Consolidated Water Co Ltd (CWCO) 2017 Q1 法說會逐字稿

Good day, and welcome to the Consolidated Water Co.'s First Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

The information that will be provided in this conference call includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements regarding the company's future revenues, future plans, objectives, expectations and events, assumptions and estimates. Forward-looking statements can be identified by use of the following words or phrases: will, will likely result, are expected to, will continue, estimate, project, potential, believe, plan, anticipate, expect, intend or similar expressions and variations of such words. Statements that are not historical facts are based on the company's current expectations, beliefs, assumptions, estimates, forecasts and projections for its business and the industry and markets related to its business.

Any forward-looking statements made during this conference call are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Actual outcomes and results may differ materially from what is expressed in such forward-looking statements. Important factors, which may affect these actual outcomes and results, include, without limitation, tourism and weather conditions in the areas the company serves; the economies of the U.S. and other countries in which the company conducts business; the company's relationships with the governments it serves; regulatory matters, including resolution of the negotiations for the renewal of the company's retail license on Grand Cayman; the company's ability to successfully enter new markets, including Mexico, Asia and the United States; and other factors, including those risk factors set forth under Part 1, Item 1A, Risk Factors in the company's annual report on Form 10-K.

Any forward-looking statements made during this conference call speak as of today's date. The company expressly disclaims any obligation or undertaking to update or revise any forward-looking statements made during this conference call to reflect any change in its expectations with regard thereto, or any change in events, conditions or circumstances on which any forward-looking statement is based, except as it may be required by law.

I would now like to turn the conference over to Rick McTaggart, Chief Executive Officer. Please go ahead.

Thank you, Kate. Good morning, ladies and gentlemen. Our CFO, David Sasnett, is also on the call with me this morning.

The company's consolidated net income this past quarter increased by approximately $600,000 or 28% compared with the first quarter of 2016 due to higher gross profits generated by all 4 of our reporting segments. Earnings per fully diluted share increased to $0.18 per share this past quarter compared to $0.14 in the first quarter of 2016.

Beginning with this quarter, we are reporting separate results for our recently acquired subsidiary, Aerex Industries, in a new reporting segment, which we titled Manufacturing.

Retail revenues increased by approximately $500,000 or 8% this past quarter due to an 8% increase in water volume sales compared to the first quarter of last year. We believe that this water volume increase is due to severe drought conditions on Grand Cayman, which prevailed during 2016 and have continued into 2017.

Rainfall data gathered within our utility service area indicates that rainfall in the first quarter of this year was only 37% of rainfall recorded in the first quarter of 2016 and was only 26% of the January through March 30-year average. Gross profit generated by our Retail segment increased by about $450,000 on higher revenues.

The Dart Group, which developed the recently opened Kimpton Seafire Resort as well as the 500-acre Camana Bay development in Grand Cayman, continues to move forward with plans to build a second luxury hotel and residential property within our utility service area in Grand Cayman. In February, the Dart Group submitted the postal works permit application as a proposed beachfront property, which would ultimately be comprised of a 5-star, 225-room hotel, 80 residences and 10 villas and is slated to open in 2020.

In October 2015, the Cayman Islands' government commenced the $66 million project to expand the airport in Grand Cayman. When completed next year, the airport will be capable of handling 2.5 million passengers per year compared to its current capacity of 1 million passengers per year, thus, ensuring that air transport capacity is available to fill these new and planned hotel properties.

Earlier this year, as the government of Cayman Islands passed new legislation, which transferred responsibility for water utility regulation from the Water Authority-Cayman to a new independent, multisector regulatory office called OFREG. We view this new regulatory framework as a positive development and believe that this major change will facilitate the resolution of our water utility license negotiations, which have been underway since mid-2008.

Bulk segment revenues increased by approximately $400,000 this past quarter compared to the first quarter of 2016, resulting primarily from higher energy pass-through charges to our customer in the Bahamas. Gross profit for the Bulk segment remained flat in spite of higher sales, since these incremental sales representing the energy pass-through charges were offset by approximately equal energy expenses.

