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 June 30, 2015
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 August 3, 2015, there were 52,231,186 shares of the registrant’s common stock outstanding.

  

 

ENERGY RECOVERY, INC.

 

QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2015

 

TABLE OF CONTENTS

 

		Page No.
	PART I.FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014	3
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2015 and 2014	4
	Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2015 and 2014	5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014	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	31
Item 4.	Controls and Procedures	32
	PART II.OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 6.	Exhibits	32
	Signatures	33

  

 

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)

 

		June 30, 2015				December 31, 2014
ASSETS
Current assets:
Cash and cash equivalents		$	18,107			$	15,501
Restricted cash			1,347				2,623
Short-term investments			4,713				13,072
Accounts receivable, net of allowance for doubtful accounts of $162 and $155 at June 30, 2015 and December 31, 2014, respectively			7,429				10,941
Unbilled receivables, current			1,193				1,343
Inventories			9,703				8,204
Deferred tax assets, net			240				240
Prepaid expenses and other current assets			1,080				1,317
Total current assets			43,812				53,241
Restricted cash, non-current			1,704				2,850
Unbilled receivables, non-current			504				414
Long-term investments			262				267
Property and equipment, net of accumulated depreciation of $16,777 and $15,143 at June 30, 2015 and December 31, 2014, respectively			12,085				13,211
Goodwill			12,790				12,790
Other intangible assets, net			2,849				3,166
Other assets, non-current			2				2
Total assets		$	74,008			$	85,941
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	2,366			$	1,817
Accrued expenses and other current liabilities			4,886				8,427
Income taxes payable			8				4
Accrued warranty reserve			747				755
Deferred revenue			1,224				519
Current portion of long-term debt			11				—
Total current liabilities			9,242				11,522
Long-term debt, net of current portion			42				—
Deferred tax liabilities, non-current, net			2,119				1,989
Deferred revenue, non-current			68				59
Other non-current liabilities			839				2,453
Total liabilities			12,310				16,023
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; 54,510,642 shares issued and 52,031,186 shares outstanding at June 30, 2015, and 54,398,421 shares issued and 51,918,965 shares outstanding at December 31, 2014			55				54
Additional paid-in capital			127,803				124,440
Accumulated other comprehensive loss			(47	)			(73	)
Treasury stock, at cost 2,479,456 shares repurchased at both June 30, 2015 and December 31, 2014			(6,835	)			(6,835	)
Accumulated deficit			(59,278	)			(47,668	)
Total stockholders’ equity			61,698				69,918
Total liabilities and stockholders’ equity		$	74,008			$	85,941

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Net revenue		$	10,484			$	6,407			$	16,348			$	10,304
Cost of revenue			4,836				3,332				7,367				4,984
Gross profit			5,648				3,075				8,981				5,320
Operating expenses:
General and administrative			5,362				2,995				11,640				5,034
Sales and marketing			1,994				2,702				4,427				5,197
Research and development			1,410				1,724				3,943				2,958
Amortization of intangible assets			158				215				317				430
Total operating expenses			8,924				7,636				20,327				13,619
Loss from operations			(3,276	)			(4,561	)			(11,346	)			(8,299	)
Interest expense			—				—				(40	)			—
Other non-operating (expense) income			20				8				(82	)			129
Loss before income taxes			(3,256	)			(4,553	)			(11,468	)			(8,170	)
Provision for income taxes			71				58				142				124
Net loss		$	(3,327	)		$	(4,611	)		$	(11,610	)		$	(8,294	)
Basic and diluted net loss per share		$	(0.06	)		$	(0.09	)		$	(0.22	)		$	(0.16	)
Shares used in basic and diluted per share calculation			52,026				51,566				51,987				51,506

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Net loss		$	(3,327	)		$	(4,611	)		$	(11,610	)		$	(8,294	)
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustments			(6	)			3				25				46
Unrealized (loss) gain on investments			(2	)			16				1				18
Other comprehensive (loss) income			(8	)			19				26				64
Comprehensive loss		$	(3,335	)		$	(4,592	)		$	(11,584	)		$	(8,230	)

