Energy Recovery(ERII) - 2019 Q2 - Quarterly Report

PART I — FINANCIAL INFORMATION Item 1 — Financial Statements (Unaudited) This section presents the unaudited condensed consolidated financial statements, including balance sheets, statements of operations, comprehensive income, stockholders' equity, cash flows, and related explanatory notes Condensed Consolidated Balance Sheets The condensed consolidated balance sheets provide a snapshot of the company's financial position as of June 30, 2019, and December 31, 2018, detailing assets, liabilities, and stockholders' equity Condensed Consolidated Balance Sheets (in thousands) | Metric | June 30, 2019 (in thousands) | December 31, 2018 (in thousands) | | :---------------------- | :--------------------------- | :------------------------------- | | Total Assets | $183,465 | $179,841 | | Total Liabilities | $56,005 | $66,463 | | Total Stockholders' Equity | $127,460 | $113,378 | Condensed Consolidated Statements of Operations The condensed consolidated statements of operations report the company's financial performance for the three and six months ended June 30, 2019, and 2018, showing revenue, cost of revenue, operating expenses, and net income Condensed Consolidated Statements of Operations (in thousands) | Metric (in thousands) | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Product Revenue | $19,226 | $17,406 | $35,298 | $28,464 | | License & Dev Revenue | $3,570 | $3,358 | $7,293 | $6,107 | | Net Income | $3,719 | $15,743 | $6,373 | $15,017 | | Basic EPS | $0.07 | $0.29 | $0.12 | $0.28 | | Diluted EPS | $0.07 | $0.28 | $0.11 | $0.27 | Condensed Consolidated Statements of Comprehensive Income This statement details the components of comprehensive income, including net income and other comprehensive income (loss) items such as foreign currency translation adjustments and unrealized gains/losses on investments Condensed Consolidated Statements of Comprehensive Income (in thousands) | Metric (in thousands) | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Net Income | $3,719 | $15,743 | $6,373 | $15,017 | | Foreign Currency Translation Adjustments | $7 | $(33) | $(1) | $(12) | | Unrealized Gain (Loss) on Investments | $64 | $7 | $132 | $(57) | | Comprehensive Income | $3,790 | $15,717 | $6,504 | $14,948 | Condensed Consolidated Statements of Stockholders' Equity The condensed consolidated statements of stockholders' equity show changes in common stock, additional paid-in capital, accumulated other comprehensive loss, treasury stock, and accumulated deficit for the three and six months ended June 30, 2019, and 2018 Condensed Consolidated Statements of Stockholders' Equity (in thousands) | Metric (in thousands) | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Total Stockholders' Equity | $127,460 | $102,361 | $127,460 | $102,361 | | Common Stock Issued (shares) | 60,360 | 58,951 | 60,360 | 58,951 | | Treasury Stock (shares) | (5,456) | (5,456) | (5,456) | (5,456) | Condensed Consolidated Statements of Cash Flows The condensed consolidated statements of cash flows present cash generated from or used in operating, investing, and financing activities for the six months ended June 30, 2019, and 2018 Condensed Consolidated Statements of Cash Flows (in thousands) | Metric (in thousands) | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :----------------------------- | :----------------------------- | | Net Cash from Operating Activities | $3 | $(1,670) | | Net Cash Used in Investing Activities | $(3,241) | $(4,015) | | Net Cash from Financing Activities | $4,519 | $(7,691) | | Net Change in Cash, Cash Equivalents and Restricted Cash | $1,281 | $(13,354) | Notes to Condensed Consolidated Financial Statements These notes provide detailed explanations and disclosures for the condensed consolidated financial statements, covering business description, accounting policies, revenue, earnings per share, balance sheet items, investments, goodwill, lines of credit, commitments, income taxes, stock-based compensation, segment information, and concentrations Note 1 — Description of Business and Significant Accounting Policies Energy Recovery, Inc. is an energy solutions provider for industrial fluid flow markets, specializing in water, oil & gas, and chemical processing, and early adopted ASU 2018-15 - Energy Recovery, Inc. is an energy solutions provider for industrial fluid flow markets worldwide, focusing on water, oil & gas, and chemical processing, utilizing fluid dynamics and advanced material science[26] - The Company early adopted ASU 2018-15 in the second quarter of 2019, aligning capitalization requirements for cloud computing implementation costs with internal-use software, which is expected to defer approximately $0.6 million to $0.9 million in related costs for the remainder of 2019[30] Note 2 — Revenue Revenue is disaggregated