Consolidated Water (NASDAQ:CWCO) Q2 2020 Earnings Call

0:00 Good morning. Thank you for joining us today to discuss Consolidated Water's results for the second quarter ended June 30, 2020. Joining us today is Chief Executive Officer of Consolidated Water, Mr. Rick McTaggart, and Company's Chief Financial Officer, Mr. David Sasnett. Following their remarks, we'll open the call to your questions. Before we conclude today's call, I'll provide some important cautions regarding the forward-looking statements made by management in the call. I'd like to remind everyone that today's call is being recorded and will be made available for telecom replay by instructions in last Friday's press release, which is available in the investor relations section of the company's website. I'd like to turn the call over to Consolidated Water CEO, Mr.

0:49 Rick McTaggart.

0:50 Please go ahead, sir. Thank you, Nick, and good morning, everyone. Thanks for joining us on today's call. During the second quarter, our core water production and distribution and manufacturing operations remained stable and profitable, although at reduced production levels due to the impact of the COVID-19 pandemic. This allowed our financial condition and liquidity to remain strong, with cash balances totaling $35 million. In Q2, our services segment revenue was up by more than $3.3 million, Due to the contribution from PERC Water, our new majority-owned subsidiary that we acquired in the fourth quarter of last year, PERC performed better than we expected in the first half of this year given the current market conditions created by the pandemic.

1:44 During the quarter, PERC was awarded two new contracts and secured four contract renewals for operating and maintaining advanced water treatment plants in California. We continue to see attractive opportunities for PERC in a very active market. PERC's management team is extremely talented and motivated, and when we were presented with the opportunity in early August to increase our ownership in PERC, we seized it and boosted our ownership from 51% to 61%. I'll provide additional information on PERC's growth opportunities later after David discusses our financial results. As has been the case with most businesses, the COVID-19 pandemic adversely impacted all of our segments to varying degrees during the quarter.

2:34 The volume of water spilled by our retail segment and consequently retail revenue dropped by approximately 16% last quarter compared to the previous year's quarter. due to the temporary cessation of tourism in the Cayman Islands resulting from the government actions to close the country in order to mitigate the spread of the COVID-19 pandemic. Although the Bahamas tourism industry and economy has been severely hurt by the COVID-19 pandemic, our water production volumes remain stable in the Bahamas because our plants primarily serve the general population. The bulk segment revenue generated in the Bahamas and the Cayman Islands declined in the second quarter compared to last year for non-COVID-related reasons, which David will explain.

3:28 Even though COVID-19 has impacted our business, looking beyond the pandemic, our products and services remain public health and economic imperatives for the communities we serve. Customers still need turnkey and affordable sources of drinking water from our desalination plants, and wastewater still must be treated to the highest standards for environmentally responsible disposal or reuse. Consolidated water remains well positioned financially, technically, and operationally to address the needs of the communities we serve or will serve in the future. Before I go further, I'd like to turn the call over to David, our CFO, who will take us through the financial details for the quarter.

4:14 Afterwards, I'll return to talk a little more about our operational activity and outlook for the remainder of the year. David.

4:24 Thanks, Rick. Good morning, everyone. As Rick mentioned, our second quarter was impacted significantly by our recently canceled Mexico project and by the COVID-19 pandemic. Rick will discuss the recent development in Mexico in just a moment. With respect to the remainder of our results, our revenue in the second quarter increased 4% to $19.1 million compared to last year, solely due to the addition of $3.4 million in revenue from PERC. The income of PERC revenue was partially offset by revenue decreases of $1 million in the retail segment, $1.1 million in our bulk segment, and $511,000 in the manufacturing segment. Our retail revenue declined because of a 16% decrease in the volume of water sold due to the lack of tourism on Grand Cayman that resulted from the closing of all Cayman Islands airports and seaports in March 2020 in response to the COVID-19 pandemic.

