Consolidated Water Co Ltd (CWCO) 2014 Q1 法說會逐字稿

Good morning, and welcome to Consolidated Water Co. first-quarter investor results conference call. All participants will be in listen-only mode. (Operator Instructions)

This conference may include statements that may constitute forward-looking statements usually containing the words believe, estimate, project, intend, expect, or similar expressions. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements.

Factors that would cause or contribute to such differences include, but are not limited to, continued acceptance of the Company's products and services in the marketplace; changes in its relationship with the governments of 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 products profitably; and other risks detailed in the Company's periodic reports and filings with the Securities and Exchange Commission. While making these forward-looking statements, the Company undertakes no obligation to update the statements with revisions or changes after the date of this conference. Please note this event is being recorded.

Now, I would like to turn the conference over to Rick McTaggart. Mr. McTaggart, please go ahead.

Thank you, Keith. Good morning, ladies and gentlemen, and thank you for joining us on our 2014 first-quarter earnings call. Mr. David Sasnett, the CFO of Consolidated Water, is also joining me on the call this morning.

Net income in the first quarter this year was approximately $655,000 comparing to approximately $3.7 million in the first quarter of 2013. A one-time option exercise payment to a previous shareholder of our Mexican subsidiary to maintain our 99.95% ownership in that subsidiary, and our decision to pay a contractor for fee water sampling and piloting work performed for our Mexico project, rather than extend our MOU with them, resulted in incremental Mexico project development expenses this past quarter of $1.35 million.

It's also important to note that in the first quarter of last year, our results benefited from a one-time payment to our affiliate, Ocean Conversion BVI related to the Baughers Bay litigation, which generated equity investment income for the first quarter of last year that exceeded our current quarter's amount by $1 million. So that's basically a variance in the earnings between this year and last year.

Aside from these one-time Mexico expenses and a slight weather-related drop in our retail segment revenues in Grand Cayman, our core business operations continue to perform very well. Retail water revenues declined 4% to approximately $6.1 million last quarter versus approximately $6.4 million in the first quarter of 2013. And that drop was due to a 4% decrease in the number of gallons of sold by our retail operations in Grand Cayman. We believe that this decline in sales was primarily weather-related, since rainfall for the first quarter this year was 12 times higher than that in the first quarter in 2013.

We also believe that some of our larger commercial customers have adopted water conservation strategies, which have resulted in declining sales trend over the past three years. And I think we discussed this on the last call in March. The gross profit on retail revenues was down about $400,000 compared to the first quarter in 2013 on these lower revenues.

The judicial review hearing we are looking to our retail water license in Grand Cayman occurred on April 1 as scheduled, and we are awaiting the court's interpretation of certain statutory provisions in the Water Authority and Water Production and Supply laws. Prior to the hearing, the party agreed by consent that the court would only consider the interpretation of these statutory provisions. And as part of that agreement, the Water Authority and government agreed to consider our representation that the rate of return model is not appropriate for our situation.

These representations, which will include an alternate model, the rate of return, and a draft license, are to be presented by us to the Water Authority and government prior to May 30. And we will keep investors apprised as this issue progresses.

Our Bali, Indonesia operation contributed less than $25,000 to our revenues this past quarter. However, we are still very optimistic about the future of this project, given that we recently connected a large golf course and boutique hotel to our water system in Salungan, and we are receiving more inquiries about new connections now that the rains have stopped for the summer, and water is becoming more limited in the area. We presently have 250,000 gallons per day of water for sale. And we are in the process of commissioning an expansion to 750,000 per day, just in time for the dry season.

Bulk revenues were about the same this past quarter compared to last year at approximately $10 million versus $9.9 million last year. Our Cayman Islands' Bulk business generated about $150,000 more in revenues this past quarter compared to last year, and accounted for all the increase to our revenues. Gross profit on Bulk revenues increased 7% to approximately $2.8 million or 29% of revenues compared with approximately $2.7 million or 27% of revenues a year earlier, due to higher Cayman revenues and lower operating costs, which increased our Bulk segment gross profit in Cayman from 24% last year to a very respectable 30% this past quarter.

