Energy Recovery Inc (ERII) 2010 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Thanks for standing by. Welcome to the Fourth 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, Thursday, March 3, 2011. I will now turn the conference over to Tom Willardson, Chief Financial Officer. Please go ahead, sir.

Thank you. Good afternoon, and welcome to Energy Recovery Incorporated's Fourth Quarter and Fiscal Year 2010 Earnings Conference Call. Joining me today on the call is Tom Rooney who was appointed by the Board of Directors on February 16th as ERI's President and Chief Executive Officer, replacing GG Pique.

Also joining the call today is Borja Blanco, our Executive Vice President of Global Sales and Marketing. Before we begin I will make a few brief statements 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 Full Year 2010 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 in 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 the call, except as required by law. Before I provide an overview of our financial performance, which includes a comparison to last year, it is important to note that our 2009 financial results only included the last 10 days in December of Pump Engineering's financials.

The full year impact in 2010 of the acquisition had a pronounced affect on the mix of our products we sold in 2010. The margins generated from selling more turbo charger and pump products, and additional operating expenses acquired in the acquisition. In addition, in 2010, we picked up certain non-cash related expenses from the acquisition, such as amortization of intangibles totaling $2.6 million, and a one time step up charge of $870,000 to the costs of goods sold from revaluing the inventory we acquired from PEI at fair market value.

Our net revenue in the fourth quarter of $13 million fell short of our guidance, due to the slippage of four large projects totaling $5 million. The slippage was due to a variety of reasons outside of our control that resulted in shipping delays. Over half of the $5 million that slipped from Q-4 has been shipped in this quarter. And we anticipate the remaining portion will be recognized as revenue before the end of this quarter.

The net revenue in the fourth quarter includes the 500,000 cubic meter per day Magtaa project in Algeria, the largest RO desalination plant in the world, which is deploying the largest turbo chargers ever installed in a desalination plant. Sales to foreign customers for the full year accounted for 93% of our net revenue with shipments to Australia and Algeria making up 31% and 12% respectively. Revenue from customers representing 10% or more of our total revenue included (technical difficulty)and [High Flux] at 23% and 12% of our net revenue respectively.

Our margins were negatively impacted by several factors, including the shift in our product mix from almost exclusively selling PX devices to selling a significant number of turbo chargers and high pressure pumps that have lower margin. For the full year approximately 61% of our net revenue was generated from the sales of PX devices and related services and parts, with turbo chargers and pumps comprising 39%.

In contrast, for the full year 2009 sales of our PX devices and related service and parts comprised approximately 96% of our net revenue, with pumps and turbo chargers only comprising 4%. Other factors contributing to the margin decline include higher overhead costs from our new, expanded production facility in San Leandro, increased overhead cost due to low throughput through our ceramics factory as we progress through the ramp up phase, and deterioration of our average selling price of our PX devices due to intense competition.

The gross margin for turbo chargers and pumps in 2010 also includes the $870,000 one time step up charge of purchased inventory from the PEI acquisition which negatively affected gross margin. For 2011 we expect continued pressure on our gross margin for our pressure exchangers due to under utilization of our manufacturing facilities, including our ceramics facility, and intense competition.

As the pace of new construction of desalination plants hopefully improves over the next 12 to 18 months, and assuming we remain successful in winning the majority of these projects as we have demonstrated over the past six years, we expect to see the benefits of leveraging the fixed nature of these capital investments as throughput increases.

For the full year G&A expense increased by $3.3 million or 24% to $17 million. Of the $3.3 million increase, $2.4 million related to the amortization of intangible assets from PEI acquisition, and $1.2 million related to occupancy costs from our expanded manufacturing facility in San Leandro which we moved into in November of 2009.

Sales and marketing expense, which includes sales commissions and marketing programs increased to 18% of net revenue in 2010 from 14% in 2009. The increase of the percentage of revenue was due to the fixed nature of the base salaries for our sales personnel, and lower revenues in 2010 compared to 2009, and increased sales commissions paid to outside contractors for the sale of turbo chargers, and high pressure pumps as we were integrating the sale of these products into our existing direct sales force.

Research and development expenses for the full year increased by $900,000 to 9% of revenue, compared to 6% in the previous year 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 for energy recovery applications in markets outside of desalination is critical to our future success. And consequently we expect to increase research and development expenses in future periods.

