Consolidated Water Co Ltd (CWCO) 2006 Q4 法說會逐字稿

Good morning. My name is Larry and I will be your conference operator today. At this time, I would like to welcome everyone to the Consolidated Water Co. Ltd. fourth quarter earnings and year end conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS]

This conference call may include statements that may constitute forward-looking statements, usually containing the words believe, estimate, project, intend, expect, or similar expressions. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences include, but are not limited to; continued acceptance of the Company's products and services in the marketplace, changes in its relationship with the governments of jurisdictions in which it operates, the ability to successfully secure contacts for water projects in other countries, the ability to develop and operate such projects profitably, and other risks detailed in the Company's periodic report filings with the Securities & Exchange Commission. By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. Thank you.

It is now my pleasure to turn the floor over to your host, President and CEO, Mr. Rick McTaggart. Sir, you may begin your conference.

Thanks very much, Larry. Good morning, ladies and gentlemen. Thanks for joining us this morning to discuss our 2006 results. I am calling in today from our corporate offices in Grand Cayman, and David Sasnett, our CFO, is joining me from our offices in Deerfield Beach, Florida. David will discuss our financial results in some detail. But first, I would like to give you a brief overview of what the Company has been doing during the past year and what we can look forward to in 2007.

All in all, Consolidated Water had a very good year with all three of our business segments reporting higher revenues and an overall Company net profit which exceeded 2005 by 36%. The fourth quarter was obviously a disappointment to us. But you should recognize that the quarter was affected by a couple of things that are either non-recurring or will be mitigated going forward. And we certainly believe that fourth quarter performance is not indicative of the Company's performance going forward.

Our retail operations performed very well for the year, with revenues up 35% in spite of a disappointing flat fourth quarter sales. We've talked to investors before about our cyclical retail sales, and typically, September and October of every year are our lowest sales months in Cayman. However in 2006, the November and December sales did not recover and grow at the same year-over-year rates that we had in previous quarters in '06, so the fourth quarter sales ended up being flat on our retail segment. We already see that these flat sales were an anomaly, and our first quarter '07 sales appeared to be growing at expected rates.

We continue to plan for long-term sales growth in Grand Cayman, and we have just recently commissioned an additional one million gallons of production capacity at Governor's Harbor in Grand Cayman, which is quickly being utilized to meet demand. We also continue to design and plan for and another -- or an additional one million gallons at Governor's Harbor. And we're presently navigating this project to the various planning procedures, and we expect this plant to be operational sometime in 2008. So although fourth quarter was a disappointment, we're certainly continuing to plan for growth in Cayman, and we're implementing our capital improvement plans that were formulated last year. We continue on target with that.

Our 2006 retail sales overall were specifically affected by a sharp recovery in water demand within our Seven Mile Beach and West Bay service areas as tourism properties recovered in late '05 and all through '06 from the damage inflicted by Hurricane Ivan in September of 2004. Redevelopment of damaged properties, construction and new higher-density seven-story condominium projects continued through 2006, and we should see some of these projects coming online this year as they are completed and sold.

Turning now to bulk; our bulk sales grew at a very respectable 56% for the year due to additional sales and reduced production penalties from the Windsor plant in Nassau; and more importantly, because of new sales being generated from the Blue Hills plant in Nassau, which was commissioned in late July; to a lesser extent, from the water authority in Grand Cayman taking additional water from the expanded Lower Valley plant, which was commissioned in January last year.

However, as you can see from the results, gross profit in the bulk segment was lower in proportion to sales in the fourth quarter because of some start-up problems at Blue Hills, and these problems were related to feed water quality which affected chemical usage, pre-filter costs and our energy efficiency. We essentially had fouling of about half of the production units in the plant. We've now isolated the problem wells and have implemented changes to the operation of the plant to mitigate this fouling. I really want to stress here that these problems are, although similar in nature to what we experienced at Windsor, have not impacted our operations in the Bahamas nearly to the extent that the Windsor problems had in the past. We believe that the Blue Hills problem and the Windsor fouling problems are in check at the moment, and we're implementing changes to gain back any losses in energy efficiency.

