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Consolidated Water (NASDAQ:CWCO)

Q1 2014 Earnings Call

May 13, 2014 11:00 am ET

Executives

Frederick W. McTaggart - Chief Executive Officer, President, Director and Chairman 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

Alexander Renker - Sidoti & Company, LLC

Stephen P. Percoco - Lark Research, Inc.

Hasan Doza

John Bair

Operator

Good morning, and welcome to the Consolidated Water Co. First Quarter Investors Results Conference Call. [Operator Instructions] This conference 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 profitability and other risks detailed in the company's periodic reports 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 day of this conference call. Please note this event is being recorded.

Now I'd like to turn the conference over to Rick McTaggart. Mr. McTaggart, please go ahead.

Frederick W. McTaggart

Thank you, Keith. Good morning, ladies and gentlemen, and thank you for joining us on our 2014 first quarter earnings call. Mr. David Sasnett, the CFO of Consolidated Water, is also joining me on the call this morning.

Net income in the first quarter this year was approximately $655,000 compared to approximately $3.7 million in the first quarter of 2013. A onetime option exercise payment to a previous shareholder of our Mexican subsidiary to maintain our 99.95% ownership in that subsidiary and our decision to pay a contractor for feed water sampling and piloting work performed for our Mexico project rather than extend our MOU with them resulted in incremental Mexico project development expenses this past quarter of $1.35 million.

It's also important to note that in the first quarter of last year, our results benefited from a onetime payment to our affiliate Ocean Conversion (BVI) related to the Baughers Bay litigation, which generated equity investment income for the first quarter of last year that exceeded our current quarter's amount by $1 million. So that's basically the variance in the earnings between this year and last year.

Aside from these onetime Mexico expenses and a slight weather-related drop in our retail segment revenues in Grand Cayman, our core business operations continue to perform very well.

Retail water revenues declined 4% to approximately $6.1 million last quarter versus approximately $6.4 million in the first quarter of 2013. And that drop was due to a 4% decrease in the number of gallons sold by our retail operations in Grand Cayman.

We believe that this decline in sales was primarily weather-related since rainfall for the first quarter this year was 12x higher than that of the first quarter in 2013. We also believe that some of our larger commercial customers have adopted water conservation strategies, which have resulted in declining sales trend over the past 3 years, and I think we discussed this on the last call in March.

Gross profit on retail revenues was down about $400,000 compared to the first quarter of 2013 on these lower revenues.

The judicial review hearing relating to our retail water license in Grand Cayman occurred on April 1 as scheduled, and we're waiting the court's interpretation of certain statutory provisions in the Water Authority and water production and supply laws. Prior to the hearing, the parties agreed by consent that the court would only consider the interpretation of these statutory provisions, and as part of that agreement, the Water Authority and government agreed to consider our representation that the rate of return model is not appropriate for our situation. These representations, which will include an alternate model to rate of return and a draft license, are to be presented by us to the Water Authority and government prior to May 30. And we will keep investors apprised as this issue progresses.

Our Bali, Indonesia operation contributed less than $25,000 to our revenues this past quarter. However, we're still very optimistic about the future of this project given that we recently connected a large golf course and boutique hotel to our water system in Sawangan, and we are receiving more inquiries about new connections now that the rains have stopped for the summer and water is becoming more limited in the area.

We presently have 250,000 gallons per day of water for sale and we're in the process of commissioning an expansion to 750,000 per day just in time for the dry season.

Bulk revenues were about the same this past quarter compared to last year at approximately $10 million versus $9.9 million last year. Our Cayman Islands bulk business generated about $150,000 more in revenues this past quarter compared to last year and accounted for all the increase to our revenues.

Gross profit on bulk revenues increased 7% to approximately $2.8 million or 29% of revenues compared with approximately $2.7 million or 27% of revenues a year earlier due to higher Cayman revenues and lower operating costs, which increased our bulk segment gross profit in Cayman from 24% last year to a very respectable 30% this past quarter.

Our services segment continue to incur an operating loss due to the development expenses related to our 100 million gallon-per-day desalination plant project in Mexico. And as mentioned earlier, we incurred this onetime expense of $1.35 million related to the exercise of the stock option and the payment to the contractor under the MOU.

