Consolidated Water Co. Ltd. — Q2 2014 Form 10-Q
Business context and reporting period. The company produces and supplies desalinated water in the Caribbean and Indonesia, and provides desalination engineering, construction and operating services. This unaudited filing covers the quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Amounts are in U.S. dollars.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $16.93 million | $16.57 million | $33.28 million | $33.12 million |
| Gross profit (margin) | $6.37 million (38%) | $6.40 million (39%) | $12.34 million (37%) | $12.62 million (38%) |
| Operating income | $2.59 million | $2.80 million | $3.22 million | $5.45 million |
| Net income attributable to company shareholders | $2.76 million | $2.85 million | $3.41 million | $6.60 million |
| Diluted EPS | $0.19 | $0.19 | $0.23 | $0.45 |
| Operating cash flow | Not separately presented for the quarter | $21.98 million | $6.54 million |
Quarterly revenue rose about 2%, while shareholder net income declined about 3%. For the six months, revenue was nearly flat, but shareholder net income fell about 48%. The decrease reflected higher general and administrative expense—especially NSC’s Mexico project development costs—and substantially lower OC-BVI earnings and profit sharing. The 2013 comparison included OC-BVI income related to the Baughers Bay litigation award. Six-month G&A was $9.12 million versus $7.16 million; operating margin declined to about 10% from 16%.
Segments. Retail revenue increased, but retail operating income declined to $0.83 million for the half-year from $1.56 million, amid higher repairs, depreciation, legal fees and losses at the underutilized Bali plant. Bulk revenue decreased slightly; bulk operating income increased to $5.16 million from $5.02 million, with improved Cayman margins partly offset by lower Bahamas sales. Services revenue increased, but its operating loss widened to $2.77 million from $1.13 million, principally because of NSC development spending; management expects services losses to continue absent significant new contracts or a change in NSC funding activity.
Balance sheet, liquidity and debt
- At June 30, cash and cash equivalents were $34.44 million; working capital was approximately $38.9 million. Total assets were $162.01 million and total liabilities $18.90 million.
- Cash from operations was $21.98 million for the half-year. Investing activities used $23.49 million, including $17.43 million for Mexico land and $5.0 million placed in a certificate of deposit. Financing provided $2.32 million, including a new $10.0 million demand loan, partly offset by debt repayments and dividends.
- The company paid off the remaining bonds in February. The new $10.0 million loan, used to fund NSC land purchases, bears interest at LIBOR plus 1.5%, is payable on demand, and is secured by substantially all company assets in the Cayman Islands. If not called, it has quarterly payments on a five-year amortization schedule, with the remaining balance due after two years.
- Management estimated remaining-2014 requirements of approximately $4.3 million for existing-operations capital expenditure, $1.1 million for demand-loan debt service and $2.5 million for NSC development, in addition to any declared dividends. Management stated it expected sufficient liquidity for 2014 and thereafter.
Material developments, outlook and risks
- Cayman retail license: The license is significant, producing about 38% of first-half revenue and 55% of gross profit. Following a June court ruling that the Water Authority-Cayman is the proper negotiating entity and public bidding is not required, negotiations were expected to resume. The license was extended through December 31, 2014 after quarter-end. A less favorable renewal or loss of the exclusive license could materially affect earnings and cash flow and could trigger goodwill impairment.
- Mexico development project: NSC owns 99.9% and is pursuing a proposed 100-million-gallon-per-day desalination plant and pipeline. The company reported approximately $34.2 million spent on the project by June 30. Development still requires permits, customer contracts, water and power arrangements, rights-of-way and project financing; the company estimated development could continue at least through Q1 2015 and cautioned the project may not reach construction. NSC paid $17.4 million for land in May and the company expects further funding needs.
- NSC tax contingency: Mexican authorities assessed about 5.74 million pesos, or approximately $442,000, including penalties and surcharges. NSC is contesting the assessment; no provision was recorded because the outcome and any amount payable could not be determined. Restricted cash of $515,849 secures a letter of credit.
- OC-BVI: Its sole customer is the BVI government. The company’s investment carrying value was $6.09 million, including approximately $2.8 million of underlying goodwill. The valuation depends on assumptions about the Bar Bay contract, including a possible seven-year extension, and a pending Baughers Bay plant valuation. Management warned that future impairment could be required, potentially materially affecting earnings.
- Other contract and regulatory exposure: The Bahamas Windsor plant agreement continues month-to-month after the contracted volume was delivered in July 2013; its future term and pricing are uncertain. A Belize regulatory dispute remains pending under a temporary injunction, with no loss provision recorded. The Baughers Bay appellate award has been paid, but the parties have not agreed on the value of the transferred plant.
- Management cited tourism and weather, regional economies, government relationships, regulation, and success in entering new markets as key uncertainties. It reported no material change in market-risk exposure and concluded disclosure controls were effective, with no material change in internal control over financial reporting.
Most important facts for investors to verify
- Progress and economic terms of the Cayman retail-license negotiations before the December 31, 2014 extension expires.
- NSC’s future funding requirements, customer commitments, permits and financing—and whether the proposed project advances toward construction.
- Repayment or any lender demand for the $10.0 million secured demand loan, and the company’s liquidity after planned spending and dividends.
- Developments in the NSC tax appeal, Belize regulatory matter, Windsor contract and Baughers Bay valuation.
- OC-BVI’s contract outlook and whether its assumptions continue to support the $6.09 million carrying value and avoid further impairment.