Energy Recovery, Inc. (ERII)

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

Results of Operations

Overview

Energy Recovery, Inc. (the “Company”, “Energy Recovery”, “we”, “our” and “us”) designs and manufactures solutions that make

industrial processes more efficient and sustainable.  Leveraging our pressure exchanger technology, which generates little to no emissions

when operating, we believe our solutions lower costs, save energy, reduce waste, and minimize emissions for companies across a variety of

commercial and industrial processes.  As the world coalesces around the urgent need to address climate change and its impacts, we are

helping companies reduce their energy consumption in their industrial processes, which in turn, reduces their carbon footprint.  We believe

that our customers do not have to sacrifice quality and cost savings for sustainability and we are committed to developing solutions that drive

long-term value – both financial and environmental.

The original product application of our technology, the PX® Pressure Exchanger® (“PX”) energy recovery device, was a major

contributor to the advancement of seawater reverse osmosis desalination (“SWRO”), significantly lowering the energy intensity and cost of

water production globally from SWRO.  Our pressure exchanger technology is being applied to the wastewater filtration market, such as

battery manufacturers, mining operations, municipalities, and other manufacturing plants that discharge wastewater with significant levels of

metals and pollutants.

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 enhance environmental sustainability and improve productivity by reducing waste and energy

consumption in high-pressure industrial fluid-flow systems.  This versatile technology works as a platform to build product applications and is

at the heart of many of our products.  In addition, we have engineered and developed ancillary devices, such as our hydraulic turbochargers

and circulation “booster” pumps, that complement our energy recovery devices.

Segments

Our reportable operating segments consist of the Desalination and Wastewater segments. 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.  Other factors for determining the reportable operating segments include the manner in which our Chief Operating Decision Maker

(“CODM”), our Interim President and Chief Executive Officer, evaluates our performance combined with the nature of the individual business

activities.  In addition, our Corporate and Other include expenditures in support of the Desalination and Wastewater segments, as well as

revenue and expenditures associated with the former Emerging Technologies segment.  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.

During the six months ended June 30, 2026, we changed the composition of our reportable segments to better reflect how the CODM

manages the business. During the fist quarter of fiscal 2026, the Water segment was separated into two segments, the Desalination segment

and the Wastewater segment. During the first quarter of fiscal 2026, the CO2 retail grocery business within the Emerging Technologies

segment was wound-down, which resulted in the Emerging Technologies segment no longer meeting the criteria of a reportable segment as

of the second quarter of fiscal 2026. As a result, revenue and expenses associated with the former Emerging Technologies segment have

been included within Corporate and Other.  Prior periods have been recast to conform to the current year presentation.

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Results of Operations

A discussion regarding our financial condition and results of operations for the three and six months ended June 30, 2026, compared

to the three and six months ended June 30, 2025, is presented below.

Revenue

As a significant portion of our revenue is derived from large project contract deliveries that are up to 36 months from contract date,

variability in revenue from quarter to quarter is typical, therefore year-on-year comparisons are not necessarily indicative of the trend for the

full year due to these variations.  There is no specific seasonality in our revenues to highlight.

Revenue by Channel Customers

Revenue Attributable to Primary Geographical Markets by Segments

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Three months ended June 30, 2026, as compared to the three months ended June 30, 2025

The decrease in Original Equipment Manufacturer (“OEM”) revenue of $3.2 million was due primarily to:

•Desalination: The decrease in revenue of $1.3 million was due primarily to lower shipments of products to the Asia and Africa

markets, partially offset by higher shipments of products to the America, Europe and Middle East markets.

•Wastewater: The decrease in revenue of $1.9 million was due primarily to lower shipments of products to the Asia markets.

The decrease in After Market (“AM”) revenue of $0.8 million was due primarily to lower shipment of products to the Europe and Asia

markets, partially offset by higher shipments of products to the Middle East market.

The decrease in Megaproject (“MPD”) revenue of $12.1 million was primarily due to lower shipments of products to the Europe,

Middle East and Asia markets.

Six months ended June 30, 2026, as compared to the six months ended June 30, 2025

The decrease in OEM revenue of $0.6 million was due primarily to:

•Desalination: The increase in revenue of $0.8 million was due primarily to higher shipments of products to the Europe, Middle

East and Africa markets, partially offset by lower shipments of products to the Asia market.

•Wastewater: The decrease in revenue of $1.4 million was due primarily to lower shipments of products to the Asia market.

