Energy Recovery, Inc. Q2 2022 Form 10-Q Summary
Business context and reporting period
Energy Recovery designs and manufactures pressure-exchanger and related technologies that improve efficiency and reduce energy use, waste, and emissions in seawater and industrial wastewater desalination, refrigeration, and other industrial processes. This unaudited Form 10-Q covers the three and six months ended June 30, 2022, compared with the corresponding 2021 periods.
Financial results and key metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Revenue | $20.3 million | $20.6 million | $52.8 million | $49.5 million |
| Gross profit | $13.4 million | $13.4 million | $36.4 million | $33.4 million |
| Gross margin | 65.9% | 65.1% | 68.9% | 67.4% |
| Income (loss) from operations | $(2.9) million | $0.3 million | $5.3 million | $6.4 million |
| Operating margin | (14.3%) | 1.4% | 10.1% | 13.0% |
| Net income (loss) | $(2.4) million | $1.1 million | $5.5 million | $7.9 million |
| Diluted EPS | $(0.04) | $0.02 | $0.10 | $0.13 |
Q2 revenue was essentially flat year over year, while six-month revenue increased 7%. Q2 revenue mix shifted toward OEM sales, which rose 80% to $7.7 million, while Megaproject revenue declined 24% to $10.1 million and aftermarket revenue declined 17% to $2.5 million. Six-month OEM revenue increased 75% to $12.4 million and aftermarket revenue increased 21% to $6.6 million, partly offsetting an 8% decline in Megaproject revenue to $33.9 million.
Q2 operating expenses increased 24% to $16.3 million, including general and administrative expense of $7.0 million, sales and marketing expense of $3.8 million, and research and development expense of $5.4 million. The Q2 operating loss included approximately $0.9 million of additional depreciation associated with the decision to cease VorTeq commercialization efforts and approximately $0.5 million of severance and share-based compensation costs.
Cash provided by operations was $7.5 million for the first six months, compared with $11.5 million in the prior-year period. Investing cash flow was $(13.0) million, primarily reflecting purchases of marketable securities, and financing cash flow was $(25.6) million, primarily reflecting $26.6 million of share repurchases. Cash, cash equivalents, and restricted cash decreased by $31.1 million to $43.3 million.
At June 30, 2022, the company held $43.2 million of cash and cash equivalents, $43.3 million of short- and long-term marketable debt investments, and $13.9 million of net accounts receivable. There were no revolving loans outstanding. The company had a $50.0 million revolving credit facility, with $16.5 million utilized for letters of credit and $12.8 million of outstanding letters of credit. Total liabilities were $29.6 million, including $15.7 million of lease liabilities. Management stated that the company was in compliance with its credit agreement covenants and expects existing resources and operating cash flows to meet liquidity needs for at least the next 12 months.
Material changes versus the prior comparable period
- Q2 revenue decreased 2%, but six-month revenue increased 7%, driven mainly by higher OEM and aftermarket activity.
- Q2 gross margin improved 80 basis points to 65.9%; six-month gross margin improved 150 basis points to 68.9%.
- Higher operating expenses, including costs associated with ending VorTeq commercialization efforts, caused a shift from Q2 operating income of $0.3 million to an operating loss of $2.9 million.
- Q2 net results shifted from $1.1 million of net income to a $2.4 million loss. Six-month net income declined 30% to $5.5 million.
- Inventory increased to $28.2 million from $20.4 million at year-end 2021 as the company increased production and raw-material purchases to mitigate supply-chain risks and prepare for second-half shipments.
- The company repurchased $26.6 million of stock during the first six months. As of June 30, it had repurchased 8.1 million shares for an aggregate cost of $80.5 million across all programs. The March 2021 authorization concluded on July 1, 2022.
- On July 15, 2022, the company amended its credit agreement to replace LIBOR with SOFR; management stated that the modification was not material.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide specific quantitative revenue or earnings guidance. Management expects revenue variability because Megaproject shipments depend on project-specific delivery timing. Management cited opportunities in seawater and industrial wastewater desalination, zero- and minimal-liquid-discharge applications, refrigeration, and other emerging markets.
Management believes it has sufficient raw materials and finished goods to mitigate supply-chain disruption, including port congestion and supplier material or labor shortages. The company expects international sales to remain significant and believes its existing facilities are adequate for the foreseeable future.
Key risks include project and shipment timing, customer and geographic concentration, supply-chain disruption, foreign-currency and customer collection risk, interest-rate and credit risk on the investment portfolio, adoption of emerging technologies, and the company’s ability to commercialize products outside its historical desalination market. A hypothetical 1% increase in interest rates was estimated to reduce the fair value of fixed-income securities by less than $0.3 million.
The company ceased VorTeq commercialization efforts in June 2022. Related fixed assets were written down to estimated residual value, resulting in $0.9 million of additional depreciation in Q2; the assets were sold in July for approximately $0.7 million. Goodwill associated with the Emerging Technologies segment was not considered impaired.
A previously closed employment-related lawsuit brought by former sales executive Borja Blanco was reopened in June 2022. The company believes an award is not probable, but a loss may be reasonably possible and cannot currently be estimated. The filing reports no other material litigation losses that were probable or reasonably possible.
Important facts for investors to verify
- Whether Megaproject shipment timing and project execution support revenue growth in the second half of 2022.
- Whether elevated inventory converts into sales and operating cash flow without material obsolescence or working-capital pressure.
- The recurring versus nonrecurring nature of VorTeq-related depreciation, severance, and share-based compensation costs.
- Future operating expense levels and the effect of continued investment in emerging technologies.
- Customer concentration and exposure to the Middle East and Africa, which generated approximately $37.0 million of six-month revenue.
- Availability of the revolving credit facility after letters-of-credit usage and continued compliance with covenants.
- Progress and commercial adoption of industrial wastewater, refrigeration, and other emerging applications.
- Potential financial exposure from the reopened Blanco litigation and other warranty or performance-guarantee obligations.