Consolidated Water Co. Ltd.
Q1 2015 Earnings Call Transcript

Published: 13 May 2015

[Operator:]

Good morning, and welcome to the Consolidated Water Company’s First Quarter 2015 Operating Results Conference Call. All participants will be in listen-only mode. [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 Mr. Rick McTaggart, President and Chief Executive Officer. Please go ahead.

[Frederick McTaggart:]

Thank you, Alisa. Good morning, ladies and gentlemen. David Sasnett, our CFO is also joining me on the call this morning from our Florida office. Our first quarter financial results were positively impacted by approximately $1.4 million reduction of development expenses related to our 100 million gallon per day desalination plant project in Rosarito Mexico and this is compared to the prior year’s quarter, and by $100,000 increase in consolidated gross profit due to reduced operating costs. These improvements were partially offset by $310,000 non-cash impairment charge of our investment in Ocean Conversion, BVI, which David will discuss in more detail later in the call. Retail revenues in terms of dollars were essentially flat this past quarter compared to the prior year’s first quarter, in spite of a 2% volume increase in our Cayman retail water sales. This volume-based revenue increase was offset by a reduction in energy-related charges, resulting from lower electricity prices. We were very pleased to see that retail sales volumes continue to trend higher consistent with the 3% average growth rate for retail sales volumes for the full-year ended December 31, 2014. Retail segment gross profit increased by approximately 2% due to cost reductions resulting from lower electricity prices, enhanced pressure control of our water distribution system on Grand Cayman, and energy savings from our newly commissioned solar energy project. According to the statistics - according to statistics from the Cayman Islands Department of Tourism, tourist air arrivals to the Cayman Islands continue to trend upward this past quarter, increasing 5.7% compared to the first quarter of 2014. And this is on the heels of a 10.8% increase in tourist air arrivals for the full year 2014 compared to the prior year. Additionally, rainfall in our Grand Cayman service area was slightly less this past quarter than in the first quarter 2014, and was slightly above the 30-year average rainfall. Based on historical results, we believe that changes in the number of tourists, visitors, as well as rainfall patterns have had an impact on our water sales in Grand Cayman. Consequently, we believe that continued growth in tourist air arrivals and possibly drier weather conditions would tend to increase our retail water sales. In three new hotel resort projects in various stages of development continue to take shape within our Seven Mile Beach Grand Cayman utility franchise area with 263 room Kimpton Hotel is under construction and is expected to open late next year. And the redevelopment of the Hyatt hotel property into a 224-room hotel and conference center, as well as a new five-star hotel development across from the Camana Bay project of Seven Mile Beach are currently in the planning stages. And each of these projects if completed should enhance our retail water sales in the future. We noted in recent disclosures that our Cayman utility license was extended to June 30th of this year, in order to allow the government and ourselves to conclude negotiations for a new utility license. On March 23, we received a letter from the Minister of Works in Grand Cayman responding to our letter of November 2014. And in that letter the Minister made various points as follows. Firstly, the Cayman Islands government plans to create a new Public Utilities Commission, however, the negotiation of our new retail license will not depend on the formation of such commission. So that means we’ll continue to negotiate with the water authority under the new law. They also made a point that they are not prepared to consider our request to include non-potable water, as well as potable water in our exclusive license area until after the negotiations for a new license of recommenced. They further made the point that rather than allow the company to submit its counterproposal to the water authorities June 2010 draft RCAM license, the water authority will prepare a new license with the understanding that we will have an opportunity to propose amendments. Furthermore, the principle of subsidization of residential customer rates, by commercial customer rates would continue under the new license, the juncture makes the residential customers happy. And finally, he suggested that in the new license, we eliminate our minimum monthly volume charge to residential customers. And I charge essentially if you used to garner income from a service connection possibly while customers not using water during a wetter part of the year, because we do have fixed overhead costs in the business that relate to customer connections. We understand that the water authority itself is currently preparing regulations to implement in RCAM type regulatory model for its own rate setting process and operations. And we further understand that the water authority will provide us with a draft of our proposed new license after their own regulatory changes have been implemented. We cannot say with any certainty when the negotiations will recommence. But we do expect to continue to be granted extensions of our current license that facilitate the negotiations in the process. Now looking at Bulk segment, Bulk segment revenues declined $1.6 million this past quarter compared with the first quarter of 2014, due to lower energy pass-through charges to our customers, resulting from significantly lower fuel prices and electricity costs in our business. However, Bulk segment gross profit increased by 3%, or approximately $100,000 due to the enhancement of the safety margin on our energy cost guarantees at some of our bulk water plants by improving energy efficiency. The water - also in our Bulk segment, the water authority that Cayman Islands accepted our proposal to operate its North Sound plant on Grand Cayman for an additional two years, subject to receiving approval from the Cayman Islands government Central Tenders Committee, although the operating agreement expired on April 1, we continue to operate the plant on the same terms and conditions otherwise by the authority. The Services segment incurred a smaller operating loss this past quarter compared to the first quarter of 2014, due to the tapering of costs relating to the development activities of our 100 million gallon per day, seawater desalination plant in Rosarito, Mexico. And this is, as we move closer to the end of the initial development cycle of this very important regional project. David, I’d like you to just speak about the OC-BVI impairment charge now.

