Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to, statements regarding our future revenue, future plans, objectives, expectations and events, assumptions and estimates. Forward-looking statements can be identified by use of the words or phrases “will,” “will likely result,” “are expected to,” “will continue,” “estimate,” “project,” “potential,” “believe,” “plan,” “anticipate,” “expect,” “intend,” or similar expressions and variations of such words. Statements that are not historical facts are based on our current expectations, beliefs, assumptions, estimates, forecasts and projections for our business and the industry and markets related to our business.
The forward-looking statements contained in this report 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. Important factors which may affect these actual outcomes and results include, without limitation:
● tourism and weather conditions in the 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
● other factors, including those “Risk Factors” set forth under Part II, Item 1A. “Risk Factors” in this Quarterly Report and in our 2021 Annual Report on Form 10-K.
The forward-looking statements in this Quarterly Report speak as of its date. We expressly disclaim any obligation or undertaking to update or revise any forward-looking statement contained in this Quarterly Report to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any forward-looking statement is based, except as may be required by law.
References herein to “we,” “our,” “ours” and “us” refer to Consolidated Water Co. Ltd. and its subsidiaries.
Critical Accounting Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Our actual results could differ significantly from such estimates and assumptions.
Certain of our accounting estimates or assumptions constitute “critical accounting estimates” for us because:
● the nature of these estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and
● the impact of the estimates and assumptions on our financial condition and results of operations is material.
Our critical accounting estimates relate to the valuations of our (i) goodwill, intangible assets and long-lived assets; and (ii) revenue recognition on our construction and manufacturing contracts.
Goodwill and intangible assets
Goodwill represents the excess cost of an acquired business over the fair value of the assets and liabilities of the acquired business. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful
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life are not amortized but are tested for impairment annually or upon the identification of a triggering event. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed periodically for impairment. We evaluate the possible impairment of goodwill annually as part of our reporting process for the fourth quarter of each fiscal year. Management identifies our reporting units, which consist of our retail, bulk, services, and manufacturing operations, and determines the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units. We determine the fair value of each reporting unit and compare these fair values to the carrying amounts of the reporting units. To the extent the carrying amount of the reporting unit exceeds the fair value of the reporting unit, an impairment loss is recorded.
For the year ended December 31, 2021, we estimated the fair value of our reporting units by applying the discounted cash flow method, which relied upon seven-year discrete projections of operating results, working capital and capital expenditures, along with a terminal value subsequent to the discrete period. These seven-year projections were based upon historical and anticipated future results, general economic and market conditions, and considered the impact of planned business and operational strategies. The discount rates for the calculations represented the estimated cost of capital for market participants at the time of each analysis.
We also estimated the fair value of each of our reporting units for the year ended December 31, 2021 by applying the guideline public company method.
We weighted the fair values estimated for each of our reporting units under each method and summed such weighted fair values to estimate the overall fair value for each reporting unit. The respective weightings we applied to each method for the year ended December 31, 2021 were 80% to the discounted cash flow method and 20% to the guideline public company method.
The fair values we estimated for our retail, bulk, services and manufacturing reporting units exceeded their carrying amounts by 32%, 51%, 15% and 15%, respectively, as of December 31, 2021.
In February 2016, we acquired a 51% ownership interest in Aerex. In connection with this acquisition, we recorded goodwill of $8,035,211. Aerex’s actual results of operations for the six months in 2016 following the acquisition fell significantly short of the projected results that were included in the 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 tested our manufacturing reporting unit’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 manufacturing reporting unit’s 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, in 2017 we updated our projections for Aerex’s future cash flows, determined that the carrying value of our manufacturing reporting unit’s 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 80% of Aerex’s revenue, and 89% of Aerex’s gross profit, for the year ended December 31, 2020 were generated from sales to one customer. While Aerex sells various products to this customer, Aerex’s revenue from this customer has historically been derived primarily from one specialized product. In October 2020, this customer informed Aerex that, for inventory management purposes, it was suspending its purchases of the specialized product from Aerex following 2020 for a period of approximately one year. This customer informed Aerex at that time that it expected to recommence its purchases of the specialized product from Aerex beginning with the first quarter of 2022. 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 assumed, in part, that Aerex’s major customer would recommence its purchases from Aerex in 2022 but at a reduced aggregate amount, as compared to 2020. Based upon these updated projections, we tested our manufacturing reporting unit’s goodwill for possible impairment as of December 31, 2020 using the discounted cash flow and guideline public company methods, with a weighting of 80% and 20% applied to these two methods, respectively. As a result of these impairment tests, we determined that the estimated fair value of our manufacturing reporting unit exceeded its carrying value by approximately 31% as of December 31, 2020.
