eri_10k-123111.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-K
(Mark One)
|
|
R
|
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
For the fiscal year ended December 31, 2011
|
|
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
|
(I.R.S. Employer
|
|
Incorporation or Organization)
|
Identification No.)
|
1717 Doolittle Drive, San Leandro, CA 94577
(Address of Principal Executive Offices)
Registrant’s telephone number, including area code:
(510) 483-7370
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of Each Class
|
Name of Exchange on Which Registered
|
Common stock, $0.001 par value
|
The NASDAQ Stock Market LLC
|
Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:
None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes £ No R
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £ No R
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 R 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 R No £
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. R
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 R
|
Non-accelerated filer £
|
Smaller reporting company £
|
|
(Do not check if a smaller reporting company)
|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R
The aggregate market value of the voting stock held by non-affiliates amounted to $122.8 million on June 30, 2011.
The number of shares of the registrant’s common stock outstanding as of March 7, 2012 was 52,646,629.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Proxy Statement for the Registrant’s Annual Meeting of Shareholders to be held in June 2012 are incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
|
|
Page
|
PART I
|
Item 1.
|
Business
|
3 |
Item 1A.
|
Risk Factors
|
6 |
Item 1B.
|
Unresolved Staff Comments
|
16 |
Item 2.
|
Properties
|
16 |
Item 3.
|
Legal Proceedings
|
16 |
Item 4.
|
Mine Safety Disclosures
|
16 |
PART II
|
Item 5.
|
Market for the Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
|
17 |
Item 6.
|
Selected Financial Data
|
19 |
Item 7.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
19 |
Item 7A.
|
Quantitative and Qualitative Disclosure About Market Risk
|
34 |
Item 8.
|
Financial Statements and Supplementary Data
|
34 |
Item 9.
|
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
|
65 |
Item 9A.
|
Controls and Procedures
|
65 |
Item 9B.
|
Other Information
|
67 |
PART III
|
Item 10.
|
Directors, Executive Officers and Corporate Governance
|
67 |
Item 11.
|
Executive Compensation
|
67 |
Item 12.
|
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|
67 |
Item 13. |
Certain Relationships and Related Transactions and Director Independence |
67 |
Item 14.
|
Principal Accountant Fees and Services
|
67 |
PART IV
|
Item 15.
|
Exhibits and Financial Statement Schedules
|
68 |
SIGNATURES
|
70 |
PART I
Item 1. Business
Overview
Energy Recovery, Inc. develops, manufactures and sells high-efficiency energy recovery devices and pumps primarily for use in seawater desalination. Our products make desalination affordable by reducing energy costs. We have one operating segment, which includes the manufacture and sale of high-efficiency energy recovery products and pumps along with related parts and services. Additional information on segment reporting is contained in Note 14 of Notes to the consolidated financial statements in this Form 10-K.
During fiscal year 2011, we completed the consolidation of our two manufacturing plants, closing our facility in Michigan and integrating all production operations at our corporate headquarters and manufacturing center in California. Likewise, we validated internal production capability for all ceramic components used in PX devices, and we expect that such vertical integration will provide increased utilization and cost savings in 2012. We also initiated the development of new centrifugal product lines for applications in the oil and gas processing markets.
In February 2011, we appointed Thomas S. Rooney, Jr. as our chief executive officer, and in April 2011, we appointed Alex J. Buehler as our chief financial officer. Additionally, we appointed three seasoned executives to drive penetration into new markets beyond desalination, with a focus on water market applications outside of desalination, ceramic product development, and products to repurpose pressure energy that is otherwise lost in high-pressure fluid applications in the oil and gas industry. We also successfully launched a new and improved PX device, known as the PX-Q 300. This new development offers customers equipment that enjoys substantial sound reduction compared to previous versions, thereby improving our competitive position. At the same time, we refined our value proposition with messaging that reinforces durability, reliability and efficiency guarantees. Finally, we received three new patents related to the PX technology and received approval for the amendment of a prior patent, further strengthening our intellectual property portfolio.
Our company was incorporated in Virginia in April 1992 and reincorporated in Delaware in March 2001. We became a public company in July 2008. The company has two wholly-owned subsidiaries: Energy Recovery Iberia, S.L., incorporated in September 2006, and ERI Energy Recovery Ireland Ltd., incorporated in November 2009. In December 2011, the company merged three subsidiaries -- Osmotic Power, Inc.; Energy Recovery, Inc. International; and Pump Engineering, Inc. -- into the parent company, Energy Recovery, Inc.
The mailing address of our headquarters is 1717 Doolittle Drive, San Leandro, California 94577. Our main telephone number is (510) 483-7370. Additional information about ERI is available on our website at http://www.energyrecovery.com. Information contained on the website is not part of this report.
Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports and the Proxy Statement for our Annual Meeting of Stockholders are made available, free of charge, on our website, http://www.energyrecovery.com, as soon as reasonably practicable after the reports have been filed with or furnished to the Securities and Exchange Commission.
Our Products
We make energy recovery devices and high-pressure and circulation pumps primarily for use in seawater desalination plants that use reverse osmosis technology. Our products are sold under the trademarks AquaBoldTM, AquaSpireTM, ERITM, PXTM, Pressure ExchangerTM, PX Pressure ExchangerTM, PEITM, Pump EngineeringTM and QuadribaricTM. Our energy recovery products reduce plant operating costs by capturing and reusing the otherwise lost pressure energy from the reject stream of the desalination process. Use of energy recovery devices can reduce energy consumption by up to an estimated 60% compared to desalination without energy recovery. By reducing energy costs, our devices increase the cost-competitiveness of reverse osmosis desalination compared to other means of fresh water production, including thermal desalination. Our pumps are designed for high efficiency and complement the operation of our energy recovery devices.
Energy Recovery Devices. We develop and sell two main lines of energy recovery devices: PX Pressure Exchanger devices and turbochargers. Each line includes a range of models and sizes to address the breadth of required process flow rates, plant designs and sizes.
Our current PX offering includes: the PX-300 and PX-Q300; the 65 series (the PX-260, PX-220 and PX-180); the 4S series (PX-140S, PX-90S, PX-70S, PX-45S and PX-30S) and brackish PX devices (for the desalination of water with a lower concentration of salt than seawater).
Our turbocharger offering includes: the HTCAT series (HTCAT-1800, HTCAT-2400, HTCAT-3600, HTCAT-4800, HTCAT-7200 and HTCAT-9600); the HALO line (HALO-50, HALO-75, HALO-100, HALO-150, HALO-225, HALO-300, HALO-450, HALO-500, HALO-600, HALO-900 and HALO-1200); and the LPT series for brackish water desalination applications (LPT-63, LPT-125, LPT-250, LPT-500, LPT-1000, LPT-2000 and LPT-3200).
High-pressure and Circulation Pumps. We manufacture and sell high-pressure feed, circulation and booster pumps for use with our energy recovery devices in reverse osmosis desalination plants. Our current line of pumps includes the AquaBold series (AquaBold 2x3x5, AquaBold 3x4x7 and AquaBold 4x6x9); the AquaSpire series (AquaSpire-300, AquaSpire-450, AquaSpire-600, AquaSpire-900, AquaSpire-1200, AquaSpire-1800, AaquaSpire-2400, AquaSpire-3600, AquaSpire-4800, AquaSpire-7200 and AquaSpire-9600) and a line of small circulation pumps.
Technical Support and Replacement Parts. We provide engineering and technical support to customers during product installation and plant commissioning. We also offer replacement parts and services for our PX devices and turbochargers . Our PX devices and turbochargers are also used to retrofit or replace older energy recovery devices in existing desalination plants.
Customers
Our customers include a limited number of major international engineering, procurement and construction firms which design and build large desalination plants, and a number of original equipment manufacturers (OEMs), which are companies that supply equipment and packaged solutions for small to medium-sized desalination plants.
Large engineering, procurement and construction firms. A significant portion of our revenue typically has come from sales of products to large engineering, procurement and construction firms worldwide that have the required desalination expertise to engineer, undertake procurement for, construct and sometimes own and operate large desalination plants or mega-projects. We work with these firms to specify our products for their plants. The time between project tender to product shipment can range from six to 16 months. Each mega-project typically represents a revenue opportunity of between $2 million to $10 million.
A limited number of these engineering, procurement and construction firms account for 10% or more of our net revenue. Revenue from customers representing 10% or more of total revenue varies from year to year. For the year ended December 31, 2011, one customer, IDE Technologies Ltd., accounted for approximately 14% of our net revenue. For the year ended December 31, 2010, two customers — Thiess Degremont J.V. (a joint venture of Thiess Pty Ltd. and Degremont S.A.) and Hydrochem (S) Pte Ltd (a Hyflux company) — accounted for approximately 23% and 12% of our net revenue, respectively. For the year ended December 31, 2009, IDE Technologies, Ltd., Acciona Agua, and UTE Mostaganem — a consortium of Inima (Grupo OHL) and Aqualia (Grupo FCC) — accounted for approximately 20%, 11%, and 11% of our net revenue, respectively. No other customer accounted for more than 10% of our net revenue during any of these periods.
Original Equipment Manufacturers. We also sell our products and services to suppliers of pumps and other water-related equipment for assembly and use in small to medium-sized desalination plants located in hotels, power plants, cruise ships, farm operations, island bottlers, and small municipalities. These original equipment manufacturers also purchase our products for “quick water” or emergency water solutions. In this market, the time from project tender to shipment ranges from one to three months.
Competition
The market for energy recovery devices and pumps in desalination plants is competitive. As the demand for fresh water increases and the market expands, we expect competition to persist and intensify.
We have two main competitors for our energy recovery devices: Flowserve Corporation (Flowserve) based in Irving, Texas and Fluid Equipment Development Company (FEDCO) based in Monroe, Michigan. We compete with these companies on the basis of price, technology, materials, efficiency and life cycle maintenance costs. We believe that our products have a competitive advantage, even though these companies may offer competing products at prices lower than ours, because we believe that our products are the most cost-effective energy recovery devices for reverse osmosis desalination over time.
In the market for large desalination projects, our PX devices and large turbochargers compete primarily with Flowserve’s DWEER product. We believe that our PX devices have a competitive advantage over the DWEER devices because they are made with highly durable and corrosion-proof ceramic parts that indicate a design life of 25 years, are warranted for high efficiencies, and offer low life cycle costs. The PX devices offer maximum plant uptime, optimum scalability with a quick startup, and no required maintenance. We believe that our large turbocharger products have a competitive advantage over the DWEER product, particularly in countries where energy costs are low and upfront capital costs are a key factor in purchase decisions, because our turbocharger products have lower upfront capital costs, a simple design with one moving part, a small physical footprint and a long operating life which leads to low total life cycle costs.
In the market for small to medium-sized desalination plants, our products compete with Flowserve’s Pelton turbines and FEDCO turbochargers. We believe that our PX devices have a competitive advantage over these products because our devices provide up to 98% energy transfer efficiency, have lower life cycle maintenance costs, and are made of highly durable and corrosion-proof ceramic parts. We believe that our turbochargers compete favorably with Pelton turbines on the basis of efficiency and price, and that our turbochargers have design advantages over competing turbochargers that enhance efficiency and serviceability.
In the market for high-pressure pumps, our products compete with pumps manufactured by Clyde Union Ltd. based in Glasgow, Scotland; FEDCO; Flowserve; Duchting Pumpen Maschinenfabrik GmbH & Co KG based in Witten, Germany; KSB Aktiengesellschaft based in Frankenthal, Germany; Torishima Pump Mfg. Co., Ltd. based in Osaka, Japan; and Sulzer Pumps, Ltd. based in Winterthur, Switzerland and other companies. We believe that our pump products are competitive with these products because our pumps are developed specifically for reverse osmosis desalination, are highly efficient and feature product-lubricated bearings.
Sales and Marketing
We market and sell our products directly to customers through our sales organization and, in some countries, through authorized, independent sales agents. In 2010, we integrated our PEI and ERI sales operations. Our current sales organization now has two groups, the Mega-Projects Group, which is responsible for sales of our PX devices and large turbochargers for desalination projects exceeding 50,000 cubic meters per day; and our OEM Group, which is responsible for sales of PX devices, turbochargers and pumps for plants designed to produce less than 50,000 cubic meters per day.
A significant portion of our revenue is from outside of the United States. Sales in the United States represented 10%, 7%, and 6% of our net revenue for the fiscal years 2011, 2010, and 2009, respectively. Additional geographical information regarding our net revenues is included in Note 14 to the consolidated financial statements in this Form 10-K.
Since many of the large engineering, procurement, and construction firms that specialize in large projects are located in the Mediterranean region, we have sales and technical staff based out of Madrid, Spain. A sales branch in Dubai, United Arab Emirates serves the Middle East where many desalination plants and key engineering, procurement and construction firms are located. We also have a sales office in Shanghai, China to address this emerging market for our energy recovery products. In the U.S., our sales office is located in California.
Manufacturing
We have a manufacturing facility in San Leandro, California, where our PX devices are made, assembled and tested. In late 2011, we also integrated the manufacturing and testing of our turbochargers and pumps into our manufacturing facility in San Leandro. Prior to the integration, we manufactured and tested our turbochargers and pumps at a manufacturing facility in New Boston, Michigan. We produce the majority of our ceramic components for our PX products in our in-house ceramics manufacturing facility; although, from time to time, we may purchase a small amount of unfinished ceramic components from a supplier. For our PX devices, we depend on two suppliers for our vessel housing and a single supplier for stainless steel castings. For our turbochargers and pumps, we rely on a limited number of foundries for castings. We finish machining and assemble in-house all ceramic components of our PX devices and many components of our turbochargers and pumps to protect the proprietary nature of our methods of manufacturing and product designs and to maintain quality standards.
For a discussion of risks attendant to our manufacturing activities, see “Risk Factors — We depend on a limited number of suppliers for some of our components. If our suppliers are not able to meet our demand and/or requirements, our business could be harmed,” and “Risk Factors — We depend on a limited number of vendors for our supply of ceramic powder, which is a key component of the ceramic components of our PX products.” in Item 1A, which is incorporated herein by reference. For a discussion of risks attendant to our planned in-house manufacture of some ceramic components of our PX devices, see “Risk Factors — Our plans to manufacture a portion of our ceramic components may prove to be more costly or less reliable than outsourcing,” in Item 1A, which is incorporated herein by reference.
Research and Development
Design, quality and innovation are key facets of our corporate culture. Our development efforts are focused on enhancing our existing energy recovery devices and pumps for the desalination market and advancing our know-how in the material science and manufacturing of ceramics. In 2011, our engineering work also led to the development of several potential new product lines for applications inside and outside of seawater desalination. Research and development expense totaled $3.5 million for 2011, $3.9 million for 2010, and $3.0 million for 2009. We expect research and development costs to increase in the future as we continue to advance our existing technology and to develop new energy recovery and efficiency-enhancing solutions for markets outside of seawater desalination.
For a discussion of risks attendant to our research and development activities, see “Risk Factors — The success of our business depends in part on our ability to enhance and scale our existing products, develop new products for desalination, and diversify into new markets by developing or acquiring new technology,” in Item 1A, which is incorporated herein by reference.
Intellectual Property
We seek patent protection for new technology, inventions and improvements that are likely to be incorporated into our products. We rely on trade secret law and contractual safeguards to protect the proprietary tooling, processing techniques and other know-how used in the production of our products.
