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ENERGY RECOVERY INC 10-Q 2016

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
erii20160331_10q.htm

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2016

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to __________

 

Commission File Number: 001-34112

 

Energy Recovery, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

01-0616867

(State or other jurisdiction of incorporation)

(IRS Employer Identification No.)

   

1717 Doolittle Drive, San Leandro, CA

94577

(Address of Principal Executive Offices)

(Zip Code)

 

(510) 483-7370

(Registrant’s Telephone Number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. 

Yes ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☑ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer     ☐

  Accelerated filer

Non-accelerated filer       ☐

(Do not check if a smaller reporting company)

Smaller reporting company 

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  Yes ☐ No ☑

 

As of April 29, 2016, there were 52,334,038 shares of the registrant’s common stock outstanding.

 



 

 
1

 

 

ENERGY RECOVERY, INC.

 

QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2016

 

TABLE OF CONTENTS

 

 

Page

No.

PART I.   FINANCIAL INFORMATION

 
Item 1. Financial Statements (unaudited) 3
  Condensed Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015 3
  Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2016 and 2015 4
  Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2016 and 2015 5
  Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015 6
  Notes to Condensed Consolidated Financial Statements 7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4.  Controls and Procedures 27
   
PART II.  OTHER INFORMATION  
Item 1. Legal Proceedings 27
Item 1A. Risk Factors 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 6. Exhibits 28
  Signatures 29

 

 
2

 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements (unaudited)

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data and par value)

(unaudited)

 

   

March 31,

2016

   

December 31,

2015

 

ASSETS

 

Current assets:

               

Cash and cash equivalents

  $ 96,527     $ 99,931  

Restricted cash

    1,232       1,490  

Short-term investments

    255       257  

Accounts receivable, net of allowance for doubtful accounts of $156 and $166 at March 31, 2016 and December 31, 2015, respectively

    7,683       11,590  

Unbilled receivables, current

    1,804       1,879  

Inventories

    6,725       6,503  

Income tax receivable

    2        

Deferred tax assets, net

    1,145       938  

Prepaid expenses and other current assets

    1,299       943  

Total current assets

    116,672       123,531  

Restricted cash, non-current

    2,911       2,317  

Unbilled receivables, non-current

          6  

Property and equipment, net of accumulated depreciation of $19,113 and $18,338 at March 31, 2016 and December 31, 2015, respectively

    9,956       10,622  

Goodwill

    12,790       12,790  

Other intangible assets, net

    2,374       2,531  

Other assets, non-current

    2       2  

Total assets

  $ 144,705     $ 151,799  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

Current liabilities:

               

Accounts payable

  $ 2,592     $ 1,865  

Accrued expenses and other current liabilities

    4,984       7,808  

Income taxes payable

          2  

Accrued warranty reserve

    428       461  

Deferred revenue

    5,619       5,878  

Current portion of long-term debt

    10       10  

Total current liabilities

    13,633       16,024  

Long-term debt, net of current portion

    36       38  

Deferred tax liabilities, non-current, net

    2,360       2,360  

Deferred revenue, non-current

    67,766       69,000  

Other non-current liabilities

    674       718  

Total liabilities

    84,469       88,140  

Commitments and Contingencies (Note 9)

               

Stockholders’ equity:

               

Preferred stock, $0.001 par value; 10,000,000 shares authorized; no shares issued or outstanding

           

Common stock, $0.001 par value; 200,000,000 shares authorized; 55,368,637 shares issued and 52,215,481 shares outstanding at March 31, 2016, and 54,948,235 shares issued and 52,468,779 shares outstanding at December 31, 2015

    55       55  

Additional paid-in capital

    132,469       129,809  

Accumulated other comprehensive loss

    (75 )     (64 )

Treasury stock at cost, 3,153,156 and 2,479,456 shares repurchased at March 31, 2016 and December 31, 2015, respectively

    (10,941 )     (6,835 )

Accumulated deficit

    (61,272 )     (59,306 )

Total stockholders’ equity

    60,236       63,659  

Total liabilities and stockholders’ equity

  $ 144,705     $ 151,799  

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 
3

 

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Product revenue

  $ 10,051     $ 5,864  

Product cost of revenue

    3,674       2,531  

Product gross profit

    6,377       3,333  
                 

License and development revenue

    1,250        
                 

Operating expenses:

               

General and administrative

    4,884       6,278  

Sales and marketing

    2,070       2,433  

Research and development

    2,665       2,533  

Amortization of intangible assets

    157       159  

Total operating expenses

    9,776       11,403  

Loss from operations

    (2,149 )     (8,070 )
                 

Other expense:

               

Interest expense

    (1 )     (40 )

Other non-operating expense

    (21 )     (102 )

Loss before income taxes

    (2,171 )     (8,212 )

(Benefit) provision for income taxes

    (205 )     71  

Net loss

  $ (1,966 )   $ (8,283 )
                 

Basic and diluted net loss per share

  $ (0.04 )   $ (0.16 )
                 

Shares used in basic and diluted per share calculation

    52,207       51,948  

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 
4

 

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Net loss

  $ (1,966 )   $ (8,283 )

Other comprehensive (loss) income, net of tax:

               

Foreign currency translation adjustments

    (12 )     31  

Unrealized gain on investments

    1       3  

Other comprehensive (loss) income

    (11 )     34  

Comprehensive loss

  $ (1,977 )   $ (8,249 )

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 
5

 

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Cash Flows From Operating Activities

               

Net loss

  $ (1,966 )   $ (8,283 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Share-based compensation

    1,188       1,140  

Depreciation and amortization

    932       979  

Unrealized loss on foreign currency transactions

    53       124  

Change in fair value of put options

    29        

Valuation adjustments for excess or obsolete inventory

    12       (10 )

Provision for doubtful accounts

    4       2  

Amortization of premiums on investments

    3       79  

Provision for warranty claims

          21  

Deferred income taxes

    (207 )     65  

Reversal of accruals related to expired warranties

    (33 )      

Other non-cash adjustments

    (44 )     428  

Changes in operating assets and liabilities:

               

Accounts receivable

    3,904       5,524  

Accounts payable

    727       215  

Unbilled receivables

    81       314  

Income taxes payable

    (4 )     2  

Inventories

    (234 )     (1,120 )