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In late July 2021, this former major customer communicated to Aerex that it expected to recommence its purchases of the specialized product from Aerex in 2022 and subsequent years, but informed Aerex that such purchases would be at substantially reduced annual amounts, as compared to the amounts it had purchased from Aerex in 2020 and prior years (based upon the most recent communications from the customer, we now expect such purchases to recommence in late 2022 or early 2023). Our updated sales estimate for this customer based on this new information was substantially below the sales we anticipated to this customer for 2022 and subsequent years that we used in the discounted cash flow projections we prepared for purposes of testing our manufacturing reporting unit’s goodwill for possible impairment as of December 31, 2020. Aerex’s efforts to replace the revenue previously generated from this customer with revenue from existing and new customers have been adversely impacted by the continuing negative economic conditions (caused in part by the COVID-19 pandemic) which have increased Aerex’s raw material costs, resulted in raw material shortages and extended delivery times for such materials and, we believe, also adversely affected the overall financial condition of Aerex’s current and prospective customers. Accordingly, in light of this new information from Aerex’s former major customer, and the weak economic conditions that we believed would continue through 2022, we updated our projections of future cash flows for the manufacturing reporting unit and tested its goodwill for possible impairment as of June 30, 2021 using the discounted cash flow and guideline public company methods, with a weighting of 80% and 20% applied to these two methods, respectively. Based upon this testing, we determined that the carrying value of our manufacturing reporting unit exceeded its fair value by $2.9 million, and we recorded an impairment loss to reduce our manufacturing reporting unit’s goodwill by this amount for the three months ended June 30, 2021.
We believe the inherent uncertainties associated with the accounting estimates and assumptions we use for our estimates of our reporting units’ fair values have increased due to the current, less predictable economic conditions, which have resulted in increasing raw material prices, extended and unexpected delays in the procurement and delivery of our raw materials, and have also, we believe, adversely affected our customers. Should interest rates rise significantly in the future we would likely be required to increase the discount rate we use under the discounted cash flow method we use to estimate the fair values of our reporting units, and such increased discount rate in and of itself could decrease the estimated fair value of our reporting units under the discounted cash flow method.
Based upon our most recent estimation prepared as of December 31, 2021, the fair value of our manufacturing reporting unit exceeded its carrying value by only 15%. If we determine in the future that Aerex’s discounted future cash inflows will be less than our present expectations, we may be required to record additional impairment losses to reduce the remaining carrying values as of March 31, 2022 of our manufacturing reporting unit’s goodwill of $1,985,211 and its remaining unamortized intangible assets balances of $824,445 recorded as a result of the acquisition of Aerex. Any such impairment losses could have a material adverse impact on our consolidated results of operations.
Based upon our most recent estimation prepared as of December 31, 2021, the fair value of our services reporting unit exceeded its carrying value by only 15%. If we determine in the future that PERC’s discounted future cash inflows will be less than our present expectations, we may be required to record impairment losses to reduce the carrying values as of March 31, 2022 of our services reporting unit’s goodwill of $5,320,416 and its remaining unamortized intangible assets balances of $2,429,721 recorded as a result of the acquisition of PERC. Any such impairment losses could have a material adverse impact on our consolidated results of operations.
Long-lived assets
We review the carrying amounts of our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and used, we recognize an impairment loss only if its carrying amount is not recoverable through its undiscounted cash flows and measure the impairment loss based on the difference between the carrying amount and fair value.
On June 29, 2020, our Mexico subsidiary, AdR, received a letter from the State of Baja California (the “State”) terminating AdR’s contract with the State involving the construction and operation of a desalination plant in Rosarito California and accompanying aqueduct to deliver the water produced by this plant to the Mexican public water system. As a result of the
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cancellation of this contract, we recorded an impairment loss for rights of way acquired for the contract’s proposed aqueduct of approximately ($3.0 million) in 2020.
Through our former subsidiary, PT Consolidated Water Bali (“CW-Bali”), we built and operated a seawater reverse osmosis plant with a productive capacity of approximately 264,000 gallons per day located in Nusa Dua, one of the primary tourist areas of Bali, Indonesia. We recorded operating losses for CW-Bali as the sales volumes for its plant were insufficient to cover its operating costs. In 2017 we determined, based upon probability-weighted scenarios for CW-Bali’s future undiscounted cash flows, that the carrying values of CW-Bali’s long-lived assets and our investment in CW-Bali were not recoverable. Consequently, we recorded impairment losses of ($1.6 million) in 2017 to reduce the carrying values of these assets to their fair values.
Construction and Manufacturing Contract Revenue Recognition
We design, construct, and sell desalination infrastructure through DesalCo, which serves customers in the Cayman Islands, The Bahamas, and the British Virgin Islands. We design, construct, and sell wastewater and water reuse infrastructure in the U.S. through PERC. Aerex, is a custom and specialty manufacturer in the U.S. of water treatment-related systems and products applicable to commercial, municipal and industrial water production.
We recognize revenue for our construction and our specialized/custom manufacturing contracts over time under the input method using costs incurred (which represents work performed) to date relative to total estimated costs at completion to measure progress toward satisfying its performance obligations as such measure best reflects the transfer of control of the promised good to the customer. Contract costs include labor, materials and amounts payable to subcontractors. We follow this method since we can make reasonably dependable estimates of the revenue and costs applicable to the various stages of a contract. Under this input method, we record revenue and recognize profit or loss as work on the contract progresses. We estimate total project or manufacturing costs and profit to be earned on each long-term, fixed price contract prior to commencement of work on the contract and update these estimates as work on the contract progresses. The cumulative amount of revenue recorded on a contract at a specified point in time is that percentage of total estimated revenue that incurred costs to date comprises of estimated total contract costs. If, as work progresses, the actual contract costs exceed estimates, the profit recognized on revenue from that contract decreases. We recognize the full amount of any estimated loss on a contract at the time the estimates indicate such a loss.