We have ten U.S. patents and sixteen patents outside the U.S. that are counterparts of several of the U.S. patents. The U.S. patents expire between 2015 and 2028, and the corresponding international patents expire at various dates through 2021. Additionally, there are two pending U.S. patent applications, thirty-three pending foreign applications corresponding to the U.S. patents and patent applications, and two pending international applications.
We have registered the following trademarks with the United States Patent and Trademark office: “ERI,” “PX,” “PX Pressure Exchanger,” “Pressure Exchanger,” the ERI logo and “Making Desalination Affordable.” We have also applied for and received registrations in international trademark offices.
For a discussion of risks attendant to intellectual property rights, see “Risk Factors — If we are unable to protect our technology or enforce our intellectual property rights, our competitive position could be harmed, and we could be required to incur significant expenses to enforce our rights,” in Item 1A, which is incorporated herein by reference.
Employees
As of December 31, 2011, we had 96 employees: 32 in manufacturing; 27 in corporate services and management; 25 in sales, services, and marketing; and 12 in engineering, research and development. Fourteen (14) of these employees were located outside of the United States. We also from time to time engage a relatively small number of independent contractors. We have not experienced any work stoppages and our employees are not unionized.
Item 1A. Risk Factors
Almost all of our revenue is derived from sales of energy recovery devices and pumps used in reverse osmosis desalination; a decline in demand for desalination or the reverse osmosis method of desalination will reduce demand for our products and will cause our sales and revenue to decline.
Products for the desalination market have historically accounted for a high percentage of our revenue. We expect that the revenue from these products will continue to account for most of our revenue in the foreseeable future. Any factors adversely affecting the demand for desalination, including changes in weather patterns, increased precipitation in areas of high human population density, new technology for producing fresh water, increased water conservation or reuse, political changes and unrest, changes in the global economy, or changes in industry or governmental regulations would reduce the demand for our energy recovery products and services and would cause a significant decline in our revenue. Similarly, any factors adversely affecting the demand for energy recovery products in reverse osmosis desalination, including new energy technology or reduced energy costs, new methods of desalination that reduce pressure and energy requirements, or improvements in membrane technology would reduce the demand for our energy recovery devices and would cause a significant decline in our revenue. Some of the factors that may affect sales of our energy recovery devices and pumps may be out of our control.
We depend on the construction of new desalination plants for revenue, and as a result, our operating results have experienced, and may continue to experience, significant variability due to volatility in capital spending, availability of project financing, and other factors affecting the water desalination industry.
We currently derive substantially all of our revenue from sales of products and services used in desalination plants for municipalities, hotels, resorts and agricultural operations in dry or drought-ridden regions of the world. The demand for our products may decrease if the construction of desalination plants declines for political, economic or other factors, especially in these regions. Other factors that could affect the number and capacity of desalination plants built or the timing of their completion include: the availability of required engineering and design resources, a weak global economy, shortage in the supply of credit and other forms of financing, changes in government regulations, permitting requirements or priorities, or reduced capital spending for desalination. Each of these factors could result in reduced or uneven demand for our products. Pronounced variability or delays in the construction of desalination plants or reductions in spending for desalination could negatively impact our sales and revenue and make it difficult for us to accurately forecast our future sales and revenue, which could lead to increased inventory and use of working capital.
Our revenue and growth model depend upon the continued viability and growth of the seawater reverse osmosis desalination industry using current technology.
If there is a downturn in the seawater reverse osmosis desalination industry, our sales would be directly and adversely impacted. Changes in seawater reverse osmosis desalination technology could also reduce the demand for our devices. For example, a reduction in the operating pressure used in seawater reverse osmosis desalination plants could reduce the need for, and viability of, our energy recovery devices. Membrane manufacturers are actively working on low-pressure membranes for seawater reverse osmosis desalination that could potentially be used on a large scale to desalinate seawater at a much lower pressure than is currently necessary.
Engineers are also evaluating the possibility of diluting seawater prior to reverse osmosis desalination to reduce the required membrane pressure. Similarly, an increase in the membrane recovery rate would reduce the number of energy recovery devices required and would reduce the demand for our product. A significant reduction in the cost of power may reduce demand for our product or favor a less expensive product from a competitor.
Any of these changes would adversely impact our revenue and growth. Water shortages and demand for desalination can also be adversely affected by water conservation and water reuse initiatives.
New planned seawater reverse osmosis projects can be cancelled and/or delayed, and cancellations and/or delays may negatively impact our revenue.
Planned seawater reverse osmosis desalination projects can be cancelled or postponed due to delays in, or failure to obtain, approval, financing or permitting for plant construction because of political factors, including political unrest in key desalination markets such as the Middle East or adverse and increasingly uncertain financial conditions or other factors. Even though we may have a signed contract to provide a certain number of energy recovery devices by a certain date, shipments may be suspended or delayed at the request of customers. Such shipping delays negatively impact our results of operations and revenue. As a result of these factors, we have experienced and may in the future experience significant variability in our revenue on both an annual and a quarterly basis.
We rely on a limited number of engineering, procurement and construction firms for a large portion of our revenue. If these customers delay or cancel their commitments, do not purchase our products in connection with future projects, or are unable to attract and retain sufficient qualified engineers to support their growth, our revenue could significantly decrease, which would adversely affect our financial condition and future growth.
There are a limited number of large engineering, procurement and construction firms in the desalination industry and these customers account for a substantial portion of our net revenue. One or more of these customers represent 10% or more of our total revenue each year and the customers in this category vary from year to year. See Note 15 — "Concentrations" to the condensed consolidated financial statements regarding the impact of customer concentrations on our condensed consolidated financial statements. Since we do not have long-term contracts with these large customers but sell to them on a purchase order or project basis, these orders may be postponed or delayed on short or no notice. If any of these customers reduces or delays its purchases, cancels a project, decides not to specify our products for future projects, fails to attract and retain qualified engineers and other staff, fails to pay amounts due us, or experiences financial difficulties or reduced demand for its services, we may not be able to replace that lost business and our projected revenue may significantly decrease, which will adversely affect our financial condition and future growth.
We face competition from a number of companies that offer competing energy recovery and pump solutions. If any of these companies produce superior technology or offer more cost-effective products, our competitive position in the market could be harmed and our profits may decline.
The market for energy recovery devices and pumps for desalination plants is competitive and evolving. We expect competition, especially competition on price and warranty terms, to persist and intensify as the desalination market grows, and new competitors enter the market. Some of our current and potential competitors may have significantly greater financial, technical, marketing and other resources, longer operating histories or greater name recognition. They may also be able to devote greater resources to the development, promotion, sale and support of their products and respond more quickly to new technology. These companies may also have more extensive customer bases, broader customer relationships across product lines, or long-standing or exclusive relationships with our current or potential customers. They may also have more extensive products and product lines that would enable them to offer multi-product or packaged solutions or competing products at lower prices or with other more favorable terms and conditions. As a result, our ability to sustain our market share may be adversely impacted, which would affect our business, operating results and financial condition. In addition, if another one of our competitors were to merge or partner with another company, the change in the competitive landscape could adversely affect our continuing ability to compete effectively.
Global economic conditions and the current crisis in the financial markets could have an adverse effect on our business and results of operations.
Current economic conditions may continue to negatively impact our business and make forecasting future operating results more difficult and uncertain. A weak global economy may cause our customers to delay product orders or shipments, or delay or cancel planned or new desalination projects, including retrofits, which would reduce our revenue. Turmoil in the financial and credit markets may also make it difficult for our customers to obtain needed project financing, resulting in lower sales. Negative economic conditions may also affect our suppliers, which could impede their ability to remain in business and supply us with parts, resulting in delays in the availability or shipment of our products. In addition, cash, cash equivalents and short- and long-term investments that we may from time to time hold are typically invested in a range of certificates of deposit, money market funds, government obligations, corporate obligations and other securities summarized in the notes to the consolidated financial statements included in this report. Given the current weak global economy, the potential instability of domestic and foreign financial institutions, and external risks such as the European sovereign debt problems, we cannot be assured that we will not experience losses on our investments, which would adversely affect our financial condition. If current economic conditions persist or worsen and negatively impact the desalination industry, our business, financial condition or results of operations could be materially and adversely affected.
Our operating results may fluctuate significantly, which makes our future operating results difficult to predict and could cause our operating results to fall below expectations or our guidance.
Our operating results may fluctuate due to a variety of factors, many of which are outside of our control. Since a single order for our energy recovery devices may represent substantial revenue, we have experienced significant fluctuations in revenue from quarter to quarter and year to year, and we expect such fluctuations to continue. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. If our revenue or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, the price of our common stock would likely decline.
In addition, factors that may affect our operating results include, among others:
|
|
|
|
•
|
fluctuations in demand, sales cycles and pricing levels for our products and services;
|
|
|
|
|
•
|
the cyclical nature of equipment purchasing for planned reverse osmosis desalination plants,
|
|
|
|
|
•
|
changes in customers' budgets for desalination plants and the timing of their purchasing decisions;
|
|
|
|
|
•
|
adverse changes in the local or global financing conditions facing our customers;
|
|
|
|
|
•
|
delays or postponements in the construction of desalination plants;
|
|
|
|
|
•
|
our ability to develop, introduce and timely ship new products and product enhancements that meet customer demand and contractual and technical requirements, including scheduled delivery dates, performance guarantees, product certifications and warranty terms;
|
|
•
|
the ability of our customers to obtain other critical plant components such as high-pressure pumps or membranes;
|
|
|
|
|
•
|
our ability to implement scalable internal systems for reporting, order processing, product delivery, purchasing, billing and general accounting, among other functions;
|
|
|
|
|
•
|
our ability to maintain efficient factory throughput in our new facility and minimize overhead given significant variability in orders from quarter to quarter and year to year;
|
|
|
|
|
•
|
unpredictability of governmental regulations and political decision-making as to the approval or building of a desalination plant;
|
|
|
|
|
•
|
our ability to control costs, including our operating expenses;
|
|
|
|
|
•
|
our ability to purchase critical raw materials from third-party suppliers;
|
|
|
|
|
•
|
our ability to compete against other companies that offer energy recovery solutions;
|
|
|
|
|
•
|
our ability to attract and retain highly skilled employees, particularly those with relevant industry experience; and
|
|
|
|
|
•
|
general economic conditions in our domestic and international markets, including conditions that affect the valuation of the U.S. dollar against other currencies.
|
If we are unable to collect unbilled receivables, our operating results will be adversely affected.
Our contracts with large engineering, procurement and construction firms generally contain holdback provisions that delay final installment payments up to 24 months after the product has been shipped and revenue has been recognized. Typically, between 10% and 20%, and in some instances up to 30%, of the revenue we receive pursuant to our customer contracts is subject to such holdback provisions and is accounted for as unbilled receivables until we deliver invoices for payment. Such holdbacks can result in relatively high current and non-current unbilled receivables. If we are unable to invoice and collect these performance holdbacks or if our customers fail to make these payments when due under the sales contracts, our results of operations will be adversely affected.\
If we lose key personnel upon whom we are dependent, we may not be able to execute our strategies. Our ability to increase our revenue will depend on hiring highly skilled professionals with industry-specific experience, particularly given the unique and complex nature of our devices.
Given the specialized nature of our business, we must hire highly skilled professionals for certain positions with industry-specific experience. Given the nature of the reverse osmosis desalination industry, the number of qualified candidates for certain positions is limited. Our ability to grow depends on recruiting and retaining skilled employees with relevant experience, competing with larger, often better known companies and offering competitive total compensation packages. Our failure to retain existing or attract future talented and experienced key personnel could harm our business.
The future success of our business may depend on our ability to diversify into new markets outside desalination while continuing to market, enhance and scale existing desalination products.
We believe that developing new products for applications outside desalination is a necessary strategy to accelerate future growth in our business, as we continue to market, enhance and scale existing desalination products.
While new or enhanced products and services have the potential to meet specified needs of new or existing markets, pricing may not meet customer expectations, and they may not compete favorably with products and services of current or potential competitors. New products may be delayed or cancelled if they do not meet specifications, performance requirements or quality standards, or perform as expected in a production environment. Product designs also may not scale as expected. We may have difficulty finding new markets for our existing technology or developing or acquiring new products for new markets. Customers may not accept or be slow to adopt new products and services and potential new markets may be too costly to penetrate. In addition, we may not be able to offer our products and services at prices that meet customer expectations without increasing our costs and eroding our margins. We may also have difficulty executing plans to break into new markets, expanding our operations to successfully manufacture new products or scaling our operations to accommodate increased business. If we are unable to develop competitive new products, open new cost-effective markets, and scale our business to support increased sales and new markets, our business and results of operations will be adversely affected.
We have hired and promoted individuals to new executive positions and undertaken other activities to pursue new markets beyond desalination. We may incur significant personnel and development expenses in these efforts without assurance as to when or if new products will contribute to revenue or be profitable.
Our plans to manufacture ceramic components may prove to be more costly or less reliable than outsourcing.
We previously outsourced the production of our ceramic components to a limited number of ceramic vendors. In 2011, to diversify our supply of ceramics, insure the availability of a reliable source of quality ceramic components, and retain more control over our intellectual property, we validated internal production capability at our own ceramics plant at our headquarters in San Leandro, California to manufacture most ceramic products used in PX devices. We also completed in 2011 the closure of our manufacturing plant in Michigan and integration of all production operations in San Leandro. We also anticipate that this internal production capacity at one location will reduce costs, improve efficiencies and quality, and enhance research and development efforts.
If we are less efficient at producing our ceramic components or are unable to achieve required yields that are equal to or greater than the vendors to which we previously outsourced, then our cost of manufacturing may be adversely affected. If we are unable to ramp up the internal production of our ceramics parts or manufacture these parts cost-effectively and/or if for any reason we are not able to purchase sufficient raw materials on a timely basis, we may be exposed to capacity shortages, and our business and financial results, including our cost of goods sold and margins, may be adversely affected. In 2011, the expenses associated with completing the integration of our ceramics facility in San Leandro contributed to the decrease in gross profit as a percentage of net revenue in 2011 compared to 2010, and we cannot currently predict whether the integration of our ceramic production at the facility will achieve the supply and cost reduction advantages that we anticipate. We also cannot predict the degree to which we will achieve future improvement in efficiency or commercial results from research and development efforts.
We do not own sources of, or mine, ceramic raw materials and rely on a limited number of vendors to supply ceramic raw materials for our PX products. If any of our ceramic suppliers were to have financial difficulties, cancel or materially change their commitments with us or fail to meet the quality or delivery requirements needed to satisfy customer orders for our products and we are unable to make up that shortfall through other sources, we could lose customer orders, be unable to develop or sell our products cost-effectively or on a timely basis, if at all, and have significantly decreased revenue, which would harm our business, operating results and financial condition.
The durable nature of the PX device may reduce or delay potential aftermarket revenue opportunities.
Our PX devices utilize ceramic components that have to date demonstrated high durability, high corrosion resistance and long life in seawater reverse osmosis desalination applications. Because most of our PX devices have been installed for a limited number of years, it is difficult to accurately predict their performance or endurance over a longer period of time. In the event that our products are more durable than expected, our opportunity for aftermarket revenue may be deferred.
Our sales cycle can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate.
Our sales efforts involve substantial education of our current and prospective customers about the use and benefits of our energy recovery products. This education process can be time-consuming and typically involves a significant product evaluation process. While the sales cycle for our OEM customers, which are involved with smaller desalination plants, averages one to three months, the average sales cycle for our international engineering, procurement and construction firm customers, which are involved with larger desalination plants, ranges from six to 16 months and has, in some cases, extended up to 24 months. In addition, these customers generally must make a significant commitment of resources to test and evaluate our technologies. As a result, our sales process involving these customers is often subject to delays associated with lengthy approval processes that typically accompany the design, testing and adoption of new, technologically complex products. This long sales cycle makes quarter-by-quarter revenue predictions difficult and results in our investing significant resources well in advance of orders for our products.
