Frederick W. McTaggart - Chief Executive Officer, President, Director and Member of Executive Committee David W. Sasnett - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Director

Hasan Doza John Bair Blake Tramill Todd - Two Oaks Investment Management, LLC Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

Hello, and welcome to the Consolidated Water Company Full Year 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 risks and uncertainties that may 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 would like to turn the conference over to Mr. Rick McTaggart, President and CEO. Please go ahead, sir. Frederick W. McTaggart: Thanks, Denise. Good morning, ladies and gentlemen. David Sasnett, our Chief Financial Officer, is also here with me this morning in our Florida office. And we'd like to thank you for joining us to hear about our 2012 financial results and the exciting opportunities for our company. I'm very pleased to announce that the company achieved a 52% year-over-year increase in net income, primarily due to a 16% increase in consolidated gross profit and a higher-than-usual earnings from our equity investment in our BVI affiliate, which arose from payments awarded in the Baughers Bay litigation. Gross profits of our retail on both water segments improved in terms of total dollars by 7% and 37%, respectively, while both gross profit as a percentage of sales for these segments were essentially consistent with the prior year. Water revenues generated by our retail segment increased by approximately 3.7% compared to 2011 to $24.2 million, primarily due to a 4.5% increase in our base rates, which was implemented in accordance with the annual inflation-based rate adjustment mechanism in our Cayman Islands license in January of 2012. However, in terms of volume, our water sales declined slightly last year by 2% compared to 2011, due to unusually rainy weather in the second quarter of the year, which partially offset the base rate increase. In spite of this decline in volume sales, we were able to achieve a modest increase of approximately 7% in the gross profit of our retail segment due to the base rate increase, coupled with savings and efficiency improvements of some production costs, which we expect will continue in future periods. It should be noted that due to the flat Cayman Islands consumer price index over 2012 and a decline in the United States Producers Price Index during that same period, both of which are used to calculate the annual inflation adjustment to our Cayman water rates, our 2013 base water rates declined slightly by 0.2% effective January 1, 2013. We're hopeful that planned efficiency improvements in our Cayman Islands water distribution system during 2013 will more than offset this slight rate decline, which will allow us to maintain or improve our retail gross profit margin this year. We're obviously disappointed that we and the current Cayman Islands government have not been able to move closer to a resolution of the ongoing negotiations to the extension of our Cayman Islands retail license. In fact, it appears at this point that the pending judicial review of the negotiation process, which we initiated in July last year, will be the only way to move these negotiations forward. On the other hand, the Cayman Islands general elections will be held on May 22, and it is possible, as a result, that a new government would be formed, in which case we would have the opportunity to negotiate with a new group of decision-makers. Water revenues generated by our bulk segment increased approximately 33% compared to 2011 to $40.8 million, primarily because of a 32% increase in the volume of water sold in 2012. This increase in volume resulted from the expansion of the Blue Hills plant in Nassau, which was expanded by 67% in November of 2011. All gross profit compared to revenues remain consistent in 20 -- consistent with 2011 at 22%. The expanded Blue Hills plant continues to operate better than we expected and so far this year, we have delivered almost 17% more water than the contracted guarantee. Also, in The Bahamas, the Windsor contract is set to expire in mid-May when we reach the contracted delivery volume to Water & Sewer Corporation of 10,950,000,000 imperial gallons over the last 15 years. We've submitted a proposal to the Corporation, in October last year, to extend the contract for an additional 5 years, and we're currently awaiting its decision. In the event that the Corporation decides not to extend the contract, then we would enter into negotiations to sell the plant and equipment to the Corporation, and lacking any agreement on the sale, we would remove the plant and equipment from the site. Our Belize operations continued to perform exceptionally well in 2012, adding $2.3 million to revenues and $900,000 to gross profit. Our local crew in Belize runs a highly efficient operation. And my thanks go out to them for their continued hard work and dedication to excellence. In Grand Cayman, the Water Authority assumed operational responsibility for the lower-value plant in mid-January when our agreement with them expired. This plant contributed about $100,000 to $200,000 per year to our gross profits over the last few years. The lower-value plant will be the Authority's first foray into the operation of a desalination