Consolidated Water Co. Ltd. (CWCO) Q2 2019 Earnings Report, Transcript and Summary

Good morning. Thank you for joining us today to discuss Consolidated Water Company's Second Quarter Ended June 30, 2019. Joining us today is the Chief Executive Officer of Consolidated Water Company, Rick McTaggart. He is joined by the company's Chief Financial Officer, David Sasnett. Following their remarks, we'll open the call to questions. But before we conclude today's call, I'll provide some important cautions regarding the forward-looking statements made by management during the call. I'd like to remind everyone that today's call is being recorded and will be made available for telecom replay via instructions in today's press release, which is available in the Investor Relations of the company's website. Now, I'd like to turn the call over to Consolidated Water Company's CEO, Rick McTaggart. Sir, please go ahead.

Thank you, Elisa, and good morning, everyone. Thanks for joining us today on the call. As you saw in the earnings release we issued on Friday, we realized another quarter of double-digit growth in revenue, gross profit and net income. This was driven mostly by a continued increased production activity in our manufacturing business, which I have to say has really come back strong this year after devoting a portion of its capacity last year to projects for our other subsidiaries. Total revenues for the quarter reached $18.3 million, up 22% over last year. Manufacturing represented $3.3 million of this growth, with retail adding another $715,000. The growth in our manufacturing was due to a renewed focus on industrial sales, with strong execution by our sales team, combined with increased customer demand for our specialized products. Given these results and a healthy backlog, we expect to continue the progress made by our manufacturing business in the second half of this year. The growth in our retail was partly due to the fact that the weather in Grand Cayman has been drier this year. Rainfall in the second quarter was down 76% compared to last year, requiring the local population to use more of our water. And looking at the first half of 2019, rainfall in our Cayman Island service area was down 55%, with rainfall in the first half compared to rainfall in the first half of 2018. And it was also 55% lower than the 30-year average. We don't know if this trend will continue, but we're prepared with adequate production capacity in any event. Now before I go further, I'd like to turn the call over to our CFO, David Sasnett, who will take us through the financial details for the quarter. And I'll come back to discuss a little more about our recent operational activities and the outlook for the remainder of the year. David?

Good morning, everyone. As Rick mentioned, our total revenues grew 22% to $18.3 million, reflecting revenue growth for both our manufacturing and our retail segment. Our manufacturing segment revenues were up due to an increase in the number of orders, which led to expanded project production activity. Our increases in manufacturing and retail revenues were partly offset by a decrease in our bulk revenues. The main reason for the decline in bulk revenues was the new contract that came into effect in February for the water we supplied to the Water Authority-Cayman from my Red Gate, North Sound plants. This, as we have disclosed, the right end of this contract is less than the one that was in effect previously. In the second quarter, our retail water segment represented 38% of our total revenue. Our bulk water segment represented 38% also, and manufacturing generated about 23.5% of our consolidated revenues. Turning to the six months results. Revenue was up 19% to $35.3 million compared to the first half of last year. And once again, this increase was driven mostly by an increase in the manufacturing segment of $5.8 million and the retail segment adding another $1 million. Consistent with the second quarter for the six months, the improvement in manufacturing revenues was due to an increase in the number of orders and greater production activity. Retail revenue was up due to the volume of water sold by Cayman Water, which increased by nearly 3%. And our retail revenues at Cayman also benefited from increased energy prices that increased the energy pass-through component of our Cayman Water retail revenues by $356,000. As we said earlier, the increases in manufacturing retail revenues for the first half of the year was partially offset by a decrease in bulk revenues. And once again, this was due to the new contract signed with the Water Authority. Gross profit for the second quarter of 2019 totaled $7.6 million or 41.3% of our revenues. This was up 22% from the $6.2 million, or 41% of revenues in the same quarter a year ago. Gross profit for the first half of 2019 was $14.5 million, or 41% of our revenues, which was up 70% from the $12.4 million, or 42% of revenues in the first half of 2018. In the second quarter, our G&A expenses on a consolidated basis were $5 million, representing a 12.3% increase for the same quarter a year ago and for the first half of the year, G&A was up 2.9% to $9.4 million. Net income attributable to stockholders for the second quarter of 2019 was $2.5 million, which equates to $0.16 per fully diluted share. This represents a 13% increase from the $2.2 million or $0.14 per fully diluted share that we reported last year. For the first half of 2019, net income attributed to stockholders totaled $8.7 million, or $0.57 per diluted share, which represents a 102% increase from the $4.3 million, or $0.28 per fully diluted share that we reported for the first half of 2018. If we turn now to our balance sheet, we're pleased to be able to report that our cash and cash equivalents have increased to $41.9 million as of June 30 as compared to $31.3 million as of the most recent year end. This is driven by cash flows generated from operations. Our accounts receivable have declined from the end of the year to $20.2 million from $24.2 million as of December 31, 2018, as we have managed to collect more money in Bahamas on our delinquent receivables from the Water and Sewage Corporation. Our property, plant and equipment increased $4.1 million and our construction in progress decreased $5.4 million from the end of the year. This was due to the commissioning of the expanded plant capacity of our Abel Castillo Water Works Plant in Grand Cayman in March 2019. Looking at our projected liquidity requirements for the rest of the year, we have anticipated capital expenditures for existing operations of about $2.2 million, and we expect to spend about $4.3 million on our project development activities in Mexico. And of course, our liquidity requirements may also include future quarterly dividends if such dividends are declared by our Board. It's important to note that our dividend payments amounted to $5.1 million for the year, last year, and we paid $2.6 million in dividends for the first six months of this year. And once again, I'd like to just emphasize that we have excellent credit standing, very liquid, solid balance sheet. We're positioned to do things for the future given the credit standing that we have in our company. And with that, I'd like to turn things back over to Rick.