Bulk gross profit margins in the third and fourth quarters were also impacted by the costs associated with our obligations under the non-revenue water reduction part of the Blue Hills contract. As you know, we are obligated to reduce the amount of water that is lost through leakage in our customers water distribution system in Nassau, and this project is proceeding very well. Until it is completed, however, we are providing free water to our customer to make-up -- some free water, I should say -- to make up their line losses and are effectively selling water to the customer at a reduced rate. And this is from Blue Hills. We expect to complete the NRW project and get the full contract rate for water in the -- sorry, in the third quarter of this year.

We are also hopeful that, going forward, after we've completed our obligations, that there will be opportunities for us to continue to provide consulting services to the government in the Bahamas to further reduce their water losses. They presently have losses of about 40% to 50% of their water that's produced and I am sure that they're interested in further reducing these losses with our help.

Our Cayman bulk operations, which are sales to the Water Authority, the government-owned utility in Grand Cayman, continue to perform very well. And we benefited from additional sales, as I mentioned earlier, from our Lower Valley plant. Also in August last year we were awarded an extension to the North Sound contract, which will start impacting sales this quarter.

We saw improvements in 2006 by our Belize bulk water operations, both in sales and gross margin, and continue to make changes to the plant which will increase production capacity and improve energy efficiency. We believe that our growth prospects in Belize are very good, and with are presently exploring ideas with the government-owned water utility to extend the water distribution system that is owned by our customer to the northern end of Ambergris Caye, and that would open up new opportunities for sales from the Belize operation. There is a lot of development going on on the north end of the island. There is presently no public water supply there. And we're -- we're very excited about the potential for expanding into that area.

Overall for the year, our gross -- our bulk gross profit margins improved, and we're optimistic that improvements over fourth quarter performance will be achieved when we realize the full benefit of the Blue Hills revenues later this year.

Turning to services, our third reporting segment; although our services segment is a small part of our total operation, it is important to note that gross profit from services was negatively impacted by about $300,000 in the fourth quarter due to increased operating costs as we geared up with personnel and other resources to handle the projects that are presently underway in Bermuda and Grand Cayman, and also to provide additional engineering support to our expanded plant operations in Nassau, and to handle a bid preparation for projects that are already out there or that we expect to come out this year. The Company has, over the past few years, relied on outside consultants for a portion of its engineering work. And we are now expanding our in-house expertise and resources, which we believe is in the best long-term interests of the Company and provides us a more competitive edge in our market.

I would like to turn the call over to David now, to talk more about the financial performance. David?

Thanks, Rick. First of all, I would like to talk about our annual results. Our net income for the year increased from $5.5 million last year or $0.45 per diluted share to $7.5 million this year or $0.59 per diluted share. This is attributable to an increase in sales, which rose about $12 million for the year. Our revenues by segment were approximately $18 million for retail, $18.3 million for bulk, and $1.9 million for services; for a total for the year of about $38.2 million.

As we mentioned previously, our retail sales for the year rose as Grand Cayman recovered from Hurricane Ivan. Our bulk sales grew due to greater demand on Grand Cayman, but more importantly, due to added sales in the Bahamas resulting from the temporary increase in our Windsor plant capacity and the commissioning of Blue Hills. Our service revenues were up as we generated significant fees from the construction of our affiliate's new Bar Bay plant -- our affiliate being OCBVI in the British Virgin Islands. As we go forward, our service revenues are not expected to continue at the rate we had for 2006, only because we do not have a third party contract, such as Bar Bay, inhouse at the moment.

