Helen Baud - Wall Street Analyst Forum
David Sasnett - EVP & CFO
Consolidated Water Co. Ltd (CWCO) Wall Street Analyst Forum September 9, 2008 9:50 AM ET
Good morning everyone. My name is Helen Baud from the Wall Street Analyst Forum, and I am the host in this room for today. (Host Instructions).
The first company we have presenting in is Consolidated Water, and presenting for us is David Sasnett, the Chief Financial Officer. Good morning, David.
Thanks, Helen. Since we have a really small group this morning, only three people, if you guys have any questions just raise your hand, I’ll be more than happy to answer them during the course of the presentation.
As Helen said, I’m David Sasnett, I’m Consolidated Water's Executive Vice President and Chief Financial Officer. There is no bio information that was provided to any of you -- I don't think for the forums. So, I will tell you briefly that I've been the CFO of four other public companies other than Consolidated Water, and I've also spent 12 years with Deloitte & Touche in the Audit Department.
I have my own company that I don’t work any more. My partners run for me the consumer products, that protects residences against hurricanes with brace for the garage door. I have a lot of public company experience and since December 2004, I joined Consolidated as the Chairman of their Audit Committee and a member of their Board of Directors. And then 18 months later, I decided to leave where I was working to become their Chief Financial Officer. So that's all you guys. Leaving all about me, let me tell you a little bit about our company.
Consolidated Water Company is often mistaken for a utility, and let me get to the forward-looking statement slide here.
We are not a utility. You need to take your understanding of the water delivery processes as a just beyond the state to sort of forget about that, because we operate in foreign countries. We are producers of Water Using Reverse Osmosis technology. We take sea water and take the salt out of it, and make it drinkable. We operate in five Caribbean countries and we're expanding to two others with the opportunity to enter into [inaudible] country also assuming that we're the successful bidder for a large contract in Trinidad.
To give you an idea of what our plans look like, I'll go back here to this previous slide. We have some pictures of Consolidated Water’s operations here. If you look at the lower left hand side, lower right hand side, these are what we call trains. These are the filters that we use to take the salt out of the seawater. What we do is we go near to the sea lining, we drill a well down through the rock structure, so we could drop sea water into the substrate of the rock that gives us a better quality feed water than taking water directly from the ocean itself. It’s almost pre-filtered.
We take this and we run it through using high pressure through membranes that have very small almost atomic level openings, the size of the opening in the membrane is just large enough to allow a water molecule to pass through. But obviously a push of water through an opening this small, takes a lot of pressure. We use high pressure pumps that are very energy intensive, they use diesel or they use electricity.
And as a result, about 45% of the variable cost of our operations historically have been energy costs. This water goes out to pipelines just like it does here in the United States. It either goes directly to our consumers if we’re a retail operation, through our own pipeline, or it goes through the government's pipeline because we sell it on a mote basis to their utility.
Right now we're operating in five countries producing a little over 24 million gallons a day. We plan to expand also and to the Island of Roatan, which is a tourist destination of the coast of Honduras. We've also recently announced that we were awarded the right to privatize the water operations in the Turks and Caicos Islands for all other islands other than Providenciales which is the largest island in that chain. We think that Turks and Caicos have tremendous opportunity for developments and what we've experienced in Grand Cayman over last 20 years.
We operate in three segments. And if you're looking at our business and you are an analyst to trying to figure out what we're doing with [pieces] it's very important to project with each of these different segments because the operating profits, sales were almost very different for each.
In the retail segment, this relates to the Seven Mile Beach and West Bay area of Grand Cayman. To give you a little history of our company, we were headquartered in Grand Cayman. We became a public company in 1995 and we were trading under NASDAQ under symbol "CWCO." We bought stock in Grand Cayman because originally we were the small operation who provided fresh water to hotels. And over the years as the island grew, the company itself grew. Now Grand Cayman has over 40,000 residents and the company has grown through both (inaudible) and through acquisition.
So now we are producing 22 million gallons a day, I think we originally started out with the 300,000 gallons a day plant. We have a 20-year license to provide water in the retail area of Grand Cayman, which really is the tourist area, while the hotels are in West Bay residential area. This license expires in 2010, but we have the right of first refusal. So if anyone wants to try to come in and match, try to take the business away from us that has some significant impairments, first of all, they have to build their own desalination plants. Second of all, they have to build their own distribution pipeline system. And third, even if they are willing to do all that, we can match their price to obtain the business.