We have a significant amount of expense in our 2010 profit and loss statement that is non-cash in nature. Share based compensation expense for the full year 2010 was $2.8 million, and is included in the cost of revenue, sales and marketing, general and administrative, and research and development expense lines on the income statement. Given the expansion of our San Leandro production facility, including our new ceramics factory, and the acquisition of intangible assets from PEI, our depreciation and amortization expense has significantly increased to $5.2 million in 2010 from only $1.2 million in 2009.

And as I mentioned earlier, our gross margin was negatively impacted by the non-cash step up of $870,000 for work in process that we acquired from PEI. When we acquired Pump Engineering we initially recognized the liability of $5.5 million as an estimate of the fair value of contingent and other consideration; $3.5 million of that liability was an estimate of the contingent consideration that was based on the weighted probability of achievement of certain base performance milestones.

During the fourth quarter of 2010 two of these base performance milestones were not met. As a result, we -- we remeasured the contingent consideration at $1.4 million to reflect the fair value as of December 31, 2010, and recognized a gain $2.1 million in our statement of operations. GAAP accounting requires us to show the gain under operating expenses.

Net income was $496,000 for the quarter, or $0.01 per share compared to net income of approximately $1.7 million or $0.03 per share in the fourth quarter of last year. Net loss for the full year was $3.6 million or $0.07 per share compared to net income of $3.7 million, or $0.07 per share for 2009. The decrease in net income and earnings compared to 2009 was the result of a shift in the product mix, under utilization of our San Leandro production facility, and higher depreciation and amortization expense.

As I mentioned earlier, our product mix of our higher margin PX devices and related parts and services shifted from 96% of total revenue in 2009 to 61% in 2010. And our total depreciation and amortization expense increased from $1.2 million in 2009 to $5.2 million last year as a result of our investment in our production facility, and the $2.6 million amortization of intangible assets from the acquisition of PEI.

Turning now to the balance sheet, we ended the year with approximately $55 million in cash, and $2 million in restricted cash supporting letters of credit for a total of $57 million. This figure does not include the $4.6 million of restricted cash and contingent escrow funds related to the purchase of Pump Engineering. We had no debt outstanding under our revolving credit facility which was put in place to issues standby letters of credit.

Our accounts receivable balance as a percentage of revenues was reduced to 21% at the end of 2010, compared to 27% at the end of 2009. Despite this difficult global credit environment, our bad debt as a percentage of accounts receivable was less than 1%.

Our property and equipment increased from $17 million last year to $22 million principally due to the completion of the ceramics factory in San Leandro, California. The ceramics factory is substantially complete, and we don't plan to spend more funds for expansion until we run out of current capacity. We measured our goodwill from [pyramid] at the end of the year, and there was no adjustment required.

Other intangible assets decreased due to amortization of certain assets with shorter amortization periods such as backlog. In our press release today we provided guidance for our expected revenue and earnings results for full year 2011. Previously we had provided guidance for the upcoming quarter, but due to the uncertainty of the timing of shipments caused by factors that we have little control over, or poor visibility on, we have provided revenue and earnings for only the full year.

We may update that guidance from time to time as business conditions warrant. For the full year of 2011 we provided guidance of $36 million to $45 million in net revenue. We projected a net loss in the range of $10 million to $7 million, or $0.19 to $0.13 per share for the full year. That concludes my financial review. I would now like to turn the call over to Tom Rooney, ERI's President and CEO.

Thank you, Tom. Good afternoon, my name is Tom Rooney, and it's a pleasure to speak with you today. On the call today I will give you a brief recap of the Company's fourth quarter performance, and major accomplishments for 2010.

Following my remarks, Borja Blanco, our Executive Vice President of Global Sales and Marketing, will provide you with an update on what we see from the front lines as far as activity in our major desalination markets this year, and also how 2012 is shaping up.

Following Borja's comments, I will provide some concluding remarks, and then we'll open up the lines to take questions. Before I begin, I would like to acknowledge my predecessor GG Pique. ERI has grown over the past decade to become the technology leader for energy recovery in the desalination industry in large measure because of the hard work and dedication of GG Pique.

GG assembled a team of very talented people who have taken ERI from a technology startup to the leading technology innovator in the desalination industry by making desalination more affordable. I have the good fortune to pick up where GG left off, and I look forward to leading ERI through its next phase of innovation and growth.

