Item
7
—
Management’s Discussion and Analysis of Financial Condition and
Results of Operations
The following Management Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our results of operations and financial condition. It should be read in conjunction with the Consolidated Financial Statements and related Notes included in “Item 8 –
Financial Statements and Supplementary Data” in this Report.
Overview
Energy Recovery, Inc. (the “Company,” “Energy Recovery,” “our,” “us,” and “we”) is an energy solutions provider to industrial fluid flow markets worldwide.
Our core competencies are fluid dynamics and advanced material science. Our products make industrial processes more operating and capital expenditure efficient. Our solutions convert wasted pressure energy into a reusable asset and preserve or eliminate pumping technology in hostile processing environments.
Our solutions are marketed and sold in fluid flow markets, such as water, oil & gas, and chemical processing, under the trademarks ERI
®
, PX
®
, Pressure Exchanger
®
, PX Pressure Exchanger
®
, AT™, AquaBold™, VorTeq™, IsoBoost
®
, and IsoGen
®
. Our solutions are owned, manufactured, and/or developed, in whole or in part, in the United States of America, (“U.S.”) and the Republic of Ireland.
Energy Recovery was incorporated in Virginia in 1992, reincorporated in Delaware in 2001, and became a public company in July 2008. We introduced the initial version of our Pressure Exchanger energy recovery device in early 1997 for sea water reverse osmosis desalination. In 2009, we acquired Pump Engineering, LLC, which manufactured centrifugal energy recovery devices, known as turbochargers, as well as high-pressure pumps. In 2012, we introduced the IsoBoost and IsoGen products for use in the oil & gas industry. In 2015, we conducted field trials for the VorTeq hydraulic fracturing solution (“VorTeq”) also for use in the oil & gas industry for oil field hydraulic fracturing operations and entered into a fifteen-year license agreement with Schlumberger Technology Corporation (the “VorTeq Licensee”)
. In 2016, we received our first major purchase order for multiple units of our IsoBoost technology for integration into a major gas processing plant to be constructed in the Middle East.
Our reportable operating segments consist of the Water Segment and the Oil & Gas Segment. These segments are based on the industries in which the technology solutions are sold, the type of energy recovery device or other technology sold, and the related solution and service.
Water Segment
Our Water Segment consists of revenues and expenses associated with solutions sold for use in reverse osmosis desalination. Our Water Segment revenue is principally derived from the sale of energy recovery devices (“ERDs”), however, we also derive revenue from the sale of our high-pressure and circulation pumps, which we manufacture and sell in connection with our ERDs for use in desalination plants. Additionally, we receive revenue from the sale of spare parts and services, including start-up and commissioning services that we provide for our customers.
With respect to product revenue from our ERDs in our Water Segment, a significant portion of our revenue is typically generated by sales to a limited number of large engineering, procurement, and construction (“EPC”) 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 sixteen (16) to thirty-six (36) months. A single large desalination project can generate an order for numerous ERDs and generally represents an opportunity for significant revenue. We also sell our devices to many small- to medium-sized original equipment manufacturers (“OEM”), which commission smaller desalination plants, order fewer ERDs per plant, and have shorter sales cycles.
We often experience substantial fluctuations in our Water Segment product revenue from quarter-to-quarter and from year-to-year because a single order for our ERDs by a large EPC firm for a particular plant may represent significant revenue. In addition, historically our EPC customers tend to order a significant amount of equipment for delivery in the fourth quarter, and as a consequence, a significant portion of our annual sales typically occurs during that quarter. Normal seasonality trends also generally lead to our lowest revenue being in the first quarter of the year.
A limited number of our customers account for a substantial portion of our product revenue and accounts receivable in the Water Segment. Revenue from customers representing 10% or more of product revenue in the Water Segment varies from period to period. For the years ended December 31, 2016, 2015, and 2014, one Water Segment customer per year accounted for approximately 11%, 14%, and 14%, respectively, of our total product revenue. See Note 14 —
“Concentrations”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further details on customer concentration.
At December 31, 2016, one Water Segment customer accounted for 13% of our accounts receivable and unbilled receivable balance. At December 31, 2015, two Water Segment customers accounted for 26% and 18%, respectively, of our accounts receivable and unbilled receivable balance. See Note 14 —
“Concentrations”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further details on customer concentration.
At December 31, 2016 and 2015, no Water Segment vendor accounted for more than 10% of our accounts payable balance. See Note 14 —
“Concentrations”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further details on vendor concentration.
During the years ended December 31, 2016, 2015, and 2014, most of our Water Segment product 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.
Oil & Gas Segment
Our Oil & Gas Segment consists of revenues and expenses associated with solutions sold or licensed for use in hydraulic fracturing, gas processing, and chemical processing. In the past several years, we have invested significant research and development costs to expand our business into pressurized fluid flow industries within the oil & gas industry.
In 2012, we introduced the IsoBoost and IsoGen products for use in the oil & gas industry. For the years ended December 31, 2014 and 2015, we recognized Oil & Gas Segment product revenue from the operating lease, subsequent lease buy-out, and commissioning services of an IsoGen system. For the year ended December 31, 2015, we also recognized Oil & Gas Segment product revenue related to the cancellation fee of a cancelled sales order for an IsoBoost system.
In 2014, we announced a new product for the hydraulic fracturing industry, the VorTeq. Field trials were initiated for the VorTeq in the second quarter of 2015 and completed in December 2015 with the successful delivery of proppant to a well located in the Bakken Formation.
In October 2015, through our subsidiary ERI Energy Recovery Ireland Ltd., we entered into a license agreement with the VorTeq Licensee (“VorTeq License Agreement”). The VorTeq License Agreement has a term of fifteen (15) years for the exclusive, worldwide right to use our VorTeq technology for hydraulic fracturing onshore operations. The VorTeq License Agreement includes $125 million in payments paid in stages: a $75 million upfront, exclusivity fee payment and two separate $25 million payments upon successful achievement of two milestone tests. Following product commercialization, the VorTeq License Agreement includes recurring royalty payments throughout the fifteen-year term.
The revenue related to the VorTeq License Agreement exclusivity fee will be recognized pro-ratably over the fifteen-year agreement. Revenue from each milestone payment will be recognized when the milestone is reached. Revenue from the recurring royalty payments will be recognized when earned throughout the term of the agreement.
In 2016, we received our first major purchase order for multiple units of our IsoBoost technology for integration into a major gas processing plant to be constructed in the Middle East and we recognized Oil & Gas Segment product revenue using the percentage-of-completion method of accounting. For the years ended December 31, 2016, we recognized Oil & Gas Segment revenue related to our VorTeq License Agreement and product revenue related to the sale of the IsoBoost systems.
