China’s Challenges Providing Usable Water for Its Population
China faces massive challenges providing its population with usable water supplies. China’s water supply is smaller than that of the U.S. but it serves five times as many people. There are an estimated 300 million Chinese citizens that have no daily access to clean water. Over 70 million people in China drink water that does not meet current World Health Organization standards. The country faces widespread water scarcity and droughts in some regions and frequent floods in others. Pollution of water supplies is widespread. As a result, China’s water infrastructure is under extreme stress and authorities are struggling to provide the population with adequate clean and potable water supplies.
TRIT is Helping Solve China’s Water and Environmental Problems
TRIT is uniquely positioned to help solve China’s water and environmental problems. The Company combines software and hardware technology to monitor and manage China’s municipal and natural water resources. The Company offers two primary lines of service and is pursuing a third:
- Water, Wastewater Treatment and Municipal Infrastructure: TRIT designs sewage treatment and odor control systems for municipalities. The systems coordinate technological solutions with hardware that enable clients to monitor and control numerous variables in the sewage treatment and odor control processes. The goal is to provide total solutions from the design processes to systems that work seamlessly to manage the process from initial intake of raw sewage to return of clean water to consumers for reuse.
- Water Resource Management Systems and Engineering Services: TRIT assists the government in monitoring natural waterways. The Company provides systems that combine technological solutions with hardware to track water levels for drought and flood control, monitor groundwater quality, and assist in the planning of water resource use and management.
- Industrial Pollution Control and Safety: TRIT is strengthening its industrial pollution services by penetrating adjacent industry verticals such as the power generation, oil and petrochemical industries. Management believes there is significant opportunity to build on its success of previously implemented air pollution control systems for the petrochemical industry to grow this segment of their business.
The Company began providing these services in 2002 and to date has successfully implemented nearly 300 projects in provinces, municipalities, autonomous regions and special administrative regions throughout China.
Impressive Trailing Three Years Growth and Bright Prospects
TRIT grew revenues and net income from approximately $4.7 million and $1.4 million in 2007 to $16.8 million and $3.9 million in 2009. Revenues and net income increased from 2007 to 2009 at compounded annual growth rates of 89% and 67%, respectively. During that period the Company also built a solid reputation of competence with its clients by getting projects done well, on time and within budget. TRIT boasts an impressive 80% repeat or follow-on business rate with existing clients.
Management has methodically and prudently built the professional engineering staff, technical resources and infrastructure required to support growth. In addition, the capital necessary to fund future growth was raised in an IPO completed in September 2009 ($10.1 million), a secondary offering in April 2010 ($30 million), and a recently negotiated line of credit with a local bank ($15 million). Management is also exploring more substantial lines of credit with other financial institutions so the Company should have the capital necessary to aggressively expand operations in 2011 and beyond.
Management’s guidance for 2010 revenues and net income are around $40.6 million and $7.0 million ($.97 per share), respectively. 2011 revenues should reach at least $70 million which would translate to around $12.4 million net income or $1.50 per share. The 2011 revenue estimate is largely accounted for by a $54.9 million backlog as of October 29, 2010 that will be recognized in 2011.
The following chart reflects actual revenues and net income for 2007-2009 and estimated revenues and net income for 2010 and 2011:
TRIT or Treat — Quarterly Results are Volatile
TRIT’s quarterly results are volatile, or as management has said are “lumpy”. Shareholders certainly took their lumps when Q III 2010 results were released in mid-November and TRIT’s shares plunged from nearly $14 to around $10 on heavy volume. The culprits causing the market angst were disappointing margins in Q III and Q IV guidance at the lower end of the expected range. Although Q III revenues were in line with expectations, margins declined to around 27% from the high 30% range previously experienced. QIII margins were driven lower by a 5% catch-up adjustment necessary to reflect a greater cost of revenues estimate than was originally anticipated for a large project. GAAP requires the adjustment be booked in the period it is discovered so Q III’s cost of revenues included the cumulative adjustment.
Perhaps more disconcerting to shareholders was that Q IV guidance was at the lower end of expectations as some project revenues will be delayed until spring 2011 due to anticipated harsh winter conditions. Many investors apparently sold without considering the revenues were only being delayed, not lost.
Going forward, investors should be mindful that TRIT is still in the early stages of its growth. At any given time the Company has around 30 projects in progress so the timing and/or profitability of one or several projects can have material impact on quarter to quarter operating results. For that reason, volatility or lumpiness of quarterly operating results present a material short to intermediate term risk factor for investors to consider.
There is, however, a possible silver lining to TRIT’s volatile or lumpy quarterly operating results. The inconsistent quarterly results strongly suggest the numbers are credible. If management was cooking the books would operating results be so lumpy? Probably not; the results would more likely always meet or beat management’s guidance. There would never be a cost estimate hiccup or delayed project. That’s just not the nature of TRIT’s business though especially at this early stage of its growth. I therefore think investors can take comfort that the Company’s financial statements are fairly presented and can be relied on. That’s no small feat in an environment with so many recent cases of confirmed or alleged incidents of financial reporting fraud attributed to US listed small cap Chinese companies.
TRIT Stepping Up in Class with Recent $40 Million Joint Contract Win
TRIT recently won a $40 million joint bid for an Inner Mongolia drinking water treatment plant. Management expects to record $32 million revenues during 2011 for its role in the project. This project puts TRIT in a new league in terms of size and scope of projects. Successfully completing the project will add to TRIT’s already impressive track record and credibility and enable the Company to compete for and win similarly sized projects in the future.
