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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
FORM 10-Q
(Mark One)
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021
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
ERII-20210930_G1.JPG
Energy Recovery, Inc.
(Exact Name of Registrant as Specified in its Charter)
Delaware 01-0616867
(State or Other Jurisdiction of Incorporation) (I.R.S. Employer Identification No.)

1717 Doolittle Drive, San Leandro, California 94577
(Address of Principal Executive Offices) (Zip Code)

(510) 483-7370
(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol Name of each exchange on which registered
Common Stock, $0.001 par value ERII The Nasdaq Stock Market LLC

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 þ  No ¨
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted 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 þ  No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer      Accelerated filer      Non-accelerated filer      Smaller reporting company      Emerging growth company  
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  Yes   No 
As of October 29, 2021, there were 56,718,626 shares of the registrant’s common stock outstanding.





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Energy Recovery, Inc. | Q3'2021 Form 10-Q



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Forward-Looking Information

This Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2021, including Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (the “MD&A”) 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, are based on assumptions, and involve risks and uncertainties. If the risks or uncertainties occur or the assumptions prove incorrect, then our results may differ materially from those set forth or implied by the forward-looking statements. Our forward-looking statements are not guarantees of future performance or events.

Words such as “expects,” “anticipates,” “aims,” “projects,” “intends,” “plans,” “believes,” “estimates,” “seeks,” “continue,” “could,” “may,” “potential,” “should,” “will,” “would,” variations of such words and similar expressions are also intended to identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are directed to risks and uncertainties identified under Part II, Item 1A, “Risk Factors,” and elsewhere in this report for factors that may cause actual results to be different from those expressed in these forward-looking statements. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Forward-looking statements in this report include, without limitation, statements about the following:
our belief that the pressure exchanger is the industry standard for energy recovery in the seawater reverse osmosis (“SWRO”) industry;
our anticipation of continued growth in product revenues as the need to expand potential water production globally is increasing, as well as the increased purchases of product for plant maintenance in advance of the anticipation of the economic recovery;
our belief that pressure exchanger technology can provide benefits to our customers, including the reduction of capital expenditures and energy use;
our belief that our pressure exchanger technology can address inefficiencies and waste within industrial systems and processes that involve high-pressure and low-pressure fluid flows;
our belief that our PX® Pressure Exchanger® (“PX”) has helped make SWRO desalination an economically viable and more sustainable option in the production of potable water;
our belief that markets not traditionally associated with desalination, including the United States of America (the “U.S.”) will inevitably develop and provide further revenue growth opportunities;
our belief that, as the existing thermal technology is replaced with reverse osmosis (“RO”) technology, demand for our products will be created;
our belief that ongoing operating costs rather than capital expenditures is the key factor in the selection of an energy recovery device (“ERD”) solution for megaproject (“MPD”) customers;
our belief that our PX offers market-leading efficiency and reduction of total lifecycle cost to the end client;
our estimate that MPD customer projects represent revenue opportunities from approximately $1 million to $18 million;
our belief that initial capital expenditure rather than future ongoing operating costs is the key factor in selection of an ERD solution for original equipment manufacturer (“OEM”) projects;
our belief that our PX has a competitive advantage, as compared to the Flowserve Corporation’s DWEER product, because our devices are made with highly durable and corrosion-resistant aluminum oxide (“alumina”) ceramic parts that are designed for a life of more than 25 years, are warrantied for high efficiencies, and cause minimal unplanned downtime, resulting in lower lifecycle costs;
our belief that our PX has a distinct competitive advantage over Fluid Equipment Development Company’s (“FEDCO”) turbochargers and Danfoss Group’s iSave ERDs because our devices provide up to 98% efficiency, have lower lifecycle maintenance costs, and are made of highly durable and corrosion-resistant alumina ceramic parts;
our belief that our Turbochargers compete favorably with FEDCO’s turbochargers based on efficiency, price, and because our Turbochargers have design advantages that enhance efficiency, operational flexibility and serviceability;
our belief that our Ultra PX enables customers to optimize their wastewater treatment process for Minimal Liquid Discharge and Zero Liquid Discharge;
Energy Recovery, Inc. | Q3'2021 Form 10-Q | FLS 1



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our belief that our pressure exchanger technology can significantly help reduce the operating costs of CO2 refrigeration systems by recycling the pressure energy of CO2 gas thereby significantly reducing the energy needed to operate these systems;
our belief that we will be able to achieve efficiencies across a wider range of temperatures that exceed incumbent CO2 refrigeration technologies;
our belief that the integration of Environmental, Social and Governance (“ESG”) principles into our corporate and risk management strategies can strengthen our existing business as well as our efforts to develop new applications of pressure exchanger technology for high-pressure fluid-flow environments;
our belief that our enhanced safety measures will allow us to help contain the spread of the novel coronavirus (“COVID-19”);
the development of major public health concerns, including the COVID-19 outbreak or other pandemics arising globally, and the future impact of such major public health concerns, and specifically in the short-term the COVID-19 pandemic, on our business and operations;
our belief that our existing cash and cash equivalents, our short and/or long-term investments, and the ongoing cash generated from our operations, will be sufficient to meet our anticipated liquidity needs for the foreseeable future, with the exception of a decision to enter into an acquisition and/or fund investments in our latest technology arising from rapid market adoption that could require us to seek additional equity or debt financing;
our expectation of increased sales and marketing expenditures for the balance of 2021 and early 2022;
our expectation that we will be able to enforce our intellectual property (“IP”) rights;
our expectation that the adoption of new accounting standards will not have a material impact on our financial position or results of operations; and
other factors disclosed under the MD&A and Item 3, “Quantitative and Qualitative Disclosures about Market Risk,” and elsewhere in this Form 10-Q.

You should not place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date of the filing of this Quarterly Report on Form 10-Q. All forward-looking statements included in this document are subject to additional risks and uncertainties further discussed under Part II, Item 1A, “Risk Factors,” and are based on information available to us as of November 5, 2021. We assume no obligation to update any such forward-looking statements, certain risks and uncertainties which could cause actual results to differ materially from those projected in the forward-looking statements, as disclosed from time to time in our Annual Reports on Form 10‑K, Quarterly Reports on Form 10‑Q and Current Reports on Form 8‑K filed with or furnished to the Securities and Exchange Commission (the “SEC”), as well as in Part II, Item 1A, “Risk Factors,” within this Quarterly Report on Form 10-Q. 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,” in our Quarterly Reports on Form 10-Q, and in our Annual Reports on Form 10-K, and from time-to-time, in our results disclosed on our Current Reports on Form 8-K. In addition, when preparing the MD&A below, we presume the readers have access to and have read the MD&A in our Annual Report on Form 10-K, pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K.

