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Consolidated Water Co. Ltd (NASDAQ:CWCO)

Q3 2007 Earnings Call

November 12, 2007 10:00 am ET


Rick McTaggart - President and Chief Executive Officer

David Sasnett - Chief Financial Officer


Heike Doerr - JMS

Ryan Conners - Boenning & Scattergood


Good morning. My name is Jessica and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Consolidated Water Company Third Quarter Conference Call. All lines havebeen placed on mute to prevent any background noise. After the speaker’sremarks there will be a question and answer period (Operator Instructions).

This conference call may include statements that mayconstitute forward-looking statements, usually containing the words believe,estimate, project, intend, expect, or similar expressions. These statements aremade pursuant to the Safe Harbor provisions of the Private SecuritiesLitigation Reform Act 1995.

Forward-looking statements inherently involve risks anduncertainties that could cause actual results to differ materially from theforward-looking statements. Factors that would cause or contribute to suchdifferences include, but are not limited to continued acceptance of thecompany's products and services in the marketplace, changes in its relationshipwith the government of the jurisdictions in which it operates, the ability tosuccessfully secure contracts for water projects in other countries, theability to develop and operate such projects profitably, and other risksdetailed in the company's periodic report filings with the Securities andExchange Commission.

By making these forward-looking statements, the companyundertakes no obligation to update these statements for revisions or changes afterthe date of this conference call. Thank you. It is now my pleasure to turn thefloor over to your host, Rick McTaggart, President and Chief Executive Officer.Sir, you may begin your conference.

Rick McTaggart

Thank you, Jessica. Good morning ladies and gentlemen. Thankyou for joining us this morning to discuss our 2007 third quarter results.David Sasnett, our Chief Financial Officer is also on the call with me thismorning. I’d like first to give you an overview of things that affected our resultsduring the quarter and then David will talk a bit more in detail about thenumbers.

I'm very pleased that revenues from our retail segmentcontinue to grow in the third quarter when compared to last year. They wereactually up by 13% over the third quarter of 2006 due to higher sales volumesin Grand Cayman.

Retail sales in total dollar terms in our third quarter aretypically somewhat lower than the first and second quarters of each year andyou will note this trend if you're comparing this quarter's results to last.This seasonality is usually due to a tapering off of tourist arrivals in GrandCayman during September and rainier weather conditions during the summermonths.

The company continues to work on two separate projects thatwill expand water production capacity in our Grand Cayman retail operation byabout 2.3 million gallons per day by the end of next year. We're very pleasedto report that our Governors Harbor site was rezoned last month and this willenable us to more efficiently utilize this site for our present expansionproject as well as for future projects.

Earlier this year we also completed the purchase of a parcelof land directly adjacent to this site, which will provide additional space forwater production and storage in the future. Tenants are now moving into thefirst phase of the 500-acre Camana Bay project, which is within our franchisearea and we expect to benefit from increased sales of this project as thisproject continues to grow over several years.

In a new development, the Ritz-Carlton project in GrandCayman recently purchased the Safe Haven 18-hole golf course property which isalso within our franchise area and which has been a valued customer for manyyears.

We understand that the new owner intends to develop theproperties around the golf course with high-end homes and condominiums tocomplement the very successful Ritz-Carlton hotel and residences, which arelocated just next door to Safe Haven.

So, as you can see, we're positioning ourselves forcontinued growth in our retail segment in Grand Cayman. In our bulk businesses,our Belize operation, although small and contributing about $1 million a yearin revenues, continues to improve with a consistent 14% year-over-year revenuegrowth.

Gross profit margins have also continued to improve since wecompleted certain modifications to the plant, which have reduced energyconsumption and maintenance costs. Our customer, the government owned waterutility on Ambergris Caye is keen to extend its water distribution system tothe northern parts of the Caye, which would generate additional revenues for usand we're currently in discussions with them to assist with this expansion.

We hope to have the opportunity to meet with seniorgovernment officials in Belize later this week to iron out the final terms ofsuch assistance.

In Grand Cayman, our bulk segment revenues grew by about 7%over the prior year's third-quarter revenues and this growth is an improvementover revenues in the second quarter of this year, which were flat compared tothe prior year's second-quarter results.

Our customer, the Water Authority completed thecommissioning of a booster pumping station earlier this year, which is pumpinggreater volumes of water to the Eastern districts of Grand Cayman and shouldcontinue to positively impact our revenues as it did in the third quarter.

