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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, 1999 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 NOVEMBER 15, 1999
Common Stock 117,100,000
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AZURIX CORP.
INDEX
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income for the three months and nine months ended
September 30, 1999 (unaudited)......................................................................... 2
Consolidated Balance Sheets as of December 31, 1998 and September 30, 1999 (unaudited)................... 3
Consolidated Statement of Cash Flows for the nine months ended September 30, 1999 (unaudited)............ 4
Notes to Consolidated Financial Statements (unaudited)................................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................. 27
Item 6. Exhibits and Reports on Form 8-K................................................................... 28
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AZURIX CORP.
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1999
------------- -------------
Operating revenues ................................................. $ 170.5 $ 418.7
Operating expenses:
Operations and maintenance ....................................... 67.1 135.8
General and administrative ....................................... 27.6 82.8
Depreciation and amortization .................................... 28.5 75.9
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Total operating expenses ................................. 123.2 294.5
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Operating income ................................................... 47.3 124.2
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Other income (expense):
Equity in earnings of unconsolidated affiliates .................. 0.4 0.9
Interest expense, net ............................................ (20.2) (50.5)
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Income before minority interest, income taxes and extraordinary
loss ............................................................. 27.5 74.6
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Minority interest .................................................. (0.5) (0.5)
Income tax expense ................................................. 9.2 20.0
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Income before extraordinary loss ................................... 18.8 55.1
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Extraordinary loss, net of income tax benefit ...................... -- 6.8
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Net income ......................................................... $ 18.8 $ 48.3
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Earnings per share of common stock:
Basic and diluted:
Before extraordinary loss ................................... $ 0.16 $ 0.51
Extraordinary loss .......................................... -- (0.06)
------------- -------------
Basic and diluted earnings per share ........................ $ 0.16 $ 0.45
============= =============
Weighted-average shares outstanding:
Basic ....................................................... 117.1 107.1
============= =============
Diluted ..................................................... 118.0 107.6
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The accompanying notes are an integral part of these
consolidated financial statements.
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AZURIX CORP.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)
ASSETS DECEMBER 31, SEPTEMBER 30,
1998 1999
------------- -------------
(UNAUDITED)
Current assets:
Cash and cash equivalents ........................................................ $ 5.3 $ 13.9
Restricted cash and cash equivalents (Note 3) .................................... -- 401.2
Trade receivables (net of allowance for doubtful accounts
of $6.3 and $9.7, respectively) ............................................... 63.7 101.0
Unbilled receivables ............................................................. 24.3 29.0
Other ............................................................................ 38.5 58.3
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Total current assets ..................................................... 131.8 603.4
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Property, plant and equipment, at cost ............................................. 2,271.1 2,479.2
Less accumulated depreciation ...................................................... (16.7) (71.6)
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Property, plant and equipment, net ....................................... 2,254.4 2,407.6
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Investments in and advances to unconsolidated affiliates ........................... 74.3 103.8
Concession rights, net ............................................................. -- 449.7
Goodwill, net ...................................................................... 877.6 1,010.4
Other assets ....................................................................... 20.2 149.1
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Total Assets ............................................................. $ 3,358.3 $ 4,724.0
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accruals .................................................... $ 143.4 $ 219.2
Accounts payable - affiliates .................................................... 20.0 5.0
Deferred income .................................................................. 71.0 27.8
Short-term debt .................................................................. -- 951.0
Current maturities of long-term debt ............................................. 27.0 36.1
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Total current liabilities ................................................ 261.4 1,239.1
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Long-term debt ..................................................................... 912.1 840.5
Long-term debt - affiliates ........................................................ 121.4 165.9
Deferred income taxes .............................................................. 404.4 449.3
Other long-term liabilities ........................................................ 13.5 46.6
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Total liabilities ........................................................ 1,712.8 2,741.4
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Commitments and contingencies (Note 7)
Minority interest .................................................................. -- 4.0
Stockholders' 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, respectively ........... 1.0 1.2
Additional paid-in capital ....................................................... 1,671.0 1,971.3
Retained earnings ................................................................ 10.2 58.5
Cumulative foreign currency translation adjustment ............................... (36.7) (52.4)
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Total stockholders' equity ............................................... 1,645.5 1,978.6
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Total Liabilities and Stockholders' Equity ............................... $ 3,358.3 $ 4,724.0
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The accompanying notes are an integral part of these
consolidated financial statements.
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AZURIX CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
NINE MONTHS
ENDED
SEPTEMBER 30,
1999
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Operating Activities:
Net income .............................................................................. $ 48.3
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization ....................................................... 75.9
Accretion and amortization of debt expenses and write-off of deferred
financing costs ................................................................... 10.9
Deferred income taxes ............................................................... 10.0
Equity in earnings of unconsolidated affiliates ..................................... (0.9)
Minority interest ................................................................... (0.5)
Changes in operating assets and liabilities:
Increase in trade receivables and other current assets ........................ (18.1)
Decrease in accounts payable and accruals ..................................... (3.8)
Increase in other assets ...................................................... (67.3)
Increase in other long-term liabilities ....................................... 2.4
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Net cash provided by operating activities .................................................... 56.9
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Investing Activities:
Capital expenditures .................................................................... (202.5)
Investments in and advances to unconsolidated affiliates ................................ (27.9)
Business acquisitions, net of cash acquired ............................................. (630.2)
Other ................................................................................... (0.7)
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Net cash used by investing activities ........................................................ (861.3)
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Financing Activities:
Proceeds from long-term borrowings ...................................................... 474.1
Repayments of long-term borrowings ...................................................... (249.0)
Proceeds from short-term borrowings ..................................................... 418.5
Net proceeds from revolving credit facilities ........................................... 232.2
Deposit to restricted cash and cash equivalents collateral account ...................... (395.7)
Issuance of common stock ................................................................ 300.5
Advances from affiliates, net of repayments ............................................. 33.1
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Net cash provided by financing activities .................................................... 813.7
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Effect of exchange rate changes on cash ...................................................... (0.7)
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Change in cash and cash equivalents .......................................................... 8.6
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Cash and cash equivalents, beginning of period ............................................... 5.3
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Cash and cash equivalents, end of period ..................................................... $ 13.9
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The accompanying notes are an integral part of these consolidated financial
statements.
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AZURIX CORP.
NOTES TO 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, 1999 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
Registration Statement on Form S-1, which was declared effective on June 9,
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 1998 amounts to conform
with the 1999 presentation. "Azurix" is used from time to time herein as a
collective reference to Azurix Corp. and its subsidiaries and affiliates.
Azurix was incorporated on January 29, 1998, however, substantially all of
Azurix's 1998 results of operations, cash flows and equity transactions occurred
during the fourth quarter of 1998, subsequent to the Wessex Water Plc
acquisition (see Note 2). Interim financial statements for the periods ended
September 30, 1998 are not presented because Azurix did not have results of
operations or cash flows during those periods.
NOTE 2 - BUSINESS ACQUISITIONS
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. Azurix completed the acquisition of the ordinary share capital of
Wessex in November 1998. The cost of the Wessex acquisition, including
transaction costs, was $2.4 billion. The purchase method of accounting was
utilized and the results of operations of Wessex have been included in the
consolidated financial statements since the date of acquisition.
The following unaudited pro forma information summarizes consolidated
results of operations of Azurix as if the Wessex acquisition had occurred as of
the beginning of the earliest period presented:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
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(IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Operating revenues ................. $ 117.6 $ 344.5
Net income ......................... 30.5 75.8
Basic and diluted earnings
per share ......................... 0.30 0.76
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 Wessex Waste Management Ltd. 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.
On May 18, 1999, Azurix acquired 100% of the stock of Canadian-incorporated
Philip Utilities Management Corporation for $107.4 million, including
transaction costs. Philip Utilities is a water and wastewater services company
that provides operations and management, engineering, residuals management and
underground infrastructure development services for municipal water and
wastewater facilities in the U.S. and Canada. This business subsequently was
renamed Azurix North America.
The purchase method of accounting was utilized, and accordingly, the assets
and liabilities of Azurix North America 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 a straight-line basis over 40 years. The results of
operations of Azurix North America have been included in the consolidated
financial statements since the date of acquisition. 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 does
not believe the final evaluation of these assessments will materially affect the
allocation of the purchase price.
