Energy Recovery, Inc. — Q1 2016 Form 10-Q Summary
Business context and reporting period
Energy Recovery provides energy-recovery devices, pumps, and related products and services for industrial fluid-flow markets, primarily water desalination and oil and gas. The unaudited report covers the three months ended March 31, 2016, compared with the same period of 2015. Reportable segments are Water and Oil & Gas.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Product revenue | $10.1 million | $5.9 million | Up 71% |
| License and development revenue | $1.3 million | — | New revenue |
| Total revenue | $11.3 million | $5.9 million | Up 93% |
| Product gross profit | $6.4 million | $3.3 million | Up 91% |
| Product gross margin | 63% | 57% | Up 6 percentage points |
| Operating loss | $(2.1) million | $(8.1) million | Improved $5.9 million |
| Net loss | $(2.0) million | $(8.3) million | Improved $6.3 million |
| Loss per share | $(0.04) | $(0.16) | Improved |
| Operating cash flow | $(0.3) million | $(1.0) million | Improved $0.7 million |
- Product revenue growth was driven primarily by $3.9 million of mega-project shipments in the Water segment, compared with none in Q1 2015. Water revenue increased 76% to $10.1 million.
- Oil & Gas product revenue was zero, compared with $0.1 million in Q1 2015.
- The $1.25 million of license and development revenue represented straight-line recognition of the $75 million initial exclusivity payment under the 15-year Schlumberger VorTeq licensing agreement.
- Operating expenses declined 14% to $9.8 million, including lower general and administrative expense of $4.9 million and sales and marketing expense of $2.1 million. Research and development expense increased 5% to $2.7 million.
- Approximate operating margin improved to negative 19% from negative 138%, and net margin improved to negative 17% from negative 141%, based on reported total revenue.
- Cash and cash equivalents were $96.5 million at March 31, 2016, compared with $99.9 million at December 31, 2015. Short-term investments were $0.3 million and accounts receivable were $7.7 million.
- Total restricted cash was $4.1 million, supporting standby letters of credit. Total assets were $144.7 million and total liabilities were $84.5 million.
- Debt was minimal: $46,000 of principal remained outstanding under a fixed-rate installment loan. No revolving borrowings were outstanding under the $16.0 million credit facility.
- Financing cash flow was $(2.6) million, primarily reflecting $4.1 million of stock repurchases, partly offset by $1.5 million from common-stock issuance related to option exercises.
Material changes versus the prior comparable period
- Total revenue nearly doubled, reflecting higher Water shipments and initial recognition of Schlumberger license revenue.
- Product gross margin increased from 57% to 63%, primarily due to product mix favoring PX devices, increased volume, and pricing.
- General and administrative expense decreased by $1.4 million, primarily because of lower professional, legal, and administrative costs.
- Net loss narrowed substantially, although the company remained loss-making and operating cash flow remained negative.
- The company repurchased 673,700 shares for $4.1 million under a $6.0 million authorization that runs through June 30, 2016.
- Customer concentration increased: one customer represented 41% of product revenue and 48% of accounts receivable and unbilled receivables at March 31, 2016.
Outlook, commentary, risks, and unusual items
- Management expects Water segment gross margins to remain sustainable if volume remains healthy, PX product mix remains favorable, pricing is stable, and manufacturing efficiencies continue.
- Management expects international sales to remain a significant portion of revenue; 98% of Q1 product revenue was international.
- Research and development and sales and marketing expenses may increase as the company expands beyond water desalination and hydraulic fracturing.
- Management believes existing cash and cash generated from operations will satisfy anticipated liquidity needs for at least the next twelve months. Acquisitions or investments in newly adopted technologies could require additional financing.
- The Schlumberger agreement provides two potential additional milestone payments of $25 million each and recurring royalties. The filing states that the company expects to meet the two milestones and receive royalties, but does not provide a timetable or assurance of achievement.
- On April 20, 2016, the company announced a Middle East gas-processing letter of award valued at approximately $7 million, with an optional additional $4 million. The optional portion may not be confirmed until late 2017.
- Water revenue is subject to substantial quarter-to-quarter volatility, long sales cycles, project timing, and historical seasonality, with the first quarter generally the lowest-revenue quarter.
- Key risks include oil-price-driven adoption of oil and gas products, foreign-currency exposure, customer and geographic concentration, execution of the VorTeq licensing milestones, and continued operating losses.
- Litigation includes securities class-action claims, former-employee claims, and a derivative action. The company cannot estimate potential losses because the matters are at an early stage or their outcomes are not considered probable.
- Unusual first-quarter items included approximately $0.5 million of additional stock-based compensation related to the former general counsel’s resignation and a $33,000 release of expired warranty accruals.
Important facts for investors to verify
- Whether the two $25 million Schlumberger milestone payments and future VorTeq royalties are achieved and when they may be recognized.
- The sustainability of the 63% product gross margin as mega-project shipments and product mix change.
- Order timing, backlog, and customer concentration in the Water segment, particularly the customer representing 41% of product revenue.
- Progress toward commercial oil and gas revenue, given zero Oil & Gas product revenue in Q1 2016.
- Cash generation and the effect of continued stock repurchases, operating losses, and restricted cash requirements.
- Potential exposure from disclosed litigation, guarantees, $5.8 million of operating lease commitments, and approximately $2.0 million of cancellable purchase orders.
- The effect of adopting new revenue-recognition and other accounting standards; the filing states that the impact of the revenue standard had not yet been determined.