by geography and product/service line, showing significant contributions from the Middle East and Africa, and the Americas, primarily from PX, pumps, and turbo devices, and license and development, with contract assets and liabilities decreasing Revenue Disaggregation (Three Months Ended June 30, 2019, in thousands) | Category | Water | Oil and Gas | Total | | :------------------------ | :----- | :---------- | :------ | | Primary Geographical Market | | | | | Middle East and Africa | $10,805 | $— | $10,805 | | Americas | $1,728 | $3,570 | $5,298 | | Asia | $5,042 | $— | $5,042 | | Europe | $1,651 | $— | $1,651 | | Total Revenue | $19,226 | $3,570 | $22,796 | | Major Product/Service Line | | | | | PX, pumps and turbo devices | $19,226 | $— | $19,226 | | License and development | $— | $3,570 | $3,570 | Contract Assets and Liabilities (in thousands) | Metric | June 30, 2019 | December 31, 2018 | | :------------------------- | :------------ | :---------------- | | Contract assets balance, end of period | $1,936 | $4,083 | | Contract liabilities balance, end of period | $35,079 | $42,809 | Estimated Revenue from Remaining Performance Obligation (June 30, 2019, in thousands) | Year | Amount | | :------------------ | :-------- | | 2019 (remaining six months) | $7,304 | | 2020 | $14,558 | | 2021 | $6,770 | | 2022 | $661 | | 2023 and thereafter | $5,031 | | Total | $34,324 | Note 3 — Earnings per Share This note details the calculation of basic and diluted earnings per share, including weighted average common shares outstanding and the effect of dilutive stock awards, and identifies anti-dilutive shares Earnings Per Share (EPS) Summary | Metric | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Basic EPS | $0.07 | $0.29 | $0.12 | $0.28 | | Diluted EPS | $0.07 | $0.28 | $0.11 | $0.27 | | Basic Weighted Average Common Shares Outstanding (thousands) | 54,681 | 53,747 | 54,400 | 53,747 | | Diluted Weighted Average Common Shares Outstanding (thousands) | 56,110 | 55,406 | 55,764 | 55,437 | Anti-Dilutive Shares Excluded from EPS Calculation (in thousands) | Period | Anti-dilutive shares excluded | | :-------------------- | :---------------------------- | | Three Months Ended June 30, 2019 | 1,650 | | Three Months Ended June 30, 2018 | 1,990 | | Six Months Ended June 30, 2019 | 2,197 | | Six Months Ended June 30, 2018 | 2,015 | Note 4 — Balance Sheet Information This note provides a breakdown of inventories by category and details accrued expenses and other current liabilities Inventories, Net (in thousands) | Category | June 30, 2019 | December 31, 2018 | | :-------------- | :------------ | :---------------- | | Raw materials | $3,175 | $2,238 | | Work in process | $2,157 | $2,689 | | Finished goods | $2,431 | $2,211 | | Total | $7,763 | $7,138 | Accrued Expenses and Other Current Liabilities (in thousands) | Category | June 30, 2019 | December 31, 2018 | | :------------------------------------- | :------------ | :---------------- | | Payroll and commissions payable | $4,000 | $5,843 | | Accrued legal expenses | $142 | $574 | | Other accrued expenses and current liabilities | $1,383 | $1,602 | | Total | $5,525 | $8,019 | Note 5 — Investments and Fair Value Measurements The company's cash, cash equivalents, and marketable securities totaled $96.692 million as of June 30, 2019, primarily invested in available-for-sale debt instruments, with fair value measurements classified into Level 1 and Level 2 Total Cash, Cash Equivalents and Marketable Securities (in thousands) | Metric | June 30, 2019 | December 31, 2018 | | :--------------------------------------- | :------------ | :---------------- | | Cash and cash equivalents | $23,331 | $21,955 | | Short-term investments | $71,854 | $73,338 | | Long-term investments | $1,507 | $1,269 | | Total | $96,692 | $96,562 | Fair Value of Financial Assets (June 30, 2019, in thousands) | Category | Total | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | | :----------------------- | :------ | :------------- | :------------- | :------------- | | Cash equivalents | $5,004 | $5,004 | $— | $— | | Short-term investments | $71,854 | $— | $71,854 | $— | | Long-term investments | $1,507 | $— | $1,507 | $— | | Total Fair Value | $78,365 | $5,004 | $73,361 | $— | Available-for-Sale Investments with Unrealized Loss Positions (in thousands) | Category | June 30, 2019 Fair Value | June 30, 2019 Gross Unrealized Losses | December 31, 2018 Fair Value | December 31, 2018 Gross Unrealized Losses | | :------------------------ | :----------------------- | :------------------------------------ | :--------------------------- | :---------------------------------------- | | U.S. Treasury securities | $802 | $— | $8,101 | $(2) | | Corporate notes and bonds | $10,213 | $(6) | $61,809 | $(88) | | Total | $11,015 | $(6) | $69,910 | $(90) | Note 6 — Goodwill and Intangible