Item 1. Business.
Our Company
Overview
AquaVenture Holdings Limited is a multinational provider of Water-as-a-Service®, or WAAS®, solutions that provide our customers with a reliable and cost-effective source of clean drinking water, processed water and wastewater treatment and water reuse solutions primarily under long-term contracts that minimize capital investment by the customer. We believe our WAAS business model offers a differentiated value proposition that generates long-term customer relationships, recurring revenue, predictable cash flow and attractive rates of return. We generate revenue from our operations in North America, the Caribbean and South America, and are pursuing expansion opportunities in North America, the Caribbean, South America, Africa, the Middle East and other select markets.
We deliver our WAAS solutions through two operating platforms: Seven Seas Water and Quench. Seven Seas Water is a multinational provider of desalination, wastewater treatment, and water reuse solutions to governmental, municipal (including utility districts), industrial, property developer and hospitality customers. Our desalination solutions provide more than 8.5 billion gallons per year of potable, high purity industrial grade and ultra-pure water (which is water that is treated to meet higher purity standards required for industrial, semiconductor, utility or pharmaceutical applications). Our wastewater treatment and water reuse solutions, which include plants ranging in capacity from 5,000 gallons per day, or GPD, to more than 1.5 million GPD, are provided through 105 leases with
customers. Quench is a U.S.-based provider of Point-of-Use, or POU, filtered water systems and related services through direct and indirect sales channels. Through its direct sales channel, Quench primarily rents and services POU units to approximately 60,000 institutional and commercial customers in the United States and Canada, including more than half of the Fortune 500. Quench’s typical initial rental contract is three years in duration and contains an automatic renewal provision. Our annual unit attrition rate, at December 31, 2019, was less than 7.5%, implying an average rental period of more than 12 years. We define “annual unit attrition rate” as a ratio, the numerator of which is the total number of removals of company-owned and billed rental units during the trailing 12-month period, and the denominator of which is the average number of company-owned and billed rental units during the same 12-month period. Through our indirect sales channel, we provide POU systems, filters, parts and services to networks of approximately 260 dealers and retailers predominantly in North America.
We are led by a talented management team with extensive industry experience, engineering knowledge, operational expertise and financial expertise. We leverage our operating and engineering expertise to develop and deliver highly reliable WAAS solutions by applying proven water purification and wastewater technologies. We believe that we are well positioned to capitalize on global growth opportunities driven by population growth, increasing urbanization and water scarcity, increasing focus on health and wellness, wastewater treatment and water reuse solutions, and the environmental impact of bottled water consumption. We believe our focus on delivering best-in-class service and efficiency to our customers will continue to lead to substantial new business, contract extensions and customer expansion opportunities. In addition, we also have a demonstrated track record of identifying, executing and integrating acquisitions, with Seven Seas Water and Quench having completed 23 transactions since our initial public offering, of which eight have occurred since the beginning of 2019. We plan to continue to pursue acquisitions that will expand our geographic presence, broaden our service offerings and allow us to move into additional markets.
As of December 31, 2019, we had 780 employees.
Seven Seas Water
Our Seven Seas Water operating platform offers WAAS solutions by providing outsourced desalination, wastewater treatment and water reuse solutions for governmental, municipal (including utility districts), industrial, property developer and hospitality customers. Our desalination solutions utilize seawater reverse osmosis, or SWRO, and other purification technologies to produce potable and high purity industrial process water in high volumes for customers operating in regions with limited access to potable water. Our wastewater treatment and water reuse products and solutions include scalable modular treatment plants, field-erected treatment plants and temporary bypass plants that are used by our customers to treat and convert wastewater into effluent or reclaimed water prior to being released back into the environment.
Desalination Solutions
For our desalination solutions, we either design, build and operate our desalination plants or acquire, refurbish and expand existing desalination plants. We assume responsibility for operating and maintaining the plants, including procuring all required equipment and supplies. In exchange, we typically enter into long-term agreements to sell to our customers agreed-upon quantities of water that meet specified quality standards for a contracted period, for which we are paid based on actual or minimum required unit consumption. We typically enter into contracts with a term of 10 to 20 years, except in situations in which emergency water is needed or we assume an existing contract from an existing owner or operator. With this approach, our customers benefit from a highly reliable, long-term clean water supply with predictable pricing, low customer capital investment and outsourced management of operations and maintenance.
We offer customized solutions, often implemented using containerized or modular equipment, which allows us to quickly commission, expand, curtail or move production capacity. We design, procure and engineer systems to meet the customer’s specific requirements with regard to source water conditions and specific water quality and quantity needs. Once a plant commences operations, customer water demand typically increases over time, often leading to plant expansion and contract extension opportunities. We also offer quick deployment solutions to address emergency water shortages, such as those caused by natural disasters or failure and/or overburdening of existing water production infrastructure, and water reuse solutions for industrial users seeking to reuse and/or minimize wastewater.
We are a leading provider of water to the Caribbean market, where we are currently the primary supplier to the United States Virgin Islands, or the USVI, St. Maarten and the British Virgin Islands, or the BVI. We also maintain
significant plant operations in Trinidad, Peru and Anguilla. We currently operate ten water treatment facilities in the Caribbean region and South America producing more than 8.5 billion gallons of purified water per year under long-term contracts.
We expect to grow our Seven Seas Water business by expanding existing operations as customer demand increases and by selectively entering underserved markets through both new project development and acquisitions. We believe that there are a large number of medium-scale desalination plants (which we define as plants with approximately 2 million GPD to 13 million GPD of output capacity) in operation globally that could benefit from our ownership and operating expertise. Leveraging our strength in the Caribbean market and our reputation for reliability, quality and operating efficiency, we are pursuing new opportunities in North America, the Caribbean, South America, Africa, the Middle East and other select markets.
Own, Operate and Maintain
Providing WAAS solutions to our customers is central to our desalination solution. We typically own, operate and maintain the desalination plants and sell water to our customers pursuant to long-term contracts. We either design, build and operate our desalination plants or acquire, refurbish and expand existing desalination plants. We assume responsibility for operating and maintaining the plants, including procuring all required equipment and supplies. We typically design our desalination plants to exceed contractually required production capacity to ensure reliability, enable expansion to meet increased demand and to have more predictable lifecycle costs. In building our plants, we often use containerized units and modular skids with preconstructed components of the plant, which enables us to commission a plant and commence production more quickly. We also use standardized designs and equipment which help us operate and maintain our plants more efficiently and cost-effectively and simplify spare parts management.
Under our WAAS business model, we manage the entire lifecycle of a desalination plant on an outsourced basis for our customers. Typically, a customer commits to purchase water at a fixed price per gallon, subject to adjustment based on a specified index, which meets agreed upon quality standards. Certain of our contracts require customers to purchase a minimum volume of water on a take-or-pay basis, and in some cases, we satisfy a customer’s water requirements by utilizing our plants as its exclusive water producer. Our water purchase agreements typically provide for initial terms of up to 20 years. However, customers may ask us to increase the capacity of plants or to build additional plants to satisfy increased demand for the reliable, high-quality water we produce. In those cases where customers ask us to expand the capacity of the plants, we typically extend the term of the initial contract and reduce the unit cost that the customer pays. The facilities in our portfolio are both operated and maintained, as needed, by Seven Seas Water employees. To ensure we continue to provide reliable and high-quality water, while remaining efficient and cost-effective, we monitor the plants we operate, both remotely and on site.
For our water supply agreements where we build, own and operate, we generally have the right to decommission and remove our desalination plants upon the expiration or termination of the term of the water supply agreement. Certain of our water supply agreements, however, provide for the transfer of the plant to our customer either at the end of the term of the agreement, upon the termination of the agreement or upon exercise of contractual buyout rights. The purchase prices payable upon exercise of the buyout rights are specified in the agreement and may be either fixed or variable based on factors set forth in the agreement. Our plants are generally built on property leased from the customer or its related parties pursuant to leases with terms that typically extend longer than the water purchase agreement, so that we may decommission and remove the plant.
Our Desalination Plants
We currently operate ten water treatment facilities with design capacities of at least 0.5 million GPD in the Caribbean and South America. Six exclusively provide water to the local government or government-owned utility companies and four serve private customers.
In addition, during 2019, we owned and operated a desalination facility in Curaçao with an aggregate design capacity of 4.9 million GPD. We sold the industrial quality water produced at this facility on a take or pay basis to Curaçao Refinery Utilities Company B.V., or CRU, a government-owned utility that provides utility services to a refinery it has leased to Petróleos de Venezuela S.A., or PDVSA, a state owned oil company of Venezuela. The contract, which expired on December 31, 2019, included a buy-out right that enabled the customer to purchase the desalination plant pursuant to the water supply agreement. On December 31, 2019, CRU exercised its right to purchase the desalination facilities, and the Company received a cash payment of $3.5 million in connection with the exercise of this buy-out right.
Trinidad
We built, own and operate a desalination plant currently with a design capacity of 6.7 million GPD located at Point Fortin, Trinidad. Under the terms of the water sale agreement with the Water & Sewerage Authority of Trinidad and Tobago, which we refer to as the Trinidad Water Sale Agreement, we are required to provide a minimum supply of water each month equal to a certain percentage of the design capacity of the plant. The Water & Sewerage Authority of Trinidad and Tobago, or WASA, is required to purchase all of the water we produce each month up to a certain percentage of the design capacity of the plant. If production levels fall below agreed upon contractual minimums, then the water payment owed by WASA to us is reduced. On September 3, 2015, we entered into a fourth amendment to expand the existing desalination plant capacity by approximately 21% and extend the initial term of the agreement, which was set to expire in 2026, by 50 months. This expansion was completed in July 2016 and added 1.2 million GPD of capacity to the plant.
The Trinidad Water Sale Agreement may be terminated upon default. If WASA terminates the Agreement early or is in default, a penalty that is based on estimated future production of the plant will be imposed. Upon termination, we have 120 days to remove our equipment from the site.
Under the Trinidad Water Sale Agreement, WASA is obligated to provide the electricity needed to operate our plant at no charge to us. We are not responsible for loss of production arising from a disruption to our electrical supply or a change in the quality or quantity of feedwater.
We sublease the site where the Point Fortin plant is located from WASA, which leases the site from Petrotrin, a state-owned oil company. The term of the lease, as extended, expires in June 2030.
United States Virgin Islands
We built and currently own and operate three principal desalination plants in the USVI with an aggregate design capacity of 8.7 million GPD.
We sell the water produced at our Richmond Generation Plant on St. Croix and our Randolph Harley Generation Plant on St. Thomas on an as-demanded basis to the Water & Power Authority of the United States Virgin Islands, or VIWAPA, pursuant to a series of water purchase agreements entered into with VIWAPA, which we refer to as the USVI Water Purchase Agreements, the current terms of which expire in 2033. Although the USVI Water Purchase Agreements do not specify a minimum consumption level, they stipulate that Seven Seas Water will be VIWAPA’s exclusive supplier. The current design capacity of our Richmond Generation Plant and the Randolph Harley Generation Plant are 3.7 million GPD and 3.3 million GPD, respectively. Under the USVI Water Purchase Agreements, VIWAPA is obligated to provide the electricity needed to operate our plants at no charge to us, provided that our electrical consumption per thousand gallons of water produced does not exceed certain thresholds. If our electrical consumption exceeds such thresholds, we are required to reimburse VIWAPA at its then-current electricity production cost, subject to adjustment for feedwater quality. We lease the sites where these plants are located from VIWAPA. The leases terminate 180 days after the contract expiration dates to enable us to remove our equipment.
In addition, we built and currently own and operate a desalination plant with the design capacity of 1.7 million GPD on St. Croix. We sell the water produced by this plant under a water sales agreement to support a storage terminal, refinery and marine facility owned by Limetree Bay Terminals, LLC. We sell the water produced at this plant on a take-or-pay basis. The original agreement with the customer was terminated during 2019 and the Company subsequently entered into a new agreement that expires in 2024 and included an expansion of the existing desalination plant capacity. The expansion was completed in November 2019 and added 1.0 million GPD of capacity to the plant.
St. Maarten
We own and operate three desalination plants with an aggregate design capacity of 5.8 million GPD in St. Maarten. We built two of these plants and acquired and refurbished the third. We sell the water produced at these plants on a take-or-pay basis to the Government of St. Maarten pursuant to the St. Maarten Water Purchase Agreements. Pursuant to an amendment in April 2018, the required minimum monthly water purchase by our customer was reduced, in exchange for a four-year extension to the water contract which will now expire in 2025. The reduction in the required minimum monthly water purchase will remain in effect for three years, at which time the average monthly minimum purchase will then revert to previous minimum requirements for the remainder of the contract. Our customer has the option to extend the lower minimum volumes for an additional two years, which, if exercised, would also extend the contract expiry from 2025 to 2027. Under the St. Maarten Water Purchase Agreements, we are obligated to pay for the electricity needed to operate our plant at a fixed rate. We lease the sites where these plants are located. The St. Maarten Water Purchase Agreements require us to transfer ownership of the plants to the government upon the expiration of the water purchase agreements and under other certain circumstances.
British Virgin Islands
In June 2015, we purchased the capital stock of Biwater Holdings, a subsidiary of which owns and operates a desalination plant with the design capacity of 2.8 million GPD located on Tortola, BVI. We sell the water produced at this plant on a take-or-pay basis to the government of the BVI pursuant to a water purchase agreement, the current term of which expires in 2030. Under this water purchase agreement, our customer is obligated to provide the electricity needed to operate our plant at no charge to us. We lease the site where this plant is located. We are required to transfer ownership of the plant to the government of the BVI upon the expiration of the water purchase agreement and upon the termination of the agreement under certain other circumstances. On August 4, 2017, we entered into an amendment to the water purchase agreement with the government of the BVI to modify, effective January 1, 2017, certain contractual provisions related to the calculation of the water rate and the overall cash payment profile in exchange for other actions between us and the customer. All other terms of the original water purchase agreement remained unchanged.
Peru
In October 2016, we completed the acquisition of all the outstanding shares of Aguas de Bayovar S.A.C., or ADB, and all the rights and obligations under a design and construction contract for a desalination plant and related
infrastructure located in Peru (the “Peru Acquisition”). We sell both seawater and desalinated process water on a take-or-pay basis to Compañia Minera Miski Mayo S.R.L under an operating and maintenance agreement. Compañia Minera Miski Mayo S.R.L uses the water to operate its Bayovar phosphate mine, which is located in north western Peru. The desalination plant and related infrastructure have the capacity to deliver more than 7.9 million GPD of seawater to the mine via a 24-mile pipeline and 2.7 million GPD of desalinated process water from a SWRO facility located at the mine site. The current term of the operating and maintenance agreement expires in 2037. The plant is constructed on property controlled by Compañia Minera Miski Mayo S.R.L, which owns the plant and related infrastructure. The rights to the design and construction contract include monthly installment payments for the construction of the desalination plant and related infrastructure, which are guaranteed by the principal shareholder of our customer and continue until 2024. These payments are accounted for as a note receivable.
Other Plants
We operate a desalination plant with the design capacity of 1.0 million GPD on the Island of Great Exuma, The Bahamas. We sell the water produced at this plant on a take-or-pay basis to Clearview Enterprises Limited, which is part of the Sandals Group. The original agreement with the customer expired in 2019. However, on August 1, 2019, we entered into a new agreement with the customer which expires in 2028.
We own and operate a desalination plant with the design capacity of 1.0 million GPD in Anguilla, which we began operating in October 2018. We sell the water produced by this plant to the Water Corporation of Anguilla, the public water utility of Anguilla. During 2019, we expanded the existing desalination plant design capacity by an incremental 0.5 million GPD to produce the current design capacity of 1.0 million GPD. The term of the agreement expires in May 2029.
We own and operate two desalination plants with the design capacity of an aggregate of 0.5 million GPD on Providenciales, Turks and Caicos Islands. We built one of these plants and acquired and refurbished the other. We sell the water produced at these plants to local customers and own the sites where these plants are located.
Wastewater Treatment and Water Reuse Solutions
For our wastewater treatment and water reuse solutions, we design, fabricate and install plants that are leased under a contractual term or sold to customers. The wastewater treatment and water reuse solutions offered to customers include scalable modular treatment plants, field-erected plants and temporary bypass plants ranging from 5,000 GPD to more than 1.5 million GPD.
The modular wastewater treatment plant is a scalable design that can be expanded to meet increases in customer demand. An example of this would be a residential property developer that needs a wastewater treatment plant for its development. As each new phase of the property development is completed, the wastewater processing demand increases with the addition of new homes. Additional modules can be added to the waste processing plant to meet this increased processing demand. Field-erected treatment plants are similar to the modular plants, including the customers they serve, with the main difference being that they are generally larger in size. The third solution offered is temporary bypass plants. These temporary transportable plants are deployed to maintain continuity of treatment services when a customer’s centralized wastewater treatment plant is not operating to enable significant maintenance or repair.
The contractual term for our modular and field-erected wastewater treatment and water reuse plants leased to customers typically range from three to five years while our temporary bypass solutions are leased under short-term contracts of less than one year. As of December 31, 2019, we had 105 leases of wastewater treatment and water reuse plants with our customers. Plants sold to the customer are designed, fabricated and installed typically over a period of typically 6 to 12 months. While operations and maintenance of the plants are typically the responsibility of the customer, we do perform these services, in limited instances, for the customer.
We currently offer our wastewater treatment and water reuse solutions in North America, including Texas where we believe we are a leading provider for modular and field-erected designs, and in the Caribbean where we operate and maintain plants owned by certain of our desalination solution customers.
Customers
Customers for our desalination solutions generally fall into three categories: (i) municipal customers or government-owned utility companies, (ii) industrial, power, refining, mining and/or other manufacturing companies which require a reliable source of industrial quality water for their operations, or (iii) resorts and/or private entities. These customers may (a) contract with us to build and operate plants, (b) become our customers after their initial plant owner or operator sells its interest in a plant or (c) become our customer after replacing an operator with Seven Seas Water. Our important target market opportunities include municipal customers or government owned utility companies that wish to contract to have a plant constructed to increase water production for residential or industrial purposes or seek our experience in operating an existing plant. Under these arrangements, the municipal customers or government owned utility company is typically responsible for distributing water, providing power and a minimum purchase guarantee. Another target market is industrial customers that require clean water for an industrial purpose. Historically, prospective industrial customers generated their own water, but increasingly more industrial users have outsourced the production of water to focus on their core competencies.
Customers for our wastewater treatment and water reuse solutions generally include property developer and municipal customers, including utility districts. These customers may contract with us to build a plant and often add more of our solutions as their property is further developed.
For the year ended December 31, 2019, revenues earned from our customer in Trinidad represented approximately 7% of our total consolidated revenues.
Business Development
Our Seven Seas Water platform focuses on desalination, wastewater treatment and water reuse solutions opportunities.
For our desalination solutions, we focus on opportunities to own and operate desalination plants designed to produce approximately 2 million GPD to 13 million GPD of water for governmental, municipal, industrial and hospitality customers, a relatively underserved sub-segment of the desalination market with limited comparable solutions and competitors. We pursue these opportunities by participating in request for proposal processes, developing plans for plants in underserved areas, acquiring existing plants and providing emergency water services. Geographically, we continue to pursue opportunities to expand in the Caribbean region, while seeking opportunities in North America, South America, Africa, the Middle East and other select markets.
For our wastewater treatment and water reuse solutions, we focus on leasing equipment for a contractual term or selling equipment to governmental, municipal (including utility districts), industrial and property developer customers. The wastewater treatment and water reuse solutions offered to customers include scalable modular treatment plants, field-erected plants and temporary bypass plants ranging from 5,000 GPD to more than 1.5 million GPD. We pursue opportunities throughout North America, including Texas where we believe we are a leading provider for modular and field-erected designs, and in the Caribbean.
We believe our desalination, wastewater treatment and water reuse solutions are complementary and can result in cross selling opportunities to customers.
Our business development function is organized into teams dedicated to pursuing opportunities in specific target markets. Company personnel focused on the North American, Caribbean, African and Middle Eastern markets operate primarily from our Tampa, Florida and Houston, Texas offices.
As part of our expansion strategy, we may acquire additional desalination, wastewater treatment and water reuse plants or businesses. Potential acquisition candidates include individual plants and businesses that operate multiple plants. We frequently evaluate potential acquisition candidates and engage in discussions and negotiations regarding potential acquisitions.
We also pursue opportunities to deploy our mobile containerized desalination solutions and our bypass wastewater treatment solutions to help parties address short-term or immediate needs. To address this business opportunity, we maintain a fleet of mobile containerized plants and bypass wastewater treatment solutions. Our ability to
quickly deploy, commission and commence operation of these plants and solutions provides us a competitive advantage in these situations. We provide these rapid deploy services pursuant to contracts that typically have terms that range from less than one year up to five years. By assisting customers with their short-term or immediate needs, we are often well positioned to expand such customer relationships into long-term arrangements.
Competition
For our desalination solutions, Seven Seas Water generally targets projects for medium-scale plants that it can own and operate that are accompanied by long-term contracts to sell water to customers. We compete primarily on the basis of the unit price at which water is sold to our customers, as well as our ability to build, commission, operate and maintain our plants to provide customers with a reliable long-term water supply. Our pricing depends on many factors, including the length of the water supply agreement term, the volume of water to be supplied, factors relating to the feedwater quality and location of the plant, infrastructure availability, electric power availability and costs (including who is responsible for paying those costs), and our cost of capital, among other factors.
The competitors in our market generally fall into three categories: (i) engineering, procurement and construction, or EPC, companies, (ii) large project developers, and (iii) other outsourced service model companies. EPC companies, which contract to build plants that satisfy specific requirements, often do not operate such plants after completion. Large project developers focus on large-scale municipal desalination projects and prefer to take the role as lead developer for a customer sponsor and often do not operate plants after completion. Many of these companies, among others, currently operate in areas in which we would like to expand our desalination business. In addition, some already maintain worldwide operations and have greater financial, managerial and other resources than we do. We believe that our low overhead costs, knowledge of local markets and our efficient manner of operating desalination water production equipment will provide us a competitive advantage in many medium scale applications and projects.
For our wastewater treatment and water reuse solutions, Seven Seas Water generally targets plants ranging from 5,000 GPD to more than 1.5 million GPD delivered to the customer through capital and financed equipment sales, and leasing arrangements. Further, our modular wastewater treatment plants provide customers with the ability to scale their plants based on demand. While we compete directly with other regional, national and international companies, many of our competitors do not offer similar modular design, financing or leasing solutions that we believe our core markets demand.
Quench
Our Quench business offers WAAS solutions by providing bottleless filtered water coolers and other products that use filtered water as an input, such as ice machines, sparkling water dispensers and coffee brewers, to customers throughout the United States and Canada. Our POU systems purify a customer’s existing water supply, offering a cost-effective, convenient, and environmentally-friendly alternative to traditional bottled water coolers, or BWC. We offer our solutions to a broad mix of industries, including government, education, medical, manufacturing, retail and hospitality, among others.
Through our direct sales channel, we install and maintain our filtered water systems in exchange for a monthly rental fee, typically under multi-year contracts that renew automatically. With an installed base of approximately 160,000 company-owned rental systems, we believe that we are one of the largest POU-focused water services companies operating in North America. We are able to service our rental customers across the United States and Canada, with Quench employee service technicians covering more than 330 metropolitan statistical areas, as defined in the 2010 U.S. Census and the 2016 Canadian Census. We generate sales by leveraging our team of field and inside sales representatives, supported by a marketing team with expertise in digital and traditional media. We believe the geographic scale of our platform, the diversity of product offering, and our customer-centric service provide us a competitive advantage. These capabilities also help to create customer loyalty and preserve our market share.
Through our indirect sales channel, we offer POU systems to networks of approximately 260 dealers and retailers predominantly in North America. The indirect sales channel expands our participation in the growing POU market domestically and internationally. In addition, this channel enhances our ability to develop, source and manufacture innovative, exclusive, bottleless filtered water coolers and related offerings. Lastly, the channel offers us the opportunity to develop deep relationships with POU dealers that could potentially lead to future acquisitions.
Products
Our filtered water systems offer customers a cost-effective, convenient and environmentally-friendly alternative to traditional BWCs. Our systems are connected to a customer’s existing water supply, which is filtered at the point of use to reduce impurities and other contaminants. Once a POU system is installed, ongoing service requirements, including routine maintenance, repair and filter changes, are typically covered under a rental agreement for our rental customers.
We offer our customers filtered water systems with varying capacities to serve low, medium and high usage environments, which are available in floor-standing, countertop, under-counter and under-sink model forms. Our systems offer a variety of water dispensing options, including hot, cold, ambient and sparkling water. These systems are also available with various features, such as hands-free dispensing, anti-microbial surfaces and leak detection. Depending on the customer’s purification requirements, Quench systems can employ various technologies such as carbon filtration, reverse osmosis filtration, deionization and ultraviolet sanitization.
In addition, we offer a line of ice machines and commercial coffee brewers, both of which utilize our water filtration systems. To our coffee brewer customers, we also offer a selection of coffees, teas and other break room supplies.
Our filtered water systems and related equipment are sourced both internally from our company-owned manufacturing facility in South Korea, and externally from a variety of domestic and international manufacturers. We also refurbish rental equipment that is returned from customer locations for future redeployment. We intend to continue working with our suppliers and leveraging our market knowledge to refine our water cooler product offerings and our other related water-enabled products, such as ice machines, sparkling water systems and coffee brewers. Some of our recent acquisitions have provided manufacturing operations and expertise and exclusive sourcing agreements, which enhance our ability to develop and source new and innovative POU products.
We provide our rental services generally under automatically-renewing contracts with a typical initial term of three years, however these contracts can range from month-to-month to four years. Our annual unit attrition rate, at December 31, 2019 was less than 7.5%, implying an average rental period of more than 12 years. In these rental agreements, we bear the up-front cost of purchasing and installing systems as well as the ongoing cost of maintaining them in exchange for a recurring fee. In certain circumstances, we sell water filtration systems to end customers, which may be accompanied by a maintenance contract or serviced on a time-and-materials basis. In 2017, we began selling certain water filtration systems exclusively through our indirect sales channel of POU dealers and retailers.
Sales and Marketing
We market our products and services through a variety of digital and traditional methods. Digital marketing activities include search engine marketing, email marketing, affiliate marketing and display advertising. Traditional marketing activities include telemarketing and trade shows. Marketing messages emphasize the benefits of water filtration versus those of delivered water, which include convenience, reliability of supply, cost savings, wellness and environmental sustainability. According to a 2016 study by Zenith International, or Zenith, POU system penetration in 2015 was 11.1% of the U.S. commercial water cooler market, by revenue, which we believe provides a significant opportunity for additional organic growth.
We have a team of Quench sales and marketing professionals dedicated to new customer acquisition activities across the United States and Canada. Our field sales representatives are focused on increasing penetration in the largest metropolitan markets in the United States and Canada. We also have specialized sales teams focused on large enterprises and specific industries to expand our market penetration. We maintain a presence in online advertising and lead generation, supported by an in-house team of digital marketing personnel.
Our Quench platform is also well-positioned to increase sales to existing customers. In addition to our sales team, our customer care representatives generate revenue by selling additional products to existing customers. In addition, as we service our rental equipment, we routinely identify opportunities to reassess our customers’ needs and offer additional services and system upgrades. Frequently, Quench rental customers will add systems during the course of their relationship with Quench.
We intend to continue to differentiate our offering to customers by adding new and innovative water filtration products and related water-enabled products. We are also considering additional international and residential market expansion in our POU business.
Customers
Within our direct sales channel, we target businesses across the United States and Canada with an emphasis on companies with 20 or more employees, as well as those operating in several key industries, such as government, education, medical, retail and hospitality. We maintain a highly diversified customer base of approximately 60,000 customers. Within our indirect sales channel, we sell to established networks with approximately 260 POU dealers and retailers in the United States and Canada, and we are actively expanding this network through our ongoing sales and marketing activities.
Customer Service
Our service technicians are trained to service our rental POU systems to ensure a convenient, reliable water supply. In larger metropolitan areas in the United States and Canada, we service rental equipment via local employee service technicians, who perform installations, preventive maintenance and repairs. In areas without local employees, Quench technicians travel to handle installations and preventive maintenance. When necessary, Quench engages third-party contractors for certain types of service calls.
Competition
We compete directly with other POU filtration, BWC, and office coffee service, or OCS, companies, as well as with retail stores and internet sites where similar products and services may be purchased. Municipal tap water is also a substitute for our POU filtration services. The POU filtration market is highly fragmented, with many small, local service providers. There are also a number of larger national competitors, including Cott Corporation, Nestlé, Aramark, Canteen and Waterlogic International. Our competitive position is based on our pricing, national service coverage and product quality.
Although Zenith reported that in 2015 the POU segment we serve accounted for 11.1% by revenue of the $4.2 billion per year, the number of POU units has been growing consistently and is projected to continue to grow at the expense of BWCs. We believe POU systems offer an attractive alternative to BWCs primarily due to cost, convenience, health benefits and environmental considerations. In 2015, approximately 29% of all new POU accounts (commercial and residential) in the United States were attributed to BWC conversions. We believe that the quality and reliability of our service, both in the field and in the back office, are differentiators within our markets.
Market Opportunity
We primarily operate in three water sectors-desalination, wastewater treatment and water reuse and commercial water filtration. We believe these sectors offer us opportunities for significant organic and inorganic growth due to their size, positive long-term growth trends and fragmentation.
A number of key macroeconomic factors shape the global water sector, including population growth, an increasing water supply-demand imbalance, urbanization, industrialization, and consumers’ heightened health and environmental awareness. Global water demand has outpaced population growth, leading to chronic water scarcity in many regions around the world. According to data from the United Nations, global water demand (excluding irrigation) will grow three times faster than the global population. According to the 2018 United Nations World Water Development Report, an estimated 3.6 billion people live in areas that are potential water scarce at least one month per year, and this population could increase between 4.8 and 5.7 billion by 2050. Further, the 2030 Water Resources Group, a public-private-civil society collaboration facilitated by the International Finance Corporation, estimates that global water demand will exceed supply by 40% by 2030. The United Nations Environment Programme, an agency of the United Nations that coordinates environmental programs, estimates that roughly half of the world’s population currently lives within 40 miles of the sea. Because of the proximity of population centers to saltwater bodies, we believe desalination through our Seven Seas Water platform is a viable solution to address future water shortages.
As clean water demand continues to grow, we believe the need for water treatment technologies, such as desalination, wastewater treatment and POU filtration, will increase, and we believe both of our operating platforms are well positioned to benefit from these trends.
Global Desalination Market
In recent years, there has been a rapid increase in the installation of new seawater desalination capacity. According to a January 2020 update by Global Water Intelligence’s (GWI) Desaldata, total estimated desalination market capital expenditures are estimated to reach approximately $8 billion in 2020 and exceed approximately $7 billion annually through 2024. Many of the existing medium scale plants are owned and operated by local governments and companies, and operating desalination facilities is generally not their core competency. As a result, we believe a large number of these plants could benefit from our ownership and operating expertise to generate more reliable and lower cost clean water.
According to the World Resources Institute’s Aqueduct rankings, the Caribbean is one of the most water-scarce regions of the world in terms of fresh water availability, comparable to the Western Sahara and parts of the Middle East. We believe our Seven Seas Water platform is a leading desalination solution provider in the Caribbean, where we currently operate nine water treatment facilities. Our installed capacity in the Caribbean has grown from 9.2 million GPD in 2010 to 26.5 million GPD as of December 31, 2019. We believe we represent a significant portion of the existing medium-scale desalination plant capacity in the Caribbean. Many of the Caribbean region’s current desalination facilities utilize older thermal technologies that are more costly to operate than membrane-based SWRO systems. We believe replacing these thermal plants with new SWRO plants is a significant additional opportunity for us. Given our compelling value proposition, extensive presence, and operational expertise in SWRO plants, we believe we are well positioned to further grow our Caribbean business.
We currently have a presence or targeted business development activities primarily in the Caribbean, South America, the Middle East, Africa and North America. The total installed capacity of medium-scale reverse osmosis desalination plants in these locations is more than 1.5 billion GPD. We target specific attractive end markets, such as the municipal drinking water, mining, oil and gas, and ultra-pure industrial process water markets, in both large and mature markets in North America and the Middle East, as well as in fast-growing developing markets in South America, Africa and the Caribbean. We believe we are well positioned to pursue opportunities in these markets through new project development, partnerships with local firms and strategic acquisitions.
Wastewater Treatment and Water Reuse Market
Wastewater treatment processes improve water quality by reducing the toxins that cause harm to humans and pollute rivers, lakes and oceans. According to the American Society of Civil Engineers (ASCE) 2017 Infrastructure report card, it is estimated that the demand on existing wastewater treatment plants will grow by more than 23% by 2032 and that $271 billion is needed in wastewater infrastructure over the next 25 years. Evidence of the funding gap in wastewater infrastructure exists already in the United States and ASCE’s 2016 Failure to Act report estimates that 900 billion gallons of untreated sewage is discharged into the environment each year. Part of the solution for reducing stress on existing centralized wastewater treatment plants will be the addition of wastewater treatment capacity through decentralized solutions. Decentralized wastewater treatment solutions reduce the need for extensive upgrades and expansion of larger, centralized plants. In addition, these decentralized wastewater treatment solutions have faster implementation cycles, have higher potential for onsite water reuse and are more capital-efficient as modular designs can be expanded as capacity is needed.
According to the United States Environmental Protection Agency’s 2017 Potable Reuse Compendium, long-term water scarcity is expected to increase over time in many parts of the United States which will drive the increase for wastewater reuse. In 2017, the WateReuse Association estimated the market for wastewater reuse in the United States was $1.8 billion, which is expected to grow by 27% by 2027. As water scarcity increases, so will the need to reuse wastewater. There is a significant opportunity to reuse wastewater in the United States as currently only approximately 7 to 8% of wastewater is reclaimed for reuse, leaving a large potential for additional reuse capacity.