Our consolidated gross profit grew almost $6.8 million as all three segments reported greater gross profits, both in terms of dollars and as a percentage of sales. While our G&A expenses increased by approximately $2.3 million for the year to $8.4 million, we would like to point out they declined as a percentage of sales from 23% in 2005 to 22% in 2006. One significant variation for the year was interest expense, which exceeded that for 2005 by almost a million dollars. This is due to the increase in our outstanding borrowings during the year that we incurred to fund the construction of our Blue Hills plant in the Bahamas.

If you look at our financial position at the end of the year; our total assets grew from approximately $88 million last year to approximately $139.5 million -- excuse me, $139 million at the end of the year -- this year, December 31, 2006. This $51 million increase in total assets reflects the construction of Blue Hills and the additional capital we raised in December from our secondary offering of our ordinary stock and due to the overall increase in the level of our revenues and operations. With our secondary offering, we were able to restructure our debt and equity to better position ourselves for the opportunities we expect to arise in our marketplace.

Our cash flows from operations were a healthy $11.6 million for the year, this is $3.8 million more than we generated last year or in 2004.

I will speak briefly here about our fourth quarter. Our net income for the quarter was $674,000, about a million dollars less than last year. However, if you look at some of the components of the fourth quarter results, I think you will understand that the $674 we reported for this quarter is not necessarily indicative of what we expect in the future. We made the decision during the quarter to repay about $8.75 million worth of long-term debt. We had $241,000 in deferred costs on the books, which we had to write-off. We also had a significant increase in interest expense from last year, but as I pointed out earlier, we did repay this debt. The interest expense on that debt will not continue into the first quarter. And at the end of the year we had approximately $30 million in short-term interest rate deposits.

So we believe you should look at the first quarter of 2007 as compared to the fourth quarter of 2006. You will see an improvement in interest income and a decrease in interest expense. And as Rick has pointed out earlier, our fourth quarter results were impacted, to a certain extent, by an unanticipated flatness in the demand in Grand Cayman.

With that, I will turn the conference call back over to Rick.

Thanks a lot, David. I would like to -- I will give you an idea what we're -- what projects we're working on going forward, and how we're really applying all of these new engineering resources that we have in the Company, as I talked about earlier. The Governor's Harbor expansion -- I mentioned that we are continuing with plans to put another million gallons in there. That plant will be expandable to two million per day as demand warrants. We expect that will be online sometime in 2008 to meet anticipated growth here in Grand Cayman.

In Bermuda -- I just returned from Bermuda over the weekend, and I was very pleased with the progress so far on the Tynes Bay project. This contract was signed back in January, and we expect to commission the plant by the end of the year. Again, we're currently working our way through the planning procedures in Bermuda, and we've started doing some work onsite with well drilling. This project is a design-build-operate type agreement, and the Bermuda government is paying us for the plant up front during its construction. So you will be seeing revenue from this project affecting our results in the first quarter of this year and rolling forward.

It was very encouraging during my visit to Bermuda. I was told that water on the island is running short already, even during their historically wet season, which is the winter. They expect a dry summer, and we hope that this encourages government to maybe talk to us about expanding that plant at Tynes Bay, going forward. We've always thought that -- I guess once you put a plant there, once you have water available, people are going to use it more freely, and it is going to generate additional demand. That's always what we've seen in water short countries that we operate in. So as production is more plentiful -- water production is more available in Bermuda, we hope that there is opportunities for us to grow that business.

I mentioned in the press release that we were bidding on a project here in Grand Cayman. The Water Authority recently released tender documents for a 2.5 million gallon per day desalination plant on the eastern end of Grand Cayman. We've been anticipating this, and we're very excited about this opportunity, which is in our backyard. The Water Authority has been expanding their pipelines on the eastern and northern end of Grand Cayman over the last couple of years, and they see this plant as meeting demand from those areas.

Although we can't make any guarantees, we're hopeful that our strong local presence and our significant experience here in Grand Cayman will give us that competitive edge that we need to win this project. We're presently working on the bid, and we believe that this could be awarded sometime over the summer and be operational late next year.