The cost estimates we prepare in connection with our construction and manufacturing contracts are subject to inherent uncertainties. Because we base our contract prices on our estimation of future construction and manufacturing costs, the profitability of our construction and manufacturing contracts is highly dependent on our ability to estimate these costs accurately, as almost all of our construction and manufacturing contracts are fixed-price contracts. The cost of materials, labor and subcontractors could increase significantly after we sign a construction or manufacturing contract, which could cause the gross profit for a contract to decline from our previous estimates, adversely affecting our recognition of revenue and gross profit for the contract. Construction or manufacturing contract costs that significantly exceed our initial estimates could have a material adversely impact our consolidated financial condition, results of operations, and cash flows.
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included under Part I, Item 1. “Financial Statements” of this Quarterly Report and our consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for our fiscal year ended December 31, 2021 (“2021 Form 10-K”) and the information set forth under Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2021 Form 10-K.
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Three Months Ended March 31, 2022 Compared to Three Months Ended March 31, 2021
Discontinued Operations – Mexico Project Development
In 2010, we began the pursuit, through our Netherlands subsidiary, Consolidated Water Cooperatief, U.A. (“CW-Cooperatief”), and our Mexico subsidiary, N.S.C. Agua, S.A. de C.V. (“NSC”), of a project (the “Project”) that encompassed the construction, operation and minority ownership of a 100 million gallon per day seawater reverse osmosis desalination plant to be located in northern Baja California, Mexico and accompanying pipelines to deliver water to the Mexican potable water system.
Through a series of transactions that began in 2012, NSC purchased 20.1 hectares of land for approximately $21.1 million on which the proposed Project’s plant was to be constructed.
Following an assessment by the State of Baja, California (the “State”) of the need for such a desalination plant and the passage of enabling legislation in November 2015, the State officially commenced the required public tender for the Project. A consortium (the “Consortium”) comprised of NSC, Suez Medio Ambiente México, S.A. de C.V. (“Suez MA”), a subsidiary of SUEZ International, S.A.S., and NuWater S.A.P.I. de C.V. (“NuWater”) submitted its tender for the Project in April 2016 and in June 2016, the State designated the Consortium as the winner of the tender process for the Project.
In August 2016, NSC and NuWater incorporated a new company under the name Aguas de Rosarito S.A.P.I. de C.V. (“AdR”) to pursue completion of the Project and executed a shareholders agreement for AdR agreeing among other things that (i) AdR would purchase the land and other Project assets from NSC on the date that the Project begins commercial operation and (ii) AdR would enter into a Management and Technical Services Agreement with NSC effective on the first day that the Project begins commercial operation. NSC initially owned 99.6% of the equity of AdR. In February 2018, we acquired the remaining 0.4% ownership in AdR from NuWater.
On August 22, 2016, the Public Private Partnership Agreement for the Project (the “APP Contract”) was executed between AdR, the State Water Commission of Baja California (“CEA”), the Government of Baja California as represented by the Secretary of Planning and Finance and the Public Utilities Commission of Tijuana (“CESPT”). The APP Contract required AdR to design, construct, finance and operate a seawater reverse osmosis desalination plant (and accompanying aqueduct) with a capacity of up to 100 million gallons per day in two phases: the first with a capacity of 50 million gallons per day and an aqueduct to the Mexican potable water system in Tijuana, Baja California and the second phase with a capacity of 50 million gallons per day. The first phase was to be operational within 36 months of commencing construction and the second phase was to be operational by July 2024. The APP Contract further required AdR to operate and maintain the plant and aqueduct for a period of 37 years starting from the commencement of operation of the first phase. At the end of the operating period, ownership of the plant and aqueduct would have been transferred to CEA. The APP Contract was subsequently amended by the parties in June 2018 to increase the scope of Phase 1 and to allow for changes in the water tariff due to the changes in the exchange rate for the peso, interest rates and construction costs that had and would occur from the date the APP Contract was signed to the date construction commenced.