We were awarded 3 new contracts this year by Water Authority-Cayman. The first is a new contract to refurbish the 800,000 gallon-per-day Lower Valley desalination plant in Grand Cayman, which will impact our service segment revenues through the first quarter of next year. And if you recall, this is a plant that we turned over to Water Authority at the end of the contract at the beginning of 2013. So now, they decided that they're going to refurbish the plant and extend the life of it.

The second is a 1-year extension through April of next year of the operating and maintenance contract for the 1.6 million gallon-per-day in North Sound plant in Grand Cayman. And revenues would continue to contribute to our bulk segment performance over the next year.

Finally, we entered into a new contract to provide a 60,000 gallon-per-day desalination plant in Cayman Brac, which is one of the sister islands in the Cayman Islands, which will also impact our services segment results through the end of this year.

The Lower Valley and Cayman Brac contracts were awarded to us through a competitive tendering process that included a number of overseas suppliers, and our success in obtaining these new contracts underscores how competitive we are in our home market.

Now David, would you like to discuss our liquidity and new financing for the land in Mexico?

David W. Sasnett

Sure, Rick. Good morning, everyone. As of March 31, 2014, our working capital amounted to $45.6 million, which is a little over 1/4 of our total asset balance. While our cash balances at the end of the quarter had declined since year end, we're pleased to announce that we have received $11 million in payments over April and May from The Bahamas government on delinquent accounts balances due to us. And The Bahamas government has informed us that additional payments will be forthcoming in the near future to further reduce their delinquent balances owed to us.

Late yesterday afternoon, we closed a short-term loan, a financing of about $10 million to fund a portion of the $17 million we plan to disperse tomorrow to complete the purchase of the land site for our proposed Mexican project. While this loan is due on-demand, principal payments are due under a 5-year amortization schedule with a balloon payment due at the end of 2 years. This well is part of a financing strategy pursuant to which we prepaid the remaining principal balances of approximately $5.2 million on our more costly bonds payable that were outstanding at the end of the year. But even after obtaining this new $10 million in financing, our debt balances constitute less than 7% of our total capital base.

In summary, we continue to maintain a very healthy balance sheet and we have ample liquidity for our operations and project development efforts.

With that, I'll turn things back over to Rick.

Frederick W. McTaggart

Thanks, David. I'll just talk a bit about the Mexico project now. We've -- in Mexico, we've held several meetings earlier this year with representatives of the Baja California state government regarding our project, which resulted in the presentation of a draft letter of intent to the state for consideration. We're currently awaiting the state's response and we're ready to proceed with detailed technical and financial negotiations as soon as we receive the signed LOI.

We also continue to work closely with Otay Water District in California as they applied for permits that are required to import water from Mexico and, in particular, we had participated in several meetings with Otay and the California Department of Public Health to ensure that our project will meet all applicable California regulatory requirements.

Otay and NSC have discussed a protocol relating to the long-term source water sampling program that is required by California regulators, and we hope to proceed with that program shortly.

And I'll just mention that I am actually in San Diego this week in Tijuana to close the acquisition of the final piece of land required for the project. This is, obviously, a very exciting long-term project for the company, and we'll keep you updated on all material developments as they occur.

I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question comes from Philip Shen with Roth Capital.

Philip Shen - Roth Capital Partners, LLC, Research Division

So I'd like to start off with Bali. You had an update there. It sounds like you've signed a golf customer or a golf course, as well as a boutique hotel. What's in the pipeline? Do you -- can you give us any sense for when you might be able to, on a contract, the full capacity they plan on bringing online? Or at least give us a sense for the number of parties you're talking to and, perhaps, in timing as to when revenues and production can ramp?

Frederick W. McTaggart

Well, I think we've mentioned on previous calls and, certainly, to investors that we believe there's about 6 million gallons of capacity in the area of the plant. The customers are price-sensitive, so they're not going to use the water when they have alternate sources that are less expensive and, as we know, desalination is a more expensive alternative. We believe that the dry weather season that they're in now will drive them towards using more of our desalinated water. We actually have our VP of Sales going over there for the next 2 weeks to work on several sales leads there, and we hope to have some additional news as we sign new customers. But investors should know that this will be a much more seasonal project than some of our other retail businesses. So you should expect that demand will vary during the year.