During the second quarter of 1999, Azurix was the successful bidder in a
tender for a 30-year concession to operate the water and wastewater systems in
two regions of the Province of Buenos Aires, Argentina, previously operated by
Administracion General de Obras Sanitarias Buenos Aires. On June 30, 1999,
Azurix, through Azurix Buenos Aires S.A., an indirect wholly owned subsidiary,
entered into a concession contract with the provincial government covering the
two regions and paid the government $438.6 million. On July 1, 1999, Azurix
assumed operation of the water and wastewater systems and risk of ownership of
the concession.
In connection with the funding of this acquisition, Azurix made an equity
investment in Azurix Buenos Aires of $45.0 million, and Azurix Buenos Aires
borrowed $394.0 million under a new credit agreement. This loan is secured by
cash and other short-term liquid investments which Azurix deposited into a cash
collateral account and pledged as security for the loan (see Note 3). Azurix
used $230.6 million of the proceeds from its initial public offering, $208.0
million in funds drawn under the senior credit facility of its indirect wholly
owned subsidiary, Azurix Europe Ltd, and interest on those funds and other funds
of Azurix, to fund the equity investment in Azurix Buenos Aires and the deposit
into the cash collateral account. Under the concession contract, a 10% interest
in Azurix Buenos Aires is required to be transferred to the employees of
Administracion General de Obras Sanitarias Buenos Aires who became employees of
Azurix Buenos Aires.
On September 24, 1999, Azurix acquired 49% of the capital stock of IASA
Holdings, S.A. de C.V. for $22.5 million, excluding transaction costs. IASA
Holdings owns 100% of Industrias del Agua, S.A. de C.V., a water and wastewater
services company based in Monterrey, Mexico that provides metering, billing,
collections, operations and maintenance services for one quarter of the Federal
District within Mexico City, a service area with a population of approximately
two million people. Industrias del Agua has provided these services since 1993,
when it signed a 10-year contract with the Water Commission of the Federal
District. In addition to holding an interest in Industrias del Agua, Azurix
provides technical services and ultimately expects to serve as a technical
participant under the Federal District contract.
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On September 24, 1999, Azurix acquired from an affiliate of AMX - Acqua
Management Inc., 100% of three Brazilian companies, Geoplan - Assessoria,
Planejamento e Perfuracoes Ltda., Aguacerta - Sistemas de Abastecimento Ltda.
and Aguacerta Saneamento Ltda. for $55.6 million, excluding transaction costs.
The acquired companies have offices in the states of Rio de Janeiro and Sao
Paulo, Brazil and provide water drilling, water supply and wastewater treatment
services in Brazil. Azurix has contingent payment obligations to a former owner
under certain negotiated formulas and has retained a former affiliate as a
consultant to its Brazilian operations.
NOTE 3 - RESTRICTED CASH AND CASH EQUIVALENTS
At September 30, 1999, Azurix had restricted cash and cash equivalents of
$401.2 million which is on deposit in a cash collateral account that secures the
$394.0 million loan to an Azurix subsidiary that was used to fund the Buenos
Aires concession acquisition (see Note 2). The amount payable under the loan is
included in "Short-term debt" on the consolidated balance sheet (see Note 4).
NOTE 4 - SHORT-TERM DEBT
On May 10, 1999, Azurix Europe entered into a revolving credit facility. At
September 30, 1999, the maximum capacity of the facility was $699.4 million. Of
this amount, $395.0 million may be used to fund acquisitions and the remaining
amount may be used to refinance existing Azurix indebtedness. A portion of the
unused borrowing capacity is reserved to provide for the refinancing of
outstanding loan notes of $103.2 million (see Note 5). Borrowings outstanding at
September 30, 1999 consisted of approximately $77.3 million used to repay all of
the remaining indebtedness outstanding on its former senior credit facility and
fees and expenses related to this facility, $386.0 million primarily used to
fund acquisitions and $13.2 million used to redeem Wessex acquisition loan
notes.
The Azurix Europe revolving credit facility bears interest at the London
interbank offered rate plus 0.75% or 1.0%, depending on the level of utilization
of the borrowing capacity. Azurix incurs commitment fees of 0.375% on the unused
borrowing capacity of this facility. Outstanding borrowings at September 30,
1999 have been borrowed under the revolving credit facility for a period of less
than 12 months. The facility terminates on May 10, 2002, but contains a clause
permitting banks, with two-thirds or more of the commitments, to terminate 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. Therefore, amounts outstanding under this facility have been classified as
short-term debt. Azurix is evaluating alternatives to replace some or all of the
outstanding borrowings under this facility with long-term debt, making this
facility available for future acquisitions and other purposes. The facility
contains restrictive covenants that include limitations on borrowings,
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 customary events of default, including non-payment, cross-defaults and
insolvency.
As of September 30, 1999, Azurix, through a wholly owned subsidiary of
Wessex, had $123.4 million outstanding under committed credit facilities with
major commercial banks. Interest accrues on the committed credit facilities
based on the London interbank offered rate plus 0.275%. The interest rate as of
September 30, 1999 was 5.37%. Azurix pays commitment fees of 0.15% on the unused
portion of committed lines of credit. The facilities expire in April 2002. The
borrowings under these facilities have been reclassified as long-term debt based
on the ability to re-borrow these funds under the facilities beyond one year and
Azurix's intent to maintain such borrowings in excess of one year (see Note 5).
In connection with the funding of the Buenos Aires concession acquisition
(see Note 2), Azurix, through its subsidiary Azurix Buenos Aires S.A., entered
into a credit agreement on June 24, 1999, and borrowed $394.0 million on June
29, 1999. The agreement is between Azurix Buenos Aires and Westdeutsche
Landesbank Girozentrale, a German bank, as the agent and lender. The loan is
secured by cash and other short-term
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
liquid investments in the aggregate amount of $401.2 million as of September 30,
1999, which Azurix deposited into a cash collateral account, including interest
earned on amounts deposited, and pledged as security for the loan (see Note 3).
The loan matures on June 22, 2000, or at an earlier time prior to such date if
the direct or indirect ownership by Enron Corp. of the outstanding voting stock
of Azurix falls below 25%, and Azurix Buenos Aires does not arrange for the
assignment of the lender's rights and obligations under the credit agreement to
a new lender. The interest rate on amounts outstanding under this credit
agreement as of September 30, 1999 was 5.53%.
On September 29, 1999, Azurix Corp. entered into a 364-day $150.0 million
unsecured revolving credit facility with a group of banks. As of September 30,
1999, $28.0 million was outstanding under the facility and the borrowings were
primarily used to reduce other debt obligations. Borrowings under the revolver
can be used to satisfy working capital requirements, make acquisitions or loans
and for any other purpose consistent with Azurix's objective of owning,
operating and investing in water and wastewater assets. This financing agreement
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 certain acts. In
addition, Azurix is required, by March 31, 2000, to amend the Azurix Europe
revolving credit facility to eliminate the clause that specifically prohibits
the payment of dividends to Azurix Europe shareholders. The financing agreement
includes standard events of default, including non-payment, cross-defaults and
insolvency.
NOTE 5 - LONG-TERM DEBT
The components of long-term debt are as follows:
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ ------------
(IN MILLIONS)
(UNAUDITED)
Amounts reclassified from short-term debt.... $ 424.0 $ 123.4
Senior credit facility ...................... 219.5 --
Senior unsecured bonds ...................... -- 488.1
Loan notes .................................. 117.2 103.2
European Investment Bank credit facilities... 68.7 65.3
Capital lease obligations ................... 109.7 87.9
Other ....................................... -- 8.7
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939.1 876.6
Less current maturities ..................... (27.0) (36.1)
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Total long-term debt .............. $ 912.1 $ 840.5
========== ==========
At December 31, 1998, Azurix had borrowings outstanding under its former
senior credit facility of $219.5 million. During the second quarter of 1999,
Azurix used proceeds from credit facilities and its Azurix Europe revolving
credit facility entered into in May 1999, to retire the outstanding borrowings
under its former senior credit facility. The former senior credit facility was
subsequently terminated.
On March 30, 1999, Azurix, through a wholly owned subsidiary of Wessex,
issued U.K. pounds sterling denominated senior unsecured bonds with a face value
of $493.7 million as of September 30, 1999. The net proceeds were primarily used
to refinance the short-term bank borrowings that were outstanding on that date.
