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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2000 COMMISSION FILE NO. 001-15065
AZURIX CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0589114
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
333 CLAY STREET
SUITE 1000
HOUSTON, TEXAS 77002
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (713) 646-6001
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
TITLE OF CLASS OUTSTANDING AT OCTOBER 31, 2000
Common Stock 117,334,100
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AZURIX CORP.
INDEX
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income (Loss) for the three months and nine months ended
September 30, 1999 and 2000 (unaudited)................................................................ 2
Consolidated Balance Sheets as of December 31, 1999 and September 30, 2000 (unaudited)................... 3
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and 2000 (unaudited)................................................................ 4
Notes to the Consolidated Financial Statements (unaudited)............................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 18
Information Regarding Forward looking Statements............................................................ 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................. 19
Item 6. Exhibits and Reports on Form 8-K................................................................... 20
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AZURIX CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating revenues ........................................... $ 170.5 $ 183.7 $ 418.7 $ 567.5
Operating expenses:
Operations and maintenance ................................ 67.1 91.6 135.8 265.6
General and administrative ................................ 27.6 36.2 82.8 107.5
Depreciation and amortization ............................. 28.5 33.9 75.9 96.4
-------- -------- -------- --------
Total operating expenses .............................. 123.2 161.7 294.5 469.5
-------- -------- -------- --------
Operating income ............................................. 47.3 22.0 124.2 98.0
-------- -------- -------- --------
Other income (expense):
Equity in earnings of unconsolidated affiliates ........... 0.4 1.6 0.9 4.8
Gain on sale of asset ..................................... -- 2.5 -- 2.5
Interest income ........................................... 7.7 3.5 11.8 20.5
Interest expense .......................................... (27.9) (34.3) (62.3) (109.3)
-------- -------- -------- --------
Income (Loss) before minority interest, income taxes and
extraordinary item ........................................ 27.5 (4.7) 74.6 16.5
-------- -------- -------- --------
Minority interest ............................................ (0.5) (0.4) (0.5) (1.6)
Income tax expense (benefit) ................................. 9.2 (0.7) 20.0 7.3
-------- -------- -------- --------
Income (Loss) before extraordinary item ...................... 18.8 (3.6) 55.1 10.8
-------- -------- -------- --------
Extraordinary loss, net of income tax benefit of $3.0 ........ -- -- 6.8 --
-------- -------- -------- --------
Net income (loss) ............................................ $ 18.8 $ (3.6) $ 48.3 $ 10.8
======== ======== ======== ========
Earnings (Loss) per share of common stock:
Before extraordinary item ............................... $ 0.16 $ (0.03) $ 0.51 $ 0.09
Extraordinary loss ...................................... -- -- (0.06) --
-------- -------- -------- --------
Basic and diluted earnings (loss) per share ............. $ 0.16 $ (0.03) $ 0.45 $ 0.09
======== ======== ======== ========
Weighted average shares outstanding:
Basic ................................................... 117.1 117.2 107.1 117.2
======== ======== ======== ========
Diluted ................................................. 118.0 117.2 107.6 117.4
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
2
<PAGE> 4
AZURIX CORP.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................................... $ 27.2 $ 39.1
Restricted cash and cash equivalents ......................................... 464.2 94.6
Trade receivables (net of allowance for doubtful accounts
of $40.7 and $52.3, respectively) ......................................... 115.7 134.9
Unbilled receivables ......................................................... 32.5 42.7
Prepaid expenses ............................................................. 39.2 60.6
Other ........................................................................ 30.5 29.6
-------- --------
Total current assets ................................................. 709.3 401.5
-------- --------
Property, plant and equipment, at cost ......................................... 2,559.1 2,607.7
Less accumulated depreciation .................................................. (90.4) (171.1)
-------- --------
Property, plant and equipment, net ................................... 2,468.7 2,436.6
-------- --------
Investments in and advances to unconsolidated affiliates ....................... 110.4 114.4
Concession intangibles, net .................................................... 451.3 445.3
Goodwill, net .................................................................. 1,029.6 965.0
Other assets ................................................................... 81.1 132.6
-------- --------
Total Assets ......................................................... $4,850.4 $4,495.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accruals ................................................ $ 236.0 $ 230.3
Deferred income .............................................................. 54.6 22.1
Accrued taxes ................................................................ 21.1 32.6
Short-term debt .............................................................. 602.2 317.7
Current maturities of long-term debt ......................................... 35.0 33.6
-------- --------
Total current liabilities ............................................ 948.9 636.3
-------- --------
Long-term debt ................................................................. 1,301.9 1,329.2
Long-term debt - affiliates .................................................... 180.0 230.0
Deferred income taxes .......................................................... 443.3 449.5
Other long-term liabilities .................................................... 31.2 33.6
-------- --------
Total liabilities .................................................... 2,905.3 2,678.6
-------- --------
Commitments and contingencies (Note 6)
Minority interest .............................................................. 3.3 6.3
Stockholders' equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized ............... -- --
Common stock, $0.01 par value, 500,000,000 shares authorized, 117,221,895
shares and 117,334,100 shares issued and outstanding, respectively ....... 1.2 1.2
Additional paid-in capital ................................................... 1,972.2 1,973.2
Retained earnings ............................................................ 47.9 58.7
Unearned compensation ........................................................ (0.6) (0.2)
Accumulated other comprehensive loss ......................................... (78.9) (222.4)
-------- --------
Total stockholders' equity ........................................... 1,941.8 1,810.5
-------- --------
Total Liabilities and Stockholders' Equity ........................... $4,850.4 $4,495.4
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE> 5
AZURIX CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1999 2000
------- -------
<S> <C> <C>
Operating Activities:
Net income ................................................................... $ 48.3 $ 10.8
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization ............................................ 75.9 96.4
Accretion and amortization of debt expenses and write-off of
deferred financing costs .............................................. 10.9 4.7
Deferred income taxes .................................................... 10.0 (1.5)
Equity in earnings of unconsolidated affiliates .......................... (0.9) (4.8)
Minority interest ........................................................ (0.5) (1.6)
Gain on sale of asset .................................................... -- (2.5)
Changes in operating assets and liabilities:
Increase in trade receivables and other current assets ................ (18.1) (67.2)
Decrease in current liabilities, excluding debt ....................... (3.8) (7.8)
(Increase) Decrease in other assets ................................... (67.3) 1.2
Increase in other long-term liabilities ............................... 2.4 3.5
------- -------
Net cash provided by operating activities ........................................ 56.9 31.2
------- -------
Investing Activities:
Capital expenditures ......................................................... (202.5) (221.7)
Proceeds from sale of asset .................................................. -- 5.4
Investments in and advances to unconsolidated affiliates ..................... (27.9) (2.8)
Business acquisitions, net of cash acquired .................................. (630.2) (16.3)
Other ........................................................................ (0.7) (44.6)
------- -------
Net cash used in investing activities ............................................ (861.3) (280.0)
------- -------
Financing Activities:
Proceeds from long-term borrowings ........................................... 474.1 594.4
Repayments of long-term borrowings ........................................... (249.0) (573.3)
Net proceeds from (repayments of) short-term borrowings ...................... 418.5 (402.1)
(Deposit to) withdrawal from restricted cash and cash equivalents account .... (395.7) 394.0
Net proceeds from revolving credit facilities ................................ 232.2 192.1
Advances from affiliates, net of repayments .................................. 33.1 60.0
Contribution to subsidiary from minority shareholder ......................... -- 4.5
Issuance of common stock ..................................................... 300.5 1.0
------- -------
Net cash provided by financing activities ........................................ 813.7 270.6
------- -------
Effect of exchange rate changes on cash .......................................... (0.7) (9.9)
------- -------
Change in cash and cash equivalents .............................................. 8.6 11.9
------- -------
Cash and cash equivalents, beginning of period ................................... 5.3 27.2
------- -------
Cash and cash equivalents, end of period ......................................... $ 13.9 $ 39.1
======= =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE> 6
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated interim financial statements and disclosures
are unaudited and have been prepared by Azurix Corp. pursuant to the rules and
regulations of the Securities and Exchange Commission. Accordingly, these
statements reflect all normal recurring adjustments necessary for a fair
presentation, in all material respects, of the results for the interim periods.