Assets The net carrying amount of goodwill remained stable at $12.8 million, with no impairment recorded, and finite-lived intangible assets, net, were $0.327 million as of June 30, 2019 - The net carrying amount of goodwill was $12.8 million as of June 30, 2019, with no impairment recorded[68] Other Intangible Assets, Net (in thousands) | Metric | June 30, 2019 | December 31, 2018 | | :------------------------- | :------------ | :---------------- | | Finite-lived intangible assets | $6,643 | $6,643 | | Accumulated amortization | $(6,316) | $(6,003) | | Intangible assets, net | $327 | $640 | Note 7 — Lines of Credit The company has a $16.0 million committed revolving credit line, extended to June 30, 2022, with no outstanding debt but $9.2 million in stand-by letters of credit deducted - The Loan and Pledge Agreement provides a committed revolving credit line of $16.0 million and an uncommitted line of $4.0 million, with no outstanding debt as of June 30, 2019[71][74] - The agreement was amended on June 17, 2019, to extend the termination date to June 30, 2022, and limit SBLC terms to three years[74] - Outstanding stand-by letters of credit totaled $9.2 million at June 30, 2019, up from $8.8 million at December 31, 2018[75] Note 8 — Commitments and Contingencies The company has operating lease liabilities totaling $13.033 million, an accrued product warranty reserve of $0.599 million, $8.6 million in cancellable purchase obligations, and $9.2 million in stand-by letters of credit, and is involved in legal proceedings Lease Liabilities Maturities (June 30, 2019, in thousands) | Year | Amount | | :------------------ | :-------- | | 2019 (remaining six months) | $918 | | 2020 | $1,856 | | 2021 | $1,653 | | 2022 | $1,812 | | 2023 | $1,714 | | 2024 and thereafter | $10,043 | | Total | $17,996 | | Less imputed lease interest | $(4,963) | | Total Lease Liabilities | $13,033 | Accrued Product Warranty Reserve (in thousands) | Metric | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Beginning Balance | $571 | $359 | $478 | $366 | | Warranty costs charged to cost of revenue | $89 | $87 | $242 | $135 | | Utilization charges against reserve | $(25) | $(23) | $(38) | $(28) | | Release of accrual related to expired warranties | $(36) | $(34) | $(83) | $(84) | | Ending Balance | $599 | $389 | $599 | $389 | - The company had approximately $8.6 million of open cancellable purchase order arrangements as of June 30, 2019[84] - Stand-by letters of credit for warranty and product performance guarantees totaled $9.2 million at June 30, 2019[85] Note 9 — Income Taxes For the six months ended June 30, 2019, the company recognized an income tax expense of $1.3 million (effective rate of 17.1%), contrasting with a $11.5 million benefit in 2018 due to international restructuring - For the six months ended June 30, 2019, the company recognized an income tax expense of $1.3 million, including a $0.4 million discrete tax benefit from stock-based compensation[89] - The effective tax rate for the six months ended June 30, 2019, was 17.1% (21.6% excluding discrete tax items)[89] - For the six months ended June 30, 2018, the company recognized an income tax benefit of $11.5 million (effective rate of -324.4%), primarily due to an $11.9 million tax benefit from changing the tax status of Irish subsidiaries as part of international restructuring under the 2017 U.S. Tax Cuts and Jobs Act[89] Note 10 — Stock-based Compensation Total stock-based compensation expense for the six months ended June 30, 2019, was $3.071 million, with unamortized costs totaling $9.629 million and vested awards having a fair value of $3.492 million Stock-based Compensation Expense (in thousands) | Metric | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :----------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Total Stock-based Compensation Expense | $1,393 | $941 | $3,071 | $3,184 | | By Type of Award: | | | | | | Options | $1,003 | $680 | $2,136 | $2,344 | | RSUs | $390 | $261 | $935 | $840 | - During the six months ended June 30, 2019, the Company recorded an additional $0.3 million in stock-based compensation expense due to modifications of equity awards for its former Chairman of the Board[94] Unamortized Stock-Based Compensation Costs (June 30, 2019, in thousands) | Award Type | Unamortized Compensation Costs | Weighted Average Service Period (years) | | :--------- | :----------------------------- | :-------------------------------------- | | Stock options | $5,896 | 2.53 | | RSUs | $3,733 | 2.92 | | Total | $9,629 | | Total Grant Date Fair Value of Vested Stock Options and RSUs (in thousands) | Period | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Stock options | $1,126 | $1,256 | $2,493 | $2,517 | | RSUs | $75 | $116 | $999 | $625 | | Total Vested Fair Value | $1,201 | $1,372 | $3,492 | $3,142 | Note 11 — Business