Energy Recovery, Inc. (ERII) FY 2024 MD&A

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.

Economic Conditions, Challenges, and Risks

Sustainability

We released our fifth annual Sustainability Report, which details our efforts to accelerate the environmental sustainability of our

customers’ operations and enhance the management of sustainability issues in our own operations.  Our Sustainability Report provides data

illustrating our products’ positive environmental impacts across the industries where we operate.  We understand the importance of being a

responsible corporate citizen and believe our sustainability objectives provide us with a strategic roadmap to become a more resilient

business, as well as a way to maintain our competitive advantage.  Our 2023 Sustainability Report (issued in June 2024) outlines our

progress on those objectives and aligns to leading sustainability frameworks and reporting standards, including the United Nations

Sustainable Development Goals, the Sustainability Accounting Standards Board, and the Task Force on Climate-related Financial

Disclosures, as well as select disclosures from the Global Reporting Initiative.

As a result of our sustainability efforts and reporting, in 2024, MSCI ESG Research LLC (“MSCI”) once again awarded to us its

highest ESG rating of AAA.  MSCI’s evaluation recognizes Energy Recovery as one of the highest performing companies within the Industrial

Machinery industry in MSCI’s All Company World Index, reflecting robust corporate governance and labor management practices and

significant opportunities in clean technology.

Our complete 2023 Sustainability Report can be found on our website at: https://energyrecovery.com/sustainability/.  The foregoing

link to our 2023 Sustainability Report is an inactive textual reference, and our 2023 Sustainability Report is not incorporated by reference into,

and is not a part of, this Annual Report on Form 10-K.

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 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.

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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, 2023, compared to the year

ended December 31, 2022, can be found under Item 7 in our Annual Report on Form 10-K for the year ended December 31, 2023, filed with

the SEC on February 21, 2024, 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

As our revenue is derived from large project contract deliveries that are between 16 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

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Year ended December 31, 2024, as compared to the year ended December 31, 2023

The increase in MPD revenue of $11.7 million was due primarily to:

•Desalination: The increase in revenue of $8.9 million was due primarily to higher shipments of products to the Middle East and

Africa (“MEA”), Europe and Asia markets, partially offset by lower shipments of products to the Americas market.

•Wastewater: The increase in revenue of $2.8 million was due primarily to higher shipments of products to the MEA market.

The increase in OEM revenue of $5.5 million was primarily due to:

•Desalination: The increase in revenue of $2.7 million was due primarily to higher shipments of products to the MEA and Europe

markets, partially offset by lower shipments of products to the Americas and Asia markets.

•Wastewater: The increase in revenue of $3.0 million was due primarily to higher shipments of products to the Asia, Americas and

MEA markets.  The Asia market has seen considerable growth this last year as certain countries in this market implement climate

control regulations.

•Emerging Technology:  The decrease in revenue of $0.3 million was due primarily to our product installation in Europe and sales

to a gas producer in the Americas, both occurring in the prior year.

The decrease in AM revenue of $0.7 million was due primarily to lower shipments of parts and service to the MEA and Europe

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

Concentration of Revenue

See Note 10, “Concentrations – Revenue by Geographic Location and Country,” of the Notes to Consolidated Financial Statements in

Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K (the “Notes”) for further discussion

regarding our concentration of revenue.

Revenues attributable to domestic and international sales

Revenues attributable to domestic and international sales as a percentage of total revenue are presented in the following table.  See

Note 10, “Concentrations – Revenue by Geographic Location and Country,” of the Notes for further discussion regarding our concentration of

revenue by geographic location.

Customers accounting for 10% or more of revenues

The following table presents all customers accounting for 10% or more of our revenues.  Although certain customers might account

for greater than 10% of our revenues at any one point in time, the concentration of revenues between a limited number of large customers

shifts regularly, depending on timing of shipments.  The percentages by customer reflect specific relationships or contracts that would

concentrate our revenue for the periods presented and do not indicate a trend specific to any one customer.  See Note 10, “Concentrations –

Customer Revenue Concentration,” of the Notes for further discussion on customer concentration.