One customer accounted for 100% of our Oil &Gas Segment license and development revenue for 2016 and 2015, which represented 9% and 2% of our total revenue for the years ended December 31, 2016 and 2015, respectively. There was no Oil &Gas Segment license and development revenue recognized for 2014.
While one customer accounted for 100% of our Oil & Gas Segment product revenue for the year ended December 31, 2016, no Oil & Gas Segment customer accounted for more than 10% of our total product revenue for the years ended December 31, 2016, 2015, and 2014, respectively. See Note 14 –
“
Concentrations
”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further details on customer concentration.
At December 31, 2016, one Oil & Gas Segment customer accounted for 16% of our accounts receivable and unbilled receivable balance. At December 31, 2015, no Oil & Gas Segment customer accounted for more than 10% of our accounts receivable and unbilled receivable balance. See Note 14 –
“Concentrations”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further details on customer concentration.
At December 31, 2016, one Oil & Gas Segment vendor accounted for 18% of our accounts payable balance. At December 31, 2015, no Oil & Gas Segment vendor accounted for more than 10% of our accounts payable balance. See Note 14 –
“Concentrations”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further details on vendor concentration.
During the years ended December 31, 2016, 2015, and 2014, all of our Oil & Gas Segment product revenue was attributable to sales outside of the United States.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. 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, including percentage-of-completion accounting for oil & gas projects; allowance for doubtful accounts; allowance for product warranty; valuation of stock options; valuation and impairment of goodwill and acquired intangible assets; valuation adjustments for excess and obsolete inventory; deferred taxes and valuation allowances on deferred tax assets; and evaluation and measurement of contingencies, including contingent consideration.
The following is not intended to be a comprehensive list of all of our accounting policies or estimates. Our accounting policies are more fully described in Note 2 –
“
Summary of Significant Accounting Policies,”
included in “Item 8 — Financial Statements and Supplementary Data” in this Report.
Revenue Recognition
Product
and service
revenue recognition
– Water Segment
We recognize revenue when the earnings process is complete, as evidenced by a written agreement with the customer, transfer of title, fixed pricing that is determinable, and collection that 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 our devices in 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.
Under our revenue recognition policy, evidence of an arrangement is met when we have an executed purchase order, sales order, or stand-alone contract. Typically, smaller projects utilize sales or purchase orders that conform to standard terms and conditions.
The specified product performance criteria for our PX ERD pertain 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, provides our management with a reasonable basis to conclude that the PX ERDs 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 ERDs 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 ERDs, as well as for turbochargers and pumps, delivery and performance have been completed upon shipment or delivery when title transfers based on the shipping terms.
We perform an evaluation of customer 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. For smaller projects, we require the customer to remit payment generally within 30 to 90 days after product delivery. In some cases, if credit worthiness cannot be determined, prepayment or other security is required.
We establish separate units of accounting for contracts, as our contracts with customers typically include one or both of the deliverables, products or commissioning, and there is no right of return under the terms of the contract.
Commissioning includes supervision of the installation, start-up, and training to ensure that the installation performed by the customer, which is relatively simple and straightforward, is completed consistent with the recommendations under the factory warranty. The commissioning services’ element of our contracts represents an incidental portion of the total contract price. The allocable consideration for these services relative to that for the underlying products has been well under 1% of any arrangement. Commissioning is often bundled into the large stand-alone contracts, and we frequently sell products without commissioning since our product can be easily installed in a plant without supervision. These facts and circumstances validate that the delivered element has value on a stand-alone basis and should be considered a separate unit of accounting.
Having established separate units of accounting, we then allocate amounts to each unit of accounting. With respect to products, we have established vendor specific objective evidence (“VSOE”) based on the price at which such products are sold separately without commissioning services. With respect to commissioning, we charge out our engineers for field visits to customers based on a stand-alone standard daily field service charge as well as a flat service rate for travel, if applicable. This has been determined to be the VSOE of the service based on stand-alone sales of other comparable professional services at consistent pricing.
The amount allocable to the delivered unit of account (in our case the product) is limited to the amount that is not contingent upon the delivery of additional items or meeting specified performance conditions. We adhere to consistent pricing in both stand-alone sale of products and professional services and the contractual pricing of products and commissioning of services in bundled arrangements.
For large projects, stand-alone contracts are utilized. For these contracts, consistent with industry practice, our customers typically require their suppliers, including Energy Recovery, to accept contractual holdback provisions (also referred to as a retention payment) whereby the final amounts due under the sales contract are remitted over extended periods of time or alternatively, stand-by letters of credit are issued to guarantee performance. These retention payments are generally 10% or less 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 up to twenty-four (24) months from the date of product delivery as described further below.
Under 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. This advance payment is accounted for as deferred revenue until shipment or when products are delivered to the customer, depending on the Incoterms and transfer of title;
|
|
•
|
a payment ranging from 50% to 70% of the total contract is typically due upon delivery of the product. This payment is often divided into two parts. The first part, which is due thirty (30) to sixty (60) days following delivery of the product and documentation, is invoiced upon shipment when the product revenue is recognized and results in an open accounts receivable with the customer. The second part is typically due ninety (90) to one hundred twenty (120) days following product delivery and documentation. This payment is booked to unbilled receivables upon shipment when the product revenue is recognized, and it is invoiced to the customer upon notification that the equipment has been received or when the time period has expired. We have no performance obligation to complete to be legally entitled to this payment. It is invoiced based on the passage of time.
|
|
•
|
a final retention payment of generally 10% or less of the contract amount is due either at the completion of plant commissioning or upon the issuance of a stand-by letter of credit, which is typically issued up to twenty-four (24) months from the delivery date of products and documentation. This payment is recorded to unbilled receivables upon shipment when the product revenue is recognized, and it is invoiced to the customer when it is determined that commissioning is complete or the stand-by letter of credit has been issued. This payment is not contingent upon the delivery of commissioning services. The Company had no performance obligation to complete to be legally entitled to this payment. It is invoiced based on the passage of time.
|
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.
Shipping and handling charges billed to customers are included in product revenue. The cost of shipping to customers is included in cost of revenue.
License
, milestone payment,
and
royalty
revenue recognition
– Oil & Gas Segment
License and development revenue is comprised of the amortization of the upfront non-refundable $75 million exclusivity fee received in connection with the VorTeq License Agreement. See Note 16 –
VorTeq
License Agreement
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. The VorTeq License Agreement comprises a fifteen-year exclusivity license for our VorTeq technology, milestone payments upon achievement of successful tests in accordance with the Key Performance Indicators (“KPIs”) and, after commercialization is achieved, royalty payments for the supply and servicing of certain components of the VorTeq. All payments are non-refundable.