While a majority of our wastewater treatment and water reuse solutions in the United States are concentrated in Texas, we are focused on and believe we are capable of providing, solutions across all 50 states and internationally. According to GWI, global installed reuse capacity has more than doubled since 2010 with this growth trend expected to continue into the future.
U.S. Water Cooler Market
A 2016 study by Zenith estimates that the U.S. water cooler market will generate $4.2 billion of revenues in 2015, on an install base of more than 5.8 million BWC and POU units. POU units represent $467 million of these revenues and 1.4 million of the installed units, of which 94% are within the commercial market segment, which we target. We believe that POU units are taking market share from BWC units for a variety of reasons, including cost, convenience, health benefits and environmental concerns. Zenith reports that in the United States, the average BWC customer will spend $50.85 per month for bottles (5.01 bottles per month at an average price of $10.15 each) plus $19.80 per month to rent the base unit, implying an average total monthly spend of $70.65 per BWC unit. This compares with Zenith’s estimated average monthly rental rate for a POU unit in the United States of $35.15. Zenith indicates that from 2010 to 2015, the market share of POU on an installed unit basis grew from 16.4% to 23.5%, which represents a unit CAGR of 10% for that period. Zenith expects the total number of POU units to grow at a CAGR of approximately 9% between 2015-2020, while the number of total installed BWC units is projected to grow at a CAGR of only 1% during the same period.
We estimate that our rental market share is less than 10% of commercial POU systems on an installed unit basis based on the industry installed unit data per the Zenith study. The U.S. POU water cooler market is highly fragmented with hundreds of small regional providers, representing an opportunity for consolidation. Given the size of our addressable market and the fragmentation of the industry, we believe we are well positioned to realize growth with our focus on the commercial POU market.
Our Strengths
Differentiated Water-as-a-Service Business Model
Our WAAS business model offers an attractive value proposition to our customers by providing clean drinking water, processed water and wastewater treatment and water reuse solutions in a reliable, capital-efficient, cost-effective and flexible manner. Our long-term, service-focused model minimizes customer capital investment and yields long-term customer relationships. We invest capital in developing and installing engineered water systems, and generate predictable and steady revenue, earnings and cash flow, as well as an attractive unit economics.
Excellence in Execution Driven by Engineering and Operational Expertise
Our experience in implementing, operating and servicing water filtration technologies is at the core of our water solutions. Our expertise drives our ability to offer customized solutions to satisfy our customers’ needs. Our engineering experience and expertise is critical in developing desalination and wastewater treatment and water reuse solutions that meet each customer’s specific needs. Another important aspect of engineering expertise is reliability, as evidenced by our ability to achieve an average plant availability of approximately 97% since 2013, which provides our customers with a highly reliable water supply.
Our Quench POU filtered water systems utilize a variety of water purification technologies, including reverse osmosis, carbon filtration, deionization, ozonation and ultraviolet sanitization. Our service technicians are trained to maintain and service our POU systems to provide a convenient, reliable and high-quality water supply.
Experienced Management Team with Demonstrated Track Record
Our Seven Seas Water and Quench management teams, led by our President and Chief Executive Officer, Anthony Ibarguen, have extensive industry experience. These teams have a demonstrated track record of managing costs, adapting to changing market conditions, developing a comprehensive safety culture and financing, acquiring, integrating and operating new businesses and solutions.
Strong Competitive Position Supported by Long-Term Customer Relationships
We have long-standing customer relationships. In our experience, customers typically extend their contracts significantly beyond the original term, as the need for the specific solution continues and the customer realizes the value proposition of our WAAS business model. Furthermore, we believe our operating and engineering expertise, experienced management team, and scale put us at the forefront of our industry, and that significant investment would be required for others to replicate our platforms.
Our water supply agreements under our Seven Seas Water platform typically provide for initial terms of up to 20 years and typically contain contractual provisions for cost pass-through and minimum volume requirements. In addition, we have a reputation for quality and customer service. We have a track record of expanding and extending our initial contracts into longer-term agreements with increasing water purchase volumes, in part, because we provide our customers with a cost-effective and reliable water solution.
Our lease agreements for wastewater treatment and water reuse solutions under our Seven Seas Water platform typically provide for initial terms of up to five years with automatic renewal provisions. With annual lease customer attrition of less than 5%, our customer relationships typically extend for 15 years or longer. Further, as our customers’ needs for additional wastewater treatment equipment expands, we believe our modular based solutions provide a strategic solution for our customers to meet the increased demand through incremental long-term agreements.
In the 2016 study by Zenith International, our Quench platform was named one of the top five companies in the POU industry based on the number of POU units rented or sold. For company-owned and billed rental units, our current typical initial contract term is three years with an automatic renewal provision, and our annual unit attrition rate, at December 31, 2019, was less than 7.5%, implying an average rental period of more than 12 years, in part, because we provide highly reliable and efficient services. We believe our scale, product breadth and reliability, and customer service are key differentiators in a highly fragmented industry primarily composed of smaller providers.
Significant Experience Identifying and Integrating Acquisitions
Identifying and executing value-enhancing acquisitions are core to our growth strategy. Under our Seven Seas Water platform, we have acquired two operating desalination facilities and one wastewater treatment and water reuse company since our initial public offering. Quench has completed 20 acquisitions since our initial public offering, of which eight have occurred since the beginning of 2019. We believe the recent acquisitions are indicative of the opportunity for future inorganic growth to increase our market share and expand our service coverage footprint. We routinely evaluate opportunities for acquisitions and believe our experience and success in identifying, executing, integrating and operating acquisitions enable us to deploy capital effectively, create shareholder value and increase our market share.
Strong Financial Performance
We have demonstrated sustained revenue growth with attractive margins under long-term customer relationships.
Our revenues grew at a CAGR of 24.8% from 2014 through 2019. We believe we can continue our revenue growth by acquiring projects and customers, expanding our relationships with our customers, expanding into new geographies and complementary services, and selectively acquiring related water services businesses.
Our net losses for the years ended December 31, 2019, 2018 and 2017 were $20.1 million, $20.7 million and $24.9 million, respectively. See Item 8. “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for more information.
Our Strategy
Continue to be an Industry Leader in Quality, Service and Efficiency
We will continue to focus on servicing our customers and responding to changing customer needs and emergency situations in the water industry. Our WAAS business model helps us to control reliability and quality and
ensure compliance with health standards and customer specifications. Our desalination plants operate safely and efficiently with an average availability of approximately 97% since 2013, providing an uninterrupted supply of water for our customers. Our wastewater treatment and water reuse equipment is based on a conventional, proven design to ensure reliability of all operating components. Our Quench platform benefits from significant economies of scale that are expected to continue as the business grows.
Drive Sustainable and Profitable Growth
We are focused on long-term, sustainable equity returns and intend to continue to deploy capital in attractive rate of return opportunities. Across both our Seven Seas Water and Quench platforms, we have recurring revenue that is derived from predictable and contractually-obligated payments. In addition, certain of our Seven Seas Water margins benefit from contractual inflation-protection and cost pass-through provisions.
We believe our differentiated WAAS business model results in attractive unit economics. As a result, we believe our growth will enhance operating leverage and drive margin expansion for both the Seven Seas Water and Quench platforms.
Develop New Business Opportunities and Add New Customers for Growth
We intend to continue to develop new business opportunities and add new customers supported by our experienced sales and marketing teams. Our Seven Seas Water platform has dedicated business development teams focusing on new project development and acquisition opportunities globally. We strategically focus on providing desalination and wastewater treatment and water reuse solutions to governmental, municipal (including utility districts), industrial, property developer and hospitality customers in North America, the Middle East, South America, Africa, new territories in the Caribbean and other select international markets.
Quench has an experienced and growing team of sales and marketing professionals responsible for new customer acquisition and expansion of existing customer relationships. Our sales representatives leverage our innovative, internet-focused marketing and lead generation platform to add new customers. We also have dedicated sales teams targeting certain industries, such as government, education and medical, as well as large enterprise, dealer and wholesale opportunities.
Drive Growth through Increased Sales to Current Customers
Both our Seven Seas Water and Quench platforms are well positioned to realize growth through incremental sales to current customers due to our longstanding relationships developed as a result of our reliable operating performance, competitive pricing and highly-rated customer service.
Our Seven Seas Water platform has a track record of increasing sales to current customers through expansions of existing facilities to meet increasing demands for the customer and extensions of existing contracts to provide water over a longer period of time.
In addition, Seven Seas Water maintains a fleet of containerized and bypass wastewater treatment solutions for rapid deployment and commissioning. This gives us a competitive advantage when responding to short-term or immediate needs. Once these systems are operating, we have the opportunity to demonstrate the high reliability our plants have achieved elsewhere. With respect to our desalination solutions, we have had significant success converting these short-term customer relationships into much longer (10 to 20 years) contractual agreements.
Within Quench’s direct sales channel, our existing customers continue to provide significant opportunities for us to offer additional products and services. Many of our rental customers add water coolers or upgrade them during their relationship with us, and many also opt to rent equipment from our newer product lines enabled by POU water filtration, such as ice machines, sparkling water coolers and coffee brewers. Within Quench’s indirect sales channel, many of our dealers are also opting to purchase equipment from our newer product lines, such as ice machines.
Continued Development of New Product Offerings to Open New Market Opportunities
We intend to pursue new market opportunities and customers with our Seven Seas Water platform by leveraging our emergency response capabilities and specialized water supply systems for large-scale industrial operations such as mining, power generation and high volume water consumption manufacturing activities. We invest in containerized and bypass wastewater treatment plants to enable us to provide rapid solutions for customers who require services quickly, including in emergency situations. We are also actively examining and pursuing governmental, municipal, industrial and hospitality wastewater recovery opportunities as well as opportunities to treat water associated with oil and gas exploration.
In our Quench business, we intend to continue leveraging our manufacturing capabilities, exclusive supply relationships, and market knowledge, to expand and refine our water cooler product offerings and our other related water-enabled products, such as ice machines, sparkling water systems and coffee brewers.
Selectively Pursue Acquisitions
Acquisitions have historically been a major growth driver for us, and we expect to continue to pursue acquisitions in the future. Both Seven Seas Water and Quench have dedicated teams that actively identify opportunities to expand our business and geographic presence, broaden our service offerings and allow us to move into additional markets.
Through our Seven Seas Water platform, we intend to continue to selectively acquire complementary businesses that will align with our current offerings. Our strategy includes proactive deal sourcing where we identify and pursue the acquisition of assets or businesses from companies that align or complement our existing Seven Seas Water offerings. As it relates to targeted desalination assets or businesses, we intend to purchase, upgrade, expand and operate existing water treatment and desalination facilities in new and current markets, including those from companies which own and operate a single desalination facility. We believe we can often operate these desalination facilities more efficiently and reliably than current operators by leveraging our engineering and operating expertise.
We believe the highly fragmented nature of the POU filtered water market will allow Quench to continue to identify and acquire POU companies to increase penetration of our current markets, broaden our product offerings and expand geographically.
While we routinely identify and evaluate potential acquisition candidates and engage in discussions and negotiations regarding potential acquisitions, there can be no assurance that any of our discussions or negotiations will result in an acquisition. If we enter into definitive agreements, there can be no assurances that all the conditions precedent to completing those acquisitions will be satisfied or waived, or that the acquisitions will be completed. Further, if we make any acquisitions, there can be no assurance that we will be able to operate or integrate any acquired businesses profitably or otherwise successfully implement our expansion strategy.
Recent Acquisitions
On June 1, 2019, we acquired substantially all of the water filtration assets and assumed certain liabilities of Aguaman, Inc. (“Aguaman”), a POU water filtration company based in Miami, Florida, pursuant to an asset purchase agreement. The aggregate purchase price, subject to adjustments, was $1.5 million, which included approximately $1.1 million of cash, $0.2 million payable on the one-year anniversary of the transaction and $0.2 million acquisition contingent consideration payable to the seller on or before the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On July 15, 2019, we acquired substantially all of the assets and assumed certain liabilities of Carolina Pure Water Systems, LLC (“Carolina Pure”), a POU water filtration company based in Raleigh, North Carolina, pursuant to an asset purchase agreement. The aggregate purchase price, subject to adjustments, was $7.3 million, which included approximately $6.8 million of cash and $0.5 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On October 1, 2019, we acquired substantially all of the assets and assumed certain liabilities of Mirex AquaPure Solutions L.P., d/b/a Mirex AquaPure Solutions (“Mirex”), a POU water filtration company based in Houston, Texas, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $11.6 million, which included approximately $10.3 million of cash, $0.9 million payable on the one-year anniversary of the transaction, $0.3 million payable on the two-year anniversary of the transaction and approximately $0.1 million of acquisition contingent consideration. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On October 1, 2019, we acquired substantially all of the assets and assumed certain liabilities of 1920277 Alberta Inc., d/b/a Flowline Canada (“Flowline”), a POU water filtration company based in Edmonton, Canada, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.9 million, which included approximately $0.8 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in Canada.
On December 2, 2019, we acquired substantially all of the assets and assumed certain liabilities of Pure Planet Water, Inc. (“Pure Planet”), a POU water filtration company based in Palm Desert, California, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.2 million, which included approximately $0.1 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On December 16, 2019, we acquired substantially all of the assets and assumed certain liabilities of Jonli Water Services, Inc. (“Jonli”), a POU water filtration company based in Quebec, Canada pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.4 million, which was paid in cash. The assets acquired consist primarily of in-place maintenance agreements in Canada.
Available Information
We maintain a website with the address http://aquaventure.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such materials with, or furnish such materials to, the Securities and Exchange Commission. Our Code of Business and Ethics is also available free of charge through our website.
In addition, the public may read and copy any materials that we file with the Securities and Exchange Commission through the Securities and Exchange Commission’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) system at www.sec.gov.
Item 1A.
Item 1A. Risk Factors
Risks related to the Merger
We may not complete the Merger within the time frame we anticipate or at all, which could have an adverse effect on our business, financial results and/or operations.
Completion of the Merger is subject to a number of closing conditions, including obtaining approval of our shareholders. Each party’s obligation to consummate the Merger is also subject to the accuracy of the representations and warranties of the other party (subject to certain qualifications and exceptions) and the performance in all material respects of the other party’s covenants under the Merger Agreement, including, with respect to us, covenants regarding operation of our business prior to closing. In addition, the Merger Agreement may be terminated under certain specified circumstances, including, but not limited to, the mutual consent of the parties or, subject to compliance with specified process and notice requirements, our exercise of a “fiduciary out” to terminate the Merger Agreement in order to enter into an agreement providing for a “Superior Proposal” (as such term is defined in the Merger Agreement). As a result, we cannot assure you that the Merger will be completed, even if our shareholders approve the merger, or that, if completed, it will be exactly on the terms set forth in the Merger Agreement or within the expected time frame.
If the Merger is not completed within the expected time frame or at all, we may be subject to a number of material risks. The price of our ordinary shares may decline to the extent that current market prices reflect a market assumption that the Merger will be completed. Further, under specified circumstances resulting in termination of the Merger Agreement, including if we exercise the “fiduciary out”, we could be required to pay Culligan a break-up fee in the amount of $34,132,500. The failure to complete the Merger may result in negative publicity and negatively affect our relationship with our shareholders, employees and clients. We may also be required to devote significant time and resources to litigation related to any failure to complete the Merger or related to any enforcement proceeding commenced against us to perform our obligations under the Merger Agreement.
The Merger Agreement provides us with limited remedies in the event of a breach by Culligan that results in termination of the Merger Agreement, including the right to a Parent Termination Fee (as such term is defined in the Merger Agreement) in the amount of $54,611,815, payable under certain specified circumstances. We cannot assure you that a remedy will be available to us in the event of such a breach or that the damages we incur in connection with such breach will not exceed the amount of the Parent Termination Fee. In addition, Culligan has obtained significant equity and debt financing commitments for the transactions contemplated by the Merger Agreement, but the obligations of any lenders to provide the debt financing under the Debt Commitment Letter (as such term is defined in the Merger Agreement) are subject to a number of conditions, including the receipt of executed loan documentation, accuracy of representations and warranties, consummation of the transactions contemplated in the Merger Agreement and contribution of the equity contemplated by the Equity Commitment Letter (as such term is defined in the Merger Agreement).
The announcement and pendency of the Merger could adversely affect our business, financial results and/or operations.
Our efforts to complete the Merger could cause substantial disruptions in, and create uncertainty surrounding, our business, which may materially adversely affect our results of operation and our business. Uncertainty as to whether the Merger will be completed may affect our ability to recruit prospective employees or to retain and motivate existing employees. Employee retention may be particularly challenging while the Merger is pending because employees may experience uncertainty about their roles following the Merger. A substantial amount of our management’s and employees’ attention is being directed toward the completion of the Merger and thus is being diverted from our day-to-day operations. Uncertainty as to our future could adversely affect our business and our relationship with clients and potential clients. For example, clients and other counterparties may defer decisions concerning working with us, or seek to change existing business relationships with us. Changes to or termination of existing business relationships could adversely affect our revenue, earnings and financial condition, as well as the market price of our ordinary shares. The adverse effects of the pendency of the Merger could be exacerbated by any delays in completion of the merger or termination of the Merger Agreement.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities, including, among other things, restrictions on our ability to acquire other businesses and assets, dispose of our assets, make investments, enter into certain contracts, repurchase or issue securities, pay dividends, make capital expenditures, take certain actions relating to intellectual property, amend our organizational documents and incur indebtedness. These restrictions could prevent us from pursuing strategic business opportunities, taking actions with respect to our business that we may consider advantageous and responding effectively and/or timely to competitive pressures and industry developments, and may as a result materially adversely affect our business, results of operations and financial condition.
In certain instances, the Merger Agreement requires us to pay a termination fee to Culligan, which could affect the decisions of a third party considering making an alternative acquisition proposal.
Under the terms of the Merger Agreement, we may be required to pay Culligan a termination fee of up to $34,132,500 if the Merger Agreement is terminated under specific circumstances. In particular, we may be obligated to pay Culligan a break-up fee in the amount of $34,132,500 if AquaVenture exercises its “fiduciary out” to terminate the Merger Agreement in order to enter into an agreement providing for a Superior Proposal (as defined in the Merger Agreement). This payment could affect the structure, pricing and terms proposed by a third party seeking to acquire or merge with us and could discourage a third party from making a competing acquisition proposal, including a proposal that would be more favorable to our stockholders than the Merger.
We have incurred, and will continue to incur, direct and indirect costs as a result of the Merger.
We have incurred, and will continue to incur, significant costs and expenses, including fees for professional services and other transaction costs, in connection with the Merger. We must pay substantially all of these costs and expenses whether or not the Merger is completed. There are a number of factors beyond our control that could affect the total amount or the timing of these costs and expenses.
Legal proceedings in connection with the Merger, the outcomes of which are uncertain, could delay or prevent the completion of the Merger.
Since the announcement of the Merger Agreement on December 23, 2019, three putative class actions have been filed in connection with the proposed Merger. On February 4, 2020, in connection with the merger, a putative class action lawsuit, Post v. AquaVenture Holdings Ltd., et al., 1:20-cv-174, was filed by purported shareholder Joseph Post against our Company and our directors in the United States District Court for the District of Delaware. On February 12, 2020, in connection with the merger, a lawsuit, Hamilton v. AquaVenture Holdings Ltd., et al., 1:19-cv-01227, was filed as an individual action by purported shareholder Peter Hamilton against our Company and our directors in the United States District Court for the Southern District of New York. On February 20, 2020, purported shareholder Christopher Jagt filed an individual lawsuit against the Company and its directors in the United States District Court for the Eastern district of New York, captioned Jagt v. AquaVenture Holdings Ltd., et. al. 1:20-cv-931. These complaints allege that, because the proxy statement concerning the Merger is materially deficient in certain respects, all of the defendants violated Sections 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder, and that the directors additionally violated Section 20(a) of the Exchange Act. The complaints seek, among other things, (1) injunctive relief preventing consummation of the Merger, (2) rescissory damage or rescission of the Merger if it has already occurred; and (3) costs and fees, including attorney and expert fees, related to the actions. The defendants believe that the respective allegations asserted against them in the lawsuits are without merit and intend to defend against the lawsuits vigorously. Similar cases may also be filed in connection with the merger. These legal proceedings could delay or prevent the Merger from becoming effective.
Risks Related to Our Business
Our results of operations may fluctuate significantly based on a number of factors.
We deliver our Water-as-a-Service, or WAAS, solutions through two operating platforms: Seven Seas Water and Quench. Seven Seas Water is a multinational provider of desalination and wastewater treatment solutions, and Quench is a U.S.-based provider of Point-of-Use, or POU, filtered water systems and related services. For each of our business platforms, there are a number of factors that may negatively impact our operating results.
For our Seven Seas Water business, these factors include:
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our ability to identify and successfully complete acquisitions and to integrate and operate any acquired assets or businesses profitably;
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limitations under the Merger Agreement on our ability to pursue acquisitions;
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the timing of the commencement of any operations of new, expanded or acquired desalination or wastewater treatment plants;
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variations in the customer demand, volume or price of water purchased by our customers;
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the timing or delay of collections from a customer, including those arising from credit issues of the customer;
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the amendment, disposition, termination or expiration of, or non-compliance with, a water supply agreement for a desalination or wastewater treatment plant;
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the timing, size and accounting treatment of acquisitions, the impact of those acquisitions on our business and financial statements, and the market perception of the benefits of those acquisitions;
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any disruptions in the operations of our plants due to severe weather conditions, natural disasters, climate change, equipment failures, power outages, extended maintenance, pandemics or other factors, including environmental factors (such as bacteria levels or contaminants in source water), that can reduce our production volume;
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changes in capital spending;
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our ability to raise sufficient debt or equity capital to fund the construction or acquisition of new plants;
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our inability to recruit and retain skilled labor and personnel changes;
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changes in the political, social and economic conditions of our markets; and
·
general economic conditions.
For our Quench business, these factors include:
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our ability to identify and successfully complete acquisitions and to integrate and operate any acquired assets or businesses profitably;
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limitations under the Merger Agreement on our ability to pursue acquisitions;
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increased customer attrition at our Quench business;
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increased competitive pressures in the POU filtration market;
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the introduction and market acceptance of new products and new variations of existing products;
·
changes in our mix of products including changes in the mix of installed rental units and sold units, and the mix in the type of rental units installed;
·
information technology systems or network infrastructure failure and cyber-attacks, which could result in loss of operational capacities or critical data or cause delays in our billing and collection cycles; and
·
general economic conditions.
The future growth of our business is dependent on our ability to identify and successfully complete acquisitions for both our Seven Seas Water and Quench businesses, and to operate any acquired assets or businesses profitably.
Acquisitions have historically been a major part of our expansion strategy, and we expect to continue to grow through acquisitions in the future, either in transactions permitted under the Merger Agreement or otherwise, if the Merger is not consummated. We expect to continue to evaluate potential strategic acquisitions of businesses or products with the intention to expand our customer and revenue bases, widen our geographic coverage and increase our product breadth. As part of the expansion strategy for our Seven Seas Water business, we may seek to acquire additional desalination and water treatment facilities. Potential acquisition candidates include individual plants and businesses that operate multiple plants. For our Quench business, we may seek to acquire additional portfolios of equipment or businesses with local, regional, national or international customer bases. Identifying attractive acquisition candidates and willing sellers, particularly for our Seven Seas Water business, has been and continues to be challenging. We routinely evaluate potential acquisition candidates and engage in discussions and negotiations regarding potential acquisitions. There is significant competition for acquisition and expansion opportunities in our businesses. We compete for acquisition and expansion opportunities with companies that have significantly greater financial and management resources. There can be no assurance that any of our discussions or negotiations will result in an acquisition. In addition,
even if we have executed a definitive agreement for an acquisition, there can be no assurance that we will consummate the transaction within the anticipated closing timeframe, or at all.
The anticipated benefits from any of these potential acquisitions may not be achieved unless the operations of the acquired facilities, portfolios or businesses are successfully integrated in a timely manner. The integration of our acquisitions will require substantial attention from management and operating personnel to ensure that the acquisition does not disrupt any existing operations, or affect our customers’ or investors’ opinions and perceptions of our services, products or customer support.
Whether we realize the anticipated benefits from these acquisitions depends, to a significant extent, on a number of factors, including the following:
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the integration of the target businesses into our company;
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the performance and development of the underlying assets, businesses, services or technologies;
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acceptance by our target’s customers;
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the retention of key employees;
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unforeseen legal, regulatory, contractual, labor or other issues arising out of the acquisitions; and
·
our correct assessment of assumed liabilities and the management of the relevant operations.
The process of integrating the various facilities, portfolios or businesses could cause the interruption of, or delays in, the activities of some or all of the existing facilities, portfolios or businesses, which could have a material adverse effect on our operations and financial results. Some acquisitions involve new management teams taking over day-to-day operations of a business. These new management teams may fail to execute at the same level as the former management team, which could reduce the cash flow of the client available to service the loan or other debt product, as well as reduce the value of the client as a going concern. Acquisitions also place a burden on our information, financial and operating systems and our employees and management. Investigation of target businesses, and negotiations and financial arrangements to acquire them, require significant management efforts and involve substantial costs for accountants, attorneys and others. The diversion of management’s attention and any difficulties encountered in the transition and integration processes could harm our business, financial condition and operating results. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing.
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires our management to assess the effectiveness of the internal control over financial reporting for the companies we acquire. In order to comply with the Sarbanes-Oxley Act, we will need to implement or enhance internal control over financial reporting at any company we acquire and evaluate the internal controls. We do not conduct a formal evaluation of companies’ internal control over financial reporting prior to an acquisition. We may be required to hire or engage additional resources and incur substantial costs to implement the necessary new internal controls should we acquire any companies. Any failure to implement required internal controls, or difficulties encountered in their implementation, could harm our operating results or increase the risk of material weaknesses in internal controls, which could, if not remediated, adversely affect our ability to report our financial condition and results of operations in a timely and accurate manner.
Our ability to manage our growth effectively and integrate the operations of acquired facilities, portfolios or businesses, or newly expanded or developed facilities, will require us to continue to attract, train, motivate, manage and retain key employees and to expand our information technology, operational and financial systems. If we are unable to manage our growth effectively, we may spend time and resources on such acquisitions that do not ultimately increase our profitability or that cause loss of, or harm to, relationships with employees, and customers as a result of the integration of new businesses.
Our Seven Seas Water desalination business is dependent on a small group of customers for a significant amount of our revenue.
Our Seven Seas Water desalination business focuses on large and complex projects. Consequently, we are dependent on a small number of customers for a significant amount of our revenue. Our desalination projects usually conduct business under long-term water supply agreements with one or a limited number of customers or a single government or quasi-government entity that purchase the majority of, and in some cases all of, the relevant facility’s output over the term of the agreement. This customer concentration exposes us to increased risk of termination, expiration, cancellation or breach of existing contracts or delay of new projects, which may cause high volatility of our revenues. For example, the aggregate of our five largest Seven Seas Water desalination customers accounted for approximately 26% of AquaVenture Holding Limited’s consolidated revenue for the year ended December 31, 2019. While we intend to maintain long-term water supply agreements for each of our facilities, due to market conditions, regulatory regimes and other factors, it may be difficult for us to secure long-term agreements where our current contracts are expiring or for new development projects. In addition, the financial performance of our facilities is dependent on the credit quality of, and continued performance by, our customers. If any significant customer ceases or delays payments to us, cancels or delays a project or otherwise ceases doing business with us, our business, results of operations and financial condition could be materially and adversely affected. Also, the failure of our customer in the BVI to pay us on a timely basis, or at all, could cause our BVI subsidiary to be in default on its debt, which could permit the lenders of that debt to accelerate its repayment. Further, if we are required to transfer or sell one or more of our desalination plants to our customers, our business, results of operations and financial condition could be materially and adversely affected. While in certain cases we serve quasi-governmental agency customers, those water supply agreements are neither guaranteed by the related government nor supported by the full faith and credit of such government, and no assurance can be given that such government would provide financial support.
We also may be unable to maintain the long-term nature and economic structure of our current contract portfolio over time. Depending on prevailing market conditions at the time of a contract renewal, our customers may desire to enter into contracts with reduced fees, and may be unwilling to enter into long-term contracts at all.
Our ability to renew or replace our expiring contracts on terms similar to, or more attractive than, those of our existing contracts is uncertain and depends on a number of factors beyond our control, including:
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the level of existing and new competition to provide competing services in our markets;
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the cost of our services as compared to the cost of services offered by our competitors;
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dissatisfaction with our services or products attached to services we provide;
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our clients selecting alternative technologies to replace us;
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the extent to which the current and potential customers in our markets are willing to provide commitments on a long-term basis; and
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the effects of federal, state or local laws or regulations on the contracting practices of our customers.
To the extent we are unable to renew or replace our existing contracts on terms that are favorable to us or successfully manage the long-term nature and economic structure of our contract profile over time, our revenues and cash flows could decline and our ability to service our debt could be materially and adversely affected.
Failure to retain certain key personnel or the inability to attract and retain new qualified personnel could negatively impact our ability to operate or grow our business.
The success of our business will continue to depend to a significant extent on our ability to retain or attract key personnel, particularly management, engineering, sales and operating personnel. Our management team, led by our Chairman, Douglas R. Brown, our President and Chief Executive Officer, Anthony Ibarguen, and our Chief Financial Officer, Lee S. Muller, and other key personnel have extensive industry experience. Our ability to attract or retain these employees will depend on our ability to offer competitive compensation, training and benefits. If we are unable to continue to hire and retain skilled management, technical, engineering, sales, service and operating personnel, we will have trouble operating and expanding our business, including developing and operating our existing and new or acquired desalination plants. Our success depends largely upon the continued service of our management, technical, engineering, sales, service and operating personnel and our ability to attract, retain and motivate highly skilled personnel. We face significant competition for such personnel from other businesses and other organizations which may be better able to attract such personnel. The ability to attract or retain these employees will depend on our ability to offer competitive compensation, training and benefits. The loss of key personnel or our inability to hire and retain personnel who have the necessary management, technical, engineering, sales, service and operating backgrounds could materially adversely affect our business and our financial performance.
Our water sales agreement in Curaçao was terminated on December 31, 2019 when our customer exercised its right to purchase our Curaçao desalination facilities, which will adversely impact the revenues, results of operations and cash flows of our Seven Seas Water business.
Our former desalination facility in Curaçao sold industrial quality water to Curaçao Refinery Utilities B.V. ("CRU"), a government owned utility that provides utility services to a refinery owned by Refineria di Korsou ("RdK") that is leased to Petróleos de Venezuela S.A., or PDVSA (the state-owned oil company of Venezuela).
On June 28, 2019, we received formal notice from CRU that it is exercising its right to purchase our desalination facilities pursuant to the terms of the existing water supply agreement. The terms of the contractual buy-out right require payment to be made at the contract expiration date. The applicable buy-out amount, which was paid on December 31, 2019, was $3.5 million. For the year ended December 31, 2019, our revenue under this water supply agreement was $8.1 million, or 4.0% of our total consolidated revenue. The expiration of this water supply agreement and purchase of the desalination facilities will adversely impact the revenues, results of operations and cash flows of our Seven Seas Water business.
The future growth of our Seven Seas Water business is dependent on our ability to identify and secure new project opportunities in a competitive environment.
We are currently pursuing new opportunities for our Seven Seas Water business in North America, the Caribbean, South America, Africa, the Middle East and other select markets, as permitted under the Merger Agreement. Any new project we implement will require achievement of critical milestones in order to commence construction, the first of which is to successfully identify markets for such projects and secure contracts with proposed customers to sell water in sufficient quantities and at prices that make the projects financially viable.
Our Seven Seas Water business typically incurs significant business development expenses in the pursuit of new projects and markets, and such expenses have had, and could have, an adverse impact on our results of operations and cash flows. We currently operate our desalination business primarily in the Caribbean where we have successfully identified markets that accept our build, own and operate, or BOO, model. We currently operate our wastewater treatment and water reuse solutions business primarily in Texas where we have successfully identified markets that accept our business model. However, we expect to face challenges when we enter new markets, including identifying and establishing relationships with appropriate local partners, locating potential sites for new plants and convincing potential customers about the benefits of our business model. New markets may also have competitive conditions and governmental or regulatory regimes that are different from our existing markets. Any failure on our part to recognize or respond competitively to these differences may adversely affect the success of our business development efforts or operations in those markets, which in turn could materially and adversely affect our results of operations.
In most cases for our desalination business, we must sign a contract and sometimes obtain, or renew, various licenses, permits and authorizations from regulatory authorities. The competition and/or negotiation process that must be followed to win such contracts is often long, costly, complex and hard to predict. The same applies to the permit authorization process for activities that may affect the environment, which are often preceded by increasingly complex studies and public investigation. We may invest significant resources in a project or public tender without obtaining the right to build the plant. This could arise for many reasons, including the failure to obtain necessary licenses, permits or authorizations or inability to respond competitively. As a result, it may increase the overall cost of our activities or, if the resulting costs were to become too high, it could potentially force us to abandon certain projects. Should such situations become more frequent, the scope and profitability of our business, growth rate, predictability of earnings and cash flow generation could be materially and adversely affected.
As part of the bidding process that must be followed to win contracts, we must, at times, share our know-how and confidential information with third parties. The need to share other confidential information and know-how increases the risk that such know-how and confidential information become known by our competitors, are incorporated into the product development of others or are disclosed or used in a way that disadvantages our business. Given that our proprietary position is based, in part, on our know-how and confidential information, a competitor’s discovery of our know-how and confidential information or other unauthorized use or disclosure would impair our competitive position and may have a material adverse effect on our business.