David W. Sasnett

And I'd like to add to Rick's comments, Philip, that, and for the other investors listening on the call, the Bali market is a bit different from the Caribbean and, apparently, customers over there are very hesitant to enter into long-term contracts. It's not normal business practice there. So therefore, we've adjusted our marketing approach, and if we're not going to give them long-term contracts, instead we'll settle with them on a short-term basis as needed. But obviously, the price we will charge will be higher than if they were willing to commit, say, a 3-, 5- or 10-year contract. So we're adjusting our approach to meet what is really expected in that marketplace. And I think, ultimately, it will result in, as Rick said, seasonal revenues but we're costing about the prospects for the plant. And Rick mentioned 6 million gallons of demand in the area. We -- it could be a size 8 million gallons of demand in this area. So it's a very fertile market for us. It's just going to take a little bit of time as it did in the Caribbean for people to realize that our water supply is of high quality and it's always there. And really, when you're looking at a solution for their problems, we're really the logical solution for them, and we are confident that sooner or later they will to come that realization and we'll sell out the capacity of that plant.

Philip Shen - Roth Capital Partners, LLC, Research Division

Great. Now let's move on to Mexico. I think in the release, you had a $350,000 expense. Can you do it due to the EPC contract that you, or the letter of intent that you had in place? Can you talk to us about what happened there? And did -- do you have a new EPC partner that you're working with as a result of moving on from this one?

Frederick W. McTaggart

Yes. So I mean, we had an exclusive arrangement with an EPC contractor for the project and that was more or less in place when we became involved in the project 4 years ago. And we evaluated what would be best for the project and what would be best for the future shareholders of this project. And we decided that we shouldn't have an exclusive arrangement. We felt like we should open up the project to more competitive landscape and there was no backroom on anything with the EPC. I mean, we still very much hope that they will eventually bid for the project. But we saw, at this point, that it would be best not to deal with somebody on an exclusive basis. So the work that they performed over the last few years, there were some compensation that was involved with that.

Philip Shen - Roth Capital Partners, LLC, Research Division

Okay. One more question for me and I'll jump back in queue. As it relates to the Cayman Islands, congrats on the awards that you've received in the quarter. Talk to us about the bidding process. Obviously, you won a competitive bid, but can you quantify the number of other bidders and, perhaps, what it took to win the business? And then if there are any other comments on -- about the Cayman Islands and the contracts that you have in place there, that would be great.

Frederick W. McTaggart

Yes, they're pretty secretive about the evaluation process that they go through. We found out just through the grapevine that there were several other companies that bid, but they didn't publish a sheet with the names or the bid amounts or anything like that, which I think is a bit unfortunate. But we submitted bids through the government with tendering commission and they were evaluated by independent people that are appointed to that commission by government and also by the Water Authority, who's our customer, and they informed us that we were successful on the 2 projects. And the third project, the extension of the North Sound agreement, we mentioned in the year end press release that we were given a 1-year extension for that, and they expect to tender that operation out early next year. So of course, we'll bid on that and, hopefully, we'll keep our successful record intact.

Operator

And the next question comes from Alexander Renker with Sidoti & Company.

Alexander Renker - Sidoti & Company, LLC

So Rosarito expenses during the quarter, about $1.9 million. Is that right?

David W. Sasnett

Yes, I think that's right, and we disclosed it in the Q. We always let investors know exactly what we spent. So you would have found that in the liquidity section and...

Alexander Renker - Sidoti & Company, LLC

Okay. I did see it in there. I just wanted to clarify because there was an issue of the exercise of the purchase option versus what other expenses were during the period. So there was the $3,500 -- yes?

David W. Sasnett

You take the total expenses and back out $1.35 million because the $1.35 million, it's really onetime expenses. So the actual ongoing project development expenses would have been the difference.

Alexander Renker - Sidoti & Company, LLC

Okay. Sure. And then on the LOI with the Baja California local government, when -- what's sort of the cadence down there? When might you expect to have some clarity on what will happen with that from the government?

Frederick W. McTaggart

We actually don't have a firm understanding. I mean, they're evaluating what we proposed and they have told us that there are other entities in the region that are promoting new water supplies and new ways of transporting water around the region. So I think they're looking at what their options might be. And we hope to hear back from them soon. That's all I can tell you at this point.

