Energy Recovery, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Energy Recovery, Inc. provides energy-efficiency and fluid-flow solutions for water desalination, oil and gas, chemical processing, and related industrial markets. The filing covers the three and six months ended June 30, 2016, with comparative periods ended June 30, 2015. Reported segments are Water and Oil & Gas.
Financial Performance and Position
| Metric | Three Months 2016 | Three Months 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Total revenue | $13.2 million | $10.5 million | $24.5 million | $16.3 million |
| Product revenue | $12.0 million | $10.5 million | $22.0 million | $16.3 million |
| License and development revenue | $1.3 million | $— | $2.5 million | $— |
| Product gross profit | $7.7 million | $5.6 million | $14.1 million | $9.0 million |
| Product gross margin | 65% | 54% | 64% | 55% |
| Operating income (loss) | $0.5 million | $(3.3) million | $(1.7) million | $(11.3) million |
| Net income (loss) | $0.5 million | $(3.3) million | $(1.5) million | $(11.6) million |
| Net income (loss) per diluted share | $0.01 | $(0.06) | $(0.03) | $(0.22) |
- Water generated all product revenue: $12.0 million in the second quarter and $22.0 million year to date. Oil & Gas generated no product revenue in either 2016 period.
- License and development revenue represents straight-line recognition of the $75 million initial exclusivity payment under the 15-year Schlumberger VorTeq licensing agreement.
- Second-quarter operating margin was approximately 4%; the six-month operating margin was approximately negative 7%. The filing does not present a consolidated gross margin including license revenue.
- Net cash provided by operating activities was $0.8 million for the six months ended June 30, 2016, compared with $8.0 million used in the prior-year period.
- Investing activities used $15.8 million, primarily for purchases of marketable securities, while financing activities used $5.9 million, primarily for share repurchases.
- At June 30, 2016, cash and cash equivalents were $79.0 million, short-term investments were $15.1 million, accounts receivable were $8.2 million, and restricted cash was $4.1 million.
- Total debt was $43,000. No revolving borrowings were outstanding under the $16.0 million credit facility, although $4.1 million of standby letters of credit was outstanding and fully collateralized by restricted cash.
- Total assets were $141.4 million and stockholders’ equity was $58.1 million, compared with $151.8 million and $63.7 million, respectively, at December 31, 2015.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue increased 26%, driven by a 14% increase in Water product revenue and $1.3 million of new license revenue. Six-month revenue increased 50%, driven by 35% higher product revenue and $2.5 million of license revenue.
- Water product revenue benefited from higher OEM and aftermarket shipments in the second quarter and higher mega-project, OEM, and aftermarket shipments for the six-month period.
- Product gross margin expanded to 65% in the second quarter and 64% year to date, primarily from improved volume, mix, pricing, and production efficiencies.
- Operating expenses declined 5% in the second quarter and 10% year to date. General and administrative expense decreased substantially, partly because the 2015 period included approximately $1.3 million of stock-based compensation related to the former CEO’s resignation.
- Research and development expense increased 72% in the second quarter and 29% year to date, reflecting continued investment in oil and gas product development and higher related headcount.
- The company repurchased 1.1 million shares for $8.4 million during the first six months. A May 2016 authorization permitted up to $10.0 million of repurchases through October 31, 2016; $4.3 million had been used by June 30.
- Cash declined by $20.9 million during the first six months, primarily because of marketable-security purchases and stock repurchases.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management believes existing cash balances and operating cash generation will satisfy anticipated liquidity needs for at least the next twelve months. Acquisitions or significant investment in new technologies could require additional equity or debt financing.
- Management expects international sales to remain significant. International product revenue represented 98% of product revenue in both the second quarter and first six months of 2016.
- Management believes Water segment gross margins may remain sustainable if volume remains healthy, product mix favors PX devices, pricing remains stable, and production efficiencies continue.
- Research and development spending may increase as the company advances existing technologies and develops new products, particularly for oil and gas applications.
- Oil price fluctuations may affect adoption of oil and gas and hydraulic-fracturing products. The company also expects foreign-currency exposure to increase with international expansion.
- The company expects two additional $25 million payments under the Schlumberger agreement if specified milestones are achieved, but the filing does not provide a definitive timing or probability for those payments. Recurring royalties are expected after commercialization.
- On July 18, 2016, the company finalized a purchase order for approximately $7 million of IsoBoost equipment and services for a Middle Eastern gas-processing plant, with an option for an additional $4 million.
- Outstanding contingencies include securities litigation, a former sales officer’s employment-related lawsuit, a derivative action, and employment claims in Spain. Losses cannot currently be estimated for several matters; management does not believe currently known claims are likely to have a material adverse effect, while acknowledging that outcomes are uncertain.
- Future contractual obligations included $5.5 million of operating lease payments, $1.4 million of cancellable purchase orders, and $43,000 of remaining loan principal.
- The company early adopted deferred-tax balance-sheet classification guidance in the second quarter, changing presentation but not expected economics. The filing states that the impact of other discussed accounting standards was not expected to be material or remained under evaluation.
Important Facts for Investors to Verify
- Whether the Water segment’s elevated 64%–65% product gross margins are sustained as project mix and shipment timing change.
- Timing and achievement of the two remaining $25 million Schlumberger milestones, commercialization of VorTeq, and any resulting royalties.
- Conversion of the $66.5 million non-current deferred-revenue balance into future revenue and cash receipts.
- Customer and geographic concentration: two customers represented 31% of second-quarter product revenue, and one customer represented all license and development revenue.
- Execution of the IsoBoost purchase order and the potential $4 million option.
- Cash deployment through securities purchases, share repurchases, research and development, and potential acquisitions, as well as compliance with credit-facility covenants.
- Developments and potential financial exposure in the disclosed litigation matters.