We may also decide to enter new markets by building reverse osmosis desalination plants before we have obtained a contract for the sale of water to be produced by the new plant or before we have established a customer base for the water to be produced by the new plant. Therefore, if we are unable to obtain a contract or sufficient number of customers for the plant, we may be unable to recover the cost of our investment in the plant, which could have a material adverse effect on our results of operations, cash flows and financial condition.
For our wastewater treatment and water reuse solutions business, our property developer customers obtain the necessary licenses, permits and authorizations from regulatory authorities. Delays in a customer obtaining the necessary licenses, permits and authorizations, or delays in building or expanding the property being developed, could materially and adversely affect the scope and profitability of our business, growth rate, predictability of earnings and cash flow generation.
A number of factors may prevent or delay our Seven Seas Water business from building new plants and expanding our existing plants, including our dependence on third-party suppliers and construction companies and the terms of the Merger Agreement.
A number of factors may prevent or delay construction, expansion or deployment of our facilities, including our dependence on third-party suppliers of equipment and materials, our dependence on third-party construction companies, and the timing of equipment purchases, and constraints on our use of and disposition of capital pursuant to the Merger Agreement.
The equipment and materials required for the uninterrupted service of our Seven Seas Water plants are supplied by only a limited number of manufacturers and could only be replaced with difficulty or at significant added cost. Some materials or equipment may become scarce or difficult to obtain in the market, or they may increase in price. This could adversely affect the lead-time within which we receive the materials or components, and in turn affect our commitments to our customers, or could adversely affect the material cost or quality. The failure of any of these suppliers to fulfill their obligations to us or our subsidiaries could have a material adverse effect on our financial results. Consequently, the financial performance of our desalination facilities is dependent in part on the credit quality of, and continued performance by, our suppliers.
We also engage in long-term engineering, procurement and construction contracts associated with developing our new desalination projects. If a construction company we have hired to build a new project defaults or fails to fulfill its contractual obligations, we could face significant delays and cost overruns. Any construction delays could have a material adverse impact on us.
In addition, the timing of equipment purchases can pose financial risks to us. We attempt to make purchases of equipment and/or material as needed. However, from time to time, there may be excess demand for certain types of equipment with substantial delays between the time we place orders and receive delivery. In those instances, to avoid
construction delays or service disruptions associated with the inability to own and place such equipment and/or materials into service when needed, we may place orders well in advance of deployment or when actual damage to the equipment and/or materials occurs. Thus, there is a risk that at the time of delivery of such equipment or materials, there may not yet be a need to use them; however, we are still required to accept delivery and make payment. In addition, due to the customization of some of our equipment and/or materials, there may be a limited market for resale of such equipment or material. This can result in our having to incur material equipment and/or material costs, with no use for or ability to resell such equipment.
Our ability to meet customer needs is dependent on the successful and efficient operation of our Seven Seas Water desalination facilities, which can be adversely impacted by a number of factors.
Our ability to meet our customers’ needs, as well as achieve our targeted level of financial performance, depends on the successful operation of our facilities in our Seven Seas Water business. We currently own or operate ten water treatment facilities in the Caribbean region and South America, which generate substantially all of the revenue of our Seven Seas Water business. Some of these facilities serve governmental and municipal customers which provide water to the ultimate consumers. If these customers fail to provide adequate service, our reputation will suffer, and our competitive position may be impaired. In addition, if the risks involved in our operations are not appropriately managed or mitigated, our operations may not be successful, and this could adversely affect our results of operations. The continued operation and maintenance of our desalination facilities may be disrupted by a number of technical problems, including:
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breakdown or failure of equipment or processes;
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contamination of, or other problems with, the raw feedwater that we process, including from environmental factors (such as bacteria levels or contaminants in source water) that can reduce our production volumes;
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service disruptions, stoppages or variations in our supply of electricity transmitted by third parties to our desalination plants resulting in service interruptions;
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availability of materials used in the desalination process;
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problems with, or delays in availability of, water distribution infrastructure or our customers’ ability to take delivery of the water we produce;
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operating hazards such as mechanical problems and accidents caused by human error, which could impact public safety, reliability and customer confidence;
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disruption in the functioning of our information technology and network infrastructure which are vulnerable to disability, failures and unauthorized access;
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natural disasters, hurricanes, floods and other extreme weather;
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the ability to secure and retain qualified labor; and
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other unanticipated operational and maintenance liabilities and expenses.
If we do not operate our business to appropriately manage or mitigate these problems, we may breach our water supply agreement, harm our customer relationships or both, which could lead to the termination of the related water supply agreement. A decrease in, or the elimination of, the revenues generated by our key plants or a substantial increase in the costs of operating such plants could materially impact our reputation, performance, financial results and financial condition.
Our negotiations of changes to existing desalination customer contracts may not be successful and may adversely affect our business and results of operations.
Our Seven Seas Water desalination business is generally conducted in accordance with the terms of long-term water supply contracts that, among other things, may provide for minimum customer purchases, guaranteed supply volumes and specified levels of pricing based on the volume of water purchased during the billing period. These contractual features are key determinants of plant revenue and plant profitability. Certain of our contracts provide for contractually scheduled price changes. In addition, most of our contracts include provisions to increase prices in accordance with a specified inflation index such as the consumer price index. Following the completion of acquisitions, we are typically bound by the contracts we acquire, which may include terms that either we or our customer might desire to change. From time to time, we also negotiate pricing or other changes with our existing customers which include, but are not limited to, extending or renewing a contract, expanding plant capacity, adjusting minimum volumes pursuant to a take-or-pay agreement, adjusting water rates or the indexation thereof, or a combination thereof. We have recently entered into, or proposed to enter into, amendments to certain of our contracts that have resulted in reductions or delays in the revenues we derive from those contracts in exchange for changes we believe are beneficial to us in the long run. As our customers are often governmental entities or affiliates, these negotiations can take considerable time and effort, and in certain situations, proposed amendments may require the approval of certain of governmental or quasi-governmental parties, our lenders or other third parties, resulting in negotiations with multiple parties. There can be no assurances that any specific negotiations will result in an amendment on a timely basis or at all, or that such amendment will be beneficial to us. The terms and timing of any such amendments may negatively impact our operating results, fail to meet our expectations or result in greater variability in our operating results from period to period. Failure to successfully conclude any such negotiations may require us to update previous public statements regarding our expected financial results, adversely affect our relationship with our customer, which could result in our customer exercising its rights under the contract (including, in certain circumstances, the right to purchase the desalination plant), or result in negative publicity, all of which could have a material adverse effect on our business and results of operations. Because we are dependent on a small number of customers for a significant amount of our Seven Seas Water bulk water revenues, any significant changes in prices or other terms of our contracts with any of those customers could significantly reduce our revenues, operating results and cash flows in specific periods or for the long term. Further, the political, economic and social conditions prevailing from time to time may lead our customers to more aggressively pursue cost reduction initiatives and contract amendments, which could adversely affect our business, revenues and operating results.
If the rental portion of our business experiences a higher annual unit attrition rate than forecasted, our revenues could decline and our costs could increase, which would reduce our profits and increase the need for additional funding.
Attrition is generally the result of competitive offerings, customers’ ceasing or reducing their use of our solutions, customer financial distress, customer dissatisfaction and other factors. If our unit attrition rate is higher than expected, it would reduce our revenues and could require increased marketing costs to attract the replacement customers required to sustain our growth plan, both of which would reduce our profits and profit margins. In addition, our ability to generate positive operating cash flow in future periods will be dependent on our ability to obtain additional funding to increase our customer acquisition activities to out-pace customer attrition and absorb operating expenses. There can be no assurance that we will be able to obtain additional funding, increase our customer base at a rate in excess of our customer attrition rate or achieve positive operating cash flows in future periods. In the absence of our raising additional funding to finance increased selling and marketing activities and new customer acquisition, our customer attrition may exceed the rate at which we can replace such customers’ business. In such case, our revenues could be reduced and our profit margin could be affected.
Increased competition could hurt our Quench business.
The water cooler markets in the United States and Canada are intensely competitive. The POU filtration market is highly fragmented, with many small, local service providers. There are also a number of larger national competitors, including Cott Corporation, Nestlé, Aramark, Canteen and Waterlogic International. Municipal tap water is also a substitute for our POU filtration services. Our competitive position is based on our pricing, national service coverage and product quality. Many of these larger businesses have substantially greater financial and management resources than we do. Our ability to gain or maintain market share may be limited as a result of actions by competitors. If we do not succeed in effectively differentiating ourselves from our competitors, based on pricing, service, value proposition,
quality of products, desirability of brands or otherwise, our competitive position may be weakened, which could also jeopardize our strategy to include the rental of additional or upgraded water coolers and the rental of equipment from our product lines enabled by POU water filtration. If we are unable to convince current and potential customers of the advantages of our services, our ability to sell our services may be limited.
Certain of our long-term water supply contracts under our Seven Seas Water business require us to transfer ownership of the desalination plant to the customer upon expiration or termination of the contract, or permit the customer to purchase the desalination plant in accordance with the contract before the expiration or termination of the contract.
Certain of our long-term water supply contracts under our Seven Seas Water business require us to transfer ownership of the desalination plant to the customer upon expiration or termination of the supply contract, either for a specified amount or for no additional payment. Some of our long-term water supply contracts permit the customer to purchase the plant for amounts determined in accordance with the contract before the expiration or termination of the contract, typically with notice of six months or less. In addition, most of our long-term water supply contracts grant us the right to remove our equipment from the site of the facility in the event that the contract terminates due to a default by the customer or otherwise. If we are required to transfer or sell a desalination plant to our customer or are unable to remove our equipment upon termination of the contract for whatever reason, including customer interference, our revenue, earnings and cash flows from that desalination plant will cease, unless we are retained by the customer to continue to operate and maintain the plant. There can be no assurances that we will be retained by a customer to continue to operate and maintain the plant after its transfer to or purchase by such customer. As a result, our revenue, earnings and cash flows would decrease materially if we were to be required to transfer or sell a desalination plant. In addition, if we are required to transfer or sell a desalination plant to a customer for less than our carrying value of the plant or no consideration, we may not recoup our investment in the plant, may not receive sufficient proceeds to enable the subsidiary that owns the plant to repay any outstanding project finance debt in full, and may have to write down or write off the remaining value of the plant, any of which could materially and adversely affect our business, assets, earnings and debt covenant compliance. See “Business-Seven Seas Water-Our Desalination Plants.”
The political, economic and social conditions impacting our geographic markets may adversely affect our Seven Seas Water business.
Currently, substantially all of our operating desalination plants are located in the Caribbean region. We often market our services, and sell the water we produce, to governments and governmental entities run by elected or politically appointed officials. Various constituencies, including our competitors, existing suppliers, local investors, developers, environmental groups and conservation groups, have competing agendas with respect to the development of desalination plants and sale of water in the areas in which we operate, which means that decisions affecting our business are based on many factors other than economic and business considerations.
Political concerns and governmental procedures and policies have hindered or delayed, and in the future are expected to hinder or delay, our ability to develop desalination plants or to enter into, amend or renew water supply contracts. We cannot predict whether changes in political administrations will result in changes in governmental policy and whether such changes will affect our business. For example, our market development activities and operations can be adversely affected by lengthy government bidding, contracting, licensing, permitting, approval and procurement processes, immigration or work permit restrictions, local laws, restrictive exchange controls or other factors that limit our customers’ access to U.S. dollars and nationalization or expropriation of property. In addition, we may need to spend significant time and resources to inform newly elected officials, local authorities and others about the benefits of outsourced management of desalination plants and other water and wastewater treatment infrastructure.
Our customers may suffer significant financial difficulties, including those due to downturns in the economy, political developments, severe weather events (such as hurricanes) or commodity price fluctuations. Some of our customers could be unable to pay amounts owed to us or renew contracts with us at current or increased rates, which would negatively affect our financial performance. Certain of the customers and governments that we serve derive significant revenue from tourism, the sale of certain commodities such as oil, petrochemicals, natural gas, precious metals and other minerals, and our customers may be adversely impacted if demand or prices for these commodities were to decline for a prolonged period. Therefore, a decline in international or regional demand or prices for certain commodities may indirectly impact the demand for the water we produce and the credit worthiness of our customers.
Furthermore, many of our targeted markets are in developing countries undergoing rapid and unpredictable economic and social changes. Many of these countries have suffered significant political, economic and social crises in the past, and these events may occur again in the future. Adverse political, economic and social conditions may affect existing operations and the development of new operations due to the resulting political economic and social changes, the inability to accurately assess the demand for water and the inability to begin operations as scheduled. Such conditions may also affect the creditworthiness of affected clients who rely on or do business in impacted countries or regions.
We expect to continue to be subject to risks associated with dealing with governments and governmental entities, and political concerns and governmental procedures and policies may hinder or delay our ability to enter into supply agreements or develop our plants. The political, economic and social conditions impacting our geographic markets may adversely affect our business.
Severe weather conditions or natural or man-made disasters may disrupt our operations and affect the demand for water produced by our Seven Seas Water business or ability to produce water, any of which could adversely affect our financial condition, results of operations and cash flows.
Our Seven Seas Water business, operating results and financial condition could be materially and adversely affected by severe weather, floods, natural disasters (such as hurricanes, particularly in the Caribbean), hazards (such as fire, explosion, collapse or machinery failure), environmental factors, or be the target of terrorist or other deliberate attacks. Repercussions of these catastrophic events may include:
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shutting down or curtailing the operation of our plants for limited or extended periods;
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fluctuations in short-term customer demand;
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the need to obtain necessary equipment or supplies, including electricity, which may not be available to us in a timely manner or at a reasonable cost;
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evacuation of and/or injury to personnel;
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damage or catastrophic loss to our equipment, facilities and project work sites, resulting in suspension of operations or delays in building or maintaining our plants;
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loss of productivity;
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the deterioration of the financial health of our customers; and
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interruption to any projects that we may have in process.
Large-scale or repetitive natural disasters, such as hurricanes, tropical storms, floods or earthquakes, can also lead to the damage or destruction of certain infrastructure (such as electricity supply, water storage tanks, water distribution infrastructure, roads and means of communication) on which we depend for the conduct of our business and can cause damage to the infrastructure for which we are responsible.
In addition, hazards (such as fire, explosion, collapse or machinery failure) are inherent risks in our operations, which may occur as a result of inadequate internal processes, technological flaws, human error or certain events beyond our control. Our Seven Seas Water facilities could also be the target of terrorist or other deliberate attacks which could harm our business, financial condition and results of operations. We maintain security measures at our facilities, and we have and will continue to bear increases in costs for security precautions to protect our facilities, operations, and supplies. Despite our security measures, we may not be in a position to control the outcome of terrorist events, or other attacks on our facilities, should they occur. Such an event could harm our business, financial condition and results of operations and cash flows.
Any contamination resulting from a natural or man-made disaster to our raw feedwater supply may result in disruption in our services, additional costs and litigation, which could harm our business, financial condition, results of
operations and cash flows. Damage or destruction to our facilities and infrastructure could temporarily inhibit our ability to deliver water as required by our contracts, which may enable our customers to terminate such contracts.
We face possible risks associated with the physical effects of climate change.
The physical effects of climate change could have a material adverse effect on our properties, operations, and business. However, the impacts of climate change on our operations are highly uncertain and their significance will vary depending on type and geographic location of any physical impact. The impacts of climate change could include changing temperatures, flooding, water shortages, changes in weather and rainfall patterns, and changing storm patterns and intensities. Many climate change predictions, if true, present several potential challenges to water and wastewater utilities, such as increased precipitation and flooding, potential degradation of water quality, and changes in demand for water services. To the extent that climate change impacts changes in weather patterns, some of our properties could experience increases in storm intensity and rising sea levels. Climate change may also have indirect effects on our business by increasing the cost of, or availability of, property insurance on terms we find acceptable, increasing the cost of energy, or adversely affecting our customers (including their creditworthiness and cash flows). There can be no assurance that climate change will not have a material adverse effect on our properties, operations, or business.
We may sustain losses that exceed or are excluded from our insurance coverage or for which we are not insured.
We may from time to time become exposed to significant liabilities for which we may not have adequate insurance coverage. Because of the location of our Seven Seas Water facilities, we are exposed to risks posed by severe weather and other natural disasters, such as hurricanes, floods, earthquakes and tsunamis. In addition to natural hazards, other hazards such as fire, explosion, collapse, riot, civil commotion, machinery failure and electrical service interruption are inherent in our operations. Liability from these hazards and other risks may occur as a result of inadequate internal processes, technological flaws, human error or events beyond our control. The hazards described above can cause significant personal injury or loss of life, severe damage to and destruction of property, plant and equipment and contamination of, or damage to, the environment and suspension of operations. The occurrence of any of these events may result in our being subject to investigation, required to perform remediation and/or named as a defendant in lawsuits asserting claims for substantial damages, environmental cleanup costs, personal injury, natural resource damages and fines and/or penalties. In addition, such events may affect the availability of personnel, proper functioning of our information technology infrastructure and availability of third parties on whom we rely, any of which consequences could have a material adverse effect on our business and results of operations.
Our Seven Seas Water facility in Tortola and our two large facilities in the U.S. Virgin Islands which serve VIWAPA are insured against earthquake, flood and hurricane damage, while our other desalination facilities are not. Our Seven Seas Water facility in Trinidad is insured against earthquake, flood and windstorm damage. The leases for certain of our wastewater treatment and water reuse equipment in the United States require the lessee to maintain insurance against earthquake, flood and hurricane damage. These insurance policies have various sub-limits, exclusions and limitations that can preclude coverage, and insurance companies may seek to deny claims we might make. Each policy includes deductibles or self-insured retentions and maximum policy limits for covered claims. As a result, we may sustain self-insured losses that are: (i) below our deductibles and self-insured retentions, (ii) exceed our policy limits or (iii) excluded from our insurance coverages. Catastrophic events can result in decreased coverage limits, more limited coverage, increased premiums and deductibles with respect to the insurance policies covering these facilities.
Our Seven Seas Water facilities are fortified to withstand damage caused by severe weather, and we have not experienced any material loss or damage resulting from the natural disasters that have impacted our facilities. However, we cannot assure that our facilities will withstand all natural disasters in the future, and an unforeseen natural disaster may cause damage to or the destruction of one or more of our facilities. In addition, an accident or safety incident could expose us to significant liability and a public perception that our operations are unsafe or unreliable. Although we conduct ongoing, comprehensive safety programs, a major accident could expose us to significant personal injury or property claims by third parties or employees. Even if we or our lessees have purchased insurance, the adverse impact on our business, including both costs and lost revenue, could greatly exceed the amounts, if any, that we might recover from the insurers. We could also suffer significant construction delays or substantial fluctuations in the pricing or availability of materials for any projects we have in process. Any of these events could cause a decrease in our revenue, cash flow and earnings.
In our Quench business, we maintain liability insurance covering our facilities and operations, including installations of company-owned equipment in the field, which could fail and cause significant property damage, personal injury and/or loss of life. We also maintain cyber and privacy liability coverage for risks related to our network and related data. However, we can make no assurance that the adverse impact of any claim will not materially exceed the amounts that we might recover from our customers, suppliers or insurers. Moreover, significant insurance claims, even if covered, can result in decreased coverage limits, more limited coverage, increased premium costs or deductibles. Any of these events could adversely affect our operations.
Our Seven Seas Water desalination operations may be affected by tourism and seasonal fluctuations which could affect the demand for our water.
Our desalination operations may be affected by the levels of tourism and seasonal variations in the areas in which we operate. Demand for our water can be affected by variations in the level of tourism, demand for real estate and rainfall levels. Tourism in our service areas is affected by the economies of the tourists’ home countries (primarily the United States and Europe), severe weather events (such as hurricanes), terrorist activity and perceived threats thereof, the cruise industry and costs of fuel and airfares. In addition, in December 2019, a strain of coronavirus was reported to have surfaced in Wuhan, China, resulting in extended holidays, travel restrictions and certain supply chain and other business disruptions. At this point, the extent to which the coronavirus may impact levels of tourism and seasonal variations in the areas in which we operate, or disruption in the supply and equipment that we use in our business or business generally, is still uncertain. A downturn in tourism or greater than expected rainfall in the locations we serve could adversely affect our revenues, cash flows and results of operations.
Quench’s largest customers account for a significant percentage of Quench’s revenues, and our business would be harmed were we to lose these customers.
We estimate Quench’s twenty largest customers accounted for approximately 8% of the revenue of our Quench business during the year ended December 31, 2019. A material reduction in purchases by, or services provided to, these customers could have a significant adverse effect on the business and operating results of our Quench business. In addition, pressures by these customers that would cause us to materially reduce the price of our products could result in a reduction to our operating margins.
Certain of our water supply contracts do not contain “take-or-pay” obligations, which may adversely affect Seven Seas Water’s financial position and results of operation.
Our water supply contracts may require customers to purchase a minimum volume of water on a take-or-pay basis over the term of those contracts. Take-or-pay provisions allow us to protect against short-term demand risk by guaranteeing minimum payments from such customers regardless of their actual requirements. However, two of our ten water supply contracts do not contain such provisions, and therefore, periods of low production requirements by our customers under such contracts may adversely affect our financial position and results of operation.
Our ability to compete successfully for acquisition opportunities and otherwise implement successfully our expansion strategy depends, in part, on the availability of sufficient cash resources, including proceeds from debt and equity financings.
Our ability to compete successfully for acquisition opportunities and otherwise implement successfully our expansion strategy depends, in part, on the availability of sufficient cash resources, including proceeds from debt and equity financings. Our growth strategies include developing projects, the success of which depends on our ability to find new sites suitable for development into viable projects and developing those sites and projects. Any new project development or expansion project requires us to invest substantial capital. We finance some of our projects with borrowings, which are repaid in part from the project’s revenues, and secured by the share capital, physical assets, contracts and cash flow of that project subsidiary and by us. This type of financing is usually referred to as project financing. Commercial lending institutions sometimes refuse to provide project financing in certain less developed countries, and in these situations, we have sought and will continue to seek direct or indirect (through credit support or guarantees) project financing from a limited number of multilateral or bilateral international financial institutions or agencies. As a precondition to making such project financing available, the lending institutions may also require governmental guarantees of certain project and sovereign related risks. We may also acquire companies that benefit from these protections. There can be no assurance, however, that project financing from international financial agencies or
that governmental guarantees will be available when needed, and if they are not, we may have to abandon the project or invest more of our own funds, which may not be in line with our investment objectives and would leave fewer funds for other projects and needs. Further, while the Merger Agreement is in effect, we are restricted from disposing of certain assets, which may leave us with fewer of our own funds for such investment.
If the demand for our products and services declines when we are raising capital, we may not realize the expected benefits from our new facility or expansion project. Furthermore, our new or modified facilities may not operate at designed capacity or may cost more to operate than we expect. The inability to complete any new project development or expansion projects or to complete them on a timely basis and in turn grow our business could adversely affect our business and results of operations.
We believe that our future capital requirements will depend upon a number of factors, including cash generated from operations and the rate at which we acquire additional facilities, portfolios or businesses. We expect to fund such capital expenditures with cash from operations and proceeds from debt and equity financings. However, we may be unable to raise capital or may be unable to raise capital on terms acceptable to us, which would have a material adverse effect on our business.
Financing risk has also increased as a result of the deterioration of the global economy and the recent crisis in the financial markets and, as a result, we may forgo certain development opportunities. We believe that capitalized costs for projects under development are recoverable; however, there can be no assurance that any individual project will be completed and reach commercial operation. If these development efforts are not successful, we may abandon a project under development and write off the costs incurred in connection with such project. At the time of abandonment, we would expense all capitalized development costs incurred in connection therewith and could incur additional losses associated with any related contingent liabilities.
Our substantial indebtedness could affect our business adversely and limit our ability to plan for or respond to changes in our business, and we may be unable to generate sufficient cash flows to satisfy our liquidity needs.
Our ability to comply with the terms of the documents governing our outstanding indebtedness, to make cash payments with respect to the outstanding indebtedness or to refinance any of such obligations will depend on our future performance, which in turn, is subject to prevailing economic conditions and financial and many other factors beyond our control.
The terms of the documents governing our outstanding indebtedness contain a number of covenants that, among other things, restrict our ability to incur additional indebtedness, pay dividends, prepay subordinated debt, dispose of certain assets, make investments, enter into sale and leaseback transactions, create liens, make capital expenditures and make certain payments, investments or acquisitions and otherwise restrict corporate activities. In addition, we are required to satisfy specified financial covenants. Our ability to comply with such provisions may be affected by events beyond our control. The breach of any of these covenants could result in a default under some or all of the documents governing our outstanding indebtedness. In the event of any such default, depending on the actions taken by the lenders under our outstanding indebtedness, such lenders could elect to declare all amounts borrowed under such indebtedness, together with accrued interest, to be due and payable. Certain of our loans have cross-default provisions that may be triggered upon our default under the documents governing our other indebtedness and, in addition, a default may restrict our ability to effect intercompany transfers of funds.
As of December 31, 2019, we had approximately $316.6 million of outstanding consolidated indebtedness. Although our cash flow from operations has been sufficient to meet our debt service obligations in the past, there can be no assurance that our operating results will continue to be sufficient for us to meet our debt service obligations and financial covenants. Certain of our outstanding indebtedness is collateralized by our assets, including the share capital of certain of our subsidiaries, and certain assets of our subsidiaries. If we were unable to repay borrowings, the lenders could proceed against their collateral. If the lenders or the holders of any other secured indebtedness were to foreclose on the collateral securing our obligations to them, there could be insufficient assets required for the continued operation of our business remaining after satisfaction in full of all such indebtedness. In addition, the loan instruments governing the indebtedness of certain of our subsidiaries contain certain restrictive covenants which limit the payment of dividends and distributions and the transfer of assets to us and require such subsidiaries to satisfy specific financial covenants.
The degree to which we are leveraged could have important consequences to the holders of our shares, including:
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our ability to obtain additional financing for acquisitions, capital expenditures, working capital, payment of dividends or general corporate purposes may be impaired in the future;
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the impact of negative pledges and financial covenants on our financial profile;
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a substantial portion of our cash flow from operations may be dedicated to the payment of principal and interest on our indebtedness, thereby reducing the funds available to us for our future growth, operations and other purposes;
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most of our borrowings are and will continue to be at variable rates of interest, which exposes us to the risk of increased interest costs; and
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we may be substantially more leveraged and at higher costs than certain of our competitors, which may place us at a competitive disadvantage and make us more vulnerable to changing market conditions and regulations.
We have significant cash requirements and limited sources of liquidity.
We require cash primarily to fund:
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debt service obligations;
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acquisitions;
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construction and other project commitments;
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inventory and equipment purchases;
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refurbishment, enhancement and improvements of existing facilities;
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other capital commitments, including business development investments;
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taxes; and
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selling and marketing and other overhead costs.
Our principal sources of liquidity are:
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operating cash flows from our existing operations;
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debt and equity financing;
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dividends and other distributions from our subsidiaries;
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intercompany receivables;
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repayment of principal and interest on intercompany loans; and
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proceeds from debt financings at the subsidiary level.
While we believe that these sources will be adequate to meet our obligations for the foreseeable future, this belief is based on a number of material assumptions, including, without limitation, assumptions about our ability to access the capital or commercial lending markets, the operating and financial performance of our subsidiaries, exchange
rates, the ability of our subsidiaries to pay dividends or repay intercompany loans, and our ability to sell assets. Any number of assumptions could prove to be incorrect and therefore there can be no assurance that these sources will be available when needed or that our actual cash requirements will not be greater than expected. In addition, our cash flow may not be sufficient to repay at maturity the entire principal outstanding of indebtedness, and we may have to refinance such obligations. We have a significant principal repayment due in August 2021. While the Merger Agreement is in effect, we are restricted from disposing certain assets, which may limit our ability to generate sufficient cash flows to satisfy our debt obligations. There can be no assurance that we will be successful in obtaining such refinancing on terms acceptable to us or at all, and any of these events could have a material effect on us.
As a part of our growth strategy, we have used, and expect to continue to use, project financing, which may adversely affect our financial results.
We sometimes rely on project financing to fund the costs of our acquisitions and project development. Our subsidiaries have incurred, and in the future, may incur, project financing indebtedness to the extent permitted by existing agreements, and may continue to do so to fund ongoing operations. In addition, we may acquire companies that have significant existing project financing indebtedness. Any such newly incurred subsidiary indebtedness would be added to our current consolidated debt levels. Our project financing debt is, and would likely be structurally senior to certain of our other debt, which could also intensify the risks associated with leverage. In addition, while the Merger Agreement is in effect, we are subject to certain restrictions on our ability to incur additional debt. Separately, failure to obtain project financing could result in delay or cancellation of future transactions or projects, thus limiting our growth and future cash flows.
While the lenders to a project subsidiary under our project financings sometimes do not have direct recourse against us (other than to the extent we give any credit support), defaults thereunder can still have important consequences for us, including, without limitation:
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our failure to receive subsidiary dividends, fees, interest payments, repayment of intercompany loans and other sources of cash, as the project subsidiary will typically be prohibited from distributing cash to us during the pendency of any default;
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triggering our obligation to make payments under any financial guarantee, letter of credit or other credit support which we have provided to or on behalf of such subsidiary;
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causing us to record a loss in the event the lender forecloses on the assets;
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triggering defaults or acceleration on our outstanding debt, and, in some cases, triggering cross-default provisions;
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the loss or impairment of investor confidence;
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the acceleration of our debt and resulting impact of the accelerated debt on our consolidated financial statements;
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foreclosure on the assets that are pledged under the non-recourse loans, therefore by eliminating any and all potential future benefits derived from those assets; or
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our repayment of such project financing from other resources that do not secure that financing in an effort to avoid the adverse consequences of a default or acceleration of such project financing.
Future revenue for our long-term water supply agreements under our Seven Seas Water business is based on certain estimates and assumptions, and the actual results may differ materially from such estimated operating results.
We operate our Seven Seas Water business based on our current estimate of the revenues we will generate under our long-term water supply agreements. Many of the costs of operating our facilities are fixed or do not vary materially based on the water produced by the facility, particularly in the short term. Our estimates and assumptions regarding what the water facilities will produce, and the revenues it will generate, during a specific period may not materialize. Unanticipated events may cause unforeseeable downtime, which would cause us to be unable to deliver
water to our customers, which could have a material adverse effect on the actual results achieved by us during the periods to which these estimates relate. If revenues generated by the facility are less than estimated, our operating profit, gross margin and profits will be adversely affected.
Our emergency response services under our Seven Seas Water business expose us to additional challenges and risks.
Our Seven Seas Water business also provides emergency response services in the event of a water crisis caused by water shortages, the failure of existing water producing equipment, and hurricanes or other natural disasters, among other reasons. We build skids, mobile desalination plants and other components in advance of a need to deploy them. To address these situations, we typically install our containerized mobile desalination plants pursuant to water supply agreements with shorter terms, typically with terms of less than five years. Due to the reactive nature of this market, we cannot predict when we will deploy our equipment, if at all, the duration of the deployment or the other terms and conditions applicable to the deployment (including the prices we will be paid for the water purchased from us). Our inability to deploy our containerized mobile desalination plants and components in a timely manner could adversely affect our results of operations, financial condition and cash flows. Further, we rely on our ability to use this equipment in other situations. If our equipment is damaged or requires extensive refurbishing after decommissioning and before it can be redeployed, our return on the investment in that equipment may be adversely affected. If we fail to perform in an emergency as our customer expects, or if our customer perceives that we failed to perform, our reputation and business could be materially and adversely affected. In addition, the deployment of our equipment on a large scale in response to an emergency may divert management’s attention and resources. This could reduce our ability to pursue other opportunities, which could have an adverse effect on our business and results of operations.
The profitability of our Seven Seas Water facilities is dependent upon our ability to estimate costs accurately and acquire, construct and operate plants within budget.
The cost estimates we prepare in connection with the acquisition, construction and operation of our plants are subject to inherent uncertainties. Any acquisition, construction and operating costs for our plants that significantly exceed our initial estimates could adversely affect our results of operations, financial condition and cash flows. Any delay in the construction of the plant may result in additional costs, and future operational costs could be affected by a variety of factors, including lower than anticipated production efficiencies and hydrological conditions at the plant site that differ materially from those we expected.
We must satisfy each customer’s specifications under our contracts, which may require additional processing steps or additional capital expenditures in order to meet such specifications. The terms of our water supply contracts typically require us to supply water for a specified price per unit during the term of the contract, subject to certain annual inflation adjustments, and to assume the risk that the costs associated with producing this water may be greater than anticipated. Because we base our contracted price of water in part on our estimation of future construction and operating costs, the profitability of our plants is dependent on our ability to estimate these costs accurately and remain within budget during the construction and operation of the facilities. In addition, most of our customers are required to supply the electricity we need to operate our desalination plants either for free or at contracted prices under their contracts with us. We will incur additional operating cost if we are required to bear the risks of fluctuations in electricity costs in the future, which may adversely and materially affect our results of operations and cash flows.
The cost of equipment, materials and services to build a plant may increase significantly after we submit our bid for, or begin construction of, a plant, which could cause the gross profit and net return on investment for the plant to be less than we anticipated. The profit margins we initially expect to generate from a plant could be further reduced if future operating costs for that plant exceed our estimates of such costs.
Failure to comply with laws, regulations and policies, including the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption legislation, could result in fines, criminal penalties and an adverse effect on our business.
