Earnings Call Transcript - CWCO Q3 2022

Operator, Operator

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. 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.

Rick McTaggart, CEO

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?

David Sasnett, CFO

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. 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 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 to design and construct 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 was 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. Thus, we were required to record a cumulative catch-up bonus accrual. 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. 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. 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 this year. Our future liquidity requirements will also include any future dividends declared by our Board. 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.

Rick McTaggart, CEO

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 welcomed thousands of passengers back to port. In August, all COVID-19-related restrictions for entry to the Cayman Islands were lifted by the government. This easing of restrictions has positively impacted tourism here in Grand Cayman. David and I are here this week in Grand Cayman, and it sure looks like there's 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 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 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. 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 a 1.7 million-gallon-per-day seawater plant in Honolulu, Hawaii, which has been extended to the end of this year. We would expect the successful bidder for this project 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. We believe our extensive experience in designing, building, and operating these seawater plants has 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. Under this project delivery model, our clients only have to deal with PERC for all aspects of the project, including design, 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 compared to 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. It's PERC's longest-term operations and maintenance contract and 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 currently experiencing unprecedented drought conditions. I'll just note that there's a lot of discussion about desal in California. It's a very difficult market for 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, are much more robust markets in those areas of the world. 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, which 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, Operator

And our first question here will come from Gerry Sweeney with ROTH Capital.

Gerard Sweeney, Analyst

Let's start with PERC. I know better than to ask what the range looks like for the last 39%. But I was curious if you could give any idea when the valuation will be finalized.

Rick McTaggart, CEO

Well, we have basically a four-month period to close the transaction 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.

Gerard Sweeney, Analyst

Got it. Speaking about PERC, it seems like there is significant activity not only in desalination but also in water reuse, recycling, and similar areas. Could you elaborate a bit on the potential opportunities, including the number of projects you're considering for PERC?

Rick McTaggart, CEO

From the perspective of new builds, we are currently in discussions regarding two or three smaller reuse projects with potential clients. These would be design-build arrangements primarily focused on addressing the impact of drought in the West, particularly affecting golf courses and recreational properties facing water shortages. Additionally, we are evaluating other large operating contracts that will be up for bidding next year. We believe that PERC stands out due to its impressive track record compared to our competitors in operating advanced water treatment plants. Securing the renewals for those WRD contracts was crucial since very few companies in the U.S. possess our level of experience in advanced water treatment. We are also in the process of starting up another plant for a client that will be operational for the next two years, with a ribbon-cutting ceremony scheduled for today or tomorrow. At the moment, we have our hands full with the current projects, and we plan to take on more as opportunities arise.

Gerard Sweeney, Analyst

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

Rick McTaggart, CEO

Yes, definitely. Over the past three years, since we had ownership interest there, we have significantly driven their growth. It's an ongoing process, and there's really no...

Gerard Sweeney, Analyst

Chunky investment, just the continuous investment.

Rick McTaggart, CEO

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 a matter of managing the growth and getting the people there that can do the work.

Gerard Sweeney, Analyst

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

David Sasnett, CFO

There are currently no significant capital restrictions on expanding that business. We don't have the same investment opportunities in facilities as we do with our desalination business. Most of these design-build contracts are self-funded, and as long as we secure the performance funding, which hasn't been an issue so far, capital is not a limiting factor for PERC.

Gerard Sweeney, Analyst

No, I wasn't looking at an investment from the perspective of large physical assets like plants. My focus was more on human capital. Things are starting to take off, and your backlog is growing. I was uncertain if there was a need to potentially bring in more engineers or salespeople, especially considering the current drought in the United States that is creating many opportunities.

Rick McTaggart, CEO

Yes. When David mentioned the increased costs, part of that was due to PERC, and we had to add about 15 staff over the last quarter, primarily related to the new WRD contract. Those revenues will begin coming in next year. Additionally, I want to highlight that the increased costs are also influenced by inflation and other economic factors. We are operating in an environment where there's a delay in our ability to adjust revenues accordingly. Next year, our bulk contracts and some PERC contracts will receive inflation adjustments, which will help mitigate some of these extra costs.

Gerard Sweeney, Analyst

That's important. Thank you. I appreciate that. Another question regarding the payments. I believe volumes increased by about 14%. What were the volumes last year? The real question is what is considered normal and how far we are from that today? How much more opportunity is there for volumes to grow in the Cayman? I also recognize that normal may vary; I’m uncertain if hotel staffing is at full capacity, among other factors. But I wanted to know if you have any insight on how close we are to returning to normal.

David Sasnett, CFO

Gerry, we initially reported that we were down about 25% from historical volumes due to the island's closure. However, after reviewing the numbers a few days ago, I found that for the third quarter of this year, our volumes were only about 10% lower than what we typically achieve in a normal year. So we've improved from a 25% decline to a 10% decline, and the trend is upward. We expect to see fourth quarter volumes that are closer to our pre-pandemic levels, which would suggest that tourism in Grand Cayman is nearing normalcy. As Rick mentioned earlier, when I arrived in Cayman, my flight was full, the airport was busy, and we had difficulty securing hotel rooms. This gives us a positive outlook. We anticipate that things will largely return to normal by the first quarter of next year.

Operator, Operator

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

John Bair, Analyst

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

Rick McTaggart, CEO

Yes, the client requested the bidders to extend their pricing until the end of the year. They have not yet made a decision on whether to proceed with the project, and they haven't provided much information regarding the reason for the extension. However, they now have until December 31 to consider the pricing we submitted back in June.

John Bair, Analyst

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

Rick McTaggart, CEO

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, Operator

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

Gerard Sweeney, Analyst

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 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?

Rick McTaggart, CEO

I would assume that's correct, as we are not intended to make any profit on the pass-through. The revenues have risen noticeably, likely due to changes in energy prices.

David Sasnett, CFO

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.

Operator, Operator

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

Christine Song, Analyst

I just had a question on capital allocation. And I know you guys had 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 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 an increase in dividends with your capital allocation?

Rick McTaggart, CEO

Yes, of course, Christine. When I mentioned earlier, I was referring to acquisitions and partnerships. The opportunity in the mining sector is primarily a partnership chance, which would mainly affect our manufacturing segment. This would involve collaborating with other entities to supply equipment to a rapidly expanding part of the mining industry, without requiring significant capital investment in that case. Regarding the other acquisition, the wastewater opportunity, we are currently negotiating with the owners and are not disclosing values at this time. However, it will align with our previous acquisitions, which typically don't involve deals of $30 million to $50 million. Recently, we've focused on opportunities that are more in the sub-$10 million range, which offer us an attractive chance to expand our existing services into a fast-growing market.

David Sasnett, CFO

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 require shareholder approval for us to have a stock buyback plan, and we proposed to our shareholders. I think it was 2008 or 2009, we proposed that we have the authority to amend articles of incorporation to allow for stock buybacks. That proposal was not approved by our shareholders. So, legally, we're not allowed to buy back our own stock at the moment.

Rick McTaggart, CEO

Without shareholder approval.

David Sasnett, CFO

We'd have to get a proxy out to them; we would have to get shareholder approval. Given that we failed once at 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 than 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 projects and new business. However, I think our Board of Directors is aware that if we continue to accumulate cash balances, we probably will increase our dividends, but I can't speak for them. But ideally, we'd like to allocate capital to new businesses, acquisitions, and projects. But if we find out that we have excess cash, I'm sure our Board will fully consider an increase.

Operator, Operator

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.

Rick McTaggart, CEO

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.

Operator, Operator

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 the 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.