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Energy Recovery, Inc (NASDAQ:ERII)

Q4 2013 Earnings Conference Call

March 6, 2014 10:30 ET

Executives

Alex Buehler - CFO

Tom Rooney - President & CEO

Analysts

George D'Angelo - Jefferies & Company

Jim McIlree - Chardan Capital Markets

JinMing Liu - Ardour Capital Investments

David Rose - Wedbush Securities

Robert Smith - Center For Performance Investing

Operator

Ladies and gentlemen welcome to the Energy Recovery year-end 2013 earnings call held on the March 6, 2014. (Operator Instructions). I would like to remind everyone that this conference call is being recorded today, November 7, 2013.

I would now like to turn the conference over to Mr. Alex Buehler, Chief Financial Officer. Please go ahead, sir.

Alex Buehler

Good morning everyone and welcome to Energy Recovery’s earnings conference call for the fourth quarter and full year of 2013. My name is Alex Buehler, CFO of Energy Recovery and I’m here today with our President and Chief Executive Officer, Tom Rooney.

In today’s call, we will provide you with information about our financial performance in the fourth quarter and full year of 2013, as well as provide an update on the progress that we are achieving in relation to our growth strategy. Consequently, 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 U.S. 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 U.S. Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statements made during this call, except as required by law.

Let’s start with an interpretation of the financial results for the fourth quarter of 2013. I do not intend to convey a methodical point by point analysis of the results as this was described in sufficient detail in the press release. Rather my objective is to provide some additional context on these results from both a quarterly and annual perspective and reflect on the trend for the previous three years of operation. Starting first with the quarterly results we’re pleased to discern the earnings power of the company in the presence of volume.

Gross profit and net margins become exceedingly compelling when the company achieved sufficient revenue as was certainly the case in the fourth quarter of 2013. A gross profit margin of 63% and a net margin of nearly 30% served as a strong reminder of the profit and return profile that is attainable when the global desalination market achieved it's full potential. Both revenue and net income in the fourth quarter of 2013 were record setting for the company. Additionally the company continued to hold the line on operating expenses while not sacrificing on critical investments meant to spur revenue growth in subsequent years.

These investments manifest in several lines on the income statement to include general and administrative sales and marketing and research and development. To summarize the quarter with revenue of 23 million gross profit margin at 63% and operating expenses of less than 8 million we generated nearly 7 million of net income and $0.13 per share. And this was in-line with our internal budget and recurring forecast. Stepping outside of the fourth quarter and instead viewing the full year of 2013 we were equally satisfied with the financial results.

Although revenue grew only modestly over prior year which incidentally was in keeping with our expectations based on the timing of large project awards and shipments. The expansion and growth profit margin was still very notable from 47% in 2012 to 60% in 2013. The trend in gross profit margin continued to reflect the realization of manufacturing efficiencies. To break this down in greater detail, we accomplished a multitude of critical initiatives over the last three years starting first with the closure of our plant in Michigan for which we recorded about 3.7 million in restructuring charges over a three year period. And this now allows us to produce our full suite of products from a single facility with much lower manufacturing overhead.

Moreover we successfully integrated our ceramics processing facility and we’re now able to produce ceramic components for far less than we were once purchasing them. Beyond consolidation and vertical integration we’ve driven kiln yields to best in class levels, completed a successful redesign of certain pumps and turbo chargers to reduce unit cost and increase efficiencies. Decrease raw material expenses through enhanced procurement discipline and achieve progressive labor efficiencies in pursuit of operational excellence.

Not to imply that we have arrived but we’re well on our way in the evolution toward world class manufacturing. As we think of the four levers that drive gross profit margin to include price mix, volume and efficiency the year-over-year comparison speaks primarily to efficiency and to a lesser extent production volume. That is to say price was relatively stable and mix was virtually unchanged. While production volume increased moderately to accommodate shipments in the fourth quarter.

Manufacturing efficiencies including lower labor content less applied overhead and less expensive raw materials allowed the company to achieve decreased unit cost and expanded margins. Also in 2013 operating expenses were flat but flat on amidst robust investments for utilization of oil and gas solutions, without which net income would have been positive. So in an effort to capstone the year we reduced our net loss by 5.1 million or $0.10 per share which represents bottom-line improvement of 62%.