In the Bahamas, we believe that we fully met our obligationsunder the NRW portion of the Blue Hill's contract as a March 1st, 2007 and wehave made a final submission to our customer with data supporting thatcompletion date. However, our customer is currently reviewing the submission.

We have therefore not yet booked any revenues for the 1million gallons per day of NRW water that we have supplied after March 1st. Thecost of producing this NRW water during the third quarter without correspondingrevenues continue to depress our profit margins and we're hopeful that ourcustomer will sign off on the project soon.

We believe that this project, although it's been difficulthas been a win for both the company and our customer. Provision of NRWreduction services helped us to win the Blue Hill's plant contract and hasgreatly benefited the Bahamas Water and Sewage Corporation, who is now savingmore than $2.5 million per year in lost water.

During the quarter, we also made good progress identifyingways to lower the incremental operating costs that we are incurring to keep ourmembranes clear from fouling at the Bahamas plants. And we will be embarking onthree separate engineering projects, which when completed are expected toimprove bulk operating margins early next year.

Resolving these technical and operational issues in theBahamas has sometimes been very difficult and finalizing the NRW program hastaken longer than we had originally planned. However, I'm extremely encouragedthat we're making progress and expect that the Bahamas operation will be moreprofitable in 2008.

Revenue and profits from our services segment was up nicelyduring the quarter as work continued on the construction of the Tynes Bay plantin Bermuda. That project, which is being constructed for the Bermudagovernment, is expected to be operational early next year and we will continueto operate the plant for a period of at least one year after its commission.

Last but not least, I would like to talk a bit about our BVIaffiliate, Ocean Conversion BVI Ltd. During the last quarter, the BritishVirgin Islands held general elections and a new government was elected in lateAugust. The government negotiating team under theold government was disbanded after the elections.

And we just recently had the first opportunity to meet withthe new minister of communications and works to discuss the Baughers Baycontractual situation and the status of the Bar Bay plant. The meeting wasproductive and we spoke about the history of the dispute and apprised thehonorable minister of the present condition of the two plants.

And the two positives outcomes that I took away from themeeting were that we have now engaged a new government in discussions about theissues and the minister fused the resolution of the Baughers Bay dispute as apriority and seems willing to take immediate action.

On another positive note, sales from Baughers Bay hasincreased significantly over last year, which is a testament to the island'scontinued dependence on the plant, which produces about 75% of Tortola's water.And the costs at this plant continue to be well under control.

I would like to turn the call over to David who will talk about the numbers in more detail.

David Sasnett

Thanks, Rick. I just want to touch on the few financialhighlights for this quarter. Our net income of $2.5 million for the threemonths ended September 30th, 2007 was more than double the net income for thesame quarter of last year and our EPS was up 70% to $0.17 for the quarter.

The nine months, our net income was $8.7 million, representsan increase of about $1.9 million from the same nine-month period of last year.On record revenues of $36.6 million, our EPS grew from $0.54 for the ninemonths ended September 30th, 2006 to $0.60 for the current nine-month period.

Our operating results reflect increases in revenues for allthree segments. As Rick mentioned earlier, our retail and bulk segments grew asa result of increased demand for water and the services revenues reflect theconstruction of the plant in Bermuda on Tynes Bay paid.

Our net other income increased by more than $1 million inthe three months September 30th 2006. The three or four components of that,interest income was up $435,000 as we have substantial cash balances that wepresently are investing paid; our interest expense was down by about $280,000.As you will recall, we took some of the proceeds from our public offering andrepaid debt.

And our net average balances, interest-bearing balances havedecreased from the same period of last year. And our equity pickup from theoperations of OC-BVI was up about $170,000 for the quarter. The increased demandhas led to increased profitability of that affiliate.

Turning briefly to our cash flows, I would like to point outthat we generated a very healthy $8.3 million from operations, which is $2million more than last year. We believe we have taken our solid financialposition at the end of the year and continued to improve it.

Our cash is up $3.5 million from year-end. Our net currentassets are $46.6 million as compared to about $40.6 million as of the end ofthe year and we continue to repay debt. So, we're healthy from a financialposition perspective.

We're generating very substantial cash flows fromoperations and net income and profits are up. So, overall we're pleased withthe results for this quarter and we're optimistic about the results for thefourth quarter and for 2008.

With that, I will turn things back over to Rick.

Rick McTaggart

Thanks, David. There's a couple of other projects that wehave underway that I would like to update you on that I didn't speak aboutearlier. In the Bahamas and we’ve talked before about the Wynton plant bid onthe east side of Nassau.

