Consolidated Water Co. Ltd. (CWCO) Q3 2022 Earnings Report, Transcript and Summary

Good morning, and thank you for joining us today to discuss Consolidated Water Company's Third Quarter 2022 Results. Hosting the call today is the Chief Executive Officer of Consolidated Water Company, Rick McTaggart; and the company's Chief Financial Officer, David Sasnett. Following their remarks, we will open the call to your questions. [Operator Instructions] 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 it will be made available for telecom replay per the instructions in yesterday's press release, which is available in the Investor Relations section 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, Joe. Good morning, everyone. Thanks for joining us today. As you saw in our earnings release issued yesterday, we reported a 53% increase in our revenues for the third quarter of 2022, reflecting revenue increases in all four of our business segments. However, certain G&A expenses increased last quarter, which impacted our net income. We believe that last quarter's higher G&A expenses and flat net income performance are not indicative of what investors should expect in upcoming quarters. David will provide an explanation of these G&A expenses later in the call. Our retail water revenues benefited from a 14% increase in the volume of water sold in Grand Cayman due to the continued return of tourist activity to the Cayman Islands. Our Services segment revenue increased by $5.5 million with most of the increase resulting from progress on PERC Water's previously announced contract for the construction of an $82 million advanced water treatment plant in Goodyear, Arizona. This Arizona project is now well underway and progressing as expected and we anticipate recognizing significant additional revenue from this project in the fourth quarter and in 2023. Also in Q3, we completed the design and preliminary permitting activities for the new desalination plant we are constructing on Grand Cayman pursuant to the 10-year design-build-operate contract that we signed with the Water Authority of the Cayman Islands. The revenue we recognized on this contract was minimal in Q3 during the design and permitting phase of the project, but construction activity is now underway so we will recognize significant additional revenue on this contract beginning in Q4. Before getting into our progress with these major projects and our outlook for the rest of the year and into 2023, I would like to turn the call over to our CFO, David Sasnett, who will take us through the financial details for the quarter. Mr. Sasnett?

