<PAGE> 1
FILED PURSUANT TO RULE 424(B)(4)
FILE NO. 333-74379
PROSPECTUS
- ----------------
36,600,000 SHARES
[AZURIX LOGO]
COMMON STOCK
----------------------
This is Azurix Corp.'s initial public offering of common stock. Azurix is
offering and selling 17,100,000 shares and Atlantic Water Trust, the selling
stockholder, is offering and selling 19,500,000 shares of common stock.
The U.S. underwriters will offer 29,280,000 shares in the United States and
Canada and the international managers will offer 7,320,000 shares outside the
United States and Canada.
Prior to the offering, there has been no public market for the common
stock. The common stock has been approved for listing on the New York Stock
Exchange under the trading symbol "AZX," subject to official notice of issuance.
INVESTING IN THE COMMON STOCK INVOLVES RISKS WHICH ARE DESCRIBED IN THE
"RISK FACTORS" SECTION BEGINNING ON PAGE 8 OF THIS PROSPECTUS.
----------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----
<S> <C> <C>
Public offering price............................. $19.00 $695,400,000
Underwriting discount............................. $1.14 $41,724,000
Proceeds, before expenses, to Azurix.............. $17.86 $305,406,000
Proceeds, before expenses, to the selling
stockholder..................................... $17.86 $348,270,000
</TABLE>
The U.S. underwriters may also purchase up to an additional 4,392,000
shares from the selling stockholder at the public offering price, less the
underwriting discount, within 30 days from the date of this prospectus to cover
over-allotments. The international managers may similarly purchase up to an
aggregate of an additional 1,098,000 shares from the selling stockholder.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of common stock will be ready for delivery in New York, New York
on or about June 15, 1999.
----------------------
MERRILL LYNCH & CO.
CREDIT SUISSE FIRST BOSTON
DONALDSON, LUFKIN & JENRETTE
PAINEWEBBER INCORPORATED
BANC OF AMERICA SECURITIES LLC DEUTSCHE BANC ALEX. BROWN
----------------------
The date of this prospectus is June 9, 1999.
<PAGE> 2
ART/DIAGRAMS
[EDGAR VERSION ONLY] Diagram showing Azurix's current asset portfolio.
In addition, a diagram depicts the three areas of the global water industry
in which we will pursue our business strategy. They include:
Asset ownership and management, which we will pursue through acquisitions
and concessions of water and wastewater assets, facility operations and new
facility development.
Services, which include operating and managing water and wastewater assets
for municipal and industrial customers, providing residuals management services
(managing the residual byproducts from wastewater) and providing infrastructure
development and maintenance services for underground water and wastewater
assets.
Resource development and management, which includes extracting,
transporting and storing water and wastewater.
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<S> <C>
Summary..................................................... 1
Risk Factors................................................ 8
Forward-Looking Statements.................................. 17
Use of Proceeds............................................. 18
Dividend Policy............................................. 18
Dilution.................................................... 19
Capitalization.............................................. 20
Selected Historical and Unaudited Pro Forma Consolidated
Financial Data............................................ 21
Currency Exchange Rates..................................... 23
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 24
Government Outsourcing Through Privatization................ 43
Business.................................................... 47
Regulatory Matters.......................................... 76
Management.................................................. 89
Transactions with Enron, Atlantic Water Trust and Marlin
Water Trust............................................... 97
Principal and Selling Stockholders.......................... 102
Description of Capital Stock................................ 105
Description of Indebtedness................................. 108
Shares Eligible for Future Sale............................. 115
Material United States Federal Tax Consequences to
Non-United States Holders of
Common Stock.............................................. 117
Underwriting................................................ 120
Legal Matters............................................... 124
Experts..................................................... 124
Where You Can Find More Information......................... 125
Index to Financial Statements............................... F-1
</TABLE>
----------------------
You should rely only on the information contained in this prospectus. We
have not, and the selling stockholder and the underwriters have not, authorized
any person to provide you with different information. If anyone provides you
with different or inconsistent information, you should not rely on it. We are
not, and the selling stockholder and the underwriters are not, making an offer
to sell these securities in any jurisdiction where the offer or sale is not
permitted. You should assume that the information appearing in this prospectus
is accurate as of the date on the front cover of this prospectus only. Our
business, financial condition, results of operations and prospects may have
changed since that date.
i
<PAGE> 4
SUMMARY
This summary highlights information contained elsewhere in this prospectus.
You should read the entire prospectus carefully, including our financial data
and related notes, before making an investment decision. Unless we indicate
otherwise, the information contained in this prospectus gives effect to the
100,000-for-1 common stock split effective February 2, 1999.
AZURIX CORP.
Azurix Corp. is a global water company engaged in the business of
acquiring, owning, operating and managing water and wastewater assets, providing
water and wastewater related services and developing and managing water
resources. Enron Corp., one of the world's leading integrated natural gas and
electricity companies, formed Azurix on January 29, 1998 to pursue opportunities
in the global water industry. Azurix's first significant step was to acquire
Wessex, a water and wastewater company based in southwestern England, for $2.4
billion on October 2, 1998.
Our asset portfolio also includes interests in long-term water concessions
in the Province of Mendoza, Argentina and in Cancun, Mexico. In addition, we
acquired Philip Utilities Management Corporation, a water and wastewater
services company with operations in the United States and Canada on May 18, 1999
for $106.3 million. On May 18, 1999, we were notified that, subject to final
confirmation, we will be awarded an interest in a long-term water and wastewater
concession in two regions of the Province of Buenos Aires, Argentina, at an
aggregate price of $438.6 million. On May 28, 1999, we entered into an agreement
to acquire an interest in a company that provides water and wastewater related
services in a portion of Mexico City, Mexico. We have made each of these
investments through one or more subsidiaries, which will be our approach as we
pursue our worldwide growth strategy.
THE GLOBAL WATER INDUSTRY
The global water industry includes the collection, treatment, storage and
supply of drinking water, and the collection, treatment and disposal of
wastewater and its by-products. Public (municipal and other governmental) and
private (non-governmental) water companies serve industrial, commercial and
residential customers. Azurix estimates that the global water industry has total
annual revenues of approximately $300 billion. In addition, Azurix estimates
that over $600 billion will be spent on worldwide water and wastewater
infrastructure over the next decade.
We believe that significant business opportunities exist for private sector
participation in the global water industry, including taking part in water and
wastewater privatizations, providing water and wastewater related services to
municipal and industrial water markets and developing and managing water
resources.
OUR COMPETITIVE STRENGTHS
We have several competitive strengths that should enable us to compete
successfully in the global water industry:
- EXPERIENCED MANAGEMENT AND BUSINESS DEVELOPMENT TEAMS. Although Azurix
was recently formed, we have an experienced management team from Enron,
Wessex and other multinational companies with experience in developing
global infrastructure projects and operating and managing water and
wastewater assets. Our senior executives are complemented by a group of
experienced business developers who identify opportunities in the global
water industry.
- WESSEX OPERATING EXPERIENCE AND TECHNICAL EXPERTISE. From Wessex, we have
obtained the operating experience and technical expertise necessary to
evaluate potential water projects, to qualify for bidding on water
projects throughout the world, to build transition and operating teams
for new acquisitions and to manage existing and new water and wastewater
assets.
1
<PAGE> 5
- REGULATORY AND GOVERNMENT AFFAIRS EXPERTISE. Our management team has
extensive experience in working with regulators and other governmental
agencies and has knowledge of the regulatory framework and privatization
processes in many of the countries in which we intend to pursue water and
wastewater opportunities.
- FINANCING EXPERTISE. Members of our management team have experience using
sophisticated financing and capital raising techniques in both global and
local markets to lower the cost of capital for the financing of projects
and acquisitions.
OUR BUSINESS STRATEGY
Our business strategy is focused on three complementary areas in the global
water industry:
- ACQUIRING, OWNING, OPERATING AND MANAGING WATER AND WASTEWATER ASSETS. We
intend to build a diversified portfolio of water and wastewater assets,
including both established businesses with stable returns and concessions
and projects in emerging markets with significant development
requirements and potential for growth and enhanced returns.
- PROVIDING WATER AND WASTEWATER RELATED SERVICES. We intend to provide a
broad range of services to municipal and industrial customers around the
world, including:
-- Operations, management and engineering -- services to design, build,
operate or maintain water and wastewater assets
-- Residuals management -- services to dispose of wastewater and biosolids
that result from wastewater treatment
-- Underground infrastructure remediation and development -- services to
repair and replace water and wastewater distribution and collection
systems
- DEVELOPING AND MANAGING WATER RESOURCES. We intend to pursue
opportunities in water resource development and management and address
the capital, technical and operational needs in this area of the water
industry.
2
<PAGE> 6
AZURIX'S CORPORATE STRUCTURE
The following chart illustrates our corporate structure after the offering
and assumes the underwriters' over-allotment option will not be exercised. This
chart does not show our complete corporate structure and should be read in
conjunction with the more detailed descriptions contained elsewhere in this
prospectus.
[CHART]
RELATIONSHIP AMONG ENRON, MARLIN WATER TRUST, ATLANTIC WATER TRUST AND AZURIX
To date, Enron has appointed all of the directors of Atlantic Water Trust
and Azurix, although Marlin Water Trust at any time has the right to elect or
replace half of the directors of Atlantic Water Trust and currently up to half
of Azurix's directors. Following the offering, as long as Atlantic Water Trust
owns a majority of our outstanding voting stock, Enron and Marlin Water Trust
will have the ability to direct Atlantic Water Trust to elect all of Azurix's
directors. As a result, Enron and Marlin Water Trust will continue to exert
significant influence over the policies, management and affairs of Azurix and
the outcome of most corporate actions requiring stockholder approval, including
the approval of transactions involving a change in control of Azurix. See
"Transactions with Enron, Atlantic Water Trust and Marlin Water Trust,"
"Principal and Selling Stockholders" and "Shares Eligible for Future Sale."
3
<PAGE> 7
TRANSACTIONS WITH ENRON
We have entered into the following agreements with Enron for purposes of
governing ongoing relationships following the offering:
- BUSINESS OPPORTUNITIES AGREEMENT. This agreement limits the scope of our
business to the businesses generally identified in this prospectus and
activities incidental to those businesses; the agreement also provides
that Enron and its affiliates may engage in water-related businesses,
even if those businesses have a competitive impact on Azurix.
- SERVICES AGREEMENT. Under this agreement, Enron provides various
corporate staff and support services to us; we expect to incur costs for
services used under the services agreement of approximately $15 million
annually.
- CREDIT AGREEMENT. Under this agreement, Enron provides funds to us for
general, administrative and operating expenditures; the credit agreement
is a revolving facility which matures December 15, 2001 or 90 days
following the date that Enron or its affiliates do not own or have the
power to vote at least one-third of our capital stock ordinarily entitled
to vote for the election of directors and fewer than one-third of our
directors are officers, directors or employees of Enron or its
affiliates; the total commitment under the credit agreement is $180
million, and advances under the credit agreement bear interest at the
federal funds rate plus 1.50%.
- LICENSE AGREEMENT. This agreement permits Azurix to use the phrase "an
Enron Company" and the Enron logo in identifying Azurix as part of the
Enron enterprise.
- COST SHARING AGREEMENT. This agreement provides for a sharing of Enron's
trademark costs with Azurix and Enron's other affiliates.
See "Transactions with Enron, Atlantic Water Trust and Marlin Water Trust"
for a more detailed discussion of these agreements.
Our principal executive offices are located at 333 Clay Street, Houston,
Texas 77002 (telephone number (713) 646-6001) and 34 Park Street, London W1Y
3PF, England (telephone number (44) 171-970-7763).
4
<PAGE> 8
THE OFFERING
The following information is based upon shares outstanding as of June 9,
1999 and excludes approximately 8.5 million shares that may be issued upon the
exercise of options. Unless otherwise indicated, all information in this
prospectus assumes that the over-allotment option will not be exercised.
<TABLE>
<S> <C> <C> <C>
Common stock offered by Azurix:
U.S. offering................................ 13,680,000 shares
International offering....................... 3,420,000 shares
-----------
Total................................ 17,100,000 shares
===========
Common stock offered by the selling
stockholder:
U.S. offering................................ 15,600,000 shares
International offering....................... 3,900,000 shares
-----------
Total................................ 19,500,000 shares
===========
Common stock outstanding after the U.S. and
international offerings...................... 117,100,000 shares
Common stock subject to over-allotment option
from the selling stockholder................. 5,490,000 shares
Use of proceeds................................ We expect the proceeds to Azurix from this sale of
common stock to be approximately $302.6 million, after
deducting underwriting discounts and commissions and
estimated expenses. Azurix will not receive any
proceeds from the sale of common stock by the selling
stockholder. We intend to use approximately $72
million of the net proceeds that we receive to repay
advances from Enron. We intend to use the remaining
proceeds, along with funds to be drawn under the
senior credit facility, to fund the acquisition of an
interest in a concession in the Province of Buenos
Aires, Argentina.
NYSE symbol.................................... "AZX"
</TABLE>
5
<PAGE> 9
SUMMARY HISTORICAL AND UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA
The following tables present summary historical and unaudited pro forma
consolidated financial data for Azurix and for Wessex, the predecessor of
Azurix, for the periods and dates indicated. The results for the three months
ended March 31, 1999 are not necessarily indicative of the results for the full
year. The unaudited pro forma financial data for Azurix is derived from the
unaudited condensed consolidated pro forma financial data included elsewhere in
this prospectus. The unaudited pro forma income statement and other financial
data give effect to the acquisition of Wessex, the redemption and elimination of
Wessex's preference shares for an aggregate price of $249.8 million, the sale by
Wessex of its interest in Wessex Waste Management Ltd., a joint venture with
Waste Management International Plc that does business as UK Waste, for $337.9
million and the offering, as though each occurred on January 1, 1998. The
unaudited pro forma balance sheet data gives effect to the offering as though it
occurred on March 31, 1999. The unaudited pro forma income statement and other
financial data presented below are not necessarily indicative of the financial
results that would have occurred had the acquisition of Wessex, the redemption
and elimination of Wessex's preference shares, the sale by Wessex of its
interest in UK Waste and the offering occurred on January 1, 1998, or indicative
of our financial position had the offering occurred on March 31, 1999, and
should not be viewed as indicative of operations or financial position in future
periods. See "Selected Historical and Unaudited Pro Forma Consolidated Financial
Data" for more information regarding the historical, the unaudited pro forma
consolidated and the other financial data.
<TABLE>
<CAPTION>
AZURIX
--------------------------
THREE
WESSEX (PREDECESSOR COMPANY) JANUARY 29, MONTHS
YEAR ENDED MARCH 31, 1998 TO ENDED
----------------------------------------------------- DECEMBER 31, MARCH 31,
1995 1996 1997 1998 1998 1999
----------- ----------- ----------- ----------- ------------ -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Operating revenues....... $ 356.3 $ 376.8 $ 403.1 $ 436.6 $ 119.7 $ 116.9
Operations and
maintenance expense.... 106.7 106.6 102.4 110.9 31.6 31.8
General and
administrative
expense................ 33.3 27.4 32.2 29.1 20.3 22.6
Depreciation and
amortization........... 48.5 53.7 58.0 64.3 22.2 23.3
Operating income......... 167.8 189.1 210.5 232.3 45.6 39.2
Net income............... 123.7 140.4 153.0 16.7(3) 10.2 16.1
Basic earnings per common
share(1)............... 0.10 0.16
Diluted earnings per
common share(1)........ 0.10 0.16
OTHER FINANCIAL DATA:
EBITDA(2) (unaudited).... $ 227.3 $ 256.9 $ 283.2 $ 309.9 $ 65.8 $ 62.7
Net cash provided by
operating activities... 214.6 240.5 246.3 125.0 4.4 12.5
Net cash used in
investing activities... (150.3) (159.4) (97.8) (195.0) (1,982.6) (109.8)
Net cash (used in)
provided by financing
activities............. (45.7) (54.6) (373.0) 6.8 1,977.5 105.1
<CAPTION>
AZURIX
------------------------
PRO FORMA AS ADJUSTED(4)
------------------------
THREE
MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1998 1999
------------ ---------
(UNAUDITED)
<S> <C> <C>
STATEMENT OF INCOME DATA:
Operating revenues....... $464.2 $116.9
Operations and
maintenance expense.... 120.9 31.8
General and
administrative
expense................ 44.4 22.6
Depreciation and
amortization........... 88.3 23.3
Operating income......... 210.6 39.2
Net income............... 87.2 16.1
Basic earnings per common
share(1)............... 0.74 0.14
Diluted earnings per
common share(1)........ 0.74 0.14
OTHER FINANCIAL DATA:
EBITDA(2) (unaudited).... $298.1 $ 62.7
Net cash provided by
operating activities...
Net cash used in
investing activities...
Net cash (used in)
provided by financing
activities.............
</TABLE>
<TABLE>
<CAPTION>
AT MARCH 31, 1999
-----------------------------
AZURIX AS ADJUSTED(4)
------------ --------------
(UNAUDITED)
(IN MILLIONS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 13.1 $ 251.5
Working capital........................................... (134.5) 168.1
Total assets.............................................. 3,349.3 3,587.7
Note payable -- affiliate................................. 117.8 117.8
Long-term debt (excluding current maturities)............. 940.3 940.3
Other long-term liabilities (including deferred taxes).... 417.2 417.2
Stockholders' equity...................................... 1,614.7 1,917.3
</TABLE>
(footnotes on following page)
6
<PAGE> 10
- ---------------
(1) The basic and diluted earnings per common share amounts for Wessex are not
meaningful on a comparative basis to Azurix and, therefore, are not
presented.
(2) EBITDA for any relevant period presented above is defined as net income
before net interest (income) expense, income tax, utility tax, depreciation
and amortization. EBITDA is not a measure recognized by generally accepted
accounting principles and should not be considered in isolation or as a
substitute for operating profit, as an indicator of liquidity or as a
substitute for net cash provided by operating activities. This method may
not be comparable to the EBITDA calculations of other entities.
(3) The year ended March 31, 1998 includes a windfall tax of $162.3 million,
which has been described by the U.K. Government as a one-time tax. Excluding
the effect of this tax, for the year ended March 31, 1998, Wessex's net
income would have been $179.0 million.
(4) As adjusted to reflect the application of the net proceeds to Azurix from
the offering. As of June 7, 1999, Azurix has $280.4 million of borrowing
capacity under the senior credit facility available to fund future
acquisitions. It is expected that $208.0 million of this facility, along
with $230.6 million of proceeds from the offering, will be used to fund the
$438.6 million acquisition of an interest in a concession in two regions of
the Province of Buenos Aires, Argentina.
7
<PAGE> 11
RISK FACTORS
Investing in our common stock will provide you with an equity ownership
interest in Azurix. As an Azurix stockholder, you will be subject to risks
inherent in our business. The performance of your shares will reflect the
performance of our business relative to, among other things, competition, market
conditions and general economic and industry conditions. The value of your
investment may increase or decline and could result in a loss. You should
carefully consider the following factors as well as other information contained
in this prospectus before deciding to invest in shares of the common stock.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, OUR FUTURE OPERATING RESULTS ARE
DIFFICULT TO FORECAST AND OUR FUTURE FINANCIAL OR OPERATING RESULTS MAY BE
MATERIALLY DIFFERENT FROM THE RESULTS IN THIS PROSPECTUS. THESE DIFFERENCES
COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
We are a new company with a limited operating history. Our limited
operating history and the unpredictable results of our acquisition strategy make
it difficult to forecast our future operating results. The financial data
presented in this prospectus under "Summary -- Summary Historical and Unaudited
Pro Forma Consolidated Financial Data" and "Selected Historical and Unaudited
Pro Forma Consolidated Financial Data" excludes financial data relating to our
recent investment in Cancun, Mexico, our acquisition of Philip Utilities and our
pending investments in Buenos Aires, Argentina and Mexico and is not indicative
of our future financial or operating results. We expect to experience
significant competition in bidding and negotiating for water projects worldwide.
As a new company, we will face competition from companies that have a longer
operating history and have more experience in bidding for water and wastewater
projects. Our limited operating history may make it difficult for us to qualify
for, or be successful in, bidding. For example, we may be at a disadvantage in
bidding for some projects when we do not have a history of operating in a
country or region, or when we do not have a history of operating a water or
wastewater system or individual treatment plant of a size comparable to the
system or facility being privatized or built.
We will derive our consolidated operating revenues almost exclusively from
the operations of Wessex until such time as our other investments begin to
generate revenue. Operating revenues from Wessex may not be available for
distribution to Azurix due to operating and financing requirements of Wessex,
financing requirements of intermediate companies, regulatory developments
affecting the rates Wessex may charge its customers and other regulatory or
other restrictions on its ability to pay dividends to its shareholders.
OUR PROFITABILITY AND PROSPECTS FOR GROWTH ARE HIGHLY DEPENDENT ON COMPLETING
ACQUISITIONS AND DEVELOPING PROJECTS, AND WE MAY NOT BE ABLE TO COMPLETE
ACQUISITIONS AND DEVELOP PROJECTS SUCCESSFULLY.
There is a risk that we may not be able to complete acquisitions of water
and wastewater assets and develop projects successfully because these
transactions involve many complexities. Such complexities include, among other
things, negotiation of satisfactory water supply and wastewater treatment
services agreements with local governments and receipt of required governmental
consents and permits. In addition, in evaluating and negotiating water projects,
water companies may encounter difficulties in determining the status and
condition of existing systems or developing accurate forecasts of material
factors such as the rate of population growth, particularly in developing
countries. In privatization transactions, we may be unable to predict with
certainty the timing of a privatization or the commitment level of a government
to completing a privatization. In addition, most privatizations are
competitively bid, and there is no assurance as to what proportion of the
projects on which we bid we ultimately will acquire. Because part of our
business strategy is to grow through acquisitions and development projects, we
have recently put in place a business development effort with associated
general, administrative and operating expenses. To the extent we are not
successful in completing acquisitions and development projects, these expenses
will not be absorbed by revenues associated with those acquisitions and
development projects and will decrease our net income. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Outlook."
8
<PAGE> 12
WATER AND WASTEWATER COMPANIES FACE PRICE AND OTHER REGULATION THAT COULD REDUCE
OUR OPERATING REVENUES.
Governments generally regulate the prices that water and wastewater
companies may charge their customers and the competitive environment in which
they operate. Regulatory regimes vary from country to country and at times can
give great discretion to the regulatory authority. Moreover, the regulatory
authorities in countries where we currently operate, or may operate in the
future, could change, as could the regulations they promulgate. These changes
could cause reductions in our operating revenues. For example, the U.K. Director
General of Water Services is currently conducting a periodic review of the price
limits for water and wastewater companies in England and Wales that is expected
to result in new price limits for the period from April 1, 2000 through 2005. In
setting price limits, the Director must act in the manner he considers best
calculated to ensure that water companies are able to finance the proper
carrying out of their functions, in particular, by securing a reasonable return
on their capital.
In October 1998, the Director proposed an initial price cut for Wessex in
excess of 17.5% from 1999-2000 to 2000-2001, with prices gradually increasing
thereafter but remaining below the 1999-2000 levels in 2004-2005. Following this
proposal, the U.K. Government announced its decision to require greater capital
expenditures for water and wastewater companies for environmental improvements.
Subsequently, in its April 1999 business plan filed with the Director, Wessex
proposed stable prices from 1999-2000 to 2000-2001, with prices gradually
increasing to 18% higher than current levels in 2005, primarily to fund capital
expenditures mandated by the new environmental standards. The Director will
consider the business plan in his review. The Director has stated that he will
publish draft price limits in July 1999 with the final determination being made
in November 1999. These price limits may differ materially from the Director's
original proposal. Although we are unable to predict the precise outcome of the
current U.K. periodic review, if Wessex were required to cut its prices as
originally proposed by the Director, Wessex's regulated operating revenues,
which represent approximately 90% of our total operating revenues, would be
reduced by over 17.5% and its earnings would be reduced materially.
FAILURE TO IDENTIFY AND ASSESS ACCURATELY THE RISKS RELATED TO AN ACQUISITION OR
PROJECT COULD REDUCE OUR OPERATING RESULTS, INCLUDING EARNINGS.
In evaluating potential transactions, we make assumptions and projections
based on the potential for increased returns, future regulatory and rate case
changes and the engineering, operations, financing, economic structuring,
insurance, tax, environmental, legal and accounting risks relating to each
transaction. Forecasts, estimates and information provided by local governments
and other sources used to bid for public tenders can prove to be materially
inaccurate or incomplete, resulting in projections for capital expenditures to
improve or build water systems that are below what is ultimately required. If
the assumptions on which we base our decision to acquire assets or develop a
project prove to be incorrect in any material respect, either because of
inaccurate or incomplete information provided by the other party or parties to
the transaction or because of a failure by us to accurately identify or assess
the risks or capital requirements related to a proposed acquisition or project,
then our operating results, including earnings, could be materially adversely
affected. Although we attempt to identify all risks associated with any given
transaction, no assurance can be given that we will identify all risks related
to a transaction.
BECAUSE OUR BUSINESS REQUIRES SUBSTANTIAL CAPITAL EXPENDITURES, DIFFICULTY
FINANCING OUR OPERATIONS, ACQUISITIONS AND PROJECTS COULD LIMIT OUR GROWTH AND
REDUCE OUR EARNINGS.
The water assets and projects in which we plan to invest may require
substantial capital expenditures, especially early in the life of our
investments. We intend to finance our investments and projects using various
techniques and instruments such as debt financing, project financing and equity
investments. We expect to engage in leveraged transactions, and we may pledge
all or substantially all of our assets. For example, the capital stock of Wessex
is pledged as security for the senior credit facility of Azurix Europe Ltd,
Wessex's holding company. In addition, there is a risk that financing may not be
readily available to acquire water and wastewater assets or develop projects.
Our ability to arrange financing will be affected by general economic and
capital market conditions, credit availability from banks or other lenders and
the
9
<PAGE> 13
risks inherent in particular concessions, projects or countries. In particular
projects, we may have a co-owner with limited resources or that may default on
its obligations to contribute capital to the project. Enron is not obligated to
provide additional financial support to Azurix for any capital expenditures or
investments.
IF WE DO NOT HAVE OPERATIONAL CONTROL IN A PROJECT, OUR OPERATING REVENUES AND
EARNINGS COULD BE REDUCED.
We may invest in water and wastewater projects and assets in which we do
not own a majority of the project or assets. In addition, we may invest in or
own projects and assets with partners, co-venturers and other parties, including
governmental entities. Some jurisdictions require participation of employees or
other stakeholders in company management. In these cases, major decisions may
require the consent of other equity owners or stakeholders.
We may also invest in projects and assets where we do not serve as
operator. For example, we do not have operational control in our Mendoza,
Argentina concession. In these cases, our ability to direct the outcome of
matters with respect to the operations of the project or assets could be
limited. A lack of operational control in a project could materially and
adversely affect our interest in the project and, as a result, our operating
revenues and earnings from the project.
IF WE ENCOUNTER PROBLEMS INTEGRATING ACQUISITIONS AND MANAGING OUR GROWTH, OUR
FINANCIAL RESULTS AND THE MARKET PRICE OF OUR COMMON STOCK COULD BE MATERIALLY
ADVERSELY AFFECTED.
We intend to grow in part through acquisitions of water and wastewater
assets. Since January 1, 1999, we have completed the Cancun and Philip Utilities
transactions and have pending transactions in Buenos Aires, Argentina and
Mexico. Because we are pursuing acquisitions around the world and because we are
actively pursuing a number of opportunities simultaneously, we may encounter
unforeseen expenses, difficulties, complications and delays, including
difficulties in staffing and providing operational and management oversight. As
we expand our operations through acquisitions, we may encounter difficulties
integrating such acquisitions and successfully managing the growth of a
portfolio of water and wastewater assets that is diverse both with respect to
types of assets and their location. We cannot assure you that our current
management, personnel and other corporate infrastructure will be adequate to
manage our growth or that our systems, procedures and controls will be adequate
to support our expanding operations. To the extent we encounter problems in
integrating acquisitions and managing our growth, our financial results and the
market price of our common stock could be materially adversely affected.
ENVIRONMENTAL FACTORS AND CHANGES IN REGULATIONS COULD INCREASE OUR COSTS OR OUR
LIABILITIES.
There is a risk that changes in regulations applying to the water supply or
wastewater treatment services industry or new, revised or inconsistent
interpretations of these regulations may adversely affect our financial
condition and results of operations. Water companies are subject to water
quality risks related to contamination of drinking water supplies or
environmental danger from effluent discharges. The occurrence of these or other
risks could have a material adverse effect on our financial position and results
of operations.
In addition, many countries in which we plan to do business have recently
developed, or are in the process of developing, new regulatory and legal
structures that regulate the delivery of drinking water and wastewater services
and accommodate private and foreign-owned water businesses. In some instances,
these regulatory and legal structures and their interpretation and application
by administrative agencies are relatively new and incomplete. The interpretation
of existing rules can be expected to evolve over time and may have an
unpredictable impact on our business. We anticipate future changes in, or
decisions affecting, regulatory regimes that will serve to expand or tighten
regulatory controls. Some of these changes or decisions could have a material
adverse effect on our financial position and results of operations.
In our industrial services business, we may handle hazardous substances in
addition to biological waste. Stringent environmental laws provide for serious
penalties and sometimes impose strict liability on those who handle these
substances or find them on their property. Accordingly, if we handle hazardous
substances in our industrial services business in the future, there is a risk
that we will incur liabilities and
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expenses related to the handling of hazardous substances. Although we maintain
insurance against many of these risks, we cannot be certain that insurance
proceeds received under our policies would adequately cover all liabilities we
might incur.
LIABILITY FOR WATER SUPPLY CONTAMINATION COULD RESULT IN MATERIAL LOSSES AND
COSTS.
Our business, in particular the supply of water to end-users, is subject to
risks of contamination of the water supply, which could result in disease or
even death or otherwise endanger the public health. As a result of
contamination, we could be subject to civil, criminal or regulatory enforcement
actions, private suits and cleanup obligations, which could have a material
adverse effect on our financial condition and results of operations. Drinking
water contamination can be caused by, among other things, wastewater effluent,
stormwater runoff from farms and industrial sites, materials used in the
construction or rehabilitation of water supply pipes, harmful nitrates
attributable to modern farming practices and various other pathogens from a
variety of sources entering the drinking water supply. Accordingly, there can be
no assurance that our water supply will remain at all times free of
contaminants. Although we maintain insurance against many of these risks, we
cannot be certain that insurance proceeds received under our policies would
adequately cover all liabilities we might incur.
POLITICAL AND ECONOMIC CHANGES IN COUNTRIES IN WHICH WE OPERATE COULD ADVERSELY
AFFECT OUR OPERATING RESULTS.
The success of our strategy in many countries will depend on a political
and economic environment that will accommodate foreign investment and project
development. Our operations will be subject to political and economic risks,
including risks of war, terrorism, expropriation, nationalization, renegotiation
or nullification of existing contracts, changes in rates and methods of taxation
and foreign exchange controls or governmental restrictions on the repatriation
of hard currency. You should be aware that we will operate in countries whose
economies differ in many respects from the economies of the United States,
Canada and most Western European countries, including their structure, levels of
capital reinvestment, growth rate, government involvement, resource allocation,
self-sufficiency, rate of inflation and balance of payments position. In many of
these countries, the government retains significant control over the economy.
Thus, there is a risk that future government actions, especially with respect to
nationally important facilities such as water systems, could have a material
adverse effect on our financial condition and results of operations.
WORK STOPPAGES AND OTHER LABOR RELATIONS MATTERS COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.
We are subject to a risk of work stoppages and other labor relations
matters because we have invested and will invest in the future in assets and
projects utilizing a workforce that in many cases will be unionized. For
example, all or a portion of the work forces at Wessex, Mendoza, Cancun and
Philip Utilities are represented by unions. On June 6, 1999, Philip Utilities'
workers at the Hamilton-Wentworth facility went on strike. Philip Utilities has
a strike plan in place, and to date Philip Utilities has continued to operate
and maintain the facility without any material adverse effect on us, Philip
Utilities or the facility's performance. As a result of the strike, however,
there is a risk that the operations at the Hamilton-Wentworth facility could be
materially adversely affected. In addition, there is a risk that Philip
Utilities could be in default under the plant operations agreement with
Hamilton-Wentworth or that Hamilton-Wentworth could attempt to terminate this
contract. See "Business -- Existing Azurix Assets -- Philip Utilities Management
Corporation."
Our ability to obtain an adequate return on an investment will often depend
on our success in optimizing the labor force through voluntary and sometimes
involuntary staff reductions. There is a risk that layoffs, where implemented,
could trigger community or union problems. We cannot assure you that issues with
our labor forces will be resolved favorably to us in the future or that we will
not experience work stoppages in future years.
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CHANGES IN CURRENCY EXCHANGE RATES, LIMITATIONS ON SENDING FUNDS OUT OF A
FOREIGN COUNTRY AND FOREIGN CURRENCY RESTRICTIONS OR SHORTAGES COULD ADVERSELY
AFFECT OUR OPERATING RESULTS.
Because we conduct operations outside the United States, limitations on the
right to convert currency or to take it out of a foreign country, changes in
exchange rates and the capacity of currency exchange markets may adversely
affect our ability to repatriate profits. As of December 31, 1998, 98.5% of our
total liabilities were non-U.S. dollar denominated. For the year ended December
31, 1998, 100% of our operating revenues were non-U.S. dollar denominated but
were in the same currencies as our non-U.S. dollar denominated liabilities.
Legal restrictions or shortages in currencies in countries outside the United
States may prevent us from converting sufficient local currency to enable us to
comply with our currency payment obligations not denominated in local currency
or to meet our operating needs and debt service requirements.
OPERATING IN COUNTRIES WITHOUT ADEQUATE REVENUE COLLECTION SYSTEMS COULD REDUCE
OUR OPERATING REVENUES.
There is a risk that we will operate in countries whose legal systems do
not have established or well-enforced collection mechanisms for water supply and
wastewater treatment services. Also, customers in such countries may not be able
or willing to pay for water services. This could have a material adverse effect
on our financial condition and results of operations. There can be no assurance
that government subsidies or taxes and other concessions will sufficiently
compensate private parties that provide these services for the economic
consequences of such conditions. Where initially available, there is a risk that
such subsidies and concessions could be reduced or eliminated before reliable
revenue sources and collection mechanisms can be established.
INTERACTION OF DIFFERENT COUNTRIES' TAX LAWS COULD LOWER OUR RETURNS.
Tax laws in various countries treat differently the taxability of various
aspects of income and gain and the deductibility of expenses and losses. Income
earned in one jurisdiction also may be taxable in another, including the United
States. Although in many instances U.S. tax laws will permit us to credit
amounts paid in taxes in other countries against our U.S. tax obligations, the
rules allowing credits are complex and do not allow credits in many
circumstances. Moreover, if we incur expenses in one jurisdiction that benefit a
project in another, they may not be deductible against income in the
jurisdiction where the expenses were incurred. This could occur, in particular,
in the United States, if our operating revenues from future U.S. operations do
not exceed the expenses we incur in the United States in supporting our
worldwide operations.
OPERATING IN COUNTRIES WITH UNDEVELOPED LEGAL SYSTEMS COULD ADVERSELY AFFECT OUR
BUSINESS BECAUSE WE MAY ENCOUNTER DIFFICULTIES ENFORCING OUR CONTRACTUAL RIGHTS.
Developing countries in which we may pursue opportunities may not have well
established legal systems and may lack a well-developed, consolidated body of
laws governing foreign investment enterprises. The uncertainty of the legal
environment in these countries could make it difficult for us to enforce our
rights, or those of our operating companies, under agreements relating to our
operations. In addition, the administration of laws and regulations by
government agencies in such countries may be subject to considerable discretion
or prejudice against foreigners or private investors. As these legal systems
develop, foreign investors may be adversely affected by new laws and changes to
existing laws. In addition, in countries where adequate laws and well-developed
legal systems do exist, it may not be possible to obtain swift and equitable
enforcement of such laws.
RESTRICTIONS IN DEBT AGREEMENTS COULD LIMIT OUR GROWTH AND OUR ABILITY TO
RESPOND TO CHANGING CONDITIONS.
We conduct substantially all of our operations through subsidiaries, and
substantially all of our assets consist of equity in our subsidiaries. Some of
the debt financing arrangements to which we or our subsidiaries are or may
become a party impose restrictions on their business operations, which may
affect our business operations. The covenants contained in the credit agreements
to which Azurix Europe and Wessex are parties will have several restrictive
effects on our future operations. For example, the covenants
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contained in the senior credit facility for Azurix Europe require Wessex to meet
financial tests and limit Wessex's ability to borrow additional funds or dispose
of assets. These covenants could hinder our flexibility in planning for, and
reacting to, changes in our business. In addition, our ability to obtain
additional financing for working capital, capital expenditures, acquisitions,
general corporate and other purposes at the Azurix level may be limited by the
fact that the capital stock of Wessex is pledged as security for Azurix Europe's
senior credit facility. Additionally, covenants contained in the senior credit
facility restrict Azurix Europe from paying dividends to Azurix. This could
limit our ability to pay dividends on our common stock. See "Description of
Indebtedness."
FAILURE OF COMPUTER SYSTEMS TO RECOGNIZE YEAR 2000 COULD HAVE AN ADVERSE EFFECT
ON OUR BUSINESS.
Year 2000 problems could result from computer hardware and software using
two digits rather than four digits to define the applicable year. These problems
include operational inefficiencies, systems failures, business disruptions and
lost revenues attributable to the inability of these two digit systems to
recognize the Year 2000. We intend to implement Enron's Year 2000 plan to
identify and remediate our Year 2000 problems. However, because we have not
completed our analysis of our Year 2000 readiness or the Year 2000 readiness of
parties on whom we rely, we cannot ensure that the identification and
remediation of our Year 2000 problems will be successful.
If our mission-critical information systems fail or if suppliers on which
we depend for essential goods and services experience mission-critical
information system failures, our business could be materially adversely
affected. We could face substantial claims by governments, governmental
authorities or customers, as well as loss of operating revenues, due to service
interruptions, violations of environmental regulations, inability to fulfill
contractual obligations, inability to account for obligations and increased
expenses associated with litigation, harm to persons or to property,
stabilization of operations following system failures and the execution of
contingency plans. In addition, we could face claims of damage to persons or
property as the result of improperly treated water or wastewater.
Our preliminary assessment of our Year 2000 issues has not demonstrated a
need to incur material Year 2000 costs. However, the following factors could
result in actual Year 2000 costs being higher than anticipated:
- Our recent and future acquisitions could have significant undetected Year
2000 problems.
- We depend on third parties, including customers, suppliers and service
providers, who may fail to address adequately their Year 2000 problems.
- We rely on automated plant systems, computerized billing procedures and
other embedded chip technologies that could necessitate expensive
corrective actions.
For a more detailed discussion of the state of our Year 2000 readiness, the
costs we anticipate incurring to become Year 2000 ready and our Year 2000
contingency plans, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000."
OUR SUCCESS DEPENDS ON KEY MEMBERS OF OUR MANAGEMENT, THE LOSS OF WHOM COULD
DISRUPT OUR BUSINESS OPERATIONS.
We depend on the continued employment of key management personnel we have
brought in from Enron, Wessex and other multinational companies. We have entered
into employment agreements with these executives. If these officers resign or
become unable to continue in their present role and if they are not adequately
replaced, our business operations could be materially adversely affected. See
"Management."
CHANGES IN OUR RELATIONSHIP WITH ENRON COULD INCREASE OUR COSTS BECAUSE WE RELY
ON ENRON FOR CORPORATE STAFF AND SUPPORT SERVICES.
We have entered into an agreement with Enron pursuant to which Enron
provides various corporate staff and support services to us. These services
include information technology, office space, building maintenance, security and
other office services as well as employee development, training and maintenance
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of compensation and other benefits programs. We also may utilize Enron's
regulatory affairs, marketing affairs, treasury and risk assessment and control
departments. In addition, Azurix may continue to participate in Enron's
corporate insurance program. The agreement provides that we may use the
international offices of Enron and its affiliates for projects, subject to our
mutual agreement with Enron or its affiliates on a project-by-project basis. Due
to prior commitments that Enron or its affiliates may have in a particular
office or due to other reasons, there is a risk that Enron or its affiliates may
not permit Azurix to use a particular international office for a particular
project.
Our agreement with Enron is for an indefinite term, but may be terminated
on 180 days' notice. If the agreement is terminated, we expect that we would be
able to arrange alternate suppliers for all the services important to our
business. We expect that these services would be available from third parties at
costs similar to those we pay Enron. However, if we have to replicate
facilities, services or employees that we are not using full time, our costs
would increase. It is not possible to predict the specific areas where our costs
would increase, as that depends on the growth and needs of our business at the
time of any such termination.
OUR BUSINESS OPPORTUNITIES COULD BE LIMITED BECAUSE ENRON AND ITS AFFILIATES MAY
COMPETE WITH AZURIX IN WATER-RELATED ACTIVITIES AND BECAUSE AZURIX MAY ONLY
ENGAGE IN ACTIVITIES GENERALLY IDENTIFIED IN THIS PROSPECTUS, INCIDENTAL
ACTIVITIES AND OTHER ACTIVITIES AS ATLANTIC WATER TRUST OR ENRON MAY APPROVE.
Enron and Azurix have entered into an agreement that limits the scope of
Azurix's business and provides that Enron and its affiliates may engage in
water-related businesses, even if those businesses have a competitive impact on
Azurix. In general, Enron is permitted to engage in any business whatsoever,
including water, wastewater and other businesses competing with Azurix, and may
compete in public tenders against Azurix, provided the business is conducted and
opportunities are identified and developed through Enron's own personnel and not
through Azurix. If an opportunity in the water industry is presented to a person
who is an officer or director of both Enron and Azurix, the opportunity must
first be offered to Azurix, unless water constitutes a minority of the fair
market value of the opportunity, as determined by that officer or director in
good faith based on information available at the time. Azurix has agreed to
indemnify Enron and its officers, directors and employees against any claim that
Enron's pursuit of any water business was a breach of any duty owed by Enron to
Azurix, provided Enron has followed the rules described above. Were Enron to
decide to pursue activities in the water or wastewater industry, its size,
access to capital and experience in developing products and markets could make
it a strong competitor.
The agreement requires Azurix to limit its purpose, in its certificate of
incorporation, to the businesses generally identified in this prospectus,
activities incidental to those businesses, and such other businesses as Enron
may approve in its sole discretion. Azurix has agreed not to amend its
certificate of incorporation to expand its purpose clause without Enron's prior
written consent. The agreement thus limits our ability to pursue potentially
profitable activities that are not primarily in the water and wastewater sector,
even though those opportunities come to our attention on account of our
activities in water and wastewater. For example, some jurisdictions may choose
to privatize their water and other utility assets together. As a result of this
agreement, we would need Enron's consent to pursue the privatization if the
water and wastewater aspects were not expected to represent a majority of the
value.
The agreement restricts Enron and Azurix from taking action to restrict
each others' businesses, to cause either of them to violate any law or to
subject them to regulation under the U.S. Public Utility Holding Company Act of
1935. The agreement expires the first date on which Enron and its affiliates do
not individually or collectively, directly or indirectly, own or have the power
to vote at least one-third of the shares of Azurix ordinarily entitled to vote
for the election of directors, and fewer than one-third of the directors of
Azurix are persons who are employees, officers or directors of Enron or any
affiliate of Enron. See "Transactions with Enron, Atlantic Water Trust and
Marlin Water Trust -- Agreement Regarding Business Opportunities and Related
Matters."
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THROUGH ATLANTIC WATER TRUST, ENRON AND MARLIN WATER TRUST WILL CONTROL THE
OUTCOME OF STOCKHOLDER VOTING AND MAY EXERCISE THIS VOTING POWER IN A MANNER
ADVERSE TO THE INTERESTS OF OTHER STOCKHOLDERS.
Atlantic Water Trust currently owns all of Azurix's outstanding common
stock. Following completion of the offering, Atlantic Water Trust will own
approximately 68.7% of our outstanding common stock, or 64.1% if the
underwriters' over-allotment option is exercised in full. Each of Enron and
Marlin Water Trust owns a 50% voting interest in Atlantic Water Trust. To date,
Enron has appointed all of the directors of Atlantic Water Trust and Azurix,
although Marlin Water Trust at any time has the right to elect or replace half
of the directors of Atlantic Water Trust and currently up to half of the Azurix
directors. Following the offering, as long as Atlantic Water Trust owns a
majority of our outstanding voting stock, Marlin Water Trust has the right to
direct Atlantic Water Trust to elect or replace a percentage of Azurix's
directors equal to 50% minus the percentage of outstanding voting stock held by
persons other than Atlantic Water Trust, Enron and its affiliates. Furthermore,
Marlin Water Trust, with the consent of the holders of a majority of our
outstanding voting stock held by persons other than Atlantic Water Trust, Enron
and its affiliates, has the right to direct Atlantic Water Trust to elect or
replace half of Azurix's directors. In each case, Marlin Water Trust's right to
designate directors shall be reduced by the number of directors that may be
elected by preferred stock entitled to elect directors as a class. Enron has the
right to direct Atlantic Water Trust to elect or replace the other half of
Azurix's directors. In all other circumstances, the board of directors of
Atlantic Water Trust will direct the voting of Atlantic Water Trust's Azurix
shares. As a result, following the offering, Enron and Marlin Water Trust will
continue to exert significant influence over the policies, management and
affairs of Azurix and will control the outcome of corporate actions requiring
stockholder approval, including the approval of transactions involving a change
in control of Azurix. Enron and Marlin Water Trust's interests may differ from
those of Azurix's other stockholders. As a result, Enron and Marlin Water Trust
may vote Azurix stock in a manner adverse to other stockholders. See
"Transactions with Enron, Atlantic Water Trust and Marlin Water Trust" and
"Principal and Selling Stockholders."
A MAJORITY OF OUR DIRECTORS MAY HAVE CONFLICTS OF INTEREST BECAUSE THEY ARE ALSO
ENRON DIRECTORS OR OFFICERS.
Currently, a majority of our directors are also directors or officers of
Enron, a situation that may create conflicts of interest. The directors and
officers of Enron have fiduciary duties to manage Enron, including its
investments in subsidiaries and affiliates such as Azurix, in a manner
beneficial to Enron and its stockholders. Similarly, the directors and officers
of Azurix have fiduciary duties to manage Azurix in a manner beneficial to
Azurix and its stockholders. In some circumstances, the duties of these
directors and officers of Enron may conflict with their duties as directors of
Azurix. In addition, other conflicts of interest exist and may arise in the
future as a result of the extensive relationships between Enron and Azurix.
Enron and Azurix have agreed that conflicts of interest between Enron and Azurix
may be resolved through approval by a majority of the directors of Azurix not
associated with Enron. See "Transactions with Enron, Atlantic Water Trust and
Marlin Water Trust" and "Principal and Selling Stockholders."
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE.
The market price of our common stock could drop due to sales of a large
number of shares of our common stock in the market after the offering or the
perception that such sales could occur. These factors could also make it more
difficult to raise funds through future offerings of common stock. See "Shares
Eligible for Future Sale."
After the offering, 117,100,000 shares of our common stock will be
outstanding. Of these shares, the 36,600,000 shares to be sold in the offering
will be freely transferable and may be sold without restriction or further
registration under the Securities Act, except for any shares acquired by an
"affiliate" of Azurix as defined in Rule 144 under the Securities Act. In
connection with the offering, Azurix, Enron and the selling stockholder, holding
80,500,000 shares of common stock post-offering, have agreed, with exceptions
specified in the lock-up agreements, not to sell any shares of common stock for
a period of 180 days after the date of this prospectus without the prior written
consent of Merrill Lynch, Pierce, Fenner & Smith
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Incorporated. Upon expiration of the lock-up period, the shares outstanding and
owned by the selling stockholder may be sold in the future without registration
under the Securities Act to the extent permitted by Rule 144 or any applicable
exemption under the Securities Act. In addition, the selling stockholder has
registration rights for all of its shares of our common stock. See "Transactions
with Enron, Atlantic Water Trust and Marlin Water Trust" and "Shares Eligible
for Future Sale."
Options to purchase approximately 8.5 million shares of common stock will
also be outstanding after the offering. Such options generally provide for
vesting over a three to five year period. In addition, more options may be
granted in the future. After the offering, we intend to file a registration
statement covering the sale of approximately 8.5 million shares of common stock
reserved for issuance under our stock plan. See "Management -- Stock Plan."
Marlin Water Trust, or the trustee under its senior notes indenture, may be
required to cause Atlantic Water Trust to sell shares of our common stock owned
by Atlantic Water Trust if the senior notes of Marlin Water Trust have not been
repaid on or before December 15, 2001 or earlier if specified events occur.
These events include defaults under specified debt obligations of Azurix, Enron
or Marlin Water Trust or a downgrading of Enron senior debt to below "Baa3" by
Moody's Investors Service, Inc., "BBB-" by Standard & Poor's Ratings Services or
"BBB-" by Duff & Phelps Credit Rating Co. and a decline in Enron's common stock
price below $37.84. The last sale price of Enron common stock, as reported by
the New York Stock Exchange, on June 9, 1999 was $78.3125. Atlantic Water Trust
may also elect to sell shares of our common stock in advance of the December 15,
2001 maturity of the senior notes of Marlin Water Trust in order to fund the
prepayment of such debt. See "Principal and Selling Stockholders -- Atlantic
Water Trust."
OUR CERTIFICATE OF INCORPORATION CONTAINS PROVISIONS THAT COULD DISCOURAGE A
TAKEOVER.
Our certificate of incorporation authorizes our Board of Directors to issue
preferred stock without stockholder approval. If our Board of Directors elects
to issue preferred stock, it could be more difficult for a third party to
acquire us. In addition, provisions of the certificate of incorporation, such as
a staggered board of directors and limitations on the removal of directors, no
stockholder action by written consent and limitations on stockholder proposals
at meetings of stockholders, could make it more difficult for a third party to
acquire control of us, even if such change of control would be beneficial to
stockholders. See "Description of Capital Stock."
THERE HAS BEEN NO PRIOR PUBLIC MARKET FOR OUR COMMON STOCK AND OUR STOCK PRICE
MAY FLUCTUATE.
There has not been a public market for our common stock. The common stock
will be listed for trading on the New York Stock Exchange. We do not know the
extent to which investor interest in Azurix will lead to the development of a
trading market for the common stock or how the common stock will trade in the
future. The initial public offering price was determined through negotiations
among us, Atlantic Water Trust, Enron and the underwriters. Investors may not be
able to resell their shares at or above the initial public offering price. See
"Underwriting."
The price at which the common stock will trade depends upon a number of
factors, including our historical and anticipated operating results and general
market and economic conditions, some of which are beyond our ability to control.
Factors such as quarterly fluctuations in our financial and operating results,
developments affecting us, our customers, the water markets in which we compete
or the water industry, including the factors listed under "Forward-Looking
Statements," also could cause the market price of the common stock to fluctuate
substantially. In addition, the stock market has from time to time experienced
extreme price and volume fluctuations. These broad market fluctuations may
adversely affect the market price of the common stock.
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FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. All statements other
than statements of historical facts contained in this prospectus, including
statements regarding our future financial position, business strategy, budgets,
projected costs and plans and objectives of management for future operations,
are forward-looking statements. Although we believe our expectations reflected
in these forward-looking statements are based on reasonable assumptions, no
assurance can be given that these expectations will prove to have been correct.
Important factors that could cause actual results to differ materially from the
expectations reflected in the forward-looking statements include, among other
things:
- Political developments in foreign countries
- The ability to enter new water and wastewater markets in the United
States and in other jurisdictions
- The timing and extent of deregulation of water and wastewater markets in
the United States and in other countries
- Regulatory developments in the United States and in other countries,
including tax legislation and regulations
- The extent of efforts by governments to privatize water and wastewater
industries
- The timing and extent of changes in non-U.S. currencies and interest
rates
- The extent of success in acquiring water and wastewater assets and
developing and managing water resources, including the ability to qualify
for and win bids for water and wastewater projects
- The timing and success of efforts to develop international water and
wastewater infrastructure projects
- The ability of counterparties to financial risk management instruments
and other contracts with us to meet their financial commitments to us
- Our success in implementing our Year 2000 plan, the effectiveness of our
Year 2000 plan and the Year 2000 readiness of third parties
- Our ability to access the debt and equity markets during the periods
covered by the forward-looking statements, which will depend on general
market conditions and our credit ratings for our debt obligations
We undertake no obligation to update or revise our forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this prospectus might not occur.
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USE OF PROCEEDS
We expect the proceeds to Azurix from this sale of common stock to be
approximately $302.6 million, after deducting underwriting discounts and
commissions and estimated expenses. Azurix will not receive any proceeds from
the sale of common stock by the selling stockholder.
We intend to use the net proceeds that we receive to repay approximately
$72 million that Enron advanced to us to fund our general, administrative and
operating expenses, from our inception through June 7, 1999, in addition to
capital expenditures. This includes $28.5 million advanced to us by Enron to
fund our acquisition of, and loan to, our investment in Cancun. The amount due
to Enron is non-interest bearing and has no maturity date.
We intend to use the remaining proceeds of $230.6 million, along with
$208.0 million in funds to be drawn under the senior credit facility entered
into on May 10, 1999 by Azurix Europe Ltd, an indirect, wholly owned subsidiary
of Azurix and the holding company for Wessex, to fund the $438.6 million
acquisition of an interest in a concession in two regions of the Province of
Buenos Aires, Argentina. See "Business -- Pending Acquisitions."
See "Description of Indebtedness -- Indebtedness of Azurix Europe" for a
description of the terms of the senior credit facility.
DIVIDEND POLICY
We have not paid any dividends on our common stock, and we do not currently
anticipate paying any dividends on our common stock. We currently intend to
retain all future earnings to fund the development and growth of our business.
The payment of any future dividends will be at the discretion of our Board of
Directors and will depend on our results of operations, financial condition,
capital requirements and other factors deemed relevant by our Board of
Directors.
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DILUTION
If you invest in our common stock, your interest will be diluted to the
extent of the difference between the public offering price per share of our
common stock and the net tangible book value per share of our common stock after
the offering. We calculate net book value per share by dividing the net assets
(total assets less liabilities) by the number of shares outstanding before the
offering. We calculate net tangible book value per share by dividing the net
tangible assets (total assets less liabilities and net intangible assets) by the
number of shares of common stock outstanding before the offering.
The net book value and net tangible book value of Azurix as of March 31,
1999 were approximately $16.15 and $7.58 per share, respectively. Without taking
into account any changes in net book value or net tangible book value after
March 31, 1999, other than to give effect to the offering and the application of
the estimated net proceeds from the offering, the pro forma net book value of
the common stock as of March 31, 1999 would have been approximately $1,917.3
million, or $16.37 per share, and the pro forma net tangible book value of the
common stock as of such date would have been approximately $1,060.5 million, or
$9.06 per share. Assuming the offering had occurred at March 31, 1999, an
immediate increase in net book value of $0.22 per share to the existing
stockholder and an immediate dilution of $2.63 per share to new investors would
have occurred. The following table shows the effect of the offering as if the
offering had occurred at March 31, 1999 and illustrates the immediate increase
in net tangible book value of $1.48 per share to the existing stockholder and an
immediate dilution of $9.94 per share to new investors:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $19.00
Net tangible book value per share as of March 31, 1999.... $ 7.58
Increase in net tangible book value per share attributable
to the offering........................................ 1.48
------
Pro forma net tangible book value per share as of March 31,
1999 after giving effect to the offering.................. 9.06
------
Dilution in net tangible book value per share to new
investors................................................. $ 9.94
======
</TABLE>
The foregoing table excludes employee stock options of Azurix to purchase
approximately 8.5 million shares of common stock. The terms of the options
provide for vesting over a period of time, generally three to five years.
Assuming all options are exercised, pro forma net tangible book value per share
would increase $0.53 per share to $9.59 per share.
The following table shows on a pro forma as adjusted basis at March 31,
1999, the number of shares of common stock purchased from us, the total
consideration (including subsequent capital contributions) paid to us and the
average price paid per share by the existing stockholder and by new investors
purchasing common stock from us in the offering:
<TABLE>
<CAPTION>
SHARES PURCHASED
----------------------- TOTAL AVERAGE PRICE
NUMBER PERCENT CONSIDERATION PER SHARE
------------- ------- ------------- -------------
(IN MILLIONS) (IN MILLIONS)
<S> <C> <C> <C> <C>
Existing stockholder............................. 100.0 85.4% $1,672.0 $16.72
New investors.................................... 17.1 14.6 324.9 19.00
----- ----- --------
Total..................................... 117.1 100.0% $1,996.9
===== ===== ========
</TABLE>
Sales by the existing stockholder in this offering will reduce the number
of shares held by the existing stockholder to 80,500,000 shares, or 68.7% of the
total number of shares outstanding after the offering, and will increase the
number of shares held by new investors to 36,600,000 shares, or 31.3% of the
total number of shares outstanding after the offering. If the underwriters'
over-allotment option is exercised in full, the number of shares of common stock
held by the existing stockholder will be reduced to 75,010,000 shares, or 64.1%
of the total shares of common stock outstanding after the offering, and will
increase the number of shares held by new investors to 42,090,000 shares, or
35.9% of the total shares of common stock outstanding after the offering.
19
<PAGE> 23
CAPITALIZATION
The following table sets forth the cash and capitalization of Azurix as of
March 31, 1999, and as adjusted to give effect to the issuance of 17,100,000
shares of common stock offered by Azurix by this prospectus and the application
of our net proceeds from the offering, assuming the offering occurred on March
31, 1999. The table should be read in conjunction with the Consolidated
Financial Statements of Azurix and related notes thereto and other financial
data included elsewhere in this prospectus. See "Use of Proceeds."
<TABLE>
<CAPTION>
AT MARCH 31, 1999
----------------------
ACTUAL AS ADJUSTED
-------- -----------
(UNAUDITED)
(IN MILLIONS)
<S> <C> <C>
Cash and cash equivalents................................... $ 13.1 $ 251.5
======== ========
Current maturities of long-term debt........................ $ 27.9 $ 27.9
-------- --------
Note payable -- affiliate(1)................................ 117.8 117.8
-------- --------
Long-term debt:
Senior credit facilities(2)............................... 213.0 213.0
Senior unsecured bonds.................................... 478.4 478.4
Acquisition loan notes.................................... 113.8 113.8
European Investment Bank credit facilities................ 61.4 61.4
Capital lease obligation.................................. 73.7 73.7
-------- --------
Total long-term debt.............................. 940.3 940.3
-------- --------
Stockholders' equity(3):
Preferred stock, $0.01 par value; 50,000,000 shares
authorized............................................. -- --
Common stock, $0.01 par value; 500,000,000 shares
authorized; 100,000,000 shares issued and outstanding;
117,100,000 shares issued and outstanding, as
adjusted............................................... 1.0 1.2
Additional paid-in capital................................ 1,671.0 1,973.4
Retained earnings......................................... 26.3 26.3
Cumulative foreign currency translation adjustment........ (83.6) (83.6)
-------- --------
Total stockholders' equity........................ 1,614.7 1,917.3
-------- --------
Total capitalization.............................. $2,700.7 $3,003.3
======== ========
</TABLE>
- ---------------
(1) Amounts outstanding under the loan to Azurix Europe from Bristol Water
Trust, a wholly owned subsidiary of Atlantic Water Trust.
(2) As of June 7, 1999, Azurix has $280.4 million of borrowing capacity under
the senior credit facility available to fund future acquisitions. It is
expected that $208.0 million of this facility, along with $230.6 million of
proceeds from the offering, will be used to fund the $438.6 million
acquisition of an interest in a concession in two regions of the Province of
Buenos Aires, Argentina.
(3) Outstanding shares do not include shares of common stock reserved for
issuance under our stock plan. Following completion of the offering, there
will be outstanding options to purchase approximately 8.5 million shares of
common stock.
20
<PAGE> 24
SELECTED HISTORICAL AND UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL DATA
The tables on the following page present selected historical consolidated
financial data for Azurix and for Wessex, the predecessor of Azurix, for the
periods and dates indicated. In addition, the tables present selected unaudited
pro forma consolidated financial data for Azurix for the periods and dates
indicated.
The historical financial data for Azurix is derived from Azurix's audited
consolidated financial statements and unaudited interim financial statements
included elsewhere in this prospectus and includes the impact of the Wessex
acquisition from the date of acquisition. The historical financial data for the
three months ended March 31, 1999 is derived from financial statements that are
unaudited but include all adjustments, consisting of normal recurring
adjustments, that Azurix considers necessary for a fair presentation of its
financial position and results of operations for the period. The results for the
three months ended March 31, 1999 are not necessarily indicative of the results
for the full year. All of Azurix's 1998 results of operations occurred in the
fourth quarter of 1998, subsequent to the acquisition of Wessex. The historical
balance sheet data for Wessex as of March 31, 1998 and historical income
statement and other financial data for the years ended March 31, 1997 and 1998
and for the six months ended October 2, 1998 are derived from Wessex's audited
consolidated financial statements included elsewhere in this prospectus. The
historical income statement and other financial data for the years ended March
31, 1995 and 1996 and the historical balance sheet data for Wessex as of March
31, 1995, 1996 and 1997 are derived from unaudited financial statements prepared
in accordance with U.S. generally accepted accounting principles that were
derived from Wessex's audited financial statements prepared in accordance with
U.K. generally accepted accounting principles.