We are subject to regulation under a wide variety of U.S. federal and state and non-U.S. laws, regulations and policies, including laws related to anti-corruption, export and import compliance, anti-trust and money laundering, due to our global operations. The U.S. Foreign Corrupt Practices Act, or the FCPA, the U.K. Bribery Act of 2010 and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials or other persons for the purpose of obtaining or retaining business. There has been an increase in anti-bribery law enforcement activity in recent years, with more frequent and aggressive investigations and
enforcement proceedings by both the Department of Justice, or DOJ, and the SEC, increased enforcement activity by non-U.S. regulators, and increases in criminal and civil proceedings brought against companies and individuals. Our policies mandate compliance with these anti-bribery laws. We operate in many parts of the world that are recognized as having governmental and commercial corruption and in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. We cannot assure you that our internal control policies and procedures will always protect us from improper conduct of our employees or business partners. If we believe or have reason to believe that our employees or agents have or may have violated applicable laws, including anti-corruption laws, we may be required to investigate or have outside counsel investigate the relevant facts and circumstances, which can be expensive and require significant time and attention from senior management. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties, and curtailment of operations in certain jurisdictions, and might adversely affect our business, results of operations or financial condition. In addition, actual or alleged violations could damage our reputation and ability to do business.
Fluctuations in interest rates may adversely impact our business, financial condition and results of operations.
We are exposed to fluctuations in interest rates. As of December 31, 2019, approximately 63% of our outstanding debt was exposed to interest rate fluctuations. We have not entered into arrangements or contracts with third parties that constitute an interest rate hedge. The portion of our debt that bears interest at a fixed rate will vary from time to time. If interest rates significantly deviate from historical ranges, or if volatility or distribution of these changes deviates from historical norms, we may experience significant losses or defaults. As a result, fluctuating interest rates may negatively impact our financial results and cash flows.
Our inability to negotiate pricing terms in U.S. dollars may adversely impact our Seven Seas Water desalination business, financial condition and results of operations.
Most of our Seven Seas Water bulk water revenue is generated and most of our operations are conducted in developing countries. Currently, customer payment obligations under substantially all of our water supply contracts are denominated in the U.S. dollar. If the U.S. dollar weakens against other foreign currencies, some of our component suppliers may increase the price they charge for their components in order to maintain an equivalent profit margin. In addition, there is no assurance that we will be able to negotiate U.S. dollar denominated pricing terms in the renewal of existing contracts or new contracts in the future. In certain situations, we are exposed to foreign exchange risk to the extent we have payment obligations in a local currency relating to labor, construction, consumable or materials costs or, of our procurement orders that are denominated in a currency other than U.S. dollars. We have not entered into any arrangements or contracts with third parties to hedge against foreign exchange risk. If any of these local currencies change in value relative to the U.S. dollar, our cost in U.S. dollars would change accordingly, which could adversely affect our results of operations.
Our business and ability to enforce our rights under agreements relating to our Seven Seas Water business may be adversely affected by changes in the law or regulatory regimes in the jurisdictions in which we operate.
Changes in laws governing capital controls, the liquidity of bank accounts or the repatriation of capital, repayment of intercompany loans and dividends could prevent or inhibit our receipt of cash from our foreign subsidiaries, resulting in longer payment cycles or impairment of our collection of accounts receivable. Although we may have legal recourse to enforce our rights under agreements to which we are a party and recover damages for breaches of those agreements, such legal proceedings are costly and may not be successful or resolved in a timely manner, and such resolution may not be enforced. Areas in which we may be affected include:
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forced renegotiation or modification of concessions, purchase agreements, land lease agreements and supply agreements;
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termination of permits or concessions and compensation upon any such termination; and
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threatened withdrawal of countries from international arbitration conventions.
Any of these factors may cause our costs to build, own, operate or maintain our desalination plants to increase, may delay the commissioning of such plants, and may delay the time when we receive revenue and cash flows from such plants.
Operational and execution risks may adversely impact the financial results of our Quench business.
Our operating results are reliant on the continued operation of our filtered water systems as well as our delivery fleet. Inherent in our operations are risks that require oversight and control, such as risks related to mechanical or electrical failure, fire, explosion, leaks, chemical use, and vehicle, lift or forklift accidents. We have established policies, procedures and safety protocols requiring ongoing training, oversight and control in an effort to address these risks. However, significant operating failures on our customers’ premises or vehicle accidents could result in personal injury or loss of life, loss of distribution capabilities, and/or damage at the site of the filtered water system, thereby adversely impacting our business, reputation and financial results. These factors could subject us to lost sales, litigation contingencies and reputational risk.
Our multi-year contracts under our business may limit our ability to quickly and effectively react to general economic changes.
The conditions under which we initially enter into a contract may change over time. These changes may vary in nature or foreseeability and may result in adverse economic consequences. These consequences may be exacerbated by the multi-year terms of our contracts, which may hinder our ability to react rapidly and appropriately to changes. For example, we may not be free to adapt our pricing in line with changes in cost or demand. We also are not typically able to suddenly or unilaterally terminate a contract we believe is unprofitable or change its terms. The inability to react to changes, or terminate or change unprofitable contracts could materially affect our business.
Changes in demand for our Quench products and services may affect operating results.
We believe that the growth of the U.S. and Canadian water cooler markets is due, in part, to consumer preferences for healthy products and consumer taste preferences for treated water over tap water and other beverages. Growth is also affected by the demand from our customers, whose tastes and preferences may be affected by energy efficiency standards and environmental concerns, as well as the form, features and aesthetics of our equipment, among other factors. To the extent such preferences change, demand for our products will be affected, which may materially adversely affect us.
In our Quench business, we face the risk that our customers may fail to properly maintain, use and safeguard our equipment, which may negatively affect us as the providers of the systems.
It is generally our responsibility to service our Quench filtered water systems throughout the duration of the contract, and our customers are generally required to maintain insurance covering loss, damage or injury caused by our equipment. However, we are not able to monitor our customers’ use or maintenance of their filtered water systems or their compliance with our contracts or usage instructions. A customer’s failure to properly use, maintain or safeguard the filtered water system or the customer’s non-compliance with insurance requirements may reflect poorly on us as the provider of the filtered water system and, as a result, damage our reputation. In addition, our Quench filtered water systems must be connected to a potable water source in order to be effective. A customer’s failure or inability to connect our filter water system to a potable water source may reflect poorly on us as the provider of the filtered water system and, as a result, damage our reputation or cause the customer to terminate its relationship with us.
Many of our Seven Seas Water facilities are located on properties owned by others. If our landlords restrict our access to those properties or damage our facilities or equipment, our ability to develop, operate, maintain and remove our equipment would be adversely affected.
Most of our Seven Seas Water facilities are located on property owned by others, some of whom are our customers. Our rights to locate our facilities and equipment on, and to access, those properties are governed by contracts with the applicable landlords. We need access to those properties to develop, operate and maintain our facilities and equipment and, in certain cases, to remove our equipment at the end of a contract term. In certain situations, personnel having access to those properties need security and other clearances. If the landlord restricts our ability to access our facilities, our ability to develop, operate, maintain and remove our equipment, our business would be adversely affected. We cannot guarantee that we will not encounter labor disputes (strikes, walkouts, blocking access to sites, or the destruction of property in extreme cases), including those relating to our landlord’s employees, that could interrupt our operations over a significant period of time. In addition, our personnel, facilities and equipment located on those
properties may be harmed by other activities or events occurring on those properties, including being subject to personal injury or death, or damage. Any such restrictions or occurrences could adversely affect our business, reputation, results of operations and financial condition.
We rely on information technology and network infrastructure in areas of our operations, and a disruption relating to such technology or infrastructure could harm our business.
Seven Seas Water relies on our information technology and network infrastructure for both operations in our headquarters as well as our facilities, where our information technology and network infrastructure are critical for monitoring plant availability and efficiency. If our information technology or network infrastructure were to fail, such failure could lead to an inability to monitor our plant activities, and therefore could lead to noncompliance with health, safety and environmental requirements as well as increased costs and potential losses. Any increase in costs or losses could have an adverse effect on our financial condition and results of operations. In addition, the operation of our facilities relies on internet-based control systems. Interruption in internet service could limit or eliminate our ability to continue our plant operations, which would have a negative effect on our revenues.
Quench relies on our information technology and network infrastructure for field service, customer service, billing, equipment service, inventory control, fixed asset management, financial reporting, accounting, accounts payable, payroll, lead generation, call center operations, sales analysis, vehicle tracking and profitability reporting. Our systems are designed to enable us to track the locations of our installed POU units and ensure customer compliance with payment obligations in connection with such POU units. Any failure or disruption relating to this technology or infrastructure could seriously harm our operations and/or reduce profitability. In addition, we are in the midst of upgrading and enhancing our capabilities, including the replacement of our primary information technology systems. A failure to successfully implement such changes could adversely impact our business and may result in an inability to remain competitive with respect to our service offerings, pricing and collections.
Failure to maintain the security of our information and technology networks, including information relating to our service providers, customers and employees, could adversely affect us.
We are dependent on information technology networks and systems, including the internet, to process, transmit and store electronic information and, in the normal course of our business, we collect and retain certain information pertaining to our service providers, customers and employees, including credit card information for certain of our customers. In addition, the operation of our facilities relies on internet-based control systems. If security breaches in connection with the delivery of our solutions allow unauthorized third parties to access any of this data or obtain control of our customers’ systems or the systems controlling our plant operations, our reputation, business, results of operations and financial condition could be harmed.
The legal, regulatory and contractual environment surrounding information security, privacy and credit card fraud is constantly evolving and companies that collect and retain such information are under increasing attack by cyber-criminals around the world. A significant actual or potential theft, ransom, loss, fraudulent use or misuse of service provider, customer, employee or other personally identifiable data, whether by third parties or as a result of employee malfeasance or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy and security policies with respect to such data could result in loss of confidential information, damage to our reputation, early termination of our service provider contracts, significant costs, fines, litigation, regulatory investigations or actions and other liabilities or actions against us. Moreover, to the extent that any such exposure leads to credit card fraud or identity theft, we may experience a general decline in existing or prospective customer confidence in our business, which may lead to an increase in attrition rates or may make it more difficult to attract new customers. Such an event could additionally result in adverse publicity and therefore adversely affect the market’s perception of the security and reliability of our services. Security breaches of, or sustained attacks against, this infrastructure could create system disruptions and shutdowns that could result in disruptions to our operations. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures. We cannot be certain that advances in cyber-attack capabilities or other developments will not compromise or breach the technology protecting the networks that support our platform and solutions. If any one of these risks materializes our business, financial condition, results of operations and cash flows could be materially and adversely affected.
We have not experienced, but may in the future experience, service disruptions, outages and other performance problems with our information technology due to a variety of factors, including infrastructure changes, malicious actors, human or software errors or capacity constraints. In some instances, we or our third-party service providers may not be able to identify the cause or causes of these performance problems within an acceptable period of time. Although we have recovery plans, any incident affecting our information infrastructure that may be caused by fire, flood, severe storm, earthquake or other natural disasters, cyber-attacks, terrorist or other attacks, and other similar events beyond our control could negatively affect our business, results of operations, cash flows or financial condition.
We may experience difficulty obtaining materials or components for our Quench products.
Our Quench business utilizes third parties both inside and outside the United States to manufacture our equipment and relies upon these manufacturers to produce and deliver quality equipment on a timely basis and at an acceptable cost. Disruptions to the business, financial stability or operations, including due to strikes, labor disputes, political or governmental issues, pandemics, or other disruptions to the workforce, of these manufacturers, or to their ability to produce the equipment we require in accordance with our and our customers’ requirements could significantly affect our ability to fulfill customer demand on a timely basis which could cause reputational harm, and materially adversely affect our revenues and results of operations. For example, in December 2019, a strain of coronavirus reported to have surfaced in Wuhan, China has slowed international commerce. While at this point, the extent to which the coronavirus may impact our business supply chains or results is uncertain, it may result in delays in receiving key raw materials for our products or decreased demand for our products, which may negatively impact our business results of operations, cash flows or financial condition.
Our holding company structure effectively subordinates our parent company to the rights of the creditors of certain of our subsidiaries.
A majority of our assets are held by our subsidiaries. As a result, our rights and the rights of our creditors to participate in the distribution of assets of any subsidiary upon such subsidiary’s liquidation or reorganization will be subject to the prior claims of such subsidiary’s creditors, except to the extent that we are reorganized as a creditor of such subsidiary, in which case our claims would still be subject to the claims of any secured creditor of such subsidiary and of any holder of indebtedness of such subsidiary senior to that held by us. As of December 31, 2019, our subsidiaries had approximately $167.0 million of indebtedness (net of discounts and excluding intercompany indebtedness) outstanding, of which AquaVenture Holdings Limited, the ultimate parent company, is jointly and severally liable for $148.9 million (net of discounts).
Since operations are conducted through our subsidiaries, our cash flow and ability to service debt is dependent upon the earnings of our subsidiaries and distributions to us. Our subsidiaries are separate and distinct legal entities, and in some cases, have no obligation, contingent or otherwise, to pay amounts due pursuant to indebtedness of other subsidiaries or us or to make any funds available therefor. In addition, the payment of dividends and the making of loan advances to us by our subsidiaries are contingent upon the earnings of those subsidiaries and are subject to various business considerations and, for certain subsidiaries, restrictive loan covenants contained in the instruments governing the indebtedness of such subsidiaries, including covenants which restrict in certain circumstances the payment of dividends and distributions and the transfer of assets to us.
Seven Seas Water may invest in projects with third-party investors that could result in conflicts.
We may from time to time invest in projects with third-party investors who may possess certain shareholder rights. Actions by an investor could subject our assets to additional risk as a result of any of the following circumstances:
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the investors might have economic or business interests or goals that are inconsistent with our, or the project-level entity’s, interests or goals; or
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the investor may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives.
Although we generally seek to maintain sufficient control of any investment to permit our objectives to be achieved, we might not be able to take action with respect to certain matters without the approval of the investors or
lenders. We may experience strained relations with certain of our investors, resulting in liquidity constraints due to our third-party investors’ failure to fund their respective capital commitments.
Our ability to grow our business could be materially adversely affected if we are unable to raise capital on favorable terms.
From time to time, we rely on access to capital markets as a source of liquidity for capital requirements not satisfied by operating cash flows. Our ability to arrange for financing on either a recourse or non-recourse basis and the costs of such capital are dependent on numerous factors, some of which are beyond our control, including:
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general economic and capital market conditions;
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the availability of bank credit or access to institutional credit markets;
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access to bilateral or multilateral funding sources;
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investor confidence;
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our financial condition, performance and prospects in general and/or that of any subsidiary requiring the financing as well as companies in our industry or similar financial circumstances; and
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changes in tax and securities laws which are conducive to raising capital.
Should future access to capital not be available to us, it may become necessary for us to sell assets or we may decide not to build new plants, expand or improve existing facilities or pursue acquisitions, any of which would affect our future growth, results of operations and financial condition.
An impairment in the carrying value of long-lived assets, contract costs, goodwill or intangible assets would negatively impact our consolidated results of operations and net worth.
Long-lived assets are initially recorded at cost and are amortized or depreciated over their useful lives. Contract costs consist of contract acquisition costs, deferred lease costs and contract fulfillment costs which are all recorded within other assets in the consolidated balance sheets. Contract costs are generally amortized on a straight-line basis over the remaining contract period or lease term.
Long-lived assets and contract costs are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recognition and measurement of a potential impairment is performed on assets grouped with other assets and liabilities at the lowest level where identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of long-lived assets are measured by a comparison of the carrying amount of an asset or asset group to future undiscounted cash flows expected to be generated by the asset or asset group. Recoverability of contract costs classified as deferred contract costs are measured by a comparison of the carrying amount of an asset or asset group to undiscounted future cash flows expected to be generated through the performance of the remaining services under the contract. If the carrying amount of an asset or asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. There are inherent uncertainties related to these factors and management’s judgment in applying these factors. These events or changes in circumstances and the related analyses could result in additional long-lived asset impairment charges in the future. Impairment charges could substantially affect our financial results in the periods of such charges.
We have significant goodwill and intangible assets that are susceptible to valuation adjustments as a result of events or changes in circumstances. As of December 31, 2019, intangible assets, net and goodwill were $186.4 million and $198.9 million, respectively. We assess the potential impairment of goodwill and indefinite lived intangible assets on an annual basis, as well as when interim events or changes in circumstances indicate that the carrying value may not be recoverable. Events or changes in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include disruptions to our business, failure to realize the economic benefit from
acquisitions of other companies and intangible assets, slower industry growth rates and declines in operating results and market capitalization. Determining whether an impairment exists, along with the amount of the potential impairment, involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment. Future events, new information or changes in circumstances may alter management’s valuation of an intangible asset. The timing and amount of impairment charges recorded in our consolidated statements of operations and comprehensive income and write-downs recorded in our consolidated balance sheets could vary if management’s conclusions change.
We did not record any goodwill impairment during 2019, 2018 and 2017 for any of our reporting units.
We may not be able to adapt to changes in technology and government regulation fast enough to remain competitive.
The water purification industry is highly technical and thus impacted by changing technology, competitively imposed process standards and regulatory requirements, each of which influences the demand for our products and services. Advances in technology and changes in legislative, regulatory or industrial requirements may render certain of our purification products and processes obsolete or increase our compliance costs. Our inability to adapt to these changes could affect our ability to compete, which could impact our future growth and materially affect our business.
Changes in tax law, determinations by tax authorities and/or changes in our effective tax rates may adversely affect our business and financial results.
Under current law, we expect to be treated as a non-U.S. corporation for U.S. federal income tax purposes. However, uncertainties in the relative valuation between our U.S. business and our non-U.S. business at the time of our corporate reorganization could adversely affect our status as a non-U.S. corporation for U.S. federal income tax purposes under Section 7874 of the Internal Revenue Code of 1986, as amended, and could adversely affect our effective tax rate. In addition, changes to Section 7874 or the Treasury Regulations promulgated thereunder, other changes in law, or new interpretations of the meaning or scope of these rules, could adversely affect our status as a non-U.S. corporation for U.S. federal income tax purposes and adversely affect our effective tax rate. Some of the Section 7874 regulations are complex, and as such their application to any particular set of facts is uncertain. While we believe we will be treated as a non-U.S. corporation for U.S. federal income tax purposes, such belief is based on, among other things, facts that may change or be unclear, valuations which are inherently subjective and judgments that may prove to be incorrect. If such belief is incorrect, there could be a material adverse impact on our expected tax position and effective tax rate.
Our Quench business operates in the United States, Canada and South Korea. Our Seven Seas Water customer revenue is generated both inside and outside of the United States in areas such as the Caribbean and South America. In light of the global nature of our business and the fact that we are subject to tax at the federal, state and local levels in the United States and in other countries and jurisdictions, a number of factors may increase our future effective tax rates, including:
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our decision to distribute U.S. or non-U.S. earnings to the parent company;
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the jurisdictions in which profits are determined to be earned and taxed;
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sustainability of historical income tax rates in the jurisdictions in which we conduct business;
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the resolution of issues arising from tax audits with various tax authorities;
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our ability (or inability) to use net operating loss carry-forwards to offset future taxable income and any adjustments to the amount of the net operating loss carry-forwards we can utilize;
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changes in tax laws, including legislative changes, some of which could include fundamental tax reform, that impact favorable tax treatment and/or the deductibility of certain expenses from taxable income; and
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changes in the valuation of our deferred tax assets and liabilities, and changes in deferred tax valuation allowances.
Any significant increase in our future effective tax rates could reduce net income for future periods.
We could be adversely impacted by environmental, health and safety legislation, regulation and permits and climate change matters.
We are subject to numerous international, national, state and local environmental, health and safety laws and regulations, as well as the requirements of the independent government agencies and development banks that provide financing for many of our projects, which require us to incur significant ongoing costs and capital expenditures and may expose us to substantial liabilities. Such laws and regulations govern, among other things: emissions to air; discharges to water; the generation, handling, storage, transportation, treatment and disposal of waste materials; and the cleanup of contaminated properties. Currently, we believe we are in compliance with these laws and regulations, but there is no assurance that we will not be adversely impacted by any such liabilities, costs or claims in the future, either under present laws and regulations or those that may be adopted or imposed in the future. If we are found not to be in compliance, we may be subject to lawsuits asserting claims or fees, fines, or penalties, which could adversely affect our business.
We must obtain, maintain and/or renew a number of permits that impose strict conditions, requirements and obligations, including those relating to various environmental, health and safety matters, in connection with our current and future operations and development of our facilities. The permitting rules and their interpretations are complex, and the level of environmental protection needed to obtain required permits has tended to become more stringent over time. In many cases, the public (including environmental interest groups) is entitled to comment upon and submit objections to permit applications and related environmental analysis, attend public hearings regarding whether such permits should be issued and otherwise participate in the permitting process, including challenging the issuance of permits, validity of environmental analyses and determinations and the manner in which permitted activities are conducted. Permits required for our operations and for the development of our facilities may not be issued, maintained or renewed in a timely fashion or at all, may be issued or renewed upon conditions that restrict our ability to operate or develop our facilities economically or may be subsequently revoked. Any failure to obtain, maintain or renew our permits, as well as other permitting delays and permitting conditions or requirements that are more stringent than we anticipate, could have a material adverse effect on our business, results of operations and financial condition.
Foreign, federal, state and local regulatory and legislative bodies have proposed various legislative and regulatory measures relating to climate change, regulating greenhouse gas emissions and energy policies. If these laws, regulations and requirements become more stringent in the future, we may experience increased liabilities, compliance costs and capital expenditures or difficulty in our ability to comply with applicable requirements or obtain financing for our projects.
We are subject to litigation and reputational risk as a result of the nature of our business, which may have a material adverse effect on our business.
From time to time, we are involved in lawsuits that arise from our business. Litigation may, for example, relate to product liability claims, personal injury, property damage, vehicle accidents, regulatory issues, contract disputes or employment matters. The occurrence of any of these matters could also create possible damage to our reputation. The defense and ultimate outcome of lawsuits against us may result in higher operating expenses. Higher operating expenses or reputational damage could have a material adverse effect on our business, including to our liquidity, results of operations and financial condition.
We will incur significant costs as a result of operating as a public company and in connection with the Merger Agreement, and our management will devote substantial time to new compliance initiatives. We may fail to comply with the rules that apply to public companies, including Section 404 of the Sarbanes-Oxley Act of 2002, which could result in sanctions or other penalties that would harm our business.
As a public company, and particularly in connection with the Merger Agreement and after we cease to be an “emerging growth company,” we will incur significant legal, accounting and other expenses as a public company, including costs resulting from public company reporting obligations under the Securities Exchange Act of 1934, or the Exchange Act, and regulations regarding corporate governance requirements relating to director independence, distributing annual and interim reports, shareholder meetings, approvals and voting, soliciting proxies, conflicts of interest and a code of conduct. The listing requirements of the New York Stock Exchange, or the NYSE, have imposed various requirements on public companies, including establishment and maintenance of effective disclosure and
financial controls and corporate governance practices. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations cause us to incur significant legal and financial compliance costs and make some activities more time-consuming and costly. These reporting requirements, rules and regulations, coupled with the increase in potential litigation exposure associated with being a public company, could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or board committees or to serve as executive officers, or to obtain certain types of insurance, including directors’ and officers’ insurance, on acceptable terms.
The Sarbanes Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually and the effectiveness of our disclosure controls and procedures quarterly. In particular, Section 404 of the Sarbanes Oxley Act, or Section 404, requires management to report on, and our independent registered public accounting firm potentially to attest to, the effectiveness of our internal control over financial reporting. As an emerging growth company, we expect to avail ourselves of the exemption from the requirement that our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting under Section 404. However, we may no longer avail ourselves of this exemption when we cease to be an emerging growth company. When our independent registered public accounting firm is required to undertake an assessment of our internal control over financial reporting, the cost of our compliance with Section 404 will correspondingly increase. Our compliance with applicable provisions of Section 404 will require that we incur substantial accounting expense and expend significant management time on compliance related issues as we implement additional corporate governance practices and comply with reporting requirements. Moreover, if we are not able to comply with the requirements of Section 404 applicable to us in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources.
We have adopted certain new accounting pronouncements that will result in changes to our previously reported results and forecasts and the patterns of our revenues, gross profit, net loss and other key metrics, including non-GAAP measures.
In May 2014, the FASB issued authoritative guidance regarding revenue from contracts with customers that specifies that revenue should be recognized when promised goods or services are transferred to customers in an amount that reflects the consideration which the company expects to be entitled in exchange for those goods or services. This guidance is effective for annual reporting periods beginning on or after December 15, 2017 and interim periods within those annual periods and will require enhanced disclosures. In addition, the FASB issued authoritative guidance in March 2017 related to the determination of the customer in a service concession arrangement, which is effective for annual reporting periods beginning on or after December 15, 2017 and interim periods within those annual periods. We adopted the guidance regarding both revenue from contracts with customers and the determination of the customer in a service concession contract (together referred to as “Adopted Revenue Guidance”) on a full retrospective basis on January 1, 2018 applying the guidance to all contracts that were not completed as of January 1, 2016.
While the Adopted Revenue Guidance will have no impact on the amount of cash generated under our contracts, we concluded that the timing and amount of revenue recognized under our contracts that are accounted for as service concession arrangements, including current contracts and those entered into in the future, will be different from the way we have recognized revenue through the year ended December 31, 2017. Under the Adopted Revenue Guidance, we are required to recognize revenue based on the completion of the identifiable performance obligations of the contract, including the construction of infrastructure for the customer and providing operating and maintenance services (“O&M”) on the infrastructure constructed for the customer, and the timing in which control is transferred to the customer for each of the performance obligations. This timing of revenue recognition, among other less material changes to the accounting for our contracts with customers, will have an effect on revenues, gross profit, net loss and other key metrics, including non-GAAP measures, for both current and potential future contracts entered into with customers. The Adopted Revenue Guidance will result in differences in our previously reported amount of revenues, gross profit, net loss and other key metrics, including non-GAAP measures. See Note 2-“Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further discussion.
In addition, during February 2016 the FASB issued authoritative guidance regarding leases that requires lessees to recognize a lease liability and right-of-use asset for operating leases, with the exception of short-term leases. In addition, lessor accounting was modified to align, where necessary, with lessee accounting modifications and the authoritative guidance regarding revenue from contracts with customers. This guidance is effective for annual reporting periods beginning on or after December 15, 2018, including interim periods within those annual periods, and early adoption is permitted. The Company adopted this guidance on a modified retrospective basis on January 1, 2019 with the cumulative effect of transition as of the effective date of adoption. The Company has elected the package of practical expedients provided for within the authoritative guidance which exempts the Company from having to reassess: (i) whether expired or existing contracts contain leases, (ii) the lease classification for expired or existing leases, and (iii) initial direct costs for existing leases. In addition, the Company has elected the practical expedient that permits lessors to not separate non-lease components from the associated lease components if certain conditions are met. Lastly, the Company has utilized the short-term exemption for lessees and establish an accounting policy to not recognize a right-of-use asset or lease liability for any lease with a term of less than 12 months. The Company did not elect to utilize any of the other practical expedients. For lessor accounting, as a result of electing the practical expedients, there were no material impacts to the accounting for operating leases or sales-type leases that existed prior to the adoption date. For lessee accounting, the Company recognized a lease liability and right-of-use asset for operating leases with a term of more than 12 months. The adoption of the lease guidance for lessor accounting could result in a change in the accounting for leases amended or new leases entered into after January 1, 2019 from how we have historically accounted for leases. This change in accounting could result in changes to revenues, gross profit, net loss and other key metrics, including non-GAAP measures and could impact the relative attractiveness of certain transactions from an accounting perspective and potentially limit our investment opportunities.
As a result, our future reported financial results will change from those previously reported, making comparisons based on previously reported financial statements difficult. While we expect to endeavor to educate the investment community regarding the impacts of adopting these new accounting pronouncements, there can be no assurance that their adoption will not cause confusion in the marketplace, which may adversely impact the trading price for our shares.
U.S. holders of our ordinary shares may suffer adverse tax consequences if we are characterized as a passive foreign investment company.
Based on the current and anticipated value of our assets and the composition of our income, assets and operations, we do not expect to be a “passive foreign investment company,” or PFIC, for the current taxable year or in the foreseeable future. However, the application of the PFIC rules is subject to uncertainty in several respects, and we cannot assure you that the U.S. Internal Revenue Service, or the IRS, will not take a contrary position. Furthermore, a separate determination must be made after the close of each taxable year as to whether we are a PFIC for that year. Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year or any future taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if (i) at least 75% of its gross income is passive income, or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. The value of our assets generally will be determined by reference to the market price of our Shares, which may fluctuate considerably. If we were to be treated as a PFIC for any taxable year during which a U.S. Holder holds a share, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder.
You may be subject to adverse U.S. federal income tax consequences if we are classified as a Controlled Foreign Corporation.
Each “Ten Percent Shareholder” (as defined below) in a non-U.S. corporation that is classified as a “controlled foreign corporation,” or a CFC, for U.S. federal income tax purposes generally is required to include in income for U.S. federal tax purposes such Ten Percent Shareholder’s pro rata share of the CFC’s “Subpart F income” and investment of earnings in U.S. property, even if the CFC has made no distributions to its shareholders. Each Ten Percent Shareholder is also required to include in gross income its “global intangible low-taxed income” (within the meaning of Code Section 951A), which is determined by reference to the income of CFCs of which such Ten Percent Shareholder is a Ten Percent Shareholder. Ten Percent Shareholders that are corporations may be entitled to a deduction equal to the foreign portion of any dividend when a dividend is paid. A non-U.S. corporation generally will be classified as a CFC for U.S. federal income tax purposes if Ten Percent Shareholders own in the aggregate, directly or indirectly (including pursuant to attribution rules), more than 50% of either the total combined voting power of all classes of stock of such corporation
entitled to vote or of the total value of the stock of such corporation. A “Ten Percent Shareholder” is a U.S. person (as defined by the Code), who owns or is considered to own 10% or more of the total combined voting power of all classes of stock entitled to vote of such corporation or 10% or more of the value of all classes of stock of such corporation. The determination of CFC status is complex and includes attribution rules, the application of which is not entirely certain. We believe certain of our non-US subsidiaries are CFCs, and will continue to be CFCs. In addition, even if we or certain of our non-US subsidiaries are not currently CFCs, it is possible that one or more shareholders treated as U.S. persons for U.S. federal income tax purposes will acquire, directly or indirectly (including pursuant to attribution rules), enough shares to be treated as a Ten Percent Shareholder after application of the constructive ownership rules and, together with any other Ten Percent Shareholders of the company, cause us or certain of our non-US subsidiaries to be treated as CFCs for U.S. federal income tax purposes in the future. Holders are urged to consult their own tax advisors with respect to the potential adverse U.S. tax consequences of becoming a Ten Percent Shareholder in a CFC.
Comprehensive tax reform legislation could adversely affect our business and financial condition.
The U.S. government has recently enacted comprehensive tax legislation that includes significant changes to the taxation of business entities, commonly referred to as the “Tax Cuts and Jobs Act” (“TCJ Act”). These changes include, among others, a permanent reduction to the corporate income tax rate, limiting interest deductions, the elimination or modification of certain previously allowed deductions (including substantially limiting interest deductibility), allowing for the expensing of capital expenditures, and putting into effect the migration from a “worldwide” system of taxation to a territorial system. The overall impact of this tax reform is uncertain, and it is possible that our business and financial condition could be adversely affected. We continue to examine the impact this tax reform legislation may have on our business. We urge our shareholders to consult with their legal and tax advisors with respect to any such legislation and the potential tax consequences of investing in our ordinary shares.
Significant developments from the recent and potential changes in U.S. trade policies could have a material adverse effect on us.
The U.S. government has announced and, in some cases, implemented a new approach to trade policy, including renegotiating, or potentially terminating, certain existing bilateral or multi-lateral trade agreements, as well as imposing additional tariffs on certain foreign goods, including finished products and raw materials such as steel and aluminum. These tariffs and potential tariffs have resulted or may result in increased prices for certain imported goods and materials and, in some cases may result or have resulted in price increases for domestically sourced goods and materials. Various countries and regions, including, without limitation, China, Mexico, Canada and Europe, have announced plans or intentions to impose or have imposed tariffs on a wide range of U.S. products in retaliation for new U.S. tariffs. Discussions and negotiations around such trade and tariffs are still ongoing and, in January 2020, the U.S. government entered an agreement between the U.S. and China on trade matters pursuant to which certain tariffs are expected to be reduced. At this time, it remains unclear what additional actions, if any, will be taken by the U.S. or other governments with respect to international trade agreements, the imposition of tariffs on goods imported into the U.S., tax policy related to international commerce or other trade matters. These conditions and future actions could have a significant adverse effect on world trade and the world economy.
Our Quench business generates revenue from the rental and sale of filtered water coolers and other products that use filtered water as an input, such as ice machines, sparkling water dispensers and coffee brewers, to customers across the United States and Canada. We purchase our systems and related parts and filters from a variety of manufacturers, both in the United States and overseas. As a result of the changes in world trade described above, we have experienced, and may experience further, increased costs for goods imported into the U.S. or make adjustments to our supply chain. Either of these could require us to increase prices to our customers, which may reduce demand, or, if we are unable to increase prices, result in lowering our margin on products sold. We continue to evaluate the impact of these trade policies and actions on our supply chain and to consider appropriate responses in our sourcing of products. For certain products, we have shifted purchases to vendors whose products are not subject to the new tariffs. We cannot predict future trade policy or the terms of any renegotiated trade agreements and their impacts on our business. The adoption or expansion of trade restrictions, the occurrence of a trade war, or other governmental action related to tariffs or trade agreements or policies has the potential to adversely impact demand for our products, our costs, our customers, our suppliers, and the U.S. economy, which in turn could adversely impact our business, financial condition and results of operations.
Reforms to and uncertainty regarding the London InterBank Offered Rate (“LIBOR”) may adversely affect our business, financial condition, ability to refinance loans and results of operations.