The results of operations for the periods ended September 30, 2000 are not
necessarily indicative of results to be expected for the full year. Certain
information and notes normally included in financial statements, prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted pursuant to such rules and regulations, although Azurix believes that
the disclosures are adequate to make the information presented not misleading.
These consolidated interim financial statements should be read in conjunction
with the financial statements and the notes thereto included in Azurix's Annual
Report on Form 10-K for the year ended December 31, 1999.
The preparation of 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.
Certain reclassifications have been made in the 1999 amounts to conform with
the 2000 presentation.
"Azurix" is used from time to time herein as a collective reference to
Azurix Corp. and its subsidiaries and affiliates.
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 contracts.
It requires an entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. In June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 137, which deferred the
effective date of Statement of Financial Accounting Standards No. 133 to fiscal
years beginning after June 15, 2000. Additionally, in June 2000, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which amended a limited number of accounting and reporting
standards of Statement of Financial Accounting Standards No. 133. Statement of
Financial Accounting Standards No. 133 may be implemented, as of the beginning
of any fiscal quarter after issuance, however, the statement cannot be applied
retroactively. 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. Azurix will adopt the statement beginning
fiscal year 2001.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," to
provide guidance on the recognition, presentation and disclosure of revenue in
financial statements. Staff Accounting Bulletin No. 101B was issued in June 2000
and delays the effective date of Staff Accounting Bulletin No. 101 until no
later than the fourth quarter of fiscal years beginning after December 15, 1999.
Azurix is currently evaluating the impact of Staff Accounting Bulletin No. 101,
but does not anticipate that application of this bulletin will have a material
impact on its financial position or results of operations.
5
<PAGE> 7
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 2 - RESTRICTED CASH AND CASH EQUIVALENTS AND SHORT-TERM DEBT
In April 2000, Azurix used $415.5 million of proceeds from a cash collateral
account to repay a $394.0 million bank loan and related interest of $19.7
million. The cash collateral account was classified on the Consolidated Balance
Sheets as "Restricted cash and cash equivalents" and secured the bank loan that
was used to fund the Buenos Aires concession acquisition. An additional $1.8
million of the proceeds were deposited into a non-restricted cash account. The
bank loan was classified on the Consolidated Balance Sheets as "Short-term
debt."
In February 2000, the Azurix Europe revolving facility was amended so that
Azurix Europe may borrow a portion of the facility capacity in a manner allowing
for its use by Azurix for general corporate purposes. Such capacity is
denominated in U.K. pound sterling and at September 30, 2000 was equivalent to
$354.9 million. That portion of the facility capacity was repaid in its entirety
with a portion of the proceeds from the senior notes issued in February 2000
(see Note 3). As of September 30, 2000, Azurix had outstanding borrowings of
$118.0 million under that portion of the facility available for use by Azurix
for general corporate purposes. These borrowings were used primarily to fund
capital expenditures, acquisitions and other general corporate purposes.
NOTE 3 - LONG-TERM DEBT AND LONG-TERM DEBT -- AFFILIATES
In February 2000, Azurix issued U.S. dollar and U.K. pound sterling senior
notes with a U.S. dollar equivalent face value of $599.8 million. The senior
notes consisted of $240.0 million and (pound)100.0 million, each due in 2007 and
bearing an interest rate of 10 3/8% and $200.0 million due in 2010 and bearing
an interest rate of 10 3/4%. Net proceeds after underwriters' discount and other
offering costs were $583.1 million. Of this amount, $150.0 million was used to
pay down the Azurix revolving credit facility, $386.0 million was used to pay
down the Azurix Europe revolving credit facility and $18.1 million was used to
pay down amounts outstanding under the credit agreement with Enron. In addition,
$11.5 million was used to pay accrued interest on the three credit facilities.
The remaining proceeds were made available for general corporate purposes. The
notes were issued under an indenture that contains certain covenants that limit
Azurix's ability to incur additional debt, pay dividends or make other
distributions, incur liens on its assets, enter into sale/leaseback transactions
and to enter into transactions with affiliates, or sell assets to, or merge
with, another entity.
As of September 30, 2000, Azurix, through Wessex, had, among other credit
facilities, committed credit facilities with major commercial banks providing
for an aggregate of $110.9 million of borrowing capacity. The balance
outstanding under these facilities at September 30, 2000 was $53.2 million.
There were no borrowings outstanding at December 31, 1999 under these
facilities.
During the nine months ended September 30, 2000, Azurix increased its
borrowings under its credit agreement with Enron by $56.6 million, to $109.9
million. Amounts outstanding under the credit agreement may not exceed $120
million and $180 million at any time during calendar years 2000 and 2001,
respectively.
NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes and interest expense is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1999 2000
------- -------
(IN MILLIONS)
<S> <C> <C>
Income taxes ............................................ $ 14.5 $ 5.1
Interest expense (net of amounts capitalized) ........... 47.2 87.1
</TABLE>
6
<PAGE> 8
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NON-CASH TRANSACTION
During the nine months ended September 30, 2000, Azurix acquired assets by
entering into capital leases totaling approximately $5.4 million.
NOTE 5 - RELATED PARTY TRANSACTION
During the second quarter of 2000, Azurix provided certain services that
included arranging, negotiating and structuring water supply arrangements for a
project being developed by an Enron subsidiary. Revenues earned and received
during the second quarter of 2000 related to these services were $1.1 million.
