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Consolidated Water Co. Ltd. (NASDAQ:CWCO)

Q3 2012 Earnings Call

November 12, 2012; 11:00 a.m. ET

Executives

Frederick McTaggart - President & Chief Executive Officer

David Sasnett - Chief Financial Officer

Analysts

Tim Fronda - Sidoti & Company

John Bair - SKA Financial Services

Operator

Hello, and welcome to the Consolidated Water Company, third quarter 2012 operating results conference call. All participants will be in a 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 government 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 in 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 that this conference is being recorded.

I would now like to turn the conference over to Rick McTaggart. Mr. McTaggart, the floor is your sir.

Frederick McTaggart

Thanks Mike and good morning ladies and gentlemen. David Sasnett our Chief Financial Officer is also on the call today and we appreciate you taking time to join us.

Overall revenues of the company increased by 24% compared to the third quarter of 2011, reflecting increased revenues from all three of our business segments. This is a very positive change compared to the second quarter 2012 results, which were adversely impacted by high rainfall amounts in Grand Cayman, thus causing our retail sales to be depressed in the second quarter.

Consolidated gross profit also increased by 31%, reflecting higher overall revenues and higher margins in our retail segment.

The company continues to vigorously pursue various business expansion opportunities in existing markets, as well as new markets and I’ll discuss those opportunities in more detail later in the call. Subsequently or consequently we use a portion of these increased profits from the third quarter to fund business development activities, resulting in higher administrative expenses compared to the third quarter of 2011.

Retail revenues increased by 8% compared to the third quarter of 2011, reflecting a 7% increase in the number of gallons sold to our customers in Grand Cayman. This is more consistent with our expectations and builds on the 14% increase in retail revenues that we achieved in the third quarter of 2011. This increases also compares favorably to the drop in the retail revenues in the second quarter of this year due to unusually higher rainfall, which obviously did not impact the third quarter.

Gross profits of our retail segment increased by 20%, reflecting higher revenues during the quarter.

It’s worth nothing that our retail revenues have become a smaller part of our total revenues over the last few years as we have grown our bulk business segment. Retail revenues represented 40% of our total revenues in the third quarter of 2011 and now represent 36% of our total revenues this past quarter.

Investors will be aware that we have been operating our retail business in our Grand Cayman since July 2010 under several short-term extensions of our 1990 water production license and have attempted to secure a long-term extension of the license though discussions with the government of the Cayman Islands and its statutory authority, Water Authority Cayman.

These discussions have proven to be much more challenging and complex than anticipated and have not progressed since early 2011. In an effort to resolve these issues, as well as to get clarity of certain provisions of two laws that were passed by the Cayman government, in January last year we filed – in July an application for leave to apply for judiciary review with the Grand Court at the Cayman Islands, stating first that certain provisions of the amended laws appear to be incompatible.

Secondly that the Water Authority Cayman’s rule is the principal license negotiator, statutory regulator and our business competitor creates a clear and irreconcilable conflicts of interest for the authority. And lastly, that the authorities decision to replace our existing rate stricture with the RCAM model, which is a rate of return on invested capital model. This was pre-determined and unreasonable.

On October 22 the company was notified that the Grand Court of the Cayman Islands had agreed to consider the issues raised by the company in its application for Leave to Apply for Judicial Review. Shortly after that we were surprised to learn in the local press that on October 30 the Cayman Islands Government amended the base water and sewerage rates charged by our regulator, Water Authority-Cayman, to include an annual inflation adjustment mechanism that is functionally the same as the inflation adjustment mechanism included in the company’s existing 1990 license.

This particular rate adjustment mechanism has been the primary source of contention in our negotiations with Water Authority-Cayman since late 2009. In addition the government amended Water Authority-Cayman’s rates for sewerage services to include a monthly energy adjustment charge that allows the authority to increase or decrease its sewerage rates to reflect monthly changes in energy costs. This new energy adjustment charge is also functionally similar to the energy adjustment charge in our 1990 license.