The United Kingdom Financial Conduct Authority announced in July 2017 that it will no longer persuade or require banks to submit rates for LIBOR after 2021. This announcement, in conjunction with financial benchmark reforms more generally and changes in the interbank lending markets, have resulted in uncertainty about the future of LIBOR and certain other rates or indices which have historically been used as interest rate “benchmarks” in financial contracts, including, but not limited to, credit facilities, interest rate swap agreements and interest rate cap agreements. Also, certain of the water supply agreements of our Seven Seas Water desalination business include adjustments based on LIBOR and other benchmarks. These actions and uncertainties may have the effect of triggering future changes in the rules or methodologies used to calculate benchmarks or lead to the discontinuation or unavailability of benchmarks. In addition, there can be no assurance that we and other market participants will be adequately prepared for an actual discontinuation of benchmarks, including LIBOR, that existing payment obligations, assets and liabilities based on or linked to benchmarks will transition successfully to alternative reference rates or benchmarks or of the timing of adoption and degree of integration of such alternative reference rates or benchmarks in the markets. The discontinuation of benchmarks, including LIBOR, may have an unpredictable impact on the contractual mechanics of financial contracts (including, but not limited to, interest rates to be paid to or by us) and certain of our water supply agreements, require renegotiation of outstanding water supply agreements, financial assets and liabilities, cause significant disruption to financial markets that are relevant to our business, increase the risk of litigation, yield increased expenses related to the transition to alternative reference rates or benchmarks, and/or interfere with our ability to refinance loans, among other adverse consequences. In addition, any transition from current benchmarks may alter the Company’s risk profiles and models, valuation tools, cost of financing and effectiveness of hedging strategies. Reforms to and uncertainty regarding transitions from current benchmarks may adversely affect our business, financial condition or results of operations.
Risks Related to Our Ordinary Shares
Insiders have substantial control over us, which could limit your ability to influence the outcome of key transactions, including a change of control.
Our directors, executive officers and each of our shareholders who own greater than 5% of our outstanding ordinary shares and their affiliates, in the aggregate, currently own more than 50% of our outstanding ordinary shares. As a result, these shareholders, if acting together, would be able to influence or control matters requiring approval by our shareholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may have interests that differ from yours and may vote in a way with which you disagree and that may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our other shareholders of an opportunity to receive a premium for their ordinary shares as part of a sale of our company and might affect the market price of our ordinary shares.
Anti-takeover provisions in our memorandum and articles of association could make an acquisition of us, which may be beneficial to our shareholders, including the Merger Agreement, more difficult and may prevent attempts by our shareholders to replace or remove our current management and limit the market price of our ordinary shares.
Provisions in our memorandum and articles of association may have the effect of delaying or preventing a change of control or changes in our management. Our memorandum and articles of association include provisions that:
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Authorize our board of directors to issue, without further action by the shareholders undesignated preferred shares;
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Require that action by written consent in lieu of a meeting be adopted only if the shareholders unanimously consent to this manner of decision making;
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Establish an advance notice procedure for shareholder approvals to be brought before an annual meeting of our shareholders, including proposed nominations of persons for election to our board of directors;
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Limit the manner in which our shareholders can remove directors from the board;
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Prohibit certain persons who own in excess of 15% of our outstanding ordinary shares from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding ordinary shares, unless the merger or combination is approved in a prescribed manner;
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Establish that our board of directors is divided into three classes-Class I, Class II and Class III-with each class serving staggered terms; and
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Require a super-majority of votes to amend certain of the above-mentioned provisions.
These provisions, alone or together, could delay or prevent hostile takeovers and changes in control. These provisions may also frustrate or prevent any attempts by our shareholders to replace or remove our current management by making it more difficult for shareholders to replace members of our board of directors, which is responsible for appointing the members of our management.
Any provision of our memorandum and articles of association or British Virgin Islands law that has the effect of delaying or deterring a change of control could limit the opportunity for our shareholders to receive a premium for their ordinary shares, and could also affect the price that some investors are willing to pay for our ordinary shares.
It may be difficult to enforce a U.S. or foreign judgment against us, our directors and officers outside the United States, or to assert U.S. securities laws claims outside of the United States.
We are a company limited by shares incorporated under the laws of the British Virgin Islands. As a result, it may be difficult for a shareholder to effect service of process within the United States upon us, our directors and officers, or to enforce against us, or them, judgments obtained in U.S. courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state therein. Additionally, it may be difficult to assert U.S. securities law claims in actions originally instituted outside of the United States. Foreign courts may refuse to hear a U.S. securities law claim because foreign courts may not be the most appropriate forums in which to bring such a claim. Even if a foreign court agrees to hear a claim, it may determine that the law of the jurisdiction in which the foreign court resides, and not U.S. law, is applicable to the claim. Further, if U.S. law is found to be applicable, the content of applicable U.S. law must be proved as a fact, which can be a time-consuming and costly process, and certain matters of procedure would still be governed by the law of the jurisdiction in which the foreign court resides.
As the rights of shareholders under British Virgin Islands law differ from those under U.S. law, you may have fewer protections as a shareholder.
Our corporate affairs are governed by our Amended Memorandum and Articles of Association, the British Virgin Island Business Companies Act, 2004, as amended from time to time (the "BVI Act") and the common law of the British Virgin Islands. The rights of shareholders to take legal action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are to a large extent governed by the BVI Act and the common law of the British Virgin Islands. The common law of the British Virgin Islands is derived in part from judicial precedent in the British Virgin Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the British Virgin Islands.
The rights of shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the British Virgin Islands has a less developed body of securities laws as compared to the United States, and some states (such as Delaware) have more fully developed and judicially interpreted bodies of corporate law. In addition, British Virgin Islands law does not make a distinction between public and private companies and some of the protections and safeguards (such as statutory pre-emption rights, save to the extent that they are expressly provided for in the Amended Memorandum and Articles of Association) that investors may expect to find in relation to a public company are not provided for under British Virgin Islands corporate statutory law.
As a result of all of the above, holders of our ordinary shares may have more difficulty in protecting their interests in the face of actions taken by our management, directors or major shareholders than they would as shareholders of a U.S. company.
Shareholders in British Virgin Islands companies may not be able to initiate shareholder derivative actions, thereby depriving a shareholder of the ability to protect its interests.
While statutory provisions do exist in British Virgin Islands law for derivative actions to be brought in certain circumstances, shareholders in British Virgin Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States. The circumstances in which any such action may be brought, and the procedures and defenses that may be available in respect to any such action, may result in the rights of shareholders of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States. Accordingly, shareholders may have fewer alternatives available to them if they believe that corporate wrongdoing has occurred. The British Virgin Islands courts are also unlikely to: (i) recognize or enforce against us judgments of courts in the United States based on certain civil liability provisions of U.S. securities laws; or (ii) to impose liabilities against us, in original actions brought in the British Virgin Islands, based on certain civil liability provisions of U.S. securities laws that are penal in nature or that relate to taxes or similar fiscal or revenue obligations or would be viewed as contrary to British Virgin Island public policy or the proceedings pursuant to which judgment was obtained were contrary to natural justice. There is no statutory recognition in the British Virgin Islands of judgments obtained in the United States, although the courts of the British Virgin Islands will in certain circumstances recognize and enforce the non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.
The laws of the British Virgin Islands provide limited protection for minority shareholders, so minority shareholders will not have the same options as to recourse in comparison to the United States if the shareholders are dissatisfied with the conduct of our affairs, including our entry into the Merger Agreement.
Under the laws of the British Virgin Islands, there is limited statutory protection of minority shareholders other than the provisions of the BVI Act dealing with shareholder remedies. The principal protections under statutory law are unfair prejudice relief and an action to enforce the BVI Act or the Amended Memorandum and Articles of Association brought by the shareholders. Shareholders are entitled to have the affairs of the company conducted in accordance with the BVI Act and the Amended Memorandum and Articles of Association.
There are common law rights for the protection of shareholders that may be invoked, largely dependent on English company law, since the common law of the British Virgin Islands is limited. Under the general rule pursuant to English company law known as the rule in Foss v. Harbottle, a court will generally refuse to interfere with the management of a company at the insistence of a minority of its shareholders who express dissatisfaction with the conduct of the company's affairs by the majority or the board of directors and that the principal remedy for an aggrieved minority shareholder was presentation of a winding up petition on just and equitable grounds. The BVI Act amplifies this position by providing that a shareholder is not entitled to bring an action or intervene in proceedings in the name of or on behalf of a BVI company. Every shareholder is entitled to have the affairs of the company conducted properly according to British Virgin Islands law and the company's constituent documents.
If securities or industry analysts do not publish or cease publishing research or reports about us, our business or our market, or if they change their recommendations regarding our share, our share price and trading volume could decline.
The trading market for our ordinary shares will depend on the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If any of the analysts change their recommendation or outlook regarding us or our shares, or provide more favorable relative recommendations or outlooks about our competitors, our share price could likely decline. Additionally, if any of the analysts do not publish or cease publishing research or reports about us, our business or our market, our share price and trading volume could decline.
Future sales of our ordinary shares in the public market could cause our share price to fall.
Sales of a substantial number of our ordinary shares in the public market or the perception that these sales might occur could significantly reduce the market price of our ordinary shares and impair our ability to raise adequate capital through the sale of additional equity securities.
The holders of certain of our ordinary shares will be entitled to rights with respect to registration of such shares under the Securities Act pursuant to an investors’ rights agreement between such holders and us. If such holders, by exercising their registration rights, sell a large number of shares, the market price for our ordinary shares could be
harmed. If we file a registration statement for the purpose of selling additional shares to raise capital and are required to include shares held by these holders pursuant to the exercise of their registration rights, our ability to raise capital may be impaired. We have filed a registration statement on Form S-8 under the Securities Act to register shares for issuance under our equity incentive plans, including our 2016 Share Option and Incentive Plan and our 2016 Employee Share Purchase Plan. Each of these plans provides for automatic increases in the shares reserved for issuance under the plan which could result in additional dilution to our shareholders. Once we register these shares, they can be freely sold in the public market upon issuance and vesting.
We do not intend to pay dividends for the foreseeable future.
We have never declared or paid any dividends on our ordinary shares. We currently intend to retain any earnings to finance the operation and expansion of our business and do not anticipate paying any cash dividends in the future. In addition, our ability to pay dividends on our ordinary shares may be limited by restrictions under the terms of one of our credit agreements. As a result, you may only receive a return on your investment in our ordinary shares if the market price of our ordinary shares increases.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
On April 20, 2007, we entered into a lease for 18,750 square feet of office space in Tampa, Florida with a lease term that ended on July 30, 2019. We subsequently extended this lease through July 31, 2024. This lease pertains to our Seven Seas Water segment.
On November 1, 2018 we entered into a lease, for approximately 31,758 square feet of office space in King of Prussia, Pennsylvania with a lease term that ends on April 30, 2030. This lease pertains to our Quench segment.
On November 1, 2018, we assumed in the AUC Acquisition, a lease for 5,267 square feet of office space in Houston, Texas with a lease term that ends on November 30, 2022. This lease pertains to our Seven Seas Water segment.
On December 18, 2018, we assumed in the PHSI Acquisition, a lease for 15,657 square feet of warehouse space in Bensenville, Illinois with a lease term that ends on March 31, 2023. This lease pertains to our Quench segment.
On December 18, 2018, we assumed in the PHSI Acquisition, a lease for 14,371 square feet of office space in Lincolnshire, Illinois with a lease term that ends on January 31, 2020. This lease pertains to our Quench segment.
On August 9, 2019, we entered into a lease, for approximately 33,363 square feet of office space in Las Vegas, Nevada with a lease term that ends on October 31, 2024. This lease pertains to our Quench segment.
On September 1, 2019, we entered into a lease, for approximately 53,000 square feet of office space in Audubon, Pennsylvania with a lease term that ends on July 31, 2024. This lease pertains to our Quench segment.
We are a party to numerous other small office, warehouse, storage yard and month-to-month storage unit leases. We believe that our warehouse and office space is sufficient to meet our current needs until the expiration of these leases and we expect to lease additional space as we expand our business.
Please refer to “Our Desalination Plants” section within Item 1 included elsewhere in this Annual Report on Form 10-K for information on our desalination plants.
Item 3.
Item 3. Legal Proceedings.
Since the announcement of the Merger Agreement on December 23, 2019, three putative class actions have been filed in connection with the proposed Merger. On February 4, 2020, in connection with the merger, a putative class action lawsuit, Post v. AquaVenture Holdings Ltd., et al., 1:20-cv-174, was filed by purported shareholder Joseph Post against our Company and our directors in the United States District Court for the District of Delaware. On February 12,
2020, in connection with the merger, a lawsuit, Hamilton v. AquaVenture Holdings Ltd., et al., 1:19-cv-01227, was filed as an individual action by purported shareholder Peter Hamilton against our Company and our directors in the United States District Court for the Southern District of New York. On February 20, 2020, purported shareholder Christopher Jagt filed an individual lawsuit against the Company and its directors in the United States District Court for the Eastern district of New York, captioned Jagt v. AquaVenture Holdings Ltd., et. al. 1:20-cv-931. These complaints allege that, because the proxy statement concerning the Merger is materially deficient in certain respects, all of the defendants violated Sections 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder, and that the directors additionally violated Section 20(a) of the Exchange Act. The complaints seek, among other things, (1) injunctive relief preventing consummation of the Merger, (2) rescissory damage or rescission of the Merger if it has already occurred; and (3) costs and fees, including attorney and expert fees, related to the actions. The defendants believe that the respective allegations asserted against them in the lawsuits are without merit and intend to defend against the lawsuits vigorously. Similar cases may also be filed in connection with the merger. These legal proceedings could delay or prevent the Merger from becoming effective.
From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of any such outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors. We are not currently aware of any such proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or results of operations. For more information on our litigation see Note 15-“Litigation” in the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further discussion.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our ordinary shares began trading on the New York Stock Exchange under the symbol “WAAS” on October 6, 2016.
Holders
As of March 2, 2020, there were approximately 50 holders of record. The actual number of shareholders is greater than this number of record holders and includes shareholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include shareholders whose shares may be held in trust by other entities.
Dividends
We have not paid any cash dividends on our ordinary shares since inception of the Company and do not anticipate paying cash dividends in the foreseeable future.
Securities authorized for issuance under equity compensation plans
The following table provides information about our ordinary shares that may be issued under all of our existing equity compensation plans as of December 31, 2019:
(1)
In addition to the number of securities listed in this column, an aggregate 624,949 restricted share units have been granted and remain unvested as of December 31, 2019 and 51,969 phantom share units have been granted and remain unissued as of December 31, 2019 under our existing equity compensation plans. The 624,949 unvested restricted share units and 51,969 phantom share units were issued under the 2016 Share Option and Incentive Plan (“2016 Equity Plan”).
(2)
As of December 31, 2019, no options to purchase ordinary shares under the 2016 Employee Share Purchase Plan (“2016 ESPP”) were outstanding. The 2016 ESPP provides that an additional number of shares will automatically be added to the shares authorized for issuance under the 2016 ESPP on January 1, 2017 and each January 1 thereafter through January 1, 2021. The number of shares added each year will be equal to the lesser of: (i) 1% of the number of shares issued and outstanding on the immediately preceding December 31, (ii) 200,000 shares, or (iii) such number of shares as determined by the administrator of the 2016 ESPP.
(3)
The ordinary shares that remain available for future issuance under the 2016 Equity Plan may be issued in the form of share options, share appreciation rights, restricted share awards, restricted share units, unrestricted share awards, cash-based awards, performance share awards and dividend equivalent rights. Each future grant shall reduce the available shares under the 2016 Share Option and Incentive Plan by an equal amount. The 2016 Equity Plan provides that an additional number of shares will automatically be added to the shares authorized for issuance under the 2016 Equity Plan on January 1 of each year. The number of shares added each year will be equal to 4% of the outstanding shares of the Company on the immediately preceding December 31.
(4)
Issuances of securities under the AquaVenture Holdings LLC Amended and Restated Equity Incentive Plan, Quench USA Holdings LLC 2014 Equity Incentive Plan and Quench USA, Inc. 2008 Stock Plan Incentive Stock Option Plan ceased effective October 5, 2016 at the time of the effectiveness of our initial public offering. As a result, no securities remain available for issuance under these plans, other than issuances upon exercises of outstanding options.
Use of Proceeds from Registered Securities
None.
.
Item 6.
Item 6. Selected Financial Data.
The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements and related notes, and other financial information included in this Annual Report on Form 10-K. The related financial data in this section are not intended to replace the consolidated financial statements and are qualified in their entirety by the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. All financial data for the years ended December 31, 2019 and 2018 included within Item 6 in this Annual Report on Form 10-K has been restated in accordance with the adoption of authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) regarding revenue from contracts with customers and the determination of the customer in a service concession contract (together referred to as the “Adopted Revenue Guidance”) on a full retrospective basis on January 1, 2018.
(1)
Includes the operations of our bulk water business in the BVI from the date of acquisition of June 11, 2015. In addition, the Company recorded a goodwill impairment charge of $27.4 million related to the Quench reporting unit during 2015. The tax benefit associated with this impairment charge was $716 thousand.
(2)
Includes the operations acquired in the Peru Acquisition from the date of acquisition of October 31, 2016. In addition, we recorded a $1.4 million gain on bargain purchase, net of deferred taxes, from the Peru Acquisition in the Seven Seas Water reportable segment.
(3)
Includes IPO triggered cash compensation and associated payroll taxes of $6.1 million which was paid during the fourth quarter of 2016.
(4)
Includes a gain of $1.6 million on early extinguishment of a note payable on December 1, 2016.
(5)
Includes a loss of $1.4 million on early extinguishment of debt on August 4, 2017.
(6)
Includes the operations of Pure Water Innovations, Inc. (“PWI”), Quench Water Canada, Inc. (“Quench Canada”), and Wellsys USA Corporation (“Wellsys”) from their respective dates of acquisition of June 1, 2017, August 2, 2017 and September 8, 2017.
(7)
Includes Clarus, Watermark, Wa-2, Aqua Coolers, Avalon, Alpine, Quality Water Services, AUC Acquisition, Bluline and PHSI operations from their respective acquisition dates of January 15, 2018, January 15, 2018, March 1, 2018, April 2, 2018, June 4, 2018, August 6, 2018, October 2, 2018, November 1, 2018, December 3, 2018 and December 18, 2018, respectively.
(8)
Includes Aguaman, Carolina Pure, Mirex, Flowline, Pure Planet and Jonli operations from their respective acquisition dates of June 1, 2019, July 15, 2019, October 1, 2019, October 1, 2019, December 2, 2019 and December 16, 2019, respectively.
Includes $6.6 million of expenses incurred in connection with the definitive merger agreement entered into in December 2019.
Includes $3.0 million net gain on sale of property, plant and equipment primarily in connection with our customer in Curaçao exercising its right to purchase the desalination facilities pursuant to the water supply agreement.
(9)
Represents loss per share and weighted-average shares outstanding for the period following the corporate reorganization and IPO. There were no ordinary shares outstanding prior to October 6, 2016 and, therefore, no loss per share information has been presented for any period prior to that date.
(10)
Net proceeds of $188.8 million were received in 2016 in connection with our initial public offering and net proceeds of $75.4 million were received in connection with our follow on offering in July 2019.
(11)
Long-term debt was refinanced in conjunction with a Corporate Credit Agreement which was entered into on August 4, 2017. In addition, there was one amendment to the Corporate Credit Agreement during the year ended December 31, 2017 and three amendments to the Corporate Credit Agreement during the year ended December 31, 2018, which included, among other things, incremental borrowings. See further discussion within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K.
(12)
As a result of the Adopted Revenue Guidance, the Company recorded a cumulative net increase of $8.4 million to accumulated deficit as of January 1, 2016.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section titled “Selected Consolidated Financial Data” and financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that
could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” included elsewhere in this Annual Report on Form 10-K.
Overview
AquaVenture Holdings Limited and its subsidiaries (the “Company”, “AquaVenture”, “we”, “us” and “our”) is a multinational provider of Water-as-a-Service®, or WAAS®, solutions that provide our customers with a reliable and cost-effective source of clean drinking water, processed water and wastewater treatment and water reuse solutions primarily under long-term contracts that minimize capital investment by the customer. We believe our WAAS business model offers a differentiated value proposition that generates long-term customer relationships, recurring revenue, predictable cash flow and attractive rates of return. We generate revenue from our operations in North America, the Caribbean and South America and are pursuing expansion opportunities in North America, the Caribbean, South America, Africa, the Middle East and other select markets.
We deliver our WAAS solutions through two operating platforms: Seven Seas Water and Quench. Seven Seas Water is a multinational provider of desalination, wastewater treatment and water reuse solutions to governmental, municipal (including utility districts), industrial, property developer and hospitality customers. Our desalination solutions provide more than 8.5 billion gallons per year of potable, high purity industrial grade and ultra-pure water (which is water that is treated to meet higher purity standards required for industrial, semiconductor, utility or pharmaceutical applications). Our wastewater treatment and water reuse solutions, which include plants ranging in capacity from 5,000 gallons per day, or GPD, to more than 1.5 million GPD, are provided through 105 leases with customers as well as through the sale of equipment. Quench, is a U.S.-based provider of Point-of-Use, or POU, filtered water systems and related services through direct and indirect sales channels to approximately 60,000 institutional and commercial customers, including more than half of the Fortune 500, throughout the United States and Canada.
Our Seven Seas Water platform generates recurring revenue through long-term contracts for our desalination and wastewater treatment and water reuse solutions. For the year ended December 31, 2019, the significant majority of our Seven Seas Water revenue is derived from our desalination solutions in six different locations:
·
The USVI: Seven Seas Water provides all of the municipal potable water needs for the islands of St. Croix, St. Thomas and St. John through its two seawater desalination plants, one on St. Croix and one on St. Thomas, having a combined capacity of approximately 7.0 million GPD. We also provide ultrapure water for use in power generation units by further processing a portion of the potable water we produce for certain of our customers.
·
St. Maarten: Seven Seas Water is the primary supplier of municipal potable water needs for St. Maarten through its three seawater desalination plants, which have a combined capacity of approximately 5.8 million GPD.
·
Curaçao: Seven Seas Water provided industrial grade water through seawater and brackish water desalination facilities having a combined capacity of approximately 4.9 million GPD.
·
Trinidad: Seven Seas Water provides potable water to southern Trinidad through its seawater desalination plant having a capacity of approximately 5.5 million GPD. Upon completion of an expansion during July 2016, total capacity was increased to 6.7 million GPD.
·
The BVI: Seven Seas Water is the primary supplier of Tortola’s potable water needs through its seawater desalination plant having a capacity of approximately 2.8 million GPD, which we began operating after we acquired the capital stock of Biwater (BVI) Holdings Limited on June 11, 2015.
·
Peru: Seven Seas Water provides seawater and desalinated process water to a phosphate mine through a pipeline and seawater reverse osmosis facility having a capacity of approximately 2.7 million GPD, which we began operating after we completed the acquisition of all the outstanding shares of Aguas de Bayovar S.A.C. (“ADB”) and all the rights and obligations under a design and construction contract for a desalination plant and related infrastructure located in Peru (the “Peru Acquisition”) on October 31, 2016.
On June 28, 2019, we received formal notice from Curaçao Refinery Utilities B.V. (“CRU”) that it is exercising its right to purchase our desalination facilities pursuant to the terms of the existing water supply agreement. The existing water supply agreement with CRU began in December 2008, with the Company providing water from a desalination plant with an initial design capacity of 0.5 million gallons per day under a five-year contract. This agreement has been amended several times, resulting in both expanded water production to the current design capacity of 4.9 million GPD and an extended contract expiration date of December 31, 2019. Pursuant to the terms of the water supply agreement, the applicable buy-out amount, upon consummation of the buyout right by CRU, was $3.5 million due upon the contract expiration date of December 31, 2019. On December 31, 2019, CRU consummated the execution of its buy-out right, and the Company received a cash payment of $3.5 million.
Through our Seven Seas Water wastewater treatment and water reuse solutions, we design, fabricate and install plants that are leased under a contractual term or sold to customers. The wastewater treatment and water reuse solutions offered to customers include scalable modular treatment plants, field-erected plants and temporary bypass plants ranging from 5,000 GPD to more than 1.5 million GPD. These solutions are provided through 105 leases with customers. With the November 1, 2018 AUC Acquisition, in which we acquired all of the issued and outstanding membership interests of AUC pursuant to a membership interest purchase agreement, we significantly increased our wastewater treatment and water reuse solutions, which has contributed significantly to our Seven Seas Water revenues.
We are supported by operations centers in Tampa, Florida and Houston, Texas, which provides business development, engineering, field service support, procurement, accounting, finance and other administrative functions.
Our Quench platform generates recurring revenue from the rental and servicing of POU water filtration systems and related equipment, such as ice and sparkling water machines, and from the contracted maintenance of customer owned equipment. Quench also generates revenue from the sale of coffee and consumables under agreements requiring customers to purchase a minimum amount monthly in exchange for the use of a coffee brewer. Our annual unit attrition rate at December 31, 2019 was less than 7.5%, implying an average rental period of more than 12 years. Through our direct sales channel, we receive recurring fees for the units we rent or service throughout the life of our customer relationship. In addition, we also receive non-recurring revenue from some customers for the sale of equipment and for certain services, such as the installation, relocation or removal of equipment. Through our indirect sales channel, we receive re-occurring revenue from the sale of equipment, parts and filters to dealers and retailers. We achieve an attractive return on our rental assets due to strong customer retention. We provide our systems and services to a broad mix of industries, including government, education, medical, manufacturing, retail, and hospitality, among others. We operate principally throughout the United States and Canada and are supported by a primary operations center in King of Prussia, Pennsylvania.
For the fiscal years ended December 31, 2019 and 2018, our consolidated revenue was $203.5 million and $145.6 million, respectively. The $57.9 million increase from 2018 to 2019 was primarily due to inclusion of incremental revenues from our acquisitions during 2018 and 2019 in addition to organic growth of existing operations. Including both organic and inorganic growth, our CAGR for revenue was 24.8% from 2014 to 2019.
Agreement and Plan of Merger
On December 23, 2019, we entered into an Agreement and Plan of Merger, or Merger Agreement, with Culligan International Company, or Culligan, a Delaware corporation, and Amberjack Merger Sub Limited, or Merger Sub, a business incorporated under the laws of the British Virgin Islands and wholly-owned subsidiary of Culligan. Pursuant to the Merger Agreement, and subject to the satisfaction or waiver of the conditions therein, Merger Sub will merge with and into the Company (the “Merger”). As a result of the Merger, the Company will become a wholly-owned subsidiary of Culligan. The closing of the Merger remains subject to the satisfaction or waiver of the remaining conditions to the Merger set forth in the Merger Agreement. We expect the Merger to close no later than the end of the second quarter of 2020.
2019 Acquisition Activities
On June 1, 2019, we acquired substantially all of the water filtration assets and assumed certain liabilities of Aguaman, Inc. (“Aguaman”), a POU water filtration company based in Miami, Florida, pursuant to an asset purchase agreement. The aggregate purchase price, subject to adjustments, was $1.5 million, which included approximately $1.1 million of cash, $0.2 million payable on the one-year anniversary of the transaction and $0.2 million acquisition contingent
consideration payable to the seller on or before the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On July 15, 2019, we acquired substantially all of the assets and assumed certain liabilities of Carolina Pure Water Systems, LLC (“Carolina Pure”), a POU water filtration company based in Raleigh, North Carolina, pursuant to an asset purchase agreement. The aggregate purchase price, subject to adjustments, was $7.3 million, which included approximately $6.8 million of cash and $0.5 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On October 1, 2019, we acquired substantially all of the assets and assumed certain liabilities of Mirex AquaPure Solutions L.P., d/b/a Mirex AquaPure Solutions (“Mirex”), a POU water filtration company based in Houston, Texas, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $11.6 million, which included approximately $10.3 million of cash, $0.9 million payable on the one-year anniversary of the transaction, $0.3 million payable on the two-year anniversary of the transaction and approximately $0.1 million of acquisition contingent consideration. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On October 1, 2019, we acquired substantially all of the assets and assumed certain liabilities of 1920277 Alberta Inc., d/b/a Flowline Canada (“Flowline”), a POU water filtration company based in Edmonton, Canada, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.9 million, which included approximately $0.8 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in Canada.
On December 2, 2019, we acquired substantially all of the assets and assumed certain liabilities of Pure Planet Water, Inc. (“Pure Planet”), a POU water filtration company based in Palm Desert, California, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.2 million, which included approximately $0.1 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
On December 16, 2019, we acquired substantially all of the assets and assumed certain liabilities of Jonli Water Services, Inc. (“Jonli”), a POU water filtration company based in Quebec, Canada pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.4 million, which was paid in cash. The assets acquired consist primarily of in-place maintenance agreements in Canada.
While we routinely identify and evaluate potential acquisition candidates and engage in discussions and negotiations regarding potential acquisitions, there can be no assurance that any of our discussions or negotiations will result in an acquisition. If we enter into definitive agreements, there can be no assurances that all the conditions precedent to completing those acquisitions will be satisfied or waived, or that the acquisitions will be completed. Further, if we make any acquisitions, there can be no assurance that we will be able to operate or integrate any acquired businesses profitably or otherwise successfully implement our expansion strategy.
Operating Segments
We have two reportable segments that align with our operating platforms, Seven Seas Water and Quench. The segment determination is supported by, among other factors, the existence of individuals responsible for the operations of each segment and who also report directly to our chief operating decision maker (“CODM”), the nature of the segment’s operations and information presented to our CODM. For the year ended December 31, 2019, revenues for the Seven Seas Water and Quench segments represented approximately 43% and 57%, respectively, of our consolidated revenues.
In addition to the Seven Seas Water and Quench segments, we record certain general and administrative costs that are not allocated to either of the reportable segments within “Corporate and Other” for the CODM and for segment reporting purposes. These costs include, but are not limited to, professional service fees and other expenses to support the activities of the registrant holding company. Corporate and Other does not include any labor allocations from the Seven Seas Water and Quench segments. We believe this presentation more accurately portrays the results of the core operations of each of the operating and reportable segments to the CODM. The Corporate and Other administration function is not treated as a segment.
As part of the segment reconciliation, intercompany interest expense and the associated intercompany interest income are included but are eliminated in consolidation.
Components of Revenues and Expenses
Management reviews the results of operations using a variety of measurements and procedures including an analysis of the statements of operations and comprehensive income which management considers an important aspect of our performance analysis. To help the reader better understand the discussion of operating results, details regarding certain line items have been provided below.
On January 1, 2018, the Company adopted the guidance regarding both revenue from contracts with customers and the determination of the customer in a service concession contract on a full retrospective basis (the “Adopted Revenue Guidance”). Several of the Company’s contracts were impacted primarily due to the identification of multiple performance obligations within a single contract. However, the Adopted Revenue Guidance did not have a cash impact and, therefore, does not affect the economics of our underlying customer contracts. The adoption did, however, result in differences in the way our revenues, gross profit and net loss are determined compared to historical periods as presented within our Annual Report on Form 10-K for the year ended December 31, 2017. More specifically, the Adopted Revenue Guidance impacted contracts with customers in our Seven Seas Water segment determined to be service concession arrangements and the classification of financing income. Contracts with customers within the Quench segment remained substantially unchanged.
For a discussion on our accounting policies as restated in accordance with the Adopted Revenue Guidance, please refer to Note 2-“Summary of Significant Accounting Policies” to the Consolidated Financial Statements, included elsewhere in this Annual Report on Form 10-K.
Revenues
Seven Seas Water
Our Seven Seas Water business generates revenue from our desalination and wastewater treatment and water reuse solutions provided to governmental, municipal (including utility districts), industrial, property developer and hospitality customers. Revenues from our desalination solutions are primarily generated from contracts with customers to deliver treated bulk water, through both bulk water sales and service and service concession arrangements. Revenues from our wastewater treatment and water reuse solutions are primarily generated from capital and financed equipment sales, and leasing arrangements of up to five years.
Bulk water sales and service, which represent our desalination solutions, can include the delivery of bulk water or bulk water services, including the operations and maintenance of a customer-owned plant. We recognize revenues from the delivery of bulk water or the performance of bulk water services at the time the water or services are delivered to the customers in accordance with the contractual agreements. Certain agreements contain a minimum monthly charge provision which allows the Company to invoice the customer for the greater of the water supplied or a minimum monthly charge. The volume of water supplied is based on meter readings performed at or near the end of the month. Estimates of revenue for unbilled water are recorded when meter readings occur at a time other than the end of a period.
Certain contracts with customers which require the construction of facilities to provide bulk water to a specific customer contain multiple obligations, including an implicit lease for the bulk water facilities and bulk water services, including operations and maintenance. The implicit lease obligation is generally accounted for as an operating lease as a result of the provisions of the contract. Revenues for contracts with both implicit lease and non-lease components are generally recognized ratably over the contract period as delivered to the customer after taking into consideration our analysis of contingent rent, any minimum take-or-pay provisions and contractual unit pricing.
Service concession arrangements are agreements entered into with a public-sector entity which controls both (i) the ability to modify or approve the services and prices provided by the operating company and (ii) beneficial entitlement to, or residual interest in, the infrastructure at the end of the term of the agreement. Service concession arrangements typically include the construction of infrastructure for the customer and an obligation to provide operations and maintenance on the infrastructure constructed.
Our wastewater treatment and water reuse solutions generate recurring revenue from the rental of wastewater treatment and water reuse equipment. Our equipment is typically rented under multi-year term, automatically renewing contracts. We record the recurring fees received as revenue for the units we rent ratably throughout the term of each contract period.
Revenues related to the construction of infrastructure, or product sales revenue, for both our desalination and wastewater treatment and water reuse solutions are recognized over time, using the input method based on cost incurred, which typically begins at the later of commencement of the construction or transfer of control, with revenue being fully recognized upon the completion of the infrastructure as control of the infrastructure is transferred to the customer. Timing differences between when the construction performance obligations are completed and when cash is received from the customer could result in a significant financing component. If a significant financing component is identified, the Company will recognize interest income, or financing revenues, on a long-term receivable established upon the completion of the construction of the infrastructure. Future cash flows received from the customer related to the long-term receivable are bifurcated between the principal repayment of the long-term receivable and the related financing revenue. Revenues related to the operations and maintenance are recognized as revenues as the services are provided to the customer.
