Consolidated Water Co Ltd (CWCO) 2007 Q2 法說會逐字稿

Good morning. My name is Henry and I will be your conference operator today. At this time, I would like to welcome everyone to the Consolidated Water Co. second-quarter conference call.

Please note the statements made on this conference call which are not historical fact are forward-looking statements based upon the Company's current plan and strategies and reflect the Company's current assessment of the risks and uncertainties related to its business, including such things as product demand, market acceptance, the economic and business environment and the impact of government pressures, currency risks, capacity, efficiency and supply constraints, and other risks details in the Company's press releases, shareholder communication and Securities and Exchange Commission filings. The Company urges you to consider reviewing its 10-Q and 10-K SEC filings.

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).

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

Thanks a lot, Henry. Good morning, ladies and gentlemen, and thank you for joining us this morning on our conference call. I am joined on the call by our Chief Financial Officer, Mr. David Sasnett. We're actually calling in from our Baughers Bay water plant in Tortola today. We're down for some Board meetings. So I apologize if you hear some background noise every once in a while, but that is our water plant running in the background.

David will discuss our financial results in just a minute, but first I would like to give you a brief overview of our business activities so far this year. In our retail segment, our sales in Grand Cayman in dollar terms grew nicely over the second quarter of 2006, and we continue to be encouraged by the pace of development within our retail franchise area in Grand Cayman.

We are pleased that revenue growth appears to have picked back up after a couple of flat quarters. However, as always, we like to caution investors that our sales are affected by things like the number of visitors on the island and the weather, and particularly, the sales tend to be lower during the third quarter, when tourism ebbs and the weather becomes a bit wetter during hurricane season.

Having said that, there are several large developments nearing completion in Grand Cayman and we expect these developments will provide good incremental sales when they come online. These include the Camana Bay development, which was recently expanded from 240 acres to 500 acres. And it looks like the first stage of this project, which is primarily office and commercial space, will be completed sometime later this year or early next year.

We continue to work through our rezoning application for one of our sites where we are going to put a new 1 million gallon per day RO plant on Grand Cayman for our retail area. And this has delayed the project a bit. As we mentioned earlier, we expect to experience growth in our Cayman retail business, and this new plant, as well as some other initiatives that we are considering, will ensure that we have sufficient production capacity to meet expected 2008 and 2009 demand.

In March, we commissioned four containerized RO units that were previously in Nassau. And these plants are being used as a stopgap measure until the new permanent RO facility can be completed. And the total capacity of these units was 1 million gallons per day.

Now looking at our bulk segment, we have shown significant revenue growth since the second quarter of '06 due to the commissioning of the Blue Hills plant in the Bahamas last July. While we continue to meet our sales targets and contractual requirements in the Bahamas, the operational costs at the Blue Hills plant and the Windsor plants have been higher than expected due to the quality of the feedwater to the plants and the freewater that we are providing under the NRW part of the Blue Hills contract.

You know, we've mentioned that some time ago we took steps to eliminate and prevent membrane fouling at the Windsor plant. That was successful, and we have implemented similar programs to prevent fouling at Blue Hills. However, these programs, while they are controlling the fouling and eliminating production penalties, have contributed to some higher operating costs. So we're continuing to evaluate ways to reduce these costs with further modifications to the plants.

These issues have caused our gross profit margin to be lower than the first quarter, and combined with the operating cost benefits we enjoyed from the temporary RO plants in the second quarter of '06, have caused some variance from our '06 profit margin, second quarter. David will talk a bit more about that.

Bulk sales in Grand Cayman to the Water Authority were actually flat over last year and we are short of our expectations for the second quarter. We're in discussions with our customer to try to determine what the causes of that are. We don't have control over their demand, so obviously we are just looking for information from them. Based on the customer's aggressive pipeline expansion program on the north and east sides of Grand Cayman, we hope that this segment will soon show growth and more fully utilize the expanded North Sound plant.

We also expect to see a positive impact on this segment when we complete the new 2.4 million gallon per day Frank Sound plant in late 2008. The customer in Grand Cayman had some specific water quality requirements that differ from our typical bulk contract and also wanted a large standby power system for the plant. So we expect the price of water that we get from Frank Sound to be somewhat higher than what our average 2000 bulk rate was, if you refer to our '06 10-K.

Turning to our services segment, we benefited from revenue from the construction of two desalination plants in the quarter. One of them is completed, the other one is ongoing -- the Tynes Bay plant in Bermuda, which is currently under construction, and the North Sound plant expansion in Grand Cayman, which was completed on April 1. We did pick up some revenue there.