Under a separate agreement with the Enron subsidiary, Azurix has agreed to
provide future water supply and water management services to the project for a
period of approximately 25 years. Future services to be provided under this
agreement are contingent upon the Enron subsidiary receiving certain government
approvals to proceed with its project.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Azurix is involved in various claims and lawsuits, the significant items of
which are discussed below. Although no assurances can be given, Azurix believes,
after considering appropriate reserves that have been established and except
where noted below, that the ultimate resolution of such items will not have a
material adverse effect on its financial position or results of operations.
On October 27, 2000, a lawsuit styled Thomas Turberg against Azurix Corp.,
Herbert S Winokur, Jr., John H. Duncan, John Wakeham, Joseph W. Sutton, Kenneth
L. Lay, Jeffrey K. Skilling, and Enron Corp., was filed in the Court of Chancery
in the State of Delaware, New Castle County. The suit is a purported class
action filed on behalf of Azurix's public shareholders for the purpose of
enjoining a transaction proposed by Enron for taking Azurix private at a price
of $7.00 for each of Azurix's publicly traded shares (see Note 13). Enron
currently owns a 50% voting interest in Atlantic Water Trust, which currently
owns approximately 67% of the outstanding shares of Azurix common stock, with
the public shareholders owning the remainder. The letter from Enron making this
proposal and the related press release issued by Azurix were filed with the
Securities and Exchange Commission on October 27, 2000, as exhibits to Azurix's
Current Report on Form 8-K. The suit generally alleges that the buy-out price of
$7.00 per share is unconscionable and unfair and grossly inadequate and that the
defendants have breached their duties of loyalty and care with respect to
Azurix's public shareholders. The plaintiff seeks a judgment (i) enjoining the
acquisition under the terms presently proposed; (ii) to the extent the
transaction is consummated prior to a final judgment, rescinding the transaction
or awarding rescissory damages to the class; (iii) directing that the defendants
account to the plaintiff and the class for all damages caused to them and
account for all profits and any special benefits obtained by the defendants as a
result of their alleged unlawful conduct; (iv) awarding to the plaintiff the
costs and disbursements of the lawsuit, including a reasonable allowance for
attorney fees and expenses; and (v) granting such other and further relief as
the court deems appropriate. Several similar actions have subsequently been
filed in the Court of Chancery in the State of Delaware, New Castle County and
an additional similar action, styled Ruthy Parnes v. John H. Duncan, Joseph W.
Sutton, Jeffrey K. Skilling, John Wakeham, Kenneth L. Lay, Rebecca P. Mark,
Herbert S. Winokur, Azurix Corp. and Enron Corp., has been filed in the 55th
Judicial District Court of Harris County, Texas. Certain of the actions filed in
the Delaware court have added Atlantic Water Trust as a defendant. Azurix
intends to deny the allegations in each complaint and defend these cases
vigorously. In particular, at this time Azurix has not determined whether to
accept the Enron proposal. At this early stage of the litigation, it is not
possible to estimate potential damages, if any. If liability were established,
an unfavorable judgment or settlement could have a material adverse effect on
Azurix's financial position and results of operations.
7
<PAGE> 9
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
On October 6, 2000, a lawsuit styled Irving Rosenzweig, on behalf of himself
and others similarly situated v. Azurix Corp., Rebecca Mark, Rodney Faldyn,
Joseph Sutton, Jeffrey Skilling, Kenneth Lay, and Enron Corp., was filed in the
United States District Court for the Southern District of Texas, Houston
Division. The suit is a purported class action filed on behalf of those persons
who purchased the common stock of Azurix during the period from June 9, 1999,
the date of Azurix's initial public offering, through and including August 8,
2000. The suit generally alleges that the defendants violated Sections 11, 12(a)
and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5. The plaintiff contends that the defendants
issued and disseminated materially false and misleading information to the
plaintiff and the investing public in connection with Azurix's initial public
offering and during the class period. The plaintiff seeks rescissory and/or
compensatory damages, interest and costs, including attorneys and experts fees.
The plaintiff also seeks extraordinary and/or injunctive relief, including
attaching, impounding, imposing a constructive trust upon or otherwise
restricting the proceeds of defendants' trading activities or their other assets
so as to assure that plaintiffs have an effective remedy. Several similar
actions have been filed in the United States District Court for the Southern
District of Texas. These lawsuits are subject to the Private Securities
Litigations Reform Act of 1995 and in each case the plaintiff seeks to have the
action certified as a class action with plaintiff as the class representative.
Azurix intends to deny the allegations in each complaint and defend these cases
vigorously. At this early stage of the litigation, it is not possible to
estimate potential damages, if any. If liability were established, an
unfavorable judgment or settlement could have a material adverse effect on
Azurix's financial position and results of operations.
As previously reported in Azurix's Annual Report on Form 10-K for the year
ended December 31, 1999, and other filings, Azurix is party to a lawsuit styled
Synagro Technologies, Inc. v. Azurix Corp., in the 270th Judicial District Court
of Harris County, Texas. The lawsuit relates to various agreements between the
parties regarding potential business transactions and the possible acquisition
by Azurix of two subsidiaries of Waste Management, Inc., commonly called BioGro.
On May 9, 2000, Synagro filed its First Amended Petition in the District Court
seeking (i) damages in excess of $57 million resulting from the alleged breach
by Azurix of an agreement to purchase up to $23 million of Synagro convertible
preferred stock and (ii) unspecified damages resulting from Azurix's alleged
breach of confidentiality and standstill agreements. On August 4, 2000, Azurix
filed its First Amended Answer and Counterclaim (i) denying all of the material
allegations contained in Synagro's First Amended Petition and (ii) seeking
damages in excess of $175 million for misrepresentations by Synagro that induced
Azurix to agree to restrictions on its ability to purchase BioGro and to enter
into negotiations with Synagro and Synagro's interference with Azurix's
acquisition of BioGro. On September 15, 2000, Azurix filed a motion for partial
summary judgment on the issue of Azurix's obligation to purchase the preferred
stock. The court held a hearing on this motion on October 27, 2000, and ruled
against Azurix's motion. Azurix intends to continue to vigorously defend itself
against Synagro's claims and to continue to pursue its claims for damages
resulting from Synagro's conduct regarding BioGro.
During April 2000, residents of the city of Bahia Blanca, Argentina and
surrounding areas began noticing unpleasant taste and odor in their water
supply, which is provided by Azurix Buenos Aires, S.A. The taste and odor were
traced to a substance released by algae that had grown to higher than normal
levels in a reservoir operated by an agency of the Province of Buenos Aires and
that had entered the local water supply. On becoming aware of the cause of the
unpleasant taste and odor, Azurix Buenos Aires instituted measures that restored
the taste and odor to acceptable levels. Tests performed by government
officials, as well as Azurix Buenos Aires, have shown that there were no harmful
biological or toxic substances in the water supply, and provincial officials
have stated publicly that there was no danger to public health. However, algae
continue to be present in the reservoir, and therefore issues of taste, odor and
color may recur.
