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Executives

Frederick W. McTaggart - President & Chief Executive Officer

David W. Sasnett - Executive Vice President & Chief Financial Officer

Analysts

Ryan Conners – Boenning & Scattergood

Michael Gaugler – Brean Murray, Carret & Co.

CJ Purtill – Janney Montgomery Scott

George Whiteside – SWS Financial Services

Robert Smith – Center for Performance Investment

Consolidated Water Co. Ltd. (CWCO) Q4 2008 Earnings Call Transcript March 17, 2009 11:00 AM ET

Operator

Hello, and welcome to the Consolidated Water Co. year-end conference call. All participants are currently in a listen-only mode. There will an opportunity for you to ask questions at the end of today’s presentation. I will give you instructions on how to ask your questions at that time.

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 or the jurisdiction 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.

(Operator Instructions) Please note that this conference is being recorded. At this time, I would like to turn the conference call over to Mr. McTaggart. Mr. McTaggart, you may begin.

Frederick McTaggart

Thanks Jamie. Good morning ladies and gentlemen. Thank you for joining us this morning to discuss our fourth quarter and year-end results. I’m calling in from our corporate offices in Grand Cayman and David Sasnett, our Executive Vice President and Chief Financial Officer joins us from our Florida office.

2008 was certainly a challenging year for most investors and CWCO's stock was not spared from the market carnage in the fourth quarter of '08 and early '09. However, we hope that investors recognize it. Consolidated Water's financial position continues to be strong and stable, and that we expect much of our core business to be relatively unaffected by the financial downturn since we provide an essential commodity, drinking water. Approximately half of our revenues are generated by large take-or-pay water supply contracts with government-owned utilities.

With a healthy cash balance of $36 million at year-end and a low debt to equity ratio of approximately 0.2 to 1, the company is well positioned to write-out the remainder of this financial crisis and to take advantage of any new business opportunities that may arise. We certainly have the ability to take on additional debt if required to handle future projects and we do not expect to require any new equity capital to complete projects that are currently underway or presently contemplated.

During the fourth quarter, we believe that our business behaved as expected in response to external factors such as energy and commodity cost increases, weather conditions and declining tourist numbers in some markets. For example, our retail water revenues declined in the fourth quarter compared to prior year primarily because of adverse weather conditions in October and November, lower tourist arrivals in November and December in Grand Cayman and what appears to be efforts by our customers to conserve water particularly at some of the hotel properties.

This is not surprising given the spike in water rates over the summer due to higher energy cost, passthrough charges, but these passthrough charges have come down significantly over the past several months as oil prices have fallen and hopefully this will allow customers to return to historically usage habits.

So far in 2009, retail sales by water volume have declined slightly year-over-year, but at a much smaller percentage than we saw in the fourth quarter of 2008. Fortunately, this decline has been offset by our annual inflation adjustment that was implemented in accordance with our Cayman franchise license on January 1 of this year.

And anecdotally, rainfall in our service area in 2009 so far has been conspicuously lower than in the fourth quarter of last year when we had several months with rainfall well in excess of the 30-year average, and we would expect this drier weather to enhance sales in the first quarter of 2009.

Our bulk water revenues increased over 2007 levels, primarily in response to sharp energy price increases during the year, which increased the energy cost passthrough charges to our bulk customers. These three revenues, however were relatively unchanged due to the fixed sales volume nature of these contracts and we believe that in these difficult financial times, the fixed take-or-pay nature of these contracts provide significant benefit to the company and the shareholders since we would not expect revenues from these contracts to be materially impacted by any underlying declines in water demand that our customers may experience.

At the end of the third quarter, we completed the replacement of feed water wells at our Windsor plant in the Bahamas, and in the fourth quarter, we benefited from improved energy efficiency at that plant. We've undertaken an improved maintenance program at the plant and have hired additional skilled staff, which we hope will payoff by further reductions in operating costs and improved operating margins.