We now believe that the Bahamas government is consideringother options to supply water to Nassau including the expansion of existingdesalinization facilities and the construction of new plants on differentsites.

The government continues to barge water from Andros Islandto Nassau and I believe they are trying to further reduce or eliminate thisbarging. Recent bad weather associated with tropical storm Noel stopped thebarging operation for almost a week while our desalinization plants wereunaffected.

So, hopefully this quarters some brownie points with thegovernment and again alerted them to the unreliability of the barges. We'reworking closely with our customer in the Bahamas and would likely pursue anynew desalinization projects that go to bid or we would certainly bid on them.

For the time being, however, I think that the government isreassessing its options and that the Wynton bid is probably not going toproceed. In Grand Cayman, we mentioned earlier in the year that we had beenawarded a 2.6 million gallons per day plant by the Water Authority, which isour bulk customer in Grand Cayman.

We're working on this project and we expect it to be onlinetoward the end of next year. That will start to impact our bulk segmentrevenues and profitability next year. A new project I would like to talk aboutis in Roatan, Honduras.

Earlier this year we purchased two parcels of land andformed an operating company on the Roatan, which is one of the Bay Islands offof the northern coast of Honduras and it's become a coveted destination fortourists from North America and Europe and there has been a lot of investmentby North Americans in second homes and vacation homes on the island.

We've been investigating this market for about three yearsand we're presently in discussions with the local government officials toobtain the necessary permissions to produce and distribute water on the island.Firstly, on the western end of the island and in future to other areas ofRoatan.

This project would start out as a relatively small operationbut we believe there is great potential for the project to become moresignificant to our retail segment as the island continues to develop and weexpand our water production and distribution systems there.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from HeikeDoerr of JMS.

Heike Doerr - JMS

Good morning.

David Sasnett

Hi, Heike. Good morning Heike.

Heike Doerr - JMS

I wanted to ask a couple of questions. First, I see that thebulk revenue increased about 290,000, a little under 6%. Can you tell us whatpercentage of that is associated with Blue Hills and what percentage of that iscoming from your expanded operations on Grand Cayman?

David Sasnett

Most of the increase Heike, is coming from the Bahamas. Idon't have the exact percentage in front of me. But the majority of theincrease came from the Bahamas.

Heike Doerr - JMS

Okay. And the non-revenue water charges, will that bleedinto the fourth quarter as you wait for the government to sign off that youhave fulfilled your end of the obligations?

David Sasnett

As we disclosed in the Q, the non-revenue water billingsthat we have made to the WSC were not recorded in this revenue. The WSC has tolook at the assessment that we prepared and agree with it and they could agreethat the requirement is March 1st or at some later period or they could disputeeverything, but what we've done is, we've built them and we're not recognizingany revenues.

As soon as they agree with our assessment, at whateverperiod in time we would recognize the revenues I guess from that date forth,and those revenues would be quarterly to the extent that they relate to periodsprior to September 30th, they would be recorded in the current quarter.

Heike Doerr - JMS

And do you have any idea what the government's timeline ison resolving this matter?

Rick McTaggart

Heike, I’ll just say that I'm going to be over there laterthis week and I have a meeting with them. Obviously, we're anxious to get thisresolved. The government I think is going to be reasonable about it and try toget it resolved as quickly as possible. It's a big number for them and theyobviously want to have enough time to do their own internal reviews, so werespect that.

Heike Doerr - JMS

Great, and it's a lot of numbers for them to go through,correct?

Rick McTaggart

Yes, it certainly is. Yes.

Heike Doerr - JMS

One last thing on this Honduras project, you say it's asmall operation. Can you quantify that in relationship to Belize? Would it besmaller than what you had in Belize currently?

Rick McTaggart

Yeah. I think initially it would be smaller than Belize. Thekey here is that it would be a retail operation. Belize is a bulk operation.So, our margins on retail are typically a bit higher, and it would be aGreenfield project, so it would take a number of years to really becomesignificant to our results, I think. But it's a new market for us and we'revery excited about it.

Heike Doerr - JMS

Okay, and a final question. Assuming that thesemembrane-fouling issues get resolved where do you think those margins end up? Iknow in the second quarter last year they were as high as 28%. Do you thinkthat that is around the range that we could expect to see once the operating kinkshave been worked out?

David Sasnett

Heike, this is David. Last year at this time, we had somecontainerized units that were in use over in the Bahamas.

Heike Doerr - JMS

That's right, and that was included in the second quarter.