[David Sasnett:]

Okay. Good morning, everyone. Consolidated Water qualities investment in our British Virgin Islands affiliate back in 2003. The time the amount we pay for this investment significantly exceeded our percentage ownership for the book value of OC-BVI’s assets. And as a result our investment in OC-BVI contained a significant amount of underlying goodwill. A portion of this goodwill is written off back when OC-BVI lost the cash flows from its Bar Bay state plant, as a result of this agreement with the government and litigation which discussed extensively in our filings. The remaining carrying value of our investment at OC-BVI after that write-off was then estimated at market value, which was based upon the cash flows OC-BVI expected to generate from its remaining principal operations which are the Bar Bay plant. On the U.S. GAAP, we required to periodically compare the market value of our investment in OC-BVI just carrying value. And for market value if such investment exceeds carrying value to record an impairment charge through this carrying value to market. On each quarter the expected cash flows from Bar Bay decreased as OC-BVI’s water supply contract with the BVI government matures. So, as this cash flows decrease, its projected market value or estimated market value decreases. Consequently, we necessarily required to amortize our goodwill by writing down our investment in OC-BVI each quarter as the contract matures. Now presently after the end of this quarter, we have about $1.6 billion of the implied goodwill in our investment at OC-BVI. This is after the adjustment the impairment charge we took this quarter on that investment with $310,000. And $1.6 million will continue to be amortized written off until such time as OC-BVI gains to contract for its Bar Bay plant. So investors that are looking at our results can expect a comparable write-off in future quarters the $1.6 million until we booked about $3.10 this quarter. So not a reasonable, I think the comparable amount will be booked each subsequent quarter until such time as we can announce hopefully that we have a new contract for OC-BVI at the Bar Bay plant. But if such contract is not obtained then full $1.6 million ultimately be written off. Furthermore, the worst-case scenario occurs and OC-BVI required to shutdown this Bar Bay plant. OC-BVI will be required to take impairment charge on the book value of the assets there. Net loss will flow to our income statement as we pick up our accessories of their equity results. So I hope that clarifies the situation. As I earlier we booked $310,000 our impairment charge this quarter, it’s reasonable to assume that until this time or less OC-BVI, you get a contract for Bar Bay, we’ll have to take a comparable charge into each quarters. And I hope that explains things for people. And I’ll turn next back to you Rick.

[Frederick McTaggart:]

Thanks, David. I’d like to speak a bit more about our Mexico project now. In February we received approval or approved environmental permit from the Mexican environmental regulator for the Rosarito plant, as well as the rezoning confirmation from Municipality of Rosarito, which rezoned the project site for industrial use. Also in February, we entered into a Letter of Intent with a potential equity partner with substantial financial resources and successful track record and completing capital projects in Mexico. And we did this to enhance the quality of our proposal under the new public-private partnership law in the state of Baja California, Mexico. And this law was enacted last summer. This new law sets the framework through which private entities such as ourselves can make unsolicited proposals to the state for services and infrastructure, such as the Rosarito plant. Consequently, this past quarter we submitted our initial proposal to the state to provide desalinated water from the Rosarito plant. In accordance with the requirements of the new law, and we’re currently awaiting the results of the state’s evaluation process. If the state decides to proceed with the project then it’s required to conduct a public tender and, we and our partners intend to submit a more detailed proposal in the future consistent with the terms of the tender. Right now, we can’t say one that’s all going to happen, they have a certain leeway within the law, I think up to six months to review the proposal. So we would expect to hear back from them sometime between the end of March and six months forward. And we and our partners obviously look forward to further progress, including obtaining other required permits for the project during the remainder of 2015, and we hope that we’ll be able to see the completion of this very important projects which will be the largest in the company’s history. Now, I’d like to open up the call for questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Michael Gaugler from Janney Montgomery. Please go ahead.

