Energy Recovery Inc (ERII) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Energy Recovery first quarter 2010 earnings conference call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be open for questions.

(Operator Instructions)

This conference is being recorded today, Thursday, May 6, 2010. I would now like to turn the conference over to Tom Willardson, Chief Financial Officer. Please go ahead.

Thank you. Good afternoon, and welcome to Energy Recovery, Incorporated's first quarter earnings conference call. Joining me today on the call is G.G. Pique, President and CEO. Today we will discuss the financial results of our first quarter, update our outlook for 2010, and discuss the progress on our various strategic initiatives, including our ceramics production facility and the integration of Pump Engineering.

In the press release today, we provided guidance on our upcoming second 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 first quarter performance and 2010 projections that exclude certain noncash charges that we view as either one-time or nonoperating 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 our 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 forward-looking remarks you may hear on today's call. The primary purpose of today's call was to provide you with information about our first quarter financial 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 strategy. 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 first quarter results, ERI achieved net revenue of $12.6 million and GAAP earnings of $68,000, and non-GAAP earnings of $717,000, adjusting for the effects of purchase accounting. Our revenues and net income for the first quarter were all slightly better than the guidance ranges that we provided in March. 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.

Thank you, Tom. Good afternoon. In the call today I will update you on the outlook for our business and the procurement activity in the global desalination markets. I will also comment on the reviving market conditions we continue to see and how this effects 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 for the first quarter 2010 and give you some guidance on our full-year 2010, and then I will make some concluding comments. Afterwards we will open up the line to take questions from research professionals.

During the first quarter 2010, we made $68,000 and $12.6 million in revenue. During the quarter we deployed $8.8 -- $8.6 million of our cash into ceramics strategic initiatives and operations. We ended the quarter with slightly more than $50 million in cash. In Q1 we had net revenue in our guidance range and met our guidance on earnings per diluted share by generating 0.0 per share for the quarter. Revenues for the quarter compared to Q1 2009 were flat.

Procurement and contracting activity for large desalination projects is better a year ago. However, some projects like Carlsbad and the large project in Libya keep getting delayed for political and legal reasons. Altogether, we're looking at 11 large projects, which may ship in 2010, but the projects are getting bigger and the timing of the revenue harder to predict. The good news is that desalination demand is still very strong worldwide, except for Eastern Australia, which is Sydney on the Gulf Coast, where they got very strong rainfall this year.

In our OEM business, we continue to see improvement in desalination projects planned in 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 continue to be stalled. We are experiencing hotels and resorts in Egypt continue to improve, and we have been booking PX-300 orders into that market. Some of these projects are expansion retrofit opportunities and involve replacing Pelton turbines in existing flat PX devices.

Beginning in late 2009, we started to see an increase in the level of new plant construction and retrofits in Mexico, the Caribbean, and Latin America. We continue to see India emerges -- emerging as an important [SWRO] market, especially in power plant projects.

Our OEM group is enjoying the benefit of the PEI integration. During the first quarter, our OEM group booked the first sale of PEI high pressure pump, to be combined with PI -- PX device installation, and this group already has some $7 million in PEI pump quotes outstanding.

Political and legal issues have delayed the Carlsbad, California, website Algeria and all of the Libyan projects into 2011. For this reason, we see the growth of our large projects' shipments shifting to 2011 and beyond. Given the trend towards larger and larger plane capacities and the fact that even after the PEI acquisition, mega projects still comprise roughly 60 -- 70% of our annual revenue stream. A shift of a few large projects can cause a significant variation in our financial results.

The Pump Engineering integration is progressing extremely well. We are making great progress integrating our ERI and PEI sales forces. We have strong leadership in place, a wonderful motivated team, and we share the same culture. Furthermore, we have expanded the addressable market by broadening our product portfolio, adding high pressure pump -- high pressure and circulation pumps to the isobaric PX product solution. Our $7 million in outstanding pump quotes is a good example of the market's positive reaction to this acquisition.

We are also recruiting additional talent and providing resources to reinforce the Company and further differentiate from competing alternatives. Our customers are perceiving ERI and PEI as a single Company, as stronger and able to provide additional solutions to desalination and water treatment needs.

As we mentioned this past March, when we look at the total picture for our business for the near term, we continue to see the drivers of desalination growth intact and our competitive positioning improving when new products offerings for seawater RO, like the PX-300, the hydraulic turbocharger options for [low] power cost areas, and a larger range of booster pumps and the PEI MSRO high pressure pumps. Turbocharger technology also allows us to aggressively go after the brackish water and gas processing markets.

A week ago in Paris, Christopher Gasson, editor of Global Water Intelligence, gave his outlook for the desalination business. He sees new contracts for seawater RO plant capacity growing by 50% this year to about four million cubic meters per day. Longer term, he sees the industry contracted capacity rate doubling to 8 million cubic meters per day by 2016.