So there is a significant barrier to entry for anyone who wants to come in and take our retail license away from us in 2010. I think the bigger issue is that we talked to you about this to other people, is will the government come back and ask for some kind of price concessions on our retail license, because we're renegotiating in 2010.
Good thing about it is that if they lower the price for us, they provided water to the rest of the island. So they will have to lower their prices too. So we'll have to see how that plays out. We also sold water on a bulk basis. What I mean by a bulk basis is rather than sell to individual consumers as we do with the retail operation, we'll sell through one big pipeline and send it to one big storage tank to the government. And the government will operate this utility and sell the water to their distribution system to the individual consumers.
Typically, the margins for our bulk basis is lower, but the operating costs and the administrative costs are lower, because we are dealing only with one customer. We had three plants with almost 4 million gallons per day capacity in Grand Cayman that sells water to the Water Authority-Cayman. We have two large plants in the Bahamas that provide 10 million gallons of drinking water a day there to the Water and Sewage Corporation of the Bahamas.
A small plant in Belize and our affiliate in the British Virgin Islands has two plants with a 1.7 million gallons of capacity. The British Virgin Islands affiliate plant do not include 700,000 gallon a day plant that we have constructed -- affiliates constructed. Because they believe [there is suppressing] need for water there and they are in the process of negotiating with the government to see if they can get the government to send a license for that plant.
We also have a third segment of our business, the Services Division, where we design and build plants, and manage plants for other people. We design and build and manage plants typically under a [VVO] arrangement, where we retain ownership for the plant. And in some cases, we also will transfer the ownership. And in that case, you'll see our financial statements will book a gain on sale under the percentage of completion basis.
Right now, we're building a 3.4 million gallon per day plant for the Water Authority in Cayman. We are building a plant for the Government of Bermuda. We also do other services. We will manage a plant that is owned by other people. And we just recently completed a project in the Bahamas, where we looked at the distribution system and save the government about 1 million gallons of leakage. It's not just what you make is, what you can get the consumer and reducing the amount of water loss in the system is very important to maximizing revenues.
We've been very successful, especially over the last five years. People ask how we are able to compete against some of the very large companies that are in the business. We compete against companies like GE and Veolia, Tuscan [ph] Biwater 70s. There are a significant number of players in our marketplace.
Now, first of all, we're not a manufacturer. We don't make the equipment that we use, rather we choose the best component that's available in the marketplace today. That gives us flexibility to buy filters from anywhere we want to buy from and we buy high pressure pumps.
The other components of our business from those suppliers, we think provide the best value for customers. The reliability, the success from this business is depended upon that manufacturing and efficient plant one that operates without too many problems, without too many breakdowns.
We think that our ability to both, design plants and to manage them gives us an advantage to our competitors, who simply just build the plants. Just when you walk right the plants for a while, you understand what you did right and you did wrong with manufacturing process, and it helps you in the next plant design.
We have been doing this for 35 years. Everybody in our business has a tremendous amount of experience in the [de-sell] arena. It's very important when you are dealing with these Caribbean countries to understand the way they do business, you have credibility with them. And our management team has that.
We have a unique business model. I mentioned earlier how important energy costs are to our business. Well, when we sign a contract with our customer, first of all, we guarantee if they purchase a minimum quantity is sufficient to make the contract profitable. So it's a take or pay; whether they use the water or not they have to pay us for it -- and that minimum amount ensures the contract is profitable. Typically, they buy a lot more than the minimum amount, however.
The other things that we put into the contract to protect ourselves are adjustments -- policy to adjust for inflation. I mentioned earlier how important the energy costs are to us. Well, our energy costs are adjusted monthly and passed through to the end customer, either to the retail customer or the bulk customer. So each month, we do a calculation of energy costs and we adjust the pricing. Once a year, we adjust the other operating costs. If there have been increases in capital cost or payroll or chemicals or things like that we are allowed to adjust our prices once a year for those types of items.
So essentially, we protect our margins. And now in the long-run, we have actually improved margins because when we build a plant we guarantee it operates at a certain level of efficiency. If the plant operates at a better efficiency than what we've guaranteed, we get to keep the additional profit. For instance to give you an example, if we tell the customer, this plant will produce one gallon of water for every gallon of diesel fuel that it uses, if we use less than a gallon of diesel fuel we could still bill the customer for the full gallon of diesel fuel.