**Zero or less than 10%.

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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 increase in gross profit for the year ended December 31, 2024, as compared to the prior year, was due primarily to an increase in

sales of PXs and slightly higher average selling prices related to change in product mix, partially offset by a decrease in gross margin.  The

decrease in gross margin for the year ended December 31, 2024, as compared to the prior year, was due primarily to higher manufacturing

costs and scrap costs.

Operating Expenses

The total material changes of general and administrative (“G&A”), sales and marketing (“S&M”) and research and development

(“R&D”) operating expenses for the year ended December 31, 2024, 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, 2024, as compared to the year ended December 31, 2023

Overall Operating Expenditures.  Overall operating expenditures increased by $9.2 million, or 13.5%.  This increase was due primarily

to restructuring charges, and an increase in employee costs, such as employee compensation, stock-based compensation, severance and

recruiting costs, in G&A and S&M.  Changes in non-employee costs included:

•G&A:  higher consulting costs related to the enhancement of our corporate growth strategy; partially offset by lower dues and

subscription costs.

•S&M:  lower commission costs and lower one-time sustainability consulting costs that we incurred in fiscal year 2023.

•R&D:  lower Emerging Technologies segment development costs and depreciation costs.

Water Segment.  Water segment operating expenses increased by $3.8 million, or 14.7%.  This increase was due primarily

to restructuring charges, and higher employee compensation and benefit costs and stock-based compensation expense in S&M related to an

increase in headcount to support our existing desalination operations and our growth in wastewater.  In addition, non-employee operating

expenses were higher due primarily to an increase in consulting costs to support our growth in desalination and wastewater.  These

increases were partially offset by lower commission costs and depreciation expenses.

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Emerging Technologies Segment.  Emerging Technologies operating expenses increased by $1.0 million, or 4.3%.  This increase was

due primarily to restructuring charges, and an increase in S&M employee compensation and marketing costs, partially offset by lower R&D

costs.

Corporate Operating Expenses.  Corporate operating expenses increased by $4.4 million, or 22.5%.  This increase was due primarily

to higher employee compensation and benefit costs, and stock-based compensation expense, related to an increase in headcount in G&A,

an increase in recruiting costs, and an increase in stock-based compensation expense due to modification of certain equity awards and

higher severance payments and restructuring charges.  In addition, the increase in non-employee operating expenses was due primarily to

higher consulting costs related to the enhancement of our corporate growth strategy, partially offset by lower marketing costs and

depreciation expenses.

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

in workforce in all functions of the organization, primarily in our San Leandro location, in order to lower our operating cost structure, and to

position the Company for profitable growth. We expect to record an estimated restructuring charge of approximately $3.0 million, of which

$2.5 million was recorded during the fourth quarter of fiscal year 2024.  This charge was related to severance and benefits to 38 terminated

employees, which was approximately 15% of our workforce.  We expect the implementation of the restructuring plan will be substantially

complete by the end of the first quarter of fiscal year 2025.  See Note 4, “Other Financial Information – Restructuring,” of the Notes for further

discussion and disclosure on our restructuring program.

Other Income, Net

The increase in “Total other income, net” in the year ended December 31, 2024, as compared to the comparable period in the prior

year, was due primarily to an increase in short- and long-term investments.

Income Taxes

The higher provision for income taxes in 2024, as compared to the prior year, was due primarily to an increase in income from

operations, a decrease in tax benefit of $0.3 million related to Foreign Derived Intangible Income (“FDII”), and a decrease of $0.4 million in

R&D tax credits, partially offset by $0.7 million net change on the tax impact of stock-based compensation and executive compensation limits.

