Consolidated Water Co Ltd (CWCO) 2008 Q4 法說會逐字稿

Hello. And welcome to the Consolidated Water Company year-end conference call. All participants are currently in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. I will give you instructions on how to ask your questions at that time.

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 Provision 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 or the jurisdictions in which it operates, the ability to successfully secure contracts 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 and 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.

(Operator Instructions). Please note that this conference is being recorded.

At this time, I would like to turn the conference call over to Mr. McTaggart. Mr. McTaggart, you may begin.

Thanks, Jamie. Good morning, ladies and gentlemen. Thank you for joining us this morning to discuss our fourth quarter and year-end results. I'm calling in from our corporate offices in Grand Cayman and David Sasnett, our Executive Vice President and Chief Financial Officer joins us from our Florida office.

2008 was certainly a challenging year for most investors, and CWCO's stock was not spared from the market carnage in the fourth quarter of '08 and early '09. However, we hope that investors recognize that Consolidated Water's financial position continues to be strong and stable, and that we expect much of our core business to be relatively unaffected by the financial downturn since we provide an essential commodity, drinking water. And approximately half of our revenues are generated by large take-or-pay water supply contracts with government-owned utilities.

With the healthy cash balance of $36 million at year-end and a load debt to equity ratio of approximately 0.2 to 1, the Company is well-positioned to ride out the remainder of this financial crisis and to take advantage of any new business opportunities that may arise. We certainly have the ability to take on additional debt if required to handle future projects. We do not expect to acquire any new equity capital to complete projects that are currently underway or presently contemplated.

During the fourth quarter, we believe that our business behaved as expected in response to external factors, such as energy and commodity cost increases, weather conditions and declining tourist numbers in some markets. For example, our retail water revenues declined in the fourth quarter compared to prior-year, primarily because of adverse weather conditions in October and November, lower tourist arrivals in November and December in Grand Cayman, and what appears to be efforts by our customers to conserve water, particularly at some of the hotel properties. This is not surprising, given the spike in water rates over the summer due to higher energy costs, pass-through charges. But these pass-through charges have come down significantly over the past several months, as oil prices have fallen and hopefully, this will allow customers to return to historical usage habits.

So far in 2009, retail sales by water volume have declined slightly year-over-year, but at a much smaller percentage than we saw in the fourth quarter of 2008. Fortunately, this decline has been offset by our annual inflation adjustment that was implemented in accordance with our Cayman franchise license on January 1st of this year. And anecdotally, rainfall in our service area in 2009 so far has been conspicuously lower than in the fourth quarter of last year when we had several months with rainfall well in excess of the 30-year average. And we would expect this dryer weather to enhance sales in the first quarter of 2009.

Our bulk water revenues increased over 2007 levels, primarily in response to sharp energy price increases during the year which increased the energy cost pass-through charges to our bulk customers. Base-rate revenues, however, were relatively unchanged due to the fixed sales volume nature of these contracts. We believe that in these difficult financial times, the fixed take or pay nature of these contracts provides significant benefit to the Company and the shareholders since we would not expect revenues from these contracts to be materially impacted by any underlining declines in water demand that our customers may experience.

At the end of the third quarter, we completed the replacement of feed water wells at our Windsor plant in the Bahamas. And in the fourth quarter, we benefited from improved energy efficiency at that plant. We have undertaken an improved maintenance program at the plant and have hired additional skilled staff which we hope will pay off by further reductions in operating costs and improved operating margins. Bulk water revenues in our Cayman operation improved during the quarter, primarily due to increased energy cost pass-through charges to the customer.

Our services segment revenues grew at a robust pace in the fourth quarter due to the number and relative size of new projects that were under construction. We continue to progress on the construction of the 2.4 million-gallon per day desalination plant for the water authority in Frank Sound, Grand Cayman, albeit with some time delay associated with the bad weather at the end of last year. And we expect this plant to be commissioned in early May. Frank Sound plant will be the largest desalination plant in Grand Cayman and is expected to provide water to residents on the eastern side of the island, including the Rum Point resort area.

Turning to Bermuda, Phase 1 of the Tynes Bay desalination plant was commissioned in December and has been operating satisfactorily. We're currently finishing up Phase II of the project and are awaiting a provision of additional electrical power capacity to the site from the local utility. Both of these projects continue to track on budget.