Turning now to the fourth quarter of 2010, we generated a net income of $496,000 on $13 million in revenue. We were within the guidance ranges for earnings and adjusted EBITDA that were provided last November, but not for revenue, which fell short by approximately $5 million. Tom Willardson has already provided some detail and the reasons for the shortfall. But in short, several mega projects slipped from Q-4 into the first quarter. We've already shipped more than half of the $5 million shortfall early in this first quarter, and we expect to ship the balance before the quarter ends.

And now I'd like to briefly recap some of the Company's major accomplishments for 2010. During 2010 we launched the PX-300 device with its Quadribaric technology. I'm pleased to report that the acceptance rate of our PX-300 device was faster than what was experienced during the prior launches of our PX-220 and PX-260 devices. We shipped a significant number of PX-300 devices to our OEM customers last year. And we expect the PX-300 device to be a significant portion of our mega project sales in 2011.

Now that the PX-300 device is gaining rapid acceptance, we continue to work on developing even higher flow PX devices. In 2009 the Company began construction of a state of the art ceramics factory; our largest capital project ever. Under the management of our VP of Manufacturing, Terry Sandlin, and Chief Technology Officer, Tim Dyer, we successfully completed the ceramics plant in the fourth quarter of 2010 on time and under budget.

We are currently going through the final stages of startup, and have already achieved percentage yields out of our kilns that exceed our initial estimates. We are not yet enjoying the operating leverage benefits that we expect to achieve when our production volumes increase. But we remain confident that the vertical integration of our most important component will yield financial and intangible benefits for many years to come.

Yet another important achievement in 2010 was the integration of Pump Engineering into our existing sales, marketing, servicing, production, and engineering groups at ERI. We have re-branded Pump Engineering's product line to communicate to our customers that PEI is now melded into ERI's total comprehensive solution. A menu that currently includes pressure exchangers, turbo chargers, and high pressure pumps.

With the integration of PEI into ERI, the competitive advantages of PEI's turbo chargers and pumps are now enhanced with the addition of world class direct sales, and field service teams that are unmatched by the competition. And finally, 2010 was noteworthy in that we successfully manufactured and shipped the largest turbo chargers ever made to the Magtaa project in Algeria solidifying ERI's technology and market leading positions.

This is not an easy accomplishment and required the combined talents of the engineering and manufacturing teams in New Boston, Michigan, and San Leandro, California. While 2010 was a challenging year for ERI, and for the desalination industry as a whole, I believe that with the launch of our most advanced pressure exchanger, the PX-300, the ramp up of our state of the art ceramics facility, and the integration of PEI's product line, our competitive position in the industry is stronger than it has ever been before. We'll now turn to Borja to give some color on how our markets are shaping up for 2011 and beyond. Borja?

Thank you, Tom. Twenty-ten was a challenging year for reasons mostly related to the global financial crisis. But at the same time, it was valuable for our sales team as we accomplished very tangible goals. We closed and shipped three of our largest contracts ever for the cities of Melbourne and Adelaide in Australia, and Magtaa in Algeria.

We saw the successful startup of several of our large [referenced] plants like [Palmachim] and [Hadera] in Israel, and (inaudible) and [Fouka] in Algeria. We work [and retrofitted] to replace our main competitors equipment with our energy recovery technology. Our team sold the first -- the first largest scale implementation of our latest and greatest PX-300 devices. And we earned (inaudible) projects in South Africa and the Caribbean.

We also contracted the ten largest desalination projects in China confirming our strong presence in a market with tremendous potential. And finally, in the second half of the year we started to see a recovery in our OEM business which ended the year with a record backlog.

This is a good indication that the world wide desalination activity is on the rise, and recently our sales team has been busy following up on supporting projects all over the world both in OEM and in mega projects. As of the end of 2010 we have completed the integration of our Pump Engineering product line by merging the PEI brand into the ERI brand.

All PEI products are now marketed and sold under the ERI brand. We have one website, one sales team, and one technical service team. By doing so, we will strengthen our market presence, and improve the customer experience alleviating any confusion with matters related to sales or technical inquiries.

Most recently we've [relaunched] our new and improved line of high pressure pumps after re-engineering them in order to offer best in class pumps that compliment our product offering of isobaric and centrifugal energy recovery technology. The ERI line of high pressure pumps includes the ERI AquaBold multi stage pump, and the ERI AquaSpire single stage pump. Both offering high efficiencies, improved performance, and are designed specifically for water treatment applications.

