Energy Recovery, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Energy Recovery, Inc. provides energy-recovery devices, pumps and related products for water desalination, oil and gas, chemical processing and hydraulic fracturing markets. This unaudited Form 10-Q covers the three and nine months ended September 30, 2015, compared with the same periods in 2014.
Beginning July 1, 2015, the company adopted Water and Oil & Gas reporting segments following a new internal reporting structure and the appointment of a new chief executive officer in April 2015. Prior-period segment information was retrospectively adjusted.
Financial Performance and Key Metrics
| Metric | Q3 2015 | Q3 2014 | Nine Months 2015 | Nine Months 2014 |
|---|---|---|---|---|
| Net revenue | $12.1 million | $5.3 million | $28.5 million | $15.6 million |
| Gross profit | $7.2 million | $2.3 million | $16.1 million | $7.7 million |
| Gross margin | 59% | 44% | 57% | 49% |
| Operating loss | $(0.3) million | $(5.4) million | $(11.6) million | $(13.7) million |
| Net loss | $(0.3) million | $(5.5) million | $(12.0) million | $(13.8) million |
| Net loss per share | $(0.01) | $(0.11) | $(0.23) | $(0.27) |
- Water revenue was $12.1 million in Q3 and $28.3 million for the nine-month period. Oil & Gas revenue was zero in Q3 and $141,000 year to date.
- Q3 revenue increased 127%, primarily from higher mega-project, OEM and aftermarket Water shipments. Nine-month revenue increased 82%.
- PX devices and related products represented 68% of Q3 revenue and 69% of nine-month revenue, compared with 44% and 57%, respectively, in the prior-year periods.
- Q3 operating expenses declined 5% to $7.4 million despite higher general and administrative expense. Nine-month operating expenses increased 30% to $27.7 million, largely because of higher general and administrative costs and share-based compensation.
- Cash used in operating activities was $7.7 million for the nine months ended September 30, 2015, compared with $268,000 used in the prior-year period.
- Investing activities provided $13.1 million, primarily from $11.8 million of marketable-security maturities and $1.9 million of released restricted cash. Financing activities provided $608,000.
- Cash and cash equivalents increased to $21.5 million from $15.5 million at December 31, 2014. Short-term investments were $1.3 million, accounts receivable were $8.1 million and unbilled receivables totaled $1.2 million.
- Total restricted cash was $3.6 million, collateralizing outstanding letters of credit.
- Total debt was $50,000, consisting of a fixed-rate installment loan at 6.35% maturing in April 2020. No revolving borrowings were outstanding.
- Total assets were $73.2 million and stockholders’ equity was $62.1 million at September 30, 2015.
Material Changes Versus the Prior Comparable Period
- Water revenue rose $7.0 million, or 135%, in Q3 and $13.2 million, or 87%, for the nine months, driven by increased mega-project, OEM and aftermarket shipments.
- Oil & Gas revenue declined because the IsoGen system lease was bought out at the end of 2014; the segment generated only $141,000 year to date from commissioning services and a canceled sales-order fee.
- Gross margin improved because of a more favorable product mix toward higher-margin PX devices and the release of an expired-warranty accrual.
- General and administrative expense increased $7.1 million year to date, including higher legal and professional costs, termination-related costs and share-based compensation associated with management changes.
- Share-based compensation increased to $3.5 million from $1.6 million for the nine-month periods, including costs related to executive departures, option modifications and director grants.
- Operating cash flow deteriorated despite the smaller net loss, reflecting working-capital timing, a $1.7 million litigation settlement and other liability payments.
Guidance, Outlook, Risks and Unusual Items
- Management expects existing cash balances and cash generated from operations to satisfy anticipated liquidity needs over the next twelve months, excluding potential acquisitions or investments in new technologies. Additional financing may be required for future expansion or acquisitions.
- Management believes Water gross margins may remain sustainable if volume remains healthy, PX products remain a favorable portion of the mix, pricing remains stable and manufacturing efficiencies continue.
- Sales are highly seasonal and project-driven; large EPC orders can cause substantial quarterly fluctuations, with historically higher shipments in the fourth quarter.
- On October 14, 2015, after the reporting period, the company entered into a 15-year exclusive VorTeq intellectual-property license agreement with Schlumberger. The agreement provides for a $75 million exclusivity payment, two potential $25 million milestone payments in 2016 and recurring royalties.
- The Schlumberger payments and royalties depend on achieving specified performance milestones and adoption rates. Oil-price weakness could reduce adoption of the VorTeq system and related royalty revenue.
- Revenue and receivables are highly concentrated internationally and among a limited number of customers. International revenue represented 97% of Q3 revenue and 95% for the nine-month period; one customer represented 32% of Q3 revenue and 42% of receivables and unbilled receivables at quarter-end.
- Outstanding standby letters of credit totaled $3.6 million and were fully collateralized by restricted cash. The company was in compliance with its credit-facility covenants.
- Legal matters include a Spanish employment claim seeking specified wages, bonuses and alleged option gains, and a consolidated securities class action for which potential loss cannot currently be estimated. Management had not determined that the Spanish claim was probable.
- Contractual obligations included $6.6 million of operating leases, $2.4 million of cancellable purchase orders and $50,000 of remaining loan principal.
- Goodwill of $12.8 million was tested under the revised reporting structure as of July 1, 2015, with no impairment identified.
Investor Verification Checklist
- Verify the terms, accounting treatment and cash-collection status of the Schlumberger exclusivity payment and the two 2016 milestones.
- Assess whether Water-segment revenue growth and the 57% nine-month gross margin are repeatable given project timing, product mix and customer concentration.
- Monitor operating cash burn, working-capital requirements and the conversion of receivables and holdbacks into cash.
- Review the effect of management turnover, restructuring, legal expenses and elevated share-based compensation on future operating expenses and dilution.
- Evaluate customer, geographic, foreign-currency and oil-price exposure, particularly the dependence on international desalination projects and future VorTeq adoption.
- Follow the Spanish employment claim and securities class action for potential financial exposure.