Finally the government immediately increased the authority’s base water and sewerage rates by an average of 9.2%. We believe that as a result of these fundamental changes, the water authorities rate structure is now in line with the rate structure in our 1990 license. In our opinion such changes are inconsistent with the authority’s previous assertion that our rate of return model is in the best interest of the public.

Since we are not aware of any change to the authority’s previously stated position, that our new license should be based on a rate of return model, in spite of the authority having now adopted our rate structure itself, we expect that the company, the Cayman Islands government and the water authority will have the opportunity to present their positions to the court in a trial proceeding and we will continue to update investors as this unfolds, and incidentally we are not aware of any court date being set for these trial proceedings at this time.

Our bulk revenues increased by 35% compared to the third quarter of 2011 and now represent approximately 63% of our total revenues. This increase reflected a 36% increase in the number of gallons sold to our customers and was primarily due to the expansion of our Blue Hills plant in Nassau, and to a lesser extent to revenue growth of our bulk businesses in Belize and the Cayman Islands, which achieved 15% and 5.5% increases respectively in revenues this past quarter compared to the third quarter of 2011.

Gross profits from our bulk businesses grew by 37% compared to the third quarter of 2011, reflecting higher revenues and gross profit margin remained consistent at 22% of revenues for our bulk segment.

Services revenues increased by about 105,000 or 205,000 this last quarter compared to 70,000 in the third quarter of 2011, reflecting an increase in management fees that we earned from our EVI affiliate.

We received written confirmation last week from the BVI government, that it will pay our BVI affiliate approximately $6.7 million by the end of the year, which represents the amounts outstanding from the September 2009 quarter ward relating to the Baughers Bay plant dispute, plus legal expenses and accrued interest. The company expects to book approximately 43.5% of this amount as equity earnings from our interest in the BVI affiliate when these amounts are received, and obviously this is very positive news.

The BVI affiliate will also continue to pursue additional compensation that was awarded by the appellate court, which relates to the value of the Baughers Bay plant and equipment at the time that the plant was turned over to the BVI government in March 2010 and again, we will keep investors informed as this develops.

Now just looking at project opportunity, as reported in the press release on Friday, the company’s business development activities in Mexico and Asia are proceeding as expected. On August 31, our Mexican subsidiary NSC Agua, and Doosan Heavy Industries and Construction Ltd. extended a memorandum of understanding for 18 months from August 19, 2012, during which time Doosan will provide, install and operate a pilot plant and collect water quality data from the proposed feed water source at the Electricity Generation Plant in Rosarito Beach, Mexico.

Doosan began installing the pilot plant about two weeks ago and it should be operational within the next two weeks. Several of our Directors recently visited the site and reviewed first-hand the pilot plant being assembled and met with local officials. We are anxious to begin collecting valuable data from the pilot plant that will ultimately assist us in the design of the 100 million gallon per day Rosarito desalination plant.

In Bali, Indonesia, work is proceeding under construction of the first phase of a 1.5 million gallon per day seawater desalination plant and distribution system in a rapidly growing resort area on the island, and we expect this first phase to be operational early next year. This particular area of Bali suffers from chronic water shortages, while at the same time enjoying tremendous development growth. We believe this particular market provides an excellent opportunity to use our business model that we have employed in the Caribbean for almost 40 years to provide a total water solution for the people of Bali.

Now Mike, I’d like to open up the call for questions.

Question-and-Answer Session

Operator

Yes sir. (Operator Instructions). And we have a question from Tim Fronda of Sidoti & Co. Please go ahead.

Tim Fronda - Sidoti & Company

Good morning. Thanks for taking my questions.

Frederick McTaggart

Hey Jim, how are you doing?

Tim Fronda - Sidoti & Company

Just on the G&A expense, can you go with that a little bit, what they related to. Are they added personnel to prepare for new business or what exactly are those expenses?

Frederick McTaggart

Tim, the additional compensation costs, we’ve hired a Chief Operating Officer to improve the bulk of our operations and raise the level of our efficiencies and also to sort of set the foundation for growing business in new markets.