The bonds mature on March 30, 2009 and bear interest at a rate of 5.875% payable
annually.
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 6 - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes and interest expense is as follows:
NINE MONTHS
ENDED
SEPTEMBER 30,
1999
--------------
(IN MILLIONS)
(UNAUDITED)
Income taxes ..................................... $ 14.5
Interest expense (net of amounts capitalized)..... 47.2
NOTE 7 - COMMITMENTS AND CONTINGENCIES
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 adverse effect on its results
of operations or financial position (see Note 13).
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.
A substantial portion of Azurix's revenues are subject to governmental
regulation of the rates that it may charge to its customers. On July 27, 1999,
the U.K. water regulator, the Director General of Water Services, announced
proposed price limits for U.K. water companies for the period April 1, 2000
through 2005. Wessex was notified of a preliminary determination of a 13.5%
price cut from 1999-2000 to 2000-2001. The announcement included level prices
for the following two years with annual price increases in 2003-2004 and
2004-2005 of 2.0% and 3.1%, respectively. The Director General and Wessex have
consulted and a final determination is expected in late November 1999. Wessex's
regulated operating revenues represented over 75% of Azurix's total operating
revenues for the nine months ended September 30, 1999, and the preliminary price
cut, if implemented, would be expected to materially reduce earnings. However,
Azurix does not expect this would have a material adverse effect on its
financial position. In addition, the U.K. Government, in October 1999, proposed
regulations to protect vulnerable groups, such as low income and large families,
from high charges for metered water. Azurix does not believe that these
regulations, if they take effect, would have a material adverse effect on
Azurix's financial position and results of operations.
Wessex currently has a virtual monopoly over water supply and wastewater
services within its service 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. This may change in
the future, however, as the U.K. Government and the Director General are seeking
to increase competition in the water sector. The Director General has announced
various steps he may take, such as reducing the threshold level of service
required before a large customer may contract with someone other than the
licensed service provider, promoting competition in new connections, and
facilitating common carriage of water through existing water service companies.
Further, the Director General has stated that he will use his powers under the
Competition Act 1998 to pursue companies that are abusing dominant market
positions. Increased competition could affect Wessex's monopoly within its own
service region, but would enable it to compete for customers in other regions,
taking advantage of its historically efficient operating levels.
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 8 - EARNINGS PER SHARE
The numerators in the basic and diluted earnings per share calculations are
equal. A reconciliation of the denominators is as follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1999
------------ -----------
(IN MILLIONS)
(UNAUDITED)
Denominator:
Weighted-average shares - basic ..... 117.1 107.1
Effect of dilutive securities:
Stock options .................... 0.9 0.5
--------- ---------
Weighted-average shares - diluted ... 118.0 107.6
========= =========
NOTE 9 - STOCKHOLDERS' EQUITY
On June 9, 1999, Azurix's Registration Statement on Form S-1 relating to
its initial public offering was declared effective. The offering of 36.6 million
shares of common stock was priced at $19.00 per share. Azurix sold 17.1 million
shares and Atlantic Water Trust, the former 100% parent of Azurix, sold 19.5
million shares. The proceeds to Azurix, after deducting expenses associated with
the offering, were $300.5 million. The proceeds were used to repay an advance
from Enron, which holds a 50% voting interest in Atlantic Water Trust, and to
partially fund the Buenos Aires concession acquisition (see Note 2).
Approximately 68.7% of Azurix's common stock was held by Atlantic Water Trust
and the remaining 31.3% was held by the public until July 8, 1999, on which date
the underwriters exercised their over-allotment option in connection with the
initial public offering of Azurix's common stock. As a result, Atlantic Water
Trust sold an additional 1,963,468 shares of Azurix's common stock, reducing its
ownership percentage in Azurix to approximately 67.1%.
Azurix has issued stock options during the nine months ended September 30,
1999 to certain employees to purchase 8.7 million shares of common stock at a
weighted-average exercise price of $17.00 per share. These stock options
generally vest over three to five years and will be exercisable for 10 years
after the date of grant. The future exercise of these options will have a
dilutive effect on basic earnings per share.
NOTE 10 - 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 U.S. 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.
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 11 - COMPREHENSIVE INCOME
Comprehensive income includes the following for the periods indicated:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1999
------------- -------------
(IN MILLIONS)
(UNAUDITED)
Net income............................................... $ 18.8 $ 48.3
Other comprehensive income (loss):
Foreign currency translation adjustment.............. 68.1 (15.7)
------ ------
Comprehensive income..................................... $ 86.9 $ 32.6
====== ======
NOTE 12 - EXTRAORDINARY LOSS
In May 1999, Azurix retired borrowings under its former senior credit
facility and terminated the facility prior to its maturity (see Note 5).
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 13 - SUBSEQUENT EVENTS
On October 4, 1999, Azurix purchased 13,600 acres of property in Madera
County, California, for $31.4 million, excluding transaction costs, with plans
of developing, owning and operating a ground water storage project in the
aquifer beneath it.
On October 18, 1999, Azurix acquired Lurgi Bamag GmbH, a process
engineering company specializing in the water sector, for $30.2 million,
excluding transaction costs. Lurgi Bamag and its subsidiaries have offices in
Germany, Brazil and the U.K.
On October 29, 1999, Azurix Corp. filed a complaint in the Chancery Court
of the State of Delaware against Synagro Technologies, Inc. Prior to this
filing, Azurix and Synagro had been in discussions regarding possible
collaborative efforts and/or strategic transactions for several months. In
connection with these discussions, the parties entered into a confidentiality
agreement and related letter agreements containing standstill provisions
restricting Azurix's ability to acquire or engage in negotiations with a number
of companies for several months. In September 1999, Synagro orally agreed to
waive these standstill provisions with regard to two subsidiaries of Waste
Management, Inc. This oral waiver was made to representatives of Waste
Management, as well as to Azurix. Azurix also agreed to purchase up to $23
million of Synagro convertible preferred stock, subject to certain conditions,
and negotiated with Synagro over other arrangements, although no written
agreement regarding those other arrangements has been signed by both parties.
Since the waiver, Azurix and Waste Management have been negotiating a possible
acquisition by Azurix of the target companies. Azurix has not entered into an
acquisition agreement for the target companies, nor has any commitment or final
determination been made by the parties to proceed with an acquisition. Azurix's
complaint seeks to enforce the waiver of the standstill provisions and an
injunction against Synagro's interfering with the potential acquisition of the
target companies by Azurix, along with money damages and a declaration that
Azurix has no further obligations to purchase stock of Synagro or pay it any
other sums. On November 1, 1999, Synagro filed suit against Azurix Corp. in the
District Court of Harris County, Texas, seeking both a temporary restraining
order and permanent injunction to enjoin Azurix from using confidential
information that Azurix had obtained from Synagro and, in particular, alleging
that Azurix's negotiating or closing the acquisition that is the subject of the
Delaware case would violate the standstill agreement between the parties.
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AZURIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On November 2, 1999, the court in the Texas action entered a temporary
restraining order preventing Azurix from using any confidential or proprietary
information that it received from Synagro, including with respect to the target
companies, and preventing both Azurix and Synagro from acquiring, or entering
into an agreement to acquire, the target companies for a 14-day period. On
November 3, 1999, Azurix filed a motion asking the Texas court to postpone the
action in Texas until the Delaware Chancery Court had heard the earlier-filed
Delaware case. The hearing on this motion was held on November 12, 1999,
although the court has not yet issued its ruling. If the Texas court does not
defer its proceedings in favor of those in Delaware, a hearing on whether Azurix
should be preliminarily enjoined from proceeding with the proposed acquisition
will be held on November 19, 1999. Azurix and Synagro have agreed to extend the
temporary restraining order through November 19, 1999. Azurix is also seeking an
early hearing date in the Delaware proceeding. During the week of November 8,
1999, certain subsidiaries of Waste Management filed a motion to intervene in
both the Texas and Delaware cases alleging that Synagro has interfered with
their negotiations with Azurix.
Azurix denies that it has breached, or that the acquisition of the target
companies would breach, any of its obligations to Synagro. Synagro has not
alleged an amount of damages, and so it is not possible in this early stage of
the litigation to predict what, if any, damages might result if the cases were
determined adversely to Azurix. Although no assurances can be given, Azurix
believes that the ultimate resolution of this litigation will not have a
material adverse effect on its results of operations or financial position.