Segment and Geographic Information The company operates in two reportable segments: Water and Oil & Gas, with the Water Segment generating $35.194 million in product revenue and $18.438 million in operating income, and international customers accounting for 98% of product revenue - The company's reportable segments are Water and Oil & Gas, based on industries, product types, and related solutions/services[107] Segment Financial Information (Six Months Ended June 30, 2019, in thousands) | Metric | Water Segment | Oil & Gas Segment | Total | | :---------------------- | :------------ | :---------------- | :-------- | | Product Revenue | $35,194 | $104 | $35,298 | | License and Development Revenue | $— | $7,293 | $7,293 | | Operating Income (Loss) - Segment | $18,438 | $(1,817) | $16,621 | Product Revenue by Geographic Location (Six Months Ended June 30, 2019) | Location | Percent of Total Revenue | | :------------ | :----------------------- | | United States | 2% | | International | 98% | | Total | 100% | | By Country: | | | United Arab Emirates | 15% | | Chile | 12% | | Saudi Arabia | 21% | | Others | 52% | Note 12 — Concentrations The company has significant customer concentrations, with Customer A accounting for 28% of Water Segment product revenue and 33% of combined accounts receivable and contract assets, and one international Oil & Gas customer accounting for 100% of license and development revenue Product Revenue Concentration by Customer (Six Months Ended June 30, 2019) | Customer | Segment | Percent of Total Revenue | | :--------- | :------ | :----------------------- | | Customer A | Water | 28% | | Customer B | Water | 12% | - One international Oil and Gas Segment customer accounts for 100% of the Company's license and development revenue for the six months ended June 30, 2019 and 2018[121] Accounts Receivable and Contract Assets Concentration by Customer (June 30, 2019) | Customer | Segment | Percent of Total Accounts Receivable and Contract Assets | | :--------- | :-------- | :------------------------------------------------------- | | Customer A | Water | 33% | | Customer G | Oil & Gas | 17% | | Customer H | Water | 14% | Item 2 — Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial condition and results of operations, including an overview of its business segments, detailed analysis of revenue, gross profit, operating expenses, other income, income taxes, liquidity, capital resources, and forward-looking statements Overview Energy Recovery, Inc. is an engineering-driven technology company providing solutions for industrial fluid flow processes in water and oil & gas markets, with the Water Segment focusing on desalination and the Oil & Gas Segment on license and development revenue - Energy Recovery, Inc. is an engineering-driven technology company that designs, manufactures, and supplies solutions for industrial fluid flow processes, operating in the water and oil & gas markets[131] - The Water Segment generates revenue from energy recovery devices (ERDs) and pumps for seawater, brackish, and wastewater reverse osmosis desalination, serving mega-project, OEM, and after-market channels[132] - The Oil & Gas Segment primarily derives revenue from license and development activities for hydraulic fracturing, gas processing, and chemical processing solutions[133] Results of Operations The company experienced a 10% increase in total revenue for the three months ended June 30, 2019, driven by the Water Segment, with improved product gross profit and margin, but significantly increased operating expenses, and a shift from tax benefit to expense Total Revenue Total revenue increased by 10% to $22.8 million for the three months ended June 30, 2019, and by 23% to $42.6 million for the six months, primarily driven by a $2.1 million (12%) increase in Water Segment product revenue for the three-month period and a $7.0 million (25%) increase for the six-month period, largely due to MPD and OEM shipments Total Revenue (in thousands) | Metric | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Change ($) | Change (%) | | :-------------- | :------------------------------- | :------------------------------- | :--------- | :--------- | | Water | $19,226 | $17,116 | $2,110 | 12% | | Oil & Gas | $0 | $290 | $(290) | (100)% | | Product Revenue | $19,226 | $17,406 | $1,820 | 10% | | License & Dev Revenue | $3,570 | $3,358 | $212 | 6% | | Total Revenue | $22,796 | $20,764 | $2,032 | 10% | Total Revenue (Six Months Ended June 30, in thousands) | Metric | 2019 | 2018 | Change ($) | Change (%) | | :-------------- | :-------- | :-------- | :--------- | :--------- | | Water | $35,194 | $28,164 | $7,030 | 25% | | Oil & Gas | $104 | $300 | $(196) | (65)% | | Product Revenue | $35,298 | $28,464 | $6,834 | 24% | | License & Dev Revenue | $7,293 | $6,107 | $1,186 | 19% | | Total Revenue | $42,591 | $34,571 | $8,020 | 23% | - Water Segment product revenue increased by $2.1 million (12%) for the three months and $7.0 million (25%) for the six months, primarily due to higher MPD and OEM shipments[137][138] Product Gross Profit and Gross Margin Product gross profit increased by 20.2% to $13.7 million for the three months ended June 30, 2019, and by 29.8% to $24.9 million for the six months, with gross margin improving by 580 basis points to 71.5% for the three months and by 310 basis points to 70.5% for the six months, driven by favorable mix and efficiencies Product Gross Profit and Gross Margin (Three Months Ended June 30, in thousands) | Segment | 2019 Gross Profit | 2019 Gross Margin | 2018 Gross Profit | 2018 Gross Margin | Change in Gross Profit ($) | | :-------- | :---------------- | :---------------- | :---------------- | :---------------- | :------------------------- | | Water | $13,743 | 71.5% | $11,476 | 67.0% | $2,267 | | Oil & Gas | $0 | 0% | $(46) | (15.9)% | $46 | | Total | $13,743 | 71.5% | $11,430 | 65.7% | $2,313 | Product Gross Profit and Gross Margin (Six Months Ended June 30, in thousands) | Segment | 2019 Gross Profit | 2019 Gross Margin | 2018 Gross Profit | 2018 Gross Margin | Change in Gross Profit ($) | | :-------- | :---------------- | :---------------- | :---------------- | :---------------- | :------------------------- | | Water | $24,964 | 70.9% | $19,296 | 68.5% | $5,668 | | Oil & Gas | $(84) | (80.8)% | $(122) | (40.7)% | $38 | | Total | $24,880 | 70.5% | $19,174 | 67.4% | $5,706 | - Product gross margin increased by 580 basis points (to 71.5%) for the three months and 310 basis points (to 70.5%) for the six months, driven by favorable price/product mix, manufacturing efficiencies, and higher production in the Water Segment[140][141] Operating Expenses Total operating expenses increased by 26% to $13.3 million for the three months ended June 30, 2019, and by 14% to $25.5 million for the six months, primarily due to a $1.9 million (52%) increase in R&D expenses and higher corporate G&A Total Operating Expenses (Three Months Ended June 30, in thousands) | Category | 2019 | 2018 | | :------------------------- | :------ | :------ | | Total Operating Expenses - Segment | $8,418 | $6,481 | | Corporate Operating Expenses | $4,900 | $4,067 | | Total Operating Expenses | $13,318 | $10,548 | Total Operating Expenses (Six Months Ended June 30, in thousands) | Category | 2019 | 2018 | | :------------------------- | :------ | :------ | | Total Operating Expenses - Segment | $15,552 | $13,293 | | Corporate Operating Expenses | $9,917 | $9,079 | | Total Operating Expenses | $25,469 | $22,372 | - Research and development expense increased by $1.9 million (52%) for the three months and $2.2 million (29%) for the six months, driven by higher employee-related expenses, depreciation, and investment in supplies and equipment for new technologies and existing product improvements[147][152] - Corporate operating expenses increased by $0.8 million (20%) for the three months and $0.8 million (9%) for the six months, primarily due to higher employee headcount and related general and administrative expenses[146][151] Other Income, Net Total other income, net, increased by $0.1 million to $0.480 million for the three months ended June 30, 2019, and by $0.4 million to $0.979 million for the six months, primarily due to higher interest income from increased investment balances Total Other Income, Net (in thousands) | Metric | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :---------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Interest Income | $528 | $373 | $1,051 | $674 | | Interest Expense | $0 | $(1) | $0 | $(1) | | Other Non-Operating (Expense) Income, Net | $(48) | $9 | $(72) | $(44) | | Total Other Income, Net | $480 | $381 | $979 | $629 | - The increase in total other income, net, was primarily due to higher interest income on increased investment balances[153][154] Income Taxes For the six months ended June 30, 2019, the company recognized an income tax expense of $1.3 million (effective rate of 17.1%), contrasting with a significant income tax benefit of $11.5 million (effective rate of -324.4%) in the prior year due to international restructuring - For the six months ended June 30, 2019, the company recognized an income tax expense of $1.3 million, including a $0.4 million discrete tax benefit[155] - The effective tax rate for the six months ended June 30, 2019, was 17.1% (21.6% excluding discrete items)[156] - For the six months ended June 30, 2018, the company recognized an income tax benefit of $11.5 million (effective rate of -324.4%), which included an $11.9 million tax benefit from changing the tax status of its Irish subsidiaries due to international restructuring under the 2017 U.S. Tax Cuts and Jobs Act[156] Liquidity and Capital Resources