Consolidated Water Co Ltd (CWCO) 2010 Q2 法說會逐字稿

Hello and welcome to the Consolidated Water Company second quarter and first half 2010 conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. Instructions on how to ask your questions will be provided at that time.

This conference call may include statements that may include statements that may constitute forward-looking statements usually containing the words belief, 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 invoke 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 product 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.

Please note this conference is being recorded. Now, I would like to turn the conference over to Rick McTaggart. Mr. McTaggart?

Thank you, Amy. Good morning everybody, and thank you for joining in this morning to hear about our second quarter results. Our second quarter financial results are as disappointing to us as they are to our investors. While our Retail and Bulk reporting segments performed as anticipated, given inflation related rate reductions that were implemented in January and the much slower organic growth in our market due to global economic conditions, our Service segment performance had the biggest impact on earnings this quarter. On the positive side, our BVI affiliate provided us with modest earnings this past quarter compared to a significant loss during the comparable quarter of last year.

Retail revenues declined by 3%, compared to the comparable period last year and this was fairly consistent with the 2% decline we saw in the first quarter of this year. The decline in Retail revenues was due to a 6% inflation based reduction to our base water rates in January and to lower sales volumes. In spite of some incremental sales the Water Authority early in the quarter, Retail sales by volume declined by about 5% in the second quarter which we believe is related to wetter weather and general conservation by customers.

Gross margin on Retail sales was 56% in the most recent quarter, and declined from 61% last year due to lower Retail revenues. Based on conditions that we see in the Cayman Islands market, specifically very little new construction activity in our service area and generally slow economic conditions, we believe that retail segment performance for the remainder of this year will be consistent with the trend we have seen in the first six months, assuming that there are no major changes to our revenues as a result of our ongoing negotiations with the Cayman Islands government for a new water supply concession.

As previously discussed, we recently received a three month extension to our present water utility license in Grand Cayman on the same terms and conditions in order to allow us to complete negotiations for a new license. Cayman government has indicated its preference to change the terms of our license from the existing rate cap model to a new model which would set our base rates based on a minimum rate of return on our rate base which is basically our invested capital. We have pointed out to the government that such a model does not promote efficiency and would ultimately result in higher water rates to consumers over the term of the new license if you compare that to the existing license rate adjust mechanisms.

As a result of our existing rate model our Retail Water licensee, Cayman Water Company, is clearly one of the most efficient water utilities in the region and probably the world and this high level of efficiency has allowed us to offer superior returns to investors for the past 20 years. Consequently, encouraging further investment in the Cayman Islands without the need of any guaranteed rate of return backstop as is now proposed by government. The government has also indicated that it would like to complete these negotiations before the October 10 extension deadline and we will continue to devote a great deal of management time and effort to satisfactorily conclude these negotiations as soon as possible.

Bulk segment revenues declined by 4% this past quarter compared to the comparable period last year which was a slightly higher decline than the 2% we saw in the first quarter. The decline in Bulk revenues was due to inflation based reductions to our base water rates in January and the loss of revenues due to the Red Gate plant being out of service during this most recent quarter. Bulk sales by volume were approximately the same as last year with the volume losses from Red Gate being made up by the North side desalination plant that was commissioned last summer.

Looking at individual performance in our Bulk Water businesses our Belize operation performed better than expected in the quarter and better than the comparable period last year due to cost control. Our Bahamas operation also exceeded our expectations for the quarter and outperformed the comparable period last year due to slightly higher revenues than expected and continued efforts to reduce costs. Our Cayman operation did not meet expectations. This is our Bulk operation; did not meet expectations for the quarter and generated lower gross profit than the comparable period last year due to the delay in commissioning the Red Gate plant and the resulting loss of revenues from that delay.

Reiterating what I said in the press release, the Red Gate project was challenging because it comprised the rehabilitation of our oldest plant and although we believe we priced appropriately, certain events including the key piece of equipment by a third-party supplier caused delays and associated costs beyond what we expected. It should be noted this is not a typical project for us because it was a rehabilitation of a plant that was in service as compared to our typical greenfield or expansion projects. And we have taken steps to ensure that the problems we experienced at Red Gate do not reoccur in future projects we might undertake.

Looking ahead at the Bulk segment, the Red Gate plant was commissioned on July 2nd and we expect to benefit from additional revenues generated by this plant going forward. Although we incurred unexpected costs in construction and commissioning, the energy efficiency of the plant is well within contractual requirements and we expect to benefit from lower than planned operational costs which will enhance profitability over the 7 year term of this contract. I would like to ask David just to go over the Service segment results and discuss our working capital and cash issues.

