Consolidated Water (NASDAQ:CWCO) Q3 2022 Earnings Call

0:00 Good morning, and thank you for joining us today to discuss Consolidated Water Co.'s third quarter 2022 results. Hosting the call today is the Chief Executive Officer of Consolidated Water Co., Rick McTaggart, and the company's Chief Financial Officer, David Sasnett. Following their remarks, we'll open the call to your questions. At any time during the call, you may join the Q&A queue by pressing the star key followed by the one on your telephone keypad. To withdraw a question, please press star, then 2. Should you need any assistance today, you may signal a conference specialist by pressing the star key followed by 0. Before we conclude today's call, I'll provide some important cautions regarding the forward-looking statements made by management during the call.

0:45 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 Co. CEO, Rick McTaggart.

1:03 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.

1:48 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 Perk 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.

2:35 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.

3:25 Mr. Sasnett.

3:27 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 investor 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 water we sold for the third quarter of this year as 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 rate. as well as a more favorable rate mix.

4:23 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 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, Liberty Utilities Design and Construction 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.

5:28 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 in the limited share for the third quarter of last year.

6:14 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 have 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 PERT years ago. It's important to note that we exercised our call option to purchase the other 39% of PERT shares in October of this year.

7:04 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 obtained the Liberty Utilities and Red Gate contracts, our projected financial results for 2022 increased substantially.

7:56 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 and 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.

8:44 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 crash 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. We still only have debt of $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.

9:45 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. The 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 of 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 and the Cayman Islands. This line was obtained to assist us with some of our short-term financing and working capital needs. To date, we have not utilized any of the borrowings under this law.

10:33 So this completes our financial summary for the quarter. And with that, I'd like to turn things back over to Rick.

10:38 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 were pleasantly surprised by the rapid return of tourism to the island. In March of this year, several major airlines resumed their flights to the island and cruise ships and thousands of passengers were welcomed 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 it's It sure looks like a lot of tourist activity around the hotels are full, so we're very pleased to see what's happening here.

11:33 We are encouraged by recent indications that the 2023 tourist 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 and David Chawla. 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.

12:19 Effective September of 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 potable water per day for the water authority. We expect revenue generated over the approximately 11 and a half 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.

13:18 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. So 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 a 1.7 million gallon per day seawater plant in Honolulu, Hawaii, which has been extended to the end of this year.

14:05 So we would expect the successful bidder and 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, have 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.

15:11 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.

16:00 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. It's 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.

16:47 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 perks, 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.

17:37 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 have developed new clients and entered new markets such as the industrial and mining sectors.

18:28 Now I'd like to give you a real quick update on the Rosarito matter. The project, as you know, is 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.

19:17 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 a second that 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.

20:05 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 multi-year 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. We will now begin the question and answer session.

20:52 To ask a question, you may press star, then 1 on your telephone keypad. 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 will pause just momentarily to assemble our roster. And our first question here will come from Jerry Sweeney with Roth Capital. Please go ahead.

21:21 Good morning, Rick, David. Thanks for taking my call.

21:24 Sure, Jerry.

21:28 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 have any idea when that valuation will be finalized.

21:45 Well, we have basically a four-month period to close the transaction, so we... under the agreement that we signed with them. So we exercise the option at the end of October. So early next year, we should complete that.

22:04 Got it. Got it. And then just speaking about PERC, what does the – it sounds like activity is very good in – You know, not just desal, but water reuse, recycling, etc. Could you, you know, maybe elaborate a little bit on what the, maybe the funnel, potential funnel and opportunities, number of projects you're looking at or anything like that for PERP?

22:33 Well, from the standpoint of new builds, I mean, there's probably two or three smaller reuse projects. that we're talking to potential clients about. So that would be a design-build type deal. They are primarily for, you know, 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.

23:20 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, Jerry, with the projects that we're working on.

24:13 We're looking to fill in behind them when the time comes.

24:22 That was actually a good lead-in to my second question. Is there an opportunity to invest more heavily into PERC in terms of the drive additional growth or capacity or how do we look at it? What's the thoughts on that?

24:39 Yeah, absolutely. I mean, we've... Over the last three years that we had ownership interests there, I mean, we've driven their growth substantially. I mean, it's just an ongoing process. There's really no... Chunky investment data?

25:01 It's just a continuous investment?

25:03 I mean, there's not incremental investment there. It's really just, you know, 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 a matter of managing the growth and getting the people there that can do the work.

25:32 Got it. And then one question on the – oh, sorry, I did it.

25:37 Yeah, 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, we don't really 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 assuming we get the performance bonding taken care of, which we've had no problem with so far, I mean, we can... In other words, capital's not constraining us with PERC.

