The accompanying notes are an integral
part of these condensed consolidated financial statements.
The accompanying notes
are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral
part of these condensed consolidated financial statements.
The accompanying notes are an integral
part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)
1. Principal activity
Consolidated Water Co. Ltd., and its subsidiaries
(collectively, the “Company”) use reverse osmosis technology to produce potable water from seawater. The Company processes
and supplies water, and provides water-related products and services, to its customers in the Cayman Islands, Belize, The Bahamas,
the British Virgin Islands, Indonesia and the United States. The Company sells water to a variety of customers, including public
utilities, commercial and tourist properties, residential properties and government facilities. The base price of water supplied
by the Company, and adjustments thereto, are determined by the terms of a retail license and bulk water supply contracts which
provide for adjustments based upon the movement in the government price indices specified in the license and contracts as well
as monthly adjustments for changes in the cost of energy. The Company also manufactures and services a wide range of products
and provides design, engineering, management, operating and other services applicable to commercial and municipal water production,
supply and treatment, and industrial water and wastewater treatment.
2. Accounting policies
Basis of presentation:
The accompanying condensed consolidated financial statements include the accounts of the Company’s (i) wholly-owned subsidiaries,
Aquilex, Inc., Cayman Water Company Limited (“Cayman Water”), Consolidated Water (Belize) Limited (“CW-Belize”),
Ocean Conversion (Cayman) Limited (“OC-Cayman”), DesalCo Limited (“DesalCo”), Consolidated Water Cooperatief,
U.A. (“CW-Cooperatief”), Consolidated Water U.S. Holdings, Inc. (“CW-Holdings”); and (ii) majority-owned
subsidiaries Consolidated Water (Bahamas) Ltd. (“CW-Bahamas”), Aerex Industries, Inc. (“Aerex”), Consolidated
Water (Asia) Pte. Limited, PT Consolidated Water Bali (“CW-Bali”) and N.S.C. Agua, S.A. de C.V. (“NSC”).
The Company’s investment in its affiliate, Ocean Conversion (BVI) Ltd. (“OC-BVI”), is accounted for using the
equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation.
The accompanying interim condensed consolidated
financial statements are unaudited. These condensed consolidated financial statements reflect all adjustments (which are of a
normal recurring nature) that, in the opinion of management, are necessary to fairly present the Company’s financial position,
results of operations and cash flows as of and for the periods presented. The results of operations for these interim periods
are not necessarily indicative of the operating results for future periods, including the fiscal year ending December 31, 2016.
These condensed consolidated financial
statements and notes are presented in accordance with the rules and regulations of the United States Securities and Exchange Commission
(“SEC”) relating to interim financial statements and in conformity with accounting principles generally accepted in
the United States of America (“US GAAP”). Certain information and note disclosures normally included in annual financial
statements prepared in accordance with US GAAP have been condensed or omitted in these condensed financial statements pursuant
to SEC rules and regulations, although the Company believes that the disclosures made herein are adequate to make the information
not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Foreign currency:
The Company’s
reporting currency is the United States dollar (“US$”). The functional currency of the Company and its foreign operating
subsidiaries (other than NSC and CW-Cooperatief) is the currency for each respective country. The functional currency for NSC
is the US$. The exchange rates between the Cayman Islands dollar, the Belize dollar, the Bahamian dollar are fixed to the US$.
CW-Cooperatief conducts business in US$ and euros, CW-Bali conducts business in US$ and Indonesian rupiahs, and NSC conducts business
in US$ and Mexican pesos. The exchange rates for conversion of euros, rupiahs and Mexican pesos into US$ vary based upon market
conditions. Net foreign currency gains (losses) arising from transactions conducted in foreign currencies were $154,409 and ($175,095)
for the three months ended March 31, 2016 and 2015, respectively, and are included in “Other income (expense)” in
the accompanying condensed consolidated statements of income.
Comprehensive income:
Comprehensive
income (loss) is defined as the change in equity during a period from transactions and other events from non-owner sources. Comprehensive
income (loss) is the total of net income and other comprehensive income (loss) which, for the Company, is comprised entirely of
foreign currency translation adjustments related to CW-Bali.
Cash and cash equivalents:
Cash
and cash equivalents consist of demand deposits at banks and highly liquid deposits at banks with an original maturity of three
months or less. Cash and cash equivalents as of March 31, 2016 and December 31, 2015 include $9.5 million and $13.6 million, respectively,
of certificates of deposits with an original maturity of three months or less.
Transfers from the Company’s Bahamas
and Belize bank accounts to Company bank accounts in other countries require the approval of the Central Bank of the Bahamas and
Belize, respectively. As of March 31, 2016, the equivalent United States dollar cash balances for deposits held in the Bahamas
and Belize were approximately $17.4 million and $4.6 million, respectively. The $17.4 million Bahamas balance includes the Company’s
certificate of deposit balance of approximately $5.6 million.
Comparative amounts:
Certain amounts
reported in the financial statements issued in prior periods have been reclassified herein to conform to the current period’s
presentation. These reclassifications had no effect on consolidated net income.
3. Purchase of interest in Aerex Industries,
Inc.
On February 11, 2016 (the “Closing
Date”), the Company, through its wholly-owned subsidiary, CW-Holdings, entered into a stock purchase agreement (the “Purchase
Agreement”) with Aerex and Thomas Donnick, Jr. (“Donnick”), Aerex’s sole shareholder prior to the Closing
Date. Pursuant to the terms of the Purchase Agreement, CW-Holdings purchased a 51% ownership interest in Aerex for an aggregate
purchase price of approximately $7.7 million in cash. After giving effect to the transactions contemplated by the Purchase Agreement,
CW-Holdings owns 51% of the outstanding capital stock of Aerex and Donnick owns 49% of the outstanding capital stock of Aerex.
CW-Holdings also acquired from Donnick an option to compel Donnick to sell, and granted to Donnick an option to require CW-Holdings
to purchase, Donnick’s 49% ownership interest in Aerex at a price based upon the fair market value of Aerex at the time
of the exercise of the option. The options are exercisable on or after the third anniversary of the Closing Date. In connection
with the Purchase Agreement, the Company guaranteed the obligations of CW-Holdings with respect to the option granted to Donnick
to require CW-Holdings to purchase Donnick’s 49% ownership interest in Aerex.
Aerex is an original equipment manufacturer
and service provider of a wide range of products and services applicable to municipal water treatment and industrial water and
wastewater treatment. Its products include membrane separation equipment, filtration equipment, piping systems, vessels and custom
fabricated components. Aerex also offers engineering, design, consulting, inspection, training and equipment maintenance services
to its customers. Aerex is an American Society of Mechanical Engineers (ASME) code accredited manufacturer and maintains the ASME
U and S and the National Board NB and R Certificates of Authorization. Its corporate offices and manufacturing facilities are
located in Fort Pierce, Florida.
In connection with the Purchase Agreement, CW-Holdings, Aerex and Donnick entered into a shareholders
agreement, pursuant to which CW-Holdings and Donnick agreed to certain rights and obligations with respect to the governance of
Aerex. Immediately following the acquisition, Aerex’s prior sole stockholder and the Company loaned $490,000 and $510,000,
respectively, to Aerex. These loans have a maturity date of August 10, 2016 and bear interest at 1% per annum.