Bulk water revenues in our Cayman operation improved during the quarter, primarily due to increased energy costs passthrough charges to the customer. Our Services segment revenues grew at a robust pace in the fourth quarter due to the number of relative size of new projects that were under construction. We continue to progress on the construction of the 2.4 million gallon per day desalination plant for the water authority and Frank Sound Grand Cayman albeit with some time delay associated with the bad weather at the end of last year and we expect this plant to be commissioned in early May.

Frank Sound plant will be the largest desalination plant in Grand Cayman and is expected to provide water to residence on the eastern side of the Island, including the Rum Point Resort Area.

Turning to Bermuda, Phase I of the Tynes Bay desalination plant was commissioned in December, and has been operating satisfactorily. We are currently finishing out Phase II of the project and are awaiting the provision of additional electrical power capacity to the site from the local utility. Both of these projects continue to track on budget.

We also announced last year that the Water Authority in Grand Cayman had asked us to rehabilitate and modernize one of the oldest desalination plants in Grand Cayman in conjunction with a seven-year operating contract extension. And we expect this work to commence during the second quarter of this year with completions slated for the fourth quarter.

And now I’ll turn the call over to David to talk in more detail about our financial performance.

David Sasnett

Thanks, Rick. Our net income in 2008 was approximately $7.2 million, or $0.50 per share. In [2000], we reported net income of $11.4 million, or $0.79 per share. The difference in net income from 2007 to 2008 of $4.2 million is attributable to the reversal of the results we recorded for our equity investment in OC-BVI. This reversal in itself amounted to more than $4.6 million.

In 2007, we've reported profit sharing income and equity in the earnings of this affiliate of $2.3 million but as we explained in our previous public filings and again in our recently filed 10-K, the ongoing dispute over OC-BVI's Baugher’s Bay plant, the lack of payments by the BVI government for water supply from that plant and the uncertainty over the resolution in this matter has resulted in a change in revenue recognition by OC-BVI to the cash method for revenues generated by the Baugher’s Bay plant.

When we implemented this policy back effective January 1, 2008, OC-BVI had a substantial accounts receivable balance from the BVI government. As cash payments by the government came in during 2008, they were applied first to this receivable balance. And the one enough cash payments during the year had covered the outstanding receivable balance that existed at the beginning of the year, so essentially OC-BVI had a year of very little or no revenues. This resulted in a loss of $5.2 million for them and our portion of that was $2.3 million.

If you take away the OC-BVI situation, the other areas of our business performed fairly consistently from 2007 to 2008. Overall, we were able to increase our operating income essentially by reducing G&A salaries. Our reduction in G&A salaries reflects our initiative back in 2008 to restructure some of our executive management composition, and as a result we paid lower bonuses to our Chairman and our CEO this year.

If you look at each of our segments, all of our operating segments increased their contribution to our income from operations in 2008 as compared to 2007. Specifically, retail had an increase in revenues primarily due to energy passthrough charges as total volumes of water sold by the retail division to climb about 4% for the year.

Our Bulk Segment increased its revenues primarily because we're now billing all the water that we produce at our Blue Hills plant in Bahamas, and as Rick talked about our Frank Sound contracts progressed during the year and consequently our Services revenues increased.

From our liquidity’s perspective in 2008, we generated significant cash from our operations. We repaid our debt. We maintained our quarterly dividends while we restricted our balance sheet. We continue to hold substantial receivables from the government of Bahamas. We believe these receivables will grow currently in 2009. Our working capital exceeded $44 million at the end of 2008, and we believe our credit standing and available liquidity provide us with the capability of aggressively pursuing new projects at a time and perhaps some of our competitors may not be able to do.

So we think where we would need to be going into 2009 and with that I would like to turn things back over to Rick.

Frederick McTaggart

Thanks, David. David discussed the issues associated with the BVI affiliate. And I just like to add on a positive note that by year-end our affiliate had signed a binding term sheet with the government of the BVI to supply water from the previously idle Bar Bay plant in eastern Tortola, and this is in our view a strong indication of government’s willingness to reestablish a sound commercial relationship with our affiliate.

The affiliate started supplying water to the government from that plant in late December and is currently constructing some additional works in accordance with the binding term sheet.