26:01 Yeah, no, no, and I didn't... And I wasn't, to be quite honest with you, I wasn't looking at an investment in terms of plant... I mean, some of that

26:35 was PERC. I mean, we had to hire, I think 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 any adjustments to our revenues for those things. I mean, next year, our bulk contracts will be getting inflation adjustments.

27:22 Some of the PERT contracts will be getting inflation adjustments. And that'll help to absorb some of those additional costs as well.

27:32 That's important. Thank you. Appreciate that. Another question just on the Caymans. The volumes were up, I believe it's the volumes were up 14%. What's the, you know, 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 2020? And I also understand that normal may be different. I'm not sure if hotel staffing is 100%, etc. But I just wanted to see if you had any idea of where we are sort of getting back to normal.

28:17 Jerry, 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. A few days ago. and the numbers for the third quarter of this year, the volumes were 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's been, you know, 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 will be pretty much back to normal, hopefully by the first quarter of next year.

29:20 Got it. Okay.

29:21 That's it for me. I appreciate it. Thanks, Jerry. Again, If you have a question, you may press star then 1 to join the queue. All right. Looks like we have another question from John Bear with Ascend Wealth Advisors. Please go ahead. Good morning, gentlemen. Good morning, John.

29:55 Just with the delay on the Hawaiian bid proposal, Project was.

30:03 I may have missed it, but... Yeah, they asked us to extend. The client asked us, asked the bidders to extend their pricing until the end of the year. They still haven't decided whether they're going to proceed with the project or not. They didn't give us too much information on why they wanted the extension, but... They have until December 31st now to get the pricing that we bid back in June.

30:38 Okay. Do you have any sense of how many other entities are bidding on the project?

30:45 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 the client 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.

31:11 Yep, so do I. Very good. That's all I've got for right now. Thank you very much. All right, John.

31:17 Take care. Again, if you have a question, you may press star then 1 to join the queue. Our next question will be a follow-up from Jerry Sweeney with Roth Capital. Please go ahead.

31:31 Thanks, guys. 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 the bulk side, when you have some of that energy pass-through, gross profit dollars sort of stay. That's a pass-through, so gross profit dollars may stay the same, but it may make the percentage look lower? Is that an accurate assessment?

32:02 I would guess so, yeah, because we're not meant to make any margin on the pass-through. So the revenues increase significantly, I think, because of the energy price changes.

32:17 Yeah, Jerry, since our plants are very efficient, We make a very small margin on the energy pass-through, very minimal. On some plants. On some plants. But, you know, when you add the number to the numerator and the denominator, it affects the margin.

32:34 That's what I figured. Okay. So it's gross profit dollars haven't changed, just the percentage has, and most of that's just because of the energy pass-through.

32:44 That's it exactly, yeah.

32:46 Got it. Okay. Thanks. I appreciate it. No problem, Jared. And our next question will come from Christine Song with New Century Advisors. Please go ahead.

32:59 Hi. Morning, guys. I just had a question on capital allocation. And I know you guys have mentioned in the M&A activity, 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? Thank you. Yeah, sure, Christine. When I spoke about that earlier

33:48 I said acquisitions and partnerships. The mining sector opportunity is a partnership opportunity. That would mainly impact our manufacturing segment. It would be a partnership with some other entities to provide equipment to a fast-growing sector of the mining industry. 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.

34:35 But it would be in line with what we've done in the past. I mean we don't do any sort of 30, 40, 50 million dollar acquisitions. We haven't done recently anyway. They're more sort of sub-10 million dollar deals that give us a very attractive opportunity to grow our existing service offerings into a new market that's grown very rapidly.

35:02 And with respect to our dividends and buybacks, our company actually proposed initiating a stock buyback program several years ago, around 2008. Unfortunately, our articles of incorporation require 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 amend our articles of incorporation to allow us to do 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, We'd have to be a proxy out of them. We'd have to get shareholder approval. Given that we failed at one time 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.

36:06 So we'd like to allocate our existing cash reserves New projects and new business. However, I think our board of directors is aware that if we continue to accumulate cash balances, we probably will, they'll 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, you know, have excess cash, I'm sure our board will approve the dividend increase. That's pretty much it, Christine.

36:41 Okay, great. Thank you very much. You're welcome. All right. At this time, this concludes our question and answer session. I'd like to now turn the call back over to Mr. McTaggart.

36:54 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 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 revenue, future plans, objectives, expectations, and events, assumptions, and estimates.

37:51 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.

39:14 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.

40:08 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.