Energy Recovery, Inc. — Q3 2019 Form 10-Q Summary
Business Context and Reporting Period
Energy Recovery, Inc. provides energy recovery devices, pumps and related solutions for industrial fluid-flow markets, primarily water desalination and oil and gas applications. The filing covers the three and nine months ended September 30, 2019, compared with the same periods in 2018. The financial statements are unaudited.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total revenue | $24.9 million | $22.2 million | $67.4 million | $56.8 million |
| Revenue growth | 12% | — | 19% | — |
| Product gross profit | $16.3 million | $13.6 million | $41.2 million | $32.7 million |
| Product gross margin | 75.1% | 73.0% | 72.2% | 69.6% |
| Income from operations | $4.6 million | $5.7 million | $11.3 million | $8.6 million |
| Operating margin | 18.4% | 25.4% | 16.7% | 15.1% |
| Net income | $5.1 million | $4.7 million | $11.5 million | $19.7 million |
| Diluted EPS | $0.09 | $0.08 | $0.21 | $0.36 |
| Cash flow from operations | Not separately reported | Not separately reported | $0.5 million | $9.7 million |
Q3 product revenue increased 17%, driven by higher Water Segment shipments. License and development revenue declined 15% to $3.1 million. Research and development expense rose 55% in Q3 and 39% for the nine-month period, reflecting increased testing, personnel, depreciation and commercialization costs.
At September 30, 2019, cash, cash equivalents and restricted cash were $29.8 million, and cash and cash equivalents were $29.7 million. Short- and long-term investments totaled $67.5 million, bringing cash, cash equivalents and marketable securities to $97.2 million. Accounts receivable were $20.8 million and total assets were $190.6 million.
The company had no debt outstanding under its revolving credit facility. Stand-by letters of credit totaled $11.2 million and were secured by U.S. investments. Total liabilities were $55.8 million and stockholders’ equity was $134.8 million.
Material Changes Versus the Prior Comparable Period
- Water product revenue rose 18% in Q3 and 22% for the first nine months, reflecting increased shipments across aftermarket, mega-project and OEM channels.
- Product gross margin improved 210 basis points in Q3 and 260 basis points for the first nine months, benefiting from favorable pricing and mix, manufacturing efficiencies and higher production levels.
- Total operating expenses increased 28% in Q3 and 19% for the first nine months. The largest increase was in research and development.
- Q3 operating income declined despite higher revenue because operating expenses grew faster than gross profit. Nine-month operating income increased.
- Nine-month net income declined $8.2 million because the prior-year period included a $10.1 million income tax benefit, including an $11.6 million benefit associated with an Irish tax-structure election. The 2019 period included only a $1.2 million tax expense.
- Operating cash flow fell to $0.5 million from $9.7 million, primarily due to the timing of customer invoicing and collections, higher accounts receivable, inventory investment and lower contract liabilities.
- Financing cash flow was positive $5.3 million versus negative $6.3 million, largely because the company did not repurchase stock in 2019, compared with a $10.0 million repurchase in 2018.
- The company entered into a Texas lease for a planned oil and gas commercial development center. Base rent is expected to be approximately $0.3 million per month, with total lease payments of approximately $4.0 million over the initial term. The facility was expected to commence in the fourth quarter of 2019.
Guidance, Outlook, Commentary and Risks
The filing does not provide formal numerical revenue or earnings guidance. Management expects to continue investing in new and enhanced energy recovery devices, diversification beyond desalination, oil and gas technologies and commercialization of products including VorTeq and MTeq. Management states that existing resources and operating cash flows should meet anticipated capital requirements for at least the next 12 months, while noting that acquisitions or rapid adoption of new technology could require additional financing.
- Revenue remains heavily concentrated in international Water Segment sales: 98% of product revenue was international in both Q3 and the first nine months.
- Saudi Arabia represented 27% of nine-month product revenue, while the United Arab Emirates represented 12%; customer and project concentration may cause quarterly volatility.
- One international Oil and Gas customer accounted for 100% of license and development revenue.
- Management cautions that project timing, customer payments, product mix and large desalination orders can cause significant quarter-to-quarter fluctuations.
- Key risks include adoption and commercialization of new products, dependence on desalination, oil and gas market conditions, international sales and foreign currency exposure, customer collection risk, intellectual-property protection, litigation and execution of product development plans.
- Open cancellable purchase orders were approximately $8.6 million. The company is subject to various litigation and claims, but the filing does not identify a currently estimable material liability.
- A 1% increase in interest rates would have reduced the fair value of fixed-income investments by approximately $0.4 million at September 30, 2019.
Important Facts for Investors to Verify
- Whether elevated Water Segment shipment levels and 72.2% nine-month product gross margin are sustainable.
- The timing and collectability of accounts receivable, given the decline in operating cash flow and $20.8 million receivable balance.
- Progress, costs and commercial traction for VorTeq, MTeq and the Texas oil and gas development center.
- The company’s exposure to concentrated international customers, particularly Saudi Arabia and the single license-and-development customer.
- The effect of continued research and development and sales investments on future operating margins.
- Outstanding stand-by letters of credit, related investment collateral and available borrowing capacity.
- The tax-rate impact of nonrecurring benefits and the comparability of future earnings with the unusually tax-benefited 2018 period.