We also announced last year that the water authority in Grand Cayman had asked us to rehabilitate and modernize one of the oldest desalination plants in Grand Cayman in conjunction with a seven-year operating contract extension. We expect this work to commence during the second quarter of this year with completion slated for the fourth quarter. And now I'll turn the call over to David to talk in more detail about our financial performance.

Thanks, Rick. Our net income in 2008 was approximately $7.2 million or $0.50 per share. In 2007, we reported net income of $11.4 million or $0.79 per share. The difference in net income from 2007 to 2008 of $4.2 million is attributable to the reversal of results we recorded for our equity investment in OC-BVI. This reversal in and of itself amounted to more than $4.6 million.

For 2007, we reported profit sharing income and equity in the earnings of this affiliate of $2.3 million, but as we explained in our previous public filings and again in our recently filed 10-K, the ongoing dispute over OC-BVI's [Baugher's] Bay plant, the lack of payments by the BVI government for its plans of that plant and the uncertainty over the resolution of this matter has resulted in a change of revenue recognition by OC-BVI to the cash method for revenues generated by the Baugher's Bay plant.

When we implemented this policy back effective January 1st, 2008, OC-BVI had a substantial accounts receivable balance from the BVI government. As cash payments by the government came in during 2008, they were applied first to this receivable balance. There weren't enough cash payments during the year to cover the outstanding receivable balance that existed at the beginning of year so essentially OC-BVI had a year of very little to no revenues. This resulted in a loss of $5.2 million for them and our portion of that was $2.3 million.

If you take away the OC-BVI situation, the other areas of our business performed fairly consistently from 2007 to 2008. Overall, we were able to increase our operating income essentially by reducing G&A salaries. Our reduction in G&A salaries reflects our initiative back in 2008 to restructure some of our executive management compensation. As a result, we paid lower bonuses to our Chairman and our CEO this year.

If you look at each of our segments, all of our operating segments increased their contribution to our income from operations in 2008 as compared to 2007. Specifically, retail had an increase in revenues, primarily due to energy pass-through charges as total volumes of water sold by the retail development by the retail division declined by 4% for the year. Our bulk segment increased its revenues primarily because we're now billing all of water that we produce out of our Blue Hills plant in the Bahamas. And as Rick talked about, our Frank Sound contracts -- the year contracts progressed during the year and consequently, our services revenues increased.

From a liquidities perspective, in 2008 we generated significant cash from our operations. We repaid more debt. We maintained our core dividends while we strengthened our balance sheet. We continue to hold substantial receivables from the government of the Bahamas. We believe these receivables were current in 2009.

Our working capital exceeded $44 million at the end of 2008. We believe our credit standing and available liquidity provide us with the capability of aggressive -- aggressively pursuing new projects at a time when perhaps some of our competitors may not be able to do so. We think we're where we need to be going into 2009. And with that, I'd like to turn things back over to Rick.

Thanks, David. David discussed the issues associated with the BVI affiliate. I'd just like to add that on a positive note that by year-end, our affiliate had signed a binding term sheet with the government of the BVI to supply water from the previously idle Bar Bay plant in eastern Tortola. This is in our view, a strong indication of the government's willingness to re-establish a sound commercial relationship with our affiliate. The affiliate started supplying water to the government from that plant in late December and is currently constructing some additional works in accordance with the binding term sheet.

I'd like to talk a bit more about projects -- potential projects. Negotiations with the government of the Turks & Caicos Islands for a retail water franchise. And the Turks & Caicos group have not progressed as of our last conference call because of structural changes in the TCI government resulting from a wide-ranging corruption investigation that was initiated by the UK government late last year. The result of which has been the suspension of parts of the Island's constitution, and the dissolution of cabinet and parliament.

And although this sounds pretty serious, we believe that it is a positive for us, ultimately. The UK government through the Governor, is now under direct control of the Islands. This is expected to continue until 2011 when new general elections are scheduled to be held. We've written to the Governor regarding our negotiations for the retail franchise and hope that we'll be able to meet with the new government soon to move things along. We don't have any reason to believe that the privatization initiative that was started by the previous government will not move forward, particularly since the Island of Grand Turk is presently suffering from a severe water crisis and is in need of significant water infrastructure replacement due to damage from hurricane Ike.

