Consolidated Water Management Discusses Q3 2013 Results - Earnings Call Transcript

Nov.13.13 | About: Consolidated Water (CWCO)

Consolidated Water (NASDAQ:CWCO)

Q3 2013 Earnings Call

November 13, 2013 11:00 am ET

Executives

Frederick W. McTaggart - Chief Executive Officer, President, Director and Member of Executive Committee

David W. Sasnett - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Director

Analysts

Philip Shen - Roth Capital Partners, LLC, Research Division

Hasan Doza

Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

Alexander Renker - Sidoti & Company, LLC

John Bair

Operator

Good morning, and welcome to the Consolidated Water Company Third 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 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 Rick McTaggart. Please go ahead, sir.

Frederick W. McTaggart

Thanks a lot, Chad. Good morning, ladies and gentlemen, and thank you for joining us today on this call.

Net income during the past quarter was approximately $910,000 compared to $1.3 million in the third quarter 2012. This decline resulted from a decline in retail segment revenues and gross profit due to wetter weather conditions in Grand Cayman this past quarter.

Retail revenues declined about 12% or $680,000 due to a 17% decline in the number of gallons sold in our Cayman retail operation compared to the third quarter of 2012. We believe that this decline in gallons sold was directly related to higher rainfall amounts in our Cayman Islands service area during the past quarter. Higher rainfall tends to reduce the amount of water, which is required by our larger customers for golf course and landscape irrigation and topping off swimming pools. So that impacted gross profit of our retail segment, which decreased by 19% or about $500,000 on lower revenues.

Looking to the future in retail, construction work continues on 2 large developments in our service area in Grand Cayman, which will eventually be significant retail water customers. The WaterColours development is a 60-unit luxury private residence project that is expected to open by mid-2014, and the Kimpton hotel, which I talked about in the last call, is a hotel-condominium property with 250 hotel rooms and 62 condo units, which is expected to open in 2016. It is estimated that together, these properties will add about 23 million gallons per year to our retail sales.

In late August, we met with representatives of the Cayman Islands government and the Water Authority to discuss the status of our retail license negotiations. As a result of this meeting, all parties agreed to await the outcome of the pending judicial review before conducting any meaningful negotiations on the license. Subsequently, our water utility license on Grand Cayman was extended until June 30, 2014, to allow additional time for the negotiations and the judicial review proceedings to conclude. The Grand Court of the Cayman Islands has scheduled the first hearing of the judicial review for April 1 and 2 of next year, and we will keep investors apprised as this issue progresses.

So looking at our bulk segment. Improvement in the performance of our bulk segment this past quarter helped to offset the decline in retail segment gross profits. Our bulk revenues increased by 2% or $200,000 in spite of the loss of revenues from one of our bulk water contracts in the Cayman Islands, which expired in January of this year.

Gross profit of our bulk segment increased 31% or $700,000 compared to a year earlier due to improved operating margins and a reduction of approximately $450,000 in depreciation expense as certain assets which we continue to operate in the business reached the end of their estimated depreciable lives during the fourth quarter of 2012 and early this year.

The company adheres to extremely rigorous equipment maintenance standards and utilizes a state-of-the-art computerized maintenance management system, or CMMS, to manage complex maintenance information and schedules. And the information captured by this CMMS, coupled with the exceptional maintenance procedures, has allowed us to extend lives of -- and service intervals of certain equipment in our plants, which is translated into cost savings and improved operating margins, particularly in the bulk segment.

We previously reported that the water supply agreement with the Bahamas Water & Sewerage Corporation for our Windsor plant ended in early July. In September, the government of the Bahamas has asked us to continue operating the plant while it decides whether or not it will extend the present Windsor contract with us on a long-term basis. So we're currently awaiting the government's decision, and we'll advise investors of any material developments.

Meanwhile, in The Bahamas, we continue to produce 20% more than contracted capacity from our Blue Hills plant to assist the Bahamas Water & Sewerage Corporation in meeting its water demand. This equates to more than 55 million U.S. gallons of additional water per month that we have been consistently delivering since the beginning of the year.

