Item 1A. Risk Factors
ITEM 1A. RISK FACTORS
Our business faces significant risks. These risks include those disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 as supplemented by the additional risk factors included below. If any of the events or circumstances described in the referenced risks actually occurs, our business, financial condition or results of operations could be materially adversely affected and such events or circumstances could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. These risks should be read in conjunction with the other information set forth in this Quarterly Report as well as in our Annual Report on Form 10-K for the year ended December 31, 2019 and in our other periodic reports on Form 10-Q and Form 8-K.
The COVID-19 pandemic will likely continue to have a material adverse impact on our financial performance and financial condition in the future, to an extent and for a period of time that cannot presently be determined.
The worldwide coronavirus (COVID-19) pandemic was formally recognized by the World Health Organization on March 11, 2020. In response to this pandemic, the governments of the countries in which we operate - the Cayman Islands, The Bahamas, and the United States - implemented preventative measures to slow the spread of COVID-19, measures which have had profound adverse consequences for the economies of those countries. Tourism, a major economic driver for the Cayman Islands and The Bahamas, has temporarily ceased in those countries due to closing of these countries to air and sea travel. Overall economic activity in the United States has also declined precipitously.
As a result of the impact of the COVID-19 pandemic on the economies of the countries in which we operate, we have experienced, and will continue to experience, the following adverse effects:
● decreases in our consolidated revenue, cash flows generated from operations, and overall liquidity as compared to comparable prior periods; and
● a deterioration in the aging of our accounts receivable, with a resulting increase in the portion of our accounts that ultimately prove to be uncollectible, necessitating an increase in our provisions and allowances for doubtful accounts.
Furthermore, the economic downturn created by the COVID-19 pandemic is adversely impacting our customers. Such adverse impacts, should they continue for a prolonged period of time, could require us to reassess its expected future cash flows from our four reporting units and could require us to record impairment losses to reduce the carrying values of one or more of these reporting units due to a decline in their fair values.
Although we cannot presently quantify the future financial impacts of the COVID-19 pandemic on our company, we believe such impacts will likely continue to have a material adverse impact on our consolidated financial condition, results of operations, and cash flows. Given the uncertainty associated with the resolution of this pandemic, we cannot presently determine how long such adverse financial impacts may last.
Our exclusive license to provide water to retail customers in the Cayman Islands has not been expressly extended and we are presently unable to predict the outcome of our on-going negotiations relating to this license.
We sell water through our retail operations under a license issued in July 1990 by the Cayman Islands government (the “1990 license”) that granted Cayman Water the exclusive right to provide potable water to customers within its licensed service area. Although the 1990 license was not expressly extended after January 2018, we continue to supply water under the terms of the 1990 license, as further discussed in the following paragraph. Pursuant to the 1990 license, Cayman Water
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has the exclusive right to produce potable water and distribute it by pipeline to its licensed service area, which consists of two of the three most populated areas of Grand Cayman Island: Seven Mile Beach and West Bay. For the three months ended September 30, 2020 and 2019, we generated approximately 28% and 39%, respectively, of our consolidated revenue and 39% and 50%, respectively, of our consolidated gross profit from the retail water operations conducted under the 1990 license. For the nine months ended September 30, 2020 and 2019, we generated approximately 32% and 39%, respectively, of our consolidated revenue and 45% and 53%, respectively, of our consolidated gross profit from the retail water operations conducted under the 1990 license.
The 1990 license was originally scheduled to expire in July 2010 but was extended several times by the Cayman Islands government in order to provide the parties with additional time to negotiate the terms of a new license agreement. The most recent express extension of the license expired on January 31, 2018. We continue to operate under the terms of the 1990 license, providing water services to the level and quality specified in the 1990 license and in accordance with our understanding of its legal obligations, treating those obligations set forth in the 1990 license as operative notwithstanding the expiration of the express extension. We continue to pay the royalty required under the 1990 license.
In October 2016, the Government of the Cayman Islands passed legislation which created a new utilities regulation and competition office (“OfReg”). OfReg is an independent and accountable regulatory body with a view of protecting the rights of consumers, encouraging affordable utility services, and promoting competition. OfReg, which began operations in January 2017, has the ability to supervise, monitor and regulate multiple utility undertakings and markets. Supplemental legislation was passed by the Government of the Cayman Islands in April 2017, which transferred responsibility for economic regulation of the water utility sector and the negotiations with us for a new retail license from the Water Authority-Cayman to OfReg in May 2017. We began license negotiations with OfReg in July 2017 and such negotiations are ongoing. We have been informed during our retail license negotiations, both by OfReg and its predecessor in these negotiations, that the Cayman Islands government seeks to restructure the terms of our license in a manner that could significantly reduce the operating income and cash flows we have historically generated from our retail license.
We are presently unable to determine what impact the resolution of our retail license negotiations will have on our cash flows, financial condition or results of operations but such resolution could result in a material reduction (or the loss) of the operating income and cash flows we have historically generated from our retail operations and could require us to record impairment losses to reduce the carrying values of our retail segment assets. Such impairment losses could have a material adverse impact on our consolidated financial condition, results of operations, and cash flows.
Periodically, our Bahamas subsidiary experiences substantial delays in the collection of its accounts receivable. As a result, our Bahamas subsidiary could have insufficient liquidity to continue operations, and our consolidated results of operations could be materially adversely affected.
