Energy Recovery's (ERII) CEO Tom Rooney on Q1 2014 Results - Earnings Call Transcript

May. 8.14 | About: Energy Recovery, (ERII)

Energy Recovery, Inc. (NASDAQ:ERII)

Q1 2014 Earnings Conference Call

May 08, 2014 10:30 AM ET

Executives

Alex Buehler - CFO

Tom Rooney - President and CEO

Analysts

Patrick Jobin - Credit Suisse

David Rose - Wedbush Securities

George D’Angelo - Jefferies

JinMing Liu - Ardour Capital

Operator

Good day ladies and gentlemen, thank you for standing by, welcome to the Energy Recovery first quarter 2014 earnings conference call. (Operator Instructions). Conference is being recorded today, May 8, 2014.

I would now like to turn the conference over to Mr. Alex Buehler. Please go ahead.

Alex Buehler

Good morning everyone and welcome to Energy Recovery’s earnings conference call for the first quarter of 2014. 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 first quarter of 2014, 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 expectation 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 first quarter 2014. As we surveyed the top-line in the current period, net revenue of 3.9 million was not a surprise for the management team as normal seasonality trends imply a lack of megaproject shipments in the first three months of the year. That is neither the first quarter of 2014 nor the comparable period in 2013 contained any revenue associated with MPD sale.

Consequently the decrease in revenue against prior year of 39% was entirely attributable to lower OEM shipment which we do not interpret as a sign of systemic market weakness but rather as a momentary lapse caused by unique project timing. Partially offsetting decline in OEM sales with increased aftermarket volume along with the initiation of revenue from oil and gas contracts, specifically the 140,000 of oil and gas revenue recognized in the first quarter represents rental income under an operating lease which pertained to an IsoGen system deployed in Saudi Arabia.

Importantly this is the first revenue that the company has recognized since the inception and announcement of the oil and gas initiative back in 2011 and this event signals an important milestone for the company, that is the transition to the commercial phase of the oil and gas development effort.

Summarizing revenue for the quarter again, we were not surprised by the amount or the decrease versus prior year as this was both budgeted and forecasted in consideration of normal seasonality trends and the anticipated timing of OEM orders and shipments, and we were encouraged to discern the realization of our first oil and gas revenue justifying bold investment in sales and marketing to accelerate subsequent growth in this market segment.

Gross profit margin of 58% in the first quarter of 2014 compared favorably to the prior period when the company recorded a gross profit margin of 47%. In sequential terms however gross profit margin decreased from 63% in the fourth quarter of 2013 and a lower margin in the current period was a reflection of decreased demand and diminished production volume due to a plant shutdown in January which was planned to accommodate holiday schedules and a full physical inventory.

On lower production volume, the company was not able to fully absorb fixed cost in the inventory which caused the decrease in gross profit margin. In light of these lower production levels the gross profit margin of 58% continues to demonstrate the realization of manufacturing efficiencies, exacted through a multitude of cost reduction efforts over the last two years. While gross profit margin increased from 47% in the first quarter of 2013 to 58% in the same period of 2014 operating expenses decreased by 1.5 million or 20% from 7.5 million to 6.0 million over the same time period.

On one hand both sales and marketing and research and development expenses increased as forecasted, sales and marketing expenses increased by 500,000 as the company staffed a dedicated global sales force to cover the oil and gas market and initiated an aggressive market launch to showcase a new product portfolio to major oil and gas customers around the world.

Likewise R&D expenses increased by 200,000 as the company seeks to proliferate new technologies for other end markets, some of which could prove disruptive. We anticipate that such levels of spending will increase in the future periods to accelerate product development cycles and sales into these new end markets.

Offsetting these increases was a decrease in general and administrative expenses of 2.1 million of which 900,000 related to a refund receivable for Spanish value-added taxes paid in 2008 and 2009 and the reversal of a liability accrued during 2011 for incremental taxes during 2009. After over four years of deliberation from the local tax authorities in Spain, the Company received a favorable ruling in March of 2014. Of the 900,000 impact, roughly 600,000 is cash related with collection expected in the current year while the balance of 300,000 is non-cash. G&A expenses also decreased due to lower legal cost from a low and litigation activity, reduced IT expenses due to the absence of ERP implementation cost in the current period, and lower accounting expenses.