I'd like to talk a bit more about projects - potential projects. Negotiations with the government of the Turks and Caicos Islands where retail water franchise in the Turks and Caicos Group have not progressed since our last conference call because of structural changes in the TCI government resulting from a wide ranging corruption investigation that was initiated by the U.K. government late last year, the result of which has been the suspension of parts of the Island’s constitution and the dissolution of Cabinet and Parliament and although this sounds pretty serious, we believe that it's a positive for us, ultimately the U.K. government, through the Governor, is now under direct control of the Island and this is expected to continue until 2011 when new general elections are scheduled to be held.

And we’ve written to the Governor regarding our negotiations for the retail franchise and hope that we'll be able to meet with the new government soon to move things along. We don’t have any reason to believe that the privatization initiative that was started by the previous government will not move forward particularly since the Island of Grand Turk is presently suffering from a severe water crisis and is in need of significant water infrastructure replacement due to damage from Hurricane Ike.

On another project, we recently did jointly with the Trinidadian engineering firm for 10 million imperial gallon per day seawater desalination plant in Trinidad at a government-owned petroleum refinery. And we are currently awaiting results of this bidding. We understand that they were four other companies that bid for the project and we hope that our proposal is competitive enough to win the job.

In general, we are hopeful that some of these longer lead projects such as Turks and Caicos will come together in 2009, but we continue to be very busy through the second quarter completing two new desalination plants in Grand Cayman that I discussed earlier as well as starting the rehabilitation and upgrade of the third plant for the Water Authority and we continue to evaluate potential new projects in the Caribbean and in South America and our outlook for continued growth in seawater desalination in these areas is still positive albeit at a slower rate in 2009.

Now I would like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ryan Conners from Boenning & Scattergood. Please go ahead with your question.

Ryan Conners – Boenning & Scattergood

Good morning, Rick and David.

Frederick McTaggart

Hi Ryan.

Ryan Conners – Boenning & Scattergood

I had a question for you on the Services segment. Obviously that’s been a real strong piece of the business for the last couple of quarters and I’m just trying to get a feel for how that the revenue and profit contribution from that segment evolves over the course of 2009. So if you could just give us an update on the outlook there and in particular the timing of when some of these current projects roll-off and what your current assumptions are for replacing or should I say sustaining, what kind of run rate that segment will run at ultimately later on this year? Any color you can give around that would be helpful?

David Sasnett

Do you want to handle that Rick or let me do?

Frederick McTaggart

You can handle the first part and then I can take the end where we talk about future outlook.

David Sasnett

Ryan, both of our contracts, the Bermuda contract and the Frank Sound contract that are generating revenues for us right now on a percentage of completion method will be finished probably before the end of the second quarter of 2009. So you'll see a significant decline in construction revenues. We have an ongoing contract for the management of the operations at OC-BVI, and those revenues will continue to be reported by the Services segment, but without replacement projects you'll see a significant decline in Services revenue next year.

Frederick McTaggart

Okay. I’ll just add that the Red Gate rehabilitation will startup in the second quarter, and that’s a much smaller project and Bermuda and Frank Sound combined. So you’ll see some revenues coming through from that but at this point that’s the project that we have on schedule for the rest of the year. Of course if things pan out in Trinidad and that could potentially change the whole picture as that’s a very large project and we were hopeful that would be competitive and get that.

Ryan Conners – Boenning & Scattergood

Okay, great that’s very helpful. And my second question was more of a big picture question. The Cayman Islands have been in the news quite a bit lately around this issue of the U.S. and the U.K. and some of the other major governments sort of trying to go after favorable tax localities like the Grand Cayman’s in terms of trying to go after people that have assets domicile there and corporations that have registered there sort of thing. My understanding is that’s a very important part of not only the Cayman economy but the Caribbean economy in general that is the two pillars of tourism and financial services. So I wonder if you could sort of developing story, but like to get your views on whether that's a real risk that could eat into that side of the economy and if so what the impact would be on the ability of some of these interior desalination plants and something that has a greatest chance of going forward in a successful growing economy. So any thoughts you have there would be appreciated.