We recognize license and development revenue in accordance with ASC 605 “Revenue Recognition,” subtopic ASC 605-25 “Revenue with Multiple Element Arrangements” and subtopic ASC 605-28 “Revenue Recognition-Milestone Method,” which provides accounting guidance for revenue recognition for arrangements with multiple deliverables and guidance on defining the milestone and determining when the use of the milestone method of revenue recognition is appropriate, respectively.
For multiple-element arrangements, each deliverable is accounted for as a separate unit of accounting if both the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. Contingent deliverables within multiple element arrangements are excluded from the evaluation of the units of accounting. Non-refundable, upfront license fees where we have continuing obligation to perform are recognized over the period of the continuing performance obligation. The VorTeq License Agreement was determined to include a single unit of accounting. The initial upfront fee of $75 million is recognized on a straight-line basis over the fifteen-year term of the arrangement based on the performance period of the last or final deliverables, which include the license and support.
We recognize revenue from milestone payments when: (i) the milestone event is substantive and its achievability has substantive uncertainty at the inception of the agreement, and (ii) it does not have ongoing performance obligations related to the achievement of the milestone earned. Milestone payments are considered substantive if all of the following conditions are met, the milestone payment: (a) is commensurate with either the Company’s performance subsequent to the inception of the arrangement to achieve the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the Company’s performance subsequent to the inception of the arrangement to achieve the milestone; (b) relates solely to past performance; and (c) is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. The VorTeq License Agreement includes two substantive milestones of $25 million each due on achievement of successful tests in accordance with KPIs. No revenues associated with achievement of the milestones have been recognized to date.
Percentage-of-completion revenue recognition
– Oil & Gas Segment
IsoBoost and IsoGen systems are highly engineered, customized solutions that are designed and manufactured over an extended period of time and are built specifically to meet a customer’s specifications. It is the Company’s position that percentage-of-completion method of accounting is appropriate for IsoBoost and IsoGen systems given the facts and circumstances of these projects. In the event that a purchase order for an IsoBoost or IsoGen does not meet these facts and circumstances, then percentage-of-completion method of accounting does not apply.
Revenue from fixed price contracts is recognized using the percentage-of-completion method of accounting in the ratio of costs incurred to estimated final costs. Contract costs include all direct material and labor costs related to contract performance. Pre-contract costs with no future benefit are expensed in the period in which they are incurred. Since the financial reporting of these contracts depends on estimates, which are assessed continually during the term of the contract, recognized revenues and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. If material, the effects of any changes in estimates are disclosed in the notes to the consolidated financial statements. When estimates indicate that a loss will be incurred on a contract, a provision for the expected loss is recorded in the period in which the loss becomes evident. No loss has been incurred to date. Revenue is recognized only to the extent costs have been recognized in the same period.
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, the aging of the accounts receivable, our historical write-offs, the credit worthiness of each customer, and general economic conditions. Account balances are charged off against the allowance when we believe that it is probable that the receivable will not be recovered. Actual write-offs may be in excess of our estimated allowance.
Warranty Costs
We sell products with a limited warranty for a period ranging from eighteen (18) months to five (5) 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 that actual warranty costs vary from the original estimates.
During the year ended December 31, 2015, we adjusted previously established warranty reserves. The adjustment related to expired warranties, which increased gross profit and reduced net loss by $0.4 million.
Stock-based Compensation
We measure and recognize stock-based compensation expense based on the fair value measurement for all stock-based awards made to our employees and directors — including restricted stock units (“RSUs”), restricted shares (“RS”), and employee stock options — over the requisite service period (typically the vesting period of the awards). The fair value of RSUs and RS 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 that 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 12 –
“Stock-based Compensation”
in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K for further discussion of stock-based compensation.
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 (1) to twenty (20) years. Acquired intangible assets with contractual terms are amortized over their respective legal or contractual lives. Customer relationships and other non-contractual intangible assets with determinable lives are amortized over periods ranging from five (5) to twenty (20) years.
We evaluate the recoverability of intangible assets by comparing the carrying amount of an asset to estimated future net undiscounted cash flows generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. The evaluation of recoverability involves estimates of future operating cash flows based upon certain forecasted assumptions, including, but not limited to, revenue growth rates, gross profit margins, and operating expenses over the expected remaining useful life of the related asset. A shortfall in these estimated operating cash flows could result in an impairment charge in the future.
Goodwill is not amortized, but is evaluated annually for impairment at the reporting unit level or when indicators of a potential impairment are present. We estimate the fair value of the reporting unit using the discounted cash flow and market approaches. Forecast of future cash flows are based on our best estimate of future net sales and operating expenses, based primarily on expected category expansion, pricing, market segment, and general economic conditions.
As of December 31, 2016 and 2015, acquired intangibles, including goodwill, relate to the acquisition of Pump Engineering, LLC during the fourth quarter of 2009. See Note 6 –
“Goodwill and Intangible Assets”
in the Notes to the Consolidated Financial Statements for further discussion of intangible assets.
Inventories
Inventories are stated at the lower of cost (using the first-in, first-out “FIFO” method) or market. We calculate inventory valuation adjustments for excess and obsolete inventory based on current inventory levels, movement, expected useful lives, and estimated future demand of the products and spare parts.
Income Taxes
Current and non-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 bases 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, 2016, we have a valuation allowance of approximately $21.1 million to reduce our U.S. deferred income tax assets to the amount expected to be realized. See Note 10 –
“Income Taxes”
in the Notes to the Consolidated Financial Statements
in Item 8 of this Form 10-K for further discussion of the tax valuation allowance.
We have recorded a valuation allowance against all of our U.S. deferred tax assets as of December 31, 2016. We intend to continue maintaining a full valuation allowance on our U.S. deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of this allowance. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that within the next twelve (12) months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease in income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve.
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
2016
Compared to 201
5
Total r
evenue
|
|
For the Year Ended December 31,
|
|
|
|
2016
|
|
|
201
5
|
|
|
|
Change
Increase (Decrease)
|
|
Product revenue
|
|
$
|
49,715
|
|
|
|
91
|
%
|
|
$
|
43,671
|
|
|
|
98
|
%
|
|
$
|
6,044
|
|
|
|
14
|
%
|
License and development revenue
|
|
|
5,000
|
|
|
|
9
|
%
|
|
|
1,042
|
|
|
|
2
|
%
|
|
|
3,958
|
|
|
|
380
|
%
|
Total revenue
|
|
$
|
54,715
|
|
|
|
100
|
%
|
|
$
|
44,713
|
|
|
|
100
|
%
|
|
$
|
10,002
|
|
|
|
22
|
%
|
Product r
evenue
|
|
For the Year Ended December 31,
|
|
S
egment
|
|
2016
|
|
|
2015
|
|
|
$ Change
|
|
|
% Change
|
|
Water
|
|
$
|
47,545
|
|
|
$
|
43,530
|
|
|
$
|
4,015
|
|
|
|
9
|
%
|
Oil & Gas
|
|
|
2,170
|
|
|
|
141
|
|
|
|
2,029
|
|
|
|
1,439
|
%
|
Total product revenue
|
|
$
|
49,715
|
|
|
$
|
43,671
|
|
|
$
|
6,044
|
|
|
|
14
|
%
|
Total product revenue increased by $6.0 million, or 14%, to $49.7 million in 2016 from $43.7 million in 2015. Of the $6.0 million increase, $4.0 million was attributable to the Water Segment and $2.0 million was attributable to the Oil & Gas Segment.
