Consolidated Water Co Ltd (CWCO) 2009 Q3 法說會逐字稿

Welcome to the Consolidated Water Company third quarter 2009 conference call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. A conference specialist will give instructions on how to ask your questions at that time.

This conference call may include statements that may constitute forward-looking statements, usually containing words "believes, estimates, projects, intends, expects" or other 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 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 this event is being recorded. I would like now to turn the conference over to Rick McTaggart, please go ahead.

Thank you, Lenia. Good morning, ladies and gentlemen. And thank you for taking time from your busy schedules to join David and me on this call. I'd like to provide you with a general overview of the quarter, and then David will provide additional financial detail.

Determination of the legal dispute between our BVI affiliate and BVI government has had the most significant impact on our net earnings this quarter. An impairment charge on the books of our affiliate, plus an impairment charge on the Company's books, both of which arose from recent rulings by the Eastern Caribbean Supreme Court, caused us to record a loss of $1.6 million for the quarter for investment in the BVI affiliate. It is important to note this is a noncash loss, and therefore, has not adversely impacted the Company's cash position or ability to fund new projects.

Just to recap what we've explained in our 10- Q, the Eastern Caribbean Supreme Court issued judgments on September 17th and on October 28th in relation to firstly the BVI government's claim of ownership and possession of the Baughers Bay plant in Tortola. And secondly, in relation to our affiliate's claim for payment of overdue invoices for the production and delivery of desalinated water to the BVI government, which had been accruing since January 2007 when the BVI government unilaterally began paying the affiliate at a significantly reduced rate for water.

With respect to the ownership claim, the judge ruled that the plant belongs to the BVI government, and dismissed our affiliate's counterclaim for payment for the cost of increasing the production capacity of the plant beyond original contract levels. This gave rise to a $2.1 million asset impairment loss on the books of the affiliate recorded to reduce the remaining value of the Baughers Bay plant on its books.

With respect to the overdue invoices, the judge ruled that our affiliate was entitled to full payment of the invoices up to December 20th, 2007, and ruled that all water delivered after that date to present should be paid for at a rate of $13.91 per thousand imperial gallons. This amounts to a total recovery to the affiliate of $10.1 million as of September 30th, 2009, plus any late interest that the judge may determine later this month is also payable. However, since the affiliate continues to recognize revenues on a cash basis, they will not book any other judgment until it has been paid by the BVI government.

We view these judgments as favorable. The adverse impact to our earnings this past quarter is almost totally related to the timing of the judgment, and receipt of the court-ordered payments to the affiliate. We expect that the $10.1 million payment ordered by the government, or ordered by the court, will eventually be received and recognized as revenue at the affiliate level which will favorably impact the equity and earnings line in our statement.

Although the BVI government has appealed the court decision with regard to the amount of the payment, the appeal does not act to stay the court's judgment, and we believe the $10.1 million will ultimately be paid.

I would like to note that this litigation has not deterred the parties from continuing discussions on a new operating agreement for the Baughers Bay plant, and we believe the recent court rulings and the poor operating condition of the plant will provide some additional motivation for all parties to reach some sort of agreement as to the future of the plant.

I'll turn to retail, our retail business. Retail sales were flat this past quarter, continuing a broad trend which started last year. Lower tourist numbers and slowed development growth have no doubt had a cooling effect on water demand growth in our Cayman market. We don't see this changing significantly in the near term.

We've experienced relatively wet weather so far in the fourth quarter, most recently this weekend with the passing of tropical storm Ida, and I would expect the weather to be a factor in our fourth quarter retail sales. However, December is almost here, and we look forward to dryer winter months and a relatively higher number of tourists that visit the island during the winter season.

Retail operating margins on the other hand continued to improve last quarter. Firstly as a result of our annual inflation adjustment, which increased our base rates in January of this year, and secondly due to lower operating and maintenance costs in our retail segment.