We are making good progress on the Bermuda project. Although we just recently broke ground on the site because of building permit delays, the overall schedule for the project remains on target. And David will talk a bit about the accounting for that when he gets on. Much of the equipment is on order, and we still expect to complete the plant in early 2008.

Sandy Lane contract in Barbados came to an end on June 20, and the customer has taken over responsibility for operating that plant after a six-year operating agreement expired. And we are obviously disappointed that Sandy Lane did not extend the agreement with us. We wish them all the best in their new and challenging role as an RO plant operator. So that will affect revenue in the services segment going forward, and it also affected the second-quarter results.

Our BVI affiliate, obviously something that is very important to us -- we are here in BVI now for Board meetings. We were pleased that in mid-June we received a letter from the BVI government which confirmed that they wished to enter into a contract with our affiliate to purchase water from the Bar Bay plant in Eastern Tortola. We're currently negotiating a definitive supply contract. We hope to have a signed agreement before the end of the year. Obviously, we can't talk about any sort of terms at this point since we're still in discussions with the customer.

Meanwhile, we have connected the Bar Bay plant to the public water supply system, and the plant is fully commissioned. We haven't supplied any water at this point. We are anticipating that we will commence supply as soon as we complete the contract negotiations.

The negotiations on a new agreement for the Baughers Bay plant continue to move slowly, and we believe that the upcoming election, which is scheduled for next Monday, has temporarily diverted government attention from the water situation here. In the meantime, we mentioned in our 10-Q that our affiliate has taken advice from local counsel here in BVI. We believe that we are in a good position to maintain an ownership position in this plant and to collect any outstanding receivables from government for water delivered from the Baughers Bay plant.

Sales from the Baughers Bay plant continue to be robust and they're up about 20% over the second quarter of last year and our operating costs are down, so David will be able to maybe explain a bit more about that when he gets on. And I would like to just turn it over to him now to talk more about the financial results.

Thanks, Rick. Hopefully by now, all of you have got a chance to look at our 10-Q and read our press release. So I won't go into any minutiae on our financial results; rather, I would just like to touch on some of the financial highlights.

Our sales for this period, our revenues were up to $11.9 million, almost $12 million, in fact. All three of our operating segments posted increases in revenues -- retail, bulk and services. Fortunately, we had a relatively flat quarter in terms of profitability. Net income this period was $2.6 million, and this compared to about $2.5 million last year, same period last year.

Our EPS was down slightly because, as you will remember, back in December we closed a public offering and raised money through the issuance of 1.75 million common shares, so that increased the number of shares that are included both in our basic and diluted EPS calculations.

From a financial position we are well capitalized -- substantial growth in assets from this time last year. We don't show a June 30 balance sheet, but since that time, we have completed Blue Hills and started construction on Governors Harbor.

From a cash flow perspective, once again, healthy results. We generated over $4 million in cash from operations, and this is even though we paid down approximately $1.6 million in payables and other liabilities from our December 31 balance sheet. We are not spending the kind of money we have in the past on construction in progress, like we did last year with Blue Hills. So our net cash position increased from the end of year to -- now we have about $35 million in cash.

Looking at the results for each of our subsidiaries and segments, retail was up in terms of sales due to a slight increase in demand. Margins, they were very steady.

When you turn to the bulk operations, we did have an increase in our bulk sales. But if you'll look at it, that is primarily due to Blue Hills, and we suffered some margin erosion in our bulk segment for some of the reasons Rick mentioned earlier, specifically the higher operating costs and the moneys we have spent to deal with membrane fouling problems at Blue Hills.

It is also important to note that this time last year in the second quarter of last year, we were operating containerized units there. The operating costs on these containerized units are relatively -- well, they are lesser than permanent-type units, and we experienced some very healthy margins there last year when we transferred those units over to Nassau. That production was picked up by the Windsor plant and by the Blue Hills plant, which don't quite operate at the same low fixed operating costs that the containerized units do. So therefore we did have some margin erosion, simply due to the transfer of those units to Grand Cayman.

From a services standpoint, we posted a significant increase in revenues because we completed the construction on the North Sound plant, which was commissioned in April of this year. We're also continuing to work on the Governors Harbor plant -- excuse me, that is not part of this segment. We're continuing to work on the Bermuda plant. And we are recognizing profits on both of those plants using the percentage of completion method.

The percentage of completion method really requires you to recognize revenues in proportion to the costs expended. Those costs are not expended in the same manner every quarter. Sometimes we will go through phases in construction where one quarter will have more in the way of construction costs, and we will make more progress in that quarter than perhaps you would in a subsequent quarter.