Countries and regions like Israel, Spain, Cyprus, Western Australia, India, and North Africa have been suffering from a severe lack of drinking and irrigation water. In North Africa, we see Libya developing into a political large market -- into -- sorry, into a potentially large market by 2011 as they emulate the Algeria model. Population growth [in the Magtaa] 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 strong. Older plants in places like Tampa, Trinidad, Cyprus, Malta, Chile, Spain have projects for expanding their capacity or saving energy by replacing legacy energy recovery devices with our PX units. As I mention earlier, our OEM group, which covers projects under 50,000 cubic meters per day, had a good quarter and a steady flow of business coming from Spain, Egypt, Israel, China, and parts of Europe.

Our sales pipeline of desalination projects over the next three or four years is still strong. New projects in Mexico, Peru, Chile, and North Africa continue to be added to our tracking list as formerly listed projects are turning to purchase orders.

Here in California, we continue to see significant water supply and demand issues. Poseidon Resources received a two month extension until the end of June to line up tax free bonds. Also, a couple of weeks ago, the Surfrider Foundation has started fresh legal action to block the Carlsbad project. For these reasons, we have pushed this prospect into 2011.

In the Monterey Peninsula, California American Water is running a 4,000 cubic meter per day installation desalination plant in Sun City with PX technology. This is the first plant of its kind to directly supply seawater to the municipalities in the area. In the nearby city of Marina, a 40,000 cubic meter per day desalination facility is being developed to serve the same area covered by California American Water. I will be attending another hearing tomorrow on this plant.

When the acquisition of Calder DWEER by Flowserve was announced a year ago, there was a lot of concern regarding ERI's competitive position. Our PX devices continue to have a significant advantage over the DWEER devices, including simplicity, reliability, endurance, and cost of manufacturing. However, Flowserve is showing signs of desperation, as evidenced by very aggressive pricing. Ultimately, with the ongoing evolution and improvements in our technology, such as the PX-300 devices, we believe we can continue to solidify our market leadership position.

Because of the low, upfront cost, turbine technology devices like Pelton wheels and turbochargers are still a factor in places where power is 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 in Saudi Arabia, where for the last 15 years or so, Pelton wheels were the almost exclusive solution.

Turbochargers also have important advantages, as compared with Pelton wheels, including higher efficiency and residual back pressure that facilitates the environmentally friendly discharge of the brine through diffusers. This is bad news for Flowserve's Calder DWEER division, as their Pelton wheels also continue to lose share to these newer technologies like our Pump Engineering turbochargers.

As mentioned earlier, we are now offering multistage high pressure pumps to be utilized with the PX systems for medium train sizes. We have near term plans to expand our multistage pump line for larger PX solutions power trains. Furthermore, we are evaluating several other markets where this pump line could be utilized. PEI has more than seven years of development experience with the hydraulic turbocharger in the treatment of sour natural gas, using a [mean] processes, which is one of the promising developments for the near future.

We are intensifying our search for new business idea and company acquisitions in the water and clean energy space. The criteria have been defined previously in previous calls and are posted in our website. We are in various stages of discussion on several opportunities we believe satisfy most, if not all, of the ERI investment criteria. We can share more details with you if and when we enter into any thing definitive. I would now to turn the call over to Tom to discuss our first quarter results in more detail. Tom?

Thanks, G.G. For the first quarter ended March 31, 2010, we achieved net revenues of $12.6 million, which was equal to the net revenue for the same period last year and slightly above the Company's guidance range of $11 million to $12 million. The percentage of net revenue derived from our mega project sales group was 52% in the first quarter and was generated from sales to the expansion of the Adelaide plant in Australia and the partial shipment to the Melbourne plant, also located in Australia. The rest of the Melbourne project was shipped last week.

Our OEM group, which includes our booster pumps, contributed $3.4 million in net revenue in the first quarter, or 27% in total. Approximately 82% of our revenue in the first quarter was generated from sales of our PX devices and related products and services, and sales of turbochargers and pumps accounted for approximately 18%. Sales to foreign customers accounted for 91% of our net revenue for the quarter, with shipments to Australia and Israel making up 54% and 3%, respectively.

Revenue from customers representing 10% or more of total revenue varies from period to period. For the first quarter, Suez Degremont JV and Acciona Agua accounted for approximately 28% and 24% of the Company's net revenue, respectively. No other customer accounted for more than 10% of net revenue during the quarter.

Overall gross profit as a percentage of net revenue was 58% for the first quarter, compared to 64% for the first quarter of last year. The decline of gross margin in the first quarter is due to several causes, including a shift in the product mix to turbochargers and pumps as a result of the purchase of Pump Engineering in December of 2009.