Bulk water sales in dollars decreased by about 16% this past quarter when compared to the third quarter last year. Primarily, because of lower energy costs pass through charges to our customers. However, the actual sales volumes increased by 7% which was not enough to offset the effective lower energy prices.

Bulk gross profit was maintained in the low 20s this past quarter and has benefited over the past year from lower operating costs resulting from, excuse me, resulting from efficiency improvements which we achieved in our Nassau desalination plants in late 2008 and earlier this year. As reported last quarter, we continue to focus on improving the mechanical reliability of our Nassau plants and believe there's room for some additional margin improvement through aggressive maintenance expense optimization.

It's important to note that bulk gross profit margin also benefited from the elimination of amortization costs associated with the Red Gate water sale contract in Grand Cayman which expired late last year and was subsequently renewed for an additional seven years.

Over the past six years, the Company has successfully negotiated extensions to all three of its bulk water contracts with the Cayman government, and was awarded through competitive tender a fourth bulk water contract for the Frank Sound desalination plant, which was commissioned in June this year. We, of course, are grateful for the level of confidence the Cayman government places on the Company.

The Red Gate plant rehabilitation project commenced during the third quarter and is now expected to be completed in the first quarter of next year, and this is a Cayman project. During the quarter, we negotiated some additional design improvements and equipment replacements with the government which will enhance the longevity and reliability of the rehabilitated plant.

During last quarter's call, I reported that the Belize government had advised the Company that it intended to regulate our Belize subsidiary under the Belize public utilities commission. But to date, we've not had any further communications with government. And the Belize operation continue to perform satisfactorily and government is keeping current with its bills.

Service segment revenues declined from $3.4 million in the third quarter last year to $1.2 million this past quarter, reflecting lower project construction activity. A decline in project related revenue is partially offset by fees earned from the services contract for the times day plant in Bermuda, which commenced operation earlier this year. Service segment gross profit also declined compared to last year, primarily due to the decline in overall revenues.

As mentioned earlier, the Red Gate project is underway and we'll see plant construction income and earnings from this project impacting our service segment financial performance through the first quarter of 2010.

Now I'd like to turn the call over to David, who will discuss our financial performance in a bit more detail.

Thanks, Rick. Good morning, everyone. I'll try to keep my comments rather brief today. First of all, I'd like to add a little clarification regarding the loss from OC-BVI that was recorded this quarter of approximately $1.6 million. This loss has three components, the first of which is a $160,000 impairment charge that our Company recorded, our Company being Consolidated Water, based upon our analysis of future cash flows we could expect from this investment.

In addition to this $160,000 loss, OC-BVI recorded on their books an impairment loss of approximately $2.1 million. And that relates to specific fixed assets for the Bar Bay plant as a result of the court ruling to be given to the BVI government. A 43.5% interest in this $2.1 million impairment loss leads to $914,000 increase in our loss from OC-BVI this quarter.

And then lastly, because of the lack of cash receipts from the Bar Bay plant invoices, OC-BVI recorded an operating loss for this quarter and our portion was approximately $510,000. When you add those three components together, you come to the approximate loss of $1.6 million we recorded for the quarter.

Looking at our financial position, we think we have continued to improve the quality of our balance sheet. Our working capital is very high, we have $42 million in cash. You'll note our accounts receivable is down from the end of the year.

We have disclosed in prior filings the issues we've a had regarding collection of receivables from the water and sewage corporation of the Bahamas, and as we've discussed in our filings, this is not an issue that relates to us but rather internal issues have arisen at the WSC that's led to a delay in paying some our invoices.

WSC is committed to paying approximately $1.2 million each month, which is about the amount of our billings to them in an effort to keep the receivable balance from increasing, and they have managed to keep up this commitment. We would hope that in 2010, after they finalize the budget for the government, they will be able to pay us some additional monies and bring their accounts receivable balance current. But it looks like for the remainder of 2009, they will continue to be in arrears.

I would like to point out we generated more than $10 million in cash from our operations for the first nine months of this year. We consider that be very significant. We have ample liquidity on the balance sheet; $42 million in cash. And we believe we have a strong credit standing with potential lenders.