We recently -- on other project, we recently bid jointly with the Trinidadian engineering firm for a ten-point -- sorry, 10 million imperial gallon per day seawater desalination plant in Trinidad at a government-owned petroleum refinery. We are currently awaiting the results of this bidding. We understand that there were four other companies that bid for the project and we hope that our proposal is competitive enough to win the job.

In general, we are hopeful that some of these longer lead projects such as Turks & Caicos will come together in 2009. But we continue to be very busy through the second quarter completing two new desalination plants in Grand Cayman that I discussed earlier, as well as starting the rehabilitation and upgrade of the third plant for the water authority. We continue to evaluate potential new projects in South America and our outlook for continued growth in seawater desalination in these areas is still positive, albeit at a slower rate in 2009. Now I'd like to open the call up for questions.

(Operator Instructions). Our first question comes from Ryan Connors from Boenning & Scattergood. Please go ahead with your question.

Good morning, Rick and David.

Hey, Ryan.

I had a question for you on the services segment. Obviously that's been a real strong piece of the business the last couple of quarters. I'm just trying to get a feel for how that -- the revenue and profit contribution from that segment evolves over the course of 2009, If you could just give us an update on the outlook there and in particular, the timing of when some of these current projects roll off and what the -- your current assumptions are for replacing or should I say sustaining -- what run rate that segment will run at ultimately later on this year. Any color you could give around that would be helpful.

Do you want to handle that, Rick? Or do you want me to?

You can handle the first part and then I can take the end where we talk about future outlook.

On both of those -- both of our contracts, the Bermuda contract and the Frank Sound contract that are generating revenues for us right now, and the percentage of completion method will be finished probably before the end of the second quarter 2009. You'll see a significant decline in construction revenues. We have an ongoing contract for the management of the operations at OC-BVI. Those revenues will continue to be reported by the services segment. But without replacement projects, you'll see a significant decline in services revenue next year.

Okay.

I'll just add that the [Red Gate] rehabilitation will start up in the second quarter. That's a much smaller project than Bermuda and Frank Sound combined so you will see some revenues coming through from that. But at this point that's the project that we have on schedule for the rest of the year. If things pan out in Trinidad, then that could potential change the whole picture as that's a very large project. We are hopeful that we would be competitive and get that.

Okay. Great. That's very helpful. My second question was more a big-picture question. The Cayman Islands have been in the news quite a bit lately around this issue of the US and the UK, and some of the other major governments trying to go after favorable tax localities, like the Grand Caymans in terms of trying to go after people who have assets domiciled there and corporations that are registered there, that sort of thing.

My understanding is that is a very important part of not only the Cayman economy, but the Caribbean economy in general, that is the two pillars of tourism and financial services. I wonder if you could -- its a developing story, but I would like to get your views on whether that is a real risk that that could eat into that side of the economy. And if so, what the impact would be on the ability of some of these -- in theory, a desalination plant is something that has a greater chance of going forward in a successful, growing economy. Any thoughts you have there would be appreciated.

Ryan, it's really difficult to say how this is going to play out. If you look back at 2000, some governments in Europe tried to do the same thing essentially, the financial action task force and blacklisting a lot of these low-tax jurisdictions. You are correct, the Cayman Islands, British Virgin Islands, Bahamas, they are all -- they fall within that category of low-tax jurisdictions. Ultimately, everyone came through it. There was a lot of new regulation here.

I think the US and these European countries are trying to find people that are evading taxes, so maybe there will be some enhanced information exchange coming out of it. It's really difficult to say. But certainly if there was a concerted effort to shut down any low-tax jurisdictions, that could affect the economies. People are still going to need water. We think that this it is not going to severely impact our business as severely as it would, say, a legal firm or accounting firm or somebody that was down here. We'll just have to see how it plays out.

Sure. That's helpful. Thanks for your time.

Yes.

Our next question comes from Michael Gaugler from Brean Murray, Carret.

Good morning, everyone.

Hey, Mike.

Rick, I want to talk a little bit about where we are in the Baugher's Bay situation. Maybe you could give us a little color as to how far along the court system is with this. And what I'm looking for is something along the lines of all the paperwork's been submitted or the case has been argued to its fullest extent, something along these lines. Are we just waiting for the court to rule or is there more testimony or paperwork to come in the future?

