Consolidated Water Co. Ltd. (CWCO) Q2 2012 Earnings Report, Transcript and Summary

Hello, and welcome to the Consolidated Water Co. Second Quarter 2012 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 risk 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 conference is being recorded. Now I'd like to turn the conference over to Rick McTaggart. Mr. McTaggart, the floor is yours, sir.

Thanks, Mike. Good morning, ladies and gentlemen. I'm joined today on the call by David Sasnett, our Chief Financial Officer. We appreciate you taking time from your busy schedules to join us. As reported in our press release yesterday evening, our operating results in the second quarter were adversely impacted by unusual weather conditions with more than 2 feet of rain following on Grand Cayman in the second quarter this year compared to just 4 inches during the same period last year. In spite of this abnormally high rainfall, which reduced our retail segment revenues by approximately 10% compared to the second quarter of 2011, we're able to achieve overall results, which are comparable to last year because of improvements in our bulk segment results. The net income was up slightly by 1% this past quarter compared to last year with a consistent diluted earnings per share of $0.13 per share. Retail sales by volume decreased by 17% this past quarter due to higher rainfall, which reduced the demand for our water. Investors may recall that we had a volume decrease in the third quarter 2010 of about 19% because of unusually high rainfall during that period. So far in the third quarter this year, rainfall amounts appear to have returned to normal levels. This profit from our retail segment declined by 14% compared to the same period last year due to lower sales volumes. Late last week, we received from the Water Authority-Cayman a fully executed extension of our exclusive retail licensing Grand Cayman through December 31, 2012. As previously disclosed to investors, we were advised by the government of Cayman Islands in late May that they consider the Water Authority-Cayman to now be the principal negotiator in our retail license negotiations, which have been ongoing for more than 4 years and previously, the government itself was the principal negotiator. At about the same time, the Water Authority-Cayman advised us that they had determined that our retail license should employ a new rate determination methodology, specifically rate of return on invested capital model, which is -- which we refer to as the RCAM rate model. The water authority state position is of such a model is in the best interest of our consumers and would protect the public interest of the Cayman Islands. However, we believe that our current rate model encourages efficiency on our part and the delivery of superior water quality and services to the public. These are rate models that served Grand Cayman quite well for more than 30 years as, we provide the island with perhaps the highest quality and most reliable water service in the Caribbean. The RCAM rate model is essentially a model, which would determine our rates based on a guaranteed return on invested capital. As I said, we're at a loss to understand firstly how this determination was made; secondly, how a model which provides private shareholders with a guaranteed almost risk-free return on our invested capital can be in the public's best interest; and thirdly, how such a model could possibly promote the efficient and cost-effective operation of any enterprise. In an effort to resolve these issues, as well as to get clarity on the certain provisions of 2 laws that were passed by the government in January last year, we filed an Application for Leave to Apply for Judicial Review with the Grand Court of the Cayman Islands in July, stating firstly that certain provisions of these 2 laws appear to be incompatible; secondly, that the water authority's role as principal license negotiator, statutory regulator and our business competitor creates a clear irreconcilable conflict of interest for the authority; and lastly, that the authority's decision to replace the rate structure driven by our current exclusive license was predetermined and unreasonable. Though the authorities conflicted position was further highlighted last week, when a Cayman government minister stated in a public meeting in West Bay, Grand Cayman that the government's firm position is that any divestment of the water authority's operating assets would be offered to Consolidated Water first. This meeting was held to communicate to the public the government's positions with respect to balancing the country's budget and with respect to a proposed new payroll tax intended to help reduce the country's large budget deficit. We hope the court will be able to deal with our application quickly, but we're unable to provide investors of the time frame for the court's decision. And we, of course, remain willing to meet with the government to discuss any reasonable way forward to deal with these pending issues. Turning to the -- our bulk segment results. Consistent with our expectations, the expansion of the Blue Hills plant in Nassau, which was completed in November last year, enhanced revenues and gross profitability of our bulk segment by 31% and 62%, respectively, reflecting a 30% increase in the volume of water sold in this operating segment. Results from our Belize and our Cayman Islands bulk water operations were consistent with our expectations and with prior year results. Services revenues declined to approximately $100,000 this past quarter compared with approximately $500,000 in the second quarter of 2011, reflecting the expiration of our management services contract in Bermuda last June. Services segment recorded a gross profit of approximately $77,000 last quarter compared to a gross profit of $325,000 in 2011 and the decline in gross profits reflected the decrease in the segment's revenues. However, investors should expect service segment results to improve when we finalize a new management and engineering services agreement with the new retail water joint venture in The Bahamas in the third quarter this year, which I will talk about a bit more after David provides a few comments on the company's financial position.

