Consolidated Water's (CWCO) CEO Frederick McTaggart on Q2 2014 Results - Earnings Call Transcript

Aug.12.14 | About: Consolidated Water (CWCO)

Consolidated Water (NASDAQ:CWCO)

Q2 2014 Earnings Call

August 12, 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

Hasan Doza

Jarrett James Perez - Two Oaks Investment Management, LLC

Michael E. Gaugler - Brean Capital LLC, Research Division

Operator

Hello, and welcome to the Consolidated Water Co. Ltd. Second Quarter Earnings -- Second Quarter Operating Results Conference Call. [Operator Instructions]

Please note, this conference may -- 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 reported -- 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, this conference is being recorded.

Now I'd like to turn the conference over to Mr. Rick McTaggart, CEO and President.

Frederick W. McTaggart

Thank you, Amy. Good morning, ladies and gentlemen, and thank you for joining David Sasnett and I on the call this morning.

Net income in the second quarter of this year was approximately $2.76 million compared to approximately $2.85 million in the second quarter last year. And this was on slightly higher revenues of $16.9 million compared to $16.6 million in the second quarter of 2013.

Retail water revenues increased by 5% to approximately $6.5 million in the most recent quarter versus $6.2 million in the second quarter last year due to an 8% increase in the number of gallons of water sold by our retail operations in Grand Cayman and our new Bali, Indonesia operation. We believe that our retail sales on Grand Cayman benefited from dry weather conditions. And it's important to note that this past quarter ended a 3-year trend of marginally declining retail sales in our Cayman Islands market.

Gross profit on retail revenues increased 2% to approximately $3.4 million compared to $3.3 million last year on these higher revenues. In June, the Cayman Islands court issued its final rulings on various matters relating to our Cayman Islands retail water license negotiations. The court determined that we're required to follow the new licensing procedures that were established by legislation enacted in 2011. So what this means is that we must obtain a license from the Water Authority, as well as a concession from the Cayman Islands government.

From a practical standpoint, we'll be negotiating with both parties to obtain a renewal of our retail water license. And as you recall, we had hoped that we would only have to negotiate with the government, but as it turns out, the court has determined that we will be negotiating with both the government and the Water Authority.

Additionally, the court determined that a competitive tender process is not required for renewal of this license given that we have the right of first refusal in the existing license.

Prior to the judicial review in April, the Water Authority and the government agreed to consider other rate models in addition to the RCAM model or rate of return model, and we submitted several expert reports to the Water Authority and the government in early June, which made recommendations regarding more appropriate alternative water rate models. We expect to receive a response to those reports soon.

In the meantime, the government has extended our existing water license until the end of this year.

As anticipated, due to drier seasonal weather conditions, revenues from our new retail water operation in Bali, Indonesia increased significantly during the past quarter due to higher volume sales to golf course and resort customers in the Nusa Dua area. Although these sales are still quite modest in dollar terms, the volumes had more than quadrupled compared to the second quarter of 2013. And we expect these higher volume sales to continue through the end of October in conjunction with the Bali dry weather season.

And it's good to note that we've been able to meet all of this incremental water demand due to the expansion of our desalination equipment earlier this year.

Now looking at our bulk segment. Bulk water revenues declined slightly by 2% this past quarter compared to the second quarter of last year, and this drop was from $10.2 million in 2013 to approximately $10 million in the most recent quarter. Revenues from our Bahamas company declined about $660,000 due to our customer's successful implementation of a multi-year water loss reduction program in their distribution system.

On the other hand, our Cayman Islands bulk business generated about $435,000 more in revenues this past quarter compared to last year due to higher volume sales to Water Authority-Cayman. So the higher Cayman sales almost offset the decline in revenues in the Bahamas business.

Gross profit on bulk revenues was essentially unchanged at $3.1 million for the 2 comparative quarters.

Now looking at services revenues. Service revenues increased by 105% or approximately $250,000 during this past year compared to 2013 -- this past quarter compared to 2013 due to revenues generated by our 2 planned construction projects for Water Authority-Cayman that we discussed during the last conference call in May, and both of these projects are progressing to our expectations.

Our service segment continued to incur an operating loss, which we expect will continue while we develop our 100 million gallon-per-day desalination plant project in Rosarito, Mexico.

Now I'll turn the call over to David for his comments.

David W. Sasnett

Thanks, Rick. I'd just like to make a few comments about our liquidity, our borrowings and our financial condition. Our cash flows from operations for the 6 months ended June 30 were almost $22 million, which I believe is the highest of any 6-month period in the history of our company. These operating cash flows included payments from the Bahamas government to satisfy the past 2 invoices and the interest that was due thereon. And that contributed to an overall decrease to our accounts receivable of $6.9 million since December 31, 2013. We elected to take some of this money that we received from the Bahamas government and invest $5 million of it in a certificate of deposit at the Bank of the Bahamas.