Thanks, David. Our strong second quarter results once again demonstrate that the teams operating each of our business segments are working hard to improve our financial performance by controlling costs and providing excellent products and services to our customers. As many of you know, our manufacturing operations are based in Florida where we manufacture and service a wide range of water-related products, we also provide design engineering, operating and other services that are applicable to the water production, supply and treatment for commercial, municipal and industrial sectors. We expect the results of our manufacturing segment for the rest of this year to continue to improve over last year given our healthy order backlog. Our bulk water business provides potable water under long-term water supply contracts in the Cayman Islands and Bahamas, where naturally occurring potable water is scarce and reverse osmosis desalination technology is economically feasible. Earlier this year, we executed a new seven-year bulk water agreement with the Water Authority-Cayman for the North Side Water Works, and this has become effective on July 1. And while we're charging a lower rate, the agreement secured our position as the dominant desalinated water supplier in the Cayman Islands for the next several years. In the Cayman Islands, we also own and operate a water utility business, our retail business that supplies desalinated water directly to residential, commercial and public authority customers within the main tourist area of Grand Cayman. Completing the expansion of the Abel Castillo Water Works plant in Grand Cayman earlier this year has ensured that we can meet future water demand from our retail customers. The Water Authority-Cayman recently made a public statement saying that they will soon put out a tender for a 2.4 million gallon per day desalination plant to replace older plants on the island and naturally, we plan to bid on this project when the tender is officially announced. Now, in terms of environmental and other factors that might come into play for our Cayman Islands operations, as I mentioned earlier, last year was a relatively dry year in Grand Cayman with rainfall 30% lower than in the year before and 31% lower than the 30-year average. So then in the first quarter of this year, rainfall amounts were higher, returning to match the 30-year average. However, rainfall in the second quarter of this year was down 76% compared to the same period last year. So on balance, for the first half of 2019, rainfall at our Cayman Island service area was down 55% with rainfall compared to the first half of last year. And it was 55% lower than the 30-year average. Sorry about all the numbers here. Rainfall is traditionally higher in the second half of the year, but we'll continue to monitor these trends. So another factor that's impacted our retail sales we believe. Stay-over-tourist numbers in Grand Cayman continued to grow in the second quarter of this year and came in at 14% higher than the second quarter of 2018. If you'll recall that there were a number of hurricanes in the Caribbean in 2017, and that's driven a lot of business to the Cayman Islands and it still continues. Lower rainfall and increased tourism appeared to be the main drivers of the increase in retail water volume sales in the second quarter of 2019. And as I mentioned, historically, we sell more water in Grand Cayman during the first and second quarters of the year due to the number of tourists visiting the country being typically greater and local rainfall being lower compared to the latter parts of the year. Now, we'll talk a bit about the Rosarito plant in Mexico. The plan is expected to be the largest seawater desalination plant in the Western Hemisphere, and will provide drinking water to the Northwestern coastal region of Baja California, Mexico for the next 37 years. The project comprises the construction of a seawater reverse osmosis desalination plant with the capacity of 100 million gallons per day to be implemented in two phases of 50 million gallons each. The first phase includes the installation of an aqueduct designed to deliver potable water from the plant to Baja California's public water system. I'll just mention that a lot of the capital that we foresee spending for the remainder of this year will be related to acquiring the remaining rights-of-ways for this aqueduct. David had mentioned a number, $4.3 million earlier in his comments. While we currently own 100% of the project development company, we have executed agreements with our potential equity partners through which we will retain at least 25% ownership in the project at the closing of these agreements. We also retain a 50% ownership position in the company that operates the facility for the owners. The need for potable water has increased significantly over