In the press release we included a three year trend pertaining to key metrics which we believe conveys a cogent story specific to our financial and operational progress. The uplift in gross profit margin is apparent moving from 28% in 2011 to 60% in 2013. As an intermediate year with 47% margin 2012 included the benefit of operating leverage, pricing and the initiation of manufacturing efficiencies while 2013 really crystalizes the full effect on manufacturing efficiencies. Operating expenses were somewhat bloated in 2012 due to non-recurring restructuring charges also demonstrated a favorable trend when viewed in the context of our heavy investment to commercialize new oil and gas solutions.

We have taken our significant OpEx and reinvested those dollars toward high value, high return opportunities by attempting to strike the right balance between efficiency and future growth. Meanwhile net loss and cash flow from operations demonstrate an undeniable trend in the right direction.

To put a finer point on our progress we have reduced our net loss from 26 million to 3 million over this time period and we have improved cash flow from operations from 8 million used in 2102 to 3 million provided in 2013.

We believe that this demonstrates sound progress with respect to operational excellence and financial performance. My conclusion therefore is this; the fourth quarter of 2013 was very strong and in-line with our expectations. The full year demonstrated meaningful bottom-line improvement due primarily to manufacturing efficiencies and the three year trend of key metrics demonstrate solid operational and financial improvement. And importantly the financial view of the fourth quarter speaks to the earnings power of the company with the benefit of revenue.

Let’s now transition from the backward looking discussion of financial performance to a forward looking perspective regarding growth strategy.

I will now turn the call over to our President and CEO, Tom Rooney.

Tom Rooney

Thank you Alex. Good morning everyone. Looking back on the fourth quarter and 2013 as a whole, I’m extremely happy with the results. The financial results that you just reported are very much in-line with management’s expectations for the year and a very closely mirror of the actual business plan that we laid out for ourselves at the beginning in 2013.

The results that we achieved in 2013 is a direct result of sound planning and three years of very hard work by a dedicated group of people at Energy Recovery. A great deal has been accomplished over the past three years and as a result the company is in a very strong position moving forward. In fact the company has never been stronger. We have now proven our ability to drive dominating market share while maintaining pricing power and we have streamlined our cost structure so as to allow us to generate very appealing gross margins and cash flow. I’m proud to say that Energy Recovery is now a company that can operate from a position of strength.

Looking to the future, we must always begin with an assessment of our core desalination business. I fully realize that everyone would like for me to provide short term guidance for our desalination business. But I’m afraid that I just can’t do that. Unfortunately the nature of this global desalination market is such that given short term revenue guidance is difficult at best and frankly borders on just educated guessing.

Given the circumstances I would prefer to tell you what I know and leave out the guesswork. Here is what we know, over the past 18 months we have seen a significant buildup of projects in desalination pipeline. To be specific our project pipeline has more than doubled over the past 18 months. This pent up demand represents a very promising trend but we remain somewhat uncertain as to the timing of all of these projects.

I can’t tell you that these projects are emanating four notable geographic regions. The Middle-East North Africa, India, China and the United States. The MENA region has always been the number one market for desalination projects and that trend appears to be continuing. We now see a very important trend of oil rich countries like Saudi Arabia moving away from thermal desalination technologies and towards reverse osmosis. That bodes well for companies like ours; we don’t work in thermal desalination.

We even anticipate seeing a number of older thermal desalination plants being phased out in favor of newer energy efficient reverse osmosis plant. And that’s very good for us.

The Indian market is a very interesting market to watch. The demand for drinking water in India is enormous as well as the needs of desalinated water for new power plants being built throughout India. These twin needs are beginning to manifest themselves in our rapidly growing sales pipeline. As with other markets the critical issue is in understanding the timing. Of particular importance is the short term effect of the upcoming National Election in India.

The National Election this April and May are considered to be the most important election in India in 30 years and the outcomes could lead to significant changes and quite possibly a short term slowdown in some planned desalination projects. In the long run these political changes could prove to be beneficial in regards to the size and pace of desalination projects in India.

The Chinese desalination market much like the Indian market presents enormous upside potential for Energy Recovery, like India, the Chinese market is driven both the needs of potable water as well as the need for desalinated water for new power plants being constructed all over China. These two needs have clearly manifested themselves in terms of realized revenue growth over the past two years as well as in future demand detected in our rapidly growing sales pipeline. The key concern at this point is the timing of all these projects coming out of China particularly given the recent slowing of China’s economy.