The Bahamas is also continuing to present opportunities to us. I was in the Bahamas about two weeks ago at the official commissioning of the Blue Hills plant. A number of government dignitaries there to make their speeches and to commission the plant. We had the Prime Minister of the Bahamas present and in his key note speech, he disclosed government's initiative to continue expanding the desalination capacity in Nassau and on the smaller family islands. And they actually released a water -- a long-term water plan that week, when I was in the Bahamas. They've also talked -- they're talking about addressing the significant waste water treatment and disposal needs in Nassau.

During that week, government released tender documents for a desalination plant on the eastern end of Nassau that would produce a guaranteed 2.4 million gallons per day of water for the government-owned utility. And we're presently working on a bid for that project. We'll certainly keep you posted as developments warrant.

Last year, we announced that we prequalified for a big water augmentation project in Barbados. And really, we haven't -- that hasn't moved forward since that time. We were prequalified with a local Barbados partner, as well as a U.S.-based engineering firm. What has happened there is Barbados is hosting the finals for the World Cricket Cup, and the government has been focused on providing stadiums and housing and all the various infrastructure that was required to host that event. Cricket is an extremely popular sport in the Caribbean, and they've been spending a huge amount of resources to make that successful in Barbados. The matches are actually going on as we speak, and I think they're to be wrapped up by the end of the month. So hopefully we'll see, over the summer, some more movement to address Barbados' water needs.

And of course we're always -- those are the big ones, and we're always evaluating other opportunities in the Caribbean and Central America. And we certainly see demand increasing for our services as populations grow and as tourism really drives development in the Caribbean right now. I will also mention -- I was in BVI early last week, and we really don't have anything new to report on that -- the status of the contracts over there. Although I was encouraged -- there was dialogue with government. We'll keep you posted as things develop in BVI.

Larry, I'd like to now open up the call to questions.

Your first question comes from Michael Gaugler of Brean Murray Carret.

Good morning, gentlemen.

Good morning, Michael.

I was wondering if you could perhaps quantify for us how much, in terms of water savings, you believe you've identified thus far in Nassau?

We're well -- we're not going to disclose any numbers because it is really based on quarterly water balances that are agreed with government. But I can tell you that we're, I think -- we're happy with the results so far. I'm not going to give you any numbers, though.

Okay. Also, we've seen some one-off charges here in the last two quarters. And outside of the non-revenue water that you expect to impact performance going forward, should we be expecting any other negative impacts to earnings, in terms of charges or anything outside the norm, going forward here -- at least for the first half of '07?

Well, when you look forward, non-recurring charges, to a certain extent, you could have -- I guess you could have anticipated the $241 we took this quarter when we were off the debt. But prospectively, Michael, I don't -- we're not aware of anything at the moment. Of course, based upon today we don't know of anything unusual. But once again, we can't offer any guarantees.

Okay. All right, gentlemen.

Your next question comes from Ryan Connors of Boenning & Scattergood.

Hi, guys.

How are you doing, Ryan?

Doing well, thanks. Just a couple. I guess first on the Blue Hills issue with the non-revenue water reduction; can you just talk about big picture, how the Company kind of ended up with the non-revenue water reduction provisions in the contract? It doesn't sound like something that you would really want to take on. Was that just something that your customer would not negotiate on and therefore, you didn't have a choice? Or is that something that is more common?

I would say it is fairly unusual for this sort of business. I mean, we did it basically to be competitive with some other people that were offering similar services to the project. And the government is obviously very keyed in on their losses, and we saw it as a value-added service that we could offer to really get that Blue Hills project.

Okay. Sure. And the other one was, can you talk about how the situation with Blue Hills impacts the competitive situation? In other words, obviously you guys still have a very, very good track record in terms of your delivery on your contracts, but will you now have competitors kind of pointing out some things in Blue Hills and sort of using that as ammunition against you in the bidding process? And if so, how do you counter act that?