CW-Bahamas’ accounts receivable balances (which include accrued interest) due from the WSC amounted to $18.4 million as of September 30, 2020 and $18.4 million as of December 31, 2019. Approximately 77% of the September 30, 2020 accounts receivable balance was delinquent as of that date. The delay in collecting these accounts receivable has adversely impacted the liquidity of this subsidiary.
Historically, CW-Bahamas has experienced delays in collecting its accounts receivable from the WSC. When these delays occur, we hold discussions and meetings with representatives of the WSC and The Bahamas government, and as a result, payment schedules are developed for WSC’s delinquent accounts receivable. All previous delinquent accounts receivable from the WSC were eventually paid in full. Based upon this payment history, CW-Bahamas has never been required to provide an allowance for doubtful accounts for any of its accounts receivable, despite the periodic accumulation of significant delinquent balances. As of September 30, 2020, we have not provided an allowance for doubtful accounts for CW-Bahamas’ accounts receivable from the WSC.
We believe the delays we have experienced in collecting CW-Bahamas’ receivables may be further extended by the impact of the COVID-19 pandemic on the economy of The Bahamas.
If CW-Bahamas continues to be unable to collect a significant portion of its delinquent accounts receivable, one or more of the following events may occur: (i) CW-Bahamas may not have sufficient liquidity to meet its obligations; (ii) we may be required to cease the recognition of revenue on CW-Bahamas’ water supply agreements with the WSC; and (iii) we
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may be required to provide an allowance for doubtful accounts for CW-Bahamas’ accounts receivable. Any of these events could have a material adverse impact on our consolidated financial condition, results of operations, and cash flows.
Most of our services segment revenue is generated under short term contracts. An inability to obtain extensions of these contracts or to obtain new contracts to replace the revenue that is lost from contracts that are not extended could adversely impact our financial results.
PERC, our principal services segment subsidiary, generates most of its revenue from contracts (“O&M contracts”) to operate and maintain water treatment and reuse facilities owned by third parties. For the three and nine months ended September 30, 2020, we generated revenue of approximately $2.5 million and $6.6 million, respectively, under these O&M contracts. PERC’s O&M contracts have terms ranging from one to five years, with varying renewal options exercisable solely at the discretion of the customer. Approximately 25% of PERC’s revenue for the nine months ended September 30, 2020 was generated under O&M contracts that expire at various dates through July 31, 2021. If we are unable to obtain extensions of these expiring O&M contracts, or are unable to replace the revenue lost from contracts that expire with revenue from new O&M contracts, our consolidated financial condition, results of operations, and cash flows could be adversely affected.
If Aerex’s future financial performance falls short of our most recent financial projections for this subsidiary, we may be required to record an impairment loss to reduce the carrying value of the goodwill recorded for our manufacturing reporting unit.
In February 2016, we acquired a 51% ownership interest in Aerex. In connection with this acquisition, we recorded initial goodwill of $8,035,211. Aerex’s actual results of operations in the six months following our acquisition of this company fell significantly short of the projected results that were included in the overall cash flow projections we utilized to determine the purchase price for Aerex and the fair values of its assets and liabilities. Due to this shortfall in Aerex’s results of operations, we updated our projections for Aerex’s future cash flows and tested Aerex’s goodwill for possible impairment as of September 30, 2016 by estimating its fair value using the discounted cash flow method. As a result of this impairment testing, we determined that the carrying value of our Aerex goodwill exceeded its fair value and recorded an impairment loss of $1,750,000 for the three months ended September 30, 2016 to reduce the carrying value of this goodwill to $6,285,211. As part of our annual impairment testing of goodwill performed during the fourth quarter of each year, we updated our projections for Aerex’s future cash flows, determined that the carrying value of our Aerex goodwill exceeded its fair value, and recorded an impairment loss of $1,400,000 for the three months ended December 31, 2017 to further reduce the carrying value of this goodwill to $4,885,211.
Approximately 84% and 68% of Aerex’s revenue, and 86% and 68% of Aerex’s gross profit, for the nine months ended September 30, 2020 and the year ended December 31, 2019, respectively, were generated from sales to one customer. In October 2020, this customer verbally informed Aerex that it expects (for inventory management purposes) to suspend its purchases from Aerex following the fourth quarter of 2020 for a period of approximately one year. This customer has verbally informed Aerex that it presently expects to recommence its purchases from Aerex beginning with the first quarter of 2022. However, we can offer no assurances that this customer will recommence its purchases from Aerex at that time. Furthermore, any such future purchases (should they occur) may not generate as much revenue and gross profit as Aerex has historically earned from this customer. We are seeking to replace the anticipated loss in revenue and gross profit for 2020 from this customer by increasing sales of other products that we manufacture to new and existing customers, however, we may not be able to do so.
As a result of this anticipated loss of revenue for Aerex, we updated our projections for our manufacturing reporting unit’s future cash flows. Such projections assume, in part, that Aerex’s major customer will recommence its purchases from Aerex in 2022 but at a reduced aggregate amount, as compared to 2020 and 2019. Based upon these updated projections we tested our manufacturing reporting unit’s goodwill for possible impairment as of September 30, 2020 using the discounted cash flow method. As a result of this impairment testing, we determined that the estimated fair value of our manufacturing reporting unit exceeded its carrying value by approximately 22% as of September 30, 2020. However, we may be required to record an impairment loss in the future to reduce the carrying value of our manufacturing reporting unit’s goodwill should we determine that Aerex’s future net cash inflows will be less than this most current estimate. Any
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such impairment loss could have a material adverse impact on our consolidated financial condition and results of operations.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.