Energy Recovery, Inc. develops, manufactures and sells high-efficiency energy recovery devices for use in seawater desalination. Our products make desalination affordable by reducing energy costs. We have one operating segment, the manufacture and sale of high efficiency energy recovery products and related services. Additional information on segment reporting is contained in Note 10 of Notes to the Consolidated Financial Statements in this Form 10-K.
Our company was incorporated in Virginia in April 1992 and reincorporated in Delaware in March 2001. We became a public company in July 2008. The company has three subsidiaries: Osmotic Power, Inc., Energy Recovery, Inc. International, and Energy Recovery Iberia, S.L. They were incorporated in September 2005, July 2006 and September 2006, respectively.
The mailing address of our headquarters is 1908 Doolittle Drive, San Leandro, California 94577. Our main telephone number is (510) 483-7370. Additional information about ERI is available on our website at http://www.energyrecovery.com. Information contained in the website is not part of this report.
Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports and the Proxy Statement for our Annual Meeting of Stockholders are made available, free of charge, on our website, http://www.energyrecovery.com, as soon as reasonably practicable after the reports have been filed with or furnished to the Securities and Exchange Commission.
Energy Recovery, Inc. makes energy recovery devices for use in the desalination industry. There are two primary methods of producing drinking water from seawater: thermal distillation and membrane or reverse osmosis desalination. Thermal distillation involves heating seawater, capturing the vapor and condensing it as potable water. Reverse osmosis desalination entails pressurizing seawater and driving it into filtering membranes to produce pure water and a concentrated brine, which is carried away in a high pressure reject stream.
Our energy recovery products are used in reverse osmosis desalination. They reduce energy costs by capturing and reusing up to 98% of the otherwise lost pressure energy from the reject stream, reducing the workload of the high pressure pump. Use of our devices can reduce energy consumption by up to an estimated 60% compared to reverse osmosis plants without energy recovery. By reducing energy costs, our devices increase the cost-competitiveness of reverse osmosis desalination compared to other means of fresh water production, including thermal desalination. Our products are sold under the trademarks ERI®, PX®, Pressure Exchanger® and PX Pressure Exchanger®.
Current Product Lines: We develop and sell different models and sizes of our PX Pressure Exchanger products to address a range of process flow rates, plant designs and sizes. Our products are designed to operate in parallel to accommodate a range of plant sizes. Their modular design also provides system redundancy and minimizes the need for costly plant shut-downs. Our current offerings include:
The 65 Series. Our 65-Series of PX devices is designed for reverse osmosis desalination plants capable of producing more than 120 gallons per minute or 27 cubic meters per hour. The PX-220, introduced in 2002, and the PX-260, introduced in late 2007, are currently our most popular products.
The 45 Series. The smaller 45-Series of PX devices are adapted for plants that process between 25 to 300 gallons per minute or 6 to 68 cubic meters per hour.
PX-30S. The PX-30S is a smaller PX device designed for pilot desalination projects. It helps municipalities qualify PX technology for use in larger projects. The product was released in October 2007. In addition to serving as a test unit, it has found application in smaller marine-based or solar-powered desalination processes.
Brackish PX devices. Brackish water has a lower concentration of salt than seawater. Given its lower salt content, brackish water typically requires less energy than seawater to desalinate. Our line of PX devices for the desalination of brackish water is designed to reduce energy costs and improve energy consumption in this lower pressure process.
New PX devices. We are in the process of testing two new PX devices designed for different ends of the desalination market. The Comp PX. Our new lower-priced Comp PX product is designed for operators of small to medium-sized plants which are sensitive to initial costs and/or are located in regions where energy costs are low. We expect to release the Comp PX device commercially in 2009.
The Titan PX. The Titan PX product is designed to process up to 1,200 gallons per minute or 273 cubic meters per hour, more than four times the capacity of our PX-260. Field testing began in February 2009. We expect to evaluate the Titan PX device in a production environment for at least two years before releasing it for commercial use.
Technical Support and Replacement Parts. We provide engineering and technical support to customers during product installation and plant commissioning. We have dedicated technical support personnel based in Spain, the United Arab Emirates, China and the United States.
As our installed base of PX devices increases and ages, we expect sales of replacement PX device parts and services to increase. Our PX devices may also be used to retrofit or replace older energy recovery devices in existing desalination plants.
High Pressure Circulation Pumps. We manufacture and sell a line of high pressure circulation pumps for use in small to medium-sized plants. These low-powered pumps are used with our products to move high-pressure water through our energy recovery devices and the membranes array.
As of December 31, 2008, we had shipped approximately 5,900 PX devices to desalination plants worldwide. Our products are used in approximately 300 plants in operation or under construction including major plants in Australia, Spain, Africa, South America, the Middle East, China, the Caribbean and India. We sell directly to our customers, which include large engineering and construction firms and original equipment manufacturers (OEMs).