We provide our Annual Reports on Form 10‑K, Quarterly Reports on Form 10‑Q, Current Reports on Form 8‑K, Proxy Statements, Forms 3, 4 and 5 filed by or on behalf of directors, executive officers and certain large shareholders, and any amendments to those documents filed or furnished pursuant to the Securities Exchange Act of 1934, free of charge on the Investor Relations section of our website, www.energyrecovery.com. These filings will become available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. From time to time, we may use our website as a channel of distribution of material company information.

We also make available in the Investor Relations section of our website our corporate governance documents including our code of business conduct and ethics and the charters of the audit, compensation and nominating and governance committees. These documents, as well as the information on the website, are not intended to be part of this Quarterly Report on Form 10-Q. We use the Investor Relations section of our website as a means of complying with our disclosure obligations under Regulation FD. Accordingly, you should monitor the Investor Relations section of our website in addition to following our press releases, SEC filings and public conference calls and webcasts.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | FLS 2



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PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements (unaudited)

ENERGY RECOVERY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

September 30,
2021
December 31,
2020
(In thousands)
ASSETS
Current assets:
Cash and cash equivalents $ 65,745  $ 94,255 
Short-term investments 41,900  20,446 
Accounts receivable, net 13,066  11,792 
Inventories, net 20,557  11,748 
Prepaid expenses and other assets 5,541  4,950 
Total current assets 146,809  143,191 
Long-term investments 765  — 
Deferred tax assets, net 12,093  11,030 
Property and equipment, net 20,905  20,176 
Operating lease, right of use asset 15,021  16,090 
Goodwill and other intangible assets 12,830  12,839 
Other assets 365  988 
Total assets $ 208,788  $ 204,314 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable $ 3,663  $ 1,118 
Accrued expenses and other liabilities 9,582  11,816 
Lease liabilities 1,518  1,243 
Contract liabilities 1,452  1,552 
Total current liabilities 16,215  15,729 
Lease liabilities 15,284  16,443 
Other liabilities 550  518 
Total liabilities 32,049  32,690 
Commitments and contingencies (Note 7)
Stockholders’ equity:
Common stock 63  62 
Additional paid-in capital 192,564  179,161 
Accumulated other comprehensive (loss) income (86) 53 
Treasury stock (47,642) (30,486)
Retained earnings 31,840  22,834 
Total stockholders’ equity 176,739  171,624 
Total liabilities and stockholders’ equity $ 208,788  $ 204,314 

See Accompanying Notes to Condensed Consolidated Financial Statements
Energy Recovery, Inc. | Q3'2021 Form 10-Q | 1



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ENERGY RECOVERY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
  (In thousands, except per share data)
Product revenue $ 20,781  $ 27,408  $ 70,328  $ 65,665 
Product cost of revenue 6,089  7,816  22,251  20,049 
Product gross profit 14,692  19,592  48,077  45,616 
License and development revenue —  —  —  26,895 
Operating expenses:
General and administrative 5,851  6,271  18,632  18,751 
Sales and marketing 2,996  2,141  8,236  5,776 
Research and development 4,416  5,098  13,342  18,159 
Amortization of intangible assets 12 
Impairment of long-lived assets —  —  —  2,332 
Total operating expenses 13,265  13,514  40,219  45,030 
Income from operations 1,427  6,078  7,858  27,481 
Other income (expense):
Interest income 36  134  179  809 
Other non-operating (expense) income, net (29) (21) (59)
Total other income, net 37  105  158  750 
Income before income taxes 1,464  6,183  8,016  28,231 
(Benefit from) provision for income taxes 393  796  (990) 5,297 
Net income $ 1,071  $ 5,387  $ 9,006  $ 22,934 
Net income per share:
Basic 0.02  0.10  0.16  0.41 
Diluted 0.02  0.10  0.15  0.41 
Number of shares used in per share calculations:
Basic 57,026  55,692  57,053  55,573 
Diluted 58,709  56,471  58,785  56,443 

See Accompanying Notes to Condensed Consolidated Financial Statements


Energy Recovery, Inc. | Q3'2021 Form 10-Q | 2



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ENERGY RECOVERY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
  (In thousands)
Net income $ 1,071  $ 5,387  $ 9,006  $ 22,934 
Other comprehensive (loss) income, net of tax
Foreign currency translation adjustments (20) 26  (40) 11 
Unrealized (loss) gain on investments (13) (45) (99) 126 
Total other comprehensive (loss) income, net of tax (33) (19) (139) 137 
Comprehensive income $ 1,038  $ 5,368  $ 8,867  $ 23,071 

See Accompanying Notes to Condensed Consolidated Financial Statements


Energy Recovery, Inc. | Q3'2021 Form 10-Q | 3



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ENERGY RECOVERY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
  (In thousands, except shares)
Common stock
Beginning balance $ 63  $ 61  $ 62  $ 61 
Issuance of common stock, net —  —  — 
Ending balance 63  61  63  61 
Additional paid-in capital
Beginning balance 191,087  173,729  179,161  170,028 
Issuance of common stock, net 242  132  8,938  1,237 
Stock-based compensation 1,235  1,068  4,465  3,664 
Ending balance 192,564  174,929  192,564  174,929 
Accumulated other comprehensive (loss) income
Beginning balance (53) 119  53  (37)
Other comprehensive (loss) income
Foreign currency translation adjustments (20) 26  (40) 11 
Unrealized (loss) gain on investments (13) (45) (99) 126 
Total other comprehensive (loss) income, net (33) (19) (139) 137 
Ending balance (86) 100  (86) 100 
Treasury stock
Beginning balance (42,040) (30,486) (30,486) (30,486)
Common stock repurchased (5,602) —  (17,156) — 
Ending balance (47,642) (30,486) (47,642) (30,486)
Retained earnings
Beginning balance 30,769  13,994  22,834  (3,553)
Net income 1,071  5,387  9,006  22,934 
Ending balance 31,840  19,381  31,840  19,381 
Total stockholders’ equity $ 176,739  $ 163,985  $ 176,739  $ 163,985 
Common stock issued (shares)
Beginning balance 63,267,293  61,133,317  61,798,004  60,717,702 
Issuance of common stock, net 31,690  36,383  1,500,979  451,998 
Ending balance 63,298,983  61,169,700  63,298,983  61,169,700 
Treasury stock (shares)
Beginning balance 6,112,873  5,455,935  5,455,935  5,455,935 
Common stock repurchased 295,728  —  952,666  — 
Ending balance 6,408,601  5,455,935  6,408,601  5,455,935 
Total common stock outstanding (shares) 56,890,382  55,713,765  56,890,382  55,713,765 