The increase in Water Segment product revenue was primarily due to higher mega-project (MPD), OEM, and aftermarket shipments in 2016 as compared to 2015. Of the $4.0 million increase in our Water Segment product revenue, $1.9 million related to MPD sales, $1.2 million related to OEM sales, $0.9 million related to aftermarket sales.
Of the $2.0 million increase in Oil & Gas Segment product revenue, $2.2 million was due to the percentage-of-completion revenue recognition associated with the sale of multiple IsoBoost systems. The increase was offset by ($0.2) million related to the commissioning of an IsoGen system and the cancellation of a purchase order for an IsoBoost in early 2015.
Product revenue attributable to domestic and international sales as a percentage of total product revenue was as follows:
|
|
For the Year Ended
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Domestic revenue
|
|
|
2
|
%
|
|
|
7
|
%
|
International revenue
|
|
|
98
|
%
|
|
|
93
|
%
|
Total product revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
License and development r
evenue
|
|
For the Year Ended December 31,
|
|
S
egment
|
|
2016
|
|
|
2015
|
|
|
$ Change
|
|
|
% Change
|
|
Water
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
Oil & Gas
|
|
|
5,000
|
|
|
|
1,042
|
|
|
|
3,958
|
|
|
|
380
|
%
|
License and development revenue
|
|
$
|
5,000
|
|
|
$
|
1,042
|
|
|
$
|
3,958
|
|
|
|
380
|
%
|
License and development revenue increased by $4.0 million, or 380%, to $5.0 million in 2016 from $1.0 million in 2015. In October 2015, we entered into a fifteen-year exclusive license agreement with the VorTeq Licensee
for the use of our VorTeq technology and received a $75 million up-front exclusivity fee. The increase of $4.0 million in license and development revenue in 2016 compared to 2015 was due to the recognition of a full year of amortization of the deferred revenue compared to a partial year of amortization in 2015 related to this license agreement.
License and development revenue attributable to domestic and international sales as a percentage of total license and development revenue was as follows:
|
|
For the Year Ended
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Domestic revenue
|
|
|
—
|
|
|
|
—
|
|
International revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Total license and development revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Product g
ross
p
rofit
|
|
Year
Ended
December 31, 2016
|
|
|
Year
Ended
December 31, 2015
|
|
|
|
Water
|
|
|
Oil &Gas
|
|
|
Total
|
|
|
Water
|
|
|
Oil &Gas
|
|
|
Total
|
|
Product gross profit
|
|
$
|
31,192
|
|
|
$
|
674
|
|
|
$
|
31,866
|
|
|
$
|
24,485
|
|
|
$
|
75
|
|
|
$
|
24,560
|
|
Product gross margin
|
|
|
66
|
%
|
|
|
31
|
%
|
|
|
64
|
%
|
|
|
56
|
%
|
|
|
53
|
%
|
|
|
56
|
%
|
Product gross profit represents our product revenue less our product cost of revenue. Our product cost of revenue consists primarily of raw materials, personnel costs (including stock-based compensation), manufacturing overhead, warranty costs, depreciation expense, and manufactured components.
Product gross profit increased by $7.3 million, or 30%, to $31.9 million in 2016 from $24.6 million in 2015. For the year ended December 31, 2016, product gross margin (total product gross profit as a percentage of product revenue) was 64% compared to 56% for the year ended December 31, 2015.
The increase in product gross profit in 2016 compared to 2015 was primarily due to increased sales volume, favorable product price and mix, and increased operational efficiencies.
Manufacturing headcount decreased to 40 for the year ended December 31, 2016 from 42 for the year ended December 31, 2015.
Stock-based compensation expense included in cost of revenue was $0.1 million for the year ended December 31, 2016 and $0.1 million for the year ended December 31, 2015.
Operating expenses
|
|
|
For the Year Ended December 31,
|
|
|
|
|
2016
|
|
|
|
2015
|
|
|
|
Change
Increase (Decrease)
|
|
Total revenue
|
|
$
|
54,715
|
|
|
|
100
|
%
|
|
$
|
44,713
|
|
|
|
100
|
%
|
|
$
|
10,002
|
|
|
|
22
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
16,626
|
|
|
|
30
|
%
|
|
|
19,773
|
|
|
|
44
|
%
|
|
|
(3,147
|
)
|
|
|
(16
|
%)
|
Sales and marketing
|
|
|
9,116
|
|
|
|
17
|
%
|
|
|
9,326
|
|
|
|
21
|
%
|
|
|
(210
|
)
|
|
|
(2
|
%)
|
Research and development
|
|
|
10,136
|
|
|
|
19
|
%
|
|
|
7,659
|
|
|
|
17
|
%
|
|
|
2,477
|
|
|
|
32
|
%
|
Amortization of intangible assets
|
|
|
631
|
|
|
|
1
|
%
|
|
|
635
|
|
|
|
1
|
%
|
|
|
(4
|
)
|
|
|
(1
|
%)
|
Total operating expenses
|
|
$
|
36,509
|
|
|
|
67
|
%
|
|
$
|
37,393
|
|
|
|
84
|
%
|
|
$
|
(884
|
)
|
|
|
(2
|
%)
|
General and
a
dministrative
General and administrative expense decreased by ($3.2) million, or 16%, to $16.6 million in 2016 from $19.8 million in 2015. Of the($3.2) million decrease in general and administrative expense, ($2.1) million related to professional, legal, and other administrative costs and ($1.1) million related to stock-based compensation expense.
General and administrative headcount increased to 30 for the year ended December 31, 2016 from 26 for the year ended December 31, 2015.
Stock-based compensation expense included in general and administrative expense was $2.1 million for the year ended December 31, 2016 and $3.1 million for the year ended December 31, 2015. The decrease in stock-based compensation is primarily related to the decrease of non-recurring expenses associated with the accelerated vesting and modification of options connected to the resignation of the former Chief Executive Officer in the first quarter of 2015.
Sales and
m
arketing
Sales and marketing expense decreased by ($0.2) million, or 2%, to $9.1 million in 2016 from $9.3 million in 2015. Of the ($0.2) million decrease in sales and marketing expense, ($0.4) million related to compensation, sales commissions, and employee-related benefits, which was partially offset by a $0.2 million increase related to bonuses.
