Energy Recovery, Inc. 10-Q Summary
Business Context and Reporting Period
Energy Recovery, Inc. provides energy recovery devices, pumps, and related technologies for industrial fluid-flow markets, primarily water desalination and oil and gas. The filing covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods. The financial statements are unaudited.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Total revenue | $22.8 million | $20.8 million | $42.6 million | $34.6 million |
| Product revenue | $19.2 million | $17.4 million | $35.3 million | $28.5 million |
| License and development revenue | $3.6 million | $3.4 million | $7.3 million | $6.1 million |
| Income from operations | $4.0 million | $4.2 million | $6.7 million | $2.9 million |
| Net income | $3.7 million | $15.7 million | $6.4 million | $15.0 million |
| Diluted EPS | $0.07 | $0.28 | $0.11 | $0.27 |
- Q2 total revenue increased 10%; six-month revenue increased 23%.
- Product gross margin was 71.5% in Q2 versus 65.7% in the prior-year quarter, and 70.5% for the six months versus 67.4% previously.
- Operating margin was approximately 17.5% in Q2 and 15.7% for the six months, compared with approximately 20.4% and 8.4%, respectively, in the prior-year periods.
- Operating expenses increased 26% in Q2 and 14% for the six months, driven principally by higher research and development, personnel, and sales and marketing costs.
- Q2 and year-to-date net income comparisons were negatively affected by the absence of the $11.9 million tax benefit recognized in Q2 2018 from the restructuring of Irish subsidiaries. The six-month 2019 effective tax rate was 17.1%, compared with negative 324.4% in 2018; excluding discrete tax items, the rates were 21.6% and 27.8%.
- Net cash provided by operating activities was $0.03 million for the six months, versus $1.7 million used in the prior-year period. Capital expenditures were $4.7 million versus $1.5 million.
- Cash, cash equivalents, and restricted cash totaled $23.4 million at June 30, 2019. Cash, cash equivalents, and marketable securities totaled $96.7 million, including $71.9 million of short-term investments and $1.5 million of long-term investments.
- Total assets were $183.5 million and total liabilities were $56.0 million. No debt was outstanding under the revolving credit facilities; $9.2 million of standby letters of credit were outstanding.
Material Changes Versus the Prior Comparable Period
- Water product revenue increased 12% in Q2 and 25% for the six months, primarily from higher mega-project and OEM shipments, partly offset by lower aftermarket shipments.
- Oil and gas product revenue declined to zero in Q2 from $0.3 million; license and development revenue increased 6% in Q2 and 19% year to date, primarily due to higher costs recognized under the input measure of progress.
- Higher production levels, favorable price and product mix, and manufacturing efficiencies increased product margins.
- Research and development expense increased 52% in Q2 and 29% for the six months, reflecting investment in existing products and commercialization of new technologies.
- Cash flow benefited from improved deferred-tax and prepaid-asset movements but was offset by increases in accounts receivable and reductions in contract liabilities.
- The company early adopted ASU 2018-15 prospectively and expects to defer approximately $0.6 million to $0.9 million of related implementation costs during the remainder of 2019.
Guidance, Outlook, Risks, and Unusual Items
- The filing does not provide a clear quantified revenue or earnings guidance range. Management expects continued investment in research and development and sales and marketing as it expands beyond desalination.
- Management expects existing cash, investments, and operating cash generation to fund anticipated requirements for at least the next 12 months, but additional financing could be required for acquisitions or accelerated investment in new technologies.
- Management highlights substantial quarter-to-quarter variability because revenue depends on the timing of large desalination projects and customer payments. The Q2 and year-to-date 2019 increases were significantly influenced by shipment timing.
- Key strategic initiatives include expansion of water products and commercialization of the VorTeq and MTeq oil and gas technologies. VorTeq milestone payments of $25 million each remain contingent on achieving specified performance indicators; achievement is uncertain.
- Remaining performance obligations totaled $34.3 million at June 30, 2019, including $7.3 million expected in the remaining six months of 2019 and $14.6 million in 2020.
- Material risks include dependence on desalination construction and project financing, customer and geographic concentration, long sales cycles, reliance on selected suppliers, product warranty and performance claims, unsuccessful commercialization of new technologies, oil and gas market conditions, foreign currency and interest-rate exposure, litigation, intellectual-property protection, tariffs, cybersecurity, and international tax matters.
- The company had approximately $8.6 million of cancellable open purchase-order commitments, $13.0 million of lease liabilities, and an executed Texas facility lease expected to commence in the second half of 2019.
- A 1% increase in interest rates was estimated to reduce the fair value of fixed-income investments by approximately $0.3 million.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2019, with no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the timing-driven increase in water mega-project shipments is sustainable and how aftermarket weakness develops.
- The progress, milestone timing, and eventual commercialization and royalty potential of VorTeq and MTeq.
- The collectability and timing of the $1.9 million of contract assets and the broader $35.1 million contract-liability balance.
- Whether elevated research and development spending produces commercially successful products and acceptable returns.
- The adequacy of liquidity after capital expenditures, Texas facility commitments, standby-letter-of-credit requirements, and potential acquisitions.
- Potential exposure from litigation, warranty claims, supplier constraints, customer concentration, and international operations.
- The effect of the 2018 tax benefit comparison and future effective tax rates on reported earnings.