Our gross margin for the sale of PX devices and related products and services in the first quarter was 64%, which was slightly less than the PX gross margin in the first quarter of last year of 65%. The slight decrease was the result of new facility overhead costs. The gross margin for our turbochargers and pumps in the first quarter, including the noncash inventory step-up of approximately $422,000, is 30%. Excluding that purchase accounting step-up of $422,000, the gross margin for turbochargers and pumps would have been 49%. By the end of the second quarter, most of the purchase accounting step-up will have been expense.

For the second quarter of 2010, we expect gross margin for our PX pressure exchanger product line [to decline] to 60% to 61%, due to a decline in the average sales price, a result of competitive pressures, a small increase in the price of ceramics we pay to our outside vendors, and the gradual ramp up of our ceramics production facility, which is beginning in the third quarter. As we ramp up production throughput during the course of the year and are able to absorb more of the fixed costs at the ceramics production facilities, 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 production for the PX device. The single largest cost of the ceramic production process is yield out of the kiln, and our ceramic vendor's average yield is approximately 60% overall. Our goal for our own ceramic production is to achieve yields in the high 80s once we are in full production by the first half of 2011. Based on the ceramics formula we purchased and perfected over the summer, our state of the art lab and equipment, and the experience of our chief ceramicist (inaudible - microphone inaccessible), we believe our goal of achieving yields in the high 80s is achievable.

Due to the average length of sales cycle for large projects, we expect modest sales in 2010 of our newest, most efficient PX pressure exchanger device, the PX-300, which provides our customers with a 15% improvement in production capacity over the PX-260 device. During the first quarter, we shipped a small number of PX-300 devices.

General and administrative expenses consist primarily of costs related to our personnel in our executive, finance and accounting, information technology, and human resource organizations, fees for professional services, including outside legal, tax, and audit services, and amortization of acquired intangible assets. G&A expenses for the first quarter increased by $1.3 million over the previous year. 89% of that net increase came from the $676,000 of amortized intangibles from the purchase of PEI last December and $448,000 related to the increased occupancy expenses from our new facility that we moved into last November. We expect the amortization of intangibles expense to be approximately $2.6 million for the full year.

Sales and marketing expense, which include sales commissions and marketing programs, was 16% of net revenue for the first quarter of 2010, compared to 12% for the same quarter in the previous year. This increase was primarily related to an increase in sales and marketing average headcount as a result of our purchase of PEI in December, 2009. Sales and marketing average headcount increased to 27 for the first quarter of 2010, from 21 for the first quarter of 2009.

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 first quarter of 2010, R&D increased to 7% of sales, compared to 6% in the first quarter of 2009. We believe that continued spending on R&D to develop new PX devices, ceramics, and other products is critical to our success and consequently, we expect to increase research and development expenses in absolute dollars in future periods.

Noncash stock based compensation expense for the first quarter was $597,000 and is included in the cost of revenue, G&A, sales and marketing, and R&D expense lines on the income statement. When we report the non-GAAP measurement of adjusted EBITDA, we will be adding back the stock based compensation to earnings, as it is noncash in nature.

GAAP net income was $68,000 for the quarter, or $0.00 per fully diluted share, compared to net income of approximately $1.6 million, or $0.03 per diluted share, in the first quarter of last year. On a non-GAAP basis, adjusting for the purchase accounting that resulted from the purchase of PEI, adjusted net income for the first quarter was $717,000, or $0.01 per diluted share.

We generated adjusted EBITDA in the first quarter of $2.3 million, or 18% of revenue, compared to $2.8 million, or 22% of revenue, for the same period last year. As described in our press release today, adjusted EBITDA adjusts earnings by adding back interest, taxes, depreciation, amortization, and stock based compensation. Our first quarter 2010 financial results included noncash expenses of $597,000 of stock based compensation, $676,000 of intangibles amortization, and $422,000 of inventory step-up expense from the purchase of PEI's inventory.

Turning now to the balance sheet, we ended the first quarter with approximately $55 million in cash, including $5 million in restricted cash supporting letters of credit. This figure does not include the $5.5 million of cash in contingent escrow funds related to the purchase of Pump Engineering.

We used $4.2 million of our cash for capital expenditures in the first quarter for our ceramics initiative and built up inventories by $2.9 million for the shipment of the Melbourne contract in the second quarter. We had no outstanding debt under our revolving credit facility. We picked up a small amount of equipment related debt from PEI -- from the 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 -- excuse me, escrow accounts.

In our press release today, we provided guidance for our expected revenue and earnings results for the second quarter of 2010. For the second quarter, we are projecting net revenue in the range of $13 million to $15 million and GAAP net income ranging between a loss of $600,000 and a $100,000 profit. On a non-GAAP basis, adjusting for the purchase accounting related to the acquisition of Pump Engineering, we are projecting net income of $100,000 to $500,000, or $0.00 to $0.01 per diluted share.

