Energy Recovery, Inc. — Q1 2020 Form 10-Q Summary
Business context and reporting period
Energy Recovery designs and manufactures fluid-flow solutions for water desalination, oil and gas, and chemical processing markets. Reported results cover the three months ended March 31, 2020, compared with the three months ended March 31, 2019. Reportable segments are Water and Oil & Gas.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total revenue | $21.5 million | $19.8 million | Up 9% |
| Product revenue | $19.0 million | $16.1 million | Up 18% |
| License and development revenue | $2.5 million | $3.7 million | Down 32% |
| Product gross profit | $13.3 million | $11.1 million | Up 20% |
| Product gross margin | 70.1% | 69.3% | Up 80 basis points |
| Income from operations | $0.1 million | $2.7 million | Down $2.6 million |
| Net income | $0.6 million | $2.7 million | Down 77% |
| Diluted EPS | $0.01 | $0.05 | Down $0.04 |
| Cash used in operating activities | $5.9 million | $6.0 million | Approximately unchanged |
Water product revenue increased 19% to $19.0 million, primarily from higher shipments to mega-project development customers. Oil and Gas product revenue was zero versus $0.1 million in the prior-year quarter; the segment generated $2.5 million of license and development revenue.
Operating expenses increased 30% to $15.7 million. General and administrative expense rose 23% to $6.9 million, primarily from employee-related costs, CEO search and severance costs, other costs, and professional services. Research and development expense increased 58% to $6.7 million, mainly due to testing supplies, employee-related costs, and equipment depreciation.
Cash, cash equivalents and restricted cash totaled $32.9 million at March 31, 2020. Short-term investments were $41.0 million and long-term investments were $19.4 million, for total cash equivalents and marketable securities of $81.0 million. Accounts receivable, net, was $13.8 million. Total assets were $190.6 million and total stockholders’ equity was $138.3 million.
The company had no debt outstanding under its revolving credit agreement. The agreement provides a $16.0 million committed revolving line and a $4.0 million uncommitted line and expires June 30, 2022. Outstanding standby letters of credit were $11.6 million. Management stated that existing cash, investments, and expected operating cash inflows should cover capital requirements for at least the next 12 months.
Material changes versus the prior comparable period
- Revenue growth was driven by Water product shipments, while license and development revenue declined because of lower Oil and Gas-related expenditures and revenue recognition.
- Product gross margin improved despite a $0.5 million charge to product cost of revenue associated with reduced manufacturing-facility utilization during the COVID-19 shutdown.
- Higher corporate, general and administrative, and research and development spending substantially reduced operating profit and net income.
- Operating cash flow remained negative at $5.9 million, while investing activities provided $11.9 million, principally from marketable-security maturities and sales. Net cash increased $6.5 million during the quarter.
- Total contract liabilities declined from $28.9 million at December 31, 2019 to $25.3 million at March 31, 2020. Remaining performance obligations totaled $49.8 million.
- New operating leases commenced for facilities in Katy, Texas and Tracy, California. Total operating lease obligations were $25.7 million, and cancellable open purchase orders were approximately $11.3 million.
Guidance, outlook, risks and unusual items
Management did not provide quantitative full-year revenue or earnings guidance in the filing. Management expects cash resources to be sufficient for at least the next 12 months and believes it can fulfill most, if not all, existing 2020 delivery obligations, subject to production and supply-chain conditions.
COVID-19 led to a temporary suspension of manufacturing activities in March, remote work for most employees, and limited manufacturing beginning in early April. The company stated that the pandemic did not materially affect first-quarter revenue or operating expenditures, but it negatively affected gross margin and may continue to do so until facilities return to planned operating levels. Delays to commissioning the Tracy facility and reduced demand, particularly in oil and gas and large desalination projects, remain risks.
Additional risks include the global downturn in oil and gas, potential postponement or cancellation of desalination projects in the Gulf Cooperation Council region, customer collection risk, supply-chain and workforce disruptions, foreign-currency exposure, investment credit and interest-rate risk, and dependence on significant customers. One international Oil and Gas customer represented 100% of license and development revenue in both periods. The company reported no material probable or reasonably possible litigation losses as of March 31, 2020.
The company recognized an $85,000 income tax benefit in Q1 2020, including a $0.2 million discrete benefit primarily related to stock-based compensation windfalls. The reported effective tax rate was negative 15.9%; excluding discrete items, the effective rate was 19.5%.
Important facts for investors to verify
- Whether COVID-19-related manufacturing constraints, facility commissioning delays, and supply-chain issues affected subsequent-quarter shipments and gross margins.
- The sustainability and timing of the Water segment’s project-driven revenue, including customer concentration and Gulf Cooperation Council desalination exposure.
- The commercial progress, funding requirements, and customer adoption of the company’s Oil and Gas technologies, including VorTeq and MTeq.
- Changes in operating cash flow, accounts receivable collections, contract liabilities, and remaining performance obligations.
- Whether the company’s $81.0 million investment portfolio remains liquid and preserves principal amid interest-rate and credit-market volatility.
- Potential obligations associated with $11.6 million of standby letters of credit, $25.7 million of operating leases, and approximately $11.3 million of open purchase orders.