Looking into 2011 and beyond, our team on the ground believes there are credible signs of a rebound in the desalination market starting with the recovery of our OEM business. And we consider ourselves firmly positioned with the most advanced technologies available in our industry as well as the largest number of references and satisfied customers world wide.

Our team is very enthusiastic about the market opportunities in the next five years. The world wide demand for fresh water is still great. And there are large gaps between supply and demand. According to a report co-published by [McKenzie & Company] the statistics are staggering. By 2030 demand in India will grow to almost 1.5 trillion cubic meters with a current water supply of approximately 740 billion cubic meters.

China's demand by 2030 is suspected to reach 818 billion cubic meters, and currently supply amounts to just over 618 billion cubic meters. Giving context to some of these overwhelming numbers, one of our very large desalination facilities produces about 100 million cubic meters per year. Desalination provides a very small fraction of the world fresh water supply, but it's the only way to produce additional fresh water.

We are closely monitoring the political changes in the Middle East and North Africa. We have local employees in several of the countries affected by the unrest and they are [living and breathing] the situation. The high probability of change and upcoming transitions bring uncertainty and instability to the region, and will certainly put on hold some of the projects and programs that were moving ahead.

The two projects that we were expecting in the short term, Tubruq in Libya, and (inaudible) in Tunisia, are fortunately two of the smallest mega projects in our pipeline. Our team is watching the regional events with a hint of optimism. Whatever the short term challenges, the region will certainly still need water.

In other parts of the world a large project was recently rewarded in Ghana, two large mega projects are expected to be awarded in Singapore and Kuwait in the short term. Israel continues along with its program to double their desalination capacity. Australia has new projects, and we have lots of bidding activity in Chile and Peru. In summary, the short term outlook is healthy, but the MPD sales cycle from projects awards and the shipping product and revenue recognition remains long. Between nine and 18 months depending on project size, location, and complexity.

For this reason most of the opportunities mentioned will present potential revenue for 2012 and beyond. In conclusion, and just as -- as we explained during our last earnings call, even though we see and will continue to see the inevitable short term fluctuations in demand for desalination projects related to politics, finance, administrative delays, and weather patterns, the long term outlook for the desalination market is very strong. And we believe our company is extremely well positioned to benefit from the opportunities that this market will bring. I will now turn the call back over to Tom Rooney.

Thank you, Borja. As I'd mentioned earlier, ERI continues to be focused on our core business which is clearly the desalination market. And I believe that we've put several critical pieces in place which will allow us to maintain our industry leading position, and will enable us to flourish as the global desalination market recovers over the next 12 to 18 months.

At the same time, it is crucial that ERI continues to seek avenues for rapid growth, as well as to diversify our product offerings in order to address energy recovery opportunities across a wide spectrum of industries and vertical markets. As a diversification starting point, our team has identified several markets that will benefit from using durable, efficient, advanced pumping and energy recovery solutions.

As a Company we have been aggressively exploring a number of exciting new technologies, and also new markets where we believe that we can create avenues for profitable growth going forward. Because of competitive forces, we're not going to be specific today about these technologies and new markets. But I can tell you that we are staying very close to our core value proposition of using advanced materials and innovative design to recover and reuse energy that would otherwise be lost in the fluids.

We have proven that we can do this in the desalination industry. And now we are working hard to perfect technologies that will allow us to do so in a number of other industrial and municipal applications. In some cases the addressable markets may even be much larger than the desalination market.

I want to be careful not to set expectations too high. But I can tell you that I'm looking forward to being able to make several important announcements this year as we look to roll out new products and technologies in 2011. I'd now like to turn the call back over to the operator, and then open up the line for questions from 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?

(Operator Instructions)

Your first question comes from the line of Michael Cox with Piper Jaffray. Please go ahead?

Thanks, a lot, guys. And Welcome, Tom, to Energy Recovery. My -- my first question, understanding that you are relatively new to the seat, could -- can you maybe talk about what sort of cost cutting, either above the gross margin line or -- or on the OpEx side that could be done, or -- or will be done to -- to try to align the cost structure to the current selling environment?

Okay, great question. Well, it is true that I've been here a short period of time -- two weeks. But we are carefully balancing cost cutting with investing right now. And so probably the most important and critical issue for us is to look at our overhead on the one side, and the efficiencies of our manufacturing on the other side.

