you assuming roughly 20%, 30% within PEI and if so, what is the impact of the Magtaa project -- 2010 when we look out to 2011?

Yes, let me take that question and we'll take it one step at a time. The reason we were attracted to Pump Engineering is that their margins are a lot higher than a typical pump company. If you look at Flowserve, I mentioned Flowserve and I have mentioned Calder. Yes, Calder DWEER and Sulzer. The margins is not high as the PX. PX, no, there's not too many things around equipment that -- rotating equipment that has these 60% to 64% margin that we have been enjoying here.

So, it's somewhere in between. So and that's really what we can disclose. But also as you study the margin, the margin for the next few quarters are going to be impacted by all these charges because we were forced by the auditors to basically take a hit on the inventory.

And that, you may want to elaborate on that.

Yes. No, I had mentioned in the call that there's approximately $875,000 of step up in the purchased inventory that basically reduces the gross margin for PEI, so that's why we'll be reporting that on an non-GAAP basis both including GAAP and excluding for non-GAAP, so people can really understand what the margins are.

And I have to say PEI is kind of at that inflection point where if they can add more to their revenues, they're more than covering their cost, there isn't going to be more falling to the bottom line. So, they -- I think they're poised for this year and in the coming years as far as getting some operating leverage off of their new facility and their fixed cost equipment.

Great. Thanks..

And our next question comes from the line of Greg McKinley with Dougherty & Company. Please go ahead.

Thank you. Guys, could you -- I wanted to ask you a few modeling related or guidance related questions. Your view for sort of mid-50% gross margin rates, is it fair to assume the year starts lower than that and works its way north given the integration of the new ceramics facility?

Yes, I'd say it's fair to assume that.

And is there a major difference in margins between the first half and the second half of the year or is it -- we're talking 100, 200 basis points here and there?

I think it's going to be more gradual. In Q2, we'll basically just be in the process of starting up the equipment. In Q3, we're going to be just gradually -- I'll just throw a number out there that I think will be pretty close, let's say, increasing it by 25% and then maybe another 25% in Q4. So, we really think we'll be hitting our stride with respect to optimum throughput through the facility in the first half of 2011. So, that's why we guided down on the revenues for the PX line to that 60%, 61%, so it will be kind of a gradual thing and it'll get a little bit better every quarter and then significantly better, we believe in the first half of 2011.

Yes, we have three moving parts, the ceramics that you mentioned because that as we ramp up -- ramp that up and get the yields up, that's going to be very important. The other moving part is the one that Tom mentioned, that we have -- in both cases, we have very large production facilities that are little bit underutilized.

So, as we drive the synergy of the sales forces and our PX sales group starts selling, especially the OEM groups going to start pushing high pressure pumps and booster pumps very hard, made by Pump Engineering, I think you're going to see by -- in the second half of the year, all of the synergies come together on that. And those things we're driving right now. We're cross-training people, we're cross-training the sales people, the service people and we're driving the full integration of the Company.

So, maybe end the year more on upper 50% to 60% type of rate at that end of the year, something that ballpark?

Yes, toward the blended is going to be the guidance that we gave you. And bear in mind, we're going to have another big fourth quarter as we have the past eight years --

Yes, and that's the other thing I wanted to ask is your guidance implies little more concentration in Q4 than we may have seen in past years. Can you help us think about seasonality as the year progresses? Should we expect sort of flattish Q2 and Q3 revenue with the big Q4 again or should we expect that to build in each of the sequential quarters, how are you thinking about that?

Well, I don't think that we've indicated that this would be an unusually large fourth quarter.

Okay.

We've indicated that it will be the largest quarter of the year and that's been the trend for the last several years. Now, what's going to smooth that out a little bit is shipments to the Magtaa project are going to be gradual during the course of the year, but that will smooth things out a little bit. We're not anticipating that Magtaa all going to ship in the fourth quarter. That is certainly not the planned schedule.

Okay. And then one final question, can you talk about CapEx for the year, what your depreciation expense and amortization expense assumptions are? Thank you.

Okay. On the CapEx, the -- and that's the reason we're going to be providing an adjusted EBITDA number. We're going to be putting -- we spent about $3 million on the ceramics initiative in 2008. We'll probably be spending say close to 70% of that total price tag for the ceramics initiative in 2010 and then the rest will be layered in 2011, and obviously that's going to increase our depreciation expense.

The major capital expenditure for the Company in 2010 is going to be the ceramics initiative. I think the lion's share of CapEx for Pump Engineering, they spent last year when they moved into their new building and they upgraded a lot of their equipment, et cetera, and for us we've done all the TIs this year. So really, the major CapEx will be the ceramics initiative.