Possibly the most interesting and in many ways the most vexing geographic market for us is the United States. We were pleased to see the Carlsbad project move ahead in 2013 after so many torturous years in the planning and permitting stages. The Carlsbad project is but one of a significant number of desalination projects that we’re currently tracking just on the West Coast of the United States. The fact that Carlsbad successfully moved forward is a critical and very helpful development for desalination projects in the United States.

Add to that the fact that a drought emergency was recently declared in California and you’ve what appears to be a pivotal movement for desalination in the United States. I would caution everyone that the inevitable ramping up of desalination projects in the United States and even in the drought stricken California may still take some time.

In summary here is what we know; we’re tracking a significant buildup of desalination projects around the world. We’re seeing this buildup coming from large and important new markets as well as from well-established desalination markets in the Middle-East.

In all of these existing and emerging markets Energy Recovery is well positioned and in fact Energy Recovery is dominant competitor in every one of these markets. Here is what we’re less certain about. In a word it's timing and unfortunately that never seems to change in this industry.

Given the uncertainty surrounding timing we’re vacating any pass guidance we provided on desalination trends and we simply aren’t going to try to provide specific revenue guidance for desalination in 2014. We do remain extremely bullish regarding the five year outlook for desalination for all of the reasons that I outlined earlier.

Three years ago when I first joined Energy Recovery I made diversification a top priority, precisely because of the timing uncertainty that we face in desalination markets around the world. The global demand for water and the commensurate need for desalination plants is a wonderful and durable megatrend and we’re pleased to be one of the world’s leading providers of desalination technologies. But the unpredictable cycles and the lumpy revenues that come with desalination are tough on a company like ours and frankly tough on our shareholders as well.

That is precisely why taking our core technologies and redeploying them in order to diversify into new verticals is critical to our future and has been a key focus of our efforts over the past three years. So let’s take stock of what we have accomplished from a diversification standpoint over the past three years and where we go from here.

Prior to 2011 Energy Recovery had only sold a handful of individual components for direct use in the oil and gas industry and exclusively through it's recently acquired Pump Engineering division. The problem with that time [ph] was that Pump Engineering really didn’t have a commercially marketable solution or even an oil and gas value proposition per se.

As 2011 unfolded we focused on restaffing and rebuilding our R&D team. We also hired new product development experts and we began to align ourselves with three major oil and gas clients who are willing to pilot new gas processing technologies with us.

In 2012 we poured millions into researching and developing three new platform technologies for use within the sour gas processing industry. Technologies that we now refer to as IsoBoost, IsoGen and IsoPro. We did sell in concert and in collaboration with our oil and gas industry plant partners. By the end of 2012 we had developed full commercial scale plant ready version of our IsoBoost, IsoGen and IsoPro technologies. Several of these even made it all the way into field operations into 2012.

In 2013 we continued to pour millions into developing, testing and refining our three platform technologies. By the end of 2013 all three of our oil and gas technology platforms have been shipped to field locations around the world. In two cases we even acquired powerful written and video endorsements of our revolutionary new technologies. The third endorsement should come this year.

In November and December of last year I personally traveled to locations in the United States and China to see our technology in action and I heard firsthand the success stories that our clients had to share. I was very moved by what I heard.

In parallel for the project trials that we’re underway in 2013 our marketing group spend a great deal of time in 2013 defining and refining our value proposition in anticipation of a major commercial market roll out in 2014. The marketing team realizing that our three new technology platforms have application well beyond simply sour gas processing spent 2013 mapping out the whole series of new industries and market verticals for us to attack in 2013 and for many years thereafter.

We see these follow-on markets as logical growth markets for us and they are very substantial in size. For perspective it's important to understand that the company intentionally kept itself in a low profile position in regards to oil and gas, sales and marketing all the way through the end of 2013.

Quietly attending a handful of industry events but never presenting publically. It's also important extremely important to know that our R&D and legal teams filed for and/or received more patents in 2013 than in all the company’s previous 20 years combined.

So, at the beginning of 2014 and now with the benefit of critical client endorsements, a highly refined value proposition and a strong portfolio of patents. We made the critical decision to commence our full scale high energy launch into the oil and gas market. In January, we hired and assembled a talented 6% oil and gas sales team up from one part-time sales position in 2013.

Just last week we debuted our Energy Recovery technologies at our very first major oil and gas international industry conference. I’m very pleased to report that the interest level and feedback at that conference was overwhelmingly positive and the inbound interest has already spawned numerous follow up for our sales force, including specific requests for commercial quotes, as well as high level strategic meetings.