Thanks, Rick, and good morning, everyone. Yesterday, we issued our earnings release for the third quarter of 2022, and you can find it in the Investors section of our website. As Rick mentioned, we reported revenue of $25.1 million in the third quarter, which is an increase of 53% from the third quarter of last year. This growth reflects increases of $1 million in our Retail segment revenue, $1.8 million in our Bulk segment revenue, $5.5 million in our Services segment revenue and $291,000 in additional manufacturing segment revenue. The increase in our retail revenue was due to the improvement in tourist activity in the Cayman Islands. We're up 14% in the volume of orders we sold for the third quarter of this year compared to last year. And our retail revenue also increased as a result of higher energy costs that increased the energy pass-through component of our water rates as well as a more favorable rate mix. As much of the increase in sales volume for Cayman Water was generated by tourist-related properties, and these such properties pay a higher per gallon rate than our residential customers. Our bulk segment revenue increased and this increase was attributable to an energy -- increase in the energy cost for CW-Bahamas. These energy costs increased the pass-through component of CW-Bahamas rates. The increase in our Services segment revenue was due to increases in both plant design and construction revenue and operating and maintenance revenue. Most of our services revenue increase in the quarter resulted from PERC's new contract with Liberty Utilities design and constructed an advanced water treatment plant in Goodyear, Arizona. But I would like to point out that even though we started work on this contract this quarter, the amount of revenue that we recognized on the Liberty Utilities contract was really small relative to what we expect to recognize in future quarters. The increase in manufacturing segment revenue was due to slightly higher project activity. Our gross profit for the third quarter of 2022 increased 20% to $6.8 million from the same period last year, while gross margin decreased 7.4 percentage points to 27.3% due to a change in the relative segment revenue mix. Net income from continuing operations attributable to Consolidated Water stockholders for the third quarter of 2022 totaled $824,000 or $0.05 per share. This compares to net income of $1.4 million or $0.09 per basic and diluted share for the third quarter of last year. This decrease in our net income from continuing operations this quarter as compared to the same quarter last year was attributable to three primary factors: Number one, higher repairs and maintenance expenses for our Bahamas operations. These were up about $361,000. We incurred these types of expenses intermittently. So they can have a significant impact on any one quarter's results as they had in this quarter. We also recognized a $247,000 loss on the revaluation of the put/call options that we issued or acquired in connection with the acquisition of PERC years ago. It's important to note that we exercised our call option to purchase the other 39% of PERC's shares in October of this year. And the third factor that created a decrease in our net income were increased G&A expenses in various categories. Most notably, increased bonus accruals arising from the improved financial performance year-to-date for the company as compared to last year, higher employee salaries due to the need to give pay raises and bank charges related to the transfer of some of our profits from our Bahamas subsidiary to the Cayman Islands. I want to point out that our bonus accruals for our management are based upon fiscal year financial performance metrics for the company. For the first six months of this year, we accrued bonuses at lower amounts based upon our initial expectations of year-end results. Once we obtain the Liberty Utilities and Red Gate contracts, our projected financial results for 2022 increased substantially. Thus, we were required to record a cumulative catch-up bonus accrual. And I want to point out that we also incurred higher business development expenses in professional fees this quarter relating to our pursuit of new business. And in general, inflation has increased most of our G&A expenses. Our net income attributable to stockholders that includes discontinued operations was $318,000 or $0.02 per basic and fully diluted share. This compares to net income of $286,000 or $0.02 per basic and fully diluted share for the third quarter of 2021. Now turning to our financial condition and our balance sheet. Our cash equivalents totaled $51.1 million as of September 30, 2022. This reflects an increase of $2 million from the $49.1 million as of June 30 of this year, and a $10.4 million increase in cash and cash equivalents year-to-date. This increase was due to cash generated from operating activities, which were almost $16 million for the first nine months of this year. As of September 30, our working capital totaled $71.1 million, and we still only have debt at $200,000, our stockholders' equity totaled $158.8 million. As of September 30, our projected liquidity requirements for the balance of the year include capital expenditures for existing operations and plant construction of approximately $6 million. This construction amount includes the $800,000 for the replacement of our West Bay seawater desalination plant on Grand Cayman and approximately $2.4 million for the construction of the water authority’s new desalination plant under our recently awarded contract. As I mentioned earlier, in October, we exercised our option to purchase the remaining 39% minority interest in PERC. So our liquidity requirements will also include the funds necessary to complete this purchase. For purchase price for PERC, the minority interest will be based upon a third-party valuation, which is presently underway. We paid approximately $1.4 million in dividends in October this year. Our future liquidity requirements will also include any future dividends declared by our Board. And during the quarter, we obtained a $10 million revolving credit line with Scotiabank in the Cayman Islands. This line was obtained to assist us with some of our short-term financing and working capital needs. However, to date, we have not utilized any of the borrowings under this line. So this completes our financial summary for the quarter. And with that, I'd like to turn things back over to Rick.