Before the situation was corrected, at the request of government officials,
Azurix Buenos Aires acquired water from other sources for delivery in trucks and
bottles to residents in Bahia Blanca. Azurix Buenos Aires agreed with
8
<PAGE> 10
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
the provincial regulatory agency not to bill residential customers for water
services for a 50-day period during which the taste and odor of supplied water
were allegedly unsatisfactory, although the regulatory agency approved billing
industrial customers for water and all customers for wastewater services during
this time. Azurix's second quarter 2000 results of operations include $3.3
million of operations and maintenance expense and $0.6 million of general and
administrative expense that were incurred in responding to this situation, in
addition to foregoing approximately $1.5 million in revenues for the 50-day
period. Azurix also incurred $0.2 million of related capital expenditures. Under
the concession contract, the provincial regulatory agency may impose penalties;
however, none have been assessed as of this date.
Under the Azurix Buenos Aires' concession agreement with the province, an
agency of the province was required to construct works to remove algae from the
water. The algae-removing works had not been completed or tested before this
incident occurred. International experts have advised Azurix Buenos Aires that
conventional algae removal facilities and reservoir operations would have
prevented the algae from entering the water system. Azurix Buenos Aires believes
the events in Bahia Blanca resulted directly from the provincial agency's
failure to deliver functioning algae removal works as required under the
agreement and is seeking reimbursement or other compensation from the province
for all costs, including any penalties that may be assessed, and forgone
revenues.
Azurix is subject to extensive federal, foreign, state and local
environmental laws and regulations. Azurix anticipates 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 its financial position and results of operations.
NOTE 7 - EARNINGS PER SHARE
The numerators in the basic and diluted earnings per share calculations are
equal. A reconciliation of the denominators is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1999 2000 1999 2000
------- ------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Denominator:
Weighted average shares - basic ............... 117.1 117.2 107.1 117.2
Effect of dilutive securities:
Non-vested restricted stock ................... -- -- -- 0.1
Stock options ................................. 0.9 -- 0.5 0.1
------ ------ ------ ------
Weighted average shares - diluted ................ 118.0 117.2 107.6 117.4
====== ====== ====== ======
</TABLE>
NOTE 8 - INCOME TAXES
During 1998, Azurix recorded a valuation allowance on a deferred tax asset
of approximately $5.1 million related to losses incurred in the United States.
During the second quarter of 1999, Azurix determined that the available evidence
attributable to the increased level of 1999 business activities (including
consideration of the proceeds generated from the initial public offering and
available U.S. tax planning strategies) indicated that it is more likely than
not that the deferred tax asset associated with the 1998 U.S. losses will be
realized. Accordingly, the valuation allowance of approximately $5.1 million was
reversed in the second quarter of 1999.
9
<PAGE> 11
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 9 - EXTRAORDINARY LOSS
In May 1999, Azurix retired borrowings under its former senior credit
facility and terminated the facility prior to its maturity. Unamortized deferred
financing fees related to this facility of $9.8 million ($6.8 million net of tax
benefit) were charged to income as an extraordinary loss.
NOTE 10 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes the following for the periods
indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1999 2000 1999 2000
------- ------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Net income (loss) .......................... $ 18.8 $ (3.6) $ 48.3 $ 10.8
Other comprehensive income (loss):
Foreign currency translation
adjustment ........................... 68.1 (40.8) (15.7) (143.0)
Unrealized gain (loss) on available
for sale securities .................. -- 0.1 -- (0.5)
------- ------- ------- -------
Comprehensive income (loss) ................ $ 86.9 $ (44.3) $ 32.6 $(132.7)
======= ======= ======= =======
</TABLE>
NOTE 11 - RESTRUCTURING CHARGE
In 1998, Azurix adopted a business strategy focused on growth through
acquisitions and development projects around the world. During the fourth
quarter of 1998 and the first half of 1999, Azurix initiated a business
development effort requiring increased personnel to pursue and support
acquisition and privatization activities worldwide. The initiative was based on
Azurix's expectations as to the size, number, location and timing of
privatization projects that would be awarded in 1999, 2000 and beyond. During
the second half of 1999, several large privatization projects were postponed or
cancelled. In the fourth quarter of 1999, Azurix reevaluated its cost structure
in relation to its business development efforts. As a result, Azurix announced a
plan to restructure its operations, which resulted in Azurix recording a
one-time pretax expense totaling $34.2 million in the fourth quarter of 1999.
The restructuring plan includes reducing personnel, reducing its leased office
space and eliminating other costs relating to the pursuit of concessions in
certain regions.
The restructuring plan involves the elimination of 206 employee positions
working in the concession acquisition effort. As of September 30, 2000, 166
employees had been terminated pursuant to the restructuring plan. Azurix expects
that the restructuring actions will be completed by the end of the fourth
quarter of 2000. The restructuring liability has been classified in "Accounts
payable and accruals" on the Consolidated Balance Sheets and is being funded
through cash provided by operating activities and borrowings under credit
agreements.
10
<PAGE> 12
AZURIX CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Amounts related to the restructuring liability are shown in the following
table:
<TABLE>
<CAPTION>
BALANCE AT FOREIGN BALANCE AT
DECEMBER 31, 2000 EXCHANGE SEPTEMBER 30,
1999 PAYMENTS DIFFERENCE 2000
------------ -------- ---------- -------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Severance and related payroll
burden ......................... $16.5 $(9.7) $(0.2) $ 6.6
===== ===== ===== =====
</TABLE>
NOTE 12 - STOCK PLAN
During the nine months ended September 30, 2000, Azurix granted 2,008,870
stock options to its employees and board of directors at a weighted average
exercise price per share of $7.509. Of this amount, 205,200 stock options will
vest over a one year period and the remainder will vest over periods of three to
six years, unless accelerated vesting occurs due to Azurix Corp. meeting or
exceeding a board of directors approved annual financial performance target.
NOTE 13 - SUBSEQUENT EVENT
On October 27, 2000, Azurix announced that its board of directors had
received a proposal from Enron to provide funding to take Azurix private at a
buy-out price of $7.00 per share (see Note 6). A special committee of the Azurix
board of directors is evaluating the proposal and has retained two investment
banking firms to advise it regarding the proposal. The special committee has not
established any timetable for this process.
11
<PAGE> 13
ITEM 2. 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 related notes
thereto, contained herein, as well as the Consolidated Financial Statements of
Azurix and related notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in Azurix's Annual
Report on Form 10-K for the year ended December 31, 1999.
RECENT DEVELOPMENTS
On October 27, 2000, Azurix announced that its board of directors had
received a proposal from Enron to provide funding to take Azurix private at a
buy-out price of $7.00 per share. A special committee of the Azurix board of
directors is evaluating the proposal and has retained two investment banking
firms to advise it regarding the proposal. The special committee has not
established any timetable for this process. See Note 6 of the Notes to the
Consolidated Financial Statements.