But I'd be remiss if I sat here and tried to elaborate on -- on much specificity for you, because, you know, having been here two weeks, initial judgments can be misleading sometimes. All right, so we're going to look at G&A and efficiencies in the marketing -- in the manufacturing.

Thank you. Our next question comes from Laurence Alexander with Jefferies & Company. Please go ahead?

Hi, this is Jeff on for Lawrence. Thanks a lot for taking my questions.

Sure.

You gave a little information on the ceramics plant, but could you please give me more color on where you are at now, and when you expect to be fully ramped up?

Well, obviously we won't be fully ramped up until we have volumes to put through to run it at -- at full ramp up. So as -- as was discussed, the -- the factory has tremendous capacity. We obviously planned it for our future needs, and right now we're running it under capacity. But it's a bit difficult to talk about how we will ramp up, you know, without first knowing about our revenue.

Okay. Thank you.

Thank you. Our next question comes from Ben Kallo with Robert W. Baird. Please go ahead?

Hi. Welcome aboard, Tom.

Thanks.

I wanted to touch on the guidance there, and just kind of see what's in that range. So I know Borja mentioned some projects in Northern Africa. Do we have anything in the guidance range there? And then what's -- can you give us some of the differences between the -- the top and the bottom range? And then on the second question, maybe Tom if you could address your CapEx needs for this year?

All right. I'll let Tom Willardson take those.

Okay, on -- on the CapEx, Ben, we're substantially complete with the ceramics factory. There's a -- there's one more piece of equipment that we've mostly paid for, but that's substantially done, and we won't be putting more money into that until our -- our capacity runs out which we're not expecting to do that certainly this year. And -- and hopefully next year when we hope volume picks up, we'll have more throughput. That would be a nice problem to have if we'd have to expand our ceramics plant.

But our maintenance CapEx is somewhere between $1.5 million and $2 million this year for the rest of the company. So it's -- it's -- it's usually pretty modest. The largest capital expenditure program we ever embarked on was this ceramics factory. And -- and absent that, we're -- we're pretty modest with our -- our capital cost needs.

With -- with regards to the -- to the projections, we -- we don't have any -- any large project in the -- in the (inaudible) region, but we do have some activity as we -- as we always have in -- in that region from the OEM side. And one thing I can tell you to -- to make you feel a little bit better is that as -- as we started -- as we mentioned we started the year with a record backlog. And our backlog in the (inaudible) region was -- is -- is right now covering about 44% of the OEM revenues that we have for that -- for that part of the world.

And that part of the world is -- is affected in -- in some specific countries. But it -- but it's a very large part of the world that requires a lot of water. So we don't -- we don't expect that right now that our guidance is going to change because of the events in -- in the region.

So let me -- let me add something else, Ben. The -- in the past the majority of our revenues has come from our mega projects; 2011 I think is going to be an exception to that historical pattern. I'd say the lions share of the business is going to be the -- from the OEM sales group. Now OEM as we define it today includes turbo chargers, pumps, and sales to projects of PX devices that are 50,000 cubic meters per day and -- and below.

So we're -- we're kind of looking at a -- at -- at a modest amount of sales from mega projects and probably a lot of that will happen in Q-1 from the -- the projects that slipped from -- from Q4. And this -- this is a year where the reason we gave such a large guidance range is because a lot of the projects we're looking for for sort of the upper end of that range for the mega projects are stacked up in the fourth quarter.

And -- and we'll have a better idea as we progress through this year as to how fast they move, and -- and whether they can keep on that track. But that's -- that's -- that's what gives a rather broader guidance range than we've given in the past, and that -- and that just reflects the uncertainty of these large projects that are more back end loaded this year.

Thank you. Our next question comes on the line of Dale Pfau with Cantor Fitzgerald. Please go ahead?

Great. Thank you, gentlemen. As a follow up to your comments there, Tom, on the OEM business, you said that you had a record backlog, and you're actually seeing some pickup in this business; X-ing out sort of the PEI and pumps, in the past we had had a run rate of about, oh, somewhere in the $4 million, $5 million a quarter run rate for the OEM business alone. Do you expect that to be higher than that this year on a quarterly basis, or about that? And then the -- the remainder pick up from the pumps and PEI?