The unaudited pro forma financial data for Azurix is derived from the
unaudited condensed consolidated pro forma financial information included
elsewhere in this prospectus. The unaudited pro forma income statement and other
financial data give effect to the acquisition of Wessex, the redemption and
elimination of Wessex's preference shares for an aggregate price of $249.8
million, the sale by Wessex of its interest in UK Waste for $337.9 million and
the offering, as though each occurred on January 1, 1998. The unaudited pro
forma balance sheet data gives effect to the offering as though it occurred on
March 31, 1999. The unaudited pro forma income statement and other financial
data presented below are not necessarily indicative of the financial results
that would have occurred had the acquisition of Wessex, the redemption and
elimination of Wessex's preference shares, the sale by Wessex of its interest in
UK Waste and the offering occurred on January 1, 1998, or indicative of our
financial position had the offering occurred on March 31, 1999 and should not be
viewed as indicative of operations or financial position in future periods.
This information should be read in conjunction with "Capitalization,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Unaudited Condensed Consolidated Pro Forma Financial
Information and related notes thereto and the Consolidated Financial Statements
of Azurix and Wessex and related notes thereto included elsewhere in this
prospectus.
21
<PAGE> 25
<TABLE>
<CAPTION>
WESSEX (PREDECESSOR COMPANY) AZURIX
-------------------------------------------------------- ---------------------------
SIX MONTHS JANUARY 29, THREE MONTHS
YEAR ENDED MARCH 31, ENDED 1998 TO ENDED
------------------------------------------- OCTOBER 2, DECEMBER 31, MARCH 31,
1995 1996 1997 1998 1998 1998 1999
----------- ----------- ------ ------ ---------- ------------ ------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Operating revenues................... $356.3 $376.8 $403.1 $436.6 $233.8 $119.7 $116.9
Operations and maintenance expense... 106.7 106.6 102.4 110.9 61.7 31.6 31.8
General and administrative expense... 33.3 27.4 32.2 29.1 36.4 20.3 22.6
Depreciation and amortization........ 48.5 53.7 58.0 64.3 35.2 22.2 23.3
Operating income..................... 167.8 189.1 210.5 232.3 100.5 45.6 39.2
Equity in earnings (loss) of
affiliates(1)...................... 11.0 14.1 14.7 13.3 5.8 (0.8) 0.2
Net interest (income) expense........ (13.8) (16.9) (10.2) 8.6 6.1 15.1 14.9
Other expense........................ -- -- -- -- -- 1.2 --
Income before income tax and utility
tax................................ 192.6 220.1 235.4 237.0 100.2 28.5 24.5
Income tax expense................... 68.9 79.7 82.4 58.0 28.4 18.3 8.4
Utility tax expense(2)............... -- -- -- 162.3 -- -- --
Net income........................... 123.7 140.4 153.0 16.7 71.8 10.2 16.1
Preference share dividends........... -- 8.0 13.5 15.1 7.7 -- --
Net income available to common
stockholders....................... 123.7 132.4 139.5 1.6 64.1 10.2 16.1
Basic earnings per common share(3)... 0.49 0.62 0.65 0.01 0.30 0.10 0.16
Diluted earnings per common
share(3)........................... 0.40 0.51 0.55 0.01 0.30 0.10 0.16
Dividends declared per common
share(4)........................... 0.19 0.25 0.26 0.31 0.23 -- --
OTHER FINANCIAL DATA:
EBITDA(5) (unaudited)................ $227.3 $256.9 $283.2 $309.9 $141.5 $ 65.8 $ 62.7
Net cash provided by operating
activities......................... 214.6 240.5 246.3 125.0 132.2 4.4 12.5
Net cash used in investing
activities......................... (150.3) (159.4) (97.8) (195.0) (108.4) (1,982.6) (109.8)
Net cash (used in) provided by
financing activities............... (45.7) (54.6) (373.0) 6.8 (23.6) 1,977.5 105.1
<CAPTION>
AZURIX
-------------------------------
PRO FORMA
PRO FORMA AS ADJUSTED(6)
AS ADJUSTED(6) THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1998 1999
-------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
STATEMENT OF INCOME DATA:
Operating revenues................... $464.2 $116.9
Operations and maintenance expense... 120.9 31.8
General and administrative expense... 44.4 22.6
Depreciation and amortization........ 88.3 23.3
Operating income..................... 210.6 39.2
Equity in earnings (loss) of
affiliates(1)...................... (0.8) 0.2
Net interest (income) expense........ 66.1 14.9
Other expense........................ -- --
Income before income tax and utility
tax................................ 143.7 24.5
Income tax expense................... 56.5 8.4
Utility tax expense(2)............... -- --
Net income........................... 87.2 16.1
Preference share dividends........... -- --
Net income available to common
stockholders....................... 87.2 16.1
Basic earnings per common share(3)... 0.74 0.14
Diluted earnings per common
share(3)........................... 0.74 0.14
Dividends declared per common
share(4)........................... -- --
OTHER FINANCIAL DATA:
EBITDA(5) (unaudited)................ $298.1 $ 62.7
Net cash provided by operating
activities.........................
Net cash used in investing
activities.........................
Net cash (used in) provided by
financing activities...............
</TABLE>
<TABLE>
<CAPTION>
WESSEX (PREDECESSOR COMPANY) AZURIX
----------------------------------------------------- -------------------------------------------
PRO FORMA
AT MARCH 31, AT AT AS ADJUSTED(6)
----------------------------------------------------- DECEMBER 31, MARCH 31, AT MARCH 31,
1995 1996 1997 1998 1998 1999 1999
----------- ----------- ----------- ----------- ------------ ----------- --------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........... $ 250.1 $ 228.3 $ (95.5) $ (307.0) $ (129.6) $ (134.5) $ 168.1
Total assets.............. 2,239.9 2,252.7 2,258.0 2,372.3 3,358.3 3,349.3 3,587.7
Long-term liabilities..... 466.3 473.3 483.4 482.3 1,451.4 1,475.3 1,475.3
Redeemable preference
shares.................. -- 235.3 254.7 259.0 -- -- --
Stockholders' equity...... 1,598.7 1,354.4 1,251.5 1,229.5 1,645.5 1,614.7 1,917.3
</TABLE>
- ---------------
(1) Equity in earnings of affiliates for all periods presented for Wessex is
related primarily to Wessex's interest in UK Waste.
(2) The year ended March 31, 1998 includes a windfall tax of $162.3 million,
which has been described by the U.K. Government as a one-time tax. Excluding
the effect of this tax, for the year ended March 31, 1998, Wessex's net
income, basic earnings per common share and diluted earnings per common
share would have been $179.0 million, $0.78 per common share and $0.77 per
common share, respectively.
(3) The basic and diluted earnings per common share amounts for Wessex are based
on the historical average ordinary shares of Wessex and average ordinary
shares of Wessex plus the share effect of the potential conversion to
ordinary shares of its dilutive securities, respectively.
(footnotes continued on following page)
22
<PAGE> 26
(4) Wessex stockholders were given the option to elect dividends declared to be
paid in cash or the issuance of additional ordinary shares. Of the dividends
declared per share for the years ended March 31, 1995, 1996, 1997 and 1998
and for the six months ended October 2, 1998, stockholders elected stock
dividends equal to $0.02, $0.01, $0.02, $0.05 and $0.18 per share,
respectively.
(5) EBITDA for any relevant period presented above is defined as net income
before net interest (income) expense, income tax, utility tax, depreciation
and amortization. EBITDA is not a measure recognized by generally accepted
accounting principles and should not be considered in isolation or as a
substitute for operating profit, as an indicator of liquidity or as a
substitute for net cash provided by operating activities. This method may
not be comparable to the EBITDA calculations of other entities.
(6) As adjusted to reflect the application of the net proceeds to Azurix from
the offering. As of June 7, 1999, Azurix has $280.4 million of borrowing
capacity under the senior credit facility available to fund future
acquisitions. It is expected that $208.0 million of this facility, along
with $230.6 million of proceeds from the offering, will be used to fund the
$438.6 million acquisition of an interest in a concession in two regions of
the Province of Buenos Aires, Argentina.
CURRENCY EXCHANGE RATES
In this prospectus, references to "U.S. dollars," "dollars," "U.S.$" and
"$" are to currency of the United States of America and references to "pounds
sterling," "L," "sterling," "pence" and "p" are to currency of the United
Kingdom. Balance sheet information included in this prospectus has been
translated from the applicable foreign currencies to U.S. dollars using the
current exchange rates in effect at the balance sheet date. Income statement
information included in this prospectus has been translated from the applicable
foreign currencies to U.S. dollars using the weighted average exchange rate
during the period or, where known or determinable, at the rate on the date of
the transaction for significant items. Except as described above, and unless
otherwise stated in this prospectus, some pounds sterling amounts have been
translated from the corresponding pounds sterling amounts, solely for the
convenience of the reader, at the noon buying rate in The City of New York for
cable transfers in pounds sterling as certified for customs purposes by the
Federal Reserve Bank of New York on March 31, 1999, which was $1.61 per L1.00.
Such translations should not be construed as representations that such U.S.
dollar amounts actually represent such pounds sterling amounts or vice versa, or
that such pounds sterling amounts could be or could have been converted into
U.S. dollars at the rate indicated or at any other rate.
23
<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the
information contained in the Consolidated Financial Statements of Azurix and
Wessex and related notes thereto and the Unaudited Condensed Consolidated Pro
Forma Financial Information of Azurix and related notes thereto included
elsewhere in this prospectus.
OVERVIEW
Azurix was incorporated on January 29, 1998. All of its operating results
and cash flows occurred during the fourth quarter of 1998 following the Wessex
acquisition. During 1998, Azurix indirectly acquired all of the outstanding
ordinary share capital of Wessex, and Enron contributed to Azurix the
outstanding common stock of a subsidiary that in June 1998 acquired an indirect
32.1% ownership interest in Obras Sanitarias Mendoza S.A. Wessex and Obras
Sanitarias Mendoza provide water and wastewater treatment services in
southwestern England and the Province of Mendoza, Argentina, respectively. In
December 1998, Enron contributed Azurix to Atlantic Water Trust and Marlin Water
Trust acquired a 50% voting interest in Atlantic Water Trust. Enron retained a
50% voting interest in Atlantic Water Trust.
BUSINESS ACQUISITION
On October 2, 1998, Azurix, through its indirect wholly owned subsidiary
Azurix Europe, acquired over 90% of the outstanding ordinary share capital of
Wessex. On that same date, Azurix Europe issued notices to the remaining Wessex
ordinary shareholders, informing them that it intended to exercise its rights
under the English Companies Act to acquire compulsorily all of the outstanding
ordinary shares not held by Azurix Europe. The compulsory share acquisition was
completed in November 1998. The per share price paid to Wessex shareholders was
L6.30. The total cost of the Wessex acquisition, including transaction costs,
was $2.4 billion, plus the assumption of $481.5 million of existing Wessex debt.
The cost included cash consideration paid to Wessex shareholders, net of $1.7
million cash acquired, and the issuance of loan notes to Wessex shareholders in
the face amount of $119.8 million. The acquisition was financed through capital
contributions from Azurix's parent company totaling $1.6 billion and the
issuance of $0.8 billion in debt by Azurix Europe. Wessex had cumulative
mandatorily redeemable preference shares outstanding when it was acquired.
Wessex redeemed these shares in December 1998 for a cash payment of $106.4
million.
SALE OF INVESTMENT IN UNCONSOLIDATED AFFILIATE
On November 30, 1998, Wessex sold its 50% interest in Wessex Waste
Management Ltd, a joint venture with Waste Management International Plc that
does business as UK Waste, for $337.9 million in cash. Azurix recorded no gain
or loss from the sale.
RECENT DEVELOPMENTS
Azurix entered into an agreement on December 19, 1998 to purchase 49.9% of
an entity whose principal asset is the water concession for the city of Cancun,
Mexico. This agreement was not binding until material conditions were met, which
included modification of the concession agreement by the local water and
wastewater regulatory agency, approvals from the local antitrust and foreign
investment agencies, as well as agreement on the terms of the credit agreement,
security arrangements and other associated documents. These conditions were
satisfied subsequent to December 31, 1998. The purchase price was $13.5 million
and the acquisition closed on March 24, 1999. In addition, Azurix has agreed to
provide up to $25.0 million in debt financing, $15.0 million of which was funded
on February 25, 1999.
On March 30, 1999, Azurix, through subsidiaries of Wessex, completed a U.K.
pounds sterling denominated bond offering in the amount of $484.2 million.
Wessex used $448.4 million of the proceeds from the sale of the 10-year bonds to
repay all outstanding amounts under its former bank credit facilities as well as
all outstanding amounts under uncommitted credit facilities. Any remaining
proceeds were
24
<PAGE> 28
available for general corporate purposes. The bonds mature March 30, 2009 and
bear interest of 5.875% payable annually. See "Description of
Indebtedness -- Indebtedness of Wessex."
Effective May 1, 1999, Azurix signed an agreement with Enron pursuant to
which Enron provides various corporate staff and support services to Azurix.
These services include information technology, office space, building
maintenance, security and other office services as well as employee development,
training and maintenance of compensation and other benefits programs. Azurix may
utilize Enron's regulatory affairs, marketing affairs, treasury and risk
assessment and control departments. In addition, Azurix may continue to
participate in Enron's corporate insurance program. The agreement provides that
Azurix may use the international offices of Enron and its affiliates for
projects, subject to mutual agreement with Enron or its affiliates on a
project-by-project basis. The agreement provides that Azurix will reimburse
Enron for direct charges related to the Enron services and facilities that it
utilizes. Azurix will also be allocated an amount for overhead charges related
to Enron corporate staff and support services which it utilizes. This overhead
charge will be allocated based upon factors such as employee headcount, payroll
and square footage. Azurix management believes the allocation methods and costs
are reasonable. Costs for services used under the agreement are expected to be
approximately $15 million annually. The agreement is for an indefinite term, but
either party may terminate the agreement on 180 days' notice. Azurix intends to
enter into a related sublease with Enron providing for the use of office space
in Houston, Texas.
Effective May 1, 1999, Azurix entered into a credit agreement with Enron,
whereby Enron will provide funds to Azurix for general, administrative and
operating expenses. The total commitment under the credit agreement will be $180
million. Advances under the credit agreement will bear interest at the federal
funds rate plus 1.50%. Amounts borrowed under the credit agreement may be
prepaid, in full or in part, at any time during the term of the credit
agreement. The credit agreement matures December 15, 2001 or 90 days following
the date that Enron or its affiliates do not own or have the power to vote at
least one-third of our capital stock ordinarily entitled to vote for the
election of directors and fewer than one-third of our directors are officers,
directors or employees of Enron or its affiliates.
On May 10, 1999, Azurix Europe entered into a L425 ($686.0) million
revolving credit facility. On May 13, 1999, Azurix Europe borrowed approximately
$75.9 million, of which approximately $67.8 million was used to repay all of the
remaining indebtedness outstanding on its former senior credit facility and
approximately $8.1 million was primarily used to pay fees and expenses related
to this facility. On May 14, 1999, Azurix borrowed $107.0 million under this
revolving credit facility, primarily to fund the purchase of Philip Utilities. A
portion of the unused borrowing capacity under this facility secures outstanding
loan notes of $113.8 million. The facility bears interest at the London
interbank offered rate plus 0.75% to 1.0%, depending on the level of utilization
of the borrowing capacity. The facility terminates on May 10, 2002. See
"Description of Indebtedness -- Indebtedness of Azurix Europe."
On May 18, 1999, Azurix acquired 100% of the stock of Philip Utilities for
$106.3 million. Philip Utilities is a water and wastewater services company in
the United States and Canada that provides operations and management,
engineering, residuals management and underground infrastructure development
services for municipal water and wastewater facilities.
On May 18, 1999, authorities in the Province of Buenos Aires, Argentina,
notified Azurix that, subject to final confirmation, Azurix will be awarded an
interest in a 30-year water and wastewater concession in two regions of the
province, at an aggregate price of $438.6 million. Assuming this award is
formally confirmed, Azurix will acquire a 100% interest in the concessionaire,
with 10% being transferred to employees of the concessionaire within several
months. Azurix is expected to assume operation of the systems in these regions
on June 18, 1999.
On May 28, 1999, Azurix entered into an agreement to acquire 49% of the
capital stock of Industrias del Agua, S.A. de C.V., a water and wastewater
service company based in Monterrey, Mexico. Pursuant to a contract with the
Water Commission of the Federal District of Mexico, Industrias del Agua provides
metering, billing, collections, operations and maintenance services for an area
covering approximately one quarter of the Federal District within Mexico City, a
service area with a population of approximately two million people. In addition
to holding an equity interest in Industrias del Agua, Azurix will serve as
25
<PAGE> 29
the technical participant in providing services under the Federal District
contract. Industrias del Agua has provided these services since 1993, when it
signed this 10-year contract with the Water Commission of the Federal District.
The purchase is subject to the receipt of administrative and regulatory
approvals, including the approval by the Water Commission of the Federal
District regarding the substitution of Azurix as the technical participant under
the contract. Azurix will pay $22.5 million in connection with the transaction,
which is expected to close by the end of July 1999.
RESULTS OF OPERATIONS
The following table sets forth condensed statements of income for the
periods indicated:
<TABLE>
<CAPTION>
AZURIX
-------------------------------------------------
WESSEX (PREDECESSOR COMPANY) PRO FORMA
------------------------------------------ JANUARY 29, 1998 THREE MONTHS AS ADJUSTED
YEAR ENDED YEAR ENDED SIX MONTHS ENDED (DATE OF INCEPTION) ENDED YEAR ENDED
MARCH 31, MARCH 31, OCTOBER 2, TO DECEMBER 31, MARCH 31, DECEMBER 31,
1997 1998 1998 1998 1999 1998
---------- ---------- ---------------- ------------------- ------------ ------------
(IN MILLIONS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Operating revenues....... $403.1 $436.6 $233.8 $119.7 $116.9 $464.2
------ ------ ------ ------ ------ ------
Operations and
maintenance expense.... 102.4 110.9 61.7 31.6 31.8 120.9
General and
administrative
expense................ 32.2 29.1 36.4 20.3 22.6 44.4
Depreciation and
amortization........... 58.0 64.3 35.2 22.2 23.3 88.3
------ ------ ------ ------ ------ ------
Operating income......... 210.5 232.3 100.5 45.6 39.2 210.6
Equity earnings (loss) of
affiliates............. 14.7 13.3 5.8 (0.8) 0.2 (0.8)
Net interest (income)
expense................ (10.2) 8.6 6.1 15.1 14.9 66.1
Other expense............ -- -- -- 1.2 -- --
------ ------ ------ ------ ------ ------
Income before income tax
and utility tax
expense................ 235.4 237.0 100.2 28.5 24.5 143.7
Income tax and utility
tax expense............ 82.4 220.3 28.4 18.3 8.4 56.5
------ ------ ------ ------ ------ ------
Net income............... $153.0 $ 16.7 $ 71.8 $ 10.2 $ 16.1 $ 87.2
====== ====== ====== ====== ====== ======
</TABLE>
Approximately 90% of operating revenues is derived from water supplied and
wastewater treated for residential, commercial and industrial customers. The
supply of water is either metered, known as measured, or unmeasured. The charge
for wastewater treated is based upon a percentage of the water supplied and
charged to that customer.
Wessex's subsidiary, SC Technology, sells and operates plants for drying
biosolids, the solid waste remaining after wastewater is treated. The majority
of SC Technology's operating revenues is derived from projects related to
selling and managing the construction of plants, and therefore each period's
operating revenues fluctuate according to the number of projects in progress.
Other unregulated activities include the sale of electricity and treatment of
organic waste.
Operations and maintenance expense consists of the costs of supplying water
and treating wastewater, including the costs of maintaining and operating the
plant and equipment used in these processes. The main categories of cost include
labor, power, rent, real estate taxes, chemicals, transport, equipment, grounds
maintenance, and tankering. SC Technology's costs relate to the construction and
delivery of the plant being installed, including the cost of equipment, civil
engineering, building and labor.
General and administrative expense includes personnel costs, transaction
expenses related to due diligence and overhead associated with Azurix's pursuit
of acquisitions and development projects, in
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<PAGE> 30
addition to support functions such as billing and customer services, quality and
scientific services, regulation, finance, human resources and public relations.
The functional currency of Wessex is U.K. pounds sterling. Accordingly, its
results of operations, translated into U.S. dollars, are affected by the change
in currency exchange rates when comparing periods. The actual average exchange
rate for each applicable period used in translating the U.K. pounds sterling
functional results to U.S. dollars, in accordance with U.S. GAAP, is $1.63 per
L1.00 for the three months ended March 31, 1999, $1.66 per L1.00 for the year
ended December 31, 1998, $1.65 per L1.00 for the six months ended October 2,
1998, $1.64 per L1.00 for the year ended March 31, 1998 and $1.59 per L1.00 for
the year ended March 31, 1997.
AZURIX -- UNAUDITED PRO FORMA FOR THE YEAR ENDED DECEMBER 31, 1998
The following discussion is derived from the Unaudited Condensed
Consolidated Pro Forma Financial Information included elsewhere in this
prospectus. The pro forma results discussed below include the 1998 results of
Wessex prior to its acquisition by Azurix.
Operating revenues of $464.2 million were all derived from Wessex.
Approximately 91% of these revenues were derived from the sale of measured and
unmeasured water and wastewater services. Operating revenues from SC Technology
and other unregulated activities, accounted for 5% and 4% of total operating
revenues, respectively.
Operations and maintenance expense was $120.9 million, of which 98% was
incurred by Wessex. Of this amount, $89.3 million relates to the costs of
supplying water and treating wastewater, including the costs of maintaining and
operating plant and equipment used in these processes, and $23.9 million relates
to the costs of the plants being installed by SC Technology.
AZURIX -- THREE MONTHS ENDED MARCH 31, 1999
Azurix had no operations as of March 31, 1998 and as a result, the
following discussion is limited to results of operations for the three months
ended March 31, 1999. All of its operating income occurred during the fourth
quarter of 1998 following the Wessex acquisition.
Operating revenues of $116.9 million for the three months ended March 31,
1999 were derived from Wessex. Approximately 90% of these revenues relate to the
sale of measured and unmeasured water and wastewater services. Operating
revenues from SC Technology and other unregulated activities each accounted for
5% of total operating revenues.
Operations and maintenance expense for the three months ended March 31,
1999, of which 98% was incurred by Wessex, was $31.8 million. Of this amount,
$22.1 million relates to the cost of supplying water and treating wastewater,
including the costs of maintaining and operating plant and equipment used in
these processes. In addition, $6.2 million relates to the cost of the plants
being installed by SC Technology.
General and administrative expenses of $22.6 million for the three months
ended March 31, 1999 include $9.5 million related to Wessex's operations and
$12.8 million related to the pursuit of acquisitions and development projects.
The expenses related to acquisitions and development projects resulted from a
business strategy initiated in the fourth quarter of 1998. See "-- Outlook."
Depreciation and amortization of $23.3 million for the three months ended
March 31, 1999 includes $5.4 million relating to amortization of goodwill
incurred by Azurix in its acquisition of Wessex. All of the depreciation expense
is derived from depreciation on the property, plant and equipment of Wessex. The
goodwill amortization and depreciation expense related to Wessex is based on a
preliminary purchase price allocation of Wessex.
Net interest expense of $14.9 million for the three months ended March 31,
1999 is related to the Wessex acquisition financing, existing Wessex debt and
funds borrowed in the fourth quarter of 1998 to redeem outstanding preference
shares.
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Income tax expense of $8.4 million was incurred during the three months
ended March 31, 1999. The majority of Azurix's pre-tax operating income is
derived in the United Kingdom where the effective 1999 statutory tax rate is
30.25%. The primary reason for the difference between effective book tax rate of
34.3% and the effective statutory tax rate is the non-deductible amortization of
goodwill resulting from the acquisition of Wessex.
Income tax expense is net of a tax benefit of $4.8 million related to
losses generated in the United States. A valuation allowance is not necessary
for this tax benefit due to expected future income resulting from finalizing
U.S. water projects and available tax planning strategies.
AZURIX -- DATE OF INCEPTION TO DECEMBER 31, 1998
Operating revenues of $119.7 million were derived from Wessex.
Approximately 90% of these revenues relate to the sale of measured and
unmeasured water and wastewater services. Operating revenues from SC Technology
and other unregulated activities accounted for 6% and 4% of total operating
revenues, respectively.
Operations and maintenance expense totalled $31.6 million. Of this amount,
$21.8 million relates to the cost of supplying water and treating wastewater,
including the costs of maintaining and operating plant and equipment used in
these processes, and $7.1 million relates to the costs of the plants being
installed by SC Technology.
General and administrative expenses of $20.3 million include $7.7 million
related to Wessex's operations and $12.3 million related to the pursuit of
acquisitions and development projects. The expenses related to acquisitions and
development projects result from a business strategy initiated in the fourth
quarter of 1998. See "-- Outlook."
Depreciation and amortization of $22.2 million includes $5.5 million for
the amortization of goodwill incurred by Azurix in the acquisition of Wessex.
All of the depreciation expense is derived from depreciation on the property,
plant and equipment of Wessex. The goodwill amortization and depreciation
expense related to Wessex is based on a preliminary purchase price allocation of
Wessex.
Interest expense is related to the Wessex acquisition financing, existing
Wessex debt and funds borrowed in the fourth quarter to redeem the outstanding
preference shares.
The effective tax rate for the period was 64.2%. The difference between the
effective tax rate and the U.S. statutory rate of 35% (U.K. statutory rate of
31%) is primarily related to the following:
- A valuation allowance recognized on a U.S. deferred tax asset generated
from general and administrative expense incurred in the United States
- A valuation allowance recognized on a U.K. deferred tax asset relating to
non-deductible interest expense prior to achieving a consolidated tax
position
- Non-deductible amortization of goodwill resulting from the acquisition of
Wessex
WESSEX (PREDECESSOR COMPANY) -- SIX MONTHS ENDED OCTOBER 2, 1998
Operating revenues for the six months ended October 2, 1998 were $233.8
million. Approximately 91% of these revenues relate to the sale of measured and
unmeasured water and wastewater services. Operating revenues from SC Technology
and other unregulated activities accounted for 5% and 4%, respectively, of total
operating revenues.
Operations and maintenance expense for the six months ended October 2,
1998, was $61.7 million. Of this amount, $46.8 million relates to the cost of
supplying water and treating wastewater, including the costs of maintaining and
operating plant and equipment used in these processes. In addition, $10.9
million relates to the cost of the plants being installed by SC Technology.
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General and administrative expenses of $36.4 million for the six months
ended October 2, 1998 include $20.7 million incurred by Wessex in connection
with its acquisition by Azurix.
Income tax expense for the six months ended October 2, 1998 was $28.4
million, which resulted in a 28% effective book tax rate compared to a statutory
tax rate of 31%. The primary reason for the variance from the statutory rate is
the effect of an enacted change in the statutory tax rate during the period from
31% to 30%, effective April 1, 1999. This was partially offset by the effect of
non-tax deductible expenses that were incurred during the period.
WESSEX (PREDECESSOR COMPANY) -- YEAR ENDED MARCH 31, 1998 COMPARED TO THE YEAR
ENDED
MARCH 31, 1997
Operating revenues for the fiscal year ended March 31, 1998 increased by
$33.5 million, or 8.3%, when compared to the fiscal year ended March 31, 1997,
primarily as a result of a 4.6% increase in the pricing formula contained in the
Wessex license, effective April 1, 1997, which resulted in $17.9 million of
additional operating revenues. In addition, operating revenues from SC
Technology increased by $4.2 million due to a higher number of construction
projects in progress during the year ended March 31, 1998.
Operations and maintenance expense for the year ended March 31, 1998
increased by $8.5 million, or 8.3%, when compared to the year ended March 31,
1997, primarily due to higher operating expenses from SC Technology due to a
higher number of construction projects in progress in the year ended March 31,
1998.
General and administrative expense for the year ended March 31, 1998
decreased by $3.1 million, or 9.6%, when compared to the year ended March 31,
1997, primarily due to cost reduction measures implemented by Wessex, and costs
of $2.1 million incurred in the year ended March 31, 1997 related to an
unsuccessful attempt to acquire a third party.
Depreciation and amortization expense for the year ended March 31, 1998
increased by $6.3 million, or 10.9%, when compared to the year ended March 31,
1997. Substantially all of this increase is due to property additions resulting
from Wessex's capital expenditure program.
Equity earnings of affiliates for the year ended March 31, 1998 decreased
by $1.4 million, or 9.5%, when compared to the year ended March 31, 1997. This
decrease resulted from a lower sales margin due to increased competition, and
higher general and administrative expense related to the hiring of additional
sales staff.
Net interest expense was $8.6 million for the year ended March 31, 1998, as
compared to net interest income of $10.2 million for the year ended March 31,
1997, primarily due to a reduction in the cash and cash equivalent position in
the current period as a result of the buy-back of its "B" and "C" classes of
ordinary shares in February 1997.
Income tax and utility tax expense for the year ended March 31, 1998 as
compared to the year ended March 31, 1997, increased by $137.9 million primarily
as a result of a one-time tax levied in the year ended March 31, 1998 of $162.3
million. The effect of the utility tax was partially offset by a change in the
U.K. statutory tax rate from 33% to 31% during the year ended March 31, 1998,
which amounted to $22.6 million.
The utility tax, introduced in the Finance (No. 2) Act 1997 and referred to
in the legislation as the Windfall Tax, was levied on privatized utilities
including the water and electricity sectors. It is a one-time tax in that the
legislation only relates to this assessment and new legislation would have to be
enacted for any additional windfall tax. In addition, the U.K. Government has
stated that it was a one-time tax. The calculation of the utility tax was based
on the profit after tax of Wessex for the average of the four years ended March
31, 1994, multiplied by a price to earnings ratio of nine. The resulting amount
was compared to the value of Wessex at the date of initial trading of its stock
in 1989, and the difference was deemed to be windfall profits and was taxed at a
23% rate.
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OUTLOOK
Several developments may significantly affect Azurix's future results of
operations.
Azurix has a business strategy consisting of growth through acquisitions
and development projects. Azurix has recently put in place a business
development effort requiring an increase in personnel to pursue and support
acquisition and privatization activity on a global scale. As of June 9, 1999,
Azurix had hired approximately 165 employees. The associated general,
administrative and operating expenses are approximately $15 million pre-tax on a
quarterly basis.
Most of our operating revenues are subject to governmental regulation of
the rates that we may charge to our customers. The U.K. water regulator, the
Director General of Water Services, is currently conducting a periodic review of
the price limits for water and wastewater companies in England and Wales that is
expected to result in new price limits for the period from April 1, 2000 through
2005. In October 1998, the Director proposed an initial price cut for Wessex in
excess of 17.5% from 1999-2000 to 2000-2001, with prices gradually increasing
thereafter but remaining below the 1999-2000 levels in 2004-2005. Following this
proposal, the U.K. Government announced its decision to require greater capital
expenditures for water and wastewater companies for environmental improvements.
Subsequently, in its April 1999 business plan filed with the Director, Wessex
proposed stable prices from 1999-2000 to 2000-2001, with prices gradually
increasing to 18% higher than current levels in 2005, primarily to fund capital
expenditures mandated by the new environmental standards. The Director will
consider the business plan in his review. The Director has stated that he will
publish draft price limits in July 1999 with the final determination being made
in November 1999. These price limits may differ materially from the Director's
original proposal. Although we are unable to predict the precise outcome of the
current U.K. periodic review, if Wessex were required to cut its prices as
originally proposed by the Director, Wessex's regulated operating revenues,
which represent approximately 90% of Azurix's total operating revenues, would be
reduced by over 17.5% and its earnings would be reduced materially. However, we
would not expect that this would have a material adverse effect on Azurix's
financial position. At the time of the acquisition of Wessex, we took into
consideration the pending rate review in our valuation of Wessex.
On February 2, 1999, Azurix granted options to purchase approximately 7.8
million shares of its common stock through an employee stock option plan. The
Stock Plan Committee of Azurix's Board of Directors determined that the exercise
price of $16.72 per share was fair market value at the date of grant. In making
this determination, the Stock Plan Committee considered factors such as the
close proximity of the grant date and the Wessex acquisition date and the
absence of any material developments in Azurix prior to the grant date. The
Board of Directors has authorized additional grants, effective as of the date of
this prospectus, of options to purchase 0.7 million shares of common stock to
employees who recently joined Azurix and to non-employee directors of Azurix.
The exercise price of these additional options will be equal to the initial
public offering price. All stock options generally vest over three to five years
and will be exercisable for ten years after the date of grant. The future
exercise of these options will have a dilutive effect on basic earnings per
share.
Azurix refinanced a portion of its existing debt in May 1999, which will
result in a one-time non-cash charge of $9.8 million ($6.9 million after-tax) in
the second quarter due to the write-off of deferred financing costs. We incurred
approximately $8.1 million in financing costs related to the new financing. See
"-- Recent Developments."
In addition to the pending acquisitions in the Province of Buenos Aires,
Argentina and in Mexico, we are continually evaluating potential acquisition
opportunities involving other water and wastewater assets, companies and water
services providers. The timing, size and success of these potential acquisitions
cannot be predicted. The completion of any one of these potential acquisitions
could have a significant impact on our business.
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LIQUIDITY AND CAPITAL RESOURCES
All of Azurix's cash flows for the period from inception to December 31,
1998 occurred in the fourth quarter following the Wessex acquisition. Cash flow
from operations totaled $4.4 million during the period from January 29, 1998 to
December 31, 1998. Related to its investment activities, Azurix used $2,270.8
million, in addition to the issuance of $119.8 million of acquisition loan
notes, to acquire ordinary shares of Wessex and $63.2 million for capital
expenditures incurred by Wessex. In addition, Azurix received $337.9 million in
proceeds from the sale of UK Waste. Cash provided by financing activities during
the period totaled $1,977.5 million, primarily comprised of $1,600.2 million
from the issuance of common stock and capital contributions and a net increase
in borrowings of $485.4 million, partially offset by the redemption of the
Wessex preference shares of $106.4 million. Cash received from the issuance of
common stock of $1.0 million and capital contributions of $1,599.2 million are
from Azurix's former parent company, Enron Water (Holding) L.L.C.
Azurix's cash flows from operations totaled $12.5 million during the three
months ended March 31, 1999. Cash used in investing activities during this
period was primarily comprised of capital expenditures of $74.5 million, the
acquisition cost of Azurix's interest in the Cancun concession of $13.5 million
and a loan made to the Cancun concession for $15.0 million. Cash provided by
financing activities of $105.1 million was primarily comprised of net borrowings
of $57.1 million and an advance from Enron of $48.0 million which was used to
fund the Cancun acquisition and the related loan and to fund general and
administrative costs incurred by Azurix to pursue acquisition and development
projects.
At December 31, 1998, Azurix had a working capital deficit of $129.6
million. Approximately 60% of Azurix's operating revenues are derived from
customers whose billings are not based on the delivery of a measured volume of
service. These customers are billed semiannually in advance. Funds received in
advance as of December 31, 1998, where service has not been provided, totaled
$71.0 million and are reflected on the Consolidated Balance Sheet as deferred
income. This component of the working capital deficit does not require the
future use of cash but is recognized in income over the remaining service period
covered by the billings. The remaining working capital deficit is related to the
timing of cash payments. Excess cash, including funds received in advance, is
used to pay down short-term revolving bank credit facilities. The funds are
re-borrowed under these credit facilities when needed to pay current
obligations. At December 31, 1998, Azurix had available capacity, under its
existing credit facilities, to provide $91.5 million of working capital.
At March 31, 1999, Azurix had a working capital deficit of $134.5 million.
Of this amount, $64.2 million is an advance from Enron that will be repaid from
the net proceeds from the offering. An additional $21.8 million is deferred
income that does not require the future use of cash as discussed above.
Management believes that cash flows from operations and available capacity under
credit facilities are sufficient to fund the working capital deficit.
At December 31, 1998, Azurix, through Azurix Europe, had in place a senior
credit facility consisting of a term loan facility of $322.6 million and a
revolving credit facility of $575.3 million. The amounts outstanding at December
31, 1998 were $211.2 million under the term loan facility and $8.3 million under
the revolving credit facility. As a result, at December 31, 1998, Azurix had
total availability under the senior credit facility of $678.4 million,
consisting of $567.0 million under the revolving credit facility and $111.4
million under the term loan facility. Of the $567.0 million under the revolving
credit facility, $91.5 million was permitted, if required, to fund the working
capital deficit that existed at year end. The term loan capacity of $111.4
million was used at March 31, 1999 to secure a substantial portion of the
acquisition loan notes issued to Wessex shareholders in lieu of cash
consideration for their shares. On May 10, 1999, Azurix Europe entered into a
$686.0 million revolving credit facility. On May 13, 1999, Azurix Europe
borrowed approximately $75.9 million, of which approximately $67.8 million was
used to repay all of the remaining indebtedness outstanding on its former senior
credit facility and approximately $8.1 million was primarily used to pay fees
and expenses related to this facility. On May 14, 1999, Azurix borrowed $107.0
million under this revolving credit facility, primarily to fund the purchase of
Philip Utilities. As of June 7, 1999, Azurix has $280.4 million of borrowing
capacity under the senior credit
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facility available to fund future acquisitions. It is expected that $208.0
million of this facility, along with $230.6 million of proceeds from the
offering, will be used to fund the $438.6 million acquisition of an interest in
a concession in two regions of the Province of Buenos Aires, Argentina. Of the
remaining $72.4 million available under this facility to fund acquisitions after
funding the Buenos Aires acquisition, $22.5 million will be used to fund the
purchase of 49% of the capital stock of Industrias del Agua in Mexico and $49.9
million will be available to fund potential future acquisitions and
privatizations.
Azurix is currently evaluating various financing strategies to raise
additional capital to further support its business strategy of growth through
acquisitions and development projects. Funds raised, combined with cash flows
from assets acquired, will be used by Azurix to fund potential future
acquisitions and privatizations. There can be no assurance that we will be
successful in securing any financing arrangements.
The credit agreement with Enron will provide $180 million of liquidity to
fund general, administrative and operating expenses through December 2001. As of
June 7, 1999, no amounts were outstanding under this credit agreement. See
"-- Recent Developments." The principal amount outstanding under the credit
agreement will be limited to no more than:
- $60 million at any time during calendar year 1999
- $120 million at any time during calendar year 2000
- $180 million at any time during calendar year 2001
As of December 31, 1998, Azurix, through Wessex, was a borrower under
committed credit facilities that provided an aggregate $399.1 million for
general corporate purposes. As of December 31, 1998, these bank facilities were
completely drawn down. Wessex also had $24.9 million outstanding under
short-term uncommitted bank borrowings at December 31, 1998. On March 30, 1999,
Wessex issued $484.2 million principal amount of 10-year bonds. Wessex used
$448.4 million of the proceeds from the sale of the bonds to repay all
outstanding amounts under its former bank credit facilities as well as all
outstanding amounts under uncommitted credit facilities. Excess proceeds were
available for general corporate purposes. See "Description of
Indebtedness -- Indebtedness of Azurix Europe" for a detailed discussion of the
terms of the credit facilities and loan agreements.
Azurix, through Wessex, maintains an ongoing asset replacement program
throughout its customer service areas in the United Kingdom based on an
expenditure plan submitted to the U.K. industry regulator. Wessex expects that
its projected capital expenditures of approximately $230 million for 1999 will
be financed with internally generated funds and from proceeds under long-term
and short-term borrowing arrangements. Included in this amount are contractual
commitments for capital expenditures to be incurred after December 31, 1998 of
$130.2 million. The projected capital expenditures consist primarily of the
following:
- Approximately $135 million for wastewater projects, such as construction
of wastewater treatment facilities and improvements to existing
facilities
- Approximately $45 million for water supply projects, such as construction
of water treatment facilities and installation of water mains
- Approximately $25 million for office space construction in the United
Kingdom
- Approximately $20 million related to information technology investment
FINANCIAL RISK MANAGEMENT
Azurix is exposed to market risks, particularly changes in U.S. and
international interest rates and changes in currency exchange rates as measured
against the functional currencies in which it operates. Azurix engages in
hedging programs aimed at limiting the impact of significant and sudden
fluctuations, but there can be no assurance that such an approach will be
successful. Factors that could impact the
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effectiveness of its hedging programs include the accuracy of revenue forecasts,
volatility of the currency and interest rate markets, and the availability of
hedging instruments. Azurix utilizes swap contracts to manage interest rate
risk. Currency exchange rate risk is the result of transactions that are
denominated in a currency other than the functional currencies in which we
operate. The primary purpose of Azurix's foreign currency hedging activities is
to manage the volatility associated with currency exchange rates. We manage
these risks by utilizing derivative financial instruments for non-trading
purposes. Azurix enters into currency or interest rate contracts for the sole
purpose of hedging an existing or anticipated exposure, not for speculation.
Azurix's accounting policies for, and the significant terms of, derivative
financial instruments are described in Note 1 and Note 8, respectively, to the
Consolidated Financial Statements.
Azurix uses J.P. Morgan's RiskMetrics(TM) system to estimate the
value-at-risk of its financial instruments. Value-at-risk is a statistical
estimate of the loss that would result from changes in market prices.
Value-at-risk is based on volatility and correlation data provided by J.P.
Morgan, a statistical confidence level and an estimate of the time period
required to liquidate the positions in the various financial instruments. The
value-at-risk estimate was based on normal market conditions, a 95% confidence
level and a liquidation period between 30 days and 60 months, depending on the
type of financial instrument. At December 31, 1998, the value-at-risk estimate
for foreign currency and interest rate exposure was $0.7 million and $0.9
million, respectively. The value-at-risk estimate includes only the risk related
to the financial instruments that serve as hedges and does not include the
related underlying hedged item. Judgment is required in interpreting market data
and the use of different market assumptions or estimation methodologies that
will affect the estimated value-at-risk amount.
YEAR 2000
The Year 2000 problem results from the use in computer hardware and
software of two digits rather than four digits to define the applicable year.
The use of two digits was a common practice for decades when computer storage
and processing was much more expensive than it is today. When computer systems
process dates both before and after January 1, 2000, two-digit year "fields" may
create processing ambiguities that can cause errors and system failures. For
example, computer programs that have date sensitive features may recognize a
date represented by "00" as the year 1900, instead of 2000, or may not recognize
the date February 29, 2000, as there was no February 29 in 1900. These errors or
failures may have limited effects, or the effects may be widespread, depending
on the computer chip, system or software, and its location and function.
The effects of the Year 2000 problem are exacerbated because of the
interdependence of computer and telecommunications systems in the United States
and throughout the world. This interdependence applies to Azurix and Azurix's
suppliers, trading partners and customers and to governments of countries where
Azurix does business. This interdependence also applies to Enron, on which
Azurix relies for services as described under "Transactions with Enron, Atlantic
Water Trust and Marlin Water Trust."
STATE OF READINESS
We intend to follow Enron's Year 2000 plan, which covers all of Enron's
business units. The aim of the Enron plan is to take reasonable steps to prevent
Enron's mission-critical business functions from being impaired due to the Year
2000 problem. As used in this prospectus, "mission-critical" functions refer to
the critical functions whose loss would cause significant injury to persons or
tangible property, or an immediate stoppage of or significant impairment to
business areas of material importance. Enron intends to modify its plan as
events warrant. In addition, we intend to adapt the Enron plan to our
operations. Among other things, we are conforming Wessex's Year 2000 efforts to
the Enron plan and are introducing this plan to our operations in Cancun.
Central information systems, such as large mainframes and midsize computer
systems at Wessex and desktop or personal computers and computer networks, can
be vulnerable to Year 2000 problems. In addition, devices with chips embedded in
them, such as flow controllers and controllers for automated pumps, are
vulnerable to Year 2000 problems. Devices with chips embedded in them may be
used for
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many purposes, and finding all of them may be difficult, even with a careful
inventory and remediation process. In addition, we are concerned with the
systems of external entities over which we do not have control. Examples of
these systems include central information systems and embedded devices of our
suppliers and contractors, financial institutions, governments in locations
where we operate, customers and co-venturers.
In general, the Enron Year 2000 plan adopted by Azurix includes phases of
awareness, inventory, remediation, verification and testing, and contingency
planning. These steps describe a process that continues to go in cycles. For
example, we will continue to refine our inventory of central information systems
and embedded devices until the early days and, if necessary, weeks of January
2000, to identify Year 2000-related problems that require remediation.
WESSEX. Under the Enron plan, Wessex will continue to:
- Inventory its mission-critical computer hardware and software systems and
embedded chips, i.e., computer chips with date related functions,
contained in a wide variety of devices, that in turn are installed in a
wide variety of equipment and that may fail to function or may function
improperly before, on or after January 1, 2000
- Assess the effects of Year 2000 problems on its mission-critical
functions
- Remedy to the maximum extent practicable material disruptions or other
material adverse effects on its mission-critical functions, processes and
systems
- Verify and test the mission-critical systems to which remediation efforts
have been applied
- Attempt to limit the adverse effect of Year 2000 problems that cannot
reasonably be remediated by January 1, 2000, including developing
contingency plans to minimize Year 2000 problems that have not been
identified or fixed by January 1, 2000
Wessex has completed most of the stages of the Enron plan and should be
Year 2000 ready by July 31, 1999 as shown in the following table:
<TABLE>
<CAPTION>
Y2K PROJECT STAGE CURRENT STATUS TARGET COMPLETION DATE
----------------- -------------- ----------------------
<S> <C> <C>
Inventory................................. Completed N/A
Assessment................................ Completed N/A
Conversion................................ Near Completion July 1, 1999
Testing................................... Near Completion July 31, 1999
Implementation............................ Near Completion July 31, 1999
Contingency Planning...................... Near Completion June 30, 1999
</TABLE>
Wessex has finished the initial cycle of identifying and assessing its
mission-critical central information systems and devices with embedded chips.
Under the Enron plan, inventory and assessment along with remediation and
contingency planning will continue in cycles through the end of 1999 and into
2000 as necessary.
All of Wessex's internal information systems are Year 2000 ready. When
Wessex performs maintenance on its mission-critical sites, it tests them to
determine whether they remain Year 2000 ready. Wessex is continuing to analyze,
convert and test its mission-critical central information systems and devices
with embedded chips. Of Wessex's 56 mission-critical information systems
applications:
- 24 were tested and classified as Year 2000 ready
- Nine were redeveloped as Year 2000 ready applications
- 23 were converted and have been tested and accepted as Year 2000 ready
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Of the nine mission-critical information systems applications that were
redeveloped:
- Seven have been tested and accepted as Year 2000 ready
- Two are currently undergoing testing
For embedded systems, Wessex inventoried 3,041 items at 405
mission-critical sites. Of these items, 87 were not Year 2000 ready. However,
Wessex has now tested and replaced 100% of its mission-critical embedded systems
that were not Year 2000 ready.
In addition, Wessex has contacted all outside entities on which it relies
for mission-critical functions.
The Enron plan recognizes that the computer, telecommunications and other
systems of outside entities have the potential to adversely affect the conduct
of our business. We do not have control of these outside entities or outside
systems. However, the Enron plan includes an ongoing process of contacting
outside entities whose systems have, or may have, a substantial effect on the
ability of each of the relevant businesses to continue to conduct its
mission-critical functions without disruption from Year 2000 problems. The Enron
plan envisions attempting to inventory and assess the extent to which these
outside systems may not be "Year 2000 ready" or "Year 2000 compatible." This
refers to the ability of a system to process data reliably, both before and
after January 1, 2000, without disruption due to an inability to process date
information reliably. This is distinguished from "Year 2000 compliant," which
implies that a system will work properly, both before and after January 1, 2000,
even if outside systems fail to operate properly. In implementing the Enron
plan, we will attempt to coordinate our efforts to prepare for the Year 2000
problem with outside entities.
Our Year 2000 program requires external entities to be ranked as
mission-critical, important or ordinary. The Azurix teams are expected to
maintain contact and receive status updates from the mission-critical entities
throughout 1999 and, if necessary, into 2000. Non-mission-critical entities are
to be addressed as time permits.
Senior personnel from the Year 2000 staff have visited Wessex's
mission-critical external entities. Entities visited to date are listed in the
following table:
<TABLE>
<CAPTION>
SERVICE PROVIDED ENTITY
---------------- ------
<S> <C>
Fuel and Electricity............. Scottish & Southern Energy plc
SEEBOARD plc
Texaco Ltd.
Chemicals........................ Air Products plc
BOC Limited
ICI Chemicals & Polymers Limited
Rhone Poulenc Chemicals Limited
Communications................... Aspect Telecommunications Limited
British Telecommunications plc
Racal Telecommunication Networks Limited
Vodaphone Limited
Materials........................ Oliver Ashworth Group plc
Stanton plc
USF Limited
Banking.......................... Midland Bank plc
</TABLE>
Wessex will continue to monitor the status of these entities throughout the
remainder of 1999.
The purpose of our Year 2000 program is to identify key entities that may
not have adequately addressed the Year 2000 problem and to mitigate Azurix's
exposure by developing appropriate contingency plans. Azurix recognizes that
comprehensive Year 2000 programs may not fully remediate all Year 2000 issues.
Therefore, we do not categorize any mission-critical entities as "Year 2000
ready."
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<PAGE> 39
Wessex has received responses to its inquiries about Year 2000 readiness
and has contacted all outside entities on which it relies for mission-critical
functions. Among other things, Wessex asked each entity to demonstrate what the
entity did to support affirmations that the entity satisfied the British
Standards Institute protocol for Year 2000 readiness. The British Standards
Institute has established the following definition for Year 2000 conformity:
"Year 2000 conformity shall mean that neither performance nor functionality is
affected by dates prior to, during and after the year 2000." In addition to this
definition, the British Standards Institute has provided the following four
rules for determining Year 2000 conformity:
- No value for current date will cause any interruption in operations
- Date-based functionality must behave consistently for dates prior to,
during and after the year 2000
- In all interfaces and data storage, the century in any date must be
specified either explicitly or by unambiguous algorithms or inferencing
rules
- Year 2000 must be recognized as a leap year
Every outside entity that responded to Wessex's inquiries demonstrated that
it satisfied the British Standards Institute standard with one exception. The
sole exception was a communications common carrier that was not able to
demonstrate that its international connections satisfy or will satisfy Year 2000
readiness standards.
Wessex's contingency plans assume that its mission-critical external
entities will experience Year 2000-related failures and disruptions. For
example, Wessex's contingency plans assume loss of electrical power and require
the installation of Year 2000 ready emergency generators to deal with this
possibility. Wessex expects that its initial contingency planning will be
completed by the end of June 1999 and will be followed by at least two rounds of
testing before September 30, 1999.
MENDOZA. We do not have operational control of the Mendoza concession.
Therefore, we consulted with SAUR, the operator of the concession, to develop an
understanding of SAUR's Year 2000 efforts at Mendoza. SAUR is pursuing a Year
2000 plan for the concession with the following stages, which are shown with a
description of their current status and target completion dates:
<TABLE>
<CAPTION>
Y2K PROJECT STAGE CURRENT STATUS TARGET COMPLETION DATE
----------------- -------------- ----------------------
<S> <C> <C>
Inventory................................ Completed N/A
Assessment............................... Completed N/A
Conversion............................... Completed N/A
Testing.................................. Initiated July 15, 1999
Implementation........................... To be initiated July 31, 1999
Contingency Planning..................... To be initiated July 31, 1999
</TABLE>
All internal information systems, both hardware and software, have been
assessed for Year 2000 readiness purposes. SAUR plans in 1999 to replace the
systems for accounting, budgeting and accounts payable and disbursements, for
measurement of water and wastewater flows and for supervisory control and data
acquisition. The customer billing, collection and customer support system
requires partial remediation to achieve Year 2000 readiness, and we understand
that SAUR expects to finish remediating the defective components by the end of
1999. All of the internal local area networks other than the servers have been
tested by SAUR and we understand they have been found to be completely Year 2000
ready. New servers for these networks have been installed but not yet tested to
ascertain Year 2000 readiness. SAUR will complete that testing before the end of
1999.
The mission-critical systems at the Mendoza concession include business
systems, such as a customer interface system and a payroll system, and devices
with embedded chips such as flow meters and a supervisory, control, and data
acquisition system. Mission-critical external entities include the local
electrical utility for power to supply water pumps, the local telephone company
and local banks that function as collection agents. SAUR has not yet started to
visit its mission-critical external entities to obtain representations as to
their Year 2000 readiness. Before the end of 1999, we understand that SAUR
36
<PAGE> 40
expects to complete visits with all its mission-critical external entities, with
the objective of obtaining representations as to their Year 2000 readiness, for
the purpose of formulating contingency plans to deal with Year 2000 disruptions
or other problems that may result from Year 2000-related problems that the
external entities experience. Although employees of SAUR plan to visit
mission-critical external entities, we cannot assure that the systems of these
external entities will be free from disruptions due to Year 2000 problems, and
SAUR cannot ensure that the Mendoza facility will be free from mission-critical
disruptions as a result. We anticipate that SAUR will include these
mission-critical external dependencies in its contingency planning.
CANCUN. The Cancun concession is in the early stages of adopting and
implementing the Enron plan for Year 2000 readiness. The concessionaire will
inventory, assess, analyze, convert and test the Cancun systems for Year 2000
readiness and develop Year 2000 contingency plans to minimize Year 2000 problems
that have not manifested themselves or have not been corrected by January 1,
2000. The schedule for this implementation is as follows:
<TABLE>
<CAPTION>
Y2K PROJECT STAGE CURRENT STATUS TARGET COMPLETION DATE
----------------- -------------- ----------------------
<S> <C> <C>
Inventory................................ Completed N/A
Assessment............................... Completed N/A
Conversion............................... Initiated July 15, 1999
Testing.................................. To be initiated July 31, 1999
Implementation........................... To be initiated August 15, 1999
Contingency Planning..................... To be initiated August 15, 1999
</TABLE>
With respect to internal information systems, 100% of Cancun's personal
computers have been tested and 56% of them will be replaced by July 1, 1999 to
achieve Year 2000 readiness. Two servers, which constitute all of the facility's
servers, will be replaced by July 1, 1999 with Year 2000 ready servers.
Internal accounting and administrative software has been tested for Year
2000 readiness by the vendor, and the vendor has stated that it will supply its
written certification of Year 2000 readiness by the end of May 1999. Invoicing
software is currently being upgraded by the vendor to achieve Year 2000
readiness, and we have been informed by the vendor that the upgraded Year 2000
ready software will be installed and functioning by the end of May 1999. Human
resources software is not mission-critical, and we expect to test it for Year
2000 readiness by the end of June 1999. This software will be upgraded or
replaced as necessary to achieve Year 2000 readiness by December 1, 1999.
We have identified the following as mission-critical external entities for
the Cancun facility: the electrical utility, Mexico's nationwide communications
common carrier, local banks, fuel suppliers for the facility's trucks and the
chlorine supplier for the facility. All these entities have been contacted.
Among these entities, we have visited two local banks to date and expect to
visit all other mission-critical entities by the end of August 1999. The
electrical utility has referred us to its Internet page for a description of the
utility's Year 2000 plan, which the utility expects to complete by July 30,
1999. The communications common carrier has informed us orally that it is Year
2000 ready, and we have been told that it will confirm this advice in a letter
that we expect to receive by the end of July. We deal with 12 local banks, and
only one of these banks has advised us orally that it is Year 2000 ready. The
other banks have asked us to inquire again later, with no definite time
specified, regarding their Year 2000 readiness, and we plan to contact them
again before the end of June 1999. The fuel suppliers for our trucks have orally
stated that they are Year 2000 ready, and we expect written confirmation from
each of them by the end of June 1999. The chlorine supplier orally advised us
that they are Year 2000 ready, but have not offered written confirmation. Our
contingency plan regarding chlorine is to stock three months' supply.
We believe that Wessex's and the Cancun concession's mission-critical
systems will be Year 2000 ready substantially before January 1, 2000. However,
unforeseen circumstances could arise during the implementation of the Enron plan
that could adversely affect Enron's, Wessex's or the Cancun concession's
mission-critical functions, thereby disrupting or materially adversely affecting
Azurix's business.
37
<PAGE> 41
PHILIP UTILITIES. Although Philip Utilities was preparing for Year 2000 at
the time we acquired it, Azurix will require Philip Utilities to adopt Enron's
Year 2000 plan. At this stage in our management of Philip Utilities, it is too
early for us to predict when Philip Utilities will complete the inventory,
assessment, conversion, testing, implementation and contingency planning stages
as required by the Enron Year 2000 plan that we adopted. However, we expect that
Philip Utilities will commence work on all of these tasks by June 1999, and will
complete initial work on these tasks by the end of December 1999, if not
earlier. Testing, implementation and contingency planning will continue in
cycles through the end of 1999 and into 2000 as necessary.
Philip Utilities' internal information systems are not mission-critical
and, in any event, we anticipate that they will be remediated for Year 2000
purposes by the end of 1999. Other computer systems and systems using devices
with embedded chips are mission-critical because they are part of water or
wastewater systems operated by Philip Utilities. We anticipate that Philip
Utilities will inventory and remediate these systems and test them for Year 2000
purposes before the end of 1999. Further, Philip Utilities will develop
contingency plans to deal with Year 2000 problems that are not found and fixed
before the end of 1999.
Azurix's Year 2000 program requires that external entities be ranked as
mission-critical, important or ordinary. External entities ranked as
mission-critical are expected to receive site visits by senior personnel from
Philip Utilities' Year 2000 teams. In addition, the Philip Utilities teams are
expected to maintain contact and receive status updates from the
mission-critical entities throughout 1999 and, if necessary, into 2000.
Non-mission critical entities are to be addressed as time permits.
Philip Utilities has yet to begin site visits with mission-critical
external entities. We anticipate that this process will begin in early July
1999. Philip Utilities has, however, identified a preliminary list of
mission-critical entities which are identified in the following table:
<TABLE>
<CAPTION>
SERVICE PROVIDED ENTITY
---------------- ------
<S> <C>
Electricity...................... Hamilton Hydro
Ontario Hydro
Chemicals........................ BEW Industries, Inc.
Diversey Water Technologies Ltd.
HCI Stanchem, Inc.
ICI Canada, Inc.
Sifto Canada, Inc.
Communications................... Bell Canada
Materials........................ Praxair, Inc.
Banking.......................... Comerica Incorporated
Toronto-Dominion Bank
</TABLE>
The purpose of our Year 2000 program is to identify key entities that may
not have adequately addressed the Year 2000 problem and to mitigate Philip
Utilities' exposure by developing appropriate contingency plans. Azurix
recognizes that comprehensive Year 2000 programs may not fully remediate all
Year 2000 issues. As such, Philip Utilities will not categorize any
mission-critical entities as "Year 2000 ready." In any case, Philip Utilities
will develop contingency plans for all mission-critical entities.
We have reviewed the most reasonably likely worst case scenarios that
Philip Utilities may face. Although unlikely, these possibilities conceivably
could include failure of computer systems or devices with embedded chips that
are used to control water or wastewater systems. In some cases, these systems
are operated by Philip Utilities. In other cases, Philip Utilities installed or
furnished consulting services with respect to these systems. In most, if not
all, cases, the computer controls for these systems can be overridden and the
systems can be operated manually. Therefore, the potential failure of the
computer control systems would be important only if the plant's operators failed
to observe that the computer systems failed. This is possible though unlikely.
38
<PAGE> 42
Other possible worst case scenarios involve a failure of electrical
utilities or communications common carriers that furnish electricity and
communications services to these facilities. This kind of failure could disrupt
or interrupt the functioning of water or wastewater plants. Philip Utilities
will develop contingency plans for these possible failures. However, if
electrical power is unavailable to a water or wastewater facility for a period
greater than several hours, Philip Utilities might not be able to keep the
facility functioning. This could cause untreated or improperly treated water and
wastewater to be discharged into waterways. This in turn could create potential
legal liability for Philip Utilities and otherwise have a material adverse
effect on Philip Utilities' business, similar to the adverse effects described
for Azurix. We recognize that the widespread unavailability of electrical power
would cause disruptions that would not be unique to Philip Utilities.
Based on our initial review, Philip Utilities has not to date incurred
material Year 2000 costs, and we do not anticipate Philip Utilities' incurring
material costs in implementing the plan or preparing Year 2000 contingency
plans. However, there can be no assurance that the actual costs of implementing
the plan will not exceed our estimates or that Philip Utilities' business will
not be materially adversely affected by Year 2000 issues.
PENDING ACQUISITIONS. We have made initial inquiries and made some
preliminary examination regarding the Year 2000 readiness status of the
mission-critical internal information systems, devices with embedded chips and
external dependencies at both Administration General de Obras Sanitarias Buenos
Aires in the Province of Buenos Aires, Argentina and Industrias del Agua, S.A.
de C.V. in Monterrey, Mexico. We have concluded that there are likely to be
significant Year 2000 problems with mission-critical internal information
systems, embedded devices and external dependencies at both locations.
