ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED WATER CO. LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
37,092,112
|
|
|
$
|
44,792,734
|
|
Certificate of deposit
|
|
|
-
|
|
|
|
5,637,538
|
|
Restricted cash
|
|
|
-
|
|
|
|
428,203
|
|
Accounts receivable, net
|
|
|
15,099,235
|
|
|
|
9,529,016
|
|
Inventory
|
|
|
2,087,716
|
|
|
|
1,918,728
|
|
Prepaid expenses and other current assets
|
|
|
1,622,789
|
|
|
|
1,282,660
|
|
Current portion of loans receivable
|
|
|
1,769,129
|
|
|
|
1,841,851
|
|
Costs and estimated earnings in excess of billings
|
|
|
1,448,393
|
|
|
|
-
|
|
Total current assets
|
|
|
59,119,374
|
|
|
|
65,430,730
|
|
Property, plant and equipment, net
|
|
|
52,742,944
|
|
|
|
53,743,170
|
|
Construction in progress
|
|
|
1,810,710
|
|
|
|
1,928,610
|
|
Inventory, non-current
|
|
|
4,817,933
|
|
|
|
4,558,374
|
|
Loans receivable
|
|
|
2,471,596
|
|
|
|
3,769,016
|
|
Investment in OC-BVI
|
|
|
3,942,869
|
|
|
|
4,548,271
|
|
Intangible assets, net
|
|
|
5,594,560
|
|
|
|
771,811
|
|
Goodwill
|
|
|
9,784,248
|
|
|
|
3,499,037
|
|
Land held for development
|
|
|
20,558,424
|
|
|
|
20,558,424
|
|
Other assets
|
|
|
2,446,865
|
|
|
|
2,767,583
|
|
Total assets
|
|
$
|
163,289,523
|
|
|
$
|
161,575,026
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
Accounts payable and other current liabilities
|
|
$
|
5,298,330
|
|
|
$
|
4,829,535
|
|
Dividends payable
|
|
|
1,183,222
|
|
|
|
1,177,246
|
|
Note payable to related party
|
|
|
490,000
|
|
|
|
-
|
|
Demand loan payable
|
|
|
-
|
|
|
|
6,958,328
|
|
Billings in excess of costs and estimated earnings
|
|
|
-
|
|
|
|
189,985
|
|
Total current liabilities
|
|
|
6,971,552
|
|
|
|
13,155,094
|
|
Deferred tax liability
|
|
|
2,061,438
|
|
|
|
-
|
|
Other liabilities
|
|
|
882,827
|
|
|
|
224,827
|
|
Total liabilities
|
|
|
9,915,817
|
|
|
|
13,379,921
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
|
|
Consolidated Water Co. Ltd. stockholders' equity
|
|
|
|
|
|
|
|
|
Redeemable preferred stock, $0.60 par value. Authorized 200,000 shares;issued and outstanding 35,739 and 38,804 shares, respectively
|
|
|
21,443
|
|
|
|
23,282
|
|
Class A common stock, $0.60 par value. Authorized 24,655,000 shares; issued and outstanding 14,818,699 and 14,781,201 shares, respectively
|
|
|
8,891,219
|
|
|
|
8,868,721
|
|
Class B common stock, $0.60 par value. Authorized 145,000 shares; none issued
|
|
|
-
|
|
|
|
-
|
|
Additional paid-in capital
|
|
|
85,131,881
|
|
|
|
84,597,349
|
|
Retained earnings
|
|
|
51,139,896
|
|
|
|
52,084,175
|
|
Cumulative translation adjustment
|
|
|
(549,555
|
)
|
|
|
(533,365
|
)
|
Total Consolidated Water Co. Ltd. stockholders' equity
|
|
|
144,634,884
|
|
|
|
145,040,162
|
|
Non-controlling interests
|
|
|
8,738,822
|
|
|
|
3,154,943
|
|
Total equity
|
|
|
153,373,706
|
|
|
|
148,195,105
|
|
Total liabilities and equity
|
|
$
|
163,289,523
|
|
|
$
|
161,575,026
|
|
The accompanying
notes are an integral part of these condensed consolidated financial statements.
CONSOLIDATED WATER CO. LTD.
CONDENSED CONSOLIDATED STATEMENTS OF
INCOME
(UNAUDITED)
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Retail revenues
|
|
$
|
5,447,200
|
|
|
$
|
5,828,288
|
|
|
$
|
17,710,271
|
|
|
$
|
18,116,111
|
|
Bulk revenues
|
|
|
7,429,732
|
|
|
|
7,919,920
|
|
|
|
22,136,086
|
|
|
|
24,489,509
|
|
Services revenues
|
|
|
1,508,421
|
|
|
|
857,441
|
|
|
|
3,972,403
|
|
|
|
1,151,810
|
|
Total revenues
|
|
|
14,385,353
|
|
|
|
14,605,649
|
|
|
|
43,818,760
|
|
|
|
43,757,430
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of retail revenues
|
|
|
2,464,841
|
|
|
|
2,640,458
|
|
|
|
7,779,831
|
|
|
|
8,065,019
|
|
Cost of bulk revenues
|
|
|
4,922,162
|
|
|
|
5,661,247
|
|
|
|
14,345,747
|
|
|
|
16,777,236
|
|
Cost of services revenues
|
|
|
1,079,027
|
|
|
|
662,201
|
|
|
|
3,004,449
|
|
|
|
1,159,836
|
|
Total cost of revenues
|
|
|
8,466,030
|
|
|
|
8,963,906
|
|
|
|
25,130,027
|
|
|
|
26,002,091
|
|
Gross profit
|
|
|
5,919,323
|
|
|
|
5,641,743
|
|
|
|
18,688,733
|
|
|
|
17,755,339
|
|
General and administrative expenses
|
|
|
4,528,679
|
|
|
|
3,487,967
|
|
|
|
13,925,439
|
|
|
|
11,042,507
|
|
Impairment loss on long-lived assets
|
|
|
2,000,000
|
|
|
|
-
|
|
|
|
2,000,000
|
|
|
|
-
|
|
Impairment of goodwill
|
|
|
1,750,000
|
|
|
|
-
|
|
|
|
1,750,000
|
|
|
|
-
|
|
Income (loss) from operations
|
|
|
(2,359,356
|
)
|
|
|
2,153,776
|
|
|
|
1,013,294
|
|
|
|
6,712,832
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
137,806
|
|
|
|
270,830
|
|
|
|
514,532
|
|
|
|
762,613
|
|
Interest expense
|
|
|
(1,246
|
)
|
|
|
(66,566
|
)
|
|
|
(95,615
|
)
|
|
|
(204,027
|
)
|
Profit sharing income from OC-BVI
|
|
|
38,475
|
|
|
|
28,350
|
|
|
|
87,075
|
|
|
|
76,950
|
|
Equity in earnings of OC-BVI
|
|
|
101,301
|
|
|
|
73,294
|
|
|
|
232,523
|
|
|
|
211,117
|
|
Impairment loss on investment in OC-BVI
|
|
|
(875,000
|
)
|
|
|
(225,000
|
)
|
|
|
(925,000
|
)
|
|
|
(810,000
|
)
|
Unrealized loss on put/call option
|
|
|
(275,000
|
)
|
|
|
-
|
|
|
|
(275,000
|
)
|
|
|
-
|
|
Other
|
|
|
110,968
|
|
|
|
(383,511
|
)
|
|
|
507,183
|
|
|
|
(530,618
|
)
|
Other income (expense), net
|
|
|
(762,696
|
)
|
|
|
(302,603
|
)
|
|
|
45,698
|
|
|
|
(493,965
|
)
|
Income (loss) before income taxes
|
|
|
(3,122,052
|
)
|
|
|
1,851,173
|
|
|
|
1,058,992
|
|
|
|
6,218,867
|
|
Provision for (benefit from) income taxes
|
|
|
(146,198
|
)
|
|
|
-
|
|
|
|
(389,860
|
)
|
|
|
-
|
|
Net income (loss)
|
|
|
(2,975,854
|
)
|
|
|
1,851,173
|
|
|
|
1,448,852
|
|
|
|
6,218,867
|
|
Income (loss) attributable to non-controlling interests
|
|
|
(1,110,522
|
)
|
|
|
75,673
|
|
|
|
(944,790
|
)
|
|
|
294,006
|
|
Net income (loss)attributable to Consolidated Water Co. Ltd. stockholders
|
|
$
|
(1,865,332
|
)
|
|
$
|
1,775,500
|
|
|
$
|
2,393,642
|
|
|
$
|
5,924,861
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
$
|
(0.13
|
)
|
|
$
|
0.12
|
|
|
$
|
0.16
|
|
|
$
|
0.40
|
|
Diluted earnings (loss) per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
$
|
(0.13
|
)
|
|
$
|
0.12
|
|
|
$
|
0.16
|
|
|
$
|
0.40
|
|
Dividends declared per common share
|
|
$
|
0.075
|
|
|
$
|
0.075
|
|
|
$
|
0.225
|
|
|
$
|
0.225
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares used in the determination of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
|
14,815,248
|
|
|
|
14,749,249
|
|
|
|
14,803,216
|
|
|
|
14,734,799
|
|
Diluted earnings per share
|
|
|
14,852,967
|
|
|
|
14,802,322
|
|
|
|
14,940,635
|
|
|
|
14,787,904
|
|
The accompanying notes
are an integral part of these condensed consolidated financial statements.
CONSOLIDATED WATER CO. LTD.
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME (LOSS)
(UNAUDITED
)
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Net income (loss)
|
|
$
|
(2,975,854
|
)
|
|
$
|
1,851,173
|
|
|
$
|
1,448,852
|
|
|
$
|
6,218,867
|
|
Other comprehensive income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
|
|
(11,208
|
)
|
|
|
(2,475
|
)
|
|
|
(17,042
|
)
|
|
|
(45,226
|
)
|
Total other comprehensive income (loss)
|
|
|
(11,208
|
)
|
|
|
(2,475
|
)
|
|
|
(17,042
|
)
|
|
|
(45,226
|
)
|
Comprehensive income (loss)
|
|
|
(2,987,062
|
)
|
|
|
1,848,698
|
|
|
|
1,431,810
|
|
|
|
6,173,641
|
|
Comprehensive income (loss) attributable to non-controlling interests
|
|
|
(1,111,082
|
)
|
|
|
75,550
|
|
|
|
(945,642
|
)
|
|
|
291,745
|
|
Comprehensive income (loss) attributable to Consolidated Water Co. Ltd. stockholders
|
|
$
|
(1,875,980
|
)
|
|
$
|
1,773,148
|
|
|
$
|
2,377,452
|
|
|
$
|
5,881,896
|
|
The accompanying notes are an integral part
of these condensed consolidated financial statements.
CONSOLIDATED WATER CO. LTD.
CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS
(UNAUDITED)
|
|
Nine Months Ended
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Net cash provided by operating activities
|
|
$
|
4,516,088
|
|
|
$
|
11,703,961
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of certificate of deposit
|
|
|
-
|
|
|
|
(5,637,538
|
)
|
Maturity of certificate of deposit
|
|
|
5,637,538
|
|
|
|
5,000,000
|
|
Additions to property, plant and equipment and construction in progress
|
|
|
(2,569,066
|
)
|
|
|
(2,498,275
|
)
|
Proceeds from sale of equipment
|
|
|
547,332
|
|
|
|
10,160
|
|
Acquisition of business, net of cash acquired
|
|
|
(7,742,853
|
)
|
|
|
-
|
|
Collections on loans receivable
|
|
|
1,370,142
|
|
|
|
1,284,191
|
|
Release/(restriction) of cash balance
|
|
|
398,744
|
|
|
|
(42,715
|
)
|
Net cash used in investing activities
|
|
|
(2,358,163
|
)
|
|
|
(1,884,177
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Dividends paid to CWCO common shareholders
|
|
|
(3,322,793
|
)
|
|
|
(3,312,050
|
)
|
Dividends paid to non-controlling interests
|
|
|
(182,663
|
)
|
|
|
(183,372
|
)
|
Dividends paid to CWCO preferred shareholders
|
|
|
(9,151
|
)
|
|
|
(8,944
|
)
|
Repurchase of redeemable preferred stock
|
|
|
(9,599
|
)
|
|
|
(2,960
|
)
|
Proceeds received from exercise of stock options
|
|
|
174,853
|
|
|
|
244,368
|
|
Issuance of note payable to related party
|
|
|
490,000
|
|
|
|
-
|
|
Repayments of demand loan payable
|
|
|
(7,000,000
|
)
|
|
|
(1,500,000
|
)
|
Net cash used in financing activities
|
|
|
(9,859,353
|
)
|
|
|
(4,762,958
|
)
|
Effect of exchange rate changes on cash
|
|
|
806
|
|
|
|
(4,390
|
)
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(7,700,622
|
)
|
|
|
5,052,436
|
|
Cash and cash equivalents at beginning of period
|
|
|
44,792,734
|
|
|
|
35,713,689
|
|
Cash and cash equivalents at end of period
|
|
$
|
37,092,112
|
|
|
$
|
40,766,125
|
|
|
|
|
|
|
|
|
|
|
Interest paid in cash
|
|
$
|
67,689
|
|
|
$
|
113,244
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
Issuance of 8,421 and 8,615, respectively, shares of redeemable preferred stock for services rendered
|
|
$
|
111,410
|
|
|
$
|
110,703
|
|
Issuance of 9,964 and 0, respectively, shares of common stock for services rendered
|
|
$
|
106,415
|
|
|
$
|
-
|
|
Conversion (on a one-to-one basis) of 11,558 and 7,195, respectively, shares of redeemable preferred stock to common stock
|
|
$
|
6,935
|
|
|
$
|
4,317
|
|
Dividends declared but not paid
|
|
$
|
1,114,083
|
|
|
$
|
1,109,248
|
|
Transfers from (to) inventory to (from) property, plant and equipment and construction in progress
|
|
$
|
134,362
|
|
|
$
|
114,733
|
|
Transfers from construction in progress to property, plant and equipment
|
|
$
|
1,787,580
|
|
|
$
|
1,606,314
|
|
The accompanying notes are an integral part
of these condensed consolidated financial statements.
