Energy Recovery Inc (ERII) 2015 Q3 法說會逐字稿

Good day and welcome to Energy Recovery's third-quarter 2015 earnings conference call. Today's conference is being recorded.

At this time I would like to turn the conference over to Chris Gannon, CFO. Please go ahead, sir.

Good afternoon, everyone, and welcome to Energy Recovery's earnings conference call for the third quarter of 2015. My name is Chris Cannon, Chief Financial Officer of Energy Recovery, and I'm here today with our President and Chief Executive Officer, Mr. Joel Gay.

To begin, some of our comments and responses to questions may contain forward-looking statements about market trends, future revenue, growth expectations, cost structure, gross profit margins, new products, and business strategy. Such forward-looking statements are based on 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 from those discussed. A detailed discussion of these factors and uncertainties is contained in the reports that 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.

Now turning to the financials, I will begin with a brief analysis of our financial results on a consolidated basis. I will then turn to a segmented examination of our financial results to provide further transparency and clarity to our business. As such, I will discuss our three segments, namely water, oil and gas, and corporate.

First, however, as I walk through the third-quarter financial review, I want to emphasize the overarching themes I will discuss. Namely, revenues continue to strengthen as the water desalinization market rebounds and operating expenses are now in line with our guidance of $7 million to $7.5 million per quarter as austerity measures are fully reflected in our numbers.

Now turning to the financial review. On a consolidated basis, the Company generated strong revenue of $12.1 million, representing a 127% increase over third quarter of 2014 and a 15.5% increase sequentially, which is to say is compared to the second quarter of 2015. The increase in revenue year over year was primarily driven by a shift in sales channel mix towards megaprojects. In addition, OEM and aftermarket outperformed during this period as well.

The increase sequentially was primarily driven by a shift towards OEM and aftermarket revenue. In addition, megaproject revenue remained strong, yet flat, quarter over quarter.

Product mix for the third quarter was 68% and 32% for PXs and pumps and turbos, respectively. This represents a 200 -- 2,400 basis point favorable shift towards PXs away from both pumps and turbos and oil and gas, as the prior-period quarter included rental income from the lease of an IsoGen system with Saudi Aramco. Sequentially, this represented a 250 basis point unfavorable shift towards pumps and turbos, away from PXs, as our OEM channel demand shifted to more pumps and turbo products.

As a result of increased revenues and a shift in channel and product mix, gross margins increased by 1,500 basis points to 59.1% from 43.7% in the third quarter of 2014. Sequentially, margins increased by 520 basis points from 553.9% in the second quarter of 2015, mainly due to increases in aftermarket shipments.

Now turning to operating expenses. Reporting operating expenses were $7.4 million, representing a decline of $360,000 from the third quarter of 2014. The year-over-year decrease reflects our austerity measures implemented earlier this year.

Sequentially, OpEx increased by $1.5 million from $8.9 million in the second quarter of 2015. The sequential decrease in OpEx reflects nonrecurring expenses of $2.7 million in the second quarter, primarily related to the CEO transition and various legal matters, partially offset by increased R&D spending and management reconstitution.

It is important to note that our third-quarter 2015 OpEx is in line with our previous run rate guidance of $7 million to $7.5 million per quarter. Our operating expenses now fully reflect the austerity measures implemented at the beginning of the year.

In summary, on increased revenues, favorable mix, lower OpEx, the Company generated a net loss of $340,000 or $0.01 per share. Comparatively, the Company reported a net loss of $5.5 million, or $0.11 per share, in the third quarter of 2014. Again, our reported performance benefited from austerity measures initiated earlier this year.

Now turning to the segment analysis, I will begin with commentary on the water business. This segment generated revenue of $12.1 million in the current quarter, representing 135% increase over the third quarter of 2014 and a 15.5% increase sequentially over the second quarter of 2015.

The increase in revenue year over year was primarily driven by a shift in sales channel mix towards megaprojects; however, the OEM and aftermarket sales channels outperformed as well. The increase sequentially was primarily driven by a shift towards OEM and aftermarket revenue as megaproject revenue remains strong at flat quarter over quarter. As a result of increased revenue and a shift in channel and product mix, gross margins increased by 1,700 basis points to 59.1% from 41.6% in the third quarter of 2014.