Our Services segment continued to incur an operating loss, due to the development expenses related to our 100 million gallon per day desalination plant project in Mexico. And as mentioned earlier, we incurred this one-time expense of $1.35 million related to the exercise of the stock option and the payment to the contractor under the MOU.

We were awarded three new contracts this year by Water Authority-Cayman. The first is a new contract to refurbish the 800,000 gallon per day Lower Valley desalination plant in Grand Cayman, which will impact our Service segment revenues through the first quarter of next year. And, if you recall, this is a plant that we turned over to Water Authority at the end of the contract at the beginning of 2013. So now they've decided that they are going to refurbish the plant and extend the life of it.

The second is a one-year extension through April of next year of the operating and maintenance contract for the 1.6 million gallon per day North Sound plant in Grand Cayman. And revenues will continue to contribute to our Bulk segment performance over the next year. Finally, we entered into a new contract to provide a 60,000 gallon per day desalination plant in Cayman Brac, which is one of the sister islands in the Cayman Islands, which will also impact our Services segment results through the end of this year.

The Lower Valley and Cayman Brac contracts were awarded to us through a competitive tendering process that included a number of overseas suppliers. And our success in obtaining these new contracts underscores how competitive we are in our home market.

Now, David, would you like to discuss our liquidity and new financing for the land in Mexico?

Sure, Rick. Good morning, everyone. As of March 31, 2014, our working capital amounted to $45.6 million, just a little over one-fourth of our total asset balance. Of our cash balances at the end of the quarter had declined since year-end, and we are pleased to announce that we had received $11 million in payments over April and May from the Bahamas government on delinquent accounts balances due to us. And the Bahamas government has informed us that additional payments will be forthcoming in the near future to further reduce their delinquent balances owed to us.

Late yesterday afternoon, we closed a short-term loan, financing of about $10 million to fund a portion of the $17 million we plan to disperse tomorrow to complete the purchase of the land site for our proposed Mexican project. While this loan is due on demand, principle payments are made under a five-year amortization schedule with a balloon payment due at the end of two years.

This loan is part of our financing strategy pursuant to which we prepaid the remaining principal balances of approximately $5.2 million on our more costly bonds payable that were outstanding at the end of the year. But even after obtaining this new $10 million in financing, our debt balances cost to less than 7% of our total capital base.

So, in summary, we continue to maintain a very healthy balance sheet, and we have ample liquidity for our operations and project development efforts.

With that, I'll turn things back over to Rick.

Thanks, David. I'll just talk a bit about the Mexico project now. In Mexico, we've held several meetings earlier this year with representatives of the Baja California State government regarding our project, which resulted in the presentation of a draft Letter of Intent to the State for consideration. We are currently awaiting the State's response, and we are ready to proceed with detailed technical and financial negotiations as soon as we receive the signed LOI.

We also continue to work closely with Otay Water District in California, as they apply for permits that are required to import water from Mexico. And in particular, we have participated in several meetings with Otay and the California Department of Public Health to ensure that our project will meet all applicable California regulatory requirements. Otay and NSC have discussed a protocol relating to the long-term source water sampling program that is required by California regulators. And we hope to proceed with that program shortly.

And I'll just mention that I'm actually in San Diego this week and Tijuana to close the acquisition of the final piece of land required for the project. This is obviously a very exciting long-term project for the Company, and we'll keep you updated on all material developments as they occur.

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

(Operator Instructions) Philip Shen, ROTH Capital.

Thanks for taking my questions. So, I'd like to start off with Bali. You had an update there. It sounds like you signed a golf customer -- or a golf course as well as a boutique hotel. What's in the pipeline? Can you give us some sense for when you might be able to kind of contract the full capacity that you plan on bringing online? Or at least give us a sense for the number of parties you're talking to, and perhaps some timing as to when revenues and production can ramp.