On June 29, 2020, AdR received a letter (the “Letter”) from the Director General of CEA and the Director General of CESPT terminating the APP Contract. The Letter requested that AdR provide an inventory of the assets that currently comprise the “Project Works” (as defined in the APP Contract) for the purpose of acknowledging and paying the non-recoverable expenses made by AdR in connection with the Project, with such reimbursement to be calculated in accordance with the terms of the APP Contract. The applicable law required that this list of non-recoverable expenses made by AdR in connection with the Project be submitted to CEA and CESPT within 20 business days from the date of receipt of the Letter. AdR initiated an amparo claim before a federal district court in Tijuana, Baja California, to challenge the provision of the applicable law requiring submittal of the list of non-recoverable expenses within the 20 business days term, as AdR considered such term to be unreasonably short due to the magnitude of the Project and the scope of supporting documentation required to be provided with respect to the non-recoverable expenses. AdR obtained an initial provisional suspension of the lapsing of such 20-day term from the court, and on August 10, 2020 the court made such suspension definitive until the completion of the amparo trial. As such, the 20-day term for filing the list of non-recoverable expenses was suspended. Therefore, on August 28, 2020, AdR submitted their list of non-recoverable expenses, including those of NSC, to CEA and CESPT which was comprised of 51,144,525 United States dollars and an additional 137,333,114 Mexican pesos. In February 2021, AdR withdrew this amparo claim, and such withdrawal was accepted by the federal
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district court in Tijuana. To date, AdR has not received a formal response from CEA or CESPT to its submission of non-recoverable expenses.
We believe CW-Cooperatief, as a Netherlands company, has certain rights relating to its investments in NSC and AdR under the Agreement on Promotion, Encouragement and Reciprocal Protection of Investments between the Kingdom of the Netherlands and the United Mexican States entered into force as of October 1, 1999 (the “Treaty”). On April 16, 2021, CW-Cooperatief submitted a letter to the President of Mexico and other Mexican federal government officials alleging that the State’s termination of the APP Contract constituted a breach by Mexico of its international obligations under the Treaty, entitling CW-Cooperatief to full reparation, including monetary damages. This letter invites Mexico to seek a resolution of this investment dispute through consultation and negotiation, but states that if the dispute cannot be resolved in this manner, CW-Cooperatief elects to refer the dispute to the International Centre for the Settlement of International Disputes for arbitration, as provided for in the Treaty. On June 29, 2021, the Mexican Ministry of Economy responded to CW-Cooperatief’s letter and proposed to hold a consultation meeting. Two such meetings were held on July 9, 2021 and August 2, 2021 on a confidential basis, without a resolution of our investment dispute.
On February 9, 2022, CW-Cooperatief, filed a Request for Arbitration with the International Centre for Settlement of International Disputes requesting that the United Mexican States pay CW-Cooperatief damages in excess of US$51 million plus MXN$137 million (with the exact amount to be quantified in the proceedings), plus fees, costs and pre- and post-award interest.
CW-Cooperatief intends to pursue vigorously the relief sought in the arbitration, in addition to pursuing all other legal remedies and courses of action available under the operative contracts and applicable law with respect to their rights, damages, fees and expenses. We cannot provide any assurances that CW Cooperatief will be able to obtain the relief sought in the arbitration, and we will incur legal and other arbitration-related expenses that we expect will be material to our consolidated results of operations and cash flows.
We cannot provide any assurances that we will be able to obtain reimbursement for any expenses or investments made with respect to the Project.
As a result of the cancellation of the APP Contract, in 2020 we discontinued all development activities associated with the Project and commenced active marketing efforts to sell the land NSC purchased for the Project. Accordingly, the assets and liabilities of CW-Cooperatief, NSC and AdR, as well as all Project development expenses, the impairment loss of approximately ($3.0 million) recorded during 2020 for Project assets, and the costs for our legal and administrative activities to pursue reimbursement from the State of Baja California following the cancellation of the APP Contract, have been reclassified from the services segment to discontinued operations in the accompanying consolidated financial statements. Our net losses from discontinued operations for the three months ended March 31, 2022 and 2021 were ($607,314) and ($312,794), respectively. Our net loss from discontinued operations for 2022 includes a provision of $377,326 for uncollected value added taxes.
Consolidated Results
Including discontinued operations, net income attributable to Consolidated Water Co. Ltd. stockholders for 2022 was $1,716,815 ($0.11 per share on a fully diluted basis), as compared to $988,772 ($0.06 per share on a fully diluted basis) for 2021.
The following discussion and analysis of our consolidated results of operations and results of operations by segment for the three months ended March 31, 2022 as compared to the three months ended March 31, 2021 relates only to our continuing operations.
Net income from continuing operations attributable to Consolidated Water Co. Ltd. stockholders for 2022 was $2,324,129 ($0.15 per share on a fully diluted basis), as compared to net income from continuing operations of $1,301,566 ($0.08 per share on a fully diluted basis) for 2021.
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Revenue for 2022 increased to $19,557,905 from $17,103,317 in 2021, reflecting revenue increases in our retail, services and bulk segments. These increases were partially offset by a decrease in revenue generated by our manufacturing segment. Gross profit for 2022 was $7,145,764 (37% of total revenue) as compared to $6,126,510 (36% of total revenue) for 2021. For further discussion of revenue and gross profit see the “Results by Segment” discussion and analysis that follows.
General and administrative (“G&A”) expenses on a consolidated basis remained relatively consistent at $4,866,117 for 2022 as compared to $4,764,486 for 2021.
Other income, net, remained consistent at $319,727 for 2022 as compared to $314,608 for 2021.