CONSOLIDATED WATER CO. LTD.
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$”). The functional currency of the Company and its foreign operating
subsidiaries (other than NSC and CW-Cooperatief) is the currency for each respective country. Effective as of October 1, 2016,
the Company changed the functional currency of CW-Bali to the US$ as further discussed in Note 9. The functional currency for NSC
and CW-Cooperatief is the US$. The exchange rates for the Cayman Islands dollar, the Belize dollar and the Bahamian dollar are
fixed to the US$. 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 and re-measurements were $1,734
and ($388,456) for the three months ended September 30, 2016 and 2015, respectively, and $92,030 and ($660,989) for the nine months
ended September 30, 2016 and 2015, respectively, and are included in “Other income (expense) - Other” 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 and highly liquid deposits at banks with an original maturity of three months or
less. Cash and cash equivalents as of September 30, 2016 and December 31, 2015 include $4.2 million and $13.6 million, respectively,
of certificates of deposits with an original maturity of three months or less.
Transfers from the Company’s bank
accounts in The Bahamas and Belize to Company bank accounts in other countries require the approval of the Central Bank of the
Bahamas and Belize, respectively. As of September 30, 2016, the equivalent United States dollar cash balances for deposits held
in the Bahamas and Belize were approximately $6.6 million and $5.3 million, respectively.
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, Donnick and the Company
loaned $490,000 and $510,000, respectively, to Aerex. These loans bear interest at 1% per annum and mature June 30, 2017.
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
|
|
|
Accumulated Amortization
|
|
|
September 30, 2016
|
|
|
Useful life
|
Non-compete agreement
|
|
$
|
400,000
|
|
|
$
|
53,333
|
|
|
$
|
346,667
|
|
|
5 years
|
Trade name
|
|
|
1,400,000
|
|
|
|
62,223
|
|
|
|
1,337,777
|
|
|
15 years
|
Certifications/programs
|
|
|
2,000,000
|
|
|
|
444,444
|
|
|
|
1,555,556
|
|
|
3 years
|
Customer backlog
|
|
|
100,000
|
|
|
|
66,667
|
|
|
|
33,333
|
|
|
1 year
|
Customer relationships
|
|
|
2,000,000
|
|
|
|
333,333
|
|
|
|
1,666,667
|
|
|
4 years
|
|
|
$
|
5,900,000
|
|
|
$
|
960,000
|
|
|
$
|
4,940,000
|
|
|
|
Aerex’s actual results of operations
for the period subsequent to its acquisition by the Company on February 11, 2016 fell significantly short of the projected results
for this period that were included in the overall cash flow projections utilized by the Company to determine the purchase price
for Aerex and the fair values of its assets and liabilities. Due to this negative variance in actual results compared to projected
results, the Company tested Aerex’s goodwill for possible impairment as of September 30, 2016 by estimating its fair value
using the discounted cash flow method. As a result of this impairment testing, the Company determined that the carrying value of
its Aerex reporting unit exceeded its fair value, and recorded an impairment loss for the three months ended September 30, 2016
of $1,750,000 for the goodwill associated with the Aerex acquisition.
The results of operations of Aerex are
included in the services segment of the Company’s consolidated financial statements from the date of acquisition. The total
revenue and net income (loss) included for Aerex in the Company’s consolidated results of operations for the three months
ended September 30, 2016 were approximately $1.4 million and ($956,000), respectively. The total revenue and net income (loss)
included for Aerex in the Company’s consolidated results of operations for the period February 11, 2016 to September 30,
2016, were approximately $3.3 million and ($1,275,000), respectively. General and administrative expenses incurred by the Company
for the Aerex acquisition reflected in the results of operations for the three and nine months ended September 30, 2016 were $0
and approximately $144,000, respectively.
The following pro forma financial information presents the results of operations of the Company for the
nine months ended September 30, 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:
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
44,324,477
|
|
|
$
|
60,383,276
|
|
Cost of revenues
|
|
|
25,397,444
|
|
|
|
38,135,655
|
|
Gross profit
|
|
|
18,927,033
|
|
|
|
22,247,621
|
|
General and administrative expenses
|
|
|
14,240,156
|
|
|
|
12,601,144
|
|
Impairment loss on long-lived assets
|
|
|
2,000,000
|
|
|
|
-
|
|
Impairment of goodwill
|
|
|
1,750,000
|
|
|
|
-
|
|
Income from operations
|
|
|
936,877
|
|
|
|
9,646,477
|
|
Other income (expense), net
|
|
|
47,202
|
|
|
|
(487,401
|
)
|
Income before income taxes
|
|
|
984,079
|
|
|
|
9,159,076
|
|
Provision for (benefit from) income taxes
|
|
|
(462,773
|
)
|
|
|
1,027,589
|
|
Net income
|
|
|
1,446,852
|
|
|
|
8,131,487
|
|
Income (loss) attributable to non-controlling interests
|
|
|
(920,277
|
)
|
|
|
1,417,703
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
$
|
2,367,129
|
|
|
$
|
6,713,784
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
$
|
0.16
|
|
|
$
|
0.46
|
|
Diluted earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
$
|
0.16
|
|
|
$
|
0.45
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares used in the determination of:
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
|
14,803,216
|
|
|
|
14,734,799
|
|
Diluted earnings per share
|
|
|
14,940,635
|
|
|
|
14,787,904
|
|
4. Fair value measurements
As of September 30, 2016 and December 31,
2015, the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and other current liabilities, the
note payable to related party, the demand loan payable 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 as of September 30, 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 September 30, 2016 and December 31, 2015:
|
|
September 30, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted cash
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Certificate of deposit
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonrecurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in OC-BVI
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,942,869
|
|
|
$
|
3,942,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability arising from put/call options
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
658,000
|
|
|
$
|
658,000
|
|
|
|
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 the Level 3 asset and liability for the nine
months ended September 30, 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
|
|
|
319,598
|
|
Distributions received from OC-BVI
|
|
|
-
|
|
Impairment of investment in OC-BVI
|
|
|
(925,000
|
)
|
Balance as of September 30, 2016
|
|
$
|
3,942,869
|
|
|
|
|
|
|
Net liability arising from put/call options
[1]
|
|
|
|
|
Balance as of December 31, 2015
|
|
$
|
-
|
|
Issuance
|
|
|
383,000
|
|
Unrealized loss
|
|
|
275,000
|
|
Balance as of September 30, 2016
|
|
$
|
658,000
|
|
___________________
(1) The net liability arising from the
put/call options is included other liabilities in the accompanying condensed consolidated balance sheets as of September 30, 2016.
5. Segment information
The Company has three reportable segments:
retail, bulk and services. The retail segment 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 and also sells water to resort properties
in Bali, Indonesia. 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 water-related products and provides design,
engineering, management, operating and other services applicable to commercial and municipal water production, water 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 expenses 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 September 30, 2016
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Revenues
|
|
$
|
5,447,200
|
|
|
$
|
7,429,732
|
|
|
$
|
1,508,421
|
|
|
$
|
14,385,353
|
|
Cost of revenues
|
|
|
2,464,841
|
|
|
|
4,922,162
|
|
|
|
1,079,027
|
|
|
|
8,466,030
|
|
Gross profit
|
|
|
2,982,359
|
|
|
|
2,507,570
|
|
|
|
429,394
|
|
|
|
5,919,323
|
|
General and administrative expenses
|
|
|
2,811,262
|
|
|
|
425,000
|
|
|
|
1,292,417
|
|
|
|
4,528,679
|
|
Impairment loss on long-lived assets
|
|
|
2,000,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,000,000
|
|
Impairment of goodwill
|
|
|
-
|
|
|
|
-
|
|
|
|
1,750,000
|
|
|
|
1,750,000
|
|
Income (loss) from operations
|
|
$
|
(1,828,903
|
)
|
|
$
|
2,082,570
|
|
|
$
|
(2,613,023
|
)
|
|
|
(2,359,356
|
)
|
Other income (expense), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(762,696
|
)
|
Loss before income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,122,052
|
)
|
Provision for (benefit from) income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(146,198
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,975,854
|
)
|
Loss attributable to non-controlling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,110,522
|
)
|
Net loss attributable to Consolidated Water Co. Ltd. stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,865,332
|
)
|
Depreciation and amortization expenses
for the three months ended September 30, 2016 for the retail, bulk and services segments were $567,833, $811,741 and $451,267,
respectively.
|
|
Three Months Ended September 30, 2015
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Revenues
|
|
$
|
5,828,288
|
|
|
$
|
7,919,920
|
|
|
$
|
857,441
|
|
|
$
|
14,605,649
|
|
Cost of revenues
|
|
|
2,640,458
|
|
|
|
5,661,247
|
|
|
|
662,201
|
|
|
|
8,963,906
|
|
Gross profit
|
|
|
3,187,830
|
|
|
|
2,258,673
|
|
|
|
195,240
|
|
|
|
5,641,743
|
|
General and administrative expenses
|
|
|
2,728,473
|
|
|
|
357,995
|
|
|
|
401,499
|
|
|
|
3,487,967
|
|
Income (loss) from operations
|
|
$
|
459,357
|
|
|
$
|
1,900,678
|
|
|
$
|
(206,259
|
)
|
|
|
2,153,776
|
|
Other income (expense), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(302,603
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,851,173
|
|
Income attributable to non-controlling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
75,673
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,775,500
|
|
Depreciation and amortization expenses
for the three months ended September 30, 2015 for the retail, bulk and services segments were $583,551, $815,994 and $28,976, respectively.
|
|
Nine Months Ended September 30, 2016
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Revenues
|
|
$
|
17,710,271
|
|
|
$
|
22,136,086
|
|
|
$
|
3,972,403
|
|
|
$
|
43,818,760
|
|
Cost of revenues
|
|
|
7,779,831
|
|
|
|
14,345,747
|
|
|
|
3,004,449
|
|
|
|
25,130,027
|
|
Gross profit
|
|
|
9,930,440
|
|
|
|
7,790,339
|
|
|
|
967,954
|
|
|
|
18,688,733
|
|
General and administrative expenses
|
|
|
8,588,529
|
|
|
|
1,302,884
|
|
|
|
4,034,026
|
|
|
|
13,925,439
|
|
Impairment loss on long-lived assets
|
|
|
2,000,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,000,000
|
|
Impairment of goodwill
|
|
|
-
|
|
|
|
-
|
|
|
|
1,750,000
|
|
|
|
1,750,000
|
|
Income (loss) from operations
|
|
$
|
(658,089
|
)
|
|
$
|
6,487,455
|
|
|
$
|
(4,816,072
|
)
|
|
|
1,013,294
|
|
Other income (expense), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
45,698
|
|
Income before income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,058,992
|
|
Provision for (benefit from) income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(389,860
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,448,852
|
|
Loss attributable to non-controlling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(944,790
|
)
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,393,642
|
|
Depreciation and amortization expenses
for the nine months ended September 30, 2016 for the retail, bulk and services segments were $1,714,928, $2,480,314 and $1,213,282,
respectively.
