Consolidated Water Co. Ltd. — FY 2016 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2016, filed March 16, 2017. Consolidated Water develops and operates reverse-osmosis desalination plants and distribution systems, and provides water-related engineering, equipment and services. In 2016, retail, bulk and services operations generated approximately 41%, 51% and 8% of revenue, respectively. The company operated 13 plants, including its affiliate’s facilities, with combined capacity of 26.3 million gallons per day.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $57.88 million | $57.12 million |
| Gross profit / margin | $24.25 million / 41.9% | $23.31 million / 40.8% |
| Operating income | $1.82 million | $8.47 million |
| Net income | $2.78 million | $7.93 million |
| Net income attributable to company shareholders; diluted EPS | $3.96 million; $0.27 | $7.52 million; $0.51 |
| Cash provided by operating activities | $7.82 million | $17.32 million |
| Cash and cash equivalents at year-end | $39.25 million | $44.79 million |
Gross margin improved despite lower bulk revenue, while operating income and shareholder earnings fell sharply. FY 2016 includes $2.0 million of impairment on CW-Bali long-lived assets and $1.75 million of Aerex goodwill impairment. Consolidated net income differs from income attributable to company shareholders because of the non-controlling-interest allocation.
Operating cash flow fell substantially, including a $5.91 million cash use from increased receivables. Year-end accounts receivable were $16.50 million, up from $9.53 million; the Bahamas government receivable balance was $11.0 million. The company reported working capital of approximately $54.2 million. Total liabilities were $9.50 million, including a current $490,000 related-party note; there was no long-term debt at year-end. It also held $3.77 million in loans receivable from the Water Authority-Cayman. Dividends declared remained $0.30 per share for the year.
Material changes versus the prior year
- Revenue increased 1.3%, but bulk revenue decreased $2.21 million, principally because lower fuel and electricity costs reduced pass-through energy charges. Bulk gross margin increased to about 34% from 32%.
- Retail revenue rose modestly; Cayman retail water volume increased 12%, offset in part by lower energy charges and a 4.4% base-rate reduction. The segment recorded an operating loss, largely due to CW-Bali’s impairment.
- Services revenue increased to $4.72 million, mainly following the February 2016 acquisition of a 51% interest in Aerex. The services segment’s operating loss widened to $6.34 million, with Aerex underperforming acquisition projections and Mexican project-development expenses increasing.
- Consolidated G&A rose to $18.68 million from $14.84 million, reflecting Aerex expenses and higher Mexico development costs. Operating cash flow declined by more than half.
- The company acquired Aerex for approximately $7.7 million in cash and repaid a $7.0 million demand loan. Year-end cash declined by $5.54 million.
Outlook, risks and unusual items
- Cayman retail license: The latest extension expired June 30, 2016; the company continued supplying water while assuming an extension during negotiations. A proposed rate-of-return model and unresolved regulatory changes could materially reduce historical operating income and cash flow. The new OFREG office began operating in January 2017, and the regulator’s role in negotiations remained unsettled.
- Bahamas contract and investment: In December 2016, the Windsor water agreement was extended for 15 years on a take-or-pay basis, but its non-energy per-gallon price is approximately 18% below the prior price. The company estimates required Windsor improvements at $8.9 million. WSC is also a major customer, accounting for 33% of 2016 revenue.
- Mexico project: The company’s subsidiary won the tender and signed an August 2016 public-private partnership contract for a planned, two-phase desalination project. The estimated total project cost is about $463 million and projected annual revenue about $52 million, but the contract is conditional on permits, public-sector arrangements and financing. AdR requested a tariff increase in February 2017 after peso and financing conditions worsened; approval and project financing were uncertain. The company had $20.6 million in land and about $20.5 million in cumulative development expenses, and warned the land could lose value if the project does not proceed. Litigation by a minority investor could also affect execution.
- Bali and Aerex: CW-Bali generated only $91,000 of 2016 revenue and an operating loss of about $2.74 million, including impairment. The company may seek a partner, expand sales or cease operations, potentially triggering further impairment. Aerex’s results fell significantly short of purchase projections; additional goodwill impairment may be required.
- Other exposures: Belize regulatory litigation remained pending, including an order that could cap the exclusive supply arrangement at 450,000 gallons per day. OC-BVI’s Baughers Bay valuation dispute remained unresolved; its Bar Bay supply agreement was extended in February 2017 for 14 years at a price approximately 31% lower than the prior price. Tourism, weather, hurricanes, customer concentration, government payment delays, currency movements and operating-cost estimates are material risks.
- Management estimated 2017 liquidity needs of approximately $9.4 million for existing-operation capital spending, $1.2 million for Mexico development and $882,000 for note payments, in addition to any dividends declared. It stated that available liquidity should be sufficient, while noting the listed project and operating risks. No specific earnings guidance was provided.
The independent auditor issued an unqualified opinion on the consolidated financial statements and on internal control over financial reporting; management also concluded disclosure controls were effective.
Investor verification priorities
- Confirm the status and final economic terms of the Cayman retail license, including exclusivity, rate-setting and regulatory oversight.
- Track Windsor’s $8.9 million improvement program, the lower contract tariff, and collection of the elevated Bahamas receivable balance.
- Verify Mexico project conditions precedent, financing commitments, tariff negotiations, litigation status and the recoverability of the $20.6 million land carrying value.
- Assess CW-Bali’s sales, funding needs and strategic-partner prospects, and Aerex’s performance against projections and risk of further impairment.
- Monitor operating cash conversion, receivable growth, liquidity needs and the sustainability of the $0.30 annual dividend.