In May 2014, we completed the purchase of the land in Rosarito Beach required for NSC's project. This land consists of almost 45 acres and is strategically located next to a major power plant, which employs a direct seawater intake system to cool its operations. The seawater discharge in this plant is the plant's source of water for the Rosarito desalination plant project. We obtained a $10 million loan at our parent company level to facilitate the payment of the $17.4 million in cash that was due at closing for the land purchase. Technically, this is a demand loan, and it's callable by the lender. However, we expect to repay it pursuant to a 5-year amortization schedule that has a balloon payment of the unpaid principal at the end of 2 years.

We're pleased to report that we continue to enhance our financial condition over the last -- the first 6 months of this year. At June 30, 2014, our stockholders' equity of $140.4 million constituted 87% of the capital funding for all of our assets, while our total borrowings, despite the addition of the new demand loan, amounted to only 6% of our funding. And we have total liabilities of just around $18 million as compared to equity of $140 million. So we have a very ancillary balance sheet with ample borrowing capacity and substantial working capital, so I think we're well positioned to move forward to pursue new projects and to complete what we have on the table.

Now with that, I'll turn the call back over to Rick.

Frederick W. McTaggart

Yes, thanks, David. I'll just say a couple of things on these projects that -- the Rosarito project, in particular, and then just a general market overview. As discussed in the press release yesterday evening, we reached an important milestone in the development of the Rosarito project in Northern Baja California in late May, when we submitted environmental impact studies for both the desalination plant and the 30-kilometer-long conveyance pipeline from the plant to the U.S. border. We expect to receive comments from the regulators within the next several weeks and we'll keep investors updated on any material developments.

We are also implementing the second phase of source water quality monitoring and reporting, which is required by our proposed water customer, the Otay Water District, in order to support its permitting applications with state and federal authorities in the U.S.A. This phase of the testing program is being conducted directly by our company without the assistance of outside contractors, and we expect to begin collecting data from our newly fabricated testing equipment platform in late October. This phase of the testing is expected to continue for at least 2 years to meet Otay Water District's requirements. And obviously, the data that we receive from this program will also enhance the development of the project from a technical standpoint and also go to satisfy the Mexican regulatory authorities and their -- and our interaction with them.

Just generally about the Caribbean. After a multi-year low in new project activity, we're seeing a few new projects going to competitive tender in our home market. These are relatively small projects, similar in scope to the 2 that we recently won in the Cayman Islands, and they're in areas that are within or are very close to existing operations. So we believe that we can leverage existing resources to enhance our competitiveness. And we think this is a positive and we're starting to see some activity again in the Caribbean market and we're certainly going to pursue any reasonable projects in that area.

Now I'd like to turn the call over for questions. Amy?

Question-and-Answer Session

Operator

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

Philip Shen - Roth Capital Partners, LLC, Research Division

So I'd like to explore the situation in the Cayman a little bit more. So what do you expect to happen over the next 6 months with the Water Authority and the government? Now that you have to negotiate with 2 parties, how do you expect the process to unfold from here?

Frederick W. McTaggart

Well, it's basically our belief that we'll be negotiating with the Water Authority primarily, and that government will be overseeing the negotiations to ensure that some of our concerns that we had in relation to conflicts of interest and things are addressed. But by law we're required to get a license from the Water Authority, who is really the technical expert in these matters. And I would assume that the government is going to delegate most of the negotiations to them.

Philip Shen - Roth Capital Partners, LLC, Research Division

Okay. Great. Have you seen a change in the Water Authority's body language or the way they have -- the interactions since these recent proceedings?

Frederick W. McTaggart

Well, we haven't had the opportunity really to meet with them about this particular issue. They're in the process of reviewing these reports that I mentioned earlier in the call. So I would think that as soon as we get comments back from them, which I believe are due in the next couple of weeks, we'll start having some more dialogue with them and understand exactly what their intentions are. I mean, they did agree prior to the proceedings, and I think this is very important to note, that they would consider other types of regulatory models besides a regulated rate of return. So we're hoping that we can have some meaningful discussions on these other types of models.

Philip Shen - Roth Capital Partners, LLC, Research Division

Great. That sounds encouraging. In terms of the Bali opportunity, there are some negative gross margins, I think, in the area. Can you talk to us about how much -- what kind of volume increase could we see in Q3, and what the overall outlook for Bali is going forward, and how business development is coming along?

