Consolidated Water Co Ltd (CWCO) 2014 Q3 法說會逐字稿

Good morning, and welcome to the Consolidated Water Company's third-quarter 2014 operating results conference call. (Operator Instructions) This conference call may include statements that may constitute forward-looking statements usually containing the words believes, estimates, projects, 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 continuing 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.

Please note this event is being recorded. I would now like to turn the conference over to Rick McTaggert. Please go ahead.

Thank you, Kate. Good morning, ladies and gentlemen. Thank you for joining us on our third-quarter earnings call this morning. David Sasnett, the CFO of Consolidated Water, is also on the call with me this morning.

The Company's net income this past quarter more than doubled to approximately $1.9 million, or $0.13 per share, compared with approximately $900,000, or $0.06 per share, in the third quarter of 2013. This increase in earnings was due to higher water volume sales in our retail business in Grand Cayman and lower development costs for our project in Baja, California, and Mexico.

Retail segment revenues from our Grand Cayman operation increased by 18% to $5.9 million this past quarter, compared to $5 million in the third quarter of last year, due to a 17% increase in the volume of water sold. We are encouraged that retail water sales have increased during the past two consecutive quarters relative to prior-year periods, which reversed the three-year declining sales trend that began in 2010. Drier weather conditions and an increase in tourist arrivals seemed to have contributed to the turnaround.

According to government statistics, the number of stay-over tourists in the Cayman Islands was up by more than 20% this past quarter compared with third quarter of 2013. Gross margin in our retail business increased by approximately $600,000 on these higher revenues.

As we reported last quarter, the judicial review hearings related to our retail license negotiations with the water authority in the Cayman Islands government was held on April 1 of this year. Prior to the commencement of this hearing, the parties agreed that the court should only be asked to interpret certain provisions of the Cayman Islands water legislation that was passed in early 2011. As part of the agreement, the water authority also agreed to consider our submissions on their Arcam model and/or alternative pricing models for our retail concession.

These submissions were made to the authority on June 9, and subsequently on September 11 we received a letter from the authority which fully rejected our submission and stated that the water authority intends to provide the Company with a draft Arcam license in due course.

We continue to believe that an Arcam license is not in the best interest of our customers, and so far our concerns have fallen on deaf ears. Therefore, we expect to restart negotiations in the near future with the water authority for a new license based on their Arcam model, and we will keep investors informed as these negotiations progress.

Now looking to grow the potential in our retail business, recent reports in the Cayman Islands press indicate that the former Hyatt hotel property, which has been closed since it was destroyed by Hurricane Ivan in 2004, will soon be redeveloped as a 224-room hotel and conference center. Preliminary plans for this redevelopment project were submitted to the government's central planning authority in September. In addition, the Dart Group has announced plans to construct a new five-star resort in front of its flagship Caymana Bay property on the Seven Mile Beach, and both of these developments if completed would be welcome additions to our retail service area.

Now looking at bulk segment performance, bulk segment revenues declined by about 3% to $9.9 million this past quarter compared to $10.2 million in 2013, and this was on lower sales volumes in the Bahamas, which was partially offset by higher volume sales in the Grand Cayman. In 2013, our customer Water & Sewerage Corporation of the Bahamas purchased water volumes from our Blue Hills plant that were significantly higher than the minimum amounts it was required to purchase under the water supply agreement for that plant. However, due to the successful implementation of Water & Sewerage Corporation's program to reduce the amount of water it loses in its distribution system, it has been able to reduce the volume of water purchases from our Blue Hills plant and Windsor plant in Nassau. We expect the Corporation to continue to purchase the minimum volumes of water stipulated in the contracts.

Bulk sales from our Cayman Islands operations increased by about 31% to $2.6 million this past quarter compared with $2 million in the third quarter of 2013, due to higher volume sales. And this partially offset the decrease, as I mentioned, in the bulk sales and our Bahamas bulk water business.

These higher Cayman Islands volume sales were partially the result of the temporary closure of the water authority's Lower Valley plant while it is being refurbished by our engineering company. The new Lower Valley plan is expected to begin operation early next year, albeit at a new production capacity which is 75% of the plant's previous capacity.

Gross profit from our bulk segment declined by about 6% to approximately $2.8 million this past quarter compared to $3 million in 2013 on these lower sales.