the past few years in Baja California, with its rapidly growing coastal cities becoming increasingly dependent on the overtaxed Colorado River. The aging aqueduct from the river to the coastal regions crosses several earthquake zones and has been prone to failures due to its age over the past few months. Has this happened in the past? Any failures along the hundreds of miles of canals and pipelines could interrupt the flow of fresh water to an estimated two million inhabitants along the coast in Mexico. Our Rosarito Beach desalination plant will diversify the region's water resources and enhance drinking water supplies in Baja California for decades to come. For the Rosarito project, we had two major positive developments earlier this year that we reported regarding legislative approval and funding. This has allowed us to proceed to other important steps before we begin the construction phase. These steps include securing the major portions of the projects, required debt financing and the remainder of the aqueduct rights-of-ways. Beyond this area of Mexico, there remains many other water scarce countries in the Caribbean and other markets where we believe we can have a positive impact on their population by providing essential fresh water supplies. So, we are continuing to explore development opportunities where we can support the growth of regional economies and improve the quality of life in local communities. Now, looking ahead for the rest of this year. The prospects for our manufacturing business continue to look favorable, especially given that we possess specialized manufacturing capabilities and experience relating to markets with relatively high barriers to entry. For these markets, we qualify for projects that require world-class quality control and documentation systems which we possess. We also fabricate water treatment equipment for a diverse number of industries involved in wastewater treatment infrastructure, and we believe the numerous municipal utilities in need of wastewater infrastructure improvements will drive growth in our business. In anticipation of further manufacturing growth, we are expanding our production facility, which we expect to be completed within the next 12 months. This project is being led by our new VP of Manufacturing, whose knowledge and experience will play an important role as we grow this business. Appointed in the second quarter, Jamie has brought to us more than 22 years of management experience in engineering, manufacturing, plant integration and development, as well as product development and distribution. As David mentioned earlier, given our strong balance sheet with ample liquidity, both of which we have continued to improve this year, we are focusing -- focused on closing the development phase of the Rosarito project as well as expanding our businesses into new markets and complementary product lines. This includes actively evaluating M&A and partnership targets in North America that would expand our geographic footprint and diversify our revenue streams. These efforts are strongly supported by our Board of Directors, which considers acquisitions to be a strategic imperative. So, we are currently actively advancing on one potential target and we have our eyes on others. Our ideal targets would have an existing water treatment-related business and a business model similar to our Caribbean desal business model. It would give us access to new markets for our existing products and services as well. Now, I'll say a bit about the state of the industry. All indications remain that the global market value for desalination is growing strongly. According to recent reports, it is expected to double by 2026, reaching more than 20 -- $37 billion of market value. This growth is reportedly being driven by multiple catalysts, from shrinking or limited fresh water resources or adverse environmental changes, to growing populations, further increasing the demand for fresh water. On the manufacturing and services side of our business, the aging water and wastewater utility infrastructure in the US is widely recognized as being in much need of investment across the country's more than 49,000 community water systems and 18,000 wastewater systems. This has been largely due to years of deferred maintenance and upgrades. Water and wastewater capital expenditures now stand at $45 billion annually for the US municipal systems and are rising steadily. And for consolidated water, this is all good news, good for our growth and our opportunities, and especially good for building shareholder value over the quarters and years to come. And our strong performance in Q2 reflects these tremendous opportunities ahead. So having said that, I'd like to open the call for questions, Elisa.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Gerry Sweeney with ROTH Capital. Please go ahead.