Deferred revenue, product

    (245 )     574  

Prepaid and other assets

    (385 )     154  

Deferred revenue, SLB license

    (1,250 )      

Accrued expenses and other liabilities

    (2,825 )     (1,192 )

Net cash used in operating activities

    (260 )     (984 )
                 

Cash Flows From Investing Activities

               

Maturities of marketable securities

          4,675  

Capital expenditures

    (152 )     (179 )

Restricted cash

    (335 )     1,084  

Net cash (used in) provided by investing activities

    (487 )     5,580  
                 

Cash Flows From Financing Activities

               

Net proceeds from issuance of common stock

    1,515       250  

Proceeds from long-term debt

          55  

Repayment of long-term debt

    (2 )      

Repurchase of common stock

    (4,106 )      

Net cash (used in) provided by financing activities

    (2,593 )     305  

Effect of exchange rate differences on cash and cash equivalents

    (64 )     (11 )

Net change in cash and cash equivalents

    (3,404 )     4,890  

Cash and cash equivalents, beginning of period

    99,931       15,501  

Cash and cash equivalents, end of period

  $ 96,527     $ 20,391  

 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 
6

 

 

ENERGY RECOVERY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note 1 — The Company and Summary of Significant Accounting Policies

 

The Company

 

Energy Recovery, Inc. (the “Company”, “Energy Recovery”, “our”, “us”, or “we”) is an energy solutions provider. We convert wasted pressure energy into a reusable asset and preserve or eliminate pumping technology in hostile processing environments. Our core competencies are fluid dynamics and advanced material science. Our solutions are marketed and sold in fluid flow markets, such as water and oil & gas.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires our management to make judgments, assumptions, and estimates that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The accounting policies that reflect our more significant estimates and judgments and that we believe are the most critical to aid in fully understanding and evaluating our reported financial results are revenue recognition; allowance for doubtful accounts; allowance for product warranty; valuation of stock options; valuation and impairment of goodwill, long-lived assets, and acquired intangible assets; useful lives for depreciation and amortization; valuation adjustments for excess and obsolete inventory; and deferred taxes and valuation allowances on deferred tax assets. Actual results could differ materially from those estimates.

 

Basis of Presentation

 

The condensed consolidated financial statements include the accounts of Energy Recovery, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

 

The accompanying condensed consolidated financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. The December 31, 2015 condensed consolidated balance sheet was derived from audited financial statements, and may not include all disclosures required by U.S. GAAP; however, we believe that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for the fiscal year ended December 31, 2015 included in our Annual Report on Form 10-K filed with the SEC on March 3, 2016.

 

In the opinion of management, all adjustments, consisting of only normal recurring adjustments that are necessary to present fairly the financial position, results of operations, and cash flows for the interim periods, have been made. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers. The amendment requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. On July 9, 2015, the FASB voted to approve a one-year deferral of the effective date of ASU 2014-09. Based on the FASB’s decision, ASU 2014-09 will apply to us for annual reporting periods beginning after December 15, 2017, including interim reporting periods within annual reporting periods beginning after December 15, 2017. Additionally, the FASB decided to permit early adoption, but not before the original effective date (that is, annual periods beginning after December 15, 2016). The FASB issued ASU 2015-14 in August 2015, formally deferring the effective date of ASU 2014-09 by one year. We expect to adopt this guidance as of January 1, 2018. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the effect that ASU 2014-09 will have on our financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.

 

 
7

 

 

In January 2016, the FASB issued ASU No. 2016-01 Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 modifies certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. For public entities, ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. We do not expect the adoption of this standard to have a material impact on our financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02 Leases (Topic 842). ASU 2016-02 impacts any entity that enters into a lease with some specified scope exceptions. The guidance updates and supersedes Topic 840, Leases. For public entities, ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. We have not evaluated the impact of this guidance, but do not expect the adoption of this standard to have a material impact on our financial statements.

 

In March and April 2016, the FASB issued ASU No. 2016-08 and ASU No. 2016-10, respectively, Revenue from Contracts with Customers (Topic 606). The amendments in the Updates are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations and to clarify two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. The effective date and transition requirements for both ASU 2016-08 and ASU 2016-10 are the same as those for ASU 2014-09 as deferred by ASU 2015-14.

 

In March 2016, the FASB issued ASU No. 2016-09 Compensation – Stock Compensation (Topic 718). ASU 2016-09 affects any entity that issues share-based payment awards to their employees and is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public entities, ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods with those annual periods. Early adoption is permitted. We have not evaluated the impact of this guidance, but do not expect the adoption of this standard to have a material impact on our financial statements.

 

 

Note 2 — Goodwill and Other Intangible Assets

 

Goodwill as of March 31, 2016 and December 31, 2015 of $12.8 million was the result of our acquisition of Pump Engineering, LLC in December 2009. During the three months ended March 31, 2016, there were no changes in the recognized amount of goodwill, and there has been no impairment of goodwill to date.

 

The components of identifiable other intangible assets, all of which are finite-lived, as of the dates indicated were as follows (in thousands):

 

      March 31, 2016  
     

Gross

Carrying

Amount

     

Accumulated

Amortization

     

Accumulated

Impairment

Losses

     

Net

Carrying

Amount

 

Developed technology

  $ 6,100     $ (3,863 )   $     $ 2,237  

Non-compete agreements

    1,310       (1,310 )            

Backlog

    1,300       (1,300 )            

Trademarks

    1,200       (180 )     (1,020 )      

Customer relationships

    990       (990 )            

Patents

    585       (406 )     (42 )     137  

Total

  $ 11,485     $ (8,049 )   $ (1,062 )   $ 2,374  

 

   

December 31, 2015

 
                                 
   

Gross

Carrying

Amount

   

Accumulated

Amortization

   

Accumulated

Impairment

Losses

   

Net

Carrying

Amount

 

Developed technology

  $ 6,100     $ (3,711 )   $     $ 2,389  

Non-compete agreements

    1,310       (1,310 )            

Backlog

    1,300       (1,300 )            

Trademarks

    1,200       (180 )     (1,020 )      

Customer relationships

    990       (990 )            

Patents

    585       (401 )     (42 )     142  

Total

  $ 11,485     $ (7,892 )   $ (1,062 )   $ 2,531  

 

Accumulated impairment losses at March 31, 2016 include impairment charges for trademarks in 2012 and impairment charges for patents in 2007 and 2010.

