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Energy Recovery Relies on R&D for Growth

Posted on Thursday, Nov 17th 2016

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In the recently reported quarterly results, alternate energy products provider Energy Recovery (NASDAQ: ERII) had a difficult run. But the market is still hopeful of its future. With investment in product development and talent, the company believes it just needs time to prove its worth.

Energy Recovery’s Financials

For the recently announced third quarter, Energy Recovery’s revenues grew a mere 1% to $12.3 million over the year. It ended the quarter with a loss of $0.01 a share. The Street was looking for earnings of $0.06 per share. The company tried to sell a positive spin on the story by talking about its impressive gross profit performance. It reported a record total gross profit margins for the third consecutive quarter of 68%, translating to a growth of 860 basis points over the year.

By segment, product revenues fell 8% to $11 million. Within the product revenues, water segment revenue and oil and gas revenue increased by $600,000, which were offset by decreases in OEM and aftermarket segment revenue of $1.7 million. The remaining $1.3 million was revenue related to the amortization of the $75 million exclusivity fee paid by Schlumberger in the fourth quarter of 2015.

The reducing margins are partially attributed to the delayed VorTeq development. During the quarter, total operating expenses increased 21% due to higher R&D expenses related to the VorTeq commercialization process and Energy Recovery’s stated goal of investing in R&D efforts. Energy Recovery’s long-term corporate strategy includes the creation of an innovation engine that will result in the achievement of proof-of-concept of one derivative of the pressure exchanger in 24 month development cycles and it is investing in adding more talent in the R&D team to ensure that it meets these targets. Year to date, Energy Recovery has added 12 engineers to its staff of around 135 employees. Energy Recovery plans to grow its R&D spend by 30% each year.

Energy Recovery does not give an outlook. The analysts are hoping that the company will deliver on an EPS of $0.43 for the final quarter of the year.

Energy Recovery’s International Expansion

Energy Recovery continues to expand its international presence. Earlier this month, it was awarded a $2.8 million project for its PX Pressure Exchanger technology for desalination projects in India. The plants will help produce up to 95,000 cubic meters of water per day while reducing the power consumption for the projects by over 108 GWh of energy per year, and avoiding 64,000 tons of CO2 emissions per year.

It also received another $2.7 million project in the Middle East for the Pressure Exchanger technology. The Middle East project will produce up to 114,000 cubic meters of water per day, and will reduce the power consumption for the projects by more than 125 GWh of energy per year, while avoiding 74,800 tons of carbon dioxide emissions per year.

Energy Recovery’s VorTeq Commercialization

The recent quarterly performance may not have inspired the analysts too much. But one needs to remember that Energy Recovery still has big potential. Energy Recovery is yet to successfully commercialize its VorTeq product. One of the biggest problems that hydraulic fracturing engineers face is that of pump failure. VorTeq uses Energy Recovery’s PX Pressure Exchanger technology to re-route abrasive products away from high-pressure pumps. It ensures that only pure water touches the pumps, thus extending pump lifespans. The product is made of tungsten carbide which is thousand times more abrasion-resistant than steel. It is able to treat pressure up to 15,000 psi and delivers up to 95% efficient energy exchange.

There has been some delay in the VorTeq product release though. During the result announcement, Energy Recovery mentioned that while the VorTeq pressure exchangers are performing to its expectations, the product has encountered operational challenges that required design changes. The company has increased its understanding of the technology through data analysis and partnership with Schlumberger and is planning to stay the course and pursue only those actions that directly correlate to the production of a reliable offering that can be commercialized. But it expects that the achievement of the milestones will move into 2017.

And, VorTeq is not the only product worth relying upon. The company is said to announce a new derivative next year to diversify its offering. Evercore ISI believes that the next product will be focused on mud pumps for land rigs. Given that pressure pumping represents one of the harshest pumping applications in the oil patch, analysts believe that the next offering could help deliver higher probability of early success for the company.

Its stock is trading at $11.38 with a market capitalization of $595.76 million. It touched a 52-week high of $16.67 in September this year. It had fallen to a 52-week low of $5.28 in February this year. The stock has climbed more than 50% over the last twelve months. Analysts at Evercore ISI expect the stock to climb to $21.00 in the near future and reiterated a buy rating.

Photo Credit: Svetoslav Nikolov/Flickr.com

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