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 

ENERGY RECOVERY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

		Six Months Ended June 30
		2015				2014
Cash Flows From Operating Activities
Net loss		$	(11,610	)		$	(8,294	)
Adjustments to reconcile net loss to net cash used in operating activities:
Share-based compensation			3,053				1,215
Depreciation and amortization			1,959				1,998
Deferred income taxes			131				111
Amortization of premiums/discounts on investments			130				239
Other non-cash adjustments			86				(153	)
Provision for doubtful accounts			59				126
Valuation adjustments for excess or obsolete inventory			21				43
Unrealized loss on foreign currency transactions			21				41
Provision for warranty claims			15				48
Changes in operating assets and liabilities:
Accounts receivable			3,472				5,724
Deferred revenue			714				153
Accounts payable			549				610
Prepaid and other assets			239				(213	)
Unbilled receivables			60				5,281
Income taxes payable			4				4
Inventories			(1,520	)			(4,683	)
Litigation settlement			(1,700	)			—
Accrued expenses and other liabilities			(3,633	)			(2,443	)
Net cash used in operating activities			(7,950	)			(193	)
Cash Flows From Investing Activities
Maturities of marketable securities			8,235				4,065
Restricted cash			2,422				(192	)
Capital expenditures			(429	)			(2,140	)
Net cash provided by investing activities			10,228				1,733
Cash Flows From Financing Activities
Net proceeds from issuance of common stock			293				1,138
Proceeds from borrowings			55				—
Repayment of long-term debt			(2	)			—
Repurchase of common stock for treasury			—				(633	)
Net cash provided by financing activities			346				505
Effect of exchange rate differences on cash and cash equivalents			(18	)			31
Net change in cash and cash equivalents			2,606				2,076
Cash and cash equivalents, beginning of period			15,501				14,371
Cash and cash equivalents, end of period		$	18,107			$	16,447

 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

 

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”, “we”, “our”, or “us”) 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 products are marketed and sold in fluid flow markets, such as desalination and oil & gas, under the trademarks ERI^®, PX^®, Pressure Exchanger^®, PX Pressure Exchanger^®, IsoBoost^®, IsoGen^®, and VorTeq ^®. Our products are developed and manufactured in the United States of America (“U.S.”) at our headquarters in San Leandro, California, and we have five wholly-owned subsidiaries: Energy Recovery Iberia, S.L., Energy Recovery Canada Corp., ERI Energy Recovery Ireland Ltd., Energy Recovery (Cayman) Ltd., and ERI Energy Recovery Holdings Ireland Limited. We also have sales offices in Dubai, United Arab Emirates and Shanghai, Peoples Republic of China.

 

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. Our more significant estimates and judgments 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, 2014 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, 2014 included in our Annual Report on Form 10-K filed with the SEC on March 6, 2015.

 

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”) 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. We expect to adopt this guidance as of January 1, 2017. Early application is not permitted. 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.

 

 

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 expects to issue its final update formally amending the effective date by the end of the third quarter of 2015.

 

In January 2015, the FASB issued ASU 2015-01, Income Statement – Extraordinary and Unusual Items. ASU 2015-01 eliminates from GAAP the concept of extraordinary items. As a result, an entity will no longer be required to separately present an extraordinary item on its statement of operations, net of tax, after income from continuing operations, or disclose income taxes and net income per share data applicable to an extraordinary item. However, ASU 2015-01 will still retain the presentation and disclosure guidance for items that are unusual in nature and occur infrequently. ASU 2015-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided the guidance is applied from the beginning of the fiscal year of adoption. We do not expect the adoption of this standard to have a material impact on our financial statements, absent any material transactions in future periods that would qualify for extraordinary item presentation under the prior guidance.

 

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest. ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. For public entities, ASU 2015-03 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. We do not expect the adoption of this standard to have a material impact on our financial statements.

 

Also in April 2015, the FASB issued ASU 2015-05, Intangibles – Goodwill and Other- Internal-Use Software. ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 does not change GAAP for customer’s accounting for service contracts. For public entities, ASU 2015-05 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. We do not expect the adoption of this standard to have a material impact on our financial statements.

 

In July 2015, the FASB issued ASU 2015-11, Inventory – Simplifying the Measurement of Inventory. ASU 2015-11 does not apply only to inventory that is measured using last-in, first-our (“LIFO”) or to the retail inventory method. ASU 2015-11 applies to all other inventory, which includes inventory that is measured using first-in, first-out (“FIFO”) or average cost. ASU 2015-11 provides that inventory be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. For public entities, ASU 2015-11 is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early application is permitted as of the beginning of an interim or annual reporting period. We 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 June 30, 2015 and December 31, 2014 of $12.8 million was the result of our acquisition of Pump Engineering, LLC in December 2009. During the three and six months ended June 30, 2015, 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):

 

		June 30, 2015
		Gross Carrying Amount				Accumulated Amortization				Accumulated Impairment Losses				Net Carrying Amount
Developed technology		$	6,100			$	(3,405	)		$	—			$	2,695
Non-compete agreements			1,310				(1,310	)			—				—
Backlog			1,300				(1,300	)			—				—
Trademarks			1,200				(180	)			(1,020	)			—
Customer relationships			990				(990	)			—				—
Patents			585				(389	)			(42	)			154
Total		$	11,485			$	(7,574	)		$	(1,062	)		$	2,849

  

		December 31, 2014
		Gross Carrying Amount				Accumulated Amortization				Accumulated Impairment Losses				Net Carrying Amount
Developed technology		$	6,100			$	(3,101	)		$	—			$	2,999
Non-compete agreements			1,310				(1,310	)			—				—
Backlog			1,300				(1,300	)			—				—
Trademarks			1,200				(180	)			(1,020	)			—
Customer relationships			990				(990	)			—				—
Patents			585				(376	)			(42	)			167
Total		$	11,485			$	(7,257	)		$	(1,062	)		$	3,166

  

Accumulated impairment losses at June 30, 2015 and December 31, 2014, include a $1.0 million impairment loss from 2012 for trademarks, a $31,000 loss for patents from 2007, and an $11,000 loss for patents from 2010.