Good morning, everyone. We have commented in previous conference calls that we expected the Services revenue to be down this year. The significant amount of revenues we reported in the past in this segment has been driven by plant construction activity and plant construction activity is cyclical business and the lack of projects we have at the moment we think reflects general economic conditions both worldwide and in our market. In the future as the economy recovers we expect to win our share of projects but at the moment we are suffering some of the same effects that the construction and housing business in general is affected by throughout the region.

We also had the situation this quarter for the first time in missing our cost estimates under our percentage of completion accounting methodology. The Red Gate plant is the result of a failure to complete the plant on time resulted in $260,000 worth of liquidated damages being assessed to us by the Water Authority Cayman. The percentage of completion methodology really punishes a company if they miss the estimates because it requires a cumulative catch-up adjustment of any gross profits that might have been realized in the previous quarters.

As a result of the liquidated damages and the incremental expenses we incurred this quarter that exceeded our original budget, we had to take back about $403,000 worth of gross profit recognized through the quarter ended March 31st for the Red Gate plant. I want to point out that we have done an excellent job in the past of estimating the cost for our plant's constructions and this is we think a one-time situation related to things that really aren't typical in our construction business as Rick has talked about earlier.

The Services segment was also impacted by incremental G&A expenses that we incurred relative to our pursuit of a project in Baja Mexico which Rick will talk about later. If we do accomplish what we hope to accomplish in Mexico and proceed with this project, this project will be part of the Services business so we have put those costs in that segment.

I want to point out that we had $2 million in receipts this quarter from the settlement or the award that our affiliate received in the British Virgin Islands from this Eastern Caribbean court. That makes $4 million in total of the $10 million award received by our affiliate. That $2 million will roll through our equity pickup next quarter and result in incremental earnings from BVI.

Our Company continued to generate cash and improve our balance sheet. If you will notice we disclosed that we are paying back $1.5 million in Bahamian bonds next quarter request. We have, obviously, a tremendous amount of cash on our balance sheet; a very healthy working capital, and without projects or viable interest bearing investments in which to put these monies we are probably looking at further paying down our debt in the future. And with that I will turn the call back over to Rick.

Thanks, David. Just wanted to turn to discussion on future projects and our project development activities. As I mentioned in the press release, the competitive landscape in the Caribbean market has changed with the (technical difficulty) new players and profit margins which some competitors are prepared to take in order to win projects have significantly affected bid pricing. In addition, general economic conditions have made it more difficult to win projects.

In response, we are making adjustments to our business plan in the Caribbean and expanding our business development activities to other areas of the world, including Mexico and the United States. We have already begun to expand our sales and marketing resources and activities in the Caribbean and are taking a critical look at our traditional plant designs and cost structure to better compete against these new Caribbean players.

In addition, we are looking at opportunities to expand our Retail Business segment in the region which is a business segment with fewer competitors.

We are actively looking at other areas of the world where we believe we can successfully employ our business model and leverage our significant operating experience and case in point, earlier this year we were introduced to a group of investors that is developing a large seawater desalination project in Baja California, Mexico, is intended to supply freshwater to Northern Baja and Southern California. Most of you who follow the water industry are familiar with the opportunities that exist in these areas and the obstacles that must be overcome to develop a successful business there.

In May of 2010, we acquired through a subsidiary a 50% interest in a Mexican company which was formed to pursue a project encompassing the construction, ownership and operation of a seawater reverse osmosis desalination plant in Baja California, Mexico and an accompanying pipeline to deliver water to Mexico and the United States.

While this is a speculative venture in early stages of its development we believe that such project can be successful due to the acute need for new potable water supplies in these areas and most recently this need has been underscored by an earthquake in Northern Baja, Mexico which damaged key water transmission infrastructure that links the West Coast of Baja to the Colorado River. And this event has further heightened interest in alternative supplies for Tijuana and surrounding regions.

We have so far invested a great deal of time and effort and investment capital to develop this business and that has affected our second quarter results as disclosed and we expect to continue developing this project and committing resources into next year.

I would like to open the call up for questions now.

(Operator Instructions). Please limit your questions to two at a time. If you have further questions you may re-enter the question queue. (Operator Instructions). Our first question comes from Christopher Purtill at Janney Montgomery Scott.

Thank, you. Good morning, guys.

Good morning.

Good morning, Chris.

Can you just give us any more color on the Mexican joint venture? I know it is early and timing is down the horizon, but maybe talk about who your partner is there and any initial thoughts you would have on the project size there?