In summary, total operating expenses of 6 million in the first quarter was impacted by a non-recurring adjustment of 900,000 for Spanish VAT, and we expect operating expenses to increase in future periods to reflect robust investment to our product development and sales and marketing. With decreased revenue, increased gross profit margin, and reduced operating expenses, the company reported a net loss of 3.7 million or $0.07 per share in the first quarter of 2014.

Comparatively the company reported a net loss of 4.5 million or $0.09 per share in the first quarter of 2013. Accordingly net loss reduced 800,000 or 18% year-over-year.

For the first quarter of 2013 the net loss of 3.7 million included 1.7 million of non-cash expenses, with depreciation and amortization of 1 million, and share-based compensation of 600,000.

The Mid operating losses in the first quarter, an increase in inventory to facilitate future shipments and the payout of annual bonuses and sales commissions, net cash used in operating activities was 5.9 million.

Also impacting cash flow was certain financing activities including 600,000 used to repurchase stock in accordance with the company’s board approved share repurchase plan. The company repurchased 115,000 shares of common stock as part of this plan with future purchases contemplated under the existing board authorization.

Even with a relatively heavy use of cash in the first quarter, the company’s balance sheet remains strong. As of March 31, 2014, unrestricted cash was 11.4 million. Short-term investments were 8 million and long-term investments were 8.8 million which together represent a combined total of 28.2 million. Additionally the company reported nearly 18 million of accounts receivable and current unbilled receivables associated largely with revenue recognized in the fourth quarter of 2013, and these balances will be converted to cash in the near future.

I remain comfortable with the strength of our balance sheet which includes ample cash and no debt and I believe that we can continue this pace of investment to unlock shareholder value through new product innovation and new market penetration.

In closing the financial results in the first quarter of 2014 were not a surprise to us and we remain committed to the successful implementation of our long-range strategic plan.

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

Tom Rooney

Thank you Alex, and good morning everyone. Looking back at the first quarter, it’s easy to see that our ongoing desalination business continues to be lumpy and unpredictable. There really isn’t anything new or noteworthy in the first quarter desalination results. I am pleased to see that we remain the dominant player in our market. Our products continue to set the standard within our industry and our manufacturing operations continue to make efficiency improvements all along the way. We intend to work hard to maintain our strong position in the desalination industry in order to capitalize on global desalination industry growth as it unfolds over the years to come.

As I stated in our last earnings call I won't try to speculate on desalination growth trends either in the short-term or over the long run, as attempting to predict future desalination industry growth trend is brought with problems and doing so simply doesn’t benefit our shareholders. What does benefit of shareholders is driving the company as it makes progress in diversifying into new and much larger markets. So let’s now turn to our ongoing progress in building new markets beyond desalination. Since the start of 2014 and over the past two months in particular, the company has made significant advancements in our effort to penetrate and build-out or oil and gas business.

I think it’s very important to point out that as late as December of 2013 the company had no dedicated sales personnel pursuing the oil and gas market. In January of this year we recruited and deployed six full-time people as our initial sales force dedicated exclusively to the oil and gas market. Furthermore, prior to February of this year, the company had not presented any of its new oil and gas technologies at an oil and gas industry conference anywhere in the world.

Starting on February 23, at the very prominent launch Reid Gas Conditioning Conference in Oklahoma, the company launched a high profile, high energy marketing campaign aimed at the global oil and gas industry. In just the past two months we have participated in nine industry conferences spanning six countries and five continents. This high profile global marketing launch marks the official debut for energy recovery in the oil and gas industry. Our presence at this conference has included speaking engagements, technical whitepapers, seminars and sales meetings.

We have used these industry events to both educate as well as advertise our solutions to our audience, displaying sophisticated scale models and commercial economic model for our new technologies.

The response that we've received from the oil and gas industry has been somewhat overwhelming and has included requests for face to face strategic meetings all over the world, as well as numerous requests for commercial proposals. Today in 2014, we have responded to close to $100 million in requests for commercial proposals for our products. That number far exceeds anything that the company has ever experienced.