Sequentially, margins increased by 520 basis points from 53.9% in the second quarter of 2015, mainly due to a shift in sales channel mix associated with an increase in aftermarket shipments.

Operating expenses were $1.7 million for the quarter. These expenses were flat year over year as compared to the third quarter of 2014, but increased sequentially by $500,000 as compared to the second quarter of 2015. This increase was chiefly attributable to increased engineering expenses and a second-quarter litigation settlement below the accrued amount negatively impacting G&A.

In summary, on increased revenues, favorable mix, and decreased OpEx, the water segment contributed $5.4 million in operating income for the quarter, or 45% of revenue. Comparatively, the water segment generated $4.4 million in operating income, or 42% of revenue, for the second quarter of 2015. On a year-to-date basis, the water segment generated $10.8 million in operating income, or 38% of revenue.

Now I will transition to the oil and gas segment, which consists of gas processing, chemical processing, and hydraulic fracturing. This segment generated no revenue during the quarter; however, year-over-year revenues decreased as the prior-year quarter included rental income from an operating lease of our IsoGen unit with Saudi Aramco. In the second quarter of 2015, Saudi Aramco exercised the purchase option on the aforementioned lease.

Oil and gas segment OpEx reflects our investment to develop disruptive technologies for emerging markets and verticals. Our sales and marketing expenditures relate to the penetration of the gas processing, ammonia, and pipeline markets. Conversely, R&D expenses primarily relate to the continued development and commercialization of our hydraulic fracturing solution, the VorTeq, which was recently licensed to Schlumberger for a 15-year exclusive period.

Operating expenses totaled $2.5 million for the quarter, down sequentially by $100,000 as compared to the second quarter of 2015. Year over year OpEx declined by $850,000 as compared to the third quarter of 2014. On a year-to-date basis, the oil and gas segment operating expenses totaled $8.8 million.

Now transitioning to corporate OpEx; the Company incurred $3.2 million in operating expenditures for the quarter, down sequentially by $1.8 million as compared to the second quarter of 2015. This decline was primarily due to nonrecurring expenses associated with the CEO transition and various legal expenses incurred in the second quarter of 2015. These expenses were partially offset by increased R&D spending and management reconstitution.

On a year-to-date basis, corporate OpEx totaled $13.7 million. Included here are $5.4 million of nonrecurring expenses. In summary, consolidated year-to-date operating expenses totaled $27.7 million with identified nonrecurring operating expenses totaling $5.7 million.

To conclude my remarks, I will discuss our liquidity position. Through the third quarter, the Company generated net cash flow of $6 million. Cash used by operating activities was $7.7 million. This includes a net loss of $11.9 million; non-cash expenses of $6.7 million, the largest portion of which were share-based compensation expenses of $3.5 million and depreciation and amortization expenses of $2.9 million.

It is important to note that share-based compensation expenses were elevated by $1.4 million due to the CEO transition.

Favorably impacting cash from operating activities was $2.8 million in monetized receivables, a $500,000 reduction in unbilled receivables, and a $450,000 reduction in deferred revenue. Unfavorable impacting cash from operations was a $560,000 increase in inventory, a $3.6 million decrease in accrued expenses and liabilities, and a $1.7 million litigation settlement.

Cash generated from investing activities was $13.1 million. Favorably impacting cash from investing activities was $11.8 million in maturities of marketable securities, the release of $1.9 million of restricted cash. And this was partially offset by $550,000 of capital expenditures.

Cash generated from financing activities was $600,000, primarily attributable to the issuance of common stock related to option exercises. The Company ended the quarter with $21.5 million in unrestricted cash, $3.6 million in current and noncurrent restricted cash, and $1.3 million in short-term marketable securities. All of which represents a combined total of $26.5 million.

In the fourth quarter, we received an exclusivity fee of $75 million in conjunction with the VorTeq licensing agreement with Schlumberger. As such, our balance sheet has materially strengthened going forward. Taking this payment into account, as of today our cash position is now over $100 million.

At this point, I will turn the call over to our President and CEO, Joel Gay, to provide a commercial and strategic update. Joel, please go ahead.

Thanks, Chris. Now for a commercial and strategic update on the Company, beginning with brief commentary on the third quarter.