\
We have historically experienced significant fluctuations in our results of operations on a quarter to quarter basis, and expect that such fluctuations will continue, making it difficult for us and the market to anticipate future results.
We have historically experienced a variety of factors that cause our quarterly results of operations to fluctuate significantly. In some past years, customer buying patterns led to a significant portion of our sales occurring in the fourth quarter, with the risk that delays, cancellations or other adverse events in the fourth quarter had a substantial negative impact on annual results. More recently, our results have fluctuated or decreased due to adverse timing of larger orders during the year, the effects of a global decline in new desalination project construction stemming from global economic and financial pressures, and competition. It is difficult for us and the market to anticipate our future results, and our stock price may be adversely affected by the risks discussed in this paragraph.
We depend on a limited number of suppliers for some of our components. If our suppliers are not able to meet our demand and/or requirements, our business could be harmed.
We rely on a limited number of suppliers for vessel housings, stainless steel castings and alumina powder for our PX devices and castings for our PEI turbochargers and pumps. Our reliance on a limited number of manufacturers for these supplies involves a number of risks, including reduced control over delivery schedules, quality assurance, manufacturing yields, production costs and lack of guaranteed production capacity or product supply. We do not have long-term supply agreements with these suppliers and instead secure these supplies on a purchase order basis. Our suppliers have no obligation to supply products to us for any specific period, in any specific quantity or at any specific price, except as set forth in a particular purchase order. Our requirements represent a small portion of the total production capacities of these suppliers, and our suppliers may reallocate capacity to other customers, even during periods of high demand for our products. We have in the past experienced, and may in the future experience, quality control issues and delivery delays with our suppliers due to factors such as high industry demand or the inability of our vendors to consistently meet our quality or delivery requirements. If our suppliers were to cancel or materially change their commitments with us or fail to meet quality or delivery requirements needed to satisfy customer orders for our products, we could lose time-sensitive customer orders, be unable to develop or sell our products cost-effectively or on a timely basis, if at all, and have significantly decreased revenue, which would harm our business, operating results and financial condition. We may qualify additional suppliers in the future which would require time and resources. If we do not qualify additional suppliers, we may be exposed to increased risk of capacity shortages due to our dependence on current suppliers.
We are subject to risks related to product defects, which could lead to warranty claims in excess of our warranty provisions or result in a significant or a large number of warranty or other claims in any given year.
We have historically provided a warranty for certain products for a period of one to two years and provided up to a six-year warranty for the ceramic components of our PX-branded products. Based on the evolution of our ceramics technology, we currently expect to increase the ceramics warranty in certain cases at commercial rates. We test our products in our manufacturing facilities through a variety of means. However, there can be no assurance that our testing will reveal latent defects in our products, which may not become apparent until after the products have been sold into the market, or will replicate the harsh, corrosive and varied conditions of the desalination plants and other plants in which they are installed. In addition, certain components of our turbochargers and pumps are custom-made and may not scale or perform as required in production environments. Accordingly, there is a risk that we may have significant warranty claims or breach supply agreements due to product defects. We may incur additional operating expenses if our warranty provisions do not reflect the actual cost of resolving issues related to defects in our products. If these additional expenses are significant, they could adversely affect our business, financial condition and results of operations. While the number of warranty claims has not been significant to date, we have only offered up to a six-year warranty on the ceramic components of our PX products in new sales agreements executed after August 7, 2007, and we have only offered PEI products since December 2009 when we acquired Pump Engineering, LLC. We cannot quantify the error rate of our products and the ceramic components of our PX products with statistical accuracy and cannot assure that a large number of warranty claims will not be filed in a given year. As a result, our operating expenses may increase if a significant or large number of warranty or other claims are filed in any specific year, particularly towards the end of any given warranty period.
If we are unable to protect our technology or enforce our intellectual property rights, our competitive position could be harmed and we could be required to incur significant expenses to enforce our rights.
Our competitive position depends on our ability to establish and maintain proprietary rights in our technology and to protect our technology from copying by others. We rely on trade secret, patent, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which may offer only limited protection. We hold a limited number of United States patents and patents outside the U.S. that are counterparts to several of the U.S. patents and when their terms expire, we could become more vulnerable to increased competition. We do not hold issued patents in many of the countries where competing products are used, though we do have pending applications in countries where we have substantial sales activity. Accordingly, the protection of our intellectual property in some of those countries may be limited. We also do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims, and even if patents are issued, they may be contested, circumvented or invalidated. Moreover, while we believe our remaining issued patents are essential to the protection of our technology, the rights granted under any of our issued patents or patents that may be issued in the future may not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop similar or superior technologies now or in the future. In addition, our granted patents may not prevent misappropriation of our technology, particularly in foreign countries where intellectual property laws may not protect our proprietary rights as fully as those in the United States. This may render our patents impaired or useless and ultimately expose us to currently unanticipated competition. Protecting against the unauthorized use of our products, trademarks and other proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights or to determine the validity and scope of the proprietary rights of others. This litigation could result in substantial costs and diversion of management resources, either of which could harm our business.
For example, earlier in 2011, we filed a lawsuit, and obtained a temporary restraining order, against a former founder of our company who hired two of our employees and, we believe, used our proprietary technology in order to develop a competing product. Discovery has not been completed, and a trial is currently scheduled for August 2012. Although we believe we have a strong case in this matter and have obtained the temporary restraining order, we cannot predict with certainty the degree to which we will ultimately prevail in this or other possible future matters involving former employees or others seeking to use our proprietary technology.
Claims by others that we infringe their proprietary rights could harm our business.
Third parties could claim that our technology infringes their proprietary rights. In addition, we or our customers may be contacted by third parties suggesting that we obtain a license to certain of their intellectual property rights they may believe we are infringing. We expect that infringement claims against us may increase as the number of products and competitors in our market increases and overlaps occur. In addition, to the extent that we gain greater visibility, we believe that we will face a higher risk of being the subject of intellectual property infringement claims. Any claim of infringement by a third party, even those without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from our business. Furthermore, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages. A judgment against us could also include an injunction or other court order that could prevent us from offering our products. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on commercially reasonable terms, or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. Any of these events could seriously harm our business. Third parties may also assert infringement claims against our customers. Because we generally indemnify our customers if our products infringe the proprietary rights of third parties, any such claims would require us to initiate or defend protracted and costly litigation on their behalf in one or more jurisdictions, regardless of the merits of these claims. If any of these claims succeeds, we may be forced to pay damages on behalf of our customers.
We are currently involved in legal proceedings, and may be subject to additional future legal proceedings, that may result in material adverse outcomes.
In addition to intellectual property litigation risks discussed above, we are involved, and may become involved in the future, in various commercial and other disputes and related claims and legal proceedings, that arise from time to time in the course of our business. We believe we have substantial defenses in the matters currently pending. However, the process of settling or litigating claims is subject to uncertainties, and our views of these matters may change in the future. We are not able in all matters to estimate the amount or range of loss that could result from an outcome adverse to us. We could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on our results of operations and financial condition.
Please refer to Note 10, Commitments and Contingencies, to our consolidated financial statements included in this report for a description of certain legal proceedings currently pending.
Our business entails significant costs that are fixed or difficult to reduce in the short term while demand for our products is variable and subject to downturns, which may adversely affect our operating results.
Our business requires investments in facilities, equipment, R&D and training that are either fixed or difficult to reduce or scale in the short term. At the same time, the market for our products is variable and has experienced downturns due to factors such as economic recessions, increased precipitation, uncertain global financial markets, and political changes, many of which are outside our control. During periods of reduced product demand, we may experience higher relative costs and excess manufacturing capacity, resulting in high overhead and lower gross margins and causing cash flow and profitability to decline. Similarly, while we believe that our existing manufacturing facilities are capable of meeting current demand and demand for the foreseeable future, the continued success of our business depends on our ability to expand our manufacturing, research and development and testing facilities to meet market needs. If we are unable to respond timely to an increase in demand, our revenue, gross margin, cash flow and profitability may be adversely affected.
If we need additional capital to fund future growth, it may not be available on favorable terms, or at all.
We have historically relied on outside financing to fund our operations, capital expenditures and expansion. In our initial public offering in July 2008, we issued approximately 10,000,000 shares of common stock at $8.50 per share before underwriting discount and issuing expenses. We may require additional capital from equity or debt financing in the future to fund our operations or respond to competitive pressures or strategic opportunities. We may not be able to secure such additional financing on favorable terms or at all. The terms of additional financing may place limits on our financial and operating flexibility. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new securities we issue could have rights, preferences or privileges senior to those of existing or future holders of our common stock. If we are unable to obtain necessary financing on terms satisfactory to us, if and when we require it, our ability to grow or support our business and to respond to business challenges could be significantly limited.
If foreign and local government entities no longer guarantee and subsidize, or are willing to engage in, the construction and maintenance of desalination plants and projects, the demand for our products would decline and adversely affect our business.
Our products are used in seawater reverse osmosis desalination plants which are often constructed and maintained with local, regional or national government guarantees and subsidies, including tax-free bonds. The rate of construction of desalination plants depends on each governing entity's willingness and ability to obtain and allocate funds for such projects, which capabilities may be affected by the current weak global financial system and credit market and the weak global economy. In addition, some desalination projects in the Middle East and North Africa have been funded by budget surpluses resulting from once high crude oil and natural gas prices. Since prices for crude oil and natural gas vary, governments in those countries may not have the necessary funding for such projects and may cancel the projects or divert funds allocated for them to other projects. Political unrest, coups or changes in government administrations, such as recent political changes and unrest in the Middle East, may result in policy or priority changes that may also cause governments to cancel, delay or re-contract planned or ongoing projects. Government embargoes may also prohibit sales into certain countries. As a result, the demand for our products could decline and negatively affect our revenue base, our overall profitability and pace of our expected growth.
Our products are highly technical and may contain undetected flaws or defects which could harm our business and our reputation and adversely affect our financial condition.
The manufacture of our products is highly technical and some designs and components of our turbochargers and pumps are custom-made. Our products may contain latent defects or flaws. We test our products prior to commercial release and during such testing have discovered and may in the future discover flaws and defects that need to be resolved prior to release. Resolving these flaws and defects can take a significant amount of time and prevent our technical personnel from working on other important tasks. In addition, our products have contained and may in the future contain one or more flaws that were not detected prior to commercial release to our customers. Some flaws in our products may only be discovered after a product has been installed and used by customers. Any flaws or defects discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty. Our contracts with our customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld or, for reasons of good long-term customer relations, we may not be willing to enforce. Defending a lawsuit, regardless of its merit, is costly and may divert management's attention and adversely affect the market's perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be harmed.
Our international sales and operations subject us to additional risks that may adversely affect our operating results.
Historically, we have derived a significant portion of our revenue from customers whose seawater reverse osmosis desalination facilities are outside the United States. Many of these projects are located in emerging growth countries with relatively young or unstable market economies or changing political environments. These countries may be affected significantly by the current weak global economy and unstable credit markets. We also rely on sales and technical support personnel stationed in Europe, Asia and the Middle East, and we expect to continue to add personnel in other countries. Governmental changes, political unrest or reforms, or other disruptions or changes in the business, regulatory or political environments of the countries in which we sell our products or have staff could have a material adverse effect on our business, financial condition and results of operations.
Sales of our products have to date been denominated principally in U.S. dollars. If the U.S. dollar strengthens against most other currencies, it will effectively increase the price of our products in the currency of the countries in which our customers are located. This may result in our customers seeking lower-priced suppliers, which could adversely impact our revenue, margins and operating results. A larger portion of our international revenue may be denominated in foreign currencies in the future, which would subject us to increased risks associated with fluctuations in foreign exchange rates.
Our international contracts and operations subject us to a variety of additional risks, including:
|
|
|
|
•
|
political and economic uncertainties, which the current global economic crisis may exacerbate;
|
|
|
|
|
•
|
uncertainties related to the application of local contract and other laws, including reduced protection for intellectual property rights;
|
|
|
|
|
•
|
trade barriers and other regulatory or contractual limitations on our ability to sell and service our products in certain foreign markets;
|
|
|
|
|
•
|
difficulties in enforcing contracts, beginning operations as scheduled and collecting accounts receivable, especially in emerging markets;
|
|
|
|
|
•
|
increased travel, infrastructure and legal compliance costs associated with multiple international locations;
|
|
|
|
|
•
|
competing with non-U.S. companies not subject to the U.S. Foreign Corrupt Practices Act;
|
|
|
|
|
•
|
difficulty in attracting, hiring and retaining qualified personnel; and
|
|
|
|
|
•
|
increasing instability in the capital markets and banking systems worldwide, especially in developing countries, which may limit project financing availability for the construction of desalination plants.
|
As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, which in turn could adversely affect our business, operating results and financial condition.
If we fail to manage future growth effectively, our business would be harmed.
Future growth in our business, if it occurs, will place significant demands on our management, infrastructure and other resources. To manage any future growth, we will need to hire, integrate and retain highly skilled and motivated employees. We will also need to continue to improve our financial and management controls, reporting and operational systems and procedures. If we do not effectively manage our growth, our business, operating results and financial condition would be adversely affected.
Our failure to achieve or maintain adequate internal control over financial reporting in accordance with SEC rules or prevent or detect material misstatements in our annual or interim consolidated financial statements in the future could materially harm our business and cause our stock price to decline.
As a public company, SEC rules require that we maintain internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and preparation of published financial statements in accordance with generally accepted accounting principles, or GAAP, in the United States. Accordingly, we are required to document and test our internal controls and procedures to assess the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm is required to report on the effectiveness of our internal control over financial reporting. In the future, we may identify material weaknesses and deficiencies which we may not be able to remediate in a timely manner. Our acquisition of Pump Engineering, LLC and possible future acquisitions may increase this risk by expanding the scope and nature of operations over which we must develop and maintain internal control over financial reporting. If there are material weaknesses or deficiencies in our internal control, we will not be able to conclude that we have maintained effective internal control over financial reporting or our independent registered public accounting firm may not be able to issue an unqualified report on the effectiveness of our internal control over financial reporting. As a result, our ability to report our financial results on a timely and accurate basis may be adversely affected and investors may lose confidence in our financial information, which in turn could cause the market price of our common stock to decrease. We may also be required to restate our financial statements from prior periods. In addition, testing and maintaining internal control will require increased management time and resources. Any failure to maintain effective internal control over financial reporting could impair the success of our business and harm our financial results and an investor could lose all or a significant portion of their investment. If we have material weaknesses in our internal control over financial reporting, the accuracy and timing of our financial reporting may be adversely affected.
Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.
We prepare our financial statements to conform to GAAP. These accounting principles are subject to interpretation by the SEC and various other bodies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the interpretation of our current practices may adversely affect our reported financial results or the manner in which we conduct our business.
Our past acquisition and future acquisitions could disrupt our business, impact our margins, cause dilution to our stockholders or harm our financial condition and operating results.