As a result of the very strong feedback receiving from the oil and gas industry, emanating from just two short months of the industry exposure, we have decided to once again expand the number of our dedicated oil and gas sales and marketing professionals, as well as expanding our oil and gas engineering support team. The outlook is very promising.

I should also like to point out that we have expanded our site beyond the generic oil and gas industry to now include a number of important fluid inflows bound within the thin gas industry. These thin gas opportunities include ammonia, urea, methanol, nitric acid and several other downstream applications.

We have been pleasantly surprised by the strong positive feedback that we’ve received from the thin gas industry over the past two months. Our preliminary estimates suggest that the total addressable market for our products in the thin gas market is likely to be in excess of a $1 billion per year, making it roughly the same size with the total annual addressable market for our products in the more generic oil and gas market.

What makes this truly appealing is that the suite of products and technology that we have already launched for the sour gas processing market, are already well suited for immediate deployment into this thin gas industry.

Between the very positive response that we received two months into our high profile marketing launch in the oil and gas industry and the positive feedback that we’re getting from the lucrative thin gas market, we are currently very busy in energy recovery.

But we’re not stopping there. In addition to the oil and gas and thin gas, we continue to drive innovation that should enable us to expand into even larger addressable markets, spanning from our unique technical ability with fluid dynamics and material science.

As an example, we have invested millions of dollars over the past six months and plan to invest millions more in 2014 to explore a new technology which someday may turn out to be highly disruptive within a completely new market segment for us.

We may or may not succeed but we are confident that along the way we have rebuilt an internal R&D engine that will power many creative new technologies and open many new markets going forward.

In summary, our core desalination business continues to perform as expected. Our oil and gas initiative has just now moved into a highly energized commercial roll out phase as a result of our efforts over the past two months.

Our total addressable market companywide has nearly doubled since the start of the year, with the addition of this thin gas market. And our on-going investments in R&D are beginning to uncover even more possibilities for extreme growth.

As a company we remain focused on maintaining our core strength in desalination while keeping in mind that enhanced shareholder value will only come as a result of developing explosive new growth opportunities.

Given what we are currently seeing in our various markets I am confident that we are on the right course and the future is very bright for Energy Recovery. Thank you and we will now open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Patrick Jobin with Credit Suisse. Please go ahead.

Patrick Jobin - Credit Suisse

Hi, Tom and Alex, thanks for taking the question. First question just on the OEM business. I appreciate it’s incredibly difficult to predict, and there were just some projects that may be moved around. I guess are you comfortable with growth returning sequentially in that segment into Q2 given what you’ve seen in the quarter so far?

Tom Rooney

So, Patrick, the question was pertaining to OEM or just desalt in general?

Patrick Jobin - Credit Suisse

Desal, in general. So I guess excluding megaprojects.

Tom Rooney

Okay, so desalt about megaprojects. So the OEM business or the business absent the large scale projects is -- it tends to be more predictable than the large-scale project, and does in fact follow kind of a seasonal rhythm and I would say without trying to formulate any kind of guidance or what have you -- there is nothing unusual going on this year as it relates to subs and the seasonality and things like that.

Patrick Jobin - Credit Suisse

So you would expect a pickup in that in Q2?

Tom Rooney

Well I’ve commented differently, Q1 is always or not always, it’s frequently anemic. So it’s got no big surprise for us coming out of Q1.

Patrick Jobin - Credit Suisse

Great, and congrats on the first revenue for oil and gas, that's exciting, and I know it’s been many years in the making. So, just a few questions on some of the comments you have made. The $100 million of proposals, how many customers did that reflect? And then how should we think about the cadence of converting some of those proposals to orders, kind of throughout the year and kind of think about that as part of the revenue mix over time?

Tom Rooney

Yes, the $100 million worth of requests from clients was a wonderful thing for us to see and really is stressing us to keep up with it. It comes from many clients, across many continents. Quite a few out of the Middle East, but I want to say four different clients on four different continents, four or five different continents. So it’s a highly varied number of clients. I don’t know exactly how many clients. It’s not from one client. It’s not from one or two. It’s a large number of clients all over the world.

As I had mentioned we have been to nine industry conferences, literally all over the world, and we get to go to a conference where we weren't overwhelmed with requests coming out of it. So it’s a large number, it’s a high variety of clients, large number of requests.