Hey. Good morning, David and Rick. Thanks for taking my call.

Hey, Gerry. How are you?

I'm doing well. Could you maybe discuss or give a little bit more detail on potential acquisitions maybe? How big or in terms of revenue or how much you're looking to spend? Can you give us a little bit more clarity on that front?

Yeah. I mean, we're not prepared to talk about that right now, Gerry. I mean, as you know, we don't -- we're somewhat conservative in how we grow the business and we're not going to take any big chances. And if you -- we have a lot of cash on hand, so you can think of the size of these acquisitions within that sort of a scope.

Okay. That's fair. And then maybe switching gears up -- sorry, were you going to say something, David?

No, we don't expect this next acquisition to be funded by any debt. So if we have cash -- if we -- if it was [indiscernible] if we close it.

Got you. That makes sense. And that's helpful. Also maybe just switching gears a little bit. Margins, margins, obviously, I know volumes certainly help on the retail side, but even on the bulk side, they seem to be doing quite well, even with some of the repricing of the contracts. Could you maybe discuss maybe some internal improvements or processes that you put in place that could be helping out on that front and are they sustainable?

Well, I just mentioned that. I mean, I mentioned in the script that we're focused on cost control. We're always focused on cost control and the guys of the operations department has implemented some management protocols and systems that really over the last two years that I think have been very helpful in focusing the entire team, the operating team on cost control. And I think it's paying benefits. I mean, these are...

Okay. Great.

...sort of industry standard type systems that we've implemented.

And then final question for me would be just that new potential tender. Do you know, roughly speaking, when it may come to market and maybe a little bit of timing, what the expectation is, when it comes to market? And then maybe when it'll be finalized and when Grand Cayman would like to have that plan operational? Thanks.

I mean, our best guess, just based on the timing of the announcement is that we'll see something this year. Maybe the bid documents, but we don't have any firm information on that. And I'll just mention that we're not sure how that contracts going to be structured because they're -- in the past, here in the Cayman Islands, the UK has imposed some debt, some borrowing restrictions on the government and the types of deals that we do are -- they are looked at as debt at the government level. So, it could be a boot, it could be something else. I'm not sure exactly what it's going to look like when it comes out.

Okay. Great. I'll jump back in line. Thanks.

The next question comes from Michael Gaugler with Janney Montgomery Scott. Please go ahead.

Rick, maybe you could update us on Rosarito timelines in terms of when you expect to get into construction and finalize things given the developments thus far this year?

Well, I'd like to give you an exact date, but I can't. I mean, I'd tell you, there was an election there over the summer. There's a new governor -- that governor elect that comes in, in November. So, I mean, that's kind of added a new layer of, I wouldn't say complication, but getting his team up to speed and on the project and that sort of thing has been our focus over the last, I guess, month or two. I would really like to close this by the end of the year, Mike. I mean that's my goal. But there will be some political shuffling in November, and we hope that doesn't delay anything.

Okay. That's actually all I had. Gerry asked my question on acquisitions. So, I'll leave it there.

Thanks, Mike.

[Operator Instructions] The next question comes from Hassan Dosa with WAM. Please go ahead.

Hi. Good morning. Hasan Doza with Water Asset Management. Good morning, Rick and Dave. Thanks for the updates.

Sure. How you doing?

Couple of -- Good. Good. Couple of questions. One is, if I look at the last couple of years in your bulk water business, your annual revenue run rate was about $8 million, give or take. And the first two quarters in the bulk water have averaged about $7 million. So going forward, David or Rick, is $7 million-ish is kind of the new run rate we should think about per quarter versus the $8 million previously given the repricing of the two facilities?