In discussing the need for debt for these new projects that we are bidding, we found that we have ample sources that we think are debt financing to fund any future projects. So we're well positioned as we move forward to take advantage of any opportunities that may come our way. With that, I'll turn the call back over to Rick.

Thanks, David. Just going to talk briefly about some project opportunities. We reported last quarter that we were pursuing a couple of new project opportunities; one in the US Virgin Islands, and a second in Aruba. And we're excited about these projects and continue to work our way through the bid processes, which had been very comprehensive and professional.

Our sales and engineering teams generally have been kept busy evaluating opportunities and preparing proposals, even through these difficult economic times. And we're generally optimistic that we'll be successful in obtaining some of this new business.

We believe that the bad economy has not diminished the need for desalinated water in our market, and that real opportunities exist for industry consolidation both in the private and governmental sectors.

With that, I'd like to open up the call for questions.

(Operator Instructions). Our first question is from Ryan Connors of Boenning and Scattergood, please go ahead.

Good morning, Rick, David.

Hey, Ryan.

Doing well. Thanks. I don't want to belabor the details on the BVI thing, I know you've been through that ad nauseum. But just kind of a big picture perspective, I wanted to get your thoughts on how this situation impacts your view.

I mean, obviously Biwater has been surprisingly candid about the fact they were sort of tipped off to this whole situation by an investment fund and so forth. And for me, it raises the issue of whether or not it's a strategic liability to be a publicly traded entity in your business with all the visibility that gives people into your financials and so forth; having to do this kind of call, et cetera. So just be interested to get your thoughts on that, whether that's a handicap. And if so, what, just your general thoughts?

Well, I certainly would agree that being a public company requires us to provide more information to investors and to the public in general than, for example, Biwater would have to do as a private company. I think we managed that well. There's certainly many other advantages to being a public company and all in all, I think it enhances our business.

Okay. So I guess one of the advantages to being a public, Rick, is the access to capital. So I guess you do believe then there are enough opportunities enough (inaudible) out there that's going to continue to be something you'll need to have in the future -- is access to capital to deliver on those opportunities then.

Absolutely, Ryan. That would sent be one of the big advantages. And you know, I'm certain that in the future, we'll be accessing the capital markets again. We have some project opportunities that are immediate. And as I mentioned, I think that there's -- the poor economic climate in some of these Caribbean countries has given rise to some other opportunities that we would need to fund. And we hope those develop in the near future.

Ryan, I'd like to add something to what Rick said. We're not the only company that is public in this industry. But unfortunately, we seem to be smaller than some of our competitors, so some of our information is right out there in the open. Where the water business say for GE or [Veoli] is perhaps in the Caribbean is masked by the fact that they are part of much larger numbers. But really when you look at the situation here, we don't feel like being a public company is necessarily working against us.

When you look at the information in our 10-Ks, and 10-Qs, that has limited relevance to the numbers we prepared when doing a bid. We assess the situation in every marketplace and look at the cost structure we'll bring to a project. I think even though we're public and we have to disclose certain things. And with the BVS situation, we've had to be open and tell people things that perhaps, we wouldn't want to have to discuss the fact that we are having these litigation problems.

Nevertheless, the numbers we -- publicly doesn't impact us from a competitor perspective. And I think being a public company with some of our customers adds a level of credibility to our Company because we are open and people really know everything they need to know about our company from our public filings. I think it's positive and negative to be public.

Okay. If I could, just as a final kind of follow up in the same vein. Obviously, you don't want to have to write off OC-BVI, your investment there altogether. But if I could play devil's advocate for a second, why not pull up anchor altogether and just cut your losses and get out? I know you don't want to say so while negotiations are going on, but it does not seem like these guys have exactly acted in the best of faith. Why not just good riddance and say look, there's enough opportunities else where, we're going to go where people think -- where we're appreciated.