We are projecting adjusted EBITDA for the second quarter in the range of $1.5 million to $2.5 million. Our guidance for the second quarter includes $7.1 million from the second shipment to the Melbourne, Australia, project that was shipped during the last week of April.

For the full year, 2010, we lowered our guidance due to several factors. As G.G. mentioned earlier on the call, key prospects like Carlsbad are experiencing delays related to the completion of their financing and will likely push out to the first half of 2011. Other projects -- or prospects, such as website in Algeria, have had delays due to issues that are political in nature. As some of these prospects were estimated for the fourth quarter, any delays result in missing the revenue for this year.

We also widened the range of our full-year guidance, as we have fewer, but larger, projects than previous years, which result in more variability. In our press release today, we provided guidance of $55 million to $65 million in net revenue, or an increase of approximately 28% over fiscal 2009, assuming the midpoint of that guidance range.

We projected GAAP net income for the full year in the range of a loss of $1.5 million to a profit of $2.5 million, or a loss of $0.03 per diluted share to a profit of $0.05 per diluted share. On a non-GAAP basis, adjusting for the noncash purchase accounting, we projected net income in the range of $500,000 to $4.5 million, or $0.01 to $0.08 per fully diluted share for the full year. Lastly, we projected adjusted EBITDA to be in the range of $6 million to $13 million for the full year. A full reconciliation of the adjusted EBITDA to GAAP is contained in today's press release. That concludes my review of the first quarter 2010 financial results. I would now like to turn the call back over to G.G. for some concluding remarks.

Yes. Thanks, Tom. As you have heard today, our industry continues to enjoy strong fundamentals, 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 for food and power production, have not changed and continue to intensify.

Energy recovery devices, like our PX pressure exchanger and our hydraulic turbocharger products, have made desalination affordable, and we expect to see continued 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 current global recession will end, including the development of projects in Israel and new projects in Libya, India, Mexico, and Morocco, we continue to broaden our expertise into the material sciences of ceramics, beginning with the high purity metal oxide powders. We worked diligently through this last summer and fall for -- on our new ceramics lab to optimize the properties of our aluminum oxide ceramics formulation. Our factory is pretty much complete, and we will start dry runs this month. This will help us improve our yields, and we -- and as we ramp up production and help us make a better PX product.

We are investing $12 million to $15 million in this new ceramics operation. We are planning a graduated ramp up in ceramics production starting this summer, with full production in 2011. This should have a positive impact on the cost of goods sold and cash flow as we -- as the yields go up. Altogether, we believe we have put the infrastructure in place to meet the GWI projected demand, which sees contracted seawater RO project capacity tripling by 2016.

We believe this investment will lead to other innovative ceramic 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 for shareholders.

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

Thank you. We will now begin the question and answer session.

(Operator Instructions)

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

Thanks. This is Lucy Watson on for Laurence today. I guess my first question refers to your revised outlook for the full year. I think as of the end of last quarter, you had about $30 million in revenue already booked. Has that number changed at all?

Yes. The guidance that we gave is that we have 40% of the large projects booked. That was the guidance we left you in the last quarter. That is up to about 50% now. So we actually have booked more projects, but what we are seeing is these projects mentioned -- the one in Algeria, the website project, Carlsbad, and also the -- we -- I don't know if Tom mentioned or not, but the water standard project also slipping that. So we have a series of projects that we saw (inaudible) slipping into 2011.

Okay. And just, I guess, on the pipeline. At the end of last quarter, I think it stood at about $500 million in potential revenue. Even though you've had a couple of projects slip into, possibly, 2011, do you have an update on your pipeline?

Yes, we haven't updated that lately, but we have -- we keep adding projects in especially Mexico and Peru and Chile, and there's a little work coming in -- also in China. So the fundamentals are pretty strong, so we see the big number put out there by Christopher of 8 million cubic meters per year contracted capacity as that -- that is our target. So we -- that will basically -- including the 50% growth this year, that will get us into some pretty large revenue numbers for ERI/PEI.

Okay. And just to switch topics a little bit, your commentary earlier on the competition was helpful. Would you be able to provide any regional color?

No. We have seen especially Flowserve very aggressive in the marketplace, and I will say there's no regional flavor. They've been aggressive everywhere, and it started in Spain, but it's moving around everywhere, and it's -- we're just taking the blows as it goes. And for a year we were able to win 100% of the fight, and we keep fighting.

Great. Thank you very much.

Thank you. Our next question comes from the line of Michael Cox with Piper Jaffray. Please go ahead.

Thanks. Good afternoon, guys.

Hi, Michael.

Hi, Michael.

At the global water summit, there was a lot of discussion around a couple of trends, one being water reuse and another being nanomembranes, which, I guess, is debatable how far they are away from commercialization, but to what extent do you view the traction of these trends, potentially coming at the expense of desalination or energy recovery devices?