The fiscal year 2024 effective tax rate included a benefit of $2.1 million related to FDII, a benefit of $0.9 million related to R&D tax

credits and tax expense of $0.5 million related to stock-based compensation and executive compensation limits.  The fiscal year 2023

effective tax rate included a benefit of $2.4 million related to related to FDII, a benefit of $1.3 million related to R&D tax credits, and a benefit

of $0.7 million related to tax deductions from stock-based compensation related windfalls net of executive compensation limits.

See Note 8, “Income Taxes,” of the Notes for further discussion regarding further information related to our tax rate reconciliation.

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Liquidity and Capital Resources

Overview

From time-to-time, management and our Board of Directors (the “Board”) review our liquidity and future cash needs and may make a

decision to (1) return capital to our shareholders through a share repurchase program or dividend payout; or (2) seek additional debt or equity

financing.  As of December 31, 2024, our principal sources of liquidity consisted of (i) unrestricted cash and cash equivalents of $29.6 million

that are primarily invested in money market funds and U.S. treasury securities; (ii) investment-grade short-term and long-term marketable

debt instruments of $70.2 million that are primarily invested in U.S. treasury securities, corporate notes and bonds, and municipal and agency

notes and bonds; and (iii) accounts receivable, net of allowances, of $64.1 million.  As of December 31, 2024, there was unrestricted cash of

$1.0 million held outside the U.S.  We invest cash not needed for current operations predominantly in investment-grade, marketable debt

instruments with the intent to make such funds available for future operating purposes, as needed.  Although these securities are available for

sale, we generally hold these securities to maturity, and therefore, do not currently see a need to trade these securities in order to support our

liquidity needs in the foreseeable future.  We believe the risk of this portfolio to us is in the ability of the underlying companies or government

agencies to cover their obligations at maturity, not in our ability to trade these securities at a profit.  Based on current projections, we believe

existing cash balances and future cash inflows from this portfolio will meet our liquidity needs for at least the next 12 months.

Short-term Contract Assets

As of December 31, 2024, we had $2.8 million of short-term contract assets which represents unbilled trade receivables from certain

Water segment contract sales which include contractual holdback provisions, pursuant to which we will invoice the final retention payment

due within the next 12 months.  The customer holdbacks represent amounts intended to provide a form of security for the customer; and

accordingly, these contract assets have not been discounted to present value.

Credit Agreement

We entered into a credit agreement with JPMorgan Chase Bank, N.A. (“JPMC”) on December 22, 2021 (as amended, the “Credit

Agreement”).  The Credit Agreement, which will expire on December 21, 2026, provides a committed revolving credit line of $50.0 million and

includes both a revolving loan and a letters of credit (“LCs”) component. The maximum allowable LCs under the credit line component of the

Credit Agreement is $30.0 million.  As of December 31, 2024, we were in compliance with all covenants under the Credit Agreement.

Under the Credit Agreement, as of December 31, 2024, there were no revolving loans outstanding.  In addition, as of December 31,

2024, under the LCs component, we utilized $18.4 million of the maximum allowable credit line of $30.0 million, which included newly

issued LCs, and previously issued and unexpired stand-by letters of credits (“SBLCs”) and certain non-expired commitments under the

previous Loan and Pledge Agreement with Citibank, N.A., which are guaranteed under the Credit Agreement.  As of December 31, 2024,

there was $15.7 million of outstanding LCs.  These LCs had a weighted average remaining life of approximately 17 months.

See Note 6, “Lines of Credit,” of the Notes for further discussion related to the Credit Agreement.

Letters of Credit

From time-to-time, we enter into LCs related to our product warranty and performance guarantees.  As of December 31, 2024,

outstanding LCs totaled $15.7 million.  See Note 6, “Lines of Credit – Letters of Credit,” of the Notes for further discussion related to LCs and

Note 7, “Commitments and Contingencies – Guarantees,” of the Notes for further discussion related to performance guarantees.

