Greetings, and welcome to the Energy Recovery's Second Quarter 2018 Earnings Call. At this time, all participants are in a listen only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Manuel Mondragon, Vice President of Investor Relations. Thank you. Please begin.

Good morning everyone, and welcome to Energy Recovery's earnings conference call for the second quarter of 2018. My name is Manuel Mondragon, Vice President of Investor Relations, and I'm here today with our President and Chief Executive Officer, Chris Gannon. During today's call, we will make projections and other forward-looking statements under the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995 regarding future events or the future financial performance of the company. These statements may discuss our business, economic, and market outlook, the company's ability to achieve the milestones and commercialization under the VorTeq licensing agreement, growth expectations, new products, and their performance, including the MTeq system, cost structure, and business strategy. Forward-looking statements are based on information currently available to us and on management's beliefs, assumptions, estimates, and projections. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. We refer you to documents the company's files from time to time with the SEC, specifically the company's Form 10-K and 10-Q. These documents identify important factors that can cause actual results to differ materially from those contained in our projections or forward-looking statements. All statements made during this call are made only as of today, August 2, 2018, and the company expressly disclaims any intent or obligation to update any forward-looking statements made during this call to reflect subsequent events or circumstances, unless otherwise required by law. In addition, we will make some references to non-GAAP financial measures during this call. You will find supplemental data in the company's earnings press release, which was released to newswires and furnished to the SEC earlier today, which includes reconciliations of the non-GAAP measures to the comparable GAAP results. At this point, I will turn the call over to our President and Chief Executive Officer, Chris Gannon. Chris, please go ahead.

Thank you, Manny, and thank you everyone for joining us today for Energy Recovery's second quarter 2018 earnings call. I will begin with an overview of our financial results and then transition to the strategic and commercial update. Following a record year in 2017, we were determined to continue the positive momentum in 2018. I'm happy to report we have done just that. For the second quarter ended June 30, 2018, we generated total revenue of $20.8 million, representing a 49% top line growth year-over-year with product gross margin of 66% and total gross margin of 71%. In addition, we reported GAAP net income for the quarter of $15.7 million or $0.28 per diluted share. This was largely driven by $11.9 million one-time tax benefit related to simplifying the company's international tax structure in Ireland in light of the 2017 U.S. Tax Cuts and Jobs Act. On an adjusted basis, removing the impact of this tax benefit, net income was $0.07 per diluted share for the quarter. Our Water business recognized total revenue of $17 million for the second quarter, representing a 75% growth year-over-year, which is partially driven by strong MPD and aftermarket shipments. With an operating income margin of 53%, our Water segment performance underscores the strength of our position within desalination. We plan to further expand on this business segment, and I will discuss our approach to growth here shortly. Our Oil and Gas business generated total revenue of $3.6 million for the second quarter of 2018, a reduction of 500,000 or 12% year-over-year. The decline in revenue was associated with lower cost to total cost revenue recognition associated with the sale of multiple IsoBoost systems. This was partially offset by higher VorTeq license revenue recognition as a result of the new ASC606 accounting standard. As a…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Joe Gibney with Capital One. Please proceed.

Thanks. Good morning, Chris. Just a question on some of the system-level enhancements you're talking about. Curious if you could refresh us there. Sounds like -- always been in the queue, and you've taken the opportunity to accelerate on some of that for VTeq. Just curious if you could talk to maybe what some of those specific enhancements are? And I just wanted to clarify the coming about private testing as well additional testing with Liberty and Schlumberger. Was that -- a lot of well potential test was Liberty as well potentially on the table there? Just trying to understand what you're intimating there. Appreciate it.

Sure. Great to hear you, Joe. So we're not going to discuss the specific details around the system-level enhancements. We historically have, and I'm getting away from that practice because I think it's just plain confusing to investors. But our goal with our product licensee and us is to shorten the path to commercialization, and that's what we're doing.

Okay, fair enough. And on MTeq, the next round of testing being ready, you identified a testing site it sounds like. Just to clarify, this is working towards field trials in conjunction with Sidewinder or this is separate individual testing as you continue to round out the system a little bit more in its nascent stages?

Yes, so with MTeq what we're doing is we're actually doing private testing. When you look at a company like Sidewinder, I think you probably saw their recent announcement that there's a transaction going on there, plus they're very, very busy in general. So we're going to be doing private testing there, something that we're able to do because it's a closed-loop system.

Okay, understood. Okay, Chris, I appreciate it. I'll turn it back.

Okay.

Thank you. [Operator Instructions] Our next question comes from the line of Tom Curran with FBR. Please proceed.

Hi, Chris.

Hey, Tom.

So, to follow-up on Joe's questions regarding the design enhancements you'll be making to the VorTeq prototype. Could you share with us just the estimated time required solely for the enhancements, putting aside all the variables on the Schlumberger side that will determine when ultimately you'd be able to resume the M1 test. Just in terms of what's within your control with regards to these enhancements, what's the estimated time range for them?

Yes, so I'm not going to provide specific timing, partially because you like to wring my neck when I do. We're focusing on system-level designs to shorten the path to commercialization. And so we'll resume our testing with Schlumberger, specifically M1, once we can schedule that testing with them.

Okay, I had to try. And then on the Liberty front, are these enhancements that you would either have to under the Liberty contract or maybe simply prefer to make before you'd move forward with Liberty as well? Or could we potentially see you advance with Liberty on a parallel track at the same time that you're still working towards an M1 resumption with Schlumberger?

Sure. So we're currently working with Liberty in Texas, so we're testing with them right now. All of the enhancements we make with Liberty or with our licensing partner end up accruing to both of them. So everything that we're doing, regardless of who we're doing it with, benefits each of them. And everything we're doing currently is, again, focusing on commercialization. We're going down parallel paths with them, but we're trying to get to commercialization as rapidly as possible with both.

Okay. And just so I'm clear, that could result in commercialization happening first with Liberty before it might be Schlumberger?

Yes, it could. It is possible.

Okay. Turning to water, when it comes to your 2019 visibility on Mega Project and OEM demand, how far and broadly does it extend? And how does that visibility compare to this stage in prior up-cycles?

So we actually have very good visibility past '19. And so where we are right now, we feel very comfortable, certainly with '18 as I mentioned, and then ultimately with '19 given the environment we're in. However, as we look past '19 different economic considerations would come in play and change that. So it's all about timing.

Okay. And then could you just give me the standard breakdown for water that I always ask for between Mega Projects, OEM, and aftermarket, please?

Yes, so MPD was roughly 50%, OEM was, call it, 28%- almost 30%, and aftermarket was about 20%.

All right, thanks for the answers, Chris.

Absolutely, thanks, Tom.

Thank you. We have reached the end of our Q&A session. I'd like to hand the floor back over to Mr. Gannon for closing remarks.

All right, thank you for joining us this afternoon, and we appreciate your continued support of the company. We look forward to providing an update on our next earnings call. Thank you again, and have a great rest of your day.

Thank you. This concludes today's conference. You may disconnect your lines at this time. And thank you for your participation.