If that wasn’t enough on the very same day last week our technologies were also debuting at ammonia conference in France with equally promising results. Our focus in 2014 is aggressive sales and marketing of our IsoBoost and IsoGen technologies in both the oil and gas industry as well as the ammonia industry.

With sales cycle in these two industries can be long, but we will remain confident that we will achieve revenue in 2014 with serious growth leading into 2015. Where we sit today I feel very good about how far we have come in three short years. We have spent the past three years steadily and patiently building our position in the oil and gas industry to appoint where today we’re now comfortably moving into full speed commercial roll out. The long term potential for Energy Recovery in the oil and gas industry is immense. By our analysis the total addressable market for energy recovery solutions in the oil and gas industry is well in excess of a $1 billion per year and that doesn’t include the ammonia processing industry which is large in of itself.

Looking back over the past three years we have done the hard work of strengthening our core desalination business to the point where it's now in an excellent position to dominant competitively and financially for years to come. With desalination as our strength and our foundation we have also made incredible progress over the past three years in positioning ourselves for huge growth opportunities in diversified industrial applications.

I’m very proud of what we accomplished in 2013; I would argue that 2013 was the most successful year in the company’s history. The core business is now the strongest that it has ever been. In 2013 we opened and developed significant new avenues for growth and our innovation engine is now generating more new patents and technologies than ever in our history. 2013 was indeed a fantastic year.

True shareholder value creation will come from taking a long term perspective in aggressively building and capitalizing on these new industrial markets, while staking out a strong IP portfolio all along the way.

I feel very comfortable that we have and are doing exactly that. These are very exciting times in Energy Recovery.

Thank you and we will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Laurence Alexander from the company Jefferies. Please go ahead.

George D'Angelo - Jefferies & Company

This is actually George D'Angelo sitting in for Laurence today. Are you guys happy with your footprint in the oil and gas area or would it be worth looking for built on acquisitions to help accelerate sales cycle?

Tom Rooney

Yes to both. We’re happy with our footprint that we’re being opportunistic and we are aggressively and have had a corporate development effort for the last eight months or so looking for intelligent acquisitions in the oil and gas space. The problem with that George is that the oil and gas industry is so hot right now that valuations are virtually unrealistic. So as much as we might like to find a bolt on acquisitions to accelerate ourselves the cost of such an acquisition is somewhat irrational.

George D'Angelo - Jefferies & Company

And would you say competitive pressure for desal applications is increasing or stable?

Tom Rooney

Competitive pressure I mean competitors against ourselves?

George D'Angelo - Jefferies & Company

Or just industry dynamics yeah.

Tom Rooney

So I guess I will interpret your question, it mean is Energy Recovery have more fierce competition today than ever before? Yeah every day we get more and more competitors that enter the industry. The challenge is that our technologies are disruptive they are advantaged and they are recognized as such. And even in the area of pumps and turbos we have invested so heavily in the last two years to advance our technologies in pumps and turbos but we’re actually more competitive in pumps and turbos today than we were a year ago. So I think like any industry we see more and more competition every day. I guess that’s the bad news, the good news is we’re far more competitive today than even we were a year ago. So it hasn’t had any effect on us

Operator

Thank you. And the next question comes from Jim McIlree from the company Chardan Capital. Please go ahead.

Jim McIlree - Chardan Capital Markets

You talked about spending millions of dollars in R&D in the prior years and it sounds like a major portion of the product development is now behind you. Does that mean that R&D is going to come down or if you keep R&D at current levels and just invest in new projects?

Tom Rooney

No R&D is not going to go down. We are investing in new products. We’ve what I would argue are couple of blockbuster technologies that we’re working on right now that we will invest several million in them that represent tremendous opportunity for us. One of the comments that I had made was that our marketing department in 2013 investigated other verticals and other markets where our core technologies and platforms to be applicable. That has led us to recognize a few incredible upside potential for us and so we’re now investing very heavily in those areas in and around oil and gas. I don’t want to comment much more on that but we have no shortage of fantastic places to take our technologies and we don’t see pulling back from our R&D spend anytime soon.

We have created, I guess I would say we have reignited an innovation engine at the company and it's throwing off tremendous technologies and advancements and patents for us and given our focus of creating value over the next 2 to 3 years there is no reason for us to back off on the R&D spend.

