Energy Recovery, Inc. — Q1 2017 Form 10-Q Summary
Business context and reporting period
Energy Recovery, Inc. provides energy-efficiency solutions for industrial fluid-flow markets, primarily water desalination, oil and gas, and chemical processing. Reported segments are Water and Oil & Gas. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $13.5 million | $11.3 million | +20% |
| Product revenue | $12.3 million | $10.1 million | +22% |
| License and development revenue | $1.3 million | $1.3 million | Flat |
| Product gross profit | $7.7 million | $6.4 million | +20% |
| Product gross margin | 62% | 63% | Down 1 percentage point |
| Loss from operations | $(0.6) million | $(2.1) million | Improved by $1.5 million |
| Net loss | $(0.4) million | $(2.0) million | Improved by $1.5 million |
| Basic and diluted loss per share | $(0.01) | $(0.04) | Improved |
| Net cash used in operating activities | $(4.8) million | $(0.3) million | Use increased by $4.6 million |
Approximate total-revenue operating margin was negative 4.6% in Q1 2017 versus negative 19.0% in Q1 2016; approximate net margin was negative 3.2% versus negative 17.4%.
- Water product revenue was $10.7 million, up 7%, driven primarily by higher mega-project shipments. Water product gross margin increased to 67% from 63%.
- Oil and Gas product revenue was $1.5 million versus none in the prior-year quarter, primarily reflecting percentage-of-completion revenue on multiple IsoBoost systems. Oil and Gas product gross margin was 30%.
- License and development revenue of $1.25 million represented quarterly amortization of deferred revenue from the VorTeq license agreement.
- Operating expenses declined 3% to $9.5 million. General and administrative expense decreased 10%, research and development decreased 6%, and sales and marketing increased 19%.
- Cash and cash equivalents were $58.7 million at March 31, 2017, compared with $61.4 million at December 31, 2016. Short-term investments were $38.7 million and total restricted cash was $4.8 million.
- Total debt was $36,000, including $11,000 current, and no revolving advances were outstanding. The company had a committed $16 million revolving credit line and an uncommitted $4 million line under a January 2017 loan and pledge agreement.
- Total assets were $148.2 million and stockholders’ equity was $68.7 million at March 31, 2017.
Material changes versus the prior comparable period
- Revenue growth reflected both higher Water segment shipments and the initial recognition of Oil and Gas product revenue under percentage-of-completion accounting.
- Losses narrowed materially because of higher gross profit, lower general and administrative expense, and lower research and development expense.
- Operating cash flow deteriorated to a $4.8 million use, largely because of reductions in accrued liabilities, increases in unbilled receivables and contract costs in excess of billings, and working-capital effects related to deferred revenue.
- Financing activities provided $2.8 million in Q1 2017, including $3.0 million from employee stock-option exercises. In Q1 2016, financing activities used $2.6 million, including $4.1 million of share repurchases.
- The company adopted ASU 2016-09 effective January 1, 2017. Adoption increased the net operating loss carryforward deferred tax asset and related valuation allowance by $6.9 million.
- In March 2017, the board authorized repurchases of up to $15 million through September 30, 2017; no shares had been repurchased under this authorization as of March 31, 2017.
Guidance, outlook, commentary, risks, and unusual items
- Management stated that existing cash balances and cash expected from operations should meet anticipated capital requirements for at least the next twelve months, while noting that acquisitions, growth investments, or weaker operations could require additional financing.
- Management expects continued reliance on desalination revenue, substantial international sales, and increased research and development and sales and marketing spending as the company expands beyond desalination.
- Revenue is subject to significant quarter-to-quarter volatility, long sales cycles, large project timing, and typical first-quarter seasonality.
- Customer concentration is significant: one customer represented 34% of Q1 product revenue, and one customer represented 100% of license and development revenue. International customers generated 98% of product revenue.
- The company is evaluating adoption of ASC 606, expected January 1, 2018. Management indicated that timing changes could be material for percentage-of-completion transactions, certain long-term contracts, and license and development revenue.
- Stand-by letters of credit totaled $6.9 million at March 31, 2017, supported partly by restricted cash. Lease obligations totaled $4.5 million, and cancellable purchase commitments totaled approximately $7.3 million.
- Litigation remains outstanding, including securities and derivative matters. The securities class-action settlement received preliminary approval on April 11, 2017; the settlement amount was undisclosed and expected to be paid entirely by the company’s insurer. Other matters were described as reasonably possible or not estimable.
- On April 5, 2017, the company announced a ten-year exclusive licensing agreement with Alderley plc for IsoBoost and IsoGen products in the Gulf Cooperation Council and Middle East region, with royalties payable per unit sold.
Important facts for investors to verify
- Whether Oil and Gas percentage-of-completion revenue and future IsoBoost shipments convert into cash as expected.
- The sustainability of the 62% product gross margin, particularly as product mix shifts toward Oil and Gas projects.
- Working-capital requirements, including unbilled receivables, contract costs in excess of billings, deferred revenue, and customer holdbacks.
- Customer concentration and the company’s dependence on international desalination and energy-related projects.
- The commercial progress and milestone economics of the VorTeq program and the new Alderley licensing arrangement.
- The ultimate effect of ASC 606 adoption on revenue timing and reported results.
- Potential exposure from litigation, product guarantees, $6.9 million of stand-by letters of credit, lease obligations, and purchase commitments.
- Future use of the newly authorized $15 million stock-repurchase program and its effect on liquidity.