Energy Recovery, Inc. — Fiscal 2020 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2020; filed March 12, 2021. The filing is an annual report, not a quarterly filing. Energy Recovery develops and manufactures pressure-exchanger technology, energy recovery devices, pumps, and related solutions, primarily for seawater and brackish-water reverse-osmosis desalination. Its reportable segments were Water and Oil & Gas.
Financial performance and liquidity
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Total revenue | $119.0 million | $86.9 million | +37% |
| Product revenue | $92.1 million | $72.8 million | +26% |
| License and development revenue | $26.9 million | $14.1 million | +91% |
| Product gross profit | $63.8 million | $52.5 million | +22% |
| Product gross margin | 69.3% | 72.1% | Down 2.8 points |
| Income from operations | $31.3 million | $10.4 million | +202% |
| Net income | $26.4 million | $10.9 million | +142% |
| Diluted EPS | $0.47 | $0.19 | +147% |
| Cash flow from operations | $16.9 million | $5.3 million | +220% |
Based on reported figures, operating margin was approximately 26.3% and net margin was approximately 22.2%, compared with approximately 11.9% and 12.5%, respectively, in 2019. Product gross margin declined because of lower manufacturing utilization, COVID-19 safety costs, overhead from the new Tracy facility, and lower average selling prices associated with a greater mix of larger megaproject orders.
- Product revenue was concentrated in megaprojects: $66.8 million, or 73% of product revenue, up 75% year over year. OEM revenue declined 31% to $15.8 million, and aftermarket revenue declined 19% to $9.5 million.
- Research and development expense was $23.4 million, approximately 20% of total revenue, essentially flat year over year.
- General and administrative expense increased 12% to $25.5 million, while sales and marketing expense decreased 14% to $8.1 million.
- Income tax expense increased to $5.7 million from $1.3 million; the effective tax rate was 18% versus 11% in 2019.
- Net cash increased by $67.9 million, including $46.6 million of cash provided by investing activities, primarily from moving marketable securities into cash during the pandemic.
- At December 31, 2020, the company had $94.3 million of cash and cash equivalents, $20.4 million of short-term investments, and $11.8 million of net accounts receivable. Total assets were $204.3 million and stockholders’ equity was $171.6 million.
- The company had no debt outstanding under its revolving credit facility. The facility included a $16.0 million committed line and a $4.0 million uncommitted line, while outstanding standby letters of credit totaled $13.3 million.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by large Water-segment megaprojects, which were relatively unaffected by COVID-19 because of their long project cycles.
- OEM and aftermarket activity weakened as COVID-19 delayed new installations, upgrades, and non-critical maintenance, particularly in tourism and hospitality.
- In June 2020, Energy Recovery and Schlumberger terminated the VorTeq License Agreement. Energy Recovery recognized the remaining $24.4 million deferred balance from the original $75.0 million non-refundable exclusivity payment as 2020 license and development revenue. No additional payments or future revenue will be received under that agreement.
- The termination eliminated the potential for two additional $25.0 million milestone payments and resulted in a $2.3 million impairment charge for VorTeq-related machinery and equipment.
- Energy Recovery may now market VorTeq to the broader hydraulic-fracturing market, but it must continue development and commercialization without Schlumberger’s collaboration.
- The company opened its Katy, Texas commercial development center and commissioned a new 54,429-square-foot Tracy, California manufacturing and warehousing facility.
- The company introduced Ultra PX for ultra-high-pressure reverse-osmosis industrial wastewater applications and shipped its first commercial units to a chemical manufacturer in India.
- Beginning in 2021, the company expects to report Water and Emerging Technologies segments instead of Water and Oil & Gas.
Outlook, risks, contingencies, and unusual items
Management did not provide a specific numerical revenue or earnings forecast in the filing. It stated that existing cash, investments, and anticipated operating cash flow should satisfy liquidity needs for at least the next 12 months. Additional debt or equity financing could be required for acquisitions, rapid market adoption, expanded operations, or increased investment in new technology.
- Water remains the primary source of revenue and profitability. Product revenue was 98% international, with Saudi Arabia representing 34%, the United Arab Emirates 18%, and Egypt 10% of product revenue.
- Results may remain volatile because revenue depends on the timing of large desalination projects, which can involve sales cycles of 16 to 36 months or longer. The company also faces project-financing, geopolitical, economic, oil-price, and government-priority risks.
- Customer concentration is material: two Water customers represented 27% and 23% of product revenue in 2020. Two suppliers represented 19% and 16% of consolidated supply and manufacturing purchases.
- COVID-19 created risks involving customer delays, facility restrictions, supplier disruption, manufacturing utilization, and collections. Management reported limited manufacturing disruption and no known communal spread at its facilities, but stated that the ultimate financial impact remained uncertain.
- VorTeq commercialization remains uncertain, particularly following termination of the Schlumberger agreement. Oil and gas market conditions and lower oil prices could delay adoption of VorTeq and IsoBoost.
- The company recorded $1.5 million of product cost related to reduced manufacturing utilization during the pandemic and maintained a $0.8 million warranty reserve at year-end.
- A cyberattack detected on October 2, 2020 temporarily disrupted access to some systems. Management reported no material impact on operations or financial reporting and no evidence that data was compromised or stolen.
- A purported securities class action related to VorTeq disclosures was dismissed without prejudice on January 20, 2021 and was described as closed. The filing states that no material litigation losses were probable or reasonably possible at December 31, 2020.
- Operating lease liabilities totaled $17.7 million, and cancellable open purchase-order arrangements totaled approximately $6.3 million at year-end.
- The board authorized a new share repurchase program of up to $50.0 million on March 9, 2021. The authorization has no expiration date and does not require the company to repurchase shares.
Most important facts for investors to verify
- How much of 2020 earnings and cash flow was supported by the non-recurring $24.4 million VorTeq deferred-revenue recognition.
- The sustainability and timing of the megaproject backlog, including customer concentration, holdbacks, and international exposure.
- Whether OEM and aftermarket demand recovers from pandemic-related delays and whether product gross margin returns toward prior levels.
- Progress, field-test results, commercialization timing, and potential customers for VorTeq and Ultra PX.
- The terms and utilization of the revolving facility, including the $13.3 million of standby letters of credit and the June 2022 maturity.
- The effect of the 2021 change to Water and Emerging Technologies segment reporting on visibility into operating performance.
- Potential future tax effects, including valuation allowances, $1.1 million of unrecognized tax benefits, and available net operating loss and R&D credit carryforwards.
- Future cash deployment, including the proposed share repurchases, facility commitments, acquisitions, and continued research and development spending.
Audit and controls: Deloitte & Touche issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2020.