We’ve also upgraded our IT personnel. It goes hand in hand with some of the things we are doing in the factories and plants and try to improve efficiencies there and then most of the other SG&A costs relate to business development efforts, both in Bali and also in the Bahamas, so we are looking at a new joint venture there.

Tim Fronda - Sidoti & Company

And so this is more of the range we can expect going forward I guess?

Frederick McTaggart

Well, the business development expenses themselves probably would decline somewhat. Most of those funds were up-front costs and the money we are spending now, both in Mexico and especially in Asia are the type that we would capitalize. The money we are spending in Bali right now is for plant constructions. So I would think if anything, the business development costs would decline. But the other costs, relative and personnel cost, I think they are at a new level now and what you see in our balance is pretty consistent with what you see going forward.

Tim Fronda - Sidoti & Company

Okay, and with respect to the plant in Bali, do you think you will have to wait for this plant to be producing before you look to expand in other parts of Asia or you are going to go ahead and expand before that?

Frederick McTaggart

Well, as we’ve disclosed the plant, presently we haven’t contracted for this production yet. Introducing desalinated water to Indonesia is somewhat – they haven’t used it for a great extent. There is some use of desalinated water in parts of Jakarta and in other areas of Indonesia, but in Bali self-desalinated water hasn’t really been introduced there to any great extent.

So we want to teach the market of the benefits, but we would expect assuming that we conclude our product is viable, and that we make good water that’s relatively inexpensive, we would expect to increase both the production capacity of the existing plant and look for new opportunities pretty quickly.

We got to teach them a little bit about what we do and our expertise and tech them that desalinated water is of high quality and once we do that, we think that’s a very good opportunity for us.

Tim Fronda - Sidoti & Company

Got you, great. Thanks for your time.

Frederick McTaggart

Sure.

Operator

(Operator Instructions). The next question we have come from John Bair from SKA Financial Services.

John Bair - SKA Financial Services

Good morning.

Frederick McTaggart

Good morning.

John Bair - SKA Financial Services

I wanted to follow up on the Bali plant there; you’re at 1.5 million a day. What do you think the ultimate upside of that particular facility could be or is that pretty much it for this particular location?

Frederick McTaggart

Well, this location, we probably could expand it beyond 1.5 million gallons if the demand is there, we think potentially the demand is there. Now, what we are looking at though is the entire Asia area and particularly other areas of Bali and other areas of Indonesia.

It’s a growing economy. They have water problems in several of the islands there. If you look at Indonesia itself it’s a country with a bit more than 11,000 islands whose economy is growing pretty rapidly.

So and then also other areas of Asia where we see similar opportunities. Their productive capacity that exist over there is just much larger than what we are looking at right now as far as the opportunities in the Caribbean. So we are building a 0.5 million gallon a day per plant. Once we sell out that capacity we would expand the plant to a 1.5 million gallons and hopefully we’ll be able to show the people about in the private sector and the public sector there that we can deliver with higher quality of water at the least in the cost and if there are other opportunities for us.

John Bair - SKA Financial Services

So, if everything kind of went without too many hitches, when do you think that would be up and fully functional then?

Frederick McTaggart

Well, we could have a 1.5 million gallons going, I would say within 12 months. We should have the 0.5 million gallon a day plan going up by the first quarter next year, and to expand it would take us about six to nine months.

John Bair - SKA Financial Services

And are the contracts still in negotiation in that as far as what you would receive for that or is…

Frederick McTaggart

To a certain extent, yes. Our discussions with potential customers are such that we certainly wouldn’t be building a plant if we didn’t think we could sell the water at a good profit. But these guys are a bit skeptical. I mean when you go to Indonesia, none of them sort of consolidated water. So they are waiting to see that we could actually do what we say we can do.

Then they are willing to talk to us about a long-term supply contract. But for all the exposure we get in the local market and in the Caribbean, it’s kind of humbling to go in there and find out that people don’t know who we are. And so once we demonstrate our capabilities, we feel confident that we will be able to get a lot of business there.