Sales and marketing headcount decreased to 28 for the year ended December 31, 2016 from 29 for the year ended December 31, 2015.
Stock-based compensation expense included in sales and marketing expense was $0.5 million for the year ended December 31, 2016 and $0.4 million for the year ended December 31, 2015.
Research and
d
evelopment
Research and development expense increased by $2.4 million, or 32%, to $10.1 million in 2016 from $7.7 million in 2015. Of the $2.4 million increase in research and development expense, $1.2 million related to direct research and development project costs associated with new product initiatives and $1.2 million related to compensation and employee-related benefits.
Research and development headcount increased to 22 for the year ended December 31, 2016 from 17 for the year ended December 31, 2015.
Stock-based compensation expense included in research and development expense was $569,000 for the year ended December 31, 2016 and $354,000 for the year ended December 31, 2015.
Amortization of
i
ntangible
a
ssets
Amortization of intangible assets is related to finite-lived intangible assets acquired as a result of our purchase of Pump Engineering, LLC in December 2009. Amortization expense decreased by ($0.004) million, or 1%, to $0.6 million in 2016 from $0.6 million in 2015.
Other i
ncome
(expense)
|
|
For the Year Ended December 31,
|
|
|
|
2016
|
|
|
201
5
|
|
|
Change
Increase (Decrease)
|
|
Total revenue
|
|
$
|
54,715
|
|
|
|
100
|
%
|
|
$
|
44,713
|
|
|
|
100
|
%
|
|
$
|
10,002
|
|
|
|
22
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(3
|
)
|
|
|
*
|
|
|
|
(42
|
)
|
|
|
*
|
|
|
|
39
|
|
|
|
93
|
%
|
Other non-operating income (expense), net
|
|
|
290
|
|
|
|
1
|
%
|
|
|
(139
|
)
|
|
|
*
|
|
|
|
429
|
|
|
|
309
|
%
|
Total other (expense) income
|
|
$
|
287
|
|
|
|
1
|
%
|
|
$
|
(181
|
)
|
|
|
*
|
|
|
$
|
468
|
|
|
|
259
|
%
|
* less than 1%
Other income (expense) increased by $0.5 million, or 259%, to income of $0.3 million in 2016 from an expense of ($0.2) million in 2015. The increase was due to higher interest income; lower interest expense; the favorable disposition of foreign currency options; and favorable foreign currency exchange in 2016 compared to 2015.
Income
t
axes
Our income tax benefit was $0.4 million for the year ended December 31, 2016 compared to a tax benefit of $0.3 million for the year ended December 31, 2015. The tax benefit of $0.4 million for the year ended December 31, 2016, consisted of $0.7 million benefit related to the losses in our Ireland subsidiary which was partially offset by tax expense of ($0.3) million related to the deferred tax effects associated with the amortization of goodwill and other taxes.
The tax benefit of $0.3 million for the year ended December 31, 2015, consisted of $0.6 million benefit related to the losses in our Ireland subsidiary which was partially offset by tax expense of ($0.3) million related to the deferred tax effects associated with the amortization of goodwill and other taxes.
201
5
Compared to 201
4
Total r
evenue
|
|
For the Year Ended December 31,
|
|
|
|
2015
|
|
|
2014
|
|
|
Change
Increase (Decrease)
|
|
Product revenue
|
|
$
|
43,671
|
|
|
|
98
|
%
|
|
$
|
30,426
|
|
|
|
100
|
%
|
|
$
|
13,245
|
|
|
|
44
|
%
|
License and development revenue
|
|
|
1,042
|
|
|
|
2
|
%
|
|
|
—
|
|
|
|
—
|
|
|
|
1,042
|
|
|
|
—
|
|
Total revenue
|
|
$
|
44,713
|
|
|
|
100
|
%
|
|
$
|
30,426
|
|
|
|
100
|
%
|
|
$
|
14,287
|
|
|
|
47
|
%
|
Product r
evenue
|
|
For the Year Ended December 31,
|
|
S
egment
|
|
2015
|
|
|
2014
|
|
|
$ Change
|
|
|
% Change
|
|
Water
|
|
$
|
43,530
|
|
|
$
|
29,643
|
|
|
$
|
13,887
|
|
|
|
47
|
%
|
Oil & Gas
|
|
|
141
|
|
|
|
783
|
|
|
|
(642
|
)
|
|
|
(82
|
%)
|
Total product revenue
|
|
$
|
43,671
|
|
|
$
|
30,426
|
|
|
$
|
13,245
|
|
|
|
44
|
%
|
Total product revenue increased by $13.2 million, or 44%, to $43.7 million in 2015 from $30.4 million in 2014. Of the $13.2 million increase, $13.8 million was attributable to the Water Segment, which was partially offset by a decrease of ($0.6) million in the Oil & Gas Segment.
The increase in Water Segment product revenue was primarily due to significantly higher MPD, OEM, and aftermarket shipments in 2015 as compared to 2014. Of the $13.2 million increase in Water Segment product revenue, $9.8 million related to MPD sales, $2.8 million related to OEM sales, $1.2 million related to aftermarket sales.
The decrease in Oil & Gas Segment product revenue of ($0.6) million related to the lease buy-out of an IsoGen system in 2014 and the commissioning of that system in early 2015.
Product revenue attributable to domestic and international sales as a percentage of total product revenue was as follows:
|
|
For the Year Ended
December 31,
|
|
|
|
2015
|
|
|
2014
|
|
Domestic revenue
|
|
|
7
|
%
|
|
|
4
|
%
|
International revenue
|
|
|
93
|
%
|
|
|
96
|
%
|
Total product revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
License and development r
evenue
|
|
For the Year Ended December 31,
|
|
S
egment
|
|
2015
|
|
|
2014
|
|
|
$ Change
|
|
|
% Change
|
|
Water
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
Oil & Gas
|
|
|
1,042
|
|
|
|
—
|
|
|
|
1,042
|
|
|
|
—
|
|
License and development revenue
|
|
$
|
1,042
|
|
|
$
|
—
|
|
|
$
|
1,042
|
|
|
|
—
|
|
License and development revenue increased by $1.0 million, to $1.0 million in 2015 from zero in 2014. In October 2015, we entered into a fifteen-year exclusive license agreement with the VorTeq Licensee
for the use of our VorTeq technology and received a $75 million up-front exclusivity fee. The increase in license and development revenue in 2015 was due to the recognition of a partial year of amortization in 2015 related to this license agreement.
