Consolidated Water Co. Ltd. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited results are presented in U.S. dollars. The company produces and supplies desalinated water and provides water-related equipment and services across the Caribbean, Indonesia, Mexico and the United States.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $14.39 million | $14.61 million | $43.82 million | $43.76 million |
| Gross profit / margin | $5.92 million / 41% | $5.64 million / 39% | $18.69 million / 43% | $17.76 million / 41% |
| Operating income (loss) | ($2.36 million) | $2.15 million | $1.01 million | $6.71 million |
| Net income (loss) | ($2.98 million) | $1.85 million | $1.45 million | $6.22 million |
| Net income (loss) attributable to CWCO shareholders | ($1.87 million); EPS ($0.13) | $1.78 million; EPS $0.12 | $2.39 million; EPS $0.16 | $5.92 million; EPS $0.40 |
Q3 revenue declined about 1.5% year over year; nine-month revenue was essentially flat. Gross profit and gross margin improved in both comparisons, but higher G&A and impairment charges drove Q3 to a loss and sharply reduced nine-month earnings. Q3 G&A was $4.53 million, versus $3.49 million a year earlier; nine-month G&A was $13.93 million, versus $11.04 million.
- Segment trends: Nine-month retail revenue fell to $17.71 million from $18.12 million, while retail operating results included a $2.0 million CW-Bali asset impairment. Bulk revenue declined to $22.14 million from $24.49 million, principally as lower energy costs reduced energy-related rates; lower energy and maintenance costs improved bulk gross margin to 35% from 31%. Services revenue rose to $3.97 million from $1.15 million, largely reflecting Aerex, but the segment’s nine-month operating loss widened to $4.82 million.
- Cash flow: Operating activities provided $4.52 million for the nine months, down from $11.70 million. Investing activities used $2.36 million and financing activities used $9.86 million. Cash and cash equivalents fell $7.70 million to $37.09 million.
- Liquidity and debt: Current assets were $59.12 million and current liabilities $6.97 million at September 30; management reported working capital of approximately $52.1 million and said it expected sufficient liquidity. The $7.0 million demand loan was repaid in May 2016. The company had a $490,000 related-party note payable, due June 2017, and had advanced Aerex a separate $510,000 loan on the same maturity and 1% interest terms. Transfers of cash held in the Bahamas and Belize require central-bank approval.
- Dividends: $0.075 per common share was declared for Q3, matching the prior-year quarter; $0.225 per share was declared for the first nine months of each year. The company paid approximately $3.5 million in dividends during the first nine months of 2016.
Material changes and unusual items
- The February 2016 purchase of a 51% interest in Aerex for approximately $7.7 million added service revenue and goodwill/intangible assets. Aerex generated approximately $3.3 million in revenue and a $1.275 million net loss after acquisition through September 30. Its results fell significantly short of acquisition projections; the company recorded a $1.75 million goodwill impairment and said Aerex’s results for the rest of 2016 and 2017 were expected to remain below purchase-price projections.
- CW-Bali recorded a $2.0 million impairment of long-lived assets amid sustained operating losses, low sales and uncertainty about licensing, customer demand and funding. The company changed CW-Bali’s functional currency from Indonesian rupiah to U.S. dollars effective October 1, 2016.
- The company recorded $925,000 of impairment losses on its OC-BVI investment during the first nine months, including $875,000 in Q3. It also recorded a $275,000 Q3 unrealized loss from revaluation of Aerex put/call options.
- Other balance-sheet changes included accounts receivable rising about $5.6 million, primarily at CW-Bahamas; management expected collection based on payment history. Total assets were $163.29 million and total liabilities $9.92 million at September 30.
Outlook, risks and contingencies
- Mexico desalination project: The company’s consortium won the Baja California tender, and an approximately $485 million, two-phase project contract was signed in August. The planned project could generate approximately $55 million in annual revenue, but the contract is not effective until financing and numerous regulatory, rights-of-way, water-supply and other conditions are satisfied. AdR expects to arrange project debt and equity financing; the filing does not establish that financing or construction has begun. The company expects further project-development costs. If the project does not proceed, NSC’s $20.6 million land investment could lose value. Litigation by minority shareholder EWG challenging transactions that raised CWCO’s NSC ownership to 99.9% remains unresolved, although interim restrictions were suspended after a counter-guarantee was posted in October 2016.
- Cayman retail license: The most recent stated license extension expired June 30, 2016; the company continued operating while negotiations remained ongoing and said it believed a further extension would be forthcoming. The license’s renewal terms, including a possible rate-of-return model, could materially reduce income and cash flow. In October, the Cayman Islands passed legislation creating a new utilities regulator, but water was not yet within its scope; the timing and effect of any future change were uncertain. Cayman retail operations contributed about 40% of nine-month revenue and 55% of gross profit.
- OC-BVI: The Bar Bay supply agreement expires in March 2017. The company’s remaining approximately $3.9 million investment value assumes, among other things, a new water-purchase agreement and recovery of amounts related to the Baughers Bay plant. OC-BVI’s valuation expert assessed that plant at $13.0 million, implying an $11.58 million amount due under the court formula, but the BVI government disputes the valuation and the amount and timing of any payment are uncertain. OC-BVI submitted a proposal for a new 14-year Bar Bay contract in October 2016; no government response was reported.
- Other operational and legal risks: CW-Bali’s initial temporary license ended in October 2016; failure to obtain a new license, a partner or sufficient sales could force closure and further impairment. A Belize regulatory dispute remains pending. The Bahamas Windsor plant continues operating month to month under an expired agreement. Tourism, weather, energy prices, foreign exchange, government relationships and regulation are identified risks.
- Controls: Management concluded disclosure controls were effective at a reasonable assurance level; Aerex was still being integrated into the company’s disclosure-control structure.
Important facts for investors to verify
- Whether the Cayman retail license has been formally extended or renewed, and the economics and regulatory framework of any final license.
- Whether the Rosarito project has achieved financing and all conditions precedent, and the company’s expected ownership, funding obligations and project-development costs.
- Progress and financial impact of the NSC litigation, and whether the land’s carrying value remains supportable.
- Whether OC-BVI secures a replacement Bar Bay agreement and what amount, if any, is ultimately recovered for Baughers Bay.
- Whether CW-Bali secures a new operating license, customers or a strategic partner, and whether further impairments or closure are required.
- Collection timing for the increased CW-Bahamas receivables, and whether operating cash generation can support dividends, capital spending and project commitments.