Frederick McTaggart

Hey, Ryan it's really difficult to say how this is going to play out. I mean if you look back at 2000, some governments in Europe try to do the same thing essentially the financial action, task force and blacklisting a lot of these low tax jurisdictions. And you're correct. I mean, the Cayman Islands, British Virgin Islands, Bahamas were all - they fall within that category of low tax jurisdictions. Ultimately, everybody came through it. There is a lot of new regulation here. I think the U.S. and these European countries are trying to find people that are evading taxes. So maybe there will be some enhanced information exchange coming out of it. It's really difficult to say but certainly if there was a concerted effort to shutdown any sort of low tax jurisdictions that could effect the economies, people are still going to need water. So we think that it's not going to severely impact our business as severely as I would say a legal firm or an accounting firm or somebody that was down here. So we just have to see how it plays out.

Ryan Conners – Boenning & Scattergood

Well that's helpful. Thanks for your time.

Frederick McTaggart

Yep.

Operator

Our next question comes from Michael Gaugler from Brean Murray, Carret.

Michael Gaugler – Brean Murray, Carret & Co.

Good morning everyone.

Frederick McTaggart

Hi Mike.

Michael Gaugler – Brean Murray, Carret & Co.

Rick, I wanted to talk a little bit about kind of where we are with the Baugher’s Bay situation. Maybe you could give us a little color as to how far along the Court system is with this. And what I’m looking for is something in the lines of all paper works been submitted or the case has been argued to it's fullest extent, something along those lines. I mean, are we waiting just for the Court to rule? Or is there more testimony or paperwork to come in the future?

Frederick McTaggart

Mike, the trial hasn’t even started yet. If you recall, there was a question that we had asked the Courts to rule on regarding whether it should go to the court, the dispute should go to the court or go to arbitration? And in January, the Court said that they wanted to go the Court. So at this point the matter is on the Court schedule. I suppose there hasn’t been a trial date set and we haven't started arguments yet. The new claims have been filed and the defenses have been filed.

Michael Gaugler – Breann Murray, Carret & Co.

No I mean I’m not sure what the backlog is in that particular jurisdiction? But I’m guessing this probably doesn’t get resolved at the earliest until say midsummer?

Frederick McTaggart

It’s difficult to put a time on it. I know that the Courts have been inclined to treat it with priority because it is something of I guess national importance, the reliability of the water supply in Tortola. So I would think that would continue and hopefully we get an early trial date and so we are going to be pushing for and we will see how it works out.

Operator

Our next question comes from CJ Purtill from Janney Montgomery Scott.

CJ Purtill – Janney Montgomery Scott

Hello, David. Hello Rick.

Frederick McTaggart

Good morning.

David Sasnett

Good morning.

CJ Purtill – Janney Montgomery Scott

First question on the BVI situation, which you kind of just addressed. It’s disappointing that that the issue is going to essentially force you to continue to book these indefinite losses until we have a resolution. Assuming that we don’t have a real reliable timeline to go off of would you assume that that if there were to be a favorable decision that OC-BVI would go back to the accrual basis of accounting and start to book some of the positive earnings from the affiliate, immediately upon that judgment? Or I guess the question is does the positive judgment satisfy the revenue recognition requirements under SAB 104?

Frederick McTaggart

It would depend on if they appealed that judgment.

CJ Purtill – Janney Montgomery Scott

Okay.

Frederick McTaggart

We're looking for return to normal, so when it comes to the payments. And the big issue is not only have they reduced the amount of payments, the BVI government, but they've also spread them out to the point of where there's really no consistency or relationship to the contract. And so if there were a settlement by the court without an appeal and the BVI government began complying with the terms of the settlement over the new contract, then, yes, I think that OC-BVI could demonstrate that it meets all the criteria, recognized revenue under an accrual basis once the cash starts coming in.

CJ Purtill – Janney Montgomery Scott

Okay.