plant of that size and complexity. Now looking at our services segment. Services segment generated revenues of about $0.5 million for the year, which consisted primarily of management fees charged to our BVI affiliate. This segment's revenues were down from about $1 million in 2011 due to the expiration of the Bermuda operating contract in mid-2011. Services segment in 2012 contributed about $240,000 to our gross profit, down from about $530,000 in 2011 due to lower revenues. And just note that further performance of this segment -- or future performance of this segment will continue to be consistent with 2012 and will remain a small part of our gross profits until such time as we obtain new engineering and/or operating contracts for plants that we do not own. And because of the development expenses incurred and to be incurred for our ongoing project in Mexico, we expect this segment to report an operating loss for 2013 as it did in 2012. As mentioned earlier, our BVI affiliate received payments due under the Court ordered Baughers Bay judgment, of approximately $4.7 million in the fourth quarter of 2012 and a final payment of $2 million shortly after the beginning of this year, which now settles the first phase of our affiliate's dispute with the BVI government that began in 2007. Our net income in 2012 included earnings and profits -- profit-sharing from our BVI investment totaling $2.5 million. And our first quarter net income in 2013 will reflect our portion of the final judgment amount of $2 million that was received in January. OC-BVI will continue to pursue, through the courts, payment of the value of the Baughers Bay plant and equipment when it was turned over to the BVI government in March of 2010. In the Court of Appeals June 2012 ruling, the judge reversed the Lower Court's decision not to allow OC-BVI to claim for that value. The June 2012 ruling further directed that the parties agree to the value of the plant and equipment at March of 2010, and the amount due to OC-BVI in the claim would be that agreed value, less a buyout payment of $1.42 million that was included in the original contract sale. So the bottom line there is that there is a further claim that is outstanding. It's working its way through the courts, and we will keep investors updated on the status in future disclosures. So now looking at projects, what exciting opportunities do we have looking forward? During the last quarter of 2012, we achieved significant milestones in the development of our proposed 100 million-gallon per day desalination plant in Rosarito, Mexico. In November 2012, our affiliate, NSC Agua signed a letter of intent with Otay Water District in Southern California, to provide Otay no less than 20 million and up to 40 million gallons per day of desalinated water at the border between Mexico and the United States. Technical resources from both NSC Agua and Otay are coordinating their efforts to obtain the many regulatory approvals that are required on both sides of the border to achieve the project objectives. Also in November, we signed a 20-year lease with the Federal Electricity Commission of Mexico for approximately 5,000 square meters of land within the Presidente Juarez Thermoelectric Plant in Rosarito. And we intend to construct the intake and outflow works for the Rosarito desalination plant on the power plant site. Achieving access to these areas within the power plant site and being able to take the residual water from the cooling process of the power plant represent critical steps in the development process. And we're very pleased with our ability to work closely with and gain the confidence of the Commission and the achievement of this important milestone. In late November, our strategic partner, Doosan Heavy Industries & Construction, began operating a pilot-scale seawater pretreatment system on the site of the proposed Rosarito Plant. And they're currently collecting water quality and pretreatment system performance data, which will be used in the design of the full-scale desalination plant. We expect the pilot-scale testing to continue for 6 to 12 months, and we intend to tailor the program to meet the requirements of the various regulatory agencies on both sides of the border. Now looking at our Asia opportunities. Construction of our first desalination plant in Bali, Indonesia, is nearing completion after about an 18-month development cycle. And we run into the typical new market technical challenges and consequently, the project startup date has been delayed a couple of times. But we do expect to begin supplying water to resort properties in the Nusa Dua area during the second quarter of this year. The island of Bali and other similar areas in Indonesia and Asia present highly attractive opportunities for long-term business growth due to the continued development of tourist properties in these areas without access to sufficient freshwater resources. Because we have a regular management presence in the region, we're also learning of other opportunities in desalination and complimentary services, which we intend to pursue. And we will let you know if and when these opportunities develop. Now Denise, I'd like to open the call up for questions.

[Operator Instructions] The first question will come from Hasan Doza of Water Asset Management.

