Consolidated Water Management Discusses Q4 2013 Results - Earnings Call Transcript

| About: Consolidated Water (CWCO)

Consolidated Water Co. Ltd. (NASDAQ:CWCO)

Q4 2013 Earnings Conference Call

March 18, 2014 11:00 AM ET

Executives

Frederick McTaggart - President and CEO

David Sasnett - EVP and CFO

Analysts

Matthew Riley - Roth Capital Partners

Alexander Renker - Sidoti & Company

Blake Todd - Two Oaks Investment Management

Operator

Good morning, and welcome to the Consolidated Water Company 2013 Operating Results Conference Call. [Operator Instructions].

This conference call may include statements that may constitute forward-looking statements, usually containing the words believe, estimate, project, intend, expect or similar expressions. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements.

Factors that would cause or contribute to such differences include, but are not limited to, continued acceptance of the company's products and services in the marketplace, changes in its relationship with the governments of the jurisdictions in which it operates, the ability to successfully secure contracts for water projects in other countries; the ability to develop and operate such projects profitably and other risks detailed in the company's periodic report filings with the Securities and Exchange Commission. By making these forward-looking statements, the company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. Please note, this event is being recorded.

And I would now like to turn the conference over to Rick McTaggart. Please go ahead.

Frederick McTaggart

Thank you, Amy. Good morning ladies and gentlemen. Thank you for joining us at our 2013 Full Year Earnings Conference Call.

Net income during 2013 was approximately $8.6 million compared to approximately $9.3 million in 2012, and this decline resulted from a decline in earnings from our investment in our BVI affiliate, which had totaled $2.46 million in 2012 and reduced to $1.34 million in 2013.

In 2012, we had received proceeds from compensation that was awarded to us by the courts in BVI for the Baughers Bay litigation amounting to $4.7 million, and that reduced to $2 million in 2013.

Retail water revenues declined by about 5% or $1.2 million this past year, due to an 8% decline in the number of gallons sold in our Cayman retail operations, when compared to 2012. Reason for this continued decline and volume sales, which happened over the past three years is confounding, given that economic conditions and tourism numbers continue to improve in the Cayman Islands. In fact, their tourist arrivals were up about 9% in 2013, and we typically use that as an indicator for our water usage in our service areas, primarily, hotel tourism consumption. We are currently speeding with some of our customers in Grand Cayman to determine what factors may be contributing to this decline in sales volumes. Gross profit of our retail segment through the year decreased by 5% or about $700,000 on lower revenues.

Now looking to the future, construction work continues on several new developments within our retail service area in Grand Cayman, and we expect these new developments, when completed, to favorably impact our retail water sales. The water colors development is a 60-unit luxury private residence project, that would be opened later this year, and the Kimpton Hotel, which is a hotel condominium property with 250 hotel rooms and 52 condo units, and that's expected to open in 2016.

In addition to these large hotel condo projects that are coming online in the near future, recent articles in the local press have highlighted a high end residential building boom that is underway, specifically in our service area, which indicates that recent changes in the country's immigration laws have been successful in attracting high net worth individuals back to reside in the Cayman Islands.

Finally, a third 90,000 square foot office building is under construction at Camana Bay, which adds to the over 300,000 square feet of office space that is currently on this 500 acre multi-use development.

On the cost side, we continue to take steps to improve the efficiency of our retail water business by reducing costs, and we recently commenced a program to locate certain leaks in our distribution system, using state-of-the-art leak locating technology. We have been consistently reducing leakage rates over the past six months using standard methods, and have selected a new helium detection technology to locate and repair the last few elusive leaks. We expect these repairs to reduce operating costs and favorably impact operating margins in coming quarters.

We recorded in November that our water utility license on Grand Cayman was extended until June 30 of this year, to allow additional time for judicial review proceedings to conclude. We further reported that the Grand Court of the Cayman Islands is scheduled to first hearing of the judicial review for next month, April 1st and 2nd.

We have asked the court to interpret certain provisions and legislation that was enacted in 2011, which appears to impact rights in our existing license. Furthermore, we are asking the court to determine whether our current regulator, Water Authority Cayman is conflicted in the negotiations, and has taken a predetermined decision on how our water rates would be regulated going forward. We will keep investors apprised of this issue as it progresses; and from a standpoint of timing, although the court proceedings began early next month, we wouldn't expect to get any sort of decision by the courts until much later in the year.

Our bulk revenues in 2013 decreased slightly by 2% or $800,000 due to the loss of revenues from one of our bulk water contracts in the Cayman Islands, which expired in January of last year. However, gross profit of our bulk segment increased from 29% or approximately $2.6 million compared to 2012, due to improved operating margins, and particularly a reduction of approximately $2.2 million in depreciation expense for assets that reached the end of their useful lives, that are still getting used in the business. This increased our bulk segment gross profit margin from 22% in 2012, to 29% in 2013.

We had previously reported that our bulk water supply agreement with the Bahamas Water and Storage Corporation for our Windsor plant had officially ended in July of 2013. However in September, the Government of Bahamas asked us to continue operating the plant, while it decides whether or not it will extend the present contract with us on a long term basis, and they are currently awaiting government's decision, and again, we will keep everybody advised of any material developments.