 

 
8

 

 

Note 3 — Loss per Share

 

Basic and diluted net loss per share is based on the weighted average number of common shares outstanding during the period. Potential dilutive securities are excluded from the calculation of loss per share, as their inclusion would be anti-dilutive.

 

The following table shows the computation of basic and diluted loss per share (in thousands, except per share data):

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Numerator:

               

Net loss

  $ (1,966 )   $ (8,283 )

Denominator:

               

Basic and diluted weighted average common shares outstanding

    52,207       51,948  
                 

Basic and diluted net loss per share

  $ (0.04 )   $ (0.16 )

 

 

The following potential common shares were excluded from the computation of diluted loss per share because their effect would have been anti-dilutive (in thousands):

 

   

Three months Ended

March 31,

 
   

2016

   

2015

 

Stock options

    7,432       7,864  

Warrants

          200  

Restricted awards

    205        

 

 

Note 4 — Other Financial Information

 

Restricted Cash

 

We have pledged cash in connection with stand-by letters of credit. We have deposited corresponding amounts into a money market account at a financial institution for these items as follows (in thousands):

 

   

March 31,

2016

   

December 31,

2015

 

Current collateral for stand-by letters of credit

  $ 1,232     $ 1,490  

Non-current collateral for stand-by letters of credit

    2,911       2,317  

Total restricted cash

  $ 4,143     $ 3,807  

 

 

Inventories

 

Our inventories are stated at the lower of cost (using the first-in, first-out “FIFO” method) or market and consisted of the following (in thousands):

 

   

March 31,

2016

   

December 31,

2015

 

Raw materials

  $ 2,380     $ 2,590  

Work in process

    1,990       1,689  

Finished goods

    2,355       2,224  

Inventories

  $ 6,725     $ 6,503  

 

 
9

 

 

Prepaid and Other Current Assets

 

Prepaid expenses and other current assets consisted of the following (in thousands):

 

   

March 31,

2016

   

December 31,

2015

 

Foreign currency put option

  $ 4     $ 33  

Interest receivable

    15       4  

Supplier advances

    106       171  

Prepaid rent

    142       7  

Other prepaid expenses and current assets

    1,032       728  

Total prepaid and other current assets

  $ 1,299     $ 943  

 

 

Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consisted of the following (in thousands):

 

   

March 31,

2016

   

December 31,

2015

 

Payroll and commissions payable

  $ 2,194     $ 5,086  

Accrued legal expenses

    306       217  

Other accrued expenses and current liabilities

    2,484       2,505  

Accrued expenses and other current liabilities

  $ 4,984     $ 7,808  

 

 

Accumulated Other Comprehensive Loss

 

Changes in accumulated other comprehensive loss by component for the quarter ended March 31, 2016, were as follows (in thousands):

 

   

Foreign

Currency

Translation

Adjustments

Net of Tax

Benefit

   

Unrealized

Gains (Losses)

on

Investments

   

Total

Accumulated

Other

Comprehensive

Loss

 

Balance, December 31, 2015

  $ (63 )   $ (1 )   $ (64 )

Net other comprehensive (loss) income

    (12 )     1       (11 )

Balance, March 31, 2016

  $ (75 )   $     $ (75 )

 

There were no reclassifications of amounts out of accumulated other comprehensive loss, as there have been no sales of securities or translation adjustments that impacted other comprehensive loss during the quarter. The tax impact of the changes in accumulated other comprehensive loss were not material.

 

 

Note 5 — Investments

 

Our short-term investments are all classified as available-for-sale. There were no sales of available-for-sale securities during the quarter ended March 31, 2016.

 

 

Available-for-sale securities as of the dates indicated consisted of the following (in thousands):

 

   

March 31, 2016

 
   

Amortized Cost

   

Gross Unrealized

Holding Gains

   

Gross Unrealized

Holding Losses

   

Fair Value

 

Corporate notes and bonds

  $ 256     $     $ (1 )   $ 255  

Total short-term investments

  $ 256     $     $ (1 )   $ 255  

 

 
10

 

 

   

December 31, 2015

 
   

Amortized Cost

   

Gross Unrealized

Holding Gains

   

Gross Unrealized

Holding Losses

   

Fair Value

 

Corporate notes and bonds

  $ 258     $     $ (1 )   $ 257  

Total short-term investments

  $ 258     $     $ (1 )   $ 257  

 

Gross unrealized losses and fair values of our investments in an unrealized loss position as of the dates indicated, aggregated by investment category and length of time that the security has been in a continuous loss position, were as follows (in thousands):

 

   

March 31, 2016

 
   

Less than 12 months

   

12 months or greater

   

Total

 
   

Fair Value

   

Gross

Unrealized

Losses

   

Fair Value

   

Gross

Unrealized

Losses

   

Fair Value

   

Gross

Unrealized

Losses

 

Corporate notes and bonds

  $     $     $ 255     $ (1 )   $ 255     $ (1 )

Total

  $     $     $ 255     $ (1 )   $ 255     $ (1 )

 

   

December 31, 2015

 
   

Less than 12 months

   

12 months or greater

   

Total

 
   

Fair Value

   

Gross

Unrealized

Losses

   

Fair Value

   

Gross

Unrealized

Losses

   

Fair Value

   

Gross

Unrealized

Losses

 

Corporate notes and bonds

  $     $     $ 257     $ (1 )   $ 257     $ (1 )

Total

  $     $     $ 257     $ (1 )   $ 257     $ (1 )

 

 

Expected maturities can differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties. The amortized cost and fair value of available-for-sale securities that had stated maturities as of March 31, 2016 are shown below by contractual maturity (in thousands):

 

   

March 31, 2016

 
   

Amortized Cost

   

Fair Value

 

Due in one year or less

  $ 256     $ 255  

Total available-for-sale securities

  $ 256     $ 255  

 

 

Note 6 — Long-Term Debt and Line of Credit

 

Debt

 

In March 2015, we entered into a loan agreement with a financial institution for a $55,000 fixed-rate installment loan carrying an annual interest rate of 6.35%. The loan is payable in equal monthly installments and matures on April 2, 2020. The note is secured by the asset purchased.

