Energy Recovery, Inc. — Q3 2017 Form 10-Q Summary
Business Context and Reporting Period
Energy Recovery provides energy-recovery devices, pumps, and related technologies for industrial fluid-flow markets, primarily water desalination and oil and gas applications. Reported segments are Water and Oil & Gas. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total revenue | $15.1 million | $12.3 million | $40.8 million | $36.8 million |
| Product revenue | $13.8 million | $11.0 million | $37.0 million | $33.0 million |
| License and development revenue | $1.3 million | $1.3 million | $3.8 million | $3.8 million |
| Product gross profit | $9.6 million | $7.1 million | $24.6 million | $21.2 million |
| Product gross margin | 69% | 64% | 67% | 64% |
| Operating income (loss) | $1.5 million | $(0.7) million | $0.2 million | $(2.3) million |
| Net income (loss) | $1.7 million | $(0.6) million | $0.7 million | $(2.1) million |
| Diluted EPS | $0.03 | $(0.01) | $0.01 | $(0.04) |
| Operating cash flow | Not separately provided | Not separately provided | $(2.2) million | $2.3 million |
Q3 total revenue increased 23%, while nine-month revenue increased 11%. Product revenue was 97% international in Q3 and 96% international for the nine-month period. Water generated $13.2 million of Q3 product revenue and $33.7 million for the first nine months. Oil & Gas generated $0.6 million and $3.3 million, respectively.
At September 30, 2017, cash and cash equivalents were $19.2 million, short-term investments were $72.2 million, and restricted cash was $3.1 million. Total debt was $30,000, consisting of a fixed-rate installment loan. Total assets were $149.0 million and stockholders’ equity was $68.3 million.
Material Changes Versus Prior Comparable Period
- Q3 product revenue rose $2.8 million, or 25%, driven mainly by higher Water Segment shipments: MPD shipments increased $1.6 million, OEM shipments increased $0.6 million, and aftermarket shipments increased $0.5 million.
- Nine-month product revenue increased $4.0 million, or 12%. Oil & Gas contributed $2.9 million of the increase, primarily from percentage-of-completion revenue on IsoBoost systems; Water contributed $1.1 million.
- Product gross margin improved to 69% in Q3 and 67% for the nine-month period, compared with 64% in both prior-year periods, primarily due to higher Water Segment volume and favorable price and product mix.
- Q3 operating income improved from a $0.7 million loss to $1.5 million of income. Nine-month operating results improved from a $2.3 million loss to $0.2 million of income.
- Research and development expense increased 31% in Q3 and 16% year to date, reflecting new-product initiatives and higher employee costs. Sales and marketing expense decreased 18% in Q3 but increased 3% year to date.
- Cash flow from operations declined to a $2.2 million use from $2.3 million provided in the prior-year period, mainly due to working-capital investment, including inventory, costs in excess of billings, and recognition of deferred VorTeq license revenue.
- Investing cash use increased to $39.1 million, including $64.5 million of purchases of marketable securities and $6.8 million of capital expenditures. The company repurchased $4.3 million of common stock and received $3.7 million from option exercises.
- The $15.0 million stock-repurchase authorization expired September 30, 2017; 541,177 shares were repurchased under that authorization for $4.3 million.
Guidance, Outlook, Risks, and Unusual Items
- No specific numerical revenue or earnings guidance was provided. Management stated that existing cash, investments, and expected operating cash generation should meet anticipated capital requirements for at least the next 12 months, while noting that additional financing could be required for commercialization, acquisitions, or other investments.
- Management expects continued reliance on desalination-related sales, significant international revenue, and substantial quarter-to-quarter volatility because large EPC projects can materially affect results. Fourth-quarter sales are historically significant.
- The VorTeq license agreement with Schlumberger provides for $125 million of pre-commercialization payments, including upfront and milestone payments, plus future royalties. Under then-current accounting, the upfront exclusivity payment was recognized ratably over 15 years. The company was continuing commercialization and field-trial efforts.
- The company planned to adopt the new revenue standard, ASC 606, on January 1, 2018 using full retrospective transition. Management expected no material impact for water desalination revenue but was still assessing percentage-of-completion contracts; license and development revenue could experience a material timing change, potentially accelerating deferred revenue recognition.
- Customer and geographic concentration is significant. One customer represented 100% of license and development revenue, and international customers represented nearly all product revenue. Several customers collectively represented substantial receivables.
- Outstanding standby letters of credit totaled $8.4 million, up from $4.4 million at December 31, 2016. The company also had $3.1 million of restricted cash, $3.7 million of future lease obligations, and $3.1 million of cancellable purchase orders.
- Known litigation includes employment-related claims involving a former executive and derivative litigation. Management did not consider a material loss probable, but certain potential losses could not be estimated. A previously reported securities class action was dismissed with prejudice on August 28, 2017.
- Goodwill of $12.8 million was tested in July 2017 and was not impaired. The filing states that disclosure controls and procedures were effective and that there were no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether higher Water Segment volume and the 69% product gross margin are sustainable, given project timing, customer concentration, and historically seasonal fourth-quarter revenue.
- The timing, margin, collectability, and cash conversion of Oil & Gas percentage-of-completion revenue and related costs in excess of billings.
- The commercial progress, milestone status, royalty potential, and ASC 606 impact of the VorTeq license agreement.
- Whether operating cash flow improves after the working-capital uses and deferred-revenue recognition recorded through September 30, 2017.
- The extent to which international exposure, foreign currencies, standby letters of credit, and customer concentration affect liquidity and credit risk.
- The final retrospective effect of ASC 606 and the impact of other planned accounting-standard adoptions.