Yes, let me give you my view, especially on the nanomembranes. Let's assume that you have the perfect membrane that has perfect solid rejection and very low pressure drops. You have nanotubes in it. You do all these right things. You still have to deal with the loss of thermodynamics and the fact that you have to overcome the osmotic pressure of seawater.

So if you take Carlsbad as an example, the Carlsbad plant, with normal membranes, will have 50 megawatts of energy coming out of the brine. If you put the perfect membranes, you're only going to save about 20% from where we are today, so you -- instead of 50 megawatts, you're going to have about 12 megawatts. So you're not going to waste the 12 megawatts just to put energy recovery devices in it. And that's very important, so doesn't really mean that the energy recovery market goes away. It means that you're still going to do it, and you're going to have more efficient plants.

Okay. That's helpful. The -- on the price competition side, considering that you continue to win these battles, albeit at lower price levels, what is the -- what do you see in the marketplace as the end game for what Calder is trying to accomplish here?

Well, we haven't figured it out, but they have gone about 14, 15 months now without any wins, and they have a shop that they've got to keep full. So there's some desperation, and there's some very aggressive behavior based on making a $32 million investment. So they're very aggressive, and so are we.

Okay. I guess, and one just last comment, if I could. Given the difficulties in projecting the timing of these projects, would you consider just moving away from providing the -- like a full year guidance? I think, quarterly, you have pretty good visibility into it, but it seems like this has been a difficult area for you since going public. I'd just be curious, maybe, your thoughts on that.

Yes, Michael, we talk about that quite often. The thing we're challenged with is we probably have better visibility than anybody outside of the Company, including the research analysts. So if we don't put anything out there, then I think we're -- you're going to see a lot of disparity, and you're going to see some real wide ranges of guidance. And so that's the reason that we're compelled to put something out for 12 months, and I -- if I had my druthers, I'd probably wouldn't want to go out that far, just because of the fact that it's very difficult. There are so many moving parts in these large projects that we cannot control, and we get the best information that we can from our customers, but it isn't perfect information. So we'll assess that, but our current thought is that if we don't put something out there, we're likely to see some real huge standard deviations with the analysts' expectations.

Okay. Fair enough. Thanks a lot, guys.

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

Hi. Good afternoon. As far as guidance goes, could you tell us the percentage that's coming from ERI and then the percentage that's coming from PEI on your updated guidance? And which of those two slipped into 2011?

It -- I think the slippage has mainly been on the prospects that ERI was targeting. I think the range of guidance that we initially gave when we announced the PEI acquisition is still pretty much intact, and in fact, it could be a little bit better, depending on the level of pump sales that we see. But I'd say most of that slippage -- it wasn't with the [Makung] Project, which they're in the middle of manufacturing, et cetera, but it was mainly on prospects that we had on our radar.

Okay. And then, if I remember correctly, last year when you revised guidance, you gave the following year kind of a growth estimate. Can you guys do anything like that to kind of give us perspective about these projects moving into 2011? What we would see at 2010 from your midpoint to '11 growth, right?

Yes, let me talk about -- we can talk about California and Libya. I think they're cousins in many ways. But in Libya you have a huge potential for major projects, and Hyflux and Befesa will be big players in Libya. But the issue is that to get those projects going, they have to go in and change the constitution, then after they did that, they find out that their banking laws are not right to get the private sector to come in and do these projects, so they are going and doing that.

Now this is pretty complicated, but because Libya is what it is, it's a place where you can get law changed pretty quickly. They probably be able to do that within the next 12 months, and then you're going to see large booming projects in Libya.

California is more complicated, because you're dealing with all these environmental issues. But up and down the coast of California, there's a lot of potential projects here, but we need to get the first one built, and the first one is always the tough one. But the answer is, really, this is up to politics, and it's difficult to predict.

Okay.

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

Thank you. Good afternoon, gentlemen.

Shawn.

Just on the projects that are being delayed, could you give us some idea of the size of the two projects, particularly Libya and Carlsbad, and what that's doing to your -- in terms of revenue and push outs?

Well, I can talk in cubic meters per day. The Carlsbad project -- the -- currently configures about 190,000 cubic meters per day, and I think we'd given guidance to people on how to go from that number of PXs to revenue. And the Libya projects are huge. They're about 500,000 cubic meters per day each, and there's at least two or three of those in the works. So, again, the fact is that the bigger they are, the lumpier they make our quarters and our year, because it makes it really hard to predict.

So Carlsbad is probably the more important one that was pushed out into 2011? I mean, is that -- in looking into fourth quarter revenue?

Carlsbad is the biggest one for fourth quarter revenue, right.

