Energy Recovery, Inc. — Q3 2020 Form 10-Q Summary
Business context and reporting period
Energy Recovery designs and manufactures pressure-exchanger, pump, turbocharger and related technologies for industrial fluid-flow markets, principally water desalination and oil & gas applications. This unaudited report covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods.
- Water product revenue was the primary operating business and reached a quarterly record, driven mainly by higher shipments to mega-project development customers.
- The Company opened and commissioned additional manufacturing and warehousing capacity in Tracy, California during 2020.
- As of October 23, 2020, 56.1 million common shares were outstanding.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Total revenue | $27.4 million | $24.9 million | $92.6 million | $67.4 million |
| Product revenue | $27.4 million | $21.8 million | $65.7 million | $57.1 million |
| License and development revenue | — | $3.1 million | $26.9 million | $10.4 million |
| Product gross profit | $19.6 million | $16.3 million | $45.6 million | $41.2 million |
| Product gross margin | 71.5% | 75.1% | 69.5% | 72.2% |
| Income from operations | $6.1 million | $4.6 million | $27.5 million | $11.3 million |
| Net income | $5.4 million | $5.1 million | $22.9 million | $11.5 million |
| Diluted EPS | $0.10 | $0.09 | $0.41 | $0.21 |
- Operating expenses were $13.5 million in Q3 and $45.0 million for the nine-month period. Nine-month expenses included a $2.3 million impairment charge related to VorTeq assets.
- Net cash provided by operating activities was $10.4 million for the first nine months of 2020, compared with $0.5 million in the prior-year period.
- Net cash provided by investing activities was $42.2 million, primarily from $50.5 million of investment maturities and $10.6 million of investment sales, partially offset by $12.9 million of investment purchases and $6.0 million of capital expenditures.
- Cash, cash equivalents and restricted cash increased to $80.3 million at September 30, 2020, from $26.5 million at December 31, 2019. Cash and cash equivalents were $80.1 million; short-term investments were $24.4 million; and long-term investments were $1.4 million.
- The Company had no debt outstanding. Its credit agreement provided a $16.0 million committed revolver and a $4.0 million uncommitted revolver, expiring June 30, 2022. Outstanding standby letters of credit totaled $12.5 million.
- Operating lease liabilities totaled $18.0 million, and open cancellable purchase obligations were approximately $5.2 million at September 30, 2020.
Material changes versus the prior comparable period
- Q3 revenue increased 10%, as $5.7 million of additional Water product revenue more than offset the absence of $3.1 million of prior-year license revenue.
- Nine-month revenue increased 37%, reflecting 15% growth in Water product revenue and a $16.5 million increase in license and development revenue.
- Product gross margin declined 360 basis points in Q3 and 270 basis points for the nine months. Management attributed the decline primarily to product/channel mix, lower average selling prices, COVID-19-related underutilization and safety costs, and overhead from the new Tracy facility.
- Q3 operating expenses declined 9%, largely because of lower Oil & Gas research and development activity, lower travel and marketing costs, and reduced amortization. Nine-month operating expenses increased 12% due to higher corporate costs, research and development spending, and the VorTeq impairment.
- Interest income declined to $0.1 million in Q3 and $0.8 million for the nine months, from $0.5 million and $1.5 million, respectively, due primarily to lower interest rates and investment balances.
Guidance, outlook, risks and unusual items
- In June 2020, Energy Recovery and Schlumberger terminated the VorTeq License Agreement effective June 1. Energy Recovery retained the full non-refundable $75.0 million upfront exclusivity payment, recognized the remaining $24.4 million as license and development revenue in Q2 2020, and has no further payment rights or performance obligations under the agreement.
- Management stated that no future VorTeq license revenue will be recognized. The termination also resulted in a $2.3 million impairment of related long-lived assets and a discrete tax charge.
- The filing provides no formal numerical revenue or earnings guidance. Management believes existing cash, investments and operating cash flow should fund capital requirements for at least the next 12 months and expects to fulfill existing 2020 delivery obligations.
- COVID-19 temporarily suspended manufacturing in March, but production returned to full status in May with enhanced safety measures. Management reported no material revenue or operating-cash-flow impact through September 30, while noting that reduced utilization negatively affected gross margin.
- COVID-19, oil and gas demand weakness, project timing, customer credit and receivables, international sales, foreign-currency exposure, product adoption, manufacturing execution and potential acquisitions or technology investments remain important uncertainties.
- On October 2, 2020, the Company detected a cyberattack that temporarily disrupted access to some systems. Management reported no evidence of data compromise or theft and no material impact on operations or financial reporting controls, but cybersecurity remains an identified risk.
- A purported securities class action filed in July 2020 alleges misleading statements concerning VorTeq commercialization and expected license revenue. The Company believes the complaint is without merit; the potential loss cannot currently be estimated.
- Remaining performance obligations totaled $22.6 million at September 30, 2020, with $4.6 million expected in the remainder of 2020, $18.0 million in 2021, and $0.0 million in 2022 except for approximately $15 thousand.
Most important facts for investors to verify
- Whether Water segment growth and the announced desalination awards can offset the permanent loss of VorTeq license revenue.
- Whether product gross margins recover as production volumes increase and Tracy facility utilization improves.
- The sustainability and timing of operating cash flow, particularly after the large reduction in contract liabilities caused by VorTeq revenue recognition.
- The collectability and concentration of Water customer receivables; several customers represented at least 10% of product revenue.
- The status and potential financial exposure of the VorTeq-related securities litigation.
- Whether COVID-19, oil and gas market weakness, cybersecurity events or supply-chain disruptions materially affect demand, production or delivery obligations.