Consolidated Water Co. Ltd. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars. The company supplies potable water, treats water and builds, operates and manufactures water infrastructure across the Cayman Islands, The Bahamas, the United States and the British Virgin Islands.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $17.67 million | $15.89 million | $57.48 million | $51.18 million |
| Gross profit / margin | $6.22 million / 35% | $6.71 million / 42% | $21.96 million / 38% | $21.22 million / 41% |
| Operating income | $1.40 million | $2.44 million | $7.90 million | $9.28 million |
| Continuing income attributable to company shareholders | $1.81 million | $2.26 million | $7.64 million | $8.56 million |
| Total income attributable to company shareholders, including discontinued operations | $1.43 million | $1.73 million | $3.20 million | $10.39 million |
| Basic and diluted EPS | $0.09 | $0.11 | $0.21 | $0.69 |
| Operating cash flow, continuing operations | Not separately provided | Not separately provided | $11.91 million | $12.04 million |
Revenue increased year over year, principally because PERC, acquired in late October 2019, contributed $3.24 million in Q3 and $9.61 million year to date. This growth did not translate into higher operating income: reported gross margin narrowed, while revenue and profitability in the retail and bulk businesses weakened. Management attributed the lower Q3 gross margin mainly to the revenue mix and reduced gross profit in retail and bulk.
For the nine months, total shareholder income fell sharply in part because discontinued operations recorded a $4.45 million loss in 2020, while 2019 included a $3.62 million gain on the sale of CW-Belize. Continuing-operations shareholder income and EPS also declined versus 2019.
Liquidity, cash flow and debt
- Cash and cash equivalents were $38.18 million at September 30, 2020, down from $42.07 million at December 31, 2019. Working capital was $63.8 million.
- Total operating cash flow, including discontinued operations, was $10.52 million, broadly unchanged from $10.53 million in the prior-year period. Investing activities used $10.97 million, including $8.5 million to buy the remaining Aerex interest and $0.9 million to increase ownership of PERC. Financing activities used $3.87 million, almost all for dividends.
- Reported long-term debt was approximately $178,000, excluding operating lease liabilities. Operating lease obligations totaled approximately $1.62 million, of which $545,000 was current.
- Management estimated remaining-2020 capital expenditures for existing operations of about $150,000 and dividends payable of about $1.3 million. It said it expected sufficient liquidity for its needs, subject to the CW-Bahamas collection risk.
Material changes and operating developments
- Retail: Q3 revenue fell 20% to $4.99 million as water volume declined 18%, reflecting the halt in Cayman tourism. Nine-month revenue declined 9% to $18.22 million as volume fell 8%. Retail operations reported a Q3 operating loss of $0.96 million and a nine-month operating loss of $0.13 million.
- Bulk: Q3 revenue decreased to $6.06 million; gross margin fell to 27% from 34%. For the nine months, revenue decreased to $18.37 million and operating income to $4.53 million from $5.66 million. Lower rates on newer Water Authority-Cayman contracts and lower energy pass-through revenue in The Bahamas weighed on results; repairs and maintenance also affected margins.
- Services: PERC drove most of the segment’s revenue increase. Q3 services revenue was $3.35 million, versus $96,000 a year earlier; nine-month revenue was $9.94 million, versus $287,000. The comparison reflects PERC’s addition to the consolidated results.
- Manufacturing: Q3 revenue rose to $3.26 million and gross margin improved to 40% from 37%, reflecting project mix. Nine-month revenue increased to $10.95 million and gross margin to 37% from 33%.
- Ownership transactions: The company acquired Aerex’s remaining 49% interest for $8.5 million in January 2020 and an additional 10% of PERC for $0.9 million in August, bringing PERC ownership to 61%.
Outlook, risks and unusual items
- COVID-19: Management said the pandemic materially adversely affected results and expects continued adverse effects, but could not quantify their duration or future financial impact. Cayman and Bahamian tourism closures reduced retail demand; the company also warned of collection and liquidity effects and potential impairment risk.
- Mexico desalination project: Baja California terminated the Rosarito project contract on June 29, 2020, citing cost and economic feasibility concerns. The company recorded a $3.0 million impairment on project rights-of-way and reclassified NSC and AdR and project activity to discontinued operations. It is marketing the project land and pursuing reimbursement. Its August claim listed $51.1 million plus MXN 137.3 million in non-recoverable expenses; the filing gives no assurance that any reimbursement will be received.
- Cayman retail license: The express extension of the exclusive license expired January 31, 2018; negotiations with OfReg remain ongoing. The government has indicated it seeks changes that could materially reduce or eliminate the historical income and cash flow from the retail business. The licensed retail operation represented 32% of nine-month revenue and 45% of gross profit.
- Bahamas receivables: CW-Bahamas had $18.4 million due from the Water and Sewerage Corporation at September 30, with about 77% delinquent. No allowance was recorded, based on prior collection history. The company warned that continued delays could constrain subsidiary liquidity, require an allowance, or affect revenue recognition. The balance was about $15.1 million at October 31.
- Aerex concentration: One customer generated about 84% of Aerex revenue and 86% of its gross profit in the first nine months. In October, after the quarter ended, the customer verbally advised it expected to suspend purchases after Q4 2020 for about a year and currently expected to resume in Q1 2022. Management warned that 2021 manufacturing revenue and gross profit could decline and that future goodwill impairment is possible; its September 30 manufacturing reporting-unit valuation exceeded carrying value by about 22%.
- Other contracts and litigation: About 25% of PERC’s nine-month revenue came from operations and maintenance contracts expiring through July 2021, with renewals at customer discretion. Separate Mexican litigation over NSC ownership was referred to arbitration in October 2020; management said the financial impact cannot presently be determined.
- Guidance: The filing provides no specific earnings or revenue guidance. Management’s outlook is cautionary and highlights pandemic uncertainty, tourism recovery, license negotiations, receivable collections, contract renewals and Aerex customer concentration.
Investor verification priorities
- Track Cayman retail-license negotiations, renewal terms and any change to the company’s exclusive service rights.
- Monitor collections from the Bahamian utility, the delinquent balance and whether an allowance or revenue-recognition change becomes necessary.
- Verify the status and recoverability of the Mexico project’s claimed expenses and the marketability/value of its land.
- Assess the impact of the Aerex customer’s expected purchasing pause on 2021 results, diversification efforts and goodwill impairment assumptions.
- Review the pace of Cayman and Bahamas tourism/economic recovery and the related effects on water volumes, receivables and cash flow.
- Follow PERC contract renewals and margins, and compare continuing-operations performance with reported results that include discontinued operations.