Mike, the trial hasn't even started yet. If you recall, there was a question that we had asked the courts to rule on, regarding whether it should go to the court -- the dispute should go to the court or go to arbitration. In January, the court said that they wanted it to go to the courts. At this point, the matter is on the court schedule, I suppose. There hasn't been a trial date set and they haven't started arguments yet. We've just filed -- the claims have been file the and the defenses have been filed.

I'm not sure what the backlog is in this particular jurisdiction, but I'm guessing that this doesn't get resolved until at the earliest midsummer?

It is difficult to put a timeline on it. I know that the courts have been inclined to treat it with priority because it is something of national importance, the reliability of the water supply in Tortola. I would think that that would continue and hopefully we get an early trial date. That's what we're going to be pushing for and we'll see how it works out.

Our next question comes from C.J. [Purtill] from Janney Montgomery Scott.

Great. Hello, David. Hello, Rick.

Good morning.

First question on the BVI situation which you just addressed, it's disappointing that the issue is going to essentially force you to continue to book these indefinite losses until we have a resolution. Assuming that we don't have a real reliable timeline to go off of, would you assume that if there were to be a favorable decision, that OC-BVI would go back to the accrual basis of accounting and start to book some of the positive earnings from the affiliate immediately upon that judgment? Or -- the question is does a positive judgment satisfy the revenue recognition requirements under SAB 104?

It would defend on if they appealed that judgment.

Okay.

We're looking for return it normalcy when it comes to payments. The big issue is not only have they reduced the amount of their payments, the BVI government, but they've also spread them out to the point of where there's really no consistency or relationship to the contract. If there were a settlement by the court without an appeal and the BVI government began complying with the terms of the settlement or with the new contract, then yes, I think that OC-BVI could demonstrate that it meets all the criteria, recognized revenue under an accrued basis once the cash starts coming in, but -- depending on the terms of the court decision and the BVI's government's reaction to it.

Okay, okay. That's helpful. And then just really quickly on Bar Bay. I believe you've been operating that plant for almost a quarter now?

No, just a -- well, since the beginning of year.

Okay.

Yes.

Since the beginning of the year -- my question is has the government been paying that bill?

They've been billed for the water and we -- there's always delays in payment there. We don't have any reason to believe that they won't pay it. The first bill went for -- at the end of January, early February.

Our next question comes from George Whiteside from SWS Financial Services.

Good morning. I wonder if you could give us a little more detail on your recovery of increases in energy costs. Are your contracts set up in such a way as to fully recover any increases in energy costs?

Mr. Whiteside, I'll just say that --

Call me George.

Contracts guarantee the energy efficiency of the plant. On that energy usage, we fully recover any increase in energy costs. As a rule, we do recover the full increase in energy costs. We have reported in the past that we had one plant that was operating at less than optimal efficiency in the Bahamas and we were not recovering the full costs, but that's documented in our filings. But generally as a rule, we do recover the full increase in energy costs.

Conversely I presume that with the reduction in energy prices currently, that that would then be a pass-through to your customers?

That's correct. That would reduce the charges that we bill them.

Rick, I'd like to add that when you are looking at our energy pass-through costs, a good way to think of it is to look at the efficiency of the plants themselves as. As Rick said earlier, we are required to deliver a certain level of efficiency to our customers. If our plants operate at higher -- better than the minimum efficiency, then we have a slight benefit and we can actually keep a small portion of those energy costs. If our plants operate at less than the minimum efficiencies set forth in the contracts, then we don't recover anything and the energy pass-through works against us. If we're working right at efficiency, then it is a non-issue, we don't either benefit or get punished by the energy pass-through.

Thank you very much. Now I gather that the Bahamas situation involved the Windsor plant. You commented that apparently you've improved the efficiency and perhaps brought it up closer to the benchmark energy costs that you've guaranteed.

That's correct.

Our next question comes from Robert Smith from the Center for Performance Investment.

Good morning.

Good morning, Robert.

Could you give me some feel for the long-term planning function within the Company? What -- are you on a three-year or five-year plan. Where do you see yourself taking the Company over that period of time? And also, I have a second question, what might be the optimal debt/equity split in the Company?

