Consolidated Water Co Ltd (CWCO) 2014 Q4 法說會逐字稿

Good morning and welcome to the Consolidated Water Company fourth-quarter 2014 operating results conference call. (Operator Instructions)

This conference call may include statements that may constitute forward-looking statements, usually containing the words believe, estimate, project, intend, expect, or similar expressions. These statements are made pursuant to the Safe Harbor 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.

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

Thank you, Chad, and good morning, ladies and gentlemen. Thank you for joining us on the call this morning. Mr. David Sasnett, our CFO, is also with me today in our Florida office.

Our full-year earnings in 2014 were adversely impacted by essentially three items. First, the noncash impairment charge on our investment in Ocean Conversion BVI of $860,000 in the fourth quarter; secondly, one-time legal expenses relating to our Cayman Islands utility license judicial review proceedings of approximately $380,000 in the second quarter; and finally, an increase in development expenses related to our 100 million gallon per day seawater desalination plant in Rosarito, Baja California, Mexico. Those increases were approximately $540,000, which was primarily attributed to a one-time payment in the first quarter of $1 million to buy out one of former partners.

All together these expense variances accounted for almost $1.8 million in noncore business expense variances during the past year. You should note that in the year we spent $3.7 million and in 2013 $3.16 million on discretionary expenses specifically related to pursuing the Mexico project. If you add back these noncore business expenses to our net income, we showed a continuing healthy profit in our core businesses.

The remaining variance in earnings in 2014 compared to 2013 approximated a slight drop in our gross profit due to changing water sales trends in the Cayman Islands and Bahamas operations. Our 2014 consolidated core business gross profit decreased slightly by approximately $400,000; and that was specifically due to lower revenues in our Bahamas bulk operation, which were partially offset by a 5% increase in revenues in our Cayman Islands retail business.

Retail water revenues increased by 5% in 2014 compared to 2013 on higher volume sales. This reversed a recent declining sales trend. We believe that these higher volume sales can be attributed to higher numbers of tourist visitors, which increased by almost 11% for air arrivals and 17% for cruise ship arrivals in 2014 compared to 2013.

Although revenues were up in our retail business in 2014, our gross profit remained essentially flat. This was due to higher maintenance expenses, primarily resulting from work that we undertook both internally and with specialty contractors to identify some elusive water leaks in our Grand Cayman water distribution system. This project was very successful and has reduced our water losses and those associated costs, which we expect will positively impact the future performance of our retail business segment.

Looking forward in our retail business, the 263-room Kimpton Hotel is expected to open late next year within our exclusive Seven Mile Beach, Grand Cayman, utility franchise area. I also reported in November that at least two other hotel developments were announced in late 2014, the first being the redevelopment of the old Hyatt Hotel property into a 224-room hotel and conference center, and a new five-star hotel development across from the 500-acre Camana Bay development on Seven Mile Beach. So we believe that these new property developments and their expected incremental water demand, as well as the increasing trend in tourism visitors, bodes well for our retail segment performance in future.

We noted in our recent 10-K that our Cayman utility license was extended to June 30 of this year in order to allow the government and ourselves to conclude negotiations for a new utility license. We also noted that we wrote the Cayman Islands Minister of Water this past November and confirmed that we were prepared to recommence license negotiations on the basis of their proposed rate cap adjustment mechanism license; and we are awaiting a response from the Minister at this time.

Now, looking at our bulk segment, revenues declined by about $800,000 in 2014 compared to the previous year. This resulted from a $2.5 million decline in our Bahamas revenues, that was partially offset by an increase of $1.7 million in our Cayman Islands bulk revenues.

If we look deeper into that, the Bahamas variance resulted from a decrease in the number of gallons sold to our customer, the Water & Sewage Corporation, due to WSC's successful leak detection and repair program in Nassau. The increase in the Cayman Islands bulk sales was due to a temporary closing of one of the Water Authority's desalination plants on Grand Cayman for refurbishment, as well as some general growth in the Water Authority's sales.

