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 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 2022 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 Policies and Estimates
Our critical accounting policies relate to (i) the valuations of our goodwill, intangible assets and long-lived assets; and (ii) revenue recognition on our construction and manufacturing contracts.
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.
The application of our critical accounting policies involves estimates or assumptions that 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 financial condition and results of operations is material.
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 as of the date of acquisition. Goodwill and intangible assets recorded as a result of a business combination and
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determined to have an indefinite useful 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 for goodwill impairment testing purposes, which consist of Cayman Water, the bulk segment (which is comprised of CW-Bahamas and OC-Cayman), PERC, and the manufacturing segment (i.e., Aerex), 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 a reporting unit exceeds the fair value of the reporting unit, an impairment loss is recorded.
For 2022, we elected to assess qualitative factors to determine whether it was necessary to perform the quantitative goodwill impairment testing we have conducted in prior years for all reporting units other than the manufacturing unit. We assessed the relevant events and circumstances to evaluate whether it is more likely than not that the fair values of such reporting units are less than their carrying values. The events and circumstances assessed for each unit included macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, and other relevant events. Based upon this qualitative assessment we determined that it is more likely than not that the fair values of our Cayman Water and bulk segment reporting units exceeded their carrying values as of December 31, 2022. Based upon our negotiated, arms-length purchase of the remaining 39% equity interest in PERC from its minority shareholders for $7.8 million in January 2023, the fair value of our PERC reporting unit exceeded its carrying value by 79% as of December 31, 2022.
Due to the factors discussed in the following paragraphs, we elected to test the goodwill associated with our manufacturing reporting unit for possible impairment using the quantitative tests applied in prior years.
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.
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. 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. Furthermore, Aerex’s efforts to replace the revenue previously generated from this customer with revenue from existing and new customers were adversely impacted by negative economic conditions (caused in part by the COVID-19 pandemic). These negative economic conditions also increased Aerex’s raw material costs, resulted in raw material shortages and extended delivery times for such materials, and 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 on-going 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
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reporting unit exceeded its fair value by $2.9 million, and we recorded an impairment loss to reduce our manufacturing segment’s goodwill by this amount for the three months ended June 30, 2021.
For 2022, we estimated the fair value of our manufacturing reporting unit 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 the analysis. We also estimated the fair value of our manufacturing reporting unit for the year ended December 31, 2022 by applying the guideline public company method. We weighted the fair values estimated for our manufacturing reporting unit under each method and summed such weighted fair values to estimate the overall fair value for the reporting unit. The respective weightings we applied to each method for the year ended December 31, 2022 were 80% to the discounted cash flow method and 20% to the guideline public company method.
The fair value we estimated for our manufacturing reporting unit exceeded its carrying amount by 63% as of December 31, 2022.
We believe that the inherent uncertainties associated with the accounting estimates and assumptions we use for our estimates of our manufacturing reporting unit’s fair value 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 value of this reporting unit, and such increased discount rate in and of itself could decrease the estimated fair value of our manufacturing reporting unit under the discounted cash flow method.
As noted previously, based upon our estimation prepared as of December 31, 2022, the fair value of our manufacturing reporting unit exceeded its carrying value by 63%. However, 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 of our manufacturing reporting unit’s goodwill and its remaining unamortized intangible assets balances, which amounted to $1,985,211 and $684,444, respectively, as of September 30, 2023. 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 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.
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.
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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 the total estimated costs at completion to measure progress toward satisfying a contract’s performance obligations as such measure best reflects the transfer of control of the promised good to the customer. Contract costs include labor, materials, subcontractor costs and other expenses. 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 costs to be incurred 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. Due to the extended time it may take to complete many of our contracts and the scope and nature of the work required to be performed on those contracts, the estimations of total revenue and costs at completion are complicated and subject to many variables and, accordingly, are subject to changes. When adjustments in estimated total contract revenue or estimated total contract costs are required, any changes from prior estimates are recognized in the current period for the inception-to-date effect of such changes. 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 adverse impact on 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, 2022 (“2022 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 2022 Form 10-K.
Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022
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 gallons 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
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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 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 invited Mexico to seek a resolution of this investment dispute through consultation and negotiation, but stated that if the dispute cannot be resolved in this manner, CW-Cooperatief would 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.
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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 its 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 have incurred and will continue to incur legal and other arbitration-related expenses that are material to our consolidated results of operations and cash flows.
During July 2022, the State initiated discussions with us to potentially resolve the issues related to the cancellation by the government of the Rosarito desalination plant contract as well as potentially addressing the State’s acute water shortage issues. We cannot presently determine the outcome of the discussions and we have not terminated our efforts to obtain relief through the international arbitration process as a result of these discussions.
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 the costs for our legal and administrative activities to pursue reimbursement from the State of Baja California following the cancellation of the APP Contract, are classified as discontinued operations in the accompanying consolidated financial statements. Our net losses from discontinued operations for the three months ended September 30, 2023 and 2022 were ($232,994) and ($505,917), respectively.
Consolidated Results
Including discontinued operations, net income attributable to Consolidated Water Co. Ltd. stockholders for 2023 was $8,605,129 ($0.54 per share on a fully diluted basis), as compared to net income of $317,694 ($0.02 per share on a fully diluted basis) for 2022.
The following discussion and analysis of our consolidated results of operations and results of operations by segment for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022 relates only to our continuing operations.
Net income from continuing operations attributable to Consolidated Water Co. Ltd. stockholders for 2023 was $8,838,123 ($0.55 per share on a fully diluted basis), as compared to a net income from continuing operations of $823,611 ($0.05 per share on a fully diluted basis) for 2022.
Revenue for 2023 increased to $49,854,075 from $25,051,705 in 2022, reflecting revenue increases in all segments except for the bulk segment which had a slight decrease. Gross profit for 2023 was $16,614,428 (33% of total revenue) as compared to $6,843,773 (27% of total revenue) for 2022. 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 increased to $5,872,490 for 2023 as compared to $5,610,650 for 2022. The most significant increase in G&A expenses for 2023 relates to insurance expense, which increased by almost $339,000. Employee costs also increased by approximately $318,000 from 2022 to 2023 due to pay raises, new hires, and increased stock compensation expense. Decreases in various other G&A expense categories served to partially offset these increases in insurance expense and employee costs.
Other income (expense), net, increased to $236,066 for 2023 as compared to an expense of ($168,980) for 2022 in part due to an unrealized loss recorded in 2022 of $247,000 for the valuation of the put/call options associated with the initial acquisition of a controlling interest in PERC. We exercised our call option in the fourth quarter of 2022 and acquired the remaining 39% of PERC in January 2023. In addition, interest income increased by approximately $140,000 in 2023 primarily due to the increase in CW-Bahamas delinquent accounts receivable balances, on which we earn interest income.
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Results by Segment
Retail Segment:
The retail segment recorded a loss from operations of ($381,142) for 2023 as compared to loss from operations of ($774,283) for 2022.
Revenue generated by our retail water operations increased to $7,216,574 in 2023 from $6,274,650 in 2022 due to a 16% increase in the volume of water sold. This sales volume increase reflects increased tourist activity on Grand Cayman as tourism on the island in 2022 was lower than historical levels due to the lingering impact of the COVID-19 pandemic. Retail revenue also increased by approximately $92,000 due to higher energy costs which increased the energy pass-through component of our retail water rates.
Retail segment gross profit increased to $3,844,683 (53% of retail revenue) for 2023 from $3,042,677 (48% of retail revenue) for 2022 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 increased to $4,225,825 for 2023 as compared to $3,818,459 for 2022. The most significant increase in G&A expenses for 2023 relates to employee costs, which increased by $260,000 due to pay raises and increased stock compensation expense.
Bulk Segment:
The bulk segment contributed $2,305,110 and $1,749,848 to our income from operations for 2023 and 2022, respectively.