We announced earlier this year that the Water and Sewage Corporation of the Bahamas extended the term of the water supply agreement for our Windsor plant in Nassau by 15 years. Under the terms of the extended agreement, we were required to rehabilitate this plant, which was constructed in 1997. These rehabilitation works are now underway and are expected to be completed mid-next year at a cost of approximately $9 million. Our investment for this rehabilitation work will be recovered through the water tariff over the term of the extended agreement.

We are pleased to announce that the Water Authority-Cayman recently extended the terms of 2 operating agreements for plants that we operate for them in Grand Cayman. Both agreements have been extended for an additional 1-year period in the case of the North Sound plant agreement until April of 2018 and in case of the Red Gate agreement until July 2018.

Service segment revenues this past quarter remained consistent with the first quarter of 2016. Gross profit generated by our Services segment increased due to reduced employee expenses.

Now looking at our new reporting segment, Manufacturing. The increase in the revenues and expenses for our Manufacturing segment from 2016 to 2017 is attributable to the fact that we owned Aerex for full 3 months this year as compared to only 1.5 months in 2016. While our Manufacturing segment incurred an operating loss of approximately $401,000 this quarter, it's important to note that this loss reflects noncash amortization expenses of approximately $343,000 for the intangible assets recorded in connection with the Aerex acquisition. We also incurred this past quarter approximately $165,000 in nonrecurring development expenses in our Manufacturing segment, and we are confident will lead to the generation of significant revenues over the remainder of this year.

Now looking at our Mexico project. In February, we submitted proposals to our customer in Baja California, Mexico, requesting an increase to the water tariff to compensate for significant changes in foreign exchange rates, lending rates and certain changes in law, which have impacted our 100 million gallons per day desalination plant project in Rosarito, Mexico. Discussions regarding these proposals continue, and we remain optimistic that a solution will be found that will allow the project to move forward.

We are also making good progress towards achieving the various conditions precedent in the APP agreement in order to meet our goal of commencing construction of the project in the third quarter of this year. This progress includes, but is not limited to, the acquisition of rights of way for the conveyance pipeline, engineering and administrative activities in support of our ocean discharge permit and the state's application for its ocean water concession for the Mexican federal authorities and negotiations with the state to finalize payment guarantees for the project.

Kate, I'd like to open the call for questions now.

(Operator Instructions) The first question comes from Michael Gaugler of Janney Montgomery Scott.

I was wondering where you stand on financing for the Rosarito project.

Well, as we've talked about in our filings, we have an agreement with North American Development Bank, essentially to put together the banking consortium to finance the bulk of the project. We're also [less] proceeding, obviously. They're intimately involved with the discussions on the payment guarantees with the State of Baja California. We are also talking to other investors in Mexico to raise some equity for the project. I can say that both of those negotiations are proceeding well so far.

Do you have a time line as to when you expect all that to be wrapped up? Would that be before construction starts or after?

Essentially, what we're saying is by the third quarter, we expect to commence construction, so we're in a position to start construction immediately after the financing closes, so it would hopefully be in the third quarter.

The next question comes from John Bair of Ascend Advisors.

Looking at the Aerex revenues, you had about half a quarter last year included, and it looks as if for the full quarter, the revenues are about twice that, which would make sense if you're flat on the sales revenue, so I was wondering if you could shed some light on whether or not that's an adequate evaluation there that your sales run rate's about the same. And then I have another question related to that.

Well, I don't think you can extrapolate the rest of the year for the first quarter. I think that's true on certain areas of our business that you can because with our Bulk contracts and our Retail license, those are very predictable. I don't think you should infer that you can annualize your excess revenues for the first quarter and come out with the amount for the year. When we first acquired Aerex, they were doing sales volume several much higher than what they've generated since we bought them. And we're hopeful that Aerex can return to a higher sales volume (inaudible) since we first acquired the company back in February. So I caution you on extrapolating the year from the first quarter.