On August 25, 2000, Azurix announced that Rebecca P. Mark resigned as its
chairman and chief executive officer. In connection with Ms. Mark's resignation,
John L. Garrison, president and chief operating officer, was elected president
and chief executive officer and Herbert S. Winokur, Jr., a member of Azurix's
board of directors, was elected chairman of the board of directors. Azurix also
announced that it is conducting a thorough review of all of its businesses, its
cost structure and its strategy to determine how to best improve financial
performance and maximize shareholder value. On November 1, 2000, Joseph W.
Sutton resigned as a director of Azurix, simultaneous with his resignation as an
officer of Enron Corp.
During April 2000, residents of the city of Bahia Blanca, Argentina and
surrounding areas began noticing unpleasant taste and odor in their water
supply, which is provided by Azurix Buenos Aires, S.A. The taste and odor were
traced to a substance released by algae that had grown to higher than normal
levels in a reservoir operated by an agency of the Province of Buenos Aires and
that had entered the local water supply. On becoming aware of the cause of the
unpleasant taste and odor, Azurix Buenos Aires instituted measures that restored
the taste and odor to acceptable levels. Tests performed by government
officials, as well as Azurix Buenos Aires, have shown that there were no harmful
biological or toxic substances in the water supply, and provincial officials
have stated publicly that there was no danger to public health. However, algae
continue to be present in the reservoir, and therefore issues of taste, odor and
color may recur.
Before the situation was corrected, at the request of government officials,
Azurix Buenos Aires acquired water from other sources for delivery in trucks and
bottles to residents in Bahia Blanca. Azurix Buenos Aires agreed with the
provincial regulatory agency not to bill residential customers for water
services for a 50-day period during which the taste and odor of supplied water
were allegedly unsatisfactory, although the regulatory agency approved billing
industrial customers for water and all customers for wastewater services during
this time. Azurix's second quarter 2000 results of operations included $3.3
million of operations and maintenance expense and $0.6 million of general and
administrative expense that were incurred in responding to this situation, in
addition to forgoing approximately $1.5 million in revenues for the 50-day
period. Azurix also incurred $0.2 million of related capital expenditures. Under
the concession contract, the provincial regulatory agency may impose penalties;
however, none have been assessed as of this date.
Under the Azurix Buenos Aires' concession agreement with the province, an
agency of the province was required to construct works to remove algae from the
water. The algae-removing works had not been completed or tested before this
incident occurred. International experts have advised Azurix Buenos Aires that
conventional algae removal facilities and reservoir operations would have
prevented the algae from entering the water system. Azurix Buenos Aires believes
the events in Bahia Blanca resulted directly from the provincial agency's
failure to deliver
12
<PAGE> 14
functioning algae removal works as required under the agreement and is seeking
reimbursement or other compensation from the province for all costs, including
any penalties that may be assessed, and forgone revenues.
During the second quarter of 2000, Azurix acquired Baker Hughes Industrial
Services, Inc., an industrial water and wastewater operations and engineering
support company primarily serving customers in the refinery and petrochemical
market. The company, subsequently renamed Azurix Industrial Operations Corp.,
serves as a platform for Azurix's industrial services business and adds
expertise in the North American industrial services market.
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 contracts.
It requires an entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. In June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 137, which deferred the
effective date of Statement of Financial Accounting Standards No. 133 to fiscal
years beginning after June 15, 2000. Additionally, in June 2000, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which amended a limited number of accounting and reporting
standards of Statement of Financial Accounting Standards No. 133. Statement of
Financial Accounting Standards No. 133 may be implemented, as of the beginning
of any fiscal quarter after issuance, however, the statement cannot be applied
retroactively. 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. Azurix will adopt the statement beginning
fiscal year 2001.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," to
provide guidance on the recognition, presentation and disclosure of revenue in
financial statements. Staff Accounting Bulletin No. 101B was issued in June 2000
and delays the effective date of Staff Accounting Bulletin No. 101 until no
later than the fourth quarter of fiscal years beginning after December 15, 1999.
Azurix is currently evaluating the impact of Staff Accounting Bulletin No. 101,
but does not anticipate that application of this bulletin will have a material
impact on its financial position or results of operations.
1999 RESTRUCTURING CHARGE
In 1998, Azurix adopted a business strategy focused on growth through
acquisitions and development projects around the world. During the fourth
quarter of 1998 and the first half of 1999, Azurix initiated a business
development effort requiring increased personnel to pursue and support
acquisition and privatization activities worldwide. The initiative was based on
Azurix's expectations as to the size, number, location and timing of
privatization projects that would be awarded in 1999, 2000 and beyond. During
the second half of 1999, several large privatization projects were postponed or
cancelled. In the fourth quarter of 1999, Azurix reevaluated its cost structure
in relation to its business development efforts. As a result, Azurix announced a
plan to restructure its operations, which resulted in Azurix recording a
one-time pretax expense totaling $34.2 million in the fourth quarter of 1999.
The restructuring plan includes reducing personnel, reducing its leased office
space and eliminating other costs relating to the pursuit of concessions in
certain regions. The restructuring liability is being funded through cash
provided by operating activities and borrowings under credit agreements. See
Note 11 of the Notes to the Consolidated Financial Statements.
13
<PAGE> 15
RESULTS OF OPERATIONS
For the year ended December 31, 1999 and for the nine months ended September
30, 2000, 73% and 54%, respectively, of Azurix's operating revenues were
denominated in U.K. pound sterling. The average U.S. dollar to pound sterling
exchange rate for the three months and nine months ended September 30, 2000 was
1.48 and 1.54, respectively, compared to the same periods in 1999 of 1.60 and
1.61, respectively. These rates represent a decrease from 1999 to 2000 for the
three months and nine months ended September 30 periods of 8% and 4%,
respectively. The decrease in the pound sterling exchange rates for the three
months and nine months ended September 30, 2000 reduced current period net
income by approximately $1.8 and $3.5 million, respectively.
See "Recent Developments" for a discussion of the impact of the Bahia Blanca
water quality issue on results of operations.
Azurix announced on November 14, 2000 that it anticipated a loss per share
in the fourth quarter of 2000 as a result of deterioration in the pound sterling
exchange rate and underperformance at Azurix Buenos Aires.
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1999
Operating revenues for the three months ended September 30, 2000 of $183.7
million increased $13.2 million, or 8%, when compared to the three months ended
September 30, 1999. The increase included approximately $30.0 million from
acquisitions that occurred after June 30, 1999, offset partially by the impact
of the Wessex rate cut, effective April 1, 2000 and the effect of the lower
current period pound sterling exchange rate, which decreased current period
revenues by $9.9 million and $8.0 million, respectively.