Our services segment incurred an operating loss last quarter, although on higher revenues because we run all of the funding for our Mexican development project through that segment. We expect our service segment to continue to incur operating losses until we've completed the development of the Rosarito, Mexico project.

Sales from our newly constructed desalination plant in Nusa Dua, Bali were modest this quarter. However, we are experiencing ever-increasing interest in our desalinated water and toward the end of the third quarter, began selling additional water under short-term arrangements to several new customers.

As a result of the feedback we've received from these new customers, we have decided to increase the production capacity of our Bali plant from its present 250,000 gallons per day to 750,000 gallons per day in order to meet what we expect will be an inevitable increase in the demand for our water. This plant expansion should be completed by the end of the first quarter of 2014, and we remain very excited about the opportunities that lay ahead in Nusa Dua, Bali and other water-short places on the island and in the region.

We continued to make good progress on our Rosarito, Mexico desalination plant and pipeline project this past quarter and completed the first phase of our pilot plant and water sampling program in October. We're currently developing additional water sampling protocols to comply with regulatory requirements in Mexico and the United States and are coordinating with regulators to assess any future pilot testing requirements.

Also, last quarter, we completed geotechnical testing of the plant site and conveyance pipeline route and are currently developing detailed design drawings of the conveyance pipeline from the plant to the international border. We've also been working with our environmental engineers and expect to be in a position to submit our environmental impact studies for the plant and the pipeline to the Mexican authorities before the end of the year.

We had the opportunity last week to present our Rosarito project to the International Border (sic) [Boundary] and Water Commission, or IBWC, which is also known as CILA in Mexico. The presentation was attended by IBWC and CILA representatives, as well as representatives of water-related governmental agencies in both the U.S. and Mexico that have been involved in the binational desalination project for many years. We believe that our project was well received, and we're optimistic that this meeting will lead to the establishment of collaboration protocols between the company and these important governmental agencies on both sides of the border.

So Chad, I'd like to open up the call for questions now.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Philip Shen with Roth Capital Partners.

Philip Shen - Roth Capital Partners, LLC, Research Division

I was a little late to the call because I'm jumping between earnings calls, so I may have missed it. But it sounds like things are moving along with the Cayman Islands government. Can you just give us some more color as to how that relationship is developing and perhaps what you see between now and April 1 with the first court hearing date? Is there anything that can develop in a positive way? Or any opportunity to just pursue and develop things further there?

Frederick W. McTaggart

Yes. As mentioned, we met with the government and Water Authority in August. And basically, everybody agreed to kind of sit back and wait for the results of the judicial review before conducting any meaningful negotiations. I don't foresee anything changing until after the judicial review is decided. And that could -- the first hearing is obviously in April, but it could take some time after that before the judge issues his decisions on the matter. So if they want to sit down and talk with us, obviously, we're willing to continue negotiations pending any decision by the court. But it's likely that things are not going to change until after the court has issued a decision.

Philip Shen - Roth Capital Partners, LLC, Research Division

And after your first meeting, can you talk about how -- what the overall body language was? And how does that compare with the prior government?

Frederick W. McTaggart

Yes. I don't think there was anything to say other than what we said in the Q and what I just told you. I mean, there wasn't anything different really.

Philip Shen - Roth Capital Partners, LLC, Research Division

Okay, great. And can you give us an update on Bali? I know you talked about expanding capacity, and that's great. You've signed some short-term agreements. Is the situation here such that they want to just test out the water for a short period of time and they will -- if there's real potential, to sign a long-term agreement? What's their thinking on pricing? Are they coming around to your pricing model? So some additional color in Bali, which sounds like an exciting opportunity that's developing well, would be helpful.