|
|
Nine Months Ended September 30, 2015
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Revenues
|
|
$
|
18,116,111
|
|
|
$
|
24,489,509
|
|
|
$
|
1,151,810
|
|
|
$
|
43,757,430
|
|
Cost of revenues
|
|
|
8,065,019
|
|
|
|
16,777,236
|
|
|
|
1,159,836
|
|
|
|
26,002,091
|
|
Gross profit (loss)
|
|
|
10,051,092
|
|
|
|
7,712,273
|
|
|
|
(8,026
|
)
|
|
|
17,755,339
|
|
General and administrative expenses
|
|
|
8,360,765
|
|
|
|
1,187,824
|
|
|
|
1,493,918
|
|
|
|
11,042,507
|
|
Income (loss) from operations
|
|
$
|
1,690,327
|
|
|
$
|
6,524,449
|
|
|
$
|
(1,501,944
|
)
|
|
|
6,712,832
|
|
Other income (expense), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(493,965
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,218,867
|
|
Income attributable to non-controlling interests
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
294,006
|
|
Net income attributable to Consolidated Water Co. Ltd. stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5,924,861
|
|
Depreciation and amortization expenses
for the nine months ended September 30, 2015 for the retail, bulk and services segments were $1,755,123, $2,419,509 and $73,924,
respectively.
|
|
As of September 30, 2016
|
|
|
|
Retail
|
|
|
Bulk
|
|
|
Services
|
|
|
Total
|
|
Accounts receivable, net
|
|
$
|
2,479,251
|
|
|
$
|
11,704,695
|
|
|
$
|
915,289
|
|
|
$
|
15,099,235
|
|
Property plant and equipment, net
|
|
$
|
23,844,950
|
|
|
$
|
26,775,210
|
|
|
$
|
2,122,784
|
|
|
$
|
52,742,944
|
|
Construction in progress
|
|
$
|
1,545,294
|
|
|
$
|
257,557
|
|
|
$
|
7,859
|
|
|
$
|
1,810,710
|
|
Intangibles, net
|
|
$
|
-
|
|
|
$
|
616,508
|
|
|
$
|
4,978,052
|
|
|
$
|
5,594,560
|
|
Goodwill
|
|
$
|
1,170,511
|
|
|
$
|
2,328,526
|
|
|
$
|
6,285,211
|
|
|
$
|
9,784,248
|
|
Land held for development
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
20,558,424
|
|
|
$
|
20,558,424
|
|
Total assets
|
|
$
|
55,710,082
|
|
|
$
|
68,433,012
|
|
|
$
|
39,146,429
|
|
|
$
|
163,289,523
|
|
|
|
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 and unvested stock grants as computed under the treasury stock method.
The following summarizes information related
to the computation of basic and diluted EPS for the three and nine months ended September 30, 2016 and 2015.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Net income (loss) attributable to Consolidated Water Co. Ltd. stockholders
|
|
$
|
(1,865,332
|
)
|
|
$
|
1,775,500
|
|
|
$
|
2,393,642
|
|
|
$
|
5,924,861
|
|
Less: preferred stock dividends
|
|
|
(2,680
|
)
|
|
|
(2,937
|
)
|
|
|
(8,921
|
)
|
|
|
(9,118
|
)
|
Net income (loss) available to common shares in the determination of basic earnings per common share
|
|
$
|
(1,868,012
|
)
|
|
$
|
1,772,563
|
|
|
$
|
2,384,721
|
|
|
$
|
5,915,743
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares in the determination of basic earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
|
14,815,248
|
|
|
|
14,749,249
|
|
|
|
14,803,216
|
|
|
|
14,734,799
|
|
Plus:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of preferred shares outstanding during the period
|
|
|
37,719
|
|
|
|
40,194
|
|
|
|
38,516
|
|
|
|
38,510
|
|
Potential dilutive effect of unexercised options and unvested stock grants
|
|
|
-
|
|
|
|
12,879
|
|
|
|
98,903
|
|
|
|
14,595
|
|
Weighted average number of shares used for determining diluted earnings per common share attributable to Consolidated Water Co. Ltd. common stockholders
|
|
|
14,852,967
|
|
|
|
14,802,322
|
|
|
|
14,940,635
|
|
|
|
14,787,904
|
|
7. Investment in OC-BVI
The Company owns 50% of the outstanding
voting common shares and a 43.53% equity interest in the net income and net losses 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 net income 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 primary 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 $3,942,869 and $4,548,271 as of September 30, 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 in March 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; (ii) interest income due as a result of late payment of accounts receivable balances; and (iii) the amount for
the Baughers Bay plant arising from a court ruling relating to the Baughers Bay litigation (see discussion that follows).
Summarized financial information of OC-BVI is presented as follows:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Current assets
|
|
$
|
5,228,414
|
|
|
$
|
4,323,792
|
|
Non-current assets
|
|
|
4,183,483
|
|
|
|
4,682,650
|
|
Total assets
|
|
$
|
9,411,897
|
|
|
$
|
9,006,442
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Current liabilities
|
|
$
|
359,572
|
|
|
$
|
584,116
|
|
Non-current liabilities
|
|
|
1,777,950
|
|
|
|
1,650,252
|
|
Total liabilities
|
|
$
|
2,137,522
|
|
|
$
|
2,234,368
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
965,169
|
|
|
$
|
1,022,510
|
|
|
$
|
2,850,242
|
|
|
$
|
3,118,763
|
|
Cost of revenues
|
|
|
540,522
|
|
|
|
552,213
|
|
|
|
1,537,860
|
|
|
|
1,692,640
|
|
Gross profit
|
|
|
424,647
|
|
|
|
470,297
|
|
|
|
1,312,382
|
|
|
|
1,426,123
|
|
General and administrative expenses
|
|
|
231,750
|
|
|
|
228,472
|
|
|
|
714,483
|
|
|
|
734,270
|
|
Income from operations
|
|
|
192,897
|
|
|
|
241,825
|
|
|
|
597,899
|
|
|
|
691,853
|
|
Other income (expense), net
|
|
|
62,165
|
|
|
|
(56,700
|
)
|
|
|
(15,598
|
)
|
|
|
(153,900
|
)
|
Net income
|
|
|
255,062
|
|
|
|
185,125
|
|
|
|
582,301
|
|
|
|
537,953
|
|
Income attributable to non-controlling interests
|
|
|
22,346
|
|
|
|
16,748
|
|
|
|
48,133
|
|
|
|
52,960
|
|
Net income attributable to controlling interests
|
|
$
|
232,716
|
|
|
$
|
168,377
|
|
|
$
|
534,168
|
|
|
$
|
484,993
|
|
The Company recognized earnings of $101,301
and $73,294 for the three months ended September 30, 2016 and 2015, respectively, and $232,523 and $211,117 for the nine months
ended September 30, 2016 and 2015, respectively, from its investment in OC-BVI. The Company recognized profit sharing income of
$38,475 and $28,350 for the three months ended September 30, 2016 and 2015, respectively, and $87,075 and $76,950 for the nine
months ended September 30, 2016 and 2015, respectively, from its profit sharing agreement with OC-BVI.
For the three months ended September 30,
2016 and 2015, the Company recognized revenues of $125,930 and $135,023, respectively, from its management services agreement with
OC-BVI. For the nine months ended September 30, 2016 and 2015, the Company recognized revenues of $390,280 and $399,335, respectively,
from its management services agreement with OC-BVI. Amounts payable by OC-BVI to the Company were $70,746 and $91,569 as of September
30, 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 $38,052 and $105,659 as of September
30, 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 engaged a
mutually approved valuation expert to complete a valuation of the Baughers Bay plant at the date it was transferred to the BVI
government in accordance with the Appellate Court ruling.
In June 2016, OC-BVI received the final
valuation report from the valuation expert, which sets forth a value for the Baughers Bay plant of $13.0 million as of the date
OC-BVI transferred possession of the plant to the BVI government. Applying the valuation determined by the valuation expert to
the formula set forth by the Appellate Court in its ruling, OC-BVI would be entitled to $11.58 million from the BVI government
for the Baughers Bay plant. The BVI government has indicated that it disagrees with the valuation methodology used by the valuation
expert and the resulting valuation for the Baughers Bay plant. We cannot presently determine if the Appellate Court will uphold
the Baughers Bay plant valuation or when, or to what extent, any amount for the value of the Baughers Bay plant will be paid by
the BVI government to OC-BVI. Consequently, any amount due for the Baughers Bay plant valuation will not be included in OC-BVI’s
results of operations until such amount, if any, is paid by the BVI government.
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 due, as required under the final ruling of the Appellate Court for the value of the Baughers Bay plant
at the date it was transferred by OC-BVI to the BVI government.
The Company estimates the cash flows OC-BVI
will receive from its Bar Bay plant by (i) identifying various possible future scenarios which include the execution of a new agreement
for the Bar Bay plant as well as the termination of Bar Bay plant operations upon the expiration of the existing Bar Bay agreement
in March 2017; (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 plant and the pending Appellate
Court ruling.
The identification of the possible scenarios
for the Bar Bay plant 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 September 30, 2016, 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 an impairment
loss of $875,000 for the three months ended September 30, 2016. Total impairment losses recorded by the Company on its investment
in OC-BVI during the nine months ended September 30, 2016 were $925,000. The Company recorded impairment losses on its investment
in OC-BVI of $225,000 and $810,000 for the three and nine months ended September 30, 2015, respectively.
The remaining carrying value of the Company’s
investment in OC-BVI of approximately $3.9 million as of September 30, 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 enter into a new
agreement to purchase water from the Bar Bay plant after the current Bar Bay agreement expires in March 2017; and (ii) OC-BVI will
receive the pending amount due (as estimated by the Company) as required under the Appellate Court ruling for the value of the
Baughers Bay plant previously transferred by OC-BVI to the BVI government.
The BVI government is OC-BVI’s primary
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 2017 expiration date and OC-BVI receives the pending 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, decreases. The Company
will be required to record additional impairment losses to reduce the carrying value of its investment in OC-BVI to its then current
fair value if OC-BVI does not obtain a new agreement for the Bar Bay plant that generates cash flows sufficient to support the
Company’s then carrying value of its investment in OC-BVI. If OC-BVI does not obtain a new agreement for the Bar Bay plant
that generates cash flows sufficient to support OC-BVI’s carrying values for its long-lived Bar Bay plant assets, OC-BVI
will be required to record an impairment loss to reduce the carrying value of its long-lived Bar Bay plant assets to their then
estimated fair value. The Company’s equity in the net earnings or loss of OC-BVI will include 43.53% of any such impairment
loss recorded by OC-BVI. Based upon the updating of its probability-weighted scenarios for the future cash flows to be derived
from its Bar Bay plant, OC-BVI may be required to record impairment losses to reduce the carrying value of its Bar Bay plants assets
before the expiration of the Bar Bay agreement in March 2017. As of September 30, 2016, the aggregate carrying value of OC-BVI’s
long-lived Bar Bay plant assets was approximately $4.0 million. Future impairment losses on the Company’s investment in OC-BVI
and the Company’s equity in any future losses incurred by OC-BVI could have a material adverse impact on the Company’s
results of operations.
In October 2016, OC-BVI submitted a proposal
to the BVI government for a new 14 year contract for the Bar Bay plant with a selling price for the water that is lower than the
current price and is awaiting the BVI government’s response to this proposal.
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 approximately $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 may be cancelled by NSC 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”). 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 was 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. NSC submitted its tender for the Project
on the April 21, 2016 tender submission deadline date set by the State.
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 was 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.
On June 15, 2016, the State designated
the consortium comprised of NSC, NuWater S.A.P.I. de C.V. and Degremont S.A. de C.V. (the “Consortium”) as the winner
of tender process for the Project.
On August 17, 2016, NSC and NuWater incorporated
Aguas de Rosarito S.A.P.I. de C.V. (“AdR”), a special project company, to execute the Project and executed a shareholders
agreement for AdR agreeing among other things that (i) AdR would purchase the land and other Project assets from NSC on the date
that the Project begins commercial operations; and (ii) AdR would enter into a Management and Technical Services Agreement with
NSC effective on the first day that the Project begins commercial operations.
On August 22, 2016, the Public Private
Partnership Agreement for public private partnership number 002/2015, contest number SIDUE-CEA-APP-2015-002 (“APP Contract”)
was executed between AdR, CEA, the Government of Baja California represented by the Secretary of Planning and Finance (“SPF”),
and the Public Utilities Commission of Tijuana (“CESPT”). The APP Contract requires AdR to design, construct, finance
and operate a seawater desalination plant (and accompanying aqueducts) with a capacity of up to 100 million gallons per day in
two phases: the first with a capacity of 50 million gallons per day and an aqueduct to the Mexican potable water system in Tijuana,
Baja California; and the second phase with a capacity of 50 million gallons per day and an aqueduct to a second delivery point
in Tijuana. The first phase must be operational within 36 months of commencing construction, and the second phase must be operational
by the end of 2024. The APP Contract further requires AdR to operate and maintain the plant and aqueducts for a period of 37 years
starting from the commencement of operation of the first phase. At the end of the operating period the plant and aqueducts will
be transferred to CEA.