Azurix is currently evaluating its existing cost structure with respect to
its business development activities. Azurix estimates a non-recurring, pretax
charge in the fourth quarter of 1999 related to reductions in corporate
personnel, leased office space and other restructuring charges of approximately
$30 million to $35 million.
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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
Registration Statement on Form S-1, which was declared effective on June 9,
1999.
BUSINESS ACQUISITIONS
On May 18, 1999, Azurix acquired 100% of the stock of Canadian-incorporated
Philip Utilities Management Corporation for $107.4 million, including
transaction costs. Philip Utilities is a water and wastewater services company
that provides operations and management, engineering, residuals management and
underground infrastructure development services for municipal water and
wastewater facilities in the U.S. and Canada. This business subsequently was
renamed Azurix North America.
During the second quarter of 1999, Azurix was the successful bidder in a
tender for a 30-year concession to operate the water and wastewater systems in
two regions of the Province of Buenos Aires, Argentina, previously operated by
Administracion General de Obras Sanitarias Buenos Aires. On June 30, 1999,
Azurix, through Azurix Buenos Aires S.A., an indirect wholly owned subsidiary,
entered into a concession contract with the provincial government covering the
two regions and paid the government $438.6 million. On July 1, 1999, Azurix
assumed operation of the water and wastewater systems and risk of ownership of
the concession.
In connection with the funding of this acquisition, Azurix made an equity
investment in Azurix Buenos Aires of $45.0 million, and Azurix Buenos Aires
borrowed $394.0 million under a new credit agreement. This loan is secured by
cash and other short-term liquid investments, which Azurix deposited into a cash
collateral account and pledged as security for the loan. Azurix used $230.6
million of the proceeds from its initial public offering, $208.0 million in
funds drawn under the senior credit facility of its indirect wholly owned
subsidiary, Azurix Europe Ltd, and interest on those funds and other funds of
Azurix, to fund the equity investment in Azurix Buenos Aires and the deposit
into the cash collateral account. Under the concession contract, a 10% interest
in Azurix Buenos Aires is required to be transferred to the employees of
Administracion General de Obras Sanitarias Buenos Aires who became employees of
Azurix Buenos Aires. On a consolidated basis, the funding of the acquisition
resulted in an increase in the short-term debt of Azurix of $602.0 million
(representing $394.0 million drawn by Azurix Buenos Aires under the credit
agreement and $208.0 million drawn by Azurix Europe under the senior credit
facility) and a corresponding increase in the current assets of Azurix of $395.7
million (representing the amount deposited into the cash collateral account,
excluding interest earned thereon).
On September 24, 1999, Azurix acquired 49% of the capital stock of IASA
Holdings, S.A. de C.V. for $22.5 million, excluding transaction costs. IASA
Holdings owns 100% of Industrias del Agua, S.A. de C.V., a water and wastewater
services company based in Monterrey, Mexico that provides metering, billing,
collections, operations and maintenance services for one quarter of the Federal
District within Mexico City, a service area with a population of approximately
two million people. Industrias del Agua has provided these services since 1993,
when it signed a 10-year contract with the Water Commission of the Federal
District. In addition to holding an interest in Industrias del Agua, Azurix
provides technical services and ultimately expects to serve as a technical
participant under the Federal District contract.
On September 24, 1999, Azurix acquired from an affiliate of AMX - Acqua
Management Inc., 100% of three Brazilian companies, Geoplan - Assessoria,
Planejamento e Perfuracoes Ltda., Aguacerta - Sistemas de Abastecimento Ltda.
and Aguacerta Saneamento Ltda. for $55.6 million, excluding transaction costs.
The acquired companies have offices in the states of Rio de Janeiro and Sao
Paulo, Brazil and provide water drilling, water supply and wastewater treatment
services in Brazil. Azurix has contingent payment obligations to a former owner
under
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certain negotiated formulas and has retained a former affiliate as a consultant
to its Brazilian operations.
RECENT DEVELOPMENTS
On July 27, 1999, the U.K. water regulator, the Director General of Water
Services, announced proposed price limits for U.K. water companies for the
period April 1, 2000 through 2005. Wessex was notified of a preliminary
determination of a 13.5% price cut from 1999-2000 to 2000-2001. The announcement
included level prices for the following two years with annual price increases in
2003-2004 and 2004-2005 of 2.0% and 3.1%, respectively. The Director General and
Wessex have consulted and a final determination is expected in late November
1999. Wessex's regulated operating revenues represented over 75% of Azurix's
total operating revenues for the nine months ended September 30, 1999, and the
preliminary price cut, if implemented, would be expected to materially reduce
earnings. However, Azurix does not expect this would have a material adverse
effect on its financial position. The pending rate review was considered by
Azurix in its valuation of Wessex at the time of acquisition. In addition, the
U.K. Government, in October 1999, proposed regulations to protect vulnerable
groups, such as low income and large families, from high charges for metered
water. Azurix does not believe that these regulations, if they take effect,
would have a material adverse effect on Azurix's financial position and results
of operations.
Wessex currently has a virtual monopoly over water supply and wastewater
services within its service 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. This may change in
the future, however, as the U.K. Government and the Director General are seeking
to increase competition in the water sector. The Director General has announced
various steps he may take, such as reducing the threshold level of service
required before a large customer may contract with someone other than the
licensed service provider, promoting competition in new connections, and
facilitating common carriage of water through existing water service companies.
Further, the Director General has stated that he will use his powers under the
Competition Act 1998 to pursue companies that are abusing dominant market
positions. Increased competition could affect Wessex's monopoly within its own
service region, but would enable it to compete for customers in other regions,
taking advantage of its historically efficient operating levels.
On September 29, 1999, Azurix Corp. entered into a 364-day $150.0 million
unsecured revolving credit facility with a group of banks. Borrowings under the
revolver can be used to satisfy working capital requirements, make acquisitions
or loans and for any other purpose consistent with Azurix's objective of owning,
operating and investing in water and wastewater assets.
On October 4, 1999, Azurix purchased 13,600 acres of property in Madera
County, California, for $31.4 million with plans of developing, owning and
operating a ground water storage project in the aquifer beneath it. The aquifer
on the property will be used to store surplus water from local, state and
federal water customers during wet years in an effort to make this water
available for use throughout the region and state during drier years or as the
market dictates. The Madera property is strategically located near existing
state and federal canals and aqueducts and the San Joaquin River, all of which
may provide a number of alternative conveyance systems to move water to and from
the site.
On October 18, 1999, Azurix acquired Lurgi Bamag GmbH, a process
engineering company specializing in the water sector, for $30.2 million,
excluding transaction costs. Lurgi Bamag and its subsidiaries have offices in
Germany, Brazil and the U.K.
See Note 13 in the Notes to Consolidated Financial Statements found
elsewhere in this quarterly report regarding recent litigation involving Azurix.
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Azurix is currently evaluating its existing cost structure with respect to
its business development activities. Azurix estimates a non-recurring, pretax
charge in the fourth quarter of 1999 related to reductions in corporate
personnel, leased office space and other restructuring charges of approximately
$30 million to $35 million.
RECENT ACCOUNTING PRONOUNCEMENT
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. 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.
RESULTS OF OPERATIONS
Azurix had no operations as of September 30, 1998 and as a result, the
following discussion is limited to results of operations for the three months
and nine months ended September 30, 1999. All of its 1998 operating income
occurred during the fourth quarter of 1998 following the Wessex acquisition.
THREE MONTHS ENDED SEPTEMBER 30, 1999
Operating revenues of $170.5 million for the three months ended September
30, 1999 included $115.4 million derived from Wessex, $35.4 million derived from
Azurix North America and $19.1 million derived from Azurix Buenos Aires.
Approximately 94% of the revenues from Wessex related to the sale of measured
and unmeasured water and wastewater services. Wessex's remaining revenues were
derived from SC Technology and its unregulated activities, which accounted for
2% and 4% of operating revenues from Wessex, respectively.
Operations and maintenance expenses for the three months ended September
30, 1999 were $67.1 million. Of this amount, $22.0 million related to Wessex's
cost of supplying water and treating wastewater, including the costs of
maintaining and operating plant and equipment used in these processes, and $3.2
million related to the costs of the plants being installed by SC Technology. Of
the remaining amount, Azurix North America and Azurix Buenos Aires incurred
$28.8 million and $13.1 million, respectively.