The decrease in AM revenue of $2.1 million was primarily due to lower shipments to the Asia and Europe markets.

The decrease in MPD revenue of $11.8 million was due primarily to lower shipments to the Europe, Asia and Middle East markets.

Concentration of Revenue

See Note 10, “Concentrations,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1, “Financial Statements

(unaudited),” of this Quarterly Report on Form 10-Q (the “Notes”) for further discussion regarding our concentration of revenue.

Gross Profit and Gross Margin

Gross profit represents revenue less cost of revenue.  Cost of revenue consists primarily of raw materials, personnel costs (including

stock-based compensation), manufacturing overhead, warranty costs, and depreciation expense.

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The decrease in gross profit for the three months ended June 30, 2026, as compared to the prior year, was due primarily to lower

volume as compared to the prior year, partially offset by decreases to indirect manufacturing costs and channel mix.

The increase in gross margin for the three months ended June 30, 2026, as compared to the prior year, was due primarily to indirect

manufacturing costs and channel mix, partially offset by lower volume.

The decrease in gross profit and gross margin for the six months ended June 30, 2026, as compared to the prior year, was due

primarily to lower volume as compared to the prior year as well as $1.6 million of restructuring charges booked to inventory associated with

the wind down of the CO2 retail grocery business, as well as increased costs related to product and channel mix, pricing, and tariffs, partially

offset by improvements to indirect manufacturing costs during the six months ended June 30, 2026.

Operating Expenses

The total material changes of general and administrative (“G&A”), sales and marketing (“S&M”) and R&D operating expenses for the

three months ended June 30, 2026, as compared to the comparable periods in the prior year, are discussed within the following overall

operating expenditures, and the segment and corporate operating expenses discussions below.

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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 Part II, Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K.

Overview

Our reportable operating segments consist of the Water and Emerging Technologies segments.  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 or, in the case of emerging technologies, where revenues from new and/or potential devices utilizing our pressure exchanger

technology can be brought to market.  Other factors for determining the reportable operating segments include the manner in which

management evaluates the performance of the Company combined with the nature of the individual business activities.  In addition, our

corporate operating expenses include expenditures in support of the water and emerging technologies segments, as well as R&D

expenditures applicable to potential future industry verticals, or enabling technologies that could benefit either or both existing business units.

On February 25, 2026, we decided to wind down operations of the CO2 retail grocery business within our Emerging Technologies

segment due to a fundamental change in the outlook of the business.  See Note 13, “Subsequent Events,” of the Notes for further discussion

regarding the wind down.

Global Economic and Political Environment Considerations

The markets for our products are dynamic and constantly evolving.  Our products are sold in numerous countries worldwide, with a

large percentage of our sales generated outside the U.S., specifically in the Middle East, Africa and Asia markets which provide a significant

portion of our total revenue.  Therefore, we are exposed to and impacted by global macroeconomic factors, U.S. and foreign government

policies and foreign exchange fluctuations.  There is uncertainty surrounding macroeconomic factors in the U.S. and globally characterized by

the supply chain environment, inflationary pressure, rising interest rates, and labor shortages.  These global macroeconomic factors, coupled

with the U.S. political climate, political unrest internationally, and known conflicts in Europe and the Middle East, have created global

economic and political uncertainty, and have impacted demand for certain of our products.  While the impact and longevity of these factors

remain uncertain, we are constantly evaluating the extent to which these factors will impact our business, financial condition or results of

operations.

Over the long-term, demand for our energy recovery devices could correlate to global macroeconomic and geopolitical factors.  Any

disruption to the economic factors and regulations in these regions, which remain uncertain, may adversely affect our results of operations

and financial condition.

Refer to Part I, Item 1, “Business,” and Part I, Item 1A, “Risk Factors,” in this Annual Report on Form 10-K for further discussion of

these trends and other risks.

Results of Operations

A discussion regarding our financial condition and results of operations for the year ended December 31, 2024, compared to the year

ended December 31, 2023, can be found under Item 7 in our Annual Report on Form 10-K for the year ended December 31, 2024, filed with

the SEC on February 26, 2025, which is available free of charge on the SEC’s website at http://www.sec.gov and at our investor relations

website (https://ir.energyrecovery.com).

Revenue

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As a significant portion of our revenue is derived from large project contract deliveries that are up to 36 months from contract date,

there is no specific seasonality in our revenues to highlight.