Bulk segment revenue was $8,488,615 and $8,667,931 for 2023 and 2022, respectively. The impact of a 6% increase in the volume of water sold in 2023 on bulk segment revenue was more than offset by a decrease in the price of energy for CW-Bahamas, which decreased the energy pass-through component of CW-Bahamas’ rates.
Gross profit for our bulk segment was $2,652,778 (31% of bulk revenue) and $2,221,382 (26% of bulk revenue) for 2023 and 2022, respectively. Gross profit as a percentage of revenue increased in 2023 as compared to 2022 due to a reduction in repairs and maintenance expenses of almost $417,000.
Bulk segment G&A expenses decreased to $347,668 for 2023 as compared to $473,534 for 2022 as a result of incremental bank fees of approximately $123,000 in 2022 attributable to cash transfers from CW-Bahamas to our parent company in the Cayman Islands.
Services Segment:
The services segment contributed $8,391,184 and $460,434 to our income from operations for 2023 and 2022, respectively.
Services segment revenue increased to $29,427,664 for 2023 from $8,731,124 for 2022. Construction revenue increased to $24,204,446 in 2023 from $4,781,613 in 2022 with this increase resulting from (i) PERC’s progress on its contract with Liberty (Litchfield Park Water & Sewer) Corp. (“Liberty Utilities”) for the construction of a water treatment plant in Goodyear, Arizona; and (ii) progress on our contract with the WAC for the construction of its Red Gate plant. We recognized approximately $20.0 million in revenue for the Liberty Utilities contract in 2023. This contract is expected to be substantially completed by the end of the second quarter of 2024. Revenue generated under operations and maintenance contracts was $5,021,081 and $3,394,142 in 2023 and 2022, respectively. The increase in operations and maintenance revenue from 2022 to 2023 is attributable to new contracts and increased revenue on existing contracts.
Gross profit for the services segment was $9,253,019 (31% of services revenue) in 2023 as compared to $1,397,142 (16% of services revenue) for 2022. During 2023, we adjusted our previous estimates of the total costs to be incurred for the Liberty Utilities contract. These changes in accounting estimates primarily arose as a result of actual construction costs and efficiencies for the Liberty Utilities contract that differed favorably from our previous expectations. These changes in accounting estimates resulted in an increase in the services segment’s revenue, gross profit and income from operations of $1,787,275 for 2023 under the input method we use to account for construction contracts and was a significant contributing
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factor in the increase in gross profit as a percentage of services revenue from 2022 to 2023. The remainder of the increase in gross profit as a percentage of revenue from 2022 to 2023 reflects improved margins on both our construction and operations and maintenance activities.
G&A expenses for the services segment remained relatively consistent at $861,835 for 2023 as compared to $936,708 for 2022.
Manufacturing Segment:
The manufacturing segment contributed $426,786 to our income from operations for 2023 as compared to a loss incurred from operations of ($199,377) in 2022.
Manufacturing revenue was $4,721,222 and $1,378,000 for 2023 and 2022, respectively. The growth in manufacturing revenue for 2023 reflects increased production activity due to relief in supply chain and economic conditions that had resulted in significant product delivery delays in 2022.
Manufacturing gross profit was $863,948 (18% of manufacturing revenue) for 2023 as compared to a gross profit of $182,572 (13% of manufacturing revenue) for 2022. The increase in manufacturing gross profit in dollars reflects the increase in revenue. Gross profit as a percentage of revenue increased due to increased revenue and the resulting reduced impact of fixed factory overhead on this financial measure.
G&A expenses for the manufacturing segment remained relatively consistent at $437,162 for 2023 as compared to $381,949 for 2022.
Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022
Discontinued Operations – Mexico Project Development
As previously discussed, on June 29, 2020, the State of Baja California cancelled its APP Contract with AdR for the Project. As a result of the cancellation of the APP Contract, during the three months ended June 30, 2020, we discontinued all development activities associated with the Project and commenced active marketing efforts to sell the land NSC purchased for the Project.