Well, I think we've mentioned on previous calls and certainly to investors that we believe there's about 6 million gallons of capacity in the area of the plant. The customers are price-sensitive, so they are not going to use the water when they have alternate sources that are less expensive. And, as we know, desalination is a more expensive alternative.

We believe that the dry weather season that they are in now will drive them towards using more of our desalinated water. We actually have our VP of Sales going over there for the next two weeks to work on several sales leads there. And we hope to have some additional news as we sign new customers. But investors should know that this will be a much more seasonal project than some of our other retail businesses. So, you should expect that demand will vary during the year.

I'd like to add to Rick's comments, Philip, that -- and for the other investors listening on the call -- the Bali markets, they differ from the Caribbean. And apparently, customers over there are very hesitant to enter into long-term contracts. It's not normal business practice there. So, therefore, we've adjusted our marketing approach. And if we are not going to give them long-term contracts, we'll settle them on a short-term basis, as needed. But, obviously, the price we would charge will be higher than if they were willing to commit to, say, a three, five, or 10-year contract.

So, we are adjusting our approach to meet what's really expected in that marketplace. And I think, ultimately, will result in, as Rick said, seasonal revenues, but we are confident about the prospects for the plant.

And Rick mentioned 6 million gallons of demand in the area. And we -- it could be as high as 8 million gallons of demand in this area. So, it's a very fertile market for us. It's just going to take a little bit of time -- as it did in the Caribbean -- for people to realize that our water supply is of high quality and it's always there. And really, when you're looking at a solution for their problems, we are really the logical solution for them. And we are confident sooner or later they will come to that realization, and we'll sell out the capacity of that plant.

Great. Let's move on to Mexico. I think in the release, you had a $350,000 expense. Can you -- due to the EPC contract or Letter of Intent that you had in place -- can you talk to us about what happened there? And did -- do you have a new EPC partner that you are working with as a result of moving on from this one?

Yes. So, I mean, we had an exclusive arrangement with an EPC contractor for the project. And that was more or less in place when we became involved in the project four years ago. And we evaluated what would be best for the project and what would be best for the future shareholders of this project. And we decided that we shouldn't have an exclusive arrangement.

We felt like we should open up the project to more competitive landscape. And there was no acrimony or anything with the EPC. I mean, we still very much hope that they will eventually bid for the project. But we felt, at this point, that it would be best not to deal with somebody on an exclusive basis. So the work that they performed over the last few years, there was some compensation that was involved for that.

Okay. Thanks, Rick. One more question from me and I'll jump back in queue. As it relates to the Cayman Islands, congrats on the awards that you've received in the quarter. Talk to us about the bidding process. Obviously, you won a competitive bid, but can you quantify the number of other bidders? And perhaps what it took to win the business? And then if there are any other comments on -- about the Cayman Islands and the contracts that you have in place there, that would be great. Thank you.

Yes, they are pretty secretive about the evaluation process that they go through. We found out just through the grapevine that there were several other companies that bid, but they didn't publish a sheet with the names or the bid amounts or anything like that, which I think is a bit unfortunate.

But we submitted bids through the governmental Tendering Commission and they were evaluated by independent people that are appointed to that Commission by government, and also by the Water Authority, who is our customer. And they informed us that we were successful on the two projects.

On the third project, the extension of the North Sound agreement, we mentioned in the year-end press release that we were given a one-year extension for that. And they expect to tender that operation out early next year. So, of course, we bid on that. And hopefully, we'll keep our successful record intact.

Great. Thanks, Rick, and thank you, David, as well.

Alexander Renker, Sidoti & Company.

So, Rosarito expenses during the quarter, about $1.9 million. Is that right?

Yes, I think that's right. And we disclosed it in the Q. We always let investors know exactly what we spent. So you would've found that in the Liquidity section in our (multiple speakers).

Okay, I did see it in there. I just wanted to clarify, because there was an issue of the exercise of the purchase option versus what other expenses were during the period. So there was the [3500] (multiple speakers) -- yes.

You take the total expenses and back out $1.35 million.

Okay.