General and administrative expenses of $27.6 million for the three months
ended September 30, 1999 included $12.7 million primarily related to the pursuit
of acquisitions and development projects, $9.0 million related to Wessex's
operations and the remainder related to Azurix North America and Azurix Buenos
Aires.
Depreciation and amortization expenses of $28.5 million for the three
months ended September 30, 1999 included $17.3 million derived from depreciation
on the property, plant and equipment of Wessex, $5.4 million derived from
goodwill amortization expense at Wessex and the remainder related to Azurix
North America and Azurix Buenos Aires.
The effective tax rate for the period was 32.9%. The difference between the
effective tax rate and the U.S. statutory rate of 35% is primarily related to a
30% statutory tax rate in the U.K., where a majority of Azurix's results of
operations are derived, partially offset by non-deductible goodwill
amortization.
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NINE MONTHS ENDED SEPTEMBER 30, 1999
Operating revenues of $418.7 million for the nine months ended September
30, 1999 included $348.1 million derived from Wessex, $50.1 million derived from
Azurix North America and $19.1 million derived from Azurix Buenos Aires.
Approximately 93% of the revenues from Wessex related to the sale of measured
and unmeasured water and wastewater services. SC Technology's operating
revenues, and operating revenues from Wessex's unregulated activities, accounted
for 3% and 4%, respectively, of Wessex's operating revenues.
Operations and maintenance expenses for the nine months ended September 30,
1999 were $135.8 million. Of this amount, $69.5 million related to Wessex's cost
of supplying water and treating wastewater, including the costs of maintaining
and operating plant and equipment used in these processes, and $12.9 million
related to the costs of the plants being installed by SC Technology. Of the
remaining amount, Azurix North America and Azurix Buenos Aires incurred $40.3
million and $13.1 million, respectively.
General and administrative expenses of $82.8 million for the nine months
ended September 30, 1999 included $47.7 million primarily related to the pursuit
of acquisitions and development projects, $26.8 million related to Wessex's
operations and the remainder related to Azurix North America and Azurix Buenos
Aires.
Depreciation and amortization expenses of $75.9 million for the nine months
ended September 30, 1999 included $52.9 million derived from depreciation on the
property, plant and equipment of Wessex, $16.1 million derived from goodwill
amortization expense at Wessex and the remainder related to Azurix North America
and Azurix Buenos Aires.
The effective tax rate before extraordinary item for the period was 26.6%.
The difference between the effective tax rate and the U.S. statutory rate of 35%
is primarily related to the reversal of a $5.1 million deferred tax valuation
allowance that was recorded during 1998 relating to losses incurred in the U.S.
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 was reversed in the second
quarter of 1999.
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.
LIQUIDITY AND CAPITAL RESOURCES
Azurix's cash provided by operating activities for the nine months ended
September 30, 1999 was $56.9 million. Cash used by investing activities for the
period was $861.3 million and was comprised primarily of business acquisitions
of $630.2 million and capital expenditures of $202.5 million. Cash provided by
financing activities for the period was $813.7 million and was comprised
primarily of a net increase in borrowings of $908.9 million and net proceeds
from the initial public offering of Azurix's common stock of $300.5 million.
As of September 30, 1999, Azurix had a working capital deficit of $635.7
million, compared to a working capital deficit of $129.6 million at December 31,
1998. The increase in the working capital deficit is primarily related to $476.5
million of funds borrowed under a revolving credit facility. The proceeds were
primarily used to fund acquisitions and refinance existing long-term debt. The
funds were borrowed under the Azurix Europe revolving credit facility for a
period of less than 12 months. Amounts currently borrowed under the facility may
be re-borrowed through the facility's termination date in 2002. Borrowings under
this facility are classified as short-term as a result of accounting rules
issued by the Financial Accounting Standards Board that restrict a company from
reclassifying short-term debt as long-term utilizing existing borrowing capacity
under a long-term loan agreement, if that
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agreement contains a subjectively determinable or measurable clause that could
result in the lender's right not to loan funds. The Azurix Europe revolving
credit facility contains a clause permitting banks, with two-thirds or more of
the commitments, to terminate 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. Therefore, amounts outstanding
under this facility have been classified as short-term debt. Azurix is
evaluating alternatives to replace some or all of the outstanding borrowings
under this facility with long-term debt, making this facility available for
future acquisitions and other purposes.
In addition, at September 30, 1999, $27.8 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. The remaining working capital deficit is related to the timing of cash
payments. Excess cash, including funds received in advance of providing
services, is used to repay 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, 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 was used to
secure a substantial portion of acquisition loan notes issued to Wessex
shareholders in lieu of cash consideration for their shares. During the second
quarter of 1999, Azurix used proceeds from bank credit facilities and the Azurix
Europe revolving credit facility entered into in May 1999, to retire the
outstanding borrowings under its former senior credit facility. The former
senior credit facility was subsequently terminated.
Azurix's credit agreement with Enron provides $180 million of liquidity to
fund general, administrative and operating expenses through December 2001. As of
September 30, 1999, $45.8 million was outstanding under this credit agreement.
The principal amount outstanding under the credit agreement is limited to no
more than $60 million, $120 million and $180 million at any time during calendar
years 1999, 2000 and 2001, respectively.
On September 29, 1999, Azurix entered into a 364-day $150.0 million
unsecured revolving credit facility with a group of banks. Borrowings under the
revolver can be used to satisfy working capital requirements, make acquisitions
or loans and for any other purpose consistent with Azurix's objective of owning,
operating and investing in water and wastewater assets. The amount outstanding
at September 30, 1999 was $28.0 million. During October 1999, $71.4 million was
borrowed under this facility and used primarily to fund two acquisitions.
As discussed above, Azurix is currently evaluating various financing
strategies to raise additional capital to support further 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 Azurix
will be successful in securing any financing arrangements.
Azurix's liquidity could be impacted by the potential interruption of the
capital markets due to the Year 2000 problem. See "Year 2000" for a discussion
of potential problems and Azurix's Year 2000 plan.
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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 today. When computer systems must
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 by the interdependence
of computer and telecommunications systems in the U.S. and throughout the world.
This interdependence applies to Azurix and Azurix's suppliers, trading partners
and customers, as well as for governments of countries around the world where
Azurix does business. This interdependence also applies to Enron, on which
Azurix relies in part for services that involve computer processing.
STATE OF READINESS
Azurix's Board of Directors has been briefed about the Year 2000 problems
generally and as they may affect Azurix. The Board has adopted Enron's Year 2000
plan to cover all of Azurix's operating subsidiaries. The aim of the plan is to
take reasonable steps to prevent Azurix's mission-critical functions from being
impaired due to the Year 2000 problem. "Mission-critical" functions are those
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 to Azurix.
Azurix is implementing the plan under the supervision of a Year 2000
project director. The project director coordinates the implementation of the
plan among Azurix's operating subsidiaries. As part of the overall plan, each
operating subsidiary in turn has developed, and is implementing, a Year 2000
plan specific to it. Azurix also has engaged outside consultants, technicians
and other external resources to aid in formulating and implementing the plan.
Azurix will modify the plan as events warrant. Under the plan, Azurix 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 that may function
improperly before, on or after January 1, 2000; assess the effects of Year 2000
problems on the mission-critical functions of Azurix's operating subsidiaries;
remedy, to the extent practicable, systems software and embedded chips in an
effort to avoid material disruptions or other material adverse effects on
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 effects of Year 2000 problems that may not be remediated by
January 1, 2000, including the development and implementation of contingency
plans to cope with the mission-critical consequences of Year 2000 problems that
have not been identified or remediated by that date.
The plan recognizes that central information systems, such as large
mainframes and mid-size computer systems and desktop or personal computers and
computer networks, can be vulnerable to Year 2000 problems. In addition, devices
with embedded chips, such as flow controllers and controllers for automated
pumps, are vulnerable to Year 2000 problems. Devices with embedded chips may be
used for many purposes, and finding all of them may be difficult, even with a
careful inventory and remediation process.
The plan recognizes that the computer, telecommunications and other systems
of outside entities have the potential for major, mission-critical, adverse
effects on the conduct of Azurix's business. Azurix does not have
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control of these outside entities or outside systems. In some cases, outside
entities are foreign governments or businesses located in foreign countries.