So what's happened over time is that with improvements in the technology, our margins increased slightly, not a huge amount. The net [going] from 20 points to 30 points in the bulk segment, but then they go from 23 to 25 of the [life] of the contract. So where other people really have to worry about maintaining their margin, we've been actually working on improving ours over time.
We only give turnkey customer solutions to our government customers. This is very important. If you're in the Bahamas or Europe, Grand Cayman or Belize, typically these governments don't have money upfront to pay for these contracts. So we'll go in and offer to design, build, operate and finance the contract for the customer.
We have sufficient capital. We'll build the plant. They pay us nothing until we start delivering the water. The capital cost of plant is factored into price of the water. They in turn sell it to there [scituates]. They collect the money, and they send it back to us. It’s a very appealing and attractive solution for lot of these Caribbean countries that really don’t have the money upfront for these lowered capital projects. Today this is proven to be very successful for us and I think it's one of the real advantages we have in the marketplace.
Some of our competitors are either much larger than us and therefore the size plants we build are a little bit too small for them. When they don’t have the correct business model, where they are willing to provide the customer with one complete package or they don’t want to necessarily operate the plant after they build it.
All of these factors are comparative strengths for us and we really have been very successful lately and particularly in competing against some of the very large companies such as GE and Veolia. We've been doing this from 35 years. We learnt something from every plant that we build and we incorporate this additional knowledge into the next one we design and build and operate.
We think our plants for their size are some of the most efficient in the world. We're not without hiccups. In case they will have some issues with feed water, which will reduce the efficiency of the plant. We have a situation in Bahamas right now. At the [Winter] plant, where the feeder water is very poor, there is a micro that secretes iron that falls the filter. That’s something that nobody could really think better than us. It's just as one of those corps that happens to deal with the geo-hydrological conditions in the Bahamas. But with exception of one plant, our plant works very efficiently and their efficiency improves over time.
I have here some financial information. You will notice that from 2005 to 2007, we've had significant increases in revenues, profitability earnings per share. In December 2006, we completed a $40 million offering, secondary offering and that directly increased our number of shares outstanding, which you can see that in 2007 we're still able to post an increase in EPS. We've had strong revenue growth [seasoning bracket for per second], you can see here $49 million in 2007.
We've had substantial higher margins. We managed to maintain those margins, as I mentioned earlier, the pieces of our contract sort of protects our margin for us. We've had great solid profitability, 2007 was a record year from us. And if you go back and looked here, we made $11.3 million on what was $49 million in revenues, so very healthy return on our revenues. This replaced to a 28.5% compound annual growth rate for us. And we've had strong EPS growth as I mentioned earlier. In 2007, despite the fact that we did a $40 million offering in 2006, even those additional shares, our EPS went to $0.79 a share.
Unidentified Audience Member
We don't project for the Street. So, there are a couple of analysts out there to do, Brean Murray, Boenning & Scattergood and most importantly, Janney Montgomery Scott, who is the underwriter for our offerings. I suggest you take a look at their models. Our 2008 results have been impacted by a situation in the British Virgin Islands that I'll talk about here in a moment. And that's why actually earnings are down for '08. We'll talk briefly about our growth strategy here.
First of all, this retail license in Grand Cayman generates from 62 to 66 points gross margin for us. We continue to maximize the benefits of this retail license. We are continuing our best with our distribution pipeline and the efficiency of the plants. We believe that we will maintain the contract out for 2010. Unless you've been to the Grand Cayman recently, the [Drought] Corporation, you may not know the Drought Corporation is, but I know you know their products, as they are the manufactures of styrofoam cups.
I have been told they are one of the most profitable private companies in the world. They've embarked on a substantial development project in Grand Cayman where they are building a brand new, literally a brand new town called Camana Bay. It's got a small university school, shopping center, office buildings and they are doing development at the port there. And so, long-term we think that the population for Grand Cayman will increase.
In 2004 here Hurricane Ivan struck the island, and while it devastated most of Grand Cayman because it was a category five storm. It proved to be a blessing to us in one way. It destroyed a lot of the older buildings, when they came back with the new construction code, they came back and then said, you could build market buildings, taller buildings.
I think their previous restriction was two stories, now its seven stories. As a result, the Ritz Carlton was just opened there. Mandarin Oriental hotel that swung in Grand Cayman, they had the western, they have highest -- development is really taken off there especially for luxury condominiums. We found that the more affluent customers use a lot more water.
