Energy Recovery, Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
Energy Recovery, Inc. (Nasdaq: ERII) provides energy recovery devices, pumps, and related technologies for industrial fluid-flow markets. Its reportable segments are Water, primarily desalination, and Oil & Gas, including hydraulic fracturing, gas processing, and chemical processing. The filing covers the three months ended March 31, 2019, and was filed May 2, 2019.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $19.8 million | $13.8 million | +43% |
| Product revenue | $16.1 million | $11.1 million | +45% |
| License and development revenue | $3.7 million | $2.7 million | +35% |
| Product gross profit | $11.1 million | $7.7 million | +44% |
| Product gross margin | 69.3% | 70.0% | Down 0.7 points |
| Operating income | $2.7 million | $(1.3) million | Improved $4.0 million |
| Net income | $2.7 million | $(0.7) million | Improved $3.4 million |
| Diluted earnings per share | $0.05 | $(0.01) | Improved |
| Cash used in operating activities | $(6.0) million | $(6.3) million | Improved $0.4 million |
Calculated consolidated operating margin was approximately 13.7%, compared with negative 9.6% in the prior-year quarter. Net margin was approximately 13.4%, compared with negative 5.3%.
- Water product revenue was $16.0 million, up 45%, primarily from a $6.4 million increase in mega-project shipments. Oil & Gas product revenue was $0.1 million.
- Water segment operating income was $8.1 million, while Oil & Gas reported a $0.4 million operating loss. Oil & Gas license and development revenue was $3.7 million.
- Operating expenses were $12.2 million, up from $11.8 million. Sales and marketing and research and development increased, while general and administrative expense declined.
- Cash, cash equivalents, and restricted cash totaled $17.2 million at March 31, 2019. Cash and cash equivalents were $17.0 million.
- Short- and long-term investments totaled $74.3 million, producing total cash, cash equivalents, and marketable securities of approximately $91.3 million.
- Accounts receivable increased to $17.4 million from $10.2 million at December 31, 2018, while contract assets declined to $1.1 million from $4.1 million.
- No debt was outstanding under the revolving credit facility. The facility provided a $16.0 million committed line and a $4.0 million uncommitted line, subject to reductions for outstanding letters of credit.
- Standby letters of credit totaled $10.7 million and required the Company to maintain approximately $10.6 million of U.S. investments.
- Total assets were $180.0 million and stockholders’ equity was $119.9 million at March 31, 2019.
Material changes versus the prior comparable period
- Revenue growth was driven principally by the timing of Water mega-project shipments; management cautioned that quarterly results can vary significantly and may not indicate the full-year trend.
- Profitability improved substantially as higher Water volume and increased license and development revenue more than offset modestly higher operating expenses.
- Product gross margin declined slightly because of unfavorable price and product mix, despite the benefit of higher volume.
- General and administrative expense benefited from approximately $0.7 million lower stock-based compensation. The prior-year period included an approximately $0.9 million non-recurring charge related primarily to modified equity awards for the former CEO.
- Operating cash flow remained negative, primarily because of a $7.2 million increase in accounts receivable and a $3.9 million reduction in contract liabilities.
- Investing cash flow was negative $1.2 million, compared with positive $11.1 million in the prior-year quarter, reflecting investment purchases and $1.6 million of capital expenditures.
- Financing cash flow was positive $2.2 million from stock option exercises; the prior-year period included $3.5 million of share repurchases. The prior repurchase authorization expired in September 2018, and no current authorization was in place.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide formal quantitative revenue or earnings guidance. Management expects existing cash, investments, and cash generated from operations to meet anticipated requirements for at least the next 12 months, but additional financing could be required for acquisitions, rapid market adoption, or expanded investment in new technologies.
- Management expects continued investment in Water growth initiatives and diversification beyond desalination, including Oil & Gas applications. Research and development and sales and marketing expenses may increase as these markets develop.
- Management’s outlook depends on customer acceptance of new products, commercialization of the VorTeq and MTeq technologies, development timing, cost reductions, revenue growth, and the ability to secure long-term licensing arrangements.
- International operations represented 98% of product revenue. Key risks include foreign-exchange movements, customer payment and collection risk, geopolitical conditions, and reliance on international desalination markets.
- Customer concentration is material: one Oil & Gas customer represented 100% of license and development revenue in both comparable quarters.
- The Company had approximately $8.4 million of open but cancellable purchase orders, primarily for raw materials and components.
- The Company entered into a Texas lease for a planned Oil & Gas commercial development, testing, and training center. Construction was not complete and the lease had not commenced at March 31, 2019; commencement was expected in the second half of 2019.
- Litigation involving former sales executive Borja Blanco remained unresolved. An appeals court had significantly reduced the previously ordered severance amount, and the Company appealed again on April 24, 2019. The Company had accrued for a potential loss and did not believe a material loss beyond accrued amounts was reasonably possible.
- A hypothetical 1% increase in interest rates would have reduced the fair value of fixed-income investments by approximately $0.3 million at March 31, 2019.
- Management reported effective disclosure controls and procedures and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Verify whether the Q1 increase in Water mega-project shipments translated into sustained full-year demand rather than timing-related revenue concentration.
- Monitor accounts receivable, contract liabilities, and operating cash flow, which remained negative despite the return to profitability.
- Assess the commercial progress, funding requirements, and customer adoption of VorTeq, MTeq, and other Oil & Gas initiatives.
- Review the availability of the revolving facility after deducting $10.7 million of standby letters of credit and confirm continued covenant compliance.
- Track the Texas facility lease commencement, capital requirements, and resulting operating costs.
- Evaluate customer and geographic concentration, particularly the dependence on international revenue and one Oil & Gas license customer.
- Review the outcome of the Blanco litigation and any subsequent changes to accrued liabilities.