License and development revenue attributable to domestic and international sales as a percentage of total license and development revenue was as follows:
|
|
For the Year Ended
December 31,
|
|
|
|
2015
|
|
|
2014
|
|
Domestic revenue
|
|
|
—
|
|
|
|
—
|
|
International revenue
|
|
|
100
|
%
|
|
|
—
|
|
Total license and development revenue
|
|
|
100
|
%
|
|
|
—
|
|
Product g
ross
p
rofit
|
|
Year
Ended
December 31, 2015
|
|
|
Year
Ended
December 31, 2014
|
|
|
|
Water
|
|
|
Oil &Gas
|
|
|
Total
|
|
|
Water
|
|
|
Oil &Gas
|
|
|
Total
|
|
Product gross profit
|
|
$
|
24,485
|
|
|
$
|
75
|
|
|
$
|
24,560
|
|
|
$
|
15,930
|
|
|
$
|
783
|
|
|
$
|
16,713
|
|
Product gross margin
|
|
|
56
|
%
|
|
|
53
|
%
|
|
|
56
|
%
|
|
|
54
|
%
|
|
|
100
|
%
|
|
|
55
|
%
|
Product gross profit increased by $7.9 million, or 47%, to $24.6 million in 2015 from $16.7 million in 2014. For the year ended December 31, 2015, total product gross margin was 56% compared to 55% for the year ended December 31, 2014.
The increase in total product gross profit in 2015 compared to 2014 was primarily due to higher production volume and a shift in product mix toward PX ERDs due to increased MPD sales volume in the Water Segment as well as increased operational efficiencies. The increase in product gross profit in the Water Segment was slightly offset by a decrease in the product gross profit of the Oil & Gas Segment due to cost associated with the commissioning of an IsoGen in 2015.
Manufacturing headcount increased to 42 for the year ended December 31, 2015 from 38 for the year ended December 31, 2014.
Stock-based compensation expense included in cost of revenue was $0.1 million for the year ended December 31, 2015 and $0.1 million for the year ended December 31, 2014.
Operating expenses
|
|
For the Year Ended December 31,
|
|
|
|
2015
|
|
|
2014
|
|
|
Change
Increase (Decrease)
|
|
Total revenue
|
|
$
|
44,713
|
|
|
|
100
|
%
|
|
$
|
30,426
|
|
|
|
100
|
%
|
|
$
|
14,287
|
|
|
|
47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
19,773
|
|
|
|
44
|
%
|
|
|
14,139
|
|
|
|
46
|
%
|
|
|
5,634
|
|
|
|
40
|
%
|
Sales and marketing
|
|
|
9,326
|
|
|
|
21
|
%
|
|
|
10,525
|
|
|
|
35
|
%
|
|
|
(1,199
|
)
|
|
|
(11
|
%)
|
Research and development
|
|
|
7,659
|
|
|
|
17
|
%
|
|
|
9,690
|
|
|
|
32
|
%
|
|
|
(2,031
|
)
|
|
|
(21
|
%)
|
Amortization of intangible assets
|
|
|
635
|
|
|
|
1
|
%
|
|
|
842
|
|
|
|
3
|
%
|
|
|
(207
|
)
|
|
|
(25
|
%)
|
Total operating expenses
|
|
$
|
37,393
|
|
|
|
84
|
%
|
|
$
|
35,196
|
|
|
|
116
|
%
|
|
$
|
2,197
|
|
|
|
6
|
%
|
General and
a
dministrative
General and administrative expense increased by $5.7 million, or 40%, to $19.8 million in 2015 from $14.1 million in 2014. Of the $5.7 million increase in general and administrative expense, $2.0 million related to increased stock-based compensation expense, including non-recurring expense associated with the resignation of our former Chief Executive Officer in January 2015; $1.8 million related to compensation and employee-related benefits, that included non-recurring termination benefits associated with a reduction in force in the first quarter of 2015; $1.1 million related to professional, legal, and other administrative costs, including non-recurring expenses related to the termination of the former Senior Vice-President of Sales in 2014; $0.9 million related to the reversal of VAT in the first quarter of 2014 that was expensed in 2011 and prior years; $0.4 million related to bad debt expense, occupancy costs, and other taxes; and $0.2 million related to the fair value remeasurement of the contingent consideration related to the acquisition of Pump Engineering which was settled in 2014. Partially offsetting these increases was a decrease of ($0.7) million in other general and administrative miscellaneous costs.
General and administrative headcount decreased to 26 for the year ended December 31, 2015 from 28 for the year ended December 31, 2014.
Stock-based compensation expense included in general and administrative expense was $3.1 million for 2015 and $1.2 million for 2014. The increase in stock-based compensation is primarily related to the increased value of options granted to non-employee directors in February 2015, the full vesting of restricted shares granted to a non-employee director in December 2014, and non-recurring expenses related to the accelerated vesting and modification of options associated with the resignation of our former Chief Executive Officer in the first quarter of 2015.
Sales and
m
arketing
Sales and marketing expense decreased by ($1.2) million, or 11%, to $9.3 million in 2015 from $ 10.5 million in 2014. Of the ($1.2) million decrease in sales and marketing expense, ($1.3) million related to marketing, professional, occupancy, and other sales and marketing costs and ($0.7) million related to compensation and employee-related benefits. The decreases were partially offset by an increase of $0.8 million related to sales commissions and bonuses.
Sales and marketing headcount decreased to 29 for the year ended December 31, 2015 from 36 for the year ended December 31, 2014.
Stock-based compensation expense included in sales and marketing expense was $436,000 for the year ended December 31, 2015 and $487,000 for the year ended December 31, 2014.
Research and
d
evelopment
Research and development expense decreased by ($2.0) million, or 21%, to $7.7 million in 2015 from $9.7 million in 2014. Of the ($2.0) million decrease in research and development expense, ($2.4) million related to direct research and development project costs associated with new product initiatives and ($0.3) million related to consulting and professional services. The decreases were partially offset by an increase of $0.7 million related to compensation, employee-related benefits, and occupancy costs.
Research and development headcount decreased to 17 for the year ended December 31, 2015 from 22 for the year ended December 31, 2014.
Stock-based compensation expense included in research and development expense was $0.4 million for the year ended December 31, 2015 and $0.3 million for the year ended December 31, 2014.
Amortization of
i
ntangible
a
ssets
Amortization expense decreased by ($0.2) million, or 25%, to $0.6 million in 2015 from $0.8 million in 2014. The decrease was due to the full amortization of all intangibles, except developed technology, in November of 2014.
