Consolidated Water Co. Ltd. quarterly report, Q1 FY2018

Consolidated Water Co. Ltd. — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; compared with the three months ended March 31, 2017. Amounts are in U.S. dollars unless stated otherwise. The company produces and supplies desalinated water and provides water-related manufacturing and services.

Financial results and position

Metric	Q1 2018	Q1 2017 / prior date
Revenue	$15.34 million	$15.68 million
Gross profit / margin	$6.60 million / 43%	$6.83 million / 44%
Operating income	$1.84 million	$2.05 million
Net income attributable to company stockholders	$2.09 million; diluted EPS $0.14	$2.63 million; diluted EPS $0.18
Operating cash flow	$679,000 provided	$719,000 used
Capital additions	$2.87 million	$1.77 million
Cash and cash equivalents	$43.68 million	$47.18 million at Dec. 31, 2017
Total assets / liabilities	$165.91 million / $8.95 million	$165.48 million / $9.46 million at Dec. 31, 2017

Working capital was approximately $58.6 million. The balance sheet reports a $294,000 current note payable to a related party and no other significant borrowing balance is identified in the presented figures. Cash declined by $3.50 million during the quarter, primarily reflecting capital spending and dividends. Dividends declared per common share were $0.085, versus $0.075 in Q1 2017.

Changes and operating drivers

• Revenue declined about 2%, while stockholder-attributable net income fell about 20%. Lower manufacturing revenue was the main factor in the revenue decline; the prior-year quarter included more external manufacturing work.
• Retail revenue was slightly lower despite water volume sold increasing approximately 3%; management attributed the difference to a shift toward larger customers with lower effective rates. Retail operating income fell to $523,000 from $789,000.
• Bulk revenue increased to $8.23 million from $7.69 million, including approximately $555,000 of incremental Bahamas revenue associated with higher diesel and electricity prices. Higher energy expense also pressured bulk gross margin.
• Manufacturing revenue declined to $553,000 from $1.38 million. Aerex performed approximately $700,000 of work for affiliate CW-Bahamas, but that intercompany revenue was eliminated in consolidation; manufacturing operating loss widened to $515,000.
• Services continued to report an operating loss, though it narrowed to $662,000 from $715,000.
• Other income was lower, mainly because the Aerex put/call option valuation produced a $206,000 unrealized loss, compared with a $165,000 gain in Q1 2017.

Operating cash flow improved year over year, but the comparison is affected by adoption of cash-flow guidance that reclassified approximately $1.1 million of 2017 OC-BVI distributions from investing to operating activities.

Liquidity, outlook and material matters

• Management expects approximately $14.4 million of capital expenditures over the remaining three quarters of 2018, principally for the Windsor plant in the Bahamas and expansion of the Abel Castillo Water Works plant in Grand Cayman. It also anticipates about $2.8 million of Mexican project-development spending, approximately $294,000 of note payments and about $1.3 million of dividends payable. Management stated it expects sufficient liquidity for 2018 and thereafter.
• Some cash is restricted in practice: transfers from Bahamas and Belize accounts require central-bank approval. Approximately $11.9 million was held in the Bahamas and $6.0 million in Belize at quarter-end. The company reported difficulty repatriating Belize funds; $307,000 was transferred to the parent in Q1.
• The Cayman retail license extension expired January 31, 2018. The company continued service assuming an extension while negotiations with OfReg continued. The licensed retail business generated about 42% of consolidated revenue and 55% of gross profit in Q1. Management warns that an unfavorable renewal could materially reduce income and cash flow and prompt goodwill impairment.
• Operating agreements for the North Sound and Red Gate plants expire in July 2018; the North Side agreement expires in June 2019. The company plans to bid for the first two contracts; non-renewal or less favorable terms could adversely affect results.
• The proposed Rosarito, Mexico desalination project remains conditional. Phase 1 is estimated to cost 9.1 billion Mexican pesos; financing, permits, rights of way, payment arrangements and other conditions remain outstanding. A February 2018 equity subscription agreement provides for Greenfield affiliates to acquire at least 55% of AdR, with Suez having an option for 20%, subject to conditions. A requested tariff increase has not been approved; without it, financing may not be available. Project assets include land carried at approximately $20.6 million and right-of-way deposits of approximately $1.3 million, which could be impaired if the project fails.
• EWG litigation in Mexico challenges transactions affecting NSC ownership and has produced new proceedings and provisional court writs. AdR obtained a temporary suspension of certain writs; the ultimate effect on the project is uncertain. An earlier Tecate claim was declared expired, but could be appealed or refiled.
• Other contingencies include the Belize regulator’s appeal of a favorable ruling for CW-Belize, and a CW-Bali customer’s appeal after a court declined jurisdiction over its damages suit. The customer seeks damages equivalent to approximately $6.0 million in total; the outcome is uncertain.
• The company adopted the new revenue recognition standard on January 1, 2018 using the modified retrospective method, with no opening retained-earnings impact. It expects the new lease standard, effective for it in 2019, to materially increase balance-sheet assets and liabilities.
• Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.

Investor verification points

• Track the Cayman retail license negotiations and any formal extension, renewal terms or regulatory changes.
• Confirm renewal outcomes and economics for the North Sound and Red Gate operating agreements.
• Verify satisfaction of Rosarito project conditions, tariff approval, financing close, equity commitments and the status or effect of EWG litigation.
• Monitor receivable collections, particularly the increase in CW-Bahamas receivables, and the accessibility of cash held in Belize and the Bahamas.
• Assess whether projected 2018 capital spending and dividends remain consistent with cash generation and liquidity.
• Follow the CW-Belize appeal, CW-Bali arbitration-related dispute, and any resulting financial exposure or impairment assessments.