The purchase price for Aerex is summarized as follows:
|
|
February 11, 2016
|
|
Cash consideration
|
|
|
|
|
Purchase price (excluding working capital)
|
|
$
|
7,140,000
|
|
Working capital adjustment
|
|
|
605,179
|
|
Cash acquired
|
|
|
(2,326
|
)
|
Total cash consideration
|
|
$
|
7,742,853
|
|
The following table summarizes the estimated fair values of
the assets and liabilities assumed at the acquisition date:
|
|
February 11, 2016
|
|
Financial assets
|
|
$
|
456,664
|
|
Inventory
|
|
|
70,487
|
|
Costs and estimated earnings in excess of billings
|
|
|
784,465
|
|
Property, plant and equipment
|
|
|
2,159,401
|
|
Identifiable intangible assets
|
|
|
5,900,000
|
|
Deferred tax liability
|
|
|
(2,451,298
|
)
|
Accounts payable and accrued liabilities
|
|
|
(116,893
|
)
|
Net liability arising from put/call options
|
|
|
(383,000
|
)
|
Total identifiable net assets
|
|
|
6,419,826
|
|
Non-controlling interest in Aerex
|
|
|
(6,712,184
|
)
|
Goodwill
|
|
|
8,035,211
|
|
|
|
$
|
7,742,853
|
|
The identifiable intangible assets consist of the following
items with amortization calculated using a straight line method over the useful life of the asset:
|
|
February 11, 2016
|
|
|
Useful life
|
Non-compete agreement
|
|
$
|
400,000
|
|
|
5 years
|
Trade name
|
|
|
1,400,000
|
|
|
15 years
|
Certifications/programs
|
|
|
2,000,000
|
|
|
3 years
|
Customer backlog
|
|
|
100,000
|
|
|
1 year
|
Customer relationships
|
|
|
2,000,000
|
|
|
4 years
|
|
|
$
|
5,900,000
|
|
|
|
The results of operations of Aerex are
included in our consolidated financial statements from the date of acquisition. The total revenue and net income generated by Aerex
for the period February 11, 2016 to March 31, 2016, were approximately $619,000 and $22,000, respectively, and are included in
the services segment. General and administrative expenses incurred by the Company for the Aerex acquisition were approximately
$83,500 for the three months ended March 31, 2016.
The following pro forma financial information
presents the results of operations of the Company for the three months ended March 31, 2016 and 2015, as if the acquisition of
Aerex had taken place on January 1, 2015. The pro forma results have been prepared for comparative purposes only and do not purport
to be indicative of the results of operations which would have actually occurred had the transaction taken place on January 1,
2015, or of future results of operations:
|
|
Three Months Ended March 31,
|
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
14,566,024
|
|
|
$
|
20,573,746
|
|
Cost of revenues
|
|
|
8,236,741
|
|
|
|
12,793,952
|
|
Gross profit
|
|
|
6,329,283
|
|
|
|
7,779,794
|
|
General and administrative expenses
|
|
|
4,736,257
|
|
|
|
4,325,631
|
|
Income from operations
|
|
|
1,593,026
|
|
|
|
3,454,163
|
|
Other income (expense), net
|
|
|
391,061
|
|
|
|
(215,945
|
)
|
Income before income taxes
|
|
|
1,984,087
|
|
|
|
3,238,218
|
|
Provision for (benefit from) income taxes
|
|
|
(136,432
|
)
|
|
|
438,035
|
|
Net income
|
|
|
2,120,519
|
|
|
|
2,800,183
|
|
Income attributable to non-controlling interests
|
|
|
85,924
|
|
|
|
562,280
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
$
|
2,034,595
|
|
|
$
|
2,237,903
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
$
|
0.14
|
|
|
$
|
0.15
|
|
Diluted earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
$
|
0.14
|
|
|
$
|
0.15
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares used in the determination of:
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
|
14,783,380
|
|
|
|
14,718,757
|
|
Diluted earnings per share
|
|
|
14,864,125
|
|
|
|
14,764,169
|
|
4. Fair value measurements
As of March 31, 2016 and December 31,
2015, the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and other current liabilities,
the demand loan and dividends payable approximate their fair values due to the short term maturities of these instruments. Management
considers that the carrying amounts for loans receivable and long term debt as of March 31, 2016 and December 31, 2015 approximate
their fair value as the stated interest rates approximate market rates.
Under US GAAP, fair value is defined as
the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants as of the measurement date. US GAAP guidance also establishes a hierarchy for inputs used in measuring
fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most
observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability
and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect
the Company’s assumptions about the factors market participants would use in valuing the asset or liability. The guidance
establishes three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in
active markets for identical assets or liabilities.
Level 2 - Inputs other than
Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for
substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs
that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Assets and liabilities are classified
in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company reviews its
fair value hierarchy classifications on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification
of levels for certain securities within the fair value hierarchy.
The following table presents the Company’s
fair value hierarchy for assets and liabilities measured at fair value as of March 31, 2016 and December 31, 2015:
|
|
March 31, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificate of deposit
|
|
$
|
-
|
|
|
$
|
5,637,538
|
|
|
$
|
-
|
|
|
$
|
5,637,538
|
|
Nonrecurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in OC-BVI
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,578,060
|
|
|
$
|
4,578,060
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability arising from put/call options
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
383,000
|
|
|
$
|
383,000
|
|
|
|
December 31, 2015
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted cash
|
|
$
|
428,203
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
428,203
|
|
Certificate of deposit
|
|
|
-
|
|
|
|
5,637,538
|
|
|
|
-
|
|
|
|
5,637,538
|
|
Total recurring
|
|
$
|
428,203
|
|
|
$
|
5,637,538
|
|
|
$
|
-
|
|
|
$
|
6,065,741
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonrecurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in OC-BVI
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,548,271
|
|
|
$
|
4,548,271
|
|
The activity for Level 3 financial instruments for the three
months ended March 31, 2016 was as follows:
Investment in OC-BVI
|
|
|
|
Balance as of December 31, 2015
|
|
$
|
4,548,271
|
|
Profit sharing and equity from earnings of OC-BVI
|
|
|
79,789
|
|
Distributions received from OC-BVI
|
|
|
-
|
|
Impairment of investment in OC-BVI (See Note 7)
|
|
|
(50,000
|
)
|
Balance as of March 31, 2016
|
|
$
|
4,578,060
|
|
Net liability arising from put/call options
(1)
|
|
|
|
Balance as of December 31, 2015
|
|
$
|
-
|
|
Net liability arising from put/call options
|
|
|
383,000
|
|
Balance as of March 31, 2016
|
|
$
|
383,000
|
|
____________________
(1) The net liability arising from put/call options is included
in the accompanying condensed consolidated balance sheets within other liabilities as of March 31, 2016.
5. Segment information
The Company has three reportable segments:
retail, bulk and services. The retail segment primarily operates the water utility for the Seven Mile Beach and West
Bay areas of Grand Cayman Island pursuant to an exclusive license granted by the Cayman Islands government. The bulk segment supplies
potable water to government utilities in Grand Cayman, The Bahamas and Belize under long-term contracts. The services segment
manufactures and services a wide range of products and provides design, engineering, management, operating and other services
applicable to commercial and municipal water production, supply and treatment, and industrial water and wastewater treatment.
The services segment includes the operations of Aerex beginning February 11, 2016. Consistent with prior periods, the Company
records all non-direct general and administrative expenses in its retail business segment and does not allocate any of these non-direct
costs to its other two business segments.
The accounting policies of the segments
are consistent with those described in Note 2. The Company evaluates each segment’s performance based upon its income from
operations. All intercompany transactions are eliminated for segment presentation purposes.
The Company’s segments are strategic
business units that are managed separately because, while all segments derive their revenues from water-related activities, each
segment sells different products and/or services, serves customers with distinctly different needs and generates different gross
profit margins.
|
|
Three Months Ended March 31, 2016
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Revenues
|
|
$
|
5,970,238
|
|
|
$
|
7,265,293
|
|
|
$
|
799,241
|
|
|
$
|
14,034,772
|
|
Cost of revenues
|
|
|
2,629,674
|
|
|
|
4,610,324
|
|
|
|
617,743
|
|
|
|
7,857,741
|
|
Gross profit
|
|
|
3,340,564
|
|
|
|
2,654,969
|
|
|
|
181,498
|
|
|
|
6,177,031
|
|
General and administrative expenses
|
|
|
2,897,861
|
|
|
|
435,896
|
|
|
|
1,127,229
|
|
|
|
4,460,986
|
|
Income (loss) from operations
|
|
$
|
442,703
|
|
|
$
|
2,219,073
|
|
|
$
|
(945,731
|
)
|
|
|
1,716,045
|
|
Other income (expense), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
389,557
|
|
Income before income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,105,602
|
|
Provision for (benefit from) income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(73,269)
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,178,871
|
|
Income attributable to non-controlling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
124,230
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,054,641
|
|
Depreciation and amortization expenses
for the three months ended March 31, 2016 for the retail, bulk and services segments were $587,726, $827,389 and $239,707, respectively.