Quench
Our Quench direct sales channel generates recurring revenue from the rental and servicing of POU water filtration systems and related equipment, such as ice and sparkling water machines, and from the contracted maintenance of customer-owned equipment. In addition, we also receive non-recurring revenue from some customers from the sale of equipment and for certain services, such as the installation, relocation or removal of equipment. Quench also generates revenue from the sale of coffee and consumables. Through our indirect sales channel, we receive re-occurring revenue from the sale of equipment, parts and filters to dealers and retailers.
The majority of Quench’s direct sales channel customers rent our systems under multi-year, automatically renewing contracts. We record the recurring fees received as revenue for the units we rent ratably throughout the term of each contract period. Non-recurring revenues are recorded at the time services are performed or upon the customer taking control of the equipment and/or products sold.
Cost of Revenues
Seven Seas Water
Cost of revenues for our Seven Seas Water business consists primarily of the cost of equipment depreciation; cost of equipment constructed for sale; and costs for operating and maintaining equipment on behalf of the customer. Expenditures in connection with the installation of our leased equipment are capitalized as contract fulfillment costs and depreciated to cost of revenues over the estimated useful life of the contract.
Equipment depreciation is the largest component of our cost of revenues. In the future, we expect that our depreciation and cost of revenue will increase with the addition of new equipment and future acquisitions. Equipment depreciation is calculated using a straight-line method with an allowance for estimated residual values. Depreciation rates are determined based on the estimated useful lives of the assets. Depreciation commences when the equipment is placed into service.
Equipment construction related to product sales revenue can include the cost of equipment and related installation services, including construction labor costs, field engineering costs, and third-party services. Such expenses can vary depending on the size of the desalination or wastewater plant or the complexity of the application, number of projects and the prevailing labor market for the level of employees needed in the jurisdiction where the plant is being constructed.
Operating costs for operating and maintaining the equipment on behalf of the customer, which is primarily related to our desalination solutions, includes personnel costs (including compensation and other related personnel costs for employees), electric power, repairs and maintenance, personnel and travel costs for field engineering services and the cost of consumables. Labor costs are generally consistent within a normal range of plant production but can vary from
plant to plant depending on the size of the plant and the complexity of the water application. Costs of labor can vary depending on the prevailing labor market for the level of employees needed in the jurisdiction where the plant is located.
Electrical power for our large plants is generally provided by the customer or charged by us to the customer as a pass-through cost; however, our contracts normally require us to maintain electrical usage at or below a specified level of kilowatt hours for each gallon of water produced.
Expenditures for repairs and maintenance are expensed as incurred whereas betterments for property, plant and equipment owned by us that add capacity, significantly improve operating efficiency or extend the asset life are capitalized.
Field engineering services include mainly the cost of labor and travel for our specially trained and skilled employees who handle more complex maintenance tasks and to troubleshoot performance issues with our plant equipment and systems. Such expenses can vary depending on the number of projects and the time and extent of the maintenance requirements.
Consumables are typically chemical additives used in the pre- and post-production processes to meet the water quality and attribute specifications of our customers.
Quench
Cost of revenues for our Quench business consists primarily of the cost of personnel and travel for our field service, supply chain and technician scheduling and dispatch teams; depreciation of rental equipment and field service vehicles; the cost of equipment purchased or manufactured for resale; the cost of coffee and related consumables; the cost of filters and repair parts; and freight costs. Expenditures incurred in connection with the installation of our rental equipment are capitalized and depreciated to cost of revenues over their estimated useful life.
Selling, General and Administrative Expenses
Each segment reports the selling, general and administrative expenses that pertain to its business. General and administrative costs that are not allocated to either of the reportable segments are reported in “Corporate and Other” for the CODM and for segment reporting purposes. These costs include, but are not limited to, professional service fees and other expenses to support the activities of the registrant holding company. Corporate and Other does not include any labor allocations from the Seven Seas Water and Quench segments. We believe this presentation more accurately portrays the results of the core operations of each of the operating and reportable segments to the CODM. The Corporate and Other administration function is not treated as a segment.
Seven Seas Water
Selling, general and administrative expenses for Seven Seas Water consist primarily of compensation and benefits (including salaries, benefits and share-based compensation), third-party professional service fees and travel. Such expenses include personnel and travel costs of our business development organization, third party and internal engineering costs incurred in connection with new project feasibility studies or proposals, and costs for operating business development offices and activities. Selling, general and administrative expenses also include personnel and related costs for our executive, engineering, procurement, finance and human resources organizations and other administrative employees; third party professional service fees for consulting, legal, accounting and tax services; depreciation of office equipment and improvements and computer systems and software not directly related to specific revenue generating projects; amortization expense associated with intangible assets acquired in connection with business combinations, which are amortized over their expected useful lives; and other corporate expenses. In the future, we expect that our selling, general and administrative expenses will increase due to business development efforts in new markets and the general infrastructure to support our future growth.
Quench
Selling, general and administrative expenses for Quench include costs related to our selling and marketing functions as well as general and administrative costs associated with our operations center and operating locations, including information systems, finance, customer care, and human resources. Such costs include personnel costs
(including salaries, benefits and share-based compensation), non-capitalized commissions, amortization of deferred lease costs, expenses related to lead generation, amortization expense associated with intangible assets acquired in connection with business combinations, which are amortized over their expected useful lives, fees for third-party professional services (including consulting, legal, accounting and tax services), travel, depreciation of non-service equipment and other administrative expenses.
Other Expense and Income
Other expense and income consists mainly of interest expense and interest income. Interest expense primarily relates to bank and private lender debt. In the future, we expect that our interest expense will increase as a result of the use of debt financing to support our organic and inorganic growth. Interest income primarily relates to interest received on certain cash and cash equivalent investments of three months or less.
Key Factors Affecting Our Performance and Comparability of Results
A number of key factors have affected and will continue to affect our performance and the comparison of our operating results, including matters discussed below and those items described in the section entitled “Risk Factors” in Item 1A of this Annual Report on Form 10-K.
Seven Seas Water
The financial performance of our Seven Seas Water business has been, and will continue to be, significantly affected by our ability to identify and consummate acquisitions of, or to identify and secure new projects for, desalination, wastewater treatment and water reuse solutions with new and existing governmental, municipal, industrial, property developer and hospitality customers. Our performance and the comparability of results over time are largely driven by the timing of events such as acquisitions of existing plants, securing new plant projects (including bulk water sales and service), rental agreements and product sales, plant expansions, and the extension, termination or expiration of water supply agreements and rental agreements for wastewater treatment and water reuse equipment. The timing of many of these events is unpredictable. New plant projects, plant expansions and plant acquisitions, when they do occur, may require significant levels of cash and company resources before and after the commencement of revenue and their impact on our results of operations can be significant.
The table below summarizes significant events in 2019 and 2018 that affect the performance and comparability of financial results for these and future periods:
(1)
Effective April 1, 2018, we entered into an amendment to the water purchase agreement in St. Maarten. The amendment reduced the required minimum monthly water purchase by our customer, in exchange for a four-year extension to the water contract. The reduction in the required minimum monthly water purchase will remain in effect for three years, after which time the average monthly minimum purchase will then revert to previous minimum requirements for the remainder of the contract. Our customer has the option to extend the lower minimum volumes for an additional two years, which, if exercised, would also extend the contract expiry from 2025 to 2027.
(2)
Effective November 1, 2019, we terminated our original agreement in St. Croix and subsequently entered new agreement with the customer. Under the new agreement, which expires in 2024, we expanded the design capacity of the plant by 1.0 million GPD.
(3)
On December 31, 2019, our water supply agreement in Curaçao expired and our customer, CRU, exercised its right to purchase the desalination facilities pursuant to the terms of the existing water supply agreement. The applicable buy-out amount, upon consummation of the buyout right, is $3.5 million due upon the contract expiration date. On December 31, 2019, CRU consummated the execution of its buy-out right and the Company received a cash payment of $3.5 million. This payment was recorded as a gain on sale of property, plant and equipment, which is reflected within SG&A in our Seven Seas Water segment.
In addition to the table above, we also acquired all of the issued and outstanding membership interests of AUC on November 1, 2018. The acquired wastewater treatment and water reuse solutions, which include plants ranging in capacity from 5,000 GPD to more than 1.5 million GPD, are provided through 105 leases with customers.
Time and Expense Associated with New Business Development
The period of time required to develop an opportunity and secure an award can be lengthy, historically taking multiple years during which significant amounts of business development expense may be incurred. Our business development organization seeks to identify new project opportunities for both competitive bid situations and through unsolicited negotiated arrangements. Governmental water customers generally require a competitive bid for new plant development. Participation in a formal bid process and in negotiated arrangements can require significant costs, the timing of which can impact the comparability of our financial results. While our proposed pricing factors in such costs, there is no assurance that we will secure the contract and ultimately recover our costs.
The period from contract award to the commissioning of a new plant (and commencement of revenues) can also vary greatly due to, among other things, the size and complexity of the plant. In the case of a newly constructed desalination plant, there is typically a ramp-up period during which the plant operates below normal capacity.
Existing Customer Relationships
We expect to continue to grow our business with existing customers by expanding and extending the contractual term for existing plants to meet an expected increase in customer demand, each of which will impact our performance and comparability of results. As customer demand increases for either the volume of water produced and delivered or the wastewater treated, we typically experience increased sales volume through the use of additional capacity built into existing desalination plants or through the renegotiation of an existing contract and deployment of
incremental equipment to meet customer demands. Similarly, contract extensions and renewals provide economic benefits for both the customer and us. By the time we enter into an extension or renewal we have typically recovered meaningful portions of our capital investment and only incremental capital investment may be required. These factors provide a competitive advantage in a contract extension (or renewal) process and may enable us to reduce unit prices, sustain profitability and achieve an improved and continuing return on our invested capital.
Acquisition of Existing Assets or Business
Revenue and expenses will increase upon an acquisition of existing assets or businesses from a third party. In addition, the time, cost and capital required to complete an acquisition are significant. Specifically, the costs incurred prior to the acquisition can include professional fees, travel costs and, in certain instances, success fees paid to third parties. These costs may be incurred well in advance of the completion of an acquisition. Upon completion of the acquisition, certain assets, including desalination plants, may experience periods of downtime or reduced production levels as well as additional capital investment while we bring the plant up to our engineering and operating standards. Acquisitions are a part of our Seven Seas Water growth strategy and accordingly our ability to grow could be impacted by our effectiveness in completing and integrating our acquisitions.
Entry into New Markets
Our future performance will be affected by our investment and success in securing business in new markets. While continuing to penetrate the Caribbean market, we have also expanded our business development efforts to pursue a global business footprint in North America, South America, Africa, the Middle East and other select markets. As we continue to pursue entry into new markets, we may incur increasing expenses for business development that may be sustained for long periods of time before realizing the benefit of incremental revenues. In addition, our entry into some new markets may be better served through partnering arrangements such as joint ventures, which may result in a minority position. Such an arrangement may be economically attractive even though, in some circumstances, we may not be able to consolidate the operating results of a partnering arrangement with our own operating results.
Changes to Sales Volume, Costs of Sales and Operating Expenses
For our desalination solutions, our profitability is affected by changes in the volume of water delivered above any minimum required customer purchases, our ability to control plant production costs, and our ability to control equipment manufacturing costs and operating expenses. For our wastewater treatment and water reuse solutions, our profitability is affected by the number and profitability of construction projects commenced and completed during the period and the number of new leases entered into with customers.
Due to the capital-intensive nature of our desalination solutions and the relatively high level of fixed costs such as depreciation and contract cost amortization, our Seven Seas Water business model is characterized by high levels of operating leverage. As a result, significant swings in bulk water production volume could favorably or unfavorably impact profitability more significantly than business models with less operating leverage. We have mitigated the downside risk of declines in bulk water plant production through the inclusion of minimum customer purchase requirements in a majority of our eight water supply contracts with our major customers. In the other two water supply contracts, we have contractual rights to be the exclusive water supplier or our customer must purchase all the water we produce and we must provide volume at a specified percentage of installed capacity. We design our plants to meet or exceed contractual supply requirements but our failure to meet minimum supply requirements could result in penalties that may adversely affect our financial performance.
Operating costs for our desalination solutions can have a significant impact on the profitability of our operations. Electrical costs are a major expense in connection with the operation of a water treatment plant. Our major customers either, directly or through related parties, provide the electricity needed to run the plant without cost to us or reimburse us for this cost on a pass-through basis. In general, our contracts require us to maintain electrical usage at or below a specified level of kilowatt hours for each gallon of water produced. As a result, our cost risk is principally with respect to our ability to use electrical power efficiently. We have made investments in plant equipment and configuration to maintain required levels of electrical efficiency.
Personnel costs are another major cost element for plant operations. Our contracts provide for price adjustments based on inflation. Profitability, however, could be adversely affected by significant increases in market prices for labor, social taxes and benefits or changes in operations requiring additional personnel.
Repairs and maintenance can be a significant cost of the business. Because we assume the responsibility to operate and maintain our desalination plants over a long period of time, we use plant designs and equipment that seek to minimize repairs and maintenance and optimize long-term performance. We may however, from time to time experience equipment failures outside of warranty coverage which could result in significant costs to repair.
Our operations centers in Tampa, Florida and Houston, Texas incur significant selling, general and administrative expenses that are intended to support our plans for future growth. Certain of these expenses, in particular those related to business development, are largely discretionary and not correlated specifically to short-term changes in revenue. Direct engineering cost, including allocated overhead, for personnel at our operations centers are capitalized as a project cost based on hours incurred on active plant construction projects which can change from period to period. The timing of new hires, the utilization of engineering personnel and the spending in these areas may affect the comparability of our results.
Contractually Scheduled and Negotiated Changes to Terms and Conditions
Our Seven Seas Water business is conducted in accordance with the terms of long-term water supply contracts that, among other things, may provide for minimum customer purchases, guaranteed supply volumes and specified levels of pricing based on the volume of water purchased during the billing period. These contractual features are key determinants of plant revenue and plant profitability. Certain of our contracts provide for contractually scheduled price changes. In addition, our contracts may include provisions to increase prices in accordance with a specified inflation index such as the consumer price index. From time to time, we may also negotiate pricing changes with our customers as part of an arrangement to, among other things, extend or renew a contract or increase capacity by expanding the plant.
Revenues and operating income can be expected to decrease, potentially by a significant amount, upon a decrease in contracted services or contract renegotiation, termination or expiration.
Customer Demand and Certain Other External Factors
For our desalination solutions, we design plant capacity to exceed the minimum purchase requirements contained in our contracts to meet anticipated customer needs and maintain sufficient excess capacity. Our customer’s water demand and our ability to meet that demand can vary among quarters and annual periods for a variety of reasons over which we have little control, including:
·
the timing and length of shutdowns of customer facilities or infrastructure due to factors such as equipment failures, power outages, regular scheduled maintenance and severe weather which can adversely affect customer demand;
·
seasonal fluctuations or downturns in the general economy can be expected to adversely affect demand from customers for whom tourism is a significant economic driver, including our municipal or resort customers;
·
economic cycles may affect the industrial customers we serve, especially those in the energy and mining sectors where volatility in commodity prices or consolidation of capacity could adversely affect customer demand;
·
excessive periods of rain or drought can impact primary demand;
·
destruction caused by floods, tropical storms and hurricanes which can impact primary demand as well as cause delays in collections from our customers;
·
the non-renewal of contracts by customers;
·
various environmental factors and natural or man-made conditions impacting the quality of source water, such as bacteria levels or contaminants in source water, can require additional pretreatment thus adding cost and reducing the level of production throughput; and
·
technological advances especially in new filtration technologies, reverse osmosis membranes, energy recovery equipment and energy efficient plant designs may affect future operating performance and the cost competitiveness of our services in the market.
For our wastewater treatment and water reuse solutions, we utilize a modular design that enables us to expand capacity with increasing customer demand. The plants are designed to treat peak volumes of wastewater produced by our customers. Our customer’s demand for our wastewater treatment and water reuse solutions can vary among quarters and annual periods for a variety of reasons over which we have little control, including:
·
individual developers or customers inability to procure funding to initiate building or expanding certain residential developments;
·
residential development specific construction delays such as weather-related delays, changes in specifications or inability of ancillary contractors to preform works;
·
downturns in the general economy and housing market that can decrease demand for new housing developments thus limiting increases in demand for wastewater treatment;
·
replacement of our solutions by a larger, centralized facility or the connecting of customers to a centralized wastewater treatment or water reuse solution; and
·
potential changes in the regulatory environment that could impede development of further decentralized wastewater treatment systems.
Quench
Attracting New Customers
Our performance will be affected by our ability to continue to attract new customers. We believe that the U.S. commercial water cooler market is underpenetrated by POU water filtration, which represented only 11.1% by revenue of a $4.2 billion per year market in 2015. We intend to continue to invest in selling and marketing efforts to attract new customers for our filtered water systems, both within our existing geographic territories and in targeted additional territories in the United States and internationally. Our ability to attract new customers may vary from period to period for several reasons, including the effectiveness of our selling and marketing efforts, our ability to hire and retain salespeople, competitive dynamics, variability in our sales cycle (particularly related to opportunities to serve larger enterprises), the timing of the roll-out of large-enterprise orders and general economic conditions.
Customer Relationships
We believe that our existing customers continue to provide significant opportunities for us to offer additional products and services. In our direct sales channel, these opportunities include the rental of additional or upgraded water coolers, as well as the rental of equipment from our newer product lines enabled by POU water filtration, such as ice machines, sparkling water coolers and coffee brewers. In addition, we expect to invest to grow the sales of consumables associated with our systems, such as coffee and related consumables, and continue to pursue the resale of equipment to dealers, retailers and end customers who prefer to own, rather than lease, their equipment.
Typically, we rent our systems to customers on multi-year, automatically-renewing contracts, and we anticipate extending our relationships with existing customers beyond the initial contract term. Some customers terminate their agreements during the agreement term, typically due to financial constraints, and others cancel at the end of the term. Our annual unit attrition rate at December 31, 2019 was less than 7.5%, implying an average rental period of more than 12 years. Our ability to retain our existing customer relationships will affect our performance and is affected by a number of factors, including the effectiveness of our retention efforts, the quality of our products and service, our pricing, competitive dynamics in the industry, product availability, and the health of the economy. In addition, the non-
recurring revenue from the sale of equipment, coffee and consumables, is less predictable and can change based on fluctuations in demand in a specific period.
Strategic Acquisitions
The POU water filtration industry is highly fragmented, with a large number of local competitors and several larger regional operators. Quench has completed 20 acquisitions since our initial public offering, of which 8 have occurred since the beginning of 2019. We believe our recent acquisition activity is indicative of the opportunity for future inorganic growth.
Through our indirect sales channel, we offer POU systems to networks of approximately 260 dealers and retailers predominantly in North America. The indirect sales channel expands our participation in the growing POU market domestically and internationally. In addition, the channel enhances our ability to develop, source and manufacture innovative, exclusive coolers and purification offerings. Lastly, the channel offers us the opportunity to develop deeper relationships with POU dealers that could lead to future acquisitions.
We expect to continue to pursue select acquisitions to increase our scale, customer density and geographic service area, as well as to increase our participation in the broader international market for POU systems. Our ability to complete acquisitions is a function of many factors, including competition, purchase price and our short-term business priorities. Accordingly, it is impossible to predict whether any current or future discussions will lead to the successful completion of any acquisitions. Since acquisitions are a part of our growth strategy, the inability to complete, integrate and profitably operate acquisitions may adversely affect our operating results.
Changes to Cost of Sales and Operating Expenses
Profitability of our Quench platform will be affected by our ability to control our costs of sales and operating expenses.
A majority of Quench rental agreements are priced at fixed rates for multi-year periods ranging up to four years. As a result, our gross margins are exposed to potential cost of sales increases that cannot be immediately offset by price adjustments. The volume, mix and pricing of equipment and consumables purchased for immediate resale (as opposed to rental) can impact the consistency and comparability of our results. The overall compensation of field service and supply chain support (along with the costs of associated vehicles), may affect our gross margins.
Quench incurs selling, general and administrative costs to support a North American sales force, a widely dispersed installed base of customers, and a high volume of recurring business transactions. A portion of such costs is composed of new customer acquisition costs, such as lead generation expenses, which are expensed upfront and recovered over the periods following the execution of a customer contract and any subsequent renewal. Commissions and other costs that are directly related to the negotiation and execution of leases, considered contract acquisition costs, are capitalized and amortized on a straight-line basis over the contract period. Selling, general and administrative costs also include certain costs to complete business acquisitions, which precede the realization of revenues generated by the acquired new business, and discretionary investments in infrastructure to support our plans for Quench’s future long-term growth. The timing of these expenditures and their impact relative to the revenues generated can affect our performance and comparability of results.
Corporate and Other
Changes to Operating Expenses
We expect to incur increased legal, accounting and other expenses as we pursue our expansion strategy and as a public company, including costs resulting from public company reporting obligations under the Securities Exchange Act of 1934 (the “Exchange Act”), and the listing requirements of the New York Stock Exchange. We anticipate that such operating costs as a percentage of revenue will moderate over the long-term if and as our revenues increase or as a result of certain other corporate activities or projects.
Presentation of Financial Information
We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”). In the preparation of these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. To the extent that there are material differences between these estimates and actual results, our financial condition or operating results would be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below.
Adoption of New Accounting Pronouncements
Under the Jumpstart Our Business Startups Act, or JOBS Act, we meet the definition of an “emerging growth company.” We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act.
In June 2016, the FASB issued authoritative guidance regarding implementation of measurement of credit losses on financial instruments. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. We adopted this guidance on a modified retrospective basis on January 1, 2019 with the cumulative effect of transition as of the effective date of adoption. For a discussion on the impacts of the authoritative guidance on our financial statements, please refer to Note 2-“Summary of Significant Accounting Policies” to the consolidated financial statements, included elsewhere in this Annual Report on Form 10-K.
In March 2019, the FASB issued authoritative guidance regarding targeted changes to lessor accounting. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. We adopted this guidance on a retrospective basis as of January 1, 2019 (the original adoption date of the lease pronouncement). For a discussion on the impacts of the authoritative guidance on our financial statements, please refer to Note 2-“Summary of Significant Accounting Policies” to the consolidated financial statements, included elsewhere in this Annual Report on Form 10-K.
In February 2016, the Financial Accounting Standards Board, or FASB, issued authoritative guidance regarding leases that requires lessees to recognize a lease liability and right of use asset for operating leases, with the exception of short-term leases. In addition, lessor accounting was modified to align, where necessary, with lessee accounting modifications and the authoritative guidance regarding revenue from contracts with customers. During 2018, the FASB issued additional authoritative guidance which, among other things, provided an option to apply transition provisions under the standard at adoption date rather than the earliest comparative period presented as well as added a practical expedient that would permit lessors to not separate non-lease components from the associated lease components if certain conditions are met. These amendments are effective, in conjunction with the new lease standard, for annual reporting periods beginning on or after December 15, 2018, including interim periods within those annual periods.
We adopted this guidance on a modified retrospective basis on January 1, 2019 with the cumulative effect of transition as of the effective date of adoption. For a discussion on the impacts of the authoritative guidance on our financial statements, please refer to Note 2-“Summary of Significant Accounting Policies” to the consolidated financial statements, included elsewhere in this Annual Report on Form 10-K.
New Accounting Pronouncements to be Adopted
In August 2018, the FASB issued authoritative guidance regarding implementation costs incurred in a cloud computing arrangement that is a service contract. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. We adopted this guidance on January 1, 2020 on a prospective basis. Although certain implementation costs we incur going forward may now be capitalizable, there is no material impact expected to the consolidated financial statements as a result of this adoption.
In August 2018, the FASB issued authoritative guidance regarding fair value measurements. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. We adopted this guidance on January 1, 2020 on a prospective basis. Beginning with all periods subsequent to the adoption date, we will prepare the enhanced disclosures within the consolidated financial statements as a result of this adoption.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts in our financial statements. On an ongoing basis, we evaluate our estimates and judgments used. Actual results may differ from these estimates under different assumptions or conditions. In making estimates and judgments, management employs critical accounting policies.
Our significant accounting policies are discussed in Note 2-“Summary of Significant Accounting Policies” to the Consolidated Financial Statements, included elsewhere in this Annual Report on Form 10-K. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.
Leases
Lessee accounting
We lease space and operating assets, including offices, office equipment, warehouses, storage yards and storage units under non-cancelable operating leases. We account for these leases in accordance with the authoritative guidance adopted as of January 1, 2019. Please see “Adoption of New Accounting Pronouncements” section above for information regarding this adoption.
At contract inception, we determine if an arrangement is or contains a lease. If the arrangement contains a lease, we recognize a right-of-use asset and an operating lease liability at the lease commencement date. Lease expense for lease payments made is recognized on a straight-line basis over the lease term.
The operating lease liability is initially measured at the present value of the unpaid lease payments at the lease commencement date. The current portion of our operating lease liabilities are recorded within accrued liabilities in the consolidated balance sheets.
The right-of-use asset is initially measured at cost, which is comprised of the initial amount of the operating lease liability adjusted for lease payments made at or before the lease commencement date, plus any initial direct costs incurred less any lease incentives received. The right-of-use asset is subsequently measured throughout the lease term at the carrying amount of the operating lease liability, plus initial direct costs, plus (minus) any prepaid (accrued) lease payments, less the unamortized balance of lease incentives received. Right-of-use assets are periodically reviewed for impairment whenever events or changes in circumstances arise.
Key estimates and judgments in determining both the operating lease liability and right-of-use asset include the determination of (i) the discount rate it uses to discount the unpaid lease payments to present value, (ii) the lease term and (iii) the lease payments.
The discount rate applied to the unpaid lease payments is the interest rate implicit in the lease or, if that rate cannot be readily determined, our incremental borrowing rate. Generally, we cannot determine the interest rate implicit in the lease because we do not have access to the lessor’s estimated residual value or the amount of the lessor’s deferred initial direct costs. Therefore, we generally derive an incremental borrowing rate as the discount rate for the lease. Our incremental borrowing rate for a lease is the rate of interest we would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms.
The lease term for all of our leases includes the noncancelable period of the lease, plus any additional periods covered by either our option to extend (or not to terminate) the lease that we are reasonably certain to exercise, and/or an option to extend (or not to terminate) the lease controlled by the lessor.
Lease payments included in the measurement of operating lease liabilities are comprised of the following:
·
fixed payments;
·
variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date; and
·
the exercise price of our option to purchase the underlying asset if we are reasonably certain to exercise the option.
In certain instances, our leases include non-lease components, such as equipment maintenance or common area maintenance. As part of its adoption of authoritative guidance on leases on January 1, 2019, we have not elected the practical expedient to account for the lease and non-lease components as a single lease component and have elected (for all classes of underlying assets) to account for these components separately. We have allocated the consideration in the contract to the lease and non-lease components based on each component's relative standalone price. We determine standalone prices for the lease components based on the prices for which other lessors lease similar assets on a standalone basis. We determine standalone prices for the non-lease components based on the prices that suppliers might charge for those type of services on a standalone basis. If observable standalone prices are not readily available, we estimate the standalone prices maximizing the use of observable information.
We have elected to utilize the short-term lease exemption and not recognize a right-of-use asset and corresponding operating lease liability for leases with expected terms of 12 months or less. We recognize the lease payments associated with its short-term leases on a straight-line basis over the lease term.
Lessor accounting
We generate revenues through the lease of our bulk water facilities, wastewater treatment and water reuse equipment, and filtered water and related systems equipment to customers. In certain instances, we enter into a contract with a customer but must construct the underlying asset, including bulk water facilities and wastewater treatment and water reuse equipment, prior to its lease.
At the time of contract inception, we determine if an arrangement is or contains a lease.
Customer contracts that contain leases, which can be explicit or implicit in the contract, are generally classified as either operating leases or sales-type leases and can contain both lease and non-lease components, including operating and maintenance services (“O&M”) of the Company-owned equipment. As part of our adoption of authoritative guidance on leases on January 1, 2019, we elected the practical expedient for all classes of underlying assets to not separate the lease and non-lease components if certain conditions are met, including the classification of the lease component as operating and the revenue recognition pattern of both the lease and non-lease components. We will account for the contract with the customer as a combined component under the respective authoritative guidance for the predominant element in the contract, the lease or non-lease component.
For leases classified as sales-type leases, we allocate the transaction price based on the relative standalone selling prices of the identified performance obligations.
If the customer contract contains or is accounted for as a lease, the key estimates and judgments used in accounting for the lease as a lessor include the following: (i) lease term, (ii) the economic life of the underlying leased
asset, (iii) determination of lease payments and (iv) determination of the fair value at the time of contract inception and the residual value of the underlying leased asset.
The lease term for all of our leases includes the noncancelable period of the lease, plus any additional periods covered by either a lessee option to extend (or not to terminate) the lease that the lessee is reasonably certain to exercise, and/or an option to extend (or not to terminate) the lease controlled by us. Contracts entered into with customers can include either the option to renew or an auto-renewing provision that results in the automatic extension of the existing contract. In certain instances, key provisions such as the lease payment and term of the renewal are not stated and are subject to renewal.
The economic life of the underlying leased asset is determined to be either the period over which the asset is expected to be economically usable, or where the benefits it can produce exceed the cost to replace or undertake major repairs. In certain instances, the economic life of the underlying leased asset can exceed the useful life we assign.
Lease payments that are accounted for as rental revenue are comprised of the following:
·
fixed payments;
·
variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date;
·
the exercise price of a lessee option to purchase the underlying asset if the lessee is reasonably certain to exercise the option; and
·
payments for penalties for the termination of a lease if the term reflects the lessee terminating the lease.
Our leases do not typically include a requirement for the customer to guarantee the residual value of the underlying leased asset. Variable lease payments that do not depend on an index or rate are excluded from the determination of lease payments.
The fair value of the underlying leased asset at contract inception and residual value of underlying leased asset at the end of the term of the lease are determined based on the price that would be received to sell an asset in an orderly transaction at the time of valuation. Our risk management strategy for protecting the residual value of the underlying assets include our ongoing maintenance during the lease term as well as clauses and other protections within the lease agreements which require the lessee to return the underlying asset in working condition at the end of the lease term.
At contract inception, we determine the lease classification of the underlying asset. We consider inputs such as the lease term, lease payments, fair value of the underlying asset and residual value of the underlying asset when assessing the classification. The discount rate applied to the unpaid lease payments is the interest rate implicit in the lease. The rate implicit in the lease is the rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that the we expect to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized and (2) any deferred initial direct costs we incur.
In certain instances, contracts with customers may also include the option for the customer to purchase the underlying asset at the end of the lease term. When applicable and certain conditions are met, we will incorporate the stated purchase price into the determination of the interest rate implied in the lease.
Recoverable Amount of Goodwill and Intangible Assets
Goodwill represents the excess of the aggregate purchase price over the fair value of the net assets acquired in a business combination. Goodwill associated with our business combinations has been and is expected to continue increasing in the future as further acquisitions are completed. Goodwill is reviewed for impairment at least annually in the fourth quarter and more frequently if a change in circumstances or the occurrence of events indicates that potential impairment exists. We first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, we perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test is optional.
Under the quantitative analysis, the recoverability of goodwill is measured at each reporting unit by comparing the reporting unit’s carrying amount, including goodwill, to the fair market value of the reporting unit. We determine the fair market value of our reporting units based on a weighting of the present value of projected future cash flows, which we refer to as the Income Approach, and a comparative market approach under both the guideline company method and guideline transaction method, which we refer to as the Market Approach. Fair market value using the Income Approach is based on our estimated future cash flows on a discounted basis. The Market Approach compares each of our reporting units to other comparable companies based on valuation multiples derived from operational and transactional data to arrive at a fair value. Factors requiring significant judgment include, among others, the determination of comparable companies, assumptions related to forecasted operating results, discount rates, long-term growth rates, and market multiples. Changes in economic or operating conditions, or changes in our business strategies, that occur after the annual impairment analysis and which impact these assumptions, may result in a future goodwill impairment charge, which could be material to our consolidated financial statements.
In determining its reporting units, the Company reviews its operating segments to determine the number of components within each segment. If an operating segment contains only a single component, the operating segment is deemed a reporting unit. If an operating segment contains more than one component, the Company aggregates into a single reporting unit those components determined to have similar economic characteristics. Components determined to have dissimilar economic characteristics are considered a separate reporting unit. As of both December 31, 2019 and 2018, the Quench segment was determined to be composed of a single reporting unit. As of both December 31, 2019 and 2018, the Seven Seas Water segment was determined to be composed of two reporting units.
For the 2019 and 2018 goodwill impairment assessments, we performed a qualitative assessment of each reporting unit that existed at the time of the impairment assessment. Based upon the qualitative assessments, it was determined that there was substantial evidence that it was more likely than not that the fair value for each reporting unit were more than the carrying values. As such, no quantitative assessment was deemed necessary.
Other intangible assets consist of certain trade names, customer relationships and non-compete agreements. Intangible assets which have a finite life are amortized over their estimated useful lives on a straight-line basis. Customer relationships which have a finite life are amortized on an accelerated basis based on the projected economic value of the asset over its useful life. Intangible assets with a finite life are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Indefinite-lived intangible assets, which consist of certain trade names, are not amortized but are tested for impairment at least annually or more frequently if events or circumstances indicate the asset may be impaired. No impairment was recorded during the years ended December 31, 2019 and 2018.
Business Combinations
In accordance with accounting for business combinations, we allocate the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill.
Our purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates.
The valuation of net assets acquired in a business combination determines the allocation of purchase price to specific assets and the subsequent recognition of expense. A change in our estimate of the value assigned to intangibles or a change in our estimate of useful life for the intangibles could impact the amount of amortization expense recorded in any period. A 10% change in the amortization expense recorded for the year ended December 31, 2019 would have impacted our pre-tax net loss by approximately $2.3 million.