The COVID-19 pandemic had a material adverse impact on our consolidated results of operations for the three months ended March 31, 2022 and we believe the COVID-19 pandemic will continue to adversely impact our results of operations in future periods. See further discussion herein and at “LIQUIDITY AND CAPITAL RESOURCES – Material Commitments, Expenditures and Contingencies – COVID-19 .”
Results by Segment
Retail Segment:
The retail segment incurred a loss from operations of ($190,946) for 2022 as compared to a loss from operations of ($617,699) for 2021.
Revenue generated by our retail water operations increased to $6,313,200 in 2022 from $5,711,305 in 2021 due to an 8% increase in the volume of water sold. The sales volumes for both 2022 and 2021 are significantly below the historical volumes for the retail segment prior to 2020 due to the cessation of tourism on Grand Cayman resulting from border restrictions that lasted from March 2020 through November 2021 in response to the COVID-19 pandemic. The increase in the volume of water sold in 2021 as compared to 2020 reflects the lifting in November 2021 of travel restrictions to the Cayman Islands for vaccinated individuals, which resulted in the resumption of tourism to the Cayman Islands. However, we believe it will be an extended period of time before tourism to the Cayman Islands approaches pre-pandemic levels.
Retail segment gross profit increased to $3,259,460 (52% of retail revenue) for 2022 from $3,003,311 (53% of retail revenue) for 2021 due to the revenue increase.
Consistent with prior periods, we record all non-direct G&A expenses in our retail segment and do not allocate any of these non-direct costs to our other three business segments. Retail G&A expenses remained relatively consistent at $3,450,406 for 2022 as compared to $3,371,010 for 2021.
Bulk Segment:
The bulk segment contributed $2,353,222 and $1,714,814 to our income from operations for 2022 and 2021, respectively.
Bulk segment revenue was $7,350,644 and $6,245,970 for 2022 and 2021, respectively. The increase in bulk segment revenue is attributable to an increase in energy costs for CW-Bahamas, which increased the energy pass-through component of CW-Bahamas’ rates and, to a lesser extent, an increase of 6% in the volume of water sold by CW-Bahamas.
Gross profit for our bulk segment was $2,663,525 (36% of bulk revenue) and $2,090,817 (33% of bulk revenue) for 2022 and 2021, respectively. Gross profit in dollars and as a percentage of revenue increased in 2022 as compared to 2021 principally due to the revenue increase.
Bulk segment G&A expenses remained relatively consistent at $310,303 for 2022 as compared to $377,503 for 2021.
Services Segment:
The services segment income from operations was $327,124 and $96,465 for 2022 and 2021, respectively.
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Services segment revenue increased to $4,743,820 for 2022 from $3,540,846 for 2021 due to increases in both plant design revenue and operating and maintenance revenue.
Gross profit for the services segment was $1,094,640 (23% of services revenue) in 2022 as compared to $818,918 (23% of services revenue) for 2021.
G&A expenses for the services segment remained relatively consistent at $779,974 for 2022 as compared to $722,020 for 2021.
Manufacturing Segment:
The manufacturing segment incurred a loss from operations of ($197,295) for 2022 as compared to a loss from operations of ($80,489) in 2021. Manufacturing revenue was $1,150,241 and $1,605,196 for 2022 and 2021, respectively. Manufacturing revenue under certain contracts has been deferred due to significant product delivery delays requested by customers as well as continuing delayed shipments of raw materials and supplies to Aerex.
Manufacturing gross profit was $128,139 (11% of manufacturing revenue) and $213,464 (13% of manufacturing revenue) for 2022 and 2021, respectively. The decrease in manufacturing gross profit in dollars reflects the decrease in revenue. Gross profit as a percentage of revenue declined due to the greater impact of fixed factory overhead on this measure resulting from the revenue decrease, as we have elected to continue the employment of all of our manufacturing personnel in 2022 despite the decrease in production activity.
G&A expenses for the manufacturing segment remained relatively consistent at $325,434 for 2022 as compared to $293,953 for 2021.
The results of our manufacturing segment have been adversely affected by global economic conditions including but not limited to increasing raw materials prices, increasing human resources costs, tight labor markets, and extended and unexpected delays in the procurement and delivery of raw materials. We believe these global economic conditions have also resulted in product order delays from Aerex’s existing and prospective customers. The current economic conditions could continue (or further deteriorate) and therefore could continue to adversely impact the future results of our manufacturing segment.
FINANCIAL CONDITION
The significant changes in the components of our condensed consolidated balance sheet as of March 31, 2022 as compared to December 31, 2021 (other than the change in our cash and cash equivalents, which is discussed later in “LIQUIDITY AND CAPITAL RESOURCES”) and the reasons for these changes are discussed in the following paragraphs.
Current inventory increased by approximately $597,000 primarily due to the receipt of materials by Aerex for projects for which production has not commenced.
Property, plant and equipment, net decreased by approximately $1.2 million due to the scheduled depreciation of fixed assets.
Construction in progress increased by approximately $615,000 primarily due to the construction of our new West Bay seawater desalination plant.