|
|
Three Months Ended March 31, 2015
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Revenues
|
|
$
|
6,135,638
|
|
|
$
|
8,382,316
|
|
|
$
|
148,158
|
|
|
$
|
14,666,112
|
|
Cost of revenues
|
|
|
2,766,863
|
|
|
|
5,466,060
|
|
|
|
284,887
|
|
|
|
8,517,810
|
|
Gross profit (loss)
|
|
|
3,368,775
|
|
|
|
2,916,256
|
|
|
|
(136,729
|
)
|
|
|
6,148,302
|
|
General and administrative expenses
|
|
|
2,898,415
|
|
|
|
417,364
|
|
|
|
577,187
|
|
|
|
3,892,966
|
|
Income (loss) from operations
|
|
$
|
470,360
|
|
|
$
|
2,498,892
|
|
|
$
|
(713,916
|
)
|
|
|
2,255,336
|
|
Other income, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(219,557
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,035,779
|
|
Income attributable to non-controlling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
114,518
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,921,261
|
|
Depreciation and amortization expenses
for the three months ended March 31, 2015 for the retail, bulk and services segments were $590,040, $794,725 and $22,474, respectively.
|
|
As of March 31, 2016
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Accounts receivable, net
|
|
$
|
2,684,520
|
|
|
$
|
9,567,044
|
|
|
$
|
1,547,635
|
|
|
$
|
13,799,199
|
|
Property plant and equipment, net
|
|
$
|
24,914,329
|
|
|
$
|
27,661,157
|
|
|
$
|
2,242,317
|
|
|
$
|
54,817,803
|
|
Construction in progress
|
|
$
|
2,668,571
|
|
|
$
|
101,399
|
|
|
$
|
-
|
|
|
$
|
2,769,970
|
|
Intangibles, net
|
|
$
|
-
|
|
|
$
|
649,604
|
|
|
$
|
5,803,123
|
|
|
$
|
6,452,727
|
|
Goodwill
|
|
$
|
1,170,511
|
|
|
$
|
2,328,526
|
|
|
$
|
8,035,211
|
|
|
$
|
11,534,248
|
|
Land held for development
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
20,558,424
|
|
|
$
|
20,558,424
|
|
Total assets
|
|
$
|
54,291,232
|
|
|
$
|
75,334,227
|
|
|
$
|
41,697,760
|
|
|
$
|
171,323,219
|
|
|
|
As of December 31, 2015
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Accounts receivable, net
|
|
$
|
2,261,141
|
|
|
$
|
6,231,626
|
|
|
$
|
1,036,249
|
|
|
$
|
9,529,016
|
|
Property plant and equipment, net
|
|
$
|
25,204,226
|
|
|
$
|
28,421,906
|
|
|
$
|
117,038
|
|
|
$
|
53,743,170
|
|
Construction in progress
|
|
$
|
1,860,050
|
|
|
$
|
68,560
|
|
|
$
|
-
|
|
|
$
|
1,928,610
|
|
Intangibles, net
|
|
$
|
-
|
|
|
$
|
666,152
|
|
|
$
|
105,659
|
|
|
$
|
771,811
|
|
Goodwill
|
|
$
|
1,170,511
|
|
|
$
|
2,328,526
|
|
|
$
|
-
|
|
|
$
|
3,499,037
|
|
Land held for development
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
20,558,424
|
|
|
$
|
20,558,424
|
|
Total assets
|
|
$
|
54,561,577
|
|
|
$
|
83,284,439
|
|
|
$
|
23,729,010
|
|
|
$
|
161,575,026
|
|
6. Earnings per share
Earnings per share (“EPS”)
are computed on a basic and diluted basis. Basic EPS is computed by dividing net income (less preferred stock dividends) available
to common stockholders by the weighted average number of common shares outstanding during the period. The computation of diluted
EPS assumes the issuance of common shares for all potential common shares outstanding during the reporting period and, if dilutive,
the effect of stock options as computed under the treasury stock method.
The following summarizes information related
to the computation of basic and diluted EPS for the three months ended March 31, 2016 and 2015.
|
|
Three Months Ended March 31,
|
|
|
|
2016
|
|
|
2015
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
$
|
2,054,641
|
|
|
$
|
1,921,261
|
|
Less: preferred stock dividends
|
|
|
(2,850
|
)
|
|
|
(2,763
|
)
|
Net income available to common shares in the determination of basic earnings per common share
|
|
$
|
2,051,791
|
|
|
$
|
1,918,498
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares in the determination of basic earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
|
14,783,380
|
|
|
|
14,718,757
|
|
Plus:
|
|
|
|
|
|
|
|
|
Weighted average number of preferred shares outstanding during the period
|
|
|
38,584
|
|
|
|
36,840
|
|
Potential dilutive effect of unexercised options
|
|
|
42,161
|
|
|
|
8,572
|
|
Weighted average number of shares used for determining diluted earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
|
14,864,125
|
|
|
|
14,764,169
|
|
7. Investment in OC-BVI
The Company owns 50% of the outstanding
voting common shares and a 43.53% equity interest in the profits of Ocean Conversion (BVI) Ltd. (“OC-BVI”). The Company
also owns certain profit sharing rights in OC-BVI that raise its effective interest in the profits of OC-BVI to approximately
45%. Pursuant to a management services agreement, OC-BVI pays the Company monthly fees for certain engineering and administrative
services. OC-BVI’s sole customer is the Ministry of Communications and Works of the Government of the British Virgin Islands
(the “Ministry”) to which it sells bulk water.
The Company’s equity investment
in OC-BVI amounted to $4,578,060 and $4,548,271 as of March 31, 2016 and December 31, 2015, respectively.
Until 2009, substantially all of the
water sold by OC-BVI to the Ministry was supplied by one desalination plant with a capacity of 1.7 million gallons per day
located at Baughers Bay, Tortola (the “Baughers Bay plant”). As discussed later in this Note (see
“
Baughers Bay litigation”
), the BVI government assumed the operating responsibilities for the Baughers Bay
plant in March 2010. During 2007, OC-BVI completed the construction of a desalination plant with a capacity of 720,000
gallons per day located at Bar Bay, Tortola (the “Bar Bay plant”). OC-BVI began selling water to the Ministry
from this plant in January 2009 and on March 4, 2010, OC-BVI and the BVI government executed a seven-year contract for the
Bar Bay plant (the “Bar Bay agreement”). Under the terms of the Bar Bay agreement, OC-BVI delivers up to 600,000
gallons of water per day to the BVI government from the Bar Bay plant. The Bar Bay agreement includes a seven-year extension
option exercisable by the BVI government and required OC-BVI to complete a storage reservoir on a BVI government site by no
later than March 4, 2011. OC-BVI has not commenced construction of this storage reservoir due to the BVI government’s
failure to pay (i) the full amount of invoices for the water provided by the Bar Bay plant on a timely basis; and (ii) the
full amount ordered pursuant to a court ruling relating to the Baughers Bay litigation (see discussion that follows).
Summarized financial information of OC-BVI is presented as
follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Current assets
|
|
$
|
4,759,727
|
|
|
$
|
4,323,792
|
|
Non-current assets
|
|
|
4,524,902
|
|
|
|
4,682,650
|
|
Total assets
|
|
$
|
9,284,629
|
|
|
$
|
9,006,442
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Current liabilities
|
|
$
|
717,052
|
|
|
$
|
584,116
|
|
Non-current liabilities
|
|
|
1,672,650
|
|
|
|
1,650,252
|
|
Total liabilities
|
|
$
|
2,389,702
|
|
|
$
|
2,234,368
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
936,884
|
|
|
$
|
1,068,901
|
|
Cost of revenues
|
|
|
484,639
|
|
|
|
581,644
|
|
Gross profit
|
|
|
452,245
|
|
|
|
487,257
|
|
General and administrative expenses
|
|
|
260,542
|
|
|
|
244,342
|
|
Income from operations
|
|
|
191,703
|
|
|
|
242,915
|
|
Other income (expense), net
|
|
|
(68,850
|
)
|
|
|
(52,649
|
)
|
Net income
|
|
|
122,853
|
|
|
|
190,266
|
|
Income attributable to non-controlling interests
|
|
|
18,641
|
|
|
|
17,614
|
|
Net income attributable to controlling interests
|
|
$
|
104,212
|
|
|
$
|
172,652
|
|
The Company recognized $45,364 and $75,155
in earnings from its equity investment in OC-BVI for the three months ended March 31, 2016 and 2015, respectively. The Company
recognized $34,425 and $26,325 in profit sharing income from its profit sharing agreement with OC-BVI for the three months ended
March 31, 2016 and 2015, respectively.