Jim McIlree - Chardan Capital Markets

And so that touches on my next question, you mentioned that you were addressing in your diversification comments you’re talking about additional markets besides oil and gas that you’re going after and then you identify ammonia as one of them. But I’m assuming that there are one or two or three others that you’ve identified that you’re working on product development as well as market development is that correct?

Tom Rooney

That’s right. Yes.

Jim McIlree - Chardan Capital Markets

And then this year 2014, I just want to make sure I understand what you’re saying about the oil and gas market. You think you’re going to have some initial sales in that market but 2015 is the real big year for that market. Is that right?

Tom Rooney

That’s right. There is no question we will have revenues this year. We actually have at least one executed contract that I’m aware of and actually received payment from one client. So I don’t think there is any doubt at all, we will have revenue in the oil and gas industry this year. How much revenue we have from oil and gas this year is considerably less important to us than piling up wins that will drive revenue for us in 2015 and ’16 and so as has been pointed out in the past the lead time for our delivery of our technologies can be on the order of 6-7 months. We’re overwhelmed right now with commercial requests for proposals and contacts in the industry. So I would say without question we will have oil and gas revenue this year. It may be an unimpressive amount but that really doesn’t matter what we’re really focusing on is stacking up contracts this year that will drive important revenues for us in 2015, 2016 and beyond.

Jim McIlree - Chardan Capital Markets

You talked about lengthy sales cycle in oil and gas, can you just kind of go through what that might be the initial contact is to which group and then you’ve to do testing or prototypes or trials and then there is valuations. Can you just kind of like break it down into some simple steps and timeframe on that sales cycle.

Tom Rooney

Yeah so the oil and gas industry has certain clients that are early adopters and like to try technologies early. Others are incredibly conservative and want to see stuff these technology working elsewhere. So what we’re seeing right now is where we sit today we can literally take a client to a plant location and show them an operating plant with exactly the technology that we’re referring to the very happy client and that is a very convincing moment. We actually have that right now; we have clients who are extremely happy with what we have done. The device has been operating for a lengthy period of time and they are powerful endorsement. We have even produce white papers and presented those white papers at conferences.

So now that we have that and our technology is evolved the fastest I think we will see the sales cycle would be from an early conversation, we can be taking a commercial proposal in 30 days, the fastest movers might make decisions, 90 days thereafter and we would be six months thereafter to deliver product and begin to see revenue recognition.

Interestingly enough, if the assignment is large enough and the acquisition is put into a capital budget some clients will wait for their annual funding cycle which would mean that we would have to wait till the annual turnover. So because of that you see the cycle time going anywhere from 6 to 9 months to two years. This is how I would describe it to you.

Operator

Thank you. The next question comes from JinMing Liu from Ardour Capital. Please go ahead.

JinMing Liu - Ardour Capital Investments

First a follow-up on the R&D expense into next year and into the future. Can you share with us what you're upsides on the R&D front whether you are trying to get more application into volume gas [ph] or improve your current pressure exchanger or get some other applications like the osmotic power.

Tom Rooney

JinMing most of what we're spending on will be breakthrough noon new technologies that enable us to penetrate market verticals that we’re not currently in. But of course there will be some monies spent on refining our technologies.

So I would give you as an example we have IsoBoost, IsoGen and IsoPro. IsoBoost is now a proven technology and it's one that's very appealing to the oil and gas industry. It's at the core, there is the turbocharger. IsoGen is a device that generates electricity also at the core it uses turbine. IsoPro is the stallion if you will, the very, very high efficiency device. The core of which is the pressure exchanger.

It's performance is so extreme that it requires specialized operating protocols at a plant because it knocks out so much of the energy requirements at the plant that it causes the plant to change its operating protocols. So we're working to refine and develop that technology to merry up well with these plants. So we will indeed over the next 24 months continue to invest in the development of that technology but I would say that the majority of the spending we have one project right now that we may spend $2 million on an incredibly advanced disruptive technology that opens a $1 billion market to us that it is a brand new technology. We haven't talked about it and it's altogether new.

And it is the result of two things. One is the marketing study last year highlighted a very special market for us to enter and at the same time one of the top engineers that we hired had specific expertise in that area. So between our R&D acumen and an identified market, we made the decision in the fourth quarter of last year to invest very heavily to attack that new market and so that's an example of where we are not refining an existing technology but advancing a brand new disruptive technology and by the way we would seek to have 2 or 3 of those opportunities every single year.