The total Project cost is expected to be
approximately 9 billion Mexican pesos, or approximately US$485 million (based upon the current exchange rate). Annual revenues
from the Project are expected to be approximately 1.02 billion Mexican pesos, or approximately US$55.0 million (based upon the
currency exchange rate as of August 23, 2016). Water rates under the APP Contract are indexed to the Mexican national consumer
price index over its term. Electrical energy costs incurred by AdR to desalinate and deliver water are treated as a pass through
charge to CEA, subject to efficiency guarantees. AdR expects to raise Mexican peso denominated debt financing through a consortium
led by the North American Development Bank, which also provided financial advisory services to the Company and its partners through
the bidding process and contract negotiations.
The APP Contract does not become effective
until AdR secures the equity and debt financing required for the first phase of the Project and the following conditions are met:
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the State has established
and registered various payment trusts, guaranties and bank credit lines for specific use by the Project;
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the CEA has obtained the
rights from the relevant federal authority to take and desalinate seawater and distribute it for municipal use;
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various water purchase
and sale agreements between the CEA, the payment trusts and the CESPT have been executed;
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AdR has obtained all rights
of ways required for the aqueduct;
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AdR has obtained permission
from the relevant federal authority to discharge the residual water from the Project’s desalination plant; and
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all financing agreements
necessary to provide funding for the Project have been executed.
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If the Consortium is ultimately unable
to proceed with 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 the Consortium does not proceed with 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 approximately $20.6 million and any loss on sale of the land, or
impairment loss NSC 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.
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 $606,000
and $358,000 for the three months ended September 30, 2016 and 2015, respectively, and approximately $2,248,000 and $1,370,000
for the nine months ended September 30, 2016 and 2015, respectively. The assets and liabilities of NSC included in the Company’s
consolidated balance sheets amounted to approximately $21.7 million and $321,000, respectively, as of September 30, 2016 and approximately
$22.0 million and $488,000 respectively, as of December 31, 2015.
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 (“EWG”) 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, among
other things, 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.
EWG is also seeking an order directing,
among other things: (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, Mexico
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.
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.
On May 17, 2016, NSC filed a claim with
the Third District Court in Matters of Amparo and Federal Trials in the City of Tijuana, Baja California (the “Amparo Court”)
challenging the Tecate, Mexico Court ex-parte order which appointed an inspector over NSC’s commercial activities. On July
29, 2016, the Amparo Court found that such appointment is unconstitutional and reversed the Tecate, Mexico Court’s appointment
of an inspector.
On September 6, 2016, the Tecate, Mexico
Court issued a decree granting the counter guaranty requested by NSC. Such counter-guaranty was fixed in the amount of 300,000
Mexican pesos and was given to the Court on October 13, 2016 at which time all remaining ex-parte restrictions on NSC related to
the challenged transactions were suspended.
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 11, 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 in connection with this litigation of approximately $18,000 and $357,000 for the three and nine months
ended September 30, 2016.
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 United States dollars 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
the US dollar equivalent of Mexican pesos 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 and shortly thereafter obtained the release of the Mexican
pesos cash balance that had been restricted and pledged as collateral as of December 31, 2015 for the irrevocable letter of credit.
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 September 30, 2016
and 2015, the Company generated approximately 38%, and 39%, respectively, of its consolidated revenues and 52% and 57%, respectively,
of its consolidated gross profit from the retail water operations conducted pursuant to Cayman Water’s exclusive license.
For the nine months ended September 30, 2016 and 2015, the Company generated approximately 40% and 41%, respectively, of its consolidated
revenues and 55% and 58%, respectively, of its consolidated gross profit from the retail water operations conducted pursuant to
Cayman Water’s exclusive license.
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 expired on June 30, 2016. The
Company continues to provide water subsequent to June 30, 2016 under a further extension of the license that the Company believes
will be forthcoming.
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.”
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, and not the Cayman
Islands government, is the principal negotiator 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 the Company’s 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 intended 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 the following conditions:
(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.
In October 2016, the Government of the
Cayman Islands passed legislation which created a new utilities regulation and competition office (“URCO”). This legislation
will become law when it is assented to by the Governor of the Cayman Islands and published in the official Cayman Islands Gazette.
URCO is an independent and accountable regulatory body with a view of protecting the rights of consumers, encouraging affordable
utility services, and promoting competition. URCO has the ability to supervise, monitor and regulate multiple utility undertakings
and markets. Water utilities are not presently included in the scope of URCO’s regulatory functions and remain under the
regulatory control of the WAC. The Company has been advised by government officials that it is government’s intention to
include water utilities under the ambit of URCO through additional legislation in 2017. The Company has been further advised that
if and when this additional legislation is enacted, the WAC will no longer regulate water utilities since this function will be
taken over by URCO. The Company is presently unable to determine (i) when such additional legislation will be enacted and consequently
if or when URCO will become its new regulator in the Cayman Islands; or (ii) the impact of URCO on its retail license negotiations.
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 loss to reduce the carrying value of its goodwill. Such impairment
loss 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 these matters will have on its financial condition, results of operations or cash flows.
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. 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 ($2.1 million) and ($80,000)
for the three months ended September 30, 2016, and 2015, respectively. CW-Bali’s operating losses were approximately ($2.4
million) and ($383,000) for the nine months ended September 30, 2016, and 2015, respectively. CW-Bali’s operating losses
for the three and nine months ended September 30, 2016 include an impairment loss (as discussed later in this note) of $2.0 million
to reduce the carrying value of its long-lived assets to their estimated fair value.
In 2015, the Indonesian government passed
Regulation 122 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. Since commencing operations, CW-Bali has held discussions with PDAM and other governmental
entities for possible water sale arrangements, and CW-Bali is presently pursuing a formal cooperation agreement with PDAM for the
sale of water to the resorts in its target market that are not presently served by PDAM.
As an Indonesian company that is majority-owned
by foreigners, CW-Bali is required to obtain and maintain an “in-principle” (i.e. – short term, temporary) license
to operate until such time as it is able to demonstrate that it has invested sufficient capital and made sufficient progress under
its business plan to receive a non-temporary business license. The term of CW-Bali’s initial in-principle license ended in
October 2016. CW-Bali is applying for a new in-principle license. However, the Indonesian government could decide not to grant
CW-Bali a new in-principle license, in which case the Company would be required to cease CW-Bali’s operations and dispose
of its investment in this subsidiary.
In late 2015, the Company decided to seek
a strategic partner for CW-Bali to (i) purchase a major portion of its equity ownership in CW-Bali; (ii) lead CW-Bali’s sales
and marketing efforts; (iii) liaise with PDAM; and (iv) assist with CW-Bali’s on-going funding requirements.
During the three months ended September
30, 2016, the Company reassessed the prospects for CW-Bali in light of its results to date, current circumstances and uncertainties
impacting the business, and expected future funding requirements and tested its long-lived assets for possible impairment. To test
for impairment, the Company estimated the future undiscounted cash flows CW-Bali will receive from its plant by (i) identifying
various possible future scenarios for the business; (ii) estimating the undiscounted future cash flows associated with each possible
scenario; and (iii) assigning a probability to each scenario. The resulting probability-weighted sum represents the Company’s
best estimate of the future undiscounted cash flows to be derived by CW-Bali from its long-lived desalination plant assets. The
carrying value of CW-Bali’s long-lived assets exceeded the Company’s probability-weighted estimate of CW-Bali’s
future undiscounted cash flows which indicated impairment of these assets, and the Company recorded an impairment loss of $2.0
million during the three months ended September 30, 2016 to reduce the carrying value of its long-lived CW-Bali assets to their
estimated fair value.
If CW-Bali is not able to obtain a strategic
partner, sell water to PDAM or to other new customers through a cooperation agreement, or otherwise significantly increase the
revenues generated by its Nusa Dua plant in the future, the Company may cease CW-Bali’s operations. The Company will also
be required to cease CW-Bali’s operations if CW-Bali does not obtain a new in-principle license. If the Company ceases CW-Bali’s
operations, it may be required to record further impairment losses to reduce the carrying value of its investment in CW-Bali to
its fair value for the period in which the Company formally commits to exit the Bali market. Such impairment losses could have
a material adverse impact on the Company’s results of operations. Any sale of a portion of the Company’s investment
in CW-Bali may be for an amount less than its carrying amount, resulting in a loss on the sale that could have a material adverse
impact on the Company’s results of operations. The carrying value of the Company’s investment in CW-Bali as of September
30, 2016 totaled $2.1 million, consisting of net assets of approximately $1.51 million and a cumulative foreign currency translation
adjustment reflected in stockholders’ equity of $549,555.
The Company anticipated at the time CW-Bali
commenced operations that CW-Bali’s revenues, expenditures, and other cash flows would be conducted primarily in the local
currency, the Indonesian rupiah (IDR). The Company expected that financial support it and its other subsidiaries provided to CW-Bali
would not extend beyond CW-Bali’s start-up phase, and that thereafter CW-Bali would generate positive net cash flows from
its operations and thus remain relatively self-contained and integrated within the economic environment of Bali, Indonesia. As
a result, since inception of its operations through September 30, 2016, the functional currency of CW-Bali was the IDR.
However, since its inception CW-Bali has
been dependent upon on-going financial support from the Company in U.S dollars (US$) to continue its operations. The Company expects
such funding to continue until such time, if ever, that CW-Bali generates sufficient revenues to support its operations, or is
able to obtain a strategic partner to assist with its on-going funding requirements, or ceases operations. Consequently, effective
as of October 1, 2016, the Company changed the functional currency of CW-Bali to US$.
During the periods for which IDR was CW-Bali’s
functional currency, the Company recorded foreign currency gains and losses arising from CW-Bali’s transactions conducted
in currencies other than the IDR. Such foreign currency gains and losses included amounts associated with (i) transactions denominated
in currencies other than the IDR and (ii) the re-measurement of monetary assets and liabilities denominated in currencies other
than the IDR as of the balance sheet date. CW-Bali’s monetary assets and liabilities denominated in currencies other than
the IDR consist of US$-denominated bank accounts and US$-denominated loans provided to CW-Bali by the Company. Such foreign currency
transaction gains (losses) were included in income and amounted to approximately $28,000 and ($309,000) for the three months ended
September 30, 2016 and 2015, respectively and approximately $202,000 and ($542,000) for the nine months ended September 30, 2016
and 2015, respectively. After the re-measurement process of monetary assets and liabilities was completed, the assets and liabilities
of CW-Bali were translated into US$ using exchange rates in effect at the end of each period. Revenues and expenses for CW-Bali
were translated using rates that approximated those in effect during the period. The effect of these foreign currency translations
was recognized in the cumulative translation adjustment included in the Company’s stockholders’ equity, which amounted
to ($549,555) and ($533,565) as of September 30, 2016 and December 31, 2015, respectively.
This change in functional currency will
be applied on a prospective basis, and therefore, the cumulative translation adjustment of ($549,555) as of September 30, 2016
will remain unchanged until such time that the CW-Bali is no longer dependent on US$ funding to support its operations, the Company
sells all or a portion of its equity interest in CW-Bali, or the Company discontinues CW-Bali’s operations. Translated amounts
for non-monetary assets as of September 30, 2016 will become the new accounting basis for those assets effective October 1, 2016.
Monetary assets denominated in foreign currencies, including the IDR, will be re-measured to US$ at the current exchange rate as
of the balance sheet date going forward. The Company anticipates that the likely effect of this change in functional currency will
result in future foreign currency gains and losses that pertain to (i) transactions denominated in IDR and (ii) foreign currency
re-measurements associated with monetary assets and liabilities denominated in IDR. As of September 30, 2016, such balances include
IDR-denominated cash, accounts receivable, and accounts payable, which amounted to approximately $20,000, $37,000, and $35,000,
respectively, based upon the exchange rate between the IDR and US$ as of that date. Based on this change in functional currency,
the US$-denominated loans to CW-Bali from its parent and affiliates will not be subject to further re-measurement adjustments.
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 financial condition, results of operations 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 and 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 September 30, 2016 and 2015, respectively, and $4.0 million and $4.5 million during the
nine months ended September 30, 2016 and 2015, respectively.
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.
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.
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.
In May 2016, the FASB issued ASU 2016-11,
Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards
Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting
. ASU 2016-11 rescinds several
SEC Staff Announcements that are codified in Topic 605, including, among other items, guidance relating to accounting for shipping
and handling fees and freight services.
In May 2016, the FASB issued ASU 2016-12,
Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,
which clarifies implementation
guidance around collectability, sales taxes collected from customers, noncash considerations, contract modifications at transition,
and completed contracts at transition.
The effective dates of ASU 2016-08, ASU
2016-10, ASU 2016-11 and ASU 2016-12 are the same as ASU 2015-14 discussed above. The Company is currently evaluating the effect
the adoption of these standards will have on the 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.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments
, which clarifies how certain
cash receipts and payments are presented in the statement of cash flows. ASU 2016-15 is effective for annual periods beginning
after December 15, 2017 and 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.
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.