As a result of this, net bulk segment revenues declined -- sorry, the result of the net decline in revenues in the bulk segment, gross profit from our bulk segment declined slightly by $400,000 year over year. So while on the surface the Bahamas numbers may raise some concerns for our business, if we look a bit deeper we do see some very positive developments.

The WSC had been losing water, losing about 50% of the water that we provided and they get from other sources through leaks in their distribution system. This significant cost for wasted water no doubt was a big factor in WSC's prior financial problems and ultimately resulted in delayed invoice payments to us. As these water losses have been reduced, overall water service in Nassau has improved; and there is now more water available for new customers.

If we look at who these potential new customers could be, WSC's figures indicate that they only have about a 30% coverage of the 300,000-plus people in Nassau. The bulk of the people in Nassau actually get water from other sources such as wells. So there's a tremendous potential to increase sales by connecting new customers, which would be attracted by the improving service in Nassau.

In addition WSC signed an agreement to supply water to the Baha Mar development which is nearing completion in May. Baha Mar is actually very impressive to look at. It's a huge development.

This $3.5 billion development on 1,000 acres is the largest resort property in the Caribbean. It's comprised of more than 2,200 hotel rooms, a 200,000 square-foot convention center, world-class casinos, and more than 50 restaurants, bars, and clubs as well as an 18-hole golf course.

We expect this new water demand from Baha Mar as well as the new demand from customers that are currently not connected to WSC's water system in Nassau to positively impact future performance of our Bahamas business. We strongly believe that our customer's success in converting long-standing water and financial losses into new customer sales is closely linked to our own success in the Bahamas.

Now looking at services, revenues from our services segment increased by about $1.4 million in 2014 compared to 2013 due to the Lower Valley Plant refurbishment project that we are currently undertaking for the Water Authority in Grand Cayman. We expect that this project will be completed in the second quarter this year.

Services segment continued to incur an operating loss, which was higher in 2014 due to development activities of our 100 million gallon per day seawater desalination plant project in Rosarito, Baja California.

Now I'd like to let David talk a bit about the BVI situation.

Well, this year we took a $860,000 impairment charge against the carrying value of our equity investment in OC-BVI. We purchased this investment more than 10 years ago as part of an acquisition; and at that time we recorded a purchase price on our balance sheet, and included in that purchase price was an amount in excess of the underlying net book value of OC-BVI, which really constituted goodwill.

As this investment has matured and as the contract that OC-BVI has with the government at Bar Bay matures, you have a declining expected cash flow from the investment. So under US generally accepted accounting principles, each year we value the fair value of this investment; and obviously with a declining expected cash flow from this investment, its expected fair value declines as well.

So last year and again in 2014 we took impairment charges on this investment based upon our estimates going forward of the cash flow that we would derive from this investment. As the Bar Bay contract matures, the expected cash flows decline; so obviously the fair value of our investment declines, and we have been recording impairment charges.

We fully disclosed in our 10-K that if OC-BVI does not manage to extend its contract at Bar Bay or gain a new contract that we will ultimately have to write off this excess, because the fair value of our investment in OC-BVI would decline to zero simply because the company no longer has a cash flow stream from its contract.

But if for some reason -- and we are hopeful of this prospect -- OC-BVI can negotiate a new contract, then we would reevaluate the expected cash flows from that investment and perhaps the impairment charge would be changed or delayed. So at this point in time we don't know exactly how it's going to turn out, but using our best estimates we have estimated there will be declining cash flows from this investment.

I want to point out, however, this essentially has no impact on our cash flows, and it's a write-off of an amount we recorded in earlier years based upon the original valuation of this investment. It does not have an impact in our core business.

Thank you, David. Now looking at the projects that are underway, as previously reported we had some very positive developments in 2014 in relation to our Mexico project. In August last year the government of Baja California, Mexico, enacted new legislation called the Law of Public-Private Associations, which created a framework for companies to submit unsolicited proposals to the state and its associated agencies to provide essential infrastructure and other services such as our desalination plant.