 

Long-term debt consisted of the following (in thousands)

 

   

March 31,

2016

   

December 31,

2015

 

Loan payable

  $ 46     $ 48  

Less: current portion

    (10 )     (10 )

Total long-term debt

  $ 36     $ 38  

 

 
11

 

 

Future minimum principal payments due under long-term debt arrangements consist of the following (in thousands):

 

   

March 31,

2016

 

2016 (remaining 9 months)

  $ 8  

2017

    11  

2018

    11  

2019

    12  

2020

    4  

Total debt

  $ 46  

 

 

Line of Credit

 

In June 2012, we entered into a loan agreement (the “2012 Agreement”) with a financial institution. The 2012 Agreement matured in and was amended in June 2015. The 2012 Agreement, as amended, provides for a total available credit line of $16.0 million. Under the 2012 Agreement, we are allowed to draw advances not to exceed, at any time, $10.0 million as revolving loans. The total stand-by letters of credit issued under the 2012 Agreement may not exceed the lesser of the $16.0 million credit line or the credit line minus all outstanding revolving loans. At no time may the aggregate of the revolving loans and stand-by letters of credit exceed the total available credit line of $16.0 million. Revolving loans may be in the form of a base rate loan that bears interest equal to the prime rate or a Eurodollar loan that bears interest equal to the adjusted LIBOR rate plus 1.25%. Stand-by letters of credit are subject to customary fees and expenses for issuance or renewal. The unused portion of the credit facility is subject to a facility fee in an amount equal to 0.25% per annum of the average unused portion of the revolving line. The 2012 Agreement, as amended, also requires us to maintain a cash collateral balance equal to 101% of all outstanding advances and all outstanding stand-by letters of credit collateralized by the line of credit. The 2012 Agreement, as amended, matures in June 2018 and is collateralized by substantially all of our assets.

 

As of March 31, 2016 and December 31, 2015, there were no advances drawn under the 2012 Agreement. Stand-by letters of credit collateralized under the 2012 Agreement, as amended, totaled $4.1 million and $3.8 million as of March 31, 2016 and December 31, 2015, respectively. Total cash restricted related to these stand-by letters of credit totaled $4.1 million and $3.8 million as of March 31, 2016 and December 31, 2015, respectively.

 

We are subject to certain financial and administrative covenants under the 2012 Agreement, as amended. As of March 31, 2016, we were in compliance with these covenants.

 

 

Note 7 — Equity

 

Stock Repurchase Program

 

In January 2016, the Board of Directors authorized a stock repurchase program under which shares, not to exceed $6.0 million in aggregate cost, of our outstanding common stock can be repurchased through June 30, 2016 at the discretion of management. We account for stock repurchases using the cost method. Cost includes fees charged in connection with acquiring the treasury stock. As of March 31, 2016, 673,700 shares, at an aggregate cost of $4.1 million, had been repurchased under this authorization.

 

Share-Based Compensation Expense

 

For the three months ended March 31, 2016 and 2015, we recognized share-based compensation expense related to employees and consultants as follows (in thousands):

  

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Cost of revenue

  $ 38     $ 35  

General and administrative

    884       897  

Sales and marketing

    159       101  

Research and development

    107       107  

Total share-based compensation expense

  $ 1,188     $ 1,140  

 

 
12

 

 

 

As of March 31, 2016, total unrecognized compensation cost related to non-vested share-based awards, net of estimated forfeitures, was $6.2 million, which is expected to be recognized as expense over a weighted average period of approximately 3.35 years.

 

In February 2016, we granted 20,678 options to purchase stock to a new employee. The options vest over a four-year period, have an exercise price of $6.00 per share, and expire 10 years from the grant date.

 

In February 2016, we also granted 32,000 options to purchase stock to another new employee. The options vest over a four-year period, have an exercise price of $7.26 per share, and expire 10 years from the grant date.

 

In March 2016, we granted 650,301 options to purchase stock to officers and other employees. The options vest over a four-year period, have an exercise price of $8.52 per share, and expire 10 years from the grant date.

 

In March 2016, we also granted 204,514 restricted stock units to officers and other employees. The restricted units vest over a four-year period, have a grant price of $8.52 per share, and expire 10 years from the grant date.

 

In connection with the resignation of Mr. Juan Otero, as General Counsel, Chief Compliance Officer, and Secretary, additional stock based compensation of approximately $0.5 million was recorded in the first quarter of 2016 related to the continued vesting of awards granted to Mr. Otero prior to his resignation.

 

 

Note 8 — Income Taxes

 

The effective tax rate for the three months ended March 31, 2016 and 2015 was 9.4% and (1.0%), respectively. As of December 31, 2015, a valuation allowance of approximately $21.4 million had been established to reduce our deferred income tax assets to the amount expected to be realized. The tax benefit recognized for the three months ended March 31, 2016, was primarily related to losses in our Ireland subsidiary.

 

 

Note 9 — Commitments and Contingencies

 

Operating Lease Obligations

 

We lease facilities under fixed non-cancellable operating leases that expire on various dates through November 2019. Future minimum lease payments consist of the following (in thousands):

 

   

March 31,

2016

 

2016 (remaining nine months)

    1,206  

2017

    1,577  

2018

    1,600  

2019

    1,402  

Total future minimum lease payments

  $ 5,785  

 

 

Product Warranty

 

The following table summarizes the activity related to the product warranty liability during the three months ended March 31, 2016 and 2015 (in thousands):

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Balance, beginning of period

  $ 461     $ 755  

Warranty costs charged to cost of revenue

          21  

Release of accrual for expired warranties

    (33 )      

Utilization of warranty

          (20 )

Balance, end of period

  $ 428     $ 756  

 

 
13

 

 

Purchase Obligations

 

We enter into purchase order arrangements with our vendors. As of March 31, 2016, there were open purchase orders for which we had not yet received the related goods or services. These arrangements are subject to change based on our sales demand forecasts, and we have the right to cancel the arrangements prior to the date of delivery. As of March 31, 2016, we had approximately $2.0 million of cancellable open purchase order arrangements related primarily to materials and parts.

