Energy Recovery, Inc. — Q2 2015 Form 10-Q Summary
Business context and reporting period
Energy Recovery, Inc. provides energy-recovery devices, pumps and related services for fluid-flow markets, primarily seawater desalination, with developing applications in oil and gas. The unaudited report covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods.
The company operated under one reportable segment during the period but announced that it would begin reporting Water and Oil & Gas segments beginning in the third quarter of 2015. Joel Gay became President and CEO in April 2015, and Chris Gannon became CFO in June 2015.
Financial performance and key metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net revenue | $10.5 million | $6.4 million | $16.3 million | $10.3 million |
| Gross profit | $5.6 million | $3.1 million | $9.0 million | $5.3 million |
| Gross margin | 54% | 48% | 55% | 52% |
| Operating loss | $(3.3) million | $(4.6) million | $(11.3) million | $(8.3) million |
| Net loss | $(3.3) million | $(4.6) million | $(11.6) million | $(8.3) million |
| Net loss per share | $(0.06) | $(0.09) | $(0.22) | $(0.16) |
| Operating cash flow | Not separately provided for the quarter | Not separately provided | $(8.0) million | $(0.2) million |
- Q2 revenue increased 64%, primarily from $3.8 million of higher mega-project shipments, plus higher OEM and aftermarket shipments. Six-month revenue increased 59%.
- PX devices and related products represented 71% of Q2 revenue and 70% of six-month revenue. International revenue represented 91% of Q2 revenue and 93% of six-month revenue.
- Q2 operating expenses increased 17% to $8.9 million. General and administrative expense rose 79% to $5.4 million, partly due to legal and professional costs and CEO-related stock compensation.
- Six-month general and administrative expense increased 131% to $11.6 million, while research and development increased 33% to $3.9 million, reflecting investment in oil and gas applications.
- Share-based compensation was $1.9 million in Q2 and $3.1 million for the six months, including approximately $1.1 million from modification of former CEO Thomas Rooney’s options.
- At June 30, 2015, cash and cash equivalents were $18.1 million, short- and long-term investments were $5.0 million, and accounts receivable were $7.4 million. Restricted cash was $3.1 million.
- Total debt was $53,000, consisting of a fixed-rate installment loan at 6.35% maturing in April 2020. No revolving borrowings were outstanding.
- The company had a $16.0 million credit facility, including up to $10.0 million of revolving borrowings, maturing in June 2018. Approximately $3.0 million of standby letters of credit were outstanding and secured by restricted cash.
- Total assets were $74.0 million and stockholders’ equity was $61.7 million at June 30, 2015.
Material changes versus the prior comparable periods
- Revenue growth and improved product mix increased gross margin from 48% to 54% in Q2 and from 52% to 55% for the six months.
- Despite improved gross profit, losses remained substantial because operating expenses exceeded gross profit. The six-month net loss increased 40% year over year.
- Operating cash use increased materially to $8.0 million from $0.2 million, driven by the larger net loss, working-capital movements, a $1.7 million litigation settlement, and inventory growth.
- Investing cash flow was $10.2 million, principally from $8.2 million of marketable-security maturities and a $2.4 million reduction in restricted cash. Capital expenditures were $0.4 million.
- Short-term investments declined to $4.7 million from $13.1 million at December 31, 2014, primarily reflecting maturities that supported liquidity.
- Inventory increased to $9.7 million from $8.2 million, including higher finished goods and work in process.
- Accrued expenses declined to $4.9 million from $8.4 million, and other non-current liabilities declined to $0.8 million from $2.5 million, primarily reflecting reductions in accrued legal obligations.
Outlook, commentary, risks and unusual items
- Management did not provide quantitative revenue or earnings guidance. It expects gross margins to remain sustainable if volume remains healthy, PX product mix is favorable, pricing remains stable, and production efficiencies continue.
- Research and development and sales and marketing spending may increase as the company expands beyond desalination into oil and gas and other markets.
- Management stated that existing cash, investments and anticipated operating cash flows should meet capital requirements for at least the next twelve months, but additional financing could be required for acquisitions, investments in new technology, expansion or continued operating losses.
- Revenue is volatile because large EPC orders can materially affect quarterly results, sales cycles can extend from six to 16 months or longer, and shipments are historically concentrated in the fourth quarter.
- Customer concentration was significant: one customer represented 30% of Q2 revenue; two customers represented 22% and 10% of six-month revenue. Three customers represented 31%, 15% and 10% of receivables and unbilled receivables at June 30.
- International exposure remains high, and currency movements involving the euro, UAE dirham, Chinese yuan and Canadian dollar may affect results. The company does not hedge these exposures.
- The company paid $1.7 million in May 2015 to settle Morgan Technical Ceramics litigation and released approximately $0.2 million of excess legal reserve.
- A securities class action lawsuit filed in January 2015 was consolidated; potential losses could not be estimated. A separate Spanish labor claim seeks approximately €567,000 of wages and bonuses plus alleged stock-option gains of €630,000; management had not determined that an award was probable.
- Future minimum operating lease payments totaled $6.9 million, and cancellable purchase orders totaled approximately $1.6 million at June 30, 2015.
- On July 1, 2015, the final outstanding warrants were exercised for $0.2 million. The filing also states that the company adopted Water and Oil & Gas organizational segments after quarter-end.
Important facts for investors to verify
- Whether revenue growth from mega-project and OEM shipments is repeatable and whether the historically seasonal fourth-quarter pattern persists.
- Whether the 54% to 55% gross-margin levels can be maintained as product mix, pricing, volume and competition change.
- The pace of cash burn, inventory conversion and collections, particularly given $8.0 million of operating cash use in the first six months.
- Progress, commercialization costs and customer adoption for VorTeq and other oil and gas initiatives.
- The effect of CEO/CFO transitions, workforce reductions, elevated legal and professional costs, and unusually high stock-based compensation.
- Developments in the consolidated securities litigation and the Spanish labor claim, as well as the company’s $3.0 million of standby letters of credit and related restricted cash.
- The first reported results and expense allocation under the new Water and Oil & Gas segment structure.