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Energy: Thomson Reuters Street Events EDITED TRANSCRIPT

The following excerpt is from the company's SEC filing.

ERII - Energy Recovery Inc

. Signs 15-Year License With

Schlumberger to Provide Exclusive Rights to Its VorTeq

Hydraulic Fracturing Technology

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OCTOBER 20, 2015 / 12:30PM GMT, ERII - Energy Recovery Inc. Signs 15-Year License With Schlumberger to Provide Exclusive Rights to Its VorTeqTM Hydraulic Fracturing Technology

PRESENTATION

Editor

Operator - Good day, ladies and gentlemen. And welcome to the Energy Recovery announcement conference call. At this time, all participants are in a listen-only mode. Later, we’ll facilitate a question and answer discussion. During this time, you may press start one and press the pound key. If at any time during the call you require assistance, you may key start zero and a coordinator will be happy to assist you.

And now, I’d like to turn the conference over to Mr. Chris Gannon, Chief Financial Officer. You may begin.

Chris Gannon Thank you, and good morning everyone. I am pleased to welcome you to Energy Recovery’s Conference Call to discuss the VorTeq licensing agreement with Schlumberger, which was announced in a press release yesterday evening. The press release is available on Energy Recovery's website at www.energyrecovery.com.

To begin, some of our comments and responses to questions may contain forward-looking statements including, but not limited to, statements about future performance under the Schlumberger agreement, achievement of key milestones, and future revenue streams, value creation, projections as to the return to profitability, and product development.

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 Legation 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 different 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 during this call, except as required by law. With these formalities our of the way, I would like to turn a call over the Energy Recovery’s President and Chief Executive Officer, Mr. Joel Gay.

Joel Gay - Thanks, Chris. Good morning and thank you for joining us on today’s call. This is a very exciting time for Energy Recovery, especially for those investors who have stayed the course, and ultimately, a significant milestone in the evolution of our Company.

As you know, yesterday afternoon, we announced the 15-year license agreement with Schlumberger to provide exclusive rights to our VorTeq hydraulic pumping system for use on onshore fracking operations globally.

The first ever hydraulic fracturing manifold built to isolate hydraulic fracturing pumps from abrasive proppants that cause pump failure. The agreement includes $125 million in upfront payments, paid in stages, plus future royalty income over the life of the deal, which we estimate that the incremental annual royalty, could range from two to four times the annual revenue associated with Energy Recovery’s existing desalination business.

To put this deal into perspective, steady state revenues for the desalination business are in the 40 million to 50 million range, and our market cap was around 130 million.

This is a transformative transaction for Energy Recovery that validates our strategic vision to broaden and diversify our portfolio, and underscores a success of our reloaded strategy that I announced earlier this year with a bias towards execution and demonstrating results.

Indeed, not only does this transaction bring our goal of a return to profitability into sharp focus, but more importantly it once again demonstrates the explosive potential of the Pressure Exchanger and its many derivatives.

For those on the call not familiar with the VorTeq, it is a revolutionary application of Energy Recovery’s proven pressure technology—Pressure Exchanger technology—to the challenges of hydraulic fracturing, to address the major pain point of pump failure, a common occurrence that causes unnecessary downtime and lower efficiencies.

It is a hydraulic pumping system that replaces the manifolds, or missiles, traditionally used in hydraulic fracturing. In current operations, the missile routes water, proppants, and chemicals down hole at treating pressures up to 15,000 psi, resulting in frequent failures and expenses associated with maintaining and replacing high-pressure hydraulic fracturing pumps.

With the VorTeq system, the hydraulic fracturing pumps will pressurize clean water to the desired treating pressure, and transfer the hydraulic energy from clean water to the low-pressure fracturing fluid. This fluid-to-fluid exchange occurs within the VorTeq missile, more specifically, within the several Pressure Exchangers on the VorTeq itself.

Regarding the VorTeq Pressure Exchanger—with the single moving part made of tungsten carbide, one of the most abrasion-resistant materials on the planet, it is engineered to withstand tremendous pressure in harsh conditions, and transfer up to 95 percent of the hydraulic energy from one fluid to the next.

We believe the VorTeq represents a paradigm shift for Schlumberger as a leader in the hydraulic fracturing industry as it significantly reduces capital cost, maintenance, and operations to improve pump performance and the reduction of redundant equipment.

The current depressed energy market traditions did not impact our decisions to sign an agreement, nor do we expect it to significantly impact VorTeq opportunities with Schlumberger. In fact, we find the value proposition to be equally compelling in a bear market, as it is as a bull market where the user can optimize cost structure to maintain margin integrity, expand margins or compress price in a manner to increase market share.