As to the conversion, I think that takes time. We expect to see some of them, the intent to contracts this year. Although I have to say that, I’m not an expert in the pace of the oil and gas industry and I could be wrong. What is incredibly heartening to me is the unmistakable desire that the industry is now showing us. We’re not pushing proposals to them. They are asking us to respond to their specific requests.

I think it’s probably safe to say that we'll see revenue conversion in 2015 and contract conversions that would beget press releases we hope to see this year and into next year. But I guess I will not pretend to be an expert in terms of the pace at which this stuff will convert, but I will dwell on, I guess the one point that I know which is the amount of attention we are getting in the specific commercial requests and the magnitude of all of those.

Patrick Jobin - Credit Suisse

Yes, that’s very helpful and just two quick things. One, you mentioned the value proposition, the economic models you are showing people at these conferences, can you maybe just walk us through kind of high-level, how you’re framing the value proposition to customers, put some numbers around payback periods or OpEx savings per plant. And then separately back to desalt on the megaproject division, how should we think about the potential for recognition in the year with the caveat being it’s impossible to predict? But with what you know now is this still kind of potentially back half or is the duration now maybe stretching into ’15. Thanks.

Tom Rooney

Yes. So, the earlier question, or the second question first. And that is desal, yes, this industry does appear to be back ended from a seasonality standpoint, we'd expect that. I don’t think much or I don't think anybody in the industry can give you a good forecast as to the industry pace and pickup. I’ve now been directly in the desalination industry for three years, indirectly in the water industry for 10, and forecasting revenue in the water industry is precarious.

Forecasting industry in the desalination segment of the water industry is -- it goes from precarious to reckless. So I just don’t want to try to make that. I can tell you that what we see right now coming to the pipeline does appear to have the same kind of sort of seasonal rhythms that we’ve seen in the past. But I wouldn’t want to be any more definitive than that, not because I’m trying to be coy, but because predicting in the desalt industry is just, as I say almost reckless. But as to the oil and gas value proposition, you can actually -- I’ll try to answer it in simple terms here but you can pick up a lot of it off of our website.

We doubt, we basically are coming to oil and gas clients with a general suggestion of about a three year payback, economic payback, without needing any carbon offsets, carbon credits, government subsidies, so on and so forth. And not using artificial kilowatt cost or electrical cost. I say, generally speaking through years because we deal in some locations where the local cost of electricity can be $0.20 or $0.30. Pakistan, it can be higher than that, $0.30 to $0.40 a kilowatt hour. And then certain locations in the Middle East might be $0.06 or $0.08 a kilowatt hour. So that actually obviously fits the payback period.

The other thing that changes or it sways the payback period is the volumetric flow which is to say the economies of scale. So if there’s a client with a very large flow that you’re trying to deal with, it can pull the economic payback down to two years, less than two years. But in simple terms, the value proposition that we’re giving to our clients is an opportunity to reduce their OpEx through electricity savings and it’s an economic value proposition.

Having said that, many of the clients that we're dealing with now have needs and desires that go well past the OpEx savings. So I can tell you as an example, in our dealings with major Chinese oil companies, there is a political imperative to reduce the energy content in the processing of these. And I think it ultimately derives from environmental imperatives in China. Such that, if and because we are able to give a pure economic payback that makes economic sense to a CFO, then the political imperatives behind the scene then really drives it to be a profound need for the value proposition in those cases goes beyond economics.

I don’t speak mandarin, but if you do, you can listen to Cinepak in a client testimonial on our website. I think it’s been translated, so you don’t actually have to speak mandarin. But do they speak for the pak that where we deployed our technologies in China, the total economic savings, the total power savings that had a major gas processing plant, suggests that they are reducing 25% of the plants' power bill. I personally think they might be overstating a little bit but it gives you an idea what they see and what they believe.

We also see the same kind of drive coming out of clients in North America, South America, the Middle East and other places. So we come to the table with a pure economic value proposition, saving money, good economic payback period of three years, and then you know a lot of it drive with the impetus behind it then comes from a desire to be even more pertaining to energy-savings and carbon savings. Hopefully that helps you.