Accounts payable, accrued expenses and other liabilities increased by approximately $587,000 primarily due to an increase in subcontractor costs in the services segment.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Position
Our projected liquidity requirements for the balance of 2022 include capital expenditures for our existing operations of approximately $10.8 million which includes $5.3 million to be incurred for the balance of 2022 for the replacement of the
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West Bay seawater desalination plant, approximately $1.9 million for construction of the WAC’s new Red Gate plant and approximately $1.3 million for dividends payable. Our liquidity requirements may also include future quarterly dividends if such dividends are declared by our Board. Our dividend payments amounted to approximately $1.3 million for the three months ended March 31, 2022 and approximately $5.8 million for the year ended December 31, 2021.
As of March 31, 2022, we had cash and cash equivalents of $43.1 million and working capital of $70.9 million. With the possible exception of the liquidity matter relating to CW-Bahamas that is discussed in the paragraphs that follow, we are not presently aware of anything that would lead us to believe that we will not have sufficient liquidity to meet our needs.
CW-Bahamas Liquidity
CW-Bahamas’ accounts receivable balances (which include accrued interest) due from the Water and Sewerage Corporation of The Bahamas (“WSC”) amounted to $21.2 million as of March 31, 2022 and $21.5 million as of December 31, 2021. Approximately 77% of the March 31, 2022 accounts receivable balance was delinquent as of that date. The delay in collecting these accounts receivable has adversely impacted the liquidity of this subsidiary.
From time to time (including presently), 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, including accrued interest thereon, 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 March 31, 2022, we have not provided an allowance for doubtful accounts for CW-Bahamas’ accounts receivable from the WSC.
In February 2022, we received correspondence from the Ministry of Finance of the Government of the Bahamas that set forth a payment schedule providing for the gradual reduction over the course of 2022 of the CW-Bahamas' delinquent accounts receivable due from the WSC. Such correspondence also indicated that the Government intends to return all of CW-Bahamas’ accounts receivable from the WSC to current status.
As of April 30, 2022, CW-Bahamas’ accounts receivable from the WSC totaled $18.7 million.
If CW-Bahamas is ultimately 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 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 .
Discussion of Cash Flows for the Three Months Ended March 31, 2022
Our cash and cash equivalents increased to $43,144,541 as of March 31, 2022 from $40,358,059 as of December 31, 2021.
Cash Flows from Operating Activities
Net cash provided by our operating activities was $4,622,054. This net cash reflects the net income incurred for the three months ended March 31, 2022 of $1,958,245 as adjusted for (i) various items included in the determination of net income that do not affect cash flows during the year; and (ii) changes in the other components of working capital. The more significant of such items and changes in working capital components included depreciation and amortization of $1,548,151, a provision for uncollected value added taxes of $377,326 and an increase in inventory of $792,165.
Cash Flows from Investing Activities
Net cash used by our investing activities was $735,375. Cash used was primarily for additions to property, plant and equipment and construction in progress.
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Cash Flows from Financing Activities
Net cash used by our financing activities was $1,313,996, almost all of which related to the payment of dividends.
Material Commitments, Expenditures and Contingencies
COVID-19
The worldwide coronavirus (COVID-19) pandemic, which was formally recognized by the World Health Organization on March 11, 2020, has had a profound negative impact on the economies of the countries in which we operate. Consequently, the COVID-19 pandemic has had, and will continue to have, a material adverse impact on our consolidated financial condition, results of operations, and cash flows.
A discussion of the current effects of the COVID-19 pandemic on each of our operating subsidiaries is provided in the following paragraphs. However, as the worldwide impact of COVID-19 continues to develop and expand, its future effects on our company could differ materially from the information we are providing herein.
Cayman Water
As preventative measures to combat the possible spread of COVID-19, the Cabinet of the Cayman Islands (“the Cabinet”) closed all of Cayman Islands’ seaports to international passenger arrivals effective March 13, 2020; and closed all Cayman Islands airports to international passenger arrivals effective March 22, 2020. Effective March 28, 2020, the Cabinet and Cayman Islands law enforcement enacted various ‘stay-at-home’ regulations and curfews, which closed all businesses not deemed essential by the government and required citizens to stay at home unless they were purchasing necessities or engaged in an essential errand. In May 2020, the Cabinet started the phased relaxation of the shelter-in-place regulations and on October 1, 2020, the Cayman Islands reopened its borders for residents or individuals who own property in the Cayman Islands that provide evidence of a negative COVID-19 test performed within three days prior to arrival in the Cayman Islands and agree to remain in quarantine for 14 days after arrival. In July 2021, this quarantine period was reduced to five days for fully vaccinated travelers who can provide proof of vaccination from Cayman Islands government approved sources.
In November 2021, the Cayman Islands began allowing vaccinated travelers to visit the islands without the need to quarantine. However, the testing requirements upon arrival on the islands, and the fact that families with unvaccinated children were still required to quarantine, continued to restrict the number of overseas visitors. Recently, the Cayman Islands began allowing children to take the vaccination status of their parents and eliminated the testing requirements upon arrival for vaccinated visitors. This easing of restrictions has positively impacted tourism to the Cayman Islands. However, tourism to the Cayman Islands continues to be well below pre-COVID-19 levels. We expect that our retail segment revenue and cash flows will continue to be materially adversely impacted until such time as tourism and the economy in the Cayman Islands fully recover from the impact and effects of the COVID-19 pandemic.
