Consolidated Water Co. Ltd. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; unaudited. The company produces and supplies desalinated water in the Caribbean and Indonesia and provides water-plant engineering, construction, management and operating services. All amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $14.61 million | $17.02 million | $43.76 million | $50.30 million |
| Gross profit (margin) | $5.55 million (38%) | $5.70 million (33%) | $17.47 million (40%) | $18.04 million (36%) |
| Operating income | $2.15 million | $1.72 million | $6.71 million | $4.93 million |
| Net income attributable to company shareholders | $1.78 million; $0.12/share | $1.88 million; $0.13/share | $5.92 million; $0.40/share | $5.30 million; $0.36/share |
| Operating cash flow | Not presented separately for the quarter | Not presented separately for the quarter | $11.70 million | $14.14 million |
- Revenue and segment mix: Q3 revenue declined about 14%, and nine-month revenue declined about 13%. Bulk revenue fell to $7.92 million in Q3 and $24.49 million for nine months, primarily reflecting lower water volumes, lower energy-linked prices and, for certain operations, contract-rate changes. Retail revenue was also lower, largely because lower electricity prices reduced energy adjustments in water rates. Services revenue declined year over year.
- Profitability: Despite lower revenue, gross margin improved in both comparison periods. Lower general and administrative expenses lifted operating income. Nine-month shareholder earnings increased, while Q3 shareholder earnings declined. Q3 and nine-month results included OC-BVI investment impairment charges of $225,000 and $810,000, respectively.
- Cash flow and investment: Nine-month operating cash flow was $11.70 million, down from $14.14 million. Investing activities used $1.88 million, including approximately $2.50 million for property, plant and equipment and construction in progress; financing activities used $4.76 million, chiefly dividends and debt repayment. Cash and cash equivalents rose to $40.77 million from $35.71 million at year-end 2014.
- Liquidity and debt: At September 30, cash and cash equivalents plus the separately reported certificate of deposit totaled approximately $46.4 million; working capital was approximately $50.2 million. The demand loan payable was $7.5 million, down from $9.0 million at year-end 2014. It bears interest at LIBOR plus 1.5%, is payable on demand, and is secured by substantially all company assets in the Cayman Islands. Management said it expected sufficient liquidity to meet needs.
- Margins by segment: Nine-month retail gross margin was 54% versus 51% in 2014; bulk was 32% versus 29%; services recorded a small gross loss, improved from the prior-year loss. These gross-margin improvements did not prevent declines in total gross-profit dollars.
Material changes, outlook and risks
- Operating drivers: Lower fuel and electricity prices reduced energy-related water rates and revenue. Bulk water volumes also declined, including a 12% fall in Bahamas volumes and a 3% fall in Cayman volumes for the nine-month period, amid customer conservation and lower Water Authority-Cayman purchases. The company cited higher Bahamas maintenance and repair costs as another pressure on bulk gross profit.
- Expenses and unusual items: Nine-month G&A fell by about $2.35 million, including approximately $1.80 million less NSC Mexico project-development spending and lower professional fees. Other expense increased, principally due to foreign-currency losses at CW-Bali. The filing reports foreign-currency transaction losses of $660,989 for the nine months, versus $15,238 in 2014.
- Mexico project: NSC is pursuing a proposed 100-million-gallon-per-day desalination plant and aqueduct. Environmental approvals and a Tijuana urban-impact approval had been received. After quarter-end, the State of Baja California launched a public tender, with submissions due March 23, 2016; NSC’s eligibility and success are uncertain. The company expected approximately $0.7 million of further NSC development costs for the remainder of 2015 and said completion was not assured. Mexican regulators had indicated direct sales to U.S. customers might not be approved.
- Mexico litigation and tax dispute: EWG challenged transactions that raised the company’s NSC ownership to 99.9%; a Mexican court granted preliminary relief, and the outcome was uncertain. Separately, the Mexican tax authority’s revised assessment was approximately 6.91 million pesos (about $406,000). NSC contested it and had received a favorable 2014 tax-court judgment, which the authority appealed. No provision was recorded; restricted cash of $433,218 secured a letter of credit.
- Cayman retail license: The exclusive license, a major source of revenue and gross profit, had been extended through December 31, 2015 while renewal negotiations continued. The regulator favored a return-on-invested-capital model; the company warned that a new license could materially reduce earnings and cash flows and potentially require impairment of $3.50 million of goodwill. The final terms and timing were uncertain.
- Other operating exposures: CW-Bali’s sales remained insufficient to cover operating costs; its nine-month operating loss widened to approximately $383,000 from $288,000, and the company warned of possible impairment of approximately $3.0 million in plant assets. The Bahamas Windsor plant agreement continued month to month. Belize regulatory proceedings remained unresolved. OC-BVI impairment assumptions depend on a possible seven-year Bar Bay contract extension and recovery relating to the Baughers Bay plant; the company warned of further impairment absent improved contract prospects.
- Outlook and distributions: The filing provides no specific revenue or earnings guidance. Management anticipated continued services-segment operating losses while funding NSC development or until significant new contracts are secured. It estimated remaining-2015 needs of approximately $2.6 million for existing-operation capital expenditures, $0.5 million for debt service and $0.7 million for NSC development. The board declared a $0.075-per-share dividend payable October 31, 2015; future dividends remain discretionary.
Important facts for investors to verify
- Progress and final terms of the Cayman retail-license renewal, including the license extension beyond December 31, 2015 and any effect on rates, exclusivity and goodwill.
- NSC’s qualification for and outcome in the Baja California tender, financing and partner arrangements, and the effect of the EWG litigation on project control or execution.
- Resolution of the Mexican tax authority appeal and any resulting payment or further assessment.
- OC-BVI’s Bar Bay contract-extension prospects and Baughers Bay valuation; assess the likelihood and potential scale of additional impairment.
- CW-Bali’s ability to increase water sales and cover operating costs, and the risk of impairment of its plant assets.
- Availability of cash held in the Bahamas and Belize, which requires central-bank approval for transfers to accounts in other countries, and the demand-loan repayment or call risk.
- Whether reduced bulk water volumes, energy-linked rates, and maintenance costs continue to affect revenue and gross-profit dollars.