For the three months ended March 31, 2016
and 2015, the Company recognized $138,756 and $128,775, respectively, in revenues from its management services agreement with OC-BVI.
Amounts payable by OC-BVI to the Company were $40,784 and $23,803 as of March 31, 2016 and December 31, 2015, respectively. The
Company’s recorded value of this management services agreement, which is reflected as an intangible asset on the Company’s
condensed consolidated balance sheets, was $83,123 and $105,659 as of March 31, 2016 and December 31, 2015, respectively.
Baughers Bay Litigation
Under the terms of a water supply agreement
dated May 1990 (the “1990 Agreement”) between OC-BVI and the Government of the British Islands (the “BVI government”)
for the Baughers Bay plant upon the expiration of its initial seven-year term in May 1999, the 1990 Agreement would automatically
be extended for another seven-year term unless the BVI government provided notice, at least eight months prior to such expiration,
of its decision to purchase the plant from OC-BVI at the agreed upon amount under the 1990 Agreement of approximately $1.42 million.
In correspondence between the parties from late 1998 through early 2000, the BVI government indicated that it intended to purchase
the plant but would be amenable to negotiating a new water supply agreement, and that it considered the 1990 Agreement to be in
force on a monthly basis until negotiations between the BVI government and OC-BVI were concluded. Occasional discussions were
held between the parties after 2000 without resolution of the matter. OC-BVI continued to supply water from the plant and expended
approximately $4.7 million between 1995 and 2003 to significantly expand the production capacity of the plant beyond that contemplated
in the 1990 Agreement.
In 2006, the BVI government took the position
that the seven-year extension of the 1990 Agreement had been completed and that it was entitled to ownership of the Baughers Bay
plant. In response, OC-BVI disputed the BVI government’s contention that the original terms of the 1990 Agreement remained
in effect.
During 2007, the BVI government significantly
reduced its payments for the water being supplied by OC-BVI and filed a lawsuit with the Eastern Caribbean Supreme Court (the
“Court”) seeking ownership of the Baughers Bay plant. OC-BVI counterclaimed to the Court that it was entitled to continued
possession and operation of the Baughers Bay plant until the BVI government paid OC-BVI approximately $4.7 million, which OC-BVI
believed represented the value of the Baughers Bay plant at its expanded production capacity. OC-BVI subsequently filed claims
with the Court seeking payment for water sold and delivered to the BVI government through May 31, 2009 at the contract prices
in effect before the BVI government asserted its purported right of ownership of the plant.
The Court ruled on this litigation in
2009, determining that (i) the BVI government was entitled to immediate ownership and possession of the Baughers Bay plant; (ii)
OC-BVI was not entitled to compensation for the expenditures made to expand the production capacity of the plant; (iii) OC-BVI
was entitled to full payment of water invoices issued up to December 20, 2007, which had been calculated under the terms of the
original 1990 Agreement; and (iv) OC-BVI was entitled to the amount of $10.4 million for water produced by OC-BVI from the Baughers
Bay plant subsequent to December 20, 2007.
OC-BVI filed an appeal with the Eastern
Caribbean Court of Appeals (the “Appellate Court”) in October 2009 asking the Appellate Court to review the September
17, 2009 ruling by the Court as it related to OC-BVI’s claim for compensation for expenditures made to expand the production
capacity of the Baughers Bay plant. In October 2009, the BVI government also filed an appeal with the Appellate Court requesting
the Appellate Court to reduce the $10.4 million awarded by the Court to OC-BVI for water supplied subsequent to December 20, 2007
to an amount equal to the cost of producing such water.
In March 2010, OC-BVI vacated the Baughers
Bay plant and the BVI government assumed direct responsibility for the plant’s operations.
In June 2012, the Appellate Court issued
the final ruling with respect to the Baughers Bay litigation. This ruling dismissed the BVI government’s appeal against
the previous judgment of the Court awarding $10.4 million for the water supplied, and also awarded OC-BVI compensation for improvements
made to the plant in the amount equal to the difference between (i) the value of the Baughers Bay plant at the date OC-BVI transferred
possession of the plant to the BVI government and (ii) $1.42 million (the purchase price for the Baughers Bay plant under the
1990 Agreement). OC-BVI was also awarded all of its court costs at the trial level and two-thirds of such costs incurred on appeal.
OC-BVI and the BVI government have not
reached an agreement on the value of the plant at the date it was transferred to the BVI government but have engaged a mutually
approved appraiser to complete a valuation of the Baughers Bay plant in accordance with the Appellate Court ruling. Such valuation
is presently in process.
Valuation of Investment in OC-BVI
The Company accounts for its investment
in OC-BVI under the equity method of accounting for investments in common stock. This method requires recognition of a loss on
an equity investment that is other than temporary, and indicates that a current fair value of an equity investment that is less
than its carrying amount may indicate a loss in the value of the investment.
As a quoted market price for OC-BVI’s
stock is not available, to test for possible impairment of its investment in OC-BVI, the Company estimates its fair value through
the use of the discounted cash flow method, which relies upon projections of OC-BVI’s operating results, working capital
and capital expenditures. The use of this method requires the Company to estimate OC-BVI’s cash flows from (i) the Bar Bay
agreement and (ii) the pending amount awarded by the Appellate Court for the value of the Baughers Bay plant transferred by OC-BVI
to the BVI government.
The Company estimates the cash flows OC-BVI
will receive from its Bar Bay agreement by (i) identifying various possible future scenarios for this agreement, which include
the cancellation of the agreement after its initial seven-year term and the exercise by the BVI government of the seven-year extension
in the agreement; (ii) estimating the cash flows associated with each possible scenario; and (iii) assigning a probability to
each scenario. The Company similarly estimates the cash flows OC-BVI will receive from the BVI government for the amount due under
the ruling by the Appellate Court for the value of the Baughers Bay plant at the date it was transferred to the BVI government
by assigning probabilities to different valuation scenarios. The resulting probability-weighted sum represents the expected cash
flows, and the Company’s best estimate of future cash flows, to be derived by OC-BVI from its Bar Bay agreement and the
pending Appellate Court award.
The identification of the possible scenarios
for the Bar Bay plant agreement and the Baughers Bay plant valuation, the projections of cash flows for each scenario, and the
assignment of relative probabilities to each scenario all represent significant estimates made by the Company. While the Company
uses its best judgment in identifying these possible scenarios, estimating the expected cash flows for these scenarios and assigning
relative probabilities to each scenario, these estimates are by their nature highly subjective and are also subject to material
change by the Company’s management over time based upon new information or changes in circumstances.
As of March 31, 2016 and 2015, after updating
its probability-weighted estimates of OC-BVI’s future cash flows and its resulting estimate of the fair value of its investment
in OC-BVI, the Company determined that the carrying value of its investment in OC-BVI exceeded its fair value and recorded impairment
charges of $50,000 and $310,000 for the three months ended March 31, 2016 and 2015, respectively.
The remaining carrying value of the Company’s
investment in OC-BVI of approximately $4.6 million as of March 31, 2016 assumes that the BVI government will honor its obligations
under the Bar Bay agreement and also assumes (on a probability-weighted basis) that (i) the BVI government will exercise its option
to extend the Bar Bay agreement for seven years beyond its initial term, which expires March 4, 2017, and (ii) OC-BVI will receive
the pending amount (as estimated by the Company) awarded by the Eastern Caribbean Court of Appeals for the value of the Baughers
Bay plant previously transferred by OC-BVI to the BVI government.