I just wanted to clarify 2 things. So in terms of the $4.7 million, the Court ordered [ph], which you guys received, how much was booked into net income during Q4? Frederick W. McTaggart: The way it works, Hasan, is we own 43 point -- 43% of the profits of OC-BVI. We also have 2% profit-sharing. So the way you compute is just take 45% of the $4.7 million and that would be the net impact of it on our earnings.

Perfect, okay. Perfect. And the second payments, which you will receive, the $2 million, is that your portion or should I take 45% of the $2 million to understand the net income impact? Frederick W. McTaggart: 45% would be our portion.

Okay. So about 1/2 of the $2 million that you will receive in -- that you received in January? Frederick W. McTaggart: Well, what's going to happen is the $2 million will go into the income of OC-BVI. We have the right to get 45% of that income. So that impact, that will increase our piece of their income by $900,000.

Perfect, got it. So in my -- the last question is, if I kind of back out of these payments from OC-BVI and try to understand sort of the recurring earnings base of the company, this $2 million, or the payment is approximately $0.14, $0.15. I calculate kind of a recurring earnings base somewhere around $0.50 per share in terms of your operating business. Is that a right way to look at it? And secondly, can you help me understand the path for growing this recurring earning stream in 2013? Frederick W. McTaggart: Well, Hasan, yes, the payments received by OC-BVI are nonrecurring. That's going to be a total of $6.7 million, as we just discussed. If you took those payments out, you have a better understanding of what we expect to earn from OC-BVI going forward because the plant itself is -- the Bar Bay is pretty consistent to what it produces and the earnings that it generates for OC-BVI. Looking at our business, you also have to factor into the operating results, the significant amount of money we're spending in Mexico at the moment. Those expenses are discretionary. They're not a basic part of our existing operations, but we feel like they're more than merited because of the tremendous potential of the Mexico project. So if you wanted to really look at what the recurring business is, without consideration of monies that we are discretionary -- that we have discretionary spending, you should probably also factor back into our earnings the amounts we're spending in Mexico. Because that project will either be a success and will generate a significant amount of income and profits from it, or we'll stop spending that money. And we've disclosed what we plan to spend next year, and it's clearly disclosed in our 10-K what we have spent historically in 2010, 2011 and 2012. So take -- so you should also consider that if you do that, if you take the factor in those discretionary expenditures and then take out the recurring income -- nonrecurring income from OC-BVI, you'll have a pretty good understanding of where our current earnings are at the moment.

The next question will come from John Bair of SKA Financial Services.

It looks to me as if you're -- both your retail and your bulk water revenues edged up a little bit on the fourth quarter versus the third quarter. I'm wondering if that trend -- you think that trend will continue? Frederick W. McTaggart: On the retail side, it's somewhat difficult to attribute it to a trend. I mean, last year, we had some pretty significant variances from quarter-to-quarter because of weather. So I think, on a yearly basis, you should look at what our retail business is doing. And things are picking up a little bit in the Cayman Islands now. There are some new development properties coming online this year. So I would expect a similar -- or just a -- basically a flat performance for this year. I mean, our total volume sales were down about 2% in 2012 compared to 11%. But again, that was related to pretty unusual rain event in the second quarter. So I would expect relatively flat revenues there in retail. From the standpoint of bulk, the full effect of the Blue Hills plant was included in the 2012 figures. I would think that that's going to be fairly consistent going into 2013. We don't have any new plants coming online at this point in the bulk segment.

Right. So again, looks like on a quarter-to-quarter basis, it should be relatively -- I don't want to -- flat, hopefully growing a little bit year-over-year, would look more significant because of the new plant coming on or the additional capacity coming on, right? Frederick W. McTaggart: Correct, yes.