Prior to this legislation the state would have been required to conduct its own studies and prepare bid documents for public tender if it determined that it wished to proceed with a particular project. However, under the new legislation a project sponsor -- such as NSC Agua -- is required to conduct certain social impact and technical studies, which are then presented to the state on an unsolicited basis and evaluated.

If the state then decides that a project is necessary and provides a certain level of social benefit to the population, then it will proceed to the tender stage and invite other parties as well as the project sponsor to bid for the project. So this new legislation and the bid evaluation procedures provide certain material advantages to the project sponsor, in exchange for taking the risk of developing the project on its own; and it also rewards bidders for including substantial Baja California ownership in the project company.

In January 2015 the government of Baja California officially accepted our initial expression of interest to build a desalination plant and conveyance pipeline at Rosarito under the new law, and asked us to develop and submit a detailed proposal, which we're currently preparing. In February in order to enhance our chances of successfully completing the project, we partnered with a group of companies with substantial resources and a history of successful projects and investments in Mexico.

Also in February we received the approved environmental permit for the desalination plant from the Mexican environmental authority, as well as confirmation from the city of Rosarito that our application to rezone the project site for industrial use was approved. We and our new partners look forward to further progress during the remainder of this year to achieve the largest development project in our Company's history.

And now, Chad, I'd like to open the line for questions.

(Operator Instructions) John Bair, Ascend Wealth Advisors.

Good morning. Hello, Rick. I have a couple questions. I'll ask one or two and then get back in the queue.

One question is on the -- you did talk about the efficiency efforts in the Bahamas. So my question is, it sounds like they've pretty well plugged the leak so to speak. And I'm wondering if that trend in reduced purchase you think will -- you're stabilized there, and then as you mentioned have the potential of adding new customers that maybe are getting water from well source.

Well, John, we actually, I think, are stabilized from a revenues perspective because they have committed to minimum take-or-pay volumes from these plants. They are still in some cases taking a bit more than the guarantees from the plants, and we think that the water that they are saving will ultimately be taken up by these new customers. So we do expect or we believe that there is potential for some growth again in that market.

And that would be once the new developments are established? Is that -- am I interpreting that right? A combination of adding existing locals, let's say, versus new activity?

Yes, our take on the prior situation was that they were finding it hard to provide reliable service because of the level of the leaks in the system. So they've gone a long way to resolving that. Connecting to the utility is much more attractive now, and they have extra capacity there now to service new customers, whereas before they were having problems managing demand plus the leaks.

I would assume there was a public relations issue as well as -- for reliability of water delivery. Is that a fair statement?

I think that's probably true, yes.

Okay, okay. One quick one. Given that there is some supposed thawing in relationships with Cuba, do you see any opportunities in that market potentially?

Well, yes, I mean it's a huge potential market. Our understanding is they do have quite a lot of naturally occurring water there. There may be a lot of potential for companies that build infrastructure to move that water around or to improve how they get it out of the ground.

But I think desalination is probably still limited to just maybe the coastal, the keys that are separated from the mainland in Cuba. But these are typically resort areas that would need a high-quality water.

So I don't know if I have answered your question, but there is some potential there. I think it will be a while before anybody is able to realize that.

Right, okay. I've got another question but I'll get back in the queue.

Steve Percoco, Lark Research.

Thank you. I'd like an update on the regulatory status in the Cayman Islands. The court said that -- in June that the Water Authority was your regulator. The Water Authority then sent a letter in September rejecting your arguments for an alternative to the return on invested capital model.

You sent a letter in November effectively going around the Water Authority to the Ministry of Works, accepting the return on invested capital model, but saying effectively that you would not negotiate with the Water Authority. As I understand it you want a change in the law.

My concern is it's been five years since this process started and you're still not even at the negotiating table. Meanwhile shareholders are at considerable risk if a regulatory regime is forced upon the Company in an adverse economic environment.

Why do you refuse to negotiate? If the Water Authority proposes a regulatory formula that hurts the share price, doesn't that then give you the justification to argue for another regulator?