The $4.6 million carrying value of the
Company’s investment in OC-BVI as of March 31, 2016 exceeds the Company’s underlying equity in OC-BVI’s net
assets by approximately $850,000. The Company accounts for this excess as goodwill. The BVI government is OC-BVI’s sole
customer and substantially all of OC-BVI’s revenues are generated from its Bar Bay plant. As the Bar Bay agreement matures
to its March 4, 2017 expiration date, and OC-BVI receives the pending court award amount assumed due for the value of the Baughers
Bay plant, OC-BVI’s expected future cash flows, and therefore its fair value computed under the discounted cash flow method,
will decrease. Unless OC-BVI obtains an extension or modification of its Bar Bay agreement that results in a significant increase
in the estimated future cash flows from its Bar Bay plant, the Company will be required to record additional impairment losses
during 2016 to reduce the carrying value of its investment in OC-BVI to its then current fair value. These impairment losses will,
in the aggregate, at least equal the underlying $850,000 in goodwill reflected in the carrying value of the Company’s investment
in OC-BVI. The losses the Company records for its investment in OC-BVI in the future will exceed this $850,000 if OC-BVI ultimately
ceases operations at its Bar Bay plant, as OC-BVI will be required to record an impairment loss to reduce the carrying value of
its Bar Bay plant to its then estimated fair value. OC-BVI’s aggregate carrying value of the assets that comprise its Bar
Bay plant was approximately $4.3 million as of March 31, 2016. Future impairment losses for the Company’s investment in
OC-BVI and the Company’s equity in any future operating losses incurred by OC-BVI could have a material adverse impact on
the Company’s results of operations.
8. N.S.C. Agua, S.A. de C.V.
In May 2010, the Company acquired, through its wholly-owned Netherlands subsidiary, CW-Cooperatief, a
50% interest in NSC, a development stage Mexican company. The Company has since purchased, through the conversion of a loan it
made to NSC, sufficient shares to raise its ownership interest in NSC to 99.9%. NSC was formed to pursue a project (the “Project”)
that originally encompassed the construction, operation and minority ownership of a 100 million gallon per day seawater reverse
osmosis desalination plant to be located in northern Baja California, Mexico and accompanying pipelines to deliver water to the
Mexican potable water system. As discussed in paragraphs that follow, during 2015 the scope of the Project was defined by the State
of Baja California (the “State”) to consist of a first phase consisting of a 50 million gallons per day plant and a
pipeline that connects to the Mexican potable water infrastructure and a second phase consisting of an additional 50 million gallons
of production capacity.
Since its inception, NSC has engaged engineering groups with extensive regional and/or technical experience
to prepare preliminary designs and cost estimates for the desalination plant and the proposed pipeline and prepare the environmental
impact studies for local, state and federal regulatory agencies, and has also acquired the land, performed pilot plant and feed
water source testing, and evaluated financing alternatives for the Project.
Through a series of transactions completed
in 2012-2014, NSC purchased 20.1 hectares of land on which the proposed Project’s plant would be constructed for an aggregate
price of $20.6 million.
In 2012 and 2013, NSC conducted an equipment
piloting plant and water data collection program at the proposed feed water source for the Project under a Memorandum of Understanding
(the “EPC MOU”) with a global engineering, procurement and construction contractor for large seawater desalination
plants. Under the EPC MOU, the contractor installed and operated an equipment piloting plant and collected water quality data
from the proposed feed water source site in Rosarito Beach, Baja California, Mexico. The EPC MOU required that NSC negotiate exclusively
with the contractor for the construction of the 100 million gallon per day seawater reverse osmosis desalination plant, and further
required payment by NSC to the contractor of up to $500,000 as compensation for the operation and maintenance of the equipment
piloting plant should NSC not award the engineering, procurement and construction contract for the Project to the contractor.
This first phase of the pilot plant testing program was completed in October 2013. NSC decided not to extend the EPC MOU beyond
its February 2014 expiration date and NSC paid the contractor $350,000 during 2014 as compensation for the operation and maintenance
of the pilot plant.
In November 2012, NSC entered into a lease
with an effective term of 20-years from the date of full operation of the desalination plant, with the Comisión Federal
de Electricidad for approximately 5,000 square meters of land on which it plans to construct the water intake and discharge works
for the plant. The amounts due on this lease are payable in Mexican pesos at an amount that is currently equivalent to approximately
$20,000 per month. This lease is cancellable should NSC ultimately not proceed with the Project.
In August 2014, the State enacted new legislation
to regulate Public-Private Association projects which involve the type of long-term contract between a public sector authority
and a private party that NSC is seeking to complete the Project. Pursuant to this new legislation, on January 4, 2015, NSC submitted
an expression of interest for its project to the Secretary of Infrastructure and Urban Development of the State of Baja California
(“SIDUE”). In January 2015, SIDUE accepted NSC’s expression of interest and requested that NSC submit a detailed
proposal for the Project that complies with requirements of the new legislation. NSC submitted this detailed proposal (the “APP
Proposal”) to SIDUE in late March 2015. The new legislation required that such proposal be evaluated by SIDUE and submitted
to the Public-Private Association Projects State Committee (the “APP Committee”) for review and authorization. If the
Project is authorized the State would be required to conduct a public tender for the Project.
In response to its unsolicited APP Proposal, in September 2015 NSC received a letter dated June 30, 2015
from the Director General of the Comisión Estatal de Agua de Baja California (“CEA”), the State agency with
responsibility for the Project, stating that (i) the Project is in the public interest with high social benefits and is consistent
with the objectives of the State development plan and (ii) that the Project should proceed and the required public tender should
be conducted. In November 2015, the State officially commenced the tender for the Project, the scope of which the State defined
as a first phase to be operational in 2019 consisting of a 50 million gallons per day plant and a pipeline that connects to the
Mexican potable water infrastructure and a second phase to be operational in 2024 consisting of an additional 50 million gallons
per day of production capacity. The State originally set March 23, 2016 as the deadline for tender submissions but subsequently
extended such deadline to April 21, 2016.
NSC submitted its tender for the Project
on April 21, 2016. The Company cannot presently determine when the tender evaluation process will be completed by the State or
the outcome of such evaluation process.
The Company has acknowledged since the
inception of the Project that, due to the amount of capital the Project requires, NSC will ultimately need an equity partner or
partners for the Project. Consequently, NSC’s tender to the State for the Project is based upon the following: (i) NSC will
sell or otherwise transfer the land and other Project assets to a new company (“Newco”) that would build and own the
Project; (ii) NSC’s potential partners would provide the majority of the equity for the Project and thereby would own the
majority interest in Newco; (iii) NSC would maintain a minority ownership position in Newco; and (iv) Newco would enter into a
long-term management and technical services contract for the Project with an entity partially owned by NSC or another Company
subsidiary.
Included in the Company’s consolidated
results of operations are general and administrative expenses from NSC, consisting of organizational, legal, accounting, engineering,
consulting and other costs relating to NSC’s project development activities. Such expenses amounted to approximately $767,000
and $537,000 for the three months ended March 31, 2016 and 2015, respectively. The assets and liabilities of NSC included in the
Company’s consolidated balance sheets amounted to approximately $22.0 million and $502,000, respectively, as of March 31,
2016 and approximately $22.0 million and $488,000, respectively, as of December 31, 2015.
The Company expects to incur additional
project development costs on behalf of NSC during the remainder of 2016.
Despite the expenditures the Company has
made and the activities it has completed to date, upon completion of the tender process the State may award the Project to a party
other than NSC, or the State may cancel the tender process. If NSC is not awarded the Project, the land NSC has purchased may
lose its strategic importance as the site for the Project and consequently may decline in value. If NSC is not awarded the Project,
NSC may ultimately be unable to sell this land for an amount equal to or in excess of its current carrying value of $20.6 million,
and any loss on sale of the land, or impairment charge the Company may be required to record as a result of a decrease in the
fair value of the land, could have a material adverse impact on the Company’s results of operations.