Okay. What I was trying to get out was whether or not your run rate in the first quarter was comparable to -- for '17 was comparable to the run rate in '16 and realizing that hopefully as the year progresses, that will pick up. And just was wondering along those lines, whether or not you can tell us, are you seeing a more positive trend or interest in product bidding, whatever, that would give you confidence or optimism that (inaudible) contributes further as the year goes on?

We expect 2017 to be better for Aerex than 2016. We're very cautious we don't extrapolate our results, and we don't project for The Street. But we do expect 2017 to be better than '16.

Okay. I just get that -- that's what I was trying to get at, as a feel for what your outlook in general is. And then along the same lines, would you expect the margin on those sales to improve because the comparison there was a little bit less? And I don't know whether some of that is a function of the acquisition or not. So could you speak to that?

Well, it's difficult to project margins going forward. That will depend on the product mix and the nature of various contracts going forward. So I don't -- I'm hesitant. I think we should wait and see how the rest of 2017 plays out before I make any comments on margins.

Okay. Okay. Fair enough on that. 2 other quick ones. Could you give us any update, has there been any further conversation from the Otay Water District in California with regards to the submission that I believe in previous calls you'd said that they had to submit to the state department about being able to import any water coming out of the Rosarito facility? I know you said that, that's sort of out of your hands, but I was just wondering if you have any update on that or any idea where they're at with that.

Yes. I mean, we speak with them regularly. We have, I think, monthly calls with them. The information that we were getting from their side is that things are favorable for them getting their permit. We -- I haven't been advised that they'd received it yet. The -- and this is just on the U.S. side. I mean, obviously, any final deal with them is going to be controlled by the Mexicans. I'm not aware of any new discussions between Mexico and the U.S. There's always been a willingness to deliver water into the U.S. I think you probably can appreciate that some of the bigger-picture events over the last 6 months have impacted the discussions, I think, between the 2 nations. But generally, I think there's still a good chance that water will eventually go into the United States. It's really a matter of getting the 2 parties to the table again. Otay is doing what they need to do on the U.S. side. We continue on the Mexican side to gather water data and do things that they would need to have information on to get their final permits to import the water. So we're working together with Otay with the expectation that eventually, a deal will be struck between Mexico and the United States.

Okay. Do you think breaking ground on the facility in Rosarito would, perhaps, push that process along any?

Well, it certainly wouldn't hurt it. And the Mexicans understand that if we do the second phase of this facility, the price of the water goes down. So they understand that Otay is a good potential customer to allow them to expand the plant earlier than later. So there's -- all the factors are there that would encourage a deal to be struck. And hopefully, once the project is underway, there'll be more serious negotiations about the second phase.

The next question comes from Gerry Sweeney of Roth Capital.

A couple more questions on Aerex. I mean, in your prepared remarks, you talked about making, I believe, some manufacturing improvement enhancements or something along those lines that could drive -- potentially drive significant more revenue. Just curious as to what those enhancements were, what's changed, what you are working on.

Well, Aerex has some (inaudible), some quality-control improvements, so they can do a specialized form of manufacturing going forward. And the potential customer came in and take a look -- took a look at what they did. And we believe that Aerex performed very favorably in the eyes of this customer, and we hope that this customer will, in turn, give very substantial orders going forward. Beyond that, we really can't describe any more fully, Gerry.

That's fair. I mean, that's helpful. Also, at some point, would you be able to provide potentially some backlog information for the business? I'm not sure if it's multiple quarters of revenue visibility when it starts to develop, so we can track it? Is there ever a potential?

Yes. I think there's a possibility, Gerry. We'll take a look at that.

Okay, I appreciate it. And then on the -- the Water Cayman, the plants for Water Authority-Cayman extended for a year each, is that a little bit shorter than you anticipated? Or maybe expected a longer-term type contract? Obviously, it's so much interim contract, maybe working on some other ideas or thoughts. Anything comments on that front?

Actually, the one North Sound plant has been extended for a year already, I think twice, so it was consistent with previous extensions that they've agreed. I mean, I don't know what their long-term plans are for those plants. I think the 1 year was actually pretty good for us given the situation there.