[Michael Gaugler:]

Good morning, everyone.

[Frederick McTaggart:]

Hey, Mike.

[Michael Gaugler:]

Rick, I wanted to go back to your comments about the letter that came in from the Ministry of Works on Cayman. And the comment about removing the minimum charge, that would seem to be, it adds with a return on invested capital model. A return on invested capital model, which is what your - what the water authority of Cayman is proposing, in order to earn your authorized return, you would have to have a minimum charge, correct?

[Frederick McTaggart:]

That’s correct. I mean, there is things that now appear to be inconsistent with what they’re trying to achieve ultimately, including the non-potable water issues, and we would expect those things to be add out there in negotiations. And we believe that having a minimum charge particularly for some of the larger commercial customers is very important to the success of the return on capital type rate model.

[Michael Gaugler:]

Okay. And then, I guess just kind of a follow-up, don’t even know, if you can answer this or not. But I mean, would this make more sense to negotiate the new license with the plant public utility commission versus your competitor?

[Frederick McTaggart:]

Yes. And we’ve made that point recently to the government representatives. We hope that they give us some consideration.

[Michael Gaugler:]

All right. Yes, I would just, again, just kind of thinking through that earlier comment about removing a minimum charge, if they wanted to do that. They should let you keep your current license parameters versus moving to a different model?

[Frederick McTaggart:]

Yes. I’m sure, we’re going to have quite a lot of discussion with them. And, as you’ve mentioned, it’s very important to us that we have an independent entity that we are negotiating with and we’ve requested that.

[Michael Gaugler:]

Okay, thanks. That’s all I had.

[Frederick McTaggart:]

Yes.

[Operator:]

[Operator Instructions] Our next question comes from Gerry Sweeney from ROTH. Please go ahead.

[Gerry Sweeney:]

Good morning, David. Good morning, Rick.

[Frederick McTaggart:]

Hey, Gerry

[Gerry Sweeney:]

Speaking about the RCAM model, this might be a little bit premature, but have you done any type of sensitivity analysis, as to possibly what assets would be involved in model, potentially some rates. What it would do to capital spending, anything along those lines?

[Frederick McTaggart:]

Absolutely, yes, we’ve modeled it out, and we’ve made observations and done some sensitivity testing. Of course, we can only model it based on the terms of the original proposal they gave us, while it’s almost five years ago. And then also taking into consideration how they regulate the electricity company here, which is on a similar basis. So we really won’t be able to run exact models until we get a new draft license from the water authority.

[Gerry Sweeney:]

Are there any main themes that would - that sort of come on the surface, I mean, capital spending increases things like that or, anything you’re prepared to talk about?

[Frederick McTaggart:]

Well, I think rate of return model, obviously encourages the utility to invest more capital to keep its rates up. So I mean, that’s a very obvious theme. The other stuff, I think, I’ll just leave for later on to discuss.

[Gerry Sweeney:]

Okay. And then just flipping over to the charge on the OCI, I’m assuming just to clarify the contract is in place, the contract is a finable, and so as those cash flows decrease, the current value of that asset decreases, which creates that charge. Just a couple of quick questions, when does the contract come towards, I guess, the final ending borrowing any extension?

[Frederick McTaggart:]

The last month of revenue is February 2017.

[Gerry Sweeney:]

Feb 2017. And when you look at that today is there any other sources of water, or can you handicap your ability to renegotiate, I mean, traditionally if you look back at some of your history, some of the contracts have been extended or you worked under existing contracts, as you negotiated contract. Is there anything out there that would create the idea that you - this contract could go away in its entirety ?

[David Sasnett:]

Well, we have factored into the calculations the possibility that the contract could be extended. It has a seven-year renewal cost exercisable with the auction of the government. The government there recently built a very large plant to replace the Bar Bay plant. And at the moment we’re not sure, I think either board of Bar Bay. In new plant, they provide enough water, but then again that water is very expensive. So the situations in flex, and Rick could speak in detail about this, if he’d like to, but we can’t say that we - we can’t say that OC-BVI is going to get an extension, we can’t say that they are not. So we probability weighted those scenarios in our projections of expected cash flows. But the worst-case scenario is at the end of seven years, excuse me, at the end of seven-year contract, which occurs in February of 2017, they decided simply began with one plant and they have and make it combinations for getting water to the area and it’s presently served by Bar Bay. I think it doesn’t happen, but we can’t roll it up.

