Consolidated Water Co. Ltd.
Q1 2013 Earnings Call Transcript

Published: 13 May 2013

[Operator:]

Hello, and welcome to the Consolidated Water Company First Quarter 2013 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 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 change after the date of this conference call. Please note that this conference is being recorded. Now I would like to turn the conference over to Rick McTaggart. Mr. McTaggart, you may begin.

[Frederick W. McTaggart:]

Thank you, Chad. Good morning, ladies and gentlemen. David Sasnett and I are speaking with you today from San Diego, where we're spending the week working on our proposed desalination project in Rosarito, Mexico. And thank you for taking the time to join us to hear about our first quarter results. I'm pleased to report that the company had another good quarter, posting earnings of $0.26 per share, which is a $0.10 per share, $1.4 million increase to earnings compared to the first quarter of 2012. This increase in earnings primarily resulted from earnings in profit sharing derived from our equity investment Ocean Conversion-BVI and, to a lesser extent, to an increase in our consolidated gross profit. General and administrative expenses, which include spending on the development of the Rosarito project in Mexico, remained essentially unchanged compared to the first quarter of 2012. Our retail revenues actually declined slightly this past quarter compared to the first quarter last year, due to a slight decrease in the volume of water sold by our Grand Cayman utility, Cayman Water Company Limited. This volume variation doesn't necessarily reflect a trend, and the decrease was actually counter to air arrival tourism figures, which showed a year-over-year increase of 8.2%. So we think that this decline could have been related to weather, perhaps more conservative usage by customers during that period. However, retail segment gross profit increased slightly for the quarter from $3.5 million to $3.6 million, and this in spite of the revenue decline, reflecting more efficient operations. Unfortunately, I have nothing new to report regarding our negotiations with the Cayman government to extend our water utility license in Grand Cayman. We've asked the courts to consider several questions regarding the way the negotiations have been conducted by government, including our contention that the regulator that is in charge of the negotiations where government is conflicted, because that same regulator is one of our biggest customers as well as our competitor. So a hearing date has not been set yet, and we will keep investors informed as this matter progresses through the courts. The Cayman Islands is actually holding general elections on May 22, and it is likely that the present government will be replaced since the current ruling party is not running enough candidates in the election to obtain the majority of elected representatives. So at the appropriate time, we will ask to meet with the new government to explore ways to reach a solution to the present impasse. Bulk revenues also declined slightly last quarter compared to the first quarter of 2012, due in part to the January 12 expiration of our operating contract with the Water Authority-Cayman for the Lower Valley plant. And at that time, the Water Authority assumed operation of that plant in early January. This is the Water Authority's first foray into operating a $1 million gallon-per-day-plus seawater desalination plant themselves. And as reported in our last form 10-K, the profitability or the impact to profitability of the Lower Valley plant was small, relatively small, when we were operating it. So it's unlikely that the Authority would be able to achieve the operating efficiencies and reliability we've been able to achieve over the past 16 years since we benefit from a much larger operation in Grand Cayman. We have made a proposal to the Authority to provide some supplementary engineering, logistical support, and we're awaiting their reply. Bulk segment gross profit this past quarter again went counter to revenues and increased by 11%, or approximately $300,000, compared with first quarter of 2012 due to improved operating efficiencies, which I know makes my Chairman happy, and also benefited from a reduction in depreciation cost for the Windsor plant in the Bahamas as we reach the end of that operating agreement next month. In October last year, we submitted a proposal to The Bahamas Water and Sewage Corporation to extend the term of the Windsor contract for 5 years, along with a very attractive rate reduction and extended invoice payment terms to help with their cash flows. We have received confirmation that they're considering our proposal but have not yet received a definitive reply. We respect the Water and Sewerage Corporation's prerogative to fairly evaluate our proposal and even consider other options but hope that they make a decision soon as the contract is coming to an end next month and the plant urgently requires capital investment to maintain its reliability and efficiency beyond the current contract term. Similar to the Cayman Islands, we and our Bahamas customer, the Water and Sewerage Corporation, benefit from the economies of scale created by Consolidated Water's Bahamian operation and, in fact, our greater regional operations. So we wonder whether a new player in the Bahamas can impose more financially favorable terms than ours with all other things equal. Furthermore, as we've mentioned last conference call, the Water and Sewerage Corporation does not own the Windsor plant and will have to negotiate with us to purchase the plant and equipment at the end of the contract. And given the significant financial subsidy that the Corporation currently receives from government, they would -- they will probably have to increase that or rely on third-party financing to buy that plant. This is a very important contract to Consolidated Water (Bahamas) and its Bahamian investors and all investors in the company, and we stand ready to meet with the corporation to agree to mutually satisfactory terms to extend for another 5 years. Our services segment continued to incur an operating loss last quarter since we run all of the funding for our Mexican development through that segment, and we expect this loss to continue until we have completed the development of our Rosarito project, where we've secured new operating contracts. As mentioned earlier, in January, our BVI affiliate received the final $2 million settlement payment from the BVI government arising from the legal dispute over the value of the water delivered to the government from the Baughers Bay plant before it was handed over to the BVI government in 2010. So we're happy about that, and that obviously favorably impacted our net. A second claim from our affiliate for the actual value of the expanded plant and equipment at the time it was given up to government remains unresolved, and we will keep investors updated as that matter progresses through the courts. Now turning to new projects. In late April this year, our newly constructed reverse osmosis plant in Bali, Indonesia began delivering water to a resort customer located in the Nusa Dua area of Bali, which is an area that is experiencing major development of new luxury resort properties. Bali plant currently has a water production capacity of 250,000 gallons per day, which can be expanded to approximately 1.6 million gallons today -- per day in the future. The project includes a potable water storage tank, a distribution pipeline to our customer and future customers, as well as supporting infrastructure such as standby power generation. Bali project represents our first operational foray into a geographical market outside of the Caribbean and surrounding areas. We're very excited about the opportunities that lay ahead in Nusa Dua, Bali, as well as other water-short places in the region. We believe that we've created an effective and efficient management structure for this new business and hope to report only good things in the future about our Bali operations as we demonstrate to potential customers that seawater desalination is a permanent and cost-effective solution to their potable water needs. Now turning to Mexico. The Rosarito project continues to progress, and we're currently working with our engineering and financial advisors to develop specifications, cost estimates and financing models that will enable us to enter into more detailed contractual discussions with our targeted customers in Mexico and the U.S. later this year. We've recently established dialogues with agencies at the Mexican federal government level, whose support is very important for the project, and we'll continue to interact with these agencies and focus on water contract negotiations with our potential customers over the upcoming months. Our pilot plant located at the federally owned Rosarito Beach electrical power station continues to operate well, and we're working with our strategic partner, Doosan Heavy Industries & Construction, to possibly expand the scope of the pilot testing to include other pretreatment technologies. So Dave and I are here in San Diego this week to work on some administrative matters and continue our dialogue with officials on both sides of the border to educate them on the project and its significant benefits to the region. So Chad, I'd like to open the call for questions now.