Got it. Understood. And then finally, sounds like some more development is coming back to Grand Cayman. The Dart development aside, what's the general tone in terms of, I guess, tourism increases, other development? I know some of the hotels, maybe new service area, they've been enlarged at times. Just curious as to -- if we're seeing maybe a little bit more of a cycle of infrastructure investment on Grand Cayman to drive even more additional either population or increased tourism, airport aside as well?

Yes. I think it's really important to see the government and the private sector are working together. I mean, the airport has always been the bottleneck to get more tourists on the island. This project of expanding the airport, obviously, has encouraged people to make new investments in large properties. There's another hotel there that had just been basically empty for quite a few years, and it was just reopened under the Margaritaville banner. The condominium outlook there is a great demand for beachfront properties there on the island, and they really can't keep up with the demand right now for these luxury properties. And I think the airport expansion will facilitate the continued growth there in the hotel and the condo sectors. So we're pretty excited about that, and I congratulate the government there for finally dealing with the airport issue.

The next question comes from Hasan Doza of Water Asset Management.

A couple of questions. The first one is on accounts receivable. Now looking at your 10-Q, the balance sheet, your receivables stood at $22 million, which is up like 60% year-over-year and up almost 30% versus December of 2016. Can you help me understand what has caused this uptick in receivables?

Hasan, the increase on the end of the year is attributable to 2 companies: Our Bahamas subsidiary and Aerex. With respect to Aerex, they received a significant amount of those receivables after the end of the year -- excuse me, end of the quarter, so that balance has come down. And with respect to the Bahamas, which really comprises most of the increase, this is a pattern that we've experienced with Bahamian government since I've been with the company, which is 10 years. They periodically allow these receivable balances to grow substantially. Then after the budgeting process is complete, they give us substantial payments to reduce them down to much lower levels. We've been in contact with Bahamian government, and they're getting ready to send us significant payments. If there were any issues with these receivables, we would provide a reserve for them. But I mean, we've never had any nonpayment from Bahamian government on receivables, so we don't expect any problem going forward. It's just business as usual.

Okay. My second question is coming back to Aerex. And I was just reviewing your 10-Q, on Page 10, I noticed that Aerex is operating at a loss post their respective SG&A. So I'm trying to kind of model out Aerex's profitability for the year. I mean, should we continue to assume loss-making at the EBITDA level post SG&A for Aerex for 2017?

Well, Hasan, we're very -- we don't project. We've had this discussion before. I mean, obviously, the amortization expenses will continue going forward. If you look at the footnotes to our financial statements, you can see the amortization periods for those being related to intangible assets. I think most of them are being amortized over a period of 3 to 5 years. But we expect Aerex to do better this year. We've made that clear in a number of occasions. I mean, I think sales volume last year is not necessarily indicative of what we will do this year. I don't want to see you here and trying to project what we'll do for the year rather than just say, Hasan, we think we'll do better than last year.

Okay. My next question is on Cayman. Coming back to the 1-year extensions of the 2 facilities, can you help me understand as to the economics of the 1-year extensions? Meaning, specifically on the tariff level, are the tariff levels higher, similar or lower for these 1-year extensions versus your preexisting or pre-expiration tariffs for the facilities?

Yes. We did offer them a lower tariff. It was key to, obviously, doing a deal and getting both extensions. So we haven't disclosed the magnitude of that reduction, but there was a reduction in the tariff.

I know for -- in BVI, the reduction to make the deal was about 20% to 30%. I know it's a different jurisdiction, obviously. But in order of magnitude, is your discount similar? 20%, 30%? 10%, 20%? What should we think about as the order magnitude of the discount to get this 1-year extension?

I mean, I don't think I should comment on that right now. I mean, it was a meaningful discount and coupled with the fact that the capital fees are now paid off through those plants, I think it was satisfactory to them and allowed us to get the extensions. But there were other parts of the tariff that dropped away or will drop away that relate to the loans receivable from the water authority. So when looking at the whole package, they were satisfactory to the authority, and we were able to get the extensions.