Our net loss from discontinued operations for the nine months ended September 30, 2023 and 2022 was ($699,858) and ($1,533,064), respectively, and consists of the costs for our legal and administrative activities to pursue reimbursement from the State of Baja California following the cancellation of the APP Contract.
Consolidated Results
Including discontinued operations, net income attributable to Consolidated Water Co. Ltd. stockholders for 2023 was $19,742,526 ($1.24 per share on a fully diluted basis), as compared to a net income of $4,324,395 ($0.28 per share on a fully diluted basis) for 2022.
The following discussion and analysis of our consolidated results of operations and results of operations by segment for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022 relates only to our continuing operations.
Net income from continuing operations attributable to Consolidated Water Co. Ltd. stockholders for 2023 was $20,442,384 ($1.28 per share on a fully diluted basis), as compared to a net income from continuing operations of $5,857,459 ($0.38 per share on a fully diluted basis) for 2022.
Revenue for 2023 increased to $126,960,328 from $65,676,737 in 2022, reflecting revenue increases in all four of our segments. Gross profit for 2023 was $42,637,059 (34% of total revenue) as compared to $21,465,034 (33% of total revenue) for 2022. For further discussion of revenue and gross profit see the “Results by Segment” discussion and analysis that follows.
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General and administrative (“G&A”) expenses on a consolidated basis increased to $17,894,067 for 2023 as compared to $15,403,458 for 2022. The most significant increase in G&A expenses for 2023 relates to employee costs, which increased by $2,114,275 from 2022 to 2023 due to increased stock compensation, higher bonus accruals, pay raises and new hires, Insurance expense and professional fees also increased by $607,444 and $212,685, respectively, from 2022 to 2023. These increases were partially offset by decreases in various other G&A expense categories.
Other income, net, remained relatively consistent at $522,256 for 2023 as compared to $548,729 for 2022.
Results by Segment
Retail Segment:
The retail segment recorded a loss from operations of ($470,573) for 2023 as compared to a loss from operations of ($900,747) for 2022.
Revenue generated by our retail water operations increased to $22,560,998 in 2023 from $19,114,653 in 2022 due to a 17% increase in the volume of water sold. The volume of water sold in the Cayman Water license area increased by 15% and the remaining 2% increase in the volume of water sold was due to water sales made by Cayman Water directly to the WAC in January and February of 2023. The sales volume increase reflects increased tourist activity on Grand Cayman, as tourism on the island in 2022 was lower than historical levels due to the lingering impact of the COVID-19 pandemic. Retail revenue also increased by approximately $899,000 due to higher energy costs which increased the energy pass-through component of our retail water rates.
Retail segment gross profit increased to $12,205,181 (54% of retail revenue) for 2023 from $9,710,529 (51% of retail revenue) for 2022 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 increased to $12,668,467 for 2023 as compared to $10,613,975 for 2022. The most significant increase in G&A expenses for 2023 relates to employee costs, which increased by $1,531,132 due to pay raises, increased stock compensation expense and higher bonus accruals. Business development expenses increased by approximately $152,000 primarily due to the costs associated with the acquisition of Ramey Environmental Compliance (which was completed in November 2023).
Bulk Segment:
The bulk segment contributed $6,896,492 and $6,475,164 to our income from operations for 2023 and 2022, respectively.
Bulk segment revenue was $25,975,483 and $24,442,324 for 2023 and 2022, respectively. The increase in bulk segment revenue is attributable to an 8% increase in the volume of water sold.
Gross profit for our bulk segment was $7,964,765 (31% of bulk revenue) and $7,661,073 (31% of bulk revenue) for 2023 and 2022, respectively. Gross profit dollars increased from 2022 to 2023 due to the incremental revenue.
Bulk segment G&A expenses remained consistent at $1,080,543 for 2023 as compared to $1,187,909 for 2022.
Services Segment:
The services segment contributed $16,921,397 and $1,143,215 to our income from operations for 2023 and 2022, respectively.