The company's primary liquidity sources include $23.3 million in cash, $71.9 million in short-term investments, and a $16.0 million revolving credit line, with cash from operating activities improving and financing activities providing $4.5 million due to no share repurchases in 2019 Overview The company's main liquidity sources are customer payments, common stock issuance, and a strong balance of cash, cash equivalents ($23.3 million), and short-term investments ($71.9 million), with cash not needed for current operations invested in high-quality debt instruments - Principal liquidity sources as of June 30, 2019, included $23.3 million in unrestricted cash and cash equivalents, $71.9 million in short-term investments, and $15.2 million in net accounts receivable[157] - Cash not needed for current operations is invested predominantly in high-quality, investment-grade, marketable debt instruments to preserve principal and liquidity[157] Loan Agreements The company maintains a Loan and Pledge Agreement providing a $16.0 million committed revolving credit line, amended to extend the termination date to June 30, 2022, with no outstanding debt as of June 30, 2019 - The company has a Loan and Pledge Agreement with a committed revolving credit line of $16.0 million and an uncommitted line of $4.0 million[158] - The agreement was amended on June 17, 2019, to extend the termination date to June 30, 2022, and limit the term of any Stand-By Letter of Credit (SBLC) to three years[160] - As of June 30, 2019, no debt was outstanding under the Loan and Pledge Agreement, though SBLCs are deducted from the total revolving credit line[160] Stand-By Letters of Credit As of June 30, 2019, the company had $9.2 million in outstanding stand-by letters of credit (SBLCs) with various financial institutions, requiring a corresponding U.S. investment balance - Outstanding stand-by letters of credit totaled $9.2 million as of June 30, 2019, requiring a matching U.S. investment balance[161] Share Repurchase Programs The company's Board of Directors authorized a $10.0 million share repurchase program in March 2018, under which 1.2 million shares were repurchased for $10.0 million, with no other program in place as of June 30, 2019 - Under the March 2018 Authorization, the company repurchased 1.2 million shares for $10.0 million, and this authorization expired in September 2018, with no new program in place as of June 30, 2019[162] Cash Flows Net cash provided by operating activities improved by $1.7 million for the six months ended June 30, 2019, despite lower net income, driven by positive changes in deferred income taxes and prepaid assets, and financing activities provided $4.5 million due to no share repurchases in 2019 Cash Flows Summary (Six Months Ended June 30, in thousands) | Metric | 2019 | 2018 | | :--------------------------------------- | :-------- | :-------- | | Net cash provided by (used in) operating activities | $3 | $(1,670) | | Net cash used in investing activities | $(3,241) | $(4,015) | | Net cash provided by (used in) financing activities | $4,519 | $(7,691) | | Net change in cash, cash equivalents and restricted cash | $1,281 | $(13,354) | | Cash, cash equivalents and restricted cash, end of period | $23,419 | $17,272 | - Cash provided by operating activities improved by $1.7 million for the six months ended June 30, 2019, driven by positive effects from changes in deferred income taxes ($12.8 million) and prepaid assets ($11.5 million)[166] - Net cash provided by financing activities increased by $12.2 million, primarily due to no common stock repurchases in 2019 (compared to $10.0 million in 2018) and higher proceeds from common stock issuance ($2.2 million)[170] Liquidity and Capital Resource Requirements Management believes current resources and cash from operations will meet anticipated capital requirements for the next 12 months, but additional capital may be needed for future growth, acquisitions, or rapid market adoption of new technologies - Existing resources and cash generated from operations are believed to be sufficient to meet anticipated liquidity needs for at least the next 12 months[171] - Additional capital may be required for future growth, acquisitions, or funding investments in latest technology due to rapid market adoption, potentially necessitating equity or debt financing[171] Off-Balance Sheet Arrangements The company did not have any off-balance sheet arrangements with unconsolidated entities or financial partnerships during the reported periods - The company did not have any off-balance sheet arrangements during the periods presented[172] Recent Accounting Pronouncements This section refers to Note 1, 'Description of Business and Significant Accounting Policies,' for information regarding recent accounting pronouncements - Refer to Note 1, 'Description of