Patrick Jobin - Credit Suisse

I appreciate all the color and learning Mandarin is certainly on my schedule as to, but…

Tom Rooney

You and me both.

Operator

Our next question is from the line of David Rose with Wedbush Securities, please go ahead.

David Rose - Wedbush Securities

Just a couple of questions, thanks for taking my call, gentlemen. If you could clarify the comments a little bit more about the quarter being in line with expectation. I understand the seasonal nature of the business, but this was the worst revenue quarter for you folks as a publicly traded company. And clearly this was below street expectations. Was there something that led you to believe this would be this low and are there similar factors that play for the remainder of the year that could create, you know a depressed outlook for the remainder of the year? And then I have a couple of follow-ons.

Tom Rooney

Every quarter, at the beginning of the quarter we have a fair -- the management team and the board has a fair understanding of what will result that quarter, in terms of revenue. We obviously -- we frequently are surprised at the end of the quarter with a project that gets delayed. With a single phone call the project will move out of one week and into the next which can change our revenue.

But we have a fair understanding within a certain range as to what the revenue will look like in a given quarter. And I think it’s worth noting that the last three quarters in a row our revenue has come in fairly well, right on where the management believed it would. And yet, I think it was in Q3, Wall Street was shocked to the low side. And then Q4 overwhelmed at high side and now Q1 shocked to the low side and that’s unfortunate.

And I suppose, the only way to remedy that would be if we gave monthly guidance and told everybody exactly what we see in our backlog for that month. But that -- I don’t think that’s going to serve shareholders. So what I think the Street needs to see is that the desalination industry and the demand for our devices it’s lumpy. It’s very lumpy, and it has certain seasonal swings to it. And so analysts, such as yourself, do the very best as you can in trying to figure out what that will be. We do the very best that we can. And about all I can tell you is for the last four or five quarters, we have, I mean very close to what we would have expected. And it’s a tough challenge in terms of how an analyst will predict what the revenue on a given quarter will be. And I get that. I see that. I understand that. But I’ll go back to what I said before, I don’t know that there’s a single person in the global desalt industry that can predict two, three quarters out. I certainly haven’t seen it and there’s been no one that I talked to in inside the industry that can forecast particularly well. And so I am left to the conclusion that I should not be trying to predict through guidance to you and to our investors. It’s unfortunate that that’s not possible. But this is unlike selling automobiles where there’s a huge market that’s very predictable it’s just isn’t, its part of the nature of the beast here.

David Rose - Wedbush Securities

I appreciate the challenge on both side, yours and ours, but if you kind of look at the again, I think you made comments a year ago that you felt better about 2014 being up and this goes back to the prior call maybe is there a way that you can handicap that for us, downside upside for the full year, I mean certainly not the quarter. But is it possible that the full year is up down, I mean given what you’ve seen so far, 40% complete with a year. Do you have any sense that you can provide for us?

Tom Rooney

I mean, I have a sense. And if I was to pull my management team you get three or four divergent thoughts on that and I think that providing guesses or providing educated guesses or even educated estimates are likely to be more destructive and by destructive I mean, we -- it will, it won’t suit your absolute needs which are certainty. And the reason it won't suite those needs is because certainty seems to be unlikely as it relates to this industry. So rather than sit here and give you a guess or even trending I just would step back from that.

The other thing David I think is important is that where we sit right now, it’s not lost on me that there are profound movements in our stock price and apparent value of the company based on what desalination revenues do in a given quarter. And that disconnects completely from how the management team and the board see the company. We see the shareholder wealth creation not coming from yesterday’s desalination revenue and not even coming from next quarters or two quarters or three quarters. We think that the real latent value to our shareholders of this company is predicated on high growth opportunities that lay ahead of us.

And they are high growth opportunities into very large addressable markets that dwarf anything that desalinate its best they could ever produce. And so estimating and forecasting what desalt will do in one or two or three quarters, in many ways misses the point in terms of what shareholder value creation is on-going at the company. We’re spending millions on very, very exciting technologies that have a possibility of being disruptive and that in many ways is where the management team is entirely focused now. And we are very optimistic about what that has for us in the future. So if I was to give guidance and possibly therefore mislead you unintentionally, mislead you as an analyst on what desalt is possibly going to do over the quarter or two. It would also be missing the big pictures to where shareholder value generation is more likely going to come.