Okay. And then, depreciation numbers and your tax rate for 2010?

Yes, the tax rate right now we're estimating to be around 39%.

Okay. Thank you.

Thank you. (Operator Instructions).

Our next question comes from the line of Debra Coy with Janney. Please go ahead.

Thank you. Good afternoon, guys.

Hi, Debra.

Hey, G.G. Just a follow-up on the bookings that you talked about earlier that you said that it was a record bookings year in 2009 and your contracted capacity was up 40%. Can you say what the booking were in 2009 versus 2008 and a dollar number? And what I'm -- go ahead.

Yes, yes. No, we prefer -- there's a really, really good reason because we usually don't give bookings information, but this year we felt that it was valuable to give it out to show the change in the momentum because again, the -- what we're saying is that the market took three quarters off pretty much. And that reversed in September. We said that in the last conference call, but we'll have to quantify that a little bit for you guys. And that's why we gave the 40% number, which is pretty significant for the big projects. So, but that gives you a feel of the change in the momentum of the market and where the Company is going as we go forward.

Well, we've talked about this a little bit before but it's still hard for me to understand why you don't report bookings and an aggregated number. Obviously, I know you don't give revenues per projects, but why don't you report aggregate bookings?

Well, let me take this one, Debra. There is a couple of reasons that I think even from the very beginning we went public, we got asked this question a lot. One, we're not an engineering and construction company where we're booking a big backlog of projects, which we worked off with a percentage of completion. And I think we're always nervous, and our Board is nervous about giving numbers out that -- there could be lots of different definitions that are not auditable numbers, and it's nothing that we put in our financial statements.

So, we consider something a booking when the contract is fully signed with all the signatures and there's a firm shipping date and then, it goes into our ERP system to schedule for production. That wouldn't include, let's say, letters of intent, or something where we're one signature away from getting the contract signed and that sort of thing. So, it's a number that can be a little bit misleading depending on what point in time you are measuring it.

So, to me it doesn't really serve to help people trend the business. So again, what we are certainly willing to do, which many companies are nervous about doing is giving guidance for the upcoming quarter and then, we'll give continual updated guidance for the full year. And certainly embedded in those numbers would be the backlog that we know, the bookings that we know, and also the bookings that haven't gone into our ERP system that we're highly confident that we're going to get. And that's about all we can say on it.

Right. Okay. I guess I kind of understand that. It's just that it continues to difficult to forecast this business, obviously for you guys too, because 2009 didn't quite come through according to original plan. And the reason I asked about the level of bookings was obviously trying to understand 2010 and G.G., I think you said earlier that you have a quote "big chunk" of 2010 already booked. But I'm trying to get a sense of how much is still out there to be booked. Is it half, is it less than half, can you give us any kind of sense of where you are in terms of actually having your 2010 outlook in hand?

Yes. We have about 40% in hand already and booked. Again, the -- we're dealing with very big chunks --

Right, yes. That's right. I do understand

That could double in a couple of orders because of the big chunks.

Yes, yes, okay. That's helpful. And then obviously, we'll talk about it as the year goes forward. And then just to wrap up because I presume I'm at the tail end of the queue here, Tom, just to understand how the inventory step up adjustment works. Is that one-time, or is that -- the $850,000 divided by four for each quarter or how are you treating that?

No, it's -- yes, the total number is approximately $875,000 and basically the work that you have in process at the time you buy the company, the valuation experts come in and write it up to what the current market value is. So, they really kind of squeeze the margin on that whip. And so, that'll basically bleed out as PEI ships those products let's say during the first three quarters. And it's a one-time thing, it only happens when you purchase a company. So, it won't be repeated and so, we'll give the non-GAAP gross margin that excludes that because it has nothing to do with cash.

Right. Sure. So, that will just come out proportional to the actual inventory being used?

Yes, pretty much.

Okay.

That's a good estimate, Debra.

Okay, all right. So, I understand that and then on the intangibles amortization, it seems unusual to be backing that out of earnings certainly for your EBITDA adjustment, but for -- I would think that would be part of an earnings number because isn't that what -- how many years, is that a three-year amortization period, or what's your intangibles period?

No, no, no, this is a real mixed bag. You've got things like the non-compete agreements for certain people, you've got a backlog that was valued. You have a customer list that was valued. You have IP and patents. Some of it goes out. It can range from one to 20 years. There is a few things like trademarks that have a pretty short fuse on them. Obviously, customer list and backlog at the time that we bought PEI has a pretty short fuse on it. So, we estimated that about $2.6 million of amortization.