Frederick McTaggart

But it would depend on the terms of the court decision and the BVI government’s reaction to it.

CJ Purtill – Janney Montgomery Scott

Okay that’s helpful. And then just really quickly on Bar Bay, I believe you’ve been operating that plant for almost a quarter now?

Frederick McTaggart

No just – well since the beginning of the year.

CJ Purtill – Janney Montgomery Scott

Okay. So since the beginning of the year I guess, my question is has the government been paying that bill?

Frederick McTaggart

They have been billed for the water and there is always delay in payment there. We don’t have any reason to believe that they won't pay it. The first bill went for at the end of January, early February?

Operator

Our next question comes from George Whiteside from SWS Financial Services.

George Whiteside – SWS Financial Services

Good morning. I wonder if you could give us a little more detail on your recovery of increases in energy cost. All your contracts are setup in such a way as to fully recover any increases in energy cost?

Frederick McTaggart

Mr. Whiteside. I'll just say that our contracts guarantee the energy efficiency of the plant. So on that energy usage, we fully recover any increase in energy costs and as a rule we do recover the full increase in energy costs. We have reported in the past that we had one plant that was operating less than optimal efficiency in the Bahamas and we were not recovering the full cost but that’s documented in our filings, but generally as a rule we do recover the full increase in energy costs.

George Whiteside – SWS Financial Services

And conversely, I presume that with a reduction in energy prices currently that would been be a passthrough to your customers?

Frederick McTaggart

That's correct. That would reduce the charges that we bill them.

David Sasnett

Rick I would like to add that when you are looking at our energy passthrough cost, the good way to think of it is to look at the efficiency of the plants themselves. As Rick said earlier, we are required to deliver certain level of efficiency to our customers. If our plants operate at higher than the and better than the minimum efficiency, we have a slight benefit, and we can actually keep a small portion of those energy cost. If our plants operate at less than the minimum efficiency set forth in the contracts, then we don't recover everything and the energy passthrough actually works against us. If we're working right at efficiency then it's a non-issue. We don't either benefit or get punished by the energy passthrough.

George Whiteside – SWS Financial Services

Thank you very much now. I gather that the Bahama situation involved the Windsor plant and you commented that apparently you've improved the efficiency and perhaps brought about closer to the benchmark energy cost that you've guaranteed?

Frederick McTaggart

That's correct.

Operator

Our next question comes from the Robert Smith from the Center for Performance Investment.

Robert Smith – Center for Performance Investment

Hi, good morning.

Frederick McTaggart

Good morning Robert.

Robert Smith – Center for Performance Investment

Could you give me some feel for the long-term planning function within the company? I mean what kind of you run on a three-year or five-year plant and what do you see yourself taking the company over that period of time? And also I have second question what might be the optimal debt equity split in the company?

Frederick McTaggart

Just on the first question, we do have a strategic plan for the company. We don't sort of limit it on a year-to-year basis. We've disclosed in our filings that we believe that there is still lot of opportunities in the Caribbean within our existing markets and within other Islands that we don’t currently operate and to grow our business. The need for desalinated water is growing every year as water resources become stressed on these Islands and polluted and we think there is a great business opportunity for us in our current market area and having said that we also look from time-to-time at expanding our market into other areas where desalination is economically feasible. I think one of the questions earlier was how tourism impacts the economies here? Well the Caribbean market can support the cost of desalinated water because of the type of economies that operate here. And we would look for similar jurisdictions maybe in South America, maybe in the Pacific that we could make money through the sale of desalinated water.

Robert Smith – Center for Performance Investment

As that search been narrowed sufficiently to bring something like that closer?

Frederick McTaggart

I mean we are always looking at new projects. We will let everybody know if something materializes that is, outside of our current market area. We have talked in the past about looking at opportunities in Peru, in other areas of Central America, Mexico, possibly the Pacific Islands, but we don’t have anything that is close enough to announce yet.

Operator

Our next question comes again from Ryan Conners from Boenning & Scattergood. Please go ahead with your question.