5:25 The decrease in bulk water revenue was primarily due to lower energy costs in the Bahamas, which correspondedly decreased the energy pass-through component by rates. Our bulk revenue also decreased due to the lower rate that came into effect in July 2019 for the Northside Water Works Plant under our new contract for this plant where the Water Authority came in. The decrease in manufacturing revenue was due to a lower number of active projects. Our gross profit for Q2 was $7.3 billion or 38.3% of total revenue. down 3% from $7.6 million or 41.3% of total revenue in the same quarter last year.

6:11 In the second quarter of 2020, net loss attributable to consolidated water shareholders was $1.1 million or $0.07 per basic and fully diluted share. This compares to net income of $2.5 million or $0.16 per basic and fully diluted share in the same period last year. The decrease in our net income was principally due to the $3 million impairment loss that we reported for the rights-to-ways we had acquired for the Mexico project. Turning to our balance sheet, our accounts receivable balances related to our Bahamas business amounted to $19.9 million as of June 30, 2020 and paid to $18.4 million as of December 31, 2019. We believe the Bahamas government's ability to pay in a timely manner has been impacted by COVID-19. However, we're continuing to work with the Bahamian government to collect these receivables.

7:04 Historically, our Bahamas subsidiary has experienced delays in collecting its accounts receivables from the water and sewage corporation in the Bahamas. When these delays occur, we hold discussions and meetings with representatives of the Bahamas government. As a result, payment schedules are developed for delinquent accounts receivable. All previous to delinquent accounts receivable from the Bahamas were eventually paid in full. Based upon this payment history, we have never, ever been required to provide an allowance for doubtful accounts for any of our accounts receivables for our business in the Bahamas, despite the periodic accumulation of significant delinquent balances. As of June 30, 2020, we had not provided an allowance for doubtful accounts for our accounts receivable business in the Bahamas. And it's important to note that the Bahamas government made a payment of $4 million on these receivables in the month of July.

7:57 In June 30, 2020, our cash and cash equivalents totaled $35 million. Our projected liquidity requirements for the balance of 2020 include capital expenditures for existing operations of about $1 million, and about $1.3 million for dividends payable. And it's important to recognize that we spent $900,000 in August to acquire the additional 10% ownership in PERC. We believe our cash position and available funds provide us with the sufficient liquidity we need to meet things as we go forward. This wraps up my brief discussion of our financial results for the quarter. Now I'd like to turn the call back over to Rick.

8:42 Thanks, Dave. On June 29th, we received notification that the State of Baja California, Mexico had terminated our contract for the construction and operation of a desalination plant in Africa, Rosarito, Mexico. Quite frankly, we were shocked and tremendously disappointed with the State's decision to terminate a project They would have provided a drought-proof and natural disaster-resistant drinking water supply to more than 2.5 million people in the region. It's a project that we believed until we received the termination letter that the state was both supported and intended to complete. Like most other countries in the world, Mexico's economy has been damaged by the COVID-19 pandemic as well as other factors which we believe has reduced the state's revenue sources.

9:37 Furthermore, the recent devaluation of the PESO has made the project more expensive, and this factored into the state's decision to cancel, we understand. At this point, it is uncertain how much, if any, of our developmental costs and investments we can recoup, or how long any such recoupment will take. We are vigorously pursuing all legal remedies and courses of action available under the contract and applicable law with respect to collections of these amounts. Now turning to our business in the Cayman Islands. Our operations in Grand Cayman continue to be adversely affected by COVID-19 preventative measures which were enacted by the government back in March.

10:24 As a result of these measures taken, tourism in the Cayman Islands has temporarily ceased and economic activity on Grand Cayman has slowed dramatically. The preventative measures taken by the Cayman Islands government in response to the pandemic did not commence until the latter half of March and thus affected our retail sales primarily in the second quarter. Our retail sales volume for the first six months declined only by 3% compared to that same period last year. However, retail sales volume for the second quarter was 16% less than that for the same quarter last year. We also sell bulk water and Grant Kamen to the government-owned water utility, which in turn provides us water to areas that are more residential and less tourist-related.