NSC Litigation
Immediately following CW-Cooperatief’s
acquisition of its initial 50% ownership in NSC, the remaining 50% ownership interest in NSC was held by an unrelated company,
Norte Sur Agua, S. de R.L. de C.V. (“NSA”). NSA subsequently transferred ownership of half of its shares in NSC to
EWG Water LLC and the other half of its shares in NSC to Alejandro de la Vega (the “individual shareholder”). In February
2012, the Company paid $300,000 to enter into an agreement (the “Option Agreement”) that provided it with an option,
exercisable through February 7, 2014, to purchase the shares of NSC owned by the individual shareholder, along with an immediate
power of attorney to vote those shares, for $1.0 million. Such shares constituted 25% of the ownership of NSC as of February 2012.
In May 2013, NSC repaid a $5.7 million loan payable to CW-Cooperatief by issuing additional shares of its stock. As a result of
this share issuance to CW-Cooperatief, the Company acquired 99.9% of the ownership of NSC. The Option Agreement contained an anti-dilution
provision that required the Company to issue new shares in NSC of an amount sufficient to maintain the individual shareholder’s
25% ownership interest in NSC if (i) any new shares of NSC were issued subsequent to the execution of the Option Agreement and
(ii) the Company did not exercise its share purchase option by February 7, 2014. The Company exercised its option and paid the
$1.0 million to the individual shareholder to purchase the Option Agreement shares in February 2014.
In October 2015, the Company learned that
EWG had filed a lawsuit against the individual shareholder, NSC, NSA, CW-Cooperatief, Ricardo del Monte Nunez, Carlos Eduardo
Ahumada Arruit, Luis de Angitia Becerra, and the Public Registry of Commerce of Tijuana, Baja California in the Civil Court located
in Tecate, Baja California, Mexico.
In this lawsuit, EWG is challenging the
capital investment transactions that increased the Company’s ownership interest in NSC to 99.9%. EWG requested that the
court, as a preliminary matter: (a) suspend the effectiveness of the challenged transactions; (b) order public officials in Mexico
to record the pendency of the lawsuit in the public records; and (c) appoint an inspector for NSA and NSC to oversee its commercial
activities. The court granted, ex-parte, the preliminary relief sought by EWG, which resulted in the placement of inscriptions
for the lawsuit on NSC’s public records.
Additionally, EWG is also seeking an order
directing: (i) NSA, NSC and CW-Cooperatief to refrain from carrying out any transactions with respect to the Project; and (ii)
NSA, NSC and CW-Cooperatief, and the partners thereof, to refrain from transferring any interests in NSA, NSC and CW-Cooperatief.
On April 5, 2016, NSC filed a motion for
reconsideration with the Tecate, Mexico Court asking, among other things, that the Court; (i) reverse its order to record the
pendency of the lawsuit in the public records, (ii) cancel the appointment of the inspector, and (iii) allow NSC to provide a
counter-guarantee to suspend the effects of the Court’s order regarding the challenged transactions. On April 26, 2016,
the Tecate Court issued an interlocutory judgment (i) ordering the cancellation of the inscriptions on NSC’s public records
and (ii) rejecting NSC’s motion for cancellation of the appointment of the inspector. The Court’s decision regarding
NSC’s request to provide a counter-guarantee is pending.
On April 26, 2016, NSC filed a full
answer to EWG’s claims, rejecting every claim made by EWG. The Court’s response on this matter is pending.
The Company believes that the claims made
by EWG are baseless and without merit, will vigorously defend NSC and CW-Cooperatief in this litigation, and will seek dismissal
of the orders entered by the court and all claims against NSC and CW-Cooperatief. Furthermore, in November 2015, NSC and CW-Cooperatief
filed a complaint in the United States District Court, Southern District of New York against EWG and its Managing Partner, based
upon the Company’s conclusion that lawsuit filed by EWG in Mexico directly breaches a contract dated April 12, 2012 between
NSC and CW-Cooperatief, and EWG. The Company is vigorously pursuing its claims and seeking relief pursuant to this complaint.
The Company incurred legal fees of approximately $196,000 for the three months ended March 31, 2016 in connection with the NSC
litigation.
The Company cannot presently determine
the outcome of this litigation. However, such litigation could adversely impact the Company’s efforts to complete the Project.
Mexico Tax Authority
The Mexico tax authority, the Servicio
de Administracion Tributaria (“SAT”), assessed NSC for taxes relating to payments to foreign vendors on which the
SAT contended should have been subject to income tax withholdings during NSC’s 2011 tax year. As of December 31, 2015, the
assessment and related penalties, surcharges, inflation adjustments and late fees totaled 7,367,875 Mexican pesos. Such assessments
were equivalent to approximately $428,203 as of December 31, 2015 based upon the exchange rate between the US$ and the Mexican
peso.
NSC retained the assistance of Mexican
tax advisers in this matter, as it believed the assumptions and related work performed by the SAT did not support their tax assessment.
As a result, NSC elected to contest this assessment in Mexico federal tax court. NSC was required to provide an irrevocable letter
of credit which amounted to 7,367,875 Mexican pesos as of December 31, 2015 as collateral in connection with this tax case. The
restricted cash balance of $428,203 included in the accompanying consolidated balance sheet as of December 31, 2015 represented
cash on deposit with a bank to secure payment of this irrevocable letter of credit.
In November 2014, NSC received a favorable
judgment from the tax court. Based on this outcome, the SAT filed an appeal shortly thereafter to contest the judgment. On February
15, 2016, NSC received a favorable judgment from the appellate tax court.
9. Contingencies
Retail License
The Company sells water through its retail
operations under a license issued in July 1990 by the Cayman Islands government that grants Cayman Water the exclusive right to
provide potable water to customers within its licensed service area. As discussed below, this license was set to expire in July
2010 but has since been extended while negotiations for a new license take place. Pursuant to the license, Cayman Water has the
exclusive right to produce potable water and distribute it by pipeline to its licensed service area which consists of two of the
three most populated areas of Grand Cayman, the Seven Mile Beach and West Bay areas. For the three months ended March 31, 2016
and 2015, the Company generated approximately 42%, and 41%, respectively, of its consolidated revenues and 56% and 57%, respectively,
of its consolidated gross profits from the retail water operations conducted pursuant to Cayman Water’s exclusive license.
As discussed later herein, if Cayman Water is not in default of any of its terms, this license provides Cayman Water with the
right to renew the license on terms that are no less favorable than those that the government offers to any third party.
Under the license, Cayman Water pays a royalty to the government of 7.5% of its gross retail water sales
revenues (excluding energy cost adjustments). The selling prices of water sold to its customers are determined by the license and
vary depending upon the type and location of the customer and the monthly volume of water purchased. The license provides for an
automatic adjustment for inflation or deflation on an annual basis, subject to temporary limited exceptions, and an automatic adjustment
for the cost of electricity on a monthly basis. The Water Authority Cayman (the “WAC”), on behalf of the government,
reviews and confirms the calculations of the price adjustments for inflation and electricity costs. If Cayman Water wants to adjust
its prices for any reason other than inflation or electricity costs, Cayman Water has to request prior approval of the Cabinet
of the Cayman Islands government. Disputes regarding price adjustments would be referred to arbitration.
The license was scheduled to expire in
July 2010 but has been extended several times by the Cayman Islands government in order to provide the parties with additional
time to negotiate the terms of a new license agreement. The most recent extension of the license expires on June 30, 2016.
In February 2011, the Water (Production and Supply) Law, 2011 and the Water Authority (Amendment) Law,
2011 (the “New Laws”) were published and enacted. Under the New Laws, the WAC will issue any new license, and such
new license could include a rate of return on invested capital model, as discussed in the following paragraph.
Following the enactment of the New Laws,
the Company was advised in correspondence from the Cayman Islands government and the WAC that: (i) the WAC is now the principal
negotiator, and not the Cayman Islands government, in these license negotiations, and (ii) the WAC has determined that a rate
of return on invested capital model (“RCAM”) for the retail license is in the best interest of the public and Cayman
Water’s customers. RCAM is the rate model currently utilized in the electricity transmission and distribution license granted
by the Cayman Islands government to the Caribbean Utilities Company, Ltd. The Company responded to the Cayman Islands government
that it disagreed with the government’s position on these two matters and negotiations for a new license temporarily ceased.