Our services segment incurred an operating loss in 2013 on higher revenues from management and engineering fees we charged to our BVI affiliate; because we run all of the funding for our Mexican development project through this segment, we would expect our service segment to continue to incur operating losses, until it completed development of the Rosarito, Mexico project, which we hope will be later this year.

Looking at projects, sales from our newly constructed plant in Nusa Dua, Bali, Indonesia amounted to approximately $144,000 for the year, which is quite modest. However, we continue to experience increasing interest in our desalinated water, and are currently increasing the production capacity that was planned from 250,000 gallons per day, to 750,000 gallons per day; and we are doing this in order to meet expected demand in the dry season, which really starts net month and goes through October, and its really quite dry during the summer months there.

We are also extending our distribution pipeline from Sawangan, our Nusa Dua plant, to several key resort properties in the immediate area in order to facilitate connection of these properties. Our plant and pipeline extensions should be completed early in the second quarter of 2014, in advance of the dry season.

Looking at Mexico, we made further progress on our Rosarito project, this past quarter we held several productive, technical and financial meetings with officials of the Government of Baja California and the Tijuana public utility, which is called CESPT. We also continue to work closely with Otay Water District in California to develop the second phase of water testing and equipment piloting for that cause, which are in support of Otay's efforts to obtain their regulatory approvals in California, for the importation and use of desalinated water from the Rosarito project.

I think everybody has probably been following the headlines in California, and the drought in the region has continued to worsen over this past year, and we believe that the Rosarito plant offers an economical, technically feasible, and most importantly, a drought-proof solution to the region's water problems.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Philip Shen at Roth Capital.

Matthew Riley - Roth Capital Partners

Hey there, Rick. It's Matt Riley on for Phil.

Frederick McTaggart

Hey Matt, how are you doing?

Matthew Riley - Roth Capital Partners

Hey, good. Thank you. I just wanted to dig in to bulk segment a little bit in the margins. Were the margins primarily driven by the lack of depreciation or are there other factors at play here, and kind of what you expect going ahead?

Frederick McTaggart

Well certainly for the year, it was primarily driven by lack of depreciation. Basically, we are stretching out the lives of these assets, and we still controlled maintenance and replacement costs at the same time. So I think it was just an overall picture of well maintained plants that increased the margins there.

Matthew Riley - Roth Capital Partners

Okay. And do you expect to continue operating this equipment ahead and expect continued strong teens [ph] in the bulk segment?

Frederick McTaggart

It's hard to say that Matt. I mean, some of this stuff is quite hold, and at some point it will have to be replaced and we will incur some CapEx for that, and then yeah, obviously depreciation goes up. You know, historically it has been sort of a zigzag pattern with that. I mean, there is a plant in Cayman now that's fully depreciated, that at some point I think in the next couple of years, we will have to retrofit, and obviously, the Windsor Plant in the Bahamas, if we get an extension to that contract, we will be doing some work there.

Matthew Riley - Roth Capital Partners

Okay. Got it. That's helpful Rick. Just kind of quickly moving on to Bali. Can you just talk to us about the latest customer interest level? Are you extending to new resorts and is the 750,000 gallons per day currently in place, or is that still under construction?

Frederick McTaggart

I will let David talk about the customer introspect, and tell you the 750,000 gallons should be completed within the next couple of weeks, and all the equipment is on-site.

David Sasnett

Matt, this is David Sasnett. Actually, we had to learn how to do business in Bali. That market is different from many other places where we have operated. Typically they don't sign long term contracts in Indonesia, or in Bali specifically; and these people are willing -- apparently they are willing to pay higher prices and they are locked in -- again, a price over a long period of time, because they feel [indiscernible] sign long term contracts. So we have changed our business model there and once we have the pipeline laid up to all these different resorts, we expect them to come online and buy water from us. But typically, it will be -- we would expect to be on very short-term agreements, which typically is okay with us. That way, we can adjust the price periodically if we need to. Certainly, if they are going to enter into short term agreements with us, we are going to charge them more in the [indiscernible] than for long term agreements.

So we are adapting our business model to do business in a way that they feel comfortable, and we wouldn't have expanded the plant to 750,000 gallons per day, if we did to comp that, we did so much to that production pretty quickly. Even if we don't have contracts where we can still sell, on a monthly or yearly basis to all these customers. And just when we entered the market, we still see no long term solution to the water shortage in this area, other than desalination and we are the first company to have a plant there.

I hope that gave you some insight. We did a study of the area. We actually surveyed the hotels that were under construction there, and we estimated as much as 8 million gallons of demand for water in this area. So we felt comfortable building the plant. We don't necessarily carry much on that demand, make sure our plant is operating at pretty near, at full capacity.

Matthew Riley - Roth Capital Partners

Okay. Terrific. Rick and David, thank you. And I will jump back in queue.

Frederick McTaggart

Thanks Matt.

Operator

(Operator Instructions). And our next question comes from Alexander Renker at Sidoti & Company.

Alexander Renker - Sidoti & Company

Hi. Good morning.