David Rose - Wedbush Securities

Sure I was just looking into proxy and it’s said that one of the compensation factors for you the number one was actually you achieved the strong revenue quarter in the history. So I kind of infer that, those revenues numbers were very important. So maybe I guess if I think about the other opportunities in the oil and gas side, which I think you noted in the 8-K that your folks were being compensated for growth in that market. Can you provide us some sort of benchmarks for hitting that hurdle, right for compensation?

And then secondly were there any orders from existing clients for the new opportunities in oil and gas and then I am off.

Tom Rooney

I guess I don’t quite or didn’t quite follow the compensations metrics that you’re describing…

David Rose - Wedbush Securities

I think you put out in the 8-K that you -- that there is a new incentive plan for your efforts to develop the new product. So I think that’s where you were going in terms of the value creation of the company, but not [indiscernible].

Tom Rooney

Got you, okay.

David Rose - Wedbush Securities

Where are the specific metrics? Is it revenues, is it profitability and then on that note were there any customers, existing customers that have placed new orders with you [indiscernible] for example?

Tom Rooney

Right. So on the compensation side of things the -- I think you’re referring to the metrics associated with the annual incentive plan, the bonus plan. And there are a series of metrics that relate to the growth but or and they are different metrics based on different technologies that we’re rolling out, so where we sit today, we continue to desire to drive growth in desalination and that would have a certain metric to it. We have the rollout, the commercial rollout into the oil and gas sector which I’ve mentioned, we have metrics associated with rolling out into new markets that are just beginning to come to the forefront such as the (indiscernible) and then we also have metrics pertaining to the explosive future growth markets where we’re investing right now in R&D. So, there’s not a single metric that triggers the AIP plan that you described or that you’ve brought up. It’s a series of different metrics that speak to moving certain products and developing certain markets. We don’t give the explicit metrics associated with each because that would be kind of tantamount to giving guidance as to where we are from a revenue generation standpoint but we also give guidance to our competitors on where we plan to be tomorrow and the next day for strategic reason. The other question was on…

David Rose - Wedbush Securities

On orders from existing clients.

Tom Rooney

Well, yes we announced those as to get them if we’re permitted to and all I can tell you is in one or more cases, we’re not permitted to issue press releases. So to the extent that it is possible, we issue those on in press releases and only in press releases.

Operator

Our next question is from the line of George D’Angelo with Jefferies, please go ahead.

George D’Angelo - Jefferies

Hi, good morning. Can you give us some color on mix of pumps and turbos in the quarter?

Tom Rooney

Sure, so if we look at our product mix in Q1 we were about 2.4 million or 61% for PX devices, about 1.4 million or 35% for pumps and turbos and the remaining balance was related to the rental income for oil and gas revenue. And that was about 4% of mix or 140,000 in revenue. And that’s relatively stable versus prior year with the exception of the oil and gas revenue, that revenue was new.

George D’Angelo - Jefferies

Okay, thank you and are you hearing anything with regards to China on projects. I know you made a comment on the last call about China.

Tom Rooney

About China, are you thinking in terms of desalination, are you thinking in terms of beyond desalination?

George D’Angelo - Jefferies

Both.

Tom Rooney

So, desalination in China continues to be one of our most interesting markets, we continue to have very strong position there, but no, nothing new has happened in terms of China, obviously it’s a country that’s struggling with certain challenges now in terms of economic GDP growth and concurrently with climate change and energy issues, but I think [indiscernible] I think over the next five years it’s probably the most interesting market for us and I’ll point this out to you, China is the number one market in the world for ammonia processing plants which is -- it's the top of the tier within syn gas.

It’s also a country that has large gas reserves and it’s been therefore we see China as a large primary target market for us for desalination, growth we see it for sour gas processing, we see it for ammonia and we are actively attempting to build our sales force. We already have a sales force in China, very well regarded but we’re actively looking to add more industrial salespeople in China because the upside opportunity on the industrial side is profound.

As an example by the way, we haven't been -- we've been very open with the fact that Sinopec is one of our clients, Sinopec is both a crude oil company, a gas processing company and one of the premier ammonia processing companies in the world, so China has been behaving somewhat predictably in the last few quarters, predictably in a good way and looks to be a significant upside opportunity for us in the years to come.