Ryan Conners – Boenning & Scattergood

Yeah, hi guys. I just wanted to jump in with one more issue. I wanted to get your thoughts on a couple of contracts that are up for renewal. I know you probably can’t tell us too much on these given that their negotiations and so forth. But the first one is the Cayman 2010 renegotiation obviously that seems like the timing could have been better just given where the economy is et cetera, I'm sure the government is not in the mood to go out and pay a whole lot more for anything right now. And so your thought heading into that and what’s your sort of strategy is and what the issues you think will be. And then secondarily, my understanding is that the exclusive to DWEER license is up for renewal also in the relatively near future. So if you could just give us your thoughts heading into that and whether that’s something that will just be sort of automatically renewed or whether you're contemplating your options and if so what those might be?

Frederick McTaggart

Well Ryan on the Cayman franchise. We are early in discussions with the regulatory authority regarding that renewal. I mean at this point in our mind I mean we would like to get the same sort of deal that we have now but it’s very early to say how that’s going to turn out. We are going through a lot of the mechanical issues, technical issues at this point and we haven’t gotten into the meet of the discussions yet, which would be the rates. Regarding the DWEER distributorship, over the years that’s I think become lesser than important factor to our business. These other technologies that are available now that have been developed that perhaps would be more well suited to our needs. So we don’t see that as any sort of negative if we lose that distributorship or cancel it.

Ryan Conners – Boenning & Scattergood

Okay. Thanks again.

Frederick McTaggart

Yep.

Operator

Our next question comes from Robert Smith from Center for Performance Investment.

Robert Smith – Center for Performance Investment

I was just coming back into the second question about the leverage on the capital structure?

David Sasnett

I’ll take that Rick.

Frederick McTaggart

Yep.

David Sasnett

Clearly, our debt equity ratio is really low at the moment and ideally should be higher than that. Rather than give you an exact target I’ll say that what happens with our company is that for any construction projects we prefer to enter into long term 10 or 11-year fixed rate debt. And typically we're required to make some kind of equity contribution towards the project and what we like to do ideally is fund that project with anywhere from 15% to 20% equity and then leverage the rest of it. So you would expect to see our debt to equity ratio continue to increase as we win projects because given the cost of capital to us right now and we think it’s better given our credit standing to fund projects through debt. So that’s what you'll see going forward in the Company. We haven’t set an ideal debt to equity ratio. I don’t think that really exist things and things change, but you would expect to see a lot more leverage on our balance sheet as we gain new projects.

Robert Smith – Center for Performance Investment

You guys have a thought of the [restoring] the business into different area. I was just thinking about something like wind power or something there is a lot of wind in the Island so to speak?

David Sasnett

Well, we have looked to that from time to time. Energies are huge component of our cost and anything we can do to lower the cost of energy is certainly and something we would want to evaluate. They are complementary services to waste water treatment that we can do as well. Rick, do you have your thoughts on this?

Frederick McTaggart

Well I would just say from the standpoint of utilizing other technologies to enhance our core business, which is producing desalinated water. I could see as doing that and as David said diversifying into water reuse, which is a related membrane technology. From the standpoint of doing something completely different I think, our success has been the result of our expertise and seawater desalination and operating these SWRO plants very cost effectively. So we would really have to be convinced that we could get into the energy business or something and make money. I mean we want to focus on where we do best.

Robert Smith – Center for Performance Investment

Okay, you wouldn’t dismiss anything?

Frederick McTaggart

No I wouldn’t dismiss anything if we could make money for the shareholders.

Operator

And at this point in time, I’m showing no further questions and I would like to turn the conference call back over to management for any closing remarks

Frederick McTaggart

Thanks Jamie. I’d just like to thank everybody for joining us this morning and I look forward to speaking with you all in May and thank you very much.

Operator

To access the digital replay of this conference you may dial 1-877-344-7529 or 412-317-0088 beginning at 1 pm Eastern Time today. You will be prompted to enter a conference number, which will be 428960. You will be prompted to record your name and company when joining. This conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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Source: Consolidated Water Co. Ltd. Q4 2008 Earnings Call Transcript
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