And Hasan, you'll get a good feel for that going forward in the second quarter results, the impact of these renewals are overall bulk revenues.

Okay. And what is your annual run rate revenue for these 2 facilities, roughly, rough order of magnitude, if you look at preexpiration tariffs for full year 2016 for these 2 plants?

Hasan, we disclosed those amounts on the 10-K. I don't have the 10-K in front of me. But if you want to call me back later, I'll research that information and give it to you.

Yes. In the Risk Factors section, we talk about revenues from Water Authority because it's 1 of the top 2 customers, and the 3 plants that we operate for them would be in those figures.

Yes. But we also -- I think we specifically disclosed the revenues that were associated with these contracts that might not be renewed in our 10-K. So I'll go back to look at that or you may call and tell you what it is, or you can find it in the 10-K, if you want to look yourself.

And my last question is Page 31 of your 10-Q, and I'm referring to the SG&A run rate for your Mexico project. I noticed that the spent was about $700,000 for Q1, which makes it about close to $3 million SG&A run rate for the Mexico Rosarito project. Is that the right way to think about the SG&A spend for the project for 2017?

Well, Hasan, hopefully, we're closing this deal in the third quarter. And those expenses will now become part of the AdR's expenses, and we won't be incurring that on a Consolidated Water level. At that -- from that point on, we'll have an equity investment in the project. So I don't -- with the -- if we close, we're not going to incur towards the announcement of the SG&A for Mexico this year. I mean, we are incurring about $700,000 a quarter, but once we close the deal, that stops. We make our equity investment in the project, and then on the -- the project's fully funded, and it covers all the costs of the development.

And I'd also like to add that, obviously, we're in the home stretch here, Hasan, and there's a lot of cost that relate to paying the banks' advisers for due diligence and equity advisers due diligence, that sort of thing. So those are probably higher costs than we've incurred in the past because we're basically working our way toward closing. There's a lot of moving parts here.

The next question comes from [Philip O'Clair] of [P. O'Clair and Associates].

Question regarding the Rosario (sic) [Rosarito] project. I haven't seen anywhere -- I know you're partnered, and I haven't seen anywhere your percentage of the participation. Is it something you can divulge?

Well, under the terms of the bid that we submitted last year and under the terms of the law in Mexico, we were in the 25% equity interest, and we expected to be around that at the end of the day.

The next question comes from Steve Percoco of Lark Research.

I noticed in the Q that your billings in excess of costs and earnings was up, I think, close to $1 million this quarter. And I'm wondering what business that belongs to, and what were the reasons for the increase.

We entered into a contract with 1 customer, and they knew that we were going to be purchasing a significant amount of steel with their contract. So they agreed that they would prepay Aerex for some of that steel. So simply, just advance payment, yes, it's what essentially it is. We were allowed -- Aerex was allowed to bill them in advance, so they actually billed them in the contract to get reimbursement for the steel. (inaudible) So that's a billing in excess of what we've actually run on the contract today.

Okay. And then I presume that the gain that you recorded on the put/call option reflects a lower implied value for Aerex. Is that correct? And if so, what...

Yes, it does. Yes, it does.

And what's the thinking behind that? What was...

It's just simple. Well, what happens is we do that calculation market to market every quarter, and it's based upon projections for Aerex going forward, which haven't changed from when we first did our impairment charge last year. But it also reflects changes in market conditions, interest rates, the risk premiums and things like that. So it -- while -- you have a fluctuation in Aerex every quarter based upon where we stand market -- where the market stands, the risk premium assigned to that investment. So I don't think in and of itself you should say it means a long-term decline in the value of Aerex. It's just a snapshot picture of what that value is worth as of that day. And while marking it to market going forward for the rest of the year, next quarter could be a loss. It just depends on the...

Right. But it does seem at odds with your assertion that you expect Aerex will do better this year.

Well, you have to remember that the -- without getting into a detailed discussion of valuation here, that should not be -- that is not a direct correlation of what we think Aerex will do next year.