We acquired privately-held Pump Engineering, LLC in late 2009 and, in the future, we may invest in other companies, technologies or assets. We may not realize the expected benefits from our past or future acquisitions. We may not be able to find other suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. If we do complete acquisitions, we cannot assure that they will ultimately strengthen our competitive or financial position or that they will not be viewed negatively by customers, financial markets, investors or the media. Acquisitions could also result in shareholder dilution or significant acquisition-related charges for restructuring, share-based compensation and the amortization of purchased technology and intangible assets. Expenses resulting from impairment of acquired goodwill, intangible assets and purchased technology could also increase over time if the fair value of those assets decreases. A future change in our market conditions, a downturn in our business, or a long-term decline in the quoted market price of our stock may result in a reduction of the fair value of acquisition-related assets. Any such impairment of goodwill or intangible assets could harm our operating results and financial condition. In addition, when we make an acquisition, we may have to assume some or all of that entity's liabilities, which may include liabilities that are not fully known at the time of the acquisition. Future acquisitions may reduce our cash available for operations and other uses. If we continue to make acquisitions, we may require additional cash or use shares of our common stock as payment, which would cause dilution for our existing stockholders.
Acquisitions, including our 2009 acquisition of Pump Engineering, LLC, entail a number of risks that could harm our ability to achieve their anticipated benefits. We could have difficulties integrating and retaining key management and other personnel, aligning product plans and sales strategies, coordinating research and development efforts, supporting customer relationships, aligning operations and integrating accounting, order processing, purchasing and other support services. Since acquired companies have different accounting and other operational practices, we may have difficulty harmonizing order processing, accounting, billing, resource management, information technology and other systems company-wide. We may also have to invest more than anticipated in product or process improvements. Especially with acquisitions of privately held or non-US companies, we may face challenges developing and maintaining internal controls consistent with the requirements of the Sarbanes-Oxley Act and US public accounting standards. Acquisitions may also disrupt our ongoing operations, divert management from day-to-day responsibilities and disrupt other strategic, research and development, marketing or sales efforts. Geographic and time zone differences and disparate corporate cultures may increase the difficulties and risks of an acquisition. If integration of our acquired businesses or assets is not successful or disrupts our ongoing operations, acquisitions may increase our expenses, harm our competitive position, adversely impact our operating results and financial condition and fail to achieve anticipated revenue, cost, competitive or other objectives.
Insiders and principal stockholders will likely have significant influence over matters requiring stockholder approval.
Our directors, executive officers and other principal stockholders beneficially own, in the aggregate, a substantial amount of our outstanding common stock. Although they do not have majority control of the outstanding stock, these stockholders will likely have significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets.
Anti-takeover provisions in our charter documents and under Delaware law could discourage delay or prevent a change in control of our company and may affect the trading price of our common stock.
Provisions in our amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and amended and restated bylaws include provisions that:
|
|
|
|
•
|
authorize our board of directors to issue, without further action by the stockholders, up to 10,000,000 shares of undesignated preferred stock;
|
|
|
|
|
•
|
require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
|
|
|
|
|
•
|
specify that special meetings of our stockholders can be called only by our board of directors, the chairman of the board, the chief executive officer or the president;
|
|
|
|
|
•
|
establish an advance notice procedure for stockholder approvals to be brought before an annual meeting of our stockholders, including proposed nominations of persons for election to our board of directors;
|
|
|
|
|
•
|
establish that our board of directors is divided into three classes, Class I, Class II and Class III, with each class serving staggered terms;
|
|
|
|
|
•
|
provide that our directors may be removed only for cause;
|
|
|
|
|
•
|
provide that vacancies on our board of directors may be filled only by a majority vote of directors then in office, even though less than a quorum;
|
|
•
|
specify that no stockholder is permitted to cumulate votes at any election of directors; and
|
|
|
|
|
•
|
require a super-majority of votes to amend certain of the above-mentioned provisions.
|
In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law regulating corporate takeovers. Section 203 generally prohibits us from engaging in a business combination with an interested stockholder subject to certain exceptions.
Item 1B. Unresolved Staff Comments
Item 2. Properties
We lease approximately 170,000 square feet of space in San Leandro, California for product manufacturing, research and development and executive headquarters under a lease that expires in July 2019. We believe this facility will be adequate for our purposes for the foreseeable future.
Item 3. Legal Proceedings
See Note 10 to the Consolidated Financial Statements in Item 8 of this report, under the heading "Litigation," for a description of two lawsuits pending against us.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for the Registrant’s Common Stock Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Since July 2, 2008, our common stock has been quoted on the Nasdaq Global Market under the symbol “ERII”.
The following table sets forth the high and low sales prices of our common stock for the periods indicated.
|
|
High
|
|
|
Low
|
|
2010
|
|
|
|
|
|
|
First Quarter
|
|
$ |
7.25 |
|
|
$ |
5.75 |
|
Second Quarter
|
|
$ |
6.40 |
|
|
$ |
3.15 |
|
Third Quarter
|
|
$ |
4.23 |
|
|
$ |
3.08 |
|
Fourth Quarter
|
|
$ |
3.99 |
|
|
$ |
3.30 |
|
2011
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$ |
4.36 |
|
|
$ |
2.88 |
|
Second Quarter
|
|
$ |
3.40 |
|
|
$ |
2.35 |
|
Third Quarter
|
|
$ |
3.30 |
|
|
$ |
2.09 |
|
Fourth Quarter
|
|
$ |
3.50 |
|
|
$ |
2.25 |
|
Dividend Policy
We have never declared or paid any dividends on our capital stock, and we do not currently intend to pay any dividends on our capital stock for the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our capital stock will be, subject to applicable law, at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions in loan agreements or other agreements.
Stockholders
As of March 9, 2012, there were approximately 67 stockholders of record of our common stock as reported by our transfer agent, one of which is Cede & Co., a nominee for Depository Trust Company (DTC). All of the shares of common stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC, and are therefore considered to be held of record by Cede & Co. as one stockholder.
Stock Performance Graph
The following graph shows the cumulative total shareholder return of an investment of $100 on July 2, 2008 in (i) our common stock and (ii) common stock of a selected group of peer issuers (“Peer Group”) and (iii) on June 30, 2008 in the Nasdaq Composite Index. Cumulative total return assumes the reinvestment of dividends, although dividends have never been declared on our stock, and is based on the returns of the component companies weighted according to their capitalizations as of the end of each quarterly period. The Nasdaq Composite Index tracks the aggregate price performance of equity securities traded on the Nasdaq. The Peer Group tracks the weighted average price performance of equity securities of seven companies in our industry, including Consolidated Water Company Limited, Flowserve Corporation, Hyflux Ltd, Kurita Water Industries Limited, Pentair Inc., Tetra Tech, Inc. and The Gorman-Rupp Company. The returns of each component issuer of the Peer Group is weighted according to the respective issuer’s stock market capitalization at the beginning of each period for which a return is indicated. Our stock price performance shown in the graph below is not indicative of future stock price performance.
The following graph and its related information is not “soliciting material,” is not deemed “filed” with the SEC, and is not to be incorporated by reference into any filing of the Company under the 1933 Act or 1934 Act, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing.
COMPARISON OF 42 MONTH CUMULATIVE TOTAL RETURN*
Among Energy Recovery Inc., The NASDAQ Composite Index
And A Peer Group
*
|
$100 invested on 7/2/08 in stock or 6/30/08 in index, including reinvestment of dividends. Fiscal year ending December 31.
|
|
|
6/30/08 or
7/2/08(1)
|
|
|
12/31/08
|
|
|
12/31/09
|
|
|
12/31/10
|
|
|
12/31/11
|
|
Energy Recovery, Inc.
|
|
|
100.00 |
|
|
|
77.11 |
|
|
|
69.99 |
|
|
|
37.23 |
|
|
|
26.25 |
|
NASDAQ Composite
|
|
|
100.00 |
|
|
|
68.98 |
|
|
|
100.02 |
|
|
|
117.78 |
|
|
|
116.43 |
|
Peer Group
|
|
|
100.00 |
|
|
|
62.14 |
|
|
|
89.14 |
|
|
|
100.52 |
|
|
|
84.60 |
|
(1)
|
The index measurement date is 6/30/08; stock measurement dates are 7/2/08
|
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and notes thereto included in this Report on Form 10-K.
|
|
Years Ended December 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Consolidated Statement of Income Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$ |
28,047 |
|
|
$ |
45,853 |
|
|
$ |
47,014 |
|
|
$ |
52,119 |
|
|
$ |
35,414 |
|
Cost of revenue
|
|
|
20,248 |
|
|
|
23,781 |
|
|
|
17,595 |
|
|
|
18,933 |
|
|
|
14,852 |
|
Gross profit
|
|
|
7,799 |
|
|
|
22,072 |
|
|
|
29,419 |
|
|
|
33,186 |
|
|
|
20,562 |
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
16,745 |
|
|
|
14,471 |
|
|
|
13,515 |
|
|
|
11,291 |
|
|
|
4,280 |
|
Sales and marketing
|
|
|
7,997 |
|
|
|
8,205 |
|
|
|
6,472 |
|
|
|
6,549 |
|
|
|
5,230 |
|
Research and development
|
|
|
3,526 |
|
|
|
3,943 |
|
|
|
3,041 |
|
|
|
2,415 |
|
|
|
1,705 |
|
Amortization of intangible assets
|
|
|
1,360 |
|
|
|
2,624 |
|
|
|
241 |
|
|
|
30 |
|
|
|
19 |
|
Loss (gain) on fair value remeasurement
|
|
|
171 |
|
|
|
(2,147 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Restructuring charges
|
|
|
3,294 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Total operating expenses
|
|
|
33,093 |
|
|
|
27,096 |
|
|
|
23,269 |
|
|
|
20,285 |
|
|
|
11,234 |
|
Income (loss) from operations
|
|
|
(25,294 |
) |
|
|
(5,024 |
) |
|
|
6,150 |
|
|
|
12,901 |
|
|
|
9,328 |
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(34 |
) |
|
|
(73 |
) |
|
|
(46 |
) |
|
|
(79 |
) |
|
|
(105 |
) |
Other non-operating income (expense), net
|
|
|
184 |
|
|
|
(137 |
) |
|
|
54 |
|
|
|
873 |
|
|
|
517 |
|
Income (loss) before provision for (benefit from) income taxes
|
|
|
(25,144 |
) |
|
|
(5,234 |
) |
|
|
6,158 |
|
|
|
13,695 |
|
|
|
9,740 |
|
Provision for (benefit from) income taxes
|
|
|
1,299 |
|
|
|
(1,626 |
) |
|
|
2,472 |
|
|
|
5,032 |
|
|
|
3,947 |
|
Net income (loss)
|
|
$ |
(26,443 |
) |
|
$ |
(3,608 |
) |
|
$ |
3,686 |
|
|
$ |
8,663 |
|
|
$ |
5,793 |
|
Earnings (loss) per share - basic
|
|
$ |
(0.50 |
) |
|
$ |
(0.07 |
) |
|
$ |
0.07 |
|
|
$ |
0.19 |
|
|
$ |
0.15 |
|
Earnings (loss) per share - diluted
|
|
$ |
(0.50 |
) |
|
$ |
(0.07 |
) |
|
$ |
0.07 |
|
|
$ |
0.18 |
|
|
$ |
0.14 |
|
Number of shares used in per share calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
52,612 |
|
|
|
52,072 |
|
|
|
50,166 |
|
|
|
44,848 |
|
|
|
39,060 |
|
Diluted
|
|
|
52,612 |
|
|
|
52,072 |
|
|
|
52,644 |
|
|
|
47,392 |
|
|
|
41,433 |
|
|
|
As of December 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
2007(1)
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
18,507 |
|
|
$ |
55,338 |
|
|
$ |
59,115 |
|
|
$ |
79,287 |
|
|
$ |
240 |
|
Total assets
|
|
|
110,713 |
|
|
|
133,917 |
|
|
|
142,969 |
|
|
|
120,612 |
|
|
|
28,227 |
|
Long-term liabilities
|
|
|
3,880 |
|
|
|
2,770 |
|
|
|
4,505 |
|
|
|
420 |
|
|
|
620 |
|
Total liabilities
|
|
|
13,759 |
|
|
|
13,117 |
|
|
|
22,000 |
|
|
|
13,613 |
|
|
|
8,166 |
|
Total stockholders’ equity
|
|
|
96,954 |
|
|
|
120,800 |
|
|
|
120,969 |
|
|
|
106,999 |
|
|
|
20,061 |
|
____________
(1)
|
Certain prior period balances have been reclassified to conform to the current period presentation.
|
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report on Form 10-K and certain information incorporated by reference contain 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 represent our current expectations about future events and 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.
Forward-looking statements in this report include, without limitation, statements about the following:
|
•
|
our plan to enhance our existing energy recovery devices and to develop and manufacture new and enhanced versions of these devices;
|
|
•
|
Our belief that sales of our PX-300 and PX-Q300 devices will represent a higher percentage of our net revenue in 2012;
|
|
•
|
our belief that the ceramics components of our PX device will result in low life cycle maintenance costs and that our turbocharger devices have long operating lives;
|
|
•
|
our objective of finding new applications for our technology and developing new products for use outside of desalination;
|
|
•
|
our belief that our products are the most cost effective energy recovery devices over time;
|
|
•
|
our plan to manufacture all or most of our ceramics components internally and our expectation that in-house production of ceramics will reduce production costs;
|
|
•
|
our expectation that our expenditures for research and development will increase;
|
|
•
|
our expectation that we will continue to rely on sales of our energy recovery devices for a substantial portion of our revenue;
|
|
•
|
our belief that our current facilities will be adequate through 2012;
|
|
•
|
our expectation that sales outside of the United States will remain a significant portion of our revenue;
|
|
•
|
our expectation that future sales and marketing expense will increase as revenues increase;
|
|
•
|
our belief that our existing cash and investment balances and cash generated from our operations will be sufficient to meet our anticipated capital requirements for at least the next 12 months; and
|
|
•
|
our expectation that, as we expand our international sales, a small portion of our revenue could continue to be denominated in foreign currencies.
|
All forward-looking statements included in this document are subject to additional risks and uncertainties further discussed under “Item 1A: Risk Factors” and are based on information available to us as of March 13, 2012. 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. The factors that could cause our actual results to differ from those included in such forward-looking statements are set forth under the heading “Item 1A: Risk Factors,” and our results disclosed from time to time in our reports on Forms 10-Q and 8-K and our Annual Reports to Stockholders.
The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report.
Overview
We are in the business of designing, developing and manufacturing energy recovery devices for seawater reverse osmosis desalination. Our company was founded in 1992, and we introduced the initial version of our Pressure ExchangerTM energy recovery device in early 1997. In December 2009, we acquired Pump Engineering, LLC, which manufactures centrifugal energy recovery devices, known as turbochargers, and high-pressure pumps.
A significant portion of our net revenue typically has been generated by sales to a limited number of large engineering, procurement and construction firms, which are involved with the design and construction of larger desalination plants. Sales to these firms often involve a long sales cycle, which can range from six to 16 months. A single large desalination project can generate an order for numerous energy recovery devices and generally represents an opportunity for significant revenue. 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.
Due to the fact that a single order for our energy recovery devices by a large engineering, procurement and construction firm for a particular plant may represent significant revenue, we often experience significant fluctuations in net revenue from quarter to quarter and from year to year. In addition, historically our engineering, procurement and construction firm 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. In fiscal years 2010 and 2011, the fourth quarter revenues did not reflect as high of a percentage of the annual revenues as in past years due to the overall lower percentage of sales to engineering, procurement, and construction firms in 2011 and customer project delays in 2010.