Service segment revenues increased to $1.2 million this past quarter compared with $175,000 in the year-earlier quarter primarily due to construction revenues generated from contracts with the water authority of the Cayman Islands to refurbish the Lower Valley plant and to build a new containerized plant for the island of Cayman (inaudible).

The services segment continued to generate a net loss due to cost we incur to develop our 100 million-gallon-per-day desalination plant in Rosarito, Mexico. We expect this segment to continue to generate losses while we complete the development of the Mexico project or until we secure new engineering services for plant construction contracts.

Now looking at our Mexican projects specifically, we continue to make significant progress on the 100 million-gallon-per-day plant in Mexico. During this past quarter, we received initial comments from the Mexican regulator on our environmental impact study for the desalination plant and the conveyance pipeline and were pleased that the regulators did not identify any major issues in this first round of comments. We are working with our technical advisors to address all the regulators' comments and hope to obtain the necessary permits in due course.

Also this last quarter, we began the second phase of our feed water quality monitoring program and are coordinating with Otai Water District, our potential customer in the United States, to collect data that Otai requires to apply for its regulatory permits in the United States and California.

We noted in our most recent Form 10-Q that the government of Baja, California, recently enacted new legislation which regulates how the government can enter into public-private partnership agreements for infrastructure projects such as the one we are developing in Rosarito Beach. Our legal advisers tell us that this new legislation is modeled after similar federal Mexican legislation, and we believe that this development is generally positive, accretive to transparent and fair process by which we can pursue a water contract with the state of Baja, California.

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

(Operator Instructions) Gerry Sweeney, ROTH Capital.

On the bulk side of, when you are talking about the Bahamas -- the Blue Hills plant and how much the Bahamas government is taking in terms of volume, can you give us any insight as to some of the work that you are doing? Are we going to see a continual decrease of 3% per year? Or have they got some of the low-hanging fruit out of the way, so maybe we will see a gradual lessening of water decline? Just a little bit of maybe qualitative use of what's happening on that front.

Well first, this is a program that the government is undertaking -- our customer to reduce losses. We have minimum take-or-pay volumes for those plants, which they are basically at now. So we wouldn't expect any further decreases in sales from that.

You are at the minimums right now?

Yes. You have to understand; previously they were buying amounts that were significantly in excess of the minimum -- like 20% more. And those incremental sales, we deliver them to the Bahamas government. Because we are a good supplier, we didn't make a lot of money on the incremental sales. The majority of the profits derived from the minimal quantities, and they are contractually committed to buy those. So --.

Okay. Got it. That makes sense. And then also on the retail side -- Grand Cayman -- how was this year versus last year? I think last year there was a lot of wet weather. Was this year overly dry, or was it more along historic norms? I'm just trying to delineate how much is tourism versus weather. And where is sort of a weather baseline, if that's available?

I would have to direct you to check the weather site, Grand Cayman weather service, but I don't think it was unusually dry this year. We think that some of the golf courses have been using more water. There's a lot of variation in the local weather conditions, so it's very difficult to say exactly what's driving those higher sales other than they seem to correlate very well with the increase in tourist visitors. Maybe the hotels have more money to spend to keep the golf courses greener or something to that effect. But certainly, the tourism arrival figures are a very positive indicator, more so than the weather.

Okay. Got it. And finally just staying on the retail side, as you move into negotiations with the water authority, can you give us a little bit of maybe vision now that you had to look at this Arcam model? Maybe what are the potential outcomes or how it may affect your strategy or anything along those fronts?

I would prefer not to comment on that right now. I think we have made it clear that we are not happy with that type of model. We don't think that it does any justice for the customers. We will just have to keep you guys updated as we progress through the negotiations. But we don't see where we are getting much traction to retain our existing license model with the government or the authority. I think that was the main point that I wanted to make in my comments. But from the standpoint of what our strategy is and the negotiations, I prefer not to discuss that right now.

Okay. I figured as much, but I appreciate it. I'll jump back in the queue.

(Operator Instructions) John Bair, Ascend Wealth Advisors.

I was wondering if you could give us some updates on your valley operations. If I was reading the Q correctly, it looks like you are about a third capacity of your 750,000 gallons. Are you seeing a comparable -- comparable is not the right word -- seeing similar trends in tourism over there versus the Caymans? Geographically, it's a world apart. But could you update us on that?