Services segment revenue increased to $66,243,328 for 2023 from $18,530,427 for 2022. Construction revenue increased to $52,563,822 in 2023 from $5,347,023 in 2022 with this increase resulting from (i) PERC’s progress on its contract with Liberty Utilities for the construction of a water treatment plant in Goodyear, Arizona; and (ii) progress on our contract with the WAC for the construction of its Red Gate plant. We recognized approximately $44.1 million in revenue for the Liberty Utilities contract in 2023. This contract is expected to be substantially completed by the end of the second quarter of 2024. Revenue generated under operations and maintenance contracts was $12,750,902 and $10,740,623 in 2023 and
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2022, respectively. The increase in operations and maintenance revenue from 2022 to 2023 is attributable to new contracts and increased revenue on existing contracts. Design and consulting revenue generated by the services segment was $928,604 and $2,442,781 in 2023 and 2022, respectively. The decrease in design and consulting revenue from 2022 to 2023 is attributable to the work performed in 2022 on the design contract for the Liberty Utilities plant currently under construction.
Gross profit for the services segment was $19,776,464 (30% of services revenue) in 2023 as compared to $3,681,398 (20% of services revenue) for 2022. During the three months ended June 30, 2023 and the three months ended September 30, 2023, we adjusted our previous estimates of the total costs to be incurred for the Liberty Utilities contract and one other construction contract. These changes in accounting estimates arose as a result of actual construction costs and efficiencies that differed favorably from our previous expectations. These changes in accounting estimates resulted in an increase in the services segment’s revenue, gross profit and income from operations of $3,549,028 for 2023 under the input method we use to account for construction contracts and was a significant contributing factor in the increase in gross profit as a percentage of services revenue from 2022 to 2023. The remainder of the increase in gross profit as a percentage of revenue reflects improved margins on both our construction and operations and maintenance activities.
G&A expenses for the services segment increased to $2,855,067 for 2023 as compared to $2,554,721 for 2022 principally due to an increase of approximately $407,000 in employee costs attributable to pay raises, new hires and increased bonus accruals.
Manufacturing Segment:
The manufacturing segment contributed $1,402,592 to our income from operations for 2023 as compared to a loss incurred from operations of ($634,819) in 2022.
Manufacturing revenue was $12,180,519 and $3,589,333 for 2023 and 2022, respectively. The growth in manufacturing revenue for 2023 reflects increased production activity due to relief in supply chain and economic conditions that had resulted in significant product delivery delays in 2022.
Manufacturing gross profit was $2,690,649 (22% of manufacturing revenue) for 2023 as compared to a gross profit of $412,034 (11% of manufacturing revenue) for 2022. The increase in manufacturing gross profit in dollars reflects the increase in revenue. Gross profit as a percentage of revenue increased due to increased revenue and the resulting reduced impact of fixed factory overhead on this financial measure.
G&A expenses for the manufacturing segment increased to $1,289,990 for 2023 as compared to $1,046,853 for 2022 principally due to an increase of approximately $155,000 in employee costs attributable to pay raises, new hires and increased bonus accruals.
FINANCIAL CONDITION
The significant changes in the components of our condensed consolidated balance sheet as September 30, 2023 as compared to December 31, 2022 (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.
Accounts receivable increased by approximately $11.1 million primarily due to a $6.9 million increase in CW-Bahamas’ accounts receivable as well as a $3.3 million increase in Kalaeloa Desalco accounts receivable related to the construction of the Kalaeloa Seawater Desalination facility in Oahu, Hawaii.
Current inventory increased by approximately $2.2 million primarily due to an increase of $2.5 million in PERC’s inventory primarily as a result of its contract with Liberty Utilities.
Contract assets increased by approximately $6.1 million primarily due to the construction of the Red Gate plant for the WAC.
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Property, plant and equipment, net, decreased by approximately $2.5 million due to the scheduled depreciation of fixed assets.
Construction in progress increased by approximately $2.7 million primarily due to construction activity for Cayman Water’s replacement of its West Bay desalination plant.