Thanks, David. I'd like to talk a bit more about our business segments and major projects. Looking at our retail water operations in Grand Cayman, we are -- we were pleasantly surprised by the rapid return of tourism to the island. In March of this year, several major airlines resume their flights to the island and cruise ships and thousands of passengers will welcome back to port. In August, all COVID-19-related restrictions for entry to the Cayman Islands were lifted by the government. And this easing of restrictions has positively impacted tourism here in Grand Cayman. David and I are here this week in Grand Cayman and its sure looks like a lot of tourist activity around the hotels are full. So we're very pleased to see what's happening here. We are encouraged by recent indications that the 2023 tour season will return to more historical levels on Grand Cayman. At the beginning of this month, we saw the commencement of nonstop flights from Los Angeles to the Cayman Islands by Cayman Airways. So more airlift, more tourists would be the expectation. Given these factors, we expect continued improvement for our retail water operations in the fourth quarter and the first quarter of next year. Our bulk operations remain consistent with our expectations and this segment was not materially affected by COVID or the downturn in the economy. Effective September this year, another milestone, all COVID-related travel restrictions to the Bahamas were eliminated by the Bahamian government. As I mentioned earlier, we broke ground in the fourth quarter on the Red Gate seawater reverse osmosis plant in Grand Cayman. And this plant has been designed to produce up to 2.64 million gallons of portable water per day for the water authority. We expect revenue generated over the approximately 11.5 year term of this contract to total about $20 million based on January 2022 values. And I'll just note again, the contract actually allows for capital cost adjustment for inflation at the end of this year and also inflation adjustments for the operating costs in our bid at the end of this year and at the end of next year. The majority of the revenue is expected to be generated by the construction and sale of the plant during the first 18 months of the project with the remaining revenue to be earned by bulk water sales to the water authority over 10 years. Now looking at the desal outlook beyond Grand Cayman, we're finally seeing some activity in the Caribbean market, and we're following a couple of opportunities in that region. We're also awaiting the resolution of the design, build, operate bidding process for 1.7 million gallon per day seawater plant in Honolulu, Hawaii which has been extended to the end of this year. So we would expect the successful bidder in that to be announced sometime in January if they proceed with the project. This project in Hawaii is very comparable to the types of projects that we've successfully completed in the Caribbean over many years. And we believe our extensive experience in designing, building and operating these seawater plants enabled us to be shortlisted for this project and for similar projects in the future. Now looking at PERC, the U.S. operations of our California-based subsidiary, PERC Water had been working on some exciting wastewater recycling projects in the Southwest United States. As we mentioned earlier, in May, PERC was contracted to design, construct and commission a 4 million-gallon per day wastewater treatment facility for Liberty Utilities in Arizona. We believe that we were able to obtain this project from Liberty because of our unique project delivery model. Under this project delivery model, our clients only have to deal with PERC for all aspects of the project, including design, the cost, schedule and plant performance, which enabled us to design, construct and ultimately commission an advanced water treatment plant on an accelerated schedule, which was important to Liberty and at a lower overall cost versus some antiquated project delivery models such as design, bid, build. Delivery project is proceeding on schedule, and we expect to begin generating increased revenue from this project in the fourth quarter and in 2023. The project is scheduled to be fully completed by June of 2024. Also in October, we announced that PERC was awarded an expanded 10-year $49.2 million contract to operate and maintain two advanced water treatment facilities in Southern California. This was a milestone win for PERC. Its longest -- PERC's longest-term operations and maintenance contract. And it represents, we think, an affirmation of PERC’s world-class operations and asset management services. We anticipate this win will support our plans to continue growing this segment of our business in the Western U.S., a region that is currently experiencing unprecedented drought conditions. And I'll just note that there's a lot of discussion about desal in California. It's a very difficult market to do those projects. We think that PERC’s product offerings, recycled wastewater, which could be used beneficially for irrigation, golf course maintenance and even for drinking water and groundwater replenishment as they do with these two plants that they're currently operating is a much more robust market in those areas of the world. So now looking at manufacturing. In the third quarter, we continued to be held back by supply chain constraints and challenging economic conditions that have increased our costs. However, we saw some improvement in October, and this has allowed us to start moving more of our significant order backlog through the manufacturing process. Our manufacturing contracted order backlog increased over the past three months to a record $20 million. We anticipate most of this backlog will be booked as revenue over the next 18 months. However, we caution that timing can change depending on the availability of materials and equipment. Our backlog growth is due in no small part to the success of our integrated sales team who develop new clients and enter new markets, such as the industrial and mining sectors. Now I'd like to give you a real quick update on the Rosarito matter. The project, as you know, was canceled in 2020. We continue to be in active discussions with the Baja California government to resolve our claim relating to their cancellation of the project as well as potentially addressing the state's acute water shortages. I'd like to reiterate that we've agreed to delay the appointment of the arbitrators during the course of these discussions, but the arbitration has not been suspended. We hope that our ongoing discussions with Mexico will result in a positive solution for both parties. In addition to our organic growth, we continue to pursue potential acquisition and partnership opportunities that would be complementary to our existing businesses, product offerings and customer base. David mentioned earlier that some of our G&A expenses are related to business development activities this past quarter. We are actively pursuing two opportunities, one that could bring our wastewater operating services into another rapidly growing area of the United States; and the second, they could further grow our manufacturing business by providing equipment to the mining sector. We see many positive factors driving continued revenue growth and more importantly, earnings growth in future quarters. These include the continued recovery of tourism in Grand Cayman our record high manufacturing backlog and increased project bidding activity in the United States and the Caribbean. The more than $150 million in major multiyear projects that we obtained already this year will have a much bigger positive impact on our earnings in the coming quarters and support our outlook for continued growth in our Services segment. All of these activities and trends represent catalysts for greater growth ahead. Now, Joe, I'd like to open up the call for questions.

