Energy Recovery, Inc. — 2019 Form 10-K Summary
Business context and reporting period
Energy Recovery designs and manufactures fluid-flow technologies for water desalination and oil and gas applications. Its reportable segments are Water and Oil & Gas. The filing covers the fiscal year ended December 31, 2019, filed March 6, 2020; it is an annual filing rather than a standalone fourth-quarter filing. Fourth-quarter 2019 results are included below.
- Water products include PX Pressure Exchangers, turbochargers and high-pressure pumps used in reverse-osmosis desalination.
- Oil & Gas activities primarily comprise the VorTeq and MTeq technologies, IsoBoost and IsoGen solutions, and related license and development work.
- International markets generated 98% of product revenue. The Middle East and Africa accounted for $46.7 million of total revenue.
Financial performance and key metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenue | $86.9 million | $74.5 million | +17% |
| Product revenue | $72.8 million | $61.0 million | +19% |
| License and development revenue | $14.1 million | $13.5 million | +5% |
| Income from operations | $10.4 million | $10.0 million | +4% |
| Net income | $10.9 million | $22.1 million | -51% |
| Diluted EPS | $0.19 | $0.40 | Declined |
| Operating cash flow | $5.3 million | $7.6 million | -30% |
- Water product revenue increased 20% to $72.7 million, driven by higher shipments across MPD, OEM and aftermarket channels. Oil & Gas product revenue declined 80% to $0.1 million.
- Product gross profit increased 22% to $52.5 million, while product gross margin expanded to 72.1% from 70.7%, primarily due to favorable pricing and product mix, manufacturing efficiencies and higher production levels.
- Operating expenses increased 21% to $56.2 million. R&D increased 38% to $23.4 million, reflecting greater testing, headcount and commercialization spending, particularly for Oil & Gas technologies.
- The effective tax rate was 11% in 2019 versus a negative 93% in 2018. The 2018 results benefited from a $12.3 million tax benefit related to an international tax-structure election, making year-over-year net income comparisons less comparable.
- Fourth-quarter revenue was approximately $19.5 million, comprising $15.8 million of product revenue and $3.7 million of license and development revenue. Fourth-quarter net loss was $0.6 million, compared with fourth-quarter 2018 net income of $2.4 million.
Balance sheet, liquidity and debt
- Cash and cash equivalents were $26.4 million at December 31, 2019. Short- and long-term investments totaled $74.2 million, for cash, cash equivalents and marketable securities of approximately $100.5 million.
- Accounts receivable, net, was $13.0 million; inventory increased to $10.3 million from $7.1 million.
- Total assets were $188.8 million and total liabilities were $52.8 million. Stockholders’ equity increased to $136.0 million from $113.4 million.
- No debt was outstanding under the $16.0 million committed and $4.0 million uncommitted revolving credit facilities. Outstanding standby letters of credit were $11.8 million.
- Management stated that existing resources and operating cash flow should meet anticipated capital requirements for at least the next 12 months, although additional financing could be required for acquisitions, expansion or accelerated technology investment.
- Capital expenditures were $7.4 million in 2019. Contractual obligations included $17.1 million of operating lease obligations and $10.4 million of open cancellable purchase orders, excluding the subsequently commenced Katy and Tracy leases.
Material changes versus the prior comparable period
- Water growth accelerated, supported by Middle East water shortages, new and larger mega-projects, and conversion of thermal desalination facilities to seawater reverse osmosis.
- Gross margin improved by 140 basis points, but higher operating expenses—especially R&D—limited operating-income growth.
- Operating cash flow declined because of changes in working capital, including a $13.9 million reduction in contract liabilities as license revenue was recognized and a $3.3 million increase in inventory.
- Financing cash flow turned positive at $6.0 million, primarily from common-stock option exercises; no stock repurchases occurred in 2019.
- Contract liabilities declined to $28.9 million from $42.8 million. Remaining performance obligations were $47.0 million, with $23.5 million expected to be recognized in 2020.
- The company expanded capacity, including completion of phase one of its expansion and commencement of a new Tracy, California facility. It also opened a Katy, Texas commercial development and testing center for Oil & Gas technologies in January 2020.
Guidance, outlook, commentary and risks
- Management expects continued opportunities from global water scarcity, desalination capacity growth, reverse-osmosis conversions, aftermarket demand and expansion into new fluid-flow markets.
- VorTeq remained in advanced R&D and had not been commercialized. The license agreement provides for two uncertain milestone payments of $25 million each and future recurring royalties after commercialization; no assurance is provided that the milestones or royalties will be received.
- MTeq also remained in the R&D stage. The company continues to invest heavily in product development and expects R&D and sales and marketing expenses may rise as it diversifies.
- Principal risks include dependence on large and unpredictable desalination projects, customer and geographic concentration, international and geopolitical exposure, competition, supplier concentration, product defects and warranty claims, inventory obsolescence, litigation, intellectual-property protection, foreign exchange and tax uncertainty.
- The filing identifies potential effects from the emerging coronavirus outbreak, trade tariffs, Brexit and changes to LIBOR. The company also faces risks from the commercialization and customer adoption of new Oil & Gas products.
- Legal proceedings include the Borja Blanco employment litigation in Spain. The company has accrued a potential loss, but the ultimate outcome cannot be predicted with certainty.
- The financial statements received an unqualified audit opinion, and management and Deloitte & Touche concluded that internal control over financial reporting was effective as of December 31, 2019.
Important facts for investors to verify
- Whether Water segment growth and 72% product gross margins are sustainable amid project timing, pricing and competitive pressures.
- Progress toward VorTeq commercialization, achievement of the two $25 million milestones, licensee adoption and potential recurring royalties.
- Whether elevated R&D and capacity-expansion spending produces commercial returns, particularly in Oil & Gas.
- The conversion of contract liabilities and remaining performance obligations into cash revenue, including the timing of customer payments and holdbacks.
- Customer, country and supplier concentrations, including one customer representing 19% of 2019 product revenue and one customer representing all license and development revenue.
- Exposure under the $11.8 million of standby letters of credit, pending litigation, warranty obligations and the new Katy and Tracy lease commitments.
- Future tax rates and the sustainability of deferred tax assets and tax benefits that materially affected prior-period comparisons.