The thematic takeaways regarding our financial performance in the quarter are growth and fiscally disciplined spending. In generating $12.1 million in revenue, not only was it a record quarter in asset turnover as compared to prior third quarters, but the current quarter provides a clear indication of breakeven to income-positive potential.

We have been steadfast in our guidance regarding a continually strengthening global desalination market. We have been equally consistent in articulating the impact of austerity measures, a key component to our reloading strategy implemented in the first quarter of this year. With megaprojects of $3.8 million and OpEx of $7.4 million, we further discerned proof of a rebounding desalination market and achieved our guidance of quarterly OpEx of $7 million to $7.5 million.

Having incurred no nonrecurring expenses in the third quarter and expecting a cessation of such for the foreseeable future, we are increasingly bullish on the financial prospects for the fourth quarter of 2015.

On the 2014 year-end call, I announced our reloaded strategy consisting of a rationalized strategic and geographic focus as well as enhanced fiscal discipline, all in pursuit of: first, breakeven profitability and then consistent profitability, and ultimately, delivering enhanced shareholder returns. Buttressing this strategy and emerging as one of Energy Recovery's competitive advantages is an extreme bias towards execution.

While executing against the strategy is a perpetual task and sustainable performance is the product of years of effort, we are in the enviable position of having harvested early fruit from our reload, beginning first with the landmark licensing agreement of the VorTeq technology to Schlumberger announced on October 19.

Let's recap the financial highlights of this agreement: $125 million in upfront payments paid in stages, $75 million already paid, and two milestone payments of $25 million each currently expected in 2016. Beginning in 2017, we expect annual royalty income of $1.5 million per year, per VorTeq deployed, ramping up to a steady-state range of 2 to 4 times our base desalination business or roughly $80 million to $200 million in annual royalty income by 2022.

Without question, this strategic partnership represents the most significant event in the Company's history has, and will continue to have, a transformational impact. While the economics of the deal are impressive, considering our humble beginnings, the strategic value far outweighs the immediate financial rewards.

Prior to the invention of the VorTeq, Energy Recovery's product strategy exclusively contemplated the recycling of or conversion into electricity of hydraulic pressure energy. Our core market of reverse osmosis desalination is the best example here in which we reduce the specific energy consumption of the high-pressure plant system by up to 60%. Our emerging hydraulic turbocharger and turbine technologies, namely the IsoBoost and IsoGen, which target applications within oil and gas chemical processing, are further examples to this end.

The VorTeq is a radical departure from the legacy product strategy and expands the potential addressable market by all but an unquantifiable amount. Invented by our Managing Director of Engineering, Dr. Farshad Ghasripoor, the VorTeq leverages our flagship pressure exchanger technology and repurposes such as a pump. In the context of hydraulic fracturing, the VorTeq isolates the pumping infrastructure from fracturing fluid containing abrasive proppants, thereby significantly decreasing the operating and capital expenditures of the end user. In this case, Schlumberger.

This step change in how we view the pressure exchanger, namely as a pump, will fundamentally change and shape our R&D and product strategies going forward. Now, in addition to identifying and developing markets where pressure energy is being wasted, we can now target and develop markets where pumping infrastructure is compromised in hostile processing environments.

This is central to our belief that the PX is a ubiquitous technology, which is to say we can create markets and deliver value to end-users in virtually any industry, sector, market, or vertical where pumps are being destroyed due to processing of erosive, abrasive, or corrosive fluids. Indeed, we believe that over time and through our core competencies of fluid dynamics and advanced material science we can disrupt a significant portion of the global pumping market.

This transaction provides both the validation and the capital required to fund an already-robust product development pipeline, one that is dominated by derivatives of the pressure exchanger, more specifically applications of the PX as a pump.

Our enthusiasm as to the transformational impact of this agreement on Energy Recovery is only rivaled by our excitement to be partnered with the world's premier oilfield services company, Schlumberger. While we are cognizant that the product has yet to be fully commercialized and have mobilized for dogged and precise execution in support of the milestone process in 2016, we are ever confidence that the VorTeq has the potential to revolutionize the hydraulic fracturing ecosystem.