[Operator Instructions] And our first question here will come from Gerry Sweeney with ROTH Capital.

Let's start with PERC. I know better than to ask what the range is looking at for the last 39%. But I was curious if you could give -- if you have any idea when that will -- valuation will be finalized?

Well, we have basically a four-month period to close the transaction. So we under the agreement that we signed with them. So we exercised the option at the end of October. So early next year, we should complete that.

Got it. Got it. And then just speaking about PERC. What does the -- it sounds like activity is very good in not just desal but water reuse, recycling, et cetera. Could you maybe elaborate a little bit on what the -- maybe the funnel potential, funnel and opportunities, a number of projects you're looking at or anything like that on -- for PERC?

Well, from the standpoint of new builds, I mean, there's probably two or three smaller reuse projects that we're talking to client -- potential clients about. So that would be a design, build type deal. They are primarily for -- with the drought in the West, the golf course and recreational type properties are hard hit with water shortages. So it's primarily in that market. There's other large operating contracts that we're looking at, those would be bid situations into next year. We think that PERC is unique in that. It has, I think, a much more impactful resume than any of our competitors in operating these advanced water treatment plants. And it was very important that we got the renewals on those WRD contracts because there's very few companies out there in the U.S. that have the experience that we have in advanced water treatment. There's another plant that we're just starting up now for a client that will be operating for the next two years. So an advanced water treatment plant, I think they had their ribbon cutting today or tomorrow. So we have our hands full right now, Gerry, with the projects that we're working on. We're looking to fill in behind them when the time comes.

That was actually a good lead in to my second question was -- is there an opportunity to invest more heavily into PERC in terms of to drive additional growth or capacity? Or how do we look at it? What's the thoughts on that?

Yes, absolutely. I mean we're -- we've -- over the last three years that we were -- we had ownership interest there. I mean, we've driven their growth substantially. I mean it's just an ongoing process. There's really no...

Chunky investment, just the continuous investment.

I mean, there's no incremental investment there. It's really just resources, human resources and people that can do these jobs. I mean, we're not doing design, build, own, operate type work like Consolidated does where we're investing tens of millions of dollars over 15 or 20 years. So it's just it's a matter of managing the growth and getting the people there that can do the work.

Got it. And then one question on the -- sorry, go ahead David.

It's not I was going to say there's really not much in the way of capital restrictions on growing that business at the moment. I mean -- and we don't have the opportunity to invest in plants like we do with our desal business. So -- most of these design-build contracts are self-funded and assume we get the performance funding taken through of, which we've had no problem with so far. I mean we could -- in other words, capital, it's not constraining us with PERC.

No, no, I didn't -- and I wasn't -- to be quite honest I wasn't looking at an investment in terms of plant, large physical assets. I was looking at it more from the human capital side. Things are starting to kick off. You're getting obviously, your backlog building. I wasn't sure if there was a desire after requirement to maybe add more engineers, even more salespeople because we all know drought in the United States this year and drawing a lot of opportunity. So that was more on the directional...