[Gerry Sweeney:]

Okay. But at the end of the day, I mean, there is certainly some moving parts, it sounds like your water is cheaper than their large plant, and demand issues are in flex, so there is certainly some moving parts?

[David Sasnett:]

Yes, [indiscernible] obviously is the contract matures and we close at February 2017. OC-BVI’s - our partners in OC-BVI, did you talk to the government periodically, and obviously they’re proposing an extension to the contract and kind of - so the government - the merits of doing the contract for Bar Bay, we just don’t know how we will turn out at the movement.

[Gerry Sweeney:]

Okay, got it. Flipping over to Mexico a real quick, I think I read in a Q, spending levels through the rest of 2015 will be about $1.6 million.

[David Sasnett:]

That’s our estimate, yes.

[Gerry Sweeney:]

Okay. And you submitted this proposal, you’re waiting for, I guess, somewhat from the public-private associations group. If we can come back, you got a positive going from them. It’s goes out to tender, I’d assume that you Consolidated Water in the partner our best position, because you have the environmental studies. You have a recent brand. Yes, what are some potential issues or competitive issues of other people coming in and bidding, are you - where do you have a very good comfort level as opposed to any other competitors?

[Frederick McTaggart:]

Well, Gerry, I mean I don’t want to talk too much about that, because there will be a public tender process. So there is always the possibility that somebody comes in and other groups make proposals that might be attractive to the government. So from my standpoint, my perspective, we have achieved a lot of things that would take another competitor many years to achieve going forward. I mean, we have repurchased land at a very strategic side. We have an agreement with Federal Electricity Commission, where we’re leasing properties, strategic property within power plant site. And as you mentioned, we’ve already obtained some of the permits required to construct a plan, a very important permit. So we think the timing is going to be very important. The state is very enthusiastic about getting this new water supply, and also doing some sort of trade deal, or sale deal for some of that water to go into the United States, and there are actively pursuing that. So we think the timing is really going to drive the - our advantage. Obviously, the cost that we propose has to be within the expectation of the state and within market price for water in the region. So, we think we had some distinct advantages and we also get a 10% advantage in the bid process just for being the proponents of the project. So all in, I think we have a good shot at getting the project, but you never know who comes out of the woodwork.

[Gerry Sweeney:]

Okay. That’s very helpful. That’s what I need. I appreciate it. Thank you.

[Frederick McTaggart:]

Yes.

[Operator:]

Our next question comes from John Bair from Ascend Wealth Advisors. Please go ahead.

[John Bair:]

Thank you, and good morning. Your partnership that you established in February of this year, if I read it right in the Q, is good for one year to February 2016, is that right?

[Frederick McTaggart:]

Yes, correct.

[David Sasnett:]

Correct.

[John Bair:]

Okay. And the anticipation is that you’ll get something back from the regulatory agencies within six months, right just idea…?

[Frederick McTaggart:]

We would expect to have a decision on our proposal within the six-month period. And then they have time to go to - that to develop tender documents and go to public tender. So it could go towards the end of the year certainly.

[John Bair:]

Yes. So that would put you in basically about August, September timeframe right, they would go forward and then from there. So where I’m going with this is, if there are some delays the public tender aspect and so forth, do you have the comfort that you could be able to extend your LOI with your - as now unnamed partners?

[Frederick McTaggart:]

Yes, we do.

[John Bair:]

If need be, okay. And the other question I have is also looking in the Q that there was the - your import application is under review at the State Department - U.S. State Department. Can you shed any light on where that kind of stands and what the - what your hope for response back from might be on that?

[Frederick McTaggart:]

That’s not our application, that’s Otay Water District’s application. Anything that’s being done on the United States, the Board would be done by Otay Water District, we are not in a position to comment on that.

[John Bair:]

Okay. So you don’t really know what the status of that is at this point, that’s fair?

[Frederick McTaggart:]

Other than what we reported, that’s what I’m aware off.

[John Bair:]

Okay, okay. And then, switching over to Bali for a moment, it looks like your water revenues for the quarter were up almost five-fold, but the actual gallon produced, but the revenue numbers if I did my math right, it looks like about up three-fold and I was wondering if you could elaborate a little bit on that, what’s going on there, is it - and how that’s progressing, when you think you might be break-even or start making profit on that?

[Frederick McTaggart:]

Well, this recent quarter is rainy season in Bali. So it’s not a great quarter to be reporting results.