Our first priority is a full deployment in 2016 to breach the final front of commercialization and support our strategic partner to the fullest extent. We will then look forward to providing and supporting a technology that could, assuming a reconfiguration of the pumping infrastructure, reduce the cost per barrel to frac a well by $4 to $5.

As for the critical path to commercialization, we will conclude field trials with our trusted test partner, Liberty Oilfield Services, by the year's end. We will then work with Schlumberger throughout 2016 to execute against the milestone process as a prerequisite to full-scale deployment within their operations. Despite a tremendous amount of work ahead, we reaffirm our belief that we can successfully conclude the milestone process in 2016, thereby taking receipt of an incremental $50 million in payments and head commercially downrange in 2017, whereat we will begin to generate annual royalty income.

Now, for a specific discussion on our segments beginning with oil and gas, most specifically gas processing, earlier in the year we announced the installation of our IsoGen turbo generator system in a Saudi Aramco gas processing plant. We are pleased to report that in addition to crystallizing the value proposition in the form of energy produced, we have successfully emerged from the evaluation period. Consistent with our reloaded strategy and rifle shot approach to market and strategic account development, we continue to invest in growing our relationship with Saudi Aramco with the belief that the near to midterm return on investment will justify the four-year-long process. In this, we expect to deploy additional boots on the ground to further this effort.

Beyond Saudi Aramco in the Middle East we continue to face the same economic headwinds as all midstream market participants, resulting in delayed greenfield projects and deferred spending on turnaround operations, which would allow for the potential retrofit and inclusion of our technology, while we have made progress in educating the market on the merits of pressure energy recovery, our ability to generate sales orders is inexorably tied to the ongoing economic malaise. This has further sharpened our go-to-market strategy and positioning to allow for the opportunity to play offense in very challenging conditions. As and when we have quantifiably meaningful updates here, such will be communicated accordingly.

Moving on to chemical processing, more specifically ammonia. Opposite to gas processing and predicated on a three-year-low pricing point in the feedstock of natural gas, operators are benefiting from a positive demand shock and are amassing capital surpluses that could be allocated to nascent technologies such as the IsoBoost or IsoGen systems. Further consistent with our reloaded strategy of rifle-shot market development and fiscal discipline, in addition to a lean internal salesforce, we executed strategic agreements with licensors of ammonia plant technology and EPCs as a means of availing the Company of a broader distribution channel as well as indirect brand equity.

While it is still very early days, having only started market development at the beginning of this year, we are confident that our value proposition resonates with end-users and that we can achieve early adoption. As with gas processing, as and when quantifiably meaningful results are evident, they will be communicated accordingly.

Finally, on to our core segment: water, specifically desalination. We began the year quietly optimistic about the health of the market. We upgraded to simply being optimistic upon reporting the second quarter's results.

Now, having line of sight visibility to the fourth quarter's revenue potential, the entirety of fiscal year 2015 and a robust pipeline in 2016, we further upgrade our confidence level to bullish. While certain markets continue to struggle, most notably the United States and California, due to an entrenched environmental lobby and deadlocked political intelligentsia, international and historically crucial markets are funding and letting capital projects in a manner consistent with a bull cycle.

The leading indicators to market appreciation are: a shift in product mix toward the pressure exchanger within the sales pipeline, as well as a channel mix toward megaprojects or large-scale capital projects. Having been awarded and announced $26 million in large-scale capital projects in 2015, with the expectation that $18 million of the $26 million have or will ship this year, we will enter 2016 with a near record amount of the following year's revenue underwritten in projects under contract.

As encouraging as the rebound has been, we are perennially cognizant of the cyclicality of the global desalination market. In short, we have and will continue to modify our commercial strategy to ensure that we can play offense at all points of the cycle.

To this end, last call I announced a few strategic initiatives centering on varying procurement vehicles, namely an operating lease with various performance guarantees and the launch of our first new desalination product in the last four years, the PX Prime. Having launched the Prime earlier in the year and dispatched our developers to sensitize the initiatives with the market, I can report that the feedback has been positive and we expect to secure operating lease contracts in 2016 targeting first the retrofit segment of the market.

On the last call, I described Energy Recovery as a portfolio consisting of a cash cow and funding mechanism, the desalination business -- a concept that some have erroneously challenged -- and a series of pre-revenue call options such as gas processing and ammonia. As a portfolio manager of sorts then, our strategy is to fund the highest beta options and monetize them over time. The landmark agreement with Schlumberger is validation of this resource allocation and investment strategy, and to be sure, such would have not been possible without the consistent cash generation of the desalination business.