Yes. I mean when David talked about increased costs, I mean some of that was PERC, I mean we had to hire -- I think we went -- we went up by about 15 staff over the last quarter. A lot of that was related to the new WRD contract. Those revenues will start kicking in next year. And I'll just mention from the standpoint of increased costs because of inflation and other sort of broader economic factors. I mean, we're working in an environment where there's a lag to our -- any adjustments to our revenues for those things. I mean next year, our bulk contracts will be getting inflation adjustments. Some of the PERC contracts will be getting inflation adjustments, and that will help to absorb some of those additional costs as well.

That's important. Thank you. I appreciate that. Another question, just on the payments. I think volumes were up, I believe, it's about 14%. What's the -- what were volumes last year? The question -- really the question is what is normal and how far are we off of normal per se today? How much more opportunity is, volumes to increase in the Cayman? And I also understand that normal may be different, I’m not sure if hotel staffing is 100%, et cetera. But I just wanted to see if you had any idea of where we are sort of getting back to the normal?

Gerry, originally, we had disclosed that we were off about 25% from historical volumes as a result of the closing of the island. I took a look at the numbers yesterday -- not exactly yesterday, a few days ago. And the numbers for the fourth -- for the third quarter of this year, the volumes were -- but still about 10% below what we did in a normal year. So we're not down 25% anymore, we're down 10%. And the trend has been -- it's going up. So hopefully, we would see in the fourth quarter volumes that are closer to what we did pre-pandemic. And that would be an indication that things are pretty much back to normal in Grand Cayman as far as tourism is concerned. I can tell you, as Rick mentioned earlier, we're down here -- when I flew down to Cayman, it was a full flight, busy airport, we had trouble getting hotel rooms here. So we're very encouraged with what we see. We think things are going to be pretty much back to normal, hopefully, by the first quarter of next year.

Looks like we have another question from John Bair with Ascend Wealth Advisors.

Just what the delay on the Hawaiian bid project was? I may have missed it, but...

Yes, they asked us to extend the -- the client asked the bidders to extend their pricing until the end of the year. They had -- they still haven't decided whether they're going to proceed with the project or not or they didn't give us too much information on why they wanted the extension. But they have until December 31 now to get the pricing that we bid back in June.

Okay. Do you have any sense of how many other entities are bidding on the project?

Well, we know that a total of three, including ourselves were involved in the bidding process. We actually don't know how many actually bid. We had a number of questions from over the last few months. And we're just waiting for them to decide what they're going to do. It's a nice project, and we hope we get it.

[Operator Instructions] Our next question will be a follow-up from Gerry Sweeney with ROTH Capital.

Just a question on margins. Rick, you did mention there's going to be some inflationary pass-throughs at the end of the year. But even in like the bulk side, when you had some of that energy pass-through gross profit dollars sort of stayed as a pass-through. So gross profit dollars may stay the same, but it may make the percentage look lower. Is that an accurate assessment?

I would guess, yes, because we don't -- we're not meant to make any margin on the pass-through. So the revenues increased significantly, I think, because of the energy price changes.

Yes. Gerry, since our plants are very efficient we make a very small margin on the energy pass-through very minimal on some plants. But when you add the number to the numerator and the denominator, it affects the margin.

That's what I figured out. Okay. So it's -- gross profit dollars haven't changed, just the percentage has and mostly just because of the energy pass-through that revenue.

That's it exactly, yes.

And our next question will come from Christine Song with New Century Advisors.

I just had a question on capital allocation. And I know you guys had mentioned in the M&A activity you have -- you're pursuing two opportunities, the wastewater and manufacturing equipment in the mining sector, if I heard you correctly. So can you elaborate on these two opportunities, specifically the mining sector opportunity? And also, if you can kind of size in terms of what kind of multiples you guys find attractive for buying. And then also your thoughts on buybacks as well as increase in dividends with your capital allocation?