ITEM 2
.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited
to, statements regarding our future revenues, future plans, objectives, expectations and events, assumptions and estimates. Forward-looking
statements can be identified by use of the words or phrases “will,” “will likely result,” “are expected
to,” “will continue,” “estimate,” “project,” “potential,” “believe,”
“plan,” “anticipate,” “expect,” “intend,” or similar expressions and variations
of such words. Statements that are not historical facts are based on our current expectations, beliefs, assumptions, estimates,
forecasts and projections for our business and the industry and markets related to our business.
The forward-looking statements contained
in this report are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult
to predict. Actual outcomes and results may differ materially from what is expressed in such forward-looking statements. Important
factors which may affect these actual outcomes and results include, without limitation:
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tourism and weather conditions in the areas we serve;
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the economies of the U.S. and other countries in which
we conduct business;
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our relationships with the governments we serve;
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regulatory matters, including resolution of the negotiations
for the renewal of our retail license on Grand Cayman;
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our ability to successfully enter new markets, including
Mexico and Asia; and
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other factors, including those “Risk Factors”
set forth under Part II, Item 1A in this Quarterly Report and in our 2015 Annual Report on Form 10-K.
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The forward-looking statements in this
Quarterly Report speak as of its date. We expressly disclaim any obligation or undertaking to update or revise any forward-looking
statement contained in this Quarterly Report to reflect any change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any forward-looking statement is based, except as may be required by law.
References herein to “we,”
“our,” “ours” and “us” refer to Consolidated Water Co. Ltd. and its subsidiaries.
Critical Accounting Estimates
The preparation of consolidated financial
statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Our actual results could differ significantly from such estimates and assumptions.
Certain of our accounting estimates or
assumptions constitute “critical accounting estimates” for us because:
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the nature of these estimates or assumptions is material
due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such
matters to change; and
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the impact of the estimates and assumptions on financial
condition and results of operations is material.
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Our critical accounting estimates relate
to the valuation of our (i) equity investment in our affiliate, OC-BVI; (ii) goodwill and intangible assets; and (iii) long-lived
assets.
Valuation of Investment in OC-BVI
We account for our 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 our investment in OC-BVI, we estimate 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 us to estimate OC-BVI’s cash flows from (i) its water supply agreement with
the BVI government for its Bar Bay plant (the “Bar Bay agreement”); and (ii) the pending amount 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 (see
further discussion of the Baughers Bay litigation at Item 1. - Notes to the Condensed Consolidated Financial Statements - Note
7).
We estimate the cash flows OC-BVI will
receive from its Bar Bay plant by (i) identifying various possible future scenarios which include the execution of a new agreement
for the Bar Bay plant as well as the termination of Bar Bay plant operations upon the expiration of the existing Bar Bay agreement
in March 2017; (ii) estimating the cash flows associated with each possible scenario; and (iii) assigning a probability to each
scenario. We similarly estimate the cash flows OC-BVI will receive from the BVI government for the amount due under the ruling
by the Eastern Caribbean Court of Appeals 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 our best estimate of future cash flows, to be derived by OC-BVI from its Bar Bay plant and the pending court award.
The identification of the possible scenarios
for the Bar Bay plant 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 us. While we use our 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 our management over time based
upon new information or changes in circumstances.
As of September 30, 2016, after updating
our probability-weighted estimates of OC-BVI’s future cash flows and our resulting estimate of the fair value of our investment
in OC-BVI, we determined that the carrying value of our investment in OC-BVI exceeded its fair value and recorded an impairment
loss of $875,000 for the three months ended September 30, 2016. We recorded total investment losses on our investment in OC-BVI
of $925,000 for the nine months ended September 30, 2016. We recorded impairment losses of $225,000 and $810,000 for the three
and nine months ended September 30, 2015, respectively.
The remaining carrying value of our investment
in OC-BVI of approximately $3.9 million as of September 30, 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 enter into a new agreement
to purchase water from the Bar Bay plant after the current Bar Bay agreement expires in March 2017; and (ii) OC-BVI will receive
the pending amount (based upon our estimate) awarded by the Eastern Caribbean Court of Appeals for the value of the Baughers Bay
plant transferred by OC-BVI to the BVI government.
The BVI government is OC-BVI’s primary
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,
decreases. We will be required to record additional impairment losses to reduce the carrying value of our investment in OC-BVI
to its then current fair value if OC-BVI does not obtain a new agreement for the Bar Bay plant that generates cash flows sufficient
to support the Company’s then carrying value of its investment in OC-BVI. If OC-BVI does not obtain a new agreement for the
Bar Bay plant that generates cash flows sufficient to support OC-BVI’s carrying values for its long-lived Bar Bay plant assets
OC-BVI will be required to record an impairment loss to reduce the carrying value of its long-lived Bar Bay plant assets to their
then estimated fair value. Our equity in the net earnings or loss of OC-BVI will include 43.53% of any such impairment loss recorded
by OC-BVI. Based upon the updating of its probability-weighted scenarios for the future cash flows to be derived from its Bar Bay
plant, OC-BVI may be required to record impairment losses to reduce the carrying value of its Bar Bay plant assets before the expiration
of the Bar Bay agreement in March 2017. As of September 30, 2016, the aggregate carrying value of OC-BVI’s long-lived Bar
Bay plant assets was approximately $4.0 million. Future impairment losses for our investment in OC-BVI and our equity in any future
losses incurred by OC-BVI could have a material adverse impact on our results of operations.
In October 2016, OC-BVI submitted a proposal
to the BVI government for a new 14 year contract for the Bar Bay plant with a selling price for the water that is lower than the
current price and is awaiting the BVI government’s response to this proposal.
Goodwill and intangible assets
Goodwill represents the excess cost over
the fair value of the assets of an acquired business. Goodwill and intangible assets acquired in a business combination accounted
for as a purchase and determined to have an indefinite useful life are not amortized, but are tested for impairment at least annually.
Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual
values and reviewed periodically for impairment. We evaluate the possible impairment of goodwill annually as part of our reporting
process for the fourth quarter of each fiscal year. Management identifies our reporting units and determines the carrying value
of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those
reporting units. We determine the fair value of each reporting unit and compare the fair value to the carrying amount of the reporting
unit. To the extent the carrying amount of the reporting unit exceeds the fair value of the reporting unit, we are required to
perform the second step of the impairment test, as this is an indication that the reporting unit goodwill may be impaired. In this
step, we compare the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill.
The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to all the assets (recognized
and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation. The residual fair value
after this allocation is the implied fair value of the reporting unit goodwill. If the implied fair value is less than its carrying
amount, the impairment loss is recorded.
For the years ended December 31, 2015 and
2014, we estimated the fair value of our reporting units by applying the discounted cash flow method, the subject company stock
price method, the guideline public company method, and the mergers and acquisitions method.
The discounted cash flow method relied
upon seven-year discrete projections of operating results, working capital and capital expenditures, along with a terminal value
subsequent to the discrete period. These seven-year projections were based upon historical and anticipated future results, general
economic and market conditions, and considered the impact of planned business and operational strategies. The discount rates for
the calculations represented the estimated cost of capital for market participants at the time of each analysis. In preparing these
seven-year projections for our retail unit we (i) identified possible outcomes of our on-going negotiations with the Cayman Islands
government for the renewal of our retail license; (ii) estimated the cash flows associated with each possible outcome; and (iii)
assigned a probability to each outcome and associated estimated cash flows. The weighted average estimated cash flows were then
summed to determine the overall fair value of the retail unit under this method. The possible outcomes used for the discounted
cash flow method for the retail unit included the implementation of a rate of return on invested capital model, the methodology
proposed by Cayman Islands government representatives for the new retail license.
We also estimated the fair value of each
of our reporting units for the years ended December 31, 2015 and 2014 through reference to the quoted market prices for our Company
and guideline companies and the market multiples implied by guideline merger and acquisition transactions.
We weighted the fair values estimated for
each of our reporting units under each method and summed such weighted fair values to estimate the overall fair value for each
reporting unit. The respective weightings we applied to each method as of December 31, 2015 were consistent with those used as
of December 31, 2014 and were as follows:
Method
|
|
Retail
|
|
|
Bulk
|
|
Discounted cash flow
|
|
|
50
|
%
|
|
|
50
|
%
|
Subject company stock price
|
|
|
30
|
%
|
|
|
30
|
%
|
Guideline public company
|
|
|
10
|
%
|
|
|
10
|
%
|
Mergers and acquisitions
|
|
|
10
|
%
|
|
|
10
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
The fair values we estimated for our retail
and bulk units exceeded their carrying amounts by 72% and 20%, respectively, as of December 31, 2015. The fair values we estimated
for our retail and bulk units exceeded their carrying amounts by 36% and 29%, respectively, as of December 31, 2014.
We also performed an analysis reconciling
the conclusions of value for our reporting units to our market capitalization at October 1, 2015. This reconciliation resulted
in an implied control premium for our Company of 5%.
On February 11, 2016, we acquired 51% ownership
interest in Aerex. In connection with this acquisition we recorded goodwill of $8,035,211. Aerex’s actual results of operations
for the period subsequent to our acquisition of the company on February 11, 2016 fell significantly short of the projected results
for this period that were included in the overall cash flow projections we utilized to determine the purchase price for Aerex and
the fair values of its assets and liabilities. Based upon currently available information, we believe Aerex’s results of
operations for the remainder of 2016, as well as for fiscal 2017, will also fall short of our purchase price cash flow projections
for Aerex. As a result of these actual and projected shortfalls in Aerex’s results of operations, we tested Aerex’s
goodwill for possible impairment as of September 30, 2016 by estimating its fair value using the discounted cash flow method. As
a result of this impairment testing, we determined that the carrying value of our Aerex goodwill exceeded its fair value, and recorded
an impairment loss for the three months ended September 30, 2016 of $1,750,000 to reduce the carrying value of this goodwill.
Long-lived assets
We review the carrying amounts of our long-lived
assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be
recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the observable market
value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that
would indicate that the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and
used, we recognize an impairment loss only if its carrying amount is not recoverable through its undiscounted cash flows and measure
the impairment loss based on the difference between the carrying amount and fair value.
Through our subsidiary, CW-Bali, we have
built and presently operate 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. Since its inception, we have recorded operating losses
for CW-Bali as the sales volumes for its plant have not been sufficient to cover its operating costs.
During the three months ended September
30, 2016, we determined, based upon probability-weighted scenarios for CW-Bali’s future undiscounted cash flows, that the
carrying value of CW-Bali’s long-lived assets were not recoverable and recorded an impairment loss of $2.0 million to reduce
the carrying value of these assets to their fair value. See further discussion of this subsidiary at Item 2. - “Material
Commitments, Expenditures and Contingencies - CW-Bali.”
RESULTS OF OPERATIONS
The following discussion and analysis of
our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial
statements and accompanying notes included under Part I, Item 1 of this Quarterly Report and our consolidated financial statements
and accompanying notes included in our Annual Report on Form 10-K for our fiscal year ended December 31, 2015 (“2015 Form
10-K”) and the information set forth under Item 7 “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” of our 2015 Form 10-K.
Three Months Ended September 30, 2016
Compared to Three Months Ended September 30, 2015
Consolidated Results
The net loss attributable to Consolidated
Water Co. Ltd. stockholders for 2016 was ($1,865,332) or ($0.13) per share on a fully-diluted basis, as compared to net income
of $1,775,500, or $0.12 per share on a fully-diluted basis, for 2015.
Total revenues for 2016 decreased to $14,385,353
from $14,605,649 in 2015 due to lower revenues for our retail and bulk services segments that were not offset by an increase in
service segment revenues. Gross profit for 2016 was $5,919,323 or 41% of total revenues, as compared to $5,641,743 or 39% of total
revenues, for 2015. Gross profit increased in 2016 from 2015 for our bulk and services segments but decreased for our retail segment.
For further discussion of revenues and gross profit for 2016, see the “Results by Segment” analysis that follows.
General and administrative (“G&A”)
expenses on a consolidated basis were $4,528,679 and $3,487,967 for 2016 and 2015, respectively. The increase in consolidated G&A
expenses from 2015 to 2016 is primarily attributable to the addition of approximately $649,000 in expenses for Aerex Industries,
Inc. (“Aerex”) as a result of our acquisition of a 51% ownership interest in this company on February 11, 2016, and
an increase of approximately $249,000 in the project development expenses incurred by our Mexican subsidiary, NSC.
We recorded an impairment loss of $2 million
in 2016 to reduce the carrying value of CW-Bali’s long-lived assets to their estimated fair value. See further discussion
of this impairment loss at Item 2. - “Material Commitments, Expenditures and Contingencies - CW-Bali.”
We recorded an impairment loss of $1,750,000
in 2016 to reduce the carrying value of the goodwill associated with the Aerex acquisition. See further discussion of this impairment
loss at the discussion of the results of the services segment that follows.