David W. Sasnett

Philip, this is David. We've learned that Bali is a little bit different from the other markets in which we do business. Long-term contracts for things like water is really not typical there. We've had to educate these people on how we'd like to do business. What's happened is they started taking water, several of these hotels, started taking water from us around September and October sort of to try it out. And they're beginning to understand that the quality and the reliability of the water that we are providing really are better than anything they can get from any other source and they're also beginning to acknowledge the fact that at some point in time, they're going to have to address their water needs. So we've had discussions with several hotels, and we believe that ultimately, these discussions going to lead to perhaps not the kind of long-term contracts we have in other markets but contracts that are -- they're long enough, I guess, for that market to just probably going ahead and entering into an arrangement with them. Really, we think they're finally understanding and getting it when it comes to what they have to do with respect to their water supplies. So we felt confident enough based upon the feedback we've gotten from them to go ahead and expand the plant from 250,000 gallons per day to 750,000 gallons per day because we believe certainly within a year or so that we'll have all of that capacity sold or close to it. So, I mean, there's not any guarantee of that, but we used the term -- Rick used the term inevitable in his speech or in his conference call notes, and we just see it as inevitable. There's not anybody else coming in there with viable solutions to address what's going to be a water shortage in an area of the island that really uses a tremendous amount of water to support its hotels. So anyway, I don't think we'll ever have long-term contracts with these customers. I don't think the marketplace lends itself to that. But I do think we can have very profitable and short-term contracts that ultimately, for all intents and purposes, will have long durations.

Frederick W. McTaggart

They're month-to-month contracts.

Philip Shen - Roth Capital Partners, LLC, Research Division

Just a quick follow-up there. Now that you've gotten to know the market and have helped them understand the value that you provide and you've expanded capacity to the 750,000 gallons per day, how much more -- like within 2 years, I mean, how much -- I know there's a lot of potential, but on a practical kind of level, how much more -- how large could this capacity be in Bali, practically speaking, call it, within 2 or 3 years?

David W. Sasnett

Well, I don't know how long -- just to give you an idea of how much water is used in the region, I think the water usage in this area is 7 million to 8 million gallons a day. Now how much of that we will get? I don't know, there's [indiscernible] water supply. But we wouldn't have entered into Bali if there wasn't the opportunity to do a lot more than 750,000 gallons per day there. And that's just in the Nusa Dua region. There are other areas of Bali that we really haven't approached at the moment that also have water shortages. So the entire island is a very positive situation for us. It's just taking us a while to get in there and understand exactly how these people want to do business. But in the Nusa Dua area, there are several million gallons of potential business there.

Philip Shen - Roth Capital Partners, LLC, Research Division

Good. And one last question, and I'll jump back in queue. You had to educate them on pricing on the region. Have they come around to your pricing model? Or have you had to cut pricing to kind of get the first contracts going? And so if you can talk about the economics of it, that would be helpful as well.

David W. Sasnett

Well, the project that we have -- we've deployed there is pretty consistent with what we would expect from a return on investment standpoint. I mean, that's the bottom line. We don't make money. We don't invest in capital projects if we can't get the minimum return on investment that we need. So we're certainly not having to reduce our pricing below the threshold that we would say is a minimum for our ROI. And I think over time, we'll be able to increase our pricing. We've never seen a situation in our markets where people start using our water and then decide that they don't want to use it. So we feel like regardless of the price that we offer upfront, eventually, we'll have pricing that is as good or better than what we offered initially.

Operator

Our next question is from Hasan Doza with Water Asset.

Hasan Doza

I just had a quick question. In terms of the development expense for your Rosarito project, what is the total amount you guys are expecting for the full year? I did see in your 10-Q the 9-month number was around $2.2 million. So I was wondering, what is sort of your full year 2013 expectation of development costs?

Frederick W. McTaggart

I think that's actually disclosed in there, isn't it?

David W. Sasnett

Yes. We have $7 million that we expect to spend in terms of actual development cost, and then there's another requirement of about $17 million to purchase the land.

Frederick W. McTaggart

This is over the next year, though, yes.

David W. Sasnett

We haven't disclosed the remainder for this year.

Hasan Doza

Okay. Because in the beginning of the year, you guys have mentioned, if I'm not mistaken, that you plan to spend about $4 million incremental this year on development expense versus last year. So for the first 9 months, you have spent $2.2 million. So I just wanted to confirm, based on your prior comments, that the $4 million spend for this year, is that still kind of the run rate?