JinMing Liu - Ardour Capital Investments

Okay that’s good, what is your current mix in your pressure exchanger sales? Whether your newer model like PX-300 Q is the predominant in the mix?

Tom Rooney

So I would say that the Q Technology has been so rapidly adopted by the industry we almost always felt the Q version of all the other devices. Alex you want to take a stab on the size model?

Alex Buehler

Well let’s step back and speak about mix broadly first. For the year it was 80% PX devices and 20% pumps and turbos and that was largely in-line with 2012. JinMing if you look at Q4 it was 86% PX devices, 14% pumps and turbos. If I unpack the 80% about 50% of that is PX-300 so that model is being around for a couple of years and it's very quickly becoming our highest volume product. Moreover if I unpack the MPG sales revenue, almost a 100% of that PX-300 or more specifically Q300s. So that product line has really take off over the last few years.

JinMing Liu - Ardour Capital Investments

Okay. Good. So if I remember correctly you have to produce the ceramic for the Q300 in-house right?

Tom Rooney

Well we produce all ceramic in-house for all of our PX models now, including the Q300 and the PX-300.

JinMing Liu - Ardour Capital Investments

Okay, lastly for me just Tom can you comment on the mining industry in South America? I saw quite a few projects in that region and also regarding the U.S. market, what do you see going forward in here whether it's more for you it's more mega project sales or just smaller OEM sales in the U.S.?

Tom Rooney

And specifically as relates to mining?

JinMing Liu - Ardour Capital Investments

No for U.S. that’s actually those are two separate questions. Mining for the U.S. whether it's OEM or mega project in the U.S and what going on in the mining industry in South America?

Tom Rooney

Okay so let me take the second half of that question first that is to say the U.S. market. This past year as you know we saw the first mega shipment in probably forever for our company in North America. That was the Carlsbad project.

So it stands out on its own as unique data point. If you set that aside the U.S. market from a water standpoint, a desalination standpoint has been historically essentially unimportant to us. Our North American, I don't want to say it's unimportant but from a revenue standpoint it's just not one of our most significant markets and it's been all small very small devices and small applications. It's not likely going to change in that regard. The key issue is when will the large projects in North America light up.

I think it's worth noting that Benjamin Netanyahu was in here in the Bay Area yesterday essentially lecturing the Governor of California on why Israel doesn't have water problems and I relegated to being an almost embarrassing episode where California can’t get out of its own way in terms of water. Having said that I can opine on what California and West Coast in the United States needs to do but from where I sit in my chair the U.S. market is something we’re going to watch and scratch our head about and I couldn’t give you any thoughts in terms of when California or the U.S. becomes a market of important revenue for us.

So unfortunately we’re a U.S. company and U.S. market for many companies is a big portion of their business, for us it's statistically unimportant to us.

So the first part of your question though is about mining in South America. The mining industry down in South America most notably in Chile has driven a tremendous amount of economic growth in the country of Chile and with that has come the ability and the need to provide more and more water. Both for the people of Chile and for the mining industry. And so we benefited tremendously from that. I'm only aware of one project that we were not awarded in Chile in the last so many years. It's been fantastic market for us.

Some of our people even our policy advisors to the policymakers in Chile. So we have a very strong position and frankly what's been driving all of that water business for us is in fact the mining companies.

The mining companies use a tremendous amount of water to do their mining. Having said that and it's probably not well known we are actually working directly with the mining companies on some advanced materials science opportunities that we have using ceramics.

So I believe this month we will ship materials to a very large mining company in Chile as a trial. It's a pure ceramics play for us. I really don't want to get into the nitty-gritty specifics of it. But we've been working for the last several years on potential opportunities for Energy Recovery to use it's ceramic material science advantages to help the mining companies do mining and do it better and smarter, which by the way I would say to you that we’re pioneering and working on some ultra-advanced materials science here at Energy Recovery.

We have used the same alumina to work our pressure exchangers and what have you and that's been an advancement that has helped the company and its created barriers to entry for our PXs and what not.

One of the areas we’re going to be spending significant dollars and have already begun to spend significant dollars is next generation material science for use in our pressure exchangers. We see as one of our core competencies advanced materials sciences. So on the one side that means we’re going to be spending tremendously in the R&D arena to forge what is the next generation of those materials and on the other side it may soon represent a revenue opportunity for us when we collaborate with industry to sort of harden what their core business already does.