Okay, Dale, I would say that, you know, while we're still seeing encouraging signs on these small projects, the -- the -- the pace that we were doing in the past, which was around $4 million a quarter, it's going to be somewhere between $3 million and $4 million a quarter. That' -- that's our -- that's our best estimate right now.

So it -- it -- it certainly is -- is still vibrant, and -- and it -- it's a lot more active, these small projects, than we're seeing in the -- in the mega projects. But the -- the -- the three to four I think is a reasonable range for the OEM group. That's just for the PX's and then the rest of it -- the turbo charger group has been fairly consistent as -- as far as making up the -- the rest of the OEM group.

They don't have a lot of cyclicality or seasonality. There usually is -- isn't a big uplift in the fourth quarter like we've experienced with our pressure exchangers. And -- and there's about an even number of pumps and turbo chargers that are mixed up in that -- in that number.

Great. Thank you.

Thank you. Our next question comes on the line of Patrick Jobin with Credit Suisse. Please go ahead?

Hi. Thanks for taking my question. And I'd also like to extend my welcome to Tom.

Thank you.

Tom, you -- you mentioned -- and you know, it's only been two weeks -- but you're excited about some of the new technologies and new markets you're pursuing. And you mentioned some product launches potentially by the end of this year. Could you give us maybe an idea of when you expect those might be generating some revenue, and can you give an idea of the -- the size of the markets you're pursuing?

For both timing and size, we're working on now, but we definitely see announcements before the year is over. And frankly, not even towards the end of the year. The size of some of the markets that we're looking at our in a number of cases multiples of the size of the desalination market. So we're looking at some addressable markets that are very -- very large, and that are ideal fits for the product, and the technology, and the know how that we have.

So there's a lot of competitive advantage to getting there first, and -- and with smart technologies. And so we'll -- we'd refrain from being more specific about that. But this is not something new just as a result of my coming to the Company. Obviously the Company has been doing a lot of engineering and -- and analysis and R&D in a number of very interesting sectors in 2010.

And it really positions the Company to -- to make some interesting moves in 2011. And -- and that's -- that's what gets me excited. Trying to be more precise about timing or scale of markets is probably unwise at this time.

Okay. Thank you.

(Operator Instructions)

Our next question come on line of JinMing Liu with Ardour Capital. Please go ahead.

Thanks for taking my question. Tom, in terms of diversification of your revenue streams, I -- I know ERI has been looking for acquisitions into the other [contact] space. So in your pre-remarks you mentioned that you will -- your Company is looking for leverage -- leverage in your current technology into other applications. I was -- I was just wondering which -- which side you think will be more urgent for you -- or as the priority for your Company to take either acquisition or put your equipment into new markets?

We're looking at both. We're actively looking at acquisitions, and -- and also organically developing technologies that are adjacent to where we currently are. And -- and in a number of cases we're looking at both in the same space.

So what we would not do necessarily is make an acquisition just to bolt on another element of revenue. If we do acquisitions it will be to acquire technologies or market presence that we wouldn't otherwise have, or which we otherwise couldn't develop. But I would tell you that we're actively looking in both realms -- both organic and -- and by virtue of acquisition.

Thanks.

Sure. Thank you.

Thank you. Our final question comes on line of Greg McKinley with Dougherty & Company. Please go ahead.

Yes, thank you. Can you talk a little bit about your R&D investment. Is that going to be primarily with in-house capabilities, or are you going to need to maybe reach outside the company and do some time tracked R&D as you explore new markets? And I wonder if you can talk about that a little bit?

And then will the seasonality in your business be a little different this year than in past, cause it sounds like maybe a couple large mega projects may be Q1 revenues whereas we've typically seen that be a Q4 event. And then finally maybe just comment on the tax rate that's reflected in your earnings guidance? Thank you.

I -- I -- I think I've already forgotten the first question.

R&D.

R&D.

R&D, right. Yes, predominantly we do R&D in-house. But we're not afraid to reach outside and -- and get additional advice and -- and support when and where necessary. But you know that which we do is rather unique. And so, you know, in many cases, we are -- we are more the experts.

But no, we do reach outside to get additional help and support in areas where -- or market sectors where we don't have tremendous expertise. But I would say most of the R&D expenditures would happen at an organic level with a -- an occasional expenditure outside. You want to take the next one?