Okay. And then, just kind of an industry update. In terms of the project financing market for a lot of the plants around the -- or potential plants around the globe, give an update in kind of how the broader financing market is looking. I know you've spoken before about maybe that loosening up a bit and seeing more projects become available over the next 12 months, and is that happening?

Yes, well, let's start with California with the -- California just raised -- they went out about a week ago to raise $2 billion in tax free bonds for water projects, and they ended up raising $3 billion, because that's where the supply and the demand matched at pretty attractive rates. So we don't have any doubt that Poseidon will be able to go to market in the next few months and raise the money.

But then, when you go to places like Libya when you have to change the banking laws of the country, it's not so simple. It's going to take a little while. In the rest of the world, most of these projects, especially the ones in Australia and even Algeria, they have been bankable pretty quickly.

All right. Thank you.

Yes.

Thank you. Our next question comes from the line of [Christopher Vertill] with Janney Montgomery Scott. Please go ahead.

Hello, G.G. Hello, Tom.

Hi, Christopher.

Just a question for you on PEI, Tom. You mentioned that that $13 million to $15 million revenue contribution number appeared intact for 2010. Can you talk a little bit what you think they can do on the gross margin side and if those numbers are still kind of in between where ERI historically has been and where Flowserve typically is?

Yes, that -- just to reiterate what I said in my conference call remarks, the gross margin, including pumps and turbochargers together, on a GAAP basis, was 30% and if you adjust for that step-up in the inventory, which is noncash and would never have appeared on PEI's books were it not for our acquisition, it was about 49%. It would vary from quarter to quarter, depending on what the throughput is and how much of their fixed costs they pick up. So in a quarter, let's say, where Magtaa would be shipping, their gross margin that quarter would be bigger than, say, a quarter where that -- where a bunch of large projects are not shipping. So they have an opportunity for operating leverage, but it really depends on the level of revenues that they're putting through their fixed expenses.

Okay. Great. And you brought up Magtaa. Don't know if you can offer any insight there, how things are going, and maybe offer some specifics on when you expect those PEI shipments could go out this year -- if --?

Yes, it's on their testing right now. And more than likely, that would ship in the second half of the year. It could -- if it could ship earlier, we'd do it earlier, but more than likely, in the second half.

Okay. All right. Thanks, guys.

Thanks, C.J.

Our next question comes from the line of Patrick Jobin with Credit Suisse. Please go ahead.

Thanks. Good afternoon, Tom, G.G.

Hi. How's it going?

Hi. So I just want to make sure I understand just kind of the dynamics here appropriately. The guidance reduction is due to three projects slipping from the second half of this year into 2011, and is there anything to do with the pricing pressure in that guidance reduction, and if so, could you give us the split?

No. I mean, I think for competitive reasons, we're -- we don't want to give that kind of detail. I'd say the major shift in the guidance was project related, not so much a deterioration in the average sale -- selling price. As G.G. mentioned, they're getting very, very competitive out there, and for obvious reasons, they weren't very successful last year, but they haven't thrown in the towel yet. So we'll -- we expect to see that during the rest of this year. They're part of a big company, and I think they're going to continue to compete with us.

Okay. Fair enough. I mean, these projects don't just croak. They continue in your pipeline. Could you give us an idea of what percent of the remaining revenue in 2010 is booked and what percent you are still working on the contracts?

Yes, let me take the first part of that question. The first part of the question is, with one exception, the Water Standard -- that was a ship. That was a 50,000 cubic meter per day desalination pump mounted on a ship, and that was, I believe, being built in Dubai by Water Standard. But that venture never found a contract, so it was around since before our IPO, but they were never able to get a contract for the ship. So that one, because it -- that one -- it never had a real water project behind it, that one may very well go away. But everything else is a real project with a real site with a real town behind it that needs water. So that's the first part of the question. Tom?

Yes. So, I mean, it's -- what they do when we're looking at that pipeline that goes out three to four years, when something slips into 2011, it's still in the pipeline. But the challenge we have, and Michael Cox brought this up as far as the guidance, we have a predominance of orders in the fourth quarter, and when anything moves to the right from the fourth quarter, we lose it for the year. We don't lose it altogether, and so, some of the -- these projects that we were tracking that were estimated for us to ship by the fourth quarter moved in, let's say, to the first half of 2011.

The reason the guidance range, Patrick, got larger is we -- there's some really big projects in there, and it's kind of binary. You either win it all, or you don't win it, and that just amplifies the variability that we're challenged with, and so that's why we raised -- or we have a wider guidance range than we had before and what we've had in previous years. There's some awfully big projects that are in the mix.

Fair enough. So it's fair to assume that the majority or nearly all of revenue for large projects in 2010 is already booked and even some into 2011? It's just been pushed.