Consequently, promptly upon assuming responsibility for operations at each
location, Azurix will start implementing the Enron plan. At this time it is too
early for us to make estimates about when the initial cycle of work will be
completed at each location for the stages of inventory, assessment, conversion,
testing, implementation and contingency planning. We also cannot estimate the
costs for the Year 2000 work involved in each of these stages, or overall, at
each location. However, we believe that we will complete the initial cycle of
each of these stages no later than October or November of 1999, and we presently
anticipate that the costs for doing so will not be material. However, unforseen
circumstances could arise during the implementation of the Enron plan that could
adversely affect either or both locations and their mission-critical facilities,
thereby disrupting or materially adversely affecting their businesses. See
"Business -- Pending Acquisitions."
We are pursuing additional concessions, outsourcing contracts and other
water and wastewater projects. We expect that we will adapt the Enron plan to
cover our additional operations.
ENRON. Enron advises us that the internal information systems at Enron on
which Azurix will rely either are Year 2000 ready or are expected to be Year
2000 ready by June 30, 1999. Enron further advises us that it is in the process
of making contact with entities external to Enron, among them electrical
utilities and telecommunications common carriers, that are critical to the
operating mission of these Enron internal information systems, and that this
process will continue throughout 1999. Enron is aware that, despite the belief
of these mission-critical external entities that they are Year 2000 ready, that
readiness may be compromised by hidden remediated computer code, embedded chips
and the possible Year 2000-related failures of other entities on which the
external entities in turn depend. Therefore, Enron is developing contingency
plans to deal in a reasonable way with these possible interrelated failures.
These contingency plans will continue to be refined in cycles throughout the
remainder of 1999.
OUTSIDE ENTITIES THAT ARE NOT YEAR 2000 READY
Azurix realizes that Year 2000-related disruptions and their consequent
adverse effects remain a possibility. We will not rely entirely on
mission-critical external entities' assurances of Year 2000 readiness because
these entities are subject to failures resulting from the problems of embedded
chips, re-coding errors in remediated code and the potential effects of attempts
at sabotage early in the new year. Because of this potential for disruption and
material adverse consequences, Azurix never considers an external
39
<PAGE> 43
entity to be "Year 2000 compliant" or "Year 2000 ready." Further, neither Azurix
nor Enron can ensure that an external entity is, or will be, Year 2000 ready.
Instead, Azurix and Enron will deal with the possibility that mission-critical
external entities will not be Year 2000 ready by developing reasonable
contingency plans. This contingency planning will continue in cycles throughout
1999. The contingency plans will be designed to deal with the reasonably likely
effects on our operations that could result from material outages or other Year
2000-related disruptions to these external entities. Therefore, the plans will
be designed to facilitate identification and remediation of Year 2000 problems
that may manifest themselves after January 1, 2000.
COSTS TO ADDRESS YEAR 2000 ISSUES
As of June 9, 1999, we have not incurred material costs for Year 2000
issues, and we do not anticipate incurring material costs in implementing the
plan or preparing Year 2000 contingency plans. However, there can be no
assurance that the actual costs of implementing the plan will not exceed our
estimates or that our business will not be materially adversely affected by Year
2000 issues.
Year 2000 costs are difficult to estimate accurately because of
unanticipated vendor delays, technical difficulties, the impact of tests of
outside systems and similar events. For example, there can be no assurance that
all outside systems that are mission-critical to us, or are mission-critical to
the Enron systems on which we depend, will be adequately remediated so that they
are Year 2000 ready by January 1, 2000. If there are Year 2000 failures that
create substantial disruptions to our business or to Enron's business, the
adverse impact on our business could be material. Moreover, the estimated costs
of implementing the Enron plan do not take into account the costs, if any, that
might result from Year 2000 failures that occur despite our implementation of
the Enron plan.
YEAR 2000 RISK FACTORS
We plan to satisfy applicable regulatory requirements with respect to Year
2000 readiness. However, failure to comply with such requirements may cause a
regulatory authority to order the cessation of our operations, which could have
a material adverse affect on our business.
As the Year 2000 approaches, there will be increased competition for people
with the technical skills necessary to deal with Year 2000 problems. While we
intend to recruit and retain a sufficient number of people with those skills,
the shortages of skilled personnel could prevent us from doing so. In addition,
we may face shortages of other resources, such as Year 2000 ready computer chips
or components. These shortages might delay or otherwise impair our ability to
assure that our mission-critical systems are Year 2000 ready.
We will rely on Enron for services that involve computer processing. These
Enron systems are mainframe systems used for functions such as asset management,
accounting and human resources. Enron believes that its mission-critical systems
will be Year 2000 ready substantially before January 1, 2000. In addition, we
believe that Wessex's mission-critical systems will be Year 2000 ready
substantially before January 1, 2000. However, unforeseen circumstances could
arise during the implementation of the Enron plan that could adversely affect
Enron's or Wessex's mission-critical functions, thereby disrupting or materially
adversely affecting Azurix's business.
We are taking reasonable steps to identify, assess and, where necessary,
replace devices containing embedded chips. Despite these efforts, we anticipate
that we will not be able to find and replace all the devices with embedded chips
or embedded chips in our systems. Further, we anticipate that outside entities
on which we depend will also not be able to find and replace all devices with
embedded chips or embedded chips in their systems. Some of the embedded chips
that fail to operate or that produce improper results may create system
disruptions or failures. Some of these disruptions or failures may spread from
the systems in which they are located to other systems. These failures may have
adverse effects upon our ability to maintain safe operations and may also have
adverse effects upon our ability to serve our customers, to comply with
environmental statutes and regulations, and to otherwise fulfill contractual and
other legal obligations. The embedded chip problem is widely recognized as one
of the
40
<PAGE> 44
more difficult aspects of the Year 2000 problem. Therefore, the possible adverse
impact of the embedded chip problem is not, and will not be, unique to Azurix.
The external entities we are contacting include suppliers, customers,
financial institutions, and governmental entities. We intend to meet with many
external entities that are mission-critical to Azurix for Year 2000 purposes.
However, we cannot in any way ensure that these external entities will be Year
2000 ready, nor can we place complete reliance on any assurances, written or
oral, from these entities that they expect to be Year 2000 ready.
We cannot assure that suppliers upon which we depend for essential goods
and services will test their mission-critical systems in a timely manner.
Failure or delay by all or some of these entities, including U.S. and foreign
governments or governmental authorities, to assess their Year 2000 readiness
could create substantial disruptions having a material adverse effect on our
business.
We have reviewed the most reasonably likely worst case Year 2000 scenarios
we may face. Analysis of these scenarios has led us to contemplate the following
possibilities that, although unlikely, could conceivably occur:
- Widespread failure of electrical, gas and other utilities serving us
domestically and internationally
- Widespread disruption of communications
- Disruption of transportation services for us and our employees,
contractors, suppliers and customers
- Disruption to our ability to gain access to, and remain working in,
office buildings and other facilities
- The failure of substantial numbers of our mission-critical information
systems, including both hardware and software necessary to control
operational facilities such as water and wastewater treatment facilities
and distribution and collection systems
We could face substantial claims by governments, governmental authorities
or customers, as well as loss of revenues, due to service interruptions,
violations of environmental regulations, inability to fulfill contractual
obligations, inability to account for obligations and increased expenses
associated with litigation, harm to persons or to tangible property, violation
of environmental regulations, stabilization of operations following system
failures and the execution of contingency plans. We could also experience an
inability by customers and others to pay, on a timely basis or at all,
obligations owed to us. In addition, we could face claims of damage to persons
or property as the result of improperly treated water or wastewater. Under these
circumstances, there would be a material adverse effect on revenues and
operations. However, this effect can not be quantified at this time. Also, the
cumulative effect of Year 2000 failures in the United States and internationally
could have a substantial adverse effect on the domestic and worldwide economy.
We will continue to monitor business conditions in order to assess and
quantify any material adverse effects that may result from Year 2000 problems.
CONTINGENCY PLANS
As part of the Enron plan, we will develop contingency plans in case we
have not satisfactorily remediated all our internal mission-critical systems and
in case outside systems are not Year 2000 ready. Our contingency plans will be
designed to minimize the disruptions or other adverse effects resulting from
Year 2000 incompatibilities with respect to our mission-critical functions and
systems and to facilitate the early identification and remediation of Year 2000
problems that first manifest themselves after January 1, 2000.
Our contingency plans will include an assessment of our mission-critical
internal information technology systems and our internal operational systems
that use computer-based controls. The contingency planning will begin in 1999
and will continue as necessary. As we implement our contingency plans, we will
assess any mission-critical disruptions due to external Year 2000 failures.
These assessments
41
<PAGE> 45
will be conducted for both our U.S. and non-U.S. operations. In assessing Year
2000 failures, we will monitor mission-critical services such as electrical
power and telecommunications services. The contingency plans will also cover
events such as failure of the delivery of chemicals for water and wastewater
treatment or events of sabotage.
Our contingency plans will include the creation of response teams that will
be standing by and prepared to respond rapidly to Year 2000 problems. The
composition of these teams will vary according to the nature, importance and
location of the problem. We will also station response teams at our non-U.S.
operations as necessary.
OUTLOOK
The extent and magnitude of the effects of Year 2000 on us, both before and
after January 1, 2000, are difficult to predict or quantify for a number of
reasons including:
- Difficulty of locating chips embedded in computer hardware and in devices
used in mission-critical systems such as process or flow control,
environmental, transportation, access and communications
- Difficulty in evaluating and testing outside systems connected to our
computer, telecommunications, plant or other mission-critical systems or
on which our mission-critical systems depend, such as electrical
utilities or telecommunications carriers
- Difficulty locating mission-critical internal software that is not Year
2000 compatible
- The possible unavailability of trained hardware and software engineers,
technicians and other personnel to perform remediation, validation and
testing of mission-critical systems
42
<PAGE> 46
GOVERNMENT OUTSOURCING THROUGH PRIVATIZATION
Governments around the world are increasingly outsourcing the ownership,
operation and management of their water and wastewater assets and services to
the private sector. For many projects, there is a lead-time of several years
while the government, with the help of its international financial and legal
advisors, works on the concept of privatization and gains consensus among
various interest groups. The decision to privatize is generally authorized by
legislation. Different approaches are used by various governments. Many
governments choose a public tender process to ensure that privatizations occur
at market rates. In some parts of the world, particularly Latin America, an
auction format has been used successfully. In other places, notably China,
private parties often negotiate directly with the government with no formal
invitation to bid.
If a tendering process is used, rules are published. These rules generally
require some form of qualification for bidders, where parties submit financial
and operational credentials and the government accepts only qualified parties as
bidders. Qualification for bidding has heavily emphasized prior experience in
operating water and wastewater systems or individual treatment plants that are
of a size at least comparable to the system or facility being privatized or
built. The potential bidders submit extensive documentation to qualify for
bidding and often must form entities within the country through which to submit
their bids. In addition, governments often consider the financial strength of
the potential bidders and may require substantial bid bonds or letters of credit
to be provided as part of the bid.
COMMON FORMS OF OUTSOURCING
- SALE OF WATER ASSETS. A government may incorporate a water and wastewater
system and sell all or part of it to private parties. The water company
is given a monopoly license to operate in a specified service territory.
The license may be subject to revocation for non-performance or another
breach of its terms and to renewal periodically, typically every 20 to 30
years. For example, the United Kingdom privatized the ten regional water
and wastewater authorities in England and Wales through public offerings
of shares in 1989, and Berlin, Germany is in the process of selling a
49.9% interest in its water and wastewater system.
- CONCESSIONS. As an alternative to a sale of water assets, a government
may grant a private party the right to operate a water and wastewater
system for a fixed term, retaining title to the underlying assets. The
holder of a concession takes on the financial risks of managing the
assets during the term of the concession, often 20 to 30 years but in
some cases extending much longer. The concession agreement often mandates
improvements to the water and wastewater system, sets standards of water
quality that must be achieved and establishes a timeframe for realizing
these objectives. At the end of the concession, control of the assets
reverts to the government, which may renew the concession with the
existing holder or another party. Many of the water and wastewater
opportunities around the world take the form of concessions. See
"Business -- The Global Water Industry -- Trend Toward Government
Outsourcing Through Private Sector Participation."
- CONSTRUCTION AND OPERATION OF A SINGLE ASSET. Sometimes a government will
ask a private sector participant to construct and operate a particular
facility that serves its water or wastewater system. Frequent examples
are water and wastewater treatment plants, pipelines and aqueducts. Two
typical transaction structures are build-own-operate and
build-own-transfer projects. In both a build-own-operate and a
build-own-transfer project, the private party builds, owns and operates
the asset. In the case of a build-own-transfer project, the private party
then transfers the asset to the government after a fixed term, usually 15
to 25 years but often longer. The build-own-operate or build-own-
transfer contract describes the project and its services, as well as the
revenues the private party will receive for the services the asset
provides.
- LEASES. Under a lease, a government turns over control of the system for
a fixed period but, unlike in a concession, the government retains much
of the economic risk. In France, most municipalities use a type of lease
called an affermage, which is also used in many former French colonies.
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<PAGE> 47
- OPERATIONS AND MANAGEMENT CONTRACTS. Sometimes a government will ask a
private party to operate its system on a day-to-day basis, but will keep
most of the economic risk relating to the system. The term of the typical
operations and management contract is five to ten years. These contracts
are common in the United States. See "Business -- The Global Water
Industry--Trend Toward Government Outsourcing Through Private Sector
Participation -- North America."
- OUTSOURCING PARTICULAR SERVICES. A government also may ask private
parties to provide specific services to a government-operated water or
wastewater system. Examples of these services include billing,
construction projects and residuals management. The service provider
typically takes no risk for the system as a whole, only for the
particular services it provides. See "Business -- The Global Water
Industry -- Outsourcing Opportunities in the Municipal and Industrial
Services Markets."
SELECTED AWARDED WATER AND WASTEWATER PRIVATIZATIONS
The following is a list of selected water and wastewater privatizations in
Europe, North America, Latin America, the Caribbean, Asia and the Pacific Rim
that have been awarded during the past several years. The majority of these
privatizations have been in the form of concessions, build-own-transfers or
leases, except in North America, where private parties have primarily entered
into operations and management contracts. Except as otherwise indicated in the
notes to the following table, the estimated size of these awarded privatizations
is taken from the October 1998 edition of Public Works Financing. The estimated
size for operations and management contracts represents aggregated fees over the
term of the contract. The estimated size for build-own-transfer projects
represents construction costs. The estimated size for concessions represents
acquisition fees and total capital expenditure commitments in the concession
contract.
SELECTED AWARDED WATER AND WASTEWATER PRIVATIZATIONS
<TABLE>
<CAPTION>
LOCATION YEAR PROJECT ESTIMATED SIZE
-------- ---- ------- --------------
(IN MILLIONS)
<S> <C> <C> <C>
EUROPE:
Germany............... 1992 25-year concession for water supply and wastewater $ 528
treatment plant in Rostock
Germany............... 1997 Sale of 49% stake and 20-year management contract for water 139
and wastewater system for Potsdam
Hungary............... 1998 Sale of minority interest in water company serving Budapest 340
Turkey................ 1995 15-year build-own-transfer project for dam and wastewater 800
works near Izmit and pipeline supplying Istanbul
United Kingdom........ 1989 Stock offerings of 10 regional water and wastewater 8,640(1)
companies in England and Wales
NORTH AMERICA:
Georgia............... 1998 20-year operations and management contract for water system $ 400
in Atlanta
Indiana............... 1998 10-year operations and management contract for wastewater 225
treatment plants in Indianapolis
Michigan.............. 1998 7-year design, build and operate water treatment plant in 260
Detroit
New Jersey............ 1996 20-year operations and management contract for water and 200
wastewater collection in North Brunswick
Oklahoma.............. 1997 25-year contract to operate three wastewater plants in 250
Oklahoma City
Wisconsin............. 1998 10-year operations and management contract for wastewater 350
system in Milwaukee
</TABLE>
- ---------------
(1) Information is from HM Government Perspective.
44
<PAGE> 48
SELECTED AWARDED WATER AND WASTEWATER PRIVATIZATIONS (CONTINUED)
<TABLE>
<CAPTION>
LOCATION YEAR PROJECT ESTIMATED SIZE
-------- ---- ------- --------------
(IN MILLIONS)
<S> <C> <C> <C>
LATIN AMERICA AND THE
CARIBBEAN:
Argentina............. 1993 30-year concession for water and wastewater system for $4,000
the capital city of Buenos Aires
Argentina............. 1995 30-year operations and management contract for water and 1,200
wastewater system for Santa Fe, Rosario and surrounding
area
Argentina............. 1997 30-year concession for water system in Cordoba 495
Argentina............. 1998 95-year concession and sale of shares for water and 150(1)
wastewater system in the Province of Mendoza
Argentina............. 1999 Concession for water and reservoir in Misiones (final N/A
award pending)
Argentina............. 1999 Concession for water and wastewater system in the 439(2)
Province of Buenos Aires (final award pending)
Bolivia............... 1997 30-year concession for water and wastewater system in 360
both La Paz and El Alto
Chile................. 1998 35-year concession and sale of shares for water and 138(3)
wastewater system for Valparaiso and surrounding region
Colombia.............. 1997 30-year build-own-transfer contract for wastewater 130
treatment plant in Bogota
Mexico................ 1993 Four multi-year contracts to upgrade Mexico City's water 1,000
distribution program
Mexico................ 1993 25-year concession for water and wastewater system for 70(1)
city of Cancun and surrounding area
Mexico................ 1996 12-year build-own-transfer concessions for treatment 200
facilities at five Pemex refineries
Puerto Rico........... 1995 6-year operations and management contract for water and 600
wastewater plants
</TABLE>
(1) Azurix owns an interest in this concession.
(2) Azurix will own an interest in this concession.
(3) Information is from December 23, 1998 Financial Times.
45
<PAGE> 49
SELECTED AWARDED WATER AND WASTEWATER PRIVATIZATIONS (CONTINUED)
<TABLE>
<CAPTION>
LOCATION YEAR PROJECT ESTIMATED SIZE
-------- ---- ------- --------------
(IN MILLIONS)
<S> <C> <C> <C>
ASIA AND THE PACIFIC RIM:
Australia............. 1993 25-year build-own-transfer contract for wastewater $ 200
treatment plant in Sydney
Australia............. 1995 15-year operations and management contract for water and 1,100
wastewater services in Adelaide
China................. 1996 49% stake in 13 water plants in Jiangsu Province 162
China................. 1998 18-year build-own-transfer contract for water supply for 120
Chengdu
Indonesia............. 1997 Two 25-year concessions for water systems in Jakarta 1,750
Malaysia.............. 1992 20-year build-own-transfer contract for water treatment 290
facilities at Sungai Layang
Malaysia.............. 1995 25-year contracts to operate 26 water systems around 312
Kuala Lumpur
Malaysia.............. 1995 26-year upgrade and operations and management concession 800
for water treatment facilities in Selangor
Philippines........... 1997 Privatization of the metropolitan water and wastewater 5,700
system for Manila
</TABLE>
46
<PAGE> 50
BUSINESS
Azurix, a Delaware corporation, is a global water company engaged in the
business of acquiring, owning, operating and managing water and wastewater
assets, providing water and wastewater related services and developing and
managing water resources. Enron incorporated the company now called Azurix as a
shell company on January 29, 1998. Azurix's first significant step was to
acquire Wessex for $2.4 billion on October 2, 1998. Following our acquisition of
Wessex, we began implementing our global business strategy.
Our asset portfolio also includes interests in long-term water concessions
in the Province of Mendoza, Argentina and in Cancun, Mexico. In addition, we
acquired Philip Utilities on May 18, 1999 for $106.3 million. Philip Utilities
provides operations and management, engineering, residuals management and
underground infrastructure development services for municipal water and
wastewater facilities in North America. On May 18, 1999, we were notified that,
subject to final confirmation, we will be awarded an interest in a long-term
water and wastewater concession in two regions of the Province of Buenos Aires,
Argentina, at an aggregate price of $438.6 million. Except for the provincial
government finalizing its review of the legality of our bid, which we expect to
occur by mid-June 1999, there are no known contingencies to our being awarded an
interest in this concession. On May 28, 1999, we entered into an agreement to
acquire an interest in a company that provides water and wastewater related
services in a portion of Mexico City, Mexico. We have made each of these
investments through one or more subsidiaries, which will be our approach as we
pursue our worldwide growth strategy.
We are aggressively pursuing additional water and wastewater transactions
in Europe, North America, Latin America, the Caribbean, the Middle East, Africa,
Asia and the Pacific Rim. These include many of the upcoming privatizations
identified in this prospectus and various privately negotiated transactions. We
are also continually evaluating potential acquisitions of companies owning water
and wastewater assets or providing water related services. The timing, size and
success of any of these potential acquisitions cannot be predicted. The
completion of any one of these acquisitions could have a significant impact on
our business.
Our experienced management team from Enron, Wessex and other water and
wastewater systems, and multinational companies provides us with the experience
necessary to compete successfully in the global water industry. We are
transferring the skills that Enron has successfully applied in developing,
financing, operating and managing the risks of energy infrastructure projects to
our water business around the world. In addition, we are applying to our water
business the operating, management and technical skills that our executives from
Wessex and other companies have successfully used in operating and managing
water and wastewater assets while providing high quality customer service. This
management team competitively positions us to identify, evaluate, acquire,
develop, finance and operate water and wastewater projects and services
worldwide.
THE GLOBAL WATER INDUSTRY
The global water industry includes the businesses of collecting, treating,
storing and supplying drinking water, and of collecting, treating and disposing
of wastewater and wastewater by-products. Public and private water companies
serve industrial, commercial and residential customers. Azurix estimates that
the global water industry has total annual revenues of approximately $300
billion. In addition, Azurix estimates that over $600 billion will be spent on
worldwide water and wastewater infrastructure over the next decade.
The ownership of water assets and the provision of water and wastewater
services around the world remains highly concentrated in the public sector,
typically at the municipal or community level. Major capital investment and
increased efficiencies in the water sector are required by the following:
- Increasingly stringent standards for water quality, wastewater services
and environmental protection
- The need to provide growing urban populations with safe drinking water
supply and wastewater treatment systems
- The aging of existing water and wastewater infrastructure
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<PAGE> 51
Governments throughout the world frequently face budgetary constraints and
often lack the technical and operational skills of private sector participants
to address these issues efficiently. As a result, governments are increasingly
turning to the private sector to address their water and wastewater
infrastructure needs.
Industrial companies also must comply with increasingly stringent standards
for water quality, wastewater services and environmental protection. To meet the
additional expense of complying with these standards and to reduce uncertainty
in financing their operations, many industrial companies are beginning to
outsource their water supply and wastewater requirements to third parties with
the expertise to construct and operate their systems and provide services on a
more efficient and cost effective basis. The ability to manage water resources
and efficiently transport water to areas where water is scarce, including the
delivery of drinking water to growing urban centers, is becoming increasingly
important as well.
As a result, we believe that significant opportunities exist for private
sector participation in the water and wastewater industry. These opportunities
include taking part in water and wastewater privatizations, providing water and
wastewater related services to municipal and industrial water markets and
developing and managing water resources.
TREND TOWARD GOVERNMENT OUTSOURCING THROUGH PRIVATE SECTOR PARTICIPATION
Following the trend of private sector participation in the natural gas,
electricity and telecommunication industries, governments around the world are
increasingly turning to the private sector to own, operate and manage their
water and wastewater assets and services. According to World Bank statistics,
between 1984 and 1990, developing countries awarded contracts for only eight
water and wastewater projects to private companies, amounting to a total of $297
million. According to these same statistics, by the end of 1997, the cumulative
level of private sector investment had increased to $25 billion. As of October
1998, according to Public Works Financing statistics, there were approximately
380 planned, funded or completed water and wastewater projects with private
sector participation worldwide for a total estimated cost of approximately $74
billion.
The following discussion summarizes some of the water and wastewater
outsourcing arrangements that have been awarded to date and are expected to be
upcoming in various regions of the world. For a more detailed description of the
outsourcing arrangements that have been awarded to date, see "Government
Outsourcing Through Privatization."
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<PAGE> 52
EUROPE. The United Kingdom has privatized large portions of its water
sector. French municipalities have long turned to the private sector to operate
their water and wastewater systems. Several other European water and wastewater
service providers are scheduled to offer major concessions or build-own-
transfer or build-own-operate projects in 1999 and 2000. We believe that the
pace of privatization may increase once these additional privatizations have
occurred in Europe and the benefits of privatization are recognized. In
addition, European Union directives are imposing higher water and wastewater
standards on member countries and are requiring significant capital investment
for compliance throughout the region. We believe that these countries will rely
on the private sector to help fund these capital requirements. The following is
a list of selected upcoming water and wastewater privatizations expected in
Europe.
SELECTED UPCOMING WATER AND WASTEWATER PRIVATIZATIONS -- EUROPE
<TABLE>
<CAPTION>
COUNTRY PROJECT
- ------- -------
<S> <C>
Bulgaria............................. Sale of stock and concession for water and wastewater
for Sofia
Czech Republic....................... Sale of stock and concession for water and wastewater
for Prague
Estonia.............................. Sale of stock for municipal system in Tallinn
Germany.............................. Sale of stock in a holding company that holds an
interest in the water and wastewater company serving
Berlin
Greece............................... Concession for water and wastewater for Athens
Hungary.............................. Upgrade for water treatment and disposal plant in
Dunavarsany
Italy................................ Sale of stock for water and wastewater for Rome
Italy................................ Privatization of water and wastewater for Puglia
Region
Italy................................ Build-own-transfer project for wastewater facility at
Porto Marghera outside Venice
Lithuania............................ Operations and management contract and concession for
water for Vilnius
Poland............................... Concession for water and wastewater for Poznan
Portugal............................. Concession for water and wastewater for Cascais
Romania.............................. Sale of stock and concession for water and wastewater
for Bucharest
Spain................................ Design and build water treatment plant at Palma,
Majorca
Turkey............................... Operations and management contract for wastewater
services for Cesme-Alacaty
Turkey............................... Construction of wastewater treatment plants in Seyhan
and Yuregic
United Kingdom....................... Private sector participation in the Ministry of
Defence's water and wastewater assets
</TABLE>
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<PAGE> 53
NORTH AMERICA. In the United States, approximately 80% of the population is
currently served by approximately 24,000 government owned and operated water
authorities. Although the U.S. market shows significant potential for
concessions or asset sales because so small a percentage of the population is
served by private water companies, few municipalities have used these
approaches. Many municipalities have been reluctant to give up ownership of
their water and wastewater systems and access to tax exempt financing. Thus, in
the U.S. market, governments typically enter into public/private partnerships in
which private parties make equity investments in partnership with local water
and wastewater companies or provide lower-cost outside capital sources to fund
infrastructure requirements and growth opportunities. Governments are also
outsourcing the operation of their water and wastewater assets to private
parties.
The key factors contributing to these outsourcing decisions are:
- Increased regulatory and environmental requirements contained in the Safe
Drinking Water Act and the Clean Water Act
- Deteriorating water and wastewater infrastructures within the nation's
largest urban areas
- New technologies designed to improve water and wastewater solutions with
a minimal environmental impact
- Significant capital requirements to meet these needs, estimated by the
U.S. Environmental Protection Agency to be approximately $275 billion for
water and wastewater infrastructure over the next 20 years
The following is a list of selected upcoming water and wastewater
privatizations expected in North America.
SELECTED UPCOMING WATER AND WASTEWATER PRIVATIZATIONS -- NORTH AMERICA
<TABLE>
<CAPTION>
STATE PROJECT
- ----- -------
<S> <C>
California........................... Contract for construction project manager for water
capital improvements in San Francisco
Florida.............................. Design, build and operate water treatment plant for
Tampa Bay Water
Georgia.............................. Build-own-operate-transfer of wastewater system in
Atlanta
Illinois............................. Build-own-operate biosolids processing facility in
Chicago
New York............................. Privatization of wastewater system in Buffalo
New York............................. Privatization by Army Corps of Engineers of water and
wastewater at Ft. Hamilton
Tennessee............................ Contract for operation and maintenance of the water
system currently serving most of Chattanooga
Texas................................ Regionalization of water supply in El Paso
Texas................................ Design, build and operate water treatment plant for
Houston
Washington........................... Design, build and operate project for Cedar River
water treatment plant in Seattle
Washington D.C. ..................... Privatization of water treatment plants
</TABLE>
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<PAGE> 54
LATIN AMERICA AND THE CARIBBEAN. The pace of infrastructure privatizations
in Latin America and the Caribbean has accelerated since the first electricity
privatizations took place in Chile during 1982. Since then, privatizations of
electricity, natural gas and telecommunications assets have occurred in parts of
Argentina, Brazil, Chile, Colombia, the Dominican Republic, El Salvador,
Guatemala, Panama and Peru, among other countries. To date, privatizations of
water and wastewater systems have occurred in Argentina, Brazil, Bolivia, Chile,
Colombia and Mexico and are scheduled in many other countries, including the
Dominican Republic, Ecuador, Panama and Venezuela. The following is a list of
selected upcoming water and wastewater privatizations expected in Latin America
and the Caribbean.
SELECTED UPCOMING WATER AND WASTEWATER PRIVATIZATIONS -- LATIN AMERICA AND THE
CARIBBEAN
<TABLE>
<CAPTION>
COUNTRY PROJECT
------- -------
<S> <C>
Argentina............ Construction of aqueduct in Cordoba
Argentina............ Concession for water and wastewater in Tucaman Province
Bolivia.............. Concession for water for Cochambamba
Brazil............... Privatizations of state water and wastewater systems in each
of the following states: Parana, Sao Paulo, Rio Grande do
Sul, Bahia, Mato Grosso do Sul, Amazonas, Rio de Janeiro,
Santa Catarina and Espirto Santo
Chile................ Sequential sale of controlling stakes in 12 remaining
regional water and wastewater systems including Santiago,
Concepcion, Puerto Montt and Rancagua
Colombia............. Concession for water and wastewater for Monteria
Dominican Republic... Institutional strengthening and rehabilitation for country's
three principal water and wastewater service providers
Ecuador.............. Concession for water and wastewater for city of Guayaquil
Guatemala............ Build-own-transfer project for water supply wells in
Guatemala City
Panama............... Concession for countrywide water and wastewater system
Peru................. Construction of wastewater treatment plant in Lima
Venezuela............ Rehabilitation of Caracas water system
Venezuela............ Privatization of Fajardo water system in Miranda State
Venezuela............ Concession for water and wastewater in Margarita Island
</TABLE>
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<PAGE> 55
MIDDLE EAST AND AFRICA. Many Middle Eastern and African countries are faced
with acute water shortages. As a result, several Middle Eastern countries are
seeking private development of major transportation or treatment projects, which
may include build-own-transfer projects for pipelines, canals and treatment
plants. Although privatization is not widespread in Africa, there are
exceptions. Cote d'Ivoire, while still a French colony, granted a long-term
concession to a French-owned company. A majority of the concessionaire is now
owned by public stockholders. The following is a list of selected upcoming water
and wastewater privatizations expected in the Middle East and Africa.
SELECTED UPCOMING WATER AND WASTEWATER PRIVATIZATIONS -- MIDDLE EAST AND AFRICA
<TABLE>
<CAPTION>
COUNTRY PROJECT
- ------- -------
<S> <C>
Egypt................... Build-own-transfer project for water transmission and
treatment system for area of Suez Gulf and East Cairo
Israel.................. Tender for wastewater treatment plants in Beersheeva
Municipality
Jordan.................. Build-own-transfer project for water pipeline to Amman
Kuwait.................. Build-own-transfer project for wastewater treatment plant
for Sulaibiya
Lebanon................. Build-own-transfer project for water pipeline and water
treatment plant for Beirut as part of the national plan for
water privatization
Morocco................. Concession for water and wastewater system for Tangiers
Tunisia................. National plan for water privatization in advanced stages;
each city is able to independently arrange for privatization
and many are actively doing so
</TABLE>
ASIA AND THE PACIFIC RIM. In Asia, the recent financial crisis and ongoing
economic uncertainty may be limiting private investment in the water sector.
Prior to the economic downturn in Asia, water concessions had been granted in
Indonesia, Malaysia and the Philippines. In China, municipal water agencies have
entered into build-own-transfer arrangements with Western companies for water or
wastewater treatment plants through auctions and negotiation. The following is a
list of selected upcoming water and wastewater privatizations expected in Asia
and the Pacific Rim.
SELECTED UPCOMING WATER AND WASTEWATER PRIVATIZATIONS -- ASIA AND THE PACIFIC
RIM
<TABLE>
<CAPTION>
COUNTRY PROJECT
- ------- -------
<S> <C>
Armenia................. Operations and management contract for water and wastewater
for Yerevan
China................... Joint venture for Beijing No. 10 water treatment plant
China................... Build-own-transfer arrangement or joint venture for water
and wastewater system for Xunchang, Sichuan Province
Georgia................. Concession for water and wastewater for Tblisi
India................... Build-own-transfer project for water treatment plant in
Haldia
India................... Privatization of water treatment plant for Delhi
India................... Design and build water supply projects in large and medium
towns in state of Orissa
Nepal................... Operations and management contract for water supply and
wastewater collection services to Kathmandu Valley
</TABLE>
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<PAGE> 56
OUTSOURCING OPPORTUNITIES IN THE MUNICIPAL AND INDUSTRIAL SERVICES MARKETS
We believe that municipal governments and industrial companies in North
America and Western Europe, in particular, will increasingly seek to outsource
the management of their water and wastewater systems to private parties with the
operating experience and capital to provide reliable services, to comply with
more stringent regulatory requirements for water quality and environmental
protection and to reduce uncertainty in financing these operations. To comply
with stricter environmental and drinking water quality standards, municipalities
will incur increased labor costs for treatment, higher monitoring and equipment
maintenance costs and increased costs of disposing of biosolids. Federal funding
grants to help municipalities meet their financial needs have declined over
time, leaving municipal wastewater authorities facing serious budgetary
challenges. Private sector outsourcing can include any combination of design,
financing, construction, ownership or operation of a facility; administrative
services such as metering, billing, collection or maintenance; and applying
process engineering technologies such as biosolids filtration, clarification,
purification, separation, drying and disposal.
Industrial companies are also experiencing rising costs related to their
water and wastewater needs. The chemical, refining, pharmaceutical, high
technology, food and beverage, paper and pulp, steel, automobile and energy
industries have large water supply and wastewater treatment requirements. These
industries require pure water for their operations and produce effluents that
must be treated before being released into normal wastewater systems or being
discharged directly into the environment. Most industrial wastewater needs to be
pre-treated and environmental laws prohibit the direct discharge of wastewater
into the environment without a permit. Many industries treat and dispose of
their own wastewater because the relatively concentrated wastes from these
industries frequently cannot be discharged into the public sewer system and
on-site treatment is usually less expensive.
These industrial companies must invest large amounts of capital in their
water and wastewater treatment and distribution assets. By outsourcing the
management of these assets to third parties, these companies may reduce the
uncertainty associated with expenditures required by changes in water quality
standards and environmental regulations. Obtaining landfill, storage and
incineration capacity to dispose of the residue from the wastewater treatment
process is a major component of providing industrial wastewater services, and
may involve procuring long-term capacity of specially lined or hazardous waste
landfills.
The services to be provided to municipal and industrial customers generally
fall into three main categories:
OPERATIONS, MANAGEMENT AND ENGINEERING. Over the past few years, large
cities and industrial companies have reduced costs by outsourcing the design,
construction, operation or maintenance of their water and wastewater assets to
private sector service providers. Many of these service providers have
consolidated and the market is much less fragmented than either the residuals
management or the underground infrastructure markets. Consequently, competition
for major contracts for the largest cities in the United States has been
significant. Although some companies have focused on providing services to small
to medium sized municipalities and large industrial firms, many of these
companies lack the financial capacity or risk management capability to purchase
water and wastewater assets from their industrial customers or to qualify on
their own as the operators and managers of their customers' facilities.
According to the May/June 1998 issue of Environmental Business Journal, the fees
associated with providing contract operations and consulting, design engineering
and maintenance services to customers in the municipal and industrial markets in
the United States are estimated to have exceeded $5.5 billion for 1997, and are
expected to continue to grow.
RESIDUALS MANAGEMENT. Managing the biosolids that result from municipal and
industrial wastewater represents a large component of the cost of wastewater
treatment. Increasingly stringent effluent discharge standards are resulting in
a significant increase in the quantity of residuals. At the same time,
environmental regulations are limiting waste disposal options. For example,
ocean dumping of biosolids has been banned in the United States and the European
Economic Area, increasing costs for managing residuals in these regions. In
addition, environmental regulations are requiring firms to provide beneficial
reuse solutions. Incineration, landfilling, land application and producing
compost are becoming the only
53
<PAGE> 57
available disposal options in many countries and have inspired a number of new
disposal and reuse technologies. These options are themselves the subject of
increasingly stringent environmental regulation. Certain applications can turn
biosolids from waste into a substance that can be sold as soil conditioner or
that can be burned as fuel. These technologies create a product with market
value and provide an environmentally attractive alternative to the increasingly
expensive and scarce disposal options of incineration and landfilling.
Residuals management companies provide services to local and state
agencies, municipalities and private companies. Specific services include the
transportation, treatment, site monitoring, disposal and environmental
regulatory compliance services associated with biosolids and wastewater
disposal. These companies provide a variety of residuals management options to
prospective customers who seek alternative methods of biosolid treatment. Not
all methods can be profitably and practically applied in all geographic areas
due to the specific nature of the terrain and agriculture in the region and the
local biosolid content.
We estimate that 55% of biosolids produced in the United States are
recycled, and we anticipate that recycling of biosolids will continue to grow
over the next decade. As recycled uses of biosolids continue to increase, we
believe that larger and more sophisticated companies will have opportunities to
create value through economies of scale and scope by providing new solutions to
these problems.
UNDERGROUND INFRASTRUCTURE REMEDIATION AND DEVELOPMENT. We estimate that
over half of the approximately $275 billion of capital that the EPA estimates
will be spent in the United States during the next 20 years will be spent on
repairing, replacing and developing the nation's underground water and
wastewater infrastructure.
Much of the cost associated with the repair, replacement and development of
underground infrastructure is attributable to the lost revenues resulting from
the disruption of service associated with open cut excavation. During the past
decade, advances in the oil and natural gas industry have been used in the water
industry, enabling the repair of underground infrastructure without open cut
excavation. Trenchless technologies such as horizontal drilling, tunneling,
grouting and pipe lining enable the repair and replacement of water
infrastructure with a fraction of the disruption associated with traditional
open cut excavation.
Currently, small local civil engineering firms and contractors perform most
of the trenchless underground infrastructure work. As the size of these projects
grows and the capital requirements and sophistication of these newer
technologies increase, we believe larger, better capitalized and more
sophisticated firms who hold experience in the oil and gas industry will have a
competitive advantage in obtaining this business. We expect that the underground
water and wastewater infrastructure market for the municipal market in the
United States will grow during the next decade.
WATER RESOURCE DEVELOPMENT AND MANAGEMENT
We believe that the management of aquifers and other water resources and
the storage and transportation of water offer important opportunities for
business development. In many regions of the world, such as parts of North and
South America, the Middle East and many island nations, lack of abundant water
resources is a critical issue. Governments, which historically have been
responsible for developing and managing water resources, are now seeking private
sector assistance to address their water resource issues due to the operational,
technical and financial expertise required to operate, build and fund these
capital intensive projects.
In many countries, including the United States and China, water consumption
is mainly driven by patterns of population movements and industrial and urban
development. In parts of the United States, increases in water demand resulting
from large population shifts to the sunbelt, multi-year droughts and
irrigation-intensive agriculture have resulted in consumption that exceeds the
natural rate of replenishment. This has led to large scale diversions of surface
water through dams and reservoirs and to diminished groundwater supply. In
China, rapid economic growth in the Southern provinces (notably the Guandong
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<PAGE> 58
and the Shanghai areas) has significantly increased demand for water.
Drinking-quality water now used in agriculture may need to be diverted to
population centers.
In light of these factors, industry participants are focusing new efforts
on means of extracting, managing, storing and transporting water resources as
efficiently as possible. The large amount of capital required and the inability
of local governments to fund these needs compound the difficulties in developing
and managing water resources. Transporting water over long distances to urban
areas requires canals, aqueducts, underground pipelines and/or pumping stations.
These are typically large infrastructure projects requiring significant
development, construction, operational and financial expertise.
COMPETITION
Participants in the global water market face significant challenges,
including qualifying for the bidding process, obtaining and demonstrating
operating experience and management depth, accessing capital, obtaining and
demonstrating expertise in managing international infrastructure projects,
identifying and evaluating transactions and assessing and mitigating risks,
especially operational, political and regulatory risks. As a result, only a
small number of companies currently compete globally in the water and wastewater
privatization market.
Two French companies, Suez Lyonnaise des Eaux and Compagnie Generale des
Eaux, a subsidiary of Vivendi, currently are recognized as the leading
competitors in the international water and wastewater market. According to Suez
Lyonnaise des Eaux, it serves an aggregate population of approximately 77
million for water and 52 million for wastewater. According to Vivendi, Compagnie
Generale des Eaux serves an aggregate population of approximately 80 million for
water and 30 million for wastewater. These two companies are significantly
larger than the next group of international competitors, the largest of which
serves an aggregate population of approximately 32 million. These smaller
competitors include privatized water and wastewater companies from the United
Kingdom and some smaller French and Spanish companies. We are a new competitor
in the international water and wastewater market, and we currently serve an
aggregate population of approximately four million. Some construction companies
also bid on water and wastewater projects, more often on build-own-transfer
projects than on concessions.
In the United States, the water and wastewater industry is highly
fragmented, with over 55,000 public and private water entities serving
approximately 90% of the nation's population. Of this number, approximately
31,000 are investor owned and the rest are publicly owned, generally by local
municipalities. Most of these entities serve only a single community or region.
Only eight publicly traded water and wastewater companies have market
capitalizations over $200 million, and only three have market capitalizations
over $500 million. Several of these publicly traded companies have become active
consolidators by acquiring the small private and public investor owned utilities
that operate in markets contiguous to or near their own. Of the three largest
consolidators, none has more than a 3% market share in the United States, and
these three combined serve only 6% of the nation's customers. In addition,
several electric utilities have begun to acquire municipally owned water
distribution companies in the United States. Many companies compete in the
United States for municipal service contracts and industrial outsourcing
opportunities, including subsidiaries of the French and U.K. water companies.
In the United Kingdom, the water industry has achieved approximately 98%
population coverage. The 10 water and wastewater authorities in England and
Wales were privatized in 1989 to form 10 water and wastewater companies
operating in geographically discrete regions. Wessex has a virtual monopoly over
water supply and wastewater services in its licensed region, with the exception
of the cities of Bristol and Bournemouth and a small area of rural Wiltshire,
where three companies provide water and Wessex provides wastewater services.
There is some limited direct competition. For example, other companies may apply
to the industry regulator for a so-called "inset appointment" to serve
particular areas within Wessex's or any other licensee's service area. Inset
appointments may be granted for the supply of water and wastewater services to
Wessex's customers using in excess of 250 megaliters of water per year. Inset
appointments may also be granted for "greenfield sites," which are areas
previously not served by existing companies, or where an incumbent water company
consents to change its boundary to allow part of its
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<PAGE> 59
area to be transferred to another company or potential company. Historically,
very few inset appointments have been granted in England and Wales. This may
change in the future as the U.K. Government and the Director General of Water
Services seek to increase competition. The Director has announced a future work
program that includes new initiatives to extend competition. These include
lowering the threshold for inset appointments, promoting competition in new
connections, facilitating common carriage and use of competition law powers.
Wessex does have one inset appointment within its territory resulting from the
privatization of water supply activities formerly provided by the Ministry of
Defence. Wessex chose not to pursue this project because of unacceptable
contract terms. The Chancellor of the Exchequer announced in March 1999 that the
Government intends to study ways to increase competition in the United Kingdom's
water sector. We cannot predict what changes, if any, the Government will adopt
to promote competition. See "-- Existing Azurix Assets -- Wessex" and
"Regulatory Matters -- U.K. Regulatory Matters -- Changes to Regulatory Regime."
OUR COMPETITIVE STRENGTHS
We have several competitive strengths that should enable us to compete
successfully in the global water industry.
EXPERIENCED MANAGEMENT AND BUSINESS DEVELOPMENT TEAMS
Although our company was recently formed, we have a group of experienced
managers from long-established companies, including Enron, other multinational
companies, Wessex and other water and wastewater companies. Our management team
has extensive experience in competing for, developing and operating
infrastructure projects worldwide and years of experience in managing water and
wastewater companies primarily in the United Kingdom and also in the United
States. Many of our executives were actively involved in developing and managing
natural gas and power projects for Enron in the United States and around the
world. Enron is one of the world's leading integrated natural gas and
electricity companies with a market capitalization of approximately $28 billion.
Rebecca Mark, chairman and chief executive officer of Azurix and a vice chairman
of Enron, leads the Azurix team in implementing its global water strategy.
During her tenure at Enron, Ms. Mark was responsible for the successful
development of natural gas and power projects worldwide. Beginning with Enron's
first international power project in Teesside, England in 1989, Ms. Mark led the
team that developed gas and power projects around the world with total estimated
capital costs exceeding $10 billion.
Our senior executives are complemented by a group of experienced business
developers who identify opportunities in the global water industry. We believe
that the collective experience of our management and business development teams
will enable us to compete successfully for public tenders. Since our formation,
we have qualified for bidding on numerous pending privatizations in Europe,
Latin America and the Middle East. Of the 14 privatizations in which we have
actively participated, only one final award has been made. In this bid for the
concession in Valparaiso, Chile, we were second to the winning bidder. We were
recently notified that, subject to final confirmation, we will be awarded
concessions for two regions of the Province of Buenos Aires, Argentina. We were
one of the three finalists for the partial privatization of the Berlin, Germany
water and wastewater system. On June 7, 1999, we were notified that one of the
other finalists was selected as the preferred bidder, subject to approval by the
Parliament of the state of Berlin, Germany. In addition, we have successfully
identified and closed the privately negotiated Cancun and Philip Utilities
transactions and negotiated the pending acquisition in Mexico.
Our management team will build upon its extensive experience and knowledge
from Enron, Wessex, other water and wastewater systems and other multinational
companies to provide us with the necessary skills to compete effectively in the
global water industry. Although most of our management team's experience in the
water and wastewater industry has been primarily in the United Kingdom and the
United States, we believe that our management team has the requisite operating
experience and management depth to identify and evaluate potential water and
wastewater projects, to qualify for bidding on projects in
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<PAGE> 60
many countries throughout the world, to access capital and to develop and manage
projects. Our management team has the ability to:
- Mobilize the array of resources needed to enter competitive bids for
concessions tendered in privatizations
- Develop projects requiring construction of new facilities in developed
and emerging countries
- Meet the challenges of "fast-track" projects to be brought on-line within
12 to 18 months
- Execute major acquisitions
- Operate regulated companies, including managing their tariff and other
regulatory issues
- Apply innovative financing and risk management strategies in markets
worldwide
We expect to apply many of the same disciplined techniques to analyze
projects and mitigate risks that Enron has developed in its own worldwide
activities. In identifying and quantifying the risks and value of a transaction,
these processes require an analysis of the engineering, operational, regulatory,
financial, economic, structural, legal, insurance, tax and accounting
implications of the transaction. These analytical skills will competitively
position us in the identification, evaluation, development, financing and
acquisition of worldwide water and wastewater projects and in the provision of
associated services.
WESSEX OPERATING EXPERIENCE AND TECHNICAL EXPERTISE
From Wessex, we have obtained the operating experience, research skills and
technical expertise necessary to evaluate potential water projects, to qualify
for bidding on water projects in many countries throughout the world, to build
transition and operating teams for new acquisitions and to manage existing and
new water assets. Wessex supplies approximately 400 million liters of water per
day to a population of approximately 1.1 million and treats on average 484
million liters of wastewater per day from a population of approximately 2.5
million. In December 1998, the water industry regulator for England and Wales
rated Wessex the most efficiently operated privatized water and wastewater
company. Wessex's management team has been in place since the privatization of
the U.K. water industry in 1989. For a discussion of Wessex, see "-- Existing
Azurix Assets -- Wessex."
Wessex uses advanced treatment techniques, increased automation of
operations and services and state-of-the-art control and monitoring systems that
are designed to ensure consistently high standards at low cost. Since its
privatization, Wessex has improved levels of quality and standards of service,
providing reliable water supplies without requiring any water usage
restrictions. It has delivered this high quality service while reducing
operating costs and delivering capital improvements below budgeted amounts. In
addition, Wessex has developed extensive performance data that will be used for
benchmarking purposes in Azurix's operations around the world.
We will also benefit from Wessex's experience with meeting mandated capital
expenditure targets through the use of standard designs, the cost-effective
management of major projects and in-house process and concept design. In
addition, the use of local contractors and detail designers as well as
appropriate technology and efficient procurement are key factors in capital
expenditure management that have benefited Wessex in the past. During the 1990s,
Wessex has successfully managed a $2.0 billion investment program on time and
below the price allowed by regulation. Current regulatory reports show Wessex as
having among the lowest unit costs and achieving the second highest return on
capital of the water and wastewater companies in the United Kingdom.
We will apply Wessex's operational and capital expenditure management
skills in our global water business. We believe many of these skills are
transferable to other water and wastewater assets or services we will acquire or
manage.
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REGULATORY AND GOVERNMENT AFFAIRS EXPERTISE
Our management team has extensive experience in working with regulators and
other governmental agencies. For example, our executives include:
- The executive and regulatory team from Wessex, which has operated for 10
years in the U.K.'s privatized water sector
- The former general manager of the Metropolitan Water District of Southern
California, which through its 27 member public agencies provides almost
60% of the water used by nearly 16 million people living in portions of
Los Angeles and southern California
- A director of the Azurix regulatory team, who has 25 years of regulatory
experience in electricity, gas and water, both in the United States and
internationally
- Executives and lawyers who have worked on private projects and
distribution systems in the gas and electric sectors in Argentina,
Brazil, China, Colombia, Croatia, Germany, India, Italy, Malaysia, the
Philippines, Poland, the United Kingdom and the United States, among
other countries
These members of our management team have extensive government affairs
experience and have often been involved in building relationships with local and
national governments and advising these governments on how to structure their
privatization process and regulatory regime to encourage foreign investment. In
some cases, they have direct experience in the countries and even the regions or
municipalities where we will pursue projects and operate assets, sometimes
working with the same governmental officials who may make decisions regarding
water and wastewater privatizations.
As governments around the world turn to the private sector to fill their
water needs, they will draw on examples of successful privatizations in the
water sector elsewhere and, if applicable, in gas and electric sectors in their
own country. For example, the United Kingdom's privatizations of its electric
and gas sectors already has served as a model for many countries' privatizations
of those sectors, specifically, Argentina, Brazil, Chile and Colombia. We
believe governments will look to the U.K. model in water as well, and through
Wessex we are very familiar with that regime. For example, the ongoing water
privatization in Chile follows a national regulatory regime like the United
Kingdom, which adheres to the principles of incentive-based regulations.
Although the methods of calculating rates of return are slightly different, the
core principles remain the same. As another example, highly successful
build-own-transfer projects and privatizations of gas and electric distribution
networks have occurred in Argentina, Brazil, China, Colombia, Germany, Eastern
Europe, India and the Philippines. As those countries look for precedents in
water and wastewater, they will turn to many of the projects and systems on
which our executives previously have worked.
Although we believe that the regulatory and government affairs expertise
demonstrated by our management team in electricity and gas is transferable to
water and wastewater privatizations, there are some differences between the
sectors. Because water is an essential good affected by health, safety and
environmental issues, regulation of water is more influenced by socioeconomic
and welfare pressures than electricity and gas regulation. In addition, water
and wastewater utilities are typically vertically integrated natural monopolies,
often owned by a public entity, and subject to greater regulation than electric
and gas utilities which are more often privately held and subject to greater
competition. Finally, water and wastewater businesses are more often regulated
at a local or regional level, as compared to national regulation, than
electricity and gas. Despite these differences, we believe that the experience
of our management team in the fundamental aspects of regulation and
privatization is transferable to water and wastewater privatizations.
FINANCING EXPERTISE
Access to capital is essential in the global water business due to its
significant financial requirements. We plan to employ sophisticated financing
techniques and instruments similar to those successfully used by members of our
management team in other infrastructure-intensive businesses. Our executives
have
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experience in raising large amounts of capital through the capital markets and
through innovative financing structures. In addition, the team brings experience
in attracting private equity capital and using this capital to enhance the
borrowing capacity of our projects and to achieve greater returns for equity
holders. In financing a project through debt, we may enhance returns by placing
a portion of the debt at the level of the holding company created to own a
particular concession or facility. As our portfolio grows and matures, we also
intend to enhance our equity returns and reduce overall risk exposure through
opportunistic sales of all or a portion of individual assets or investments. In
addition, our management has experience in applying financing techniques
familiar to the domestic infrastructure market, such as leveraged leases, to
international markets.
Many of our executives have developed extensive contacts and experience in
the global financial market. We intend to work together with multilateral
agencies such as the World Bank, International Finance Corporation, the
Inter-American Development Bank, the European Bank for Reconstruction and
Development and the Overseas Private Investment Corporation.
We intend to apply our financial expertise and skills to the global water
industry to lower the cost of capital for our projects and acquisitions.
OUR BUSINESS STRATEGY
Our business strategy is focused on three complementary areas in the global
water industry:
- Acquiring, owning, operating and managing water and wastewater assets
- Providing water and wastewater related services, including operations,
management and engineering, residuals management, and underground
infrastructure development and remediation services
- Developing and managing water resources
Our participation in each of these areas should allow us to satisfy the
needs of a full spectrum of water and wastewater customers. The particular
characteristics of each market as well as customer needs that vary by region and
market will drive our approach to developing these business lines and providing
creative solutions to water and wastewater needs in those markets.
ACQUIRING, OWNING, OPERATING AND MANAGING WATER AND WASTEWATER ASSETS
ACQUIRING WATER AND WASTEWATER ASSETS. We intend to build a diversified
portfolio of water and wastewater assets, including both established businesses
with stable returns and concessions and projects in emerging markets with
significant development requirements and potential for growth and enhanced
returns. We intend to consider acquisitions of privately owned water and
wastewater assets throughout the world with predictable contractual or regulated
revenue streams that will complement our portfolio and strengthen our
competitive position in the global water industry.
We intend to acquire water and wastewater assets through participation in
public tenders and privately negotiated transactions throughout the world,
including Europe, North America, Latin America, the Caribbean, the Middle East,
Africa, Asia and the Pacific Rim. As the trend toward privatization continues,
we expect new opportunities to materialize around the world. See "-- The Global
Water Industry -- Trend Toward Government Outsourcing Through Private Sector
Privatization."
We intend to target opportunities where there is potential for increased
returns and where we can draw on the experience of our management team in
regulatory and rate case analysis, political risk assessment, country-specific
project development and water infrastructure operation. In some instances, we
may join with other parties, including local entities, in acquiring or bidding
on assets. We will evaluate potential projects and acquisitions based on a
variety of financial, strategic, regulatory and operational factors and utilize
our sophisticated financial, legal and tax analysis capabilities to determine
the appropriate acquisition and ownership structure designed to minimize risks.
From inception, the analysis of potential acquisitions will be staffed by our
employees with assistance from affiliated companies and
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<PAGE> 63
external experts as needed. We expect to work with Enron's extensive network of
offices and businesses around the world in identifying and pursuing potential
water and wastewater and service opportunities.
We carefully evaluate each project to assess its value. First, we conduct a
due diligence review, identifying and quantifying the specific risks of the
transaction. We then measure and manage these risks by preparing a detailed
financial projection containing elements that we believe may affect the project
materially throughout its economic life. We forecast inflation rates and, where
applicable, changes in foreign exchange rates. We test projections for debt
capacity, terms and rates along with an evaluation of local and world financial
markets to assure the accuracy of our assumptions relating to capital costs. We
quantify all other assumptions from the internal and external team of experts to
forecast costs and revenues in the transaction. We then run multiple
simulations, testing for various sensitivities and producing an analysis of the
return on capital, adjusted for the risk of the specific project.
Each of Azurix Europe and Wessex is a party to various credit facilities
and loan agreements with restrictive covenants. We do not believe that these
existing credit facilities will impair our ability to carry out our business
strategy. Although the senior credit facility places restrictions on Azurix
Europe's ability to engage in mergers, acquisitions or asset sales, it does not
place any such restrictions on Azurix. This senior credit facility specifically
permits Azurix Europe to lend funds to other subsidiaries or affiliates of
Azurix for the purpose of making investments in, or acquisitions of, water or
wastewater related assets or businesses around the world. In addition, the other
existing credit facilities and loan agreements do not prohibit Azurix from
engaging in mergers, acquisitions or asset sales. These agreements do not hinder
Azurix's ability to incur indebtedness at the Azurix level or incur project
specific indebtedness with the borrowing capacity generated from the cash flows
of future acquisitions. See "Description of Indebtedness -- Indebtedness of
Azurix Europe."
Enron and Azurix have entered into a business opportunities agreement that
limits the businesses that we may pursue. The agreement allows us, only with
Enron's consent, to engage in businesses outside the water and wastewater
industries, or in which water and wastewater is not expected to generate the
major component of value. This agreement thus limits our ability to pursue
potentially profitable ventures that are not clearly in the water and wastewater
sector, even though those opportunities come to our attention on account of our
activities in water and wastewater. See "Transactions with Enron, Atlantic Water
Trust and Marlin Water Trust -- Agreement Regarding Business Opportunities and
Related Matters."
OWNING, OPERATING AND MANAGING WATER AND WASTEWATER ASSETS. To ensure a
smooth transition and to introduce more efficient working practices in the
concessions and businesses we acquire and the start-up of new facilities we
construct, we will send specialist transition teams of experienced staff with a
full range of skills. Existing employees of Wessex, including over 300
engineers, scientists and other specialists, will be made available to operate
our assets, especially during critical periods of takeover or start-up. We
intend to use the systems and working methods that Wessex successfully employed
to increase productivity and reduce costs.
Following an acquisition of a water or wastewater asset, we intend to:
- Enhance income by extending services and increasing operating revenues
- Reduce operating costs and capital expenditures through better management
and procurement strategy
- Increase efficiency through the use of technology and management
information systems
- Apply innovative financing techniques and sound financial and risk
management techniques
Revenue Enhancements. Water and wastewater systems offer many opportunities
to increase operating revenues. For example, we might expand the number of
customers connected, while more efficiently managing the capital expenditures
required to serve them. New customers could result from inherent population
growth or migration to urban areas in the service territory. Another operating
revenue enhancement is the effective use of water meters. Many water systems
around the world do not use water
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<PAGE> 64
meters. By installing meters where appropriate, we could track water demand more
effectively and allocate water resources and service teams more efficiently.
Where permitted, we will shorten billing periods, which expedites receipt of
operating revenues and increases their collectibility. We will also apply more
sophisticated billing technology to assure that customers are being billed and
delinquent accounts are being pursued. Through improved service and better
community relations, we expect to reduce uncollectibles.
Cost Containment Strategies. Our experience at Wessex helps us identify
ways to control expenditures in operating our water and wastewater systems and
facilities worldwide. These techniques are highly transferable from one location
to another. In particular, we intend to:
- Use sophisticated tracking and monitoring equipment to reduce water
losses from leakage and theft
- Reorganize the workforce to improve productivity
- Procure equipment, chemicals and ancillary services more cost effectively
- Shorten construction periods
We expect that these value-added strategies will allow us to realize
attractive returns on our global water industry investments. Whether responding
to a tender or negotiating a contract directly, we expect to combine our
experience from the concessions and projects we already have with our financing
skills to offer a highly competitive price and, once we acquire an asset, to
serve our customers efficiently and effectively.
PROVIDING MUNICIPAL AND INDUSTRIAL SERVICES
We intend to provide a broad range of cost-effective services to owners of
water and wastewater systems in governmental, commercial, industrial and
agricultural markets around the world through innovative technological,
environmental and financial solutions.
Our water related services business will target municipal and industrial
customers, initially in the United States and Europe, that are seeking to
outsource the management of their systems. These customers generally desire a
service provider with the operating experience and capital to provide reliable
water supply and wastewater treatment services and the ability to comply with
more stringent regulatory requirements for water quality and environmental
protection. The current market has few operators that manage a large number of
diverse assets and thus have the skills to compete effectively. By consolidating
contracts for operation and management of treatment facilities and management of
biosolids disposal or reuse through acquisition and growth, we can achieve
economies of scale and operational efficiencies in this business that will allow
us to compete more effectively.
Furthermore, by offering operations, management and engineering, residuals
management and underground infrastructure remediation and development services,
we believe that we will position ourselves to capitalize on privatizations as
they occur. Providing a full range of services represents our primary method for
consolidating municipal outsourcing activities, promotes access to a full range
of governmental clients and allows municipalities to explore all their options
from outsourcing services to full privatization of their systems. Working with
municipal clients will also allow us to understand local markets and identify
attractive systems for acquisition.
DEVELOPING AND MANAGING WATER RESOURCES
We believe the growing demand for drinking water has generated a need for
better management of water resources. We believe that there are significant
capital, technical and operational needs for this area of the water industry and
that governments are increasingly turning to the private sector to manage and
meet these needs. Wessex has recently commenced a trial of aquifer storage and
recovery, which involves injecting drinking water into deep aquifers that act as
natural underground reservoirs. Water put into the aquifer at times of low
demand can be stored for months or years, to be used when demand is high. In
addition, we are pursuing build-own-transfer projects for long-distance
pipelines, aqueducts and reservoirs in the Middle East and other projects to
extract water in Latin America.