Other income (expense), net was ($762,696)
for 2016 as compared to ($302,603) for 2015. The fluctuation in this net component of our results of operations reflects (i) an
impairment loss recorded for our equity investment in OC-BVI in 2016 of ($875,000) as compared to an impairment loss of ($225,000)
for this investment in 2015; (ii) an unrealized loss of ($275,000) recorded in 2016 resulting from the revaluation of the net put/call
option value recorded in connection with the Aerex acquisition; and (iii) foreign currency gains relating to CW-Bali of approximately
$28,000 in 2016, as compared to foreign currency losses relating to CW-Bali of approximately ($309,000) in 2015.
Results by Segment
Retail Segment:
The retail segment generated a loss from
operations of ($1,828,903) in 2016 as compared to income from operations of $459,357 in 2015. The loss from operations for 2016
is attributable to a $2.0 million impairment loss recorded on the long-lived assets of CW-Bali.
Revenues generated by our retail water
operations were $5,447,200 in 2016 as compared to $5,828,288 in 2015. The decrease in retail revenues in 2016 is attributable to
(i) lower energy costs, which reduced the energy component of the rates we charge to our Cayman Water customers by $276,663 from
2015; (ii) a reduction in Cayman Water base rates in the first quarter of 2016 of 4.4% from 2015; and (iii) a decrease in the sales
for CW-Bali of approximately $95,000. The volume of water sold by our Cayman Water retail operations increased by 2% from 2015
to 2016.
Retail segment gross profit was $2,982,359
(55% of retail revenues) and $3,187,830 (55% of retail revenues) for 2016 and 2015, respectively.
Consistent with prior periods, we record
all non-direct G&A expenses in our retail segment and do not allocate any of these non-direct expenses to our other two business
segments. Retail G&A expenses for 2016 and 2015 remained relatively consistent at $2,811,262 and $2,728,473 for 2016 and 2015,
respectively.
CW-Bali owns and 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 revenues we generated from this plant amounted to $24,349 and $119,661 for 2016 and 2015, respectively.
CW-Bali’s operating loss was approximately ($2,134,000) for 2016 as we recorded an impairment loss of ($2.0 million) during
the period to reduce the carrying value of CW-Bali’s long-lived assets to their estimated fair value. CW-Bali’s operating
loss was approximately ($80,000) for 2015. See further discussion of this subsidiary at Item 2. - “Material Commitments,
Expenditures and Contingencies-CW-Bali.”
Bulk Segment:
The bulk segment contributed $2,082,570
and $1,900,678 to our income from operations for 2016 and 2015, respectively.
Bulk segment revenues were $7,429,732 and
$7,919,920 for 2016 and 2015, respectively. The decrease in bulk revenues from 2015 to 2016 is attributable to our Bahamas and
Cayman operations, which generated approximately $246,000 and $296,000 less in revenues, respectively, in 2016 than in 2015 due
to a significant decrease in the prices of diesel fuel and electricity from 2015 to 2016, which reduced the energy component of
our bulk water rates.
Gross profit for our bulk segment was $2,507,570
and $2,258,673 for 2016 and 2015, respectively. Gross profit as a percentage of bulk revenues was approximately 34% and 29% for
2016 and 2015, respectively. Gross profit as a percentage of revenues increased in 2016 as compared to 2015 due to (i) the reduced
energy prices, as energy expense for our bulk operations was approximately $486,000 less in 2016 than in 2015; and (ii) plant maintenance
expenses that were lower in 2016 than in 2015.
Bulk segment G&A expenses remained
relatively consistent at $425,000 and $357,995 for 2016 and 2015, respectively.
Services Segment:
The comparability of the services segment’s
results from 2015 to 2016 is significantly impacted by the inclusion of Aerex’s results of operations subsequent to our acquisition
of a 51% ownership interest in this company in February 2016.
The services segment incurred losses from
operations of ($2,613,023) and ($206,259) for 2016 and 2015, respectively.
Services segment revenues were $1,508,421
and $857,441 for 2016 and 2015, respectively. Services revenues increased in 2016 due to the addition of $1,382,492 of revenues
generated by Aerex in 2016. Revenues generated by the services segment in 2015 consisted primarily of approximately $722,000 recognized
on the refurbishment of the WAC’s North Sound plant.
Gross profit for our services segment was
$429,394 and $195,240 for 2016 and 2015, respectively. The increase in the service segment’s gross profit from 2015 to 2016
reflects the incremental gross profit generated by Aerex.
G&A expenses for the services segment
were $1,292,417 and $401,499 for 2016 and 2015, respectively. The increase in G&A expenses for 2016 as compared to 2015 reflects
the incremental G&A expenses of Aerex and an increase of approximately $249,000 in the project development expenses incurred
by our Mexican subsidiary, NSC. Total G&A expenses for Aerex for 2016 were approximately $649,000, and include $360,000 in
amortization expense for the intangible assets arising from our acquisition of Aerex.
Aerex’s actual results of operations
for the period subsequent to our acquisition of the company on February 11, 2016 fell significantly short of the projected results
for this period that were included in the overall cash flow projections we utilized to determine the purchase price for Aerex and
the fair values of its assets and liabilities. Based upon currently available information, we believe Aerex’s results of
operations for the remainder of 2016, as well as for fiscal 2017, will also fall short of our purchase price cash flow projections
for Aerex. As a result of these actual and projected shortfalls in Aerex’s results of operations, we tested Aerex’s
goodwill for possible impairment as of September 30, 2016. As a result of this impairment testing, we determined that the carrying
value of our Aerex goodwill exceeded its fair value, and recorded an impairment loss for the three months ended September 30, 2016
of $1,750,000 to reduce the carrying value of this goodwill.
Nine Months Ended September 30, 2016
Compared to Nine Months Ended September 30, 2015
Consolidated Results
Net income attributable to Consolidated Water Co. Ltd. stockholders for 2016 was $2,393,642 ($0.16 per
share on a fully-diluted basis), as compared to $5,924,861 ($0.40 per share on a fully-diluted basis) for 2015.
Total revenues for 2016 and 2015 were $43,818,760
and $43,757,430, respectively. Higher revenues for our services segment in 2016 served to offset decreases in retail and bulk segment
revenues. Gross profit for 2016 was $18,688,733 or 43% of total revenues, as compared to $17,755,339 or 41% of total revenues,
for 2015. Gross profit for the service and bulk segments increased from 2015 to 2016 while the retail segment gross profit declined.
For further discussion of revenues and gross profit for 2016, see the “Results by Segment” analysis that follows.
G&A expenses on a consolidated basis
were $13,925,439 and $11,042,507 for 2016 and 2015, respectively. The increase in consolidated G&A expenses from 2015 to 2016
is primarily attributable to the addition of approximately $1,671,000 in expenses for Aerex after our acquisition of a 51% ownership
interest in this company in February 2016 and an increase of approximately $879,000 in the project development expenses incurred
by our Mexican subsidiary, NSC.
We recorded an impairment loss of $2 million in 2016 to reduce
the carrying value of CW-Bali’s long-lived assets to their estimated fair value. See further discussion of this impairment
loss at Item 2. - “Material Commitments, Expenditures and Contingencies - CW-Bali.”
We recorded an impairment loss of $1,750,000
in 2016 to reduce the carrying value of the goodwill associated with the Aerex acquisition. See further discussion of this impairment
loss at the discussion of the results of the services segment that follows.
Other income (expense), net for 2016 was
$45,698 as compared to ($493,965) for 2015. The fluctuation in this net component of our results of operations reflects (i) an
impairment loss recorded for our equity investment in OC-BVI in 2016 of ($925,000) as compared to an impairment loss of ($810,000)
for this investment in 2015; (ii) an unrealized loss of ($275,000) recorded in 2016 resulting from the revaluation of the net put/call
option value recorded in connection with the Aerex acquisition; and (iii) foreign currency gains relating to CW-Bali of approximately
$202,000 in 2016, as compared to foreign currency losses relating to CW-Bali of approximately ($542,000) in 2015.
Results by Segment
Retail Segment:
The retail segment generated a loss from
operations of ($658,089) in 2016 as compared to income from operations of $1,690,327 in 2015. The loss from operations for 2016
is attributable to a $2.0 million impairment loss recorded during the three months ended September 30, 2016 on the long-lived assets
of CW-Bali.
Revenues generated by our retail water
operations were $17,710,271 in 2016 as compared to $18,116,111 in 2015. The decrease in retail revenues in 2016 is attributable
to (i) lower energy costs, which reduced the energy component of the rates we charge to our Cayman Water customers by $685,992
from 2015; (ii) a reduction in Cayman Water base rates in the first quarter of 2016 of 4.4% from 2015; and (iii) a decrease in
the sales for CW-Bali of approximately $216,000. The volume of water sold by our Cayman Water retail operations increased by 8%
from 2015 to 2016.
Retail segment gross profit was $9,930,440
(56% of retail revenues) and $10,051,092 (55% of retail revenues) for 2016 and 2015, respectively.
Consistent with prior periods, we record
all non-direct G&A expenses in our retail segment and do not allocate any of these non-direct expenses to our other two business
segments. Retail G&A expenses for the nine months ended September 30, 2016 and 2015 were $8,588,529 and $8,360,765, respectively.
G&A expenses increased from 2015 to 2016 primarily due to an increase of $166,000 in employee costs due to base salary increases.
CW-Bali owns and 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 revenues we generated from this plant amounted to $70,760 and $286,802 for 2016 and 2015, respectively.
CW-Bali’s operating loss was approximately ($2,438,000) for 2016 as we recorded an impairment loss of $2.0 million during
the three months ended September 30, 2016 to reduce the carrying value of CW-Bali’s long-lived assets to their estimated
fair value. CW-Bali’s operating loss was approximately ($383,000) for 2015. See further discussion of this subsidiary at
Item 2. - “Material Commitments, Expenditures and Contingencies - CW-Bali.”
Bulk Segment:
The bulk segment contributed $6,487,455
and $6,524,449 to our income from operations for 2016 and 2015, respectively.
Bulk segment revenues were $22,136,086
and $24,489,509 for 2016 and 2015, respectively. The decrease in bulk revenues from 2015 to 2016 is attributable to our Bahamas
and Cayman operations, which generated approximately $1,749,000 and $730,000 less in revenues, respectively, in 2016 than in 2015
due to a significant decrease in the prices of diesel fuel and electricity from 2015 to 2016, which reduced the energy component
of our bulk water rates.
Gross profit for our bulk segment was $7,790,339
and $7,712,273 for 2016 and 2015, respectively. Gross profit as a percentage of bulk revenues was approximately 35% and 31% for
2016 and 2015, respectively. Gross profit as a percentage of revenues increased in 2016 as compared to 2015 due to the reduced
energy prices, as energy expense for our bulk operations was approximately $2,188,000 less in 2016 than in 2015.
Bulk segment G&A expenses remained
relatively consistent at $1,302,884 and $1,187,824 for 2016 and 2015, respectively.
Services Segment:
The comparability of the services segment’s
results from 2015 to 2016 is significantly impacted by the inclusion of Aerex’s results of operations subsequent to our acquisition
of a 51% ownership interest in this company in February 2016.
The services segment incurred losses from
operations of ($4,816,072) and ($1,501,944) for 2016 and 2015, respectively.
Services segment revenues were $3,972,403
and $1,151,810 for 2016 and 2015, respectively. Services revenues increased in 2016 due to the addition of approximately $3.3 million
of revenues generated by Aerex in 2016. Revenues generated by the services segment in 2015 consisted primarily of approximately
$752,000 recognized on the refurbishment of the WAC’s North Sound plant.
Gross profit for our services segment was
$967,954 and ($8,026) for 2016 and 2015, respectively. The increase in the service segment’s gross profit from 2015 to 2016
reflects the incremental gross profit generated by Aerex.
G&A expenses for the services segment
were $4,034,026 and $1,493,918 for 2016 and 2015, respectively. The increase in G&A expenses for 2016 as compared to 2015 reflects
the incremental G&A expenses of Aerex and an increase of approximately $879,000 in the project development expenses incurred
by our Mexican subsidiary, NSC. Total G&A expenses for Aerex for 2016 were approximately $1,671,000, and include $960,000 in
amortization expense for the intangible assets arising from our acquisition of Aerex.
Aerex’s actual results of operations
for the period subsequent to our acquisition of the company on February 11, 2016 fell significantly short of the projected results
for this period that were included in the overall cash flow projections we utilized to determine the purchase price for Aerex and
the fair values of its assets and liabilities. Based upon currently available information, we believe Aerex’s results of
operations for the remainder of 2016, as well as for fiscal 2017, will also fall short of our purchase price cash flow projections
for Aerex. As a result of these actual and projected shortfalls in Aerex’s results of operations, we tested Aerex’s
goodwill for possible impairment as of September 30, 2016. As a result of this impairment testing, we determined that the carrying
value of our Aerex goodwill exceeded its fair value, and recorded an impairment loss for the three months ended September 30, 2016
of $1,750,000 to reduce the carrying value of this goodwill.