Operator

(Operator Instructions) Our next question is from the line of JinMing Liu with Ardour Capital, please go ahead.

JinMing Liu - Ardour Capital

Well first question regarding your oil and gas revenue recognized in this quarter, so that contract structuring as an operating base, can you just, first of all, what milestone figure the payments of the quarter and secondly, what are you planning to do to structure your future contracts for oil and gas customers, whether it’s going to be you know often leads to, you saw balance sheet of finance there CapEx or is going to be just straight forward sales?

Tom Rooney

Yes. Great question. So let me backup to [indiscernible] address this by first talking about our historic product. So I think as many people know we’ve sold a yellow pressure exchanger into the desalination industry for roughly $25,000 a unit. We sold 15,000, all that’s great. That’s what made this company truly great. But for -- and when we look at it the economic payback for selling one of those units is about three months which is to say and that’s using the global average for electricity and so on.

But it pays for itself in three months, it lasts 25 years and so on and so forth, a well-recognized story. I get asked and have been asked a dozen times, maybe 20 times since I have been here, why do you get -- three months payback period in the last 25 years, haven't we priced it wrong and the answer is to that question, yes, but once the price is set and the industry is set it's hard to move off of that.

So as we began to move into the oil and gas industry, we realize that we had an opportunity with a clean slate to be more judicious with our value proposition. But that also meant which -- on one hand would mean just raise your prices and then exact a higher price of a more reasonable payback period.

But we also realized that maybe there were other opportunities like, instead of just a onetime capital sale doing a lease arrangement or even performance contracting and I can tell you right now that we’re -- in a direct answer to your question, as we roll out various technologies in various locations around the world we are, I won’t say playing with but we are trying out various commercial models, we have a highly engaged client in the Middle East that is contemplating a performance contract where they pay nothing and we simply get paid as a percentage of the electricity savings in perpetuity.

We are -- and that by the way is very appealing to some people from the standpoint that it’s close to no risk, they have no risk on the economic payback period. And arguably they have no technology risk. So if our technology works or doesn’t work, they don’t have any money in the game, only we do and they have no economic risk. If for some reason we’ve over stated the economic payback period, it only hurts us.

So in one case, actually in more than one case, we have clients that are keenly interested in pursuing that with us and by the way these are people whose cost to capital is starts with a decimal place, I mean, it’s a fraction of what ours is. Yes, they find that highly appealing. All the way up through a straight lease as has been described that then avails someone of the opportunity not to have technology risk. And then of course we’re pursuing in most cases with people just a simple capital sale.

We’re also looking at a pure service model where we would deploy a technology based on hours of utilization and so on. All of which stems from what I first started off by saying which is our core desalination pressure exchanger is a kind of overwhelming value proposition for our client and begs the question why we have ever priced it so low. So as we enter new and novel markets with or new markets with a novel technology, we’re trying to be careful that we explore the maximum range of value proposition so as to optimize our shareholder value.

JinMing Liu - Ardour Capital

Okay. Two follow-on questions on that, one is, what happened with the other [indiscernible] demonstration projects, so whether you will recognize any revenue from the other projects.

Secondly, is the $100 million potential run you remember you mentioned, what kind of mix in the content of you just described, how did you quantify that $100 million [indiscernible]. Yes.

Tom Rooney

Yes. So the $100 million would be capital, if all were done as capital sales. And I would say more than 50% are in fact capital sales. But a fair portion of them are also performance contracts. And I can tell you that in situations where we've quoted as a performance contract are, suffice it to say they become incredibly lucrative to us as a company with long range predictable cash flow streams.

But we haven’t -- we are, we have not been explicit about the three trial projects that we have, one is, one was done as a capital sale, one was done as a complete collaborative investment on our part with a client where we were and are pioneering a transformative technology that has certain risk for the client and in that venue we agreed to do it for free for the client at no cost ever to them. In effect we bought a location to use our device in trial, so -- and then in the third case which again is in Saudi Arabia, it’s a lease with an option to purchase at the backend.

JinMing Liu - Ardour Capital

Okay, can you disclose what; you say these clients decided to purchase that equipment system at the end at what kind of a dollar amount?