If an acquisition does not meet the definition of a business combination, then we account for the transaction as an asset acquisition. In an asset acquisition, goodwill is not recognized, but rather any excess consideration transferred over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable net assets. In addition, transaction-related expenses are capitalized and allocated to the net assets acquired on a relative fair value basis.
Share-Based Compensation
We account for share-based compensation by measuring the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. The cost is recognized over the requisite service period, net of adjustments for forfeitures as they occur.
We have several equity award plans, including plans which were established prior to the corporate reorganization and IPO and one which became effective upon the effectiveness of the IPO. See Note 12-“Share-based Compensation” in the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a complete discussion on all our equity award plans.
We expense the fair value of share-based compensation awards over the requisite service period, which is typically the vesting period. The expense is then adjusted for forfeitures as they occur. We estimate the grant date fair value of options and other equity awards with hurdle rates using the Black-Scholes option-pricing model that requires management to apply judgment and make estimates, including:
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expected volatility, which is calculated based on reported volatility data for a representative group of publicly traded companies for which historical information is available. Because we only recently completed our IPO, we have continued to use an average of expected volatility based on the volatilities of a representative group of publicly traded companies for a period approximating the expected term of the grant;
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the risk-free interest rate, which is based on the U.S. Treasury yield curve in effect on the date of grant commensurate with the expected term assumption;
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expected term, which we calculate using the simplified method, as we have insufficient historical information regarding our equity awards to provide a basis for an estimate;
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fair value of the underlying securities, which is determined using the option-pricing model or by reasonably contemporaneous arm’s length transactions prior to our IPO and closing prices as reported by the New York Stock Exchange on or after the IPO; and
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dividend yield, which is zero based on the fact that we never paid cash dividends and do not expect to pay any cash dividends in the foreseeable future.
Prior to our IPO, there were significant judgments and estimates inherent in the determination of the fair value of our shares. These judgments and estimates included assumptions regarding our future operating performance, the time to completing an initial public offering, or other liquidity event, the related company valuations associated with such events, and the determinations of the appropriate valuation methods. If we had made different assumptions, our share-based compensation expense and net loss could have been significantly different. A 10% change in share-based compensation expense recorded for the year ended December 31, 2019 would have impacted our pre-tax net loss by approximately $0.5 million.
Income Taxes
We account for income taxes using the asset and liability approach to the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We are required to exercise judgment with respect to the realization of our net deferred tax assets. Management evaluates all positive and negative evidence and exercises judgment regarding past and future events to determine if it is more likely than not that all or some portion of the deferred tax assets may not be realized. If appropriate, a valuation allowance is recorded against deferred tax assets to offset future tax benefits that
may not be realized. We evaluate tax positions that have been taken or are expected to be taken in our tax returns, and we record a liability for uncertain tax positions. We use a two-step approach to recognize and measure uncertain tax positions. First, tax positions are recognized if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon examination, including resolution of related appeals or litigation processes, if any. Second, tax positions are measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement. We recognize interest and penalties related to unrecognized tax benefits in the provision for income taxes in the accompanying consolidated financial statements.
AquaVenture Holdings Limited is incorporated in the British Virgin Islands, which does not impose income taxes. Certain of our subsidiaries file separate tax returns and are subject to federal income taxes at the corporate level in the United States or in foreign jurisdictions. Certain other subsidiaries operate in jurisdictions that do not impose taxes based on income.
Various internal and external factors may have favorable or unfavorable, material or immaterial effects on our effective income tax rate and therefore, impact net income and earnings per share. These factors include, but are not limited to changes in tax rates; changes in tax laws, regulations and rulings; changes in interpretations of existing laws, regulations and rulings; changes in the evaluation of our ability to realize deferred tax assets, and changes in accounting principles; changes in current pre-tax income as well as changes in forecasted pre-tax income; changes in the mix of earnings among countries with different tax rates; and acquisitions and changes in our corporate structure. These factors may result in periodic revisions to our effective income tax rate, which could affect our cash flow and results of operations. We recorded a valuation allowance of $28.5 million as of December 31, 2019 related primarily to net operating losses.
A 0.50% change in our effective income tax rate would have impacted our net loss for the year ended December 31, 2019 by approximately $0.1 million.
Results of Operations
We have omitted discussion of the earliest of the three years covered by our consolidated financial statements presented in this report because that disclosure was already included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as amended. You are encouraged to reference Part II, Item 7, within that report, as amended, for a discussion of our financial condition and result of operations for the year ended December 31, 2017 compared to the year ended December 31, 2018.
The operating expenses of the parent, AquaVenture Holdings Limited, are reported separately from the two operating and reportable segments below. See “Operating Segments” located in the “Overview” section above for more information.
The following table sets forth the components of our consolidated statements of operations and comprehensive income for each of the periods presented.
The following table sets forth the components of our consolidated statements of operations and comprehensive income for each of the periods presented as a percentage of revenue.
Comparison of Year Ended December 31, 2019 and 2018
Revenues
The following table presents revenue for each of our two operating segments:
Our total revenues of $203.5 million for the year ended December 31, 2019 increased $57.9 million, or 39.7%, from $145.6 million for the year ended December 31, 2018 through a combination of organic and inorganic growth. In calculating organic and inorganic revenue growth, (i) organic growth represents estimated revenue from operations that existed in both the current and comparable periods, and (ii) inorganic growth includes the estimated revenue from acquisitions for the 12 months following an acquisition and any revenue contributions from divested businesses for the months in the prior year period in which the business did not exist in the current year period.
Seven Seas Water revenues for the year ended December 31, 2019 increased $21.9 million, or 33.0%, compared to the same period of 2018, which were comprised of 31.2% inorganic growth and 1.8% organic growth. Bulk water revenues increased $3.2 million, or 5.6%, compared to the prior year period, primarily due to: (i) increases of $1.4 million from our USVI operations and $0.7 million from our St. Maarten operations due to higher production volumes compared to the same period of 2018; (ii) an increase of $1.3 million in connection with the commencement of our water contract in Anguilla; and (iii) an increase of $0.4 million in our BVI operations driven by increases in the water rate compared to the prior year. This was partially offset by $0.3 million lower revenue in our Peru operations primarily due to revenue received in the prior year in connection with non-routine services performed for the customer. Rental revenues and product sales increased $12.5 million and $6.6 million, respectively, primarily due to the inclusion of the AUC operations which were acquired in November 2018.
Quench revenues for the year ended December 31, 2019 increased $36.0 million, or 45.4%, compared to the same period of 2018, which were comprised of 31.8% of inorganic growth and 13.6% organic growth. The prior year period included $3.5 million of revenue from the Atlas High Purity Solutions business that was divested in October 2018. Rental revenues increased $17.6 million, or 28.4%, compared to the prior year period, which was comprised of 20.5% inorganic net growth from acquisitions and 7.9% of organic growth due to additional units placed under new leases in excess of unit attrition. Product sales increased $18.4 million compared to the prior year, which included $12.8 million of inorganic net growth primarily due to the acquisitions of PHSI and Bluline in December 2018, and $5.6 million of organic growth driven by higher indirect dealer equipment sales and coffee sales.
Gross margin
The following table presents the major components of cost of revenues, gross profit and gross margin for our two operating segments:
Total gross margin for the year ended December 31, 2019 decreased 210 basis points to 51.1% from 53.2% in the prior year period.
Seven Seas Water gross margin for the year ended December 31, 2019 decreased 170 basis points to 54.0% compared to 55.7% in the prior year. Bulk water gross margin of 54.2% increased 50 basis points compared to 53.7% in the prior year primarily due to higher revenues in our BVI and USVI operations without a commensurate increase in costs. This was partially offset by a decrease in gross margin at our Trinidad operations due to a depreciation expense adjustment in the prior year in connection with a purchase price refund received on in-service equipment. Rental gross margin of 67.0% decreased from 74.7% in the prior year primarily due to additional depreciation expense on property, plant and equipment related to the finalization of purchase accounting for the AUC acquisition. Product sales gross margin of 15.0% decreased from 17.5% in the prior year period primarily due to higher contributions from lower-margin contracts compared to the prior year.
Quench gross margin for the year ended December 31, 2019 decreased 240 basis points to 48.8% from 51.2% for the same period of 2018. Rental gross margin of 52.7% decreased from 55.7% in the prior year, primarily due to an increase in depreciation and amortization expense as a percentage of revenue related to additional units placed on lease, partially offset by lower compensation and benefits as a percentage of revenues due to continued leveraging of the platform. Product sales gross margin increased to 40.2% for the year ended December 31, 2019 from 35.0% in the prior year, primarily driven by the higher-margin indirect PHSI dealer equipment sales.
Selling, general and administrative expenses
The following table presents selling, general and administrative, or SG&A, expenses for our operating segments:
Total SG&A expenses for the year ended December 31, 2019 increased $12.3 million, or 14.8%, compared to the same period of 2018.
Seven Seas Water SG&A expenses for the year ended December 31, 2019 decreased $5.2 million to $25.0 million compared to the prior year, which was primarily due to (i) a decrease of $4.4 million in share-based compensation expense driven by the completion of the vesting of certain equity grants made in connection with our initial public offering in 2016, (ii) a $3.0 million net gain on sale of property, plant and equipment primarily in connection with our customer in Curaçao exercising its right to purchase the desalination facilities pursuant to the water supply agreement, and (iii) $1.6 million of lower professional fees primarily due to elevated costs in the prior year related to the acquisition of the AUC operations in November 2018. Partially offsetting this decrease was an increase of $3.2 million in amortization expense of definite lived intangible assets and $0.3 million higher compensation and benefits expense primarily due to the acquisition of the AUC operations in November 2018. Seven Seas Water SG&A expenses as a percentage of revenue were 28.3% for the year ended December 31, 2019, a decline compared to 45.4% for the same period of 2018.
Quench SG&A expenses for the year ended December 31, 2019 increased $10.9 million to $59.6 million compared to the prior year. The increase was driven by $6.5 million higher amortization expense primarily related to an increase in intangible assets from recent acquisitions, $4.1 million higher compensation and benefits primarily driven by increased headcount from the inclusion of staff added from certain acquisitions and a $1.3 million increase in general expenses primarily to support the expansion of our operations. Partially offsetting this increase was $1.5 million lower acquisition-related expenses and $0.8 million lower restructuring costs primarily incurred in connection with the PHSI acquisition in December 2018, and a $1.4 million decrease in share-based compensation expense driven by the completion of the vesting of certain equity grants made in connection with our initial public offering in 2016. Quench SG&A expenses as a percentage of revenue were 51.7% for the year ended December 31, 2019, a decline compared to 61.5% for the same period of 2018.
Corporate and Other SG&A expenses for the year ended December 31, 2019 increased $6.6 million to $11.4 million compared to the same period of 2018, which was driven by $6.6 million of expenses incurred in connection with the definitive merger agreement entered into in December 2019.
Commencing on December 18, 2018, the Company initiated a restructuring of the PHSI organization which included the reduction of headcount for PHSI executive management and other employee positions determined to be duplicative with those at Quench (the “PHSI Restructuring Plan”). Certain of the positions were backfilled with additional positions at Quench depending on the needs of the business. The expected net effect of the restructuring allowed Quench to recognize synergies of reduced employee costs subsequent to the PHSI Acquisition. The restructuring was determined to be a post-combination transaction. During the years ended December 31, 2019 and 2018, the Company incurred an incremental restructuring-related charge related to severance, termination benefits and related taxes of $0.1 million and $0.9 million, respectively, which was recorded within SG&A expenses in the consolidated statements of operations and comprehensive income. As of December 31, 2019 and 2018, the Company had accrued approximately $0 and $0.8 million, respectively, within accrued liabilities on the consolidated balance sheets. The Company completed the PHSI Restructuring Plan during the second quarter of 2019.
Other expense
Interest expense, net for the year ended December 31, 2019 increased $10.3 million compared to the prior year. The increase was primarily due to incremental borrowings of $150 million in connection with expansion of our senior secured credit agreement in November and December 2018.
Other expense, net for the year ended December 31, 2019 decreased $0.4 million compared to the prior year period primarily due to $0.2 million of loss recorded in the prior year related to the divestiture of the Atlas High Purity Solutions business and $0.1 million of gain on foreign currency transactions during 2019 as compared to 2018.
Income tax expense (benefit)
We operate through multiple legal entities in a variety of domestic and international jurisdictions, some of which do not impose an income tax. Within these jurisdictions, our operations generate a mix of income and losses, which cannot be offset when calculating income tax expense or benefit for each legal entity. Income tax benefits are not recorded for losses generated in jurisdictions where either the jurisdictions do not impose an income tax, or we do not believe it is more likely than not that we will realize the benefit of such losses.
For the year ended December 31, 2019, we incurred a consolidated pre-tax loss of $17.9 million, which was composed of: (i) an aggregate of $26.0 million of pre-tax losses in jurisdictions which either do not impose an income tax or we do not believe it is more likely than not that we will realize the benefit of such losses and (ii) an aggregate of $8.1 million of pre-tax income in taxable jurisdictions. For the year ended December 31, 2018, we incurred a consolidated pre-tax loss of $22.0 million, which was composed of: (i) an aggregate of $29.3 million of pre-tax losses in jurisdictions which either do not impose an income tax or we do not believe it is more likely than not that we will realize the benefit of such losses and (ii) an aggregate of $7.3 million of pre-tax income in taxable jurisdictions.
Income tax (benefit) expense for the years ended December 31, 2019 and 2018 was $2.2 million and $(1.3) million, respectively. Income tax expense for the years ended December 31, 2019 and 2018 were composed of a current tax of $3.2 million and $2.0 million, respectively, and deferred tax (benefit) expense of $(1.0) million and $(3.3) million, respectively. The increase in income tax expense for the year ended December 31, 2019 as compared to the same period
in 2018 was primarily the result of the recognition $3.4 million tax benefit recorded in the prior year for the full release of a valuation allowance on deferred tax assets in one of our foreign jurisdictions, a gain recorded on the sale of assets in Curacao and an increase in current expense related to withholding taxes. These increases were partially offset by a decrease in income tax expense for our other jurisdictions due to lower taxable income in certain tax paying jurisdictions.
Cash paid for income taxes was $2.3 million and $1.9 million during the years ended December 31, 2019 and 2018, respectively.
Liquidity and Capital Resources
Overview
As of December 31, 2019 and 2018, our principal sources of liquidity on a consolidated basis were cash and cash equivalents of $103.3 million and $56.6 million, respectively (excluding restricted cash), which were held for working capital, investment and general corporate purposes. In addition, as of both December 31, 2019 and 2018, we had an aggregate of $4.2 million of restricted cash related to debt service reserve funds and minimum balance requirements for one of our borrowings. See Note 2-“Summary of Significant Accounting Policies-Restricted Cash” to the Consolidated Financial Statements, included elsewhere in this Annual Report on Form 10-K. Our working capital as of December 31, 2019 was $115.2 million compared to $64.6 million as of December 31, 2018.
In July 2019, we completed an underwritten sale of 4.7 million ordinary shares at a public offering price of $16.88 per share. We received net proceeds of $75.4 million, after deducting underwriting discounts and commissions and offering expenses.
Our cash and cash equivalents are held by our holding company and our subsidiaries primarily in demand deposits with domestic and international banks, money market accounts, and U.S. Treasury bills. We utilize a combination of equity financing and corporate and project debt financing through international commercial banks and other financial institutions to fund our cash needs and the growth of our business. Our debt financing arrangements contain financial covenants and provisions which govern distributions by the borrowers may limit our ability to transfer cash among us and our subsidiaries. See Note 10-“Long-Term Debt-Restricted Net Assets” to the Consolidated Financial Statements, included elsewhere in this Annual Report on Form 10-K, for a summary of limitations applicable to us and our subsidiaries as of December 31, 2019. Based on our current level of operations, we believe our cash flow from operations and available cash will be adequate to meet the future liquidity needs of our current operations for at least the next twelve months.
Our expected future liquidity and capital requirements consist principally of:
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capital expenditures and investments in infrastructure under concession arrangements related to maintaining or expanding our existing operations;
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development of new projects and new markets;
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inventory;
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acquisitions;
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costs and expenses relating to our ongoing business operations; and
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debt service requirements on our existing and future debt.
Our ability to meet our debt service obligations and other capital requirements, including capital expenditures, as well as future acquisitions, will depend on our future operating performance which, in turn, will be subject to general economic, financial, business, competitive, legislative, regulatory and other conditions, many of which are beyond our control.
We may in the future be required to seek additional equity or debt financing to meet these future capital and liquidity requirements. If additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired or needed, our business, operating results, cash flow and financial condition would be adversely affected. We currently intend to use our available funds and any future cash flow from operations for the conduct and expansion of our business, debt service requirements and general corporate purposes.
Subsidiary Distribution Policy
A significant portion of our cash flow is provided by operations from our principal operating subsidiaries and borrowings made at the corporate level.
With respect to our Seven Seas Water segment, unless cash balances are expected to be redeployed for further growth opportunities in the same jurisdiction, our distribution policy is to efficiently distribute cash from our international operating subsidiaries to our non-U.S. intermediate holding companies for redeployment in the manner intended to optimize our return on invested capital. However, one of our subsidiaries, as of December 31, 2019, has a loan agreement that restricts distributions to related parties in the event certain financial or nonfinancial covenants are not met, which could reduce our ability to redeploy cash. Distributions are typically in the form of principal and interest payments on intercompany loans, repayment of intercompany advances or other intercompany arrangements, including billings from our Tampa operations center, and dividends. When considering the amount and timing of such distributions, our Seven Seas Water operating subsidiaries must maintain sufficient funds for future capital investment, debt service and general working capital purposes.
With respect to our Quench operating segment, our current intent is for Quench to retain cash for working capital, investment for future growth within the segment and for future debt repayment.
Although the governing boards of our subsidiaries have discretion over intercompany dividends or other future distributions, the form, frequency and amount of such distributions will depend on our subsidiaries’ future operations and earnings, capital requirements and surplus, general financial condition, contractual requirements of our lenders, tax considerations and other factors that may be deemed relevant.
Cash Flows
The following table summarizes our cash flows for the following periods:
Operating Activities
The significant variations of cash provided by operating activities and net losses are principally related to adjustments to eliminate non-cash and non-operating charges including, but not limited to, amortization, depreciation, share-based compensation, changes in the deferred income tax provision, charges related to the disposal of assets and impairment charges. The largest source of operating cash flow is the collection of trade receivables and our largest use of cash flows is the payment of costs associated with revenue and SG&A expenses.
Cash provided by operations during the years ended December 31, 2019 and 2018 was $31.0 million and $26.9 million, respectively. The increase in cash flow from operations was primarily due to overall higher operating cash inflows driven by the large acquisitions in late 2018 which was partially offset by higher cash interest expense related to incremental borrowings of $150 million in connection with the expansions of our senior secured credit agreement in November and December 2018.
Investing Activities
Cash used in investing activities during the years ended December 31, 2019 and 2018 was $52.5 million and $214.6 million, respectively. The decrease in cash used in investing activities was primarily attributable to a decrease of $178.8 million of net cash paid for acquisitions during the year ended December 31, 2019 as compared to the prior year period. This was partially offset by an increase of $17.0 million in capital expenditures during the year ended December 31, 2019 as compared to the prior year period.
During the year ended December 31, 2019, net cash paid for acquisitions was $19.7 million as compared to $198.5 million for the year ended December 31, 2018. For the years ended December 31, 2019 and 2018 there were $21.0 million and $3.5 million, respectively, of capital expenditures by Seven Seas Water primarily for new plants, plant expansions and capacity upgrades and $15.6 million and $16.1 million, respectively, of capital expenditures for Quench primarily to support existing operations.
Capital Expenditures on Fixed Assets and Investments in Long-Lived Assets
For Seven Seas Water, our primary capital expenditures are composed of construction costs of our plants, including engineering, procurement and construction and equipment costs, internal direct labor and project development costs, which include engineering and environmental studies, permitting and licensing and certain legal costs. Major repairs and maintenance, which improve the efficiency or extend the life of our operating plants, are also included in capital expenditures. In addition to our contractually committed capital expenditures, we routinely explore project investment opportunities in our current and new geographic locations and business lines if we believe that any of the opportunities has the potential to meet our internal investment criteria. In the course of pursuing these investment opportunities, we may successfully bid on projects or operating plants that will require additional capital expenditures. For Quench, our primary capital expenditures are the acquisition of POU systems and related assets as well as typical capital expenditures for leasehold improvements, furniture and fixtures, computers, field tablets and software.
For the fiscal year 2020, we expect to invest approximately $27 million across our Seven Seas Water and Quench segments in capital expenditures, primarily to support growth opportunities. We expect that these investments will be financed through existing cash and cash generated from operations.
Significant 2019 Acquisitions
On June 1, 2019, we completed the acquisition of Aguaman for an aggregate purchase price of $1.5 million. On July 15, 2019, we completed the acquisition of Carolina Pure for an aggregate purchase price of $7.3 million. On October 1, 2019, we completed the acquisition of Mirex for an aggregate purchase price of $11.6 million.
Financing Activities
Cash provided by financing activities during the years ended December 31, 2019 and 2018 was $68.2 million and $126.1 million, respectively. The $57.8 million net decrease in cash provided by financing activities was primarily attributable to a decrease of $150.0 million of net proceeds from long-term debt related to incremental borrowings in connection with the expansions of our senior secured credit agreement in November and December 2018. This decrease was partially offset by net proceeds of $75.4 million received in connection with issuance of 4.7 million ordinary shares at a public offering price of $16.88 per share in July 2019.
As of December 31, 2019 and 2018, long-term debt included the following (in thousands):
Corporate Credit Agreement
On August 4, 2017, AquaVenture Holdings Limited, AquaVenture Holdings Peru S.A.C., an indirect wholly-owned subsidiary of the Company, and Quench USA, Inc., a wholly-owned subsidiary of the Company, (collectively the “Borrowers”) entered into a $150.0 million senior secured credit agreement (the “Corporate Credit Agreement”) with a syndicate of lenders. The Corporate Credit Agreement is non-amortizing, matures in August 2021, at the time it was incurred, bore interest at LIBOR plus 6.0% with a LIBOR floor of 1.0%. Interest only payments are due quarterly with principal due in full upon maturity.
On November 17, 2017, the Corporate Credit Agreement was amended to convert the interest rate applicable to 50% of the then-outstanding principal balance, or $75.0 million, from a variable interest rate of LIBOR plus 6.0% with a LIBOR floor of 1.0% to a fixed rate of 8.2%. The remaining 50% of the then-outstanding principal balance, of $75.0 million, continued to bear interest at LIBOR plus 6.0% with a LIBOR floor of 1.0%. All other material terms of the original credit agreement remained substantially unchanged.
On August 28, 2018, the Corporate Credit Agreement was amended to modify certain agreement definitions and non-financial covenants. All other material terms of the original credit agreement remained substantially unchanged.
On November 1, 2018, the Corporate Credit Agreement was amended (“Amended Corporate Credit Agreement”) to: (i) add AquaVenture Holdings Inc., a wholly-owned subsidiary of the Company, as a borrower under the Amended Corporate Credit Agreement, (ii) increase our net borrowings by $110.0 million to an aggregate principal amount of $260.0 million, (iii) reduce the interest rate for the original $150.0 million borrowings by 50 basis points on both the variable and fixed interest portions and (iv) amend certain financial covenant requirements. Of the incremental net borrowing of $110.0 million, $70.0 million bears interest at a variable rate of LIBOR plus 5.5% with a LIBOR floor of 1.0%, and the remaining $40.0 million bears interest at a fixed rate of 8.7%. In the aggregate, including the aforementioned interest rate reduction, $145.0 million of borrowings bear interest at a variable rate of LIBOR plus 5.5% with a LIBOR floor of 1.0% and the remaining $115.0 million of borrowings bear interest at a weighted average fixed rate of 8.0%. A declining prepayment fee on the incremental borrowing was due upon repayment if it occurred prior to November 1, 2019. All other material terms of the Amended Corporate Credit Agreement remained substantially unchanged.
On December 20, 2018, the Corporate Credit Agreement was amended to increase its borrowings by $40.0 million to an aggregate principal amount of $300.0 million. The incremental borrowings bear interest at a variable rate of LIBOR plus 5.5% with a LIBOR floor of 1.0%. A prepayment fee on the incremental borrowing, which declines over time, was due upon repayment if it occurred prior to December 20, 2019. These additional borrowings are non-amortizing and mature in August 2021. All other terms of the Corporate Credit Agreement remained substantially unchanged.
On December 10, 2019, the Corporate Credit Agreement was amended to modify certain covenants. All other material terms of the original credit agreement remained substantially unchanged.
As of December 31, 2019, the weighted average interest rate was 7.7%.
The Corporate Credit Agreement is guaranteed by AquaVenture Holdings Limited along with certain subsidiaries and contains financial and nonfinancial covenants. The financial covenants include minimum interest coverage ratio and maximum leverage ratio requirements, as defined in the Corporate Credit Agreement, and are calculated using consolidated financial information of AquaVenture Holdings Limited excluding the results of AquaVenture (BVI) Holdings Limited and its subsidiary Seven Seas Water (BVI) Limited. In addition, the Corporate Credit Agreement contains customary negative covenants limiting, among other things, indebtedness, investments, liens, dispositions of assets, restricted payments (including dividends), transactions with affiliates, prepayments of indebtedness, capital expenditures, changes in nature of business and amendments to documents. As of December 31, 2019, we were in compliance with, or received waivers for breaches of, all such covenants.
We may prepay in whole or in part, the outstanding principal and accrued unpaid interest under the Corporate Credit Agreement. The prepayment fee requirement has expired on the original $150.0 million borrowing. The Corporate Credit Agreement is collateralized by certain of the assets of the Borrowers and stated guarantors.
BVI Loan Agreement
In connection with our acquisition of the capital stock of Biwater (BVI) Holdings Limited in June 2015, we inherited the $43.0 million credit facility of its subsidiary, Seven Seas Water (BVI) Ltd., arranged by a bank (the “BVI Loan Agreement”). The BVI Loan Agreement closed on November 14, 2013 and was arranged to finance the construction of the 2.8 million GPD desalination facility at Paraquita Bay in Tortola, BVI and other contractual obligations. The BVI Loan Agreement is project financing with recourse only to the stock, assets and cash flow of Seven Seas Water (BVI) Ltd. The BVI Loan Agreement is guaranteed by the United Kingdom Export Finance. As of the acquisition date of June 11, 2015, $40.8 million remained outstanding. In addition, approximately $820 thousand remained available for draw through October 2016. The BVI Loan Agreement was amended on May 7, 2014 and June 11, 2015 to reflect extensions in milestone dates and our acquisition of Seven Seas Water (BVI) Ltd. The BVI Loan Agreement is collateralized by all shares and underlying assets of Seven Seas Water (BVI) Ltd.
Prior to the amendment on August 4, 2017, the BVI Loan Agreement provided for interest on the outstanding borrowings at LIBOR plus 3.5% per annum and interest was paid quarterly. The loan principal is repayable quarterly beginning in March 31, 2015 in 26 quarterly installments that escalate over the term of the loan.
On August 4, 2017, Seven Seas Water (BVI) Ltd. further amended the BVI Loan Agreement to extend the amortization on principal to May 2022 and reduce the spread applied to the LIBOR base rate used in the calculation of interest by 50 basis points to LIBOR plus 3.0% per annum. The United Kingdom Export Finance also extended its participation in the project to match the extended term of the amended BVI Loan Agreement. All other material terms of the original loan agreement remained unchanged.
As of December 31, 2019, the weighted-average interest rate was 5.1%. Seven Seas Water (BVI) Ltd. may prepay the principal amounts of the loans prior to the maturity date, in whole or in part.
The BVI Loan Agreement includes both financial and nonfinancial covenants, limits the amount of additional indebtedness that Seven Seas Water (BVI) Ltd. can incur and places annual limits on capital expenditures for this subsidiary. The BVI Loan Agreement also places restrictions on distributions made by Seven Seas Water (BVI) Ltd. which is only permitted to make distributions to shareholders and affiliates of AquaVenture Holdings Limited if specified debt service coverage and loan life coverage ratios are met and it is in compliance with all loan covenants. The BVI Loan Agreement contains a number of negative covenants restricting, among other things, indebtedness, investments, liens, dispositions of assets, restricted payments (including dividends), mergers and acquisitions, accounting changes, transactions with affiliates, prepayments of indebtedness, capital expenditures, and changes in nature of business and joint ventures. In addition, Seven Seas Water (BVI) Ltd is subject to quarterly financial covenant compliance, including minimum debt service and loan life coverage ratios, and must maintain a minimum debt service reserve fund and a maintenance reserve fund with the bank in addition to other minimum balance requirements as set forth in the agreement. As of December 31, 2019, Seven Seas Water (BVI) Ltd. was in compliance with, or received waivers for breaches of, all such covenants.
Other Debt
We finance our vehicles primarily under three-year terms with interest rates per annum ranging from 3.0% to 4.5%.
Contractual Obligations and Other Commitments
The following table summarizes our contractual obligations and other commitments as of December 31, 2019:
(1)
We calculated interest on long-term debt based on payment terms that existed at December 31, 2019. Weighted-average interest rates used are as follows: (i) Corporate Credit Agreement-7.7%; (ii) BVI Loan Agreement-5.1%; and (iii) vehicle financing-3.8%.
(2)
Operating leases include total future minimum rent payments under non-cancelable operating lease agreements.
(3)
The asset retirement obligations represent contractual requirements to perform certain asset retirement activities and are based on engineering estimates of future costs to dismantle and remove equipment from a customer’s plant site and to restore the site to a specified condition at the conclusion of a contract. We have included the total undiscounted asset retirement obligation, as determined at December 31, 2019, in the table above.
(4)
Acquisition contingent consideration represents the additional purchase price that is contingent on the future performance of an acquired business or collection of certain acquired receivables. We have included the fair value of the total expected amount as of December 31, 2019.
Off-Balance Sheet Arrangements
At December 31, 2019, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Other Matters
As of December 31, 2019 and 2018, the Company had unrecognized tax benefits of $0.7 million and $4.6 million, respectively. Of these amounts, $0.1 million and $3.9 of the Company’s unrecognized tax benefits at December 31, 2019 and 2018, respectively, have been recorded as a reduction to the related deferred tax asset for the net operating loss in accordance with the FASB issued authoritative guidance relating to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists for all periods. The remaining $0.6 million and $0.7 million of the Company’s unrecognized tax benefits at December 31, 2019 and 2018, respectively, are fully indemnified pursuant to purchase agreements for business combinations and, if realized, would impact the effective tax rate. In addition, the amount of accumulated penalties and interest related to the unrecognized tax benefit was $0.2 million and $0.3 million, respectively, as of December 31, 2019 and 2018. As of December 31, 2019 and 2018, the Company recorded, in the aggregate, an accrued liability of $0.9 million and $1.0 million, respectively, and a corresponding indemnification receivable of $0.9 million and $1.0 million, respectively, related to the uncertain tax benefits and contractual indemnifications. As a result of the indemnifications, the Company does not anticipate any material effect to our operating results, liquidity or financial condition.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to certain market risks in the ordinary course of our business. These risks primarily include credit risk, interest rate risk and foreign exchange risk.
Credit Risk
We are exposed to credit risk in our Seven Seas Water segment from our principal bulk water sales to customers in Trinidad, the BVI, the USVI, St. Maarten and Peru. While certain of our bulk water customers are quasi-governmental agencies, such customers may not be supported by sovereign guarantees or direct financial undertakings.
Interest Rate Risk
We had cash and cash equivalents totaling $103.3 million as of December 31, 2019. This amount was invested primarily in demand deposits with domestic and international banks, money market accounts and U.S. Treasury bills. The cash and cash equivalents are held for investment and working capital purposes. Our cash deposits are maintained for capital preservation purposes. We do not enter into investments for trading or speculative purposes. As of December 31, 2019, we had variable rate loans outstanding of $199.8 million that adjust with interest rate movements in LIBOR except when interest rate floors apply. Accordingly, we are subject to interest rate risk to the extent that LIBOR changes. A hypothetical 100 bps increase in our interest rates in effect at December 31, 2019 would have a $2.0 million increase to our interest expense on an annualized basis. A hypothetical 100 bps decrease in our interest rates in effect at December 31, 2019 would have a $1.8 million decrease to our interest expense on an annualized basis. We believe our mixture of fixed rate and variable rate loans helps reduce our overall exposure to interest rate risk.
Foreign Exchange Risk
For the year ended December 31, 2019, approximately 3.4% of our consolidated revenues were denominated or paid in a foreign currency. To help minimize our exposure to foreign exchange risk, we utilize payments collected in local currencies other than the U.S. dollar for payment obligations we may incur in the same local currency related to labor, construction, consumables or materials costs, manufacturing of inventory, or if our procurement orders are denominated in a currency other than U.S. dollars. If any of these local currencies change in value versus the U.S. dollar, our cost in U.S. dollars would change which could adversely affect our results of operations. We do not currently hedge our foreign currency exchange risk. However, we believe that our strategy to carefully manage the exposure to foreign currencies as well as ensure that a majority of our revenues are denominated in the U.S. dollar, helps reduce our overall exposure to foreign exchange risk.
			 		
Item 8.
Item 8. Financial Statements and Supplementary Data.
AQUAVENTURE HOLDINGS LIMITED
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
AquaVenture Holdings Limited:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of AquaVenture Holdings Limited and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive income, changes in equity, and cash flows for each of the years in the three year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases as of January 1, 2019 due to the modified retrospective adoption of Accounting Standards Update No. 2016-02, Leases (Topic 842), as amended.