 

Guarantees 

 

We enter into indemnification provisions under our agreements with other companies in the ordinary course of business, typically with customers. Under these provisions, we generally indemnify and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of our activities, generally limited to personal injury and property damage caused by our employees at a customer’s desalination plant in proportion to the employee’s percentage of fault for the accident. Damages incurred for these indemnifications would be covered by our general liability insurance to the extent provided by the policy limitations. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the estimated fair value of these agreements is not material. Accordingly, we have no liabilities recorded for these agreements as of March 31, 2016 and December 31, 2015.

 

In certain cases, we issue warranty and product performance guarantees to our customers for amounts ranging from 5% to 15% of the total sales agreement to endorse the execution of product delivery and the warranty of design work, fabrication, and operating performance. These guarantees, generally in the form of stand-by letters of credit or bank guarantees secured by stand-by letters of credit, typically remain in place for periods ranging up to 24 months and in some cases up to 68 months, and relate to the underlying product warranty period. The stand-by letters of credit are collateralized by restricted cash and our credit facility. The $4.1 million in stand-by letters of credit outstanding at March 31, 2016 were collateralized by restricted cash of $4.1 million.

 

Litigation

 

On September 10, 2014, the Company terminated the employment of its Senior Vice President, Sales, Borja Blanco, on the basis of breach of duty of trust and conduct leading to conflict of interest. On October 24, 2014, Mr. Blanco filed a labor claim against ERI Iberia in Madrid, Spain challenging the fairness of his dismissal and seeking compensation (“Case 1”). A hearing was held on November 13, 2015 after which the labor court ruled that it did not have jurisdiction over the matter. Mr. Blanco has appealed. At this time, the Company has not determined that an award to Mr. Blanco is probable.

 

On November 24, 2014, Mr. Blanco filed a second action based on breach of contract theories in the same court as Case 1, but the cases are separate. In Case 2, Mr. Blanco seek s payment of unpaid bonus, stock options, and non-compete compensation. The court ruled that this case is stayed until a final ruling is issued in Case 1. At this time, the Company has not determined that an award to Mr. Blanco is probable.

 

On January 20 and 27, 2015, two stockholder class action complaints were filed against the Company in the United States District Court of the Northern District of California, on behalf of Energy Recovery stockholders under the captions, Joseph Sabatino v. Energy Recovery, Inc. et al., Case No. 3:15-cv-00265 EMC, and Thomas C. Mowdy v. Energy Recovery, Inc, et al., Case No. 3:15-cv-00374 EMC. The complaints have now been consolidated under the caption, In Re Energy Recovery Inc. Securities Litigation, Case No. 3:15-cv-00265 EMC. The complaint alleges violations of Section 10(b), Rule 10b-5, and Section 20(a) of the Securities Exchange Act of 1934 based upon alleged public misrepresentations and seeks the recovery of unspecified monetary damages. The Company is not able to estimate the possible loss, if any, due to the early stage of this matter.

 

On January 27, 2016, a complaint was filed by the Company’s Former Chief Sales Officer, Mr. David Barnes, in the United States District Court for the Northern District of California under the caption, David Barnes v. Energy Recovery, Inc., et al. Case No. 3:16-cv-00477 EMC, related to his separation from the Company and alleging numerous legal claims including, but not limited to, wrongful termination, breach of contracts and negligent and/or intentional misrepresentations to induce Mr. Barnes to join the Company. Mr. Barnes is seeking to recover, among other things, relocation and business expenses, back pay, front pay, lost equity, contractual severance, emotional distress damages, punitive damages, damages under the California Private Attorneys General Act, attorneys’ fees, costs and interest. At this time, the Company is not able to estimate a potential loss, if any, due to the early stage of the matter.

 

 
14

 

  

On February 18, 2016, a complaint captioned Goldberg v. Rooney, et al., HG 16804359, was filed in the Superior Court for the State of California, County of Alameda, naming as defendants Thomas Rooney, Alexander J. Buehler, Joel Gay, Ole Peter Lorentzen, Audrey Bold, Arve Hanstveit, Fred Olav Johannessen, Robert Yu Lang Mao, Hans Peter Michelet, Maria Elisabeth Pate-Cornell, Paul Cook, Olav Fjell, and Dominique Trempont (“Individual Defendants”) and naming the Company as a nominal defendant. The complaint is styled as a derivative action being brought on behalf of the Company and generally alleges breach of fiduciary duty, abuse of control, gross mismanagement and unjust enrichment causes of action against the Individual Defendants. At this time, the Company is not able to estimate a potential loss, if any, due to the early stage of the matter.

 

 

Note 10 — Business Segment and Geographic Information

 

We manufacture and sell high-efficiency energy recovery devices and pumps as well as related products and services. Our chief operating decision-maker (“CODM”) is the chief executive officer (“CEO”).

 

Following the appointment of a new CEO in April 2015, new internal reporting was developed for making operating decisions and assessing financial performance. Beginning July 1, 2015, a new internal organizational and reporting structure was implemented and we began reporting segment information on a basis reflecting this new structure. Prior period amounts have been adjusted retrospectively to reflect this new internal reporting structure.

 

Our reportable operating segments consist of the Water Segment and the Oil & Gas Segment. These segments are based on the industries in which the products are sold, the type of energy recovery device sold, and the related products and services. The Water Segment consists of revenue associated with products sold for use in reverse osmosis water desalination, as well as the related identifiable expenses. The Oil & Gas Segment consists of product revenue associated with products sold for use in gas processing, chemical processing, and hydraulic fracturing and license and development revenue associated with hydraulic fracturing, as well as related identifiable expenses. Operating income for each segment excludes other income and expenses and certain expenses managed outside the operating segment. Costs excluded from operating income include various corporate expenses such as certain share-based compensation expenses, income taxes, and other separately managed general and administrative expenses not related to the identified segments. Assets and liabilities are reviewed at the consolidated level by the CODM and are not accounted for by segment. The CODM allocates resources to and assesses the performance of each operating segment using information about its revenue and operating income (loss).