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EXISTING AZURIX ASSETS
The following table details operating revenues, operating income (loss) and
identifiable assets by geographic area for Azurix for the periods indicated:
<TABLE>
<CAPTION>
JANUARY 29, 1998 AT
TO DECEMBER 31,
DECEMBER 31, 1998 1998
-------------------------- ------------
OPERATING OPERATING IDENTIFIABLE
REVENUES INCOME (LOSS) ASSETS
--------- ------------- ------------
(IN MILLIONS)
<S> <C> <C> <C>
U.S. .......................................... $ -- $(14.7) $ 4.3(1)
England........................................ 112.5 60.5 2,393.5
Switzerland.................................... 7.2 -- 9.3
Argentina...................................... -- (0.2) 73.6
------ ------ --------
Total................................ $119.7 $ 45.6 $2,480.7
====== ====== ========
</TABLE>
<TABLE>
<CAPTION>
AT
THREE MONTHS ENDED MARCH 31,
MARCH 31, 1999 1999
-------------------------- ------------
OPERATING OPERATING IDENTIFIABLE
REVENUES INCOME (LOSS) ASSETS
--------- ------------- ------------
(IN MILLIONS)
<S> <C> <C> <C>
U.S. .......................................... $ -- $(13.6) $ 32.3
England........................................ 111.0 53.5 2,373.7
Switzerland.................................... 5.9 (0.5) 8.9
Argentina...................................... -- (0.2) 73.9
Mexico......................................... -- -- 13.5
------ ------ --------
Total................................ $116.9 $ 39.2 $2,502.3
====== ====== ========
</TABLE>
- ---------------
(1) Amount represents leasehold costs and capitalized transaction costs on
active transactions.
The following table represents the operating revenues contributed by each
of the service categories of our business for the periods indicated, although
all of the operating revenues occurred after the date of the Wessex acquisition:
<TABLE>
<CAPTION>
JANUARY 29, 1998 THREE MONTHS ENDED
TO DECEMBER 31, 1998 MARCH 31, 1999
-------------------- ------------------
(IN MILLIONS)
<S> <C> <C>
Water supply..................................... $ 35.0 $ 34.0
Wastewater services.............................. 73.1 71.6
Residuals management............................. 7.2 5.9
Other............................................ 4.4 5.4
------ ------
Total.................................. $119.7 $116.9
====== ======
</TABLE>
WESSEX
Wessex's principal business is providing water supply and wastewater
services in southwestern England through Wessex Water Services Ltd., a wholly
owned subsidiary. In December 1998, the Office of Water Services, the industry
regulator for England and Wales commonly called Ofwat, published its assessment
of relative operating efficiency, which showed Wessex as the most efficiently
operated water and wastewater company under its supervision. Ofwat also has
recognized Wessex for providing among the highest overall standards of service
of water and wastewater companies in the industry. Independent research shows
that over 90% of Wessex's customers consistently rate its service as "excellent"
or "good." During the 1990s, Wessex has successfully managed a $2 billion
investment program on time and below the price allowed by regulation. Wessex's
other principal subsidiary is SC Technology, which conducts business as Swiss
Combi and designs, sells and operates biosolid drying plants.
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Much of Wessex's success in delivering high standards efficiently is due to
investment in and application of the latest technology. Sophisticated control
and planning systems have largely eliminated the need for Wessex's 2,500
installations to be permanently manned. Instead, water supply and wastewater
treatment collection and distribution systems can all be monitored from one
central base. Regular maintenance and response to customer requests or
emergencies are handled through an integrated planning and management system
that ensures rapid response in the most efficient manner.
WESSEX WATER SERVICES. Through Wessex Water Services, Wessex provides water
supply and wastewater services in southwestern England. Wessex has a virtual
monopoly over water supply and wastewater services in its region, with the
exception of the cities of Bristol and Bournemouth and a small area of rural
Wiltshire, where three other companies provide only water and Wessex provides
wastewater services.
The Wessex region covers approximately 10,000 square kilometers and is
predominantly rural. There are two major urban areas in the region, with Bristol
and Bath in the north and Bournemouth and Poole in the south. The largest town
for which Wessex provides water is Poole with a population of approximately
102,000, and the largest town for which Wessex provides wastewater services is
Bristol, with a population of approximately 400,000 (approximately 800,000
including the surrounding area). The region's economy, which is one of the
fastest growing in the United Kingdom, is based on agriculture, financial
services, aerospace, defense establishments and specialist manufacturing.
Water Supply Services. Wessex supplies approximately 400 million liters of
water per day to a population of approximately 1.1 million using its water
infrastructure. The system includes approximately 138 water sources, 128 water
treatment plants, 320 pumping stations, 360 storage reservoirs and 11,000
kilometers of water mains. Wessex serves approximately 510,000 domestic and
commercial locations. Wessex's customer base is approximately 56% residential
and 44% commercial by volume of supply.
Wessex withdraws 78% of its water from underground sources and the
remainder from reservoirs (19%) and rivers (3%). Wessex has a comprehensive
network of storage reservoirs (interlinked by a regional grid), which facilitate
water management during periods of low rainfall. As a result of its strong water
resources, internal grid network and water management, Wessex has not enforced
any restrictions on water usage in the past 22 years. Ofwat has ranked Wessex as
having fewer than average unplanned interruptions to water supply.
Wessex is strengthening its water resources through reductions in leakage
and trials in the use of aquifer storage and recovery. Wessex has reduced
leakage in terms of volume by 30% since 1993. Ofwat sets mandatory targets to
reduce leakage from both company and customer pipes. These targets are reviewed
annually and failure to meet the targets could result in enforcement action.
Wessex intends to reduce leakage by optimizing pressure in its pipes, improving
its response time for repairing leaks and replacing pipes and joints.
The flow in some rivers in Wessex's region is being affected by water being
withdrawn from underground aquifers by Wessex. This problem resulted from the
granting of water withdrawal rights to Wessex's predecessors prior to
privatization. Wessex has taken measures to reduce withdrawals of water and has
given a commitment, subject to available funding, to eliminate low river flows
caused by withdrawals of water by 2010. Wessex may need to develop additional
water resources.
By the end of 1999, Wessex will have invested approximately $700 million in
capital projects related to improvements in its water infrastructure since
privatization in 1989, of which over $400 million will have been invested since
1993. Wessex's water supply network continues to require further investment.
Wessex takes an integrated approach to water quality, based on effective
control and monitoring of treatment and distribution systems. All water
treatment works have continuous automated operation and quality monitors. Wessex
also monitors water quality through a program of regular sampling and analysis.
During the year ended December 31, 1997, Wessex tested approximately 160,000
drinking water samples and achieved 99.9% compliance with the strict U.K. and
European Union standards. Ofwat has ranked Wessex as above average for the
provision of water supplies overall.
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Wastewater Services. Wessex treats on average 484 million liters of
wastewater per day from a population of approximately 2.5 million through its
infrastructure of approximately 350 wastewater treatment plants, 1,300 pumping
stations and 15,000 kilometers of sewers. Residential customers account for
approximately 76% of wastewater revenues and commercial customers account for
24%.
Wastewater is collected in the wastewater system and pumped or gravitated
to wastewater treatment plants where the wastewater passes through processes
designed to remove biosolids and purify the wastewater. Following further
processes, Wessex disposes of 83% of its biosolids to agricultural land, uses
12% in landscaping and land reclamation work and disposes of 5% in landfills.
Approximately 20% of biosolids are subjected to an advanced heated drying
treatment at Wessex's major wastewater treatment facility at Avonmouth, near
Bristol. Wessex is currently installing similar drying facilities, referred to
as biodriers, at Bournemouth and Weston-super-Mare. A second plant is also
planned for construction in 1999 at Avonmouth.
By the end of 1999, Wessex will have invested approximately $1.3 billion in
capital projects related to improvements in its wastewater infrastructure since
privatization, of which approximately $800 million will have been invested since
1993. Wessex has been upgrading many of its wastewater treatment plants to
comply with European Union legislation. At some of its treatment facilities,
Wessex has introduced advanced filtering technology using membranes, ultraviolet
disinfection and fully enclosed underground plants in connection with the
treatment of wastewater. Wessex's new wastewater treatment plant at Porlock is
the largest operational plant in Europe to use membrane filtering technology to
process wastewater to a state that is virtually bacteria and virus free. Wessex
is building a similar system at Swanage in Dorset.
Wessex's wastewater treatment plants perform well above industry standards.
During the year ended March 31, 1998, Wessex's wastewater treatment plants were
in substantial compliance with applicable discharge standards and 99% of these
plants were in 100% compliance with applicable discharge standards. For the year
ended March 31, 1999, Wessex's rates of compliance with these standards remained
substantially the same as in 1998. Wessex is committed to providing full
treatment for all continuous coastal discharges which impact on recreational
waters. Full compliance with European Union bathing water quality standards in
the Wessex region for the year ended March 31, 1999 was 93%, and the instances
of noncompliance were due primarily to agricultural runoff and industrial
discharges, not Wessex's treatment operations.
Properties. Wessex manages over 2,500 installations. These include
approximately 138 water sources, 128 water treatment plants, 320 clean water
pumping stations, 360 storage reservoirs, 1,300 wastewater pumping stations and
350 wastewater treatment plants. The following is a list of the five largest
water treatment plants operated by Wessex:
<TABLE>
<CAPTION>
LOCATION CAPACITY
- -------- ------------------------
(MILLION LITERS PER DAY)
<S> <C>
Maundown.................................................... 72
Upton Scudamore............................................. 36
Corfe Mullen................................................ 33
Sturminster Marshall........................................ 30
Durleigh.................................................... 30
</TABLE>
The following is a list of the five largest wastewater treatment plants
operated by Wessex:
<TABLE>
<CAPTION>
ESTIMATED EQUIVALENT
LOCATION POPULATION SERVED
- -------- --------------------
<S> <C>
Bristol (Avonmouth)......................................... 897,000
Holdenhurst................................................. 180,000
Poole....................................................... 159,000
Bath (Saltford)............................................. 109,000
Bridgwater.................................................. 107,000
</TABLE>
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Customer Charges. The Director sets limits on the rates Wessex may charge
for its regulated water supply and wastewater treatment businesses, including
the extent of annual rate increases. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Outlook" and "Regulatory
Matters -- U.K. Regulatory Matters."
Charges for water supply and wastewater services are calculated separately
based on the average costs of providing each service for each class of
customers. Currently, approximately 82% of household bills are calculated in
part on the basis of the ratable value of the property, a valuation which was
used by local governments to set municipal charges until April 1, 1990, rather
than their usage. The remaining 18% of household customers pay based on metered
water usage. Where a customer receives a metered water supply, wastewater
services charges are based on the volume of water supplied. Wessex offers free
meter installation service to all its customers and, as a result, the level of
metering in Wessex's territory is above the industry average in the United
Kingdom. New properties will be subject to metering.
Charges are generally set on a standard tariff basis. Charges for bulk
supplies of water are usually determined on an individual basis, as are charges
for some larger commercial water supplies and some industrial wastewater. The
charging basis for bulk supplies in some cases provides for annual recalculation
by reference to the expenditure associated with the supply. Wastewater from
industrial users is normally charged on a formula basis taking account of the
volume of wastewater, its strength and costs of removal and treatment.
In November 1998, following public consultation in April, the U.K.
Government announced new legislation to regulate water charging in England and
Wales. The proposed legislation is currently before the U.K. Parliament and
would grant domestic customers the right:
- To resist water metering in their current homes where they are not using
water for non-essential purposes
- To have a free meter installed if they wish to have one, where this is
practicable
- Where they have taken up the right to have a free meter installed, to
revert to an unmetered basis of charging within 12 months if they so
choose
Prior to this legislation, Wessex already had implemented a free metering
program with a right to revert. In addition, the proposed legislation would:
- Protect vulnerable customers with high essential water use, who live in
homes with meters, from higher than average water bills
- Prevent water companies from disconnecting domestic customers and other
protected premises for non-payment
- Grant new powers for the Director to approve charging schemes, taking
account of guidance from the Secretary of State
The Director has recently issued a consultation document relating to the
approach he intends to take in approving charging schemes. It is expected that
additional consultations on the Director's approach will occur. These
consultations will address an increasing need to take costs into account in
developing charging schemes.
A review of the customer charges of Wessex is in process and new price
limits will apply from April 1, 2000. See "Risk Factors -- Water and wastewater
companies face price and other regulation that could reduce our operating
revenues," "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Outlook" and "Regulatory Matters -- U.K. Regulatory
Matters."
SC TECHNOLOGY. In 1996, Wessex acquired SC Technology, which does business
under the name of Swiss Combi. Based in Switzerland, SC Technology is one of the
leading biosolid drying companies in the world. SC Technology designs, sells and
operates environmentally sound biosolid drying processes and
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markets recycled biosolids for agriculture and land reclamation. SC Technology
currently has approximately 40 plants completed or under construction, located
in more than ten countries, primarily in Western Europe.
Volumes of biosolids are increasing worldwide. Historically, these
biosolids were supplied to farmers or disposed of at sea. Wessex believes that
the ban imposed on disposal of biosolids at sea, together with concerns from
food retailers about the recycling of untreated biosolids over agricultural land
and air pollution problems resulting from the incineration of biosolids, make
the biosolid drying process an attractive method of biosolid disposal for the
future. The Swiss Combi process uses a contained drying system to produce
pasteurized dried granules that are odor free and easy to handle and transport.
The granules, known as biogran, have a much lower bacterial count than digested
biosolids and can be safely sold as a soil conditioner or fuel.
MENDOZA, ARGENTINA
In May 1998, Enron, in a consortium co-led by SAUR, a French water company,
successfully bid to acquire a controlling interest in Obras Sanitarias Mendoza
S.A., a privatized company that holds a 95-year exclusive concession to provide
water and wastewater services to the majority of the Province of Mendoza,
Argentina. Enron has contributed to Azurix its 32.1% interest in Obras
Sanitarias Mendoza, the concession holder. SAUR also owns a 32.1% interest in
the concession holder, local private investors own a 3.3% interest, Italgas owns
a 2.5% interest, employees own a 10.0% interest and the Province of Mendoza owns
the remaining 20.0%. Obras Sanitarias Mendoza is currently operated by SAUR
under an operations agreement and is governed by a five-member board of
directors, two of which have been appointed by Azurix.
The concession is located in the desert bordering Chile at the base of the
Andes mountains. Its service territory covers six municipalities. The Mendoza
area has a strong economy and is one of Argentina's fastest growing provinces.
Per capita revenue is among the highest in Argentina due to the petroleum and
mining industry activity in the area, and per capita water usage is among the
highest in the hemisphere.
The concession holder is charged with operating, maintaining and upgrading
its 10 drinking water plants and 17 wastewater treatment plants as well as
associated distribution and collection networks to Mendoza. Obras Sanitarias
Mendoza serves over one million water customers and has 285,000 water
connections. Obras Sanitarias Mendoza provides wastewater services to 883,000
people and has 210,000 wastewater connections. Average billing is approximately
$30 bi-monthly per customer for water and wastewater services. The concession
contract requires Obras Sanitarias Mendoza to expand the water and wastewater
connections in the concession area over the next 10 to 15 years. Through 2015,
approximately $180 million is expected to be spent on new connections, new water
and wastewater treatment facilities and system improvements. Obras Sanitarias
Mendoza's assets include raw water transportation pipelines and aqueducts,
drinking water treatment plants and other general assets.
Water supply comes primarily from the regional river, Rio Mendoza. The
surface water feeds by gravity to treatment plants. The remaining groundwater
comes from approximately 160 wells. Obras Sanitarias Mendoza uses four large
lagoon systems to provide the majority of wastewater treatment within the
concession area.
Obras Sanitarias Mendoza is required to meet standards of service
established by the special purpose regulatory body known as Ente Provincial de
Agua y Saneamiento and to make appropriate arrangements for the improvement and
extension of service. The standards of service include quality and availability
requirements and were initially set by the concession contract. Each year, the
operator must submit an annual report that will specify, among other things,
Obras Sanitarias Mendoza's progress with respect to its plan of operation and
expansion.
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Obras Sanitarias Mendoza must pay the Province a yearly royalty based on
net operating revenues collected. This royalty is equal to 3.85% of net
operating revenues collected in the first five years of the concession and 9.98%
thereafter.
The concession may be terminated for fault of the concession holder under
any of the following circumstances:
- Repeated failure to provide service as required by the concession
contract
- Repeated violation of applicable environmental regulations
- Unjustified delays in completion of the then-current plan of operation
and expansion
- Willful withholding of information from the environmental regulator
- Failure to maintain adequate performance bonds
- Any change in the corporate structure of the concession holder or the
operator without the prior approval of the Province
The Province can undertake the partial or complete termination of the
concession for noncompliance with the terms of this contract or for public
interest reasons. In the event of a termination for public interest reasons, the
Province must compensate the concession holder for its lost investment. Obras
Sanitarias Mendoza believes it is in compliance with the concession contract in
all material respects. As the concession holder, Obras Sanitarias Mendoza would
be liable for any claims or damages, environmental or otherwise, relating to
this concession. As a shareholder, we believe that our potential liability is
limited to our investment in the concession holder.
Neither SAUR nor Azurix has any obligation to contribute further capital to
Obras Sanitarias Mendoza. However, in May 1999, each of SAUR and Azurix loaned
$2.25 million to Obras Sanitarias Mendoza to fund working capital. The loan made
by Azurix bears interest at a rate of 6.98% per annum and matures on July 20,
1999.
CANCUN, MEXICO
On March 24, 1999, we acquired for $13.5 million a 49.9% economic interest
in and the right to manage and operate the water and wastewater treatment
concession for Cancun and Isla Mujeres, Mexico. Desarrollos Hidraulicos de
Cancun, S.A. de C.V. is the concessionaire that holds the concession. Affiliates
of one of the former shareholders, Grupo Mexicano de Desarrollo, S.A., own an
aggregate 50.1% economic interest in the concessionaire. On February 25, 1999,
we lent the concessionaire $15 million to permit it to retire a portion of its
indebtedness, and we may make additional loans of up to $10 million to initiate
improvements in the wastewater treatment system.
The concession was initially granted on the condition that the
concessionaire would invest capital in projects to provide services under the
concession. As a result of the devaluation of the Mexican peso in 1994, the
concessionaire was unable to meet some of its investment obligations and the
government of the State of Quintana Roo in August 1996 designated the state
regulatory authority, known as CAPA, to operate the concession. In February
1997, Grupo Mexicano and the concessionaire agreed with the state government
that, as a condition to reassuming operation of and retaining the concession,
the concessionaire would make the necessary investments and form an association
with an experienced operator of water concessions. In general, the parties
involved agreed on the following:
- The concessionaire would be responsible for adjusting its financial
statements and making pertinent payments in order to show financial
stability and sustainability
- The concessionaire and CAPA would review the capital expenditure program
for the period 1997-2000 and would implement it immediately after
approval
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- The parties would reconstruct the concession agreement and develop a new
one with the National Water Commission (Comision Nacional de Agua) acting
as a mediator
The cost to the concessionaire for these investments is estimated at $44
million over the next five years. The concessionaire is required to pay to the
State of Quintana Roo an annual concession fee of 7.5 million pesos (in 1993
pesos), adjusted annually in accordance with changes in the Mexican consumer
price index. The concession extends to October 2023.
At the end of the concession term, and any extensions, the concessionaire
will be required to deliver to the government at no cost the facilities and
equipment used to provide services under the concession. The concession may be
revoked by the government in the event of a breach of the concession terms if
the concessionaire does not present a program to cure the breach within 30 days
of notice of default. The concession may be terminated if the concessionaire is
bankrupt, insolvent, liquidated or dissolved. The concession may also be revoked
upon the transfer of part or all of the concessionaire's rights under the
concession without government approval or if the concessionaire does not
maintain a performance bond in an amount equal to 10% of annual operating
revenues for the prior year.
Based on figures available at the date of acquisition, the concessionaire
serves a population of approximately 390,000 through 73,000 connections. An
estimated 65% of the concession's operating revenues are derived from the supply
of drinking water to tourist hotels, whose operating revenues are primarily U.S.
dollar based.
The operations and tariffs for water and wastewater systems in the State of
Quintana Roo are regulated by CAPA. The water tariff paid by the hotels and
commercial and industrial customers is adjusted monthly according to the change
in Mexico's consumer price index as published by the Mexican government. In
addition, the concession provides that the rate paid by the hotels will be
increased in the event of a variation of the Mexican peso/U.S. dollar exchange
rate in excess of 15% due to a short-term event. The remainder of operating
revenues come from residential and public services drinking water supply and
from wastewater services. Residential drinking water rates are adjusted annually
with changes in the Mexican minimum wage established by the minimum wage
commission. Currently, less than 40% of the wastewater in the Cancun urban zone
that is collected is being treated.
The tariff rates, which vary according to the customer class, resulted in
an average billed consumption of 7.95 pesos per cubic meter of water consumed in
1998. Operating revenues and expenses of the concessionaire in 1998 were 205
million pesos ($22.0 million) and 164 million pesos ($17.7 million),
respectively. Operating income in 1998 was 40 million pesos ($4.4 million).
These figures are estimated by management and have not been audited. The U.S.
dollar amounts have been translated based on the April 30, 1999 exchange rate of
9.3 pesos to one U.S. dollar.
We have three seats on the board of directors of the concessionaire, while
the 50.1% shareholders have two. We have the right to appoint the chief
executive officer, the chief financial officer and the chief operating officer
of the concessionaire. The 50.1% shareholders have the right to appoint the
chairman of the concessionaire's board and the non-voting board secretary.
Resolutions concerning major corporate actions and governance issues require
supermajority approval.
As the concessionaire, Desarrollos Hidraulicos would be liable for any
claims or damages, environmental or otherwise, relating to this concession. We
believe that our potential liability is limited to our investment in the
concessionaire.
PHILIP UTILITIES MANAGEMENT CORPORATION
On May 18, 1999, we purchased all of the stock of Philip Utilities
Management Corporation, a water and wastewater services company headquartered in
Hamilton, Ontario, Canada. We paid an adjusted purchase price of $106.3 million
in cash, approximately 68% to Philip Services Corporation and approximately 32%
to Ontario Teachers' Pension Plan Board. Under the share purchase agreement,
Philip Services and Ontario Teachers have indemnified Azurix for the breach of
any of the sellers' or Philip
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Utilities' representations, warranties or covenants made in respect of the
purchase. These indemnities are limited to claims in excess of $50,000, after
the first $1,000,000 of such claims has been absorbed by Azurix, up to an
aggregate limit of $10,000,000. In addition, the sellers prorated
indemnification obligations with respect to breaches by Philip Utilities based
upon their respective share ownership of Philip Utilities.
Philip Utilities operates facilities in three of the ten provinces of
Canada, with a concentration of operations in Ontario, and in the United States
in the states of Arizona, Florida, Georgia, Louisiana, Maine, New Jersey, Texas
and Washington. In calendar year 1998, Philip Utilities had operating revenues
of approximately $100 million. The following is a discussion of Philip
Utilities' business operations.
OPERATIONS, MANAGEMENT AND ENGINEERING. Philip Utilities' operations,
management and engineering business is divided along two business lines,
including contract operations and engineering and automation.
Contract Operations. Philip Utilities' contract operations division
contributes approximately 30% of its operating revenues. Philip Utilities'
largest contract operation projects are in Hamilton-Wentworth, Ontario and
Seattle, Washington. In 1994, Philip Utilities won the contract to operate and
maintain the 192 million-gallon-per-day water treatment facility and the 110
million-gallon-per-day wastewater treatment facility of the regional
municipality of Hamilton-Wentworth. Under the operations agreement, Philip
Utilities receives an adjustable flat fee plus a portion of any cost savings
realized under the contract. Services provided under the operations agreement
include the day-to-day operation, maintenance, repair, and permitting and
compliance of the facility.
Under the terms of the plant operations agreement between
Hamilton-Wentworth and Philip Utilities, Hamilton-Wentworth pays an annual fee
to Philip Utilities equal to an agreed upon base budget and adjusted for
inflation, salary and wage increases, insurance costs, ash, sludge and grit
disposal costs and increases in Philip Utilities' cost of corporate overhead. In
addition, Hamilton-Wentworth shares in approximately 40% of actual annual costs
savings over the base budget amount by reducing the annual fee due to Philip
Utilities. Under the first four years of the plant operations agreement,
Hamilton-Wentworth paid annual fees to Philip Utilities CN$15.4 million in 1995,
CN$15.6 million in 1996, CN$16.0 in 1997 and CN$15.8 million in 1998.
At 12:00 p.m. on Sunday, June 6, 1999, Philip Utilities' workers at the
Hamilton-Wentworth facility went on strike. In anticipation of the strike,
Philip Utilities took over operation of the facility at 2:00 a.m. on June 6,
1999. Since that time, Philip Utilities has continued to operate and maintain
the facility as required under the plant operations agreement. Philip Utilities
has a strike plan in place, and we believe that Philip Utilities can continue to
operate and maintain the facility, regardless of the duration of the strike,
without any material adverse effect on us, Philip Utilities or the facility's
performance. Philip Utilities has licensed industrial operators and other
qualified plant personnel available to it who have replaced the striking
workers. Philip Utilities will utilize its prior experience in handling water
treatment facilities during a strike, gained in part as recently as
approximately one year ago, when it successfully took over the operations of a
water treatment facility in the Halton Region during a strike by workers at that
facility. Hamilton-Wentworth has publicly expressed confidence that the strike
will have no impact on the quality and service of municipal water services in
the region, and Philip Utilities has consulted with Hamilton-Wentworth officials
on matters relating to its strike plan. The unresolved issues between the union
and Philip Utilities involve a project to partially automate the
Hamilton-Wentworth facility. The implementation of this project, opposed by the
union but approved by Hamilton-Wentworth, is expected to result in the loss by
the end of this year of 24 of 73 bargaining unit jobs.
As a result of this strike, however, there is a risk that the operations at
the Hamilton-Wentworth facility could be materially adversely affected. In
addition, under the plant operations agreement with Hamilton-Wentworth,
Hamilton-Wentworth may terminate the agreement upon the occurrence of a strike
by Philip Utilities' employees that creates a situation which poses a potential
for a real and serious threat to the health and public welfare of
Hamilton-Wentworth and its residents, or would seriously jeopardize the
operational capacity or integrity of the Hamilton-Wentworth facility where
Philip Utilities has not remedied the situation within two business days of
being notified. Although we believe that Philip Utilities'
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current strike plan will prevent such a situation from occurring, there is no
assurance that such a situation will not arise or that Hamilton-Wentworth will
not attempt to terminate the contract under these provisions.
Philip Utilities' second largest contract operation project is the design,
build and operate contract for the 120 million-gallon-per-day Tolt River
Treatment Facility that is currently under construction in Seattle, Washington.
In 1996, Philip Utilities teamed with the engineering firm of Camp Dresser &
McKee, Inc. to win this 15-year contract, which is renewable by the City of
Seattle for two additional periods of five years each. CDM Philip, Inc., an
80%-owned subsidiary of Philip Utilities, receives approximately $74.8 million
in design and construction fees. CDM Philip subcontracted the design/build
portion of the contract to Dillingham Construction, N.A., Inc. for approximately
$63 million. Construction of the Tolt River plant is currently on schedule, with
the facility scheduled to commence operations in December 2000. Once operations
have commenced, CDM Philip is entitled to an annual service fee of approximately
$1.7 million, subject to modification for incentive bonuses, pass-through costs
and other adjustments.
Engineering and Automation. Philip Utilities' engineering and automation
activities are based in Ontario and Atlanta, Georgia. Philip Utilities provides
plant design, construction, project management, and process design and
engineering services primarily for municipal customers and other Philip
Utilities operations. Philip Utilities also provides process automation and
instrumentation services including design, assembly, testing and installation of
supervisory control and data acquisition systems and other computer control
technologies primarily for municipal customers. Philip Utilities' engineering
and automation activities contributed approximately 12% of its operating
revenues in 1998.
RESIDUALS MANAGEMENT. Residuals management accounted for approximately 16%
of Philip Utilities' operating revenues in 1998. Philip Utilities' residuals
management division is comprised of three complementary operations that apply
dewatering and land application methods to residuals management:
- Trimax Residuals Management, Inc. primarily serves the municipal water
and wastewater sector, with the majority of its operating revenues
derived from dredging and removing water from sewage lagoons and tanks.
Trimax is headquartered in Edmonton, Alberta and conducts operations in
the United States and Canada. Major contracts are held with the Greater
Vancouver Regional District and the cities of San Diego and Detroit, as
well as several pulp and paper companies. Trimax has built its business
around a mobile water removal technology that provides a great deal of
flexibility and versatility in the marketplace. The product of this
process is a manageable biosolid that is typically disposed of through
land application. Trimax accounted for approximately 63% of Philip
Utilities' residuals management operating revenues in 1998.
- Braemar Acres Limited processes industrial wastewater and municipal
biosolids for disposal through land application. Braemar Acres,
headquartered in Ontario, has existing operations that are principally
located within the province of Ontario and include disposal of lime
sludge for a sugar manufacturer, processing of paper sludge for five of
the six pulp and paper companies in eastern Ontario, waste food organics
recycling, and biosolids for the Hamilton-Wentworth facilities and the
city of Niagara, Ontario. Braemar Acres accounted for approximately 10%
of Philip Utilities' residuals management operating revenues in 1998.
- Enviroganics of Texas, Inc. is a Houston-based company that provides
wastewater biosolids management and residuals management services to over
165 wastewater treatment facilities in Texas. Enviroganics' services
include removal and processing of biosolids, on-site mobile water
removal, operation of customer's processing equipment and hauling and
disposal through land application of biosolids. Services are typically
rendered under purchase orders instead of long-term contracts.
Enviroganics accounted for approximately 25% of Philip Utilities'
residuals management operating revenues in 1998.
UNDERGROUND INFRASTRUCTURE REMEDIATION AND DEVELOPMENT. Philip Utilities
offers a wide range of underground asset management services to customers in the
United States and Canada. These services
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include closed circuit television inspection and location mapping, as well as
pipeline repair and rehabilitation. Since 1996, Philip Utilities has focused on
migrating from traditional pipe rehabilitation to trenchless technologies.
Philip Utilities employs a variety of trenchless technologies for which it holds
licenses in various geographic territories. Among these licensed products are
epoxy resins, polyurethane fold-and-form pipe, a roll-down pipe product, two
cured-in-place products and a spot repair system. The underground infrastructure
division contributed approximately 40% of Philip Utilities' operating revenues
in 1998.
OWNERSHIP OF WATER AND WASTEWATER ASSETS. In addition to its outsourcing
operations, Philip Utilities owns two utilities that serve approximately 3,000
end use customers in suburban areas around Houston, Texas: Southwest Utilities,
Inc. and Walker Water Works, Inc. These two utilities own and operate both water
and wastewater treatment services and are regulated by the Texas Natural
Resource Conservation Commission and the Environmental Protection Agency. This
is Philip Utilities' smallest division and contributed approximately 2% of its
operating revenues in 1998.
PENDING ACQUISITIONS
BUENOS AIRES, ARGENTINA
On May 14, 1999, we submitted a bid for a concession for the water and
wastewater systems operated by Administracion General de Obras Sanitarias Buenos
Aires in two of the three regions of the Province of Buenos Aires, Argentina. On
May 18, 1999, the provincial government notified us that we were the prevailing
bidder on both of the regions for which we bid at a price of $438.6 million.
Assuming final confirmation by the province, the current schedule, which is
subject to modification, calls for us to assume operation of these systems on
June 18, 1999.
Azurix initially will own 100% of the concessionaire, with 10% being
transferred to employees of the concessionaire within several months. A
consortium of local electric cooperatives has agreed to acquire a 1.2% interest
for $5 million, with an option to increase its interest to up to 10% within
approximately 30 days following our assumption of operations.
The Province of Buenos Aires surrounds the Argentine capital city. It is
the country's largest province, with a total population of approximately 13.5
million. The provincial water and wastewater administration currently serves a
population of approximately 3.8 million, with municipalities, cooperatives and
private companies serving the remainder of the population having water or
wastewater service. The two regions included in our concession have a total
population of approximately two million and approximately 450,000 water or
wastewater customers. They include the provincial capital of La Plata and the
large industrial city of Bahia Blanca. We anticipate expanding operations to
surrounding municipalities and offering industrial customers cost-effective
alternatives.
The concession lasts for 30 years and requires the concessionaire to
complete a specified investment plan to improve water quality, expand customer
metering and water and wastewater connections and reduce water losses. We
estimate that this investment plan will cost approximately $1 billion over 30
years. We anticipate capital expenditures of approximately $617 million during
the first ten years of the concession, of which approximately $405 million will
be spent during the first five years of the concession. We anticipate funding
capital expenditures through operating cash flows and long-term debt and equity
at the concession level. In the concession contract, the concessionaire must
commit to the following:
- Increase water and wastewater coverage over a 10-year period in
percentages varying from region to region
- Increase metering, which is at low levels or nonexistent in some of these
regions
- Provide potable water that meets regulated parameters by mid-2003; in
most areas of the concession, this will require substantial improvements
in water quality
- Construct six water wells and associated aqueducts within 12 months of
taking over the concession under contracts requiring the doubling of
industrial waters by the end of 2000
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- Construct wastewater treatment facilities as wastewater collection
systems are constructed; this will require approximately 50 small to
medium size wastewater treatment facilities to be built by mid-2002
- Construct secondary wastewater treatment facilities at locations that
only have primary treatment by mid-2004
- Construct primary wastewater treatment by mid-2002 and secondary
wastewater treatment by mid-2009 for the facilities at La Plata and Bahia
Blanca
- Update the concessionaire's inventory within 12 months of taking over the
concession, including evaluating the condition, operation and performance
of the assets
- Conduct an emergency and prevention study and develop a contingency plan
for avoiding and managing emergencies within the first six months of
taking over the concession
The capital expenditures required for the concession are high for several
reasons, including:
- The required increase in water and wastewater connections during the
first three to five years, which will require extensive collection and
distribution networks to be built
- The lack of wastewater treatment plants in 50 communities, which requires
new construction
- The need to repair and upgrade the existing wastewater treatment plants
and collection systems
- The lack of adequate groundwater resources, which need to either be
completely or partially replaced by surface water sources or treated with
advanced treatment technologies
The concession agreement provides penalties for failure to achieve the
investment plan on time, although relief is available if the delay is due to
complications in obtaining work licenses through local municipalities. The
concessionaire will be required to obtain a number of environmental licenses
that are not carried by the current provincial company.
The concessionaire is responsible for complying with all environmental and
water quality standards, with a grace period at the beginning of the concession
term. Serious or repeated violations of the concession contract, the regulatory
law or the supervisory agency's decisions could permit the provincial government
to terminate the concession. In the event of a termination, the concessionaire
must transfer all of the service related assets to the province. In addition,
the concessionaire must provide the province with sufficient chemical and other
materials to operate the concession for 60 days. The concessionaire may use
existing assets, which remain the property of the province, but will own
improvements made to the system.
The current provincial company is employing over 2,600 people, and we
expect that approximately 1,200 of these employees will be transferred to the
concessionaire for the two regions included in our concession. Although the
concessionaire will enter into negotiations for a collective bargaining
agreement with the union after taking over the concession, no such agreement is
currently in effect. Labor expenses currently account for approximately 70% of
the operational expenses of the current provincial company, and this level is
not expected to change through the term of the concession. We anticipate that
the concessionaire will be able to negotiate a union agreement that will allow
for a severance program. The board of directors of the concessionaire will have
the authority to appoint the key technical and managerial positions at the
concession company.
Rates of collection for the current provincial company have declined from
86% in 1993 to 76% in 1996. We anticipate that increased metering will improve
collections.
The Organismo Regulador Bonarense de Aguas y Saneamiento, a newly formed
unit of the provincial Ministry of Public Works, will regulate the collection,
purification, transportation and distribution of potable water and the
collection, treatment, disposal and marketing of wastewater, including
industrial effluents. The agency's jurisdiction also includes setting tariffs
and regulating the extraction and use of common water sources.
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Initially, the tariff will remain the same as was in effect prior to
privatization. The first tariff review is expected around 2002. The tariff then
is to be reviewed every five years in light of changes to the five-year program
of investment. The concessionaire or the regulator may at any time ask for an
increase or reduction in the tariff if consumer cost indices change by more than
3% or if there are material changes in Argentine tax law, other than value added
tax or income tax, changes in water quality standards or environmental
regulations or substantial changes in the condition of the concession. Both the
concession contract and the governing law provide that tariff modifications may
not be used to penalize the concessionaire if it operates more efficiently than
expected. The concessionaire is required to provide lower rates to specified
users, including retired persons with low income, care centers for the elderly
and for physically challenged children, public schools, public sports facilities
and libraries.
INDUSTRIAS DEL AGUA
On May 28, 1999, we entered into an agreement to acquire 49% of the capital
stock of Industrias del Agua, S.A. de C.V., a water and wastewater service
company based in Monterrey, Mexico. Pursuant to a contract with the Water
Commission of the Federal District of Mexico, Industrias del Agua provides
metering, billing, collections, operations and maintenance services for an area
covering approximately one quarter of the Federal District within Mexico City, a
service area with a population of approximately two million people. In addition
to holding an equity interest in Industrias del Agua, Azurix will serve as the
technical participant in providing services under the Federal District contract.
Industrias del Agua has provided these services since 1993, when it signed this
10-year contract with the Water Commission of the Federal District. All recourse
by the Water Commission of the Federal District of Mexico is to the company that
is a party to the contract, a subsidiary of Industrias del Agua, and not to
Azurix as the technical participant.
Under the contract, Industrias del Agua has the exclusive right and
obligation to provide three stages of services. Stage I involves meter
installation, taking a census of potable water users, mapping the primary and
secondary hydraulic network, and providing recommendations for regularization of
water intakes and water meters. Stage II includes handling service requests,
installing new intakes, making readings of consumption, providing technical
support in the determination of fees, issuing and distributing bills for potable
water and public sewer services, receiving fees for potable water and public
sewer services, and maintaining, repairing and displacing meters. Stage III
involves the operation of the potable water system, detection and repair of
leaks, inspection, unclogging and maintenance of drainage networks, and the
refurbishment and rehabilitation of secondary distribution networks. Industrias
del Agua has completed Stage I, has performed most of the work required under
Stage II and expects to complete the work required under Stage II by the end of
1999, although fees from Stage II are expected to continue through the term of
the contract. Work under Stage III has recently begun. The volume of work
Industrias del Agua is required to perform every year is not fixed under the
contract and depends on the requests made by the Water Commission of the Federal
District. In 1998, Industrias del Agua received fees of 134.5 million pesos
($14.7 million) under the contract. Azurix expects these fees to increase over
the next five years as the volume of services provided under Stage III is
expected to increase. Because Industrias del Agua's fees for providing these
services under the contract are based on costs plus a fair market return,
ongoing capital commitments are immaterial.
Industrias del Agua is currently owned by Socios Ambientales de Mexico,
S.A. de C.V., a company privately held by the Brittingham family of Monterrey,
Mexico. After the purchase, we will own 49% of the capital stock of Industrias
del Agua, and a company owned by Mr. Eduardo Brittingham will own the remaining
51% of the capital stock of Industrias del Agua. We will have the right to
appoint two members of the board of directors, and the 51% shareholder will have
the right to appoint three members. Resolutions of the board of directors will
require the approval of directors appointed by Azurix, and resolutions of the
shareholders will require the approval of Azurix.
The purchase is subject to the receipt of administrative and regulatory
approvals, including the approval by the Water Commission of the Federal
District regarding the substitution of Azurix as the
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technical participant under the contract. We will pay $22.5 million in
connection with the transaction, which is expected to close by the end of July
1999.
SUPPLIERS
We intend to achieve economies of scale in buying goods and services. In
addition, we expect to centralize purchasing arrangements to reduce costs and
improve quality. Wessex's only significant supplier of goods or services is
SEEBOARD plc, a subsidiary of CSW Corporation, which supplies electricity to
approximately 100 of Wessex's sites. Wessex pays SEEBOARD approximately $6.4
million per year, which represents approximately 5% of Wessex's annual operating
costs. The contract was effective October 1, 1997 and runs for two years. The
price is based upon a negotiated pence amount per kilowatt hour for each site.
Wessex is not dependent on any single supplier, including SEEBOARD, because its
supplies are readily available from alternative sources at market rates and on
similar terms. Except for SC Technology, which supplies biodriers to Wessex, and
Enron, which provides services under a services agreement with Azurix, none of
Wessex's suppliers is affiliated with it.
RESEARCH AND DEVELOPMENT
Since our formation, we have established a link with the Water Research
Centre, which is conducting a U.K. industry-wide research and development
program that currently invests approximately $6.6 million each year in research
programs. The Water Research Centre is internationally renowned as the market
leader in water and wastewater technology. We will have a research department
based within the Water Research Centre at Swindon in the United Kingdom. The
Water Research Centre will also provide us with a service to monitor the
development of water and wastewater technologies across the world and with the
opportunity to access, and, when appropriate, invest in new technologies. Wessex
contributes approximately $160,000 per year to this program.
Wessex carries out its own research and development to improve the
reliability and effectiveness of its treatment systems. In-house research and
development projects include development of a mobile filter for wastewater
treatment and disinfection and membrane filtering technology. Wessex has spent
approximately $1.6 million on these two project areas in the last three years. A
third major project area is pasteurization of wastewater biosolids using the
Swiss Combi heated drying technique. Wessex has spent approximately $640,000
over the last three years in this area.
EMPLOYEES
As of June 9, 1999, we had approximately 165 employees, excluding employees
of Wessex and Philip Utilities. As of June 9, 1999, Wessex had approximately
1,440 employees, which includes approximately 50 employees at SC Technology. As
part of its efforts to improve operating efficiencies, Wessex has reduced the
number of its employees by approximately 500 since March 31, 1993, primarily
through attrition and voluntary retirement packages. As of June 9, 1999, Philip
Utilities had approximately 690 employees. On June 6, 1999, Philip Utilities'
workers at the Hamilton-Wentworth facility went on strike. See
"Business -- Existing Azurix Assets -- Philip Utilities Management Corporation."
INSURANCE
We believe that our insurance arrangements, including self-insurance, are
customary for the industry and are adequate. Wessex, Mendoza and Cancun have
separate locally underwritten insurance policies covering employers liability,
public and products liability, excess public and products liability and their
motor fleets. Enron's corporate insurance program covers the direct exposures of
Azurix and Philip Utilities and the indirect exposures to Azurix from its less
than wholly owned subsidiaries, to the extent not covered by the subsidiaries'
policies. Following the offering, Azurix will continue to participate in Enron's
corporate insurance program. In the future, Azurix may establish a separate
program for Azurix and Azurix's subsidiaries.
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LEGAL PROCEEDINGS
There are no legal or arbitration proceedings, including any that are
pending or threatened, of which we are aware that if adversely determined would
have a material adverse effect on our financial position, liquidity or results
of operations.
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REGULATORY MATTERS
The following is a summary of regulatory matters relating to water and
wastewater operations in the United Kingdom, Argentina, Mexico, the United
States and Canada.
In general, most countries where we have invested, or intend to consider
investments, have drinking water quality and environmental laws and regulations.
We intend to invest in companies or projects that operate in material compliance
with drinking water quality and environmental laws and regulations. However, we
cannot guarantee that the due diligence we perform in advance of investing in an
entity will identify any or all noncompliance with environmental laws and
regulations by such entities.
Because the supply of clean drinking water and the treatment of wastewater
are essential societal needs, we anticipate that these activities will be
subject to at least some form of regulation wherever we do business. The nature
and extent of environmental laws and regulations vary from country to country,
and there may be wide disparities in the requirements from one part of the world
where we do business to another. Generally speaking, compliance with these laws
and regulations is mandatory and penalties, as well as injunctive and other
relief, are usually available in the event of noncompliance. Moreover, these
laws and regulations may require improvements to water and wastewater systems
that will require additional capital and operating costs for us to remain in
compliance.
Changes in the nature of these laws and regulations, or in the level of
their enforcement, also have the potential to impact adversely our financial
results during the relevant period. These adverse impacts could cause our actual
financial results to differ materially from those we project, forecast, estimate
or budget. Moreover, changes in these laws and regulations may require
improvements in order to remain in compliance that can result in additional
capital and operating costs.
Wessex has established a comprehensive environmental auditing program that
is designed to provide early identification of potential environmental problems
associated with its activities and to provide reasonable assurance that all
identified problems are properly and promptly addressed. We expect to use the
environmental auditing capabilities already established within Wessex to
evaluate potential environmental and other regulatory risks that may be
associated with water and wastewater systems, companies and concessions in which
we may invest. We will also use these capabilities to monitor environmental and
other regulatory compliance in all water and wastewater systems, companies and
concessions in which Azurix or one of its subsidiaries takes an active
management role. Despite the demonstrated effectiveness of this environmental
auditing program with respect to Wessex's operations, there can be no assurance
that this approach will be adequate to address and manage all such risks
associated with our business.
Particularly in jurisdictions where we operate water or wastewater
companies serving end-users, we can expect to be subject to regulation on the
rates we may charge. The regulatory regime will vary from jurisdiction to
jurisdiction, but can be expected to resemble in some respects the regime in
place in the United Kingdom, Argentina, Mexico, the United States and Canada.
U.K. REGULATORY MATTERS
The economic aspects of the water industry in England and Wales are
principally regulated under the provisions of the Water Industry Act 1991.
Following privatization of the water industry in England and Wales, each of the
water and wastewater companies became regulated through a license and the
regulatory provisions of the Water Industry Act 1991 and regulations and orders
thereunder. The license designates the relevant company as a water and/or
wastewater undertaker in its own area and provides for the monitoring of the
company's performance by the Director General for Water Services and the
Secretary of State for the Environment. The Water Industry Act 1991 imposes
duties on the Secretary of State and the Director as to how and when they should
exercise their functions under the Act. In particular, their primary duties are
to exercise their functions in the manner each considers best calculated to
secure that licensees properly carry out and are able to finance their
functions, including by securing reasonable returns on their capital. Subject to
these primary duties, the Secretary of State and the Director have
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other duties, including protecting customers' interests, promoting efficiency
and economy by licensees and facilitating competition. Therefore, in setting
limits on the prices that water and wastewater companies may charge, the
Director is currently required to allow companies a projected rate of return
sufficient to finance their operations and attract the capital necessary for
investments in infrastructures required to meet environmental and other
regulatory standards. The actual rates of return achieved by individual
companies can vary significantly from the projected rates of return assumed by
the Director in setting prices.
Each water company is under a general duty to develop and maintain an
efficient and economical system of water supply within its license area and is
subject to duties of water supply. Each wastewater company is under a general
duty to provide, improve and extend a system of public sewers and to maintain
those sewers to ensure that its sewerage region is effectively drained. In
addition, discharges from wastewater treatment plants must be licensed by the
Environment Agency, and wastewater companies are responsible for regulating
discharges of industrial wastewater into sewers. Contamination caused by
wastewater discharged from a treatment plant may subject the wastewater company
to liability, including clean-up costs.
Among his functions, the Director has powers to determine terms where
Wessex and the customer cannot agree. These include terms for, and requiring,
bulk supplies of water, the provisions of water for non-domestic purposes and
the connection of sewers and the reception, treatment and disposal of industrial
wastewater to public sewers. The Director is responsible for ensuring that water
and wastewater companies comply with their license conditions and has
enforcement powers under the Water Industry Act to secure compliance. Subject to
a power of veto by the Secretary of State for the Environment, conditions may be
modified by the Director with the consent of the licensee. Before making the
modifications, the Director must publish the proposed modifications as part of a
consultation process, giving third parties the opportunity to make
representations and objections that the Director must consider. In the absence
of consent, the only means by which the Director currently can secure a
modification is following a modification reference by him to the U.K.
Competition Commission. The Commission is required to investigate and report on
whether matters specified in the reference operate or may be expected to operate
against the public interest and, if so, whether the adverse public interest
effect of those matters could be remedied or prevented by modification of the
conditions of the license. If the Commission gives an adverse finding, it will
state in its report whether any adverse effects on the public interest could be
remedied or prevented by modification of the license. The Director must then
make such modifications as appear to him necessary for the purpose of preventing
the adverse effects specified in the report after giving due notice and
consideration to any representations or objections. The Secretary of State would
have the power, among others, to modify the conditions of the license if, on
investigation, under the Fair Trading Act 1973, the Commission concluded that
matters investigated by it in relation to water or wastewater services operated
against the public interest.
A license may also be revoked or transferred to another company in
circumstances specified under law or in the license. These circumstances include
the failure to comply with an enforcement order made by the Secretary of State
for the Environment or the Director or the inability of the relevant water and
wastewater company to pay its debts.
WESSEX WATER SERVICES' LICENSE
Wessex's license continues indefinitely, or until such time as the
Secretary of State revokes Wessex's license after ten years' advance notice. The
effective date of revocation, under the terms of Wessex's license, cannot occur
prior to 2014 without Wessex's consent. If at any time Wessex becomes insolvent
or it is determined that Wessex has committed such a serious violation of its
duties so as to make it inappropriate for it to continue to hold the license,
the Secretary of State or, with his consent, the Director, may seek a special
administration order, under the terms of which Wessex's affairs, business and
property may be transferred to another company to ensure that Wessex's appointed
functions can be carried out. In either event, the legislation provides for
Wessex's assets to be transferred to the new replacement appointee on terms
approved by the Director or the Secretary of State, including the consideration
to be paid by the new appointee. The special administration provisions in effect
subordinate
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members' and creditors' rights to the achievement of the purposes of the special
administration order. The license sets out the charging formula imposed on
Wessex, which is subject to review every five years. The formula is tied to the
retail price index plus an adjustment factor, which can be positive, zero or
negative. The adjustment factor is set by the Director on a case-by-case basis
for each company at the review to bring the companies in line with the target
rate of return set by the Director. The license also regulates the fees that
Wessex may charge new customers upon connecting them to the water or wastewater
network for the first time. Wessex must fix and publicize its rates for the
provision of water and wastewater services and for first-time provision of water
supply and wastewater services and must not discriminate against any individual
or class of customer with respect to charges.
Wessex is required to maintain sufficient financial and managerial
resources to carry out the appointed business and necessary investment. The
license requires it to publish separate accounts showing its regulated business
separately from all other businesses and activities and additional accounts
prepared on a current-cost basis with respect to the same period. Regulated
businesses, such as Wessex, are subject to business practices limitations, such
as restrictions on cross-subsidies, that restrict affiliate dealings and promote
competitive contracting. The license also requires Wessex to put in place
financial structures protecting a sufficient amount of its assets so that its
water and wastewater services could still be provided in the event of Wessex's
insolvency.
Wessex's license includes service targets that are monitored by the
industry regulator. The license also requires Wessex to pay annual fees, based
on Wessex's revenues, which are intended to cover the costs of the regulation of
the water industry. In 1998, Wessex paid approximately $665,000 in such fees.
The license has been modified as a condition of regulatory clearance of
Azurix's acquisition of Wessex to address regulatory concerns arising out of the
acquisition. In particular, the modification strengthens the financial
independence and independent management of Wessex Water Services' regulated
business, providing water supply and wastewater services, by imposing the
following:
- Restrictions on transfers of assets, guarantees, intercompany loans and
loans containing cross-default provisions
- A requirement that transactions with associated companies must be entered
into on an arm's length basis at market rates
- A requirement to maintain an investment grade rating for corporate debt
of Wessex Water Services
- A requirement that Wessex issue a variable-coupon bond by December 31,
2000 and use its reasonable efforts to list such bonds on the London
Stock Exchange
- A requirement that information be published similar to that of a public
company
The license as modified also requires a dividend policy to be agreed upon
with the Director that ensures that Wessex Water Services retains sufficient
funds to finance its core activities and which should be expected to reward
efficiency and the management of economic risk. The license also requires Wessex
Water Services to conduct its regulated business as if a separate public limited
company. In addition, Wessex is obligated to obtain undertakings from its
ultimate parent company. If those undertakings are not, at any time, in place or
if there is an unremedied breach of them, then, in addition to potential
enforcement action, Wessex may not, without the Director's consent, enter into
any contract with its parent. To comply with this obligation, Azurix Europe and
Atlantic Water Trust have given a holding company undertaking that requires,
among other things, that Azurix Europe and Atlantic Water Trust give Wessex
Water Services all information necessary for it to carry out its obligations and
refrain from action that would cause Wessex Water Services to breach its
obligations. This undertaking also provides that the board of Wessex Water
Services must include at least three independent non-executive directors of
standing and relevant experience.
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TARIFF RATES
The Director regulates prices and service levels. Price controls applicable
to each water and wastewater company are subject to reviews by the Director
every five years, known as periodic reviews, but both the Director and the
individual company may seek an interim determination to adjust price limits
between the periodic reviews in limited circumstances.
Unlike "rate of return" economic regulation, such as exists for many U.S.
industries, regulation in the United Kingdom generally uses forms of "price
limitation." This is intended to reward companies for efficiency and quality of
service to customers. The U.K. regulatory system generally allows companies to
retain for a period any savings attributable to efficiencies that they are able
to achieve. These are then passed on to customers in lower price limits in the
next periodic review. The main instrument of economic regulation is a price
limitation formula set out in each company's license. This formula limits
average charges made by water and wastewater companies for a basket of principal
regulated services. The limit is expressed as a percentage change by reference
to the retail price index. This adjustment can be positive, zero or negative and
is determined in light of past operational efficiencies, assumed future
operational efficiencies, investments to meet water quality standards,
expenditures to enhance security of supply and service levels and maintain
assets and an appropriate return on capital.
During the periodic review completed in July 1994, the Director developed a
structure for determining adjustment factors based on a matrix of purpose and
cost categories. The purpose categories are comprised of base service
provisions, the maintenance of existing levels of service, as well as enhanced
service levels, the water supply/demand balance and obligatory quality
enhancements. The limits on Wessex's real price changes, i.e., in addition to
the retail price index, resulting from the 1994 periodic review were +1.5% for
each year until March 31, 2000.
The Director is currently conducting a periodic review, to conclude in
November 1999, when he will set new price limits for the period from April 1,
2000 to March 31, 2005. Large users, using over 250 megaliters per year, are to
be excluded from the tariff basket from 2000 with the effect, among others, that
companies will not be able to recover from other customers lost revenue arising
from reduced charges to their large users. As part of the current review
process, on October 29, 1998, the Director published a consultation paper
setting out proposed ranges for bills for the period from 2000 to 2005. The
Director has confirmed that, on the basis of past efficiencies achieved by water
companies and evolving views about the cost of capital, he expects substantial
price reductions in April 2000. However, the U.K. Government has recently
proposed a five-year program of mandatory capital expenditures by the water
companies aimed at quality and environmental improvements. This program is
estimated to cost the industry L8 billion, or approximately $13.3 billion, in
the aggregate over the five years. In setting the new price adjustment factor,
the Director will make an allowance for the investment needed to meet new
quality and environmental obligations.
The Director proposed, in the case of Wessex, that expected average
household bills, in real terms, could be over 17.5% lower in 2000-2001 than in
the previous year, but that bills overall would rise, by 2004-2005, to a level
exhibiting only a small reduction compared with the expected 1999-2000 bill.
This would constitute a material increase in prices following the one-time
reduction in 2000-2001. The Director's proposal preceded, and therefore did not
take into account, the recent capital expenditure proposals of the U.K.
Government. The Director has invited views on whether the one-time reduction is
appropriate or whether the initial reduction could be modified so that bills
could be broadly stable over the five-year period. The Director's estimates for
future bills assume that the scope for efficiency savings across the industry in
operating costs could vary between 2% and 4% a year, and that for capital
expenditures, the average overall scope for efficiency is between 10% and 15%
over the five-year period. They also assumed a post-tax cost of capital of 5.25%
for all but the smaller companies, although the Director more recently has
suggested a figure of around 4.75% may be more appropriate.
Customers are represented by customer service committees who have duties to
investigate customer complaints and to represent the interests of water
customers. The Wessex Customer Service Committee supports the view that there
should be an initial price reduction of at least 17%. Wessex Water has
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undertaken extensive independent market research which indicates that customers
would prefer price stability to a situation where there is an initial price
reduction followed by significant price increases to pay for the capital
expenditures mandated by the new environmental standards.
The Director held formal meetings with each of the water and wastewater
companies during January and February 1999 to discuss the issues raised by a
proposed price reduction including the responses of the public. In its April
1999 business plan filed with the Director, Wessex proposed stable prices from
1999-2000 to 2000-2001, with prices gradually increasing to 18% higher than
current levels in 2005, primarily to fund capital expenditures mandated by the
new environmental standards. The business plan will be considered by the
Director as part of the periodic review. The Director has stated that he will
publish his draft determination of new price limits to run from 2000 to 2005 in
July 1999, with his final decisions made in November 1999. These may differ
materially from his original proposal. If a company disagrees with the
Director's price determination, it may challenge his proposal by requesting a
reference to the Competition Commission. On such a reference the determination
of the Commission will be final. Although we are unable to predict the precise
outcome of the current U.K. periodic review, if Wessex were required to cut its
prices as originally proposed by the Director, Wessex's regulated operating
revenues, which represent approximately 90% of Azurix's total operating
revenues, would be reduced by over 17.5% compared to 1999-2000 and its earnings
would be reduced materially. However, we would not expect that this would have a
material adverse effect on Azurix's financial position. At the time of the
acquisition of Wessex, we took into consideration the pending rate review in our
valuation of Wessex.
CHANGES TO REGULATORY REGIME
On June 30, 1997, the U.K. Government launched a review of the framework
for the regulation of all utilities, and in March 1998 set out its proposals in
a consultation paper. In July 1998, following the consultation, the U.K.
Government published its response. Among other things, it suggested that:
- Consumer protection should be the Director's primary duty, achieved
wherever possible and appropriate through promoting effective
competition, but also taking into account the need to ensure that
regulated companies are able to finance the carrying out of their
functions.
- There should be consumer representative bodies to promote consumer
interests.
- A clearer link should be made between the prices utilities may charge and
the customer service standards they achieve.
- Full information should be available on companies' performance on
customer service standards and on the links between this performance and
the remuneration of directors.
- Ministers should issue statutory guidance on social and environmental
objectives.
On publishing the response, the Secretary of State for Trade and Industry
stated an intention to introduce legislation to implement the proposals as soon
as parliamentary time permits. In his March 1999 Budget Speech, the Chancellor
of the Exchequer announced that the Deputy Prime Minister will review
competition in the water industry.
Separately, the Competition Act 1998 will become effective in 2000. This
will, among other things, increase the ability of the UK regulatory authorities,
including the Director in relation to water and wastewater services, to
investigate and take action against anti-competitive agreements and conduct. In
particular, companies found to have violated the new prohibitions of
anti-competitive agreements and abuse of a dominant position may be fined up to
10% of their U.K. turnover. U.K. competition law, in the Fair Trading Act 1973,
also enables monopoly situations, as defined, to be investigated by the
Competition Commission. Where these are found to operate contrary to the public
interest, the Secretary of State has extensive powers to take action to remedy
or prevent those adverse effects, including the power to order businesses to be
divided.
The Director has indicated that he intends to seek public comment before
the end of 2002 on the rules and policies that should be developed in relation
to license renewal/termination. The Director has suggested that in considering
license termination after 2004, the Secretary of State should not regard the
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present structure of the industry as sacrosanct and that a less vertically
integrated industry would be more conducive to the development of competition.
The Director has stated that continuity of services to customers would be the
industry regulator's primary concern in developing any rules or policies with
respect to termination of licenses.
DRINKING WATER QUALITY AND ENVIRONMENTAL REGULATION
The water and wastewater industries in England and Wales are subject to
numerous environmental regulatory requirements under the Water Industry Act
1991, the Water Resources Act 1991 and the Environment Act 1995. The Water
Industry Act 1991 established a new, more extensive and more stringent quality
regime for the water and wastewater industry through the creation of the
National Rivers Authority, since replaced by the Environment Agency, and the
Drinking Water Inspectorate.
Under the Water Industry Act 1991, water supplied for domestic or food
production must be wholesome at the time of supply. The Drinking Water
Inspectorate is responsible for ensuring that water supplies meet this standard
as well as the standards set out in the U.K. Water Quality Regulations. Breach
of these requirements can lead to regulatory or criminal liability, and if the
water supplied causes loss or damage, the breach may lead to civil liability.
Water companies are required to carry out statutory sampling of water supplied
to customers and must provide public information on drinking water quality. The
licensed Inspectorate conducts technical audits to assess annually the quality
of the drinking water supplied by the licensed companies. If any company fails
to meet the relevant water quality standards, the Inspectorate may require it to
take any necessary remedial action.
Under the Water Resources Act, the Environment Agency may require persons
to take precautions against pollution, may prohibit or restrict activities
likely to cause pollution in areas designated by the Secretary of State for the
Environment and may require persons who hold a consent to discharge matter from
a drain or sewer. When reviewing existing consents and issuing new ones, the
stated practice of the Environment Agency is to seek to set conditions at the
level required to at least maintain and, where appropriate, improve the quality
of the receiving waters.
The activities of the U.K. water and wastewater companies are also affected
by the requirements of European Union directives, including the Drinking Water
Directive, the Bathing Waters Directive and the Urban Wastewater Treatment
Directive, each of which has been brought into force in the United Kingdom. The
environmental systems that Wessex has in place are designed to comply with
European Union and U.K. requirements.