Frederick McTaggart

Good morning.

David Sasnett

Good morning Alex.

Alexander Renker - Sidoti & Company

So David, I was wondering, on Mexico guidance. So there was a section in the 10-K there that had a rundown of some of the expenditures you guys are expecting. I think there was a $6.8 million figure quoted, that's what we should expect for SG&A there next year?

David Sasnett

Yes. That's our best estimate at this time of what was spent.

Frederick McTaggart

I will just quantify that a bit. From my talk earlier, you can see we are very focused on getting customer contracts. Once we get a clear indication of the future revenue stream from that project, we can look at capitalizing certain costs that we'd be incurring otherwise as expenses. So it's going to be very dependent on when that happens this year, when we get the contracts, and that could change the expense picture going forward.

David Sasnett

Okay. Just to add to what Rick said. We don't know when we will get those contracts. So we expect to spend $6.8 million. If at some point in time, we get a customer contract before that, then obviously the amount will probably be a little less than $6.8 million, because some of that stuff will be capitalized. But we just happen to have on the customer's a little -- there's no guarantee that they will ever sign a contract with us, but we wouldn't be pursuing this, if we didn't think we had an excellent chance of getting them to sign up. We just don't have the timing on that.

Alexander Renker - Sidoti & Company

Sure. Okay. Thank you. And then, on the depreciation point with bulk segment gross margin. I guess I am not completely clear why, if aging equipment is replaced, that margin pattern wouldn't persist, given that it seems like there have been technological changes you guys have made operationally, that allow that extended depreciation life?

David Sasnett

Well, when we put assets on the books, we do our best to estimate their useful lives, and what's happened with some of our plants is that, the people who operate our plants and maintain our equipment have done an excellent job of extending useful lives of these assets beyond what we originally thought they would last. At some point in time, Alex, we are going to have to replace those assets and there will be depreciation charged to amortize the capital expenditures we make for the replacements.

It's fair to say, that we have become better at operating our plants over the years, and gradually our bulk margins have improved. And I think, even with the depreciation charge added back to the operating results for these plants, [indiscernible] on efficiency, improving on what we had in previous years. But still, there is a substantial benefit we are getting to the margins right now, to the fact that we are not having to depreciate assets, and especially in a couple of the plants in Grand Cayman and also in the Bahamas.

I don't want to downplay the impact of the market depreciation on our margins, because it is significant. But as you said earlier, we are operating our plants better than we used to in the past, and even with the depreciation charge, the margins we earn in that will be better going forward than we have in past years, say four or five years ago.

Alexander Renker - Sidoti & Company

Okay. Understood. Thank you.

Operator

Our next question comes from Blake Todd at Two Oaks Investment Management.

Blake Todd - Two Oaks Investment Management

Good morning gentlemen. As you are going forward with the Mexico project, I notice that we are going to be purchasing the land by May of this year. There is going to be more and more capital that's going to be required for that project. Is that going to impact our dividend philosophy of the company?

David Sasnett

Well our dividend philosophy is determined by our board of directors. And I think as we have disclosed on our 10-K, we've paid dividends since 1985. We are not aware of anything at this point in time. Late in the next [indiscernible], that's going to impact our dividend policy. But we are not the ones to make that decision, that's ultimately, our Board of Directors.

So all I can offer you at this point in time, is negative assurance. We are not aware of anything that would change at this point. But obviously as our Board lets in [ph] our capital needs for various projects, and our available liquidity may change their mind and change the dividend policy. We can't speak for them.

Blake Todd - Two Oaks Investment Management

Okay. And are you looking to do joint ventures to erase most of the capital for the construction and development of Mexico, or how much of it are you trying to do yourselves?

David Sasnett

We've disclosed consistently and perhaps we need to do a more better job with this 10-K. But we have tried to disclose consistently, that once we reach the financial closed-phase of this project, we won't be putting in more money into it. Once we have contract signed with the customers that we think are financeable, that we can take to the marketplace and we use to raise capital. At that point in time, the capital for the actual construction of the plant for the development will come from third parties. Our best estimate at the moment is, its going to take some $600 million to $700 million to build a plant in Rosarito, and we expect to have only a small minority piece ownership in that plant, and raise all the other money from non-recourse debt and equity financing.

So the numbers we put in our 10-K relative to the costs we incurred on Mexico. If things go as planned, and we are able to get a financial close some time in 2015, we will be spending more money than what we have disclosed in the 2014 estimates in our K, and not a lot more. At that point in time, we should be at a point where we can get money from third parties, and we are not spending more ourselves.

Blake Todd - Two Oaks Investment Management

Super. Thank you.

Operator

(Operator Instructions). This time, we show no further questions. I would like to turn the conference back over to management for any closing remarks.

Frederick McTaggart

I'd just like to thank everybody for joining in once again, and look forward to speaking to you in May, when we release our first quarter results. Thank you.

Operator

To access the digital replay of this conference, you may dial 1877-344-7529 or 1412-317-0088 beginning at 12:30 Eastern Time today. You'll be prompted to enter a conference number, which will be 10042472. Please record your name and company when prompted.

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

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