Consolidated Water Co. Ltd. — Q3 2017 Form 10-Q
Business context and reporting period
Consolidated Water produces and supplies potable water using seawater reverse-osmosis technology and provides water-related engineering, services and manufactured products. Its operations span the Cayman Islands, Belize, The Bahamas, the British Virgin Islands, the United States and Indonesia. This unaudited filing covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
Key financial metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue | 2017: $16.57 million; 2016: $14.39 million (+15.2%) | 2017: $47.53 million; 2016: $43.82 million (+8.5%) |
| Gross profit and margin | 2017: $6.31 million (38%); 2016: $5.92 million (41%) | 2017: $19.60 million (41%); 2016: $18.69 million (43%) |
| Operating income (loss) | 2017: $0.83 million; 2016: loss of $2.36 million | 2017: $3.32 million; 2016: $1.01 million |
| Net income (loss) attributable to company shareholders | 2017: $1.16 million; 2016: loss of $1.87 million | 2017: $4.42 million; 2016: $2.39 million |
| Diluted EPS | 2017: $0.08; 2016: loss of $0.13 | 2017: $0.29; 2016: $0.16 |
For the nine-month period, operating cash flow was $11.73 million, versus $4.52 million in 2016. Investing activities used $0.56 million and financing activities used $3.44 million, principally reflecting common dividends paid. Cash and cash equivalents rose to $46.98 million from $39.25 million at December 31, 2016.
At September 30, 2017, working capital was approximately $60.5 million, total assets were $165.84 million and total liabilities were $9.87 million. Current liabilities included a $392,000 note payable to a related party. The filing reports no material change in market-risk exposure. The company declared dividends of $0.075 per common share in each of the first three quarters; a further $0.075 dividend was declared for payment October 31, 2017.
Material changes versus prior comparable periods
- Q3 revenue growth came from retail, bulk and manufacturing. Manufacturing revenue more than doubled to $3.01 million, while bulk revenue increased to $7.88 million. Higher revenue lifted gross profit dollars, but lower bulk and manufacturing gross margins reduced the consolidated gross margin to 38% from 41%.
- Q3 earnings improved substantially against 2016, when results included $2.0 million of CW-Bali asset impairment, $1.75 million of Aerex goodwill impairment and $875,000 of OC-BVI investment impairment. Q3 2017 included a $578,480 CW-Bali impairment, partly offset by a $171,000 unrealized gain on Aerex put/call options.
- For the first nine months, bulk revenue benefited from higher energy-linked water rates in The Bahamas, but higher energy costs and a lower Windsor plant water price weighed on bulk margin. Manufacturing results included a longer period of Aerex operations than in 2016, when the company owned Aerex for only part of the comparable period.
- General and administrative expense increased to $14.70 million for the nine months, from $13.93 million, reflecting higher employee costs and project-development spending.
Outlook, commentary, risks and contingencies
- Cayman retail license: Negotiations for a replacement license were continuing with OfReg. The existing exclusive license extension was due to expire January 31, 2018. Cayman retail operations represented about 38% of nine-month revenue and 52% of gross profit. Management warned that new terms could materially reduce operating income and cash flow and potentially require goodwill impairment.
- Mexico desalination project: The proposed Baja California project calls for a 50-million-gallon-per-day first phase, with a second phase planned by the end of 2024. Phase 1 was estimated to cost 9.1 billion Mexican pesos, with expected annual revenue of 1.79 billion pesos. The contract remained conditional on approvals, permits and financing. Required amendments to state legislation and a requested tariff increase were unresolved; failure to secure them could prevent financing or completion. Approximately $21.2 million of land and rights-of-way carrying value could be at risk if the project does not proceed.
- CW-Bali: The company had resolved to discontinue the loss-making operation, but its sole remaining customer sued in October 2017, claiming approximately $4.2 million in compensatory and $1.9 million in punitive damages. Management considers the claim without merit; pending resolution, the company said it is legally prohibited from disposing of its investment or assets. The carrying value was reduced to approximately $378,000 after a $578,480 Q3 impairment.
- Other legal and operating exposures: The Belize regulator’s long-standing order and licensing dispute remained unresolved. EWG’s challenge to transactions increasing the company’s NSC ownership was declared expired by a Mexican court in May 2017, but EWG could appeal or refile. Separately, OC-BVI’s Bar Bay water-supply agreement was extended for 14 years at a price about 31% below the prior price; a disputed Baughers Bay plant valuation could entitle OC-BVI to $11.58 million, but payment and outcome remain uncertain and the amount was not recognized.
- Liquidity and project funding: Management said it expected sufficient liquidity for its needs. Planned 2017 uses included approximately $2.8 million of existing-operation capital expenditures, $1.1 million of dividends payable and $1.9 million for Mexico project development. Cash held in The Bahamas and Belize totaled approximately $13.3 million and $6.0 million, respectively; transfers abroad require central-bank approval, and Belize dollar-transfer constraints remained a concern.
- Other items: Aerex-related notes were extended in October 2017; total outstanding notes to Aerex from the company and Aerex’s former shareholder were $1.4 million, due March 31, 2018. The company expects the revenue-recognition standard effective in 2018 to have no material impact, but expects the lease standard to materially increase balance-sheet assets and liabilities.
Important facts for investors to verify
- Progress and final terms of the Cayman retail license negotiations before the January 31, 2018 extension expiry.
- Whether Baja California approves the required legislative amendments and tariff request, and whether the Mexico project secures permits and committed equity and debt financing.
- Developments in the CW-Bali customer lawsuit, the restriction on asset disposition and any further impairment or exit costs.
- Cash accessibility in Belize and The Bahamas, and the company’s ability to fund dividends, capital spending and project-development needs.
- Performance and margins by segment, particularly bulk energy pass-through economics and Aerex manufacturing profitability.
- Developments in the Belize regulatory matter, EWG litigation and OC-BVI’s government receivables and Baughers Bay valuation dispute.