A limited number of our customers account for a substantial portion of our net revenue and accounts receivables. Revenue from customers representing 10% or more of total revenue varies from period to period. For the year ended December 31, 2011, one customer accounted for approximately 14% of our net revenue. For the year ended December 31, 2010, two customers accounted for approximately 23% and 12% of our net revenue, respectively. For the year ended December 31, 2009, three customers accounted for approximately 20%, 11%, and 11% of our net revenue, respectively. No other customer accounted for more than 10% of our net revenue during any of these periods. See Note 15 — “Concentrations” in the Notes to consolidated financial statements for further customer concentration detail.
During the years ended December 31, 2011, 2010 and 2009, most of our 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 revenue for the foreseeable future.
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. We also receive incidental revenue from the sale of spare parts and from services, including start-up and commissioning services, that we provide for our customers.
Critical Accounting Policies and Estimates
Our 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 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, warranty costs, share-based compensation, inventory valuation, allowances for doubtful accounts, income taxes (including our evaluation of the need for any valuation allowance on our deferred tax assets), valuation of goodwill and other intangible assets, and our evaluation and measurement of contingencies, including contingent consideration.
Cash and Cash Equivalents
We consider all highly liquid investments with an original or remaining maturity of three months or less at the time of purchase to be cash equivalents. Cash equivalents are stated at cost, which approximates fair value. Our cash and cash equivalents are maintained primarily in demand deposit accounts with large financial institutions and in institutional money market funds. We frequently monitor the creditworthiness of the financial institutions and institutional money market funds in which we invest our surplus funds. We have not experienced any credit losses from our cash investments.
Allowances for Doubtful Accounts
We record a provision for doubtful accounts based on historical experience and a detailed assessment of the collectability of our accounts receivable. In estimating the allowance for doubtful accounts, we consider, among other factors, (1) the aging of the accounts receivable, (2) our historical write-offs, (3) the credit worthiness of each customer and (4) general economic conditions. Account balances are charged off against the allowance when we believe that it is probable the receivable will not be recovered. Actual write-offs may be in excess of our estimated allowance.
Short-Term and Long-Term Investments
Our short-term and long-term investments consist primarily of investment grade debt securities, all of which are classified as available-for-sale. Available-for-sale securities are carried at fair value. Changes in the fair value of available-for-sale securities are reported as a component of accumulated other comprehensive income within shareholders’ equity on the consolidated balance sheet. Realized gains and losses on the sale of available-for-sale securities are determined by specific identification of the cost basis of each security. Long-term investments generally will mature within three years.
Inventories
Inventories are stated at the lower of cost (using the weighted average cost method) or market. We calculate inventory valuation adjustments for excess and obsolete inventories based on current inventory levels, expected useful life and estimated future demand of the products and spare parts.
Property and Equipment
Property and equipment is recorded at cost and reduced by accumulated depreciation. Depreciation expense is recognized over the estimated useful lives of the assets using the straight-line method. Estimated useful lives are generally three to ten years. A small portion of our manufacturing equipment was acquired under capital lease obligations. These assets are amortized over periods consistent with depreciation of owned assets of similar types, generally five to seven years. Certain equipment used in the development and manufacturing of ceramic components is generally depreciated over estimated useful lives of up to ten years. Leasehold improvements represent remodeling and retrofitting costs for leased office and manufacturing space and are depreciated over the shorter of either the estimated useful lives or the term of the lease using the straight-line method. Software purchased for internal use consists primarily of amounts paid for perpetual licenses to third-party software providers and are depreciated over the estimated useful lives of three to five years. Estimated useful lives are periodically reviewed and, when appropriate, changes are made prospectively. When certain events or changes in operating conditions occur, asset lives may be adjusted and an impairment assessment may be performed on the recoverability of the carrying amounts. We own our manufacturing facility in New Boston, Michigan, which had been depreciated over an estimated useful life of 39 years. As a result of our plan to consolidate our North American manufacturing operations, amounts related to the building and land were classified as held for sale as of December 31, 2011. Accordingly, we impaired the building and land held for sale by $728,000 in December 2011 to reduce the carrying value to estimated fair value. See Note 4. — “Other Financial Information” for further details related to the impairment of property held for sale.
Maintenance and repairs are charged directly to expense as incurred, whereas improvements and renewals are generally capitalized in their respective property accounts. When an item is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed and the resulting gain or loss is recognized in the results of operations.
Goodwill and Other Intangible Assets
The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business with the residual purchase price recorded as goodwill. The determination of the value of the intangible assets acquired involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital.
Acquired intangible assets with determinable useful lives are amortized on a straight-line or accelerated basis over the estimated periods benefited, ranging from one to 20 years. Acquired intangible assets with contractual terms are generally amortized over their respective legal or contractual lives. Customer relationships and other non-contractual intangible assets with determinable lives are amortized over periods generally ranging from five to 20 years. Patents developed internally are recorded at cost and amortized on a straight-line basis over their expected useful life of 16 to 20 years. When certain events or changes in operating conditions occur, an impairment assessment is performed and lives of intangible assets with determinable lives may be adjusted. Goodwill is not amortized, but is evaluated annually for impairment at the reporting unit level or when indicators of a potential impairment are present. Such indicators would include a significant reduction in our market capitalization, a decrease in operating results, or deterioration in our financial positions. We operate under a single reporting unit and, accordingly, all of our goodwill is associated with the entire company. The annual evaluation for impairment of goodwill is based on our market capitalization. As of December 31, 2011 and 2010, acquired intangibles, including goodwill, relate to the acquisition of Pump Engineering, LLC during the fourth quarter of 2009. See Note 7. — “Goodwill and Intangible Assets” to the consolidated financial statements included in this report for further discussion of intangible assets.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, restricted cash, investments in marketable securities, accounts receivable, accounts payable, and debt. The carrying amounts for these financial instruments reported in the consolidated balance sheets approximate their fair values. See Note 8 “Fair Value Measurements” for further discussion of fair value.
Revenue Recognition
We recognize revenue when the earnings process is complete, as evidenced by an agreement with the customer, transfer of title occurs, fixed pricing is determinable and collection is reasonably assured. Transfer of title typically occurs upon shipment of the equipment pursuant to a written purchase order or contract. The portion of the sales agreement related to the field services and training for commissioning of a desalination plant is deferred until we have performed such services. We regularly evaluate our revenue arrangements to identify deliverables and to determine whether these deliverables are separable into multiple units of accounting. On January 1, 2011, we adopted guidance issued by the Financial Accounting Standards Board (“FASB”) on revenue arrangements with multiple deliverables. In accordance with the new guidance, when multiple elements exist in a sales agreement, we allocate revenue to all deliverables based on their relative selling prices. The new guidance provides a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence (“VSOE”), (ii) third-party evidence (“TPE”) if available and when VSOE is not available, and (iii) best estimate of the selling price (“BESP”) if neither VSOE nor TPE is available. We have established VSOE for most of our products and services as a substantial majority of selling prices fall within a narrow range when sold separately. For deliverables with no established VSOE, we use BESP to determine the standalone selling price for such deliverables as TPE is generally not available given that our products contain significant proprietary technology and solutions that differ substantially from our competitors. We have an established process for developing BESP, which incorporates historical selling prices, the effect of market conditions, gross margin objectives, pricing practices, as well as entity-specific factors. We monitor and evaluate estimated selling price on a regular basis to ensure that changes in circumstances are accounted for in a timely manner. We may modify our pricing in the future, which could result in changes to our VSOE and BESP. The services element of our contracts represents an incidental portion of the total contract price. The adoption of the new accounting standard did not have a significant impact on our consolidated financial statements.
Under our revenue recognition policy, evidence of an arrangement has been met when we have an executed purchase order or a stand-alone contract. Typically, smaller projects utilize purchase orders that conform to standard terms and conditions that require the customer to remit payment generally within 30 to 90 days from product delivery. In some cases, if credit worthiness cannot be determined, prepayment is required from the smaller customers.
For large projects, stand-alone contracts are utilized. For these contracts, consistent with industry practice, our customers typically require their suppliers, including ERI, to accept contractual holdback provisions whereby the final amounts due under the sales contract are remitted over extended periods of time. These retention payments typically range between 10% and 20%, and in some instances up to 30%, of the total contract amount and are due and payable when the customer is satisfied that certain specified product performance criteria have been met upon commissioning of the desalination plant, which may be 12 months to 24 months from the date of product delivery as described further below.
The specified product performance criteria for our PX device generally pertains to the ability of our product to meet its published performance specifications and warranty provisions, which our products have demonstrated on a consistent basis. This factor, combined with historical performance metrics measured over the past 11 years, provides our management with a reasonable basis to conclude that its PX device will perform satisfactorily upon commissioning of the plant. To ensure this successful product performance, we provide service, consisting principally of supervision of customer personnel and training to the customers during the commissioning of the plant. The installation of the PX device is relatively simple, requires no customization and is performed by the customer under the supervision of our personnel. We defer the value of the service and training component of the contract and recognize such revenue as services are rendered. Based on these factors, our management has concluded that, for sale of PX devices, delivery and performance have been completed when the product has been delivered (title transfers) to the customer.
We perform an evaluation of credit worthiness on an individual contract basis to assess whether collectability is reasonably assured. As part of this evaluation, our management considers many factors about the individual customer, including the underlying financial strength of the customer and/or partnership consortium and management’s prior history or industry-specific knowledge about the customer and its supplier relationships.
Under the stand-alone contracts, the usual payment arrangements are summarized as follows:
|
•
|
an advance payment due upon execution of the contract, typically 10% to 20% of the total contract amount;
|
|
•
|
a payment upon delivery of the product due on average between 90 and 150 days from product delivery, and in some cases up to 180 days, typically in the range of 50% to 70% of the total contract amount; and
|
|
•
|
a retention payment due subsequent to product delivery as described further below, typically in the range of 10% to 20%, and in some cases up to 30%, of the total contract amount.
|
Under the terms of the retention payment component, we are typically required to issue to the customer a product performance guarantee that takes the form of an irrevocable standby letter of credit, which is issued to the customer approximately 12 to 24 months after the product delivery date. The letter of credit is either collateralized by restricted cash on deposit with a financial institution or funds available through a credit facility. The letter of credit remains in place for the performance period as specified in the contract, which is generally 12 to 36 months and, in some cases, up to 65 months from issuance. The performance period generally runs concurrent with our standard product warranty period. Once the letter of credit has been put in place, we invoice the customer for this final retention payment under the sales contract. During the time between the product delivery and the issuance of the letter of credit, the amount of the final retention payment is classified on the balance sheet as an unbilled receivable, of which a portion may be classified as long-term to the extent that the billable period extends beyond one year. Once the letter of credit is issued, we invoice the customer and reclassify the retention amount from unbilled receivable to accounts receivable where it remains until payment.
We do not provide our customers with a right of product return. However, we will accept returns of products that are deemed to be damaged or defective when delivered that are covered by the terms and conditions of the product warranty. Product returns have not been significant. Reserves are established for possible product returns related to the advance replacement of products pending the determination of a warranty claim.
Shipping and handling charges billed to customers are included in net revenue. The cost of shipping to customers is included in cost of revenue.
Warranty Costs
We sell products with a limited warranty for a period ranging from one to six years. We accrue for warranty costs based on estimated product failure rates, historical activity and expectations of future costs. Periodically, we evaluate and adjust the warranty costs to the extent actual warranty costs vary from the original estimates.
Share-Based Compensation
We measure and recognize share-based compensation expense based on the fair value measurement for all share-based payment awards made to our employees and directors — including restricted stock units, restricted shares and employee stock options — over the requisite service period (typically the vesting period of the awards). The fair value of restricted stock units and restricted stock is based on our stock price on the date of grant. The fair value of stock options is calculated on the date of grant using the Black-Scholes option pricing model, which requires a number of complex assumptions, including expected life, expected volatility, risk-free interest rate, and dividend yield. The estimation of awards that will ultimately vest requires judgment and, to the extent actual results or updated estimates differ from our current estimates, such amounts are recorded as a cumulative adjustment in the period in which the estimates are revised. See Note 13 — “Share-Based Compensation” to the consolidated financial statements included in this report for further discussion of share-based compensation.
Foreign Currency
Our reporting currency is the U.S. dollar, while the functional currencies of our foreign subsidiaries are their respective local currencies. The asset and liability accounts of our foreign subsidiaries are translated from their local currencies at the rates in effect at the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the period. Gains and losses resulting from the translation of our subsidiary balance sheets are recorded as a component of accumulated other comprehensive income. Realized gains and losses from foreign currency transactions are recorded in other income and expense in the Consolidated Statements of Operations.
Income Taxes
Current tax assets and liabilities are based upon an estimate of taxes refundable or payable for each of the jurisdictions in which we are subject to tax. In the ordinary course of business, there is inherent uncertainty in quantifying income tax positions. We assess income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting dates. For those tax positions where it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit is recognized in the financial statements. When applicable, associated interest and penalties are recognized as a component of income tax expense. Accrued interest and penalties are included within the related tax asset or liability on the Consolidated Balance Sheets.
Deferred income taxes are provided for temporary differences arising from differences in basis of assets and liabilities for tax and financial reporting purposes. Deferred income taxes are recorded on temporary differences using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Significant judgment is required in determining whether and to what extent any valuation allowance is needed on our deferred tax assets. In making such a determination, we consider all available positive and negative evidence including recent results of operations, scheduled reversals of deferred tax liabilities, projected future income and available tax planning strategies. As of December 31, 2011, a valuation allowance of approximately $10.3 million was established to reduce our deferred income tax assets to the amount expected to be realized. See Note 11 — “Income Taxes” to the consolidated financial statements included in this report for further discussion of the tax valuation allowance.
Our operations are subject to income and transaction taxes in the U.S. and in foreign jurisdictions. Significant estimates and judgments are required in determining our worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.