And to me, I've always understood EBITDA that A in that EBITDA always to mean amortization; it's not in cash, it's pretty much notional. So, most people back that out when they give an EBITDA number. Our adjusted EBITDA, and the only adjustment that's not included in the initial EBITDA would be stock based compensation. It just makes the acronym too long, so we call it adjusted EBITDA. But these are all non-cash items that are pretty standard.

But your adjusted earnings guidance, the $0.11 to $0.15 backs those items out as well?

Yes, it backs out interest, taxes, depreciation, stock based compensation, and the effects of this one time purchase accounting.

Okay, all right. I'll follow-up with you afterwards.

Okay, yes, we --

Thanks, that's it.

You bet.

Thank you. (Operator Instructions).

And our next question comes from the line of JinMing Liu with Ardour Capital. Please go ahead.

Hi, G.G. and Tom.

Hi.

Hi, JinMing.

Hi. I have a few questions related to PEI. Before you mentioned that PEI has another product line, which is the high pressure pump. I'm wondering whether you have already observed some pickup in order in that product line? And also, the SG&A expense from PEI was very high in last year. Do you guys have any plan to streamline operation over there?

Yes, let me take the pump question first. PEI has a pump that is very -- this is very specific and it's very -- actually it's a perfect pump to couple with the turbocharger. And that pump is completely designed and ready to go. They also have a line of MSRO pumps, which goes to medium size ranges. Those are also ready to go and we're already offering those pumps. For the bigger line, the pumps need to be designed and tested and validated, and then we'll be launching it.

So, it depends on where you are in the products range and also, we will be able to make bigger booster pumps. So, for the -- the answer is for the smaller pumps, up to medium size, we are offering them right now. And we hope to have -- to be able to report some successes here by the second quarter. And for the bigger pumps, we have to do a little bit more testing before we can give guarantees for this big projects. But we can already tell you about our sales people, our PX sales people have been very successful selling turbochargers already in China and all other places. We are pretty aggressive out there and helping each other.

Okay, how about --

Yes, if you can repeat the second part of the question, we'll take it.

Okay, it's -- that part is about SG&A expense in PEI. Last year, that expense was relatively high. Have you guys have any plan to streamline the operation there?

Did you say G&A expense?

SG&A. Both selling and the general and administrative expense from Pump Engineering.

Yes, let me take that one, one piece at a time. We are -- we have done restructuring of the Company and we are actually short of some key people and that's in the budget or guidance that we had given you. But also, we have a brand new facility that is underutilized. So, the -- as just as we do. And it's part of the -- what we're doing here as part of the integration is driving revenue and driving gross margins.

So, we can absorb these two new facilities and then as you do that, then the -- as a percentage of sales, the G&A will come down. And hopefully, it's not going to go up anymore because some of the -- no, all of the big G&A items are for both the companies are already in place.

Yes. And I'd also say that as a private company, they ran pretty lean. Certainly, their accounting personnel and other general and administrative staff as a percentage of the revenues is actually pretty low. The opportunity that we have in the sales part of it as we're looking at integrating our sales forces, they've got some very strong outside people that we may retain and who are really good and there's other parts of the world where we would use our direct sales force.

So, there's an opportunity there to get some synergies and that's an ongoing process. The same thing for field service. We had most of our field service team in Detroit back there a week or so going to do training, to do the field service on their pumps. So, we're trying to take advantage of synergies. And then, in addition to that accounting, HR, finance, and things like that, we're taking the lead or -- from them on that. So, there should be some leverage on that G&A for PEI.

Okay. Lastly, have you ever received any orders on your PX-300 unit for like --?

Yes, we have a couple of orders, both of them in Egypt, interesting enough, which was -- Egypt is a market that had been dead. It happened last year, but now it's becoming very active. So, we have a couple of orders into -- going into Egypt. So -- and we are -- again as I mentioned, we are pushing it for smaller projects and for bigger projects, we will prefer to have our ceramic facilities running so we can do it in-house.

Okay, thanks.

Thank you. And Mr. Pique, there are no further questions. Please continue with any further remarks.

Okay. Thank you very much. And we are -- if you have any further questions, Tom and I will take your calls and we look forward to meeting some of you and I'm going to be meeting Debra in her conference in two weeks and we look forward to meeting all of you as we go to the various conferences here.

So, thank you very much and great questions.

And ladies and gentlemen, that concludes the Fourth Quarter 2009 Earnings Conference Call. If you'd like to listen to a replay of today's conference, you may dial 303-590-3030 or 1-800-406-7325 and enter the access code of 4226967. Thank you for your participation and you may now disconnect.