However, Azurix's plan includes an ongoing process of identifying and contacting
outside entities whose systems, in Azurix's judgment, have or may have a
substantial effect on Azurix's ability to continue to conduct the
mission-critical aspects of its business without disruption from Year 2000
problems. The plan envisions Azurix attempting to inventory and assess the
extent to which these outside systems may not be "Year 2000 ready." 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. Azurix is coordinating as is
reasonable with these outside entities in an ongoing effort to obtain assurance
that the outside systems that are mission-critical to Azurix will be Year 2000
ready before January 1, 2000. Consequently, Azurix is working prudently with
outside entities in a reasonable attempt to inventory, assess, analyze, convert
where necessary, test and develop contingency plans for Azurix's connections to
these mission-critical outside systems and to ascertain the extent to which they
are, or can be made to be, Year 2000 ready to work with Azurix's
mission-critical systems.
The plan requires outside 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 outside entities throughout
1999 and, if necessary, into 2000. Non-mission-critical outside entities are
being addressed as time permits.
It is important to recognize that inventorying, assessing, analyzing,
converting, where necessary, testing and developing contingency plans for
mission-critical items in anticipation of the Year 2000 are necessarily
iterative processes. That is, the steps are repeated as Azurix learns more about
the Year 2000 problem and its effects on Azurix's internal systems and on
outside systems, and about the effects that embedded chips may have on Azurix's
systems and outside systems. As the steps are repeated, it is likely that new
problems will be identified and addressed. Azurix anticipates that it will
continue with these processes through January 1, 2000 and, if necessary based on
experience, into the Year 2000 in order to assess and remediate problems that
reasonably can be identified only after the start of the new century.
The plan called for most operating subsidiaries to have completed initial
rounds of inventory, assessment, remediation and validation testing by June 30,
1999. Azurix met that deadline for most of its operations under its control.
Many systems were found to be Year 2000 ready. However, Azurix cannot guarantee
that these systems do not continue to contain hidden Year 2000 defects in
computer code or in embedded devices.
As of October 31, 1999, Azurix and all of its operating subsidiaries were
at various stages in implementation of the plan, as shown in the following
tables. The first table deals with the Azurix operating subsidiaries'
mission-critical internal systems, including embedded chips, and the second
deals with the operating subsidiaries' mission-critical outside systems of
outside entities. Any notation of "complete" conveys the fact only that the
initial iteration of this phase has been substantially completed. Azurix does
not have operational control of the Mendoza concession. The information included
in the following tables relating to the Mendoza concession is based on
information provided to Azurix by SAUR, the operator of the concession.
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YEAR 2000 PLAN READINESS BY AZURIX OPERATING SUBSIDIARY AS OF OCTOBER 31, 1999
(Mission-Critical Internal Items)
--------- ---------- -------- ---------- ------- --------- -----------
INVENTORY ASSESSMENT ANALYSIS CONVERSION TESTING Y2K-READY CONTINGENCY
PLAN
Azurix Buenos Aires.......... C IP IP IP IP IP IP
Cancun....................... C C C IP IP IP C
Obras Sanitarias Mendoza..... C C C IP IP IP C
Azurix North America......... C C C C IP IP IP
Wessex....................... C C C C C C C
Industrias del Agua.......... C C C C C C C
Azurix Brasil................ C C C IP IP IP C
Legend: C = Complete IP= In Process
YEAR 2000 PLAN READINESS BY AZURIX OPERATING SUBSIDIARY AS OF OCTOBER 31, 1999
(Mission-Critical Outside Entities)
--------- ---------- -------- ---------- ------- --------- -----------
INVENTORY ASSESSMENT ANALYSIS CONVERSION TESTING Y2K-READY CONTINGENCY
PLAN
Azurix Buenos Aires.......... C C IP IP IP IP IP
Cancun....................... C C C C C C C
Obras Sanitarias Mendoza..... C C C C IP IP IP
Azurix North America......... C C C C IP IP IP
Wessex....................... C C C C C C C
Industrias del Agua.......... C C C C C C C
Azurix Brasil................ C C C C C C C
Legend: C = Complete IP= In Process
The following tables show, by operating subsidiary, historical and
estimated completion dates, as applicable, for the initial iteration of various
stages of the plan. The first table deals with the Azurix operating
subsidiaries' mission-critical internal systems, including embedded chips, and
the second deals with the operating subsidiaries' mission-critical outside
systems of outside entities.
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YEAR 2000 COMPLETION DATES BY AZURIX OPERATING SUBSIDIARY AS OF OCTOBER 31, 1999
(Mission-Critical Outside Entities)
--------- ---------- -------- ---------- ------- --------- -----------
INVENTORY ASSESSMENT ANALYSIS CONVERSION TESTING Y2K-READY CONTINGENCY
PLAN
Azurix Buenos Aires.......... 8/99 11/99 11/99 11/99 11/99 12/99 11/99
Cancun....................... n/a n/a n/a 11/99 11/99 12/99 9/99
Obras Sanitarias Mendoza..... n/a n/a n/a 12/99 12/99 12/99 9/99
Azurix North America......... 8/99 8/99 9/99 10/99 11/99 11/99 11/99
Wessex....................... n/a n/a n/a 6/99 6/99 6/99 6/99
Industrias del Agua.......... n/a n/a n/a n/a n/a 10/99 10/99
Azurix Brasil................ n/a n/a n/a 11/99 11/99 11/99 8/99
n/a = Not applicable (work completed before Azurix's ownership or investment)
YEAR 2000 COMPLETION DATES BY AZURIX OPERATING SUBSIDIARY AS OF OCTOBER 31, 1999
(Mission-Critical Outside Entities)
--------- ---------- -------- ---------- ------- --------- -----------
INVENTORY ASSESSMENT ANALYSIS CONVERSION TESTING Y2K-READY CONTINGENCY
PLAN
Azurix Buenos Aires.......... 8/99 10/99 11/99 11/99 11/99 12/99 11/99
Cancun....................... n/a n/a n/a 7/99 7/99 8/99 8/99
Obras Sanitarias Mendoza..... n/a n/a n/a n/a 11/99 11/99 11/99
Azurix North America......... 6/99 10/99 10/99 10/99 11/99 11/99 11/99
Wessex....................... n/a n/a n/a 5/99 5/99 6/99 6/99
Industrias del Agua.......... n/a n/a n/a n/a n/a n/a 10/99
Azurix Brasil................ n/a n/a n/a n/a n/a 8/99 8/99
n/a = Not applicable (work completed before Azurix's ownership or investment)
Azurix will continue closely to monitor work under the plan. Because the
plan treats Year 2000 efforts as an iterative process, Azurix may commence
additional cycles of inventory, assessment, remediation and validation testing,
which will be conducted in parallel, and in coordination, with Azurix's Year
2000 contingency planning.
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RECENT ACQUISITION
Azurix has made initial inquiries and made some preliminary examinations
regarding the Year 2000 readiness of the mission-critical internal information
systems, devices with embedded chips and external dependencies at Lurgi Bamag.
Azurix has concluded that there are unlikely to be significant Year 2000
problems with mission-critical internal information systems with embedded
devices and external dependencies. Azurix will incorporate Lurgi Bamag into its
overall Year 2000 plan.
Azurix is pursuing additional concessions, outsourcing contracts and other
water and wastewater projects. If Azurix completes any new acquisitions before
January 1, 2000, Azurix will seek to deal with potential Year 2000 problems
through the contingency planning process, as it is likely that the short time
available will not reasonably permit a different approach. Consequently, Year
2000 disruptions may have a higher likelihood of occurring in these situations,
and material adverse consequences might result.
COSTS TO ADDRESS YEAR 2000 ISSUES
Under the plan and otherwise, Azurix has not incurred material historical
costs for Year 2000 awareness, inventory, assessment, analysis, conversion,
testing or contingency planning. Further, Azurix anticipates that its future
costs for these purposes, including those for implementing its Year 2000
contingency plans, will not be material.
Azurix continues to be concerned with hidden defects in computer code,
including recoding errors in remediated code, sabotage of remediated code,
embedded devices with Year 2000 defects and the potential failure of
mission-critical outside entities, both domestic and international, including
foreign governments. Azurix has developed reasonable contingency plans to
prepare to the extent practicable to avoid substantial Year 2000-related
disruptions that may have a material adverse effect on Azurix and its business.