So if you look at our financial results going forward, we will continue to recognize revenues and profits on the construction of Bermuda, but it may not be a straight-line relationship from quarter to quarter. We are required to have that project finished by January of 2008, so all revenues will be recognized through then.

That is pretty much the financial highlights of this quarter. I will turn things back over to Rick.

I would just like to mention, in addition to the projects that you know about already, just update you on a couple of other initiatives that are underway and talk about some future prospects.

In the Bahamas, back in April, we submitted a bid to the Bahamas government for a new 3 million gallon per day RO plant for the government at Winton, and we have been asked on two occasions to extend the validity of that bid. They haven't made a decision on it yet. And we hope to hear soon whether the Bahamas government will proceed with this project.

In Belize, we mentioned last quarter that we're presently working with a customer to provide resources, help them extend their water distribution system to the northern end of Ambergris Caye, where they are experiencing quite a bit of tourism-related development. And we continue to work with them and try to come up with terms that we could help them to accomplish that. And that, of course, would generate more sales from our plant in San Pedro over the -- we have a 23-year supply contract with the government there. So any additional demand that they could get benefits us.

In addition to those projects, we're looking at a couple of other opportunities in the Caribbean in new markets. We will certainly update you if and when these opportunities develop, and we will keep you posted.

I would like to just ask Henry to open up the call for questions.

(OPERATOR INSTRUCTIONS). [Charles Lansberg, Bondtrac].

Just checking to see the impact on earnings that the Blue Hills water project is costing with freewater, both earnings per share and maybe revenue that you would normally get from that project?

We disclosed, I think, in the 10-Q that it is costing us about $450,000 in incremental variable operating costs. I think it is maybe around $433,000. We do sell for Blue Hills positive margins, so the revenue reduction is greater than the $433,000. But there is no guarantee that once we stop providing freewater that that's -- generally, they will buy the freewater from us. So we don't give revenue projections of the impact of Blue Hills. But as I said earlier, the cost to us in terms of variable operating costs that could be eliminated if we weren't providing that freewater is around $430,000.

Ryan Connors, Boenning & Scattergood.

Just a couple of questions on accruals. First, on Tynes Bay, that facility is still under construction, as I understand. So is what's being accrued there -- is that the fee for constructing the plant and not necessarily for selling the water? Is that what is happening there?

Yes, that contract is in two phases. One is a construction phase and the other is an operating phase. What is being recognized at this point in time are the revenues for the construction of the plant. When it is completed, we will turn it over our operating personnel, and they have a contract to run the plant for one year. And we will recognize revenues under that portion of the contract as well. What we recognize today is percentage of completion revenues for the construction of the facility.

I would also like to clarify something regarding the previous answer I gave to the last questioner. Our incremental operating costs for Blue Hills is about $433,000 for the six months. It is running a little over $200,000 per quarter.

Got it. Now, secondly, on the Baughers Bay plant, in terms of the receivables being booked there, the 10-Q mentions that the Ministry has said that it'll only pay for the water costs until that agreement is reached, which you say equates to about 40% of what is, I guess, effectively being booked right now.

Yes, when the government has said is that we're only going to pay you 40%. And that is their estimate of our cost. BVI has come back to the government and said, we don't know how you came up with 40%, but the operating costs for our plant are higher than 40% of what we're billing you. The government has pulled an arbitrary figure out of the air to use to determine how much it is going to pay us in BVI.

OC-BVI's position is that, first of all, the operating costs are higher than that, and second of all, we're entitled to the full payment under the contract. There is still a month-to-month contract in place that has not been superseded by another contract. So it is OC-BVI's position that they are entitled to full payment of all amounts billed under that contract. The government is still taking the water. As long as they keep taking the water, they are still under the previous contract. And it is the position of OC-BVI, and us as a partner in OC-BVI, that we're entitled to full payment of everything billed under that contract at the existing contract rates.

So I guess we should infer, then, that you're confident enough in your legal position there to continue accruing at that higher level, that you feel ultimately that your views will win out?

Well, we're not attorneys, and any time you put something like this in front of a jury or a judge, you don't know how it turns out. But right now, the existing legal position as we understand from talking to our attorneys is there is a contract in place, and they are continuing to buy water under that contract. So we don't know of another amount to the record receivable at. We certainly feel we are entitled under the contract to full payment of all those amounts. So that is what we believe we will collect.

There is no reason for us to believe at this point that we should be making any sort of provision for that.