In May 1997, the Secretary of State for the Environment announced a review
to examine ways in which environmentally damaging abstractions can be equitably
curtailed. The review will consider arrangements to reduce abstractions under
existing licenses and for revoking licenses in areas where pumping causes
significant environmental damage. He has also announced that the Director will
be setting mandatory targets to reduce leaks from water supplies, which will be
reviewed annually. Failure to meet the targets would carry penalties and could
ultimately lead to a water and wastewater company being put into the hands of an
administrator appointed by the Director. In addition, in March 1999 the U.K.
Government announced that new water abstraction licenses will include time
limits and limits may be imposed on existing licenses.
In view of the age and history of many sites owned by Wessex, Wessex may
incur liability for sites that are found to be contaminated, resulting in
increased costs of managing or cleaning up such sites. Environmental legislation
requires the polluter (or if the polluter cannot be found, the owner or
occupant) of contaminated land to clean up any contamination which causes, or is
likely to cause, significant harm to the environment. Polluters are also
required to clean up any pollution of water sources. Other proposals that may
impose strict liability for environmental damage are also under consideration by
the European Union. Wessex expects that the direction of future changes will be
towards further tightening of controls. However, Wessex does not believe that
any liability that it may incur under environmental legislation or published
European Union directives will have a materially adverse effect on its results
of operations, financial position or liquidity.
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ARGENTINE REGULATORY MATTERS
GENERAL REGULATION OF WATER
Argentina has a federal system of government that grants significant
regulatory powers to the provinces. Under the Argentine Constitution, each
province has jurisdiction over its own natural resources, including water, and
the legal power to create standards to protect those resources.
Federal laws apply to areas within national jurisdiction, such as the
federal capital, and to matters that affect the nation as a whole and not merely
one province. At the national level, the Secretariat of Natural Resources and
Sustainable Development is principally responsible for the protection of the
environment, and the Ministry of Health and Social Action is principally
responsible for the protection of public health. The Secretariat of Natural
Resources and Sustainable Development also is responsible for the development
and implementation of national water policy and for establishing priorities of
uses for multiple-use water resources.
Under the Argentine Constitution, the provision of water services at the
local level generally is within the authority of the provinces and
municipalities. In the Province of Mendoza, for example, the Ministry of Public
Works and the Environment is granted general authority over all non-agricultural
water services, and environmental regulation. Concessions for the provision of
water services are granted by the provincial government by statute and decree,
with oversight vested in the Ministry of Public Works and in a special purpose
regulatory body known as EPAS. Decisions of EPAS may be reviewed by the Minister
of the Ministry of Public Works and the Governor of the Province of Mendoza. In
the Province of Buenos Aires, these duties will be carried out by the Organismo
Regulador Bonarense de Aguas y Saneamiento, a unit of that province's Ministry
of Public Works.
REGULATION OF WATER SERVICE AND TARIFF RATES
In Argentina, provision of local water service and tariff rates are
generally controlled by provincial regulatory authorities, through a framework
established by statute and concession contracts. Governmental acts are subject
to judicial review in Argentine courts, but there is no right to appeal
provincial decisions setting tariffs to the Argentine federal government. Where
a water service concession is held by a company substantially owned by a U.S.
company, however, recourse eventually may be available through international
arbitration under the Bilateral Investment Treaty between the United States and
Argentina, which provides for fair and nondiscriminatory treatment of
investments. To date, however, this treaty has not been ratified by Argentina.
The Province of Mendoza provides an example of the process of granting
concessions and setting tariffs on a provincial level in Argentina. In Mendoza,
the basic regulatory framework is established by provincial statutes and
decrees. Within that framework, the local regulatory agency, known as EPAS, and
the Ministry of Public Works regulate the provision of services and the setting
of tariffs.
In Mendoza, tariffs are proposed by EPAS, and then submitted to the
Minister of the Ministry of Public Works, the provincial legislature and the
Governor for approval. EPAS must recommend rate regimes with an aim to reflect
efficient costs of operations, maintenance and expansion and renewal of the
water system, including debt service. EPAS also strives to promote rational and
efficient use of services and resources leading to a balance of supply and
demand, and to address sanitation and social objectives. EPAS is authorized to
establish tariff rates that require some users to pay rates that subsidize the
cost of providing service to other users. Argentine law provides that in setting
tariffs, EPAS must take into account costs of operations, maintenance,
amortization of services and a "reasonable" rate of return for the
concessionaire in the context of an efficient level of operation. The basic
tariff regime is to be reviewed every five years.
The current tariff schedule imposes a fixed monthly charge per customer,
based on a formula which takes into account the customer's land area, types and
size of structures and uses of the land, that normally will remain unchanged
until the new tariff regime is implemented. Changes in current tariffs are
allowed for several enumerated reasons, including if operating costs increase or
decrease by 4% as reflected
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in official national indices, if there is a change in the national
"convertibility law" which establishes a 1:1 exchange rate of the peso with the
dollar, if there are changes in the capital program due to government or
regulatory reasons or if there are changes in taxes, other than income taxes.
A new tariff regime is to be implemented in Mendoza within the next several
years based on a metered charge per liter of water used. The concession contract
contains assurances that the concessionaire will receive the same level of
revenue as under the prior regime, thus allowing the concessionaire to retain
efficiency gains and pass through changes in costs. The contract contains no
provision for direct pass-through for inflation or revisions in tariffs for
capital expenditures. The concessionaire may request adjustments to the new
tariff if any of the following occurs:
- The new tariff lowers consumption significantly
- The concessionaire shows that the new tariff does not promote rational
use of the assets and capital employed for the operations of the company
or does not allow it to carry out the obligations of the company
- The concessionaire shows that most of the benefits of cost reductions are
inuring to consumers
The Province of Buenos Aires employs a similar regime. Initially, the
tariff will remain the same as was in effect prior to privatization. The first
tariff review is expected around 2002. The tariff then is to be reviewed every
five years in light of changes to the five-year program of investment. The
concessionaire or the regulator may ask at any time for an increase or reduction
in the tariff if consumer cost indices change by more than 3% or if there are
material changes in Argentine tax law, other than value added tax or income tax,
changes in water quality standards or environmental regulations or substantial
changes in the condition of the concession. Both the concession contract and the
governing law provide that tariff modifications may not be used to penalize the
concessionaire if it operates more efficiently than expected. The concessionaire
is required to provide lower rates to specified users, including retired persons
with low income, care centers for the elderly and for physically challenged
children, public schools, public sports facilities and libraries.
ENVIRONMENTAL MATTERS
Beginning in the early 1990s, Argentina began addressing environmental
matters systematically at the federal level. For instance, in 1991 the Argentine
government enacted a law establishing the Secretariat of the Environment and
calling for a balancing of economic development with the conservation of natural
resources, the improvement of the environment and the prevention and
amelioration of the effects of pollution. In August 1994, the Argentine
Constitution was amended to assure the right of all residents of Argentina to a
healthy environment and granted the Argentine government authority to establish
minimum standards of environmental protection which are to be implemented by the
provinces. The 1994 amendments to the Constitution also provide that damage to
the environment must be repaired immediately in accordance with applicable law,
and prohibit the importation of actually or potentially toxic or radioactive
waste. In 1995, the Argentine government initiated a program to protect the
environment by promulgating rules regarding water, land, air and noise pollution
and hazardous substances.
Throughout Argentina, the provinces take the lead in regulating discharges
of pollutants into waterways. These provinces typically set permissible
standards for pollutant levels in the discharges, issue permits and enforce
them. In Mendoza, wastewater discharges are regulated at the provincial level by
the Ministry of Public Works, which has adopted laws respecting water quality.
As in most provinces in Argentina, the Ministry of Public Works issues permits
and regulates discharges of pollutants into water bodies. In addition, the
concessionaire is required to comply with the drinking water quality standards
set by the concession contract and enforced by EPAS. In the Province of Buenos
Aires, Organismo Regulador Bonarense de Aguas y Saneamiento will regulate
wastewater disposal, including industrial wastewater discharges. In both
provinces, the Argentine government can enforce the provisions of the Argentine
Civil and Criminal Codes against the concessionaire.
Most provinces in Argentina have also adopted their own regulations for air
and waste as well. The various provincial laws establish different compliance
and enforcement requirements.
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MEXICAN REGULATORY MATTERS
WATER PROVISION ISSUES
Article 27 of the Mexican Constitution reserves water resources to the
nation. Article 115 of the Mexican Constitution places responsibility for
providing public services, including water and wastewater treatment, on the
municipalities with the participation of the state when required by law. The
Ministry of Environment, Natural Resources and Fisheries, through the National
Water Commission, is responsible for:
- Assigning water rights and discharge rights to users and assessing the
relevant fees
- Enforcing water-related environmental regulations
- Planning the efficient development of water resources
- Developing regulatory, legal and financial structures for water
concessions at the municipal level with an emphasis on private
participation
- Providing technical assistance to local water authorities and advising on
project feasibility
- Providing financial support for priority water projects, particularly in
low-income areas
The Water Commission of the Federal District of Mexico is responsible for
the provision of water and wastewater services within the Federal District of
Mexico. The Water Commission has contracted with Industrias del Agua, S.A. de
C.V. to provide services relating to the water and wastewater system. These
services are to be provided in accordance with the terms of the contract and
reimbursed according to the rate schedule set forth in the contract.
For areas outside the Federal District, the states and municipalities are
responsible for setting conditions for concessions and for establishing a tariff
structure for all customer groups, collecting payments from customers and paying
the National Water Commission for use of water rights. The Cancun concession is
regulated by Concession Integral de los Servicos de Agua Potable, Alcantarillado
Sanitario y Saneamiento, referred to as CAPA, an agency of the State of Quintana
Roo. One of the requirements of the concession is that the concessionaire
achieve and maintain a 95% connection rate for water and wastewater for the
population. Changes to the connection rate requirement will be subject to the
mutual consent of both CAPA and the concessionaire.
The Governor of the State of Quintana Roo appoints the members of CAPA. If
the Governor is not supportive of the concessionaire, CAPA may be less inclined
to approve concessionaire initiatives and less understanding of problems it
encounters. Azurix believes Desarrollos Hidraulicos, the concessionaire, has
good relations with the state's new governor.
TARIFF RATES FOR THE CANCUN CONCESSION
The tariff rates for the Cancun concession are set by CAPA and are based on
the principle of full recovery of operations and maintenance costs and can be
revised to maintain the economic equilibrium of the concession. There is no
provision that tariffs should provide a return on equity or permit the
concessionaire to earn a profit.
Initial tariffs were set when the concessionaire was first awarded the
concession in October 1993. At current levels, the tariffs are sufficient to
cover cost of operations, capital expenditures required under the concession and
return on investment. These expenditures should not necessitate a real tariff
increase over the term of the concession. However, should significant,
unexpected capital expenditures be required, the concessionaire can propose to
CAPA a tariff increase.
CAPA has indicated that it intends to change the tariff rate in the near
term to eliminate the cross-subsidy between water and wastewater. Currently,
wastewater service is charged a flat rate of 20% of the water bill, regardless
of actual usage. This would have the effect of increasing wastewater rates and
reducing water rates. If the concessionaire wants to increase rates in real
terms, it will be required to submit a rate case to CAPA, with supporting
economic and financial documents explaining the reason for
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the increase. In all cases, the real rate for the residential and communal
customer classes shall not exceed the combined operation and maintenance costs
of supplying those customers. The concession will be evaluated every five years
to determine whether real tariff increases are justified. However, the
concessionaire may propose real increases at any time, though CAPA's consent
must still be obtained.
Under the terms of the concession amendments, the concessionaire is
permitted to disconnect a customer for non-payment.
ENVIRONMENTAL MATTERS FOR THE CANCUN CONCESSION
The concessionaire at Cancun represented to Azurix that it is and has been
in compliance with all state and federal environmental standards associated with
the operation of the concession and that there are no outstanding non-compliant
environmental issues with the state and federal agencies associated with the
concession's operation. If the representation made by the concessionaire is
incorrect, then any environmental liability will be a liability of the
concessionaire. In any event, the concessionaire and an affiliate of the former
shareholders must indemnify Azurix up to $300,000.
The wastewater plants operated by the concessionaire are designed to
discharge an effluent containing no more than 30 milligrams per liter of total
suspended solids and biochemical oxygen demand. The Mexican federal quality
criterion for the saltwater injection discharge that is operated by the
concessionaire is 70 milligrams per liter of total suspended solids and
biochemical oxygen demand. With the completion of the plant under construction,
the existing biosolid management system will need to be modified or expanded to
manage the disposal of the additional volume of biosolids that will be produced,
and other environmental systems will need to be reevaluated for ongoing
operations. The majority of the planned capital expenditures is dedicated to the
improvement of the wastewater collection and treatment system, and we believe
that the amounts planned are sufficient to meet treatment goals and
environmental regulations.
U.S. REGULATORY MATTERS
Philip Utilities, which we acquired on May 18, 1999, has operations in the
United States. The business sectors in which we operate, or intend to operate,
in the United States are generally highly regulated by national, state and local
laws and regulations.
TARIFF RATES
In the United States, the rates for water and wastewater services are
generally subject to state and local laws and regulation. Although the system is
highly fragmented among jurisdictions, most jurisdictions in the United States
utilize "rate of return" economic regulation in setting water and wastewater
rates. Under rate of return economic regulation, the service provider is allowed
to recover its reasonable and necessary operations and maintenance expenses, and
a recovery of and a reasonable return on its invested capital. In most
jurisdictions, a water or wastewater service provider is required to keep a
current set of tariffs on file with the governing regulatory authority. A
service provider generally can charge less than the approved tariffs. Typically,
a service provider cannot change its rates without the approval of the governing
regulatory authority. We can give no assurance regarding our ability to obtain
approvals for rate changes, given the vast number of regulatory authorities with
jurisdiction over water and wastewater service in the United States, and the
fact that decisions regarding rate changes are often subject to political, as
well as economic, factors.
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DRINKING WATER QUALITY
The Safe Drinking Water Act directs the EPA to set drinking water standards
for the approximately 55,000 community water supply systems in the United
States. The Safe Drinking Water Act Amendments of 1996 bring important changes
to the regulation and financing of water systems. The amendments have several
potentially significant regulatory initiatives, which include the following:
- Recent adoption of two rules that may require more sophisticated
treatment. First, the disinfectants and disinfection by-products rule,
establishes maximum residual disinfectant levels for chlorination and
maximum contaminant level goals for potentially harmful disinfection
by-products. Second, the enhanced surface water treatment rule focuses on
treatment requirements for waterborne pathogens, particularly
cryptosporidium.
- A requirement that the EPA list 30 previously unregulated contaminants
for monitoring, risk assessment and potential regulation at least once
every five years. The new Act also specifies that the EPA shall study
radon, arsenic and sulfates and propose rulemakings in 1999, 2000 and
2001, respectively, if the EPA determines that these chemicals threaten
the public health. Such a program poses the risk of additional
contaminants being regulated as the EPA implements this research, with
the attendant risks of potentially increased capital and operational
costs.
- Adoption of regulations to reduce lead and copper in drinking water.
Water providers that exceed specified levels of lead and copper in
drinking water may be required to perform additional monitoring and
develop measures to reduce the lead and copper content.
The EPA has other long-term plans to develop regulations governing the
treatment of drinking water, such as the recycling of filter backwash into
influent streams at public utilities and additional groundwater disinfection. It
is unclear what precise form these and other regulations will take, so potential
regulatory risks and costs of compliance cannot be evaluated at this time. As is
true for any drinking water provider, by operating water assets in the United
States, we face the risk that water we will provide could be contaminated,
including for reasons outside our control, and such contamination could expose
us to regulatory sanctions and potential liability for injury to persons and
property.
ENVIRONMENTAL MATTERS
Among other things, environmental laws and regulations in the United States
generally set requirements for:
- The quality of the discharges from treatment facilities
- The handling and disposal of biosolids from treatment facilities
- The management of associated materials and wastes
- Good housekeeping practices for the management and monitoring of the
operations
We intend to invest in companies or projects that operate in material
compliance with environmental laws and regulations. It is impossible, however,
to predict how the precise regulatory framework governing companies in which we
will invest will operate.
Changes in environmental laws and regulations, or in the level of their
enforcement, may adversely impact our financial results. These adverse impacts
could cause our actual financial results to differ materially from those we
project, forecast, estimate or budget. Moreover, changes in these laws and
regulations may require improvements in order to remain in compliance that can
result in additional capital and operating costs. Environmental protection
statutes in the United States typically provide for the imposition of
substantial civil and criminal penalties, as well as the possibility of permit
revocation and corrective action orders, for violations of their requirements.
These laws may also provide for retroactive, strict liability without regard to
a party's negligence or fault.
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The Federal Water Pollution Control Act, known as the "Clean Water Act,"
establishes a system of standards, permits and enforcement procedures for the
discharge of pollutants from industrial and municipal wastewater sources. The
law requires permits for discharges from water treatment facilities and sets
treatment standards for industries and wastewater treatment plants. Discharge
permits issued under the Clean Water Act are subject to renewal once every five
years. When discharge permits are renewed and reissued, it is customary for the
EPA or the state agency issuing the permit to impose more stringent discharge
limitations in the new permit. In addition, the EPA and the states have been
establishing new standards for bodies of water that receive wastewater treatment
plant discharges and these new standards may result in the imposition of more
stringent effluent limitations as discharge permits are renewed. Compliance with
these requirements is monitored closely and the Clean Water Act provides the EPA
with an array of enforcement mechanisms for companies that fail to comply,
including penalties and injunctive relief. Additionally, the EPA has recently
published regulations of the use and disposal of biosolids when they are applied
to land or incinerated. Although controls on biosolid disposal may be tightened,
we believe it unlikely that the EPA would take drastic measures such as banning
the land application of biosolids. Although we cannot predict the nature of
these and other regulations under the Clean Water Act, we do not believe that
such regulations will materially harm our business.
Other U.S. environmental laws and regulations may also impact Azurix. These
include the Clean Air Act, the Resource Conservation and Recovery Act and the
Comprehensive Environmental Response, Compensation and Liability Act. Generally
speaking, responsibility for implementing and enforcing the regulations
promulgated by the EPA under the Clean Air Act and the RCRA rests with
individual states, whereas the CERCLA is administered by the EPA itself. In some
instances, state regulations have established standards that are more demanding
than the federal standards. Although we anticipate that Azurix's industrial
wastewater treatment services business will focus primarily on the operation and
management of on-site wastewater treatment facilities, Azurix may also operate
and manage facilities that receive and treat third party industrial wastewater
that is generated at an off-site location. Biosolids and other residues
resulting from the treatment of industrial wastewater, particularly wastewater
from third party off-site generators, may be subject to classification as
"hazardous waste" under the RCRA and consequently become subject to more
stringent handling and disposal requirements imposed under the RCRA.
We believe that Azurix possesses the expertise necessary to comply with all
U.S. environmental laws applicable to Azurix's operations. We also expect that
our U.S. operations will be subject to a comprehensive environmental auditing
program similar to the program that Wessex has implemented for operations in the
United Kingdom that is designed to provide early identification of potential
environmental problems and to provide reasonable assurance that identified
problems are properly and promptly addressed. Nevertheless, there can be no
assurance that our operations will comply with all environmental laws at all
times.
CANADIAN REGULATORY MATTERS
Philip Utilities has operations in Canada. Water and wastewater treatment
operations in Canada are subject to comprehensive federal, provincial and local
laws, regulations and guidelines pertaining to the provision of drinking water
and wastewater treatment services, as well as protection of the environment.
These laws and implementing regulations and guidelines establish standards for
the quality and quantity of effluent discharged from wastewater treatment
facilities, the handling and disposal of biosolids and other generated wastes
and materials, and the treatment and distribution of drinking water to
customers. Water and wastewater treatment facilities may only be constructed
after required environmental permits, certificates and approvals have been
obtained from appropriate governmental agencies. These facilities must then be
operated in compliance with the terms and conditions found in those permits,
certificates and approvals. Some Canadian provinces also regulate and control
the quality of drinking water, using standards relating to the design,
construction and operation of water facilities that may be more burdensome than
federal requirements. Moreover, there are extensive federal and provincial laws,
regulations and guidelines relating to the proper management and safe control of
biosolids and other wastes
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and materials that are accumulated at water or wastewater treatment facilities
and require proper disposal. The failure to comply with these laws, regulations
and guidelines or any applicable permits, certificates and approvals may result
in the assessment of fines, penalties or administrative orders.
We believe that technical and operating personnel at Azurix possess the
expertise necessary to ensure that any water or wastewater treatment concessions
acquired in Canada will be operated materially in compliance with applicable
Canadian laws, regulations and guidelines, but there can be no guarantee that
these operations will comply with all environmental laws, regulations and
guidelines at all times. Any new environmental laws, regulations and guidelines,
changes to existing laws, regulations and guidelines, or more stringent terms
and conditions in permits, certificates or approvals relating to facilities we
operate may result in additional regulatory compliance costs that may or may not
be recoverable through rate increases. Nevertheless, we do not expect any new or
changed laws, regulations and guidelines or the modification of any permits,
certificates or approvals to be any more burdensome to the operations of Azurix
than any other water and wastewater treatment services company performing
similar operations in Canada.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table provides information regarding our executive officers
and directors.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Rebecca P. Mark...................... 44 Director, Chairman and Chief Executive Officer
Rodney L. Gray....................... 47 Director and Vice Chairman, Finance, Risk
Management and Investments and Chief Financial
Officer
W. Nicholas Hood..................... 63 Director and Vice Chairman
John C. Ale.......................... 45 Executive Director and General Counsel
Alex Kulpecz......................... 45 Executive Director, Europe, Middle East, Asia,
Africa
Amanda K. Martin..................... 38 Executive Director, Americas
Edward N. Robinson................... 53 Executive Director, Strategy and Corporate
Development
Colin F. Skellett.................... 53 Executive Director, Technical and Operating,
Environmental and Safety Services
John H. Duncan....................... 71 Director
Kenneth L. Lay....................... 57 Director
Jeffrey K. Skilling.................. 45 Director
Joseph W. Sutton..................... 51 Director
John Wakeham......................... 66 Director
Herbert S. Winokur, Jr. ............. 55 Director
</TABLE>
Rebecca P. Mark has served as Director, Chairman and Chief Executive
Officer of Azurix since July 1998. Ms. Mark has served as Vice Chairman of Enron
since May 1998, and, until recently, was Chairman of Enron International Inc.
since January 1996 and Chairman and Chief Executive Officer of Enron Development
Corp. since July 1991. She was also Chief Executive Officer of Enron
International from January 1996 to May 1998 and Vice President and Chief
Development Officer of Enron Power Corp. from July 1990 to July 1991. Enron
International Inc., Enron Development Corp. and Enron Power Corp. are wholly
owned subsidiaries of Enron. Ms. Mark is also a Director of Brunswick Corp.
Rodney L. Gray has served as Director of Azurix since July 1998, as Vice
Chairman, Finance, Risk Management and Investments and Chief Financial Officer
of Azurix since November 1998 and Executive Director, Finance, Risk Management
and Investments of Azurix from October 1998 until November 1998. Mr. Gray was
Executive Vice President, Finance of Enron International from January 1997 until
he joined Azurix. In addition, Mr. Gray was Chairman and Chief Executive Officer
of Enron Global Power & Pipelines L.L.C. from June 1995 until November 1997 and
was also President of Enron Global Power & Pipelines L.L.C. from November 1995
to November 1997. Mr. Gray also served as a Managing Director of Enron
Development Corp. from August 1995 through December 1996, as Chairman and Chief
Executive Officer of Enron International from June 1993 to December 1995, and as
Senior Vice President, Finance & Treasurer of Enron from October 1992 through
June 1993. Mr. Gray is also a Director of Harmon Industries Inc.
W. Nicholas Hood has served as Director and Vice Chairman of Azurix since
October 1998 and as Chairman of Wessex since September 1989. From 1987 to 1989,
Mr. Hood served as Chairman of Wessex Water Authority, Wessex's predecessor. He
is Chairman of MHIT plc and is a Non-executive Director of Winterthur Life U.K.
Ltd. and Commercial Union Environment Trust plc, President of the International
Water Services Association and a Member of the Water Training Council. Mr. Hood
is Deputy Chairman
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of Business in the Community, a Member of The Prince's Council, Chairman of
@Bristol and a Director of the Harbourside Foundation and of the Harbourside
Center.
John C. Ale has served as Executive Director and General Counsel of Azurix
since December 1998. Prior to joining Azurix, Mr. Ale was with the law firm of
Vinson & Elkins L.L.P. for more than 17 years, and was a partner for more than
12 years. From December 1996 to October 1998, Mr. Ale served as managing partner
of the London office of Vinson & Elkins. From July 1993 to October 1998, he was
chairman of Vinson & Elkins' project finance and development practice. Prior to
joining Vinson & Elkins, Mr. Ale served as law clerk to the Honorable Warren E.
Burger, then Chief Justice of the United States.
Alex Kulpecz has served as Executive Director, Europe, Middle East, Asia,
Africa of Azurix since September 1998. From October 1995 to September 1998, Mr.
Kulpecz served as Director of Development for Russia, Central/Eastern Europe,
Latin America and Africa for Shell International Gas & Power. Prior to that
time, he led the reorganization teams for Shell International's exploration and
production business in The Hague, acted as Senior Management Liaison for Shell
International's oil and gas production business in Europe and the United Kingdom
and held management positions in the Middle East and the United Kingdom.
Amanda K. Martin has served as Executive Director, Americas of Azurix since
September 1998. Commencing in 1991, Ms. Martin served in various positions with
Enron Capital & Trade Resources Corp., including President of Energy and Finance
Services from January 1998 to September 1998, Managing Director and Vice
President of Business Ventures and Asset Management from September 1996 to
January 1998, Vice President of Business Ventures and Asset Management from
April 1994 to September 1996, and Senior Counsel from March 1993 to April 1994.
Edward N. Robinson has served as Executive Director, Strategy and Corporate
Development of Azurix since November 1998. Prior to joining Azurix, Mr. Robinson
served as Member of the Executive Committee from 1992 to 1998, Executive Vice
President and Manager, The Private Bank, from 1995 to 1998 and Executive Vice
President and Manager, Investment Banking from 1992 to 1994 of Chase Bank of
Texas, formerly Texas Commerce Bank. Mr. Robinson also served as Vice President
and then Director from 1983 to 1989 and Managing Director from 1989 to 1992 of
The First Boston Corporation.
Colin F. Skellett has served as Executive Director, Technical and
Operating, Environmental and Safety Services of Azurix since October 1998 and as
Chief Executive of Wessex since January 1995. Mr. Skellett served as Managing
Director of Wessex from September 1989 to January 1995. Mr. Skellett is also
Chairman of Wessex Water Services Ltd. and is the U.K. representative on the
European Union of National Associations of Water Suppliers and Waste Water
Services.
John H. Duncan has served as Director of Azurix since March 1999. Mr.
Duncan's principal occupation has been investments since 1990. Mr. Duncan is
also a Director of Enron, EOTT Energy Corp., the general partner of EOTT Energy
Partners, L.P., Enron Oil & Gas Company, Chase Bank of Texas, National
Association and Group 1 Automotive Inc.
Kenneth L. Lay has served as Director of Azurix since November 1998. Mr.
Lay has been a Director of Enron since 1985 and a Director of Enron Oil & Gas
Company since 1985. For over five years, Mr. Lay has been Chairman of the Board
and Chief Executive Officer of Enron. Mr. Lay is also a Director of Eli Lilly
and Company, Compaq Computer Corporation, EOTT Energy Corp. and Trust Company of
the West.
Jeffrey K. Skilling has served as Director of Azurix since November 1998.
Mr. Skilling has been a Director of Enron and of Enron Oil & Gas Company since
1997. Since January 1, 1997, Mr. Skilling has served as President and Chief
Operating Officer of Enron. From June 1995 until December 1996, he served as
Chief Executive Officer and Managing Director of Enron Capital & Trade Resources
Corp. From August 1990 until June 1995, Mr. Skilling served Enron Capital &
Trade Resources Corp. in a variety of senior managerial positions.
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Joseph W. Sutton has served as Director of Azurix since March 1999. Mr.
Sutton has served as President of Enron International, Inc. since January 1996
and its Chief Executive Officer since May 1998. From January 1996 to May 1998,
he also served as Enron International's Chief Operating Officer. From 1995 to
January 1996, Mr. Sutton served as President and Chief Operating Officer and
from 1992 to 1995 was a Vice President of Enron Development Corp. Before joining
Enron Development Corp., Mr. Sutton served as a career officer in the U.S. Army.
John Wakeham has served as a Director of Azurix since March 1999. Lord
Wakeham has been a Director of Enron since 1994. Lord Wakeham is a retired
former U.K. Secretary of State for Energy and Leader of the Houses of Commons
and Lords. He served as a Member of Parliament from 1974 until his retirement
from the House of Commons in April 1992. Prior to his government service, Lord
Wakeham managed a large private practice as a chartered accountant. In the U.K.,
he is currently Chairman of the Press Complaints Commission and Chairman or
Director of a number of publicly traded U.K. companies.
Herbert S. Winokur, Jr. has served as a Director of Azurix since April
1999. Mr. Winokur has been a Director of Enron since 1985. Mr. Winokur is
Chairman and Chief Executive Officer of Capricorn Holdings, Inc., a private
investment company, and Managing General Partner of Capricorn Investors, L.P.
and Capricorn Investors II, L.P., private investment partnerships concentrating
on investments in restructure situations, organized by Mr. Winokur in 1987 and
1994, respectively. Prior to his current appointment, Mr. Winokur was Senior
Executive Vice President and a director of Penn Central Corporation. Mr. Winokur
is also a director of NAC Re Corporation, The WMF Group, Ltd., Mrs. Fields
Holding Company, Inc., CCC Information Services Group, Inc. and DynCorp.
BOARD OF DIRECTORS
Our Board of Directors is divided into three classes serving staggered
terms. Directors in each class are elected to serve for three-year terms and
until their successors are elected and qualified. Each year, the directors of
one class stand for election as their terms of office expire. Mr. Hood, Mr.
Duncan and Mr. Sutton have been designated as Class I directors, with their
terms of office expiring in 2000; Mr. Gray, Mr. Skilling and Lord Wakeham have
been designated as Class II directors, with their terms of office expiring in
2001; and Ms. Mark, Mr. Lay and Mr. Winokur have been designated as Class III
directors, with their terms of office expiring in 2002.
Following the offering, we will appoint two individuals independent of
Azurix, Enron, Marlin Water Trust and Atlantic Water Trust to serve on our Board
of Directors.
COMMITTEES OF THE BOARD
Our Board of Directors has established an Executive Committee, an Audit and
Finance Committee, a Corporate Governance Committee, a Human Resources and
Compensation Committee and a Stock Plan Committee.
EXECUTIVE COMMITTEE
Mr. Lay, Ms. Mark and Mr. Winokur serve on the Executive Committee. The
Executive Committee is authorized to take all actions within the authority of
the Board of Directors between regular meetings of the Board of Directors when
it is not practicable, in the judgment of the Chairman of the Board and the
chairman of the Executive Committee, to convene a meeting of the Board of
Directors.
AUDIT AND FINANCE COMMITTEE
Mr. Winokur and Mr. Duncan serve on the Audit and Finance Committee. This
committee reviews and reports to the Board of Directors with respect to the
selection, retention, termination and terms of engagement of our independent
public accountants, and maintains communications among the Board of Directors,
the independent public accountants and our internal accounting staff with
respect to accounting and audit procedures. The Audit and Finance Committee also
reviews, with management and our independent auditors, our annual financial
statements, the adequacy of our internal accounting and control
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procedures and policies and related matters. This committee periodically reviews
the results of capital proposals previously approved by the Board of Directors
to assess how they compare with the plan as adopted by the Board of Directors.
This committee may review other financial matters when requested by the Board of
Directors or by management.
CORPORATE GOVERNANCE COMMITTEE
Lord Wakeham, Mr. Hood, Mr. Lay and Mr. Sutton serve on the Corporate
Governance Committee. This committee coordinates the functioning of the Board of
Directors, including assessing the membership of the Board of Directors and
reviewing the processes and procedures of the Board of Directors. This committee
reviews with the Chief Executive Officer our organizational structure and
corporate governance mechanisms.
HUMAN RESOURCES AND COMPENSATION COMMITTEE
Mr. Duncan and Mr. Winokur serve on the Human Resources and Compensation
Committee. This committee determines the compensation to be paid to our top
management and will establish policies for, and administer, all compensation and
benefit plans in which other senior managers participate. Following the
offering, this committee will administer our stock plan. This committee also
reviews and reports to the Board of Directors on all other compensation and
benefit plans.
STOCK PLAN COMMITTEE
Mr. Lay, Ms. Mark and Mr. Skilling currently serve on the Stock Plan
Committee. This committee was established to administer our stock plan prior to
completion of the offering.
BOARD COMPENSATION
Employee directors will not receive additional compensation for serving on
our board of directors. Non-employee directors will be compensated entirely in
options to purchase our common stock and will each receive an initial grant of
options to purchase 12,000 shares of common stock at the offering price.
Committee chairmen will each receive an additional grant to purchase 1,500
shares of common stock at the initial public offering price. Options will be
exercisable for ten years. These options will vest 50% on the first anniversary
of the grant date and 100% on the second anniversary of the grant date.
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EXECUTIVE COMPENSATION
The following table sets forth compensation information for the year ended
December 31, 1998 for the Chairman and Chief Executive Officer and each of the
four other most highly compensated executive officers of Azurix. These five
individuals are referred to in this prospectus as the "Named Executive
Officers." Because each of these individuals joined Azurix during 1998, the
amounts shown in the table below represent amounts attributable to and paid by
Azurix after each individual joined Azurix.
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------------------------------------------
OTHER ANNUAL ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION COMPENSATION
--------------------------- ---- -------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Rebecca P. Mark(1)..................... 1998 $145,306 -- $ 65,653(4) --
Chairman and Chief Executive Officer
Rodney L. Gray(1)...................... 1998 $156,269 $101,250 -- --
Vice Chairman, Finance, Risk
Management and Investments and Chief
Financial Officer
Amanda K. Martin(1).................... 1998 $106,999 $181,250 -- $350,000(6)
Executive Director, Americas
Alex Kulpecz(2)........................ 1998 $177,172 $200,000 $188,613(5) $250,000(7)
Executive Director, Europe, Middle
East, Asia, Africa
Colin F. Skellett(3)................... 1998 $105,825 $ 85,000 -- --
Executive Director, Technical and
Operating, Environmental and Safety
Services
</TABLE>
- ---------------
(1) Rebecca P. Mark, Rodney L. Gray and Amanda K. Martin were paid by Enron
and/or its affiliates for the entire year. The salary and bonus amounts
shown in the table are the amounts of their total compensation received from
Enron that were allocated by Enron to Azurix and paid by Azurix to Enron for
services rendered to Azurix. Ms. Mark's bonus arrangement is described below
under "-- Employment Agreements." The bonus amounts allocated to Azurix by
Enron for Mr. Gray and Ms. Martin were based on qualitative criteria and
were awarded in relation to the formation of Azurix's strategic business
development and corporate financing organization, in the case of Mr. Gray,
and Azurix's business development effort for the Americas, in the case of
Ms. Martin.
(2) Alex Kulpecz joined Azurix during September 1998. Mr. Kulpecz's bonus was
based on qualitative criteria and was awarded in relation to the formation
of Azurix's London office and business development effort for Europe, the
Middle East, Africa, Asia and the Pacific Rim.
(3) Colin F. Skellett joined Azurix in October 1998 in conjunction with the
acquisition of Wessex. Mr. Skellett's bonus was based on qualitative
criteria and was awarded in relation to the formation of Azurix's technical
and operational organization.
(4) Includes $62,419 reported as income and paid by Azurix for Ms. Mark for
personal airplane usage.
(5) Includes $127,533 for payment of U.K. income taxes.
(6) Represents compensation paid to Ms. Martin for forgoing compensation from
her previous employer, Enron Capital & Trade Resources Corp.
(7) Represents a sign-on bonus for forgoing compensation from his previous
employer.
EMPLOYMENT AGREEMENTS
Rebecca P. Mark entered into an employment agreement, effective May 1998,
with Enron through December 31, 2001 as Chairman of Enron International and Vice
Chairman of Enron. The agreement was amended when it was assumed by Azurix, in
addition to Enron, effective February 1, 1999, in connection
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with Ms. Mark's assumption of the role as Chairman and CEO of Azurix, in
addition to her role as Vice Chairman of Enron. The agreement provides for an
annual salary of not less than $710,000. Under the agreement, in May 1998, Ms.
Mark was granted 100,000 Enron stock options that have a ten-year term and vest
one-third on each of January 1, 1999, January 1, 2000 and January 1, 2001, and
350,000 Enron stock options which have a ten-year term and vest one-third on
each of May 4, 1999, May 4, 2000 and May 4, 2001. The agreement stipulated Ms.
Mark's 1998 bonus target to be one percent of Enron International's after-tax
net income subject to adjustment in the sole discretion of Enron's Chairman and
CEO, taking into consideration after-tax net income and funds flow targets set
each year by the Board of Directors, as well as other performance criteria. The
agreement also stipulates that bonus calculations for 1999 through 2001 will be
determined prospectively. The agreement provides that Ms. Mark is eligible to
participate in either the Enron executive compensation long-term incentive
program or the Azurix stock incentive plan. During the term of this agreement,
Ms. Mark was granted 2,000,000 Azurix stock options from the Azurix stock
incentive plan, effective February 2, 1999, which will vest 25% per year over
the next four-year period. The agreement also provides for full vesting of
specific grants and awards made to Ms. Mark under long-term incentive plans
maintained by Enron in the event of involuntary termination, death or disability
and, as recently amended, precludes full vesting of long-term grants made under
the Azurix stock incentive plan in the event of termination. The agreement
provides 100% of base pay and unpaid bonuses through the contract term in the
event of involuntary termination. The employment agreement contains
noncompetition provisions in the event of Ms. Mark's termination of employment.
Rodney L. Gray entered into an employment agreement with Azurix effective
February 16, 1999. The agreement, which expires February 15, 2004 and entitles
Mr. Gray to an annual salary of $430,000, provides that Mr. Gray will
participate in an annual incentive plan with a bonus target of 100% of his
annual base salary. The agreement provides that Mr. Gray is eligible to
participate in the Azurix stock incentive plan. Under his agreement, Mr. Gray
was granted 1,000,000 Azurix stock options, effective February 2, 1999, which
will vest 20% per year over the next five-year period. If Mr. Gray is
involuntarily terminated, which includes a termination by Azurix without cause,
then he will receive a monthly severance payment equal to 100% of his monthly
salary and annual bonus payments until the end of the term of the agreement as
if he had not been terminated. The agreement prohibits Mr. Gray from competing
with Azurix until February 15, 2004.
Amanda K. Martin entered into an employment agreement with Enron Capital &
Trade Resources, which subsequently was assigned to Azurix. The agreement runs
through August 31, 2003 and entitles Ms. Martin to an annual salary of $400,000.
In connection with the transfer of her agreement to Azurix, Ms. Martin received
a bonus of $350,000. The agreement provides that Ms. Martin will participate in
an annual incentive plan with a bonus target of between 100% and 200% of her
annual base salary and that Ms. Martin is eligible to participate in the Azurix
stock incentive plan. Under her agreement, Ms. Martin was granted 1,000,000
Azurix stock options, effective February 2, 1999, which will vest 25% per year
over the next four-year period. If Ms. Martin is involuntarily terminated, which
includes a termination by Azurix without cause, then she will receive a monthly
severance payment equal to 100% of her monthly salary and unpaid annual bonuses
until the end of the term of the agreement as if she had not been terminated. In
order to receive these payments, Ms. Martin may not compete with Azurix during
the term of the agreement following an involuntary termination. The agreement
also prohibits Ms. Martin from competing with Azurix until six months after the
termination of employment or the expiration of the agreement.
Alex Kulpecz entered into an employment agreement with Azurix which runs
through September 14, 2001 and entitles Mr. Kulpecz to an annual salary of
$492,000. In connection with his agreement, Mr. Kulpecz received a sign-on bonus
of $250,000. The agreement provides that Mr. Kulpecz will participate in an
annual incentive plan with a bonus target of 100% of his annual base salary.
Under the terms of the agreement, upon commencing employment, Mr. Kulpecz was
granted 100,000 Enron stock options that have a ten-year term and vest one-third
on each anniversary of the date of grant and 30,000 Enron stock options which
have a ten-year term and are 100% vested. If Mr. Kulpecz is involuntarily
terminated, which includes a termination by Azurix without cause, then he will
receive a
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monthly severance payment equal to 100% of his monthly salary until the end of
the term of the agreement as if he had not been terminated, plus a pro rata
portion of his bonus earned for the year of termination. In addition, in the
case of involuntary termination except if he has failed to meet performance
objectives, Mr. Kulpecz will be entitled to a payment so that the value of the
equity in Enron and Azurix which he has received pursuant to his employment
agreement plus the payment equals one million dollars. The agreement prohibits
Mr. Kulpecz from competing with Azurix until the later of September 14, 2001 or
one year following termination of employment.
Colin F. Skellett entered into an employment agreement with Wessex which
entitles Mr. Skellett to an annual salary of $423,300. The agreement provides
that Mr. Skellett is eligible to participate in the Azurix stock incentive plan.
Under his agreement, Mr. Skellett was granted 600,000 Azurix stock options,
effective February 2, 1999, which will vest 33 1/3% per year over the next
three-year period. The employment agreement may be terminated by either Wessex
or Mr. Skellett upon 12 months' notice. The agreement otherwise terminates on
Mr. Skellett's 60th birthday. The agreement provides that Mr. Skellett will
participate in an annual bonus plan. The agreement prohibits Mr. Skellett from
competing with Wessex for one year following termination of employment.
STOCK PLAN
We have adopted a stock incentive plan. Grants of incentive stock options
and nonqualified stock options and awards of restricted stock may be made
pursuant to the stock plan. At any particular time, the number of shares of
common stock issued under the plan plus the number of shares of common stock
issuable upon the exercise of all outstanding stock options under the plan may
not exceed 15% of the total number of shares of common stock then outstanding,
assuming the exercise of all outstanding options. The stock plan will be
administered by the Stock Plan Committee, which currently consists of Rebecca P.
Mark, Kenneth L. Lay and Jeffrey K. Skilling. The exercise price for an option
granted under the stock plan will be determined by the Stock Plan Committee and
will be no less than the fair market value of the common stock on the date that
the option is granted. If our outstanding common stock is adjusted because of a
recapitalization, stock split, combination of shares, reclassification, stock
dividend or other similar change, the Stock Plan Committee will make appropriate
adjustments to the total number of shares covered by the plan and the exercise
price and number of shares covered by each outstanding option or restricted
stock award.
As long as Enron owns 30% or more of our common stock, if there is a change
in control of Enron, then each outstanding restricted stock award or option,
regardless of vesting, will be surrendered and canceled and each grantee will
receive a cash payment from Azurix. If there is a change in control of Azurix,
then each outstanding restricted stock award or option, regardless of vesting,
will be surrendered and canceled and each grantee will receive a cash payment
from Azurix. In either case, the cash payment for restricted stock awards will
equal the fair market value of a share of our common stock on the date of
cancellation multiplied by the number of shares subject to the restricted stock
award. In either case, the cash payment for canceled options will equal the
difference between the fair market value of a share of our common stock on the
date of cancellation minus the exercise price of the canceled options multiplied
by the number of shares covered by the canceled options. In the case of a change
in control of Azurix by means of a merger, sale or other business combination or
a tender offer, the fair market value of our common stock for purposes of the
calculation set forth in the previous sentence will be the per share price
offered to our stockholders in such transaction.
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STOCK OPTION GRANTS
During 1998, there were no options held, granted or exercised. On February
2, 1999, Azurix granted options to purchase a total of 7,800,150 shares of
common stock. The following table sets forth information regarding options
granted to the Named Executive Officers on February 2, 1999.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE AT
NUMBER OF SHARES ASSUMED RATES OF STOCK PRICE
OF COMMON STOCK PERCENT OF TOTAL EXERCISE APPRECIATION FOR OPTION TERM
UNDERLYING OPTIONS OPTIONS GRANTED AT PRICE EXPIRATION ---------------------------------
NAME GRANTED(1) FEBRUARY 2, 1999 ($/SHARE)(2) DATE 0%(3) 5%(3) 10%(3)
---- ------------------ ------------------- ------------ ---------- ----- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Rebecca P. Mark...... 2,000,000 25.6% $16.72 02/02/2009 $0 $21,040,000 $53,300,000
Rodney L. Gray....... 1,000,000 12.8 16.72 02/02/2009 0 10,520,000 26,650,000
Amanda K. Martin..... 1,000,000 12.8 16.72 02/02/2009 0 10,520,000 26,650,000
Alex Kulpecz......... 1,000,000 12.8 16.72 02/02/2009 0 10,520,000 26,650,000
Colin F. Skellett.... 600,000 7.7 16.72 02/02/2009 0 6,312,000 15,990,000
</TABLE>
- ---------------
(1) These options are subject to vesting based on the following schedule:
Rebecca P. Mark -- 25% per year over four years; Rodney L. Gray -- 20% per
year over five years; Amanda K. Martin -- 25% per year over four years; Alex
Kulpecz -- 20% per year over five years; and Colin F. Skellett -- 33 1/3%
per year over three years.
(2) Each of these options was granted pursuant to our stock incentive plan and
is subject to the terms of the stock incentive plan as described above.
These options were granted at an exercise price equal to the fair value of
our common stock as determined by our Board of Directors on the date of the
grant.
(3) The 0%, 5% and 10% assumed annual rates of compounded stock price
appreciation are mandated by the rules of the SEC. There can be no assurance
that the actual stock price appreciation over the ten-year option term will
be at the assumed 0%, 5% or 10% levels or at any other defined level. Unless
the market price of the common stock appreciates over the option term, no
value will be realized from the option grants. The potential realizable
value is calculated by assuming that the fair market value of the common
stock on the date of grant of the options appreciates at the indicated rate
for the entire term of the option and that the option is exercised at the
exercise price and sold on the last day at the appreciated price.
In addition to the option grants to the Named Executive Officers in the
table above, Azurix granted options to purchase a total of 2,200,150 shares of
common stock at an exercise price of $16.72 per share to other employees with
vesting schedules generally providing for vesting over three to five years. All
of these options expire ten years after the grant date of February 2, 1999.
In approving the grants described above, the Stock Plan Committee sought to
provide incentives in addition to compensation to Azurix's employees to devote
their utmost effort and skill to the advancement and betterment of Azurix by
providing such employees with an opportunity to participate in the ownership of
Azurix and thereby have an interest in the success and increased value of Azurix
as well as to enhance Azurix's ability to retain the services of its key
employees. As a member of the Stock Plan Committee, Rebecca P. Mark participated
in approving these grants, except with respect to the grant of options to
herself.
In addition to the grants of stock options described above, our Board of
Directors has authorized additional grants, conditioned on the completion of the
offering and effective as of the date of this prospectus, of options to purchase
an aggregate of 626,500 shares of common stock to employees who recently joined
Azurix. These options will have an exercise price equal to the initial public
offering price, will generally vest over three to five years and will be
exercisable for ten years after the date of grant.
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TRANSACTIONS WITH ENRON, ATLANTIC WATER TRUST AND MARLIN WATER TRUST
In 1998, there were significant transactions among us, Enron, Atlantic
Water Trust and Marlin Water Trust. For purposes of governing these ongoing
relationships, we will enter into, or continue in effect, various agreements and
relationships, including those described below. Some of the agreements
summarized below will be included as exhibits to the registration statement of
which this prospectus is a part. The following summaries of these agreements
discuss the material provisions of these agreements and are qualified completely
by reference to such exhibits which we incorporate in this prospectus by
reference.
During 1998, Azurix indirectly acquired all of the outstanding ordinary
share capital of Wessex, and Enron contributed to Azurix the outstanding common
stock of a subsidiary that in June 1998 acquired a 32.1% ownership interest in
Obras Sanitarias Mendoza. In December 1998, Enron contributed Azurix to Atlantic
Water Trust and Marlin Water Trust acquired a 50% voting interest in Atlantic
Water Trust. Enron retained a 50% voting interest in Atlantic Water Trust.
On February 25, 1999, in connection with the Cancun acquisition, Enron
advanced to Azurix $15.0 million, which was used by Azurix to fund a loan to
Cancun. On March 24, 1999, Enron advanced to Azurix $13.5 million to fund the
Cancun acquisition, which closed on that date.
Enron currently provides office space to Azurix and various services such
as computer hardware and software and support services such as risk management,
accounts payable, payroll and information technology services. Costs are
allocated to Azurix based upon usage, or where no direct method can be
efficiently applied due to administrative burden, upon factors such as
annualized payroll or employee headcount. Employees, other than Wessex
employees, are covered by various employee benefit plans of Enron such as
retirement, stock option, medical, dental, life insurance and other benefit
plans. These costs are allocated to Azurix based upon Enron's costs of
administering and providing the benefit plans.
Enron has paid on behalf of Azurix approximately $72 million to fund our
general, administrative and operating expenses, from our inception through June
7, 1999, in addition to capital expenditures. This includes $28.5 million
advanced to us by Enron in connection with our investment in Cancun, as well as
advances relating to the services described above. The amount paid by Enron is
non-interest bearing and has no maturity date. We intend to use a portion of the
net proceeds that we receive from the offering to repay this amount. See "Use of
Proceeds."
ACQUISITION OF WESSEX
On October 2, 1998, Azurix, through Azurix Europe, acquired over 90% of the
outstanding ordinary share capital of Wessex. On that same date, Azurix Europe
issued notices to the remaining Wessex ordinary shareholders, informing them
that it intended to exercise its rights under the English Companies Act to
acquire compulsorily all of the outstanding ordinary shares not held by Azurix
Europe. The compulsory share acquisition was completed in November 1998. The per
share price paid to Wessex shareholders was L6.30. The total cost of the Wessex
acquisition, including transaction costs, was $2.4 billion, plus the assumption
of $481.5 million of existing Wessex debt. The cost included cash consideration
paid to Wessex shareholders, net of $1.7 million cash acquired, and the issuance
of loan notes to Wessex shareholders in the face amount of $119.8 million.
The acquisition was financed through capital contributions from Enron Water
(Holding) L.L.C., formerly Azurix's parent company and a wholly owned subsidiary
of Enron, totaling $1.6 billion and the issuance of $0.8 billion in debt by
Azurix Europe. The financing of the Wessex acquisition by Azurix, through Azurix
Europe, was as follows:
- Enron made a $500.2 million capital contribution to Enron Water (Holding)
L.L.C.
- Enron borrowed $1.1 billion under a revolving credit facility, which
Enron loaned to Enron Water (Holding) L.L.C.
- Enron Water (Holding) L.L.C. made a capital contribution of these funds
to Azurix, and Azurix, through a wholly owned subsidiary, made a capital
contribution of these funds to Azurix Europe
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- Enron lent L73 million ($124.4 million) to Azurix Europe under a senior
loan agreement
- Enron lent L72 million ($122.7 million) to Azurix Europe under a
short-term, senior, unsecured credit facility, which loan, together with
$2.1 million of accrued interest, was subsequently repaid with the
proceeds from the sale of UK Waste in December 1998
- Azurix Europe borrowed L252 million ($429.3 million) under the existing
senior credit facility
- Azurix Europe issued seven-year, senior, unsecured loan notes in the face
amount of L70.5 million ($119.8 million) to Wessex shareholders who
elected to take loan notes instead of cash
In connection with regulatory clearance of the acquisition of Wessex,
Atlantic Water Trust and Wessex's immediate parent, Azurix Europe, made
undertakings regarding the modification of Wessex Water Services' license as a
provider of water and wastewater services. The objective of the modifications
was to allow Wessex to operate as if it is a stand-alone organization and to
ensure that Wessex has sufficient financial and managerial resources. See
"Regulatory Matters -- U.K. Regulatory Matters."
ACQUISITION OF INTEREST IN ATLANTIC WATER TRUST
In December 1998, Enron contributed Azurix to Atlantic Water Trust, a
Delaware business trust, by contributing Enron Water (Holding) L.L.C. and
merging it into Azurix. In connection with Enron's contribution, Marlin Water
Trust acquired for $1.149 billion a 50% voting interest in Atlantic Water Trust,
with Enron retaining a 50% voting interest. Of the $1.149 billion paid by Marlin
Water Trust, $900 million was used to repay a portion of the indebtedness
incurred by Enron and its affiliates in connection with the Wessex acquisition.
See "Principal and Selling Stockholders -- Atlantic Water Trust."
CONFLICTS OF INTEREST
Atlantic Water Trust currently owns all of Azurix's outstanding common
stock. Following completion of the offering, Atlantic Water Trust will own
approximately 68.7% of our outstanding common stock, or 64.1% if the
underwriters' over-allotment option is exercised in full. Each of Enron and
Marlin Water Trust owns a 50% voting interest in Atlantic Water Trust. To date,
Enron has appointed all of the directors of Atlantic Water Trust and Azurix,
although Marlin Water Trust at any time has the right to elect or replace half
of the directors of Atlantic Water Trust and currently up to half of the Azurix
directors. Following the offering, as long as Atlantic Water Trust owns a
majority of our outstanding voting stock, Marlin Water Trust has the right to
direct Atlantic Water Trust to elect or replace a percentage of Azurix's
directors equal to 50% minus the percentage of outstanding voting stock held by
persons other than Atlantic Water Trust, Enron and its affiliates. Furthermore,
Marlin Water Trust, with the consent of the holders of a majority of our
outstanding voting stock held by persons other than Atlantic Water Trust, Enron
and its affiliates, has the right to direct Atlantic Water Trust to elect or
replace half of Azurix's directors. In each case, Marlin Water Trust's right to
designate directors shall be reduced by the number of directors that may be
elected by preferred stock entitled to elect directors as a class. Enron has the
right to direct Atlantic Water Trust to elect or replace the other half of
Azurix's directors. In all other circumstances, the board of directors of
Atlantic Water Trust will direct the voting of Atlantic Water Trust's Azurix
shares. As a result, following the offering, Enron and Marlin Water Trust will
continue to exert significant influence over the policies, management and
affairs of Azurix and will control the outcome of corporate actions requiring
stockholder approval, including the approval of transactions involving a change
in control of Azurix.
Currently, a majority of our directors are also directors or officers of
Enron, a situation that may create conflicts of interest. The directors and
officers of Enron have fiduciary duties to manage Enron, including its
investments in subsidiaries and affiliates such as Azurix, in a manner
beneficial to Enron and its stockholders. Similarly, the directors and officers
of Azurix have fiduciary duties to manage Azurix in a manner beneficial to
Azurix and its stockholders. In some circumstances, the duties of these
directors and officers of Enron may conflict with their duties as directors of
Azurix. In addition, other conflicts of interest exist and may arise in the
future as a result of the extensive relationships between Enron and
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Azurix. Enron and Azurix have agreed that conflicts of interest between Enron
and Azurix may be resolved through approval by a majority of the directors of
Azurix not associated with Enron. See "Principal and Selling Stockholders."
AGREEMENT REGARDING BUSINESS OPPORTUNITIES AND RELATED MATTERS
Enron and Azurix have entered into an agreement that limits the scope of
Azurix's business and provides that Enron and its affiliates may engage in
water-related businesses, even if those businesses have a competitive impact on
Azurix. In general, Enron is permitted to engage in any business whatsoever,
including water, wastewater and other businesses competing with Azurix, and may
compete in public tenders against Azurix, provided the business is conducted and
opportunities are identified and developed through Enron's own personnel and not
through Azurix. If an opportunity in the water industry is presented to a person
who is an officer or director of both Enron and Azurix, the opportunity must
first be offered to Azurix, unless water constitutes a minority of the fair
market value of the opportunity, as determined by that officer or director in
good faith based on information available at the time.
In the agreement, Azurix acknowledges that Enron has fiduciary and
contractual obligations to other persons and entities under existing agreements
and relationships and has agreed that, in the event of a conflict between the
duties of Enron under the agreement and the duties of Enron to third parties
under agreements or relationships that exist on the date of execution of the
agreement, Enron will be entitled to perform its duties to such third parties
without any liability to Azurix.
The agreement provides that any standard of care, any duty of loyalty and
any other duty imposed by the agreement or under Delaware law or any other
applicable law, rule or regulation shall be modified, waived or limited as
required in order to permit Enron to act under the agreement and to make any
decision pursuant to the authority prescribed in the agreement so long as such
action is reasonably believed by Enron to be in, or not inconsistent with, the
agreement or the interests of Azurix. Azurix has agreed to indemnify Enron and
its officers, directors and employees against any claim that Enron's pursuit of
any water business was a breach of any duty owed by Enron to Azurix, provided
Enron has followed the rules described above.
Azurix's purpose clause permits it to engage in the businesses generally
identified in this prospectus, activities incidental to those businesses, and
such other businesses as Enron may approve in its sole discretion. Azurix has
agreed not to amend its certificate of incorporation to expand its purpose
clause without Enron's prior written consent.
The agreement restricts Enron and Azurix from taking action that might
cause either of them to violate any law or that would require either of them to
register as a public utility holding company under the Public Utility Holding
Company Act of 1935.
The agreement states that whenever a potential conflict of interest exists
or arises between Enron and Azurix, any resolution or course of action in
respect of such conflict of interest shall be permitted and deemed approved, and
will not constitute a breach of any duty stated or implied by law or equity, if
the resolution or course of action is authorized by the agreement or, by
operation of the agreement, is deemed to be fair and reasonable to Azurix. The
agreement states that any conflict of interest and any resolution of such
conflict of interest shall be conclusively deemed fair and reasonable to Azurix
if such conflict of interest or resolution is:
- Approved by special approval (the approval by a majority of the directors
of Azurix not associated with Enron)
- On terms no less favorable to Azurix than those generally being provided
to or available from unrelated third parties
- Fair to Azurix, taking into account the totality of the relationships
between the parties involved, including other transactions that may be
particularly favorable or advantageous to Azurix
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Enron may adopt a resolution or course of action that has not received
special approval. Enron and any person voting in connection with a special
approval will be authorized in connection with its determination of what is
"fair and reasonable" to Azurix and in connection with its resolution of any
conflict of interest to consider:
- The relative interests of any party to such conflict, agreement,
transaction or situation and the benefits and burdens relating to such
interest
- Any customary or accepted industry practices and any customary or
historical dealings with a particular person
- Any applicable generally accepted accounting or engineering practices or
principles
- Such additional factors as such person determines in its sole discretion
to be relevant, reasonable or appropriate under the circumstances
In the absence of bad faith by Enron, the resolution, action or terms so
made, taken or provided by Enron with respect to such matter shall not
constitute a breach of the agreement or a breach of any standard of care, any
duty of loyalty or any other duty imposed by the agreement or under Delaware law
or any other law, rule or regulation.
Disputes under the agreement are to be resolved through arbitration. The
agreement will continue indefinitely, except that it will expire on the first
date on which both of the following occur:
- Enron and its affiliates do not individually or collectively, directly or
indirectly, own or have the power to vote at least one-third of the
shares of Azurix ordinarily entitled to vote for the election of
directors
- Fewer than one-third of the directors of Azurix are persons who are
employees, officers or directors of Enron or of any affiliate of Enron
The mutual covenants and agreements in the agreement will be the
consideration given by each party to the other in support of the agreement. In
addition, the agreement states that Enron's investment in Atlantic Water Trust
was predicated on the execution and delivery of an agreement containing
substantially the terms set forth in the agreement.
SERVICES AGREEMENT
Effective May 1, 1999, we entered into an agreement with Enron pursuant to
which Enron provides various corporate staff and support services to us. These
services include information technology, office space, building maintenance,
security and other office services as well as employee development, training and
maintenance of compensation and other benefits programs. We also may utilize
Enron's regulatory affairs, marketing affairs, treasury and risk assessment and
control departments. In addition, Azurix may continue to participate in Enron's
corporate insurance program. The agreement provides that we may use the
international offices of Enron and its affiliates for projects, subject to
mutual agreement with Enron or its affiliates on a project-by-project basis. We
intend to enter into a related sublease with Enron providing for the use of
office space in Houston, Texas. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Recent Developments."
CREDIT AGREEMENT
Effective May 1, 1999, we entered into a credit agreement with Enron,
whereby Enron will provide funds to us for general, administrative and operating
expenses. The credit agreement matures December 15, 2001 or 90 days following
the date that Enron or its affiliates do not own or have the power to vote at
least one-third of our capital stock ordinarily entitled to vote for the
election of directors and fewer than one-third of our directors are officers,
directors or employees of Enron or its affiliates. The total commitment under
the credit agreement will be $180 million. Advances under the facility will bear
interest
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at the federal funds rate plus 1.50%. Amounts borrowed under the credit
agreement may be prepaid, in full or in part, at any time during the term of the
credit agreement. Amounts prepaid may be re-borrowed during the term of the
credit agreement. The principal amount outstanding under the credit agreement
will be limited to no more than:
- $60 million at any time during calendar year 1999
- $120 million at any time during calendar year 2000
- $180 million at any time during calendar year 2001
No further amounts may be borrowed, and all outstanding amounts must be
repaid within 90 days after the first date on which both of the following occur:
- Enron and its affiliates do not individually or collectively, directly or
indirectly, own or have the power to vote at least one-third of the
capital stock of Azurix ordinarily entitled to vote for the election of
directors, and
- Fewer than one-third of the directors of Azurix are persons who are
employees, officers or directors of Enron or of any affiliate of Enron.