Good morning, everyone. For the first 6 months of this year, we've continued to strengthen our strategic financial position. In addition to generating earnings and cash flow, we decided to utilize some of our available cash balances to reduce our outstanding debt and to make investments in what we consider to be very promising new business opportunities. If you look at our cash flow statement in our balance sheet, you'll note that we have prepaid $8.5 million bonds in the first quarter this year that were payable by our Bahamas subsidiary. These bonds were issued initially in 2005 to fund the construction of the first phase of our Blue Hills plant. We've also paid off $7.5 million of short-term borrowings during this quarter that we incurred to finance the Phase 2 expansion of Blue Hills. You'll note that as a result of these repayments, our interest expense declined by more than $220,000 over the first 6 months of 2012 when you compare that amount to 2011. At June 30, 2012, our capitalization consisted of $131 million in equity and only $7.6 million in debt, and that gives us perhaps the lowest and healthiest debt-to-equity ratio in our industry. Even with these prepayments, our working capital remains quite healthy at more than $42 million. While our receivable balances have gone somewhat since year end, we expect improved collections and reduction of these balances over the remainder of 2012 as we anticipate The Bahamas government will reduce its level of past-due receivables to our Bahamas subsidiary. We're also hopeful that we'll receive some additional cash payments during the remainder of 2012 from our OC-BVI affiliate as a result of their successful appeal with respect to the Baughers Bay litigation that's been ongoing for some time now. In our company's long-held view that our business model can be successfully implemented beyond our current geographical footprint, and with this strategic belief in mind, we've elected over the past 2 years to incur certain discretionary expenditures to pursue new business opportunities in Mexico and Asia. And Rick's going to talk about both of these in a moment. We remain optimistic of our success in both of these markets. However, those of you that invest and otherwise follow our company should be aware that we will continue to expend funds as we deem appropriate over the remainder of 2012 for these ventures. Those of you who are looking at our cash flows and earnings for the latter half of the year should also factor into the equation our upcoming $7 million investment in our joint venture with MTDC in The Bahamas and the impact of that joint venture on our earnings during the latter half of this year. And with that, I'll turn things back over to Rick.

Thanks, David. Earlier this year, we announced that we agreed to purchase 50% of the ownership of the joint venture in The Bahamas, which provides water to approximately 1,000 customers on the western end of New Providence Island pursuant to a 25-year exclusive water utility franchise granted by The Bahamas government. This new venture is an excellent addition to our Bahamas operations and will be the first retail venture for our company outside the Cayman Islands. Although we had anticipated closing this deal on or before June 30, various administrative nonbusiness matters delayed the closing, and we expect this transaction to close very soon. On the 100 million-gallon per day project in Northern Mexico, we extended our rights to purchase an 8.3-hectare parcel of land in Rosarito, Mexico, which is important to the success of the project. And we also continue to make progress on establishing a small pilot plant on the site with our strategic partner, Doosan Heavy Industries of Korea. For a while now, we've been talking about a project which we've been developing in Asia, and we're pleased to announce that we have secured a contract with a resort property in Bali, Indonesia initially to supply less than 100,000 gallons per day. However, we expect to be delivering water to that property in the fourth quarter this year, and we believe that this is just the start of a larger opportunity to supply water to other resort properties in the area, and we're developing the project with that in mind so it can accommodate the expected growth. So with that, I'd like to open the call up for questions, Mike.[Operator Instructions] The first question we have comes from Tim Fronda of Sidoti & Company.

And with the pilot plant operation in Mexico, can you give any guidance as to the timing for renewing the rights to land and actually constructing the site and also how big of an operation will this pilot plant be?

Well, the pilot plant is not going to generate any revenues. That will -- it's basically a test plant to help us -- assist us with the design of the project. We expect that to be operational in the fourth quarter, and that will start providing the days that we need to progress with the project.

Okay. And do you have any other new projects outside of Mexico and Bali sort of close to being finalized, maybe start developing in the remainder of 2012 or early 2013?

I mean, I think we've summarized pretty well what we're working on. There are some other opportunities that may come up, I mean, we have a contract renewal in The Bahamas. It's coming up, and it's possible that they may want some changes to that plant. That will be early next year. In addition, I mentioned that earlier that the water authority in Grand Cayman appears to be up for sale and the government seems to be very predisposed to talking to us about acquiring that asset. So that would be an excellent addition to our retail business in Grand Cayman.