 

The following summarizes financial information by segment for the periods presented (in thousands):

 

   

Three Months Ended March 31, 2016

   

Three Months Ended March 31, 2015

 
   

Water

   

Oil &Gas

   

Total

   

Water

   

Oil &Gas

   

Total

 

Product revenue

  $ 10,051     $     $ 10,051     $ 5,723     $ 141     $ 5,864  

Product cost of revenue

    3,674             3,674       2,503       25       2,531  

Product gross profit

    6,377             6,377       3,220       113       3,333  
                                                 

License and development revenue

          1,250       1,250                    
                                                 

Operating expenses:

                                               

General and administrative

    219       188       407       604       332       936  

Sales and marketing

    1,129       807       1,936       1,170       1,120       2,290  

Research and development

    359       2,297       2,656       345       2,160       2,505  

Amortization of intangibles

    157             157       159             159  

Operating expenses

    1,864       3,292       5,156       2,278       3,612       5,890  
                                                 

Operating income (loss)

  $ 4,513     $ (2,042 )     2,471     $ 942     $ (3,499 )     (2,557 )

Less:

                                               

Corporate operating expenses

                    4,620                       5,513  

Consolidated operating loss

                    (2,149 )                     (8,070 )

Non-operating expenses

                    (22 )                     (142 )

Loss before income taxes

                  $ (2,171 )                   $ (8,212 )

 

 
15

 

 

The following geographic information includes net revenue to our domestic and international customers based on the customers’ requested delivery locations, except for certain cases in which the customer directed us to deliver our products to a location that differs from the known ultimate location of use. In such cases, the ultimate location of use, rather than the delivery location, is reflected in the table below (in thousands, except percentages):

 

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Domestic product revenue

  $ 185     $ 264  

International product revenue

    9,866       5,600  

Total product revenue

  $ 10,051     $ 5,864  
                 

Product revenue by country:

               

Qatar

    39 %     * %

Spain

    11 %     13 %

United States

    2 %     5 %

Egypt

    1 %     22 %

Others **

    47 %     60 %

Total

    100 %     100 %

 

 

*

Less than 1% or none.

  ** Includes remaining countries not separately disclosed. No country in this line item accounted for more than 10% of our product revenue during the periods presented.

 

All of our long-lived assets were located in the United States at March 31, 2016 and December 31, 2015.

 

 

Note 11 — Concentrations

 

Customers accounting for 10% or more of our accounts receivable and unbilled receivables were as follows:

 

   

March 31,

2016

   

December 31,

2015

 

Customer A

    48 %     18 %

Customer B

    5 %     26 %

 

Revenue from customers representing 10% or more of product revenue varies from period to period. For the periods indicated, customers representing 10% or more of product revenue were:

 

   

Three Months Ended

March 31,

 
    2016     2015  
Customer A     41 %     * %

Customer C

    * %     12 %

Customer D

    3 %     12 %

 

*     Less than 1% or none.

 

A single customer, Customer E, represents 100% of our license and development revenue for the three months ended March 31, 2016. There was no license and development revenue recognized for the three months ended March 31, 2015.

 

Vendors accounting for 10% or more of our accounts payable were as follows:

 

   

March 31,

2016

   

December 31,

2015

 

Vendor A

    14 %     0 %

 

 
16

 

 

Note 12 — Fair Value Measurements

 

The authoritative guidance for measuring fair value provides a hierarchy that prioritizes the inputs to valuation techniques used in measuring fair value as follows:

 

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2 — Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and

Level 3 — Unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions that market participants would use in pricing.

 

The carrying values of cash and cash equivalents, restricted cash, accounts receivable, unbilled receivables, accounts payable, and other accrued expenses approximate fair value due to the short-term maturity of those instruments. For our investments in available-for-sale securities, if quoted prices in active markets for identical investments are not available to determine fair value (Level 1), then we use quoted prices for similar assets or inputs other than quoted prices that are observable either directly or indirectly (Level 2). The investments included in Level 2 consist of corporate agency obligations and the premium paid for foreign currency put options.

 

The fair value of financial assets and liabilities measured on a recurring basis for the indicated periods was as follows (in thousands):

 

   

March 31,

2016

   

Level 1
Inputs

   

Level 2

Inputs

   

Level 3

Inputs

 

Assets:

                               

Available-for-sale securities

  $ 255     $     $ 255     $  

Foreign currency put option

    4             4        

Total assets

  $ 259     $     $ 259     $  

 

   

December 31,

2015

   

Level 1
Inputs

   

Level 2

Inputs

   

Level 3

Inputs

 

Assets:

                               

Available-for-sale securities

  $ 257     $     $ 257     $  

Foreign currency put options

    33             33        

Total assets

  $ 290     $     $ 290     $  

 

Note 13 — Related Party Transactions

 

In January 2016, the Company entered into a lease agreement with EMS USA, Inc. for the use of office space. The President and Chief Executive Officer of EMS USA, Inc. is also a member of the Board of Directors of the Company. The lease is for a term of ninety (90) days with continuation on a month-to-month basis thereafter, with each month being an “Additional Term.” Additional Terms are not to exceed a total of three. The Company paid EMS USA, Inc. $1,668 related to this agreement during the three months ended March 31, 2016.

 

In March 2016, the Company extended an employee loan to one of its employees for $21,786. The loan is repayable to the Company monthly over six months and is non-interest bearing.

 

 

Note 14 - Subsequent Events

 

On April 20, 2016, the Company announced the receipt of a Letter of Award to provide our IsoBoostTM technology for integration into a major gas processing plant to be constructed in the Middle East. The award value is approximately $7 million worth of equipment and services with a potential to supply an additional $4 million worth of equipment and services. The total potential value could be worth approximately $11 million; however the optional supply may not be confirmed by our client until the latter portion of 2017.

 

 
17

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The discussion in this item and in other items of this Form 10-Q contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements in this report include, but are not limited to, statements about our expectations, objectives, anticipations, plans, hopes, beliefs, intentions, or strategies regarding the future.

 

Forward-looking statements that represent our current expectations about future events are based on assumptions and involve risks and uncertainties. If the risks or uncertainties occur or the assumptions prove incorrect, then our results may differ materially from those set forth or implied by the forward-looking statements. Our forward-looking statements are not guarantees of future performance or events.