Also on the last call, I provided a conservative $4 to $5 per share growing perpetuity valuation of the desalination business. Considering this, the economic magnitude of the Schlumberger agreement, the theoretical value of our current portfolio of call options, and indeed future opportunities within the PX as a pump market, we are of the opinion that the share price, while substantially up from an artificially low level, remains significantly undervalued.

In closing, we stand before the brightest horizon ever facing the Company and, with a reconstituted board and management team, are united with the singular goal of delivering enhanced returns to our shareholders.

With that, I will now open the line up for questions.

(Operator Instructions) Patrick Jobin, Credit Suisse.

Thanks for taking the question. Great work this quarter and thanks for all the disclosure, thinking about the business by segment. Three questions from me, if I may.

First, lots of opportunities to invest more to tackle the other markets beyond fracking and obviously desal. How do you plan on prioritizing markets and how do you think about OpEx kind of ramping on the R&D line next year?

Sure. So from a prioritization standpoint, Patrick, it starts with our product development roadmap, which is something we began creating this year and we will complete said process by the end of this year. Our focus is going to be on derivatives of the pressure exchanger. That product has always been at the heart of the Company.

It is the most novel. It is the most prohibitive and, therefore, proprietary and the pre-commercialization of the VorTeq and certainly the agreement we assigned with Schlumberger is, in fact, a validation that the aperture of that technology has only begun to be defined.

And so from a prioritization standpoint, you can think of it as follows. P1 will be any derivative of the pressure exchanger as a pump. P2 will be a derivative of the pressure exchanger as an energy recovery device. So we will have line-of-sight visibility as to which initiatives we will fund. We will run them through our stage gate process, and as and when we achieve proof-of-concept, we will communicate such accordingly.

Now specific to an actual ramp-up in OpEx, specifically at the R&D line, look, we're happy about this agreement, but we are not going to start spending money like a sailor on three-day shore leave. We will remain in a period of austerity. What you can expect is a steady increase in actual engineering headcount. We are currently targeting anywhere from five to seven that we will bring on next year, so from a percentage standpoint I would not expect R&D to increase any more than 20% to 30%.

Got it. Then two questions on the VorTeq and Schlumberger announcement.

First, on the adoption curve, you've talked about game-changing potential using VorTeq with different pumping technology, principally the centrifuge pumps. Is the value proposition compelling enough and do you expect adoption using traditional plunger pumps? Or does this require a pumping fleet technology change concurrent with initial adoption?

That's first question. I have one follow-up.

Sure. So, yes, the value proposition stands on its own with respect to integrating the VorTeq into the existing frac spread. That is the priority for both parties, which is to say Energy Recovery and Schlumberger.

The opportunity to revolutionize the frac ecosystem, as you put it, to migrate to this new pumping technology, ergo the centrifugal pumps, we are keenly interested in doing that, but you've got to crawl before you walk and walk before you run. So all we are focused on right now as a team and certainly as an engineering cadre is getting the VorTeq within Schlumberger's existing fleet. And, yes, the economics are more than compelling enough to induce them into adopting at the prescribed rate in our contract.

Got it. So I think you just alluded to it, but what got you comfortable to sign up with one company besides the obvious magnitude of upfront payments? Is there a risk the Company sits on the exclusive license or are their minimum adoption requirements or something?

I will answer that severally, Patrick. Number one, the brand of Schlumberger speaks for itself and so I think most people can understand that if you're going to exclusively partner with anyone in OFS it would be Schlumberger.

Number two, as a company we are very cognizant of what we are good at and what we are not good at. What we are good at is manipulating highly-pressurized fluids to extract value and arbitrage and material science, if you will. We are not a logistics company. We're not an oilfield services company, so that kind of considers operational risk. Anything we do we have to be mindful of operational risk and partnering with Schlumberger mitigates said risk.