Well, it's terminology. When you say booked, we consider it booked when the contract is completely negotiated, and we have a pretty firm shipping date. It goes into our ERP system for scheduling it for production, so what I can tell you is that we're in negotiations on a lot of contracts. We're at various stages, but I wouldn't use the term booked. Now the number that G.G. gave of 50% of our large projects either being shipped already or (inaudible), that's still an accurate statement for sure.

Okay. Thank you.

Thank you. Our next question comes from the line of [Peter Mahon] with [Dougherty Brokerage]. Please go ahead.

Good afternoon, guys. Say, just a couple questions that I had. Looking at G&A, we did $4.4 million in the March quarter. Kind of, what are your thoughts on how that will track throughout the rest of the year? Are we kind of at our sustained run rate level here, or do we expect that to creep up more as the year progresses?

No, I mean -- I think that's pretty much at a steady rate for this year. Now next year it's likely to come down, because we've got a lot of intangibles mixed up in that number, and a lot of those intangible expenses are accelerated in this year. The intangibles have all sorts of useful lives from an accounting standpoint, and so there were some, like customer lists and things that were already in the pipeline, that have a fast burn rate in 2010. So we'll have some big amortization expenses that hit the G&A line this year, and then that should scale back next year to maybe half as much for intangibles.

Yes, but let me add that as far as the GIA -- G&A components that we can actually control, we have all kinds of things in place to make sure that we are in constant control of the G&A. We're not going to let it creep up.

Yes, I -- most of the increase, year over year, Q1 compared to Q1, was the additional rent for this building and stock based compensation and things that are -- a lot of these are noncash in nature or don't have to do with people. I mean, I can say, for instance, the finance and accounting department we've actually trimmed back some resources, and we're at a steady state, and we can certainly handle more revenue (inaudible - background noise) as a percentage of revenue.

Yes, plus we asked the entire Board of Directors to take a 20% pay cut, and they went along. So we're looking for places to reduce the G&A, and we keep looking.

Excellent. So, all in all, that $4.4 million, $4.5 million range is probably what you're looking at per quarter for the rest of the year until we kind of move past these intangibles?

Yes, that's correct.

Okay. And then, my final question is looking at your -- kind of what you -- you're thinking around G&A, what is your blended gross margin kind of outlook for the remainder of the year? It implies -- guidance implies a pretty nice decline for the remainder of the year, even from the March level. Is that kind of how you guys are thinking about it, or how should we think about gross margins as the year plays out? From a blended perspective.

Well, from a blended perspective, the gross margin that you're likely to see out of the turbochargers and the pump business is lower, and as I say, there's some accounting this that -- actually, after the first quarter and the second quarter, the step-up of the purchase inventory is pretty much going to be completed and through the expense line. So in Q3 and Q4, we don't have as much explaining to do as far as the non-GAAP gross margin. But the blended -- I think we gave guidance on this, and I mentioned this in my remarks. Somewhere around 55% is probably the blended margin for the two businesses combined.

Okay. Great. Well, thanks, guys.

Our next question comes from the line of Jinming Liu with Ardour Capital. Please go ahead.

Thanks for taking my questions. Given your OEM group's exposure to Spain and what's going on right now in Europe, do you expect the -- that part of your revenue stream will be affected in the ramp up this year?

Yes, probably not, because we have put a lot of additional resources in our OEM group in Asia, where we -- outside of China, we were not very strong in Asia, and we have been putting a lot of effort there in the last year. And also, we're now putting a lot of effort into Latin America. Especially Venezuela and the Caribbean have had a very, very dry winter, and so we see a lot of medium sized projects all over the Caribbean -- retrofits, including Trinidad. So we see a lot of activity in places that will not be affected by what is going on in Europe.

Yes. Jin, this is Tom. No one asked this question, but I'm going to volunteer the question raised by people. As far as your foreign currency exposure, we've only booked one relatively small project in Euros, and everything else is in dollars, and the small amount of Euro exposure that we have is basically the tail end of these 10% holdbacks from projects that we booked, maybe, a couple of years ago. So we're actually in very good shape with respect to all of the turmoil going on with the Euro and other currencies around the world.

Okay. Related to -- and last question related to your OEM group is historically, you expected about $4 million run rate per quarter for that group. Do you expect more from that -- coming from that segment?

It depends where you put the pump sales, because eventually -- we mentioned that the OEM group has about $7 million of high pressure pumps out there. They sold one year-to-date, but they're quoting a lot of them. So if count that as incremental OEM revenue, eventually that could be significant, and we could grow that -- or you could count that as incremental PEI revenue. But we see -- we have a lot, because of the -- we have lower market share in the OEM group than the big projects group, especially in places like Asia. There's a lot of places to -- for the OEM group to grow. So that's an area where we're putting a lot of effort, because we can grow it, even in uncertain times.

Okay. Thanks.