Just on first question, we do have a strategic plan for the Company. We don't limit it on a year-to-year basis. We've disclosed in our filings that we believe that there's still a lot of opportunities in the Caribbean within our existing markets and within other islands that we don't currently operate in to grow our business. The need for desalinated water is growing every year as water resources become stressed on these islands and polluted. We think there's a great business opportunity for us in our current market area.

And having said that, we also look from time to time at expanding our market into other areas where desalination is economically feasible. I think one of the questions earlier was how tourism impacts the economies here. The Caribbean market can support the cost of desalinated water because of the type of economies that operate here. We would look for similar jurisdictions, maybe in South America, maybe in the Pacific that could -- that we could make money through the sale of desalinated water.

Has that search been narrowed sufficiently to bring something like that closer?

We're always looking at new projects. We'll let everybody know if something materializes that is outside of our current market area. We have talked in the past about looking at opportunities in Peru and other areas of Central America, Mexico and possibly the Pacific Islands. But we don't have anything that we would -- that's close enough to announce yet.

Our next question comes again from Ryan Connors from Boenning & Scattergood. Please go ahead with your question.

Hi, guys. Just wanted to jump in with one more issue here. I wanted to get your thoughts on a couple of contracts that are up for renewal. I know you probably can't tell us too much on these, given that there are negotiations and so forth. The first is the Cayman 2010 renegotiation, it seems that the timing could have been better given where the economy is, et cetera that most -- I'm sure the government is not in the the mood to go out and pay a whole lot more for anything right now. And your thoughts heading into that and what's your strategy is and what the issues you think will be? Secondarily, my understanding is that the exclusive [Dwier] license is up for renewal also in the relatively near future so if you could just give us your thoughts heading into that and whether that's something that will just be automatically renewed or whether you're contemplating your options. And if so, what those might be.

Ryan, on the Cayman franchise, we're early in discussions with the regulatory authority regarding that renewal. At this point, in our mind, we'd like to get the same deal that we have now, but it's very early to say how that's going to turn out. We're going through a lot of the mechanical issues, technical issues at this point and we haven't gotten into the meat of the discussions yet which would be the rates.

Regarding the Dwier franchise or the Dwier distributorship, over the years that's I think become less of an important factor to our business. There's other technologies that are available now that have been developed that perhaps would be more well-suited to our needs. We don't see that as any negative if we lose that distributorship or cancel it.

Okay. Thanks again.

Yes.

Our next question comes from Robert Smith from Center for Performance Investment.

I was just coming back into the second question about the leverage of the capital structure.

I'll take that, Rick.

Yes.

Clearly our debt to equity ratio is very low at the moment and ideally, it should be higher than that. Rather than give you a exact target, I will say that what happens with our company is that we prefer to -- for any construction project, we prefer to enter into long-term, 10, 11-year fixed rate debt. Typically we're required to make some kind of equity contribution towards the project. What we like to do ideally is fund that project with anywhere from 15% to 20% equity and then leverage the rest of it. You would expect to see our debt to equity ratio continue to increase as we win projects because given the cost of capital to us right now, we think it is better given our credit standing to fund projects through debt. That's what you will see going forward with the Company.

We haven't set an ideal debt to equity ratio. I don't think that that really exists. Things change, but you would expect to see a lot more leverage on our balance sheet as we gain new projects.

Have you guys ever thought about diversifying the business into another area -- a different area? I was just thinking about something like wind power? There's a lot of wind on the islands so to speak.

There's a -- we have looked at that from time to time. Energy is a huge component of our costs and anything we can do to lower the cost of our energy is certainly something that we would want to evaluate. There are complimentary services, such as wastewater treatment that we can do as well. Rick, do you have any thoughts on this?

I would just say that from the standpoint of utilizing other technologies to enhance or [poor business] which is producing desalinated water, I could see us doing that, and as David said, diversifying into water reuse which is a related membrane technology. From the standpoint of doing something completely different, I think our success has been the result of our expertise in seawater desalination and operating these RO plants very cost effectively. We would really have to be convinced that we could, say, get into the energy business or something and make money. We want to focus on what we do best.

Okay. But you're not -- you wouldn't dismiss them?

No, I won't dismiss anything if we can make money for the shareholders.

At this point in time, I'm showing no further questions. I would like to turn the conference call back over to management for any closing remarks.

Thanks, Jamie. I'd just like to thank everybody for joining us this morning. I look forward to speaking with you all in May. Thank you very much.

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