Operations and maintenance expense for the three months ended September 30,
2000 of $91.6 million increased $24.5 million, or 37%, when compared to the
three months ended September 30, 1999. The increase included approximately $21.5
million from acquisitions that occurred after June 30, 1999, offset partially by
the effect of the lower current period pound sterling exchange rate, which
resulted in a $1.9 million decrease from the prior period.
General and administrative expense for the three months ended September 30,
2000 of $36.2 million increased $8.6 million, or 31%, when compared to the three
months ended September 30, 1999. The increase included approximately $5.5
million from acquisitions that occurred after June 30, 1999 and approximately
$3.9 million of higher costs at Azurix Buenos Aires, which primarily resulted
from being at full staffing levels in the current period compared to the three
months ended September 30, 1999, which immediately followed the July 1999
acquisition.
Depreciation and amortization expense for the three months ended September
30, 2000 of $33.9 million increased $5.4 million, or 19%, when compared to the
three months ended September 30, 1999. The increase included $5.4 million
related to the capital expenditure programs at Wessex, Azurix Buenos Aires and
corporate headquarters, and approximately $1.6 million from acquisitions that
occurred after June 30, 1999. These increases were offset partially by the
impact of the lower current period pound sterling exchange rate, which resulted
in a $2.0 million decrease in the current period.
During the three months ended September 30, 2000, Wessex recorded a $2.5
million gain on the sale of real estate. There were no asset sales during the
three months ended September 30, 1999.
Interest income for the three months ended September 30, 2000 of $3.5
million decreased $4.2 million, or 55%, when compared to the three months ended
September 30, 1999. The decrease resulted primarily from $5.1 million of
interest income earned during the prior period on restricted cash that was on
deposit in a cash collateral account securing a bank loan to an Azurix
subsidiary that was used to fund the Buenos Aires acquisition. The loan was
repaid in April 2000 with the restricted cash proceeds. This decrease was
partially offset by an increase of $1.0
14
<PAGE> 16
million in interest income earned during the current period on restricted cash
that partially secures borrowings under the Azurix Europe revolving credit
facility.
Interest expense for the three months ended September 30, 2000 of $34.3
million increased $6.4 million, or 23%, when compared to the three months ended
September 30, 1999. Higher cost of borrowings during the current period,
primarily resulting from the senior notes issued in February 2000, resulted in a
$9.2 million increase in interest expense. This was partially offset by higher
capitalized interest of $2.1 million and lower current period pound sterling
exchange rate which lowered current period interest expense by $1.5 million. As
of September 30, 2000, approximately 63% of Azurix's debt was denominated in
pound sterling.
Income tax expense (benefit) for the three months ended September 30, 2000
of $(0.7) million decreased $9.9 million, or 108%, when compared to the three
months ended September 30, 1999. The effective tax rate for the three months
ended September 30, 2000 was 16% compared to the effective tax rate for the
three months ended September 30, 1999 of 33%. The decrease in the effective tax
rate was due primarily to the impact of non-deductible goodwill amortization
relative to lower current period pre-tax loss.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999
Operating revenues for the nine months ended September 30, 2000 of $567.5
million increased $148.8 million, or 36%, when compared to the nine months ended
September 30, 1999. The increase included $178.7 million from acquisitions that
occurred during 1999, partially offset by the Wessex rate cut and the lower
current period pound sterling exchange rate, which decreased current period
revenues by $13.9 million and $14.6 million, respectively.
Operations and maintenance expense for the nine months ended September 30,
2000 of $265.6 million increased $129.8 million, or 96%, when compared to the
nine months ended September 30, 1999. The increase included $131.0 million from
acquisitions that occurred during 1999, offset partially by the effect of the
lower current period pound sterling exchange rate, which resulted in a $3.4
million decrease from the prior period.
General and administrative expense for the nine months ended September 30,
2000 of $107.5 million increased $24.7 million, or 30%, when compared to the
nine months ended September 30, 1999. The increase included $38.2 million from
acquisitions that occurred during 1999. This increase was offset partially by
the effect of the lower current period pound sterling exchange rate and a
reduction in costs associated with the pursuit and support of worldwide water
and wastewater privatization projects that was implemented in the fourth quarter
of 1999, which decreased the current period general and administrative expense
by $0.9 million and $11.5 million, respectively.
Depreciation and amortization expense for the nine months ended September
30, 2000 of $96.4 million increased $20.5 million, or 27%, when compared to the
nine months ended September 30, 1999. The increase included $14.0 million from
acquisitions that occurred during 1999 and $9.2 million from capital expenditure
additions at Wessex and corporate headquarters. These increases were offset
partially by the effect of the lower current period pound sterling exchange
rate, which accounted for a decrease of approximately $3.5 million.
Equity in earnings of unconsolidated affiliates for the nine months ended
September 30, 2000 of $4.8 million increased $3.9 million when compared to the
nine months ended September 30, 1999. The increase resulted primarily from
higher earnings from Azurix's investment in the entity which manages and
operates the water and wastewater concession for Cancun and Isla Mujeres,
Mexico.
During the nine months ended September 30, 2000, Wessex recorded a $2.5
million gain on the sale of real estate. There were no asset sales during the
nine months ended September 30, 1999.
15
<PAGE> 17
Interest income for the nine months ended September 30, 2000 of $20.5
million increased $8.7 million, or 74%, when compared to the nine months ended
September 30, 1999. The increase primarily resulted from higher average funds on
deposit in interest bearing restricted cash accounts during the current period.
Interest expense for the nine months ended September 30, 2000 of $109.3
million increased $47.0 million, or 75%, when compared to the nine months ended
September 30, 1999. Higher cost of borrowings during the current period,
primarily resulting from the senior notes issued in February 2000, and higher
current period average borrowings outstanding, resulted in higher current period
interest expense of $27.8 million and $26.4 million, respectively. This was
partially offset by the lower current period sterling exchange rate which
lowered current period interest expense by $2.6 million and higher current
period capitalized interest of $4.6 million. As of September 30, 2000,
approximately 63% of Azurix's debt was denominated in pound sterling.
Income tax expense for the nine months ended September 30, 2000 of $7.3
million decreased $12.7 million, or 64%, when compared to the nine months ended
September 30, 1999. The effective tax rate for the nine months ended September
30, 2000 was 40% compared to the effective tax rate before extraordinary item
for the nine months ended September 30, 1999 of 27%. The effective tax rate for
the nine months ended September 30, 1999 included the effect of a reversal of a
$5.1 million deferred tax valuation allowance that was recorded during 1998.
During the second quarter of 1999, Azurix had determined that the available
evidence indicated that it was more likely than not that the deferred tax asset
would be realized. Accordingly, the valuation allowance was reversed in the
second quarter of 1999. Excluding the effect of the valuation allowance
reversal, the effective tax rate for the nine months ended September 30, 1999
was 33%. The decrease in the effective tax rate was due primarily to the impact
of non-deductible goodwill amortization relative to lower current period pre-tax
income.