Well, I think you would probably get a good overview of what the opportunities are for size; their is a report that was done back in 2005 by Parsons that identified a number of sites in Northern Mexico and California that would be appropriate for this type of development so that will give you an idea on the scale.

With regard to our partners, I think it is a bit early to be talking about details of the project. We are very excited about it and we are spending a lot of time on it and as it develops I think we will provide more information to investors.

Okay. And then I guess based on the startup costs that you incurred associated with that this quarter, and would you expect there to be continued operating losses in the Services segment through 2010?

Based on current conditions, as David disclosed, we don't have any new projects underway. That could change later this year. And we are incurring costs with no associated revenues to develop this project in Mexico. We have disclosed that we have committed $4 million to fund the development at this project and that will continue well into next year.

Okay. Great, thanks, guys.

Yes.

The next question comes from [Cory Johnson at Atastraphe Operator]. Mr. Johnson?

Thanks for question. Guys, can you give me some sense about what the rates you are able to get right now and of the volume number in your queue is a comparison over last year. I guess the hard questions or the easy question. What is the hard number and what is the volume both in Retail and in Bulk that you sold last quarter?

in terms of total number of gallons?

Yes, that's correct.

I don't have that number in front of me. We disclose typically the volume increases in terms of percentages but not in terms of total volume. If you want to --.

Well, maybe to follow-up then. Give me a sense about what you are able to get right now in terms of price on a per gallon or per (technical difficulty)--?

All of our prices are pretty much --- our prices are fixed per the terms of the contract. I mean they are not adjustable, so I'm not sure if I understand your question as to what we can get. What we get is contractually determined. Right now we had, as we have disclosed, we had rate decreases from last year because there are clauses in our contract where we price our rates annually during the first quarter of every year based upon changes in the CPI. So I'm not sure if I quite follow your question.

I'm trying to understand, you are talking about the changes in the landscape and how other competitors are willing to take a lower price essentially. You said -- (technical difficulty)that means lower price as well. I want to know what their price is and what your price is -- (technical difficulty).

I can say that we have been on projects recently in the US Virgin Islands and Aruba and in Anguilla and we priced it based on what we project our operating costs to be and then we put in a minimum return on the investment. One that we think is appropriate given the profile of the project and the risks associated with it and what we have seen recently is that there have been competitors in the marketplace that are willing to take much lower returns apparently because they are pricing their water per customer at much lower rates than what we can price it at. That is what Rick was talking about earlier.

Some people in the market that are just I think at the moment very desperate for projects and so they are bidding prices that are typically -- or much lower than what has been experienced historically in the marketplace.

So, I can't say what the winning price is for us at the moment because some of these people are bidding much lower than what we are willing to bid.

If you want some information on that, Mr. Johnson, there are technical publications, (technical difficulty) report for example that publish bid results pretty regularly for the region, and if you look at our 10-K for 2009 we annually give you the volumes that we sell in the various segments and we also give you the average selling prices for those business segments. So that is all disclosed in the 10-K.

We just don't report the actual volume of gallons sold on a quarterly basis, but you can extrapolate that from the information that is provided in the 10-K.

Thank you very much. I appreciate it.

Sure.

The next question comes from Michael Gaugler at Brean Murray, Carret.

Morning, everyone.

Hey, Michael.

Good morning, Michael.

Two questions. First, wondering if you've got any bids out there that you would be expecting to hear back on between now and the end of the year? And then maybe second, what your thoughts are on the Service segment in terms of staffing there and how long do you hold staffing levels constant?

Well, from the standpoint of new bids we don't have any out there. We had been working on the Trinidad projects earlier in the quarter and I think you probably know that those were put on hold by the government so there is nothing out there at the moment that we are bidding on.

From the standpoint of staffing and resources, we are just finishing up the Red Gate plant and we are taking a look at what resource levels we need to have on hand given that we don't have any projects underway at the moment.

Okay. That's all I had, guys, thank you.

Sure.

(Operator Instructions). Our next question comes from [Joe Purdue] at Wells Fargo Advisors.

It seems like many of these international projects are difficult. Is there things that you can do with inside the United States with your expertise? Are there areas that need your help and you might do better with the United States government than some of these foreign projects?

Well, Mr. Purdue, I mean I think the Mexico project is a good example. We would have a customer on the US side of the border as well. We are looking at those types of opportunities now.

Okay. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. McTaggart for any closing remarks.

Thanks, Amy. I would just like to thank everybody for joining in today and hopefully we will speak with you again in November. Thank you.

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