So we think that there is still some growth to be obtained and some additional profitability on our retail license, even with the renegotiations coming up in 2010 with the government. We just recently awarded a contract to build another $3.4 million gallon plant in Grand Cayman. Then last week the government started to come back to us and rather than mock bowling one of their existing plans, they've decided to extend their contract with us for another seven years.
So immediately, we've added (inaudible) on this $4 million gallons of capacity in Grand Cayman. Belize is not as attractive and opportunity for growth as the Bahamas is. The Bahamas right now has a pressing water issue, they still barge water over to the island. That's a very inefficient way to supply water. I mean the logical step for them would be to expand one of their plants with us. We've talked to them about that, but we don't know where it is this point in time.
But long-term the Bahamas needs to do something about their water supply. So we're hopeful and optimistic they'll come back to us for plant expansion. When we expand an existing plant, it's always more profitable than the original capital improvements. So we think long-term there's an excellent opportunity for us to expand on a profitable level our business in Bahamas.
In the Caribbean, if you're an island the only way that you can provide enough water for your population, eventually is to do desalination. Few of these islands have sufficient natural resources. If you want to be a tourist destination, you want to have a nice hotel. You've got to have two things, you got to have utilities, you got to have power and you got to have a quality drinking water supply. I'm very proud of the quality the water our company produces.
You have this reputation for Caribbean Islands (inaudible) standard of water. With the quality of the water that we produce in Grand Cayman is as good as any US drinking water. The matter of fact, when the water comes through these filters, depending upon how many times we filter the water, it will (inaudible) that we have to add [darfur] to it on the other side, because if water is a natural staple we want to leach minerals to buying with something.
So if you put it through a pipe after it first comes through our system, so purely try to take the minerals out of pipes. So we actually have to add some hardening agents to it when it comes through with [some flooring] to protect it from microorganisms, as it goes to distribution system. But if you go to Great Cayman and you are drinking water at the tap, it's very good. It's very comfortable, in many cases fairly equal to what you get here in US.
The purest water we produce is actually in Bahamas at our winter plant. And it's so pure that the government actually mixes less pure water with it, to get something that's drinkable, but it doesn’t have to be you know the super high quality that saves the some money there.
So if you are trying to develop your tourism base, you want a water strategy that will make sure that tourists, when they drink the water, the (inaudible) will come back to your island. That was one of the things that we used as a selling approach to the Turks and Caicos. So we think there is a very strong market in Caribbean for desalination. We have just recently bid on a big contract in Trinidad for the oil refinery there.
As I mentioned earlier, we recently won a contract with the Turks and Caicos to provide water to all the islands (inaudible). We are expanding operations in (inaudible) and really the level of activity or the level [iniquities] that we are getting now on projects and new customers in Caribbean as they are been [sized] they are now. And how much of this will translate into additional business I don't know, but still it is encouraging to see.
Then last but not the least either through acquisition or through internal growth, we would like to expand our business in to complementary services. Once you make all this desalinated water you are going to have a place to put it and given the gray initiative that exists in many countries today, they don't want to pollute their environment. But wastewater management is a key component of integrating strategy. With wastewater management, the technology is very, very similar to desalination except you don't need energy cost on its part.
So we can do wastewater management as well and we’re expecting to expand in this area our business as well. So I mean we have a lot of opportunities in front of us, a lot of complimentary products we can offer, but we think it is just a right time to be in our business. And with that I will talk briefly about what happened this year in 2008 to give you some background information of a lot of stock prices drop. [One time] we were $37, we are down around $22 now.
We have a big investment with an affiliate, the British Virgin Islands. We own 43% of the equity results of this affiliate. And in 2006 the British Virgin Island government came in and reported a right of ownership over our largest plant there. When I say our, it is really our affiliate, and it was under a contract that was signed many years ago and after seven years the government had the right to either buy the plant for $1.4 million or to extend the contract for another seven years, and what happened is, they did neither, they didn't buy the plant and they didn't formerly extend the contract, they said the contract was down a month-to-month basis until they decided what they wanted to do.
Over the following seven years, our affiliate expanded the plant and under the premise, the old contract wasn't in place, there was a month-to-month contract. When the seventh seven-year period expired, the government came in and claimed ownership of the plant. So right now the plants are in litigation, and the government has refused to pay our affiliate the receivables they’ve billed them for, and this uncertainty with this particular plant has really impacted our stock price. Because if ultimately the governments right of ownership is upheld then they would take the plant from us, from our affiliate and we have to write in our investment for this affiliate.