We generally track our revenues by channels.  The channels we recognize and channel definitions we utilize are as follows:

•Megaproject (“MPD”) channel: The MPD channel has been the main driver of our long-term growth as revenue from this channel

benefits from a growing number of projects as well as an increase in the capacity of these projects in some cases.  MPD projects

are large-scale in nature and generally have shipment timelines from 16 to 36 months from contract date.  Recognition of

revenue is dependent on customers’ project timing and execution of these projects.

•Original Equipment Manufacturer (“OEM”) channel: The OEM channel reflects sales to a wide variety of industries in the

desalination, wastewater, and the refrigeration markets.  This channel contains projects smaller in size and revenue, and of

shorter duration compared to those projects in the MPD channel.

•Aftermarket (“AM”) channel: The AM channel represents support and services rendered to our installed customer base.  AM

revenue generally fluctuates from year-to-year and is dependent on our customers’ timing of product upgrades, as well as their

replenishment of spare parts and supplies.

Revenue by Channel Customers

Revenue Attributable to Primary Geographical Markets by Segments

Year ended December 31, 2025, as compared to the year ended December 31, 2024

Revenues associated with our Water segment represented 99% of total revenues during the years ended December 31, 2025 and

2024. Revenues associated with our Emerging Technologies segment were immaterial.

The decrease in MPD revenue of $12.5 million was due primarily to lower shipments to the Africa and Asia markets, partially offset by

higher shipments of products to the Middle East and Europe markets.

The increase in OEM revenue of $0.4 million was primarily due:

•Desalination: The increase in revenue of $2.5 million was due primarily to higher shipments of products to the Asia market.

•Wastewater: The decrease in revenue of $2.1 million was due primarily to lower shipments of products to the Asia market.

The increase in AM revenue of $2.1 million was due primarily to higher shipments to the Asia and Middle East markets.

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Revenues attributable to domestic and international sales

Revenues are primarily attributable to international sales and are concentrated in the Middle East and Africa.  See Note 10,

“Concentrations – Revenue by Geographic Location and Country,” of the Notes for further discussion regarding our concentration of revenue

by geographic location.

Gross Profit and Gross Margin

Gross profit represents revenue less cost of revenue.  Cost of revenue consists primarily of raw materials, personnel costs (including

stock-based compensation), manufacturing overhead, warranty costs, and depreciation expense.

The decrease in gross profit and gross margin for the year ended December 31, 2025, as compared to the prior year, was due

primarily to lower sales volume spread over fixed costs, increased costs related to product and channel mix, pricing and tariffs, partially offset

by a decrease in indirect manufacturing costs during the year ended December 31, 2025.

Operating Expenses

The total material changes of general and administrative (“G&A”), sales and marketing (“S&M”) and R&D operating expenses for the

year ended December 31, 2025, as compared to the comparable period in the prior year, are discussed within the following overall operating

expenditures, and the segment and corporate operating expenses discussions below.

Year ended December 31, 2025, as compared to the year ended December 31, 2024

Overall Operating Expenditures.  Overall operating expenditures decreased by $13.2 million, or (17.1%).  This decrease was due

primarily to a decrease in employee costs, such as employee compensation and stock-based compensation, as well as lower Emerging

Technologies segment development costs, facility expenses and restructuring charges, partially offset by impairment costs associated with

the sublease of the Katy, Texas lease incurred during the year ended December 31, 2025.

Water Segment. Water segment related operating expenses represented 40% and 38% of overall operating expenses during the

years ended December 31, 2025 and 2024, respectively and decreased by $3.7 million, or (12.5%).  This decrease was due primarily to

lower employee costs, including stock-based compensation costs, and lower restructuring charges.

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Emerging Technologies Segment. Emerging Technologies segment related operating expenses represented 23% and 31% of overall

operating expenses during the years ended December 31, 2025 and 2024, respectively and decreased by $9.2 million, or (38.7%).  This

decrease was due primarily to lower employee costs, including stock-based compensation, lower development costs and lower restructuring

charges.

Corporate Operating Expenses.  Corporate operating expenses decreased by $0.3 million, or (1.3%).  This decrease was primarily

due to lower employee costs, such as employee compensation, partially offset by an increase in consulting costs and impairment costs

associated with the sublease of the Katy, Texas lease incurred during the year ended December 31, 2025.

Restructuring Charges.  During the fourth quarter of fiscal year 2024, we implemented a restructuring plan which included reductions

in our workforce in all functions of the organization, primarily within the G&A functi

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