Results of Operations
2011 Compared to 2010
The following table sets forth certain data from our historical operating results as a percentage of revenue for the years indicated:
|
|
For the Year Ended December 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
Change
Increase (Decrease)
|
|
Results of Operations: **
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$ |
28,047 |
|
|
|
100 |
% |
|
$ |
45,853 |
|
|
|
100 |
% |
|
$ |
(17,806 |
) |
|
|
(39 |
)% |
Cost of revenue
|
|
|
20,248 |
|
|
|
72 |
% |
|
|
23,781 |
|
|
|
52 |
% |
|
|
(3,533 |
) |
|
|
(15 |
)% |
Gross profit
|
|
|
7,799 |
|
|
|
28 |
% |
|
|
22,072 |
|
|
|
48 |
% |
|
|
(14,273 |
) |
|
|
(65 |
)% |
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
16,745 |
|
|
|
60 |
% |
|
|
14,471 |
|
|
|
32 |
% |
|
|
2,274 |
|
|
|
16 |
% |
Sales and marketing
|
|
|
7,997 |
|
|
|
29 |
% |
|
|
8,205 |
|
|
|
18 |
% |
|
|
(208 |
) |
|
|
(3 |
)% |
Research and development
|
|
|
3,526 |
|
|
|
13 |
% |
|
|
3,943 |
|
|
|
9 |
% |
|
|
(417 |
) |
|
|
(11 |
)% |
Amortization of intangible assets
|
|
|
1,360 |
|
|
|
5 |
% |
|
|
2,624 |
|
|
|
6 |
% |
|
|
(1,264 |
) |
|
|
(48 |
)% |
Loss (gain) on fair value remeasurement
|
|
|
171 |
|
|
|
1 |
% |
|
|
(2,147 |
) |
|
|
(5 |
)% |
|
|
(2,318 |
) |
|
|
(108 |
)% |
Restructuring charges
|
|
|
3,294 |
|
|
|
12 |
% |
|
|
— |
|
|
|
* |
|
|
|
3,294 |
|
|
|
* |
|
Total operating expenses
|
|
|
33,093 |
|
|
|
118 |
% |
|
|
27,096 |
|
|
|
59 |
% |
|
|
5,997 |
|
|
|
22 |
% |
Loss from operations
|
|
|
(25,294 |
) |
|
|
(90 |
)% |
|
|
(5,024 |
) |
|
|
(11 |
)% |
|
|
20,270 |
|
|
|
403 |
% |
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense & finance charges
|
|
|
(34 |
) |
|
|
* |
|
|
|
(73 |
) |
|
|
* |
|
|
|
(39 |
) |
|
|
(53 |
)% |
Other non-operating income (expense), net
|
|
|
184 |
|
|
|
1 |
% |
|
|
(137 |
) |
|
|
* |
|
|
|
321 |
|
|
|
234 |
% |
Net loss before provision for income tax
|
|
|
(25,144 |
) |
|
|
(90 |
)% |
|
|
(5,234 |
) |
|
|
(11 |
)% |
|
|
19,910 |
|
|
|
380 |
% |
Provision for (benefit from) income tax expense
|
|
|
1,299 |
|
|
|
5 |
% |
|
|
(1,626 |
) |
|
|
(4 |
)% |
|
|
(2,925 |
) |
|
|
(180 |
)% |
Net loss
|
|
$ |
(26,443 |
) |
|
|
(94 |
)% |
|
$ |
(3,608 |
) |
|
|
(8 |
)% |
|
$ |
22,835 |
|
|
|
633 |
% |
____________
* Not meaningful
** Percentages may not add up to 100% due to rounding
Net Revenue
Our net revenue decreased by $17.8 million, or 39%, to $28.0 million for the year ended December 31, 2011 from $45.8 million for the year ended December 31, 2010. The decrease in revenue was primarily due to decreased shipments of PX devices, turbochargers and pumps resulting from the continued global decline in new construction of large desalination plants, which was further exacerbated in 2011 as compared to 2010 by unanticipated global events such as civil uprisings in the Middle East and the Euro financial crisis. Additionally, we consolidated our North American operations and transferred our Michigan-based operations to our manufacturing center and headquarters in San Leandro, California. The transfer of operations resulted in some delays in shipments during the fourth quarter of 2011. Lastly, the average sales prices of our PX devices and turbochargers decreased slightly during 2011 due to product mix and customized configurations.
For the year ended December 31, 2011, the sales of PX devices and related products and services accounted for approximately 66% of our revenue and sales of turbochargers and pumps accounted for approximately 34%. For the year ended December 31, 2010, the sales of PX devices and related products and services accounted for approximately 61% of our revenue and sales of turbochargers and pumps accounted for approximately 39%.
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 is reflected in the table below instead of the delivery location. The amounts below are in thousands, except percentage data.
|
|
Years Ended December 31,
|
|
|
|
2011
|
|
|
2010
|
|
Domestic net revenue
|
|
$ |
2,798 |
|
|
$ |
3,334 |
|
International net revenue
|
|
|
25,249 |
|
|
|
42,519 |
|
Total net revenue
|
|
$ |
28,047 |
|
|
$ |
45,853 |
|
|
|
|
|
|
|
|
|
|
Revenue by country:
|
|
|
|
|
|
|
|
|
India
|
|
|
18 |
% |
|
|
3 |
% |
United States
|
|
|
10 |
|
|
|
7 |
|
Australia
|
|
|
2 |
|
|
|
31 |
|
Algeria
|
|
|
1 |
|
|
|
12 |
|
Others
|
|
|
69 |
|
|
|
47 |
|
Total
|
|
|
100 |
% |
|
|
100 |
% |
The impact of the current global economic climate on future demand for our products is uncertain.
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. The largest component of our cost of revenue is raw materials, primarily ceramic materials. For the year ended December 31, 2011, gross profit as a percentage of net revenue was 28%, as compared to 48% for the year ended December 31, 2010.
The decrease in gross profit as a percentage of net revenue was primarily due to underutilization of our manufacturing facilities in 2011 as a result of the decline in product demand during the current year as compared to prior year, the phase-out of our Michigan-based manufacturing facility as part of the consolidation of our North American operations and the integration of our new ceramics facility, which went online in 2011. To a lesser extent, gross profit decreased in the current year compared to the prior year due to a slight drop in average sales prices due to changes 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 own ceramics factory and our assembly operations that determines our operating leverage. Accordingly, we are not able to predict our future gross profit levels with certainty. In addition, our recent production facility expansion will continue to have a negative impact to our margins if our production volume does not increase in the foreseeable future.
General and Administrative Expense
General and administrative expense increased by $2.3 million, or 16%, to $16.7 million for the year ended December 31, 2011 from $14.5 million for the year ended December 31, 2010. General and administrative expense as a percentage of our net revenue increased to 60% for the year ended December 31, 2011 from 32% for the year ended December 31, 2010 as general and administrative costs increased period over period while net revenue decreased.
General and administrative average headcount decreased to 31 for the year ended December 31, 2011 from 40 for the year ended December 31, 2010, largely as a result of reductions in force at our corporate headquarters during late 2010 and early 2011 and reductions in force at our Michigan-based facility during the second half of 2011. In February 2011, our chief executive officer (CEO) announced his retirement, and our board of directors appointed a new CEO. During the second quarter of 2011, our board of directors appointed a new chief financial officer (CFO). General and administrative costs increased primarily as a result of non-recurring expenses related to the departures of the former CEO and CFO and the appointments of a new CEO and new CFO.
Of the $2.3 million net increase in general and administrative expense, increases of $1.4 million related to compensation and employee-related benefits, $0.4 million related to adjustments to bad debt reserves, $0.3 million related to value added taxes, $0.2 million related to professional and other services, and $0.4 million related to other administrative costs. These increases in costs were partially offset by a decrease of $0.4 million related to occupancy costs. Share-based compensation expense included in general and administrative expense was $1.6 million for the year ended December 31, 2011 and $1.8 million for the year ended December 31, 2010.
Sales and Marketing Expense
Sales and marketing expense decreased by $208,000, or 3%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. Sales and marketing average headcount increased to 27 for the year ended December 31, 2011 from 26 for the year ended December 31, 2010. As a percentage of our net revenue, sales and marketing expense increased to 29% for the year ended December 31, 2011 from 18% for the year ended December 31, 2010, as the percentage decrease in net revenue exceeded the percentage decrease in sales and marketing expense year over year.
Of the $208,000 net decrease in sales and marketing expense for the year ended December 31, 2011, a decrease of $944,000 related to sales commissions was partially offset by increases of $693,000 in direct and other marketing costs and $43,000 in employee compensation and benefits. Share-based compensation expense included in sales and marketing expense was $591,000 for the year ended December 31, 2011 and $599,000 for the year ended December 31, 2010.
Research and Development Expense
Research and development expense decreased by $0.4 million, or 11%, to $3.5 million for the year ended December 31, 2011 from $3.9 million for the year ended December 31, 2010. Research and development expense as a percentage of our net revenue increased to 13% for the year ended December 31, 2011 compared to 9% for the year ended December 31, 2010, as the percentage decrease in net revenue exceeded the percentage decrease in research and development expense year over year.
Average headcount in our research and development department decreased to 12 for the year ended December 31, 2011 compared to 17 for the year ended December 31, 2010. Share-based compensation expense included in research and development expense was $164,000 for the year ended December 31, 2011 and $214,000 for the year ended December 31, 2010.
The $417,000 decrease in research and development expense for the year ended December 31, 2011 compared to prior year was primarily due to decreases of $251,000 in occupancy costs, $149,000 related to research and development direct project costs, and $53,000 related to other costs. These decreases in expense were slightly offset by an increase in compensation and employee benefits of $36,000.
We anticipate that our research and development expenditures will increase in the future as we expand and diversify our product offering.
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. These intangible assets include developed technology, non-compete agreements, backlog, trademarks, and customer relationships. Amortization expense decreased by $1.3 million during the year ended December 31, 2011 compared to the year ended December 31, 2010 due to backlog being fully amortized during fiscal year 2010.
Loss on Fair Value Remeasurement
We acquired Pump Engineering, LLC in December 2009. Under the business combinations guidance of U.S. GAAP, we initially recognized a liability of $5.5 million as an estimate of the acquisition date fair value of contingent and other consideration, consisting of $3.5 million of contingent consideration subject to pay-out to the sellers upon the acquired company’s achievement of certain milestones and $2.0 of other consideration securing the sellers’ indemnification obligations. The fair value measurement of the $3.5 million of contingent consideration was based on the weighted probability of achievement, as of the acquisition date, that the milestones would be achieved. In the fourth quarter of 2010, some of the milestones were not met. Accordingly, we remeasure the estimated fair value contingent consideration on a recurring basis. In December 2011, we remeasured the contingent consideration at $1.5 million to reflect its estimated fair value at December 31, 2011. This was an increase in the estimated fair value compared to $1.4 million at December 31, 2010. We recognized a loss of $171,000 in our Consolidated Statement of Operations as a result of the change in estimated fair value in 2011. See Note 6 — “Business Combinations” to the consolidated financial statements included in this report for further discussion of the loss on fair value remeasurement.
Restructuring Charges
In July 2011, we initiated a restructuring plan to consolidate our North American operations and transfer our Michigan-based operations to our manufacturing center and headquarters in San Leandro, California. The consolidation is expected to reduce costs, improve efficiencies and enhance research and development activities. For the year ended December 31, 2011, we have recorded total pre-tax charges of $3.1 million related to this plan. Additionally, we initiated a restructuring plan to reduce operating expenses related to our sales branch office in Spain. For the year ended December 31, 2011, we have recorded total pre-tax charges of $0.2 million related to this plan. See Note 16 — “Restructuring Activities” to the consolidated financial statements included in this report for further discussion of restructuring activities. Both restructuring plans were essentially completed by December 31, 2011 and, with the exception of a continued evaluation of assets held for sale for impairment, we do not expect significant restructuring charges related to these restructuring plans in the future.
Non-operating Income (Expense), Net
Non-operating income (expense), net, changed favorably by $360,000 to $150,000 of other net income for the year ended December 31, 2011 from $(210,000) of other net expense for the year ended December 31, 2010. The favorable change was primarily due to favorable changes in net foreign currency gains of $295,000, an increase in interest income of $31,000, and a decrease in interest expense of $39,000. The favorable change in net foreign currency gains is primarily a result of favorable changes in exchange rates and an increase in Euro-denominated trade receivables during 2011 compared to last year. The favorable changes in net non-operating income (expense) during the year ended December 31, 2011 were slightly offset by an increase in other non-operating expenses $5,000.
2010 Compared to 2009
The following table sets forth certain data from our historical operating results as a percentage of revenue for the years indicated:
|
|
For the Year Ended December 31,
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
Increase (Decrease)
|
|
Results of Operations: **
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$ |
45,853 |
|
|
|
100 |
% |
|
$ |
47,014 |
|
|
|
100 |
% |
|
$ |
(1,161 |
) |
|
|
(2 |
)% |
Cost of revenue
|
|
|
23,781 |
|
|
|
52 |
% |
|
|
17,595 |
|
|
|
37 |
% |
|
|
6,186 |
|
|
|
35 |
% |
Gross profit
|
|
|
22,072 |
|
|
|
48 |
% |
|
|
29,419 |
|
|
|
63 |
% |
|
|
(7,347 |
) |
|
|
(25 |
)% |
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
14,471 |
|
|
|
32 |
% |
|
|
13,515 |
|
|
|
29 |
% |
|
|
956 |
|
|
|
7 |
% |
Sales and marketing
|
|
|
8,205 |
|
|
|
18 |
% |
|
|
6,472 |
|
|
|
14 |
% |
|
|
1,733 |
|
|
|
27 |
% |
Research and development
|
|
|
3,943 |
|
|
|
9 |
% |
|
|
3,041 |
|
|
|
6 |
% |
|
|
902 |
|
|
|
30 |
% |
Amortization of intangible assets
|
|
|
2,624 |
|
|
|
6 |
% |
|
|
241 |
|
|
|
1 |
% |
|
|
2,383 |
|
|
|
* |
|
Gain on fair value remeasurement
|
|
|
(2,147 |
) |
|
|
(5 |
)% |
|
|
— |
|
|
|
0 |
% |
|
|
2,147 |
|
|
|
* |
|
Total Operating Expenses
|
|
|
27,096 |
|
|
|
59 |
% |
|
|
23,269 |
|
|
|
49 |
% |
|
|
3,827 |
|
|
|
16 |
% |
Income (loss) from operations
|
|
|
(5,024 |
) |
|
|
(11 |
)% |
|
|
6,150 |
|
|
|
13 |
% |
|
|
(11,174 |
) |
|
|
(182 |
)% |
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense & finance charges
|
|
|
(73 |
) |
|
|
* |
|
|
|
(46 |
) |
|
|
* |
|
|
|
27 |
|
|
|
59 |
% |
Other non-operating income (expense), net
|
|
|
(137 |
) |
|
|
* |
|
|
|
54 |
|
|
|
* |
|
|
|
(191 |
) |
|
|
(354 |
)% |
Net income (loss) before provision for income tax
|
|
|
(5,234 |
) |
|
|
(11 |
)% |
|
|
6,158 |
|
|
|
13 |
% |
|
|
(11,392 |
) |
|
|
(185 |
)% |
Provision for (benefit from) income tax expense
|
|
|
(1,626 |
) |
|
|
(4 |
)% |
|
|
2,472 |
|
|
|
5 |
% |
|
|
(4,098 |
) |
|
|
(166 |
)% |
Net Income (Loss)
|
|
$ |
(3,608 |
) |
|
|
(8 |
)% |
|
$ |
3,686 |
|
|
|
8 |
% |
|
$ |
(7,294 |
) |
|
|
(198 |
)% |
* Not meaningful
** Percentages may not add up to 100% due to rounding
Net Revenue
Our net revenue decreased by $1.2 million, or 2%, to $45.9 million for the year ended December 31, 2010 from $47.0 million for the year ended December 31, 2009. Revenues from the sales of PX devices and related products and services decreased by approximately $17.3 million while revenues from the sales of turbochargers and pumps increased by approximately $16.1 million. The decrease in revenue from sales of PX devices was primarily due to the timing of larger orders, a global decline in the construction of new projects and competition. Additionally, there was a slight decrease in the average sales price of PX units during fiscal year 2010. The increase in revenue from sales of turbochargers and pumps was primarily due to a full year of shipments by our subsidiary, Pump Engineering, Inc., which was acquired late in the fourth quarter of 2009, and the timing of larger orders. Revenues from the sales of our turbochargers and related products had a very small impact on our 2009 revenue base, totaling only $0.2 million for the 2009 fiscal year.
For the year ended December 31, 2010, the sales of PX devices and related products and services accounted for approximately 61% of our revenue and sales of turbochargers and pumps accounted for approximately 39%. For the year ended December 31, 2009, the sales of PX devices and related products and services accounted for approximately 96% of our revenue and sales of turbochargers and pumps accounted for approximately 4%. Turbochargers and related high-pressure pumps, manufactured by our subsidiary, Pump Engineering, Inc., had a negligible impact on our product offering in 2009, as the subsidiary was acquired late in the fourth quarter of 2009.