As you are probably aware, the current environment for energy companies is challenging, with lower oil prices pressuring margins and accelerating the need to reduce cost while at the same time delivering results. The application of the VorTeq technology will help Schlumberger achieve this end, and we believe it to be one of the most disruptive products ever developed by Energy Recovery.

As disclosed and previously characterized as the third order of value creation, we believe the VorTeq could further and significantly impact the hydraulic fracturing ecosystem by providing the opportunity or the option to reconfigure hydraulic fracturing fleets by swapping out existing equipment with more efficient pumping solutions that could increase pump life expectancy by an order of magnitude.

This pump life expectancy increase, combined with a several other cost benefits associated with the VorTeq, could materially drive down the cost per barrel to frac a well.

While excited by the development progress of the VorTeq and signing the deal with Schlumberger, we remained sharply focused on fully commercializing and customizing the designs for seamless integration in Schlumberger’s best-in-class operations, thereby realizing the full potential of this disruptive technology. We are encouraged by our field trials with our test partner Liberty Oilfield Services, and have not encountered any challenges that would temper our confidence in its viability as our next breakthrough product.

Although it’s still a long road ahead, our team is excited and ready to execute against the challenge.

We were diligent and patient in evaluating all potential partners for this product, and found the perfect strategic fit with Schlumberger.

This landmark partnership will commercialize the VorTeq technology with the world’s leading supplier of technology integrated project management, and information solutions to customers in the oil and gas industry globally. We are similarly an innovative energy-and technology-centered Company, driven by our unrivalled expertise in industrial fluid flows. We view this partnership as highly synergistic and the best fit for our Company and its shareholders.

In terms of licensing agreement criteria, this deal aligns perfectly with our growth plan and answers the Energy Recovery value proposition, and delivers strong financial returns that allow us to reinvest in our business and bolster our robust pipeline of future products.

Schlumberger was the ideal partner for this, given its proven track record of innovation, strong management team, and rapid deployment of nascent technologies. With Schlumberger’s expertise combined with our technology, we believe the VorTeq will become the standard for hydraulic fracturing operations worldwide.

While the agreement was recently executed, we do have a couple of milestones that will further the commercialization of the technology and allow for production-level deployment within Schlumberger’s operations.

Activities around these milestones center on, again, seamless integration in the Schlumberger best-in-class operating protocols.

I will now take a moment to discuss the financial aspects of the agreement. Under the terms of the agreement, Schlumberger will pay a 75 million exclusivity fee immediately and another 50 million upon Energy Recovery meeting the two commercial milestones previously described.

We believe that there is a high probability that we can achieve these milestones and collect the 50 million in 2016, but will, as we have throughout the development of this product, stay the course and not succumb to explosive deadlines, and only proceed, therefore, to the next phase of development when the full operating envelope has been defined and vetted.

As for the annual royalties throughout the term of the agreement, we expect incremental revenue generation to be at least two to four times the existing desalination business, which has steady-state revenues of 40 million to 50 million.

While still too early to provide an anticipated timeline of realizing royalty revenues, our expectation is that we will not start receiving royalty revenues until 2017.

In terms of the key benefits of the transaction, it affords Energy Recovery access to additional non-dilutive, non-debt capital to invest in R & D and bolster our pipeline of future products.

Innovation and technology is in our DNA, and is the cornerstone of our success. Our significant investment in R & D over the past four years has incubated a robust pipeline of new products which are yet to be harvested.

In the first half of 2015, we spent more than 20 percent of sales on R &D, and upwards of 30 percent of sales in 2014. The cash payment generated from this agreement will further enhance an already robust R & D product development pipeline, replete with concepts and applications that have the opportunity to come to fruition, and continue our track record of developing disruptive, game-changing products across the oil and gas, water and chemical industries.

We are in the unique and enviable position of having a pristine balance sheet, with no debt, and significant net cash. This transaction ensures that we can deploy capital towards the funding and development of additional technologies with significant revenue opportunities.

As always, we will deploy capital to opportunities with the highest risk-adjusted returns in pursuit of further delivering quantifying meaningful results as we seek to drive long-term value for our shareholders.

The VorTeq demonstrates the ubiquitous nature of the Pressure Exchanger and how our proven technologies adapt to other large addressable markets including the oil and gas, and petrochemical industries.

We have already developed one application for this disruptive technology, sea water reverse osmosis desalination, and in doing so, have maintained the most dominant market share of all market participants across the entire value chain.

The development and introduction of the VorTeq represents not only a near-term opportunity in hydraulic fracturing, but an expansion of the utility of the PX to that of a pump versus solely an energy recovery device.

This point deserves further explanation. Prior to the VorTeq, we only considered potential applications and market opportunities where the Pressure Exchanger could be used to recycle hydraulic energy that would otherwise be wasted. Now...


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