11:14 Consequently, our bulk water volumes sold in Grant Kamen were relatively stable compared to the same periods last year, similar to our Bahamas business. In May 2020, the Cayman Islands government started a phased relaxation of the shelter-in-place restrictions at the local level, and most recently the government designated October 1, 2020 as the planned date for the phased reopening of the Cayman Islands borders, although this date is subject to reassessment at this time, at the time in October. We expect that retail segment revenue and cash flows will continue to be adversely impacted until such time as tourism and the economy in the Cayman Islands recovers from the impact and effects of the COVID-19 pandemic.

12:10 For our business in the Bahamas, tourist travel to New Providence Island, where we operate, has been suspended. and economic activity in the Bahamas has slowed dramatically as a result of COVID-19. In May, the Bahamian government relaxed some of the shelter-in-place regulations and reinstated the regulations effective August 4th through August 19th, at least. In July, the government enacted a limited reopening of the Bahamas to air travel, reinstated travel restrictions, and shortly thereafter, referred to the increased COVID-19 cases. While the world is focused on defeating the global pandemic, global challenges with water availability and shortages continue to grow, and desalination and water reuse continue to present the best solutions in many areas around the world. Today, nearly 90 million cubic meters of water is being produced daily by more than 18,500 desalination plants in operation globally.

13:19 These plants are providing drinking water to more than 300 million people. As we look to expand geographically beyond our current areas of operation, Our mission remains focused on providing water services to those areas of the world where the supply of naturally occurring potable water is scarce, and particularly areas where reverse osmosis technology is economically and environmentally feasible. Historically, we focused on seawater desalination projects in the Caribbean. Our government and private customers long ago embraced our design, build, own, and operate project delivery model. However, because of the extreme financial strains caused by the COVID-19 pandemic, we believe that many state and local governments in the United States will find our project delivery model well suited to expand and improve vital water services for these cash-strapped communities.

14:22 In addition to the growing demand for potable water, water management challenges are also increasing the opportunity for wastewater treatment and reuse projects. Our acquisition of PERC, which is based in Southern California, represented a major step toward addressing this growth market and its many emerging opportunities. Similar to our existing approach, PERC provides their customers with a comprehensive solution to deploying or upgrading their water infrastructure. They develop, design, and build state-of-the-art facilities for both water and wastewater recycling, and provide ongoing operational and management services to keep these facilities operating at peak performance. Since PERC's founding in 1998, it has completed and continues to support numerous water infrastructure projects, including new facilities, facility upgrades, short- and long-term operations services, and asset management engagements.

15:22 For this, they won numerous industry awards for organizing their innovative designs and highly efficient project delivery model. At present, Trump generates a sufficient revenue from business, foundations, and maintenance contracts for water treatment and reuse facilities owned by third parties. Given the challenging market conditions brought on by COVID-19, Kirk performed better in the first half of the year than we expected. We expect FERC to secure, as I mentioned earlier, two new O&M contracts effective April, as well as four contract extensions in the first half of the year. We expect FERC's two new O&M contracts to add revenues of approximately $1.7 million in the second half of this year.

16:09 FERC's growth potential is largely due to its excellent product and service offerings and its strong presence in the southwestern United States. Water Spas are increasingly under stress. FERC has been highly complimentary to our existing business and overall mission, supporting our pursuit of water reuse projects and other emerging opportunities with a comprehensive suite of solutions for improving water infrastructure. FERC also provides us a solid platform upon which to expand to North America our core business of designing, constructing, and operating desalination plants. Given these compelling growth factors, earlier this week we acquired an additional 10% in PERC from another shareholder for $900,000, raising our ownership to 61%.

17:00 Overall, consolidated water continues to be well-positioned to successfully navigate these uncertain and turbulent times. Thanks to the strong balance sheet and well-established growth strategy that brought us PERC as we anticipate other successful future acquisitions. Looking beyond the pandemic, we expect the growth drivers inherent in our markets to persist over the long term, which bodes well for consolidated water and our efforts to enhance shareholder value over the years to come. Now with that, I'd like to open the call for questions. Next. Well, I'll begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone.