Other i
ncome
(expense)
|
|
For the Year Ended December 31,
|
|
|
|
2015
|
|
|
2014
|
|
|
Change
Increase (Decrease)
|
|
Total revenue
|
|
$
|
44,713
|
|
|
|
100
|
%
|
|
$
|
30,426
|
|
|
|
100
|
%
|
|
$
|
14,287
|
|
|
|
47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(42
|
)
|
|
|
*
|
|
|
|
—
|
|
|
|
*
|
|
|
|
(42
|
)
|
|
|
*
|
|
Other non-operating income (expense), net
|
|
|
(139
|
)
|
|
|
*
|
|
|
|
69
|
|
|
|
*
|
|
|
|
(208
|
)
|
|
|
(301%
|
)
|
Total other (expense) income
|
|
$
|
(181
|
)
|
|
|
*
|
|
|
$
|
69
|
|
|
|
*
|
|
|
$
|
(250
|
)
|
|
|
(362%
|
)
|
* less than 1%
Other income (expense) decreased by ($0.3) million, or 362%, to an expense of ($0.2) million in 2015 from income of $0.1 million in 2014. The decrease was due to lower interest income; higher interest expense; unfavorable fair value re-measurement of put foreign currency options; and favorable foreign currency exchange in 2015 compared to 2014.
Income
t
axes
Our income tax benefit was $0.3 million for the year ended December 31, 2015 compared to a tax provision of ($0.3) million for the year ended December 31, 2014. The tax benefit of $0.3 million for the year ended December 31, 2015, consisted of $0.6 million benefit related to the losses in our Ireland subsidiary. The benefit was partially offset by tax expense of ($0.3) million related to the deferred tax effects associated with the amortization of goodwill and other taxes.
The tax provision of ($0.3) million for the year ended December 31, 2014, consisted of tax expense of ($0.3) million related to the deferred tax effects associated with the amortization of goodwill and state and other taxes. The tax expenses were offset by a tax benefit associated with foreign currency translation adjustments recorded in other comprehensive income.
Liquidity and Capital Resources
Historically, our primary sources of cash are proceeds from customer payments for our products and services and the issuance of common stock. In October 2015, we received a payment of $75 million for an exclusive license to our VorTeq. From January 1, 2005 through December 31, 2016, we issued common stock for aggregate net proceeds of $94.8 million, excluding common stock issued in exchange for promissory notes. The proceeds have been used to fund our operations and capital expenditures.
As of December 31, 2016, our principal sources of liquidity consisted of unrestricted cash and cash equivalents of $61.4 million, some of which is invested in money market funds; short-term investments in marketable debt securities of $39.1 million; and accounts receivable of $11.8 million. We generally invest cash not needed for current operations predominantly in high-quality, investment-grade, and marketable debt instruments with the intent to make such funds available for operating purposes as needed.
We currently have unbilled receivables pertaining to customer contractual holdback provisions, whereby we will invoice the final retention payment(s) due under certain sales contracts in the next six (6) to twenty-four (24) months. The customer holdbacks represent amounts intended to provide a form of security for the customer; accordingly, these receivables have not been discounted to present value. At December 31, 2016 and 2015, we had $0.2 million and $1.9 million, respectively, of short-term and long-term unbilled receivables.
In June 2012, we entered into a loan agreement with a financial institution. The loan agreement was amended in June 2015, (as amended, the “Loan Agreement”). The Loan Agreement provides for a total available credit line of $16.0 million. Under the Loan Agreement, we are allowed to draw advances not to exceed the lesser of the $16 million credit line or the credit line minus all outstanding revolving loans. Revolving loans may be in the form of a base rate loan that bears interest equal to the prime rate or a Eurodollar loan that bears interest equal to the adjusted LIBOR rate plus 1.25%. Stand-by letters of credit are subject to customary fees and expenses for issuance or renewal. The unused portion of the credit facility is subject to a facility fee in an amount equal to 0.25% per annum of the average unused portion of the revolving line. The Loan Agreement also requires us to maintain a cash collateral balance equal to 101% of all outstanding advances and all outstanding stand-by letters of credit collateralized by the line of credit. The Loan Agreement matures in June 2018 and is collateralized by substantially all of our assets. As of December 31, 2016 and 2015, there were no advances drawn under the Loan Agreement. This Loan Agreement was terminated on January 24, 2017.
As of December 31, 2016, the amount outstanding on stand-by letters of credit collateralized under the Loan Agreement totaled $3.1 million, and restricted cash related to the stand-by letters of credit issued under the Loan Agreement was $3.1 million. Of the $3.1 million in restricted cash, $1.0 million was classified as current and $2.1 million was classified as non-current.
We are subject to certain financial and administrative covenants under the Loan Agreement. As of December 31, 2016, we were in compliance with these covenants.
At December 31, 2016, we also had stand-by letters of credit collateralized by restricted cash at two other financial institutions totaling $1.3 million. Total restricted cash related to these stand-by letters of credit totaled $1.3 million as of December 31, 2016, all of which was classified as current.
On January 27, 2017, we entered into a loan and pledge agreement (the “Loan and Pledge Agreement”) with another financial institution. The Loan and Pledge Agreement provides for a committed revolving credit line of $16.0 million and an uncommitted revolving credit line of $4.0 million. Under the Loan and Pledge Agreement we are allowed to borrow and request letters of credit against the eligible assets held from time to time in the pledged account maintained with the financial institution. Stand-by letters of credit are secured by pledged U.S. investments and there is no cash collateral balance required. Stand-by letters of credit are subject to fees, in an amount equal to 0.7% per annum of the face amount of the letter of credit, that are payable quarterly and are non-refundable. Revolving loans incur interest per annum on the base rate equal to the LIBOR rate plus the Margin defined as 1.5%. Any default bears the aforementioned interest plus an additional 2%. The unused portion of the credit line is subject to a fee equal to the product of 0.20% per annum multiplied by the difference, if positive, between $16.0 million and the average daily balance of all advances under the committed facility plus aggregate average daily undrawn amounts of all letters of credit issued under the committed facility during the immediately preceding month or portion thereof.
Cash Flows from Operating Activities
Net cash provided by (used in) operating activities was $5.0 million, $69.1 million, and ($3.7) million, for the years ended December 31, 2016, 2015, and 2014, respectively. For the years ended December 31, 2016, 2015, and 2014, net income (losses) of $1.0 million, ($11.6) million, and ($18.7) million, respectively, were adjusted to $7.2 million, ($4.3) million, and ($10.9) million, respectively, by non-cash items totaling $6.2 million, $7.3 million, and $7.8 million, respectively.
Non-cash adjustments of $6.2 million in 2016 primarily included $3.7 million of depreciation and amortization; $3.3 million of stock-based compensation; $0.2 million of amortization of premiums paid on investments; $0.2 million provision for warranty claims; $0.1 million of reserves for doubtful accounts; ($0.5) million of deferred income taxes; ($0.4) million of valuation adjustments to excess and obsolete inventory reserves; ($0.2) million reversal of accruals related to expired warranties; and ($0.2) million of other non-cash items.
