Energy Recovery, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Energy Recovery, Inc. develops, manufactures and sells energy recovery devices, high-pressure pumps and circulation pumps used primarily in seawater reverse-osmosis desalination. The company operates as one reportable segment, with manufacturing in California and Michigan and sales and technical support offices in Spain, the United Arab Emirates and China. This unaudited Form 10-Q covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods.
Financial Performance and Liquidity
| Metric | Q2 2011 | Q2 2010 | Six Months 2011 | Six Months 2010 |
|---|---|---|---|---|
| Net revenue | $6.6 million | $13.3 million | $17.0 million | $25.9 million |
| Gross profit | $2.3 million | $6.6 million | $7.0 million | $14.0 million |
| Gross margin | 35% | 50% | 41% | 54% |
| Loss from operations | $(5.2) million | $(0.7) million | $(8.1) million | $(0.6) million |
| Net loss | $(3.3) million | $(0.3) million | $(5.1) million | $(0.3) million |
| Net loss per share | $(0.06) | $(0.01) | $(0.10) | $(0.00) |
| Net cash used in operating activities | Not separately provided | Not separately provided | $(5.3) million | $(1.5) million |
Q2 revenue declined 50%, while six-month revenue declined 34%. The six-month revenue mix was approximately 70% PX devices and related products and services and 30% turbochargers and pumps. International revenue represented approximately 89% of six-month revenue.
At June 30, 2011, cash and cash equivalents were $50.4 million, restricted cash was $5.5 million, accounts receivable were $8.4 million and total assets were $128.7 million. Total liabilities were $11.6 million, including approximately $0.1 million of current long-term debt, $0.02 million of long-term debt and $0.2 million of total capital lease obligations. The company had no advances outstanding under its $16.0 million credit facility, although approximately $7.0 million of standby letters of credit were collateralized under the facility.
Cash and cash equivalents decreased by $4.9 million during the first six months of 2011, ending at $50.4 million. Investing activities provided $0.5 million, principally because capital expenditures declined substantially from 2010 and restricted cash was released. Financing activities used $0.2 million.
Material Changes Versus the Prior Comparable Period
- Revenue fell by $6.7 million in Q2 and $8.9 million for the first six months, primarily because of lower shipments of PX devices, turbochargers, pumps, aftermarket parts and services.
- Gross margin decreased to 35% in Q2 from 50% and to 41% for the six months from 54%. Management attributed the decline primarily to product mix, lower production volume and underutilized manufacturing facilities, including the ramp-up of the new ceramics facility.
- Operating expenses increased 3% for the first six months despite lower revenue. General and administrative expense increased 13%, partly because of costs associated with executive departures and the appointments of a new CEO and CFO. Research and development expense increased 12%.
- Operating losses widened to $5.2 million in Q2 and $8.1 million for the first six months, compared with $0.7 million and $0.6 million, respectively, in the comparable 2010 periods.
- The effective tax rate for the first six months was 35%, compared with 64% in 2010, reflecting the company’s forecasted pretax loss position for 2011.
- Other non-operating income improved because of favorable foreign-currency movements, partially offset by a $77,000 loss on the sale of equipment during the first six months.
- The company authorized a program to repurchase up to five million shares over 12 months, but no shares had been repurchased as of June 30, 2011.
Guidance, Outlook, Risks and Unusual Items
- Management expected existing cash balances and cash generated from operations to satisfy anticipated capital requirements for at least the next 12 months, but noted that additional equity or debt financing could be required in the future.
- Management anticipated substantially higher research and development spending as it expands and diversifies its products. It also cautioned that margins could remain under pressure if production volume does not increase.
- In July 2011, the company initiated a plan to consolidate Michigan operations into its San Leandro, California facility. The consolidation was expected to be completed by December 31, 2011 and to generate approximately $4.7 million of non-recurring expenses in 2011.
- The consolidation triggered an impairment evaluation of long-lived assets with a June 30, 2011 net book value of $5.3 million. No impairment was recognized, but a future impairment charge was considered reasonably possible if cash-flow estimates changed or assets became held for sale.
- The company was non-compliant with a minimum-net-income covenant at June 30, 2011 because of its 2010 net loss. The lender waived the violation in July 2011, and the covenant was removed under an amended credit agreement.
- In July 2011, $1.1 million of contingent acquisition consideration was released from escrow and remitted to the former owners of Pump Engineering.
- Key risks include dependence on desalination projects and a limited number of large customers, long and unpredictable sales cycles, international and foreign-currency exposure, project delays or cancellations, competition, manufacturing underutilization, reliance on key suppliers and ceramics vendors, product warranty exposure, potential impairment, and the need for future capital.
- The company reported no material litigation and concluded that its disclosure controls and procedures were effective.
Important Facts for Investors to Verify
- Whether revenue and production volumes recover after the significant Q2 decline and whether the business remains subject to fourth-quarter shipment concentration.
- Progress, total cost and operational impact of the Michigan-to-California consolidation, including any impairment or restructuring charges.
- Whether the company generates sufficient operating cash flow while reporting losses and funding research, manufacturing and working-capital needs.
- The status and collateral requirements of the amended credit facility, including approximately $7.0 million of standby letters of credit.
- Customer concentration, unbilled receivables and the collectability of performance holdbacks, which can remain outstanding for up to 24 months.
- Warranty claims, supplier capacity and the cost-effectiveness of internally produced ceramic components.
- The realizability of approximately $1.8 million of net deferred tax assets, which depends on future taxable income.