(Operator Instructions) The next question comes from John Bair of Ascend Advisors.

Just a follow-up on that, I guess, I mean, with regards to that put/call provision, how -- what's the term on that? I don't recall that. I think you initially put that in your release when you bought them. Is that 3 years?

Yes. It's 3 years from the day. It's exercisable 3 years from the day of the acquisition. So it's exercisable 3 years from February 2016. It gives us the right to buy the remaining 49% of Aerex. It also gives Aerex's former sole shareholder the right to sell the remaining 49% to us. Anytime 3 years after the acquisition date, and the selling -- the price will be based upon the valuation of the company at that point in time.

Okay. So if Aerex were to get a significant increase in order activity or whatever, then the seller might want to exercise their option to sell the remainder of the company to you at whatever you value that price. I mean, it's kind of -- it sounds to me like it's very much structured like an oil and gas company selling -- hedging their production and conceptually the same way that you don't know what's going to happen in 3 months, 6 months, 12 months. Is that fair?

Well, we can't predict exactly what the value of Aerex will be 3 years from now or 2 years from now. I agree with that. It was a deal we thought works for both parties. If the company does very well, we'd want to buy it; the rest of it, perhaps, the former shareholder would want to sell it. It's not a requirement that either of us exercise our option. After 3 years, we could continue the status quo. I mean, we have a good -- we're very comfortable saying we have an excellent relationship with the former sole shareholder of Aerex in making this acquisition. We really want to make sure that you felt like you fit into our corporate culture. So I mean, this is a situation where you can't guarantee that the option will be exercised by either parties 3 years from now. It gives both of us a chance if we want to do that. Who said that after the deal going forward.

Would you then -- let's assume for a minute that neither side exercises that, would you then -- would you likely renegotiate a similar put/call agreement with that individual or that entity?

Well, it doesn't expire. It stays out there. It's just not exercisable for 3 years. So it's not even renegotiated. At some point in time, I mean, look, obviously, if we thought that this was going to suddenly increase rapidly in value, we might exercise our option to buy it before we think everything takes off. So I mean, there's a lot of -- there are a lot of decisions that are speculative at this point because we really don't know where we'll be 2 years from now, so.

Okay. Fair enough. My other question, and it may be in the Q. But there was no mention in the press release, I don't believe about any further developments regarding Bali. And I was just wondering if you might be able to touch on that a little bit.

Well, I think we've been pretty blunt in our disclosures with respect to Bali. We've had and continue to have discussions with people that might be partners or investors. For the entire situation in Bali we saw for the year, we're not very confident at this point in time regarding those investors. I mean, we've had discussions as we've disclosed for a while. So I mean, the very -- there's a very real possibility that we'll end up exiting that business. Our board will have to make a decision on it later this year at some point in time, and they'll have to decide, are we going to continue to fund this company and lose money, in the hopes that we could find a partner and certainly turn things around. I mean, we've had -- we've been there for a while now, and the investment is not gone as we thought it would. So at this point, I don't think it -- I don't think that things look good for Bali at all. We have about $1.8 million investment there. If the board decides to shut things down, we'll probably run off a good portion of all of that. It won't be a cash charge. It would be an impairment charge. We're actually spending only about $300,000 a year in cash, actually, to keep it open. But I mean, the situation in Bali is the same as when we entered the market. They don't have a solution for their water problems. But trying to do business in that environment is proven to be far more difficult than we ever imagined. And they just don't seem to have a plan to deal with their problems and address the shortages. But I mean, how long do we continue to maintain an investment in the hopes they get their act together? I'm just -- at this point in time, I don't think we have that kind of aspect for Bali any (inaudible) in that market.

Yes. That's fair. I think it -- from my perspective, until the population at large squawks enough about the poor quality of their water, the government probably isn't going to do anything about it. So probably talk to the people in Flint, Michigan about that, but anyway.

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

Just thanks, everybody. Great questions today. Look forward to speaking with you guys again in August to discuss our second quarter 2017 results. Thanks.

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