Non-cash adjustments of $7.3 million in 2015 primarily included $4.1 million of stock-based compensation; $3.8 million of depreciation and amortization; $0.2 million of amortization of premiums paid on investments; a $0.1 million provision for warranty claims; $0.1 million of reserves for doubtful accounts; ($0.4) million reversal of accruals related to expired warranties; ($0.3) million of deferred income taxes; and ($0.3) million of valuation adjustments to excess and obsolete inventory reserves.
Non-cash adjustments of $7.8 million in 2014 primarily included $4.0 million of depreciation and amortization; $2.1 million of stock-based compensation; $0.7 million of deferred income taxes and other non-cash items; $0.4 million of amortization of premiums paid on investments; $0.3 million of reserves for doubtful accounts; $0.3 million of valuation adjustments to excess and obsolete inventory reserves; a $0.2 million provision for warranty claims; ($0.2) million related to the change in fair value of a contingent consideration, which was associated with the acquisition of Pump Engineering; and ($0.1) million of unrealized gains on foreign currency transactions.
The net cash effect from changes in operating assets and liabilities was ($2.3) million, $73.3 million, and $7.2 million for the years ended December 31, 2016, 2015, and 2014, respectively. Net changes in assets and liabilities of $(2.3) million in 2016 were primarily attributable to a ($5.0) million decrease in deferred revenue due to the recognition of revenue related to our exclusive license agreement; a ($1.8) million increase in cost and estimated billings related to a percentage-of-completion revenue recognition project; a ($0.4) million increase in prepaid expenses and other assets; and a ($0.4) million decrease in accounts payable. These were offset by a $2.3 million decrease in inventories due to increased shipments; a $1.5 million decrease in accounts receivable and unbilled receivables due to timing of invoices and payments; a $1.2 million increase in accrued expenses and other liabilities; and a $0.3 million increase in product deferred revenue.
Net changes in assets and liabilities of $73.3 million in 2015 were primarily attributable to the receipt of a $75.0 million exclusive license payment, of which $1.0 million was recognized as revenue and the remainder deferred; a $2.0 million decrease in inventories related to increased shipments; a $0.3 million increase in product deferred revenue; and a $0.3 million decrease in prepaid expenses and other assets. These were offset by a ($1.7) million litigation settlement payment; a ($0.9) million increase in accounts receivable and unbilled receivables related to increased shipments; and a ($0.7) million decrease in accrued expenses and other liabilities related to decrease legal expenses and litigation matters.
Net changes in assets and liabilities of $7.2 million in 2014 were primarily attributable to an $8.9 million decrease in accounts receivable and unbilled receivables as a result of lower sales and the collection of outstanding amounts; a $1.9 million increase in accrued expenses and other liabilities related to increased legal expense and litigation matters; and a $0.6 million increase in accounts payable due to the timing of payments to employees, vendors, and other third parties. These were offset by a $3.6 million increase in inventory of which $2.3 million was an increase in finished goods principally related to a large MPD shipment built in the fourth quarter of 2014 but expected to ship in the first quarter of 2015; a $0.3 million increase in prepaid expenses; and a $0.3 million decrease in deferred revenue.
Cash Flows from Investing Activities
Cash flows from investing activities primarily relate to maturities and purchases of marketable securities to preserve principal and liquidity while at the same time maximizing yields without significantly increasing risk, capital expenditures to support our growth, and changes in our restricted cash used to collateralize our stand-by letters of credit and other contingent considerations.
Net cash (used in) provided by investing activities was ($40.7) million, $14.0 million, and $6.5 million for the years ended December 31, 2016, 2015, and 2014, respectively. Cash used in 2016 of ($40.7) million was primarily attributable to ($46.5) million used to purchase investments; ($1.1) million for capital expenditures; and ($0.6) million increase in restricted cash related to additional stand-by letters of credit. These were offset by $7.5 million in maturities of marketable security investments.
Cash provided in 2015 of $14.0 million was primarily attributable to $12.9 million in maturities of investments and the release of $1.7 million of restricted cash related to the expiration of stand-by letters of credit. These were offset by the use of ($0.6) million for capital expenditures.
Cash provided in 2014 of $6.5 million was primarily attributable to $6.0 million in maturities of investments and the release of $3.3 million of restricted cash primarily related to the settlement of a contingent consideration associated with the acquisition of Pump Engineering. These were offset by uses of ($2.6) million for capital expenditures and ($0.2) million in purchases of marketable security investments.
Cash Flows from Financing Activities
Net cash (used in) provided by financing activities was ($2.8) million, $1.4 million, and ($1.8) million for the years ending December 31, 2016, 2015, and 2014, respectively. Net cash used in 2016 of ($2.8) million was primarily due to the use of ($9.4) million to repurchase our common stock offset by $6.6 million received from the issuance of common stock related to option exercises.
Net cash provided in 2015 of $1.4 million was primarily due to $1.3 million received from the issuance of common stock related to option and warrant exercises and $0.1 million of proceeds from long-term debt.
Net cash used in 2014 of ($1.8) million was primarily due to the use of ($2.8) million to repurchase our common stock and ($1.4) million to pay the contingent consideration related to the acquisition of Pump Engineering, which were offset by $2.4 million received from the issuance of common stock related to option and warrant exercises.
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 twelve months. However, we may need to raise additional capital or incur additional indebtedness to continue to fund our operations or to support acquisitions in the future. Our future capital requirements will depend on many factors, including the continuing market acceptance of our products, our rate of revenue growth, the timing of new product introductions, the expansion of our research and development, manufacturing, and sales and marketing activities, the timing and extent of our expansion into new geographic territories, and the amount and timing of cash used for stock repurchases. In addition, 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. Should we need additional liquidity or capital funds, these funds may not be available to us on favorable terms or at all.
Contractual Obligations
We lease facilities and equipment under fixed non-cancellable operating leases that expire on various dates through 2021. Additionally, in the course of our normal operations, we have entered into cancellable 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, 2016 (in thousands):
|
|
Payments Due by Period
|
|
Contractual obligations
|
|
Less Than
1 Year
|
|
|
1-3
Years
|
|
|
3-5
Years
|
|
|
Total
|
|
Operating leases
|
|
$
|
1,705
|
|
|
$
|
3,122
|
|
|
$
|
93
|
|
|
$
|
4,920
|
|
Loan payable
|
|
|
11
|
|
|
|
23
|
|
|
|
4
|
|
|
|
38
|
|
Purchase obligations
(1)
|
|
|
6,755
|
|
|
|
—
|
|
|
|
—
|
|
|
|
6,755
|
|
|
|
$
|
8,471
|
|
|
$
|
3,145
|
|
|
$
|
97
|
|
|
$
|
11,713
|
|
|
(1)
|
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, 2016, we believe that our exposure related to these guarantees and indemnities as of December 31, 2016 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
”
included in “Item 8 — Financial Statements and Supplementary Data” in this Report
regarding the impact of certain recent accounting pronouncements on our Consolidated Financial Statements.