Yes, I'll -- I'll take the other two questions, Greg. It's probably going to look more like the shape of a saddle. I -- I think we're going to have a -- a good Q1 and -- and part of it is because some of these mega projects were -- were already shipped out. So we know that's going to happen. Q2 and Q3 will be mainly supported by the OEM business. And then Q4 is where we're looking for some of these mega projects to hit before the end of the year.

And you know, coming up on that guidance, we -- we certainty -- even at the top end, we didn't put every project that we could possibly put. So I -- I think we've been fairly realistic recognizing that there is going to continue to be slippage and some lumpiness in the business.

Okay.

And the the last question, on the -- the tax rate, as you can see from the guidance we're in -- in sort of a negative tax position, I -- I think for modeling purposes a good rate to use would be around 31%.

Okay. Thank you.

I -- I would comment too in terms of, you know, your question on seasonality that we right now are sort of calibrating the desalination market as having maybe three elements to it in terms of the pace. The first is that, you know, 2011 and right now we see as -- as slow. Because we're clearly -- this industry, the desalination industry, is clearly working through the back end of -- of the downturn associated with the global economic issues.

But the second point I guess I would say is that that our sales force both in the OEM and the -- and the mega projects, is picking up discernible signals that -- that, you know, we've reached the -- the turning point toward the end of that downtown. You know, that doesn't turn into revenue per se in this year, but it's noticeable the degree to which we're seeing the -- the indications of interest and expressions of interest, and -- and what have you that -- that predates orders and so on.

And -- and that's very encouraging to us. And the third element I'd -- I'd give you is that in general -- overall and in general we are still very bullish on the -- the mega trends associated with desalination. So we're kind of working through a one-two-three step analysis in -- in terms of how we think about investing in the company, and -- and in our people, and our technologies.

The first is that we have to do -- do extremely well in 2011 with -- with what we have to work with. And we have to position secondly for what we see as an -- an absolute pick up in -- in interest for desalination coming in the back end of 2011 and into 2012. And we also have to be invested wisely for, you know, the three to five year mega trend in the desalination industry.

And so as managers, we have to do all three. So the first question that was asked was about cost cutting and whatnot, and that's a challenging question, because it would depend on which of those three trends we felt we were going to be operating in. We do have to be frugal, and -- and fiscally responsible in the short run. But we've also got to invest intelligently for the medium and long run. And that sometimes is -- always creates great questions for us.

Thank you.

No, thank you.

Thank you. Our final question comes on the line of Christopher Purtill with Janney Montgomery Scott. Please go ahead?

Yes. Thank you. Good afternoon, guys.

Good afternoon.

Tom, I'm -- Tom Willardson -- I guess we're going to have to start that now. I'm sorry if I missed this. Could you give us the fourth quarter revenue break out between mega and OEM revenue? I know you did it for the full year, but did you get the fourth quarter numbers there?

Yes, you know, I -- that's -- that's a good question, Christopher. In -- in our comments, because the -- the OEM group has shifted so dramatically because of the purchase of -- of ERI, sort of the -- the old 70-30 split that we've been experiencing historically has really changed. And so now our OEM group, you know, has turbo chargers, and pumps, and small PX projects. And -- and it's becoming sort of less meaningful to compare to our historical year.

So as -- as I mentioned previously, our OEM business is going to be the lions share of our revenues this year just because the mega projects are sort of -- sort of lagging behind what we see as a -- as a recovery in the smaller projects. And then we hope the mega projects are -- are going to follow closely behind that. But it's mainly going to be a -- a -- an OEM year with the mega projects from the -- in the beginning of the year, and -- and probably towards the -- the latter part of the year in -- in Q-4.

But we -- we really haven't -- and -- and -- we're -- we're from this point on, I think we're -- we're just going to talk about sales in general and -- and not break it up between OEM and -- and mega projects. They're -- they're kind of morphing.

Thank you. And I'm showing that there are no questions at this time. I'll turn the call back to management for any closing remarks.

So we've given our closing remarks, but I just wanted to emphasize that this is a great time at a personal level for me to be joining ERI and the desalination industry. And -- and with the very bright future that we have. So I'm very excited to be here, and I thank everybody for joining us on the conference call today. Tom Willardson and I will be available by phone to take follow up questions as necessary. Thank you.

Thank you. Ladies and gentlemen, this will conclude our conference for today. If you would like to listen to replay of the conference please dial 1-800-406-7325 or 303-590-3030, and enter the access code 440-6924. We thank for your participation and you may now disconnect.