   

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 June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Numerator:
Net loss		$	(3,327	)		$	(4,611	)		$	(11,610	)		$	(8,294	)
Denominator:
Basic and diluted weighted average common shares outstanding			52,026				51,566				51,987				51,506
Basic and diluted net loss per share		$	(0.06	)		$	(0.09	)		$	(0.22	)		$	(0.16	)

  

The following potential common shares were not considered in the computation of diluted loss per share because their effect would have been anti-dilutive (in thousands):

 

		Three and Six Months Ended June 30,
		2015				2014
Stock options			8,267				7,573
Warrants			200				600

  

 

Note 4 — Other Financial Information

 

Restricted Cash

 

We have pledged cash in connection with stand-by letters of credit. We have deposited a corresponding amount into a non-interest bearing account at one financial institution for these items as follows (in thousands):

 

		June 30, 2015				December 31, 2014
Collateral for stand-by letters of credit		$	1,347			$	2,623
Current restricted cash		$	1,347			$	2,623
Collateral for stand-by letters of credit		$	1,704			$	2,850
Non-current restricted cash		$	1,704			$	2,850
Total restricted cash		$	3,051			$	5,473

 

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):

 

		June 30, 2015				December 31, 2014
Raw materials		$	2,743			$	2,903
Work in process			2,331				1,915
Finished goods			4,629				3,386
Inventories		$	9,703			$	8,204

 

Prepaid and Other Current Assets

 

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

 

		June 30, 2015				December 31, 2014
Interest receivable		$	52			$	112
Supplier advances			159				107
Other prepaid expenses and current assets			869				1,098
Total prepaid and other current assets		$	1,080			$	1,317

 

Accrued Expenses and Other Current Liabilities

 

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

 

		June 30, 2015				December 31, 2014
Accrued legal expenses		$	188			$	1,734
Payroll and commissions payable			2,368				3,116
Other accrued expenses and current liabilities			2,330				3,577
Accrued expenses and other current liabilities		$	4,886			$	8,427

 

Other Non- Current Liabilities

 

Other non- current liabilities consisted of the following (in thousands):

 

		June 30, 2015				December 31, 2014
Deferred rent expense, non-current		$	796			$	866
Accrued legal expenses, non-current			43				1,587
Accrued expenses and other current liabilities		$	839			$	2,453

  

 

Accumulated Other Comprehensive Loss

 

Changes in accumulated other comprehensive loss by component for the six months ended June 30, 2015 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, 2014		$	(67	)		$	(6	)		$	(73	)
Net other comprehensive income			25				1				26
Balance, June 30, 2015		$	(42	)		$	(5	)		$	(47	)

 

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 and long-term investments are all classified as available-for-sale. There were no sales of available-for-sale securities during the quarter ended June 30, 2015.

 

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

 

		June 30, 2015
		Amortized Cost				Gross Unrealized Holding Gains				Gross Unrealized Holding Losses				Fair Value
Short-term investments:
Corporate notes and bonds		$	4,717			$	—			$	(4	)		$	4,713
Total short-term investments		$	4,717			$	—			$	(4	)		$	4,713
Long-term investments:
Corporate notes and bonds		$	263			$	—			$	(1	)		$	262
Total long-term investments		$	263			$	—			$	(1	)		$	262
Total available-for-sale securities		$	4,980			$	—			$	(5	)		$	4,975

 

		December 31, 2014
		Amortized Cost				Gross Unrealized Holding Gains				Gross Unrealized Holding Losses				Fair Value
Short-term investments
State and local government obligations		$	225			$	—			$	—			$	225
Corporate notes and bonds			12,851				4				(8	)			12,847
Total short-term investments		$	13,076			$	4			$	(8	)		$	13,072
Long-term investments
Corporate notes and bonds			268				—				(1	)			267
Total long-term investments		$	268			$	—			$	(1	)		$	267
Total investments		$	13,344			$	4			$	(9	)		$	13,339

  

  

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):

 

		June 30, 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		$	262			$	(1	)		$	3,380			$	(4	)		$	3,642			$	(5	)
Total		$	262			$	(1	)		$	3,380			$	(4	)		$	3,642			$	(5	)

 

		December 31, 2014
		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		$	5,085			$	(6	)		$	1,205			$	(3	)		$	6,290			$	(9	)
Total		$	5,085			$	(6	)		$	1,205			$	(3	)		$	6,290			$	(9	)