Frederick W. McTaggart

Well, it continues to be a difficult market, Phil. They're very price-sensitive there. Over the last 3 months, we have connected up new customers that are taking, compared to last year, quite a bit of water. I mentioned in the call that we expect that to continue through October, and then it really starts to rain. The market is going to be very seasonal going forward, so during the rainy season we'll probably see a marked drop in sales. And that goes through, I think, until April of next year. So from the standpoint of business opportunities, they continue to improve there, although they're difficult customers from a pricing standpoint. I mentioned in the press release that some of the existing groundwater resources are becoming brackish and unusable. So that will continue to drive people toward desalination and that we believe there's still a great number of opportunities there to sign up commercial properties, resort properties within close proximity of the plant.

Operator

The next question comes from Hasan Doza at Water Asset.

Hasan Doza

On the Rosarito development expenses, I saw in your 10-Q about $2.5 million was spent year-to-date. I think you guys had previously talked about spending an incremental $4 million versus last year's SG&A level. So I just wanted to confirm that you're still on track to spend the incremental $4 million for full year 2014.

Frederick W. McTaggart

David, do you want to address that? I think we had a disclosure in there that projects our cash requirements for the rest of the year for Rosarito. You want to point us on to that? David? Well, anyway, Hasan, in the Q, we do try to indicate what our expected expenditures are for the rest of the year. I would say $4 million is probably on the high side based on the progress that we've made to date on the project. Really, what we're trying to do now before we spend any significant amounts of money on technical issues is to obtain the commitment in principle from the Mexican customer that he wants to proceed to buy water from us. And that's really where our focus has been over the last 4 to 5 months.

Hasan Doza

Okay. And so -- okay. That's fair. And I would love to just follow up on the last question in terms of your potential negotiation with the Water Authority-Cayman. And the reason I ask is that you guys had been negotiating with the Water Authority for years, and essentially, after the court order, we're kind of back to square one. So I was kind of thinking, how should we think about a timeframe for your negotiations to conclude with the Water Authority-Cayman because in the past, you guys were not able to come to a conclusion, so how this time could be different and would love to get some thought process as to how -- what kind of a timeframe do you guys think about for these new rounds of discussions to be complete?

Frederick W. McTaggart

Well, from a standpoint of timeframe, I mean, it's really difficult to say until we get to sit around the table with these guys again. It's been several years since we actually conducted negotiations with them. Certainly, it must have been early 2012. So the timeframe to us, as long as they continue to be willing to negotiate and extend the license, the existing license, I think, is less important than the actual objectives that we have in the negotiations. So it could take 6 months or it could take another couple of years before we reach an agreement. It depends on how they come to the table in this next round.

Operator

[Operator Instructions] And our next question comes from Jarrett Perez at Two Oaks Investment Management.

Jarrett James Perez - Two Oaks Investment Management, LLC

You had mentioned that the Cayman was considering other models for possible negotiation. Do you guys have kind of a frontrunner in terms of preference for what you're putting out there, what you guys would like to see, besides the current model?

Frederick W. McTaggart

Well, we do, but I'd rather not discuss that right now until we can actually sit around the table with these guys again. I mean, obviously, we think that the inflation-adjusted rate model is best for our particular situation and for our customer's situation. So it could be something similar to that.

Operator

Our next question comes from Michael Gaugler at Brean Capital.

Michael E. Gaugler - Brean Capital LLC, Research Division

One thing I -- Rick, in your comments, you had said testing for Rosarito for about 2 years. I'm wondering if that pushes back the timeline in terms of completion on the project versus what your previous expectations were.

Frederick W. McTaggart

Well certainly over the last couple of years, we've developed this idea that the project could be phased. The U.S. side has a lot more -- is going to take more time to get the regulatory approvals there, so we think that potentially could be a second phase for the project. And we'd like to proceed with the Mexican side as soon as possible. And we believe that the water needs are acute there, and there's certainly a demand there. I mentioned earlier that we've been basically focused on getting the Mexicans to sign on through an LOI or some sort of letter, letter of intent, letter of interest, similar to what we did on the U.S. side. So as soon as that happens, we'll have a better understanding of what their timetable is. Based on the technical meetings that we've had in the past with the local utility there in Tijuana, we believe that there is certainly an immediate need for water there and potentially, a larger need to satisfy regional demands that would involve trades, international trading between the 2 countries, the U.S. and Mexico. So to answer your question, I think it's going to be a phased project, and the U.S. demand will come later as they meet the regulatory hurdles.

Operator

We show no further questions at this time. I would like to turn the conference back over to Mr. McTaggart for any closing remarks.

Frederick W. McTaggart

All right. Thanks a lot, Amy. Just again, thank you to everybody for joining us on the call, and I look forward to speaking with you again in November for our third quarter earnings call. Thank you.

Operator

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