See Accompanying Notes to Condensed Consolidated Financial Statements
Energy Recovery, Inc. | Q3'2021 Form 10-Q | 4



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ENERGY RECOVERY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30,
2021 2020
(In thousands)
Cash flows from operating activities:
Net income $ 9,006  $ 22,934 
Adjustments to reconcile net income to cash provided by (used in) operating activities
Stock-based compensation 4,574  3,672 
Depreciation and amortization 4,141  3,963 
Amortization of premiums and discounts on investments 340  311 
Deferred income taxes (1,063) 5,443 
Impairment of long-lived assets —  2,332 
Other non-cash adjustments 161  316 
Changes in operating assets and liabilities:
Accounts receivable, net (1,274) 1,862 
Contract assets 1,892  (747)
Inventories, net (8,874) (506)
Prepaid and other assets (1,097) 295 
Accounts payable 2,739  656 
Accrued expenses and other liabilities (3,132) (2,579)
Contract liabilities (119) (27,602)
Net cash provided by operating activities 7,294  10,350 
Cash flows from investing activities:
Sales of marketable securities —  10,573 
Maturities of marketable securities 20,686  50,467 
Purchases of marketable securities (43,339) (12,855)
Capital expenditures (4,899) (6,019)
Other — 
Net cash (used in) provided by investing activities (27,547) 42,166 
Cash flows from financing activities:
Net proceeds from issuance of common stock 8,939  1,260 
Tax payment for employee shares withheld —  (23)
Repurchase of common stock (17,156) — 
Net cash (used in) provided by financing activities (8,217) 1,237 
Effect of exchange rate differences on cash and cash equivalents (40) 11 
Net change in cash, cash equivalents and restricted cash (28,510) 53,764 
Cash, cash equivalents and restricted cash, beginning of year 94,358  26,488 
Cash, cash equivalents and restricted cash, end of period $ 65,848  $ 80,252 

See Accompanying Notes to Condensed Consolidated Financial Statements
Energy Recovery, Inc. | Q3'2021 Form 10-Q | 5


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ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Description of Business and Significant Accounting Policies

Energy Recovery, Inc. and its wholly-owned subsidiaries (the “Company” or “Energy Recovery”) create technologies that solve complex challenges for industrial fluid-flow markets worldwide. Building on the Company’s pressure exchanger technology platform, the Company designs and manufactures solutions that improve operational efficiency by reducing waste, energy consumption and costs across a range of industrial processes. What began as a game-changing invention for desalination has grown into a global business advancing the environmental sustainability of the Company’s customers’ operations in multiple industries. The Company’s solutions are marketed, sold in, or developed for, the fluid-flow and gas markets, such as water, industrial waste, oil & gas, chemical processing and refrigeration, under the trademarks ERI®, Ultra PX, PX®, Pressure Exchanger®, PX Pressure Exchanger® (“PX”), PX PowerTrain, VorTeq, IsoBoost®, AT, AquaBold, and PX G1300. The Company owns, manufactures and/or develops its solutions, in whole or in part, in the United States of America (the “U.S.”).

Basis of Presentation

The Condensed Consolidated Financial Statements include the accounts of Energy Recovery, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

The accompanying Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The December 31, 2020 Condensed Consolidated Balance Sheet was derived from audited financial statements and may not include all disclosures required by GAAP; however, the Company believes that the disclosures are adequate to make the information presented not misleading.

The September 30, 2021 unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and the notes thereto for the fiscal year ended December 31, 2020 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2021 (the “2020 Annual Report”).

All adjustments consisting of normal recurring adjustments that are necessary to present fairly the financial position, results of operations and cash flows for the interim periods have been made. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Reclassifications

Certain prior period amounts have been reclassified in the Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Cash Flows, and certain notes to the Condensed Consolidated Financial Statements, to conform to the current period presentation.

Use of Estimates

The preparation of Condensed Consolidated Financial Statements, in conformity with GAAP, requires the Company’s management to make judgments, assumptions and estimates that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes.

The accounting policies that reflect the Company’s more significant estimates and judgments and that the Company believes are the most critical to aid in fully understanding and evaluating its reported financial results are revenue recognition; valuation of stock options; valuation and impairment of goodwill; inventory; deferred taxes and valuation allowances on deferred tax assets; and evaluation and measurement of contingencies. Those estimates could change, and as a result, actual results could differ materially from those estimates.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 6


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ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Due to the novel coronavirus (“COVID-19”) pandemic, and the impact on the Company’s customers, there has been uncertainty and disruption in the global economy and financial markets. The Company is not aware of any specific event or circumstance that would require an update to its estimates or judgments or a revision of the carrying value of its assets or liabilities as of November 5, 2021, the date of issuance of this Quarterly Report on Form 10-Q. These estimates may change, as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions. The Company undertakes no obligation to update publicly these estimates for any reason after the date of this Quarterly Report on Form 10-Q, except as required by law.

Significant Accounting Policies

Except for adopting new accounting pronouncements, as noted under “Recently Adopted Accounting Pronouncements,” there have been no material changes to the Company’s significant accounting policies in Note 1, “Description of Business and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data,” in the 2020 Annual Report.

Recently Adopted Accounting Pronouncements

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. The new standard is effective for interim and annual periods beginning after December 15, 2020. The Company adopted ASU 2019-12 on January 1, 2021. The adoption of ASU 2019-12 did not have a material impact on the Company’s consolidated financial condition, results of operations, and cash flows.

Recently Issued Accounting Pronouncements Not Yet Adopted

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848) (“ASU 2020-04”), which provided optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (“LIBOR”) or by another reference rate expected to be discontinued. The FASB later issued ASU No. 2021-01, Reference Rate Reform (Topic 848): Scope, to clarify the scope of Topic 848 so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions in Topic 848 (“ASU 2021-01”). Entities may apply the provisions of the new standards as of the beginning of the reporting period when the election is made (i.e., as early as the first quarter of 2020). Unlike other topics, the provisions of this update are only available until December 31, 2022, when the reference rate replacement activity is expected to have been completed. An entity may elect to apply amendments prospectively through December 31, 2022. The optional expedients were available to be used upon issuance of this guidance but the Company has not yet applied the guidance because the Company has not yet modified its existing contract for reference rate reform. The Company does not expect the provisions of ASU 2020-04 or ASU 2021-01 to have a material impact on its financial condition, results of operation, and cash flows.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 7


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 2 — Revenue

Disaggregation of Revenue

The following tables present the disaggregated revenues by product and service line, product revenue by geography based on the “shipped to” addresses of the Company’s customers, product revenue by channel, and product revenue by segment. Sales and usage-based taxes are excluded from revenues. See Note 10, “Segment Reporting,” for further discussion related to the Company’s segments.