As of June 7, 1999, no amounts were outstanding under this credit
agreement.
LICENSE AGREEMENT
Enron has licensed to Azurix the non-exclusive right to use the phrase "an
Enron Company" and its logo in identifying Azurix as part of the Enron
enterprise for use in its businesses permitted under the business opportunities
agreement described above, until the first date on which both of the following
occur:
- Enron and its affiliates do not individually or collectively, directly or
indirectly, own or have the power to vote at least one-third of the
shares of Azurix ordinarily entitled to vote for the election of
directors, and
- Fewer than one-third of the directors of Azurix are persons who are
employees, officers or directors of Enron or of any affiliate of Enron.
The license is royalty free, although Azurix bears costs associated with
its use under a related cost sharing agreement. The license agreement is for a
term of one year, and renews automatically and repetitively for similar terms,
unless terminated by either party upon 30 days' notice or earlier upon uncured
default. Following termination, Azurix must phase out use of existing materials
within 90 days. The cost sharing agreement provides for a sharing of Enron's
costs incurred to develop, maintain, enhance, promote or defend the licensed
trademarks. Our share of such costs will be pro rata based on our earnings
before interest and taxes. We do not anticipate that our share of such costs
will be material.
REGISTRATION RIGHTS AGREEMENT
We have entered into an agreement with Atlantic Water Trust, which allows
Atlantic Water Trust to request us to register 80,500,000 shares of our common
stock owned by Atlantic Water Trust following the offering. Atlantic Water Trust
has the right to request one such registration during each 12-month period
following the date of the offering, plus one additional such registration. The
number of shares requested to be registered shall have an aggregate offering
price of at least $25 million. In addition, Atlantic Water Trust has the right,
which it may exercise at any time, to include such shares in any registration of
common stock made by us in the future. We have agreed to cooperate fully in
connection with any such registration and with any offering made under the
registration rights agreement and to pay all costs and expenses, other than
underwriting discounts and commissions, related to shares sold by Atlantic Water
Trust in connection with any such registration. The rights of Atlantic Water
Trust under the registration rights agreement are transferable by Atlantic Water
Trust. The agreement is for an indefinite term. See "Risk Factors -- Future
sales of our common stock may depress our stock price" and "Shares Eligible for
Future Sale."
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of June 9, 1999, and as adjusted to reflect the
sale of the common stock offered hereby, by (1) the selling stockholder, (2) all
persons known by Azurix to own beneficially more than 5% of the common stock,
(3) each director of Azurix, (4) the Chief Executive Officer and each of the
other Named Executive Officers and (5) all directors and executive officers as a
group. Unless otherwise stated in the notes to the table, each of the
stockholders has sole voting and investment power with respect to the shares of
common stock beneficially owned by them.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO THE OFFERING NUMBER OF AFTER THE OFFERING
------------------------- SHARES BEING --------------------------
NAME AND ADDRESS OF BENEFICIAL OWNERS NUMBER PERCENT OFFERED NUMBER PERCENT
- ------------------------------------- ------------- --------- ------------ ------------- ----------
<S> <C> <C> <C> <C> <C>
Atlantic Water Trust(1)(2).................
c/o Wilmington Trust Company
Rodney Square North
1100 North Market Street
Wilmington, Delaware 19890-0001
Enron Corp.(2)(3).......................... % %
1400 Smith Street 100,000,000 100 19,500,000 80,500,000 68.7
Houston, Texas 77002
Marlin Water Trust(2)(4)...................
c/o Wilmington Trust Company
Rodney Square North
1100 North Market Street
Wilmington, Delaware 19890-0001
Rebecca P. Mark(5)......................... -- -- -- -- --
Rodney L. Gray............................. -- -- -- -- --
W. Nicholas Hood........................... -- -- -- -- --
Alex Kulpecz............................... -- -- -- -- --
Amanda K. Martin........................... -- -- -- -- --
Colin F. Skellett.......................... -- -- -- -- --
John H. Duncan............................. -- -- -- -- --
Kenneth L. Lay(5).......................... -- -- -- -- --
Jeffrey K. Skilling(5)..................... -- -- -- -- --
Joseph W. Sutton........................... -- -- -- -- --
John Wakeham............................... -- -- -- -- --
Herbert S. Winokur, Jr. ................... -- -- -- -- --
All directors and executive officers
as a group (14 persons)(6)............... -- -- -- -- --
</TABLE>
- ---------------
(1) Atlantic Water Trust is a Delaware business trust. Atlantic Water Trust
holds 100% of the common stock. Atlantic Water Trust is also the selling
stockholder.
(2) Each of Enron Corp. and Marlin Water Trust has a 50% voting interest in
Atlantic Water Trust, and each may be deemed to beneficially own all of the
Azurix shares owned by Atlantic Water Trust because of certain shared voting
and dispositive power. See " -- Atlantic Water Trust."
(3) Enron Corp. is an Oregon corporation.
(4) Marlin Water Trust is a Delaware business trust.
(5) Does not include 100,000,000 shares owned by Atlantic Water Trust with
respect to which Enron has shared voting and dispositive power. Messrs. Lay
and Skilling and Ms. Mark in their capacities as Chairman of the Board and
Chief Executive Officer, as President and Chief Operating Officer and as
Vice Chairman, respectively, of Enron may be deemed to beneficially own such
shares as a result of their positions with Enron.
(6) Our officers and directors are eligible to purchase shares, and may purchase
shares, of our common stock in the offering directly from the underwriters.
See "Underwriting -- Reserved Shares."
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ATLANTIC WATER TRUST
In December 1998, Enron contributed Azurix to Atlantic Water Trust, a
Delaware business trust. The principal purpose of Atlantic Water Trust is to own
equity interests in Azurix and to own Bristol Water Trust, and to engage in
other transactions related to the sale of an interest in Atlantic Water Trust to
Marlin Water Trust. In connection with Enron's contribution of Azurix to
Atlantic Water Trust, Marlin Water Trust acquired for $1.149 billion a 50%
voting interest in Atlantic Water Trust, with Enron retaining a 50% voting
interest. Marlin Water Trust financed the acquisition of its interest in
Atlantic Water Trust by issuing senior notes for $1.024 billion that mature
December 15, 2001, and issuing trust certificates for a total of $125 million.
Currently, five institutional investors and their affiliates hold the trust
certificates of Marlin Water Trust.
Of the $1.149 billion paid by Marlin Water Trust, $900 million was used to
repay a portion of the indebtedness incurred by Enron affiliates in connection
with the acquisition of Wessex. The remaining $249 million was deposited in an
account established by Bristol Water Trust, a wholly owned subsidiary of
Atlantic Water Trust. The funds in this account should generate sufficient
liquidity to fund distributions from Atlantic Water Trust to Marlin Water Trust
that will provide Marlin Water Trust with sufficient funds to service interest
on the senior notes and provide a yield to the trust certificate holders at
least through 2001. Azurix is not required to make any distributions to Atlantic
Water Trust, including any of its proceeds from the offering. Additionally,
neither Azurix nor any of its subsidiaries has guaranteed any obligations of
Marlin Water Trust and no assets of Azurix nor any of its subsidiaries are
pledged as security for the senior notes of Marlin.
Enron is entitled, with respect to distributions resulting from the sale of
Azurix stock by Atlantic Water Trust, to receive the first $180 million of
distributions by Atlantic Water Trust. After the receipt of $180 million by
Enron, further distributions resulting from the sale of Azurix stock by Atlantic
Water Trust and other non-liquidating distributions are generally to be paid
first to Marlin Water Trust until Marlin Water Trust has received funds equal to
the amount then in its trust account, with the remainder to Enron. Liquidation
distributions by Atlantic Water Trust are generally to be paid to Enron and
Marlin Water Trust pro rata based on their then respective trust accounts.
If Atlantic Water Trust fails by December 15, 2001 to make aggregate
distributions to Marlin Water Trust of amounts sufficient to repay the senior
notes of Marlin Water Trust, then Marlin Water Trust has the right to cause
Atlantic Water Trust to liquidate and sell its remaining shares of Azurix. In
order to prevent the liquidation of Atlantic Water Trust by Marlin Water Trust,
Enron has the right to contribute funds generated from Enron equity offerings to
Atlantic Water Trust to fund distributions to Marlin. In such event, Enron's
beneficial interest, but not voting interest, in Atlantic Water Trust would
increase and Marlin Water Trust's beneficial interest, but not voting interest,
in Atlantic Water Trust would decrease. Other actions, such as the refinancing
of the senior notes of Marlin Water Trust, might also be taken which could
eliminate the necessity of Atlantic Water Trust selling additional shares of
Azurix. However, Atlantic Water Trust may elect to sell, or be required to sell,
some or all of its remaining shares of Azurix in order to fund Marlin Water
Trust's obligations. The proceeds to Atlantic Water Trust from this initial
public offering are expected to be approximately $345.1 million, after deducting
underwriting discounts and commissions and estimated expenses and assuming no
exercise of the over-allotment option. After payment of underwriting discounts
and commissions and expenses, $180 million of these proceeds will be distributed
to Enron and the remainder will be distributed to Marlin Water Trust. The
proceeds distributed to Marlin Water Trust are expected to be used to redeem a
portion of the senior notes.
Marlin Water Trust, or the trustee under its senior notes indenture, may
cause the liquidation of Atlantic Water Trust prior to December 15, 2001 if
specific events occur and the senior notes are not repaid from other sources.
These events include: (1) defaults under certain of Azurix's, Enron's or Marlin
Water Trust's debt obligations or (2) a downgrading of Enron senior debt to
below "Baa3" by Moody's Investors Service, Inc., "BBB-" by Standard & Poor's
Ratings Services or "BBB-" by Duff & Phelps Credit Rating Co. and a decline in
Enron's common stock price below $37.84. The last sale price of Enron common
stock, as reported by the New York Stock Exchange, on June 9, 1999 was $78.3125.
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Each of Marlin Water Trust and Enron has the right and power at all times
to appoint up to 50% of the members of the board of directors of Atlantic Water
Trust. Marlin Water Trust's certificateholders are entitled to exercise Marlin
Water Trust's appointment rights. If the Marlin Water Trust certificateholders
defer exercising their appointment rights, Enron has the right to appoint such
members, but Marlin Water Trust has the right, at any time, without cause, to
remove any such members. To date, Enron has appointed all of the directors of
Atlantic Water Trust.
Following the offering, as long as Atlantic Water Trust owns a majority of
our outstanding voting stock, Marlin Water Trust has the right to direct
Atlantic Water Trust to elect or replace a percentage of Azurix's directors
equal to 50% minus the percentage of outstanding voting stock held by persons
other than Atlantic Water Trust, Enron and its affiliates. Furthermore, Marlin
Water Trust, with the consent of the holders of a majority of our outstanding
voting stock held by persons other than Atlantic Water Trust, Enron and its
affiliates, has the right to direct Atlantic Water Trust to elect or replace
half of Azurix's directors. In each case, Marlin Water Trust's right to
designate directors shall be reduced by the number of directors that may be
elected by preferred stock entitled to elect directors as a class. Enron has the
right to direct Atlantic Water Trust to elect or replace the other half of
Azurix's directors. In all other circumstances, the board of directors of
Atlantic Water Trust will direct the voting of Atlantic Water Trust's Azurix
shares. Under the terms of the Atlantic Water Trust agreement, Enron can be
prevented from appointing more than half of Azurix's directors at any time.
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of Azurix consists of 500,000,000 shares of
common stock, par value $0.01 per share, and 50,000,000 shares of preferred
stock, par value $0.01 per share. Prior to the offering, 100,000,000 shares of
common stock were outstanding. No shares of preferred stock have been issued.
The following summarizes the material provisions of our capital stock and
anti-takeover provisions of our certificate of incorporation and bylaws. This
summary is qualified by our certificate of incorporation and bylaws, copies of
which have been filed as exhibits to the registration statement of which this
prospectus is a part and by the provisions of applicable law.
COMMON STOCK
Following the offering, 117,100,000 shares of common stock will be issued
and outstanding. Holders of common stock are entitled to one vote per share on
all matters to be voted upon by the stockholders. Because holders of common
stock do not have cumulative voting rights, the holders of a majority of the
shares of common stock can elect all of the members of the board of directors
standing for election. Subject to preferences of any preferred stock that may be
issued in the future, the holders of common stock are entitled to receive such
dividends as may be declared by the board of directors. The common stock is
entitled to receive pro rata all of the assets of Azurix available for
distribution to its stockholders. There are no redemption or sinking fund
provisions applicable to the common stock. All outstanding shares of common
stock are fully paid and non-assessable.
PREFERRED STOCK
Subject to the provisions of the certificate of incorporation and
limitations prescribed by law, the board of directors has the authority to issue
up to 50,000,000 shares of preferred stock in one or more series and to fix the
rights, preferences, privileges and restrictions thereof, including dividend
rights, dividend rates, conversion rates, voting rights, terms of redemption,
redemption prices, liquidation preferences and the number of shares constituting
any series or the designation of such series, which may be superior to those of
the common stock, without further vote or action by the stockholders. There will
be no shares of preferred stock outstanding upon the closing of the offering and
Azurix has no present plans to issue any preferred stock.
One of the effects of undesignated preferred stock may be to enable the
board of directors to render more difficult or to discourage an attempt to
obtain control of Azurix by means of a tender offer, proxy contest, merger or
otherwise, and thereby to protect the continuity of Azurix's management. The
issuance of shares of the preferred stock pursuant to the board of directors'
authority described above may adversely affect the rights of the holders of
common stock. For example, preferred stock issued by Azurix may rank prior to
the common stock as to dividend rights, liquidation preference or both, may have
full or limited voting rights and may be convertible into shares of common
stock. Accordingly, the issuance of shares of preferred stock may discourage
bids for the common stock or may otherwise adversely affect the market price of
the common stock.
ANTI-TAKEOVER PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BYLAWS
CLASSIFIED BOARD OF DIRECTORS AND LIMITATIONS ON REMOVAL OF DIRECTORS
Our Board of Directors is divided into three classes. The directors of each
class are elected for three-year terms, with the terms of the three classes
staggered so that directors from a single class are elected at each annual
meeting of the stockholders. Until such time, called the "Trigger Date," as
neither Atlantic Water Trust nor Enron together with its subsidiaries owns a
majority of the outstanding voting stock of Azurix, the holders of a majority of
our outstanding voting stock may remove a director with or without cause. On and
after the Trigger Date, stockholders may remove a director only for cause and to
do so, at least 66 2/3% of the voting power of the outstanding shares of common
stock must vote for removal. The
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Board of Directors, not the stockholders, will have the right to appoint persons
to fill vacancies on the Board of Directors.
WRITTEN CONSENT OF STOCKHOLDERS
Our certificate of incorporation provides that prior to the Trigger Date
any action required or permitted to be taken by our stockholders may be taken at
a duly called meeting of stockholders or by written consent of stockholders
owning the minimum number of shares required to approve such action. On and
after the Trigger Date, any action by our stockholders must be taken at an
annual or special meeting of stockholders. Special meetings of the stockholders
may be called only by the board of directors. This provision, which requires a
vote of at least 66 2/3% of the voting power of the outstanding shares of common
stock to be amended, could have the effect of deterring hostile takeovers or
delaying changes in control.
ADVANCE NOTICE PROCEDURE FOR STOCKHOLDER PROPOSALS
Our bylaws establish an advance notice procedure for the nomination of
candidates for election as directors as well as for stockholder proposals to be
considered at annual meetings of stockholders. In general, notice of intent to
nominate a director must be delivered to or mailed and received at our principal
executive offices as follows:
- With respect to an election to be held at the annual meeting of
stockholders, 120 days prior to the anniversary date of the proxy
statement for the immediately preceding annual meeting of stockholders.
- With respect to an election to be held at a special meeting of
stockholders for the election of directors, not later than the close of
business of the 10th day following the day on which such notice of the
date of the meeting was mailed or public disclosure of the date of the
meeting was made, whichever first occurs, and must contain specified
information concerning the person to be nominated.
Notice of stockholders' intent to raise business at an annual meeting must
be delivered to or mailed and received at our principal executive offices not
less than 120 days prior to the anniversary date of the proxy statement for the
preceding annual meeting of stockholders. These procedures may operate to limit
the ability of stockholders to bring business before a stockholders meeting,
including with respect to the nomination of directors of considering any
transaction that could result in a change in control. These advance notice
procedures are not applicable prior to the Trigger Date.
LIMITATION OF LIABILITY OF OFFICERS AND DIRECTORS
Our certificate of incorporation provides that no director shall be
personally liable to Azurix or its stockholders for monetary damages for breach
of fiduciary duty as a director, except for liability as follows:
- For any breach of the director's duty of loyalty to Azurix or its
stockholders
- For acts or omissions not in good faith or which involve intentional
misconduct or knowing violation of laws
- For unlawful payment of a dividend or unlawful stock purchase or stock
redemption
- For any transaction from which the director derived an improper personal
benefit
The effect of these provisions is to eliminate the rights of Azurix and its
stockholders, through stockholders' derivative suits on behalf of Azurix, to
recover monetary damages against a director for breach of fiduciary duty as a
director, including breaches resulting from grossly negligent behavior, except
in the situations described above. These provisions will not change after the
Trigger Date.
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BUSINESS COMBINATIONS UNDER DELAWARE LAW
Under the terms of our certificate of incorporation and as permitted under
Delaware law we have elected not to be subject to Delaware's anti-takeover law.
This law provides that specified persons who, together with affiliates and
associates, own, or within three years did own, 15% or more of the outstanding
voting stock of a corporation may not engage in certain business combinations
with the corporation for a period of three years after the date on which the
person became an interested stockholder. The law does not include interested
stockholders prior to the time our common stock is listed on the NYSE. This
includes Atlantic Water Trust and Enron. The law defines the term "business
combination" to encompass a wide variety of transactions with or caused by an
interested stockholder, including mergers, asset sales and other transactions in
which the interested stockholder receives or could receive a benefit on other
than a pro rata basis with other stockholders. With approval of our
stockholders, we could amend our Certificate of Incorporation in the future to
become subject to the anti-takeover law. This provision would then have an
anti-takeover effect with respect to transactions not approved in advance by our
Board of Directors, including discouraging takeover attempts that might result
in a premium over the market price for the shares of our common stock.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the common stock is First Chicago
Trust Company of New York.
LISTING
The common stock has been approved for listing on the New York Stock
Exchange under the symbol "AZX," subject to official notice of issuance.
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DESCRIPTION OF INDEBTEDNESS
INDEBTEDNESS OF AZURIX
Enron has advanced Azurix approximately $72 million for our general,
administrative and operating expenses, from our inception through June 7, 1999,
in addition to capital expenditures. This includes $28.5 million advanced to us
by Enron to fund our acquisition of and loan to our acquisition in Cancun. The
amount due to Enron is non-interest bearing and has no maturity date. We intend
to use a portion of the net proceeds that we receive from the offering to repay
these amounts. See "Use of Proceeds."
Effective May 1, 1999, we entered into a credit agreement with Enron,
whereby Enron will provide funds to us for general, administrative and operating
expenses. The credit agreement matures December 15, 2001. The total commitment
under the credit agreement will be $180 million. Advances under the facility
will bear interest at the federal funds rate plus 1.50%. Amounts borrowed under
the facility may be prepaid, in full or in part, at any time during the term of
the agreement. Amounts prepaid may be re-borrowed during the term of the
facility. The principal amount outstanding under the credit agreement will be
limited to no more than:
- $60 million at any time during calendar year 1999
- $120 million at any time during calendar year 2000
- $180 million at any time during calendar year 2001
No further amounts may be borrowed, and all outstanding amounts must be
repaid within 90 days after, the first date on which both of the following
occur:
- Enron and its affiliates do not individually or collectively, directly or
indirectly, own or have the power to vote at least one-third of our
capital stock ordinarily entitled to vote for the election of directors,
and
- Fewer than one-third of the directors of Azurix are persons who are
employees, officers or directors of Enron or of any affiliate of Enron.
As of June 7, 1999, no amounts were outstanding under this credit
agreement.
INDEBTEDNESS OF AZURIX EUROPE
SENIOR CREDIT FACILITY
Azurix Europe, an indirect, wholly owned subsidiary of Azurix and the
holding company for Wessex, has a senior credit facility with a group of banks.
The senior credit facility was entered into on May 10, 1999 with Chase Manhattan
Plc and Westdeutsche Landesbank Girozentrale, as arrangers, Westdeutsche
Landesbank Girozentrale, as facility agent, and Chase Manhattan Trustees
Limited, as security agent. The senior credit facility consists of a revolving
credit facility of L425 ($686.0) million. Amounts outstanding under the senior
credit facility bear interest at a rate based on the London interbank offered
rate, plus a margin. If loans outstanding at the time of a new loan are less
than 50% of the total commitment of the facility, then the margin applied to the
new loan will equal 0.75% per annum. If loans outstanding at the time of a new
loan are greater than or equal to 50% of the total commitment of the facility,
then the margin applied to the new loan will equal 1.00% per annum. Azurix
Europe will pay a commitment fee on the undrawn, uncancelled amount of the
facility at the rate of 0.375% per annum. As of June 1, 1999, L113.3 ($182.9)
million was outstanding under the facility. Of this amount, L66.3 ($107.0)
million was used primarily to fund the acquisition of Philip Utilities, L42.0
($67.8) million was used to refinance all of the amounts previously outstanding
under a former senior credit facility and approximately L5.0 ($8.1) million was
used to pay fees and expenses related to this facility. The interest rate on the
loan used to refinance existing debt of Azurix Europe is 6.10% per annum payable
August 13, 1999. The outstanding loan relating to the Philip Utilities
acquisition bears an interest rate of 5.70% per annum payable July 14, 1999. As
of June 1, 1999, a portion of the unused borrowing capacity under this facility
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secures outstanding loan notes of L70.5 ($113.8) million described below. Of the
remaining borrowing capacity as of June 1, 1999, L67.5 ($108.9) million is
available to refinance any outstanding debt of Azurix Europe and L173.7 ($280.4)
million is available to make loans to affiliates of Azurix Europe for the
purpose of financing acquisitions of and investments in water and wastewater
assets and businesses. Loans to affiliates made under the facility will be
senior obligations, maturing on or before the maturity date of the facility,
and, if practicable at interest rates at least equal to the interest rates on
the facility. These loans will be guaranteed by Azurix in favor of Azurix
Europe. The affiliates will be direct or indirect wholly owned subsidiaries of
Azurix that have been created as special purpose vehicles. The facility is a
secured facility, and Azurix Europe has pledged all its existing assets,
including all the ordinary shares of Wessex. The facility is for a period of
three years from May 10, 1999.
COVENANTS. Azurix Europe has agreed that it will not, and will ensure that
its subsidiaries will not, create or permit to exist any other security interest
on any of their assets, except in the ordinary course of business, to secure
project finance indebtedness or other security interests in an aggregate amount
not to exceed L35 ($56.5) million. Azurix Europe will not sell, transfer or
otherwise dispose of any of the ordinary shares of Wessex. Azurix Europe has
also agreed that it will not, and will ensure that its subsidiaries will not,
sell, transfer, grant or lease or otherwise dispose of all or any part of its
assets, except in the ordinary course of business or other disposals in an
aggregate amount not to exceed L35 ($56.5) million. Azurix Europe may not make
any substantial change to the general nature or scope of its business as a water
and wastewater company in the United Kingdom. Azurix Europe may conduct business
only as a holding company. Azurix Europe has agreed that it will not, and will
ensure that its subsidiaries will not, enter into any amalgamation, demerger,
merger or reconstruction. Azurix Europe has agreed that it will not, and will
ensure that its subsidiaries will not, acquire any assets or business or make
any investment if the assets, business or investment is substantial in relation
to Azurix Europe and its group, except in the ordinary course of business, as a
required capital expenditure or other acquisitions in an aggregate amount not to
exceed L10 ($16.1) million. Azurix Europe may not declare, recommend, make or
pay any dividend, distribution or payment to any of its shareholders and will
covenant to ensure that Wessex Water Services will dividend to Wessex the
maximum distribution permissible by the dividend policy, from time to time, of
Wessex Water Services and Wessex will dividend to Azurix Europe its maximum
distributable reserves from time to time. The facility also requires that the
aggregate borrowings plus liabilities for borrowings of Wessex that Azurix
Europe and its subsidiaries may have outstanding at any time do not exceed
L1,050 ($1,694.7) million. All excess cash flow of Azurix Europe (i.e., all cash
flow after deducting interest, taxes and operating expenses) will be paid into a
debt service reserve account. All excess cash flow will be applied to build up,
within six months of closing of the facility, an amount determined by the
security agent to be one year's gross interest payable under the facility. All
amounts credited to the debt service reserve account may be invested in cash and
cash equivalents with minimum credit ratings and, provided credit enhancement is
provided, may be lent by Azurix Europe to certain other entities, including
Azurix and Enron.
FINANCIAL COVENANTS. Azurix Europe must maintain, and ensure Wessex
maintains, the following financial ratios on a quarterly and annual basis:
- The ratio of consolidated EBITDA to consolidated net interest payable
will be no less than, in the case of Azurix Europe, 2.25:1 and, in the
case of Wessex, 2.5:1. At December 31, 1998, the ratios were 4.4:1 and
12.1:1, respectively. At March 31, 1999, the ratios were 4.2:1 and 8.3:1,
respectively.
- The ratio of debt to total capitalization will not, as of each date on
which it is tested, exceed, in the case of Azurix Europe, 50% and, in the
case of Wessex, 55%. At December 31, 1998, the ratios were 39.7% and
28.6%, respectively. At March 31, 1999, the ratios were 40.5% and 30.4%,
respectively.
- The ratio of dividends received by Azurix Europe to net interest payable
by Azurix Europe will not be less than 1.5:1.
Azurix Europe currently is in compliance with these covenants.
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DEFAULT. Each of the following events is an event of default under the
senior credit facility:
- Not paying any amount that is due and payable by it within three business
days after notice of non-payment
- Azurix Europe failing to comply with its covenants, or failing to comply
with any provision of a finance document or a representation, warranty or
statement made or repeated in any finance document being materially
incorrect and not remedied within 28 days
- A cross-default related to any financial indebtedness of Azurix Europe or
its subsidiaries occurring, except when the aggregate amount of financial
indebtedness involved in all cross-defaults is less than L15 ($24.2)
million
- Insolvency or bankruptcy of Azurix Europe or a material subsidiary
occurring
- Any attachment, or execution affecting any assets of Azurix Europe or a
material subsidiary having an aggregate value of L15 ($24.2) million that
is not discharged within 14 days or is not being contested in good faith
- At any time Azurix Europe ceases to be a wholly owned subsidiary of
Azurix
- Wessex's license as a water and wastewater company being revoked or
surrendered or ceasing to be held by Wessex Water Ltd or a wholly owned
subsidiary of Azurix Europe, except if the U.K. Water Industry Act 1991
is changed to permit Wessex or one of its subsidiaries to carry on the
water and wastewater business of Wessex Water Ltd to the same extent as
it is currently carried out without the license
- Wessex's license or the rights or obligations under the license being
materially modified in any manner that, in the reasonable opinion of a
majority-in-interest of the lenders, has a material adverse effect on
Azurix Europe
- Any event or series of events occurring that, in the reasonable opinion
of a majority-in-interest of the lenders, has a material adverse effect
on the ability of Azurix Europe to perform its payment obligations under
the finance documents
ACQUISITION LOAN NOTES
In connection with the acquisition of Wessex, Azurix Europe issued U.K.
pound denominated loan notes in a principal amount of L70.5 ($113.8) million to
Wessex shareholders in lieu of cash consideration for the ordinary shares of
Wessex. As of June 1, 1999, all L70.5 ($113.8) million principal amount of
acquisition loan notes were outstanding. The acquisition loan notes are
redeemable, at the option of the holder, semiannually beginning September 30,
1999 and ending on September 30, 2005 when the acquisition loan notes mature.
Interest on the acquisition loan notes accrues at the London interbank offered
rate and is payable semiannually. The interest rate for the period the
acquisition loan notes were outstanding during 1998 was 7.125%. Holders of
acquisition loan notes can require a redemption of their notes at par plus
accrued interest in insolvency situations and if any principal or interest
payment is not paid within 30 days of its due date.
SENIOR LOAN AGREEMENT -- AFFILIATE NOTE
Bristol Water Trust entered into a L73 ($117.8) million senior loan
agreement with Azurix Europe in December 1998. As of June 1, 1999, all L73
($117.8) million was outstanding under this senior loan agreement. Bristol Water
Trust is a wholly owned subsidiary of Atlantic Water Trust. The interest rate on
this loan is 6.25% per annum payable semiannually. Upon receipt of the interest
due under the senior loan agreement, Atlantic Water Trust may make capital
contributions or loans to Azurix in the interest amount payable under the senior
loan agreement. Repayment of this loan is required by December 12, 2001.
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COVENANTS. In addition to agreeing to provide Bristol Water Trust with
quarterly financial information regarding its business and with notice of
defaults or changes in its accounting principles, Azurix Europe has agreed not
to:
- Sell, transfer or otherwise dispose of or cease to control the ordinary
shares of Wessex Water Ltd
- Make any substantial change to the general nature or scope of its
business as a water and wastewater company in the United Kingdom
- Declare, recommend, make or pay any dividend, distribution or payment to
any of its shareholders or make any payment in respect of any
subordinated debt unless no default is then outstanding or will result
from the relevant dividend, distribution or payment
- Amend or replace its articles of association or by-laws in any way which
would materially adversely affect the interests of Bristol Water Trust
FINANCIAL COVENANTS. Azurix Europe has agreed to maintain, on a quarterly
and annual basis, the following financial ratios:
- Consolidated EBITDA to consolidated net interest payable of at least
1.75:1; at December 31, 1998 and March 31, 1999, the ratio was 4.4:1 and
4.2:1, respectively
- A ratio of debt to total capitalization equal to or less than 60%; at
December 31, 1998 and March 31, 1999, the ratio was 39.7% and 40.5%,
respectively
Azurix Europe is currently in compliance with these covenants.
DEFAULT. Each of the following events is an event of default under this
loan agreement:
- Azurix Europe failing to pay any principal amount that is due and payable
by it within three business days after notice of non-payment
- Azurix Europe failing to comply with its covenants or a representation,
warranty or statement made by it being materially incorrect and not
remedied within 28 days
- The debt under the senior secured credit facility or any replacement
facility becoming prematurely due and payable as a result of an event of
default under the relevant credit agreement
- Insolvency of Azurix Europe or a material subsidiary of Azurix Europe
- Wessex's license being revoked or surrendered or ceasing to be held by
Wessex Water Ltd, a wholly owned subsidiary of Wessex Water Ltd or Azurix
Europe, except if the U.K. Water Industry Act 1991 is changed to permit
Wessex or one of its subsidiaries to carry on the water and wastewater
business of Wessex Water Ltd to the same extent as it is currently
carried out without the license
- Wessex's license or the rights or obligations under the license being
materially modified in any manner that, in the reasonable opinion of
Bristol Water Trust, has a material adverse effect on Azurix Europe
- Any person other than Wessex Water Ltd or one of its subsidiaries being
authorized to be a water or wastewater company in the area covered by
Wessex's license such that there would be a material adverse effect on
Azurix Europe
If a default occurs, Bristol Water Trust will have the right, by notice to
Azurix Europe at least three business days following the occurrence of the event
of default, to accelerate the payment of all outstanding principal and interest
under this loan agreement.
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INDEBTEDNESS OF WESSEX
BANK FACILITIES
Wessex Water Services is a borrower under credit facilities with three
major banks that provide an aggregate of L75 ($121.1) million of availability
for general corporate purposes. As of June 1, 1999, L75 ($121.1) million was
outstanding under these credit facilities. These credit facilities were entered
into on April 1, 1999 and mature on April 1, 2002. Loans under these credit
facilities accrue interest daily at the London interbank offered rate plus a
margin of 0.275% per annum. Each of these credit facilities requires Wessex
Water Services to pay an annual commitment fee equal to 0.15% of the available
amount of the facility.
Each of these facilities requires Wessex Water Services to maintain a ratio
in excess of 2:1 of earnings before interest received, interest costs,
exceptional charges and tax to interest costs less interest received. At
December 31, 1998 and March 31, 1999, the ratio was 5.1:1 and 5.1:1,
respectively. Wessex Water Services is currently in compliance with this
covenant.
Each of these facilities provides that each of the following will be an
event of default:
- Wessex Water Services failing to pay any amount due and payable under the
facility on its due date
- Wessex Water Services failing to comply with any other obligation under
the facility, unless remedied within 30 days of the breach
- Wessex Water Services providing the bank with materially inaccurate
factual information
- Wessex Water Services defaulting under any borrowing, where the
outstanding amount exceeds L15 ($24.2) million, such that prepayment of
such borrowing is required
- The Secretary of State or the Director making an application for an order
of the High Court directing that Wessex's business be managed by a person
appointed by the High Court because Wessex materially breaches any
principal duty or any enforcement order, Wessex is insolvent or the
Secretary of State determines that Wessex should be liquidated
- Wessex Water Services losing its license as the water and wastewater
services provider over a portion of its geographical region such that it
would lose 15% or more of its gross revenues
- Wessex Water Services ceasing to be a subsidiary of Azurix
In addition, as of June 1, 1999, L1.8 ($2.9) million was outstanding under
uncommitted credit facilities.
EUROPEAN INVESTMENT BANK LOANS
Wessex Water Services is a borrower under facilities provided by the
European Investment Bank for purposes of financing its capital investment
program. These facilities currently consist of two separate loans with an
aggregate principal balance outstanding as of June 1, 1999 of L41.3 ($66.6)
million, including the effect of currency swap contracts in place as follows:
- A U.S. dollar denominated floating rate loan of $48.4 million repayable
in full on October 1, 2001
- A 25.0 billion Italian lire ($18.2 million) fixed rate loan repayable in
ten semiannual installments through June 15, 2002
Wessex guarantees the obligations of Wessex Water Services under these
facilities.
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The U.S. dollar dominated loan bears interest at the London interbank
offered rate less 0.25% per annum. The Italian lire loan bears interest at 11.6%
per annum. Each of these facilities requires Wessex to maintain the following
financial covenants:
- Consolidated net borrowings will not exceed 150% of consolidated net
tangible worth; at December 31, 1998 and March 31, 1999, the ratio was
39.9% and 42.9%, respectively
- Operating profits will be at least 2.0x total interest expense on an
annual basis; at December 31, 1998 and March 31, 1999, the ratio was 9.8x
and 6.6x, respectively
- Consolidated net tangible worth will be at least L400 million; at
December 31, 1998 and March 31, 1999, consolidated net tangible worth was
L904.5 million and L908.2 million, respectively
In each of these facilities, Wessex Water Services has agreed that it will
not carry on any business other than the business of providing water and
wastewater services in the area covered by its license and any ancillary
activity. An event of default will occur under each facility, allowing the bank
to require immediate payment, in the following instances:
- Wessex Water Services or Wessex is bankrupt or insolvent
- Wessex Water Services ceases to be a subsidiary of Wessex
- Wessex Water Services loses its license as the water and wastewater
services provider over a portion of its geographical region such that it
would lose 15% or more of its revenues
FINANCE LEASE AGREEMENT
Wessex Water Services is the lessee under a finance lease agreement with
Barclays Mercantile Business Finance Limited pursuant to which L59.7 ($96.4)
million of capital lease obligations (excluding interest on such obligations)
were outstanding as of June 1, 1999. Under the lease agreement, Wessex Water
Services is reimbursed by Barclays for the acquisition cost of machinery and
equipment acquired in connection with its capital expenditure program. Wessex
Water Services then makes periodic rental payments to Barclays. Payments are
made in installments payable semiannually through September 2002. Barclays has a
lien on the property that has been acquired in connection with the leases.
Wessex guarantees the obligations of Wessex Water Services under the lease
agreement. As guarantor, Wessex has agreed to maintain the same financial
covenants as required by the European Investment Bank facilities described
above.
The leasing of the equipment may be terminated at any time in the following
instances:
- Wessex Water Services defaults in making any rental payment
- Wessex Water Services or Wessex is bankrupt or insolvent
- Wessex Water Services sells or mortgages or agrees to sell or mortgage
any of the equipment or otherwise prejudices Barclays' ownership of, and
rights with respect to, the equipment
- Wessex Water Services fails to maintain adequate liability and property
insurance
- Wessex Water Services or Wessex defaults under any other debt agreement,
where the outstanding amount exceeds L5 ($8.1) million, such that
repayment of such debt is required
- Wessex ceases to own a majority of the capital stock of Wessex Water
Services
- A material adverse change occurs to Wessex Water Services which
substantially impairs its ability to perform its obligations under the
lease agreement
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SENIOR UNSECURED BONDS
On March 30, 1999, Wessex Water Services issued L300 ($484.2) million
principal amount of 10-year senior unsecured bonds bearing interest at 5.875%
per annum through its wholly owned subsidiary, Wessex Water Services Finance
Plc. Wessex Water Services has unconditionally and irrevocably guaranteed
payment of principal and interest of the bonds. All principal will be due on
March 30, 2009. Wessex Water Services used most of the proceeds from the sale of
the bonds to repay all outstanding amounts under its former bank credit
facilities as well as all outstanding amounts under uncommitted credit
facilities. The remaining proceeds will be used for general corporate purposes.
The bonds will be redeemed by Wessex Water Services as follows:
- On March 30, 2009 at their principal amount
- At the option of Wessex Water Services, if it becomes obligated to pay
additional amounts because of a change in law, at their principal amount
- At the option of Wessex Water Services, in whole or in part, at the
higher of the following:
-- their principal amount
-- a redemption price, which is calculated based on the published
redemption yield for a reasonably equivalent U.K. Government issued
security with similar maturity and coupon
Bondholders have the right to require Wessex to buy back their bonds prior
to maturity at a price equal to the principal amount of the bond plus all
accrued but unpaid interest in the following instances:
- Wessex's license as a water and wastewater company is terminated
- Wessex Water Services Finance Plc ceases to be a subsidiary of Wessex
Water Services
- Material changes occur to the rights or benefits of Wessex's license and
the rating on the bonds is downgraded below investment grade
- Legislation is enacted which materially changes the duties or powers of
the Secretary of State for the Environment or the Director General of
Water Services and the rating on the bonds is downgraded below investment
grade
In addition, the bonds could become immediately due and payable if an event
of default occurs. These events include a cross-default by Wessex Water Services
or its subsidiaries under other debt instruments and events of insolvency.
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SHARES ELIGIBLE FOR FUTURE SALE
Immediately prior to this offering, there was no public market for our
common stock. Future sales of substantial amounts of our common stock in the
public market could adversely affect the market price of our common stock. After
this offering is completed, the number of shares available for future sale into
the public markets will be subject to legal and contractual restrictions, some
of which are described below. The lapsing of these restrictions will permit
sales of substantial amounts of our common stock in the public market or could
create the perception that such sales could occur, which could adversely affect
the market price for our common stock. These factors could also make it more
difficult to raise funds through future offerings of common stock.
After the offering, 117,100,000 shares of our common stock will be
outstanding. Of these shares, the 36,600,000 shares sold in the offering will be
freely transferable and may be sold without restriction or further registration
under the Securities Act, except for any shares acquired by an "affiliate" of
Azurix as defined in Rule 144 under the Securities Act. The remaining 80,500,000
shares of common stock outstanding and owned by Atlantic Water Trust will be
"restricted securities," as that term is defined in Rule 144, and may be sold in
the future without registration under the Securities Act to the extent permitted
by Rule 144, as described below, or any applicable exemption under the
Securities Act. In addition, shares owned by Atlantic Water Trust or its
transferee may be registered for sale under the Securities Act of 1933 under the
terms of its registration rights agreement with us. See "Transactions with
Enron, Atlantic Water Trust and Marlin Water Trust -- Registration Rights
Agreement" for more information regarding these registration rights.
RULE 144
In general, under Rule 144 as currently in effect, a person, or persons
whose shares are aggregated, including an affiliate, who has beneficially owned
"restricted securities" for at least one year would be entitled to sell within
any three-month period a number of shares that does not exceed the greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 1,171,000 shares immediately after the offering
- The average weekly trading volume of the common stock on the New York
Stock Exchange during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale with the SEC
Sales under Rule 144 are also subject to certain other requirements
regarding the manner of sale, notice and availability of current public
information about Azurix.
Since Atlantic Water Trust, the selling stockholder, is likely an
"affiliate" of us, subject to its exercise of registration rights described
under "Transactions with Enron, Atlantic Water Trust and Marlin Water Trust,"
the Rule 144 restrictions and requirements would be applicable to Atlantic Water
Trust's shares of Azurix for as long as the selling stockholder retains
affiliate status.
RULE 144(k)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an "affiliate," is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
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LOCK-UP AGREEMENTS
In connection with the offering, we, Enron and the selling stockholder have
agreed not to directly or indirectly engage in the following activities for a
period of 180 days after the date of this prospectus without the prior written
consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated:
- Offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant for the sale of, lend or otherwise dispose of or
transfer any shares of common stock or securities convertible into or
exchangeable or exercisable for or repayable with common stock, whether
now owned or thereafter acquired by the person executing the agreement or
with respect to which the person executing the agreement thereafter
acquires the power of disposition, or file a registration statement under
the Securities Act relating to any shares of common stock
- Enter into any swap or other agreement that transfers, in whole or in
part, the economic consequence of ownership of common stock whether any
such swap or transaction is to be settled by delivery of common stock or
other securities, in cash or otherwise, see "Underwriting -- No Sales of
Similar Securities"
As exceptions to these restrictions, we may:
- Issue shares of our common stock upon the exercise of options or warrants
- Issue shares of our common stock or grant options to purchase shares of
common stock pursuant to our existing employee benefit plans
- Issue shares of our common stock pursuant to any non-employee director
stock plan or dividend reinvestment plan
- Issue shares of our common stock or securities convertible or
exchangeable into our common stock as payment of any part of the purchase
price for businesses we acquire; however, shares issued in this manner
shall not be transferable during the 180-day lock-up period
In addition, if Atlantic Water Trust is compelled to sell some or all of
its shares of our common stock in the event of a default under specified debt
obligations or a major decline in the price of Enron's common stock combined
with a downgrading of Enron's senior debt to below investment grade, then such
sale will be permitted. See "Risk Factors -- Future sales of our common stock
may depress our stock price."
STOCK PLAN
After the offering, we intend to file a registration statement covering the
sale of approximately 8.5 million shares of common stock reserved for issuance
under our stock plan.
Upon expiration of the lock-up period, these shares may be sold at any time
subject to compliance with the volume limitations and other restrictions of Rule
144. Options to purchase approximately 8.5 million shares of common stock will
also be outstanding after the offering. Such options generally provide for
incremental vesting over a three to five year period. In addition, more options
may be granted in the future. See "Management -- Stock Plan."
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MATERIAL UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS OF COMMON STOCK
The following is a summary of material U.S. federal income and estate tax
consequences expected to result under current law from the purchase, ownership
and taxable disposition of common stock by non-U.S. holders of common stock. A
"non-U.S. holder" is any person or entity other than:
- A citizen or resident of the United States
- A corporation, partnership or other entity created or organized in or
under the laws of the United States or any state thereof
- An estate, the income of which is includable in gross income for U.S.
federal income tax purposes regardless of its source
- A trust whose administration is subject to the primary supervision of a
United States court and which has one or more U.S. persons who have the
authority to control all substantial decisions of the trust
This summary does not address all of the U.S. federal income and estate tax
considerations that may be relevant to non-U.S. holders in light of their
particular circumstances or to non-U.S. holders that may be subject to special
treatment under United States federal income tax laws. This summary does not
discuss any aspect of state, local or foreign taxation. This summary is based on
current provisions of the Internal Revenue Code of 1986, as amended, Treasury
regulations, judicial opinions, published positions of the U.S. Internal Revenue
Service and other applicable authorities, all of which are subject to change,
possibly with retroactive effect. In this prospectus, the Internal Revenue Code
of 1986, as amended, is called the "Code." Prospective purchasers of common
stock are advised to consult their tax advisors regarding the U.S. federal,
state and local, and non-U.S. income and other tax consequences of acquiring,
holding and disposing of common stock.
DIVIDENDS
Azurix does not currently anticipate paying any dividends. Any dividends
paid to a non-U.S. holder on shares of common stock will be subject to
withholding of U.S. federal income tax at a rate of 30%, unless a lower rate is
prescribed under an applicable tax treaty. U.S. federal income tax withholding
will not be required, however, if the dividends are effectively connected with
the conduct of a trade or business of the non-U.S. holder within the United
States or, in the case of an applicable tax treaty, are attributable to a U.S.
permanent establishment maintained by the non-U.S. holder. Dividends that are
effectively connected with the conduct of a trade or business within the United
States, or are attributable to a U.S. permanent establishment will be subject to
U.S. federal income tax on a net income basis which is not collected by
withholding provided the non-U.S. holder files the appropriate certification
with Azurix or its agent. Any dividends received by a foreign corporation that
are effectively connected with the conduct of a trade or business within the
United States may also be subject to a "branch profits tax" at a rate of 30% or
such lower rate as may be specified by an applicable tax treaty.
For purposes of the withholding tax rules discussed above and for purposes
of determining the applicability of a tax treaty rate under current U.S.
Treasury Regulations, dividends paid to an address outside the United States
will be presumed to be paid to a resident of the country of address, unless the
payor has knowledge to the contrary. Under recently issued U.S. Treasury
Regulations (referred to as "final regulations") that are effective for payments
made after December 31, 1999, a non-U.S. holder of common stock who wishes to
claim the benefit of a tax treaty rate would be required to satisfy applicable
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certification and other requirements. In addition, under the final regulations,
in the case of common stock held by a foreign partnership:
- The certification requirement generally would be applied to the partners
of the partnership
- The partnership would be required to provide certain information,
including a U.S. taxpayer identification number
A non-U.S. holder of common stock that is eligible for a reduced rate of
U.S. federal income tax withholding pursuant to a tax treaty may obtain a refund
of any excess amounts currently withheld by filing an appropriate claim for
refund with the Internal Revenue Service.
SALE OR DISPOSITION OF COMMON STOCK
A non-U.S. holder generally will not be subject to U.S. federal income tax
in respect of any gain recognized on the sale or other taxable disposition of
common stock so long as:
- The gain is not effectively connected with the conduct of a trade or
business of the non-U.S. holder within the United States nor under an
applicable tax treaty, is attributable to a U.S. permanent establishment
maintained by the non-U.S. holder
- In the case of a non-U.S. holder who is an individual and holds the
common stock as a capital asset, either:
-- Such holder is not present in the United States for 183 or more days
during the taxable year of the disposition
-- Such holder does not have a "tax home" in the United States for U.S.
federal income tax purposes nor does such holder maintain an office
or other fixed place of business in the United States to which such
gain is attributable
- Such non-U.S. holder is not subject to tax pursuant to the provisions of
U.S. federal income tax law applicable to certain U.S. expatriates
- The common stock continues to be "regularly traded on an established
securities market" for U.S. federal income tax purposes and the non-U.S.
holder has not held, directly or indirectly, at any time during the
five-year period ending on the date of disposition (or, if shorter, the
non-U.S. holder's holding period) more than five percent of the
outstanding common stock
INFORMATION REPORTING AND BACKUP WITHHOLDING
Azurix must report annually to the Internal Revenue Service and to each
non-U.S. holder the amount of dividends paid to, and the tax withheld with
respect to, each non-U.S. holder. These reporting requirements apply regardless
of whether withholding was reduced by an applicable tax treaty. Copies of these
information returns may also be made available under the provisions of a treaty
or information exchange agreement with the tax authorities in the country in
which the non-U.S. holder resides or is established. Under current law, U.S.
backup withholding tax, which is a withholding tax currently imposed at the rate
of 31% on certain payments to persons who fail to furnish the information
required under U.S. information reporting requirements, generally will not apply
to dividends paid on common stock to a non-U.S. holder at an address outside the
United States unless the payor has knowledge that the payee is a U.S. person.
However, under the final regulations, dividends paid on common stock after
December 31, 1999 may be subject to backup withholding unless applicable
certification requirements are satisfied.
Payment of the proceeds from a sale of common stock to or through a U.S.
office of a broker will be subject to information reporting and backup
withholding unless the owner certifies as to its status as a non-U.S. holder
under penalties of perjury or otherwise establishes an exemption. Payment of the
proceeds from a sale of common stock to or through a non-U.S. office of a broker
generally will not be subject to information reporting or backup withholding.
However, if such broker is a U.S. person, a "controlled foreign corporation" or
a foreign person that derives 50% or more of its gross income from the conduct
of
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a trade or business in the United States, such payment will be subject to
information reporting, but currently not backup withholding, unless such broker
has documentary evidence in its records that the owner is a non-U.S. holder and
certain other conditions are met or the owner otherwise establishes an
exemption.
Any amounts withheld under the backup withholding rules will be credited
against the non-U.S. holder's federal income tax liability, if any, or refunded,
provided the required information is furnished to the Internal Revenue Service.
ESTATE TAX
The fair market value of common stock owned, or treated as owned, by an
individual at the time of his death will be includable in his gross estate for
U.S. federal estate tax purposes and thus may be subject to U.S. estate tax,
even though the individual at the time of death is neither a citizen of nor
domiciled in the United States, unless an applicable estate tax treaty provides
otherwise.
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UNDERWRITING
GENERAL
We intend to offer our common stock in the United States and Canada through
a number of U.S. underwriters and elsewhere through international managers.
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston
Corporation, Donaldson, Lufkin & Jenrette Securities Corporation, PaineWebber
Incorporated, BT Alex. Brown Incorporated and Banc of America Securities LLC are
acting as U.S. representatives of each of the U.S. underwriters named below.
Under a U.S. purchase agreement among Azurix, the selling stockholder, Enron and
the U.S. underwriters, and concurrently with the sale of 7,320,000 shares of
common stock to the international managers, Azurix and the selling stockholder
have agreed to sell to the U.S. underwriters, and each of the U.S. underwriters
severally and not jointly has agreed to purchase from Azurix and the selling
stockholder, the number of shares of common stock set forth opposite its name
below.
<TABLE>
<CAPTION>
NUMBER OF
U.S. UNDERWRITERS SHARES
- ----------------- ----------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated................................... 8,139,000
Credit Suisse First Boston Corporation...................... 5,426,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 5,426,000
PaineWebber Incorporated.................................... 5,426,000
BT Alex. Brown Incorporated................................. 1,356,500
Banc of America Securities LLC.............................. 1,356,500
CIBC World Markets Corp..................................... 100,000
Dresdner Kleinwort Benson North America LLC................. 100,000
A.G. Edwards & Sons, Inc.................................... 100,000
Lazard Freres & Co. LLC..................................... 100,000
Morgan Stanley & Co. Incorporated........................... 100,000
Prudential Securities Incorporated.......................... 100,000
Salomon Smith Barney Inc.................................... 100,000
Sanders Morris Mundy........................................ 100,000
Schroder & Co. Inc.......................................... 100,000
Warburg Dillon Read LLC..................................... 100,000
Blackford Securities Corp................................... 50,000
Blaylock & Partners, L.P.................................... 50,000
J.C. Bradford & Co.......................................... 50,000
Cazenove Incorporated....................................... 50,000
Fahnestock & Co. Inc........................................ 50,000
First Analysis Securities Corporation....................... 50,000
First Union Capital Markets Corp............................ 50,000
Gruntal & Co., L.L.C........................................ 50,000
Hanifen, Imhoff Inc......................................... 50,000
Harris Webb & Garrison, Inc................................. 50,000
Janney Montgomery Scott Inc................................. 50,000
Edward D. Jones & Co., L.P.................................. 50,000
Legg Mason Wood Walker, Incorporated........................ 50,000
McDonald Investments Inc.................................... 50,000
Needham & Company, Inc...................................... 50,000
Neuberger Berman, LLC....................................... 50,000
Ragen MacKenzie Incorporated................................ 50,000
Raymond James & Associates, Inc............................. 50,000
Scott & Stringfellow, Inc................................... 50,000
Muriel Siebert & Co., Inc................................... 50,000
Stifel, Nicolaus & Company, Incorporated.................... 50,000
Tucker Anthony Cleary Gull.................................. 50,000
Utendahl Capital Partners, L.P.............................. 50,000
----------
Total.......................................... 29,280,000
==========
</TABLE>
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Azurix, the selling stockholder and Enron have also entered into an
international purchase agreement with the international managers outside the
United States and Canada for whom Merrill Lynch International, Credit Suisse
First Boston (Europe) Limited, Donaldson, Lufkin & Jenrette International,
PaineWebber International (U.K.) Ltd., ABN AMRO Rothschild and HSBC Investment
Bank plc are acting as lead managers. Under the international purchase
agreement, and concurrently with the sale of 29,280,000 shares of common stock
to the U.S. underwriters under the U.S. purchase agreement, Azurix and the
selling stockholder have agreed to sell to the international managers, and the
international managers have agreed to purchase from Azurix and the selling
stockholder, an aggregate of 7,320,000 shares of common stock. The initial
public offering price per share and the total underwriting discount per share of
common stock are identical under the U.S. purchase agreement and the
international purchase agreement.
In the U.S. purchase agreement and the international purchase agreement,
the U.S. underwriters and the international managers, respectively, have agreed,
under the terms of those agreements, to purchase all of the shares of common
stock being sold under those agreements if any of the shares of our common stock
being sold under those agreements are purchased. In the event of a default by an
underwriter, the U.S. purchase agreement and the international purchase
agreement provide that, in some circumstances, the purchase commitments of
nondefaulting underwriters may be increased or the purchase agreements may be
terminated. The closings for the sale of shares of our common stock to the U.S.
underwriters and the international managers are conditioned upon one another.
Azurix and Enron have agreed to indemnify the U.S. underwriters and the
international managers against some liabilities, including some liabilities
under the Securities Act, or to contribute to payments the U.S. underwriters and
the international managers may be required to make in respect of those
liabilities.
The shares of common stock are being offered by the underwriters, subject
to prior sale, when, as and if issued to and accepted by them, subject to
receipt of legal opinions and officers certificates, or waiver of these
conditions, as specified in the purchase agreements. The underwriters reserve
the right to withdraw, cancel or modify offers and to reject orders in whole or
in part.
COMMISSIONS AND DISCOUNTS
The U.S. representatives have advised Azurix and the selling stockholder
that the U.S. underwriters propose initially to offer the shares of our common
stock to the public at the initial public offering price set forth on the cover
page of this prospectus, and to certain dealers at such price less a concession
not in excess of $.70 per share of common stock. The U.S. underwriters may
allow, and such dealers may reallow, a discount not in excess of $.10 per share
of common stock to certain other dealers. After the initial public offering, the
public offering price, concession and discount may be changed.
The following table shows the per share and total public offering price,
the underwriting discount to be paid by Azurix and the selling stockholder to
the U.S. underwriters and the international managers and the proceeds before
expenses to Azurix and the selling stockholder. This information is presented
assuming either no exercise or full exercise by the U.S. underwriters and the
international managers of their over-allotment option.
<TABLE>
<CAPTION>
WITHOUT WITH
PER SHARE OPTION OPTION
--------- ------------ ------------
<S> <C> <C> <C>
Public offering price......................... $19.00 $695,400,000 $799,710,000
Underwriting discount......................... $1.14 $41,724,000 $47,982,600
Proceeds, before expenses, to Azurix.......... $17.86 $305,406,000 $305,406,000
Proceeds, before expenses, to the selling
stockholder................................. $17.86 $348,270,000 $446,321,400
</TABLE>
The expenses of this offering, exclusive of the underwriting discount, are
estimated at $5,912,000 and are payable by Azurix and the selling stockholder.
121
<PAGE> 125
INTERSYNDICATE AGREEMENT
The U.S. underwriters and the international managers have entered into an
intersyndicate agreement that provides for the coordination of their activities.
Under the terms of the intersyndicate agreement, the U.S. underwriters and the
international managers are permitted to sell shares of common stock to each
other for purposes of resale at the public offering price, less an amount not
greater than the selling concession. Under the terms of the intersyndicate
agreement, the U.S. underwriters and any dealer to whom they sell shares of our
common stock will not offer to sell or sell shares of common stock to persons
who are non-U.S. or non-Canadian persons or to persons they believe intend to
resell to persons who are non-U.S. or non-Canadian persons, and the
international managers and any dealer to whom they sell shares of common stock
will not offer to sell or sell shares of common stock to U.S. persons or to
Canadian persons or to persons they believe intend to resell to U.S. persons or
Canadian persons, except in the case of transactions under the terms of the
intersyndicate agreement.
OVER-ALLOTMENT OPTION
The selling stockholder has granted an option to the U.S. underwriters,
exercisable for 30 days after the date of this prospectus, to purchase up to an
aggregate of 4,392,000 additional shares of our common stock at the initial
public offering price set forth on the cover page of this prospectus, less the
underwriting discount. The U.S. underwriters may exercise this option solely to
cover over-allotments, if any, made on the sale of our common stock offered
hereby. To the extent that the U.S. underwriters exercise this option, each U.S.
underwriter will be obligated, subject to receipt of legal opinions and officers
certificates, or waiver of these conditions, as specified in the purchase
agreement, to purchase a number of additional shares of our common stock
proportionate to such U.S. underwriter's initial amount reflected in the
foregoing table.
The selling stockholder also has granted an option to the international
managers, exercisable for 30 days after the date of this prospectus, to purchase
up to an aggregate of 1,098,000 additional shares of common stock to cover
over-allotments, if any, on terms similar to those granted to the U.S.
underwriters.
RESERVED SHARES
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 3,660,000 of the shares offered hereby to be sold
to our directors, officers and employees who have expressed an interest in
purchasing our common stock. The number of shares of our common stock available
for sale to the general public will be reduced to the extent that those persons
purchase the reserved shares. Any reserved shares that are not orally confirmed
for purchase within one day of the pricing of the offering will be offered by
the underwriters to the general public on the same terms as the other shares
offered by this prospectus.
NO SALES OF SIMILAR SECURITIES
Azurix, Enron and the selling stockholder have agreed, with exceptions
specified in the lock-up agreements, not to directly or indirectly engage in the
following activities for a period of 180 days after the date of this prospectus
without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith
Incorporated:
- Offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant for the sale of, lend or otherwise dispose of or
transfer any shares of our common stock or securities convertible into or
exchangeable or exercisable for or repayable with our common stock,
whether now owned or later acquired by the person executing the agreement
or with respect to which the person executing the agreement later
acquires the power of disposition, or file a registration statement under
the Securities Act relating to any shares of our common stock
122
<PAGE> 126
- Enter into any swap or other agreement that transfers, in whole or in
part, the economic consequence of ownership of our common stock whether
any such swap or transaction is to be settled by delivery of our common
stock or other securities, in cash or otherwise.
As an exception to these restrictions, we may issue shares of our common
stock or securities convertible or exchangeable into our common stock as payment
of any part of the purchase price for businesses we acquire. However, shares
issued in this manner shall not be transferable during the 180-day lock-up
period. In addition, if Atlantic Water Trust is compelled to sell some or all of
its shares of our common stock in the event of a default under specified debt
obligations or a major decline in the price of Enron's common stock combined
with a downgrading of Enron's senior debt to below investment grade, then such
sale will be permitted. See "Risk Factors--Future sales of our common stock may
depress our stock price" and "Shares Eligible for Future Sale."
NEW YORK STOCK EXCHANGE LISTING
The common stock has been approved for listing on the New York Stock
Exchange under the symbol "AZX," subject to official notice of issuance. To meet
the requirements for listing of our common stock on that exchange, the
underwriters have undertaken to sell lots of 100 or more shares to a minimum of
2,000 beneficial owners.
Before this offering, there has been no public market for our common stock.
The initial public offering price will be determined through negotiations among
Azurix, the selling stockholder, Enron, the U.S. representatives and the lead
managers. The factors considered in determining the initial public offering
price, in addition to prevailing market conditions, are the valuation multiples
of publicly traded companies that the U.S. representatives and the lead managers
believe to be comparable to us, including adjusted market value to EBITDA
multiples, price to book value multiples and price to earnings multiples,
certain of our financial information, the history of, and the prospects for, our
company and the industry in which we compete, an assessment of our management,
our past and present operations, the prospects for and timing of our future
revenues, the present state of our development, and the above factors in
relation to market values and various valuation measures of other companies
engaged in activities similar to ours. There can be no assurance that an active
trading market will develop for our common stock or that the common stock will
trade in the public market subsequent to this offering at or above the initial
public offering price.
The underwriters do not expect sales of our common stock to any accounts
over which they exercise discretionary authority to exceed 5% of the number of
shares being offered in this offering.
PRICE STABILIZATION AND SHORT POSITIONS
Until the distribution of our common stock is completed, rules of the SEC
may limit the ability of the underwriters and selling group members to bid for
and purchase our common stock. As an exception to these rules, the U.S.
representatives and the lead managers are permitted to engage in certain
transactions that stabilize the price of our common stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of our common stock.
If the underwriters create a short position in our common stock in
connection with this offering, i.e., if they sell more shares of common stock
than are set forth on the cover page of this prospectus, the U.S.
representatives and the lead managers may reduce that short position by
purchasing our common stock in the open market. The U.S. representatives and the
lead managers may also elect to reduce any short position by exercising all or
part of the over-allotment option described above.