Yes, I mean, I can't lie to you. It has crossed my mind. But we do have partners there and I think investors that have been following the situation closely can see that there are differences of opinion, even within the government as to how the situation should be resolved. And we continue to believe that there is support for us getting future contracts there at least within some parts of the government, and that's why we continue to participate in the market.

I think that if we were -- if it was as bad as perhaps some people think, we wouldn't be there. But I think that there are still some opportunities for us to salvage this and to make money there in the future.

Ryan, we have been, at least OC-BVI has been a very reliable supplier of water on Tortola for a number of years, and the company did go back to the government on occasions in the past and seek to negotiate a new contract. And these facts are not lost on certain members of the BVI government. If they bring in someone different, if they do go forward with Biwater. I mean, there's no guarantee the level of service they will have about comparable to what OC-BVI has provided in the past.

We have some support within the government. And I think going forward, this market, you know, if we can somehow reach an agreement with Bar Bay. We still have the Bar Bay plant, and there's a chance to do additional business.

I echo Rick's comments, we certainly have thought about pulling out of the situation. But really from a business standpoint, we need to see this thing through because there could still be a very valuable asset investment for us.

I think it's important just to add that the courts have sided with us on virtually all of our arguments over this dispute. As we indicated, we are appealing our counterclaim for compensation for the transfer of ownership of the plant to the government, but if you look at the bigger picture, we have been doing the right things there. I think some people in government recognize that. We'll just proceed down this road until it ends, I think.

That's very helpful perspective. Thanks for your time.

Yes.

Next question is from Michael Gaugler of Brean Murray, Carret & Co. Go ahead

I wanted to follow up a little bit. The appeal that you filed on 10-28 for the $4.7 million, I was wondering is there a court date set yet to hear that?

No, there's not. I don't think the appeals court is meeting until early next year.

Next up, Rick, I was wondering if you could provide a little color on a couple of the new opportunities for you. US Virgin Islands, Aruba, maybe what kind of size --

These are all public tenders. The US Virgin Islands Water and Power Authority has tendered for two plants; one on St. Croix, one in Saint Thomas between two and four million gallons per day each. And the Aruba, I guess, water and power company has tendered for a 6 million gallon per day plant. So we're in the process of working our way through those processes.

And finally, is there any update on the Turks and Caicos?

Unfortunately, we don't have anything to update you on -- the government there continues to recover from, I guess, the takeover from the UK. And we haven't had any recent discussions with them since the last time we reported.

All right. That's all I had, guys. Thank you.

Okay, Mike.

The next question is from Peter Park with Park West Asset Management. Please go ahead.

Hi, a couple of questions. What is the $11 million loan receivable that showed up on the June 30 balance sheet?

That loan receivable arises from the sale -- the construction and sale of the Frank Sound plant to the Water Authority of Cayman.

When do we think we'll get that?

Amortized, I think the term of the loan is ten years.

I see. What's the interest rate on that?

It's around, I believe, 7%? Somewhere in there, 7% - 8%?

And does it presumably amortize like 10% every year?

Yes, it's on a normal amortization schedule, yes.

Got it. And second topic is again on the topic of backlog and the construction projects that you're bidding. How much money are we talking about? And I'm trying to get a sense of what kind of service business revenue and margin we might think about over the next couple of years.

Rick, I don't know if we've disclosed the amount of the Red Gate expansion, I can't remember.

No, we haven't. Again, these are things that we try not to talk about directly because of competitive issues, but we haven't disclosed the actual costs of these projects. And certainly on the new projects, we are in the process of bidding, so we're not in a position to do that.

Are there any public estimates or other people's bids that have been made public?

Peter, what we talk about in general is -- and we've talked about this practically every time we make an investor presentation. The benchmark is for each billion gallons of capacity, depending on the requirements of the customer, it costs about anywhere from $4 to $6 to build out that capacity. So a 2 million gallon per day plant, you're talking about $8 million to $12 million in capital expenditures for that plant.

That's helpful. Thanks. I'll get back in the queue.

Next question is Christopher [Partel] with Janney Montgomery Scott. Please go ahead.