Accounts payable, accrued expenses and other liabilities increased by approximately $3.0 million primarily due to a $1.5 million increase in subcontractor costs for PERC’s contract with Liberty Utilities, and a $1.9 million increase in taxes payable offset by a $1.5 million decrease in Aerex’s accrued expenses.
Contract liabilities increased by approximately $725,000 primarily due to $1.8 million increase in billings made by the services segment in connection with PERC’s contract with Liberty Utilities and Kalaeloa Desalco’s contract with the Board of Water Supply of the City and County of Honolulu, Hawaii. These increases were offset by a $1.1 million reduction in Aerex’s contract liabilities.
LIQUIDITY AND CAPITAL RESOURCES
Certain transfers from our Bahamas bank accounts to our bank accounts in other countries require the approval of the Central Bank of The Bahamas.
The Cayman Islands does not have a tax treaty with the United States. Consequently, should we be required (or elect) to transfer any profits generated by our U.S. operations to our parent company in the Cayman Islands, the amount of any such profits transferred would be subject to a 30% withholding tax.
Liquidity Position
We paid approximately $3.85 million in November 2023 to acquire Ramey Environmental Compliance. Our remaining projected liquidity requirements for the fourth quarter of 2023 include capital expenditures for our existing operations of approximately $5.1 million, which includes approximately $292,000 to be incurred for the replacement of the West Bay seawater desalination plant and approximately $2.5 million for construction of the WAC’s new Red Gate plant. Additionally, approximately $4.7 million in raw materials purchase commitments were outstanding as of September 30, 2023. We paid approximately $4.0 million in dividends in 2023 and our liquidity requirements may include future quarterly dividends if such dividends are declared by our Board.
As of September 30, 2023, we had cash and cash equivalents of $48.8 million and working capital of $83.1 million.
With the 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 WSC amounted to $23.2 million and $16.3 million as of September 30, 2023 and December 31, 2022, respectively. Approximately 76% and 65% of the accounts receivable balances were delinquent as of those dates, respectively.
From time to time, 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 September 30, 2023, we have not provided an allowance for doubtful accounts for CW-Bahamas’ accounts receivable from the WSC.
CW-Bahamas recently held discussions with the Ministry of Finance of the Government of the Bahamas which stated that the Government intends to return all of CW-Bahamas’ accounts receivable from the WSC to current status.
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In a report dated October 6, 2022, Moody’s Investor Services (“Moody’s”) downgraded the Government of The Bahamas’ long-term issuer and senior unsecured ratings to B1 from Ba3. Moody’s also lowered The Bahamas’ local currency ceiling to Baa3 from Baa2 and its foreign currency ceiling to Ba1 from Baa3. Moody’s iterated these ratings in April 2023, noting that such ratings are “stable.” Based upon our review of this Moody’s correspondence, we continue to believe no allowance for doubtful accounts is required for CW-Bahamas’ accounts receivable from the WSC.
If CW-Bahamas is unable to collect a sufficient 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 Nine Months Ended September 30, 2023
Our cash and cash equivalents decreased to $48,845,606 as of September 30, 2023 from $50,711,751 as of December 31, 2022.
Cash Flows from Operating Activities
Net cash provided by our operating activities was $8,395,625. This net cash reflects the net income generated for the nine months ended September 30, 2023 of $20,206,301 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 $4,862,781, an increase in accounts receivable of $11,062,456, an increase in contract assets of $6,059,018, an increase in inventory of $2,671,769, and an increase in accounts payable and accrued expenses of $2,925,670.
Cash Flows from Investing Activities
Net cash used by our investing activities was $6,542,387. On January 4, 2023, we purchased the remaining 39% ownership interest in PERC for $2,440,027 and 368,383 shares of the Company’s common stock. We also used $4,123,770 for additions to property, plant and equipment and construction in progress.
Cash Flows from Financing Activities
Net cash used by our financing activities was $3,972,022, almost all of which related to the payment of dividends.