David W. Sasnett

I don't think we got any -- we've had any update to what we plan to spend this year. I think that's pretty much on track. Is that right, Rick?

Frederick W. McTaggart

I think this will a little less than the $4 million, actually.

David W. Sasnett

Yes, I would say $4 million is still a good number. Then if I understand you correctly, you're going back to [indiscernible] so we've spent $2.2 million so far, so you're asking me -- I don't think the amount we will spend for the fourth quarter will exceed $1.8 million. I don't think that's going to happen.

Hasan Doza

Okay. But it could be $1.8 million, right?

David W. Sasnett

Yes, it could be in that range.

Hasan Doza

Okay. So for modeling purposes in the fourth quarter, then we should think about a meaningful SG&A incremental number, something like $1.8 million for the fourth quarter. That's kind of what we should think about for fourth quarter?

Frederick W. McTaggart

That would be the maximum amount we would spend, Hasan, based on what we know today.

Hasan Doza

That's fair. That's helpful. So I can model fourth quarter properly. And last question is, do you have any preliminary thoughts as to how we should think about this run rate for 2014? I mean, should I think about another incremental $4 million? I mean, what's your run rate that I should think about for next year?

David W. Sasnett

I think we've disclosed that we expect to spend $7 million.

Frederick W. McTaggart

By the third quarter of next year.

David W. Sasnett

Yes. That's the best estimate we have right now. We are hopeful to have all the development work done by the end of the third quarter next year.

Hasan Doza

Okay. So if you've spent $4 million this year and then basically I should plan on another $3 million for next year, that's your $7 million. Is that a fair way to think about it?

David W. Sasnett

No, no, it's $7 million from the end of this quarter.

Hasan Doza

Okay, $7 million from the end of this quarter, okay. So if you do $1.8 million, as you said, max in fourth quarter, then we should think about another, say, $5 million for...

David W. Sasnett

$5.2 million, yes, that's correct.

Hasan Doza

Okay, that's very helpful. I appreciate it.

Frederick W. McTaggart

I'll just mention, Hasan, that, that is dependent on how much additional pilot testing we need to do because that's a pretty expensive item. If we're required to go and do a second phase of equipment testing, then that's sort of the worst case that David gave you.

Operator

Our next question comes from Ryan Connors with Janney Capital Markets.

Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

This is actually Ken Dorell in for Ryan. I just have one question kind of pertaining to the Bali. It's very encouraging that you guys are seeing the demand to increase capacity from 250,000 to 750,000. And I'm just curious, activity there, obviously, increased in 3Q from 2Q as well. Can you give us an idea as to the capacity that you were operating at in 3Q as far as the demand you saw, the 250,000 gallons per day?

Frederick W. McTaggart

We weren't selling. We weren't even selling the 250,000 in Q3. That 67,000 -- I think we have the 67,000 gallons, $67,000 worth of revenue reported in Q3, that was just for one customer. The other customers that we're bringing on, they didn't start -- they won't impact revenues until the fourth quarter. And really, all of these are guys that just took small -- they took relatively small amounts of water from us on short-term arrangements to test out things, to see the quality of the water. But they're -- I think they're coming around because they understand that we are very, very reliable and some of the other sources on the island are not. So we'll be able to give you a lot more insight into what we expect to do in 2014 towards the end of the fourth quarter.

Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

Okay. And just as far as the terms are for the short-term contracts, are those on a month-to-month basis or annual? How does that work?

David W. Sasnett

Month-to-month.

Frederick W. McTaggart

Month-to-month, yes.

Operator

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

Alexander Renker - Sidoti & Company, LLC

So on the retail revenue decline, I know the weather played a part. But was there anything else that you guys saw, maybe adjustments to pricing with the consumer price index, anything like that, contract changes, et cetera?

Frederick W. McTaggart

No, there wasn't anything. The pricing doesn't change until January 1 under our license.