FINANCIAL CONDITION
The increases in the amounts reported in
our consolidated balance sheets for intangible assets, goodwill, deferred tax liability and non-controlling interests from December
31, 2015 to September 30, 2016 result from the acquisition of Aerex in February 2016.
Accounts receivable increased by approximately
$5.6 million from December 31, 2015 to September 30, 2016 primarily due an increase in the accounts receivables for CW-Bahamas
of approximately $5.7 million. We believe, based upon prior payment history, that CW-Bahamas’ accounts receivable balances
will be collected in full.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Position
Our projected liquidity requirements for
the remainder of 2016 include capital expenditures for our existing operations of approximately $1.3 million. Our liquidity requirements
for the rest of 2016 may also include quarterly dividends, if such dividends are declared by our Board. Our dividend payments amounted
to approximately $4.4 million for the year ended December 31, 2015 and approximately $3.3 million for the nine months ended September
30, 2016.
In May 2014, we obtained financing (the
proceeds of which were used to fund NSC’s land purchases in May 2014) in the form of a demand loan payable with an initial
principal balance of $10 million. The outstanding balance on this demand loan payable was approximately $7.0 million as of December
31, 2015. Payments on this loan were due quarterly under a five year amortization schedule with the remaining principal balance
due on May 14, 2016. This loan bore interest at LIBOR plus 1.5%. We repaid this loan with available cash balances in May 2016.
Immediately following our acquisition of
51% of the ownership interest in Aerex, we and the former sole shareholder of Aerex loaned Aerex $510,000 and $490,000, respectively,
in the form of notes payable which mature on June 30, 2017 and bear interest at 1% per annum.
As of September 30, 2016, we had cash and
cash equivalents of approximately $37.1 million and working capital of approximately $52.1 million. We are not presently aware
of anything that would lead us to believe that we will not have sufficient liquidity to meet our needs.
Transfers from our bank accounts in The
Bahamas and Belize to our bank accounts in other countries require the approval of the Central Banks of the Bahamas and Belize,
respectively. As of September 30, 2016, the equivalent United States dollar cash balances for our bank account deposits in the
Bahamas and Belize were approximately $6.6 million and $5.3 million, respectively.
Discussion of Cash Flows for the Nine
Months Ended September 30, 2016
Our cash and cash equivalents decreased
to $37.1 million as of September 30, 2016 from $44.8 million as of December 31, 2015.
Cash Flows from Operating Activities
Our operating activities provided cash
of approximately $4.5 million. This net cash provided reflects net income generated for the nine months of approximately $1.4 million
as adjusted for (i) various items included in the determination of net income that do not affect cash flows during the year; and
(ii) changes in the other components of working capital. The more significant of such items and changes in working capital components
included depreciation and amortization of approximately $5.4 million, a net increase in accounts receivable of approximately $5.8
million, and non-cash impairment losses aggregating approximately $4.7 million.
Cash Flows from Investing Activities
Net cash used in our investing activities
was approximately $2.4 million. In February 2016, we acquired a 51% ownership interest in Aerex through a stock purchase agreement
for an aggregate purchase price of approximately $7.7 million in cash. We purchased property plant and equipment and expended funds
on construction in progress in the normal course of business in the aggregate of amount of approximately $2.6 million. We received
approximately $5.6 million upon the maturity of a certificate of deposit. We collected approximately $1.4 million in principal
repayments on our loans receivable from the WAC. As a result of a favorable ruling by a Mexico appellate court in February 2016,
we also obtained the release of approximately $399,000 in cash that had been restricted and pledged as collateral for a letter
of credit at December 31, 2015.
Cash Flows from Financing Activities
Our financing activities used approximately
$9.9 million in net cash as we paid dividends of approximately $3.5 million and repaid a $7.0 million demand note payable. We also
obtained a $490,000 working capital loan from Aerex’s prior sole stockholder that matures on June 30, 2017.
Material Commitments, Expenditures and Contingencies
Retail License
We sell water through our 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, we have the exclusive right to produce
potable water and distribute it by pipeline to our 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 September 30, 2016 and 2015, we generated
approximately 38%, and 39%, respectively, of our consolidated revenues and 52% and 57%, respectively, of our consolidated gross
profit from the retail water operations conducted pursuant to Cayman Water’s exclusive license. For the nine months ended
September 30, 2016 and 2015, we generated approximately 40% and 41%, respectively, of our consolidated revenues and 55% and 58%,
respectively, of our consolidated gross profit from the retail water operations conducted pursuant to Cayman Water’s exclusive
license.
Under our license, we pay a royalty to
the government of 7.5% of our gross retail water sales revenues (excluding energy cost adjustments). The selling prices of water
sold to our 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 WAC, on behalf
of the government, reviews and confirms the calculations of the price adjustments for inflation and electricity costs. If we want
to adjust our prices for any reason other than inflation or electricity costs, we have 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 expired June 30, 2016. We continue
to provide water subsequent to June 30, 2016 under a further extension of the license that we believe will be forthcoming.
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.”
In February 2011, the Water (Production
and Supply) Law, 2011 and the Water Authority (Amendment) Law, 2011 (the “New Laws”) were published and are now in
full force and effect. 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.
We have been advised in correspondence
from the Cayman Islands government and the WAC that: (i) the WAC, and not the Cayman Islands government, is the principal negotiator
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 our 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. We have advised the Cayman Islands government that we disagree with its position on these two issues.
In July 2012, in an effort to resolve several
issues relating to our retail license renewal negotiations, we 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 our competitor put the WAC in a position
of hopeless conflict; and (iii) the WAC’s decision to replace the rate structure under our current exclusive license with
RCAM was predetermined and unreasonable. In October 2012, we were 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 1990 License does not
require a public bidding process; and (ii) the WAC is the proper entity to negotiate with us for the renewal of the 1990 License.
Our submissions on the RCAM model and/or
alternative models of pricing were made to the WAC on June 9, 2014. We received a letter from the WAC dated September 11, 2014,
which fully rejected our submissions and stated that the WAC intended to provide us with a draft RCAM license in due course.
On November 21, 2014, we wrote to the Minister
of Works offering to recommence license negotiations on the basis of the RCAM model subject to the following conditions: (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 we
would mutually appoint an independent referee and chairman of the negotiations, (iii) our new license would provide exclusivity
for the production and provision of all piped water, both potable and non-potable, within our Cayman Islands license area, (iv)
the Government would allow us to submit our 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,
we received a letter from the Minister of Works with the following responses to our November 21, 2014 letter: (1) that while the
Cayman government plans to create a public utilities commission, the provision of a new 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 us to submit a counter proposal to the WAC’s June 2010 RCAM license draft, the WAC will
draft the license with the understanding that we 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 we consider
eliminating our monthly minimum volume charge in the new license.
We recommenced license negotiations with
the WAC during the third quarter of 2015. However, we are presently unable to determine when such negotiations will be completed
or the final outcome of such negotiations.
In October 2016, the Government of the
Cayman Islands passed legislation which created a new utilities regulation and competition office (“URCO”). This legislation
will become law when it is assented to by the Governor of the Cayman Islands and published in the official Cayman Islands Gazette.
URCO is an independent and accountable regulatory body with a view of protecting the rights of consumers, encouraging affordable
utility services, and promoting competition. URCO has the ability to supervise, monitor and regulate multiple utility undertakings
and markets. Water utilities are not presently included in the scope of URCO’s regulatory functions and remain under the
regulatory control of the WAC. We have been advised by government officials that it is government’s intention to include
water utilities under the ambit of URCO through additional legislation in 2017. We have been further advised that if and when this
additional legislation is enacted, the WAC will no longer regulate water utilities since this function will be taken over by URCO.
We are presently unable to determine (i) when such additional legislation will be enacted and consequently if or when URCO will
become its new regulator in the Cayman Islands; or (ii) the impact of URCO on our retail license negotiations.
The resolution of these license negotiations
could result in a material reduction of the operating income and cash flows we have historically generated from our retail license
and could require us to record an impairment loss to reduce the carrying value of our goodwill. Such impairment loss could have
a material adverse impact on our results of operations.
N.S.C. Agua, S.A. de C.V.
In May 2010, we acquired, through our wholly-owned
Netherlands subsidiary, Consolidated Water Cooperatief, U.A., (“CW-Cooperatief”) a 50% interest in N.S.C. Agua, S.A.
de C.V. (“NSC”), a development stage Mexican company. We have since purchased, through the conversion of a loan we
made to NSC, sufficient shares to raise our ownership interest in NSC to 99.9%. NSC was formed to pursue a project (the “Project”)
encompassing 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 the 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 approximately $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 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 may be cancelled by NSC 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”). 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 was authorized
the State would be required to conduct a public tender for the Project.
In response to its 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 and accompanying
required public tender process should be conducted. In November 2015, the State officially commenced the tender for the Project,
the scope of which the State has 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. NSC submitted its tender for the Project on the April 21, 2016
tender submission deadline date set by the State.
We have 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 was 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.
On June 15, 2016, the State designated
the consortium comprised of NSC, NuWater S.A.P.I. de C.V. and Degremont S.A. de C.V. (the “Consortium”) as the winner
of tender process for the Project.
On August 17, 2016, NSC and NuWater incorporated
a special purpose project company named Aguas de Rosarito S.A.P.I. de C.V. (“AdR”) to execute the Project and executed
a shareholders agreement for AdR agreeing among other things that (i) AdR would purchase the Land and other Project assets from
NSC on the date that the Project begins commercial operation; and (ii) AdR would enter into a Management and Technical Services
Agreement with NSC effective on the first day that the Project begins commercial operation.
On August 22, 2016, the Public Private
Partnership Agreement for public private partnership number 002/2015, contest number SIDUE-CEA-APP-2015-002 (“APP Contract”)
was executed between AdR, CEA, the Government of Baja California represented by the Secretary of Planning and Finance (“SPF”),
and the Public Utilities Commission of Tijuana (“CESPT”). The APP Contract requires AdR to design, construct, finance
and operate a seawater desalination plant (and accompanying aqueducts) with a capacity of up to 100 million gallons per
day in two phases: the first with a capacity of 50 million gallons per day and an aqueduct to the Mexican potable water system
in Tijuana, Baja California; and the second phase with a capacity of 50 million gallons per day and an aqueduct to a second delivery
point in Tijuana. The first phase must be operational within 36 months of commencing construction, and the second phase
must be operational by the end of 2024. The APP Contract further requires AdR to operate and maintain the plant and aqueducts for
a period of 37 years starting from the commencement of operation of the first phase. At the end of the operating period the plant
and aqueducts will be transferred to CEA.
The total Project cost is expected to be
approximately 9 billion Mexican pesos, or approximately US$485 million (based upon the current exchange rate). Annual revenues
from the Project are expected to be approximately 1.02 billion Mexican pesos, or approximately US$55.0 million (based upon the
currency exchange rate as of August 23, 2016). Water rates under the APP Contract are indexed to the Mexican national consumer
price index over its term. Electrical energy costs incurred by AdR to desalinate and deliver water are treated as a pass through
charge to CEA, subject to efficiency guarantees. AdR expects to raise Mexican peso denominated debt financing through a consortium
led by the North American Development Bank, which also provided financial advisory services to us and our partners through the
bidding process and contract negotiations.
The APP Contract does not become effective
until AdR secures the equity and debt financing required for the first phase of the Project and the following conditions are met:
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the State has established and registered various payment
trusts, guaranties and bank credit lines for specific use by the Project;
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the CEA has obtained the rights from the relevant federal
authority to take and desalinate seawater and distribute it for municipal use;
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various water purchase and sale agreements between the
CEA, the payment trusts and the CESPT have been executed;
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AdR has obtained all rights of ways required for the
aqueduct;
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AdR has obtained permission
from the relevant federal authority to discharge the residual water from the Project’s desalination plant; and
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all financing agreements necessary to provide funding
for the Project have been executed.
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If the Consortium is ultimately unable
to proceed with 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 the Consortium does not proceed with 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 approximately $20.6 million, and any loss on sale of the land, or
impairment loss NSC 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 our results of operations.
Included in our 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 $606,000 and $358,000 for
the three months ended September 30, 2016 and 2015, respectively, and approximately $2,248,000 and $1,370,000 for the nine months
ended September 30, 2016 and 2015, respectively. The assets and liabilities of NSC included in the Company’s consolidated
balance sheets amounted to approximately $21.7 million and $321,000, respectively, as of September 30, 2016 and approximately $22.0
million and $488,000 respectively, as of December 31, 2015.
We expect to incur additional project development costs on behalf
of NSC and AdR during the remainder of 2016 and during 2017.
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 (“EWG”) and the other half of its shares in NSC to Alejandro de la Vega (the “individual shareholder”).
In February 2012, we paid $300,000 to enter into an agreement (the “Option Agreement”) that provided us 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, we acquired 99.9% of the ownership of NSC. The Option Agreement contained an anti-dilution
provision that required us 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)
we did not exercise our share purchase option by February 7, 2014. We exercised our option and paid the $1.0 million to the individual
shareholder to purchase the Option Agreement shares in February 2014.