 

Words such as expects, anticipates, believes, estimates, variations of such words, and similar expressions are also intended to identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties, and assumptions that are difficult to predict; therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Forward-looking statements in this report include, without limitation, statements about the following:

 

 

our expectation that sales outside of the United States will remain a significant portion of our product revenue;

 

 

our expectation that we will meet the two key milestones associated with our VorTeqTM licensing agreement with Schlumberger Technology Corporation and will receive annual royalties under said agreement;

 

 

our expectation that oil price fluctuations may impact the acceptance or rate of adoption of our oil & gas and hydraulic fracturing products;

 

 

our belief that levels of gross profit margin for our Water Segment are sustainable to the extent that volume grows, we experience a favorable product mix, pricing remains stable, and we continue to realize cost savings through production efficiencies and enhanced yields;

 

 

our expectation that, as we expand our international sales, a portion of our revenue could continue to be denominated in foreign currencies;

 

 

our expectation that our expenses for research and development and sales and marketing may increase as a result of the diversification into markets outside of water and hydraulic fracturing; and

 

 

our belief that our existing cash balances and cash generated from our operations will be sufficient to meet our anticipated liquidity needs for the foreseeable future, with the exception of a decision to enter into an acquisition and/or fund investments in newly developed technologies or product offerings arising from rapid market adoption that could require us to seek additional equity or debt financing.

 

You should not place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date of the filing of this Quarterly Report on Form 10-Q. All forward-looking statements included in this document are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected in the forward-looking statements, as disclosed from time to time in our reports on Forms 10-K, 10-Q, and 8-K as well as in our Annual Reports to Stockholders and, if necessary, updated in “Part II, Item 1A: Risk Factors.” We assume no obligation to update any such forward-looking statements. It is important to note that our actual results could differ materially from the results set forth or implied by our forward-looking statements.

 

 
18

 

 

Overview

 

We are an energy solutions provider to industrial fluid flow markets worldwide. We make industrial processes more operating and capital expenditure efficient. Our solutions convert wasted pressure energy into a reusable asset and preserve or eliminate pumping technology in hostile processing environments. Our core competencies are fluid dynamics and advanced material science. Our company was founded in 1992, and we introduced the initial version of our Pressure Exchanger® energy recovery device in early 1997 for sea water reverse osmosis desalination. In December 2009, we acquired Pump Engineering, LLC, which manufactured centrifugal energy recovery devices known as turbochargers as well as high-pressure pumps. In 2012, we introduced the IsoBoost and IsoGen branded products for use in the oil & gas industry. In 2015, we conducted field trials for the VorTeq hydraulic pumping solution also for use in the oil & gas industry for oil field hydraulic fracturing operations and entered into a fifteen year license agreement with Schlumberger Technology Corporation.

 

Following the appointment of a new Chief Executive Officer in April 2015, new internal reporting was developed for making operating decisions and assessing financial performance. Beginning July 1, 2015, a new internal organizational and reporting structure was implemented and we began reporting segment information on a basis reflecting this new structure. Prior period segment results have been adjusted retrospectively to reflect this new internal reporting structure.

 

Our reportable operating segments consist of the Water Segment and the Oil & Gas Segment. These segments are based on the industries in which the products are sold, the type of energy recovery device sold, and the related solution and services.

 

Water Segment

 

The Water Segment consists of revenue associated with products sold for use in reverse osmosis water desalination, as well as the related identifiable expenses. Our Water Segment revenue is principally derived from the sale of our energy recovery devices for use in water desalination plants worldwide. We also derive product revenue from the sale of our high-pressure and circulation pumps which we manufacture and sell both separately and in connection with our energy recovery devices for use in water desalination plants. Additionally, we receive product revenue from the sale of spare parts and services, including start-up and commissioning services that we provide to our customers.

 

With respect to product revenue from our energy recovery devices in our Water Segment, a significant portion of our revenue typically has been generated from sales to a limited number of large engineering, procurement, and construction, or EPC, firms that are involved with the design and construction of large desalination plants. Sales to these firms often involve a long sales cycle that can range from 16 to 36 months. A single large desalination project can generate an order for numerous energy recovery devices and generally represents a significant revenue opportunity. We also sell our devices to many small- to medium-sized original equipment manufacturers, or OEMs, which commission smaller desalination plants, order fewer energy recovery devices per plant, and have shorter sales cycles.

 

We often experience substantial fluctuations in our Water Segment net revenue from quarter to quarter and from year to year because a single order for our energy recovery devices by a large EPC firm for a particular plant may represent significant revenue. In addition, historically our EPC customers tend to order a significant amount of equipment for delivery in the fourth quarter, and as a consequence, a significant portion of our annual sales typically occurs during that quarter. This historical trend was reflected in the fourth quarter of the last several years. Normal seasonality trends also generally show our lowest revenue in the first quarter of the year.

 

A limited number of our customers account for a substantial portion of our product revenue and of our accounts receivable and unbilled receivables. Product revenue from customers representing 10% or more of product revenue varies from period to period. For the three months ended March 31, 2016, one customer accounted for 41% of our product revenue. For the three months ended March 31, 2015, two customers accounted for 12% each of our product revenue. No other customer accounted for more than 10% of our product revenue during any of these periods.

 

At March 31, 2016, one customer accounted for 48% of our accounts receivable and unbilled receivables balance. At December 31, 2015, two customers accounted for 26% and 18%, respectively, of our accounts receivable and unbilled receivables balance.

 

At March 31, 2016, one vendor accounted for 14% of our accounts payable balance. At December 31, 2015, no customer accounted for more than 10% of our accounts payable balance.

 

During the three months ended March 31, 2016 and 2015, most of our product revenue and accounts receivable were attributable to sales outside of the United States. We expect sales and accounts receivable outside of the United States to remain a significant portion of our Water Segment product revenue and accounts receivable for the next few years.

 

 
19

 

 

Oil &Gas Segment

 

The Oil & Gas Segment consists of revenue associated with products sold or licensed for use in gas processing, chemical processing, and hydraulic fracturing, as well as related identifiable expenses. In the past several years, we have invested significant research and development costs to expand our business into pressurized fluid flow industries within the oil & gas industry. In 2014, we announced a new product for the hydraulic fracturing industry, the VorTeq hydraulic fracturing system. Field trials were initiated for the VorTeq in the second quarter of 2015 and successfully completed in December 2015.

 

No oil & gas product revenue was recognized during the three months ended March 31, 2016. In the first quarter of 2015, we recognized oil & gas product revenue of $0.1 million from oil & gas commissioning services and fees related to the cancellation of a ConocoPhillips sales order.