Alexander Renker - Sidoti & Company, LLC

Interesting. Can you say anything about your knowledge of what some of those other options might be for them at this point?

Frederick W. McTaggart

Well, if you want my personal opinion, I don't see that they're on the same sort of level that we're proposing and they don't solve the same problems. So that's really up to the government officials to decide though.

Operator

And the next question comes from Steve Percoco with Lark Research.

Stephen P. Percoco - Lark Research, Inc.

Could you tell us what's your estimated expenses in Mexico for this year? How much more do you expect to spend there in development costs? And if you have a number for next year, that would be great, too.

David W. Sasnett

If you look at the 10-K in the liquidity section, we talk about Mexico. We outlined the $17 million we're going to pay for the land. We talked about the $1.35 million that was paid for this quarter. And then there's also a figure that we gave for the remaining cost of the full year. If you take that figure and back out what we spent this quarter, we have no reason to update at this point in time. We think still that's our best estimate.

Stephen P. Percoco - Lark Research, Inc.

Okay. So even though this -- the $1 million payment wasn't a surprise, it was factored into your estimate for the 10-K and likewise...

David W. Sasnett

That's correct. Just take a look at liquidity section and also look at the NSC disclosure in our 10-K, and we outlined in as much detail as possible exactly what we plan to spend for the rest of this year. We do not have any estimates yet for 2015.

Stephen P. Percoco - Lark Research, Inc.

Okay. And are you going to spend the $5 million for land this year, as well?

David W. Sasnett

It's $17 million, and we're actually going to disperse that money tomorrow. But $10 million of it is already in the balance sheet. So we'll replace the $10 million of land purchase commitment with $10 million with the new financing and fund an incremental $7 million from our cash balances.

Stephen P. Percoco - Lark Research, Inc.

Right. And on the financing for Mexico, it sounds like your intention is to keep this loan outstanding, even though it is a demand loan, and not refinance it with longer-term, say, fixed-rate debt, is that true?

David W. Sasnett

Well, the plan is to sell the land ultimately to the special purpose vehicle that will build the plant. So hopefully, we'll be moving towards financial closure within 2 years and that the land that's sold will be paid on that way. We could prepay the loan. We have substantial cash balances, including balances that are in The Bahamas, will probably, ultimately, be sent back to the Cayman Islands, assuming we get approval from The Bahamas Central Bank to do that. So yes, we'll look at the possibility of prepaying this loan. It's not at the high interest rate, so it's not really going to hamper us that much. The financing is really cheap, but it depends on what our strategy is. I don't think we necessarily have any plans to take that $10 million loan or refinance it long-term only to repay it ourselves, or we'll end up selling the property to the development project company and getting the payment on the land and then repaying the loan that way.

Stephen P. Percoco - Lark Research, Inc.

Okay. Could you talk a little bit more about the court hearing and the process that's in place right now? As I recall, there were 2 objections that you had to the regulatory law. One, you saw the Water Authority of Caymans as a competitor and thought that there was a conflict. Second, you objected to the rate of return. From your comments in court on April 1, did you argue against WAC as a regulator, or did you drop that? And now, as a sole issue, the formula for reimbursement, any color that you can give around this would be helpful.

Frederick W. McTaggart

Well, as I mentioned earlier, we agreed before the hearing that the court would only deal with, well, there's actually a third thing that we were asking the court to consider, and that was some conflicting -- what we viewed as conflicting provisions of new legislation that was passed back in 2011. So before the hearing, we agreed that the court would only consider the interpretation of the new legislation. And we agreed that by consent that the Water Authority and the government would consider our representations that the rate of return model was not appropriate for our situation, which really address the issues of the Water Authority's -- what we viewed as a pre-determined outlook on the rate of return model and also the conflict, more or less addressed that. So now, the parties will discuss other regulatory options, which was agreed by consent and did not ultimately go to the court. And what we're waiting from -- are waiting on from the court is really an interpretation of the laws in the Cayman Islands and how they apply to us.

Stephen P. Percoco - Lark Research, Inc.

Right. Okay. So I guess I'm trying to understand how things might unfold here. Obviously, if they come around to your view that the rate of return model is inappropriate and they modified their approach, then you're happy with it and you'll accept WAC as a regulator and everything will get resolved at this point. Is that fair?