Alexander Renker - Sidoti & Company, LLC

Okay, okay, that's helpful. And then on the N.S.C. project, it looks like you guys converted the loans. So basically, you have full ownership of that entity now, is that right?

Frederick W. McTaggart

That's correct, yes.

Alexander Renker - Sidoti & Company, LLC

Okay. So that means that -- I guess could you remind me of the time frame there? I mean, after the pilot testing is done, if everything goes according to plan, and that finishes up in the third quarter of next year, what does construction look like after that?

Frederick W. McTaggart

Well, the objective is to finish the development in third quarter, take the project to a financing phase and close financing on the project around the third quarter, fourth quarter of next year, and then construction would presumably start soon after that. We wanted to get the project operational by 2017. So that's the objective. What we're finding -- well, I mean, our focus now is really on getting contracts with customers. In California, what that means is working through these regulatory issues that they have in the United States. So we mentioned in the press release that we're developing new sampling protocols to meet those requirements. And presumably, we'll begin negotiating the contract within the next 3 months or so. On the Mexican side, again, the focus is to begin contract negotiations for the offtake agreement in Mexico. There were elections in Baja at the municipal level in Tijuana back in July. So the new governor or the new mayors of Rosarito and Tijuana have been taking their positions over the last few weeks. And obviously, that has slowed down any meaningful discussions on the Mexican side until those people are settled in. So I would expect to have some good things to report early next year regarding the offtake agreements. And that's really where our focus is now.

Alexander Renker - Sidoti & Company, LLC

Okay. And that 20 million to 40 million preliminary agreement with Otay in California still stands?

Frederick W. McTaggart

Yes, 25 million to 40 million gallons a day is what they indicated they're interested in.

Alexander Renker - Sidoti & Company, LLC

25 million to 40 million, okay. And then as construction starts and that financing round gets done, what are your expectations as far as financing goes? Have you formulated any at this point?

Frederick W. McTaggart

Well, I mean, we do have estimates, obviously. I mean, we're not prepared to disclose any of that. KPMG is doing work for us on that part of it, really testing the bond markets in Mexico and things like that and coming up with estimates for us on financing terms and pricing that we could expect. So that's well underway.

Operator

Our next question is from John Bair with Ascend Wealth Advisors.

John Bair

Just a couple of quick questions. The land purchase obligation, when is that due? Is that after next year? You put it on as a liability there, so when does that become due?

David W. Sasnett

I think it's May of 2014.

Frederick W. McTaggart

May 15 is when we have to close those 2 purchases.

John Bair

Okay. And another question is what are your incremental costs to expanding your Bali operations there? Is it...

David W. Sasnett

We disclosed about $2 million.

John Bair

Okay. And is that -- okay. Is that part of that -- the incremental amount for -- that was discussed earlier going from...

David W. Sasnett

We talked about an incremental amount of $7 million of operating development costs for Mexico and another $17 million for the land. But not included in that is $2 million of additional capital cost to finish expanding [ph] the Bali plant.

John Bair

Okay, okay, very good, okay. And one last question, and I'll get back in the queue. And that is your services trend seemed to be -- revenues trend seems to be headed back up again. Do you feel like that's something that's sustainable? Or is that -- what are your thoughts on that?

David W. Sasnett

The services revenues we're getting right now are primarily derived from the agreement we have with OC-BVI to manage their business there. And that's pretty stable. There's not any -- there's not really any incremental growth there that would be expected. So you're not going to see it very significantly going forward.

Operator

[Operator Instructions] There appears to be no further questions at this time. So I'd like to turn the conference back over to Rick McTaggart for any closing remarks.

Frederick W. McTaggart

Yes, thanks, Chad. I just want to thank everybody for joining us, and I look forward to speaking to you guys again in March 2014 to discuss our year-end results. Thank you.

Operator

Thank you very much. To access the digital replay of this conference, you may dial 1 (877) 344-7529 or (412) 317-0088 beginning at 1:00 Eastern Time today. You'll be prompted to enter a conference number, which will be 10036317. Please record your name and company when prompted. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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