That's very helpful. Thanks a lot, guys.

Debra Coy, Janney Montgomery.

A couple of follow-ups. On Blue Hills, with the higher operating costs, the plant performed very well in Q1 and then we're seeing weakness again in terms of these higher feedwater costs in Q2. Are there some seasonal issues at work there? And how should we think about that for the rest of year and going into '08, as you say you're making some operational improvements?

Going forward, it is difficult to give you an answer to that. It is a challenging operating environment, and as problems or issues raise their heads, we try to address them. So I think it would be difficult to give you some sort of undertaking or guidance on what we're going to be doing for the rest of the year. But there have been issues that come up that have affected the margin, and we are addressing them as quickly as we can.

Why is it a more challenging operational environment? It's just simply more contaminants in the feedwater?

It is a feedwater issue, yes.

And then coming back to Dave, you noted the transfer of the RO units, and Rick, you noted it as well. Was the higher cost related to the actual transfer or related to operating costs? It was interesting to note that the RO units were running at a higher margin than the actual fixed units.

The RO units themselves don't cost as much to operate. But they're not the solution our customer was looking for there. They were a stopgap measure. And what happened is we put them in place and they really don't result in a significant amount of additional fixed operating costs. We ran them with the same personnel that we had in place.

It was different water quality requirements as well. Under the temporary supply contract, the Blue Hills plant has a significant amount of posttreatment after the RO process, which the customer wanted in the permanent solution.

So what we had is really a period of time where the margins on those containerized units were just better than what we have for the permanent solution we now have in place. And when we transferred those units over, that production was picked up by -- the existing ones, but primarily by Blue Hills. So that did have an impact on the margins.

And then my final question is coming back to what is going on in the bulk water business in Grand Cayman. You noted that you have moved the RO units over there. The permit for the 1 MGD expansion has taken a little longer than expected. And now we have a new contract that has some additional requirements, it sounds like, in it as well. Is your sense that the falloff in demand there is temporary and that all of this new capacity will be fully taken up within a year at the end of '08? What is the current thinking on the island in terms of how these new developments are going to get filled out in terms of owners and occupants?

Well, just to clarify what I said earlier, we have seen growth in the retail segment, which is our high-margin (multiple speakers) in Grand Cayman. The temporary units were moved over to address demand requirements in the retail segment, so they are being utilized there.

Okay, not in bulk, got it.

Not in bulk, no. And we expect that growth to continue. That is why we are investing dollars into permanent expansion. And there's some other initiatives that we're looking at to increase production capacity there to meet expected demand.

Now, as always, the timing of some of these bigger projects is not predictable. The developers will give you sort of a general idea when they are going to come on. So we need to be prepared for those new demands. The bulk segment in Grand Cayman, which is the Water Authority sales, has been flat. However, they have asked us and they've put out a bid -- they want to construct a new 2.5 MGD plant there. And that is a take-or-pay contract. We will be receiving revenue from that whether or not they take the full capacity of the plant. So that is not a concern to us at this point.

Thanks, and thanks for the additional information. That's helpful. Appreciate it.

(OPERATOR INSTRUCTIONS). David [Hoff, Hoffline] Enterprises.

My question is are you planning to construct any desalination plants in the southwestern United States in states such as Nevada, Arizona or California?

Henry, are there any other questions?

Did they get the first question?

(technical difficulty) plants in the southwestern U.S.

If there was another question, we didn't hear it.

[Chris Noon], Brean Murray, Carret.

I just had a quick question here. Could you maybe just talk about some near-term opportunities for additional contracts, if there are any?

Well, we did mention earlier that we're waiting to hear regarding the Winton bid in the Bahamas. That is a 3 million gallon per day plant. The government hasn't decided if and who they will award that contract to. And we believe there's further water needs in the Bahamas that we're looking at, although no official bids have come out, or discussion.

(OPERATOR INSTRUCTIONS). Jan Carroll, RJ Falkner.

There appear to be no further questions at this time. I will now turn the floor back over to Rick McTaggart for any closing remarks.

Thanks, Henry. Just in closing, we appreciate your time listening in, and we look forward to talking to you again next quarter. Thanks very much.

Thank you. That does conclude today's teleconference. If you have missed any portion of today's teleconference, you may dial into the digital replay at 877-519-4471 for domestic parties and 973-341-3080 for international parties. All parties must enter the PIN number 9096341 followed by the #. This replay will be available from August 13, 2007, until August 20, 2007. You may disconnect your lines at this time, and have a wonderful day.