The company affiliate of CBVI also built a plant a in Bar Bay which is not being used at the moment and they did this under the expectation the government would sign a plant, would sign a contract for this plant because there is such an suppressing need for water in that part of the island and that hasn't happened either because of this dispute of the ownership of the other plant, negotiations have not been completed for the new plant. So there is a tremendous amount of uncertainty as to whether or not we will have to take write-off on this affiliate investment and that's impacted our stock prices this year.
And I wish I could tell you something one way or the other, but we don't have a resolution of this matter yet. It may ultimately have to be decided by the courts, but based upon the advice our affiliates received from the council, they believe they have a very good position to argue with it. The government doesn't own the plant. But that’s why the attorneys’ always tell you, right?
Anyway, that's the end of my formal presentation. If any of you have any questions about the company, please, we have time here, I'll be happy to answer them for you.
Unidentified Audience Member
That is correct.
Unidentified Audience Member
There are two legal issues associated with the plant. One is, does the government own the plant? Two, is the government required to pay our affiliate for the water they produce regardless of ownership. Through December of 2007, our affiliate took position that even if the government owned the plant ultimately, they still own the affiliate for the water produced. So, the affiliates continue to build. What happened is when we got ready to consolidate the results of the affiliate, we being Consolidated Water, I being CFO, I looked at it, and the SEC is very strict on its rules to revenue recognition. Because of the uncertainty associated with the collection of these receivables, effective January the 1st, we adopted a policy to put the affiliate to adjust their results and make them as if they were on a cash basis.
There was a large receivable due from the government, and every time that receivable was paid, any cash that the affiliate would see, we just considered it the collection on the receivable. Any revenues they build, we did not recognize those in our equity pick of adjustment because of the uncertainty associated with collecting those revenues.
So what you see there for the six months ended is really the operating cost of that affiliate, 43.5% of the net loss of the affiliate assuming they had no revenues. If for whatever reason, either we reach an agreement with the government or we win in court, if it is proven those receivables are collectable, all that money will come in, in one quarter once the uncertainty associated with their collection is cleared up.
So, it is due really a change in the accounting policy. There is a significant contingent gain in there. Once again that gain is contingent upon the positive result in court or favorable resolution and right now in negotiations with the BVI government.
Unidentified Audience Member
It is not more than $2 million. I think it is about 1.1 million, is not it?
Unidentified Audience Member
Yes, for the affiliate, you are correct. That represents 43.5% from the total loss…
Unidentified Audience Member
That is correct.
Unidentified Audience Member
Not for the British Virgin Island situation, no.
Unidentified Audience Member
Unidentified Audience Member
Yes, we have protection. As a matter of fact when Hurricane Ivan destroyed a couple of plants in Grand Cayman in 2004 and interrupted operations there, the company posted a net gain from it is insurance proceeds because the amount of money they got was higher than the property destroyed.
So we do have business interruption insurance in every location. It protects us from the natural disasters such as a hurricane. It is important to note that our plants are designed to withstand even a Category 5 hurricane. We had a couple of them which were somewhat weak. When Hurricane Ivan hit Grand Cayman in 2004, one of those plants was completely destroyed and another one was significantly damaged, but those were older plants. We since rebuilt those, and the new plants we build of concrete and steel and designed to withstand up to eight feet of flooding and the Category 5 hurricanes.
But the big issue with business interruption is, even though our plant might be okay, the entire look of the economy could be devastated. So therefore, we are not, they are not buying water, tourists on arriving. We had business interruption insurance to protect us from that.
Unidentified Audience Member
We buy our own power. We have to either buy diesel for the diesel pumps or we buy electricity from the local utility. With respect to interruption of service, we will require to produce a certain number of gallons per day. If due to inefficiencies and if we do not reach that level, we have to pay penalties to the government. There has only been one plant where that's been the case. There is this one plant in Bahamas, where we have this ongoing issue with feed water quality as I mentioned earlier. If the plant is destroyed to an [active guard] or weather or something like that we are not responsible. If you get the, of course, if we have something like that, if anything like that happens, we are not responsible. If they are all [incompetence] and we screw up the plant, then yes we are responsible and we have to rather work.
Any other questions? Look, I am going to be hanging around here for another 30 or 40 minutes, so if any of you have any questions, you can catch me outside. I want to thank you for (inaudible). Thank you.
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