  

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 June 30, 2015 are shown below by contractual maturity (in thousands):

 

		June 30, 2015
		Amortized Cost				Fair Value
Due after one year through three years		$	4,980			$	4,975
Total available-for-sale securities		$	4,980			$	4,975

   

Note 6 — Long-Term Debt and Lines of Credit

 

Debt

 

In March 2015, we entered into a loan agreement with a financial institution for a $55,000 fixed-rate installment loan with 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)

 

		June 30, 2015				December 31, 2014
Loan payable		$	53			$	—
Less: current portion			(11	)			—
Total long-term debt		$	42			$	—

 

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

 

		June 30, 2015
2015 (remaining 6 months)		$	5
2016			11
2017			11
2018			11
2019			11
Thereafter			4
Total debt		$	53

  

Lines of Credit

 

In June 2012, we entered into a loan agreement (the “2012 Agreement”) with a financial institution. The 2012 Agreement matured in June 2015 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 plus 0% 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 June 30, 2015 and December 31, 2014, there were no advances drawn under the 2012 Agreement, as amended. Remaining stand-by letters of credit collateralized under the 2012 Agreement, as amended, totaled $3.0 million and $3.1 million as of June 30, 2015 and December 31, 2014, respectively. Total cash restricted related to these stand-by letters of credit totaled $3.1 million as of June 30, 2015 and December 31, 2014.

 

 

We are subject to certain financial and administrative covenants under the 2012 Agreement, as amended. As of June 30, 2015, we were in compliance with these covenants.

 

In 2009, we entered into a loan and security agreement (the “2009 Agreement”) with another financial institution. The 2009 Agreement, as amended, provided a total available credit line of $16.0 million. Under the 2009 Agreement, we were allowed to draw advances of up to $10.0 million on a revolving line of credit or utilize up to $15.9 million as collateral for stand-by letters of credit, provided that the aggregate of the outstanding advances and collateral did not exceed the total available credit line of $16.0 million. Advances under the revolving line of credit incurred interest based on a prime rate index or LIBOR plus 1.375%. The 2009 Agreement, as amended, also required us to maintain cash collateral balances equal to at least 101% of the face amount of all outstanding stand-by letters of credit collateralized by the line of credit and 100% of the amount of all outstanding advances. The amended 2009 Agreement expired in May 2012, at which time we became required to maintain a cash collateral balance equal to at least 105% of the face amount of all outstanding stand-by letters of credit collateralized by the line of credit. There were no advances drawn under the 2009 Agreement’s credit line at the time it expired. Remaining stand-by letters of credit issued under the 2009 Agreement totaled zero and $2.3 million as of June 30, 2015 and December 31, 2014, respectively. Total cash restricted related to these stand-by letters of credit totaled zero and $2.4 million as of June 30, 2015 and December 31, 2014, respectively.

   

Note 7 — Equity

 

Share-Based Compensation Expense

 

For the three and six months ended June 30, 2015 and 2014, we recognized share-based compensation expense related to employees and consultants as follows (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Cost of revenue		$	37			$	26			$	72			$	48
General and administrative			1,679				365				2,576				694
Sales and marketing			106				155				207				308
Research and development			91				88				198				165
Total share-based compensation expense		$	1,913			$	634			$	3,053			$	1,215

 

As of June 30, 2015, total unrecognized compensation cost related to non-vested share-based awards, net of estimated forfeitures, was $3.9 million, which is expected to be recognized as expense over a weighted average period of approximately 2.77 years.

 

In February 2015, we granted 344,090 stock options to our non-employee directors. The vesting start date for options granted to incumbent non-employee directors was June 20, 2014, the date of our last annual meeting. The vesting start date for options granted to newly appointed non-employee directors was the date of grant. The options became fully vested on June 19, 2015, the date of our annual meeting; had an exercise price of $3.53 per share, as determined on the date of grant; and expire 10 years from the grant date. The total compensation cost associated with these option grants was recognized over the period from the grant date in February 2015 (which was determined to be the service inception date) to the vesting end date in June 2015. Accordingly, the six months ended June 30, 2015 includes compensation expense from the service inception date through the vesting end date of June 19, 2015.

 

In March 2015, we granted 1,415,739 stock options to certain officers and other employees. The options vest over a four-year period, have an exercise price of $2.75 per share, and expire 10 years from the grant date.

 

In connection with the resignation of Mr. Thomas S. Rooney, Jr. as President and Chief Executive Officer, additional stock based compensation of approximately $170,000 was recorded in the first quarter of 2015 related to the accelerated vesting of options previously granted to Mr. Rooney.

 

In June 2015, we entered into a consulting agreement with Mr. Rooney, under which his unvested options outstanding on the first day of consultancy continue to vest for the period of consultancy and all vested options continue to be exercisable through the 90 day period following the last day of the consultancy. In connection with this modification, we recorded additional stock based compensation of approximately $1.1 million related to the additional vesting and extended exercise period in the three months ended June 30, 2015.