17:46 If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we'll pause momentarily to assemble the roster. First question comes from Jerry Sweeney of Roth Capital. Please go ahead. Thanks for taking my call.

18:10 I wanted to talk a little bit about PERC since it was some of the key points that you raised in your remarks. I'm assuming that $1.7 million of the O&M contract that you're expecting to hit in the second half of 2020, can we extrapolate that out to $3.4 million on a full year basis?

18:38 Jerry, this is David. When you cook for those particular contracts, PERC has a number of contracts that are up for renewal. This is part of their business. So when you look forward to trying to project their revenues, if you want to assume that they'll get renewals of all existing contracts, then that would be a reasonable assumption. But we did add a risk factor in our 10-Q this quarter to point out the fact that a number of these contracts These contracts expire over the course of the next few months. I think the deadline we provided or the timeframe we provided was July of 2021. We are hopeful that they can get renewals of all those contracts. There are renewal options in the contracts exercisable at the discretion of the customer.

19:23 So, I mean, PERC's O&M business is fluid. because of the renewal processes. But, you know, over the long term, we hope to continue to grow that business because PERC's proven to be very good at bringing in new contracts and also paying extensions of existing contracts. But I don't think it's fair just to automatically extrapolate going forward. I think it requires a little less uncertainty than that. Okay.

19:52 Taking a half a step back, maybe I misinterpreted when I read the queue, but I thought for the press release, I thought there's two new O&M contracts that you won just recently that had a value of $1.7 million in the second half of this year. That's correct. Just those two, right? But how long is the average contract for PERC?

20:15 The average contract for PERC ranges anywhere from one to five years. Okay. So when you're projecting O&M revenue, some of those contracts come up for renewal. Assuming that we get the renewals, then the revenue will continue to grow. And if everything else remained the same and we renewed all the contracts and got more contracts, the impact of the new contracts would be incremental over a 12-month period of about $3 million, close to $3.4 million. But there are other factors that go into the O&M revenue.

20:48 Yeah, well, my next question was... on the O&M side, or I guess it's in the services side. How much of that is O&M from PERC, and how much of it is design, build, or PERC? I believe that's first in our queue.

21:04 I'll take a look at it real quick here. Right. Actually, Jerry, if you look at the risk factor, what's that exactly, how much? Okay.

21:22 I have it here. That could change before the end of the year as well, Jerry. That could change the mix before the end of the year, depending on the design.

21:40 And I have the number here for you, Jerry. For the three-bunch set, the Perks O&M revenue was $2.5 billion. and for the six-month synergy, it was $4.1 million. That's their O&M revenue.

21:55 I apologize. I did not read everything about the risk factors. It's okay. I apologize on that front. I was just going through. That's helpful. So, did they maybe switch gears to the revenue on the... on the desal business, Caymans and the Bahamas. So obviously the Caymans and the Bahamas are shut down for tourism. You know, is this a decent run rate on revenue or volume in this sort of COVID world where there isn't tourism? And then conversely, I know historically there's also been some seasonality as tourism has picked up, but... Does that change because the weather gets a little cooler potentially and there is no tourism? I'm just trying to see how we look at the revenue on the water side from that perspective.

22:52 So the first half of the year is typically our biggest sales business.

23:10 because of its drier conditions and tourism is up. The 16% drop we saw in the second quarter, I think that's fairly indicative of what we should expect for the end of this year. Historically, rainfall has also impacted the sales slightly. from time to time. But, you know, a 16% change because the hotels are closed, I'd say that's a pretty consistent way to look at it in the retail segment going forward. And just to remind you, the bulk segments were not adversely impacted on volume sales because of COVID. It was other things, which, again, you can roll forward because they were basically one-time events.

24:01 You know, the contract changes and came at it. and then the electricity rates. If you think electricity is going to continue to be low, then, you know, that's going to be the impact on the sales going forward. Got it. I should have delineated. I understood bulk was less than that of COVID.