[Operator Instructions] The next question we have comes from John Bair of SKA Financial Services.

A number of questions you addressed already, but a couple of quick ones here. The $75 -- or $7.5 million of restricted cash that was shown up in your last quarterly report, did that just get moved into cash and equivalents, or is that part used up for paying the debt down?

Yes, any way you look at it, it's the same thing. We used it to pay off the debt or you can move it into the unrestricted cash and use that cash to pay off the debt. That is going off the balance sheet.

Right. And then it looks like the -- your ARs dropped pretty good quarter-over-quarter and you think that's going to come down on a comparable -- looked like it was about $4 million or so, $3 million to $4 million. You think that will happen again this coming quarter? Is that just kind of dependent on Bahamas paying you in...

Well, The Bahamas got behind somewhat in their receivables to us, but they recently completed their budgeting process to governmental budgeting process and under which we understand they allocated moneys to us to pay off our receivables. So we will expect to get those moneys in the latter half of 2012. Bahamas always maintains a significant receivable balance from -- with us. That's just the nature of the way they operate. We're usually about -- usually, we have about 3 months of receivables due from them. It's a little bit more than that now. But we expect them to pay it down to more -- on the 90-day level over the latter half of 2012. It's been a pattern, they have done it before and we expect that again for this year.

Okay. And I wonder -- I've got a number -- others and I'll give one and then get back in the queue so somebody else can ask, and that is the -- as far as getting the rights for the Mexico project, is there a term for that, in other words a contract of 5 or 10 years or how that does work?

It was rights to purchase a strategic piece of land. It was -- the agreement is actually until May of 2014, so 1.5 years approximately. We believe that at that point, we'll be in a position to proceed with the project and have financing for the project. Our window has been sort of at the end of next year to be in a position to raise financing and to proceed with the construction.

[Operator Instructions]

I'm just wondering if the Cayman Water Authority are ex-U.S. Congressmen or something. They seem to have kicking this issue down the road, but just wondering what do you think is the -- I mean, your comments indicate you were hoping that you get some kind of resolution on this by the end of 2012. But if it isn't addressed at the court level or whatever, you have any sense of how long this is -- I mean, it's dragged up for 4 years. Is it going to be another 4 years, do you think or...

I really can't say at this point. I mean, we'd like to get it resolved as quickly as possible. We just want to make sure that we're talking to the right parties in the negotiations and that there's no other interest, which conflict -- make these -- the parties conflicted. So that's all we're looking for at this point. And I think once we can sit around the table with somebody and talk reasonably that we can move this forward quickly.

Okay. One last question here. On your general administrative expenses, can we expect that the level is going to stabilize out here that you're spending? I mean, you got these projects kicking in and I realize that's going to spend some money to do that. Can you give us a sense as to what your expectations are there?

Our basic SG&A expenses, John, are fairly stable. There had been some changes this year from last year. We've made some discretionary hires. We've hired a Chief Operating Officer. We've beefed up our IT personnel, and so slightly more payroll involved than last year. The project development expenses, as I've mentioned last -- earlier, are going to continue. We're doing things not only in Bali but elsewhere in Asia. We're not spending a huge sum of money there, but we are spending money there. We've tried to give investors a little bit of insight as to how much money we're going to spend over the remainder of this year in our 10-Q, but we talked about the money as to -- we expect to incur over the next 4 quarters relative to Mexico. So the wild card in all of this and it -- is going to be the project development expenses, and like I said, take a look at our Q. We've added a little bit of disclosure there as to what we expect to spend over the next year there. But we don't expect to grow SG&A significantly without a greater increase in revenues and gross profits. It's not like we're frivolous with the money we spend in this area. We had have to hire a couple of people, though. If you want to move your business to the next level, you need to prop the appropriate IT platform to do so. And we felt the addition of the Chief Operating Officer was important to enable us to take some of the pressure off of our CEO and to provide some additional expertise in the company. So those were strategic hires that we thought were very important. Other than that, we're not looking to hire a lot of new people or anything.

Well, we're showing no further questions at this time. I would like to turn the conference back over to Mr. McTaggart and Mr. Sasnett for any closing remarks. Gentlemen?

I'd just like to thank everybody for joining us on the call, and I look forward to speaking with you again in November on our third quarter call. Take care.

Thank you also, sir. And we thank you, gentlemen, for your time. The conference call has now concluded. We thank you all, again, for participating in today's conference. At this time, you may disconnect your lines. Thank you, and take care.