PENALTY BIDS
The U.S. representatives and the lead managers may also impose a penalty
bid on underwriters and selling group members. This means that if the U.S.
representatives or the lead managers purchase shares of our common stock in the
open market to reduce the underwriters' short position or to stabilize the price
of our common stock, they may reclaim the amount of the selling concession from
the underwriters and selling group members who sold those shares.
123
<PAGE> 127
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of our common stock to the extent that it
discourages resales of our common stock.
None of Azurix, the selling stockholder or any of the underwriters makes
any representation or prediction as to the direction or magnitude of any effect
that the transactions described above may have on the price of our common stock.
In addition, none of Azurix, the selling stockholder or any of the underwriters
makes any representation that the U.S. representatives or the lead managers will
engage in such transactions or that such transactions, once commenced, will not
be discontinued without notice.
OTHER RELATIONSHIPS
Some of the underwriters and their affiliates engage in transactions with,
and perform services for, our company, Enron and Enron's affiliates in the
ordinary course of business and have engaged, and may in the future engage, in
commercial banking and investment banking transactions and services with our
company, Enron and Enron's affiliates, for which they have received, or will
receive, customary compensation.
We have engaged Merrill Lynch & Co. to act as our financial advisor in
evaluating two potential acquisition opportunities for which we will pay an
ordinary and customary fee if we decide to pursue these opportunities and they
result in an acquisition. We have also agreed to reimburse Merrill Lynch & Co.
for all reasonable out-of-pocket expenses incurred in connection with these
engagements.
STAMP TAXES
Purchasers of the shares of common stock offered hereby may be required to
pay stamp taxes and other charges in accordance with the laws and practices of
the country of purchase in addition to the offering price set forth on the cover
page hereof.
LEGAL MATTERS
Legal matters with respect to the validity of the issuance of the shares of
our common stock offered hereby will be passed upon for us by Vinson & Elkins
L.L.P., Houston, Texas. Legal matters relating to our common stock offered
hereby will be passed upon for the U.S. underwriters and the international
managers by Andrews & Kurth L.L.P., Houston, Texas.
EXPERTS
The consolidated financial statements and schedules for Azurix Corp. and
subsidiaries as of December 31, 1998 and for the period from January 29, 1998
(Date of Inception) to December 31, 1998, included in this prospectus and
elsewhere in the registration statement, have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.
The consolidated statements of income, changes in stockholders' equity and
cash flows and schedule for Wessex Water Plc (now renamed Wessex Water Ltd)
(predecessor company) for the period from April 1, 1998 to October 2, 1998
included in this prospectus have been audited by Arthur Andersen, independent
accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
The consolidated financial statements and schedule for Wessex Water Plc
(now renamed Wessex Water Ltd) (predecessor company) as of March 31, 1998 and
for the years ended March 31, 1998 and 1997, included in this prospectus, have
been audited by PricewaterhouseCoopers, independent accountants, as indicated in
their reports with respect thereto, and are included herein in reliance upon the
authority of that firm as experts in giving said reports.
124
<PAGE> 128
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act, and the rules and regulations
promulgated thereunder, with respect to the common stock offered under this
prospectus. This prospectus, which constitutes a part of the registration
statement, does not contain all of the information set forth in the registration
statement and the attached exhibits and schedules. Statements contained in this
prospectus as to the contents of any contract or other document that is filed as
an exhibit to the registration statement are summaries of the material
provisions of those documents. These summaries are qualified in all respects by
reference to the full text of such contract or document.
The registration statement can be inspected and copied at the public
reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the SEC's regional offices at Seven World Trade
Center, 13th Floor, New York, New York 10048 and Northwestern Atrium Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of all or any
portion of the registration statement can be obtained from the Public Reference
Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. You may obtain information on the operation of the Public
Reference Section by calling the SEC at (800) 732-0330. In addition, the
registration statement is publicly available through the SEC's site on the
internet, located at http://www.sec.gov.
Upon completion of this offering, we will be required to comply with the
informational requirements of the Securities and Exchange Act of 1934 and,
accordingly, will file current reports on Form 8-K, quarterly reports on Form
10-Q, annual reports on Form 10-K, proxy statements and other information with
the SEC. Those reports, proxy statements and other information will be available
for inspection and copying at the regional offices, public reference facilities
and internet site of the SEC referred to above. We intend to furnish our
stockholders with annual reports containing consolidated financial statements
certified by an independent public accounting firm.
125
<PAGE> 129
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AZURIX CORP. -- UNAUDITED CONDENSED CONSOLIDATED PRO FORMA
FINANCIAL INFORMATION:
Unaudited Condensed Consolidated Pro Forma Financial
Information............................................ F-2
Unaudited Condensed Consolidated Pro Forma Statement of
Income for the Year Ended December 31, 1998............ F-3
Unaudited Condensed Consolidated Pro Forma Statement of
Income for the Three Months Ended March 31, 1999....... F-4
Unaudited Condensed Consolidated Pro Forma Balance Sheet
at March 31, 1999...................................... F-5
Notes to Unaudited Condensed Consolidated Pro Forma
Financial Statements................................... F-6
AZURIX CORP. -- CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Public Accountants.................. F-8
Consolidated Statements of Income for the period from
January 29, 1998 (Date of Inception) to December 31,
1998 and for the Three Months Ended March 31, 1999
(unaudited)............................................ F-9
Consolidated Statements of Comprehensive Income (Loss) for
the period from January 29, 1998 (Date of Inception) to
December 31, 1998 and for the Three Months Ended March
31, 1999 (unaudited)................................... F-10
Consolidated Balance Sheets at December 31, 1998 and at
March 31, 1999 (unaudited)............................. F-11
Consolidated Statements of Cash Flows for the period from
January 29, 1998 (Date of Inception) to December 31,
1998 and for the Three Months Ended March 31, 1999
(unaudited)............................................ F-12
Consolidated Statements of Changes in Stockholder's Equity
for the period from January 29, 1998 (Date of
Inception) to December 31, 1998 and for the Three
Months Ended March 31, 1999 (unaudited)................ F-13
Notes to Consolidated Financial Statements................ F-14
WESSEX WATER PLC (NOW RENAMED WESSEX WATER LTD) (PREDECESSOR
COMPANY) -- CONSOLIDATED FINANCIAL STATEMENTS:
Reports of Independent Accountants........................ F-31
Consolidated Statements of Income for the Six Months Ended
October 2, 1998 and the Years Ended March 31, 1998 and
1997................................................... F-33
Consolidated Balance Sheet at March 31, 1998.............. F-34
Consolidated Statements of Cash Flows for the Six Months
Ended October 2, 1998 and the Years Ended March 31,
1998 and 1997.......................................... F-35
Consolidated Statements of Changes in Stockholders' Equity
for the Six Months Ended October 2, 1998 and the Years
Ended March 31, 1998 and 1997.......................... F-36
Notes to the Consolidated Financial Statements............ F-37
</TABLE>
F-1
<PAGE> 130
AZURIX CORP.
UNAUDITED CONDENSED CONSOLIDATED PRO FORMA
FINANCIAL INFORMATION
The following unaudited condensed consolidated pro forma statements of
income for the year ended December 31, 1998, and the three months ended March
31, 1999, give effect to the October 2, 1998 acquisition of Wessex by Azurix,
the related redemption of the preference shares of Wessex and sale of its
interest in Wessex Waste Management Ltd, a joint venture with Waste Management
International Plc, and Azurix's initial public offering of its stock, as though
each occurred on January 1, 1998. The unaudited condensed consolidated pro forma
balance sheet at March 31, 1999 gives effect to the offering as though such
offering occurred on March 31, 1999. The unaudited condensed consolidated pro
forma statements of income do not include the results of operations from
Azurix's investment in Obras Sanitarias Mendoza S.A. prior to the date it was
acquired, and do not include any pro forma or historical effects from Azurix's
investment in a water concession for the city of Cancun, Mexico prior to the
date it was acquired in 1999 or the acquisition of Philip Utilities Management
Corporation in May 1999. The unaudited condensed consolidated pro forma balance
sheet does not include any pro forma effect from Azurix's acquisition of Philip
Utilities.
The unaudited condensed consolidated pro forma statements of income and
balance sheet have been prepared based upon the Azurix and Wessex consolidated
statements of income and balance sheet included elsewhere in this prospectus and
have been prepared based upon available information and assumptions that the
management of Azurix believes are reasonable. The unaudited condensed
consolidated pro forma statements of income are for informational purposes only,
and do not purport to represent what Azurix's actual results of operations would
have been had the Wessex acquisition, the related redemption of the preference
shares of Wessex and sale of its interest in Wessex Waste Management Ltd, a
joint venture with Waste Management International Plc, and the offering,
occurred on January 1, 1998. The unaudited pro forma balance sheet is for
informational purposes only, and does not purport to represent Azurix's actual
financial position had the offering occurred on March 31, 1999. In addition, the
unaudited condensed consolidated pro forma financial statements are not
necessarily indicative of future results of operations or financial position of
Azurix and should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements of Azurix and Wessex and the related notes thereto included
elsewhere in this prospectus.
F-2
<PAGE> 131
AZURIX CORP.
UNAUDITED CONDENSED CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
WESSEX PRO FORMA FOR WESSEX OFFERING PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS ACQUISITION ADJUSTMENTS AS ADJUSTED
---------- ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues........... $119.7 $344.5 $ -- $464.2 $ -- $464.2
Operating expenses:
Operations and
maintenance............. 31.6 89.3 -- 120.9 -- 120.9
General and
administrative.......... 20.3 44.8 (20.7)(a) 44.4 -- 44.4
Depreciation and
amortization............ 22.2 50.0 16.1(b) 88.3 -- 88.3
------ ------ ------ ------ ------ ------
Total operating
expenses......... 74.1 184.1 (4.6) 253.6 -- 253.6
------ ------ ------ ------ ------ ------
Operating income............. 45.6 160.4 4.6 210.6 -- 210.6
------ ------ ------ ------ ------ ------
Other income (expense):
Equity in earnings (loss)
of unconsolidated
affiliates.............. (0.8) 9.1 (9.1)(c) (0.8) -- (0.8)
Interest income............ 1.3 0.2 -- 1.5 -- 1.5
Interest expense, net...... (16.4) (9.7) (41.5)(d) (67.6) -- (67.6)
Other expense.............. (1.2) -- 1.2(e) -- -- --
------ ------ ------ ------ ------ ------
Income before income taxes... 28.5 160.0 (44.8) 143.7 -- 143.7
------ ------ ------ ------ ------ ------
Income tax expense........... 18.3 53.2 (15.0)(f) 56.5 -- 56.5
------ ------ ------ ------ ------ ------
Net income................... $ 10.2 $106.8 $(29.8) $ 87.2 $ -- $ 87.2
====== ====== ====== ====== ====== ======
Earnings per share of common
stock -- basic and
diluted.................... $ 0.10 $ 0.87 $ 0.74
====== ====== ======
Weighted average shares
outstanding -- basic and
diluted.................... 100.0 100.0 17.1(g) 117.1
====== ====== ====== ======
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
consolidated pro forma financial statements.
F-3
<PAGE> 132
AZURIX CORP.
UNAUDITED CONDENSED CONSOLIDATED PRO FORMA STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
OFFERING PRO FORMA
HISTORICAL ADJUSTMENTS AS ADJUSTED
---------- ----------- -----------
<S> <C> <C> <C>
Operating revenues........................................ $116.9 $ -- $116.9
Operating expenses:
Operations and maintenance.............................. 31.8 -- 31.8
General and administrative.............................. 22.6 -- 22.6
Depreciation and amortization........................... 23.3 -- 23.3
------ ----- ------
Total operating expenses........................ 77.7 -- 77.7
------ ----- ------
Operating income.......................................... 39.2 -- 39.2
------ ----- ------
Other income (expense):
Equity in earnings of unconsolidated affiliates......... 0.2 -- 0.2
Interest income......................................... 2.1 -- 2.1
Interest expense, net................................... (17.0) -- (17.0)
------ ----- ------
Income before income taxes................................ 24.5 -- 24.5
------ ----- ------
Income tax expense........................................ 8.4 -- 8.4
------ ----- ------
Net income................................................ $ 16.1 $ -- $ 16.1
====== ===== ======
Earnings per share of common stock -- basic and diluted... $ 0.16 $ 0.14
====== ======
Weighted average shares outstanding -- basic and
diluted................................................. 100.0 17.1(g) 117.1
====== ===== ======
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
consolidated
pro forma financial statements.
F-4
<PAGE> 133
AZURIX CORP.
UNAUDITED CONDENSED CONSOLIDATED PRO FORMA BALANCE SHEET
AT MARCH 31, 1999
(IN MILLIONS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
OFFERING PRO FORMA
HISTORICAL ADJUSTMENTS AS ADJUSTED
---------- ----------- -----------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents................................ $ 13.1 $ 238.4(h) $ 251.5
Trade receivables (net of allowance for doubtful accounts
of $6.9).............................................. 40.6 -- 40.6
Unbilled receivables..................................... 25.7 -- 25.7
Other.................................................... 45.4 -- 45.4
-------- -------- --------
Total current assets............................. 124.8 238.4 363.2
-------- -------- --------
Property, plant and equipment, at cost..................... 2,276.5 -- 2,276.5
Less accumulated depreciation.............................. (32.8) -- (32.8)
-------- -------- --------
Property, plant and equipment, net............... 2,243.7 -- 2,243.7
-------- -------- --------
Investments in and advances to unconsolidated affiliates... 103.0 -- 103.0
Goodwill, net.............................................. 847.0 -- 847.0
Other assets............................................... 30.8 -- 30.8
-------- -------- --------
Total Assets..................................... $3,349.3 $ 238.4 $3,587.7
======== ======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable -- affiliates........................... $ 67.9 $ (64.2)(i) $ 3.7
Accounts payable and accruals............................ 95.2 -- 95.2
Deferred income.......................................... 21.8 -- 21.8
Accrued taxes............................................ 37.9 -- 37.9
Accrued interest......................................... 8.6 -- 8.6
Current maturities of long-term debt..................... 27.9 -- 27.9
-------- -------- --------
Total current liabilities........................ 259.3 (64.2) 195.1
-------- -------- --------
Note payable -- affiliate.................................. 117.8 -- 117.8
Long-term debt............................................. 940.3 -- 940.3
Deferred taxes............................................. 402.5 -- 402.5
Other long-term liabilities................................ 14.7 -- 14.7
-------- -------- --------
Total liabilities................................ 1,734.6 (64.2) 1,670.4
-------- -------- --------
Commitments and contingencies
Stockholder's equity:
Preferred stock, $0.01 par value, 50,000,000 shares
authorized............................................ -- -- --
Common stock, $0.01 par value, 500,000,000 shares
authorized, 100,000,000 shares and 117,100,000 shares,
issued and outstanding, historical and as adjusted,
respectively.......................................... 1.0 0.2(j) 1.2
Additional paid-in capital............................... 1,671.0 302.4(j) 1,973.4
Retained earnings........................................ 26.3 -- 26.3
Cumulative foreign currency translation adjustment....... (83.6) -- (83.6)
-------- -------- --------
Total stockholder's equity....................... 1,614.7 302.6 1,917.3
-------- -------- --------
Total Liabilities and Stockholder's Equity....... $3,349.3 $ 238.4 $3,587.7
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
consolidated pro forma financial statements.
F-5
<PAGE> 134
AZURIX CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED PRO FORMA
FINANCIAL STATEMENTS
The following pro forma adjustments give effect to the Wessex acquisition,
and the related redemption of the preference shares of Wessex, sale of its
interest in Wessex Waste Management Ltd, a joint venture with Waste Management
International Plc, and the offering, as though each occurred on January 1, 1998
for income statement purposes, and give effect to the offering, as though it
occurred on March 31, 1999 for balance sheet purposes. The historical results of
Wessex for the period prior to the Wessex acquisition were derived by combining
the Wessex historical audited results for the period April 1, 1998 to October 2,
1998 and the Wessex historical audited results for the year ended March 31,
1998, less the historical unaudited results for the nine months ended December
31, 1997. The unaudited condensed consolidated pro forma statement of income
includes the results of operations from Azurix's investment in Obras Sanitarias
Mendoza S.A. from the date it was acquired, and does not include any pro forma
or historical effects from Azurix's $13.5 million investment in a water
concession for the city of Cancun, Mexico prior to the date it was acquired in
March 1999 or the acquisition of Philip Utilities in May 1999.
The cost of the Wessex acquisition, including transaction costs, was $2.4
billion. The pro forma adjustments are based on a preliminary purchase price
allocation because Azurix is in the process of finalizing its assessment of the
related fair values. This preliminary purchase price allocation includes
tangible assets of $2.7 billion, goodwill of $0.9 billion, liabilities assumed
of $1.1 billion and redeemable preferred stock of $0.1 billion. Azurix does not
believe the final evaluation of these assessments will materially affect the
allocation of the purchase price.
The historical results of operations for Azurix are for the period from
January 29, 1998 (date of inception) to December 31, 1998. However,
substantially all of Azurix's results of operations occurred during the fourth
quarter of 1998, subsequent to the Wessex acquisition.
(a) To adjust Wessex historical general and administrative expense for
costs incurred by Wessex prior to the Wessex acquisition, but directly related
to the Wessex acquisition.
(b) To adjust historical Wessex depreciation of tangible assets and
amortization of goodwill acquired in the Wessex acquisition for the period
during 1998 prior to the Wessex acquisition. The adjustment to depreciation and
amortization was based on a preliminary purchase price allocation. Goodwill is
being amortized over 40 years.
(c) To adjust historical equity earnings from Wessex's historical results
to reflect the sale of its interest in Wessex Waste Management Ltd for $337.9
million.
(d) To record the following:
(1) Interest expense for the period January 1, 1998 to October 2, 1998
on U.K. pounds sterling denominated loan notes issued to Wessex
shareholders to finance the Wessex acquisition. The average balance
outstanding was $116.4 million, adjusted for foreign currency exchange
rates, and an average interest rate of 7.8% was assumed;
(2) Interest expense for the period January 1, 1998 to October 2, 1998
on U.K. pounds sterling denominated affiliate note payable used to finance
the Wessex acquisition in the amount of $120.5 million, adjusted for
average foreign currency exchange rates, at an assumed interest rate of
6.25%;
(3) Interest expense for the period January 1, 1998 to October 2, 1998
on U.K. pounds sterling denominated funds borrowed under a five year bank
credit facility used to finance the Wessex acquisition less a portion of
the proceeds received from the sale of its interest in Wessex Waste
Management Ltd that were used to paydown such borrowings. The average
balance outstanding was $209.7 million, adjusted for foreign currency
exchange rates, and an average interest rate of 8.2% was assumed;
F-6
<PAGE> 135
(4) Interest expense for the period January 1, 1998 to December 9,
1998 on U.K. pounds sterling denominated funds borrowed to redeem Wessex's
preference shares. The weighted average funds borrowed was $215.5 million,
adjusted for foreign currency exchange rates, and an average interest rate
of 8.1% was assumed.
(e) To reflect the reduction in dividends related to the redemption of the
Wessex preference shares.
(f) To record the tax impact of the pro forma adjustments described above
at the U.K. statutory rate of 31%, excluding non-deductible goodwill
amortization.
(g) To reflect shares issued by Azurix in the offering.
(h) To record the estimated net proceeds of $302.6 million to Azurix from
the offering less $64.2 million of the proceeds used to repay funds advanced to
Azurix by Enron as of March 31, 1999. As of June 7, 1999, Azurix has $280.4
million of borrowing capacity under the senior credit facility available to fund
future acquisitions. It is expected that $208.0 million of this facility, along
with $230.6 million of proceeds from the offering, will be used to fund the
$438.6 million acquisition of an interest in a concession in two regions of the
Province of Buenos Aires, Argentina.
(i) To record the partial use of proceeds to Azurix from the offering to
repay funds advanced to Azurix by Enron.
(j) To reflect the offering of Azurix's stock. The number of shares to be
offered by Azurix is 17.1 million. The offering price per share is $19.00 and
the underwriting discounts and estimated expenses related to the shares offered
by Azurix are $22.3 million.
F-7
<PAGE> 136
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder of Azurix Corp.:
We have audited the accompanying consolidated balance sheet of Azurix Corp.
(a Delaware corporation) and subsidiaries as of December 31, 1998, and the
related consolidated statements of income, comprehensive income (loss), cash
flows and changes in stockholder's equity for the period from January 29, 1998
(Date of Inception) to December 31, 1998. These financial statements are the
responsibility of Azurix Corp.'s management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Azurix Corp. and
subsidiaries as of December 31, 1998, and the results of their operations, cash
flows and changes in stockholder's equity for the period from January 29, 1998
(Date of Inception) to December 31, 1998, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Houston, Texas
February 22, 1999
F-8
<PAGE> 137
AZURIX CORP.
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JANUARY 29, 1998 THREE MONTHS
(DATE OF INCEPTION) ENDED
TO DECEMBER 31, MARCH 31,
1998 1999
------------------- ------------
(UNAUDITED)
<S> <C> <C>
Operating revenues.......................................... $119.7 $116.9
Operating expenses:
Operations and maintenance................................ 31.6 31.8
General and administrative................................ 20.3 22.6
Depreciation and amortization............................. 22.2 23.3
------ ------
Total operating expenses.......................... 74.1 77.7
------ ------
Operating income............................................ 45.6 39.2
------ ------
Other income (expense):
Equity in earnings (loss) of unconsolidated affiliates.... (0.8) 0.2
Interest income........................................... 1.3 2.1
Interest expense, net..................................... (16.4) (17.0)
Other expense............................................. (1.2) --
------ ------
Income before income taxes.................................. 28.5 24.5
------ ------
Income tax expense.......................................... 18.3 8.4
------ ------
Net income.................................................. $ 10.2 $ 16.1
====== ======
Earnings per share of common stock -- basic and diluted..... $ 0.10 $ 0.16
====== ======
Weighted average shares outstanding -- basic and diluted.... 100.0 100.0
====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-9
<PAGE> 138
AZURIX CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 29, 1998 THREE MONTHS
(DATE OF INCEPTION) ENDED
TO DECEMBER 31, MARCH 31,
1998 1999
------------------- ------------
(UNAUDITED)
<S> <C> <C>
Net income.................................................. $ 10.2 $ 16.1
Other comprehensive income:
Foreign currency translation adjustment................... (36.7) (46.9)
------ ------
Comprehensive income (loss)................................. $(26.5) $(30.8)
====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-10
<PAGE> 139
AZURIX CORP.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 5.3 $ 13.1
Trade receivables (net of allowance for doubtful accounts
of $6.3 and $6.9, respectively)........................ 63.7 40.6
Unbilled receivables...................................... 24.3 25.7
Other..................................................... 38.5 45.4
-------- --------
Total current assets.............................. 131.8 124.8
-------- --------
Property, plant and equipment, at cost...................... 2,271.1 2,276.5
Less accumulated depreciation............................... (16.7) (32.8)
-------- --------
Property, plant and equipment, net................ 2,254.4 2,243.7
-------- --------
Investments in and advances to unconsolidated affiliates.... 74.3 103.0
Goodwill, net............................................... 877.6 847.0
Other assets................................................ 20.2 30.8
-------- --------
Total Assets...................................... $3,358.3 $3,349.3
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable -- affiliates............................ $ 20.0 $ 67.9
Accounts payable and accruals............................. 101.8 95.2
Deferred income........................................... 71.0 21.8
Accrued taxes............................................. 31.8 37.9
Accrued interest.......................................... 9.8 8.6
Current maturities of long-term debt...................... 27.0 27.9
-------- --------
Total current liabilities......................... 261.4 259.3
-------- --------
Note payable -- affiliate................................... 121.4 117.8
Long-term debt.............................................. 912.1 940.3
Deferred taxes.............................................. 404.4 402.5
Other long-term liabilities................................. 13.5 14.7
-------- --------
Total liabilities................................. 1,712.8 1,734.6
-------- --------
Commitments and contingencies (Note 15)
Stockholder's equity:
Preferred stock, $0.01 par value, 50,000,000 shares
authorized............................................. -- --
Common stock, $0.01 par value, 500,000,000 shares
authorized, 100,000,000 shares issued and
outstanding............................................ 1.0 1.0
Additional paid-in capital................................ 1,671.0 1,671.0
Retained earnings......................................... 10.2 26.3
Cumulative foreign currency translation adjustment........ (36.7) (83.6)
-------- --------
Total stockholder's equity........................ 1,645.5 1,614.7
-------- --------
Total Liabilities and Stockholder's Equity........ $3,358.3 $3,349.3
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-11
<PAGE> 140
AZURIX CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
JANUARY 29, 1998 THREE MONTHS
(DATE OF INCEPTION) ENDED
TO DECEMBER 31, MARCH 31,
1998 1999
------------------- ------------
(UNAUDITED)
<S> <C> <C>
Operating Activities:
Net income................................................ $ 10.2 $ 16.1
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization............................. 22.2 23.3
Amortization of deferred financing cost................... 0.6 0.5
Deferred income taxes..................................... 13.4 5.3
Equity in (earnings) loss of unconsolidated affiliates.... 0.8 (0.2)
Changes in operating assets and liabilities:
(Increase) decrease in trade receivables and other
current assets....................................... (17.1) 9.7
Decrease in accounts payable and accruals.............. (25.7) (44.1)
(Increase) decrease in other assets.................... (2.5) 0.3
Increase in other long-term liabilities................ 1.3 1.6
Other.................................................. 1.2 --
--------- -------
Net cash provided by operating activities................... 4.4 12.5
--------- -------
Investing Activities:
Capital expenditures...................................... (63.2) (74.5)
Business acquisition, net of cash acquired................ (2,270.8) --
Proceeds from the sale of equity investment............... 337.9 --
Investment in and advances to unconsolidated affiliates... -- (28.5)
Other..................................................... 13.5 (6.8)
--------- -------
Net cash used in investing activities....................... (1,982.6) (109.8)
--------- -------
Financing Activities:
Net proceeds from (repayments of) revolving credit
facilities............................................. 160.8 (410.8)
Proceeds from long-term borrowings........................ 550.8 477.7
Repayments of long-term borrowings........................ (226.2) (9.8)
Issuance of common stock and capital contributed.......... 1,600.2 --
Redemption of subsidiary preference shares................ (106.4) --
Dividends paid on subsidiary preference shares............ (1.7) --
Advances from Enron....................................... -- 48.0
--------- -------
Net cash provided by financing activities................... 1,977.5 105.1
--------- -------
Effect of exchange rate changes on cash..................... 6.0 --
--------- -------
Change in cash and cash equivalents......................... 5.3 7.8
--------- -------
Cash and cash equivalents, beginning of period.............. -- 5.3
--------- -------
Cash and cash equivalents, end of period.................... $ 5.3 $ 13.1
========= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-12
<PAGE> 141
AZURIX CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CUMULATIVE
ADDITIONAL FOREIGN CURRENCY
PREFERRED COMMON PAID-IN RETAINED TRANSLATION
STOCK STOCK CAPITAL EARNINGS ADJUSTMENT TOTAL
--------- ------ ---------- -------- ---------------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 29, 1998
(Date of Inception)......... $-- $ -- $ -- $ -- $ -- $ --
Issuance of 100,000,000
shares of common stock... -- 1.0 -- -- -- 1.0
Capital contributions....... -- -- 1,599.2 -- -- 1,599.2
Subsidiary stock
contributed.............. -- -- 71.8 -- -- 71.8
Foreign currency translation
adjustment............... -- -- -- -- (36.7) (36.7)
Net income.................. -- -- -- 10.2 -- 10.2
--- ---- -------- ----- ------ --------
Balance at December 31,
1998........................ -- 1.0 1,671.0 10.2 (36.7) 1,645.5
--- ---- -------- ----- ------ --------
Foreign currency translation
adjustment (unaudited)... -- -- -- -- (46.9) (46.9)
Net income (unaudited)...... -- -- -- 16.1 -- 16.1
--- ---- -------- ----- ------ --------
Balance at March 31, 1999
(unaudited)................. $-- $1.0 $1,671.0 $26.3 $(83.6) $1,614.7
=== ==== ======== ===== ====== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-13
<PAGE> 142
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Azurix Corp. was formed by Enron Corp. on January 29, 1998. Azurix is
engaged in the business of acquiring, owning, operating and managing water and
wastewater assets, providing water and wastewater related services and managing
and developing resources in the global water industry. Azurix is a wholly owned
subsidiary of Atlantic Water Trust, in which Enron and Marlin Water Trust each
hold a 50% voting interest. During 1998, Azurix indirectly acquired all of the
outstanding ordinary share capital of Wessex Water Plc (see Note 2) and Enron
contributed to Azurix the outstanding common stock of a subsidiary that in June
1998 acquired a 32.1% ownership interest in Obras Sanitarias Mendoza S.A. Wessex
and Obras Sanitarias Mendoza provide water and wastewater treatment services in
southwestern England and the Province of Mendoza, Argentina, respectively.
Azurix entered into an agreement on December 19, 1998 to purchase 49.9% of
an entity whose principal asset is the water concession for the city of Cancun,
Mexico. This agreement was not binding until specific material conditions were
met, and these conditions were met subsequent to December 31, 1998. As a result,
the Cancun concession is not reflected in Azurix's 1998 financial statements.
The purchase price was $13.5 million and Azurix agreed to provide up to $25.0
million in debt financing. On February 25, 1999, Azurix funded $15.0 million of
debt financing to the Cancun concession. The Cancun concession acquisition
closed on March 24, 1999. The results of the Cancun concession acquisition are
reflected in the financial statements as of the acquisition closing date.
Azurix was incorporated on January 29, 1998, and as a result, the
Consolidated Statement of Income, Consolidated Statement of Comprehensive Income
(Loss), Consolidated Statement of Cash Flows and Consolidated Statement of
Changes in Stockholder's Equity are from the date of inception to December 31,
1998. However, substantially all of Azurix's results of operations, cash flows
and equity transactions occurred during the fourth quarter of 1998, subsequent
to the Wessex acquisition.
INTERIM PRESENTATION (UNAUDITED)
The accompanying consolidated interim financial statements and disclosures
are unaudited and have been prepared by Azurix in accordance with generally
accepted accounting principles and reflect all adjustments, consisting solely of
normal recurring adjustments, necessary for a fair presentation in all material
respects of the results for the interim period. The results of operations for
the three months ended March 31, 1999 are not necessarily indicative of results
to be expected for the full year. Interim financial statements for the period
January 29, 1998 to March 31, 1998 are not presented because Azurix did not have
any results of operations or cash flows during the period.
CONSOLIDATION POLICY AND USE OF ESTIMATES
The consolidated financial statements include the accounts of all
majority-owned subsidiaries and are prepared in accordance with generally
accepted accounting principles in the United States. All significant
intercompany balances and transactions have been eliminated in consolidation.
Azurix uses the equity method of accounting for all investments where it owns
less than a majority of the voting stock but is able to exercise significant
influence over the operating and financial policies of the investee.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management 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 financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-14
<PAGE> 143
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
REVENUE RECOGNITION
Operating revenue represents income earned in the ordinary course of
business, excluding value added tax. Revenue for metered customers is recognized
based on actual usage and accrued based on the estimated amount of water sold
but not billed as of the balance sheet date. Revenue for non-metered customers,
who pay an annual fixed charge based on the rateable value of their property, is
recognized uniformly over the year.
DERIVATIVE FINANCIAL INSTRUMENTS
Azurix utilizes derivative financial instrument contracts for non-trading
purposes to manage exposure to fluctuations in interest rates and foreign
currency exchange rates. Hedge accounting is utilized in non-trading activities
where there is a high correlation of price movements in the derivative and the
contract is designated as a hedge. In instances where the anticipated
correlation of price movements no longer exists, hedge accounting is terminated
and future changes in the value of the derivative financial instruments are
recognized as gains or losses to net income.
Interest rate swaps involve the exchange of amounts based on a fixed
interest rate for amounts based on variable interest rates over the life of the
contract without an exchange of the notional amount upon which payments are
based. The difference to be received or paid is recognized in income over the
life of the contracts as adjustments to interest expense.
Currency swap contracts are denominated in one foreign currency and are to
be repaid in another currency. These contracts are designated as hedges of firm
commitments to pay interest and principal on debt, which would otherwise expose
Azurix to foreign currency risk.
The fair values of the swap contracts are not recognized in the financial
statements. The income and cash flow impact of financial instruments is
reflected as an adjustment of the hedged item. Gains and losses on terminations
of interest rate and currency swap contracts are deferred as an adjustment to
the carrying amount of the outstanding obligation and amortized as an adjustment
to interest expense related to the obligation over the remaining term of the
original contract life of the terminated swap contract. In the event of early
extinguishment of the obligation, any realized or unrealized gain or loss from
the swap would be recognized in net income at the time of extinguishment.
INCOME TAXES
Azurix accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under the
asset and liability method of Statement of Financial Accounting Standards No.
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. For U.S. tax purposes, Azurix is presently a member of Enron's
consolidated group and is included in Enron's consolidated federal income tax
return. Members of the consolidated group are charged with the amount of income
tax expense (benefit) determined as if they filed separate federal income tax
returns. There is no formal tax sharing arrangement between Enron and Azurix.
EARNINGS PER COMMON SHARE
Statement of Financial Accounting Standards No. 128, "Earnings Per Share,"
requires dual presentation of earnings per common share and earnings per common
share assuming dilution on the face of the income statement. Basic earnings per
share is computed by dividing the net income available to common stockholders by
the weighted average number of common shares outstanding during the period.
F-15
<PAGE> 144
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
Diluted earnings per common share is computed by adjusting basic earnings per
share for the net income and share effect of the potential conversion to common
shares of all dilutive securities. For the year ending December 31, 1998, Azurix
did not have any securities outstanding that could have been potentially
converted into common shares, therefore, basic and diluted earnings per share
are the same. At March 31, 1999, Azurix had stock options outstanding to
purchase 7.8 million shares of its common stock (see Note 13). For the three
months ended March 31, 1999, these options were not dilutive to basic earnings
per share.
CASH EQUIVALENTS
Azurix considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost. Cost of acquired property,
plant and equipment includes an allocation of the purchase price based on the
asset's fair market value. Cost of property, plant and equipment placed in
service includes direct charges for material, labor and services and indirect
charges related to construction, such as engineering, supervision, payroll taxes
and employee benefits. The October 1998 acquisition of Wessex represents
substantially all of the property, plant and equipment as of December 31, 1998
(see Note 2). Additions, replacements, modifications and enhancements to units
of property are capitalized. Major improvements to leasehold properties are
amortized over the shorter of the asset life or the life of the respective
lease. Repairs, maintenance and minor replacements are charged to operations and
maintenance expense as incurred. Interest capitalized is based on the average
value of construction work in progress at Azurix's average borrowing rate during
the period. The amount of interest capitalized during 1998 was approximately
$2.3 million.
Azurix's infrastructure assets comprise a network of systems of mains and
sewers, impounding and pumped raw water storage reservoirs, dams, sludge
pipelines and infrastructure investigations and studies.
The cost of property, plant and equipment is charged to depreciation using
the straight-line method over the estimated useful lives of the assets.
Depreciation is computed based on estimated useful lives as follows:
<TABLE>
<CAPTION>
YEARS
--------
<S> <C>
Buildings and operational structures........................ 15 to 80
Infrastructure.............................................. 115
Plant machinery and vehicles................................ 3 to 30
Other assets................................................ 4 to 15
</TABLE>
LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," long-lived assets held and used by Azurix are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. For purposes of evaluating
the recoverability, a test is performed comparing the estimated future
undiscounted cash flows associated with the asset to the asset's carrying
amount, including allocated goodwill, to determine if a write-down to market
value or discounted cash flow value is required.
F-16
<PAGE> 145
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
GOODWILL
Goodwill represents the excess of purchase price and related costs over the
value assigned to the net assets of businesses acquired (see Note 2). Goodwill
is amortized on a straight-line basis over the estimated useful life, not to
exceed 40 years. Accumulated amortization of goodwill at December 31, 1998 was
$5.5 million.
OTHER ASSETS
Other assets consist primarily of deferred charges, such as financing costs
and external costs of acquisition activities. Deferred financing charges are
amortized to interest expense over the lives of the related debt issuances and
external acquisition costs are capitalized as a cost of successful acquisitions
or expensed during the period in which it is determined that the project is
unsuccessful or the pursuit is terminated.
DEFERRED INCOME
Azurix bills some customers in advance of providing water and wastewater
services and classifies these amounts as "Deferred income" on the Consolidated
Balance Sheet until earned.
PENSION BENEFITS
The pension plans maintained by Wessex (see Note 12) are of the defined
benefit type, and are valued by an independent actuary. Current service costs
for the plans are accrued in the period to which they relate. Prior service
costs and actuarial gains and losses, if any, relating to amendments to the
plans, are recognized on a basis designed to spread the costs over the remaining
average service lives of employees.
FOREIGN CURRENCY TRANSLATION
The functional currency for Azurix's foreign operations is the applicable
local currency. The translation from the applicable foreign currencies to U.S.
dollars is performed for balance sheet accounts using the current exchange rates
in effect at the balance sheet date and for revenue and expense accounts, using
the weighted average exchange rate during the period or, where known or
determinable, at the rate on the date of the transaction for significant items.
The resulting translation adjustments are recorded in comprehensive income as a
component of stockholder's equity and are included in income only upon the sale
or liquidation of the underlying investments.
ENVIRONMENTAL COSTS
Environmental expenditures that relate to current operations are expensed
as incurred. Expenditures providing a future benefit are capitalized as
appropriate. Remediation costs that relate to an existing condition caused by
past operations are accrued when it is probable that these costs will be
incurred and can be reasonably estimated.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement establishes accounting and reporting
standards for derivative instruments, including instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging activities.
It requires an entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure
F-17
<PAGE> 146
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
those instruments at fair value. This statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. Azurix is currently
evaluating and has not yet determined the effect that the adoption of Statement
of Financial Accounting Standards No. 133 will have on its financial statements.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities," which requires that costs for start-up activities and organization
costs be expensed as incurred and not capitalized as had previously been
allowed. Statement of Position 98-5 is applicable to all financial statements
for fiscal years beginning after December 15, 1998 and initial adoption is
required to be reflected as a cumulative effect of accounting change. Azurix
adopted the treatment prescribed by Statement of Position 98-5 in 1998, the year
of Azurix's inception, and therefore there is no cumulative effect.
SEGMENT, GEOGRAPHIC AND QUARTERLY REPORTING
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and
Related Information," which is effective for fiscal years beginning after
December 31, 1997, and establishes standards for reporting information about
operating segments in annual financial statements and requires selected
information about operating segments in interim financial reports. Operating
segments are defined as components of an enterprise about which separate
financial information is available and evaluated regularly by the chief
operating decision maker, or decision making group, in deciding how to allocate
resources and in assessing performance. The operating subsidiaries of Azurix in
1998 operated in one segment and were substantially located in one geographic
region. In addition, Azurix's operations began in the fourth quarter of 1998 and
therefore separate quarterly disclosures have been omitted.
NOTE 2 -- BUSINESS ACQUISITION
On October 2, 1998, Azurix, through its indirect wholly owned subsidiary
Azurix Europe Ltd, acquired over 90% of the outstanding ordinary share capital
of Wessex. On that same date, Azurix Europe issued notices to the remaining
Wessex ordinary shareholders, informing them that it intended to exercise its
rights under the English Companies Act to acquire compulsorily all of the
outstanding ordinary shares. The compulsory share acquisition was completed in
November 1998. The cost of the Wessex acquisition, including transaction costs
was $2.4 billion. The cost included a combination of cash consideration paid to
Wessex shareholders, net of $1.7 million cash acquired, and the issuance of loan
notes to Wessex shareholders in the face amount of $119.8 million (see Note 7).
On October 2, 1998, Wessex had cumulative mandatorily redeemable preference
shares outstanding. These were redeemed by Wessex in December 1998.
The purchase method of accounting was utilized, and accordingly, the assets
and liabilities of Wessex have been recorded at their estimated fair values on
the date of acquisition. The excess of the purchase price over the fair values
of the net assets acquired has been recorded as goodwill, and is being amortized
on the straight-line basis over 40 years. The results of operations of Wessex
have been included in the consolidated financial statements since the date of
acquisition. Assets acquired, liabilities assumed, debt issued and consideration
paid (which includes proceeds from borrowings by Azurix Europe), as a result of
the Wessex acquisition are detailed below. The allocation of the purchase price
to the net assets acquired is preliminary because Azurix is in the process of
finalizing its assessment of the related fair values. Azurix
F-18
<PAGE> 147
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
does not believe the final evaluation of these assessments will materially
affect the allocation of the purchase price. The preliminary allocation of the
purchase price is as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
Fair value of assets acquired............................... $ 2,738.7
Goodwill.................................................... 903.9
Fair value of liabilities assumed........................... (1,141.0)
Mandatorily redeemable preferred stock assumed.............. (109.3)
---------
Total purchase price.............................. $ 2,392.3
=========
</TABLE>
The following unaudited pro forma information presents summarized
consolidated results of operations of Azurix as if the Wessex acquisition had
occurred on January 1, 1998:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1998 1998
------------ ------------
(UNAUDITED)
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Revenues.................................................... $464.2 $111.0
Net income.................................................. 87.2 20.7
Basic and diluted earnings per share........................ 0.87 0.21
</TABLE>
These unaudited pro forma results of operations have been prepared for
illustrative purposes only and include adjustments in addition to the
pre-acquisition historical results of Wessex, such as additional amortization
expense as a result of goodwill, increased depreciation expense resulting from
allocation of fair market value to fixed assets acquired, increased interest
expense on acquisition debt and preference share redemption and the sale of
Wessex's interest in UK Waste (see Note 3). The unaudited pro forma financial
information is not necessarily indicative of the results of operations that
would have occurred had the Wessex acquisition occurred on the date indicated,
and should not be viewed as indicative of operations in future periods.
NOTE 3 -- SALE OF ACQUIRED EQUITY INVESTMENT
On November 30, 1998, Azurix, sold its interest in Wessex Waste Management
Ltd, a joint venture with Waste Management International Plc that does business
as UK Waste, to Waste Management International for $337.9 million. Azurix's
interest in UK Waste was acquired in the Wessex acquisition (see Note 2). UK
Waste provides solid waste collection, treatment and recycling services
throughout the United Kingdom.
The value allocated to the equity investment in purchase accounting was
based on the cash flows during the period UK Waste was owned by Azurix,
including incremental debt costs incurred during the holding period. Azurix's
results of operations do not reflect the equity earnings of UK Waste during the
ownership period of $2.5 million and no adjustments to the carrying amount of
the investment were necessary. Accordingly, Azurix recorded no gain or loss from
the sale.
F-19
<PAGE> 148
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
NOTE 4 -- OTHER CURRENT ASSETS
Other current assets at December 31, 1998 is comprised of the following:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
Prepayments................................................. $18.6
Other receivables........................................... 11.7
Other....................................................... 8.2
-----
$38.5
=====
</TABLE>
NOTE 5 -- PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 1998 is comprised of the
following:
<TABLE>
<CAPTION>
PROPERTY, PLANT
ACCUMULATED AND EQUIPMENT,
HISTORICAL COST DEPRECIATION NET
--------------- ------------ ---------------
(IN MILLIONS)
<S> <C> <C> <C>
Buildings and operational structures......... $ 494.2 $ (2.6) $ 491.6
Infrastructure............................... 1,184.9 (2.7) 1,182.2
Plant machinery and vehicles................. 412.3 (9.7) 402.6
Construction work-in-progress................ 154.7 -- 154.7
Other assets................................. 25.0 (1.7) 23.3
-------- ------ --------
Total.............................. $2,271.1 $(16.7) $2,254.4
======== ====== ========
</TABLE>
NOTE 6 -- SHORT-TERM DEBT
As of December 31, 1998, Azurix had $424.0 million outstanding from credit
facilities with major commercial banks. Of this amount, $399.1 million relates
to committed credit facilities and the remaining $24.9 million relates to credit
facilities that are on an uncommitted basis. Interest accrues on the committed
credit facilities and the uncommitted facilities based on the London interbank
offered rate plus 0.18% and the London interbank offered rate plus a negotiated
margin, respectively. The weighted average interest rate on short-term bank
borrowings outstanding as of December 31, 1998 was 6.66%. Azurix pays commitment
fees of 0.09% on the unused portion of committed lines of credit. The facilities
expire in April 1999. At December 31, 1998, Azurix intended to refinance the
$424.0 million of short-term bank borrowings with long-term debt. At December
31, 1998, Azurix had amounts available under the senior credit facility (see
Note 7) to refinance the short-term bank borrowings on a long-term basis and
accordingly, reclassified its short-term bank borrowings as long-term debt.
On March 30, 1999, Azurix repaid all of its short-term bank borrowings
outstanding on that date with the proceeds from a bond offering that matures in
2009 (see Note 7).
F-20
<PAGE> 149
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
NOTE 7 -- LONG-TERM DEBT AND AFFILIATE NOTE PAYABLE
The components of long-term debt are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
(IN MILLIONS)
<S> <C> <C>
Amounts reclassified from short-term debt (see Note 6)...... $424.0 $ --
Senior credit facility...................................... 219.5 213.0
Senior unsecured bonds...................................... -- 478.4
Loan notes.................................................. 117.2 113.8
European Investment Bank credit facilities.................. 68.7 66.6
Capital lease obligation.................................... 109.7 96.4
------ ------
939.1 968.2
Less current maturities..................................... (27.0) (27.9)
------ ------
Total long-term debt.............................. $912.1 $940.3
====== ======
</TABLE>
Azurix entered into a U.K. pounds sterling denominated senior secured bank
credit facility in August 1998, as amended. At December 31, 1998, the senior
credit facility consisted of a term loan facility of $322.6 million and a
revolving credit facility of $575.3 million bearing interest at a rate of the
London interbank offered rate plus 0.625%, which was 6.9% at December 31, 1998.
The amounts outstanding at December 31, 1998 were $211.2 million and $8.3
million, under the term loan facility and the revolving credit facility,
respectively. The remaining term loan capacity of $111.4 million is used to
secure a substantial portion of the loan notes, described below. The term loan
facility requires repayment of $199.5 million by July 24, 2000, and repayment of
any remaining outstanding term loans in July 2003. The revolving credit facility
terminates in July 2003. Azurix may borrow up to $99.8 million of the revolving
credit facility balance available for general corporate purposes. Azurix has
pledged all of a subsidiary's existing assets, including all of the ordinary
shares of Wessex, under this facility. The unused borrowing capacity under the
revolving credit facility at December 31, 1998 was $567.0 million. Azurix incurs
commitment fees of 0.3125% on the unused portion of this facility, which are
recorded as interest expense.
Azurix issued U.K. pounds sterling denominated loan notes of $117.2 million
face value, as of December 31, 1998, to Wessex shareholders in lieu of cash
consideration for the ordinary shares purchased in the Wessex acquisition (see
Note 2). The loan notes are redeemable, at the option of the holder, semi-
annually beginning September 30, 1999, with final redemption occurring September
30, 2005. The loan notes may be redeemed at the holders' option within one year,
and therefore, are potential current obligations. If redeemed by the holders
prior to maturity, Azurix will utilize available capacity on the senior credit
facility or a commitment from Enron to refinance the loan notes on a long-term
basis, and accordingly, the loan notes are classified as long-term debt.
Interest on the loan notes accrues at the London interbank offered rate and is
payable semi-annually. The London interbank offered rate for the period the loan
notes were outstanding during 1998 was 7.125%.
The European Investment Bank credit facilities consist of two separate
loans, one of which has a floating interest rate based on the London interbank
offered rate less 0.25%, and the other has a fixed interest rate of 11.6%. The
floating rate obligation, due October 2001, has an outstanding balance of $49.9
million at December 31, 1998 and is U.S. dollar denominated. The fixed rate
loan, denominated in Italian lire, has an outstanding balance of $18.8 million
at December 31, 1998 and is payable in semiannual installments through June
2002.
F-21
<PAGE> 150
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
Azurix issued U.K. pounds sterling denominated senior unsecured bonds on
March 30, 1999, with a face value of $484.2 million. The net proceeds were
primarily used to refinance the short-term bank borrowings that were outstanding
on that date. The senior unsecured bonds mature March 30, 2009 and bear interest
of 5.875% payable annually.
The U.K. pounds sterling denominated capital lease obligation provides for
semi-annual payments. At December 31, 1998, future minimum lease payments total
$129.1 million, including $19.4 million representing interest. Currently, $158.3
million of historical cost and $21.5 million of related accumulated amortization
is recorded under a capital lease and included in property, plant and equipment.
Each of these financing agreements contains restrictive covenants which
include limitations on borrowings, the maintenance of financial ratios such as
interest coverage, net worth and debt to equity and contracts to perform or
refrain from undertaking acts related to regulations of the industry. The
financing contracts include standard events of default, including non-payment,
cross-defaults and insolvency. Azurix is currently in compliance with these
covenants.
At December 31, 1998, long-term borrowing and capital lease obligation
maturities over the next five years are $27.0 million in 1999, $230.0 million in
2000, $84.6 million in 2001, $36.3 million in 2002 and $561.2 million in 2003.
At March 31, 1999, long-term borrowing and capital lease obligation
maturities over the next five years are $16.0 million during the remainder of
1999, $336.9 million in 2000, $82.1 million in 2001, $35.2 million in 2002 and
$19.6 million in 2003.
Azurix has executed interest rate and currency swap contracts related to
its outstanding debt (see Note 8).
Azurix has an affiliate note payable of $121.4 million outstanding at
December 31, 1998 (see Note 11).
NOTE 8 -- FINANCIAL INSTRUMENTS
Azurix uses derivative financial instruments in the normal course of its
business for purposes other than trading. These financial instruments include
interest rate and currency swap contracts. Azurix has U.K. pounds sterling
interest rate swap contracts having a total notional principal amount of $833.6
million. Interest rate swap contracts relating to notional principal amounts of
$665.1 million, $149.7 million and $18.8 million terminate in 2000, 2001 and
2002, respectively. Azurix also has cross-currency swap contracts to exchange
U.S. dollars of $49.9 million to U.K. pounds sterling of L30 million, which
expires in 2001, and Italian lire of 25.0 billion to U.K. pounds sterling of
L11.3 million, which expires in 2002.
The carrying amount of cash and cash equivalents, trade accounts receivable
(net of an allowance for doubtful accounts) and accounts payable and accruals
approximates their fair value due to their short-term nature. The fair value of
long-term debt and affiliate long-term debt is based on the quoted market prices
for the same or similar issues or on the current rates offered to Azurix for
debt of the same remaining maturities. The fair value of currency swap and
interest rate swap contracts was determined based on a model which estimates the
fair value of these swap contracts using market rates at December 31, 1998 or
was based on quoted market prices for similar instruments with similar
maturities. Judgment is necessarily required in interpreting market data and the
use of different market assumptions or estimation
F-22
<PAGE> 151
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
methodologies may affect the estimated fair value amounts. The comparison of
estimated fair value and carrying amount are as follows:
<TABLE>
<CAPTION>
ESTIMATED
FAIR CARRYING
VALUE AMOUNT
--------- --------
(IN MILLIONS)
<S> <C> <C>
Note payable -- affiliate................................... $121.9 $121.4
Long-term debt(1)........................................... 960.9 936.5
Derivatives:
Interest rate swaps....................................... (9.1) --
Currency swaps............................................ 7.2 2.6
</TABLE>
- ---------------
(1) The sum of the carrying amount for long-term debt and the currency swaps, as
indicated above, equals long-term debt including current maturities (see
Note 7).
Azurix is exposed to risks due to the nature of derivative financial
instruments. In the event of non-performance by third parties, the amounts of
interest rate and currency swap contracts are potentially subject to credit
risk. Third parties to these contracts are major commercial banks with
high-quality credit ratings. Accordingly, Azurix does not anticipate
non-performance by any of these counterparties on these financial instruments.
Azurix is exposed to market risk in the form of foreign exchange rate and
interest rate risks. Several variable and fixed rate loans in foreign currencies
are hedged through a combination of cross-currency swaps and interest rate
swaps.
NOTE 9 -- INCOME TAXES
The components of income before income taxes from date of inception through
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
United States............................................... $(14.7)
Foreign..................................................... 43.2
------
$ 28.5
======
</TABLE>
Total income tax expense (benefit) from date of inception through December
31, 1998 is summarized as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
Current tax expense (benefit):
Federal................................................... $ --
State..................................................... --
Foreign................................................... 4.9
-----
4.9
-----
Deferred tax expense (benefit):
Federal................................................... --
State..................................................... --
Foreign................................................... 13.4
-----
13.4
-----
Total income tax expense (benefit)................ $18.3
=====
</TABLE>
F-23
<PAGE> 152
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
The differences between taxes computed at the U.S. federal statutory tax
rate and Azurix's effective income tax rate from date of inception through
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
AMOUNT PERCENT
------------- -------
(IN MILLIONS)
<S> <C> <C>
Statutory federal income tax provision...................... $10.0 35.0%
U.S. loss not benefited..................................... 5.1 17.9
U.K. subsidiary company loss not benefited.................. 2.4 8.4
Nondeductible goodwill amortization......................... 1.7 6.0
Consolidated foreign earnings taxed at other than the U.S.
rate...................................................... (1.8) (6.3)
Equity loss of foreign investment........................... 0.4 1.4
Other....................................................... 0.5 1.8
----- ----
$18.3 64.2%
===== ====
</TABLE>
The principal components of Azurix's net deferred income tax liability at
December 31, 1998 was as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
Deferred income tax assets:
U.K. Advance Corporation Tax receivable................... $ 83.1
U.S. net operating loss carryforward...................... 5.1
U.K. net operating loss carryforward...................... 3.5
Other..................................................... 5.9
Valuation allowance....................................... (8.6)
-------
Total deferred tax assets......................... 89.0
-------
Deferred income tax liabilities:
Depreciation, depletion and amortization.................. (490.6)
Pension plan differences.................................. (1.8)
Other..................................................... (1.0)
-------
Total deferred tax liabilities.................... (493.4)
-------
Net deferred tax assets (liabilities)............. $(404.4)
=======
</TABLE>
Azurix has U.K. Advance Corporation Tax credit carryforwards at December
31, 1998 of approximately $83.1 million that can be used to offset U.K. taxes
payable in future years. At December 31, 1998, the U.K. Advance Corporation Tax
credit has an indefinite carryforward period. At December 31, 1998, Azurix has a
U.S. tax loss carryforward of approximately $14.7 million that will expire in
2018. Management believes that sufficient uncertainty exists regarding the
realizability of the U.S. loss carryforwards, such that a valuation allowance is
appropriate at December 31, 1998. At March 31, 1999, management believes that no
valuation allowance is necessary for U.S. losses generated in the first three
months of 1999 due to the expected future income resulting from finalizing water
projects and available tax planning strategies. All deferred tax assets will be
reassessed as future business activity occurs. At December 31, 1998, Azurix has
U.K. subsidiary company loss carryforwards of approximately $11.8 million that
can be carried forward for an indefinite period. However, due to restrictions on
the use of such loss carryforwards, the benefits have not been reflected in
Azurix's results of operations.
U.S. and foreign income taxes have been provided for earnings of foreign
subsidiary and affiliate companies that are expected to be remitted to the U.S.
Foreign subsidiaries' and affiliates' cumulative
F-24
<PAGE> 153
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
undistributed earnings of approximately $43.2 million are considered to be
indefinitely reinvested outside the U.S. and, accordingly, no U.S. income taxes
have been provided thereon. In the event of a distribution of those earnings in
the form of dividends, Azurix may be subject to both foreign withholding taxes
and U.S. income taxes net of allowable foreign tax credits.
NOTE 10 -- SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for taxes and interest expense is as follows:
<TABLE>
<CAPTION>
JANUARY 29, 1998 THREE MONTHS
(DATE OF INCEPTION) ENDED
TO DECEMBER 31, MARCH 31,
1998 1999
------------------- ------------
(UNAUDITED)
(IN MILLIONS)
<S> <C> <C>
Utility taxes(1)....................................... $81.7 $ --
Income taxes........................................... -- 12.6
Interest (net of amounts capitalized).................. 9.6 12.8
</TABLE>
- ---------------
(1) One-time tax levied on private utilities by the U.K. Government. This amount
was recorded to Wessex's net income in 1997.
NON-CASH TRANSACTIONS
During 1998, Azurix issued debt in the form of loan notes in connection
with the Wessex acquisition (see Note 7). During 1998, Azurix received a capital
contribution from Enron of the outstanding stock of a subsidiary that holds an
interest in Obras Sanitarias Mendoza. The transfer was recorded at the book
value of Enron of $71.8 million.
NOTE 11 -- RELATED PARTY TRANSACTIONS
During 1998, Azurix entered into a U.K. pounds sterling denominated loan
with Enron for $119.7 million. Interest of $2.1 million accrued during the
period the loan was outstanding at the London interbank offered rate plus 0.8%.
The principal and accrued interest were repaid to Enron in 1998.
Enron will exert influence over the policies, management and affairs of
Azurix. Some individuals who serve as officers and directors of Enron also serve
as directors of Azurix. The directors and officers of Enron have fiduciary
duties to manage Enron, including its investments in subsidiaries and affiliates
in a manner beneficial to Enron and its stockholders. Similarly, the directors
and officers of Azurix have fiduciary duties to manage Azurix in a manner
beneficial to Azurix and its stockholders.
Enron and Azurix propose to enter into an agreement that addresses the
scope of Azurix's business and it is anticipated that it will provide that
certain activities in which Enron and its affiliates may engage are permitted,
even if those activities have a competitive impact on Azurix. In general, it is
anticipated that Enron will be permitted to engage in any business whatsoever,
including water, wastewater and other businesses competing with Azurix, and may
compete in public tenders against Azurix, provided the business is conducted and
opportunities are identified and developed through Enron's own personnel and not
through Azurix. The agreement is expected to contain other provisions regarding
the activities to be performed by Azurix and Enron's involvement in those
activities.
Enron provides office space (see Note 15) to Azurix and various services
such as computer hardware and software and support services such as risk
management, accounts payable, payroll and information technology services. Costs
are allocated to Azurix based upon usage, or where no direct method can be
F-25
<PAGE> 154
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
efficiently applied due to administrative burden, upon factors such as
annualized payroll or employee headcount. During 1998, the expense recorded for
these services was approximately $1.5 million.
Employees, other than Wessex employees, are covered by various employee
benefit plans of Enron such as retirement, stock option, medical, dental, life
insurance and other benefit plans. These costs are allocated to Azurix based
upon Enron's costs of administering and providing the benefit plans. During 1998
the expense recorded under the plan arrangements was approximately $1.4 million.
During 1998, Enron advanced funds to Azurix for costs incurred by Azurix
from third parties. In addition, during 1998, Enron advanced funds to Azurix
related to office space and other services provided by Enron and costs of
benefit plans for employees, each described above. The amount advanced during
1998 was $17.7 million and is reported in the Consolidated Balance Sheet as a
component of "Accounts payable -- affiliates."
Management believes the above allocation methods and costs are reasonable.
A director of a subsidiary of Wessex owns assets utilized in the
subsidiary's operations. The subsidiary was charged $0.1 million for the use of
those assets during the period Azurix owned Wessex.
BRISTOL WATER TRUST
During 1998, Azurix entered into a U.K. pounds sterling denominated senior
loan agreement with Bristol Water Trust, as amended and restated, an affiliate
company wholly owned by Atlantic Water. The note accrues interest at 6.25% per
annum and is payable semi-annually, beginning June 1999. Under the note
agreement maturing December 2001, prepayment is allowed in whole or part at any
time. The principal balance outstanding at December 31, 1998 was $121.4 million.
Interest expense recorded for 1998 was $1.9 million.
NOTE 12 -- PENSION BENEFITS
Wessex maintains three defined benefit pension plans that cover
substantially all of its employees. The assets are held in separate trustee
administered funds. The pension cost charged to the consolidated statement of
income has been determined on the advice of independent qualified actuaries and
is accrued over the service lives of the employees expected to be eligible to
receive such benefits.
The following weighted average assumptions were used in determining the
funded status and pension charge for the period October 2, 1998 through December
31, 1998:
<TABLE>
<CAPTION>
PERCENT
-------
<S> <C>
Discount rate............................................... 5.8%
Expected return on plan assets.............................. 6.8%
Rate of compensation increase............................... 4.3%
Pension increases........................................... 2.5%
</TABLE>
F-26
<PAGE> 155
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
The plan's funded status and related pension accrual as of December 31,
1998 are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
Change in benefit obligation:
Benefit obligation at Wessex acquisition date............. $231.5
Service cost........................................... 1.5
Interest cost.......................................... 3.4
Plan participants' contributions....................... 0.5
Actuarial loss......................................... 16.7
Benefits paid.......................................... (2.2)
Exchange difference.................................... (5.2)
------
Benefit obligation at end of period............... $246.2
======
Change in plan assets:
Fair value of plan assets at Wessex acquisition date...... $237.3
Actual return on plan assets........................... 27.7
Employer contribution.................................. 1.3
Plan participants' contribution........................ 0.5
Benefits paid.......................................... (2.2)
Exchange difference.................................... (5.4)
------
Fair value of plan assets at end of period........ $259.2
======
Funded status:
Fair value of plan assets.............................. $259.2
Projected benefit obligation........................... 246.2
------
Funded status.......................................... 13.0
Unrecognized net actuarial loss........................ (6.9)
------
Prepaid benefit cost.............................. $ 6.1
======
</TABLE>
Net periodic benefit cost includes the following components:
<TABLE>
<S> <C>
Service cost.............................................. $ 1.5
Interest cost............................................. 3.4
Expected return on plan assets............................ (4.0)
------
Net periodic benefit cost................................. $ 0.9
======
</TABLE>
Two of the three pension plans have an aggregate prepaid benefit cost of
$7.6 million that is included in "Other assets" on the Consolidated Balance
Sheet and the remaining plan has an accrued benefit obligation of $1.5 million
that is included in "Other long-term liabilities" on the Consolidated Balance
Sheet.