Then of course, from a financial risk standpoint, while we had a very healthy balance sheet, call it $30 million, prior to executing the agreement, it would have placed a degree of stress or strain on our balance sheet to take this product to market ourselves. Now, with respect to the possible shelving of our technology, that is not possible in the context of the agreement. In fact, there are minimum adoption curves. There are actually two: one to deploy the VorTeq within the existing configuration and then a second to deploy the VorTeq within the new pumping configuration.

The contract is on a take-or-pay basis and if, for whatever reason, the minimum adoption rate is not met or satisfied, the exclusivity is foregone. The agreement would remain in place, but the exclusivity would be foregone. Therefore, we would not incur the opportunity cost of singularly licensing that technology to Schlumberger for the next 15 years.

Got it. Congratulations again. Thank you.

Craig Moss, Morgan Stanley.

Joel, congratulations on some really good announcements this quarter. I was just curious; do you have any plans whatsoever of redeploying some of that cash to shareholders, either in buyback or dividends going forward?

Well, I would never make a definitive statement which is to say, yes, we have plans of doing that or, no, we don't have plans of doing that. Obviously, myself and the Board, we actively manage our capital structure and we will always execute in the best interest of the shareholders.

Now having said all of that, I think it comes down to what is the identity of the Company as you are talking about typical stock demographics? We're not a value company. We are not General Electric growing at 5 to 7 points a year and paying out 20% of div ratios. That's not who we are.

We are a growth company and I alluded to the product of element pipeline or roadmap that is, frankly, replete with very exciting opportunities. And so, our first priority will be to fund the next disruptive and explosive idea. The perfect case study is the VorTeq and let me provide some color there.

We spent about $12 million developing that technology. Now, had we decided to repurchase shares with that $12 million, understanding that's a zero sum gain, who knows with the impact on the share price would've been? But, the appreciation that we've witnessed over the last 3.5 weeks I think speaks for itself. That is consistent with being a growth company and always been mindful of how we can deliver the highest risk-adjusted returns to our shareholders.

I have a couple of questions concerning -- the application of the technology into the gas and pipeline and ammonia industries, is it right to say that there are about -- in terms of the market potential, about a third the size of fracking, in terms of the opportunity?

What I would tell you about -- let's treat them separately. You've got three markets that we've been attempting to develop: gas processing, ammonia, and pipelines. So gas processing, just based on the downward pricing pressure on crude, and, of course, the associated pressure on nat gas, is such that no one is spending money. It is a CapEx freeze universally in virtually every market except for the Middle East, specifically with Saudi Aramco.

And so when you think about the total addressable market for gas processing in the current economic conditions, it's much smaller than it was a 1.5, 2 years ago. Pipelines is pretty much the same thing; although pipelines always need to be maintained, so there's going to be a consistent amount of spend there.

And then ammonia, you could argue that the ammonia addressable market has, in fact, grown again based on the fact that the feedstock to produce ammonia and ultimately fertilizer is, of course, natural gas. There's been some movement, obviously based on systematic risk and how we size those markets. But to compare them to fracking, our fracking market now is basically Schlumberger and we're excited about that.

So lastly on that Schlumberger thing, I don't know if you've had a chance to comment on it, but my understanding is Schlumberger is number two in fracking. Halliburton is number one. What made you decide on Schlumberger and was Halliburton also interested in the VorTeq?

Great question, and Chris and I have been fielding that as we have been out on our non-deal roadshow. Number one, Schlumberger is a technology company. They are, of course, oilfield services but at their core they are a technology company. And they have a phenomenal track record of bringing nascent technologies into the oil patch in record time.

And of course, we like that because we're a technology company and we move quickly. That's one of our competitive advantages, alacrity.

Number two, they have the broadest international footprint. And so as you look at the dispersion of hydrocarbons outside of the United States, you may be surprised to know that only about 14%, 15% of the global shale reserve, if you will, is in North America or specifically the United States. The vast majority of the hydrocarbons are outside of the United States.

This is a 15-year agreement and, of course, we are long on E&P and so we wanted to position ourselves with a service provider that would grow as the international market develops. So that's number two.

As it relates to other strategic partners, I would submit that we could have partnered with anyone we wanted to. As I said, I talked about it on the year-end call; I talked about it on the Q2 call. I believe the exact quote was we are engaged with anywhere from 85% to 90% of the industry.

So understanding that, and if you assume that our value proposition resonated as loudly with them, you can naturally impute that we could've chosen whomever we wanted and we chose Schlumberger. We are quite happy about that.