Large engineering and construction firms. Most of our revenue comes from sales of our products to the international engineering and construction firms that design and build large desalination plants or mega-projects. We work with these firms to specify our products for their plants. The time between project tender to product shipment can range from six to 16 months. Each large mega-project typically represents a revenue opportunity of between $2 million to $7 million.
A limited number of these engineering and construction firms account for a substantial portion of our net revenue. In 2008, sales to Hyflux Ltd. and Befesa Agua, S.A. and affiliated joint ventures accounted for approximately 16% and 11%, respectively, of our total revenue. In 2007, sales to Acciona Agua S.A.; Geida and its member companies; and Doosan Heavy Industries & Construction Co., Ltd. represented approximately 20%, 23% and 13%, respectively, of our total sales (Geida is a consortium of Befesa Agua, a subsidiary of Abengoa S.A; Cobra-Tedagua, a subsidiary of ACS Actividades de Construcción y Servicios, S.A.; and Sadyt S.A., a subsidiary of Sacyr Vallehermoso, S. A.). Sales to GE Water and Process Technologies (formerly GE Ionics) and Geida and its member companies represented approximately 18% and 11% respectively of our total sales in 2006. No other customers accounted for more than 10% of our total revenue during any of these periods.
Original Equipment Manufacturers. We also sell our products and services to suppliers of pumps and other water-related equipment for assembly and use in small to medium-sized desalination plants for hotels, power plants, cruise ships, farming operations, island bottlers, and small municipalities. These original equipment manufacturers also purchase our products for “quick water” or emergency water solutions. In this market, the time from project tender to shipment ranges from one to three months.
The market for energy recovery devices in desalination plants is competitive. As the demand for fresh water increases and the market expands, we expect competition to persist and intensify.
We have three main competitors: Calder AG based in Switzerland; Fluid Equipment Development Company (FEDCO) based in Monroe, Michigan and Pump Engineering Incorporated (PEI) based in Monroe, Michigan. We compete with these companies on the basis of price, technology, materials, efficiency and life cycle maintenance costs. We believe that our products have a competitive advantage, even though these competitors may offer their products at prices lower than ours, because our product is the most cost effective energy recovery device for reverse osmosis desalination over time.
In the market for large desalination projects, our PX devices compete primarily with Calder’s DWEER product. Like our products, the DWEER uses isobaric or pressure-equalizing technology to transfer pressure energy directly from the brine reject stream to seawater. We believe that we have a competitive advantage because our products are made with highly durable and corrosion-proof ceramic parts, have a simple design with one moving part and a small physical footprint, provide system redundancy and scaling capability, and offer lower life cycle maintenance costs.
In the market for small to medium-sized desalination plants, we compete with turbine technology from Calder, FEDCO and PEI. Unlike products that use isobaric or pressure-equalizing technology, turbine-based energy recovery products use the reject stream to turn a hydraulic turbine wheel that is coupled to a high-pressure pump. These products reduce energy costs by reducing the workload of the high pressure pump. These devices convert pressure energy to mechanical energy and back to pressure energy, and can recycle the pressure energy from the reject stream with a net transfer efficiency of between 50%-79%. We believe that our products have a competitive advantage because they provide up to 98% energy transfer efficiency, have lower life cycle maintenance costs, are made of highly durable and corrosion-proof ceramic parts and feature a modular design.
Sales and Marketing
Our sales and marketing groups work with companies that design and build desalination plants to specify our PX technology in their plants early in the design phase. We market and sell our products directly to these customers through our regional sales organization. In some countries, we also work with industry consultants.
Our sales organization has two groups, the Mega-Projects Group, which is responsible for sales opportunities for desalination projects exceeding 50,000 cubic meters per day, and our OEM Group, which targets projects designed to produce less than 50,000 cubic meters per day.
Since many of the large engineering and construction firms that specialize in mega-projects are located in Spain and other European countries, we maintain a sales and technical center in Madrid. We have an office in Dubai, United Arab Emirates to serve the Middle East where many desalination plants and key engineering and construction firms are located. We also have an office in China where we have many small and medium projects and opportunities for several large desalination projects. Our China office is located in Shanghai. Our U.S. sales offices are located in California and Florida.
We assemble, test and package all of our finished products in our manufacturing facility in San Leandro, California. We purchase unfinished ceramic components for our PX products from several suppliers. We depend on three suppliers for our vessel housing and single suppliers for our end covers and stainless steel castings. We perform finish machining and assembly in-house on all ceramic components to protect the proprietary nature of our methods of manufacturing and product designs and to maintain our quality control standards.
For a discussion of risks attendant to our manufacturing activities, see “Risk Factors — We depend on third-party suppliers, and our revenue and gross margin could suffer if we fail to manage supplier issues properly,” in Item 1A, which is incorporated herein by reference.