In July 2012, in an effort to resolve
several issues relating to its retail license renewal negotiations, the Company filed an Application for Leave to Apply for Judicial
Review (the “Application”) with the Grand Court of the Cayman Islands (the “Court”), seeking declarations
that: (i) certain provisions of the New Laws appear to be incompatible and a determination as to how those provisions should be
interpreted, (ii) the WAC’s roles as the principal license negotiator, statutory regulator and the Company’s competitor
put the WAC in a position of hopeless conflict, and (iii) the WAC’s decision to replace the rate structure under the Company’s
current exclusive license with RCAM was predetermined and unreasonable. In October 2012 the Company was notified that the Court
agreed to consider the issues raised in the Application.
The hearing for this judicial review was
held on April 1, 2014. Prior to the commencement of the hearing, the parties agreed that the Court should solely be concerned
with the interpretation of the statutory provisions. As part of this agreement, the WAC agreed to consider our submissions on
the RCAM model and/or alternative models of pricing. In June 2014, the Court determined that: (i) the renewal of the license does
not require a public bidding process; and (ii) the WAC is the proper entity to negotiate with the Company for the renewal of the
license.
The Company’s submissions on the
RCAM model and/or alternative models of pricing were made to the WAC on June 9, 2014. The Company received a letter from the WAC
dated September 11, 2014, which fully rejected the Company’s submissions and stated that they intend to provide the Company
with a draft RCAM license in due course.
On November 21, 2014, the Company wrote
to the Minister of Works offering to recommence license negotiations on the basis of the RCAM model subject to certain conditions
which are: (i) the Government would undertake to amend the current water legislation to provide for an independent regulator and
a fair and balanced regulatory regime more consistent with that provided under the electrical utility regulatory regime, (ii)
the Government and the Company would mutually appoint an independent referee and chairman of the negotiations, (iii) the Company’s
new license would provide exclusivity for the production and provision of all piped water, both potable and non-potable, within
its Cayman Islands license area, (iv) the Government would allow the Company to submit its counter proposal to the WAC’s
June 2010 RCAM license draft, and (v) the principle of subsidization of residential customer rates by commercial customer rates
would continue under a new license. On March 23 2015, the Company received a letter from the Minister of Works with the following
responses to the Company’s November 21, 2014 letter: (1) while the Cayman government plans to create a new public utilities
commission, the provision of the new retail license will not depend upon the formation of such a commission; (2) any consideration
regarding inclusion of the exclusive right to sell non-potable water within the area covered by the retail license will not take
place until after the draft license has proceeded through the review process of the negotiations; (3) rather than allow the Company
to submit its counter proposal to the WAC’s June 2010 RCAM license draft, the WAC will draft the license with the understanding
that the Company will be allowed to propose amendments thereto; (4) the principle of subsidization of residential customer rates
by commercial customer rates would continue under the new license; and (5) a request that the Company consider eliminating its
monthly minimum volume charge in the new license.
The Company recommenced license negotiations
with the WAC during the third quarter of 2015 based upon a draft RCAM license provided by the WAC. Such license negotiations remain
on-going. The Company is presently unable to determine when such negotiations will be completed or the final outcome of such negotiations.
The Cayman Islands government could ultimately
offer a third party a license to service some or all of Cayman Water’s present service area. However, as set forth in the
existing license, “
the Governor hereby agrees that upon the expiry of the term of this Licence or any extension thereof,
he will not grant a licence or franchise to any other person or company for the processing, distribution, sale and supply of water
within the Licence Area without having first offered such a licence or franchise to the Company on terms no less favourable than
the terms offered to such other person or company.”
The resolution of these license negotiations
could result in a material reduction of the operating income and cash flows the Company has historically generated from its retail
license and could require the Company to record an impairment charge to reduce the carrying value of its goodwill.
Such impairment charge could have a material adverse impact on the Company’s results of operations.
The Company is presently unable to determine
what impact the resolution of this matter will have on its financial condition, results of operations or cash flows.
CW-Belize
By Statutory Instrument No. 81 of 2009,
the Minister of Public Utilities of the government of Belize published an order, the Public Utility Provider Class Declaration
Order, 2009 (the “Order”), which as of May 1, 2009 designated CW-Belize as a public utility provider under the laws
of Belize. With this designation, the Public Utilities Commission of Belize (the “PUC”) has the authority to set the
rates charged by CW-Belize and to otherwise regulate its activities. On November 1, 2010, CW-Belize received a formal complaint
from the PUC alleging that CW-Belize was operating without a license under the terms of the Water Industry Act. CW-Belize applied
for this license in December 2010. On July 29, 2011, the PUC issued the San Pedro Public Water Supply Quality and Security Complaint
Order (the “Second Order”) which among other things requires that (i) CW-Belize and its customer jointly make a submission
to the responsible Minister requesting that the area surrounding CW-Belize’s seawater abstraction wells be designated a
forest reserve or national park and be designated a Controlled Area under section 58 of the Water Industry Act, (ii) CW-Belize
submit an operations manual for CW-Belize’s desalination plant to the PUC for approval, (iii) CW-Belize and its customer
modify the water supply agreement between the parties to (a) include new water quality parameters included in the Order and (b)
cap the current exclusive water supply arrangement in the agreement at a maximum of 450,000 gallons per day, (iv) CW-Belize keep
a minimum number of replacement seawater RO membranes in stock at all times and (v) CW-Belize take possession of and reimburse
the PUC for certain equipment which the PUC purchased from a third-party in late 2010. CW-Belize has applied for declaratory judgment
and has been granted a temporary injunction to stay the enforcement of the Second Order by the PUC until such time as the Belize
courts could hear the matter. The initial hearing on this matter was conducted on October 30 and 31, 2012 with an additional hearing
on November 29, 2012. The ruling on this case is pending. The Company is presently unable to determine what impact the Order and
the Second Order will have on its results of operations, financial position or cash flows.
Windsor Plant Water Supply Agreement
CW-Bahamas provides bulk water to the
Water and Sewerage Corporation of The Bahamas (“WSC”), which distributes the water through its own pipeline system
to residential, commercial and tourist properties on the Island of New Providence. Pursuant to a water supply agreement, CW-Bahamas
was required to provide the WSC with at least 16.8 million gallons per week of potable water from the Windsor plant. This water
supply agreement was scheduled to expire when CW-Bahamas delivered the total amount of water required under the agreement in July
2013, but has been extended on a month-to-month basis. At the conclusion of the agreement, the WSC has the option to:
|
i.
|
extend the agreement for an additional five years at
a rate to be negotiated;
|
|
ii.
|
exercise a right of first refusal to purchase any materials, equipment and facilities that CW-Bahamas
intends to remove from the site at a purchase price to be negotiated with CW-Bahamas; or
|
|
iii.
|
require CW-Bahamas to remove all materials, equipment
and facilities from the site.
|
At the request of the government of The
Bahamas, CW-Bahamas continues to operate and maintain the Windsor plant on a month-to-month basis to provide the government of
The Bahamas with additional time to decide whether or not it will extend CW-Bahamas’ water supply agreement for the Windsor
plant on a long-term basis. CW-Bahamas generated revenues from the operation of this plant of approximately $1.3 million, and
$1.5 million during the three months ended March 31, 2016, and 2015, respectively.
CW-Bali
Through its subsidiary CW-Bali, the Company has built and presently operates a seawater reverse osmosis
plant with a productive capacity of approximately 790,000 gallons per day located in Nusa Dua, one of the primary tourist areas
of Bali, Indonesia. The Company built this plant based upon its belief that future water shortages in this area of Bali will eventually
enable CW-Bali to sell all of this plant’s production. However, since its inception, the sales volumes for this plant have
not been sufficient to cover its operating costs. CW- Bali’s operating losses were approximately ($147,000), and ($161,000)
for the three months ended March 31, 2016, and 2015, respectively. As of March 31, 2016, the capitalized costs for this plant reflected
on the Company’s consolidated balance sheet were approximately $3.1 million.