Well, it all sounds really terrific, Joel. I can't wait to see how this all plays out over the next couple of years in terms of the royalties, because it sounds like the numbers that you used on the last call of 2 to 4 times the desal revenues, based on what you just said about the opportunity internationally for fracking, and assuming that oil eventually does turn around and move higher, it sounds like those numbers were pretty conservative.

Yes. We're from the University of Chicago, Craig; we only know how to be conservative.

Okay. Well, thanks again.

(Operator Instructions) Robert Smith, Center for Performance Investing.

Good afternoon and congratulations. Take a bow; it's really a great achievement.

You seem to have added a little more color to the information that you provided previously by stating the year 2022 as sort of the ramp date for the $80 million to $200 million. If I'm correct, could you just give us some ideas to the ramp rate going from 2017 to 2022? Thanks much.

Chris, why don't you take that?

So essentially we have within the contract what is called a minimum adoption curve, and that's over the course of five years they have to reach 100% penetration of our technology into their fracking ecosystem. We cannot tell you specifically how many active fleets they currently have, or we're not going to do that, but if you look back historically, that is to say a year or two back, they had roughly 120 fleets.

So you can impute from that $80 million to $200 million, roughly a 50 to 130 fleets count or active fleet count over that time. And that's how we are coming up with that number.

Thanks much. Good luck.

Other thing is it does not consider the adoption of a novel pump. If Schlumberger adopts the novel pump into their system, our royalty rate increases substantially and we see a much larger revenue.

So you just lost me on that. Much larger than what?

We said that it's $1.5 million per year, per VorTeq income, royalty income. That is if the VorTeq is deployed within their current pump configuration. If they move to this new pumping model, which we have deemed or termed the novel pumping model, then clearly their savings would increase and we would have an opportunity to share in those increased savings. So our annual royalty payment would be well in excess of $1.5 million.

We're not going to peg that number right now, because such would be unduly speculative. All we're trying to say is that, yes, there is upside in this agreement if in fact we can get this product to the point of full commercialization.

So does the $80 million to $200 million range reflect that or is this something in addition?

No. It would be incremental to that.

Okay, fantastic. Thanks.

(Operator Instructions) Robert Smith.

Just a thought. So what do you have to do to get to that additional development stage or is Schlumberger's acceptance?

Robert, there are a lot of milestones. To be frank, the only two milestones that we are focused on right now are the ones that we expect to successfully execute against in 2016, which will trigger the two $25 million payments. We can be a lot more forthcoming as it relates to future milestones after we have done that.

So we're just going to focus on those two milestones, and assuming we are successful there, we can have a much more robust conversation.

Is it question of technology development or are you there?

It is partially technology development. Not on our side; this would be technology development around the pumps. And then, of course, just the science of integration.

Thanks, again.

Patrick Jobin, Credit Suisse.

Thanks for taking the follow-up and all the incremental information here. There's a lot more teeth to this agreement and contract.

So when I think about the next two milestones for 2016, I presume, since Liberty is going to finish up by the end of this year, it's that prototype that you need for the two milestones. Or are there any other capital uses in 2016 that you are planning for the work on those two milestones?

As soon as the prototype is done, rather as soon as Liberty has completed the final frac, we will be retrofitting the missile with our gen two cartridge, so I guess there's another update. We are very close to gen two, which of course we are quite excited about. Once it is outfitted or retrofitted with the gen two cartridge it will be delivered to Schlumberger, and then both teams will participate -- not participate, rather coordinate in executing against the milestone process.

As for CapEx, yes, we are going to have to spend a little bit, Patrick, to retrofit this missile. Whether or not those costs are incurred in 2015 or 2016, timing will tell. And I guess I should be more precise; it would not be CapEx, it would still be OpEx. There are some GAAP hurdles that still need to be met to allow us to capitalize the expenses. So you would see that in the form of R&D.

Makes a lot of sense, thank you.

Thank you. It appears we have no further questions at this time. I will turn it back to Joel Gay for any closing remarks.

Thank you all and we look forward to speaking to you at the next juncture. Goodbye.

Thank you, this does conclude today's conference. We appreciate your participation. You may disconnect at any time and have a great day.