Yes, sure, Christine. The -- when I spoke about that earlier, I mean I said acquisitions and partnerships. The mining sector opportunity is a partnership opportunity. So that would mainly impact our manufacturing segment. It would be partnership with some other entities to provide equipment to a fast-growing sector of the mining industry. So there wouldn't be necessarily any or much capital investment there in that particular situation. The other acquisition, the wastewater acquisition, I mean we don't talk about values right now. I mean we're in the midst of negotiating something with the owners. But it would be in line with what we've done in the past. I mean we don't do any sort of $30 million, $40 million, $50 million acquisitions. We haven't done recently anyway. They're more sort of sub-$10 million deals that give us a very attractive opportunity to grow our existing service offerings into a new market that's grown very rapidly.

And with respect to our dividends and buybacks. Our company actually proposed initiating a stock buyback program several years ago around in 2008. Unfortunately, our articles of incorporation requires shareholder approval for us to have a stock buyback plan and we proposed to our shareholders. I think it was 2008, 2009, we proposed that we have the authority to mend articles of incorporation to allow us to stock buybacks. And that proposal was not approved by our shareholders. So legally, we're not allowed to buy back our own stock at the moment.

Without shareholder approval.

We'd have to get a proxy out of them, we would have to get shareholder approval given that we failed one time doing -- getting that approval, I don't think we're contemplating it again anytime soon. Look, our dividend policy is such that -- we believe our company's valuation is based more upon our growth and the amount of dividends that we pay. We think we're viewed as a growth company, more than an income stock. So we'd like to allocate our existing cash reserves to do projects and new business. However, I think our Board of Directors is aware that if we continue to accumulate cash balances, we probably will -- probably increase our dividends, but I can't speak for them. But ideally, we'd like to allocate capital new businesses, acquisitions, projects. But if we find out that we have excess cash, I'm sure our Board will fully do the increase.

At this time, this concludes our question-and-answer session. I'd like to now turn the call back over to Mr. McTaggart. Sir, please go ahead.

Thanks, Joe. I'd like to thank everybody for being on the call today for your interest in Consolidated Water, and I look forward to speaking with you again in March when we announce our fourth quarter and full year earnings for the company. Take care. Thank you.

Ladies and gentlemen, before we conclude today's call, I would like to provide the company's Safe Harbor statement that includes cautions regarding forward-looking statements made during today's call. The information that we've 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 revenue, future plans, objectives, expectations and events, assumptions and estimates. Forward-looking statements can be identified by the use of words or phrases usually containing the words believe, 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 markets 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. Factors that would cause or contribute to such differences include, but are not limited to, tourism and weather conditions in areas we serve, the impacts of the COVID-19 pandemic, particularly on our retail and manufacturing segments, the economic, political and social conditions of each country in which we conduct or plan to conduct business, our relationships with the government entities and other customers we serve, regulatory matters, including resolution of the negotiations for the renewal of our retail license on Grand Cayman. Our ability to successfully enter new markets and various other risks as detailed in the company's periodic report filings with the Securities and Exchange Commission. For more information about risks and uncertainties associated with the company's business, please refer to the management's discussion and analysis of financial conditions or results of operations and Risk Factors sections of the company's SEC filings, including, but not limited to, its annual report on the Form 10-K and quarterly reports for Form 10-Q. Any forward-looking statements made during the conference call speaks as of today's date. The company expressly disclaims any obligations or undertaking to update or revise any forward-looking statements made during the conference call to reflect any change in its expectations with regard thereto or any changes in its events, conditions or circumstances of which any forward-looking statement is based, except as 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. Please refer to yesterday's earnings release for dial-in and replay instructions available via the company's website at www.cwco.com. Thank you for attending today's presentation. This concludes the conference call. You may now disconnect your lines.