So those are some of the exciting things so we will begin to directly do business with mining companies but we’re also benefiting indirectly from the draw that they have on the waterside. Hopefully that answers both of your questions.

Operator

Thank you. And the next question comes from David Rose from Wedbush Securities. Please go ahead.

David Rose - Wedbush Securities

I was hoping a follow-up on a couple of other questions and then maybe kind of dwell on ONG side [ph] but particularly as it relates to guidance last quarter in the conference call you stated you had 10 months of visibility and you've got to have some visibility for quarter or two. So I was hoping maybe you can provide what’s your expectations are for this quarter up or down versus last year and then if you can give us a range handicap the bottom end of the range and the top end of the revenue range for this year in terms of up or down. Could you be down 20%? Could you be up 20%? Based on what I'm looking at in terms of mega projects. I'm looking at about 800,000 cubic meters in desal [ph] capacity for 2013.

So if I kind of think about that what sort capacity have you been awarded for 2014 to get you to the bottom end or the top end of the range? So I guess you kind of incorporate those into the guidance range for the next two quarters and for the year, top and low end and then lastly if you could give us an idea of how you’re going to build out inventory starting in Q1 and will you start to level load your factories so you can get those margins that you got in 2013.

Tom Rooney

Yes so let me answer the last question first. We've been level loading for 18 months or so in our factory. That's the only way to run an efficient factory. If you look at the last four quarters you see tremendous lumpiness obviously Q3, Q4 of last year represents that in its entirety.

So we do level loading. It's only way to run an efficient factory. But the first part of your question is really just driving at trying to get us to give guidance. The way I look at it is this, we give guidance if we think we can do so intelligently without guessing, without much uncertainty. If we give that guidance we destroy shareholder value. We have to give good to perfect guidance to create benefit for our shareholders and unless or until I think we can do that we simply won't give guidance.

I've come to the conclusion and frankly I look back at how things played out last year. We gave very high level broad guidance at the beginning of 2013. We gave guidance as to what the revenue levels would be. We gave guidance that it was all going to be back ended, very, very heavily in the fourth quarter and then we got beaten up all year long. Our stock price got pounded when the lumpy revenues that we knew were going to happen came in and what that really signals to me is that giving guidance tends only to create a negative effect in terms of shareholder value.

The truth to be told for our company, investors are investing in our company for the potential that we have over the next 2 to 3 years. The potential that we have over the next 2 to 3 years is very significant. The entire management team has an Outlook the 24 to 36 month Outlook. We’re very fortunate to have an incredibly supportive Board in that regard. We’re also very fortunate to have some very strong balance sheet and our core business is operating perfectly.

So we’re one of the few companies that has opportunity to aim at the 2 to 3 year horizon. We focus every single day on running efficiently, so we never lose track of the short-term. But David to sit and give guidance on a quarterly basis as you're suggesting or even a yearly basis is just destructive and a lot of companies frankly are moving away from giving guidance.

So we're very clearly doing that. I'm happy that we’re doing that. I know that doesn't make analyst happy but the fact is if all I’m doing is giving educated guessing I'm not sure what that value is any way.

David Rose - Wedbush Securities

Okay. I appreciate that and last year you provided kind of a forward guidance of two years of over 20% growth and this last year you put up 1% growth. So can we still say that you’re on that two year track?

Tom Rooney

We’re simply not going to give guidance as we have suggested David and with all due respect you can ask me the questions 10 different ways and that’s the answer.

David Rose - Wedbush Securities

Okay. I appreciate that and maybe we can shift to the oil and gas side. In your press release you had said that you expected meaningful awards in 2014. I think that implied that that would be 2015 revenues. Can you give us some sort of guidance or maybe clarity around what meaningful means? Is it greater than 5 million? Is it greater than 10 million? Just so we have an idea of what the growth outlook is for two years out in 2015.

Tom Rooney

All right. So let me say this. I'll give you the full range. In the last several weeks we proposed on deals that range in size from $800,000 to $20 million, okay? And the contract terms and conditions on those range from a one off sale to performance contracting which means that we provide the technology for free and we get paid on energy savings. The revenue recognition from a performance contract would stretch out over years as much as a decade.