No, not in itself, because they are the regulator by law. We didn't actually intend to go around the Water Authority; we accept that they are the legal regulator. We asked the Minister to accommodate one of our concerns, which is that the Water Authority is not impartial in this process; and we've asked for an impartial independent essentially referee for the negotiations.

But we haven't asked to exclude the Water Authority at all. So that may be a misunderstanding.

We're trying to be as cooperative as possible. We've always said that we're not going to do things precipitously that would impact our shareholders. And we think that over the last five years the Company has continued to be as profitable as it has been in the past, and retained our existing license structure while this matter is sorted out.

And then the prospect of them imposing a new license on us, that's always there. But what we're trying to do is to, I guess, see things a bit more from their perspective on the type of license that they want.

But the intention is certainly not to significantly reduce the profitability of the Company. We don't think that that's warranted in the market or generally, based on the price that we charge water there now.

So it has been a long process. But I'll just tell the shareholders again that we're not going to do things precipitously that damage the Company. So we will take -- it's a very complicated issue.

I think five years is not precipitously. I think it's long overdue to get this resolved.

They sent you a letter in September saying that they were going to propose a formula; and it's been six months, okay? It seems to me just on the surface -- I obviously don't know what's going on behind the scenes -- but your November letter would probably have stopped them in their tracks, given that you're still not effectively accepting them as the regulator.

Now it's been three months since you sent that letter. What makes you think that this process is going to start anytime soon? And I don't understand why you don't see that this is putting shareholders at considerable risk.

Well, Steve, the ball is in their court. It's essentially been in their court since September of last year when they wrote us.

I'd like to get it resolved probably as much as you would. But again, it has to be resolved in a favorable manner; and there are underlying issues have prevented us from just jumping on the negotiating -- back into the negotiations with the Water Authority because we view them as conflicted.

So again I'll say we don't reject them as the regulator. We're only asking for some accommodation from the government to make it more independent, make the process more independent and fair.

I'll just make this comment. It seems to me that until you see a proposal and negotiate a proposal you can't argue that there is substance to their being conflicted, especially when the court has said that they are your regulator.

Well, that's where I see that -- I think you haven't considered that they did make a proposal in June of 2010 that we actually rejected. And we haven't seen anything new from them for essentially 4 1/2 years.

So we've asked in the letter to the Minister that we have the opportunity to respond to their proposal from June of 2010. So they have put something on the table, which we did not view as acceptable.

I'll just say essentially they've gone silent for several months. It's not a lack of refusal to negotiate on our part.

We've acted in good faith. We don't know what's happening on their side, but for some reason they haven't come back to us.

So I understand shareholders' concern about the fact that this has taken five years. We believe we've acted prudently and in the best interest of our shareholders every step of the way.

And for those out there that might think differently, well, I'm sorry; but we believe our actions have been appropriate to this point in time and we've acted in the best interest of our shareholders, which is always our primary purpose.

Gerry Sweeney, ROTH Capital.

Good morning, guys. A couple other questions. On the OC-BVI goodwill, did you write that all the way down, or is that an ongoing process? I didn't quite follow that. So it sounds like (multiple speakers)

Gerry, there is about $2 million still sitting there. Then there is a possibility that OC-BVI will have to take an impairment charge on those assets if they don't get a contract. And keep in mind, in writing this goodwill off we're not saying they won't get a contract.

No, I understand that; it's early yet.

Well, under GAAP we make -- we do some probability estimates and we include in there the possibility they will get a contract, the possibility the thing will not get extended. That's required under US GAAP.

Then we do an expected -- based upon these probabilities we do an expected future cash flow. But just keep in mind, with each passing year those cash flows decline.

So even if they ultimately get a contract and get an extension, if that happens the day the contract expires and we don't know about it ahead of time, then we will have to continue to write down that asset, because with each passing years the expected future cash flow for the Bar Bay contract as it matures declines.

It's just an accounting mechanism. It's required for GAAP, and we are following it.

If we knew tomorrow that we had a seven-year extension and that the extension was reasonable profits that impairment charge would be deferred or -- or who knows for how long? As long as there's a contract there and cash flows the company's cash flows have historically supported the value of that goodwill.