LIQUIDITY AND CAPITAL RESOURCES
Azurix's cash provided by operating activities for the nine months ended
September 30, 2000 was $31.2 million. Cash used in investing activities for the
period was $280.0 million and included capital expenditures and business
acquisitions, which totaled $238.0 million. Cash provided by financing
activities for the period was $270.6 million and primarily resulted from net
borrowings during the period.
As of September 30, 2000, Azurix had a working capital deficit of $234.8
million, compared to a working capital deficit of $239.6 million at December 31,
1999. Of the working capital deficit at September 30, 2000, $300.4 million is
related to borrowings outstanding or secured by the Azurix Europe revolving
credit facility that terminates in 2002. The Azurix Europe revolving credit
facility contains a provision permitting banks, with two-thirds or more of the
commitments, to terminate the facility at an earlier time if, in their
reasonable opinion, changes have occurred resulting in a material adverse effect
on the borrower's ability to repay the outstanding debt. Azurix has no knowledge
of the lenders' intent to exercise this right; however, the existence of this
provision requires amounts outstanding under the facility to be classified as
short-term debt under generally accepted accounting principles.
In addition, at September 30, 2000, $22.1 million of the working capital
deficit related to funds received from customers in advance of providing
services that are reflected on the Consolidated Balance Sheet as deferred
income. This component of the working capital deficit does not require the use
of cash, but is recognized in income over the period in which the services are
provided. Azurix, and Wessex, its predecessor company, has during the past
several years, operated with a working capital deficit as part of its normal
business practice.
In February 2000, the Azurix Europe revolving credit facility was amended so
that Azurix Europe may borrow a portion of the facility capacity in a manner
allowing for its use by Azurix for general corporate purposes. Such capacity is
denominated in U.K. pound sterling and at September 30, 2000 was equivalent to
$354.9 million. That portion of the facility capacity was repaid in its entirety
with a portion of the proceeds from the senior notes issued in February 2000. As
of September 30, 2000, Azurix had outstanding borrowings of $118.0 million under
that portion
16
<PAGE> 18
of the facility available for use by Azurix for general corporate purposes.
These borrowings were used primarily to fund capital expenditures, acquisitions
and other general corporate purposes.
As of September 30, 2000, Azurix, through Wessex, had, among other credit
facilities, committed credit facilities with major commercial banks providing
for an aggregate of $110.9 million of borrowing capacity. The balance
outstanding under these facilities at September 30, 2000 was $53.2 million.
There were no borrowings outstanding at December 31, 1999 under these
facilities.
Azurix's credit agreement with Enron provides $180 million of liquidity to
fund general, administrative and operating expenses through December 2001.
During the nine months ended September 30, 2000, borrowings outstanding under
this credit agreement increased $56.6 million to $109.9 million. The principal
amount outstanding under the credit agreement is limited to no more than $120
million and $180 million at any time during calendar years 2000 and 2001,
respectively.
In February 2000, Azurix issued U.S. dollar and U.K. pound sterling senior
notes with a U.S. dollar equivalent face value of $599.8 million. The senior
notes consisted of $240.0 million and (pound)100.0 million, each due in 2007 and
bearing an interest rate of 10 3/8% and $200.0 million due in 2010 and bearing
an interest rate of 10 3/4%. Net proceeds after underwriter's discount and other
offering costs were $583.1 million. Of this amount, $150.0 million was used to
pay down the Azurix revolving credit facility, $386.0 million was used to pay
down the Azurix Europe revolving credit facility and $18.1 million was used to
pay down amounts outstanding under the credit agreement with Enron. In addition,
$11.5 million was used to pay accrued interest on the three credit facilities.
The remaining proceeds were made available for general corporate purposes. The
notes were issued under an indenture that contains certain covenants that limit
Azurix's ability to incur additional debt, pay dividends or make other
distributions, incur liens on its assets, enter into sale/leaseback transactions
and to enter into transactions with affiliates, or sell assets to, or merge
with, another entity.
Azurix estimates that required capital expenditures, primarily related to
its ownership of water and wastewater concessions, will be approximately $1.5
billion for the period 2000 to 2004. Azurix intends to finance its projected
capital expenditures for its existing businesses principally with internally
generated funds and proceeds under existing long-term and short-term borrowing
arrangements and future financing arrangements.
In addition to Azurix's short-term debt, as of September 30, 2000 it had
approximately $179.1 million of long-term debt and $217.8 million of long-term
debt with affiliates that mature before the end of 2004. Included in these
amounts are Azurix's existing liquidity capacity under the credit agreement with
Enron and a $107.9 million loan with another affiliate, each of which mature in
December 2001 and the Wessex committed bank facilities and the Azurix Europe
revolving credit facility which mature in April 2002 and May 2002, respectively.
Azurix anticipates that it will need to renew, refinance or replace the related
borrowings and facilities when they mature. If Azurix is not successful in these
efforts, it will need to raise capital through other means, which may include
issuing additional equity or disposing of assets.
17
<PAGE> 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 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 Azurix operates. The primary purpose of
Azurix's foreign currency hedging activities is to manage the volatility
associated with currency exchange rates. Azurix manages 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
included in Azurix's Annual Report on Form 10-K for the year ended December 31,
1999.
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, 1999, the value-at-risk estimate
for foreign currency and interest rate exposure was $0.1 million and
approximately $19,000, respectively. At September 30, 2000, the value-at-risk
estimate for foreign currency and interest rate exposure was approximately
$40,000 and $5,000, 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 in the use of different market assumptions or estimation
methodologies that will affect the estimated value-at-risk amount.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q may constitute
"forward-looking statements" as such term is defined in the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The
forward-looking statements are based on management's current expectations and
beliefs and are subject to a number of factors and uncertainties that could
cause actual results to differ materially from those described in the
forward-looking statements. Words such as "anticipates," "believes," "expects,"
"estimates," "intends," "plans," "projects," and similar expressions may
identify such forward-looking statements. Important factors that could cause
actual results to differ materially from those described in the forward-looking
statements include the following: 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 resource
markets in the United States and in other countries; regulatory developments in
the United States and in other countries, including tax and environmental
legislation and regulation; the timing and 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 securing new
service contracts, acquiring water and wastewater assets and developing and
managing water resources; Azurix's ability to access the debt and equity markets
during periods covered by the forward-looking statements; regulatory
developments affecting the purchase and sale of water resources; acceptance and
utilization by buyers and sellers of an internet marketplace for water
transfers; Azurix's ability to enter into, and retain, strategic relationships
with governmental and quasi-governmental agencies; increased competition and
technological changes in the internet-based marketplace; Azurix's ability to
hire and train, in a highly competitive market, individuals highly skilled in
the internet and e-commerce and other factors discussed elsewhere in this Form
10-Q and in Azurix's other filings with the Securities and Exchange Commission.