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Share Repurchase Program

The Board, from time-to-time, has authorized a share repurchase program under which we may, at our discretion, repurchase the

Company’s outstanding common stock in the open market, or in privately negotiated transactions, in compliance with applicable state and

federal securities laws.  The timing and amounts of any purchase under the share repurchase programs are based on market conditions and

other factors including price, regulatory requirements, and capital availability.  We account for stock repurchases under these programs using

the cost method.  As of December 31, 2024, we have cumulatively repurchased 11.4 million shares of the Company’s common stock at an

aggregate cost of $130.5 million under all closed share repurchase programs.  The following is a discussion of the share repurchase

programs during the last 3-years ended December 31, 2024.  See Part II, Item 5, “Market for Registrant’s Common Equity, Related

Stockholder Matters and Issuer Purchases of Equity Securities – Share Repurchase Program,” included in this Annual Report on Form 10-K

for discussion of shares repurchased in the fourth quarter of fiscal year 2024 and Note 11, “Stockholders’ Equity – Share Repurchase

Program,” of the Notes for further discussion related to share repurchase programs and a reconciliation of the latest share repurchase plan

balance.

On March 11, 2021, we announced that the Board authorized a share repurchase program under which we may repurchase, at

management’s discretion, up to $50.0 million in aggregate cost, which includes both the share value of the acquired common stock and the

fees charged in connection with acquiring the common stock (the “March 2021 Authorization”).  On July 1, 2022, we concluded all share

repurchases under the March 2021 Authorization.  Under the March 2021 Authorization, we repurchased 2,692,577 shares of our common

stock at an aggregate cost of approximately $50.0 million.

On November 18, 2024, we announced that the Board authorized a share repurchase program under which we may repurchase our

outstanding common stock, at the discretion of management, up to $50.0 million in aggregate cost, which includes both the share value of the

acquired common stock and the fees charged in connection with acquiring the common stock (the “November 2024 Authorization”).  On

December 11, 2024, the Company concluded all share repurchases under the November 2024 Authorization.  Under the November 2024

Authorization, we repurchased 3,248,533 shares of our common stock at an aggregate cost of approximately $50.0 million.

On February 26, 2025, we announced that the Board authorized a share repurchase program under which we may repurchase our

outstanding common stock, at the discretion of management, up to $30.0 million in aggregate cost, which includes both the share value of the

acquired common stock and the fees charged in connection with acquiring the common stock (the “February 2025 Authorization”).  We

expect to commence repurchasing our outstanding common stock after March 4, 2025.

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Cash Flows

Cash Flows from Operating Activities

Net cash provided by operating activities is subject to the project driven, non-cyclical nature of our business.  Operating cash flow can

fluctuate significantly from year to year, due to the timing of receipts of large project orders.  Operating cash flow may be negative in one year

and significantly positive in the next, consequently individual reporting period results and comparisons may not necessarily indicate a

significant trend, either positive or negative.

The higher net cash used for operating assets and liabilities for the year ended December 31, 2024, as compared to the prior year,

was due primarily to the following factors:

•Accounts receivable and contract assets: an increase in cash used primarily due to an increase in revenues late in the fourth

quarter of 2024 resulting in increased billed and unbilled receivables.  In addition, our collections efforts have been timely

throughout the year;

•Accounts payables: a decrease in cash provided was primarily due to the timing of payments and vendor invoices received; and

•Accrued liabilities: an increase in cash provided was primarily due to the accrual of restructuring related costs.

Cash Flows from Investing Activities

Net cash used in investing activities primarily relates to sales, maturities and purchases of investment-grade marketable debt

instruments, such as corporate notes and bonds, and capital expenditures supporting our growth.  We believe our investments in marketable

debt instruments are structured to preserve principal and liquidity while at the same time maximizing yields without significantly increasing

risk.  The lower net cash used in investing activities of $3.5 million in the year ended December 31, 2024, as compared to the prior year, was

primarily driven by lower net cash used for purchases of marketable debt instruments of $2.1 million and lower capital expenditures of

$1.3 million.