[David Sasnett:]

But quite frankly speaking, the marketplace continues to be very price sensitive. And you’ll see the increase in the volume of water that we produced going forward this quarter, because there due to the dry season, that’s what has really impressed the supply there. At some point in time, we’ve made a long-term investment in Bali. At some point in time, we’re confident that, they simply will have to buy from us. But for the time being, they’re continuing, a lot of these hotels are continuing to tap into ground wells, which just provides them the freshwater, not the best freshwater in the world, they can filter at least in their hotels and is practically free at the moment. The reason why we invested in Bali is, because long-term that that’s not a viable solution, they’re going to exhaust the aquifer and don’t have the source of water other than coming to our plant. There will be opportunities that exited their own diesel there and some hotels actually tried to do reverse as much as on their own and they’ve not been particularly successful. But for us it’s still a waiting game. And I can’t say the uncertainty when they’ll finally pull the trigger on this. We’re therefore minimizing our investment in Bali, and if we do anything else in the future there, we’ll probably end up building plants rather people until we’re comfortable we can be able to currency list there, in India where the price sensitivity in some of these markets.

[John Bair:]

Is there any way that you can get these different hotels and resort areas to kind of do a co-Operator, I guess would - maybe a way to where they would all be able to be supplied water from you folks, and thereby everybody benefits?

[David Sasnett:]

No, we actually talks to the government that Bali is kind of a strange place, it’s difficult to deal with governments in general, and for some reason, Bali governments even more challenging the most. If they were quick and proactive and did things the way I think, we would expect them to do things, so wouldn’t really be a lot of questions on Bali, because they would build reservoirs, dams, and things like that. So while you support, you suggest like a sense we have talked about hotels, none of them seem to want to pull the resources or talk about our unified solution. And we’ve had discussions with the government there who’d been very interesting in perhaps working with us, but the same select - those discussion is same like momentum, not only in the government or even in the hotels is really worried about this right now. The old situation you see in California in the West Coast. They have issues that have been coming for years. They takes the crisis and then actually take action. So I can’t answer as to why they haven’t done more. We sort of think they would be viable solution for them to pull over source to deal with us, but they haven’t find it so [ph] far.

[John Bair:]

Okay. All right. Thank you very much.

[Frederick McTaggart:]

Sure. Thanks, John.

[Operator:]

Our next question comes from George Whiteside from SWS Financial. Please go ahead.

[George Whiteside:]

Good morning. One of my questions is in regard to Cayman and you referenced the fact that there would be the possibility of someone recovered or unamortized capital costs there, if for some reason the contract were not renewed on those assets. What were Cayman’s alternatives on water be?

[Frederick McTaggart:]

I think we were mentioning that in relation to the Ocean Conversion BVI business in Tortola that that’s not an issue in Cayman license negotiations.

[George Whiteside:]

All right. I misunderstood then.

[Frederick McTaggart:]

Sure. Not a problem.

[George Whiteside:]

My second question is what is the status of your involvement in belief?

[Frederick McTaggart:]

Well, we have a plant there on Ambergris Caye, which we’ve been operating since the last 15 years. The government is our customer there. They’ve been very good about paying their monthly bills. We are, as we noted in the 10-Q,0 we’re waiting decision from the courts there as to whether the Public Utilities Commission would regulate us or not, and that’s been outstanding for several years right now. It’s a matter that’s what the chief justice. It’s difficult to get current - hard currency out of the country. There is a process that you have to go through. So we do have a lot of our - well, all of our earnings and believes who are presently there and believes dollars. So that’s kind of an overview of the business, I mean, where the plans runs well and we have a good customer there at the moment.

[George Whiteside:]

Well, it sounds as though the major issue is, as you described the currency kind of repatriation, if you will. And I presume you’re under negotiations on that issue.

[Frederick McTaggart:]

Well, it’s just a waiting game early to - when the banks get the currency then it’s available for us to purchase and repatriate.

[George Whiteside:]

Thank you.

[Frederick McTaggart:]

My pleasure.

[Operator:]

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. McTaggart for any closing remarks.

[Frederick McTaggart:]

I just like to thank everybody for joining us. We had some great questions today, and I look forward to speaking with you again in August when we e reporter our second quarter results. Thank you.

[Operator:]

The access to digital replay of this conference, you may dial 1877-344-7529 or 1412-317-0088, beginning at approximately 1 PM Eastern Time. You will be prompted to enter our conference number, which will 10065412. Please record your name and company when prompted. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.