Tom Rooney

I can’t. Its suffice it to say our client in Saudi Arabia constrains our ability to make any public announcements about the terms and conditions, so I’m limited in that regard.

JinMing Liu - Ardour Capital

Okay.

Tom Rooney

I can’t even tell you the name of the client in Saudi Arabia.

JinMing Liu - Ardour Capital

Okay, but $100 million number potentially is very helpful, but can you further give us some insight into the potential [indiscernible] commonly customers putting made inquiries and those type of things.

Tom Rooney

So we’ve had, what I call social inquiries or technology inquiries from dozens and dozens of clients, some have asked, some of the biggest names in the oil and gas -- well, quite a few of the biggest names in the oil and gas industry, we’ve now had several follow up meetings including being invited to their world headquarters to present to rooms that can have a dozen engineers in them.

Beyond that we have been -- we received requests for very specific commercial proposals pertaining to specific locations with technical specs already provided to us. Requesting commercial proposals for a substantial number of clients and the sum total of all that is as I say, close to a $100 million, if all were converted to one time cash sales. And these are, I would say these are much further along the line than just casual, what would it be if I wanted a such and such, these are where we received a couple of pages of technical specs about a specific plant located in a specific location looking for a technical proposal from us and a commercial proposal from us.

So these are, these are not casual browsing by clients, we get that too, but it kind of [indiscernible] to see the level of commercial interest that we received in just the first 60 days. We do not by the way intend to update the level of commercial activity that we have.

So, next quarter I won’t be saying that a $100 million is now $300 million or something like that, we absolutely do not intend to do that, we’re not going to engage in that sort of level of disclosure.

I just felt that because we, until February 23 we had not had an outward presence in the oil and gas industry. We had not presented at a major oil and gas industry conference. We started that entire process on February 23 of this year and saw overwhelming response, so much so that it led to this inbound interest for technical and commercial proposals at a level we never expected and I thought it would be valuable.

A lot of analysts, lot of investors have asked us to give some kind of data point as to progress being made and I felt that that data point was factual and would give great insight into the tremendous level of interest coming from the industry and it’s not one client, or it’s not two clients, it’s a large number of clients, I think it’s coming if I recall, coming from four different continents. And I think that speaks volumes to what has transpired just in the last 60 days.

JinMing Liu - Ardour Capital

Okay. Fair enough. Yes, just a question if I may, back to your balance sheet, your accounts receivable at the end of first quarter was high, I was surprised to see it stay high from the fourth quarter number, and how you changed the revenue recognition policy or your customers changed their habit of payments, yes.

Tom Rooney

So, no, we have not changed our revenue recognition policy JinMing, when you look at AR on the balance sheet, you should do so in conjunction with unbilled receivables, so you will see AR went up about 2 million quarter over quarter but unbilled went down almost 5 million, so essentially what happened was we billed and collected a lot but we billed far more from Q4 of 2013.

So because we had the revenue spike, we were talking about 23 million in the fourth quarter. We are billing and collecting from that revenue spike right now and we’ll continue to monetize those receivables over the next three to four months, so you’ll see that balance come down here shortly, but I guess if I can summarize, always look at those two numbers together and when you do you’ll see that the number came down rather substantially quarter over quarter, in sequential terms.

JinMing Liu - Ardour Capital

Okay, fair enough. Lastly, just on your inventory build-up, are you just preparing for next quarter’s shipments or you’re just preparing for whole year?

Tom Rooney

So we typically level load our productions, so we look at the entire year’s demand and then divide that evenly over the 12 months of the year, we did see diminished production in Q1 for the reasons I’ve already mentioned but the short answer to your question is yes, we do see anticipated shipments on the horizon in Q2, therefore we did build up some inventory in Q1, to facilitate those shipments.

JinMing Liu - Ardour Capital

Okay, thanks a lot.

Tom Rooney

Great.

Alex Buehler

Well, that’s great, thank you everybody, I think that brings us to the end of our call. We appreciate everybody’s involvement and ongoing interest in the company, thank you very much.

Operator

Ladies and gentlemen thank you for your participation, that does conclude our conference call for today, you may now disconnect.

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