Revolving Credit Facility
In September 2022, Cayman Water entered into an agreement (the “Credit Agreement”) with Scotiabank & Trust (Cayman) Ltd. (the “Bank”) for a revolving credit facility in an aggregate principal amount of up to $10.0 million (the “Credit Facility”). We expect to utilize the funds obtained from the Credit Facility for general working capital purposes.
The Credit Facility matures two years following the date of the initial advance (the “Maturity Date”). All amounts outstanding under the Credit Facility are due and payable upon the earlier of the Maturity Date, demand from the bank or the acceleration of the Credit Facility upon an event of default.
The principal balance of the Credit Facility bears interest at a rate of 2.0% plus the secured overnight financing rate (“SOFR”) as determined by the SOFR Administrator for a one-month period on the day that is two days prior to the first day of the interest period. All interest calculations will be made based on a 360-day year. So long as the Bank has not demanded repayment, interest will be payable monthly, commencing one month from the initial advance, with the outstanding balance due on the Maturity Date, unless the Bank agrees to renew the Credit Facility for an additional period.
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Cayman Water’s obligations under the Credit Agreement are secured by a first priority lien on all its fixed and floating assets and an assignment of insurance proceeds with respect to its fixed assets. Further, the Company has guaranteed the repayment of all of Cayman Water’s present and future debts and liabilities owed to the Bank.
The Credit Agreement requires Cayman Water to meet certain financial covenants.
Cayman Water has not yet utilized any of its available borrowings under the Credit Facility.
Material Commitments, Expenditures and Contingencies
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 discussed in the following paragraphs. 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 September 30, 2023 and 2022, we generated approximately 14% and 25%, respectively, of our consolidated revenue and 23% and 44%, respectively, of our consolidated gross profit from the retail water operations conducted under the 1990 license. For the nine months ended September 30, 2023 and 2022, we generated approximately 18% and 29%, respectively, of our consolidated revenue and 29% and 45%, 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 a royalty of 7.5% of the revenue we collect as 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 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 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 impairment losses to reduce the carrying value of our retail segment assets. Such impairment losses could have a material adverse impact on our consolidated financial condition and results of operations .
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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
Financial Accounting Standard Update (“ASU”) 2016-13, Measurement of Credit Losses on Financial Instruments, and related amendments, introduces new guidance which makes substantive changes to the accounting for credit losses. This guidance introduces the current expected credit losses (“CECL”) model which applies to financial assets subject to credit losses and measured at amortized cost, as well as certain off-balance sheet credit exposures. The CECL model requires an entity to estimate credit losses expected over the life of an exposure, considering information about historical events, current conditions, and reasonable and supportable forecasts and is generally expected to result in earlier recognition of credit losses. We adopted this guidance as of January 1, 2023 using the modified retrospective approach. The impact of this adoption was not material to our consolidated financial statements.
Effect of Newly Issued but not yet Effective Accounting Standards
None.
Dividends
● On January 31, 2023, we paid a dividend of $0.085 to shareholders of record on January 3, 2023.
● On April 28, 2023, we paid a dividend of $0.085 to shareholders of record on April 3, 2023.
● On July 31, 2023, we paid a dividend of $0.085 to shareholders of record on July 3, 2023.
● On August 22, 2023, our Board declared a dividend of $0.095 payable on October 31, 2023 to shareholders of record on October 2, 2023.
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 consolidated results of operations and cash flows could be materially adversely affected. In general, our operating and maintenance contracts are adjusted annually for the impacts of inflation.
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While PERC’s operations and maintenance contracts are generally adjusted for inflation on an annual basis, such adjustment for some of these contracts is limited to 3% annually.
Kalaeloa Desalco, which is jointly owned by PERC and CW-Holdings, has signed a definitive agreement with the Honolulu Board of Water Supply to design, build, operate and maintain a 1.7 million gallons per day seawater reverse osmosis desalination plant in Oahu, Hawaii. More than 90% of the costs we expect to incur to construct this plant are subject to inflationary increases based upon changes in inflation indices from the date the contract was executed to the date construction begins.
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, 2022 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.