It's the $1.35 million that's really the one-time expenses. So the actual project, ongoing project relevant expenses would've been the difference.

Okay, sure. Thank you. And then on the LOI with the Baja California local government, when -- what's sort of the cadence down there? When might you expect to have some clarity on what will happen with that from the government?

We actually don't have a firm understanding. I mean, they are evaluating what we proposed. And they have told us that there are other entities in the region that are promoting new water supplies and new ways of transporting water around the region. So, I think they are looking at what their options might be. And we hope to hear back from them soon. That's about all I can tell you at this point.

Interesting. Can you say anything about your knowledge of what some of those other options might be for them at this point?

Well, if you want my personal opinion, I don't see that they are on the same sort of level that we are proposing. And they don't solve the same problems. So, that's really up to the government officials to decide, though.

Okay. Thank you.

Steve Percoco, Lark Research.

Could you tell us what your estimated expense is in Mexico for this year, how much more you expect to spend there on development costs? And if you have a number for next year, that would be great too.

If you look at the 10-K, in the Liquidity section, we talk about Mexico. We outlined the $17 million we are going to pay for the land. We talk about the $1.35 million that was paid for this quarter. And then there is also a figure that we gave for the remaining costs of the full-year. If you take that figure and back out what we spent this quarter, we have no reason to update that at this point in time. We still think that's our best estimate.

Okay. So, even though the $1 million payment wasn't a surprise, it was factored into your estimate for the 10-K? And likewise (multiple speakers) --?

That's correct. Just take a look at the Liquidity section, and also look at the NSC disclosure in our 10-K. And we outlined in as much detail as possible exactly what we plan to spend for the rest of this year. We do not have any estimates yet for 2015.

Okay. And are you going to spend the $5 million for land this year as well?

It's $17 million and we are actually going to disburse that money tomorrow. But $10 million of it is already on the balance sheet. So we'll replace the $10 million land purchase commitment with $10 million worth of new financing, and fund an incremental $7 million from our cash balances.

Right. And on the financing for Mexico, it sounds like your intention is to keep this loan outstanding, even though it is a demand loan, and not refinance it with longer-term, say, fixed rate debt. Is that true?

Well, the plan is to sell the land ultimately to the special purpose vehicle that will build the plant. So, hopefully, we'll be moving towards financial closure in two years, and that when the land is sold, we'll [repay] it on that way. We could prepay the loan. We have substantial cash balances, including balances that in the Bahamas will probably ultimately be sent back to the Cayman Islands, the sooner we get approval from Bahama's central bank to do that.

So, yes, we'll look at the possibility of prepaying this loan. It's not at a high interest rate, so it's not really going to hamper us that much. It's going to actually be pretty cheap. But, you know, it depends on what our strategy is. I don't think we necessarily have any plans to take that $10 million loan and refinance it long-term. We'll either repay it ourselves or we'll end up selling the property to the development project company, and getting the payment on the land and then repay the loan that way.

Okay. Could you talk a little bit more about the court hearing and the process that's in place right now? As I recall, there were two objections that you had to the regulatory law. One, you saw the Water Authority of Caymans as a competitor and thought that there was a conflict. Second, you objected to the rate of return.

From your comments in court on April 1, did you argue against WAC as a regulator? Or did you drop that? And now as a sole issue, the formula for reimbursement? And any color that you can give around this would be helpful.

Well, as I mentioned earlier, we agreed before the hearing that the court would only deal with -- well, there is actually a third thing that we were asking the court to consider, and that was some conflicting -- what we viewed as conflicting provisions of new legislation that was passed back in 2011.

So, before the hearing, we agreed that the court would only consider the interpretation of the new legislation. And we agreed that, by consent, that the Water Authority and the government would consider our representations that the rate of return model was not appropriate for the situation, which really address the issues of the Water Authority's pre -- what we viewed as a predetermined outlook on the rate of return model, and also the conflict more or less addressed that.