  

 

In April 2015, Ms. Audrey Bold resigned as our Chief Marketing Officer. In connection with her resignation and the providing of a general release, the Company agreed to provide her with continued vesting of granted options during the six month period following her termination and the ability to exercise the vested options through the 90 days following this six month period. In connection with this modification, we recorded additional stock based compensation of approximately $43,000 related to the additional vesting and extended exercise period in the three months ended June 30, 2015.

 

In June 2015, we granted 300,000 stock options to our new Chief Financial Officer and Vice President of Strategy. These options vest over a four year period, have an exercise price of $2.61 per share, and expire 10 years from the grant date.

 

In June 2015, we granted 16,000 stock options to an employee. The options vest over a four year period, have an exercise price of $2.60 per share, and expire 10 years from the grant date.

 

In June 2015, we granted 373,744 stock options to our non-employee directors. The vesting start date was June 23, 2015, the date of grant. The options will become fully vested on June 17, 2016, the anticipated date of our next annual meeting. The options have an exercise price of $2.92 per share, as determined on the date of grant, and expire 10 years from the grant date.

   

Note 8 — Income Taxes

 

The effective tax rate for the six months ended June 30, 2015 and 2014 was (1.23%) and (1.5%), respectively. As of December 31, 2014, a full valuation allowance of approximately $20.4 million had been established to reduce our deferred income tax assets to the amount expected to be realized. As such, no tax benefit related to our pre-tax loss was recognized for the six months ended June 30, 2015, as there was no change in our assessment of the amount of deferred income tax assets expected to be realized.

   

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):

 

		June 30, 2015
2015 (remaining six months)		$	805
2016			1,576
2017			1,567
2018			1,591
2019			1,398
Total future minimum lease payments		$	6,937

 

Product Warranty

 

The following table summarizes the activity related to the product warranty liability during the three months ended June 30, 2015 and 2014 (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Balance, beginning of period		$	756			$	705			$	755			$	709
Warranty costs charged to cost of revenue			(6	)			50				15				53
Utilization of warranty			(3	)			(50	)			(23	)			(57	)
Balance, end of period		$	747			$	705			$	747			$	705

  

  

Purchase Obligations

 

We enter into purchase order arrangements with our vendors. As of June 30, 2015, 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 June 30, 2015, we had approximately $1.6 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 June 30, 2015 and December 31, 2014.

 

In certain cases, we issue warranty and product performance guarantees to our customers for amounts ranging from 5% to 10% 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 65 months, and relate to the underlying product warranty period. The stand-by letters of credit are collateralized by restricted cash and our credit facility. All of the $3.0 million in outstanding stand-by letters of credit at June 30, 2015 was issued under the 2012 Agreement. The stand-by letters of credit outstanding at June 30, 2015 were collateralized by restricted cash of $3.1 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 3, 2014, Mr. Blanco filed a labor claim against ERI Iberia in Madrid, Spain alleging breach of contract and termination without cause. The claim seeks wages (salary and bonus) of €567,000 and alleged stock option gains of €630,000. The matter has been delayed until November 2015. At this time, the Company has not determined that an award to Mr. Blanco is probable.

 

In January 2015, two stockholder class action complaints were filed against the Company in the Northern District of California, on behalf of Energy Recovery stockholders under the captions, Joseph Sabatino v. Energy Recovery, Inc. et al. and Thomas C. Mowdy v. Energy Recovery, Inc. et al. The complaints have now been consolidated under the caption In Re Energy Recovery Inc. Securities Litigation. The complaint alleges violations of Section 10(b), Rule 10b-5, and Section 20(a) of the Securities Exchange Act of 1934 and seeks the recovery of unspecified monetary damages. We are not able to estimate the possible loss, if any, due to the early state of this matter.

 

On May 8, 2015, we entered into a post-judgment settlement and mutual general release agreement (the “Agreement”) in the matter entitled “Morgan Technical Ceramics, Inc v. Energy Recovery, Inc” in the County of Alameda, State of California. Under the Agreement, the Company in exchange for a general release paid $1.7 million to the plaintiffs. The Company had reserved the full amount of the judgment entered against it in the amount of approximately $1.9 million and consequently released $0.2 million from its legal reserve.

   

Note 10 — Business Segment and Geographic Information

 

We manufacture and sell high-efficiency energy recovery devices and pumps as well as related services under one reportable segment. Our chief operating decision-maker is the chief executive officer (“CEO”). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. Accordingly, we have concluded that we have one reportable segment.