NOTE 13 -- STOCKHOLDER'S EQUITY
COMMON STOCK
During 1998, Azurix issued 1,000 shares of $1.00 par value common stock. On
February 2, 1999, Azurix effected a 100,000-for-one stock split and restated the
par value to $0.01 that resulted in 100 million shares issued and outstanding.
Share and per share data for 1998 presented herein have been adjusted to give
effect to this split as if it had occurred on the date of inception of Azurix.
F-27
<PAGE> 156
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
ADDITIONAL PAID-IN CAPITAL
During 1998, Azurix received cash contributions of approximately $1.6
billion. In addition, Azurix received a capital contribution from Enron of the
outstanding stock of a subsidiary that holds a 32.1% ownership interest in Obras
Sanitarias Mendoza. The transfer was recorded at Enron's book value of $71.8
million.
STOCK INCENTIVE PLAN
In February 1999, Azurix established a stock incentive plan which provides
for the granting or awarding of stock options and restricted stock to directors,
officers and key employees of Azurix. At any particular time, the number of
shares of common stock issued under the stock incentive plan may not exceed 15%
of the total number of shares of common stock outstanding. Under the stock
incentive plan, Azurix granted options to purchase 7.8 million shares of its
common stock, at an exercise price per share of $16.72. The options vest from
three to five years after the grant date and expire ten years after the grant
date.
NOTE 14 -- RESTRICTED NET ASSETS OF SUBSIDIARIES
Certain subsidiaries of Azurix have governmental and regulatory
restrictions or approvals required in order to pay dividends or make
intercompany loans and advances to it. The amount of restricted net assets of
Azurix's subsidiaries at December 31, 1998 is approximately $1.5 billion.
NOTE 15 -- COMMITMENTS AND CONTINGENCIES
Azurix leases office space from Enron under a lease obligating only Enron
and specific subsidiaries and affiliates (see Note 11). Azurix has no
contractual obligation under these office lease agreements but pays to Enron the
amount determined in the lease or the contract rate applied to square footage
occupied. Azurix accrued rent expense to Enron for office space totaling $0.3
million in 1998.
Azurix leases property under various operating leases. Future minimum
operating lease payments as of December 31, 1998, in the aggregate and for each
of the five succeeding fiscal years, are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
1999........................................................ $0.7
2000........................................................ 0.5
2001........................................................ 0.5
2002........................................................ 0.3
2003........................................................ 0.8
----
Total minimum lease payments................................ $2.8
====
</TABLE>
Azurix has contractual commitments for capital expenditures to be incurred
after December 31, 1998 of $130.2 million.
Azurix is involved in various claims and lawsuits incidental to its
business. Although no assurances can be given, Azurix believes that the ultimate
resolution of such items will not have a material effect on its results of
operations or financial position.
Azurix is subject to extensive federal, foreign, state and local
environmental laws and regulations. We anticipate future changes in, or
decisions affecting, regulatory regimes that will serve to expand or tighten
F-28
<PAGE> 157
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
regulatory controls. Some of these changes or decisions could have a material
adverse effect on our financial position and results of operations.
A substantial portion of Azurix's revenues are subject to governmental
regulation of the rates that it may charge to its customers. The U.K. government
is currently conducting a periodic review of the price limits for water and
sewerage companies in England and Wales that is expected to result in new price
limits for the period from April 1, 2000 through 2005 that will be lower than
current price limits. Although we are unable to predict the precise outcome of
the current U.K. rate review, it is likely to significantly reduce Wessex's
revenues and earnings, but should not have a material adverse effect on Azurix's
financial position.
NOTE 16 -- EVENTS SUBSEQUENT TO THE DATE OF REPORT OF INDEPENDENT PUBLIC
ACCOUNTANTS (UNAUDITED)
Azurix entered into an agreement on March 25, 1999 to acquire 100% of the
stock of Canadian-based Philip Utilities Management Corporation for $106.3
million. Philip Utilities is a water and wastewater services company in the U.S.
and Canada that provides operations and management, engineering, residuals
management and underground infrastructure development services for municipal
water and wastewater facilities. The acquisition closed on May 18, 1999 and will
be reflected in Azurix's financial statements as of that date.
On May 10, 1999, Azurix entered into a $686.0 million revolving credit
facility. On May 13, 1999, Azurix borrowed approximately $75.9 million, of which
approximately $67.8 million was used to repay all of the remaining indebtedness
outstanding on the former senior credit facility (see Note 7) and approximately
$8.1 million was used to pay fees and expenses related to this facility. On May
14, 1999, Azurix borrowed $107.0 million under this revolving credit facility
primarily to fund the purchase of Philip Utilities. A portion of the unused
borrowing capacity under this facility secures outstanding loan notes of $113.8
million (see Note 7). The facility bears interest at the London interbank
offered rate plus 0.75% to 1.0%, depending on the level of utilization of the
borrowing capacity. After funding the Philip Utilities acquisition, the
revolving credit facility has approximately $280.4 million of borrowing capacity
for acquisitions. Azurix incurs commitment fees of 0.375% on the unused
borrowing capacity of this facility. The facility terminates on May 10, 2002.
The facility contains restrictive covenants which include limitations on
borrowings, the maintenance of financial ratios such as interest coverage and
debt to equity and contracts to perform or refrain from undertaking certain
acts. The facility includes standard events of default, including non-payment,
cross-defaults and insolvency. Azurix is currently in compliance with these
covenants.
Effective May 1, 1999, Azurix signed an agreement with Enron pursuant to
which Enron will provide various corporate staff and support services to Azurix.
These services include information technology, office space, building
maintenance, security and other office services as well as employee development,
training and maintenance of compensation and other benefits programs. Azurix may
utilize Enron's regulatory affairs, marketing affairs, treasury and risk
assessment and control departments. In addition, Azurix may continue to
participate in Enron's corporate insurance program. The agreement provides that
Azurix may use the international offices of Enron and its affiliates for
projects, subject to mutual agreement with Enron or its affiliates on a
project-by-project basis. The agreement provides that Azurix will reimburse
Enron for direct charges related to the Enron services and facilities that it
utilizes. Azurix will also be allocated an amount for overhead charges related
to Enron corporate staff and support services which it utilizes. This overhead
charge will be allocated based upon factors such as employee headcount, payroll
and square footage. Azurix management believes the allocation methods and costs
are reasonable. Costs for services used under the agreement are expected to be
approximately $15 million annually. The agreement is for an
F-29
<PAGE> 158
AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION PRESENTED HEREIN FOR THE PERIOD SUBSEQUENT TO DECEMBER 31, 1998 IS
UNAUDITED)
indefinite term, but either party may terminate the agreement on 180 days'
notice. Azurix intends to enter into a related sublease with Enron providing for
the use of office space in Houston, Texas.
Effective May 1, 1999, Azurix entered into a credit agreement with Enron,
whereby Enron will provide funds to Azurix for general, administrative and
operating expenses. The credit agreement terminates December 15, 2001 or 90 days
following the date that Enron or its affiliates do not own or have the power to
vote at least one-third of our capital stock ordinarily entitled to vote for the
election of directors and fewer than one-third of our directors are officers,
directors or employees of Enron or its affiliates. The total commitment under
the credit agreement will be $180 million. Advances under the credit agreement
will bear interest at the federal funds rate plus 1.50%. Amounts borrowed under
the credit agreement may be prepaid, in full or in part, at any time during the
term of the credit agreement.
On May 18, 1999, authorities in the Province of Buenos Aires, Argentina,
notified Azurix that, subject to final confirmation, Azurix will be awarded an
interest in a 30-year water and wastewater concession in two regions of the
province, at an aggregate price of $438.6 million. Assuming this award is
formally confirmed, Azurix will acquire a 100% interest in the concessionaire,
with 10% being transferred to employees of the concessionaire within several
months. Azurix is expected to assume operation of the systems in these regions
on June 18, 1999.
On May 28, 1999, Azurix entered into an agreement to acquire 49% of the
capital stock of Industrias del Agua, S.A. de C.V., a water and wastewater
service company based in Monterrey, Mexico. Pursuant to a contract with the
Water Commission of the Federal District of Mexico, Industrias del Agua provides
metering, billing, collections, operations and maintenance services for an area
covering approximately one quarter of the Federal District within Mexico City, a
service area with a population of approximately two million people. In addition
to holding an equity interest in Industrias del Agua, Azurix will serve as the
technical participant in providing services under the Federal District contract.
Industrias del Agua has provided these services since 1993, when it signed this
10-year contract with the Water Commission of the Federal District. The purchase
is subject to the receipt of administrative and regulatory approvals, including
the approval by the Water Commission of the Federal District regarding the
substitution of Azurix as the technical participant under the contract. Azurix
will pay $22.5 million in connection with the transaction, which is expected to
close by the end of July 1999.
On June 9, 1999, the Securities and Exchange Commission declared the
registration statement relating to the initial public offering of the common
stock of Azurix effective.
F-30
<PAGE> 159
REPORT OF INDEPENDENT ACCOUNTANTS
To the stockholder of Wessex Water Ltd (formerly Wessex Water Plc):
We have audited the accompanying consolidated statements of income, changes
in stockholders' equity and cash flows of Wessex Water Plc (now renamed Wessex
Water Ltd) (predecessor company) (the "Company") and subsidiaries for the period
from April 1, 1998 to October 2, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations, cash flows and changes in
stockholders' equity of Wessex Water Plc (now renamed Wessex Water Ltd)
(predecessor company) and subsidiaries for the period from April 1, 1998 to
October 2, 1998 in conformity with generally accepted accounting principles.
Arthur Andersen
London, England
March 12, 1999
F-31
<PAGE> 160
REPORT OF INDEPENDENT ACCOUNTANTS
To the stockholder of Wessex Water Ltd (formerly Wessex Water Plc)
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, stockholders' equity and cash flows present
fairly, in all material respects, the financial position of Wessex Water Plc
(now renamed Wessex Water Ltd) and its subsidiaries (the "Company") at March 31,
1998, and the results of their operations and their cash flows for each of the
two years in the period ended March 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS
CHARTERED ACCOUNTANTS
Bristol, England
March 12, 1999
F-32
<PAGE> 161
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
CONSOLIDATED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED OCTOBER 2, 1998 AND THE YEARS ENDED MARCH 31, 1998 AND
1997
(TRANSLATED INTO U.S. DOLLARS -- SEE NOTE 1)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED MARCH 31,
OCTOBER 2, --------------------
1998 1998 1997
---------- ------- -------
IN MILLIONS U.S. DOLLARS
(EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C>
Operating revenues.......................................... $233.8 $436.6 $403.1
Operating expenses:
Operations and maintenance................................ 61.7 110.9 102.4
General and administrative................................ 36.4 29.1 32.2
Depreciation and amortization............................. 35.2 64.3 58.0
------ ------ ------
Operating income............................................ 100.5 232.3 210.5
------ ------ ------
Other income (expense):
Interest income........................................... 0.2 4.4 23.0
Interest expense.......................................... (6.3) (13.0) (12.8)
Equity earnings........................................... 5.8 13.3 14.7
------ ------ ------
Income before taxes......................................... 100.2 237.0 235.4
------ ------ ------
Taxation on ordinary activities............................. 28.4 58.0 82.4
Utility tax................................................. -- 162.3 --
------ ------ ------
Net income.................................................. 71.8 16.7 153.0
Dividends on preference shares.............................. 7.7 15.1 13.5
------ ------ ------
Net income attributable to common stockholders.............. $ 64.1 $ 1.6 $139.5
====== ====== ======
Basic earnings per share.................................... $ 0.30 $ 0.01 $ 0.65
====== ====== ======
Diluted earnings per share.................................. $ 0.30 $ 0.01 $ 0.55
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-33
<PAGE> 162
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
CONSOLIDATED BALANCE SHEET
AT MARCH 31, 1998
(TRANSLATED INTO U.S. DOLLARS -- SEE NOTE 1)
<TABLE>
<CAPTION>
MARCH 31,
1998
-------------
IN MILLIONS
U.S. DOLLARS,
EXCEPT
SHARE AMOUNTS
-------------
<S> <C>
ASSETS
Current Assets
Cash and cash equivalents................................. $ 1.8
Trade receivables (net of allowance for doubtful accounts
of $5.9)................................................ 43.5
Unbilled receivables...................................... 29.7
Other current assets...................................... 19.5
--------
Total current assets............................... 94.5
--------
Property, Plant and Equipment
Cost...................................................... 2,487.4
Less-accumulated depreciation............................. (549.9)
--------
Property, plant and equipment, net........................ 1,937.5
--------
Investments and Other Assets
Investment in equity method investee...................... 311.2
Goodwill, net of accumulated amortization................. 21.6
Other..................................................... 7.5
--------
Total Assets....................................... $2,372.3
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Borrowings from banks..................................... $ 82.7
Current portion of long-term debt......................... 38.3
Accounts payable and accruals............................. 227.5
Amounts due to equity method investee..................... 6.2
Advances from customers................................... 23.7
Proposed dividend......................................... 23.1
--------
Total current liabilities.......................... 401.5
--------
Long-Term Debt.............................................. 169.7
Deferred Credits and Other Liabilities
Deferred income taxes..................................... 306.5
Other..................................................... 6.1
--------
Total long-term liabilities........................ 482.3
--------
Commitments and Contingent Liabilities (Note 18)
Redeemable Preference Shares (Authorized -- 310,000,000;
issued and paid 308,984,402 shares of 50p each, redeemable
at par)................................................... 259.0
--------
Stockholders' Equity:
Common stock (Authorized: 346,666,670; issued and paid:
212,677,552 shares of 60p).............................. 188.3
Additional paid-in capital................................ 80.6
Accumulated other comprehensive income.................... 182.0
Retained earnings......................................... 778.6
--------
Total stockholders' equity......................... 1,229.5
--------
Total Liabilities and Stockholders' Equity......... $2,372.3
========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-34
<PAGE> 163
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED OCTOBER 2, 1998 AND THE YEARS ENDED MARCH 31, 1998 AND
1997
(TRANSLATED INTO U.S. DOLLARS -- SEE NOTE 1)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED MARCH 31,
OCTOBER 2, ---------------------
1998 1998 1997
---------- --------- --------
IN MILLIONS U.S. DOLLARS
----------------------------------
<S> <C> <C> <C>
Operating Activities:
Net income.................................................. $ 71.8 $ 16.7 $153.0
Adjustments required to reflect cash flows from operating
activities:
Income and expense items not involving cash flows:
Share in profits of equity method investee, net of related
taxes.................................................. (3.1) (6.7) (9.5)
Depreciation and amortization............................. 35.2 64.3 58.0
Deferred taxes............................................ 23.2 24.9 (2.1)
Loss on disposal of fixed assets.......................... 0.8 2.5 1.3
Other..................................................... 0.1 0.5 (1.8)
------- ------- ------
128.0 102.2 198.9
------- ------- ------
Changes in operating asset and liability items:
(Increase) decrease in trade accounts receivable.......... 6.9 (4.8) 2.2
(Increase) in prepayments................................. (0.3) (0.8) (6.5)
(Increase) decrease in other current assets............... (8.3) 22.3 3.6
Increase (decrease) in advances from customers............ 2.5 1.1 (3.0)
Increase in accounts payable and accruals................. 3.4 5.0 51.1
------- ------- ------
4.2 22.8 47.4
------- ------- ------
Net cash provided by operating activities................... 132.2 125.0 246.3
------- ------- ------
Investing Activities:
Purchase of fixed assets.................................. (108.9) (198.6) (149.1)
Decrease in short-term investments........................ -- -- 49.6
Other..................................................... 0.5 3.6 1.7
------- ------- ------
Net cash used in investing activities....................... (108.4) (195.0) (97.8)
------- ------- ------
Financing Activities:
Repurchase of ordinary shares............................. -- -- (300.8)
Repurchase of preference shares........................... (143.4) -- --
Short-term loans received................................. 177.5 80.7 --
Repayment of lease obligations............................ (8.7) (15.6) (12.8)
Dividends paid............................................ (51.4) (65.7) (62.9)
Other..................................................... 2.4 7.4 3.5
------- ------- ------
Net cash (used in) provided by financing activities......... (23.6) 6.8 (373.0)
------- ------- ------
Effect of exchange rate changes on cash balances............ (0.3) (1.3) 19.1
------- ------- ------
Decrease in cash and cash equivalents....................... (0.1) (64.5) (205.4)
Balance of cash and cash equivalents at beginning of
period.................................................... 1.8 66.3 271.7
------- ------- ------
Balance of cash and cash equivalents at end of period....... $ 1.7 $ 1.8 $ 66.3
======= ======= ======
Supplemental Cash Flow Items:
Interest paid (net of amounts capitalized)................ $ 8.6 $ 12.3 $ 12.5
Income taxes paid......................................... 5.3 86.5 21.6
Utility tax paid.......................................... -- 83.1 --
Non-Cash Investing and Financing Activities:
Scrip dividends........................................... 37.4 9.8 4.4
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-35
<PAGE> 164
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED OCTOBER 2, 1998 AND THE YEARS ENDED MARCH 31, 1998 AND
1997
(TRANSLATED INTO U.S. DOLLARS -- SEE NOTE 1)
(IN MILLIONS U.S. DOLLARS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN COMPREHENSIVE RETAINED COMPREHENSIVE
STOCK CAPITAL INCOME EARNINGS TOTAL INCOME
------ ---------- ------------- -------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1996.................. $228.3 $ 13.8 $ 54.1 $1,058.2 $1,354.4
Net income............................... 153.0 153.0 $153.0
Other comprehensive income:
Translation differences............... 104.3 104.3 104.3
Unrealized gain on listed
investment.......................... (0.3) (0.3) (0.3)
------
Total comprehensive income....... $257.0
======
Shares issued............................ 2.4 6.8 9.2
Repurchase of shares..................... (45.5) (255.3) (300.8)
Amount transferred to capital reserve.... 45.5 (45.5) --
Dividends................................ (68.3) (68.3)
------ ------ ------ -------- --------
Balance at March 31, 1997.................. 185.2 66.1 158.1 842.1 1,251.5
Net income............................... 16.7 16.7 $ 16.7
Other comprehensive income:
Translation differences............... 22.8 22.8 22.8
Unrealized gain on listed
investment.......................... 1.1 1.1 1.1
------
Total comprehensive income....... $ 40.6
======
Shares issued............................ 3.1 14.5 17.6
Dividends................................ (80.2) (80.2)
------ ------ ------ -------- --------
Balance at March 31, 1998.................. 188.3 80.6 182.0 778.6 1,229.5
Net income............................... 71.8 71.8 $ 71.8
Other comprehensive income:
Translation differences............... 18.8 18.8 18.8
Unrealized gain on listed
investment.......................... (0.2) (0.2) (0.2)
------
Total comprehensive income....... $ 90.4
======
Shares issued............................ 5.1 33.8 38.9
Dividends................................ (57.1) (57.1)
Amount transferred to capital reserve.... 151.0 (151.0)
------ ------ ------ -------- --------
Balance at October 2, 1998................. $193.4 $265.4 $200.6 $ 642.3 $1,301.7
====== ====== ====== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-36
<PAGE> 165
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the operations
of Wessex Water Plc (now renamed Wessex Water Ltd) and its subsidiaries. On
October 2, 1998, Wessex was purchased by Azurix Europe Ltd, a wholly owned
subsidiary of Azurix Corp. The financial statements of Wessex have been prepared
for the purpose of presenting the financial statements of the predecessor
company of Azurix.
These financial statements have been prepared in accordance with generally
accepted accounting principles in the United States. The functional currency of
Wessex is pounds sterling. These accounts have been presented using U.S. dollars
as the reporting currency by translating the functional currency financial
statements using the current rate methodology described in the Statement of
Financial Accounting Standard 52, "Foreign Currency Translation."
The period from April 1 to October 2, 1998 will hereafter be referred to as
the "six months ended October 2, 1998."
NATURE OF OPERATIONS
Wessex Water Plc was incorporated on April 1, 1989. On September 1, 1989,
Wessex Water Plc acquired the entire issued share capital of Wessex Water
Services Ltd, a company formed to continue the business of Wessex Water
Authority, as a result of the privatization by the U.K. government of the water
industry in England and Wales. The acquisition was effected through the issue of
49,998 Wessex shares to the Secretary of State for the Environment which were
credited as fully paid. The assets and liabilities acquired by Wessex were
recorded at book value as Wessex was owned by the U.K. government at the date of
the transfer making the transaction an exchange between entities under common
control. Wessex's principal activity is the provision of water supply and
wastewater services in southwestern England through its wholly owned subsidiary,
Wessex Water Services Ltd. Wessex's other business activities include SC
Technology AG, which does business as Swiss Combi and sells and operates sludge
drying plants.
Wessex Water Services Ltd is licensed to operate as a water and sewerage
company in its region, subject to regulation of its water supply and wastewater
treatment services by government agencies including the Office of Water Services
and the Drinking Water Inspectorate. Wessex is subject to regulation of the
rates it may charge for its regulated water supply and wastewater treatment
businesses.
BASIS OF CONSOLIDATION
The consolidated financial statements include the financial statements of
Wessex Water Plc and all its majority owned and controlled subsidiaries. All
inter-company transactions are eliminated as part of the consolidation process.
Investments in companies in which Wessex owns 20 percent to 50 percent of
the voting stock and has significant influence are accounted for using the
equity method with Wessex's share of profits and losses included in the
consolidated income statement. Wessex's share of post-acquisition retained
profits/losses is added to/deducted from the cost of the investee in the
consolidated balance sheet.
USE OF ESTIMATES
Preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management 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 financial
F-37
<PAGE> 166
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FOREIGN CURRENCIES
On consolidation, assets and liabilities of subsidiaries denominated in
foreign currencies, where the local currency is the functional currency, have
been translated at year-end rates. Income and expense items are translated using
the annual weighted average rates of exchange or, where known or determinable,
at the rate on the date of the transaction for significant items. Adjustments
arising from the translation have been recorded in other comprehensive income
and are included in income only upon sale or liquidation of the underlying
investments.
Transactions in currencies other than the functional currency are recorded
at the rate of exchange at the date of the transaction. Assets and liabilities
in currencies other than the functional currency are translated at year-end
rates. Any resulting exchange differences are taken to the consolidated income
statement.
The exchange rates used to translate the pounds sterling functional
currency financial statements to U.S. dollars were:
<TABLE>
<CAPTION>
U.S. DOLLARS PER
POUNDS STERLING
-----------------
<S> <C> <C>
Period from April 1 to October 2, 1998..................... Average 1.6536
As of March 31, 1998....................................... Year end 1.6765
Year ended March 31, 1998.................................. Average 1.6413
Year ended March 31, 1997.................................. Average 1.5853
</TABLE>
CASH AND CASH EQUIVALENTS
Cash and cash equivalents represent cash and short-term highly liquid
investments with original maturities of three months or less.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment assets are stated at historical cost, less
accumulated depreciation. Depreciation is charged on a straight-line basis over
the estimated useful lives of the respective assets, based on the following
useful lives:
<TABLE>
<CAPTION>
YEARS
-------
<S> <C>
Buildings and operational structures........................ 15 - 80
Infrastructure assets....................................... 85
Plant, machinery and vehicles............................... 3 - 30
Other assets................................................ 4 - 15
</TABLE>
Major improvements to leasehold properties are amortized over the shorter
of the asset life and the life of the respective lease.
Interest is capitalized on qualifying assets during the time required to
prepare the assets for their intended use using Wessex's weighted average
borrowing rate. The capitalized interest is amortized over the life of the
assets.
F-38
<PAGE> 167
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GOODWILL
Goodwill is the excess of the purchase price over the fair value of the
identifiable assets acquired less the liabilities assumed of the acquired
company. Goodwill is capitalized and amortized over its estimated useful life
which ranges from twenty years (SC Technology) to forty years (Wessex Waste
Management Ltd.).
LEASES
Assets held under finance lease agreements are treated as tangible assets
and the present value of the related lease payments is recorded as a liability.
Costs for operating leases are charged to the income statement in the period
incurred.
LONG-LIVED ASSETS
Wessex evaluates the carrying value of long-lived assets to be held and
used, including goodwill and other intangible assets, when events and
circumstances warrant such a review. The carrying value of a long-lived asset is
considered impaired when the estimated undiscounted cash flow from such an asset
is less than its carrying value. In that event, a loss is recognized based on
the amount by which the carrying value exceeds the estimated fair market value
of the long-lived asset. Fair market value is determined primarily using the
estimated cash flows discounted at a rate commensurate with the risk involved.
TAXATION
Provision is made for all taxes payable in respect of profit earned in the
year. Deferred income tax is provided using the liability method for all
temporary differences arising between the tax basis of assets and liabilities
and their carrying value for financial reporting purposes, using the enacted tax
rate. Deferred tax assets are reduced by a valuation allowance to the extent
that it is more likely than not that all or part of the asset will not be
realized. No deferred tax liability has been recognized for undistributed
earnings of domestic subsidiaries since such earnings can be transferred to the
parent company without tax consequences.
REVENUE RECOGNITION
For metered customers, Wessex recognizes revenue based on actual usage and
accrues revenue for the estimated amount of water sold but not billed as of the
balance sheet date. The revenue for non-metered customers, who pay an annual
fixed charge based on the rateable value of their property, is recognized
uniformly over the year.
PENSIONS
Current service costs for defined benefit plans are accrued in the period
to which they relate. Prior service costs, if any, relating to amendments of the
plans, are recognized over the remaining average service lives of those
employees. The pension schemes are of the defined benefit type, which are
externally funded and valued by an independent actuary.
INVESTMENTS IN EQUITY SECURITIES
Available-for-sale securities are reported at fair value and individual
securities are classified as a current or non-current asset, as appropriate.
Unrealized holding gains and losses for all available-for-sale
F-39
<PAGE> 168
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
securities are reported net, as a separate component of other comprehensive
income, a part of stockholders' equity, until the gains and losses are realized.
DERIVATIVE FINANCIAL INSTRUMENTS
Wessex uses cross-currency and interest rate swaps for the purpose of
hedging specific exposures as part of its risk management program and holds all
derivatives for purposes other than trading. Deferral (hedge) accounting is
applied only if the derivative reduces the risk of the underlying hedged item
and is designated at inception as a hedge with respect to the underlying hedged
item. Additionally, the derivative must result in cash flows that are expected
to be inversely correlated to those of the underlying hedged item. Under hedge
accounting, the changes in market value of the derivatives and the hedged assets
or liabilities are deferred and recognized in net income in the same period. If
Wessex's use of derivatives did not qualify for hedge accounting treatment, the
derivative would be recorded at fair value with changes in fair value recognized
in net income.
EARNINGS PER SHARE
Basic earnings per share is based on the earnings from continuing
operations available to common stockholders divided by the weighted average
number of shares outstanding during each period. Diluted earnings per share is
calculated in the same manner as basic earnings per share except that the
numerator is increased by the amount of dividends payable to the holders of
convertible securities and the denominator is increased, using the treasury
stock method, to include the number of additional ordinary shares that would
have been outstanding, assuming the exercise of all employee stock options and
the conversion of all convertible securities that would have had a dilutive
effect on basic earnings per share.
ENVIRONMENTAL COSTS
Environmental expenditures that relate to current operations are expensed.
Expenditures providing a future benefit are capitalized as appropriate.
Remediation costs that relate to an existing condition caused by past operations
are accrued when it is probable that these costs will be incurred and can be
reasonably estimated.
STOCK-BASED COMPENSATION
Wessex follows Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations in accounting for its
employee stock options. Under Accounting Principles Board Opinion No. 25,
compensation expense is recorded when the exercise price of employee stock
options is less than the fair value of the underlying stock on the measurement
date.
ACCOUNTING STANDARDS ISSUED
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 133 "Accounting for Derivative Instruments and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments and hedging activities. Statement of Financial Accounting
Standard 133 requires that an entity recognize all derivatives as either assets
or liabilities in the balance sheet at fair value. Statement of Financial
Accounting Standard 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Wessex is currently evaluating, and has not yet
determined, the effect that the adoption of Statement of Financial Accounting
Standard 133 will have on its financial statements.
F-40
<PAGE> 169
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities," which requires that costs for start-up activities and organization
costs be expensed as incurred and not capitalized as had previously been
allowed. Statement of Position 98-5 is applicable to all financial statements
for fiscal years beginning after December 15, 1998 and initial adoption is
required to be reflected as a cumulative effect of an accounting change. The
adoption of Statement of Position 98-5 is not expected to have a material effect
on Wessex's financial position or results of operations.
NOTE 2 -- INTEREST EXPENSE
<TABLE>
<CAPTION>
SIX
MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, ---------------
1998 1998 1997
----------- ------ ------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C>
Gross interest expense...................................... $11.3 $21.4 $18.7
Interest capitalized........................................ (5.0) (8.4) (5.9)
----- ----- -----
Net interest expense........................................ $ 6.3 $13.0 $12.8
===== ===== =====
</TABLE>
NOTE 3 -- OTHER CURRENT ASSETS
<TABLE>
<CAPTION>
MARCH 31,
1998
---------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
Other receivables........................................... $ 8.0
Available-for-sale securities............................... 4.7
Prepayments................................................. 3.5
Other....................................................... 3.3
-----
$19.5
=====
</TABLE>
F-41
<PAGE> 170
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
BUILDINGS PLANT TOTAL
AND MACHINERY PROPERTY,
OPERATIONAL INFRASTRUCTURE AND OTHER CONSTRUCTION- PLANT &
STRUCTURES ASSETS VEHICLES ASSETS IN-PROGRESS EQUIPMENT
----------- -------------- --------- ------ ------------- ---------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C> <C> <C> <C>
Cost:
March 31, 1997............. $573.5 $ 961.2 $ 594.1 $42.9 $ 87.7 $2,259.4
Additions.................. 25.6 61.0 39.4 3.8 82.9 212.7
Transfers.................. 0.7 26.9 12.8 6.9 (47.3) --
Disposals.................. (0.5) -- (26.3) (5.5) -- (32.3)
Translation differences.... 11.6 20.5 12.0 1.0 2.5 47.6
------ -------- ------- ----- ------ --------
March 31, 1998............... $610.9 $1,069.6 $ 632.0 $49.1 $125.8 $2,487.4
====== ======== ======= ===== ====== ========
Accumulated depreciation:
March 31, 1997............. $ 96.4 $ 169.4 $ 214.5 $24.7 $ -- $ 505.0
Additions.................. 10.5 11.8 34.6 6.1 -- 63.0
Disposals.................. (0.2) -- (22.8) (5.6) -- (28.6)
Translation differences.... 2.1 3.5 4.5 0.4 -- 10.5
------ -------- ------- ----- ------ --------
March 31, 1998............... $108.8 $ 184.7 $ 230.8 $25.6 $ -- $ 549.9
====== ======== ======= ===== ====== ========
Net book value:
March 31, 1998............. $502.1 $ 884.9 $ 401.2 $23.5 $125.8 $1,937.5
====== ======== ======= ===== ====== ========
</TABLE>
Included in property, plant and equipment are the following amounts
relating to capital leases:
<TABLE>
<CAPTION>
BUILDINGS PLANT TOTAL
AND MACHINERY PROPERTY,
OPERATIONAL INFRASTRUCTURE AND OTHER CONSTRUCTION- PLANT &
STRUCTURES ASSETS VEHICLES ASSETS IN-PROGRESS EQUIPMENT
----------- -------------- --------- ------ ------------- ---------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C> <C> <C> <C>
Cost......................... $ 40.1 $ 73.1 $ 45.2 $ 1.2 $ -- $ 159.6
Accumulated depreciation..... (3.9) -- (14.6) (0.8) -- (19.3)
------ -------- ------- ----- ------ --------
Net.......................... $ 36.2 $ 73.1 $ 30.6 $ 0.4 $ -- $ 140.3
====== ======== ======= ===== ====== ========
</TABLE>
The net book value of property, plant and equipment as of March 31, 1998
includes interest capitalized of $62.5 million.
NOTE 5 -- GOODWILL
Goodwill arising on the acquisition of SC Technology on January 3, 1996 was
$24.3 million, with an annual amortization charge of $1.2 million. Accumulated
amortization as of March 31, 1998 is $2.7 million.
F-42
<PAGE> 171
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- INVESTMENT IN EQUITY METHOD INVESTEE
At March 31, 1998, Wessex had a 50.0% share of Wessex Waste Management Ltd,
holding Class B shares of L1 each. Wessex Waste Management Ltd trades as UK
Waste through its wholly owned subsidiaries. UK Waste collects, recycles and
disposes of waste from commercial and domestic customers.
<TABLE>
<CAPTION>
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
Investment at cost, April 1, 1997
Share in net identifiable assets acquired................... $ 48.3
Goodwill.................................................... 225.2
------
Cost........................................................ 273.5
Less: Accumulated amortization of goodwill.................. (30.9)
Share of retained profit.................................... 63.3
Translation difference...................................... 5.3
------
Book value at March 31, 1998................................ $311.2
======
</TABLE>
Summarized financial information for Wessex Waste Management Ltd is
presented below. At March 31, 1998, Wessex's share of earnings and of the net
assets of Wessex Waste Management Ltd was 50.0%.
<TABLE>
<CAPTION>
MARCH 31,
1998
---------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
Current assets.............................................. $ 89.9
Non-current assets.......................................... 643.3
------
Total assets...................................... $733.2
======
Current liabilities......................................... $ 74.3
Non-current liabilities..................................... 36.5
Stockholders' equity........................................ 622.4
------
Total liabilities and stockholders' equity........ $733.2
======
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, -----------------
1998 1998 1997
----------- ------- -------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C>
Revenues................................................. $145.2 $285.1 $237.8
Operating profit......................................... 10.6 25.1 28.7
Net income before tax.................................... 11.6 26.6 29.4
</TABLE>
F-43
<PAGE> 172
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -- ACCOUNTS PAYABLE AND ACCRUALS
<TABLE>
<CAPTION>
MARCH 31,
1998
---------------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
Trade accounts payable...................................... $ 8.4
Capital expenditure accruals................................ 56.0
Corporation tax............................................. 16.8
Advance corporation tax..................................... 19.3
Utility tax................................................. 83.0
Accruals.................................................... 42.7
Other....................................................... 1.3
------
Total............................................. $227.5
======
</TABLE>
NOTE 8 -- BORROWINGS FROM BANKS
<TABLE>
<CAPTION>
MARCH 31,
1998
---------------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
Bank overnight credit facility.............................. $24.0
Revolving line of credit.................................... 58.7
-----
Total............................................. $82.7
=====
</TABLE>
Wessex has an overnight overdraft facility with two banks. In addition,
Wessex maintains a credit agreement with a syndicate of banks which provides
$402 million, denominated in pounds sterling, of committed lines of credit which
expire on April 21, 1999. The interest rate on draw-downs is the London
interbank offered rate plus 0.18%. Wessex pays commitment fees of 0.09% on the
unused portion of the lines of credit. The weighted average effective interest
rate at March 31, 1998 on short-term borrowings is 7.75%.
NOTE 9 -- LONG-TERM DEBT
<TABLE>
<CAPTION>
MARCH 31,
1998
----------------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
European Investment Bank loan #1 -- U.S. dollar, variable
interest rate of 6 month London interbank offered rate
minus 0.25% due October 2001.............................. $ 50.3
European Investment Bank loan #2 -- Italian lire, fixed
interest rate of 11.6% due June 2002...................... 24.5
European Investment Bank loan #3 -- European currency unit,
fixed interest rate of 5.7% due December 1998............. 12.7
Capital lease, fixed interest rate of 8.06% due September
2002...................................................... 120.0
Other long-term debt........................................ 0.5
------
208.0
Less: Current portion included in current liabilities....... (38.3)
------
Total............................................. $169.7
======
</TABLE>
F-44
<PAGE> 173
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Minimum annual principal payments due on long-term debt are as follows:
<TABLE>
<S> <C>
Year ending March 31:
1999...................................................... $ 38.3
2000...................................................... 29.0
2001...................................................... 32.9
2002...................................................... 87.5
2003...................................................... 20.3
------
Total............................................. $208.0
======
</TABLE>
The three European Investment Bank currency term loans which are due and
payable from 1998 through June 2002 have both fixed and variable interest rates
in their respective currencies with semiannual interest payments. Using a
combination of interest rate swaps and currency swaps these rates are changed to
variable and fixed pounds sterling interest rates.
Wessex's term loans and credit facilities are subject to certain financial
covenants, including the maintenance of minimum interest cover, maximum gearing
levels and minimum net worth.
NOTE 10 -- FINANCIAL INSTRUMENTS
Wessex uses a variety of financial instruments denominated in foreign
currencies, at both floating and fixed interest rates, to finance its
operations. Wessex manages the risk arising on these instruments by entering
into cross-currency and interest rate swaps.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amount of short-term financial instruments including cash and
cash equivalents, accounts receivable, accounts payable, and all other
short-term financial assets and liabilities, including bank debt, approximates
fair value due to the short maturity of those instruments.
The fair value of preference shares with mandatory redemption requirements
and long-term debt are estimated using discounted cash flow analyses based on
Wessex's current incremental financing rates for similar types of securities.
The fair value of currency swaps and interest rate swaps was determined based on
a model which estimates the fair value of these swap contracts using market
rates at March 31, 1998 or was based on quoted market prices for similar
instruments with similar maturities. A comparison of the carrying value and fair
value of these instruments is included below:
<TABLE>
<CAPTION>
MARCH 31, 1998
---------------------
ESTIMATED CARRYING
FAIR VALUE AMOUNT
---------- --------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C> <C>
Long-term debt (including current portion).................. $ 79.2 $ 78.4
Preference shares with mandatory redemption................. 272.2 259.0
Derivatives:
Interest rate swaps....................................... (9.0) --
Currency swaps............................................ 14.2 9.6
</TABLE>
RISKS AND CONCENTRATIONS
Wessex's cash equivalents consist primarily of short-term money market
deposits. Wessex has deposited its cash equivalents with reputable financial
institutions and believes the risk of loss to be
F-45
<PAGE> 174
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
remote. Wessex has accounts receivable from customers concentrated in
southwestern England with no single customer accounting for more than 10% of
sales.
Wessex is exposed to credit risk in the event of non-performance by
counterparties to interest rate and cross-currency swap contracts. However,
because Wessex deals only with major commercial banks with high-quality credit
ratings, it does not anticipate non-performance by any of these counterparties.
Wessex is exposed to market risk in the form of foreign exchange rate and
interest rate risks. Wessex has one consolidated foreign subsidiary, which has a
functional currency of Swiss francs. On consolidation the functional currency
accounts are translated to the reporting currency with translation gains and
losses recorded in other comprehensive income. Wessex has several variable and
fixed rate loans in foreign currencies which are fully hedged through a
combination of cross-currency swaps and interest rate swaps. In addition, Wessex
is subject to foreign currency risk on translation from its functional currency
(pounds sterling) to the reporting currency (U.S. dollar).
NOTE 11 -- STOCKHOLDERS' EQUITY
ORDINARY SHARES
As of March 31, 1996, there were 214,417,242 issued and paid ordinary
shares of 60p each. During fiscal 1997, Wessex repurchased 722,771 ordinary
shares at L3.55 per share and 6,675,068 shares at L3.80 per share. Also during
fiscal 1997, 783,967 shares were issued to existing stockholders in lieu of a
cash dividend, 1,510,118 shares were issued under the stock-based compensation
plans and 193,756 shares were issued under the profit-sharing scheme.
During fiscal 1998, 1,359,267 shares were issued to existing stockholders
in lieu of a cash dividend, 1,673,643 shares were issued under the stock-based
compensation plans and 137,398 shares were issued under the profit-sharing
scheme.
CLASS B AND C ORDINARY SHARES
As of March 31, 1996 there were 30,225,106 issued and paid B ordinary
shares of 60p each and 13,285,088 C ordinary shares of 60p each. During fiscal
1997 Wessex repurchased all issued B and C ordinary shares at L3.55 per share.
On September 10, 1997, the authorized but unissued B and C ordinary shares were
redesignated as authorized ordinary shares of 60p each.
ACCUMULATED OTHER COMPREHENSIVE INCOME
Other comprehensive income at March 31, 1998 comprises the foreign currency
translation reserve of $178.8 million and unrealized gains on available-for-sale
securities of $3.2 million. The majority of the foreign currency translation
reserve is generated by the translation of the pounds sterling functional
currency financial statements into the U.S. dollar reporting currency.
PROFIT-SHARING STOCK PLAN
Wessex operates a profit-sharing stock plan whereby employees can apply for
free shares and also purchase shares. If the employee purchases shares, Wessex
matches the number of shares purchased up to a set limit. The fair market value
of the free and matching shares on the grant date is written off to the income
statement in the year of issue. Employees are entitled to all dividends on these
shares when issued. At March 31, 1998, 452,623 ordinary shares were held by
Wessex Water Trustee Company Ltd on behalf
F-46
<PAGE> 175
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of employees who were beneficially entitled to the shares under this plan. The
market value of these shares at March 31, 1998 was $3.9 million.
STOCK OPTIONS
Wessex applies Accounting Principles Board Opinion No. 25 in accounting for
its stock-based compensation plans. Accordingly, compensation expense of $0.2
million, $0.2 million and $0.3 million was recorded for the six months ended
October 2, 1998 and for the years ended March 31, 1998 and 1997, respectively.
Wessex has two share option plans. The first is a savings-related share
option plan, based on save-as-you-earn contracts, under which options were
granted between August 1991 and August 1997 at prices between L1.47 and L3.58
per share. At March 31, 1998, there were options outstanding in respect of
2,367,465 shares, exercisable between April 1, 1998 and February 28, 2005. The
second share option plan is an executive share option plan whereby options
outstanding in respect of 762,116 ordinary shares were granted at prices between
L1.85 and L3.16 per share. These options are exercisable between April 1, 1998
and August 1, 2004.
Details of the share option plans are summarized in the table below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE PRICE
OPTIONS SHARES (IN POUNDS STERLING)
- ------- ---------- --------------------
<S> <C> <C>
Outstanding at March 31, 1996.......................... 5,678,630 2.20
Granted................................................ 509,463 2.80
Exercised.............................................. (1,531,156) 1.66
Forfeited.............................................. (126,011) 2.20
---------- ----
Outstanding at March 31, 1997.......................... 4,530,926 2.46
---------- ----
Granted................................................ 477,003 3.58
Exercised.............................................. (1,673,259) 2.36
Forfeited.............................................. (205,089) 2.49
---------- ----
Outstanding at March 31, 1998.......................... 3,129,581 2.68
---------- ----
Granted................................................ 371,597 3.64
Exercised.............................................. (320,197) 2.62
Forfeited.............................................. (24,688) 2.73
---------- ----
Outstanding at October 2, 1998......................... 3,156,293 2.80
---------- ----
Exercisable at March 31, 1997.......................... 1,061,306 2.46
Exercisable at March 31, 1998.......................... 762,116 3.11
Exercisable at October 2, 1998......................... 629,674 3.10
</TABLE>
The exercise price of the savings-related share options granted was 20%
below market price.
F-47
<PAGE> 176
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about options outstanding as at
March 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
REMAINING
CONTRACTUAL
NUMBER LIFE NUMBER
RANGE OF EXERCISE PRICES (POUNDS STERLING) OUTSTANDING (YEARS) EXERCISABLE
- ------------------------------------------ ----------- ------------ -----------
<S> <C> <C> <C>
1.00 - 1.49......................................... 235,152 0.50 --
1.50 - 1.99......................................... 248,246 1.62 13,372
2.00 - 2.49......................................... 1,003,938 2.17 4,772
2.50 - 2.99......................................... 430,808 3.29 --
3.00 - 3.49......................................... 743,972 5.94 743,972
3.50 - 3.99......................................... 467,465 4.22 --
</TABLE>
If Wessex had elected to recognize compensation expense based on the fair
value of the stock options at the grant date in accordance with Statement of
Financial Accounting Standard 123, "Accounting for Stock Based Compensation,"
compensation expense of $0.3 million, $0.5 million, and $0.3 million would have
been recorded for the six months ended October 2, 1998 and for the years ended
March 31, 1998 and 1997, respectively. Net income would have been reduced to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, ----------------
1998 1998 1997
----------- ------ -------
(IN MILLIONS OF U.S. DOLLARS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net income:
As reported............................................... $71.8 $16.7 $153.0
Pro forma................................................. 71.7 16.4 153.0
Basic earnings per share:
As reported............................................... $0.30 $0.01 $ 0.65
Pro forma................................................. 0.30 0.01 0.65
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used for
grants for the six months ended October 2, 1998 and for the years ended March
31, 1998 and 1997:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED MARCH 31,
OCTOBER 2, ---------------------
1998 1998 1997
---------- --------- ---------
<S> <C> <C> <C>
Dividend yield.............................................. 4.1% 3.3% 4.4%
Expected volatility......................................... 21% 22% 23%
Risk-free interest rate..................................... 6.3% 7.1% 7.2%
Expected lives.............................................. 4.9 years 4.8 years 4.8 years
Weighted average option price (pounds sterling)............. 3.64 3.58 2.80
Weighted average fair market value at date of grant (pounds
sterling)................................................. 1.24 1.42 1.03
</TABLE>
NOTE 12 -- REDEEMABLE PREFERENCE SHARES
On September 7, 1995, a bonus issue of 308,984,402 fully paid 50p
cumulative redeemable preference shares was made to holders of record as of
August 31, 1995 of B and C ordinary shares on a one-for-one
F-48
<PAGE> 177
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
'basis; 310,000,000 of these shares were authorized. The preference shares were
originally redeemable at par in four equal tranches on the dividend payment date
in each of the years 1998, 1999, 2000 and 2001. The preference dividend is paid
annually in arrears at a gross dividend rate, fixed in advance, of the 12 month
London interbank offered rate plus 0.5%. Preference shares have priority on
winding up, but are non-voting unless a resolution is passed to vary their
rights.
Beginning in September 1998, Wessex redeemed all of its 308,984,402
cumulative redeemable preference shares at the par value of 50p per share. This
was pursuant to resolutions passed by its stockholders on July 29, 1998 and
November 23, 1998 to cancel the preference shares by repaying capital to the
preference stockholders.
NOTE 13 -- EARNINGS PER SHARE
Reconciliation of the numerator and denominator as used in the calculation
of earnings per share:
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, ---------------
NUMERATOR (IN MILLIONS OF US DOLLARS) 1998 1998 1997
- ------------------------------------- ---------- ------ ------
<S> <C> <C> <C>
Basic
Net income attributable to ordinary stockholders....... $ 64.1 $ 1.6 $139.5
Dividends paid to convertible stockholders............. -- -- 0.6
------ ------ ------
Diluted
Net income available to ordinary and convertible
stockholders........................................ $ 64.1 $ 1.6 $140.1
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
DENOMINATOR (IN MILLIONS)
- -------------------------
<S> <C> <C> <C>
Basic
Weighted average shares outstanding during year........ 213.0 211.3 214.7
Effect of dilutive securities:
Stock options....................................... 1.5 1.4 2.0
Convertible securities.............................. -- -- 38.0
------ ------ ------
Diluted.................................................. 214.5 212.7 254.7
====== ====== ======
</TABLE>
The UK Finance (No. 2) Act 1997 required the payment of utility tax, which
for Wessex Water Plc was $162.3 million, and was charged in full in the results
for the year ended March 31, 1998. The adjusted earnings per share adding back
this utility tax would have been:
<TABLE>
<CAPTION>
YEAR
ENDED
MARCH 31,
1998
---------
<S> <C>
Basic....................................................... $0.78
Diluted..................................................... 0.77
</TABLE>
F-49
<PAGE> 178
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- INCOME TAXES
Total income tax expense is summarized as follows:
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, ----------------
1998 1998 1997
----------- ------- ------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C>
Current tax............................................... $ 3.0 $ 26.5 $79.3
Deferred tax.............................................. 23.2 24.9 (2.1)
Share of tax of equity method investee.................... 2.2 6.6 5.2
Utility tax............................................... -- 162.3 --
----- ------ -----
Total income tax expense........................ $28.4 $220.3 $82.4
===== ====== =====
</TABLE>
The differences between taxes computed at the statutory tax rate and
Wessex's effective income tax rate are as follows:
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, ----------------
1998 1998 1997
----------- ------- ------
(IN MILLIONS OF U.S. DOLLARS
EXCEPT PERCENTAGES)
<S> <C> <C> <C>
Tax at statutory tax rate 31% (1997: 33%)................ $ 31.1 $ 73.5 $77.7
Change in tax rate....................................... (12.7) (22.6) --
Non-deductible expenses.................................. 7.9 1.6 1.6
Equity investee.......................................... 0.5 2.5 0.4
Other.................................................... 1.6 3.0 2.7
------ ------ -----
Total before utility tax....................... 28.4 58.0 82.4
------ ------ -----
Utility tax.............................................. -- 162.3 --
------ ------ -----
Total.......................................... $ 28.4 $220.3 $82.4
====== ====== =====
Effective rate before utility tax........................ 28% 24% 35%
Effective rate after utility tax......................... 28% 93% 35%
</TABLE>
The change in tax rate from 33% to 31% effective from April 1, 1997 was
enacted on July 31, 1997. The subsequent reduction in the tax rate from 31% to
30% effective from April 1, 1999 was enacted on July 31, 1998.
F-50
<PAGE> 179
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The principal components of Wessex's net deferred liability are as follows:
<TABLE>
<CAPTION>
MARCH 31,
1998
--------------
(IN MILLIONS
OF U.S.
DOLLARS)
<S> <C>
Deferred tax assets:
Advance corporation tax recoverable....................... $114.2
Other temporary differences............................... 7.7
------
Total deferred tax asset.......................... 121.9
------
Deferred tax liabilities:
Accelerated capital allowances............................ 371.5
Other temporary differences............................... 56.9
------
Total deferred tax liability...................... 428.4
------
Net deferred tax liability.................................. $306.5
======
</TABLE>
NOTE 15 -- PENSIONS
Wessex maintains three defined benefit pension plans that cover
substantially all of its employees. The assets are held in separate trustee
administered funds. The pension cost charged to the income statement has been
determined on the advice of independent qualified actuaries and is accrued over
the service lives of the employees expected to be eligible to receive such
benefits.
The following assumptions were used in determining the funded status and
pension charge for each period, and are determined as of the beginning of the
period:
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, -----------
1998 1998 1997
---------- ---- ----
<S> <C> <C> <C>
Discount rate............................................... 6.5% 8.3% 9.0%
Yield on government bonds................................... 6.0 7.6 8.5
Expected return on plan assets.............................. 7.5 8.5 9.0
Rate of compensation increase............................... 5.0 6.0 6.5
Pension increases after April 5, 1997....................... 3.0 4.0 4.5
</TABLE>
F-51
<PAGE> 180
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The plan's funded status and related pension accrual at March 31, 1998 are
as follows:
<TABLE>
<CAPTION>
MARCH 31,
1998
---------------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
Change in benefit obligation
Benefit obligation at beginning of year................... $ 186.8
Service cost.............................................. 4.6
Interest cost............................................. 15.4
Plan participants' contributions.......................... 2.1
Termination costs......................................... 1.3
Actuarial losses.......................................... 25.9
Benefits paid............................................. (9.4)
Exchange movement......................................... 4.6
-------
Benefit obligation at end of year......................... $ 231.3
=======
Change in plan assets
Fair value of plan assets at beginning of year............ $ 211.6
Actual return on plan assets.............................. 44.8
Employer's contribution................................... 3.6
Plan participants' contribution........................... 2.1
Benefits paid............................................. (9.4)
Exchange difference....................................... 5.0
-------
Fair value of plan assets at end of year.................. $ 257.7
=======
Fair value of plan assets................................. $ 257.7
Projected benefit obligation.............................. (231.3)
-------
Funded status............................................. 26.4
Unrecognized transition asset............................. (6.2)
Unrecognized net actuarial gain........................... (16.6)
Unrecognized prior service cost........................... 7.8
-------
Prepaid benefit cost...................................... $ 11.4
=======
</TABLE>
Net periodic benefit cost includes the following components:
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED
ENDED MARCH 31,
OCTOBER 2, -----------------
1998 1998 1997
----------- ------- -------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C>
Service cost............................................. $ 3.1 $ 4.6 $ 4.4
Interest cost............................................ 7.4 15.4 14.3
Expected return on plan assets........................... (9.4) (17.9) (16.9)
Recognition of transition asset.......................... (0.5) (1.0) (1.0)
Amortization of prior service cost....................... 0.3 0.7 0.6
Recognized actuarial gain................................ -- -- (0.3)
Curtailments............................................. -- 1.3 1.6
----- ------ ------
Net periodic benefit cost................................ $ 0.9 $ 3.1 $ 2.7
===== ====== ======
</TABLE>
F-52
<PAGE> 181
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The prepaid benefit accrual is included within other non-current assets in
the balance sheet. The net periodic benefit cost is included within operating
expenses in the income statement.
NOTE 16 -- SEGMENT AND GEOGRAPHIC INFORMATION
Wessex's principal business is the provision of water supply and wastewater
services in southwestern England. For management reporting purposes the
operations are divided into three service categories: regulated water services,
unregulated water services and SC Technology. Regulated water services accounted
for approximately 91%, 93% and 93% of revenues for the six months ended October
2, 1998, and for the years ended March 31, 1998 and 1997, respectively. Wessex's
management regularly reviews financial information relating to these three
service categories. The financial information provided to and reviewed by the
chief operating decision maker does not include balance sheet information by
segment. The financial management information is prepared using U.K. generally
accepted accounting principles which differ in significant respects from U.S.
generally accepted accounting principles.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED YEAR ENDED
OCTOBER 2, 1998 MARCH 31, 1998 MARCH 31, 1997
-------------------------- -------------------------- --------------------------
REGULATED REGULATED REGULATED
WATER WATER WATER
SERVICES OTHER TOTAL SERVICES OTHER TOTAL SERVICES OTHER TOTAL
--------- ----- ------ --------- ----- ------ --------- ----- ------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
External revenue................ $213.6 $20.2 $233.8 $404.3 $32.3 $436.6 $375.7 $27.4 $403.1
Intersegment revenue............ -- 2.1 2.1 -- -- -- -- -- --
------ ----- ------ ------ ----- ------ ------ ----- ------
Total revenue................... 213.6 22.3 235.9 404.3 32.3 436.6 375.7 27.4 403.1
Segment result.................. 95.2 5.3 100.5 221.1 10.3 231.4 204.5 8.7 213.2
Depreciation.................... 27.4 0.5 27.9 51.4 0.5 51.9 45.6 0.5 46.1
</TABLE>
Reconciliation of segment results to income before taxes:
<TABLE>
<CAPTION>
SIX
MONTHS
ENDED YEAR ENDED MARCH 31,
OCTOBER 2, ---------------------
1998 1998 1997
---------- -------- --------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C> <C>
Total segment result for reportable segments........... $100.5 $231.4 $213.2
Intersegment profit.................................. (0.3) -- --
Head office charges.................................. (2.8) (5.1) (7.6)
U.S. GAAP adjustments:
Infrastructure renewals charge.................... 8.3 16.2 15.2
Depreciation on infrastructure assets............. (6.3) (11.8) (10.5)
Other............................................. 1.1 1.6 0.2
------ ------ ------
U.S. GAAP operating profit........................... 100.5 232.3 210.5
Share in results of equity method investee........... 5.8 13.3 14.7
Net interest income (expense)........................ (6.1) (8.6) 10.2
------ ------ ------
Income before tax.................................... $100.2 $237.0 $235.4
====== ====== ======
</TABLE>
F-53
<PAGE> 182
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- RELATED PARTY TRANSACTIONS
At March 31, 1998,Wessex had a 50.0% interest in Wessex Waste Management
Ltd. This investment is further described in Note 6. Waste Management (UK)
Holdings Ltd, a subsidiary of Waste Management International, is the other 50.0%
owner of Wessex Waste Management Ltd. Related party transactions with Wessex
Waste Management Ltd and Waste Management International group companies for the
six months ended October 2, 1998 and for the years ended March 31, 1998 and 1997
were as follows:
(a) In fiscal 1997, Wessex stock options granted to UK Waste
Management Holdings in respect of 10,605,303 ordinary shares were
cancelled.
(b) Also in fiscal 1997, Wessex repurchased 722,771 ordinary shares,
30,225,106 B ordinary shares and 13,285,088 C ordinary shares from UK Waste
Management Holdings at a total cost of $254.3 million.
(c) At March 31, 1998, a loan of $6.2 million had been received by
Wessex from Wessex Waste Management Ltd.
(d) Wessex provided guarantees on loans issued by Wessex Waste
Management Ltd. The maximum liability as of March 31, 1998 was $7.0
million.
Other related party transactions are as follows:
(e) A director of SC Technology owns some of the assets at the
company's operation in Biel, Switzerland, for which a charge was made to SC
Technology of $0.2 million, $0.3 million and $0.5 million for the six
months ended October 2, 1998 and for the years ended March 31, 1998 and
1997, respectively.
NOTE 18 -- COMMITMENTS AND CONTINGENCIES
LEASES
Wessex leases property, plant and equipment. Commitments for minimum
rentals under non-cancelable leases as at March 31, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
---------------
(IN MILLIONS OF
U.S. DOLLARS)
<S> <C>
For the years ending March 31:
1999........................................................ $0.7
2000........................................................ 0.5
2001........................................................ 0.5
2002........................................................ 0.5
2003........................................................ 0.3
Thereafter.................................................. 0.9
----
Total minimum lease payments................................ $3.4
====
</TABLE>
Rent expense amounted to approximately $0.3 million, $0.5 million and $0.5
million for the six months ended October 2, 1998 and for the years ended March
31, 1998 and 1997, respectively.
F-54
<PAGE> 183
WESSEX WATER PLC
(NOW RENAMED WESSEX WATER LTD)
(PREDECESSOR COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CAPITAL EXPENDITURES
Capital expenditure contracted but not provided at March 31, 1998 was $79.1
million.
GUARANTEES
Wessex Water Plc has acted as guarantor for some borrowing facilities made
available to Wessex Water Services Ltd. As part of the banking arrangements,
Wessex Water Plc has entered into a cross-undertaking with Wessex Water Services
Ltd in relation to the latter's overdraft and related facilities.
At March 31, 1998, Wessex Water Plc had provided guarantees on loans issued
by Wessex Waste Management Ltd, the maximum liability at March 31, 1998 being
$7.0 million.
Wessex Water Plc has provided performance guarantees on behalf SC
Technology on the tendering of contracts. The maximum liability as of March 31,
1998 was $4.9 million.
NOTE 19 -- SUBSEQUENT EVENTS
On Friday July 24, 1998 Enron Corp. of Houston, Texas, United States, made
a cash offer of 630p per share for the shares of Wessex. This offer was
recommended to the stockholders by the Board of Directors of Wessex. The offer
ran to August 28, 1998, but was extended to September 18, 1998 to allow the
Secretary of State for Trade and Industry to consider if there should be an
investigation by the Monopolies and Mergers Commission. On September 10, 1998 it
was announced that there would be no reference to the Monopolies and Mergers
Commission. On September 21, 1998 Enron announced that the offer had become
unconditional, having received by September 18, 1998 acceptances representing
87.2 percent of all ordinary shares.
On October 2, 1998 Enron announced that it had received acceptances
representing more than 90 percent of all ordinary shares. On that same date
notices were issued to the remaining Wessex ordinary shareholders, informing
them that Enron intended to exercise its rights under Section 429 of the
Companies Act 1985 to acquire compulsorily all of the outstanding ordinary
shares. The compulsory share acquisition was completed in November 1998. Offer
documents were also sent to the stock option holders in the Savings-Related
Share Option Scheme. The options outstanding under this scheme and the Executive
Share Option Scheme were either exercised and the shares acquired by Enron, or
compensation was paid to settle the liabilities under the schemes. All stock
option schemes are now closed.
On November 30, 1998, Wessex sold its interest in Wessex Waste Management
Ltd to Waste Management International for $337.9 million.
In December 1998, all of the remaining 128,339,909 redeemable preference
shares were redeemed and Wessex Water Plc changed its name to Wessex Water Ltd.
F-55
<PAGE> 184
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THROUGH AND INCLUDING JULY 4, 1999 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THESE SECURITIES, WHETHER OR
NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
36,600,000 SHARES
[AZURIX LOGO]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
MERRILL LYNCH & CO.
CREDIT SUISSE FIRST BOSTON
DONALDSON, LUFKIN & JENRETTE
PAINEWEBBER INCORPORATED
BANC OF AMERICA SECURITIES LLC
DEUTSCHE BANC ALEX. BROWN
JUNE 9, 1999
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