Yes, okay. And can you share anything about what kind of water volumes you might expect out of that Bali plant? David W. Sasnett: Well, first of all, just let me add to something what Rick said. When you look at our business, it's very important to understand that the weather patterns have the biggest impact on how much water we sell. Tourism does have an impact, but to a lesser extent. Population increase is clearly our drivers of increased water usage. But there's no reason to believe that Cayman Islands is going to suddenly increase in population overnight, for a significant amount. So retail, really, if you factor in the weather situation, is going to remain about the same. With respect to Bali, I -- the situation in Bali is that we built a plant there in anticipation of selling water to a number of resorts in the area. There's really no solution for the water problems they have now. Desal, to us seems like the only possible solution. But we're having to educate the resorts in that area on the benefits of desal because no one has really done it in Bali before. So we're building a 500,000-gallon per day plant, that's expandable to 1.5 million gallons. And we fervently believe that once we start producing water and show people the quality of the water, the reverse osmosis, desalination process produces, they'll be eager to buy from us. And we've had some real very -- some very strong interest from a number of large resorts in that area. They're just waiting for us to deliver on our promise. They want to see us produce first. So we would expect that plant to be up and running. And if it receives the kind of acceptance from the customer base in the area, then we would -- that we anticipate, then we will proceed to expanding the plant to 1.5 million gallons sometime in the next year or so. The entire area of Bali has a very public and acknowledged water prices. Even though the island receives a lot of rainfall, they don't have reservoir systems to catch it. And so consequently, most of it runs off. And they need another solution to provide water to a population of over 3 million people. So they're looking at a number of things, but desal, in one form or the other, will be a contributing factor to the solution, the overall solution. And we'd like to be a part of that piece of desal that's done in Bali, in the entire area of Indonesia, and many other areas of Asia are in similar situations. So we're looking at a number of areas at the moment. And hopefully, we'll be able to proceed with some new business in Asia and Bali in the near future.

Okay. And geographically, how far can you distribute the water from the existing plant that you're building there? In other words if you're going to potentially supply to different resorts, several different ones, are they all kind of clustered together, or fairly close by? David W. Sasnett: Yes, the Nasa Dua area has a number of very large resorts in close proximity to each other. So it's not a huge amount of distribution there.

So it's pretty efficient in that regard? David W. Sasnett: Very similar to the 7-mile beach area of Grand Cayman. The only difference is, the resorts in Bali are truly spectacular. And they have huge, huge water needs. The pools and lagoons and things like that, it seems like they decorate their entire landscape with some kind of lake or -- anyway, they use a lot of water, a lot of waterfalls. So it's a great opportunity for us if we can convince them to buy from us.

So one last quick one on that. And then I'll get out back into the queue. But how long of a sort of a trial period, once you get that plant up and running, would you anticipate you'd need before they'd say, yes, this is great, let's go forward on it on an ongoing basis and get your contracts and all that kind of thing, are you looking at 3 months, 6 months, a year? David W. Sasnett: Yes, within 6 months, we could sell out the capacity. But you have to understand the need for water in that area is much, much greater than the capacity of our plant. We don't need to have all the hotels sign up. We could sell out the capacity of that plant with just 1 hotel and 1 resort, there's 1 capable of taking all the water. Their water usage is in excess of the capacity of our plant. We're taking a baby step here, we're not committing too much money, but we believe that the potential for water sales in this area is much, much greater than 0.5 million gallons a day.

The next question will come from Blake Todd of Twin Oaks Investment Management. Blake Tramill Todd - Two Oaks Investment Management, LLC: I'm trying to get an understanding of the length of time that you guys would estimate before you're actually going to be selling the water in Mexico. Is that 2014, end of, '15, 16? Frederick W. McTaggart: Unfortunately, it's more likely to be like 2017. It's a very large project, and it's a 2- to 3-year construction period once we raise the financing for it. So it's likely to be 2017. Blake Tramill Todd - Two Oaks Investment Management, LLC: Okay, great. The second thing is I noticed that you guys have done a great job in cleaning your balance sheet up, very low debt and so forth. Your dividend payments have been kept pretty constant. From all the development projects you guys are doing, it looks like you want to conserve cash for these development projects. Is that a fair statement that we shouldn't expect any dividend increases for the future? David W. Sasnett: Well, the dividend policy is set by our Board of Directors, but we have experienced in the past very little growth in the price of our stock when we increased our dividend. So I'm not sure if the increase will be used as an income stock or a growth stock. So I can't speak for the Board, but we haven't increased our dividend in a while. So I'm not sure if there's any real reason for us to do so in the future. But that's a policy of the Board. They may -- ultimately, they may decide not to pay dividends at all, based upon our capital needs. We just don't know, and we make that very clear in our 10-K. So I guess that's really a non-answer. I'm sorry I can't give you more guidance. But determination is yet to be made by the Board as to what we'll do for next year.