David Sasnett

Those units generate very high margins. And, I don't know ifwe would ever reach 28% again. You mentioned the membrane fouling problems.We've solved the problems. We've had to incur some incremental costs relativeto chemicals and other things that have depressed the margin somewhat.

We think we've come up with alternative solutions that arecheaper than the previous solutions we implemented. We think those margins willimprove as a result of those reduced costs. Two things that will really impactthe bulk operations going forward relative to margins will be lowering thesecosts and being able to bill for the NRW water.

So, that's what you should really focus on, I think, ifyou're trying to look at where our margins would be going forward.

Heike Doerr - JMS

Okay, understood. Thank you so much for your time.

David Sasnett

Thanks Heike.


Your next question comes from Ryan Conners of Boenning &Scattergood.

Ryan Conners - Boenning & Scattergood

Good morning Rick, good morning Dave.

David Sasnett

Hey Ryan, how are you doing?

Ryan Conners - Boenning & Scattergood

Feeling good. Few questions. Number one, on the NRW issue, Iwondered, it seems to me that according to your March 30 completion date,you're actually able to complete that portion of the project fairlyexpeditiously.

So, my question is, going forward, number one, are thereother territories you'd be bidding on where NRW would be an issue? And if so,given your experience here is that a service you wouldconsider including again as part of your proposal?

Rick McTaggart

Well I mean certainly, if it benefited us, we see it as avalue-added service that we can offer to potential customers and we used it asI mentioned earlier to get the Blue Hills project. So, I think it's somethingwe would consider in the future if it benefited us.

Ryan Conners - Boenning & Scattergood

Okay. So, the fact that there's been a little bit of anissue in terms of it hasn't worked exactly as planned doesn't scare you offfrom offering similar service in the future?

Rick McTaggart

I think we've learned a lot in this project and we couldcertainly employ that to remove some of the uncertainty in future projects.

Ryan Conners - Boenning & Scattergood

Sure. And secondarily on the service business, obviously theservice business is doing very well right now. I wondered; if you could justtalk at a high level about what direction the market is taking in terms ofdesign-build transfer versus design-build operate.

I know your preference in the past has been to retainownership wherever possible. But, are you kind of seeing a shift towardsprojects like Tynes Bay where the customer wants to own the assets or should wenot expect that to be a more prevalent type of project for you going forward?

Rick McTaggart

I think that sort of project is going to be the exceptionmore than the rule. We actually see continued interest in the design-buildoperate and finance projects more than the DBOs.

Ryan Conners - Boenning & Scattergood

Okay, and then just one last one quickly if I could. David,you talked about the cash flow, obviously the cash flow generation isimpressive. I guess cash is well over $40 million now. Obviously, there areprojects out there that are taking up capital.

But I wondered if there's been any talk or considerationabout a substantial increase on the dividend side in addition to the debtpaydown now that cash does seem to be accumulating.

David Sasnett

We have looked at the dividend at our Board meetings. Wecontinue to discuss it each quarter when we approve the interim dividends.There's got to be some conclusion from our perspective that it really wouldimprove the share price.

Right now, our dividend is relatively small and if you lookat its impact on our market cap, I don't think it's that significant. I'm notan investment banker so perhaps I'm not -- maybe someone can point outsomething different to me. And we are not sure that increasing the dividendwould necessarily do much for our stock price. We will certainly consider it.

We like the fact that we have this cash available, becausewe do think that over the next two to three years there will be a lot of opportunityin the Caribbean, either for new projects or to acquire assets and things likethat.

And, the purpose of our offering was to put us in a positionto take advantage of those opportunities. So, we always try to balance thedividend against having cash to pursue new projects. We do look at the dividendI couldn't say at any point in time that we would be about to increase it.

Ryan Conners - Boenning & Scattergood

That’s makes sense. Thanks for the time this morning guys.

David Sasnett

Sure, Ryan. Take care.


(Operator Instructions) There appear to be no furtherquestions at this time. I'd now like to turn the floor back to Rick McTaggartfor any closing comments.

Rick McTaggart

Thanks, Jessica. I just would like to thank everybody againfor listening in this morning and wish everybody a happy holidays and we willbe talking to you again sometime in March of next year. Thank you.


Thank you. This concludes today's Consolidated Water Companyconference call. A replay of this call will be available through November 19,2007 using dial-in numbers 877-519-4471 or 973-341-3080, with a pin number of944-2680. You may now disconnect your lines and have a wonderful day.

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