Cash Flows from Financing Activities

Net cash used in financing activities for the year ended December 31, 2024, as compared to the cash provided by financing activities

in the prior year, was due primarily to an increase in cash used for the repurchase of our common stock under the November 2024

Authorization, partially offset by a net increase of cash from exercises of employee stock options granted under our equity incentive plans.

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Liquidity and Capital Resource Requirements

We believe that our existing resources and cash generated from our operations will be sufficient to meet our anticipated capital

requirements for at least the next 12 months.  However, we may need to raise additional capital or incur additional indebtedness to continue

to fund our operations or to support acquisitions in the future and/or to fund investments in our latest technology arising from rapid market

adoption.  These needs could require us to seek additional equity or debt financing.  Our future capital requirements will depend on many

factors including the continuing market acceptance of our products, our rate of revenue growth, the timing of new product introductions, the

expansion of our R&D, manufacturing and S&M activities, and the timing and extent of our expansion into new geographic territories.  In

addition, we may enter into potential material investments in, or acquisitions of, complementary businesses, services or technologies in the

future which could also require us to seek additional equity or debt financing.  Should we need additional liquidity or capital funds, these funds

may not be available to us on favorable terms, or at all.

Facility and Equipment Leases.  We lease facilities and equipment under fixed noncancelable operating leases that expire on various

dates through fiscal year 2030.  See Note 7, “Commitments and Contingencies – Operating Lease Obligations,” of the Notes for additional

information related to our fixed noncancelable operating leases.

Purchase Order Arrangements.  We have purchase order arrangements with our vendors for which we have not received the related

goods or services.  These arrangements are subject to change based on our sales demand forecasts.  We have 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.  See Note 7, “Commitments and Contingencies – Purchase Obligations,” of the Notes for additional information

related to our purchase order arrangements.

Off-balance Sheet Arrangements.  During the periods presented, we did not have any relationships with unconsolidated entities or

financial partnerships such as entities often referred to as structured finance or special purpose entities which would have been established

for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates

Our Consolidated Financial Statements are prepared in accordance with U.S. GAAP.  These accounting principles require us to make

estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the Consolidated Financial

Statements as well as the reported amounts of revenue and expense during the periods presented.  We believe that the estimates and

judgments upon which we rely are reasonable based upon information available to us at the time that we make these estimates and

judgments.  To the extent that there are material differences between these estimates and actual results, our consolidated financial results

will be affected.  The accounting policies that reflect our more significant estimates and judgments and which we believe are the most critical

to aid in fully understanding and evaluating our reported financial results are revenue recognition; valuation of stock options; valuation and

impairment of goodwill; inventory; and deferred taxes and valuation allowances on deferred tax assets.

The following is not intended to be a comprehensive list of all of our accounting policies or estimates.  See Note 1, “Description of

Business and Significant Accounting Policies,” of the Notes for further detailed discussion regarding our accounting policies and estimates.

Revenue Recognition

Revenues are recognized when control of the promised goods or services is transferred to our customers in an amount that reflects

the consideration we expect to be entitled to in exchange for those goods or services.  At the inception of each contract, performance

obligations are identified and the total transaction price is allocated to the performance obligations.  Our contracts with customers may

include multiple performance obligations.  For such arrangements, we allocate revenue to each performance obligation based on its relative

stand-alone selling price.  We generally determine stand-alone selling prices based on the prices charged to customers.  With respect to

termination, we do not have the ability to cancel a contract for convenience.  In general, customers can cancel for convenience upon the

payment of a termination fee that covers costs and profit.  It is rare for customers to cancel contracts.  See Note 1, “Description of Business

and Significant Accounting Policies – Significant Accounting Policies – Revenue Recognition (Product and Service Revenue Recognition),” of

the Notes for more detail on product and service revenue recognition.