18
<PAGE> 20
Further, with respect to the transaction proposed by Enron for taking Azurix
private, there can be no assurance that a transaction ultimately will be
negotiated with Enron that is acceptable to Azurix's directors or that a
transaction will be concluded and, if so, what the final terms of that
transaction would be.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 27, 2000, a lawsuit styled Thomas Turberg against Azurix Corp.,
Herbert S Winokur, Jr., John H. Duncan, John Wakeham, Joseph W. Sutton, Kenneth
L. Lay, Jeffrey K. Skilling, and Enron Corp. , was filed in the Court of
Chancery in the State of Delaware, New Castle County. The suit is a purported
class action filed on behalf of Azurix's public shareholders for the purpose of
enjoining a transaction proposed by Enron for taking Azurix private at a price
of $7.00 for each of Azurix's publicly traded shares. Enron currently owns a 50%
voting interest in Atlantic Water Trust, which currently owns approximately 67%
of the outstanding shares of Azurix common stock, with the public shareholders
owning the remainder. The letter from Enron making this proposal and the related
press release issued by Azurix were filed with the Securities and Exchange
Commission on October 27, 2000, as exhibits to Azurix's Current Report on Form
8-K. The suit generally alleges that the buy-out price of $7.00 per share is
unconscionable and unfair and grossly inadequate and that the defendants have
breached their duties of loyalty and care with respect to Azurix's public
shareholders. The plaintiff seeks a judgment (i) enjoining the acquisition under
the terms presently proposed; (ii) to the extent the transaction is consummated
prior to a final judgment, rescinding the transaction or awarding rescissory
damages to the class; (iii) directing that the defendants account to the
plaintiff and the class for all damages caused to them and account for all
profits and any special benefits obtained by the defendants as a result of their
alleged unlawful conduct; (iv) awarding to the plaintiff the costs and
disbursements of the lawsuit, including a reasonable allowance for attorney fees
and expenses; and (v) granting such other and further relief as the court deems
appropriate. Several similar actions have subsequently been filed in the Court
of Chancery in the State of Delaware, New Castle County and an additional
similar action, styled Ruthy Parnes v. John H. Duncan, Joseph W. Sutton, Jeffrey
K. Skilling, John Wakeham, Kenneth L. Lay, Rebecca P. Mark, Herbert S. Winokur,
Azurix Corp. and Enron Corp., has been filed in the 55th Judicial District Court
of Harris County, Texas. Certain of the actions filed in the Delaware court have
added Atlantic Water Trust as a defendant. Azurix intends to deny the
allegations in each complaint and defend these cases vigorously. In particular,
at this time Azurix has not determined whether to accept the Enron proposal. At
this early stage of the litigation, it is not possible to estimate potential
damages, if any. If liability were established, an unfavorable judgment or
settlement could have a material adverse effect on Azurix's financial position
and results of operations.
On October 6, 2000, a lawsuit styled Irving Rosenzweig, on behalf of himself
and others similarly situated v. Azurix Corp., Rebecca Mark, Rodney Faldyn,
Joseph Sutton, Jeffrey Skilling, Kenneth Lay, and Enron Corp., was filed in the
United States District Court for the Southern District of Texas, Houston
Division. The suit is a purported class action filed on behalf of those persons
who purchased the common stock of Azurix during the period from June 9, 1999,
the date of Azurix's initial public offering, through and including August 8,
2000. The suit generally alleges that the defendants violated Sections 11, 12(a)
and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5. The plaintiff contends that the defendants
issued and disseminated materially false and misleading information to the
plaintiff and the investing public in connection with Azurix's initial public
offering and during the class period. The plaintiff seeks rescissory and/or
compensatory damages, interest and costs, including attorneys and experts fees.
The plaintiff also seeks extraordinary and/or injunctive relief, including
attaching, impounding, imposing a constructive trust upon or otherwise
restricting the proceeds of defendants' trading activities or their other assets
so as to assure that plaintiffs have an effective remedy. Several similar
actions have been filed in the United States District Court for the Southern
District of Texas. These lawsuits are subject to the Private Securities
Litigations Reform Act of 1995 and in each case the plaintiff seeks to have the
action certified as a class action with plaintiff as the class representative.
Azurix intends to deny the allegations in each complaint and defend these cases
vigorously. At this early stage of the litigation, it is not possible to
estimate potential damages, if any. If liability were established, an
unfavorable judgment or settlement could have a material adverse effect on
Azurix's financial position and results of operations.
19
<PAGE> 21
As previously reported in Azurix's Annual Report on Form 10-K for the year
ended December 31, 1999, and other filings, Azurix is party to a lawsuit styled
Synagro Technologies, Inc. v. Azurix Corp., in the 270th Judicial District Court
of Harris County, Texas. The lawsuit relates to various agreements between the
parties regarding potential business transactions and the possible acquisition
by Azurix of two subsidiaries of Waste Management, Inc., commonly called BioGro.
On May 9, 2000, Synagro filed its First Amended Petition in the District Court
seeking (i) damages in excess of $57 million resulting from the alleged breach
by Azurix of an agreement to purchase up to $23 million of Synagro convertible
preferred stock and (ii) unspecified damages resulting from Azurix's alleged
breach of confidentiality and standstill agreements. On August 4, 2000, Azurix
filed its First Amended Answer and Counterclaim (i) denying all of the material
allegations contained in Synagro's First Amended Petition and (ii) seeking
damages in excess of $175 million for misrepresentations by Synagro that induced
Azurix to agree to restrictions on its ability to purchase BioGro and to enter
into negotiations with Synagro and Synagro's interference with Azurix's
acquisition of BioGro. On September 15, 2000, Azurix filed a motion for partial
summary judgment on the issue of Azurix's obligation to purchase the preferred
stock. The court held a hearing on this motion on October 27, 2000, and ruled
against Azurix's motion. Azurix intends to continue to vigorously defend itself
against Synagro's claims and to continue to pursue its claims for damages
resulting from Synagro's conduct regarding BioGro. Although no assurances can be
given, Azurix believes that the ultimate resolution of this litigation will not
have a material adverse effect on its financial position or results of
operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER: EXHIBIT
10.1 First Amendment to Executive Employment Agreement of
John C. Ale effective October 10, 2000, with the
Registrant.
27 Financial Data Schedule (included only in the
electronic filing of this document).
(b) Reports on Form 8-K:
On October 27, 2000, the Registrant filed a Current Report on Form
8-K to announce that its Board of Directors had received a proposal from Enron
Corp. to provide funding to take the Registrant private at a buy-out price of
$7.00 per share.
20
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AZURIX CORP.
Date: November 13, 2000 By: /s/ J. Michael Anderson
-----------------------------------
Managing Director and
Chief Financial Officer
(Duly Authorized Officer)
(Principal Financial Officer)
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
10.1 First Amendment to Executive Employment Agreement of
John C. Ale effective October 10, 2000, with the
Registrant.
27 Financial Data Schedule (included only in the
electronic filing of this document).
</TABLE>