24:24 Let me just, Jared, let me point out two additional things. The energy pass-through doesn't have a huge impact on margins. So you should keep that in mind. And the other thing is don't discount the impact of rainfall. If it was really dry in Grand Cayman, you know, out of necessity, the existing population would have to use more water. And we have seen significant fluctuations in the volume of water used in times of excessive rainfall and during droughts. So I think the 16% decrease gives you a good indication of how much of the water we sell on several beach lakes for tourism, but it's not an absolute movement. No, absolutely.

25:07 This is a broad brush. And then the third question, and I'll jump back in line. Mexico calls, they were down this quarter, but obviously a disappointment that Rosarito is not coming through. How do we look at these calls? How do they run down for the second half of this year into next year? I mean, you had some leased. Thank you. Thank you.

25:55 So, Jerry, on the lease, just to clarify, we said that we expect to terminate it or to transfer it to a state. So we haven't terminated that CFE lease yet. On the cost side, you know, the running costs for the business, obviously, are tapering down. We still have staff there that are dealing with the claim. So I wouldn't expect, you know, a huge... Thank you for joining us. I really can't say how much. This is a prolonged legal exercise.

26:58 It could take more time to get it resolved.

27:01 Got it. And then on the claims part, it was my understanding that you had some, at least in the contract, some ability to recoup costs. And I'll paint this as potential. but is there an opportunity to recoup some costs not only on the asset investment side but also, you know, plant power type capital investment project?

27:37 Yeah, I mean, the contract gives us the right to recoup all of our costs related to the development of the project and the assets that we purchased to execute the project. So, I mean, that's what we intend to do. As we mentioned in the queue, I mean, we've done some legal challenges of the timetable to submit, you know, a tally of these costs, and that was successful. So it gives us a little more time to get everything in order and get it in the correct order. I appreciate it. Pretty solid quarter, I think.

28:51 But I'll jump back to you. Thank you. All right. Thank you. Again, if you have a question, please press star, then 1. Our next question is for Michael Gogler. Kenny Montgomery, Scott. Please go ahead. Good morning, everyone.

29:10 Hey, Mike. How are you?

29:14 First question on Cayman in general. Is the government indicating that tourism will probably be ceased through year-end and then kind of as a follow-up, how are the finances on Cayman with tourism down for such a prolonged period? I mean, does the government continue to have the ability to pay its bills?

29:41 Yeah, so your guess is as good as mine on when they're going to actually open back up, Mike. Okay. You know, they've said October 1st, subject to review at the time. And, you know, they said September 1st, and then as that got closer, they changed it. So, I don't know. They're really very concerned about bringing the virus back into the country. You know, they've been virus-free for, I don't know, three or four weeks now. No cases. So, I don't know what they're going to do. I mean, I hope that they... They open it back up by the end of the year. And then it'll be up to the tourists to decide whether they want to go through the screening procedures that most countries are requiring to travel now. From the standpoint of their financial position, I think Cayman is one of the better positions around the world.

30:42 I mean, they haven't had much debt historically, so I think they're Okay. That's all I had, John. Thank you. All right, Mike. Again, if you have a question, please press star, then 1. Next question comes from John Bearer. Accent, well, please go ahead.

31:32 Thank you. Good morning, Rick and David. Good morning, John. Two questions. Your information about PERC seems to be... that they are geographically focused in the southwest. So my question is wondering whether they operate in other parts of the country. Is there expansion potential there or do they have operations outside of the southwest? And secondly on that, Do they do any international work or are there any opportunities there that they're either actively involved in or looking to do?

32:21 John, at present, they don't have active projects or operations outside of the Southwest. They're primarily California, Arizona, Utah. We've combined our business development teams, obviously, with the acquisition. So they are working with us, looking at a project in Florida and also a major project with some partners up in Oregon. So those projects would be, you know, they're definitely good projects, and PERCA is well-qualified to do them. That's one of the things that they've leveraged off of us on, you know, having exposure to different markets, and we expect their business to grow into these markets in the future.