John Bair - SKA Financial Services

Well, if you take your business model that you have in existence in the Caribbean would translate pretty well. I mean that’s – I guess I have a hard time understanding why they can’t see that it works in the Caribbean. So why wouldn’t it work in Bali, so…?

Frederick McTaggart

Well, we though the fact that we were a public company would be all we need to prove that we can do this over there. But I guess people have moved into the Bali market and not delivered on what they are planning to be able to deliver on. So there’s a bit of skepticism there is generally about foreigners coming in and doing business there and we are just trying to overcome that skepticism.

John Bair - SKA Financial Services

Is that at the government level or at the local level?

Frederick McTaggart

No, I think its…

David Sasnett

The customer level.

Frederick McTaggart

The customer level, not the government level. The government is very difficult to deal with. It’s a typical government bureaucracy and getting anything through the government there takes a while. We are dealing directly with the resource, and the resource is such that they won’t commit to us and create a liability for themselves, so they are sure we can actually meet their needs, because once they commit to us, then they close off alternative supplies of water.

But most of the customers we talk to are very positive about what we are offering them. They are just waiting for us to actually be able to deliver it and then once we can I think we’ll sign up contracts very quickly.

John Bair - SKA Financial Services

So in that comment then about the government versus the private sector there, are there any roadblocks from the governmental agencies for permitting and getting this up and running. In other words, if you satisfy your private sector customers, there shouldn’t be any obstacles going forward then.

Frederick McTaggart

We haven’t encountered any yet, and we are actually trying to deliver water to an area where the governments are obviously going to have problems supping this area. So if you do any kind of research on the water situation in Bali, you would be surprised to find out that even though it’s a tropical island, they have huge kind of water shortages, because of the way they manage their system water resources. And it’s an island, its still undergoing tremendous development. So there’s not many roadblocks in the government to-date and we don’t expect any. We are actually trying to supply water in areas where they really can’t meet the demand.

John Bair - SKA Financial Services

Very good. One last quick question on the Cayman thing, do you anticipate – you said there was no date sets for this court review. Do you think its likely or would reach out to the government agencies and sit down and say, okay, you basically made some changes to your proposals, that kind of fits with what we’ve been arguing all long. So can we just kind of get this straightened out and move forward. Is that something that might happen?

Frederick McTaggart

Well this Rick. John, I’d love that to happen. We just have to see how it plays out.

John Bair - SKA Financial Services

So in other words, do you don’t have any sense one way or other whether they’d be willing to accommodate. In other words, if you reached out with them and said, look okay, can we accelerate this. I mean right now it sounds like you are just sitting in limbo waiting for some kind of date for a trail, which would be three months, six months is that a fair statement.

Frederick McTaggart

It could be as long as that, yes. I mean it is hard for me to say at this point whether they’d be receptive to us reaching out. I mean I’d like that to happen and if there is an opportunity for us to do that, we will take advantage of it. In the mean time, sometimes it’s hard to – once you’re in a court situation to get the government to talk with you. I mean they feel more guarded about things. So we’ll just have to see how it plays out.

John Bair - SKA Financial Services

Okay, very good. Thank you.

Frederick McTaggart

No problem.

Operator

Mr. McTaggart, Mr. Sasnett, gentlemen it appears there are no future questions at this time.

Frederick McTaggart

Alright, well I’ll just make a quick closing remark and thank everybody for joining us today, and we certainly look forward to speaking with you early next year when we release our Annual Result.

Operator

And we thank you sir for your time. To access the digital replay of this conference you may dial 1-877-344-7529 or area code 412-317-0088 beginning at about 12:30 p.m. Eastern Time today. You will be prompted to enter a conference number, which will be 1-002-0201. Again that number is 1-002-0201. Please record your name and company when prompted.

The conference has now concluded. We thank you all for attending today’s presentation. At this time you may disconnect your lines. Thank you and take care everyone.

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