In October 2015, we learned that EWG has
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, among
other things, the capital investment transactions that increased our ownership interest in NSC to 99.9%. EWG requested that the
court, as a preliminary matter: (a) suspend of the effectiveness of the challenged transactions; (b) order of 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.
EWG also is seeking an order directing,
among other things: (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, Mexico
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.
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.
On May 17, 2016, NSC filed a claim with
the Third District Court in Matters of Amparo and Federal Trials in the City of Tijuana, Baja California (the “Amparo Court”)
challenging the Tecate, Mexico Court ex-parte order which appointed an inspector over NSC’s commercial activities. On July
29, 2016, the Amparo Court found that such appointment is unconstitutional and reversed the Tecate, Mexico Court’s appointment
of an inspector.
On September 6, 2016, the Tecate, Mexico
Court issued a decree granting the counter guaranty requested by NSC. Such counter-guaranty was fixed in the amount of 300,000
Mexican pesos and was given to the Court on October 13, 2016 at which time all remaining ex-parte restrictions on NSC related
to the challenged transactions were suspended.
We believe 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. We cannot presently determine the outcome of this litigation.
However, such litigation could adversely impact our efforts to complete the Project. The Company incurred legal fees in connection
with this litigation of approximately $18,000 and $357,000 for the three and nine months ended September 30, 2016.
CW-Bali
Through our subsidiary CW-Bali, we have
built and presently operate 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. We built this plant based upon our belief that future
water shortages in this area of Bali would eventually enable us to sell all of this plant’s production. However, since its
inception, our sales volumes for this plant have not been sufficient to cover its operating costs.
In 2015, the Indonesian government passed
Regulation 122 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. Since commencing operations in CW-Bali, we have held discussions with PDAM and other governmental
entities for possible water sale arrangements, and we are presently pursuing a formal cooperation agreement with PDAM for the sale
of water to the resorts in CW-Bali’s target market that are not presently served by PDAM.
As an Indonesian company that is majority-owned
by foreigners, CW-Bali is required to obtain and maintain an “in-principle” (i.e. – short term, temporary) license
to operate until such time as it is able to demonstrate that it has invested sufficient capital and made sufficient progress under
its business plan to receive a non-temporary business license. The term of CW-Bali’s initial in-principle license ended in
October 2016. We are applying for a new in-principle license and expect to obtain this license. However, the Indonesian government
could decide not to grant CW-Bali a new in-principle license, in which case we would be required to cease operations and dispose
of our investment in CW-Bali.
CW-Bali’s target resort customers
in Nusa Dua (as do many other parties in Bali) obtain their fresh water from wells on their properties that access the island’s
underground fresh water aquifer. The continued use of such wells threatens to permanently damage the aquifer making it vulnerable
to intrusion by seawater, sewage and pollution. The Bali government has sought to discourage and/or eliminate the use of such wells
by threatening to impose substantial taxes on the value of water drawn from them. Our decision to build a speculative plant in
Bali was based upon (i) PDAM’s inability to provide water to the various newer and planned resorts in Nusa Dua, resorts that
required large quantities of fresh water; (ii) these resorts’ apparent interest in securing a new water supply given their
eventual reduced access to fresh water wells due to governmental taxation, other regulatory actions or eventual contamination of
the aquifer; and (iii) desalination as the only viable new means of supplying large amounts of fresh water to Nusa Dua in a reasonable
time frame. We believed the resorts would utilize CW-Bali as a much higher quality, drought-proof, environmentally safe water supply
and reduce or eliminate their dependence on wells and/or trucked water. However, no taxes have yet been assessed or governmental
regulatory actions yet taken to discourage or end the use of fresh water wells. Economic conditions in Bali have declined significantly
since CW-Bali commenced operations and, to date, the resorts in Nusa Dua have not elected to replace or supplement their much less
expensive well water with CW-Bali’s alternative supply. CW-Bali’s sales have been inadequate to cover its costs and
we have incurred operating losses for this subsidiary since its inception.
In late 2015, we decided to seek a strategic
partner for CW-Bali to (i) purchase a major portion of its equity ownership in CW-Bali; (ii) lead CW-Bali’s sales and marketing
efforts; (iii) liaise with PDAM; and (iv) assist with CW-Bali’s on-going funding requirements. While we have held discussions
and exchanged information with potential partners, we have not yet received an offer for an investment in, a purchase of, or a
joint venture for CW-Bali on terms we consider acceptable.
While we continue to believe that desalination
technology will play a major part in addressing the long term water supply needs of CW-Bali’s target market in Nusa Dua and
Bali in general, the time frame for the widespread market adoption of such technology will likely be significantly longer than
we anticipated when we decided to commence business in Bali. Consequently, during the three months ended September 30, 2016, we
reassessed the prospects for CW-Bali in light of (i) its results to date; (ii) current circumstances and the uncertainties impacting
the business; and (iii) its on-going funding requirements and our willingness to continue to provide such funding, and tested CW-Bali’s
long-lived assets for possible impairment. To test for impairment, we estimated the future undiscounted cash flows CW-Bali will
receive from its plant by (i) identifying various possible future scenarios for the business; (ii) estimating the undiscounted
future cash flows associated with each possible scenario; and (iii) assigning a probability to each scenario. The resulting probability-weighted
sum represents our best estimate of the future undiscounted cash flows to be derived by CW-Bali from its long-lived desalination
plant assets. The carrying value of our Bali long-lived assets exceeded our probability-weighted estimate of CW-Bali’s future
undiscounted cash flows which indicated impairment of these assets, and we recorded an impairment loss of $2.0 million during the
three months ended September 30, 2016 to reduce the carrying value of our long-lived CW-Bali assets to their estimated fair value.
If we are not able to obtain a strategic
partner for CW-Bali, sell water to PDAM or to other new customers through a cooperation agreement, or otherwise significantly increase
the revenues generated by our Nusa Dua plant in the future, we may cease CW-Bali’s operations. We will also be required to
cease CW-Bali’s operations if we do not obtain a new in-principle license. If we cease operations at CW-Bali, we may be required
to record further impairment losses to reduce the carrying value of our investment in CW-Bali to its fair value for the period
in which we formally commit to exit the Bali market. Such impairment losses could be material to our results of operations. Any
sale of a portion of our investment in CW-Bali may be for an amount less than our carrying amount, resulting in a loss on the sale
that could be material to our results of operations. The carrying value of our investment in CW-Bali as of September 30, 2016 totaled
$2.1 million, consisting of net assets of $1.51 million and a cumulative foreign currency translation adjustment reflected in our
stockholders’ equity of $549,555.
We anticipated at the time CW-Bali commenced
operations that CW-Bali’s revenues, expenditures, and other cash flows would be conducted primarily in the local currency,
the Indonesian rupiah (IDR). We expected that financial support we provided to CW-Bali would not extend beyond CW-Bali’s
start-up phase, and that thereafter CW-Bali would generate positive net cash flows from its operations and thus remain relatively
self-contained and integrated within the economic environment of Bali, Indonesia. As a result, since inception of its operations
through September 30, 2016, the functional currency of CW-Bali was the IDR.
However, since its inception CW-Bali has
been dependent upon on-going financial support in U.S dollars (US$) to continue its operations. We expect such funding to continue
until such time, if ever, that CW-Bali generates sufficient revenues to support its operations, or is able to obtain a strategic
partner to assist with its on-going funding requirements, or ceases operations. Consequently, effective as of October 1, 2016,
we changed the functional currency of CW-Bali to US$.
During the periods for which IDR was CW-Bali’s
functional currency, we recorded foreign currency gains and losses arising from CW-Bali’s transactions conducted in currencies
other than the IDR. Such foreign currency gains and losses included amounts associated with (i) transactions denominated in currencies
other than the IDR and (ii) the re-measurement of monetary assets and liabilities denominated in currencies other than the IDR
as of the balance sheet date. CW-Bali’s monetary assets and liabilities denominated in currencies other than the IDR consist
of US$-denominated bank accounts and US$-denominated we loans provided to CW-Bali. Such foreign currency transaction gains (losses)
were included in income and amounted to approximately $28,000 and ($309,000) for the three months ended September 30, 2016 and
2015, respectively and approximately $202,000 and ($542,000) for the nine months ended September 30, 2016 and 2015, respectively.
After the re-measurement process of monetary assets and liabilities was completed, the assets and liabilities of CW-Bali were translated
into US$ using exchange rates in effect at the end of each period. Revenues and expenses for CW-Bali were translated using rates
that approximated those in effect during the period. The effect of these foreign currency translations was recognized in the cumulative
translation adjustment included in our stockholders’ equity, which amounted to ($549,555) and ($533,365) as of September
30, 2016 and December 31, 2015, respectively.
This change in functional currency will
be applied on a prospective basis, and therefore, the cumulative translation adjustment of ($549,555) as of September 30, 2016
will remain unchanged until such time that the CW-Bali is no longer dependent on US$ funding to support its operations, we sell
all or a portion of our equity interest in CW-Bali, or we discontinue CW-Bali’s operations. Translated amounts for non-monetary
assets as of September 30, 2016 will become the new accounting basis for those assets effective October 1, 2016. Monetary assets
denominated in foreign currencies, including the IDR, will be re-measured to US$ at the current exchange rate as of the balance
sheet date going forward. We anticipate that the likely effect of this change in functional currency will result in future foreign
currency gains and losses that pertain to (i) transactions denominated in IDR and (ii) foreign currency re-measurements associated
with monetary assets and liabilities denominated in IDR. As of September 30, 2016, such balances include IDR-denominated cash,
accounts receivable, and accounts payable, which amounted to approximately $20,000, $37,000, and $35,000, respectively, based upon
the exchange rate between the IDR and US$ as of that date. Based on this change in functional currency, our US$-denominated loans
to CW-Bali will not be subject to further re-measurement adjustments.
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. We are presently unable to determine what impact the Order and the Second
Order will have on our financial condition, results of operations or cash flows.
Windsor Plant Water Supply Agreement
Our subsidiary CW-Bahamas provides bulk
water to the 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, we are required to provide the WSC with at least 16.8 million
gallons per week of potable water from the Windsor plant, and the WSC had contracted to purchase at least that amount on a take-or-pay
basis. This water supply agreement was scheduled to expire when we 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 Windsor plant site, and negotiate a purchase
price 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, we continue 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 September 30, 2016 and 2015, respectively, and $4.0 million and $4.5 million during the nine months
ended September 30, 2016 and 2015, respectively.
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.
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.
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.
In May 2016, the FASB issued ASU 2016-11,
Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards
Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting
. ASU 2016-11 rescinds several
SEC Staff Announcements that are codified in Topic 605, including, among other items, guidance relating to accounting for shipping
and handling fees and freight services.
In May 2016, the FASB issued ASU 2016-12,
Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,
which clarifies implementation
guidance around collectability, sales taxes collected from customers, noncash considerations, contract modifications at transition,
and completed contracts at transition.
The effective dates of ASU 2016-08, ASU
2016-10, ASU 2016-11 and ASU 2016-12 are the same as ASU 2015-14 discussed above. The Company is currently evaluating the effect
the adoption of these standards will have on the 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.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments
, which clarifies how certain
cash receipts and payments are presented in the statement of cash flows. ASU 2016-15 is effective for annual periods beginning
after December 15, 2017 and 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.
Dividends
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On January 31, 2016, we paid a dividend of $0.075 to
shareholders of record on January 1, 2016.
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On April 30, 2016, we paid a dividend of $0.075 to shareholders
of record on April 1, 2016.
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On July 31, 2016, we paid a dividend of $0.075 to shareholders
of record on July 1, 2016.
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On August 16, 2016, our Board declared a dividend of
$0.075 payable on October 31, 2016 to shareholders of record on October 3, 2016.
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We have paid dividends to owners of our
common shares and redeemable preferred shares since we began declaring dividends in 1985. However, the payment of any future cash
dividends will depend upon our earnings, financial condition, cash flows, capital requirements and other factors our Board of
Directors deems relevant in determining the amount and timing of such dividends.
Dividend Reinvestment and Common Stock
Purchase Plan
.
This program is available to our common
shareholders, who may reinvest all or a portion of their common cash dividends into shares of common stock at prevailing market
prices and may also invest optional cash payments to purchase additional shares at prevailing market prices as part of this program.
Impact of Inflation
Under the terms of our Cayman Islands license
and our water sales agreements in The Bahamas, Belize and the British Virgin Islands, our water rates are automatically adjusted
for inflation on an annual basis, subject to temporary exceptions. We, therefore, believe that the impact of inflation on our gross
profit, measured in consistent dollars, will not be material. However, significant increases in items such as fuel and energy costs
could create additional credit risks for us, as our customers’ ability to pay our invoices could be adversely affected by
such increases.