[Operator:]

[Operator Instructions] Our first question today comes from Hasan Doza with Water Asset.

[Hasan Doza:]

I just wanted to confirm one item. I think in the last quarterly call, you gentlemen had mentioned the -- in terms of your SG&A, it is going to be up $4 million year-over-year due to incremental development expense in your Mexico project, and I just wanted to confirm that if you still feel the $4 million is a sufficient year-over-year increase in SG&A related to your development expense in Mexico.

[Frederick W. McTaggart:]

Yes, we think it is, Hasan. I mean, essentially, we're managing how we spend the money. And as we reach certain milestones, we'll release more funding for various parts of the project. So we think that, that's still a good number.

[David W. Sasnett:]

And Hasan, if you look at our 10-Q, we disclosed -- we'll disclose each quarter our estimate of how much we're going to spend. We want to keep the investors appraised of that number.

[Hasan Doza:]

No, that's helpful. And in the first quarter, I saw in your release is that you spent about $138,000 for the expense. Is that an accurate number for the first quarter?

[David W. Sasnett:]

We spent $138,000 more than we did last year on -- so if you go -- specifically, if you look at the risk factor, if you look at the disclosure of materials and contingencies that's in the MD&A section of the 10-Q, we've detailed exactly what we expect to spend for the remainder of 2013 for this project.

[Operator:]

Our next question comes from Philip Chan [ph] with Roth Capital Partners.

[Unknown Analyst:]

My first question is related to water volumes. I know you talked about the volumes being down year-over-year. Do have a sense for what they might be going forward? Obviously, you've added some volumes in Bali, but to what extent can you help us understand if volumes might increase or might stay flat going forward?

[Frederick W. McTaggart:]

You have to look at it on a segment basis. I think in the retail segment, there's really nothing we can say now to sort of project those for the end of the year other than to direct you to historical usage and historical numbers in the retail segment. But that's impacted by -- they're not guaranteed. I mean, it's impacted by weather and usage patterns. So for example last year, during the second quarter, the sales were down compared to historical because of rains. So we would think that, that will carry forward to this year and it should follow historical trends. The bulk segment is basically fixed take-or-pay contracts, and the effect of the Lower Valley plant will obviously roll forward and then we'll get small variations in bulk, but it should stay around where it is now, I would think.

[Unknown Analyst:]

Great. And my second question is related to Bali. You talked about 1.6 million gallons per day as a target. How are the water deliveries going so far? And can you give us a sense for what the timing might be to expand to 1.6 million gallons per day? Is that even within the realm of possibility this year? Or is it likely more of a '14 event?

[Frederick W. McTaggart:]

Well, our objective is to try to get as many customers on board this year as possible. At this point, we're delivering modest amounts to one resort, and we have sales resources that are going over to Indonesia within the next month or so to talk to other potential customers. I think the key was really getting the plant operating and producing water. We have a skeptical market there. So now they see that we're actually supplying good, drinkable water from the plant, I think the sales people are going to have a bit of an easier job. But obviously, we can't predict who's going to sign up when at this point.

[Operator:]

Our next question is from Alexander Renker with Sidoti & Company.

[Alexander Renker:]

I just had a quick question regarding possible outcomes of the negotiation surrounding the Windsor plant. What sort of are some of the range of possibilities that you could see coming out of that -- those negotiations?

[Frederick W. McTaggart:]

Well, Alexander, they're detailed in the 10-Q, and I think I'm not sure it's a risk factor, but we talk about the 3 options there. I mean, basically, they can extend the contract for 5 years, which would give us the time we need to recover the capital investment that's required to keep that plant operating efficiently. Or they could negotiate with us to buy the plant and equipment that are on site. I can't really give you any sort of timeframe for that at this point. Or they could just say take the plant away and clear the site. But those are the 3 possibilities right now.

[Alexander Renker:]

Right. And taking it away would be very literally taking it away?

[Frederick W. McTaggart:]

Yes, that's correct. That's an option in the contract. I mean, practically, I don't think they have replacement capacity there to meet their needs. So that's probably at the bottom of their list.

[Operator:]

[Operator Instructions] We show no further questions at this time, so I'd like to turn the conference back over to management for any closing remarks.

[Frederick W. McTaggart:]

Thanks, Chad. I'd just like to thank everyone for joining us today, and I look forward to speaking with you again next quarter.

[Operator:]

Thank you very much. To access the digital replay of this conference, you may dial 1 [phone] or 1 [phone] beginning at 12