Cayman Water’s operations have been designated as essential services by the Cayman Islands government. Presently, the day-to-day operations of Cayman Water’s water production facilities and distribution network have not been materially impeded by the COVID-19 pandemic – we continue to produce and supply water to meet the demand for water in our retail license area. We believe Cayman Water has adequate spare parts and supplies in stock to continue normal operations.
OC-Cayman
Although it operates on Grand Cayman - and therefore is also affected by the preventative measures enacted by government that have been discussed previously - OC-Cayman sells water on a bulk basis to the WAC, which in turn provides this water to areas of Grand Cayman that are more residential, and less tourist related, than the license area served by Cayman Water. The monthly amounts OC-Cayman charges the WAC for water supplied under its water supply agreements consist of fixed amounts that constitute most of the amounts charged, and lesser amounts that vary with the volume of water supplied. Therefore, unlike Cayman Water, OC-Cayman’s revenue is not as directly affected by tourism on Grand Cayman and, due to the structure of the underlying water supply agreements, is not as acutely sensitive to declines in water demand.
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OC-Cayman’s operations have been designated as essential services by the Cayman Islands government. Presently, OC-Cayman’s day-to-day operations have not been materially impeded by the COVID-19 pandemic – we continue to produce and supply water to meet the requirements of our two water supply agreements with the WAC. We believe OC-Cayman has adequate spare parts and supplies in stock to continue normal operations. However, OC-Cayman’s operations could be adversely affected should a significant number of its operations personnel be required to miss work due to illness or a requirement to quarantine.
CW-Bahamas
The government of The Bahamas enacted Emergency Powers Regulations which became effective March 18, 2020 in an effort to combat the spread of COVID-19. Initially, these regulations closed all businesses not deemed essential by the government, encouraged the employees of non-essential businesses to work remotely and imposed 24-hour shelter-in-place curfew on all residents of The Bahamas other than those engaged in essential or pre-approved activities. On March 24, 2020, the government banned all international travel to The Bahamas by closing all airports and seaports. As a result of the measures taken by The Bahamas government, tourism on New Providence Island, where CW-Bahamas operates, temporarily ceased and economic activity in The Bahamas slowed dramatically. During the summer of 2020, travel restrictions were briefly lifted then reimposed. In November 2020, shelter-in-place regulations were loosened, and commercial and retail operations were permitted to open with limited capacity although working from home was still encouraged. The Emergency Powers Regulations expired on November 13, 2021 and the government then enacted new rules to prevent and manage community spread of COVID-19. Restrictions on economic activity have largely been lifted subject to businesses adhering to social distancing protocols, requiring customers to wear face masks and practicing regular sanitization. International travel to The Bahamas is permitted and individuals that wish to travel to The Bahamas must obtain a travel health visa which will be issued upon receipt of a negative COVID-19 test taken no more than three days prior to the date of arrival; the nature of the test depends on whether the individual travelling is fully vaccinated or not. Any visitor who is not fully vaccinated must complete a mandatory daily health questionnaire during their stay. Home port cruise ship departures from the Port of Nassau commenced in June 2021 and cruise ship arrivals into The Bahamas commenced in July 2021. Cruise ships are no longer required to disclose passenger and crew vaccination status.
CW-Bahamas sells the water produced by its plants on a bulk basis to the WSC, which in turn provides water to the residences, businesses, and other end users on New Providence. Under the terms of each of its water supply agreements with the WSC, CW-Bahamas charges the WSC a fixed monthly amount, an amount each month that is based upon the amount of water supplied during the month, and pass-through energy charges, therefore CW-Bahamas’ revenue is impacted by changes in energy prices and, to a lesser extent, changes in demand. The volume of water CW-Bahamas sells to the WSC has not adversely impacted by the COVID-19 pandemic notwithstanding the significant downturn in economic activity on New Providence in 2021 and 2020, and water volume sales remain steady as economic activity has increased in 2022. However, the adverse impact of the COVID-19 pandemic on The Bahamas government’s revenue in 2021 and 2020 may continue to delay the collection of CW-Bahamas’ delinquent accounts receivable from the WSC.
CW-Bahamas’ operations have been designated as essential services by the government of The Bahamas. Presently, CW-Bahamas’ day-to-day operations have not been materially impeded by the COVID-19 pandemic – we continue to produce and supply water to meet the requirements of our two water agreements with the WSC. We believe CW-Bahamas has sufficient spare parts and consumables inventories to continue normal operations.
Aerex
Aerex presently has 13 manufacturing employees. Should a number of these employees become ill or be required to enter quarantine because of COVID-19, Aerex could be required to reduce or cease its manufacturing activities, which could have a material adverse impact on our consolidated financial condition, results of operations and cash flows.