Ryan, what's happening at Blue Hills is not impacting our service to our customers. So they really don't have any ammunition that they could use. We're providing world class service there. We're not falling short of any of our contractual obligations there. What I think it will do is maybe give some of our competitors pause to think about, well, the Bahamas is -- there is obviously some issues there, and we better know exactly what we're doing when we bid on a project there. And Consolidated has really seven or eight years experience in that market when others don't. So hopefully it will help us.

Great. That's very helpful. Thanks for the time this morning, guys.

No problem, Ryan.

Your next question comes from Debra Coy of Janney Montgomery.

Good morning, Rick. Good morning, Dave.

Good morning, Debra.

Just following up on the NRW provisions. Can you just explain a little bit about what kind of services you're providing? You're not actually getting out there and fixing leaky pipes. What exactly are you doing? And how much control over that project do you have.

We're not fixing the leaks. That's not part of the deal. We're identifying leaks, and we're making changes to the system -- to their distribution system, which include operational changes, provision of monitoring equipment, control valves, things like that, that will mitigate their losses. Basically operate their system in a better manner so that they save on water losses.

And are you responsible for paying for that stuff? Or are you just providing some consulting service? Are you out buying and installing monitors and valves?

Yes, we are. And that's part of the number that we put in the 10-K that is really the accumulated cost of that project to date.

Debra, you will see that cost in other assets.

Right.

And it is the reason why we had an increase from last year. It is about $2.3 million as of December 31st. And that's being amortized over the twenty-year life of the Blue Hills contract.

And it sounds like that number is going to continue to go up a bit further in '07, as well, until you get done the project over the next couple of quarters?

That's correct.

Okay. And this is about what you expected? It seems -- my sense is that when you got in there that the leakage issues were a little more persistent or stubborn that you might have thought. I had thought we would get ramped up onto profitability a little more quickly on Blue Hills. So I am trying to get a sense of the distribution system, whether it turned out to be a bigger bear than you really expected?

Actually, we knew that it was going to be a pretty big project there with the types of losses that they have. It's really -- I think it has come off at my expectations. Hopefully, we'll finish up even earlier than what I expected.

Okay. Following up on Ryan's question about the competitive situation; number one, can you say anything about how the competition seems to be lining up? Are you seeing two or three competitors also likely to prepare bids in the Bahamas? It sounds like there are several additional plants that are likely to come after the one you're bidding on now.

And finally, as you develop your relationship with the government there, and clearly are getting more involved in the overall management of the system, if you will, understanding the distribution system, would that be part of additional plants? And does it give you some advantage in that basically you're becoming more of an active operator, not just a provider of bulk water, in some ways?

I wouldn't go so far as to say that we're becoming an operator in the Bahamas. We're helping the government resolve their distribution leakage problems. But when that's done -- we'll certainly have a lot more knowledge about their system. Whether we can apply that going forward, probably in competitive situations, it gives us an edge over somebody else in that we know where the bottlenecks are in their system. But definitely we're not getting into operating anything there, other than the bulk water supply.

Okay. How many competitors are you seeing gathered around for this one and in the Grand Cayman bid?

The typical people. We talk about Veolia and GE being big competitors in the region. I am not familiar with anybody else that may be interested in these projects at the moment.

Okay. And finally, on Bermuda, Dave, you mentioned earlier -- or maybe Rick, you said it -- that you would start to see some contribution from this as early as 1Q. And it was about a $10.5 million contract, as I recall. I had expected that to be primarily coming in late in the year. Can you just walk through how that will work, in terms of what we should expect to see in the income statement and balance sheet?

David, do you want to take that one?

I'm not sure -- I didn't hear the first part of your question, Debra.

I am just trying to understand how we should see the revenue ramping up related to Bermuda? And then also potential balance sheet impacts as you get that one up and going?