  

 

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 June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Domestic revenue		$	922			$	235			$	1,186			$	584
International revenue			9,562				6,172				15,162				9,720
Total revenue		$	10,484			$	6,407			$	16,348			$	10,304
Revenue by country:
United Arab Emirates			35	%			2	%			23	%			3	%
United States			9				4				7				6
Bahamas			*				14				*				10
China			4				11				4				8
Israel			2				9				1				10
Others **			50				60				65				63
Total			100	%			100	%			100	%			100	%

 

 

*

Less than 1%.

**

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

 

All of our long-lived assets were located in the United States at June 30, 2015 and December 31, 2014.

   

Note 11 — Concentrations

 

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

 

		June 30, 2015				December 31, 2014
Customer A			31	%			—
Customer B			15	%			—
Customer C			10	%			32	%
Customer D			8	%			11	%

 

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

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Customer A			30	%			—				22	%			—
Customer B			9	%			*				10	%			1	%
Customer E			2	%			14	%			2	%			9	%

 

*

Less than 1%

   

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 primarily of corporate, and agency obligations.

 

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

 

		June 30, 2015				Level 1 Inputs				Level 2 Inputs				Level 3 Inputs
Assets:
Short-term available-for-sale securities		$	4,713			$	—			$	4,713			$	—
Long-term available-for-sale securities			262				—				262				—
Total assets		$	4,975			$	—			$	4,975			$	—

 

		December 31, 2014				Level 1 Inputs				Level 2 Inputs				Level 3 Inputs
Assets:
Short-term available-for-sale securities		$	13,072			$	—			$	13,072			$	—
Long-term available-for-sale securities			267				—				267				—
Total assets		$	13,339			$	—			$	13,339			$	—

  

Note 13 — Subsequent Events

 

On July 1, 2015, warrants to purchase 200,000 shares of our common stock were exercised for cash at a price of $1.00 per share. The proceeds from this exercise totaled $200,000. This exercise represents the last outstanding warrant issued in 2005. 

 

Subsequent to June 30, 2015, the Company adopted a new organizational structure based on the operating segments Water and Oil & Gas. In accordance with GAAP, segment information on this basis will be presented commencing in the period of change and will be included for the quarter ended September 30, 2015.

 

 

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 belief that levels of gross profit margin 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 our expenses for research and development and sales and marketing may increase as a result of the diversification into markets outside of desalination;

 

•

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

 

•

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 technology arising from rapid market adoption that could require us to seek additional equity or debt financing; and

 

•

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

 

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.

 

  

Overview

 

We are 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 company was founded in 1992, and we introduced the initial version of our Pressure Exchanger^® energy recovery device in early 1997. In December 2009, we acquired Pump Engineering, LLC, which manufactured centrifugal energy recovery devices known as turbochargers as well as high-pressure pumps.

 

Our energy recovery devices are primarily used in seawater reverse osmosis desalination. In the past several years, we have invested significant research and development costs to expand into other pressurized fluid flow industries such as oil & gas. In 2014, we introduced a new product for the fracking industry, the VorTeq ^TM hydraulic pumping solution.

 

Our revenue is principally derived from the sale of our energy recovery devices. We also derive revenue from the sale of our high-pressure and circulation pumps which we manufacture and sell in connection with our energy recovery devices for use in desalination plants. Additionally, we receive revenue from the sale of spare parts and services, including start-up and commissioning services that we provide to our customers. In 2014, we recognized oil & gas revenue of $784,000 from the operating lease and lease buy-out of an IsoGen ^®system. In the first quarter of 2015, we recognized oil & gas revenue of $60,000 from commissioning services and $81,000 from fees related to the cancellation of a ConocoPhillips sales order.

 

A significant portion of our net 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 6 to 16 months, and in some cases, up to 24 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 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 net revenue and of our accounts receivable and unbilled receivables. Revenue from customers representing 10% or more of net revenue varies from period to period. For the three months ended June 30, 2015, one customer accounted for 30% of our net revenue. For the three months ended June 30, 2014, one customer accounted for 14% of our net revenue. For the six months ended June 30, 2015, two customers accounted for 22% and 10%, respectively, of our net revenue. For the six months ended June 30, 2014, no customer accounted for 10% or more of our net revenue. No other customer accounted for more than 10% of our net revenue during any of these periods. At June 30, 2015, three customers accounted for 31%, 15%, and 10%, respectively, of our accounts receivable and unbilled receivable balance. At December 31, 2014, two customers accounted for 32% and 11%, respectively, of our accounts receivable and unbilled receivable balance.

 

During the three and six months ended June 30, 2015 and 2014, most of our net revenue was attributable to sales outside of the United States. We expect sales outside of the United States to remain a significant portion of our net revenue for the next few years.

 

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.

 

On January 12, 2015, Mr. Thomas S. Rooney, Jr., President, Chief Executive Officer, and Director, announced his intent to resign to allow the Company to facilitate a transition during which the Company would identify and appoint a successor. To facilitate this transition the Company entered into an amendment to Mr. Rooney’s offer letter dated February 14, 2011 (the “Amendment”). Under the terms of the Amendment, Mr. Rooney resigned as a member of the Board of Directors and its subsidiaries effective January 13, 2015. Mr. Rooney continued to serve as Chief Executive Officer until the appointment of Mr. Gay as Chief Executive Officer on April 24, 2015.