Three Months Ended September 30, 2021 Nine Months Ended September 30, 2021
Water Emerging Technologies Total Water Emerging Technologies Total
(In thousands)
Revenue by product and service line
PXs, pumps and turbo devices, and other $ 20,767  $ 14  $ 20,781  $ 70,275  $ 53  $ 70,328 
Revenue by primary geographical markets
Middle East and Africa $ 14,825  $ 14  $ 14,839  $ 52,186  $ 53  $ 52,239 
Asia 3,563  —  3,563  13,066  —  13,066 
Europe 1,386  —  1,386  2,662  —  2,662 
Americas 993  —  993  2,361  —  2,361 
Total revenue $ 20,767  $ 14  $ 20,781  $ 70,275  $ 53  $ 70,328 
Product revenue by channel
Megaproject $ 13,261  $ 14  $ 13,275  $ 50,254  $ 53  $ 50,307 
Original equipment manufacturer 4,844  —  4,844  11,909  —  11,909 
Aftermarket 2,662  —  2,662  8,112  —  8,112 
Total product revenue $ 20,767  $ 14  $ 20,781  $ 70,275  $ 53  $ 70,328 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 8


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended September 30, 2020 Nine Months Ended September 30, 2020
Water Emerging Technologies Total Water Emerging Technologies Total
(In thousands)
Revenue by product and service line
PXs, pumps and turbo devices, and other $ 27,408  $ —  $ 27,408  $ 65,665  $ —  $ 65,665 
License and development —  —  —  —  26,895  26,895 
Total revenue $ 27,408  $ —  $ 27,408  $ 65,665  $ 26,895  $ 92,560 
Revenue by primary geographical markets
Middle East and Africa $ 22,667  $ —  $ 22,667  $ 55,402  $ —  $ 55,402 
Asia 2,226  —  2,226  3,618  —  3,618 
Europe 1,358  —  1,358  3,126  —  3,126 
Americas 1,157  —  1,157  3,519  26,895  30,414 
Total product revenue $ 27,408  $ —  $ 27,408  $ 65,665  $ 26,895  $ 92,560 
Product revenue by channel
Megaproject $ 20,725  $ —  $ 20,725  $ 47,147  $ —  $ 47,147 
Original equipment manufacturer 4,081  —  4,081  11,687  —  11,687 
Aftermarket 2,602  —  2,602  6,831  —  6,831 
Total product revenue $ 27,408  $ —  $ 27,408  $ 65,665  $ —  $ 65,665 

In June 2020, the Company and Schlumberger Technology Corporation (“Schlumberger”) entered into an agreement to terminate the 2015 license agreement between the Company and Schlumberger (the “VorTeq License Agreement”). The VorTeq License Agreement was entered into to provide Schlumberger with the exclusive worldwide rights to the VorTeq technology. The termination of the VorTeq License Agreement was effective June 1, 2020. As there were no future performance obligations to be recognized under the VorTeq License Agreement after the effective date, the Company recognized in full the remaining deferred revenue balance of $24.4 million in the second quarter of fiscal year 2020. In addition, no future license and development revenue was recognized under the VorTeq License Agreement after the second quarter of fiscal year 2020.

Contract Balances

The following table presents contract balances by category.
September 30,
2021
December 31,
2020
(In thousands)
Accounts receivable, net $ 13,066  $ 11,792 
Contract assets:
Contract assets, current (included in prepaid expenses and other assets) $ —  $ 1,309 
Contract assets, non-current (included in other assets) —  583 
Total contract assets $ —  $ 1,892 
Contract liabilities:
Contract liabilities, current $ 1,452  $ 1,552 
Contract liabilities, non-current (included in other liabilities) 69  88 
Total contract liabilities $ 1,521  $ 1,640 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 9


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Contract Liabilities
The Company records contract liabilities when cash payments are received in advance of the Company’s performance. The following table presents significant changes in contract liabilities during the period.
September 30,
2021
December 31,
2020
(In thousands)
Contract liabilities, beginning of year $ 1,640  $ 28,866 
Revenue recognized (1,300) (28,414)
Cash received, excluding amounts recognized as revenue during the period 1,181  1,188 
Contract liabilities, end of period $ 1,521  $ 1,640 

Future Performance Obligations

The following table presents the future estimated revenue by year expected to be recognized related to performance obligations that are unsatisfied or partially unsatisfied.
  September 30,
2021
(In thousands)
2021 (remaining three months) $ 7,890 
2022 12,191 
Total future performance obligations $ 20,081 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 10


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 3 — Net Income Per Share

Net income for the reported period is divided by the weighted average number of common shares outstanding during the reported period to calculate basic net income per common share.

Basic net income per share excludes any dilutive effect of stock options and restricted stock units ("RSU").
Diluted net income per common share reflects the potential dilution that would occur if outstanding stock options to purchase common stock were exercised for shares of common stock, using the treasury stock method, and the shares of common stock underlying each unvested RSU were issued.

Outstanding stock options to purchase common stock and unvested RSUs are collectively referred to as “stock awards.”

The following table presents the computation of basic and diluted net income per share.
  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
(In thousands, except per share amounts)
Numerator
Net income $ 1,071  $ 5,387  $ 9,006  $ 22,934 
Denominator (weighted average shares)
Basic common shares outstanding 57,026  55,692  57,053  55,573 
Dilutive stock awards 1,683  779  1,732  870 
Diluted common shares outstanding 58,709  56,471  58,785  56,443 
Net income per share
Basic 0.02  0.10  0.16  0.41 
Diluted 0.02  0.10  0.15  0.41 

Certain shares of common stock issuable under stock awards have been omitted from the diluted net income per share calculations because their inclusion is considered anti-dilutive. The following table presents the weighted potential common shares issuable under stock awards that were excluded from the computation of diluted net income per share.
  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
(In thousands)
Anti-dilutive stock award shares 26  3,033  456  2,700 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 11


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 4 — Other Financial Information

Cash, Cash Equivalents and Restricted Cash

The Condensed Consolidated Statements of Cash Flows explain the changes in the total of cash, cash equivalents and restricted cash. The following table presents a reconciliation of cash, cash equivalents and restricted cash(1) reported within the Condensed Consolidated Balance Sheets that sum to the total of such amounts presented.
September 30,
2021
December 31,
2020
September 30,
2020
(In thousands)
Cash and cash equivalents $ 65,745  $ 94,255  $ 80,149 
Restricted cash, non-current (included in other assets, non-current) 103  103  103 
Total cash, cash equivalents and restricted cash $ 65,848  $ 94,358  $ 80,252 
(1)    The Company pledged and deposited cash amounts into restricted cash accounts in connection with the Company’s credit cards.