Now the parties will discuss other regulatory options, which was agreed by consent and did not ultimately go to the court. And what we are waiting from -- waiting on from the court is really an interpretation of the laws in the Cayman Islands and how they apply to us.

Right, okay. So, I guess I'm trying to understand how things might unfold here. Obviously, if they come around to your view that the rate of return model is inappropriate, and they modify their approach, then you're happy with it and you'll accept WAC as a regulator, and everything will get resolved at this point. Is that fair?

Well, there is no option for us not to accept them. I mean, they are the regulator under the law. But what it does is allow us to at least negotiate on the regulatory model now. Whereas before the hearing, they were basically determining that it will be a rate of return model. So, it gives us the opportunity to have some dialogue about what we think would be better for all the parties.

But presumably, if they say, well, we've considered your comments and we disagree, and this is the way it's going to be, I mean, that's something that you'll have to accept. Is that also fair? Or -- I mean, I know you didn't want to get into what your negotiations might be, but if you could give any color around that, that would be helpful.

Well, I mean all I can say is we will determine what our further actions would be at that point, and we haven't gotten to that point yet. In fact, we've gotten them to agree at least hear our point of view. So I think we should just -- we are focused on that and we are focused on making a very reasonable and logical argument to them that there are alternatives to the rate of return. And we'll just see where it takes us.

Okay, thank you very much.

Hasan Doza, Water Asset.

My question was on your account receivable, year-over-year, your receivables went from $14 million last year to $24 million at the end of last quarter. Can you just give a little bit more color as to what caused the kind of the bulge in the receivables and the plan to collect some of those receivables?

Yes. David mentioned earlier that we had actually received $11 million in payments after March 1 that are (technical difficulty) [anticipated] in our Liquidity section of the 10-Q. So, most of that increase was related to receivables in the Bahamas. And we've had discussions with the government there for several months now, and we have received payments subsequent to the balance sheet data in the 10-Q.

And they gave us $11 million, Hasan, and they told us more was on the way, so.

All right. Thanks.

(Operator Instructions) John Bair, Ascend Wealth Advisors.

A couple of questions. On your new contracts, are those -- the payment schedules on those, do you get paid as you do the work? Or is it a kind of end-of-completion payment on those?

I believe both of them are completion payments. I think that was one of the things that we offered to the Water Authority to enhance our competitiveness. So, we will book the work in progress as we move through the agreement. But I believe the payments are based on completion.

Okay. So that would -- I was trying to interpret when you said it will impact your Services segment. And so that made me wonder if that's -- it was a payment upon completion. So, okay.

And the other question I have with -- in regards with Bali. Since the locals will buy water sort of as needed, how do you go about your operating of your desal plant to accommodate the ongoing needs? And is there a possibility or do you actually store water for later use? Or does that make any sense? In other words, how do you adjust your production of water to accommodate the seasonality, let's say, of the demand?

Well, I mean, we can just run the plant less frequently when the demand is lower. And then we do have water storage on our site that smoothes out the starts and stops of the plant. So, we don't see that as an issue at all. There is no operating issues that arise because of that, because of the seasonality.

And can some of that water that's produced there, could it be -- would it be feasible to, say, truck it to other areas outside of the immediate resorts areas for sale?

Well, yes, it's (multiple speakers) clearly for that.

I'd say a number of companies do that with us at the moment. But we are not going to get into the water trucking business ourselves. We have water trucks pull up to the plant. They've bought water from us in the past.

Actually, the capacity issue in the plant hopefully will work in our favor, because we expect, at some point in time, the demand on the plant during the dry season to exceed our capacity. And therefore, customers will be willing to commit to longer-term contracts, which would justify our further expansion of the plant. So, in a way, we are going to make the lack of seasonality, we hope, work in our favor.

Right. Okay. Thank you very much.

You're welcome.

Thank you. And as there are no more questions at the present time, this concludes our question-and-answer session. I would like to turn the call back over to management for any closing remarks.

Well, just I want to thank everybody for joining us and for the good questions this morning. And I look forward to speaking with you again in August when we talk about our second-quarter results. Thank you.

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