So hopefully you can digest what I'm saying which is the scale of the deals that we’re looking at, as I say range from 800,000 to 20 million and the revenue recognition side could come quickly if there was a capital sale or could come in powerful recurring revenue over a decade. So with all of that in play it's, you have to sort of define [ph] what that means in terms of revenue recognition which I think is what you’re trying to get after. Is that helpful at all for you?

David Rose - Wedbush Securities

That does help actually. I appreciate it and with that said in the fourth quarter, your comment suggested that we should see some announcements in the first quarter of awards. You commented on the call that you’ve one award. Should we start to see some announcements in March or is that pushed out a little bit?

Tom Rooney

I would just say that you’re going to see a stream of announcements over the next six months and exactly when the timing comes I don’t know.

David Rose - Wedbush Securities

Okay. So over the next six months. Okay, well thank you very much.

Tom Rooney

Sure. Thank you.

Operator

(Operator Instructions) Moving on to the next question comes from Robert Smith from Center For Performance Investing. Please go ahead.

Robert Smith - Center For Performance Investing

Congratulations on the quarter and thanks for the wow profile of the business. Most of my questions have been answered and thanks for the additional color on the word meaningful. So my question is when you mentioned Israel's, they said that they would, offering to assist California. Do you have any inkling or color on that what is meant by that?

Tom Rooney

I can give you the politically correct answer or I could.

Robert Smith - Center For Performance Investing

I mean as far as product goes and where you might come in.

Tom Rooney

Okay. So let me just say this, several of the most successful developers desalination projects in the world actually come from Israel and to put a finer point on that the Carlsbad project that we’re operating under or that we’re helping to build is actually being built up IDE Technologies out of Israel. And IDE is one of our very strong partners. We have done a significant number of projects in Israel with Israeli players and those same Israeli players are successful and operate all over the world. So as to what technologies Mr. Netanyahu or support and advice are giving, I think maybe he would be thinking more along the lines of drip irrigation and water recycling. His commentary was in three areas, drip irrigation, recycling of water and desalination.

California is already, from the desalination standpoint, California is already benefiting from the technologies in desal. My sort of half kidding comment about political correctness is that in my opinion the best help that Israel could give to California is around policy. And so if Prime Minister Netanyahu can advise California and California policy makers that’s going to be the greatest help.

California is essentially dysfunctional right now in terms of water policy and so I was very pleased to see Israeli leadership helping California leadership figure out water issues and so I think it's less about bringing technology to California I think it's more about bringing enlightened water policy.

Robert Smith - Center For Performance Investing

When you say a $1 billion market, say in oil and gas, is that market opportunity in your specific product areas?

Tom Rooney

That $1 billion is exactly and exclusively our specific product area.

Robert Smith - Center For Performance Investing

And you said it was an annually recurring?

Tom Rooney

Yes.

Robert Smith - Center For Performance Investing

And you spoke of a new materials, is one of the new materials that you are beginning to work with is graphene?

Tom Rooney

No.

Robert Smith - Center For Performance Investing

No? Okay.

Tom Rooney

Graphene is very interesting but our assessment of graphene as it relates to are industry is that it's still years away. But no, we’re not, it's really advanced material science at the core of our products.

Robert Smith - Center For Performance Investing

And you made a comment about India being, the political scene there been short term limitations but long term promise. Can you just give me a little clarification of that?

Tom Rooney

Well India, it has major National Elections coming up and some of the pundits would suggest that one party may win over another and I’m not going to get into that but some of the candidates that are running or seen as incredibly business friendly and some of the candidates are seen as more or less corrupt than others and so a lot of that which ails India today is lack of power. They have intermittent power, they don't have enough power and the reason that that’s relevant to us is that with every new power plant in India they have to use desalinated water to cool them and so that’s a tremendous business opportunity for us.

So if a pragmatic government takes place in India you will see more power, more water, and therefore big lift for us as a company. We don’t get a say in who gets to rule countries but we’re carefully watching what happens there.

Robert Smith - Center For Performance Investing

And if I went to your website would the three ISOs be explained and is it profiled on the website already?

Tom Rooney

Yes.

Robert Smith - Center For Performance Investing

Okay great. Well congratulations again and thanks for the exciting times. It's wonderful. Good luck.

Tom Rooney

Great. I think that brings us to the end of the questions. So thanks again everybody for participating in the call. We feel very good about where the company is positioned and where we’re headed going forward. So thanks again for participating.

Operator

Thank you. Ladies and gentlemen that does conclude the conference call for today. Thank you for your participation and you may now disconnect.

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