Accounts Receivable, net

The following table presents the components of accounts receivable, net.
  September 30,
2021
December 31,
2020
(In thousands)
Accounts receivable, gross $ 13,183  $ 12,189 
Allowance for doubtful accounts (1)
(117) (397)
Accounts receivable, net $ 13,066  $ 11,792 
(1)    The Company wrote-off $0.3 million of uncollectible receivables, which had been previously reserved as of December 31, 2020, during the second quarter of 2021.

Inventories, net

Inventories are stated at the lower of cost or net realizable value, using the first-in, first-out method. The following table presents gross inventory by category and reconciliation to net inventory.
  September 30,
2021
December 31,
2020
(In thousands)
Raw materials $ 6,515  $ 4,647 
Work in process 3,423  2,475 
Finished goods 11,181  5,160 
Inventories, gross 21,119  12,282 
Valuation adjustments for excess and obsolete inventory (562) (534)
Inventories, net $ 20,557  $ 11,748 

The Company has increased its raw material inventory according to its production forecast and to ensure there is sufficient raw material supply to mitigate any supply chain issues, such as potential shipment delays related to port congestion, and/or supplier material and labor shortages. The Company has increased its finished goods inventory according to its shipment forecast as well as increasing inventory for future demand while maintaining reasonable minimums to be able react to certain market conditions.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 12


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Prepaid Expenses and Other Assets
  September 30,
2021
December 31,
2020
(In thousands)
Contract assets $ —  $ 1,309 
Cloud computing arrangement implementation costs 1,080  1,087 
Supplier advances 2,110  996 
Other prepaid expenses and other assets 2,351  1,558 
Total prepaid expenses and other assets $ 5,541  $ 4,950 

Goodwill and Other Intangible Assets
September 30,
2021
December 31,
2020
(In thousands)
Goodwill $ 12,790  $ 12,790 
Other intangible assets, net 40  49 
Total goodwill and other intangible assets $ 12,830  $ 12,839 
Goodwill is tested for impairment annually in the third quarter of the Company’s fiscal year or more frequently if indicators of potential impairment exist. The recoverability of goodwill is measured at the reporting unit level, which represents the operating segment.

On July 1, 2021, the Company estimated the fair value of its reporting units using both the discounted cash flow and market approaches. The forecast of future cash flows, which are based on the Company’s best estimate of future net sales and operating expenses, are based primarily on expected category expansion, pricing, market segment, and general economic conditions. The Company incorporates other significant inputs to its fair value calculations, including discount rate and market multiples, to reflect current market conditions. The analysis performed indicated that the fair value of each reporting unit that is allocated goodwill significantly exceeds its carrying value. As a result, no impairment charge was recorded during the three months ended September 30, 2021. The Company continues to actively monitor the industries in which it operates and its business performance for indicators of potential impairment.

Accrued Expenses and Other Liabilities
  September 30,
2021
December 31,
2020
(In thousands)
Payroll, incentives and commissions payable $ 6,719  $ 8,400 
Warranty reserve 830  760 
Other accrued expenses and other liabilities 2,033  2,656 
Total accrued expenses and other liabilities $ 9,582  $ 11,816 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 13


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 5 — Investments and Fair Value Measurements

Available-for-Sale Investments

The Company’s investments in investment-grade short-term and long-term high-quality marketable debt instruments, such as U.S. treasury securities, and corporate notes and bonds, are classified as available-for-sale. As of September 30, 2021 and December 31, 2020, available-for-sale investments were classified on the Condensed Consolidated Balance Sheets as either short-term and/or long-term investments.

The classification of available-for-sale investments on the Condensed Consolidated Balance Sheets and definition of each of these classifications are provided in Note 1, “Description of Business and Significant Accounting Policies - Significant Accounting Policies,” subsections “Cash and Cash Equivalents” and “Short-term and Long-term Investments,” of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data,” in the 2020 Annual Report.

Expected maturities can differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties. The Company generally holds available-for-sale investments until maturity; however, from time-to-time, the Company may elect to sell certain available-for-sale investments prior to contractual maturity.

Fair Value of Financial Instruments

All of the Company’s financial assets and liabilities are remeasured and reported at fair value at each reporting period, and are classified and disclosed in one of the following three pricing category levels:
Level 1    —    Quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2    —    Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and
Level 3    —    Unobservable inputs in which little or no market activity exists, thereby requiring an entity to develop its own assumptions that market participants would use in pricing.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 14


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table presents the Company’s financial assets measured on a recurring basis by contractual maturity, including pricing category, amortized cost, gross unrealized gains and losses, and fair value.
September 30, 2021 December 31, 2020
Pricing Category Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
(In thousands)
Cash equivalents
Money market securities Level 1 $ 41,841  $ —  $ —  $ 41,841  $ 59,132  $ —  $ —  $ 59,132 
Total cash equivalents 41,841  —  —  41,841  59,132  —  —  59,132 
Short-term investments
U.S. treasury securities Level 2 10,000  —  —  10,000  1,614  —  1,621 
Corporate notes and bonds Level 2 31,910  (14) 31,900  18,708  117  —  18,825 
Total short-term investments 41,910  (14) 41,900  20,322  124  —  20,446 
Long-term investments
Corporate notes and bonds Level 2 766  —  (1) 765  —  —  —  — 
Total long-term investments 766  —  (1) 765  —  —  —  — 
Total short and long-term investments 42,676  (15) 42,665  20,322  124  —  20,446 
Total $ 84,517  $ $ (15) $ 84,506  $ 79,454  $ 124  $ —  $ 79,578 

As of September 30, 2021 and December 31, 2020, the Company had no financial liabilities and no Level 3 financial assets. During the nine months ended September 30, 2021, the Company had no transfers of financial assets between any levels.