Research and Development
Design, quality and innovation are key elements of our culture. Our development efforts are focused on designing and testing new PX devices adapted for different niches of the seawater reverse osmosis desalination market and creating new applications for our technology outside of desalination. We are also committed to developing know-how in the material science and manufacturing of ceramics. Research and development expense totaled $2.4 million for 2008, $1.7 million for 2007 and $1.3 million for 2006.
For a discussion of risks attendant to our research and development activities, see “Risk Factors — The success of our business depends in part on our ability to develop new products and services and increase the functionality of our current products,” in Item 1A, which is incorporated herein by reference.
We seek patent protection for inventions and improvements that are likely to be incorporated into our products. We rely on trade secret law and contractual safeguards to protect the proprietary tooling, processing techniques and other know-how used in the production of our products.
We have five U.S. patents and eleven patents outside the U.S. that are counterparts to one of the U.S. patents. The U.S. patents expire between 2011 and 2025, and the corresponding international patents expire at various dates through 2021. We have also applied for two additional U.S. patents and seven pending international applications corresponding to the U.S. patents and patent applications.
We have registered the following trademarks with the United States Patent and Trademark office: “ERI,” “PX,” “PX Pressure Exchanger,” “Pressure Exchanger,” the ERI logo, and “Making Desalination Affordable.” We have also applied for and received registrations in international trademark offices.
For a discussion of risks attendant to intellectual property rights, see “Risk Factors — If we are unable to protect our technology or enforce our intellectual property rights, our competitive position could be harmed and we could be required to incur significant expenses to enforce our rights.” in Item 1A, which is incorporated herein by reference.
As of December 31, 2008, we had 89 employees: 26 in manufacturing, 21 in sales and marketing; 34 in corporate services and management; and eight in engineering/research and development. Nine of these employees were located outside of the United States. We also from time to time engage a relatively small number of independent contractors. We have not experienced any work stoppages. Our employees are not unionized.
Item 1A. Risk Factors
We have relied and expect to continue to rely on sales of our PX devices for almost all of our revenue; a decline in demand for desalination, reverse osmosis desalination or our PX devices will reduce demand for our products and will cause our sales and revenue to decline.
Our primary product is the PX device, and sales of our PX device historically have accounted for approximately 95% of our revenue. While we sell a variety of models of the PX device depending on the design of the desalination plant and its desired output, all of our models rely on the same basic technology developed and refined over the past 12 years. We expect that the revenue from our PX devices will continue to account for most of our revenue for the foreseeable future. Any factors adversely affecting the demand for desalination, including changing weather patterns, increased precipitation, new technology for producing fresh water, new energy technology or reduced energy costs, changes in the global economy, and political changes, would reduce the demand for PX devices and would cause a significant decline in our revenue. For example, desalination projects have in the past been cancelled or delayed due to political issues, changes in precipitation and problems with financing. Similarly, any other factors adversely affecting the demand for our PX devices, including new methods of reverse osmosis desalination that reduce pressure and energy requirements, improvements in membrane technology, new energy recovery technology, increased competition, changes in customer spending priorities and industry regulations would also cause a significant decline in our revenue. Some of the factors that may affect sales of our PX device may be out of our control.
We depend on the construction of new desalination plants for revenue, and as a result, our operating results have experienced, and may continue to experience, significant variability due to volatility in capital spending, availability of project financing, and other factors affecting the water desalination industry.
We derive substantially all of our revenue from sales of products and services used in desalination plants for municipalities, hotels and resorts and agricultural operations in dry or drought-ridden regions of the world. The demand for our products may decrease if the construction of desalination plants declines, especially in these regions. Other factors could affect the number and capacity of desalination plants built or the timing of their completion, including the current weak global economy, the current crisis in the credit and banking systems, changes in government priorities, changes in governmental regulations, reduced capital spending for desalination and lower energy costs, which could result in cancelled orders or delays in plant construction and the installation of our products. As a result of these factors, we have experienced and may in the future experience significant variability in our revenue, on both an annual and a quarterly basis. Pronounced variability, extended delays or reductions in spending with respect to the construction of desalination plants could negatively impact our sales and revenue and make it difficult for us to accurately forecast our future sales, which could lead to increased spending by us that is not matched by equivalent or higher revenue.
New planned seawater reverse osmosis projects can be cancelled and/or delayed, and cancellations and/or delays may negatively impact our revenue.
Planned seawater reverse osmosis desalination projects can be cancelled or delayed due to delays in, or failure to obtain, financing or the approval of or permitting for, plant construction because of political factors, adverse and increasingly uncertain financing conditions or other factors, especially in countries with political unrest. Even though we may have a signed contract to provide a certain number of PX devices by a certain date, if a customer requests a delay of shipment and we delay shipment of our PX devices, our results of operations and revenue will be negatively impacted.