Business and Significant Accounting Policies,' for details on recent accounting pronouncements[173] Item 3 — Quantitative and Qualitative Disclosures About Market Risk The company's market risk exposure primarily stems from foreign currency fluctuations and interest rate changes, with a hypothetical 1% interest rate increase estimated to decrease fair value by $0.3 million, and credit risk mitigated through investment policy Foreign Currency Risk The company is exposed to foreign currency fluctuations, particularly between the USD and various other currencies, potentially impacting international revenue and expenses, though it has not hedged this exposure due to historical insignificance - The company's foreign currency exposures are due to fluctuations in exchange rates for USD versus the British Pound, Saudi Riyal, United Arab Emirates Dirham, Euro, Chinese Yuan, Indian Rupee, and Canadian Dollar[175] - As international sales expand, a portion of revenue could be denominated in foreign currencies, increasing the impact of exchange rate changes on cash, cash equivalents, and operating results[175] - The company has not hedged its foreign currency exposure because foreign currency expenses have been insignificant, and exchange rate fluctuations have had minimal impact on operating results and cash flows to date[175] Interest Rate Risk and Credit Risk The company's investment portfolio of $73.4 million in fixed-income marketable debt securities is subject to interest rate fluctuations; a hypothetical 1% increase in interest rates would decrease its fair value by approximately $0.3 million, and credit risk is minimized through an investment policy - The company's investment portfolio of approximately $73.4 million in fixed-income marketable debt securities is subject to interest rate fluctuations[177] - A hypothetical 1% increase in interest rates would result in an approximately $0.3 million decrease in the fair value of fixed-income debt securities as of June 30, 2019[177] - Credit risk is minimized through an investment policy that mandates high credit rating requirements and restricts exposure to any single corporate issuer by imposing concentration limits[177] Item 4. — Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of June 30, 2019, with no material changes in internal control over financial reporting during the period Evaluation of Disclosure Controls and Procedures The President and Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the company's disclosure controls and procedures and concluded they were effective as of June 30, 2019 - Management concluded that disclosure controls and procedures were effective as of June 30, 2019[178] Changes in Internal Controls There were no material changes in internal control over financial reporting during the period covered by this report that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting - No material changes in internal control over financial reporting occurred during the period[179] PART II — OTHER INFORMATION Item 1. — Legal Proceedings This section refers to Note 8, 'Commitments and Contingencies – Litigation,' in the Notes to Condensed Consolidated Financial Statements for an update on legal proceedings - For an update on litigation matters, refer to Note 8, 'Commitments and Contingencies – Litigation,' in the Notes to Condensed Consolidated Financial Statements[182] Item 1A. — Risk Factors This section outlines significant risks across the company's operations, including those specific to the Water and Oil & Gas segments, as well as broader business risks such as supply chain, regulations, and international trade Risk Related to our Water Segment Risks in the Water Segment include dependence on new desalination plant construction, intense competition, challenges in collecting unbilled receivables, and reliance on a limited number of suppliers for critical components - The Water Segment's revenue depends on new desalination plant construction, leading to significant variability due to factors like capital spending, project financing, and government regulations[184] - The Water Segment faces intense competition, particularly on price, which could harm its competitive position and reduce profits if competitors offer superior technology or more cost-effective products[184] - Inability to collect unbilled receivables, often due to holdback provisions in contracts with large engineering, procurement, and construction firms, could adversely affect operating results[184] - Reliance on a limited number of suppliers for critical components (e.g., vessel housings, stainless steel parts) poses risks related to delivery schedules, quality assurance, production costs, and supply continuity[186] Risk Related to our Oil & Gas Segment Risks in the Oil & Gas Segment include potential failure to commercialize VorTeq and MTeq