    The following table presents a summary of the fair value and gross unrealized losses on the available-for-sale securities that have been in a continuous unrealized loss position, aggregated by type of investment instrument. The available-for-sale securities that were in an unrealized gain position have been excluded from the table.
  September 30, 2021 December 31, 2020
  Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
(In thousands)
Corporate notes and bonds $ 25,873  $ (15) $ —  $ — 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 15


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Sales of Available-for-Sale Investments

The following table presents the sales of available-for-sale investments. There were no sales of securities and realized gains on sales of securities during the three and nine months ended September 30, 2021.
  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
(In thousands)
Corporate notes and bonds $ —  $ 806  $ —  $ 10,573 

Realized gains on sales of securities were immaterial during the three and nine months ended September 30, 2020.
Energy Recovery, Inc. | Q3'2021 Form 10-Q | 16


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 6 — Lines of Credit

Stand-by Letters of Credit

The Company entered into a loan and pledge agreement with a financial institution during January 2017, which has been amended multiple times to accommodate the growth of the Company (the original loan and pledge agreement and its subsequent amendments are hereinafter referred to as the “Loan and Pledge Agreement”). Under the Loan and Pledge Agreement, the Company is allowed to issue stand-by letters of credit (“SBLCs”) up to one year past the expiration date of the Loan and Pledge Agreement and to hold SBLCs with other financial institutions up to an aggregate amount of $5.1 million. SBLCs have a term limit of three years, are secured by pledged U.S. investments, and do not have any cash collateral balance requirements. SBLCs are deducted from the total revolving credit line under the Loan and Pledge Agreement and are subject to a non-refundable quarterly fee that is in an amount equal to 0.7% per annum of the face amount of the outstanding SBLCs.

The following table presents the outstanding SBLCs issued by the Company related to product warranty and performance guarantees to its customers.
September 30,
2021
December 31,
2020
(In thousands)
Outstanding stand-by letters of credit $ 14,065  $ 13,266 
Energy Recovery, Inc. | Q3'2021 Form 10-Q | 17


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 7 — Commitments and Contingencies

Operating Lease Obligations

The following table presents a summary of operating lease, right of use assets and lease liabilities.
September 30,
2021
December 31,
2020
(In thousands)
Operating lease, right of use asset $ 15,021  $ 16,090 
Lease liabilities, current $ 1,518  $ 1,243 
Lease liabilities, non-current 15,284  16,443 
Total lease liability $ 16,802  $ 17,686 

The Company leases office, warehouse and manufacturing facilities under operating leases that expire on various dates through fiscal year 2030.

The following table presents operating lease activities related to all leased properties.
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
(In thousands)
Operating lease expense $ 643  $ 669  $ 1,928  $ 1,940 
Cash payments 647  655  1,783  1,763 
Non-cash lease liabilities arising from obtaining right-of-use assets —  —  —  6,384 

The following table presents other information related to outstanding operating leases as of September 30, 2021.
Weighted average remaining lease term 7.7 years
Weighted average discount rate 7.0%

The following table presents the minimum lease payments by year under noncancelable operating leases, exclusive of executory costs.
  September 30,
2021
(In thousands)
2021 (remaining three months) $ 647 
2022 2,650 
2023 2,580 
2024 2,812 
2025 2,736 
2026 and thereafter 10,462 
Total future minimum lease payments 21,887 
Less imputed lease interest (5,085)
Total lease liabilities $ 16,802 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 18


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Warranty

The following table presents the changes in the Company’s accrued product warranty reserve.
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
(In thousands)
Warranty reserve balance, beginning of period $ 809  $ 673  $ 760  $ 631 
Warranty costs charged to cost of revenue 104  143  312  316 
Utilization charges against reserve (1) (5) (14) (7)
Release of accrual related to expired warranties (82) (64) (228) (193)
Warranty reserve balance, end of period $ 830  $ 747  $ 830  $ 747 

Purchase Obligations

The Company has purchase order arrangements with its vendors for which the Company has not received the related goods or services as of September 30, 2021. These arrangements are subject to change based on the Company’s sales demand forecasts. The Company has the right to cancel the arrangements prior to the date of delivery. The purchase order arrangements are related to various raw materials and component parts, as well as capital equipment. As of September 30, 2021, the Company had approximately $8.7 million of such open cancellable purchase order arrangements.

Litigation

The Company is named in and subject to various proceedings and claims in connection with its business. The outcome of matters the Company has been, and currently is, involved in cannot be determined at this time, and the results cannot be predicted with certainty. There can be no assurance that these matters will not have a material effect on the Company’s results of operations in any future period, and a significant judgment could have a material impact on the Company’s financial condition, results of operations and cash flows. The Company may in the future become involved in additional litigation in the ordinary course of business, including litigation that could be material to its business.

The Company considers all claims on a quarterly basis and, based on known facts, assesses whether potential losses are considered reasonably possible, probable and estimable. Based upon this assessment, the Company then evaluates disclosure requirements and whether to accrue for such claims in its consolidated financial statements. The Company records a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and are adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. As of September 30, 2021, there were no material losses which were probable or reasonably possible.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 19


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 8 — Income Taxes

  Three Months Ended September 30, Nine Months Ended September 30,
  2021 2020 2021 2020
(In thousands, except percentages)
(Benefit from) provision for income taxes $ 393  $ 796  $ (990) $ 5,297 
Discrete items 28  2,364  (54)
Provision for income taxes, excluding discrete items $ 402  $ 824  $ 1,374  $ 5,243 
Effective tax rate 26.8  % 12.9  % (12.4  %) 18.8  %
Effective tax rate, excluding discrete items 27.5  % 13.4  % 17.2  % 18.6  %

The Company’s tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, the Company makes a cumulative adjustment in such period. The Company’s quarterly tax provision and estimate of its annual effective tax rate are subject to variation due to several factors, including variability in accurately predicting its pre-tax income or loss and the mix of jurisdictions to which they relate, intercompany transactions, the applicability of special tax regimes, and changes in how the Company does business.

For the nine months ended September 30, 2021, the recognized income tax benefit included a benefit primarily related to the U.S. federal research and development (“R&D”) tax credit and a discrete tax benefit due primarily to stock-based compensation windfalls. For the nine months ended September 30, 2020, the recognized income tax charge included a discrete tax charge related to the termination of the VorTeq License Agreement, partially offset by a benefit primarily related to the U.S. federal R&D tax credit and a discrete tax benefit due primarily to stock-based compensation windfalls.