As a result of current economic conditions (resulting in part from the COVID-19 pandemic), in late March 2021 Aerex began experiencing issues with its supply chain for the raw materials and components used in its manufacturing operations, including higher prices, scarcities/shortages, and longer fulfillment times for its orders to suppliers. These conditions, and a decline in projected future sales to Aerex’s former largest customer, required us to record an impairment loss of ($2.9 million) for the three months ended June 30, 2021 to reduce the carrying value of our manufacturing reporting unit’s goodwill. While these economic conditions and issues continue, Aerex could have difficulty completing its orders from
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its customers and obtaining new business, which could have a material adverse impact on our consolidated revenue, results of operations and cash flows, and could require us to record additional impairment losses to reduce the carrying value of the goodwill recorded for our manufacturing reporting unit. Any such impairment losses could have a material adverse impact on our consolidated financial condition and results of operations.
PERC
PERC’s operations are considered essential services by the states within which it operates. Presently, the COVID-19 pandemic has not materially impeded PERC’s day-to-day operations.
Approximately 62% of PERC’s revenue of $4.6 million for the three months ended March 31, 2022 was generated in California under contracts with government entities. The State of California has publicly acknowledged on-going difficulties due to the COVID-19 pandemic, and such difficulties presently, or could in the future, extend to the various counties, municipalities, and other government-related entities in California, including PERC’s customers, which could adversely impact PERC’s revenue and the collection of its accounts receivable.
PERC employs state-certified water and wastewater operators to operate various water treatment facilities in California and Arizona. Should a number of these employees become ill or be required to enter quarantine as a result of COVID-19, PERC could have difficulty meeting its contractual and statutory obligations for operating these water treatment facilities, which could have a material adverse impact on our consolidated financial condition, results of operations and cash flows.
Cayman Water Retail 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 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 March 31, 2022 and 2021, we generated approximately 32% and 33%, respectively, of our consolidated revenue and 46% and 49%, 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 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 the economic regulation of the water utility sector and the retail license negotiations from the WAC to OfReg in May 2017. We began license negotiations with OfReg in July 2017 and such negotiations are continuing. 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.
The Cayman Islands government could seek to grant a third party a license to service some or all of Cayman Water’s present service area. However, as set forth in the 1990 license, “the Governor hereby agrees that upon the expiry of the term of this Licence or any extension thereof, he will not grant a licence or franchise to any other person or company for
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the processing, distribution, sale and supply of water within the Licence Area without having first offered such a licence or franchise to the Company on terms no less favourable than the terms offered to such other person or company.”
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 an impairment loss to reduce the carrying value of our retail segment assets. Such impairment losses could have a material adverse impact on our consolidated financial condition, results of operation and cash flows .
CW-Bahamas Performance Guarantees
Our contracts to supply water to the WSC from our Blue Hills and Windsor plants require us to guarantee delivery of a minimum quantity of water per week. If the WSC requires the water and we do not meet this minimum, we are required to pay the WSC for the difference between the minimum and actual gallons delivered at a per gallon rate equal to the price per gallon that WSC is currently paying us under the contract. The Blue Hills contract expires in 2032 and requires us to deliver 63.0 million gallons of water each week. The Windsor contract expires in 2033 and requires us to deliver 16.8 million gallons of water each week.
Adoption of New Accounting Standards
None.
Effect of Newly Issued but not yet Effective Accounting Standards
None.
Dividends
● On January 31, 2022, we paid a dividend of $0.085 to shareholders of record on January 3, 2022.
● On April 29, 2022, we paid a dividend of $0.085 to shareholders of record on April 1, 2022.
We have paid dividends to owners of our common stock and redeemable preferred stock since we began declaring dividends in 1985. Our payment of any future cash dividends will depend upon our earnings, financial condition, cash flows, capital requirements and other factors our Board of Directors deems relevant in determining the amount and timing of such dividends.
Dividend Reinvestment and Common Stock Purchase Plan
This plan is available to our shareholders, who may reinvest all or a portion of their common stock dividends into shares of common stock at prevailing market prices and may also invest optional cash payments to purchase additional shares at prevailing market prices as part of this plan.
Impact of Inflation
Under the terms of our Cayman Islands license and our water sales agreements in The Bahamas and the British Virgin Islands, our water rates are automatically adjusted for inflation on an annual basis. Therefore, the impact of inflation on our gross profit, measured in consistent dollars, historically has not been material. However, we have not increased our retail water rates since January 2018 (despite the inflation that has occurred since that date) due to the lack of a resolution of our negotiations with OfReg for a new retail license. This lack of a rate increase has contributed to a decline in the gross profit generated by our retail segment. Furthermore, our manufacturing segment has been adversely impacted by recent significant increases in raw material costs and our services segment could suffer similar adverse impacts in the future. Should the current inflationary trend continue, our results of operations and cash flows could be materially adversely affected.
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Increases in fuel and energy costs and other items could create additional credit risks for us, as our customers’ ability to pay our invoices could be adversely affected by such increases.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in our exposure to market risk from December 31, 2021 to the end of the period covered by this report.
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.