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 is reflected in the table below instead of the delivery location. The amounts below are in thousands, except percentage data.
|
|
Years Ended December 31,
|
|
|
|
2010
|
|
|
2009
|
|
Domestic net revenue
|
|
$ |
3,334 |
|
|
$ |
3,022 |
|
International net revenue
|
|
|
42,519 |
|
|
|
43,992 |
|
Total net revenue
|
|
$ |
45,853 |
|
|
$ |
47,014 |
|
Revenue by country:
|
|
|
|
|
|
|
|
|
Australia
|
|
|
31 |
% |
|
|
19 |
% |
Algeria
|
|
|
12 |
|
|
|
24 |
|
Israel
|
|
|
2 |
|
|
|
21 |
|
Others
|
|
|
55 |
|
|
|
36 |
|
Total
|
|
|
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. The largest component of our cost of revenue is raw materials, primarily ceramic materials. For the year ended December 31, 2010, gross profit as a percentage of net revenue was 48% as compared to 63% for the year ended December 31, 2009.
The decrease in gross profit as a percentage of net revenue was primarily due to a shift of product sales to lower margin turbochargers and high-pressure pumps, a result of our acquisition of Pump Engineering, LLC in late 2009, and an increase in overhead costs related to our PX devices, largely attributed to the underutilization of our newly expanded manufacturing facility. Additionally, the amortization of an inventory valuation step-up of $0.9 million, stemming from our acquisition of Pump Engineering, LLC, and a slight decline in the average selling prices of our PX devices also served to negatively impact gross margin in fiscal year 2010.
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 own ceramics factory and our assembly operations that determines our operating leverage. Accordingly, we are not able to predict our future gross profit levels with certainty. In addition, our recent production facility expansion will continue to have a negative impact to our margins if our production volume does not increase in the foreseeable future.
General and Administrative Expense
General and administrative expense increased by $1.0 million, or 7%, to $14.5 million for the year ended December 31, 2010 from $13.5 million for the year ended December 31, 2009. The increase of general and administrative expense was attributable primarily to increases in general and administrative headcount related to the acquisition of Pump Engineering, LLC in December 2009 and increases in occupancy costs related to our new corporate headquarters. General and administrative expense as a percentage of our net revenue increased to 32% for the year ended December 31, 2010 from 29% for the year ended December 31, 2009, as general and administrative costs increased in 2010 while net revenue decreased.
Of the $1.0 million net increase in general and administrative expense, increases of $1.2 million related to occupancy costs, $0.5 million related to compensation and employee-related benefits, and $0.3 million related to local taxes and other administrative costs. These increases in costs were offset in part by decreases of $0.6 million related to professional and other services, $0.3 million related to changes in bad debt and other reserves, and $0.1 million related to value added taxes. Share-based compensation expense included in general and administrative expense was $1.8 million for the year ended December 31, 2010 and $1.5 million for the year ended December 31, 2009.
General and administrative average headcount increased to 40 for the year ended December 31, 2010 from 36 for the prior year largely as a result of the acquisition of Pump Engineering, LLC in December 2009. Increased compensation and employee benefit costs related to this increase in headcount were largely offset by the effects of cost-cutting measures implemented at our corporate headquarters in 2010.
Sales and Marketing Expense
Sales and marketing expense increased by $1.7 million, or 27%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. This increase was primarily related to an increase in sales and marketing headcount as a result of the Pump Engineering acquisition in December 2009. Sales and marketing average headcount increased to 26 for the year ended December 31, 2010 from 22 for the year ended December 31, 2009. As a percentage of our net revenue, sales and marketing expense increased to 18% for the year ended December 31, 2010 from 14% for the year ended December 31, 2009, as sales and marketing expense increased in 2010 while net revenue decreased.
The $1.7 million net increase in sales and marketing expense for the year ended December 31, 2010 was primarily related to increases in compensation, employee-related benefits, and commissions to outside sales representatives as a result of the acquisition of Pump Engineering, LLC in December 2009. Sales and marketing headcount increased due to the acquisition. Additionally, Pump Engineering has historically relied on outside sales agents rather than inside sales representatives to generate sales, resulting in higher commission rates. Share-based compensation expense included in sales and marketing expense was $599,000 for the year ended December 31, 2010 and $488,000 for the year ended December 31, 2009.
Research and Development Expense
Research and development expense increased by $0.9 million, or 30%, to $3.9 million for the year ended December 31, 2010 from $3.0 million for the year ended December 31, 2009. Research and development expense as a percentage of our net revenue increased to 9% for the year ended December 31, 2010 compared to 6% for the year ended December 31, 2009, as research and development expense increased in 2010 while net revenue decreased.
Of the $0.9 million increase in research and development expense for the year ended December 31, 2010, $0.4 million related to increased compensation and employee-related benefits as a result of our acquisition of Pump Engineering, LLC in December 2009, $0.2 million related to increased occupancy costs and consulting and professional fees, and $0.3 million related to an increase in research and development direct project costs.
Average headcount in our research and development department increased to 17 for the year ended December 31, 2010 from 11 for the year ended December 31, 2009, primarily due to the acquisition of Pump Engineering, LLC in December 2009. Share-based compensation expense included in research and development expense was $214,000 for the year ended December 31, 2010 and $246,000 for the year ended December 31, 2009.
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. These intangible assets include developed technology, non-compete agreements, backlog, trademarks, and customer relationships. Amortization expense in 2009 represented one month of amortization compared to twelve months of amortization in 2010.
Gain on Fair Value Remeasurement
We acquired Pump Engineering, LLC in December 2009. Under the business combinations guidance of U.S. GAAP, we initially recognized a liability of $5.5 million as an estimate of the acquisition date fair value of contingent and other consideration, consisting of $3.5 million of contingent consideration subject to pay-out to the sellers upon the acquired company’s achievement of certain milestones and $2.0 of other consideration securing the sellers’ indemnification obligations. The fair value measurement of the $3.5 million of contingent consideration was based on the weighted probability of achievement, as of the acquisition date, that the milestones would be achieved. In the fourth quarter of 2010, some of the milestones were not met. Accordingly, we remeasured the contingent consideration at $1.4 million to reflect its estimated fair value at December 31, 2010 and recognized a gain of $2.1 million in our Consolidated Statement of Operations. See Note 6 — “Business Combinations” to the consolidated financial statements included in this report for further discussion of the gain on fair value remeasurement.
Non-operating Income (Expense), Net
Non-operating income (expense), net, changed unfavorably by $218,000 to $(210,000) of other net expense for the year ended December 31, 2010 from $8,000 of other net income for the year ended December 31, 2009. The unfavorable variance was primarily due to a decrease of $0.1 million in interest income and a decrease of $0.1 million increase in net foreign currency losses year over year.
Liquidity and Capital Resources
Our primary source of cash historically has been proceeds from the issuance of common stock, customer payments for our products and services and borrowings under credit facilities. From January 1, 2005 through December 31, 2011, we issued common stock for aggregate net proceeds of $84.0 million, excluding common stock issued in exchange for promissory notes. The proceeds from the sales of common stock have been used to fund our operations and capital expenditures.
As of December 31, 2011, our principal sources of liquidity consisted of unrestricted cash and cash equivalents of $18.5 million, which are invested primarily in money market funds, short- and long-term investments in marketable debt securities of $22.9 million, and accounts receivable of $6.5 million. We invest cash not needed for current operations predominantly in high-quality investment grade marketable debt instruments with the intent to make such funds available for operating purposes as needed.
We have unbilled receivables pertaining to customer contractual holdback provisions, whereby we invoice the final installment due under a sales contract 12 to 24 months after the product has been shipped to the customer and revenue has been recognized. The customer holdbacks represent amounts intended to provide a form of security for the customer rather than a form of long-term financing; accordingly, these receivables have not been discounted to present value. At December 31, 2011 and 2010, we had $1.1 million and $2.3 million of current unbilled receivables, respectively.
In 2008, we entered into a credit agreement (“2008 credit agreement”) with a financial institution. The 2008 credit agreement, as amended, allowed borrowings of up to $12.0 million on a revolving basis at LIBOR plus 2.75%. This agreement was terminated during the first quarter of 2009. As a result of terminating the 2008 credit agreement, we were required to transfer cash to a restricted cash account as collateral for outstanding irrevocable standby letters of credit that were collateralized by the credit agreement as of the date of its termination. We were also required to restrict cash as collateral for the outstanding balance on our equipment promissory note. As of December 31, 2011, $519,000 and $89,000 in cash remains restricted under this arrangement for outstanding standby letters of credit and the equipment promissory note, respectively. These restricted cash amounts are expected to be released at various dates through 2013.
In 2009, we entered into a loan and security agreement (“2009 loan and security agreement”) with another financial institution. The 2009 loan and security agreement, as amended, provides a total available credit line of $16.0 million. Under this credit agreement, we are allowed to draw advances up to $10.0 million on a revolving line of credit or utilize up to $15.9 million as collateral for irrevocable standby letters of credit, provided that the aggregate of the outstanding advances and collateral do not exceed the total available credit line of $16.0 million. Advances under the revolving line of credit incur interest based on either a prime rate index or LIBOR plus 1.375%. The amended agreement expires in May 2012 and is collateralized by substantially all of our assets.
During the years ended December 31, 2011 and 2010, we provided certain customers with irrevocable standby letters of credit to secure our obligations for the delivery and performance of products in accordance with sales arrangements. These standby letters of credit were issued primarily under our 2009 loan and security agreement. The standby letters of credit generally terminate within 12 to 36 months from issuance. As of December 31, 2011, the amounts outstanding on irrevocable standby letters of credit collateralized under our credit agreement totaled approximately $6.7 million. Effective July 2011, the loan and security agreement was amended, requiring us to maintain a cash collateral balance equal to at least 101% of the face amount of all outstanding letters of credit collateralized by the line of credit and 100% of the amount of all outstanding advances. As of December 31, 2011, restricted cash related to these standby letters of credit was approximately $6.8 million. There were no advances drawn under the line of credit as of December 31, 2011.
We are subject to certain financial and administrative covenants under the amended loan and security agreement. As of December 31, 2011, we were non-compliant with one financial covenant related to the timing of financial reporting. We received a waiver for this noncompliance in January 2012.
Cash Flows from Operating Activities
Net cash (used in) provided by operating activities was $(8.3) million and $1.7 million for the years ended December 31, 2011 and 2010, respectively. For the years ended December 31, 2011 and 2010, net losses of $(26.4) million and $(3.6) million, respectively, were adjusted to a net loss of $(11.8) million and net income of $4.2 million, respectively, by non-cash items totaling $14.6 million and $7.8 million, respectively. Non-cash adjustments primarily include depreciation and amortization, gains or losses on acquisition-related contingencies, share-based compensation, asset write-downs and impairments, deferred income taxes, provisions for doubtful accounts, warranty reserves, and excess and obsolete inventory reserves. In 2011, non-cash items also included $2.2 million related to non-cash impairment related restructuring charges.
The net cash effect from changes in operating assets and liabilities was an approximately $3.5 million increase and $(2.5) million decrease for the years ended December 31, 2011 and 2010, respectively. Net changes in assets and liabilities are primarily attributable to changes in inventory as a result of the timing of order processing and product shipments, changes in accounts receivable and unbilled receivables as a result of the timing of invoices and collections for large projects, and changes in prepaid expenses and accrued liabilities as a result of the timing of payments to employees, vendors and other third parties.
Net cash provided by operating activities was $1.7 million and $12.8 million for the years ended December 31, 2010 and 2009, respectively. For the years ended December 31, 2010 and 2009, net loss of $(3.6) million and net income of $3.7 million, respectively, were adjusted to $4.2 million and $7.1 million, respectively, by non-cash items totaling $7.8 million and $3.4 million, respectively. Non-cash adjustments include depreciation, amortization, unrealized gains and losses on foreign exchange, share-based compensation, provisions for doubtful accounts, warranty reserves and excess and obsolete inventory reserves. In 2010, non-cash items also included a $2.1 million gain related to the fair value remeasurement of contingent consideration for the 2009 acquisition of Pump Engineering, LLC.
The net cash effect from changes in operating assets and liabilities was an approximately $(2.5) million decrease and $5.7 million increase for the years ended December 31, 2010 and 2009, respectively. Net changes in assets and liabilities are primarily attributable to changes in inventory as a result of the timing of order processing and product shipments, changes in accounts receivable and unbilled receivables as a result of timing of invoices and collections for large projects, and changes in prepaid expenses and accrued liabilities as a result of the timing of payments to employees, vendors and other third parties.
Cash Flows from Investing Activities
Cash flows used in investing activities primarily relate to company acquisitions, capital expenditures to support our growth, and increases in our restricted cash used to collateralize our letters of credit.
Net cash used in investing activities was $28.2 million and $5.5 million for the years ended December 31, 2011, and 2010, respectively. The increase of $22.7 million in net cash used by investing activities was primarily attributable to our investment of $22.9 million in short-term and long-term financial instruments. We increased restricted cash by $4.0 million during fiscal year, compared to releasing restricted cash of $4.0 million during the prior year. This $8.0 million change in cash used for restricted cash balances was primarily the result of new requirements to collateralize outstanding irrevocable standby letters of credit under an amended credit line agreement. The increases in cash used in investing activities year over year was partially offset by a decrease in capital expenditures of $7.5 million due to the significant completion of key capital projects in the prior year and an increase of $0.7 million in proceeds from the sale of property and equipment in the current year.
Net cash used in investing activities was $5.5 million and $31.9 million for the years ended December 31, 2010, and 2009, respectively. The decrease of $26.3 million in net cash used by investing activities was primarily attributable to the purchase of Pump Engineering, LLC in 2009, which resulted in a cash payment, net of cash acquired, of $13.6 million. Additionally, during fiscal year 2010, restricted cash of $0.9 million, related to the acquisition of Pump Engineering, LLC, and restricted cash of $3.0 million, used to collateralize outstanding irrevocable standby letters of credit, were released. Comparatively, there was a net increase in restricted cash of $10.5 million — $5.5 million related to escrow amounts for the acquisition of Pump Engineering, LLC and $5.0 million for use as collateral of standby letters of credit during fiscal year 2009. The decreases in cash used in investing activities in 2010 compared to 2009 were slightly offset by an increase in capital expenditures of $1.8 million during 2010 for the completion of seismic upgrades and the build-out of ceramics manufacturing capabilities at our headquarters.
Cash Flows from Financing Activities
Net cash (used in) provided by financing activities was $(267,000) and $121,000 for the years ending December 31, 2011 and 2010, respectively. The unfavorable change in net cash flows from financing activities in 2011 compared to 2010 was primarily due to a decrease in cash received from warrant and stock option exercises of $584,000, including excess tax benefits related to share-based compensation arrangements, and a decrease in repayments of notes receivable from shareholders of $38,000. Unfavorable changes were partially offset by a decrease in debt and capital lease payments of $234,000 due to our early payoff of a promissory note in 2010 and several capital leases reaching the end of their terms in late 2010 and early 2011.
Net cash provided by (used in) financing activities was $0.1 million and $(1.1) million for the years ending December 31, 2010 and 2009, respectively. The favorable change in net cash flows from financing activities was primarily due the repayment of $1.6 million of long-term debt obligations in December 2009 owed by our subsidiary, Pump Engineering, Inc. and an increase of $0.2 million in proceeds received for warrant and stock option exercises. Favorable changes in financing cash flows were slightly offset by an increase in capital lease payments of $0.2 million, a decrease in collections on promissory notes of $0.2 million, and a decrease in excess tax benefits related to share-based compensation arrangements of $0.2 million.