The decrease in the effective tax rate for the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020, is largely related to the discrete tax benefit from stock-based compensation windfall tax deductions. Excluding the discrete tax benefit in both nine month periods presented, the effective tax rate was comparable.
Energy Recovery, Inc. | Q3'2021 Form 10-Q | 20


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 9 — Stockholders’ Equity

Share Repurchase Program

On March 9, 2021, the Company’s Board of Directors authorized a share repurchase program under which the Company may repurchase, at the discretion of management, up to $50.0 million in aggregate cost of the Company’s outstanding common stock (the “March 2021 Authorization”). Under the March 2021 Authorization, purchases of shares of common stock may be made from time to time in the open market, or in privately negotiated transactions, in compliance with applicable state and federal securities laws. The timing and amounts of any purchases will be based on market conditions and other factors including price, regulatory requirements, and capital availability. The March 2021 Authorization does not obligate the Company to acquire any specific number of shares in any period, and may be expanded, extended, modified or discontinued at any time without prior notice. The Company accounts for stock repurchases using the cost method. The aggregate cost includes fees and expenses charged in connection with acquiring the shares.

The following table presents the share repurchase activities and remaining program balance under the March 2021 Authorization as of September 30, 2021.
Number of Shares Purchased
Average Price Paid per Share(1)
Plan Activity
(In thousands)
March 2021 Authorization $ 50,000 
Repurchases under March 2021 Authorization 952,666  $ 17.99  (17,156)
Remaining amount under March 2021 Authorization $ 32,844 
(1)    Excluding commissions

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 21


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 10 — Segment Reporting

The Company’s chief operating decision-maker (“CODM”) is its chief executive officer. The Company continues to monitor and review its segment reporting structure in accordance with authoritative guidance to determine whether any changes have occurred that would impact its reportable segments. As a result of the evolution of the Company’s products, operations and research and development efforts in new product development, and the way in which the CODM manages and assesses the performance of the business, starting in the first quarter of fiscal year 2021, the Company realigned its segment reporting and has recast the prior year amounts for comparability. In addition, to better align the activities of the segments, the Company has re-allocated certain corporate resources to the segments’ operations.

Income and type of expense activities that are included in the Water and Emerging Technologies segments and corporate operating expenses are as follows:

Water segment: The continued development, sales and support of the PX, hydraulic turbochargers and pumps used in seawater desalination and industrial wastewater activities.
Emerging Technologies segment: The continued development, sales and support of activities related to emerging technologies, such as the PX G1300 used in industrial and commercial refrigeration applications; the VorTeq used in the oil and gas markets; the ISOBoost used in natural gas processing; and certain other new products.
Corporate operating expenses: Corporate activities outside of the operating segments, such as audit and accounting expenses, general legal costs, board of director fees and expenses, and other separately managed general expenses not related to the identified segments.

Segment Financial Information

For each of the periods presented in the following tables, operating income (loss) for each segment excludes other income and expenses, and corporate operating expenses not included in how the CODM assesses the performance of the operating segments, such as income taxes and other separately managed expenses not attributed to the operating segments. Assets and liabilities are reviewed at the consolidated level by the CODM and are not attributed to the segments. The CODM allocates resources to, and assesses the performance of, each operating segment using information about its revenue and operating income.

The following tables present a summary of the Company’s financial information by segment and corporate operating expenses.
  Three Months Ended September 30, 2021 Nine Months Ended September 30, 2021
  Water Emerging Technologies Total Water Emerging Technologies Total
(In thousands)
Product revenue $ 20,767  $ 14  $ 20,781  $ 70,275  $ 53  $ 70,328 
Product cost of revenue 6,089  —  6,089  22,251  —  22,251 
Product gross profit 14,678  14  14,692  48,024  53  48,077 
Operating expenses
General and administrative 1,435  1,373  2,808  4,768  3,854  8,622 
Sales and marketing 2,250  327  2,577  6,535  735  7,270 
Research and development 762  3,654  4,416  1,858  11,484  13,342 
Amortization of intangible assets —  — 
Total operating expenses 4,449  5,354  9,803  13,170  16,073  29,243 
Operating income (loss) $ 10,229  $ (5,340) 4,889  $ 34,854  $ (16,020) 18,834 
Less: Corporate operating expenses 3,462  10,976 
Income from operations 1,427  7,858 
Other income, net 37  158 
Income before income taxes $ 1,464  $ 8,016 

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 22


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  Three Months Ended September 30, 2020 (Recast) Nine Months Ended September 30, 2020 (Recast)
  Water Emerging Technologies Total Water Emerging Technologies Total
(In thousands)
Product revenue $ 27,408  $ —  $ 27,408  $ 65,665  $ —  $ 65,665 
Product cost of revenue 7,816  —  7,816  20,049  —  20,049 
Product gross profit 19,592  —  19,592  45,616  —  45,616 
License and development revenue (1)
—  —  —  —  26,895  26,895 
Operating expenses
General and administrative 2,371  1,359  3,730  6,417  4,001  10,418 
Sales and marketing 1,507  327  1,834  4,307  901  5,208 
Research and development 723  4,375  5,098  2,585  15,574  18,159 
Amortization of intangible assets —  12  —  12 
Impairment of long-lived assets —  —  —  —  2,332  2,332 
Total operating expenses 4,605  6,061  10,666  13,321  22,808  36,129 
Operating income (loss) $ 14,987  $ (6,061) 8,926  $ 32,295  $ 4,087  36,382 
Less: Corporate operating expenses 2,848  8,901 
Income from operations 6,078  27,481 
Other income, net 105  750 
Income before income taxes $ 6,183  $ 28,231 
(1)    In June 2020, the Company and Schlumberger entered into an agreement to terminate the VorTeq License Agreement. The termination of the VorTeq License Agreement was effective June 1, 2020. As there were no future performance obligations to be recognized under the VorTeq License Agreement after the effective date, the Company recognized in full the remaining deferred revenue balance of $24.4 million in the second quarter of fiscal year 2020. In addition, no future license and development revenue was recognized under the VorTeq License Agreement after the second quarter of fiscal year 2020.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 23


ENERGY RECOVERY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 11 — Concentrations

Product Revenue

The following table presents customers accounting for 10% or more of product revenue by segment. Although certain customers might account for greater than 10% of product revenue at any one point in time, the concentration of product revenue between a limited number of customers shifts regularly, depending on contract negotiations. The percentages by customer reflect specific relationships or contracts that would concentrate product revenue for the periods presented and does not indicate a trend specific to any one customer.
Three Months Ended September 30, Nine Months Ended September 30,
  Segment 2021 2020 2021 2020
Customer A Water ** 28% ** 24%
Customer B Water 20% 30% 19% 27%
Customer C Water ** ** 16% 12%
Customer D Water 25% ** 12% **
**    Zero or less than 10%.