Okay. Switching over to the Blue Hills and the Bahamas, understand that the creation of excess supply, the authority over there may be able to expand their base. You have some resort towns coming in as well.

But how much is left between what they are taking now and the actual take-or-pay? Is it de minimis, or is there a little bit left there? Can you quantify that at all?

Yes, I actually don't have those figures in front of me. My understanding is that certain parts of the year last year they fell below the minimum; but on an average it was slightly above. I can --

Okay, that's fine. But it's relatively close, so.

Then I think it was, what was it, the WSC, are they actively out trying to acquire or encourage additional connections? Or is this on the planning board? Where is that in development, and also the resorts coming online and the ability to hook into the capacity?

Well, I know they've signed an agreement with Baha Mar to supply them water; so that's done. That's in process.

With respect to connecting new customers, I can't comment on that. I would hope that that would be a goal that they have. I know they have talked about it in the past, but I haven't seen anything recently in the press or from them on their plans to do that.

Okay. Then a real quick one. Do you know how much -- what the water loss is at now? I mean, did they cut it in half (technical difficulty)

And this is just more of a function longer-term. It's how many new customers they can add over time and how much water loss there still is?

I don't have that information, Gerry. (multiple speakers)

I can follow-up with you. Okay; I will jump back in queue. Thanks.

Hassan Doza, Water Asset.

Good morning, guys. How are you? A quick question. I noticed in your 10-K that for your Mexican development spending for 2015 you expect an incremental $2 million this year.

So my question is, if I look at your SG&A for full-year 2014, which came out to be $16.7 million, should we think about an incremental $2 million on top of the $16.7 million of total SG&A you incurred in 2014?

Hasan, if you'll go to the footnote on SG&A you will see in there that we disclosed that we spent $3.7 million this year and $3.158 million, I think, something like that in 2013 for Mexico. So what we're saying in our 10-K is that you would eliminate the $3.7 million that appears this year and the new amount would be $2.1 million.

So that's a $1.6 million drop in the expenses that we expect to incur next year for NSC and for the Rosarito project.

Got it. Clear. Thank you.

[Brian Nervino], private investor.

Hi, my name is Brian Nervino and I'm a shareholder. I would just first of all like to congratulate the Company on its consecutive dividend growth.

I have a couple questions, the first of which is: with such a large demand for water in California, both in terms of population growth and their agricultural production -- I believe it's the largest in the country -- why hasn't there been more efforts to capture market space in this state?

And then on top of that question, what is the Company's strategy behind all of its retail services in what I'll call foreign countries? It seems that there's not too much US exposure. Do you think there could be potential concern down the road in terms of government regulations and control of operations?

And then my last question. I live in California, so I'm aware of the drought situation. According to the California Water Association, in San Diego and Tijuana and all throughout California there is mandatory water rationing during 2015.

How do you see this affecting the business? Do you think revenues might take a hit because of lower demand? Or do you see this being offset by the scarcity in water in the first place? Thank you.

Well, that's a lot of questions, Brian. Let me -- I'll lump some of them together in the answers, I think.

From the California perspective we certainly see a great opportunity there to do business indirectly into California. The basis of us pursuing this Mexico project was to provide water to Mexico and also into California.

We presently have a letter of intent with Otay Water District, which is right on the Mexican border, to provide 25 million to 40 million gallons per day of desalinated water from the Mexican plant. It's likely that that would be an indirect sale.

The government of the state of Baja California has indicated that it wishes to purchase all of the water from a desalination plant in Mexico; and then presumably they would sell some of that into the United States or swap water on the Colorado River through some sort of trade mechanism.

So that's really the value proposition for the Mexican project. It's not just for Mexico. It's a regional solution based in Mexico.

From the standpoint of -- we don't have any revenue changes in California. We don't presently have any operations there. So the prolonged drought creates opportunities for us and doesn't impact our business at the moment.

Okay, thank you.

Brian, we'd love to sell a desal plant into California. Presently there's a plant that's recently been constructed up at Carlsbad, but I believe it took them 12 years to get all the permitting necessary to build that plant.