 

On October 14, 2015, the Company, through our subsidiary ERI Energy Recovery Ireland Ltd., entered into a Licensing Agreement (the “Agreement”) with Schlumberger Technology Corporation, a subsidiary of Schlumberger Limited (NYSE:SLB). The Agreement has a term of fifteen (15) years for the exclusive right to use certain intellectual property related to our VorTeq Hydraulic Fracturing System technology. The Agreement provided for a $75 million exclusivity payment in connection with the execution of the Agreement, two separate $25 million payments upon the meeting of two milestones, and recurring royalty payments throughout the term of the Agreement. License and development revenue related to the exclusivity payment is recognized over the term of the agreement with $1.3 million of license and development revenue recognized in the three months ended March 31, 2016.

 

Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. These accounting principles require us to make estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements as well as the reported amounts of revenue and expense during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that we make these estimates and judgments. To the extent that there are material differences between these estimates and actual results, our consolidated financial results will be affected. The accounting policies that reflect our more significant estimates and judgments and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results are revenue recognition; allowance for doubtful accounts; allowance for product warranty; valuation of stock options; valuation and impairment of goodwill, long-lived assets, and acquired intangible assets; useful lives for depreciation and amortization; valuation adjustments for excess and obsolete inventory; and deferred taxes and valuation allowances on deferred tax assets.

 

 

First Quarter of 2016 Compared to First Quarter of 2015

 

Results of Operations

 

Total Revenue

 

   

Three Months Ended March 31,

 
   

2016

   

2015

   

Change

Increase / (Decrease)

 

Product revenue

  $ 10,051       89 %   $ 5,864       100 %   $ 4,187       71 %

License and development revenue

    1,250       11 %                 1,250       100 %

Total revenue

  $ 11,301       100 %   $ 5,864       100 %   $ 5,437       93 %

 

 

Product Revenue

 

   

Three Months Ended

March 31,

 

Segment

 

2016

   

2015

   

$ Change

   

% Change

 

Water

  $ 10,051     $ 5,723     $ 4,328       76 %

Oil & Gas

          141       (141 )     (100 %)

Product revenue

  $ 10,051     $ 5,864     $ 4,187       71 %

 

Product revenue in the Water Segment increased by $4.3 million, or 76%, to $10.1 million for the three months ended March 31, 2016 from $5.7 million for the three months ended March 31, 2015. The increase was primarily due to increased mega project (“MPD”) shipments of $3.9 million compared to no MPD shipments in the three months ended March 31, 2015. Also contributing to the increase were higher OEM shipments of $0.3 million and higher aftermarket shipments of $0.1 million.

 

 
20

 

 

Product revenue in the Oil & Gas Segment decreased by $0.1 million, or 100%, to zero for the three months ended March 31, 2016 from $0.1 million for the three months ended March 31, 2015.

 

The following table reflects product revenue by category and as a percentage of total product revenue (in thousands, except percentages):

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 

PX devices and related products

  $ 7,987       80 %   $ 4,076       70 %

Turbochargers, pumps, and related products

    2,064       20 %     1,647       28 %

Oil & gas product operating lease

                141       2 %

Product revenue

  $ 10,051       100 %   $ 5,864       100 %

 

 

During the three months ended March 31, 2016 and 2015, a significant portion of our product revenue was attributable to sales outside of the United States. Product revenue attributable to domestic and international sales as a percentage of product revenue was as follows:

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Domestic revenue

    2 %     5 %

International revenue

    98 %     95 %

Product revenue

    100 %     100 %

 

 

License and Development Revenue

 

   

Three Months Ended

March 31,

 

Segment

 

2016

   

2015

   

$ Change

   

% Change

 

Water

  $     $     $        

Oil & Gas

    1,250             1,250       100 %

License and development revenue

  $ 1,250     $     $ 1,250       100 %

 

The increase in license and development revenue during the three months ended March 31, 2016 was due to the recognition of $1.3 million in revenue associated with the licensing agreement with Schlumberger. The $1.3 million is representative of the straight-line basis of revenue recognition of the $75 million initial payment over the fifteen-year term of the agreement.

 

License and development revenue attributable to domestic and international sales as a percentage of license and development revenue was as follows:

 

   

Three Months Ended

March 31,

 
   

2016

   

2015

 

Domestic revenue

           

International revenue

    100 %      

License and development revenue

    100 %      

 

 

Product Gross Profit

 

   

Three Months Ended March 31, 2016

   

Three months Ended March 31, 2015

 
   

Water

   

Oil &Gas

   

Total

   

Water

   

Oil &Gas

   

Total

 

Product gross profit

  $ 6,377     $     $ 6,377     $ 3,220     $ 113     $ 3,333  

Product gross margin

    63 %           63 %     56 %     80 %     57 %

 

 

Product gross profit represents our product revenue less our product cost of revenue. Our product cost of revenue consists primarily of raw materials, personnel costs (including share-based compensation), manufacturing overhead, warranty costs, depreciation expense, and manufactured components. For the three months ended March 31, 2016, product gross profit as a percentage of product revenue was 63% compared to 57% for the three months ended March 31, 2015.

 

 
21

 

 

The increase in product gross profit as a percentage of product revenue in the three months ended March 31, 2016 compared to the three months ended March 31, 2015 was primarily due to a shift in product mix toward PX devices, increased sales volume, and pricing.

 

Future product gross profit is highly dependent on the product and customer mix of our product revenue, overall market demand and competition, and the volume of production in our manufacturing plant that determines our operating leverage. Accordingly, we are not able to predict our future product gross profit levels with certainty. We believe that the current levels of product gross profit margin are sustainable to the extent that volume remains healthy, our product mix favors PX devices, and we continue to realize cost savings through production efficiencies and enhanced yields.

 

Manufacturing headcount increased to 42 in the first quarter of 2016 from 37 in the first quarter of 2015.

 

Share-based compensation expense included in cost of revenue was $38,000 and $35,000 for the three months ended March 31, 2016 and 2015, respectively.

 

Operating Expenses

 

   

Three Months Ended March 31,

 
   

2016

   

2015

   

Change

Increase / (Decrease)

 

Total revenue

  $ 11,301       100 %   $ 5,864       100 %   $ 5,437       93 %
                                                 

Operating expenses:

                                               

General and administrative

    4,884       43 %     6,278       107 %     (1,394 )     (22 %)

Sales and marketing

    2,070       18 %     2,433       41