Because of the nature of potential Year 2000 deficiencies, their impact cannot
be quantified. None of these problems is unique to Azurix.
Although Azurix believes that its estimates are reasonable, there is no
assurance, for the reasons stated under "Summary" below, that the actual costs
of implementing the plan will not differ materially from the estimated costs or
that Azurix will not be materially adversely affected by Year 2000 issues.
YEAR 2000 RISK FACTORS
REGULATORY REQUIREMENTS. Most of Azurix's operating subsidiaries are
regulated by governmental authorities, some of which have Year 2000
requirements. Azurix expects to satisfy these regulatory authorities'
requirements for achieving Year 2000 readiness. If Azurix's reasonable
expectations in this regard are in error, and if a regulatory authority should
order the temporary cessation of Azurix's operations in one or more of these
areas, the adverse effect on Azurix could be material. Outside entities could
face similar problems that materially adversely affect Azurix.
SHORTAGE OF RESOURCES. Between now and January 1, 2000, there will be
increased competition for people with the technical and managerial skills
necessary to deal with the Year 2000 problem. These shortages might delay or
otherwise impair Azurix's progress towards making its mission-critical systems
Year 2000 ready. Outside entities could face similar problems that materially
adversely affect Azurix. Azurix believes that the possible impact of the
shortage of skilled people is not, and will not be, unique to Azurix.
POTENTIAL SHORTCOMING. Azurix anticipates that most of its mission-critical
systems, domestic and international, will be Year 2000 ready before January 1,
2000. However, there is no assurance that the plan will succeed in accomplishing
its purposes or that unforeseen circumstances will not arise during
implementation of the plan that would materially and adversely affect Azurix.
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24
CASCADING EFFECT. Azurix and its operating subsidiaries are taking
reasonable steps to identify, assess and, where appropriate, replace devices
that contain embedded chips. Despite these reasonable efforts, Azurix
anticipates that it may not be able to find and replace all devices with
embedded chips in Azurix's systems. Further, Azurix anticipates that outside
entities on which Azurix depends also may not be able to find and remediate all
devices with embedded chips. 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 cascading failures may have adverse effects upon
Azurix's ability to maintain safe operations and may also have adverse effects
upon Azurix's ability to serve its customers, to comply with environmental
statutes and regulations and otherwise to fulfill contractual and other legal
obligations. The embedded chip problem is widely recognized as one of the more
difficult aspects of the Year 2000 problem across industries and throughout the
world. Azurix believes that the possible adverse impact of the embedded chip
problem is not, and will not be, unique to Azurix.
OUTSIDE ENTITIES. Azurix has been meeting and continues to meet with some
of the outside entities that are mission-critical to Azurix for Year 2000
purposes. The outside entities that Azurix is contacting include suppliers,
customers, financial institutions and governmental entities. However, Azurix
cannot in any way ensure that these outside entities will be Year 2000 ready,
nor can Azurix place complete reliance on assurances, written or oral, from
these outside entities that they expect to be Year 2000 ready. These outside
entities are subject to failure resulting from the problems of embedded chips,
re-coding errors in remediated code and the effects of possible sabotage, as
well as the failure of entities external to them. Because of this potential for
disruption and material adverse consequences, Azurix never considers an external
entity to be "Year 2000 compliant" or "Year 2000 ready." Instead, Azurix will
deal with the possibility that mission-critical outside entities will not be
Year 2000 ready by developing reasonable contingency plans.
Azurix cannot assure that suppliers upon which it depends for essential
goods and services will convert and test their mission-critical systems and
processes in a timely and effective manner. Failure or delay to do so by all or
some of these outside entities, including U.S. federal, state or local
governments and foreign governments, could create substantial disruptions having
a material adverse affect on Azurix's business.
Although Azurix relies in part on Enron for computer processing services at
its offices in Houston and London, Azurix's systems at its operating
subsidiaries function independently of Enron's systems. Azurix relies on Enron's
mainframe system used for functions such as accounting and human resources.
Enron has advised Azurix that it believes that its mission-critical systems will
be Year 2000 ready substantially before January 1, 2000. However, unforeseen
circumstances could arise during the implementation of the plan that could
adversely effect Enron's mission-critical functions, thereby disrupting Azurix's
business. Azurix does not believe that such disruptions would have a material
adverse effect on Azurix.
U.S. Y2K ACT. Azurix may face additional risk as a result of the
uncertainties and probable additional litigation, resulting from the enactment
of the U.S. federal "Y2K Act." Because experience with this recently enacted
legislation is very limited, Azurix cannot at this time quantify the financial
impact or potential business disruption that may result from this legislation.
However, the adverse impact on Azurix's business may be material.
CONTINGENCY PLANS
As part of the plan, Azurix has developed and continues to revise,
contingency plans that deal with two aspects of the Year 2000 problem: (1) that
Azurix, despite its good-faith, reasonable efforts, may not have satisfactorily
remediated all of its internal mission-critical systems and (2) that outside
systems may not be Year 2000 ready, despite Azurix's good-faith, reasonable
efforts to work with outside entities.
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25
Azurix's contingency plans are designed to minimize the disruptions or
other adverse effects resulting from Year 2000 problems or failures with these
mission-critical functions or systems, and to facilitate the early
identification and remediation of mission-critical Year 2000 problems that first
manifest themselves after January 1, 2000.
Azurix's contingency plans will include an assessment of all its
mission-critical internal information technology systems and its internal
operational systems that use computer-based controls. This process will commence
in the early minutes of January 1, 2000, and continue for hours, days or weeks
as circumstances require. Further, Azurix will in that time frame assess any
mission-critical disruptions due to Year 2000-related failures that are external
to Azurix. The assessment process will cover, for example, loss of electrical
power from utilities, telecommunications services from carriers or building
access, security or elevator service in facilities occupied by Azurix. The
contingency plans will also include events such as failure of the delivery of
chemicals for water and wastewater treatment or events of sabotage.
Azurix's contingency plans include the creation of teams that will be
standing by on the evening of December 31, 1999 and the morning of January 1,
2000, prepared to respond rapidly and otherwise as necessary (including
reverting to certain manual or other alternative methods of operation) to
mission-critical Year 2000-related problems when they become known. The
composition of teams that are assigned to deal with Year 2000 problems will vary
according to the nature, mission-criticality and location of the problem.
Because Azurix operates internationally, some of its Year 2000 contingency teams
will be stationed at Azurix's mission-critical facilities overseas.
WORST CASE SCENARIO
Azurix has reviewed the most reasonably likely worst case Year 2000
scenarios that Azurix may face. Analysis of these scenarios has led Azurix to
contemplate the following possibilities which, although unlikely, could
conceivably occur: (1) widespread or localized failure of electrical, gas and
similar supplies by utilities serving Azurix domestically and internationally,
(2) widespread or localized disruption of the services of communications common
carriers domestically and internationally, (3) widespread or localized
disruption to transportation services for Azurix and its employees, contractors,
suppliers and customers, (4) disruption to Azurix's ability to gain access to,
and remain working in, office buildings and other facilities, (5) the failure of
substantial numbers of Azurix's mission-critical information systems, including
both internal business systems and systems controlling operational facilities
such as water and wastewater treatment plants, domestically and internationally,
and (6) the failure, domestically and internationally, of outside systems, the
effects of which would have a cumulative material adverse impact on Azurix's
mission-critical systems.
If electrical power is unavailable to a water or wastewater facility for a
period greater than several hours, Azurix might not be able to keep the facility
functioning and, as a result, water might be discharged into the distribution
system and untreated or improperly treated wastewater might be discharged into
waterways. Azurix could face substantial claims by governments, governmental
authorities or customers, or loss of revenues, due to service interruptions,
inability to fulfill contractual obligations, inability to account for certain
revenues or obligations or to bill customers accurately and on a timely basis,
and increased expenses associated with litigation, harm to persons or to
tangible property, stabilization of operations following mission-critical
failures and the execution of contingency plans. Azurix could also experience an
inability by customers and others to pay, on a timely basis or at all,
obligations owed to Azurix. Under these circumstances, the adverse effect on
Azurix and the diminution of Azurix's revenues could be material, although not
quantifiable at this time. Further, in this scenario, the cumulative effect of
these failures could have a substantial adverse effect on the economy,
domestically and internationally. The adverse effect on Azurix and the
diminution of Azurix's revenues from a domestic or global recession or
depression, also are likely to be material, although not quantifiable at this
time.