Good morning, Rick, good morning, David. Quick question going back to BVI. Baughers Bay now under government ownership, you are still running the plant there. Trying to get an idea of what is still kind of conclude in the OC-BVI revenue. And I know we have Bar Bay, but I'm trying to think what else is there and what kind of revenue you envision if you're successful in procuring a new operating contract at the plant.

Again, we're in the process of negotiating, we continue to negotiate with the BVI government on that issue. So all I can tell you is that the court has ordered a rate of $13.91 per thousand gallons. And that's about the best that I could do right now on helping to model revenues from that plant.

Chris, it's important to note if you read the 10-Q this quarter, we are recognizing revenues from the Bar Bay plant on a cash basis until we get a definitive contract there. So the recognition for, for OC-BVI is very small right now.

You could factor in, if you're modeling the Company, you can take a number of scenarios in there. I don't think we'll be earning the same level of revenues obviously that we earned at OC-BVI under the previous Bar Bay contract. I think the government is certainly looking for a reduction from that level.

Right.

But everything else is pretty much open for discussion.

Okay. So then if we look at Bar Bay, they're now on a take or pay, it sounds like now that you've completed the first round of the expansion. But there's really no definitive contract signed there.

So just kind of wondering if the contract would be at risk considering, Biwater trying to get on to the island. And if your thoughts on how that translates into future impairments that OC-BVI would have to take and then you would likely have to take on your investment in OC-VBI.

I'll point out one fact relative to the Biwater situation. Regardless of whether or not the Buy Water is brought in to build a new plant, it will take them a period of time to build that plant, Chris.

Right.

So there's a time factor involved here. Rick, you want to address the rest of this question?

Well, let me just say the public discussion has been, and certainly the Premier of the BVI has said, that publicly he doesn't want to put ocean conversion out of business by giving Biwater the whole water supply on the island. I mean he's indicated that the competition is good and presumably that means that the government will honor its commitments under the Bar Bay heads of terms as they've been doing so far.

Okay. So you think that Biwater and Baughers Bay and Bar Bay can all peacefully co exist on the island?

I think that's what the public talk is. We'll just have to see how it works out.

Okay. Great. Thanks, guys.

Yes.

The next question is a follow up from Peter Park with Park West Asset Management. Please go ahead.

Thanks, can you describe what the bid process looks like and what I mean is how many folks show up on bidder contracts like the two to four million gallon or six million gallon? Is it that you have more competitors show up to something like that as opposed to the smaller plants? Thanks.

Yes, of course. I mean, things are a bit slower in the economy so these have been attracting a number of bidders and even new players into the market.

Is it already known who else is bidding? I haven't looked at those contracts or those bid processes. Who else is already known to be bidding?

I think they are still in the process of certainly on one of the projects of short listing people that express interest in it. So, that sort of information isn't out there yet.

What is your success rate look like when you bid on projects?

Well, we've been very successful, certainly over the last five to six years when you look in total. As I mentioned earlier, we've renegotiated contracts at least three contracts here in Grand Cayman, which were set to expire. We expanded the plants. We obtained a fourth contract here and that plant was completed in June. That was a competitive tender. We've grown our business into Bermuda over the last three to four years. That was again through competitive tender. The Bahamas projects have been competitive tender.

Of the last, I suppose, three projects that were bid in the Bahamas, we were the low bidder on all of them. One of them ended up being built. The other two projects were canceled. Competitive generally in the market -- I think we win more than we lose to be honest.

The only significant loss we've had recently is in Trinidad and Tobago with the [Petritrend] bid. And from what I understand, that project is not moving forward at the moment. There were some issues, I'm not sure exactly what they were with the winning bid. Other than that particular bid, I'm not aware of any of significance that we've lost.

Fantastic. Thanks very much.

Our next question is from Ryan Connors of Boenning & Scattergood, Inc.