  

 

On February 6, 2015, the Board of Directors appointed Mr. Ole Peter Lorentzen and Mr. Alexander J. Buehler as directors. The addition increased the number of directors on the Board to nine, following the resignation of Mr. Rooney on January 13, 2015.

 

On April 24, 2015, the Board of Directors appointed Mr. Joel Gay as President and Chief Executive Officer and as a member of the Board of Directors effective immediately. Mr. Gay served as the Company’s Chief Financial Officer from June 2014 until his appointment as President.

 

In June 2015, the Board of Directors appointed Mr. Chris Gannon as Chief Financial Officer.

 

At the annual meeting of stockholders, our stockholders elected Mr. Olav Fjell, Mr. Lorentzen, and Mr. Gay as Class I directors. Incumbent Class I directors, Mr. Johannessen, Mr. Cook, and Ms. Pate-Cornell, decided not to stand for re-election.

  

 

Second Quarter of 2015 Compared to Second Quarter of 2014

 

Results of Operations

 

The following table sets forth certain data from our operating results as a percentage of net revenue for the periods indicated (in thousands, except percentages):

   

		Three Months Ended June 30,
		2015								2014								Change Increase / (Decrease)
Results of Operations:*
Net revenue		$	10,484				100	%		$	6,407				100	%		$	4,077				64	%
Cost of revenue			4,836				46	%			3,332				52	%			1,504				45	%
Gross profit			5,648				54	%			3,075				48	%			2,573				84	%
Operating expenses:
General and administrative			5,362				51	%			2,995				47	%			2,367				79	%
Sales and marketing			1,994				19	%			2,702				42	%			(708	)			(26%	)
Research and development			1,410				13	%			1,724				27	%			(314	)			(18%	)
Amortization of intangible assets			158				2	%			215				3	%			(57	)			(27%	)
Total operating expenses			8,924				85	%			7,636				119	%			1,288				17	%
Loss from operations			(3,276	)			(31%	)			(4,561	)			(71%	)			1,285				28	%
Other non-operating (expense) income			20				0	%			8				0	%			12				150	%
Loss before income taxes			(3,256	)			(31%	)			(4,553	)			(71%	)			1,297				28	%
Provision for income taxes			71				1	%			58				1	%			13				22	%
Net loss		$	(3,327	)			(32%	)		$	(4,611	)			(72%	)		$	1,284				28	%

 

*     Percentages may not add up to 100% due to rounding

   

Net Revenue 

 

Our net revenue increased by $4.1 million, or 64%, to $10.5 million for the three months ended June 30, 2015 from $6.4 million for the three months ended June 30, 2014. The increase was primarily due to increased mega project shipments of $3.8 million, higher OEM shipments of $0.2 million, and higher aftermarket shipments of $0.3 million. The increases were offset by lower oil & gas revenue of $0.2 million.

 

Although we operate under one segment, we categorize revenue based on the type of energy recovery device and its related products and services. The following table reflects revenue by product category and as a percentage of total net revenue (in thousands, except percentages):

 

		Three Months Ended June 30,
		2015								2014
PX devices and related products and services		$	7,429				71	%		$	4,053				63	%
Turbochargers, pumps, and related products and services			3,055				29	%			2,149				34	%
Oil & gas product lease and related services			—				—				205				3	%
Net revenue		$	10,484				100	%		$	6,407				100	%

  

During the three months ended June 30, 2015 and 2014, a significant portion of our net revenue was attributable to sales outside of the United States. Revenue attributable to domestic and international sales as a percentage of net revenue was as follows:

 

		Three Months Ended June 30,
		2015				2014
Domestic revenue			9	%			4	%
International revenue			91	%			96	%
Net revenue			100	%			100	%

 

  

Gross Profit

 

Gross profit represents our net revenue less our cost of revenue. Our 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 June 30, 2015, gross profit as a percentage of net revenue was 54%. For the three months ended June 30, 2014, gross profit as a percentage of net revenue was 48%. The increase was attributable to a favorable shift in product mix.

 

Future gross profit is highly dependent on the product and customer mix of our net revenues, 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 gross profit levels with certainty. We believe that the current levels of 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 decreased to 36 at the end of the second quarter of 2015 from 37 at the end of the second quarter of 2014.

 

Share-based compensation expense included in cost of revenue was $37,000 and $26,000 for the three months ended June 30, 2015 and 2014, respectively.

 

General and Administrative Expense

 

General and administrative expense increased by $2.4 million, or 79%, to $5.4 million for the three months ended June 30, 2015 from $3.0 million for the three months ended June 30, 2014. As a percentage of net revenue, general and administrative expense increased to 51% for the three months ended June 30, 2015 from 47% for the three months ended June 30, 2014.