Liquidity and Capital Resource Requirements
We believe that our existing resources and cash generated from our operations will be sufficient to meet our anticipated capital requirements for at least the next 12 months. However, we may need to raise additional capital or incur additional indebtedness to continue to fund our operations in the future. Our future capital requirements will depend on many factors, including our rate of revenue growth, if any, the expansion of our sales and marketing and research and development activities, the timing and extent of our expansion into new geographic territories, the timing of new product introductions and the continuing market acceptance of our products. We may enter into potential material investments in, or acquisitions of, complementary businesses, services or technologies in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.
Contractual Obligations
We lease facilities and equipment under fixed non-cancelable operating leases that expire on various dates through 2019. We have purchased property and equipment under capital leases and notes payable. Additionally, in the course of our normal operations, we have entered into cancelable purchase commitments with our suppliers for various key raw materials and component parts. The purchase commitments covered by these arrangements are subject to change based on our sales forecasts for future deliveries.
The following is a summary of our contractual obligations as of December 31, 2011 (in thousands):
|
|
Payments Due by Period
|
|
Payments Due During Year Ending December 31,
|
|
Operating
Leases
|
|
|
Capital
Leases(1)
|
|
|
Notes
Payable
|
|
|
Purchase
Obligations(2)
|
|
|
Total
|
|
2012
|
|
$ |
1,504 |
|
|
$ |
85 |
|
|
$ |
85 |
|
|
$ |
1,673 |
|
|
$ |
3,347 |
|
2013
|
|
|
1,474 |
|
|
|
18 |
|
|
|
— |
|
|
|
— |
|
|
|
1,492 |
|
2014
|
|
|
1,560 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,560 |
|
2015
|
|
|
1,477 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,477 |
|
2016
|
|
|
1,514 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,514 |
|
Thereafter
|
|
|
4,476 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
4,476 |
|
|
|
$ |
12,005 |
|
|
$ |
103 |
|
|
$ |
85 |
|
|
$ |
1,673 |
|
|
$ |
13,866 |
|
(1)
|
Present value of net minimum capital lease payments is $100,000, as reflected on the balance sheet.
|
|
|
(2)
|
Purchase obligations are related to open purchase orders for materials and supplies.
|
This table excludes agreements with guarantees or indemnity provisions that we have entered into with customers and others in the ordinary course of business. Based on our historical experience and information known to us as of December 31, 2011, we believe that our exposure related to these guarantees and indemnities as of December 31, 2011 was not material.
Off-Balance Sheet Arrangements
During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Recent Accounting Pronouncements
See Note 2, “Summary of Significant Accounting Policies” to the consolidated financial statements regarding the impact of certain recent accounting pronouncements on our consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Foreign Currency Risk
Currently, the majority of our revenue contracts have been denominated in United States dollars. In some circumstances, we have priced certain international sales in Euros. The amount of revenue recognized and denominated in Euros amounted to $1.4 million, $2.1 million, and zero in 2011, 2010, and 2009, respectively. We experienced a net foreign currency gain (loss) of approximately $172,000, $(152,000), and $(44,000) related to our revenue contracts for the years ended December 31, 2011, 2010, and 2009, respectively.
As we expand our international sales, we expect that a portion of our revenue could continue to be denominated in foreign currencies. As a result, our cash and cash equivalents and operating results could be increasingly affected by changes in exchange rates. Our international sales and marketing operations incur expense that is denominated in foreign currencies. This expense could be materially affected by currency fluctuations. Our exposures are to fluctuations in exchange rates for the United States dollar versus the Euro. Changes in currency exchange rates could adversely affect our consolidated operating results or financial position. Additionally, our international sales and marketing operations maintain cash balances denominated in foreign currencies. In order to decrease the inherent risk associated with translation of foreign cash balances into our reporting currency, we have not maintained excess cash balances in foreign currencies. We have not hedged our exposure to changes in foreign currency exchange rates because expenses in foreign currencies have been insignificant to date, and exchange rate fluctuations have had little impact on our operating results and cash flows.
Interest Rate Risk and Credit Risk
We have an investment portfolio of fixed income marketable debt securities, including amounts classified as cash equivalents, short-term investments, and long-term investments. At December 31, 2011, our short-term investments and long-term investments totaled approximately $22.9 million. The primary objective of our investment activities is to preserve principal and liquidity while at the same time maximizing yields without significantly increasing risk. We invest primarily in high quality short-term and long-term debt instruments of the U.S. government and its agencies and high-quality corporate issuers. These investments are subject to interest rate fluctuations and will decrease in market value if interest rates increase. To minimize the exposure due to adverse shifts in interest rates, we maintain investments with an average maturity of less than three years. A hypothetical 100 basis point increase in interest rates would result in an approximately $120,000 decrease (less than 1%) in the fair value of our fixed-income debt securities as of December 31, 2011.
In addition to interest rate risk, our investments in marketable debt securities are subject to potential loss of value due to counterparty credit risk. To minimize this risk, we invest pursuant to a Board approved investment policy. The policy mandates high credit rating requirements and restricts our exposure to any single corporate issuer by imposing concentration limits.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
Energy Recovery, Inc.
San Leandro, California
We have audited the accompanying consolidated balance sheets of Energy Recovery, Inc. as of December 31, 2011 and 2010 and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011. In connection with our audits of the financial statements, we have also audited the financial statement schedule (“schedule”) listed in Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Energy Recovery, Inc. at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Energy Recovery, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 13, 2012 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
San Jose, California
March 13, 2012
ENERGY RECOVERY, INC.
CONSOLIDATED BALANCE SHEETS
|
|
December 31,
2011
|
|
|
December 31,
2010
|
|
|
|
(In thousands, except share data and par value)
|
|
ASSETS
|
|
Current assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
18,507 |
|
|
$ |
55,338 |
|
Restricted cash
|
|
|
5,687 |
|
|
|
4,636 |
|
Short-term investments
|
|
|
11,706 |
|
|
|
— |
|
Accounts receivable, net of allowance for doubtful accounts of $248 and $44 at December 31, 2011 and 2010
|
|
|
6,498 |
|
|
|
9,649 |
|
Unbilled receivables, current
|
|
|
1,059 |
|
|
|
2,278 |
|
Inventories
|
|
|
7,824 |
|
|
|
9,772 |
|
Deferred tax assets, net
|
|
|
460 |
|
|
|
2,097 |
|
Prepaid expenses and other current assets
|
|
|
4,929 |
|
|
|
4,428 |
|
Total current assets
|
|
|
56,670 |
|
|
|
88,198 |
|
Restricted cash, non-current
|
|
|
5,232 |
|
|
|
2,244 |
|
Long-term investments
|
|
|
11,198 |
|
|
|
— |
|
Land and building held for sale
|
|
|
1,660 |
|
|
|
— |
|
Property and equipment, net
|
|
|
16,170 |
|
|
|
22,314 |
|
Goodwill
|
|
|
12,790 |
|
|
|
12,790 |
|
Other intangible assets, net
|
|
|
6,991 |
|
|
|
8,352 |
|
Other assets, non-current
|
|
|
2 |
|
|
|
19 |
|
Total assets
|
|
$ |
110,713 |
|
|
$ |
133,917 |
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$ |
1,506 |
|
|
$ |
1,429 |
|
Accrued expenses and other current liabilities
|
|
|
6,474 |
|
|
|
5,248 |
|
Income taxes payable
|
|
|
21 |
|
|
|
13 |
|
Accrued warranty reserve
|
|
|
852 |
|
|
|
1,028 |
|
Deferred revenue
|
|
|
859 |
|
|
|
2,341 |
|
Current portion of long-term debt
|
|
|
85 |
|
|
|
128 |
|
Current portion of capital lease obligations
|
|
|
82 |
|
|
|
160 |
|
Total current liabilities
|
|
|
9,879 |
|
|
|
10,347 |
|
Long-term debt
|
|
|
— |
|
|
|
85 |
|
Capital lease obligations, non-current
|
|
|
18 |
|
|
|
144 |
|
Deferred tax liabilities, non-current, net
|
|
|
1,516 |
|
|
|
317 |
|
Deferred revenue, non-current
|
|
|
261 |
|
|
|
157 |
|
Other non-current liabilities
|
|
|
2,085 |
|
|
|
2,067 |
|
Total liabilities
|
|
|
13,759 |
|
|
|
13,117 |
|
Commitments and Contingencies (Note 10)
|
|
|
|
|
|
|
|
|
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; 52,645,129 and 52,596,170 shares issued and outstanding at December 31, 2011 and 2010
|
|
|
53 |
|
|
|
53 |
|
Additional paid-in capital
|
|
|
114,619 |
|
|
|
112,025 |
|
Notes receivable from stockholders
|
|
|
(23 |
) |
|
|
(38 |
) |
Accumulated other comprehensive loss
|
|
|
(92 |
) |
|
|
(80 |
) |
(Accumulated deficit) retained earnings
|
|
|
(17,603 |
) |
|
|
8,840 |
|
Total stockholders’ equity
|
|
|
96,954 |
|
|
|
120,800 |
|
Total liabilities and stockholders’ equity
|
|
$ |
110,713 |
|
|
$ |
133,917 |
|
See accompanying Notes to consolidated financial statements
ENERGY RECOVERY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
Years Ended
December 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
|
(In thousands, except per share data)
|
|
Net revenue
|
|
$ |
28,047 |
|
|
$ |
45,853 |
|
|
$ |
47,014 |
|
Cost of revenue
|
|
|
20,248 |
|
|
|
23,781 |
|
|
|
17,595 |
|
Gross profit
|
|
|
7,799 |
|
|
|
22,072 |
|
|
|
29,419 |
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
16,745 |
|
|
|
14,471 |
|
|
|
13,515 |
|
Sales and marketing
|
|
|
7,997 |
|
|
|
8,205 |
|
|
|
6,472 |
|
Research and development
|
|
|
3,526 |
|
|
|
3,943 |
|
|
|
3,041 |
|
Amortization of intangible assets
|
|
|
1,360 |
|
|
|
2,624 |
|
|
|
241 |
|
Loss (gain) on fair value remeasurement
|
|
|
171 |
|
|
|
(2,147 |
) |
|
|
— |
|
Restructuring charges
|
|
|
3,294 |
|
|
|
— |
|
|
|
— |
|
Total operating expenses
|
|
|
33,093 |
|
|
|
27,096 |
|
|
|
23,269 |
|
Income (loss) from operations
|
|
|
(25,294 |
) |
|
|
(5,024 |
) |
|
|
6,150 |
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(34 |
) |
|
|
(73 |
) |
|
|
(46 |
) |
Other non-operating income (expense), net
|
|
|
184 |
|
|
|
(137 |
) |
|
|
54 |
|
Income (loss) before provision for income taxes
|
|
|
(25,144 |
) |
|
|
(5,234 |
) |
|
|
6,158 |
|
Provision for (benefit from) income taxes
|
|
|
1,299 |
|
|
|
(1,626 |
) |
|
|
2,472 |
|
Net Income (loss)
|
|
$ |
(26,443 |
) |
|
$ |
(3,608 |
) |
|
$ |
3,686 |
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
(0.50 |
) |
|
$ |
(0.07 |
) |
|
$ |
0.07 |
|
Diluted
|
|
$ |
(0.50 |
) |
|
$ |
(0.07 |
) |
|
$ |
0.07 |
|
Number of shares used in per share calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
52,612 |
|
|
|
52,072 |
|
|
|
50,166 |
|
Diluted
|
|
|
52,612 |
|
|
|
52,072 |
|
|
|
52,644 |
|
See accompanying Notes to consolidated financial statements
ENERGY RECOVERY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (LOSS)
Years Ended December 31, 2011, 2010 and 2009
|
|
|
|
|
|
Notes
|
|
Accumulated
|
|
Retained
|
|
|
|
|
|
|
|
Additional
|
|
Receivable
|
|
Other
|
|
Earnings
|
|
Total
|
|
|
|
Common Stock
|
|
Paid-in
|
|
from
|
|
Comprehensive
|
|
(Accumulated
|
|
Stockholders’
|
|
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Stockholders
|
|
Income (Loss)
|
|
Deficit)
|
|
Equity
|
|
|
|
(In thousands)
|
|
Balance at December 31, 2008
|
|
50,016 |
|
$ |
50 |
|
$ |
98,527 |
|
$ |
(296 |
) |
$ |
(44 |
) |
$ |
8,762 |
|
$ |
106,999 |
|
Net income
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
3,686 |
|
|
3,686 |
|
Foreign currency translation adjustments
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(22 |
) |
|
— |
|
|
(22 |
) |
Comprehensive income
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
3,664 |
|
Issuance of common stock
|
|
1,200 |
|
|
1 |
|
|
7,483 |
|
|
— |
|
|
— |
|
|
— |
|
|
7,484 |
|
Interest on notes receivable from stockholders
|
|
— |
|
|
— |
|
|
— |
|
|
(6 |
) |
|
— |
|
|
— |
|
|
(6 |
) |
Repayment of notes receivable from stockholders
|
|
— |
|
|
— |
|
|
— |
|
|
212 |
|
|
— |
|
|
— |
|
|
212 |
|
Stock option income tax benefit
|
|
— |
|
|
— |
|
|
232 |
|
|
— |
|
|
— |
|
|
— |
|
|
232 |
|
Employee share-based compensation
|
|
— |
|
|
— |
|
|
2,354 |
|
|
— |
|
|
— |
|
|
— |
|
|
2,354 |
|
Non-employee share-based compensation
|
|
— |
|
|
— |
|
|
30 |
|
|
— |
|
|
— |
|
|
— |
|
|
30 |
|
Balance at December 31, 2009
|
|
51,216 |
|
|
51 |
|
|
108,626 |
|
|
(90 |
) |
|
(66 |
) |
|
12,448 |
|
|
120,969 |
|
Net loss
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(3,608 |
) |
|
(3,608 |
) |
Foreign currency translation adjustments
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(14 |
) |
|
— |
|
|
(14 |
) |
Comprehensive loss
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(3,622 |
) |
Issuance of common stock
|
|
1,380 |
|
|
2 |
|
|
555 |
|
|
— |
|
|
— |
|
|
— |
|
|
557 |
|
Interest on notes receivable from stockholders
|
|
— |
|
|
— |
|
|
— |
|
|
(2 |
) |
|
— |
|
|
— |
|
|
(2 |
) |
Repayment of notes receivable from stockholders
|
|
— |
|
|
— |
|
|
— |
|
|
54 |
|
|
— |
|
|
— |
|
|
54 |
|
Stock option income tax benefit
|
|
— |
|
|
— |
|
|
60 |
|
|
— |
|
|
— |
|
|
— |
|
|
60 |
|
Employee share-based compensation
|
|
— |
|
|
— |
|
|
2,785 |
|
|
— |
|
|
— |
|
|
— |
|
|
2,785 |
|
Non-employee share-based compensation
|
|
— |
|
|
— |
|
|
(1 |
) |
|
— |
|
|
— |
|
|
— |
|
|
(1 |
) |
Balance at December 31, 2010
|
|
52,596 |
|
|
53 |
|
|
112,025 |
|
|
(38 |
) |
|
(80 |
) |
|
8,840 |
|
|
120,800 |
|
Net loss
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(26,443 |
) |
|
(26,443 |
) |
Net change in unrealized gains and losses on available-for-sale securities
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(14 |
) |
|
— |
|
|
(14 |
) |
Foreign currency translation adjustments
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
2 |
|
|
— |
|
|
2 |
|
Comprehensive loss
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(26,455 |
) |
Issuance of common stock
|
|
49 |
|
|
— |
|
|
49 |
|
|
— |
|
|
— |
|
|
— |
|
|
49 |
|
Interest on notes receiva |