Frederick W. McTaggart

Well, there's no option for us not to accept them. I mean, they are the regulator under the law. But what it does is allow us to at least negotiate on the regulatory model now. Whereas before the hearing, they were basically determining that it will be a rate of return model. So it gives us the opportunity to have some dialogue about what we think would be better for all the parties.

Stephen P. Percoco - Lark Research, Inc.

But presumably, if they say, we've considered your comments and we disagree and this is the way it's going to be, I mean, that's something that you'll have to accept. Is that also fair? Or I mean, I know you don't want to get into what your negotiations might be, but if you could give any color around that, that would be helpful.

Frederick W. McTaggart

Well, I mean, all I can say is we'll determine what our further actions would be at that point and we haven't gotten to that point yet. In fact, we've gotten them to agree to at least hear our point of view. So I think we should just -- we're focused on that and we're focused on making a very reasonable and logical argument to them that there are alternatives to the rate of return, and we'll just see where it takes us.

Operator

And the next question comes from Hasan Doza with Water Asset.

Hasan Doza

My question was on your account receivable. Year-over-year, your receivables went from $14 million last year to $24 million at the end of last quarter. Can you just give a little bit more color as to what caused the kind of bulging of the receivables and the plan to collect some of those receivables?

Frederick W. McTaggart

Yes, David mentioned earlier that we have actually received $11 million in payments after the March 1 -- you can locate in our liquidity section of the 10-Q. So most of that increase was related to receivables in The Bahamas, and we've had discussions with the government there for several months now and we have received payments subsequent to the balance sheet data in the 10-Q.

David W. Sasnett

They gave us $11 million, Hasan, and they told us more was on the way. So...

Operator

[Operator Instructions] And the next question comes from John Bair with Ascend Wealth Advisors.

John Bair

A couple of questions. On your new contracts, are those -- the payment schedules on those, do you get paid as you do the work or is it a kind of end-of-completion payment on those?

Frederick W. McTaggart

I believe both of them are completion payments. I think that was one of the things that we offered to the Water Authority to enhance our competitiveness. So we'll book the work in progress as we move through the agreement, but I believe that the payments are based on completion.

John Bair

Okay. So that would -- I was trying to interpret when you said they will impact your services segment and so that made me wonder if that's -- it was a payment upon completion, so okay. And the other question I have in regards with Bali, since the locals will buy water sort of as needed, how do you go about your operating of your desal plant to accommodate the ongoing needs? And is there a possibility or do you actually store water for later use? Or does that make any sense? In other words, how do you adjust your production of water to accommodate the seasonality, let's say, of the demand?

Frederick W. McTaggart

Well, I mean, we can just run the plant less frequently when the demand is lower, and then we do have a water storage on our site that smooths out the starts and stops of the plant. So we don't see that as an issue at all. There's no operating issues that arise because of that, because of the seasonality.

John Bair

And can some of that water that's produced there, could it be -- would it be feasible to like truck it to other areas outside of the immediate resorts areas for sale?

Frederick W. McTaggart

Well, yes, absolutely, in fact.

David W. Sasnett

I'll also say a number of companies do that with us at the moment, but we're not going to get into the water trucking business ourselves.

Frederick W. McTaggart

Yes.

David W. Sasnett

And we have water trucks pull up to the plant. They bought water from us in the past. Actually, the capacities from the plant, hopefully, will work in our favor because we expect, at some point in time, the demand on the plant during the dry season to exceed our capacity and, therefore, customers will be willing to commit to longer-term contracts, which will justify our further expansion of the plant. So in a way, we're going to make the lack of the seasonality, we hope, work in our favor.

Operator

And as there are no more questions in the present time, this concludes our question-and-answer session. I would like to turn the call back over to management for any closing remarks.

Frederick W. McTaggart

So I just want to thank everybody for joining us and for the good questions this morning. And I look forward to speaking with you again in August when we talk about our second quarter results. Thank you.

Operator

Thank you. To access the digital replay of this conference, you may dial 1 (877) 344-7529 or 1 (412) 317-0088 beginning at 1:00 p.m. Eastern Time today. You'll be prompted to enter a conference number, which will be 10045961. Please record your name and the company when prompted.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a nice day.

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