I personally believe and I think most of the people in our Company believe that long-term desalinization will be a huge contributing factor to alleviating the problem of the water shortage in California. But when the state of California is willing to pull the trigger on that solution is unclear.

Hopefully we'll have a chance to build a plant actually in California in addition to the one we have in Rosarito. There are also other areas of the country where they are looking at desalination.

We're not opposed to at all to doing business in the US. We'd like to have a US operation to complement the things we do elsewhere in the world. We just have to have the right project, one that makes sense for us and one that really capitalizes on our strengths.

(Operator Instructions). [Rob Faber], private investor.

Good morning guys. I was just wondering if you could expand a little bit on the nature of the partnerships that you discussed in Mexico. I know you mentioned that you're partnering with different companies there.

I was just hoping to get a little bit more details. Are there any equity agreements? Or just basically what the nature of those partnerships are. Thanks so much.

Yes. Essentially we've signed a term sheet with a group of companies, and we're not at liberty to disclose any names or anything like that right now. But the term sheet will build -- it's created a partnership to pursue the contract with the state of Baja California, and there will be certain things -- changes in ownership structure -- that occur in the future if we achieve that contract.

David, I think maybe you have some other comments.

Yes, I just want to point out we've always disclosed to everyone that this was a project that would cost somewhere in the range of $600 million to $700 million. While we have a healthy balance sheet and pretty excellent access to credit, we don't have the ability to borrow or raise $600 million to $700 million ourselves. So we've always contemplated bringing in both an equity partner and lenders for this project.

We've decided now that, to enhance our proposal to the state, it would be beneficial for us to bring in those equity partners -- partners that not only provide money, but also provide expertise and experience in Mexico. So this is something we had contemplated doing all along.

We didn't know if we would do it at this point or at financial close. We've decided that strategically it's best to bring in a partner now.

I think this bodes well for our overall chances of getting the project, because it greatly increases our credibility with the Mexican government. And it still puts us in the same position that we always thought we would be relative to our participation in this project going forward and the incremental revenues we think we can earn from it. So I think this is something that our investor group should look at -- or investors should look at positively.

Thank you, I do. Is there a point in the future where some of the terms, actually the dollar amounts or percentage of equity, might be disclosed, so we can back into an overall value of the investment?

Yes, when something definitive is signed, when we have binding commitments from the government and with our partners, those documents will actually be filed in the form of an 8-K. You can take a look at them. It will be a material agreement for us, and we will fully disclose in our public filings those terms.

Great, I appreciate it. Thank you guys so much.

John Bair, Ascend Wealth Advisors.

Yes, it's actually a little follow-up to the previous question there. You answered a number of the angles on my question.

But one of them is: when those agreements materialize, does the Company expect to recoup some of your upfront cash costs as part of the deal?

Well, from a standpoint of the timing that's going to depend on when the government puts out -- if they ultimately put out a tender for the project through the APP law structure. We would hope that it's sometime this year.

If we're awarded that project, then there's triggers that would allow us to -- well, it would allow us to recoup some of our investment in the project and would also reduce our ownership percentage in the project at that time.

The way the deal is structured you can see -- just take a look at the disclosure in the 10-K; it gives you a good understanding of what could be expected if the deal goes through. We made it very clear in our disclosures there.

Yes, I just haven't looked at that quite recently. And I'm assuming then too -- I know that you've always stated the intent would be that you would have an operating contract for the project. I'm assuming you would be looking for a long-term 10 type, 20-year type operating agreement. Is that correct?

That's a reasonable assumption.

Yes? Okay, very good. Thank you very much.

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

I just want to thank you again for joining us today. We had some really great questions, and I look forward to speaking with you hopefully again in May to discuss our first-quarter results.

Thank you, sir. To access the digital replay of this conference you may dial 1-877-344-7529 or 412-317-0088 beginning at 1:00 p.m. Eastern Time today. You will be prompted to enter a conference number, which will be 10061979. Please record your name and company when prompted.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.