[Operator Instructions] The next question will come from Ryan Connors of Janney Montgomery Scott. Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division: This is actually Ken Dorell in for Ryan. I have 2 quick questions, one regarding the profit-sharing for OC-BVI. It was broken out this year that it was 3 40, but there was none -- it wasn't mentioned last year in previous quarters. I was wondering if that was wholly attributed to the settlement or if it just hasn't been broken out between that and equity earnings in the past? David W. Sasnett: Well, under the terms of the profit-sharing agreement, there weren't -- it's not necessarily straightforward if you look at the terms of the agreement. But under the terms of the agreement, previous years, there were no profits as defined in the agreement to share. So that's why if you go back and look many years ago, if you go back and look at 2007, 2008, back when OC-BVI was making a lot of money, and the Baughers Bay contract was in effect, those consistent profit-sharing amounts reported in our income statement. When the OC-BVI had those issues regarding the Baughers Bay plant, and its profits were up significantly, there were not profits in the profit-sharing agreement for us to share. Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division: Okay, perfect. And just finally, regarding the bulk segment for operating margin, it looks like in the fourth quarter, operating margin was down significantly even after exiting out the impairment loss. I was just wondering what kind of margin pressures you guys may have seen in the market in the fourth quarter? David W. Sasnett: I haven't looked specifically at the fourth quarter in detail. So if you're telling me, that our operating margins are down, I can't confirm that. I'm not aware of anything that happened in the fourth quarter that would impact our operating margins at all. Frederick W. McTaggart: I was looking through those numbers again.

The next question will be a follow-up from Hasan Doza of Water Asset Management.

A follow-up, on the Mexico incremental costs. I was just reading your 10-K, page 21. I think you're expecting to spend about additional $5.7 million during 2013? Frederick W. McTaggart: That's what we have projected at this point, Hasan.

Well, got it. And how much of that is going to come through the SG&A line for 2013? Frederick W. McTaggart: All of it.

Okay. So -- and the $2.2 million deposit for the land parcel, is that going to be SG&A or that's more like CapEx? Frederick W. McTaggart: That would be CapEx, capitalized. Of course, if we didn't proceed with the purchase of the land, these deposits will be forfeited. So...

Okay, so -- okay. So on an apples-to-apples basis, your G&A for the Mexico development was $1.7 million in 2012, right? Frederick W. McTaggart: That's correct.

Okay, so the $1.7 million is increasing to $5.7 million for 2013? David W. Sasnett: Yes, we're now accelerating development. We've reached the point where we made enough progress, where we feel justified spending that money.

And you expect this run rate of $5.7 million to continue for 2014 and '15? David W. Sasnett: We haven't projected 2014 and 2015 yet. So we're not sure, but we would not expect it to continue with that level. Is that correct, Rick? Frederick W. McTaggart: Yes, the objective is to have the project development phase completed by May of next year. So there would be some costs in 2014 related to development. But certainly, not full year costs.

The next question will be a follow-up from John Bair of SKA Financial Services.

Going back to Bali again, could you -- what are you seeing on your cost projections? Are you having any kind of higher costs than expected to get that up and running? Or is that running pretty much on target? David W. Sasnett: No, we're -- I think we have disclosed that it's going to cost us $4.2 million to complete the plant. That was pretty close to our original estimate. We're going to be very aggressive in our pricing and make sure that we get the customers on board for that plant. But the only issues we're having right now in Bali is we have to learn how to do business the way they do it in Indonesia and the permitting processes and the licensing processes are a bit complicated for us, for a foreign company. And -- but we've hired the right attorneys and we have the right people helping us, so we're going through that process. But the actual construction costs in building the plant, that's been pretty much consistent with our expectations.

And at this time, we show no further questions. I would like to turn the conference back over to Mr. Rick McTaggart for any closing remarks. Frederick W. McTaggart: Thanks, Denise. I just like to close the call and thank everybody for dialing in, and I look forward to speaking with you again in May. Thank you.

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