License and Development Revenue

There was no Emerging Technologies segment customer license and development revenue for the three and nine months ended September 30, 2021. The Emerging Technologies segment had one international customer, Schlumberger, which accounted for 100% of the license and development revenue for the nine months ended September 30, 2020. See Note 2, “Revenue,” for further discussion related to the termination of the VorTeq License Agreement.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 24



Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We create technologies that solve complex challenges for industrial fluid-flow markets worldwide. Building on our pressure exchanger technology platform, we design and manufacture solutions that improve operational efficiency by reducing waste, energy consumption and costs across a range of industrial processes. What began as a game-changing invention for desalination has grown into a global business advancing the environmental sustainability of our customers’ operations in multiple industries. We are a global team with sales and on-site technical support available worldwide, and we maintain international direct sales offices and technical support centers to service the European, Middle Eastern and Asian markets.

Our core technology is the pressure exchanger. Our pressure exchanger technology efficiently transfers energy between high-pressure and low-pressure liquid or gas through continuously rotating ducts. Our PX® Pressure Exchanger® (“PX”) can operate in both low-pressure and high-pressure environments between 1,000 pounds per square inch (“psi”), or 70 bar, and up to approximately 10,000 psi, or 700 bar. Our pressure exchanger technology can also handle a variety of relatively clean to dirty liquids, and we are actively developing capabilities to handle gases. When applied to industrial systems with pressure differentials, our pressure exchanger technology can provide certain benefits including our customers’ ability to reduce capital expenditures and energy use, which leads to lower carbon emissions, as well as lower operating costs.

Engineering and research and development (“R&D”) have been, and remain, an essential part of our history, culture and corporate strategy. Since our formation, we have developed leading technology and engineering expertise through the continual evolution of our pressure exchanger technology, which can improve productivity by reducing waste and energy consumption in high-pressure industrial fluid-flow systems. This versatile technology powers several of our products, including our flagship PX energy recovery device (“ERD”), which we believe is the industry standard for energy recovery in the seawater reverse osmosis desalination (“SWRO”) industry. Today, we continue to push the boundaries of our pressure exchanger technology to handle different operating environments and industrial applications. Leveraging our proven pressure exchanger technology platform, we are identifying new ways to solve and developing new solutions for solving challenges for critical industries, such as industrial wastewater treatment, commercial and industrial refrigeration, natural gas processing and hydraulic fracturing.

Quarterly Highlights

The decrease in product revenues during the quarter, as compared to the same period in 2020, was as expected due primarily to the project timeline of megaproject (“MPD”) channel shipments, which can fluctuate from quarter-to-quarter. Management anticipates continued growth based on existing backlog, as well as the increasing need to expand potential water production globally and the increased purchases of product for continued plant maintenance in advance of the anticipation of an economic recovery and greenfield projects in industries affected by the novel coronavirus (“COVID-19”) pandemic, such as travel and hospitality. The 2021 year-to-date total revenues, as compared to the 2020 year-to-date total revenues, was lower due primarily to the elimination of license and development revenue in 2021, of which none was recognized after the termination of the VorTeq License Agreement in the second quarter of 2020.

Our PX G1300 has moved into the next phase of development, which will involve holding field trials at commercial refrigeration sites. During the quarter, we have had many fruitful conversations with U.S. and international grocery chains and manufacturers, and have recently entered into an agreement to deploy our PX G1300 energy recovery device to a grocery store in California. We expect increased sales and marketing (“S&M”) expenditures for the balance of 2021 and 2022 related to these endeavors.

The world has been experiencing significant inflationary and supply chain issues in recent months. To date, we have remained materially unaffected by these events. We cannot protect ourselves from all risks but have been proactively working to mitigate risks where possible. We are working with customers to ensure timely delivery of product, by adjusting shipping schedules, where necessary, to avoid disruptions to our end customers. In addition, in anticipation of such issues, we have increased our raw material inventory to alleviate or avoid any external shocks on our ability to manufacture and ship products to customers. These decisions have increased inventory levels above historic trends, nearly doubling inventory values. This has not only alleviated supply chain issues, but has also had the positive effect of delaying the impact of raw material inflation, and in some cases, reduce raw material costs due to higher volume purchases.

Energy Recovery, Inc. | Q3'2021 Form 10-Q | 25



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During the quarter, we released our second annual Environmental, Social and Governance (“ESG”) report, which details our efforts to accelerate the environmental sustainability of our customers’ operations and enhance management of ESG issues in our own operations. We understand the importance of being a responsible corporate citizen and believe our ESG program provides us with a strategic roadmap to become a more sustainable and resilient business. Our ESG report outlines our ESG commitments and aligns to leading sustainability frameworks and reporting standards, including the Sustainability Accounting Standards Board as well as select disclosures from the Global Reporting Initiative and the United Nations Sustainable Development Goals.

As part of our efforts to transparently communicate our ESG performance to our stakeholders, in September 2021, we hosted an ESG-focused webinar, “Charting Sustainable Growth with ESG Principles,” in which our Company leaders reviewed highlights of our ESG program and how ESG is linked to driving long-term, sustainable growth for us and our stakeholders.

Our complete 2020 ESG report can be found on our website at: https://energyrecovery.com/about-us/environmental-social-governance/.

Segments

We continue to monitor and review our segment reporting structure in accordance with authoritative guidance to determine whether any changes have occurred that would impact our reportable segments. As a result of the evolution of our products, operations and R&D efforts in new product development, such as industrial and commercial refrigeration applications, and the way in which our chief operating decision maker (“CODM”) manages and assesses the performance of the business, starting in the first quarter of fiscal year 2021, we realigned our segment reporting and have recast the prior year amounts for comparability. In addition, to better align the activities of the segments, we have re-allocated certain corporate resources to the segments’ operations.

Water

Our Water segment includes the continued development, sales and support of the PX, hydraulic turbochargers and pumps used in seawater desalination and industrial wastewater activities. Our Water segment revenue is principally derived from the sale of ERDs and high-pressure and circulation pumps to the MPD, original equipment manufacturer (“OEM”) and aftermarket (“AM”) channels. MPD sales are typically made to global e