(Operator Instructions)

Our next question comes from the line of David Rose with Wedbush Securities. Please go ahead.

Afternoon, gentlemen. Tom, you and I had spoken about the issue of receivables before, and I was hoping you can give me a little bit more color as to the growth in the receivables and DSOs for the quarter. They're pretty substantial, and I understand you want to use your balance sheet when you can, but maybe you can give me a little bit more -- give all of us a little bit more color on which projects were driving these increase in DSOs.

Yes, it depends on any point in time whether we've had big shipments of projects. The Melbourne project was a pretty big project that we shipped, and that, of course, is a booked receivable. The one thing I can say is that our collection rates have been 98% over the past several years, and so we do a very thorough job at Dun & Bradstreet's on companies, and if we have any concerns, we work with letters of credit. And on top of that, we have insurance from US Action Bank on just about all of our foreign orders.

So we think we're in pretty good shape on that, but it just -- the DSOs -- I prefer to look at it on an annual basis, because if you look at it in any one quarter, it could be lumpy, and the DSOs that we gave in -- for last year were a bit of an improvement from the previous year. But it's something that has been institutionalized in these big desal projects that our customers like pretty lengthy receivable terms, and we just sort of have to go with the market flow on that. There's not a lot we can do, but just about all of the credit worthiness of each of these projects is very secure. (inaudible - background noise) by 25 year take or pay water contracts, and they wouldn't be getting the construction financing from the bank unless they were very secure. So we can feel comfortable about that, and with small customers, we typically don't give terms at all. That's mostly with our mega projects.

Okay. Great. And lastly, if you can quantify a little bit better for me, the contracts that you have in Q3 and Q4 that you're expecting -- just so we have a better idea -- if there are any particular big projects that can be pushed back, what the risk factors are for those contracts? I don't know if you can list some of the big projects that you have expected for Q3 that you consider 90% in.

I would say since our competitors always listen in to these calls, and we don't to discuss anything public, so our philosophy and our past practice has been that we don't announce a win until we have a contract signed, sealed, and delivered, and there's no more negotiating going on with it. And what I can tell you is that there are a lot of contracts that we're still competitively bidding on and negotiating terms, et cetera, and when we're all done, not only winning the project, but completing the contract and all of the details, that's when we'll announce it.

Okay. So maybe you can better -- as far as risk factors go, would you say that you feel, like, 90% comfortable with your Q3 order flow, that maybe 10% can be pushed back, or is there a way you can quantify it for us? I mean, for example, Carlsbad being pushed back was a bigger surprise.

No, what I would say is that's all factored into our guidance. We look at all of the things that affect the probability of success -- the competitive pressures, the pricing, and [what they're probably saying] about the pace of the project and it moving forward in a certain timeframe. And all those things are taken into account, and that's all factored into our guidance, David.

Okay. Well, great. Thanks anyways. I appreciate it.

Thanks.

Thank you. And our final question is a follow-up question from the line of Ben Kallo with the Baird Company. Please go ahead.

Hi. Good afternoon. Thanks for the follow-up. As far as your guidance goes, which percentage of those projects have actual financing in them? Maybe you can give me that number.

Most of these big projects -- by the time they're getting on our radar screen to ship have got their financing. Now sometimes a project will stall out for one reason or another, because of political issues, et cetera, but most of the ones that are on our radar screen to be shipped this year have their financing.

So it's not a question of whether they have their construction financing. It's a matter of the pace at which they're proceeding, whether or not they hit any bumps on the road as far as getting permits or any political issues or that sort of thing. So I'd say, just kind of scrolling in my mind through the list of projects, these are ones that have financial backing, so that's not an issue. In the case of Carlsbad, I think the beginning of the year, the Poseidon people on their website declared victory. Everything was full speed ahead, and then they hit some road bumps as far as getting their tax exempt financing and asked for, basically, a continuance, and that's what prompted us to move that one out to the first half of 2011.

And then, on the pricing pressure discussion, what's the timeframe where we'll start to see that flow through since you do have long-term sales cycles here? Is it next year we'll start seeing the effects of that?

Yes, you'll probably see a little of it this year, but also, as we launch the PX-300, you're going to see the margins improve. Keep in mind that every time we launch a new product, we have the potential of either getting a lot higher margins or becoming a lot more competitive, but we intend to do both.

Okay, great. Thank you very much.

Okay, thank you, Operator.

That concludes the Q&A. I would now like to turn it over to management for any closing responses.

Yes. Okay, we look forward to seeing some of you in California at the shareholders' meeting on June 4. Also, Tom and I will be around to take calls from analysts who might have further questions. So thank you for your questions and for your call today, and we look forward to powwowing with you. Thank you. Bye.

Ladies and gentlemen, this concludes the Energy Recovery first quarter 2010 earnings conference call. You may now disconnect. Thank you for using ACT.