Well, the Bermuda contract has two components, one of which is the construction of the plants and second is the operation for year after. Based on -- we're still looking at the accounting for the Bermuda contract. We've established a subsidiary there -- not really a subsidiary, an affiliate, Consolidated Water Bermuda. But based upon what we see right now, Debra, it looks like we'll be consolidating that subsidiary and accounting for the construction of the plant using percentage of completion accounting.

Oh, okay.

And then with a portion of the revenues deferred and recognized over the life of the operating contract. That's tentatively what we're seeing now. We still have to confirm things with our accountants.

That's helpful. We'll know that in another few weeks -- by the end of this quarter.

Take a look at the accounting -- we'll disclose it in the first quarter Q as to how we're accounting for Bermuda.

Fair enough. I guess I do have one other question. On BVI, it seems that the negotiation there have been dragging on. I heard you say, Rick, that you feel encouraged and certainly that was the language in the 10-K as well, that the negotiations are amicable. But can you give us any sense of how much longer it might take to get this resolved?

And then secondly, I assume that on the Baugher's Bay plant, it continues with revenues at the earlier contracted level. And on the Bar Bay plant, it is done, it's ready to go, and it is just sitting there waiting for a contract. Are those essentially correct assumptions?

Those two assumptions are correct, yes. I don't want to say too much about BVI because we are in the midst of some pretty delicate negotiations, I suppose. And we'll keep you posted as things develop. But I will stress again that I was encouraged last week when I was there and did have some dialogue with government.

Your next question comes from David Bunzel of Irvine Capital.

Hi, guys.

Hi, David. Good morning.

I got on the call a little late, so I will apologize if advance if this was covered. This is probably for David. Could you give us a little more detail -- I am a little confused -- sounded like, when you were answering a question before, you were able to write off part of these costs -- and I am referring to Blue hills now. It sounded like you were able to write-off part of the costs over the life of the contract, yet it sounded like you took part of it and also took a bigger hit here in this quarter, and I guess in the following quarter. Could you just walk me through why all of it didn't flow over the life of the contract? Or why it was broken up the way it was?

Well, there is -- a portion of the costs relate to the actual improvement of the system itself, NRW. And we can quantify those costs and amortize them over the life of the contract. There is a certain portion of the costs that are associated with producing the free water, and that's part of the operation costs of the plant. And our accountants have looked at it and said they think the appropriate accounting treatment, with which we concur, is those costs have to be expensed. In other words, you can't carve out the operating costs associated with providing the free water.

Why not? Why aren't those quantifiable in the same way that these other costs are?

Because there is no defined benefit -- in other words, we think these costs will be -- we'll finish these in 2007. There is not a definite time period for that, though. And our accountants have taken a position that those are part of the operating costs associated -- in other words, they're looking at the million dollars worth of free water as just adjustment of the rate. And we get to increase the rate once we complete the other part of the contract.

So if you pay for a valve -- I am just throwing something -- if you pay for a valve, you get to write that off over the life of the contract, but the actual free water, you have to take that hit all at once? Is that the right way to look at it?

Yes, we take the -- it's just the operating costs are blended in in what they viewed as -- they said, once you get the free water provision -- as soon as you have the NRW contract completed, then you get to adjust the rate on the water and you get to bill for that additional water. They view it as a -- that portion of the contract as a rate increase rather than something you can defer the costs on. When we get the NRW project completed, we'll be able to either not sell free water to them and not -- supply it. Or if they do want that million gallons, we will charge them for it.

[OPERATOR INSTRUCTIONS] There appear to be no further questions at this time. Mr. McTaggart, I will turn the floor back over to you.

Thanks a lot, Larry. Just like to close quickly and thank everybody for listening in today. And thanks again for supporting the Company with your investment. And we hope that you'll be very pleased with the long-term performance of the Company going forward. And we believe we had a great 2006. And thank you very much.

This concludes today's Consolidated Water Co. conference call. You may now disconnect.