33:14 What about a big state like Texas or that area of Oklahoma? I mean, certainly water needs in that area as well. Do they have any other...

33:28 Not at the moment, but again, we've been following projects in Texas for a number of years on the D-South side. So the combination of the business development teams, I think, will pay dividends in some of these other states. I don't know anything in Oklahoma. I'm not aware of anything up there. But certainly Texas, Florida, California, Arizona, Oregon, those are the areas that the business development team is most focused on at the moment.

33:58 Okay, great. And then another question that is a real speed of project. How long would, I'm not afraid to actually, but how long do you try to pursue this? Is there any time clock ticking on what you have to do to get resolution? Do you have any sense if there is any possibility that it be resurrected and that the I realize that the economic situation there is tough, but a lot of potential water for their folks down there that isn't going to be available.

34:48 My opinion is that

34:55 You know, it's a big mistake what they did. I mean, just from a technical standpoint, but a little much water right now. They could come back to us. I have to say what they have in mind, you know, what the reaction will be when we present the claim. But obviously... The driver here was that the economic conditions had changed in the region, and it didn't make, you know, what they pulled us in the termination letters, that the project was not financially feasible. So it's kind of, it's hard to say. But, I mean, we'll work with them however they want.

35:42 I mean, my main goal is to try to recover our costs. and our investment costs at the moment. And if anything else, any other opportunity presents itself, then we'll certainly look at

35:57 it. Is there any information that, in other words, they've had access to some plans or anything like that that they could kind of utilize on their own if they decided to try to... built that project themselves at this point. Is there anything along those lines?

36:23 Well, I mean, we did a lot of work just developing the intake strategy, the ocean intake, the lease on the power plant site, the permitting, all that was done for that particular site. Unless they're going to do a large plant like was envisioned, The actual designs of the plan, we never got far enough where we were presenting any of those for approval to the state, so they don't have access to any of that information. Okay.

37:15 All right. That was very disappointing, and please don't have an epiphanal event change their minds, and you can proceed on, but I'm not going to hold my breath on that one. All right. Thank you very much. We'll talk to you next year. Thanks, John. Yep. This concludes our question and answer session. I'd like to turn the conference back over to Mr. Rick McTaggart for any closing remarks. Please go ahead. Thank you, Nick.

37:47 I'd just like to, again, thank everybody for dialing in today, and I wish you all the best, and we'll talk to you again, I guess, in November. Take care. Stay safe. 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 have provided in this call includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, included but not limited to statements regarding the company's futures revenue, future plans, objectives, Expectation 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.

38:55 Statements that are not historical facts or 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 statement made during this conference call or not guarantees a future performance and involves 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, are but not limited to, continued acceptance of the company's projects and services in the marketplace, Changes in its relationship with the government to the jurisdictions in which it operates.

39:45 The outcome of negotiations with the Cayman government regarding a new retail license agreement. The future financial performance of its subsidiary that manufactures water treatment-related systems and projects and provides design, engineering, management, operating, and other services applicable to commercial, municipal, and industrial water production. the collection of its delinquent accounts receivables in the Bahamas, its ability to integrate and profitably operate recently acquired subsidiary DER Seawater Corporation, the possible adverse impact of the COVID-19 virus on the company's business, and various other risks as detailed in the company's periodic reportings with the Securities Exchange Commission.

40:35 For more information about risks and necessities, Associated with the company's business, please refer to the management's discussion and analyst of financial conditions and results of operations and risk factor section of the company's SEC columns, included but not limited to its annual report on the Form 10-K and quarterly reports for Form 10-Q. Any forward-looking statement 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 a conference call to reflect any changes 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 where it may be required by law.

41:28 Before we could end today's conference call, I would like to remind everyone that this call will be and running through August 24th. Please refer to today's earnings release for dial-in replay instructions available by the company's website at www.cwco.com. Thank you for attending today's presentation. This concludes the conference call. You may now disconnect.