technologies, dependence on the VorTeq Licensee, and the adverse impact of prolonged deflation in global oil prices on market penetration and profitability - The company may not successfully commercialize the VorTeq technology, potentially failing to meet milestones and receive royalty payments from the VorTeq Licensee due to technological challenges in hydraulic fracturing[187] - Failure to successfully complete early stage testing of the MTeq, secure a long-term licensing agreement, or overcome technological challenges in mud pumping could prevent its commercialization[187][188] - Prolonged deflation in global oil prices could delay or cancel projects by Oil & Gas Segment customers, negatively affecting market penetration, revenue, and profitability[189] Risk Related to our Entire Business Broader business risks include the uncertainty of successful diversification into new fluid flow markets, significant fluctuations in operating results due to long and unpredictable sales cycles, and the challenge of managing fixed costs against variable demand, along with risks related to inventory, R&D, product defects, business interruptions, intellectual property, global operations, IT security, international tax, capital, and acquisitions - Diversification into new fluid flow markets like oil and gas may not be successful, potentially damaging reputation, limiting growth, and negatively affecting operating results[190] - Operating results may fluctuate significantly due to long and unpredictable sales cycles, making future results difficult to predict and potentially causing them to fall below expectations[190] - The business entails significant fixed costs that are difficult to reduce in the short term, while demand for products is variable, potentially leading to higher relative costs, excess manufacturing capacity, and lower gross profit margins during downturns[190][192] - The company is exposed to risks related to product defects, which could lead to warranty claims in excess of provisions or significant damages, especially with new product introductions[195] - Global operations expose the company to risks from geopolitical instability, changes in U.S. fiscal and trade policies (e.g., tariffs on Chinese imports), and compliance with international laws like the Foreign Corrupt Practices Act (FCPA)[199][201][202] - If additional capital is needed to fund future growth or acquisitions, it may not be available on favorable terms or at all, potentially limiting the company's ability to grow or respond to challenges[210] Item 2. — Unregistered Sales of Equity Securities and Use of Proceeds There was no activity in the share repurchase program during the six months ended June 30, 2019, but 1.2 million shares were repurchased for $10.0 million under the March 2018 Authorization, which expired in September 2018 - No activity occurred in the share repurchase program during the six months ended June 30, 2019[218] - Under the March 2018 Authorization (expired September 2018), 1.2 million shares were repurchased for an aggregate cost of $10.0 million[218] Item 3. — Defaults Upon Senior Securities The company reported no defaults upon senior securities - No defaults upon senior securities were reported[219] Item 4. — Mine Safety Disclosures This item is not applicable to the company - Mine Safety Disclosures are not applicable[221] Item 5. — Other Information The company reported no other information - No other information was reported[222] Item 6. — Exhibits This section refers to the Exhibit Index for a comprehensive list of exhibits filed or furnished with this report - Refer to the Exhibit Index for a list of exhibits filed or furnished with this report[223] Exhibit Index The Exhibit Index lists all documents filed or furnished with the Form 10-Q, including the Sixth Amendment to Loan and Pledge Agreement, certifications from executive officers (302 and 906), and various XBRL taxonomy extension documents Key Exhibits Filed | Exhibit Number | Exhibit Description | | :------------- | :---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | | 10.1 | Sixth Amendment to Loan and Pledge Agreement between Energy Recovery, Inc. and Citibank, N.A. | | 31.1 | Certification of Principal Executive Officer, pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | 31.2 | Certification of Principal Financial Officer, pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | 32.1* | Certification of Principal Executive Officer and Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | Signatures The report is duly signed on behalf of Energy Recovery, Inc. by Chris Gannon, President and Chief Executive Officer, and Joshua Ballard, Chief Financial Officer, on August 2, 2019 - The report was signed by Chris Gannon, President and Chief Executive Officer, and Joshua Ballard, Chief Financial Officer, on August 2, 2019[232]