Azurix will continue to monitor business conditions with the aim of
assessing and minimizing adverse effects, if any, that result or may result from
the Year 2000 problem.
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SUMMARY
Azurix has a plan to deal with the Year 2000 challenge and believes that it
will be able to achieve substantial Year 2000 readiness with respect to the
mission-critical systems that it controls. However, from a forward-looking
perspective, the extent and magnitude of the Year 2000 problem as it will affect
Azurix, both before and for some period after January 1, 2000, are difficult to
predict or quantify for a number of reasons, including the difficulty of
locating "embedded" chips that may be in a great variety of mission-critical
hardware used for process or flow control, environmental, transportation,
access, communications and other systems; the difficulty of inventorying,
assessing, remediating, verifying and testing outside systems; the difficulty in
locating all mission-critical internal software that is not Year 2000 ready, or
that may be subject to re-coding errors or sabotage; the unavailability of
certain necessary internal or external resources, including but not limited to
trained hardware and software engineers, technicians and other personnel to
perform adequate remediation, verification and testing of mission-critical
internal or outside systems. Accordingly, there can be no assurance that all of
Azurix's systems and all outside systems will be adequately remediated so that
they are Year 2000 ready by January 1, 2000, or by some earlier date, so as not
to create a material disruption to Azurix's business. If, despite Azurix's
reasonable efforts under the plan, there are mission-critical Year 2000-related
failures that create substantial disruptions to Azurix's business, the adverse
impact on Azurix's business could be material. Additionally, while Azurix's Year
2000 costs are not expected to be material, such costs are difficult to estimate
accurately because of unanticipated vendor delays, technical difficulties, the
impact of tests of outside systems and similar events. Moreover, the estimated
costs of implementing the plan do not take into account the costs, if any, that
might be incurred as a result of Year 2000-related failures that occur despite
Azurix's implementation of the plan.
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 Registration Statement on Form S-1.
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. At September 30, 1999, the value-at-risk estimate was
$0.2 million for both foreign currency and interest rate exposure. 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.
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FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. Although Azurix believes its
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:
o Political developments in foreign countries
o The ability to enter new water and wastewater markets in the U.S. and
in other jurisdictions
o The timing and extent of deregulation of water and wastewater markets
in the U.S. and in other countries
o Regulatory developments in the U.S. and in other countries, including
tax legislation and regulations
o The timing and extent of efforts by governments to privatize water and
wastewater industries
o The timing and extent of changes in non-U.S. currencies and interest
rates
o The timing and 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
infrastructure projects
o The ability of counterparties to financial risk management instruments
and other contracts with Azurix to meet their financial commitments to
Azurix
o The effectiveness of Azurix's Year 2000 plan and the Year 2000
readiness of outside entities, including foreign governments
o Azurix's 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 its credit ratings for its debt
obligations
Azurix undertakes no obligation to update or revise these 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 herein might not occur.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 29, 1999, Azurix Corp. filed a complaint in the Chancery Court
of the State of Delaware against Synagro Technologies, Inc. Prior to this
filing, Azurix and Synagro had been in discussions regarding possible
collaborative efforts and/or strategic transactions for several months. In
connection with these discussions, the parties entered into a confidentiality
agreement and related letter agreements containing standstill provisions
restricting Azurix's ability to acquire or engage in negotiations with a number
of companies for several months. In September 1999, Synagro orally agreed to
waive these standstill provisions with regard to two subsidiaries of Waste
Management, Inc. This oral waiver was made to representatives of Waste
Management, as well as to Azurix. Azurix also agreed to purchase up to $23
million of Synagro convertible preferred stock, subject to certain conditions,
and negotiated with Synagro over other arrangements, although no written
agreement regarding those other arrangements has been signed by both parties.
Since the waiver, Azurix and Waste Management have been negotiating a possible
acquisition by Azurix of the target companies. Azurix has not entered into an
acquisition agreement for the target companies, nor has any commitment or final
determination been made by the parties to proceed with an acquisition. Azurix's
complaint seeks to enforce the waiver of the standstill provisions and an
injunction against Synagro's interfering with the potential acquisition of the
target companies by Azurix, along with money damages and a declaration that
Azurix has no further obligations to purchase stock of Synagro or pay it any
other sums. On November 1, 1999, Synagro filed suit against Azurix Corp. in the
District Court of Harris County, Texas, seeking both a temporary restraining
order and permanent injunction to enjoin Azurix from using confidential
information that Azurix had obtained from Synagro and, in particular, alleging
that Azurix's negotiating or closing the acquisition that is the subject of the
Delaware case would violate the standstill agreement between the parties.
On November 2, 1999, the court in the Texas action entered a temporary
restraining order preventing Azurix from using any confidential or proprietary
information that it received from Synagro, including with respect to the target
companies, and preventing both Azurix and Synagro from acquiring, or entering
into an agreement to acquire, the target companies for a 14-day period. On
November 3, 1999, Azurix filed a motion asking the Texas court to postpone the
action in Texas until the Delaware Chancery Court had heard the earlier-filed
Delaware case. The hearing on this motion was held on November 12, 1999,
although the court has not yet issued its ruling. If the Texas court does not
defer its proceedings in favor of those in Delaware, a hearing on whether Azurix
should be preliminarily enjoined from proceeding with the proposed acquisitions
will be held on November 19, 1999. Azurix and Synagro have agreed to extend the
temporary restraining order through November 19, 1999. Azurix is also seeking an
early hearing date in the Delaware proceeding. During the week of November 8,
1999, certain subsidiaries of Waste Management have filed a motion to intervene
in both the Texas and Delaware cases alleging that Synagro has interfered with
their negotiations with Azurix.
Azurix denies that it has breached, or that the acquisition of the target
companies would breach, any of its obligations to Synagro. Synagro has not
alleged an amount of damages, and so it is not possible in this early stage of
the litigation to predict what, if any, damages might result if the cases were
determined adversely to Azurix. Although no assurances can be given, Azurix
believes that the ultimate resolution of this litigation will not have a
material adverse effect on its results of operations or financial position.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
---------
Exhibit
Number: Exhibit
------- -------
3 Restated Bylaws of Azurix Corp., as amended on
November 2, 1999.
10.1 U.S. $150,000,000 Revolving Credit Agreement, dated
as of September 29, 1999, among the Registrant, as
Borrower, the Banks named therein, as Banks, Chase
Bank of Texas, N.A., as Administrative Agent, and
Credit Suisse First Boston, as Documentation Agent.
10.2 First Amendment to Azurix Corp. 1999 Stock Plan, dated
October 11, 1999.
27 Financial Data Schedule (included only in the
electronic filing of this document).
(b) Reports on Form 8-K:
A Report on Form 8-K/A was filed on August 25, 1999, whereby the Registrant
amended "Item 7. Financial Statements and Exhibits" of its Form 8-K dated June
30, 1999, to include as an exhibit, the Concession Contract dated June 30, 1999,
between the Executive Authorities of the Province of Buenos Aires and Azurix
Buenos Aires S.A.
A Report on Form 8-K was filed on November 10, 1999, with respect to the
Registrant's financial results for the period ended September 30, 1999, and
includes a discussion of its financial outlook for the fourth quarter of 1999
and the fiscal year 2000.
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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 15, 1999 By: /s/ Rodney L. Faldyn
------------------------------
Rodney L. Faldyn
Chief Accounting Officer
(Duly Authorized Officer)
(Principal Accounting Officer)
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EXHIBIT INDEX
Exhibit
Number: Description
------- -----------
3 Restated Bylaws of Azurix Corp., as amended on
November 2, 1999.
10.1 U.S. $150,000,000 Revolving Credit Agreement, dated
as of September 29, 1999, among the Registrant, as
Borrower, the Banks named therein, as Banks, Chase
Bank of Texas, N.A., as Administrative Agent, and
Credit Suisse First Boston, as Documentation Agent.
10.2 First Amendment to Azurix Corp. 1999 Stock Plan, dated
October 11, 1999.
27 Financial Data Schedule (included only in the
electronic filing of this document).