Well, let's not forget that in the third quarter this year, there'll be another adjustment because we've signed that third -- a contract for the third plant. So, all of the bulk water contracts for us, you see have been renegotiated. And going forward, I think you need to wait until the end of the third quarter of this year to get a better idea of what the run rate will be on our bulk business. But it's important to remember, Hasan, that revenues -- the decline in revenues doesn't automatically translate to the same kind of decline in profits. All of these contracts had energy pass-through components where we would pay the energy and then the government would pay us back. The new contracts have been restructured so that the government pays those energy charges directly. So while the revenues for these contracts have gone down, so have the cost of revenues. So the impact on the margin is not the full amount of revenues that we lost. So if you're looking to see how things are going to shake out, it's better that you wait until the end of the third quarter of this year and then you'll have a better idea of the run rate for our revenues. And it's important to understand also, Hasan, that a good portion of the margin on these bulk contracts is protected because they had these minimum charge amounts in there. The government have to pay us certain amount, whether or not they use the water or not. So, our margins on our bulk business are somewhat protected. So, I know what you -- and so if you want to get an idea where we'll be, take a look at things after the end of the third quarter.

Okay. And David, you had mentioned, for the Rosarito facility, the development expense this year in 2019, if I heard you correctly is $4.3 million, you said?

No, that's the amount of money we expect to spend for the rest of this year, and most of that will be spent on acquiring rights-of-ways. If you look at us, we're spending about anywhere from $1 million to $2 million historically per year in G&A cost in Mexico. That doesn't include the amounts that we're capitalizing our balance sheet for the rights-of-ways. So the remainder, I can tell you exactly what our projections are at this point in time. One second, I'll go back to my comments that I made here in the conference call. I have my numbers here. So, what we're talking about is spending about $4.3 million for Mexico and that will include rights-of-ways and everything. So, a portion of that will be capitalized and then for the rest of our stuff, capital expenditure is only going to be $2.2 million.

Okay. So the amount flowing through your G&A line is how much, roughly, on an annual run rate?

About a $1.5 million a year. That goes away, Hasan, if we close the Mexico deal. Those numbers were transferred over to ADR and we would own 25% to 35% of ADR. So that G&A hit for our company goes away if we can close the Mexico project.

Got you. And one closing one. Rick, it's for you. Any update on the kind of the Cayman retail license? I know we've been speaking on this for years on the call. I would love to get update on where do your negotiations stand?

Well, we continue to negotiate with the regulator. We don't have any other sort of update to give. We're in active negotiations with them. And again, this is something I'm hoping to close out before the end of the year certainly. You there?

Got it. Thank you.

Okay.

[Operator Instructions] The next question comes from John Bair of Ascend Wealth Advisors. Please go ahead.

Good morning, gentlemen. Thanks for taking the call.

Hey, John.

I've got a couple questions. First one, referring to the right-of-ways. Are you having any issues with holdouts? I don't quite understand how that works. Is this -- are you trying to get leases or actually buy the rights-of-way? How long are those terms and so forth? And in other words, if it is a private ownership, land ownership that you're trying to acquire those rights-of-ways from and are some of those people bidding or entities kind of holding out and slowing the process down?

Yeah, their private rights-of-ways, the public rights-of-ways are easier to deal with. Those are -- obviously the government supports the project. So, a big part of the actual 30 kilometer right-of-way is public. But then we have to deal with private owners as well, a lot of different situations. I mean, we haven't found anything that we haven't been able to get around and these are indefinite rights-of-ways that we're purchasing from the owners. So, I mean, it's always challenging, I mean, when you're dealing with dozens of different parties along this pipeline path, but we've been able to overcome all the big challenges. And where we can't overcome a challenge, we look at relocating the pipeline to avoid it. So, we do have a little bit of flexibility on that.

Things like title, you have to go through title searches and that kind of stuff to confirm ownership and so forth, I would assume.

Oh, yeah. That's the big part of it. And those are the ones that become problematic when the owner doesn't have good title and then we have to go around it, but we haven't found too much of that.

Okay. And my second question involves the additional manufacturing, your order outlook and so forth. Are these orders coming more from municipal end users or are they food and beverage type companies? Can you shed a little more light on that? And secondly, are they more domestic or exclusively domestic, or kind of where are they coming from, generally speaking.