In 2015, the Indonesian government passed
Regulation 121 which provides a mechanism for governmental regulatory oversight over the utilization of Indonesia’s water
resources. Under this new regulation, the approval or cooperation of the local government water utility is required for any water
supply contracts executed by non-governmental providers after the effective date of the regulation. Consequently CW-Bali will
be required to enter into a cooperation agreement with Bali’s local government water utility, PDAM, or otherwise obtain
PDAM’s approval, to supply any new customers.
The Company is presently seeking a strategic
partner to (i) purchase a major portion of its equity ownership in CW-Bali; (ii) lead CW-Bali’s sales and marketing efforts
and liaise with PDAM; and (iii) assist with CW-Bali’s on-going funding requirements. The Company also plans to market the
available productive capacity of CW-Bali’s Nusa Dua plant to PDAM. If the Company is not able to obtain a strategic partner
for CW-Bali, sell water to PDAM or other new customers, or otherwise significantly increase the revenues generated by its Nusa
Dua plant in the future, the Company will be required to record an impairment charge to reduce the carrying value of CW-Bali’s
plant assets to their fair value. Such an impairment charge could have a material adverse impact on the Company’s results
of operations.
10. Impact of recent accounting standards
Adoption of New Accounting Standards:
In February 2015, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-02,
Consolidation (Topic 810)
- Amendments to the Consolidation Analysis
. The amendments in this update require management to reevaluate whether certain
legal entities should be consolidated. Specifically, the amendments (1) modify the evaluation of whether limited partnerships
and similar legal entities are variable interest entities (“VIEs”) or voting interest entities, (2) eliminate the
presumption that a general partner should consolidate a limited partnership, (3) affect the consolidation analysis of reporting
entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships, and (4) provide
a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply
with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for
registered money market funds. The amendments in this update are effective for public business entities for fiscal years, and
interim periods within those fiscal years, beginning after December 15, 2015. The adoption of ASU 2015-02 did not have a material
impact on the Company’s consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03,
Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
. ASU 2015-03 provides
authoritative guidance related to the presentation of debt issuance costs on the balance sheet, requiring companies to present
debt issuance costs as a direct deduction from the carrying value of debt. The amendments in this update are effective for public
business entities in fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The new guidance
must be applied retrospectively to each prior period presented. The adoption of ASU 2015-03 did not have a material impact on
the Company’s consolidated financial statements.
In August 2015, the FASB issued ASU 2015-15,
Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements
, which clarifies
the treatment of debt issuance costs from line-of-credit arrangements after adoption of ASU 2015-03. The SEC Staff announced they
would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred
debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings
on the line-of-credit arrangement. The amendment requires retrospective application and represents a change in accounting principle.
The amendment becomes effective in fiscal years beginning after December 15, 2015. The adoption of ASU 2015-15 did not have a
material impact on the Company’s consolidated financial statements.
In September 2015, the FASB issued ASU
2015-16,
Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments
, which requires an acquirer
to recognize adjustments identified during the measurement period in the reporting period in which the adjustment amounts are
determined. The adjustment must include the cumulative effect of the adjustment as if the accounting had been completed on the
acquisition date. The update should be applied prospectively and becomes effective January 1, 2016. Early application is permitted.
The adoption of ASU 2015-16 did not have a material impact on the Company’s consolidated financial statements.
Effect of newly issued but not yet effective accounting
standards:
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers
. ASU 2014-09 requires revenue recognition to depict the transfer of goods or services
to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods
or services. ASU 2014-09 prescribes a five step framework in accounting for revenues from contracts within its scope, including
(a) identification of the contract, (b) identification of the performance obligations under the contract, (c) determination of
the transaction price, (d) allocation of the transaction price to the identified performance obligations and (e) recognition of
revenues as the identified performance obligations are satisfied. ASU 2014-09 also prescribes additional disclosures and financial
statement presentations. ASU 2014-09 may be adopted retrospectively or under a modified retrospective method where the cumulative
effect is recognized at the date of initial application. This amendment was originally effective January 1, 2017. In August 2015,
the FASB issued ASU 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
, which defers
the effective date by one year to January 1, 2018. Early application is permitted but not before January 1, 2017. The Company
is currently evaluating the effect the adoption of this standard will have on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-08,
Principal versus Agent Considerations (Reporting Revenue Gross versus Net
), that amends the principal versus agent guidance
in ASU 2014-09. ASU 2016-08 clarifies that the analysis must focus on whether the entity has control of the goods or services
before they are transferred to the customer. ASU 2016-08 also provides additional guidance about how to apply the control principle
when services are provided and when goods or services are combined with other goods or services. The effective date of the standard
for the Company will coincide with ASU 2014-09 during the first quarter 2018. The Company is currently evaluating the effect that
the updated standard will have on Company’s consolidated financial statements.
In April 2016, the FASB issued ASU 2016-10,
Identifying Performance Obligations and Licensing,
that amends the revenue guidance in ASU 2014-09 on identifying performance
obligations and accounting for licenses of intellectual property. ASU 2016-10 changed the FASB's previous proposals on renewals
of right-to-use licenses and contractual restrictions. The effective date of the standard for the Company will coincide with ASU
2014-09 during the first quarter 2018. The Company is currently evaluating the effect that the updated standard will have on Company’s
consolidated financial statements.
In July 2015, the FASB issued ASU 2015-11,
Inventory (Topic 330): Simplifying the Measurement of Inventory
. ASU 2015-11 applies to all inventory that is measured
using first-in, first-out or average cost. The guidance requires an entity to measure inventory at the lower of cost or net realizable
value. ASU 2015-11 is effective prospectively for fiscal years, and for interim periods within those years, beginning after December
15, 2016. Early application is permitted. The Company is currently evaluating the effect the adoption of this amendment will have
on the Company’s consolidated financial statements.
In November 2015, the FASB issued ASU
2015-17,
Income Taxes (Topic 740), Balance Sheet Classification of Deferred Taxes
. ASU 2015-17 requires net deferred tax
assets and liabilities be classified as noncurrent in a classified balance sheet and eliminates the classification between current
and noncurrent amounts ASU No. 2015-17 is effective for financial statements issued for annual periods beginning after December
15, 2016 and interim periods within those annual periods. Early adoption is permitted. The Company is currently evaluating the
effect the adoption of this amendment will have on the Company’s consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01,
Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,
which provides guidance for the recognition, measurement, presentation and disclosure of financial assets and financial liabilities.
ASU 2016-01 is effective for fiscal years, and for interim periods within those years, beginning after December 15, 2017 and,
for most provisions, is effective using the cumulative-effect transition approach. Early application is permitted for certain
provisions. The Company is currently evaluating the effect the adoption of this amendment will have on the Company’s consolidated
financial statements.
In February 2016, the FASB issued ASU
2016-02,
Leases (Topic 842)
, which provides guidance for accounting for leases. The new guidance requires companies to
recognize the assets and liabilities for the rights and obligations created by leased assets. The accounting guidance for lessors
will remain relatively largely unchanged. ASU 2016-02 is effective for annual and interim periods beginning after December 15,
2018. Early adoption is permitted. The Company is currently evaluating the effect the adoption of this amendment will have on
the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07,
Investments- Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting,
which eliminates the requirement to apply the equity method of accounting retrospectively when a reporting entity obtains significant
influence over a previously held investment. ASU 2016-07 will be effective for the Company’s fiscal year beginning January
1, 2017 and subsequent interim periods. The Company is currently evaluating the effect the adoption of this amendment will have
on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
C
ompensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,
which
simplifies
several aspects related to the accounting for share-based payment transactions, including the accounting for income taxes, statutory
tax withholding requirements and classification on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning
after December 15, 2016, and interim periods within those annual periods. The Company is currently evaluating the effect the adoption
of this amendment will have on the Company’s consolidated financial statements.
11. Subsequent events
The Company’s management evaluated
subsequent events through the time of the filing of this report on Form 10-Q. Other than as disclosed in these condensed consolidated
financial statements, the Company’s management is not aware of any significant events that occurred subsequent to the balance
sheet date but prior to the filing of this report that would have a material impact on its consolidated financial statements.