Well, the situation in the valley is a little bit different than what we see in the Grand Caymans because historically the resorts in Bali have been able to tap into the fresh-water wells, and they use the local aquifer to supply water to the extent that the local utilities couldn't meet their needs.

The reason why we decided to enter Bali -- the Bali market is because there is no new supplies of fresh water appearing there. And they are draining the aquifer steadily. At some point in time, they will see seawater intrusion -- sewage intrusion into the aquifers, and that will limit their ability to get fresh water from that source.

But what we have seen in Bali that's a bit of a surprise is the lack of recognition on the part of the resorts to secure a new supply of drought-free water. We really thought we built a plant that would quickly become customers. But what's happened is they are still quite sensitive in that market. They are so used to paying very little for water, they defer contracting with us as much as possible. And we are still are very confident in the long term our plan is going to do quite well there.

It's just going to take a little bit of time for these people to realize -- the resort owners -- that they really don't have an alternative. And it's better to go ahead and lock up the supply now than wait two years and find out that they are the last ones in line and we don't have any available capacity for them. We are starting to negotiate with a couple of additional small hotels. So we would expect the utilization of the plant to be higher in 2015 than it was in 2014. How quickly we will reach the level of capacity that is sure to make that operation profitable is unclear, but eventually we will get there; we are very confident of that.

Is there any kind of monitoring either at the government level or amongst the resorts as to the water quality? And where I am going with this is at some point you are going to get that encroachment at aquifer deterioration and so forth. I don't know -- I'm not a resort operator, obviously, but I would certainly think I would want to be able to promote that I have a reliable and clean source of water for my guests and you don't have to worry about that. I guess the real point of this question is at what point can it be determined or would it be determined that you are having a significant deterioration and a potential health hazard from bad aquifer water?

What's amazing when you travel to Bali and stay in these five-star and four-star resort hotels, you cannot drink water that comes out of the pipes. The water that's supplied by the local utility and the water that they get from the ground wells is not potable. It has to be treated extensively by the hotels themselves through means of filtration and ultraviolet purification just so it's suitable for use in the pools or for bathing. You certainly can't drink it. And it's really surprising that when you are spending $2,000 a night in a hotel, you have to be careful not to brush your teeth with the water that is coming out of the tap, and you can only drink bottled water.

That's the thing about Bali: they have never have a concern about water quality. The idea of drinking pipe water is alien to them, it's foreign. Nowhere in Indonesia is there a pipe supply of drinking water.

So gradually -- the water we supply is vastly superior to anything they have had in the past. Eventually they are going to realize that if they buy our water they don't have to spend all this money on filtration equipment or purification equipment for the water they are getting from other sources. It's going to be ultimately a cost savings for them. But it's a matter of educating this market because they have never really had access to water of the quality we can provide.

So the trends are in our favor. It's just going to take a while for these people to realize that we are the solution.

Is there an upfront cost for them to convert -- basically so if they walked in and said, you know what, we are going to do this, is that part of the hindrance on their part, to make that kind of conversion?

Not really. But if you think about it, right now they are paying practically nothing for well water. So the cost of our water is substantially higher. And even though it's not, in our opinion, material to the operating costs of the resorts, they are very cost conscious over there. And they are looking at practically paying nothing for water at the moment or paying a lot for the water we provide. And if you are a (inaudible) the budget or you are manager of the hotel, it is significant to you.

Eventually, they are going to run out of sources that they are using now. The government has actually tried to impose a huge tax on water drawn from these wells because they recognize that the use of these wells damages the ecology, drains the aquifer, has long-term adverse consequences to Bali. But they are sort of stuck because they can't eliminate the use of these wells or tax them too heavily. They end up harming the economy because then the resorts aren't successful and they have no water. So the government is sort of in a catch-22 situation.

And we've actually had discussions with the government there about providing water to them. But it takes a long time to negotiate a deal with the government. So we really haven't focused on that potential customer at the moment. It's just kind of a different situation in Bali. Eventually, they will come around; they will have to.

Okay. I'll get back in the queue. Thank you.

(Operator Instructions) There are no questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. McTaggart for any closing remarks.

Thanks, Kate. Just again, I'd like to thank everybody for calling in today. And I look forward to speaking with you again in March when we announce our full-year earnings. Have a good holiday.

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