Well, bulk of them is coming from the power industry and then other orders are coming from, as we mentioned, municipal wastewater treatment plants, pipe work that we're building for those projects and that sort of thing. Everything is domestic. We're selling all domestically. I think I covered in my comments about sort of the water treatment industry, desalination. And in desalination, us includes brackish water treatment or any type of membrane treatment plant. I mean, that's where we see the bulk of the orders coming from that part of the business, from the wastewater industry and from continued orders from the power industry, water treatment type equipment for the power industry.

Okay. Is there any potential for international sales in this area? I mean, surely looking at that to some extent.

Yeah. I mean, we've done orders in the past for the Middle East, but for a client that's doing a project in the Middle East. I mean, we're fabricators, so we typically don't bid these projects directly. So, we're just building pieces of them or for a client. And it's different, much different from the rest of our business where we lead the development on the projects. We're just -- at Aerex, we're just -- we're building bits and pieces for these projects. So, we're a contractor basically to the main contractor.

Okay. Great. One last quick question. At what point might you consider another dividend, hopefully increase, in what, year and a half?

John, we always consider this not to -- not to the wisdom of our Board of Directors. It's -- at some point in time, John, we'd like to devote that capital to acquisitions. It makes more sense to us to put that money into growing the business. If at some point in time, we accumulate so much cash that we don't think it's reasonable to hold it back for acquisitions, then certainly we'll increase our dividend. I think a big impact of all this, it will be Mexico. After we close the Mexico, that would change the situation with our company significantly. Now, we're not spending $1.5 million a year to continue to develop that project. And we have -- we've got to sell the land back into the project. So, I think that might be a sort of a signal for when we might increase the dividend. But once again, it's not -- it's not really our choice, per se. It's up to what does the Board feels like doing on what they believe is prudent.

And I'll just add, John, I mean, in the past when we have more visibility on what our cash flows are going to look like, I mean, we have increased the dividend. So a few years ago, we felt comfortable that we had renewed was quite a few contracts that had come up for renewal over, I guess, a two-year period. We felt more comfortable that those were secured and if long-term cash flows look better then, we'll certainly consider increasing the dividend.

You've got two piece -- two elements of uncertainty, the renegotiation of the retail license in Mexico. Once those are resolved, I think we'd be -- we would have a much better picture as to how we could change our dividend amounts, John.

Sure. Sure. That completely makes sense. And appreciate you taking the call and good luck.

Thanks a lot, John.

This concludes the question-and-answer session. I would now like to turn the call back over to Mr. McTaggart for any closing remarks.

Thank you, Elisa. Just wanted to thank everybody for joining us today. And we look forward to presenting another good quarter in November and hopefully, we'll speak to you again there. Thanks.

Thank you, ladies and gentlemen. Now before we conclude today's call, I would like to provide the company's safe harbor statements that include important cautions regarding forward-looking statements made during today's call. The information that we have provided in this conference call includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to; statements regarding the company's future revenues, future plans, objective, expectations and events, assumptions and estimates. Forward looking statements can be identified by the use of words or phrases usually containing the words; belief, estimate, project, intend, expect should, will, or similar expressions. Statements that are not historical facts are based on the company's current expectations, beliefs, assumptions, estimates, forecasts and projections for its business and the industry and market related to its business. Any forward looking statements made during this conference call are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Actual outcomes and results may differ materially from what is expressed in such forward-looking statements. Important factors which may affect these actual outcomes and results include, without limitation, continued acceptance of the company's products and services in the marketplace, changes in its relationship with the government of its jurisdictions in which it operates, its ability to successfully secure contracts for new water projects, including the project under development in Baja California, Mexico; its ability to develop and operate such projects profitably and its ability to renew existing bulk water supply contracts, and its ability to manage growth and other risks, including those risk factors set forth under Part 1, Item 1A, Risk Factors in the company's Annual Report on Form 10-K. Any forward looking statements made during this conference call may speak as of today's date. The company expressly disclaims any obligation or undertaking to update or revise any forward-looking statements made during this conference call to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any forward-looking statements is based, except as it may be required by law. Before we end today's conference call, I would now like to remind everyone that this call will be available for replay starting later this evening and running through August '19. Please refer to today's earnings release for dial-in replay instructions available via the company's website at www.cwco.com. Thank you for joining today's call with us. This concludes the conference call. You may now disconnect.