Just a couple of quick follow up. David, the SG&A costs did kind of jump and you laid that out a little bit in the Q. And I guess professional fees was one thing that was a factor there. Can you just talk a little more detail about what exactly was going on there? Was that to do with prep work and for the re-upping of the core of Grand Cayman franchise? Or what exactly was going on there?

That was some work commissioned by our Board. I won't go into it in further detail, but it's definitely discretionary costs that's non- recurring, Ryan. And then we transferred a lot of money out of the Bahamas. We're generating cash there.

Unfortunately, when you have money in the Bahamas and you want to convert Bahamian dollars to US dollars, they are going to charge you a conversion fee and then they are going to charge you a wire transfer fee to get the money out of the country.

So we sent several million dollars to Cayman, but as a result, we have some very significant bank charges this nine month period. So that's why I think it came up, but the professional fees were discretionary in nature, something the Board decided to spend money on. But it's not something that's recurring, so you shouldn't factor that in.

And then, Rick, I wanted to get your take on something, an issue we've kind of been following, but I guess you can follow better being right on the island there. And that has to do with, I guess there's talk that given the UK had to float a loan to the Grand Cayman government. And some people are making some noise over at the UK that the Cayman government should start to institute some kind of an income tax, either on corporations and/or individuals.

Obviously to the extent that ever were to happen, that would be a negative to the bottom line for the Company. What are you hearing and what's your perspective on that? Is that something that could actually -- that will ever happen?

Yes, I mean I was actually at a function on Friday night where the Premier spoke, and he reaffirmed that the government doesn't support any sort of income tax or property taxes here. And they have formed a committee which was part of the requirement, one of the requirements of the UK in order to allow them to raise their debt. And this committee is looking at various ways of improving government revenues. Certainly, they are going to look at taxation as an option, but I don't think there's any real support for that in government right now. I mean, who knows, but I don't really see it happening any time soon, Ryan.

Okay. Thanks again for your time, guys.

Yes.

Next question is from Corey Johnson of Ekspres, please go ahead.

Hi, guys, I'm wondering if you can you talk me through a little bit about the write off from OC-BVI. If you own 50% of the stock, and they are taking a $2.1 million writeoff, you're taking less than half of that. I'm trying to understand what that relates to in terms of your thoughts about future earnings from that plant, if you able to work things out and how you are understanding that impairment.

We own 43.5% of the equity interest. We have 50% of the voting rights, but the way the deal is structure was we just have an interest in 43.5% of the profits and losses. And that's why you have 43.5%.

Going forward, if the company become profitable, we'll make 43.5% of their profits. And we have a profits sharing agreement at OC-BVI for which we recognized no profits because they haven't been profitable obviously. But if company turns around and starts generating net income, then we get approximately an additional 1.5% of their profits. Between the profit sharing arrangement and equity interest in the profits, it equates to about 45% equity pickup.

Your impairment costs then assumes you're going to be able to keep making money there or start making money there and that will go on for some time?

That's correct.

Is there a point at which -- I know an earlier caller said isn't it at some point worth kicking it to the curb. That would certainly change the impairment at that point, yes?

That's correct.

Let me also ask you about the departure of your chairman. Is part of that increase SG&A cost spending money to find a new chairman and in search of that nature and we expect those costs to go away? Could you talk a little bit about that?

The cost incurred were not for a search for a new chairman. So I don't want to get into specifically a discussion of what we spent money on. I don't think it's relevant to our overall business. But I don't think those types of SG&A costs will increase. But no, we didn't spend money on a search for a new chairman.

Are those legal costs then as it relates to OC-BVI?

They are actually consulting costs.

Okay. Thanks, guys.

(Operator Instructions) Gentlemen, we show no further questions at this time. I would like to turn the conference back to Rick McTaggart for any closing remarks.

Thanks, I would like to say thank you again for joining us today, and we look forward to speaking with you early next year. Take care, bye.

To access the video replay, you may dial 1-877-344-7529 or 1-412-317-0088 beginning at 1:00 PM eastern today. You will be prompted to enter a conference number, which will be 435557. You'll be asked to record your name and company when joining. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.