TRIT’s Disciplined Bidding Process and Effective Project Management
TRIT’s projects are contracted on a fixed fee basis. If management underestimates the costs and risks associated with a project and/or fail to effectively manage the project, margins and the profitability of the business will suffer. That’s why a disciplined and targeted bidding process and effective project management are essential to the Company’s success in managing risk and maintaining margins.
An indication of just how disciplined, targeted and successful management’s bidding process has been is that at any point in time they bid on only 25% of the total contracts seeking bids and win 50% to 70% of the projects they bid on. A key factor in achieving that level of success is that sales personnel maintain ongoing contact with existing and targeted government agencies believed to be readying contracts for bids. TRIT’s management therefore generally knows what contracts are going to be put out for bid and who the competition is likely to be and prepare accordingly. This practice gives TRIT an edge since management is prepared to quickly submit targeted, qualified and compelling bids early in the bidding process.
Consistent margins over time are another indication of both an effective bidding process and how well projects are managed. Margins are also affected by revenue mix and the size of and competition for projects but the value of an effective bidding process and project management can’t be underestimated. TRIT’s gross margins in 2007, 2008, 2009, and the first nine months of 2010, were 42%, 37%, 39% and 32% (includes catch up adjustment for large project), respectively.
TRIT’s Past Performance and Hard-Earned Credibility a Competitive Edge
The amount of a contractor’s bid is only one factor considered by agencies when awarding contracts. Other factors include: the agency’s past experience with the contractor; the contractor’s track record with similar projects; proprietary software, hardware and technology; the quality of personnel committed to the project and how well their backgrounds mesh with the requirements of the project; value added services the contractor offers; and the financial condition of the contactor and its ability to deliver the project on time and within budget. TRIT has built a solid record of meeting those criteria since 2002 and that bodes well for management’s ability to bid on and win more and larger contracts in the future.
Working Capital and Personnel are Key Gating Factors for Future Growth
It takes money to make money. TRIT is in a business that requires cash and/or financing to fund both the costs of the projects and receivables after projects are completed. That’s because a good portion of the contract costs are incurred before payments are received from customers. The standard payment schedule for the Company’s clients is 30% of the contract value when the project begins, 30% when the site is finished and equipment deployed, 30% upon completion of the project, and a 10% retention retainer held back for 12 months after the project is completed.
Plenty of Trained Engineers Available but Qualified Project Managers are Scarce. Even if TRIT has the capital resources it needs to grow operations and fund more and larger projects it can’t get anything done without qualified engineers and competent project managers. China produces more engineers than any other country but qualified project managers are hard to find. The project manager must be both technically competent as an engineer and have the ability to manage both the project team and the relationship with the client. TRIT’s management can acquire project managers in two ways; grow and groom existing staff over time or “steal” them from the completion. TRIT’s solid reputation and strong growth has enabled the Company to attract experienced project managers needed to manage the ever increasing number and size of projects. The Company recently augmented its management team by employing a highly qualified senior human resources and administrative officer. Many investors might have yawned when they saw the press release announcing the appointment but people are TRIT’s inventory. The quality and availability of personnel when and where they are needed is a complex management challenge. It is critical that management get that right and employing the right person to lead those efforts was essential to support future growth.
Management’s Vision for the Future and Outlook for Continued Growth
Often companies complete IPO’s as a quest and once that goal is attained rest on their laurels. That is not at all the case with TRIT’s management team that is highly qualified, young and dynamic. Interviews with TRIT’s Co-President, Phil Fan, indicate management believes the Company’s growth is just beginning. The good work done since 2002 establishing the Company’s reputation for timely, efficient and cost effective execution of contracts and the ability to deliver value added services to customers is driving both new and repeat business. Each year the Company has operated since inception it has built staff, technology and infrastructure that served as the platform from which it grew in the next year. The successful IPO, secondary offering and negotiations for substantial lines of credit provide the capital necessary to fund accelerated growth of the business since they can now bid on more and larger contracts than they could handle in the past. In other words management is just beginning to grow TRIT; the Company is at the end of the beginning of its growth cycle, not the beginning of the end. I believe investors can look forward to continued outsized revenue, net income and eps gains from TRIT for years to come as they partner with Chinese authorities to solve the country’s pressing water supply issues. TRIT is currently trading at around $11.00, less than 12X likely 2010 and 8X estimated 2011 eps.
Other Factors Investors Should Consider:
Other factors investors should consider particularly given the recent controversies associated with ChinaHybrid stocks include:
- Management intends to fund growth with cash on hand, cash flows from operations, and expanded credit lines. Future equity raises are possible but will be avoided if at all possible. Directors and executives as a group own around 39% of the shares outstanding so it is in their interest not to dilute ownership. Management’s ability to negotiate more substantial lines of credit though is necessary to support my longer term bullish thesis and to mitigate the risk of dilution through equity raises.
- TRIT was an IPO, not a reverse merger. There is far more due diligence involved with companies going through the IPO process.
- TRIT trades on NASDAQ, another indication of quality and due diligence to qualify for listing.
- The Company’s auditor is Bernstein & Pinchuk, an independent member of the BDO Seidman LLP alliance. Management has a year round relationship with the auditor including quarterly GAAP reviews so there shouldn’t be disagreements or yearend surprises with TRIT’s operating results.
- The fact TRIT was able to secure a substantial line of credit with a bank and is presently negotiating for an even larger line with another bank provides additional comfort given the due diligence the bankers would perform approving or considering the lines of credit.
- GeoInvesting has obtained copies of past SAIC filings that are in line with the SEC filings and management is working to reconcile and or explain differences.
Positions: At time of article, Dan was long TRIT