 

General and administrative headcount decreased to 24 at the end of the second quarter of 2015 from 28 at the end of the second quarter of 2014.  

 

Of the $2.4 million increase in general and administrative expense for the three months ended June 30, 2015 compared to the same quarter of 2014, $1.3 million related to stock based compensation expense primarily associated with the resignation of the Chief Executive Officer and the modification of his vested options, $1.0 million related to professional and legal costs, and $0.3 million related to occupancy costs, compensation and employee related benefits, other taxes, and bad debt expense. These changes were offset by a decrease of approximately $0.2 million primarily in other administrative costs.

 

Share-based compensation expense included in general and administrative expense was $1.7 million and $365,000 for the three months ended June 30, 2015 and 2014, respectively. The increase in share-based compensation is primarily related to the modification of vested options associated with the resignation of the Chief Executive Officer.

 

Sales and Marketing Expense

 

Sales and marketing expense decreased by $0.7 million, or 26%, to $2.0 million for the three months ended June 30, 2015 from $2.7 million for the three months ended June 30, 2014. As a percentage of net revenue, sales and marketing expense decreased to 19% for the three months ended June 30, 2015 from 42% for the three months ended June 30, 2014.

 

Sales and marketing headcount decreased to 29 at the end of the second quarter of 2015 from 35 at the end of the second quarter of 2014.

 

Of the $0.7 million decrease in sales and marketing expense for the three months ended June 30, 2015 compared to the same quarter of 2014, $0.4 million related to compensation and employee related benefits associated with decreased stock-based compensation expense and lower annual incentive bonus accruals, $0.2 million related to marketing costs, and $0.1 million related to professional and other sales and marketing services.

 

Share-based compensation expense included in sales and marketing expense was $106,000 and $155,000 for the three months ended June 30, 2015 and 2014, respectively.

 

Research and Development Expense

 

Research and development expense decreased by $0.3 million, or 18%, to $1.4 million for the three months ended June 30, 2015 from $1.7 million for the three months ended June 30, 2014. As a percentage of net revenue, research and development expense decreased to 13% for the three months ended June 30, 2015 from 27% for the three months ended June 30, 2014.

  

 

Research and development headcount decreased to 16 at the end of the second quarter of 2015 from 19 at the end of the second quarter of 2014.

 

Of the $0.3 million decrease in research and development expense for the three months ended June 30, 2015 compared to the same quarter of 2014, $0.2 million related to costs associated with the Company’s investment in product development for oil & gas applications, and $0.1 million related to outside consulting and professional fees.

 

Share-based compensation expense included in research and development expense was $91,000 and $88,000 for the three months ended June 30, 2015 and 2014, respectively.

 

As we continue to advance our existing technologies and develop new energy recovery and efficiency-enhancing solutions for markets outside of seawater desalination, we anticipate that our research and development expenses may increase in the future.

 

Amortization of Intangible Assets

 

Amortization of intangible assets is primarily related to finite-lived intangible assets acquired as a result of our purchase of Pump Engineering, LLC in December 2009. Amortization expense decreased by $57,000, or 27%, to $158,000 for the three months ended June 30, 2015 from $215,000 for the three months ended June 30, 2014. The decrease was due to the full amortization of all intangibles, except developed technology, in the fourth quarter of 2014.

 

Non-Operating Income (Expense), Net

 

Non-operating income (expense), net, including interest expense, increased by $12,000 to income of $20,000 in the three months ended June 30, 2015 from income of $8,000 in the three months ended June 30, 2014. The increase was primarily due to $28,000 higher net foreign currency gains offset by a $16,000 decrease in interest income related to interest receivable on investments.

 

Income Taxes

 

The income tax provision was $71,000 in the three months ended June 30, 2015 compared to $58,000 in the three months ended June 30, 2014. The tax expense for the three months ended June 30, 2015 and June 30, 2014 primarily relate to the tax basis amortization of goodwill and state and other taxes. The three months ended June 30, 2015 also includes a tax true-up of approximately $3,000.

  

 

Six Months Ended June 30, 2015 Compared to Six Months Ended June 30, 2014

 

Results of Operations

 

The following table sets forth certain data from our operating results as a percentage of net revenue for the periods indicated (in thousands, except percentages):

   

		Six Months Ended June 30,
		2015								2014								Change Increase / (Decrease)
Results of Operations:*
Net revenue		$	16,348				100	%		$	10,304				100	%		$	6,044				59	%
Cost of revenue			7,367				45	%			4,984				48	%			2,383				48	%
Gross profit			8,981				55	%			5,320				52	%			3,661				69	%
Operating expenses:
General and administrative			11,640				71	%			5,034				49	%			6,606				131	%
Sales and marketing			4,427