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Stock-based Compensation

We account for stock-based compensation according to U.S. GAAP relating to stock-based payments, which requires the

measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair

values on the grant date.  The fair value of stock options is calculated on the date of grant using a Black-Scholes (also referred to as the

“Black-Scholes-Merton”) model, which requires a number of complex assumptions including the expected life to exercise a vested award

based upon the Company’s exercise history, expected volatility based upon the Company’s historical stock prices, risk-free interest rate

based upon the U.S. Treasury rates, and the Company’s dividend yield.  See Note 1, “Description of Business and Significant Accounting

Policies – Significant Accounting Policies – Stock-based Compensation” and Note 12, “Stock-based Compensation,” of the Notes for further

discussion of our accounting policy and stock-based compensation activities, respectively.

Goodwill

Our goodwill represents the excess of the purchase price of a business combination over the fair value of the net assets acquired.

Goodwill impairment testing requires significant judgment and management estimates, including, but not limited to, the determination of (i) the

number of reporting units, (ii) the goodwill and other assets and liabilities to be allocated to the reporting units and (iii) the fair values of the

reporting units.  The estimates and assumptions described above, along with other factors such as discount rates, will significantly affect the

outcome of the impairment tests and the amounts of any resulting impairment losses.  We perform a quantitative assessment of goodwill for

impairment on an annual basis during the third quarter of each year, and between annual tests, a qualitative assessment whenever events or

changes in circumstances indicate that the carrying amount may not be recoverable.  If these interim qualitative factors were to indicate that it

is more-likely-than-not that the fair value of the reporting unit is less than its carrying value, we would then perform a quantitative assessment,

which would consist primarily of a discounted cash flow analysis to determine the fair value of the reporting unit’s goodwill.  To the extent the

carrying amount of the reporting unit’s allocated goodwill exceeds the unit’s fair value, we recognize an impairment of goodwill for the excess

up to the amount of goodwill of that reporting unit.  See Note 1, “Description of Business and Significant Accounting Policies – Significant

Accounting Policies – Goodwill” and Note 4, “Other Financial Information – Goodwill,” of the Notes for further discussion of our accounting

policy and goodwill activities, respectively.

Inventories

We determine at each balance sheet date how much, if any, of our inventory may ultimately prove to be either unsalable or unsalable

at its carrying cost.  Reserves are established to effectively adjust the carrying value of such inventory to lower of cost (first-in, first-out

method) or net realizable value.  See Note 1, “Description of Business and Significant Accounting Policies – Significant Accounting Policies –

Inventories” and Note 4, “Other Financial Information – Inventories, net,” of the Notes for further discussion of our accounting policy and

estimates, and inventory activities, respectively.

Income Taxes

Our annual tax rate is determined based on our income and the jurisdictions where it is earned, statutory tax rates, and the tax

impacts of items treated differently for tax purposes than for financial reporting purposes.  Also inherent in determining our annual tax rate are

judgments and assumptions regarding the recoverability of certain deferred tax balances, and our ability to uphold certain tax positions.  We

are subject to complex tax laws, in the U.S. and numerous foreign jurisdictions, and the manner in which they apply can be open to

interpretation.  Realization of deferred tax assets is dependent upon generating sufficient taxable income in the appropriate jurisdiction in

future periods, which involves business plans, planning opportunities, and expectations about future outcomes.  Our assessment relies on

estimates and assumptions, and may involve a series of complex judgments about future events.  We use an estimate of our annual effective

tax rate at each interim period based on the facts and circumstances available at that time, while the actual effective tax rate is calculated at

year-end.  See Note 1, “Description of Business and Significant Accounting Policies – Significant Accounting Policies – Income Taxes” and

Note 8, “Income Taxes,” of the Notes for further discussion of our income tax policy and our tax valuation allowance, respectively.

Recent Accounting Pronouncements

Refer to Note 1, “Description of Business and Significant Accounting Policies – Recently Issued Accounting Pronouncement Not Yet

Adopted,” of the Notes.

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