Emphasis of a Matter
As discussed in Note 1 to the consolidated financial statements, on December 23, 2019, the Company entered into an agreement and plan of merger to be acquired by Culligan International Company (Culligan). Subject to the satisfaction or waiver of the remaining conditions set forth in agreement and plan of merger, the Company will become a wholly-owned subsidiary of Culligan.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2007.
Tampa, Florida
March 5, 2020
AQUAVENTURE HOLDINGS LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
See accompanying notes to the consolidated financial statements.
AQUAVENTURE HOLDINGS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes to the consolidated financial statements.
			 		
AQUAVENTURE HOLDINGS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(IN THOUSANDS)
See accompanying notes to the consolidated financial statements.
AQUAVENTURE HOLDINGS LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See accompanying notes to the consolidated financial statements.
AQUAVENTURE HOLDINGS LIMITED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the Business
AquaVenture Holdings Limited is a British Virgin Islands (“BVI”) company that was formed on June 17, 2016. AquaVenture Holdings Limited and its subsidiaries (collectively, “AquaVenture” or the “Company”) provides its customers Water-as-a-Service® (“WAAS®”) solutions through two operating platforms: Seven Seas Water and Quench. Both operations are critical to AquaVenture, which is headquartered in the BVI.
Seven Seas Water offers WAAS solutions by providing outsourced desalination, wastewater treatment and water reuse solutions to governmental, municipal (including utility districts), industrial, property developer and hospitality customers. Seven Seas Water’s desalination solutions utilize reverse osmosis and other purification technologies to produce potable and high purity industrial process water in high volumes for customers operating in regions with limited access to potable water. Through this outsourced desalination service model, Seven Seas Water assumes responsibility for designing, financing, constructing, operating and maintaining the water treatment facilities. In exchange, Seven Seas Water enters into long-term agreements to sell to customers agreed-upon quantities of water that meet specified water quality standards. For its wastewater treatment and water reuse solutions, Seven Seas Water designs, fabricates and installs plants which can be sold or leased to customers for a contractual term. The wastewater treatment and water reuse solutions offered include scalable modular treatment plants, field-erected plants and temporary bypass plants.
Seven Seas Water currently operates in the Caribbean region, the United States and in South America and is pursuing new opportunities in North America, the Caribbean, South America, Africa, the Middle East and other select markets. Seven Seas Water is supported by operations centers in Tampa, Florida and Houston, Texas, which provide business development, engineering, field service support, procurement and administrative functions.
Quench offers WAAS solutions by providing bottleless filtered water coolers and related services through direct and indirect sales channels. Through its direct sales channel, Quench primarily rents and services point-of-use (“POU”) units to institutional and commercial customers. Quench’s typical initial rental contract is three years in duration and contains an automatic renewal provision. Quench’s indirect sales channel provides POU systems, filters, parts and services to a network of approximately 260 dealers and retailers.
Quench primarily operates throughout the United States and Canada. Quench is supported by a primary operations center in King of Prussia, Pennsylvania, which provides marketing and business development, field service and supply chain support, customer care and administrative functions.
On December 23, 2019, we announced that we entered into an agreement and plan of merger, or Merger Agreement, to be acquired by Culligan International Company, or Culligan, a Delaware corporation. Pursuant to the Merger Agreement, and subject to the satisfaction or waiver of the conditions therein, Amberjack Merger Sub Limited, or Merger Sub, a business incorporated under the laws of the British Virgin Islands and wholly-owned subsidiary of Culligan will merge with and into the Company (the “Merger”). As a result of the Merger, the Company will become a wholly-owned subsidiary of Culligan. The closing of the Merger remains subject to the satisfaction or waiver of the remaining conditions to the Merger set forth in the Merger Agreement. We expect the Merger to close no later than the end of the second quarter of 2020.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of AquaVenture Holdings Limited and its subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP 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. Significant items subject to such estimates and assumptions include: accounting for revenue from contracts with customers and the determination of transaction prices and allocation of revenues to remaining performance obligations; accounting for leases and the determination of operating lease liabilities and right-of-use assets; accounting for goodwill and identifiable intangible assets and any related impairment; property, plant and equipment and any related impairment; contract costs and any related impairment; share-based compensation; allowance for doubtful accounts; obligations for asset retirement; acquisition contingent consideration; and valuation of deferred income taxes. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.
Cash and Cash Equivalents
The Company classifies all highly liquid investments with an original initial maturity of three months or less as cash equivalents. Cash and cash equivalents consist of cash on hand with domestic and foreign banks and, at times, may exceed insurance limits of the Federal Deposit Insurance Corporation, or similar insurance in foreign jurisdictions. Cash and cash equivalents can also include certain money market accounts and U.S. Treasury bills. All cash and cash equivalents are stated at cost, which approximates fair value due to the short duration of their maturities.
Restricted Cash
As of December 31, 2019 and 2018, the Company had an aggregate of $4.2 million and $4.2 million, respectively, deposited in restricted bank accounts or deemed restricted for one the Company’s borrowings both of which were classified as long-term in the consolidated balance sheets.
The Company is required to maintain deposits in local restricted bank accounts as a debt service reserve fund and a maintenance reserve fund for a credit facility between a bank and Seven Seas Water (BVI) Limited, an indirect wholly-owned subsidiary of the Company (collectively, the “BVI Loan Agreement”). The required balance of the restricted cash will fluctuate over the term of the agreements based on required debt service payments and is based a percentage of loan proceeds as determined by the bank for the BVI Loan Agreement.
As of December 31, 2019 and 2018, $3.7 million and $3.7 million, respectively, was deposited into restricted bank accounts as debt service and maintenance reserve funds in accordance with the terms of the Company’s credit agreements and are classified as a noncurrent asset in the consolidated balance sheets.
As of December 31, 2019 and 2018, $0.5 million and $0.5, respectively, was deemed restricted as a minimum balance requirement in accordance with the terms of one of the Company’s credit agreements and classified as a noncurrent asset in the consolidated balance sheets.
Trade Receivables, net
Trade receivables are recorded at invoiced amounts, based principally on meter readings; minimum take-or-pay amounts as provided in contractual arrangements; rental agreements; upon the completion of service work performed; or delivery of goods. Trade receivables do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable balance. The Company determines the allowance for doubtful accounts based on historical write-off experience, delinquency trends, and a specific analysis of significant receivable balances that are past due. Account balances are charged off against the allowance for doubtful accounts after all reasonable collection efforts have been exhausted. As of December 31, 2019 and 2018, the allowance for doubtful accounts was $1.2 million and $1.0 million, respectively.
The provision for bad debt expenses for the years ended December 31, 2019, 2018 and 2017 was $1.2 million, $1.0 million and $0.6 million, respectively, and is included in selling, general and administrative expenses (“SG&A”) in the consolidated statements of operations and comprehensive income. Deductions, including write-offs of uncollectible
accounts receivable, to the allowance for doubtful accounts for the years ended December 31, 2019, 2018 and 2017 were $1.0 million, $1.0 million and $0.7 million, respectively.
Inventory
Inventory is categorized as finished goods, raw materials, work in process and parts, supplies and miscellaneous equipment. Finished goods represent POU water coolers and purification systems which are sold directly to customers, dealers, and retailers. Finished goods also represent POU systems which are held for future rental as well as coffees, teas and other break room supplies which are used in conjunction with the Company’s coffee brewers. Raw materials relate to the underlying materials used to manufacture certain POU units. Work in process relates to POU units and wastewater treatment and water reuse solution projects that are being constructed by the Company and have not yet been completed. Spare parts, supplies and miscellaneous equipment includes plant and filtration and related equipment, filters and parts, and other ancillary products and supplies and relate to the plant and rental assets recorded within property, plant and equipment.
All inventory is valued at the lower of cost or net realizable value on a first-in, first-out basis and is periodically reviewed for excess and damage. The Company’s inventory, by category, as of December 31, 2019 and 2018, were as follows (in thousands):
Revenue Recognition
Through the Seven Seas Water and Quench operating platforms, the Company generates revenues from the following primary sources: (i) bulk water sales and services; (ii) service concession arrangements; (iii) rental of equipment; and (iv) product sales. The revenue recognition policy for each of the primary sources of revenue are as follows:
Bulk Water Sales and Services. Through the Seven Seas Water operating platform, the Company enters into contracts with customers with a single performance obligation to deliver bulk water or a series of performance obligations to perform substantially the same services with the same pattern of transfer, which can include the operations and maintenance (“O&M”) of a customer-owned or leased plant. The Company recognizes revenues from the delivery of bulk water or the performance of bulk water services at the time the water or services are delivered to the customers in accordance with the contractual agreements. Billings to the customer for both bulk water and the bulk water services are typically based on the volume of water supplied to a customer and typically contain a minimum monthly charge provision which allows the Company to invoice the customer for the greater of the water supplied or a minimum monthly charge. The volume of water supplied is based on meter readings performed at or near the end of the month. The transaction price calculated for bulk water sales and service can include, if applicable, contractual minimum monthly charges and the expected amount of variable consideration to the extent it is probable that a significant reversal of the cumulative revenue will not occur. The variable consideration generally includes the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied at contractually established rates. Estimates of revenue for unbilled water are recorded when meter readings occur at a time other than the end of a period. A contract asset or liability may be recognized in instances where there is a difference between the amount billed to a customer and the revenue recognized for the completed O&M performance obligations during the period. Revenues generated from both the delivery of bulk water and performance of services related to bulk water are recorded as bulk water revenue within the consolidated statements of operations and comprehensive income.
Certain contracts with customers which require the construction of facilities to provide bulk water to a specific customer include two performance obligations, including an implicit lease for the bulk water facilities and bulk water services, and a non-lease component related to O&M services. The implicit lease performance obligation is generally accounted for as an operating lease as a result of the provisions of the contract. As the bulk water services are deemed to
be the more predominant element, the Company considers the arrangement to be a combined bulk water component. The calculated transaction price can include, if applicable, contractual minimum monthly charges and the expected amount of variable consideration to the extent it is probable that a significant reversal of the cumulative revenues will not occur. The variable consideration generally includes the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied at contractually established rates. The revenue recognition pattern for both the lease and non-lease components are the same, with revenues being recognized ratably over the contract period as water is delivered to the customer. Revenues generated from both the lease and non-lease performance obligations are recorded as bulk water revenue within the consolidated statements of operations and comprehensive income.
Service Concession Arrangements. Through the Seven Seas Water operating platform, the Company enters into contracts with customers that are determined to be service concession arrangements. Service concession arrangements are agreements entered into with a public sector entity which controls both (i) the ability to modify or approve the services and prices provided by the operating company and (ii) beneficial entitlement to, or residual interest in, the infrastructure at the end of the term of the agreement. Service concession arrangements typically include more than one performance obligation, including the construction of infrastructure for the customer and an obligation to provide O&M services for the infrastructure constructed for the customer. Billings to the customer for service concession arrangements are typically based on the volume of water supplied to a customer and typically contain a minimum monthly charge provision which allows the Company to invoice the customer for the greater of the water supplied or a minimum monthly charge. The volume of water supplied is based on meter readings performed at or near the end of the month. The transaction price calculated for service concession arrangements includes, if applicable, contractual minimum monthly charges and the expected amount of variable consideration to the extent it is probable that a significant reversal of the cumulative revenues will not occur. The variable consideration generally includes the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied at contractually established rates. The transaction price is allocated to the identified performance obligations based on the relative standalone selling prices of the identified performance obligations.
The transaction price allocated to the construction of infrastructure performance obligation is recognized as product sales within the consolidated statements of operations and comprehensive income. Product sales are recognized over time, using the input method based on cost incurred, which typically begins at commencement of the construction with revenue being fully recognized upon the completion of the infrastructure as control of the infrastructure is, or is deemed to be, transferred to the customer. In addition, service concession contracts typically include a difference in timing of when control is, or is deemed to be, transferred and the collection of cash receipts, which are collected over the term of the entire arrangement. The timing difference could result in a significant financing component for the construction performance obligations if determined to be a material component of the transaction price. If a significant financing component is identified, the future cash flows included in the transaction price allocated to the construction performance obligations are discounted using a discount rate comparable to a market-based borrowing rate specific to both the customer and terms of the contract. The resulting present value of the allocated future cash flows is recorded as construction revenue with a related long-term receivable as control of the infrastructure is, or is deemed to be, transferred to the customer while the discount amount is considered to be the significant financing component. Future cash flows received from the customer related to the construction performance obligations are bifurcated between principal repayment of the long-term receivable and the imputed interest income related to the customer financing. The interest income is recorded as financing revenue within the consolidated statements of operations and comprehensive income as providing financing to our customers is a core component of our business model.
The transaction price allocated to the O&M performance obligation is recorded as bulk water revenue within the consolidated statements of operations and comprehensive income as the services are provided to the customer. A contract asset or liability may be recognized in instances where there is a difference between the amount billed to a customer and the revenue recognized for the completed O&M performance obligations during the period.
Rental of Equipment. Through the Seven Seas Water and Quench operating platforms, the Company generates revenues through the rental of its wastewater treatment and water reuse equipment and filtered water and related systems to customers. Rental agreements classified as operating leases can contain both lease and non-lease components, including O&M services on Company-owned equipment. For rental agreements that meet all conditions of the elected practical expedient to not separate lease and non-lease components and where the lease component is determined to be the predominant element of the contract, the Company allocates all revenues under the contract to the lease component of the contract. Billings to the customer for the rental of this equipment, which generally occur either monthly or
quarterly, are based on the rental rate as stated within the rental agreement. The transaction price is based on the minimum lease payment as stated within the rental agreement. Rental revenues, including revenues in connection with certain installation type activities are recognized ratably over the rental agreement term and amounts paid by customers in excess of recognizable revenue are recorded as a contract liability, or deferred revenue, in the consolidated balance sheets.
Certain revenues associated with shipping, delivery, installation or similar activities that occur prior to lease commencement do not provide a service to the lessee and are not a non-lease component of the contract. Payments for these activities are recorded as prepaid lease payments which are recognized ratably with the rental revenue over the lease term. Upon the expiration of the initial rental agreement term, the Company may enter into rental agreement extensions in which revenues are recognized ratably over the extension term.
Revenues generated under these rental agreements are recorded as rental revenue within the consolidated statements of operations and comprehensive income.
Product Sales. Through both the Seven Seas Water and Quench operating platforms, the Company enters into contracts to construct desalination and wastewater treatment and water reuse equipment and facilities and to sell customers water and related filtration equipment, coffee and consumables, which may include contracts accounted for as sales-type leases.
Contracts with customers to sell water and related filtration equipment and coffee and consumables typically include a single performance obligation. The Company recognizes revenues at the time the equipment, coffee or consumables is transferred to the customer, which can be upon either shipment or delivery to the customer. The transaction price is based on the contractual price with the customer. Shipping and handling costs paid by the customer are included in revenues. Billings to the customer for the sale of water and related filtration equipment, coffee and consumables occur at the time the product is transferred to the customer and are based on contract price.
Contracts with customers to construct desalination and wastewater treatment and water reuse equipment and facilities typically include a single performance obligation. Construction and equipment revenues are recognized over time, using the input method based on cost incurred, which typically begins at the later of commencement of the construction or at the time the infrastructure is, or is deemed to be, transferred to the customer with revenue being fully recognized upon the completion of the infrastructure. Billings to the customer to construct desalination and wastewater treatment and water reuse equipment and facilities can occur at contractual intervals throughout the construction period, at the time the equipment or facility is deemed transferred to the customer, or, in the case of sales-type leases, as stated within the rental agreement. The transaction price is based on the contractual price with the customer.
For contracts deemed to be, or that include a sales-type lease, the transaction price is based on the minimum lease payments as stated within the rental agreement. For contracts that contain both a lease and non-lease component, the transaction price is allocated based on the relative standalone selling prices of the lease and non-lease components. The transaction price, excluding variable lease payments, allocated to the lease component is discounted at the implicit rate of the contract and is recognized as revenue upon commencement of the lease.
Revenues generated under these contracts are recorded as product sales revenue within the consolidated statements of operations and comprehensive income.
Future cash flows received from sales-type leases are bifurcated between principal repayment of the long-term receivable and the related imputed interest income related to the customer financing. The interest income is recorded as financing revenue within the consolidated statements of operations and comprehensive income.
Leases
Lessee accounting
The Company leases space and operating assets, including offices, office equipment, warehouses, storage yards and storage units under non-cancelable operating leases. The Company accounts for these leases in accordance with the authoritative guidance adopted as of January 1, 2019. Please see “Adoption of New Accounting Pronouncements” section below for information regarding this adoption.
At the time of contract inception, the Company determines if an arrangement is or contains a lease. If the arrangement contains a lease, the Company recognizes a right-of-use asset and an operating lease liability at the lease commencement date. Lease expense for lease payments made is recognized on a straight-line basis over the lease term.
The operating lease liability is initially measured at the present value of the unpaid lease payments at the lease commencement date. The current portion of the Company’s operating lease liabilities are recorded within accrued liabilities in the consolidated balance sheets.
The right-of-use asset is initially measured at cost, which is comprised of the initial amount of the operating lease liability adjusted for lease payments made at or before the lease commencement date, plus any initial direct costs incurred less any lease incentives received. The right-of-use asset is subsequently measured throughout the lease term at the carrying amount of the operating lease liability, plus initial direct costs, plus (minus) any prepaid (accrued) lease payments, less the unamortized balance of lease incentives received. Right-of-use assets are periodically reviewed for impairment whenever events or changes in circumstances arise. During the year ended December 31, 2019, the Company incurred no impairment charges related to right-of-use assets.
Key estimates and judgments in determining both the operating lease liability and right-of-use asset include the determination of (i) the discount rate it uses to discount the unpaid lease payments to present value, (ii) the lease term and (iii) the lease payments.
The discount rate applied to the unpaid lease payments is the interest rate implicit in the lease or, if that rate cannot be readily determined, the Company’s incremental borrowing rate. Generally, the Company cannot determine the interest rate implicit in the lease because it does not have access to the lessor’s estimated residual value or the amount of the lessor’s deferred initial direct costs. Therefore, the Company generally derives an incremental borrowing rate as the discount rate for the lease. The Company’s incremental borrowing rate for a lease is the rate of interest it would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms.
The lease term for the Company’s leases includes the noncancelable period of the lease, plus any additional periods covered by either a Company option to extend (or not to terminate) the lease that the Company is reasonably certain to exercise, and/or an option to extend (or not to terminate) the lease controlled by the lessor.
Lease payments included in the measurement of operating lease liabilities are comprised of the following:
·
fixed payments;
·
variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date; and
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the exercise price of a Company option to purchase the underlying asset if the Company is reasonably certain to exercise the option.
In certain instances, the Company's leases include non-lease components, such as equipment maintenance or common area maintenance. As part of its adoption of authoritative guidance on leases on January 1, 2019, the Company has not elected the practical expedient to account for the lease and non-lease components as a single lease component and has elected (for all classes of underlying assets) to account for these components separately. The Company allocates the consideration in the contract to the lease and non-lease components based on each component's relative standalone price. The Company determines standalone prices for the lease components based on the prices for which other lessors lease similar assets on a standalone basis. The Company determines standalone prices for the non-lease components based on the prices that suppliers might charge for those types of services on a standalone basis. If observable standalone prices are not readily available, the Company estimates the standalone prices maximizing the use of observable information.
The Company has elected to utilize the short-term lease exemption and not recognize a right-of-use asset and corresponding operating lease liability for leases with expected terms of 12 months or less. The Company recognizes the lease payments associated with its short-term leases on a straight-line basis over the lease term.
Lessor accounting
The Company generates revenues through the lease of its bulk water facilities, wastewater treatment and water reuse equipment, and filtered water and related systems equipment to customers. In certain instances, the Company enters into a contract with a customer but must construct the underlying asset, including bulk water facilities and wastewater treatment and water reuse equipment, prior to its lease.
At the time of contract inception, the Company determines if an arrangement is or contains a lease.
Customer contracts that contain leases, which can be explicit or implicit in the contract, are generally classified as either operating leases or sales-type leases and can contain both lease and non-lease components, including operating and maintenance services (“O&M”) of the Company-owned equipment. As part of its adoption of authoritative guidance on leases on January 1, 2019, the Company elected the practical expedient for all classes of underlying assets to not separate the lease and non-lease components if certain conditions are met, including the classification of the lease component as operating and the revenue recognition pattern of both the lease and non-lease components. The Company will account for the contract with the customer as a combined component under the respective authoritative guidance for the predominant element in the contract, the lease or non-lease component.
For leases classified as sales-type leases, the Company allocates the transaction price based on the relative standalone selling prices of the identified performance obligations.
If the customer contract contains or is accounted for as a lease, the key estimates and judgments used by the Company in accounting for the lease as a lessor include the following: (i) lease term, (ii) the economic life of the underlying leased asset, (iii) determination of lease payments and (iv) determination of the fair value at the time of contract inception and the residual value of the underlying leased asset.
The lease term for the Company’s leases includes the noncancelable period of the lease, plus any additional periods covered by either a lessee option to extend (or not to terminate) the lease that the lessee is reasonably certain to exercise, and/or an option to extend (or not to terminate) the lease controlled by the Company. Contracts entered into with customers can include either the option to renew or an auto-renewing provision that results in the automatic extension of the existing contract. In certain instances, key provisions such as the lease payment or term of the renewal are not stated and are subject to negotiation.
The economic life of the underlying leased asset is determined to be either the period over which the asset is expected to be economically usable, or where the benefits it can produce exceed the cost to replace or undertake major repairs. In certain instances, the economic life of the underlying leased asset can exceed the useful life assigned by the Company.
Lease payments that are accounted for as rental revenue are comprised of the following:
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fixed payments;
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variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date;
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the exercise price of a lessee option to purchase the underlying asset if the lessee is reasonably certain to exercise the option; and
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payments for penalties for the termination of a lease if the term reflects the lessee terminating the lease.
The Company’s leases do not typically include a requirement for the customer to guarantee the residual value of the underlying leased asset. Variable lease payments that do not depend on an index or rate are excluded from the determination of lease payments.
The fair value of the underlying leased asset at contract inception and residual value of underlying leased asset at the end of the term of the lease are determined based on the price that would be received to sell an asset in an orderly transaction at the time of valuation. The Company’s risk management strategy for protecting the residual value of the underlying assets include the ongoing maintenance by the Company during the lease term as well as clauses and other protections within the lease agreements which require the lessee to return the underlying asset in working condition at the end of the lease term.
At contract inception, the Company determines the lease classification of the underlying asset. The Company considers inputs such as the lease term, lease payments, fair value of the underlying asset and residual value of the underlying asset when assessing the classification. The discount rate applied to the unpaid lease payments is the interest rate implicit in the lease. The rate implicit in the lease is the rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that the Company expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the Company and (2) any deferred initial direct costs of the Company.
In certain instances, contracts with customers may also include the option for the customer to purchase the underlying asset at the end of the lease term. When applicable and certain conditions are met, the Company will incorporate the stated purchase price into the determination of the interest rate implied in the lease.
Contract Costs
Contract costs includes contract acquisition costs, deferred lease costs and contract fulfillment costs which are all recorded within other assets in the consolidated balance sheets.
Contract Acquisition Costs. Prior to January 1, 2019, the Company accounted for initial direct costs incurred by the Company to originate leases as deferred lease costs. The costs capitalized were directly related to the negotiation and execution of leases and primarily consisted of internal compensation and benefits as lease origination activities were performed internally by the Company. Deferred lease costs capitalized prior to the adoption of the authoritative guidance on leases will be amortized on a straight-line basis over the remaining lease term.
For all leases originated on or after January 1, 2019, subsequent to the adoption of authoritative guidance on leases, the incremental costs incurred by the Company to originate contracts with customers are capitalized as contract acquisition costs. Contract acquisition costs, which generally include commissions and other costs that are only incurred as a result of obtaining a contract, are capitalized when the incremental costs are expected to be recovered over the contract period. All other costs incurred regardless of obtaining a contract are expensed as incurred. Contract acquisition costs are amortized over the period the costs are expected to contribute directly or indirectly to future cash flows, which is generally over the initial contract term, on a basis consistent with the transfer of goods or services to the customer to which the costs relate.
Contract acquisition costs, net as of December 31, 2019 and December 31, 2018 were $4.9 million and $3.7 million, respectively, and were recorded in other assets in the consolidated balance sheets.
Contract Fulfillment Costs. Costs incurred by the Company to fulfill a contract with a customer are capitalized when the costs generate or enhance resources that will be used in satisfying future performance obligations of the contract and the costs are expected to be recovered. Capitalized contract fulfillment costs generally include contracted services, direct labor, materials, and allocable overhead directly related to resources required to fulfill the contract, including shipping and installation activities. Contract fulfillment costs are amortized over the period the costs are expected to contribute directly or indirectly to future cash flows, which is generally over the initial contract term, on a basis consistent with the transfer of goods or services to the customer to which the costs relate.
Contract fulfillment costs, net as of December 31, 2019 and December 31, 2018 were $6.2 million and $1.5 million, respectively, and were recorded in other assets in the consolidated balance sheets.
Total contract costs amortization for the years ended December 31, 2019, 2018 and 2017 was $5.4 million, $2.7 million and $2.2 million, respectively.
Contract costs are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company had no impairment charges related to contract costs during the year ended December 31, 2019.
Sales Taxes Assessed by Governmental Agencies
The Company collects sales tax for various taxing authorities and records these amounts on a net basis; thus, sales tax amounts are not included in revenues.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation or amortization. Depreciation and amortization is calculated using a straight-line method with an allowance for estimated residual values. Depreciation and amortization rates are determined based on the estimated useful lives of the assets as follows:
Depreciation expense related to the plant operations and rental property is included in cost of revenues in the consolidated statements of operations and comprehensive income. Expenditures for repairs and maintenance are expensed as incurred whereas major betterments are capitalized.
Construction in Progress
Construction in progress is composed of the cost of the contracted services, direct labor, materials, and allocable overhead related to plant construction projects and are capitalized when the construction of the asset has been deemed probable. Costs incurred prior to the construction of the asset being deemed probable are expensed as incurred. Assets under construction are recorded as additions to property, plant, and equipment upon completion of the projects. Depreciation commences in the month the asset is placed in service.
Capitalized Interest
The Company capitalizes interest incurred during the period of plant construction. Construction period interest is recorded within construction in progress during the construction period and as a cost of the underlying property, plant and equipment once the asset is placed into service.
Long-term Receivable
The Company has long-term receivables relating to service concession arrangements, sales-type leases and certain notes receivable acquired in business combinations.
Payments of principal and interest on the Company’s long-term receivables are due as required by the underlying contracts. Interest on these long-term receivables range from 7.5% to 9.0%. The Company monitors collections and evaluates the collectability of the long-term receivables, based primarily on the financial condition of the customer (and in certain cases the customer’s guarantor), to determine whether an allowance for doubtful accounts should be recorded or if the long-term receivables should be written off, in whole or in part. As of both December 31, 2019 and 2018, there were no allowances on any of the Company’s long-term receivables.
Interest income is recorded as financing revenue within the consolidated statements of operations and comprehensive income.
Principal payments due within one year or less are recorded within current portion of long-term receivables in the consolidated balance sheet. All other principal payments are recorded within long-term receivables, non-current in the consolidated balance sheet.
As of December 31, 2019, the remaining undiscounted balance to be collected including principal and interest on all of our long-term receivables was $48.5 million.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the aggregate purchase price over the fair value of the net assets acquired in a business combination. Goodwill is reviewed for impairment at least annually during the fourth quarter and more frequently if a change in circumstances or the occurrence of events indicates that potential impairment exists. The Company first performs a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, the Company performs the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test is optional.
Under the quantitative analysis, the recoverability of goodwill is measured for each of our reporting units by comparing the reporting unit’s carrying amount, including goodwill, to the fair market value of the reporting unit. The Company determines the fair value of its reporting units based on a weighting of the present value of projected future cash flows (the “Income Approach”) and a comparative market approach under both the guideline company method and guideline transaction method (collectively, the “Market Approach”). Fair value using the Income Approach is based on the Company’s estimated future cash flows on a discounted basis. The Market Approach compares each of the Company’s reporting units to other comparable companies based on valuation multiples derived from operational and transactional data to arrive at a fair value. Factors requiring significant judgment include, among others, the determination of comparable companies, assumptions related to forecasted operating results, discount rates, long-term growth rates, and market multiples. Changes in economic or operating conditions, or changes in the Company’s business strategies, that occur after the annual impairment analysis and which impact these assumptions, may result in a future goodwill impairment charges, which could be material to the Company’s consolidated financial statements.
In determining its reporting units, the Company reviews its operating segments to determine the number of components within each segment. If an operating segment contains only a single component, the operating segment is deemed a reporting unit. If an operating segment contains more than one component, the Company aggregates into a single reporting unit those components determined to have similar economic characteristics. Components determined to have dissimilar economic characteristics are considered a separate reporting unit. As of both December 31, 2019 and 2018, the Quench segment was determined to be composed of a single reporting unit. As of both December 31, 2019 and 2018, the Seven Seas Water segment was determined to be composed of two reporting units.
Other intangible assets consist of certain trade names, customer relationships, contract intangibles, backlog and non-compete agreements. Contract intangibles includes the fair value of future cash flows from contracts with customers in excess of the fair value for the remaining performance obligations under such contracts. Trade names and non-compete agreements which have a finite life are amortized over their estimated useful lives on a straight-line basis. Customer relationships and contract intangibles which have a finite life are amortized on an accelerated basis based on the projected economic value of the asset over its useful life. Intangible assets with a finite life are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Indefinite-lived intangible assets, which consist of certain trade names, are not amortized but are tested for impairment at least annually or more frequently if events or circumstances indicate the asset may be impaired.
Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recognition and measurement of a potential impairment is performed on assets grouped with other assets and liabilities at the lowest level where identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset or asset group to future undiscounted net cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. During 2019 and 2018, there were no indicators of potential impairments identified.
Share-Based Compensation
AquaVenture accounts for share-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value. The cost is recognized over the requisite service period, net of adjustments for forfeitures as they occur.
Asset Retirement Obligations
The Company has asset retirement obligations (“AROs”) arising from contractual requirements to perform certain asset retirement activities at the time it disposes of certain plants and equipment. The liability is recorded in the period in which the obligation meets the definition of a liability, which is generally when the asset is constructed or placed in service. The ARO liability is based on the Company’s engineering estimates of future costs to dismantle and remove equipment from a customer’s plant site and to restore the site to a specified condition at the conclusion of a contract. The corresponding asset retirement costs are capitalized as plant and equipment and depreciated over the asset’s useful life. The liability is initially measured at fair value and subsequently adjusted for accretion expense and changes in the amount or timing of the estimated cash flows. Accretion expense is recorded in cost of revenues in the consolidated statements of operations and comprehensive income. Actual costs are charged against the related liability as incurred and any difference between the actual costs incurred and the liability is recognized as a gain or loss in the consolidated statements of operations and comprehensive income. As of December 31, 2019 and 2018, the Company recorded the short-term portion of the ARO liability within accrued liabilities on the consolidated balance sheets. As of December 31, 2019 and 2018, the Company recorded the long-term portion of the ARO liability within other long-term liabilities on the consolidated balance sheets.
Acquisition Contingent Consideration
Acquisition contingent consideration represents the net present value of the additional purchase price that is either (i) held for potential adjustments or claims as set forth in the purchase agreements, (ii) contingent on the future performance of an acquired business or (iii) contingent on the future collections of certain acquired receivables. The acquisition date fair value of acquisition contingent consideration is recognized, as deemed appropriate, as an asset, liability or equity. Acquisition contingent consideration is re-measured to fair value at the end of each reporting period with the change in fair value recorded as a gain or loss in SG&A in the consolidated statements of operations. As of December 31, 2019 and 2018, the Company recorded the short-term portion of the acquisition contingent consideration within accrued liabilities on the consolidated balance sheets. As of December 31, 2019 and 2018, the Company recorded the long-term portion of the acquisition contingent consideration within other long-term liabilities on the consolidated balance sheets.
Income Taxes
The Company accounts for income taxes using the asset and liability approach to the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Unless it is “more likely than not” that a deferred tax asset can be utilized to offset future taxes, a valuation allowance is recorded against that asset.
The Company evaluates tax positions that have been taken or are expected to be taken in its tax returns and records a liability for uncertain tax positions. The Company uses a two-step approach to recognize and measure uncertain tax positions. First, tax positions are recognized if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon examination, including resolution of related appeals or litigation processes, if any. Second, tax positions are measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement. The Company recognizes interest and penalties related to unrecognized tax benefits in the provision for income taxes in the accompanying consolidated financial statements.
AquaVenture Holdings Limited is incorporated in the British Virgin Islands, which does not impose income taxes. Certain of our subsidiaries file separate tax returns and are subject to federal income taxes at the corporate level in the U.S. or in other foreign jurisdictions. Certain other subsidiaries operate in jurisdictions that do not impose taxes based on income.
Fair Value Measurements
Fair value is an exit price that represents the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. Accordingly, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The Company discloses the manner in which fair value is determined for assets and liabilities based on a three-tiered fair value hierarchy. The hierarchy ranks the quality and reliability of the information used to determine the fair values. The three levels of inputs described in the standard are:
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Level 1: Quoted prices in active markets for identical assets or liabilities.
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Level 2: Observable inputs, other than Level 1 prices, for the assets or liabilities, either directly or indirectly, for substantially the full term of the assets or liabilities.
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Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Certain assets, in specific circumstances, are measured at fair value on a non-recurring basis utilizing Level 3 inputs such as goodwill, other intangible assets and other long-lived assets. For these assets, measurement at fair value in periods subsequent to their initial recognition would be applicable if one or more of these assets were determined to be impaired.
The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and other current assets and liabilities approximate fair value because of the short-term nature of these instruments.
Foreign Currency
For its foreign operations where the functional currency is the U.S. dollar, the Company records foreign currency transaction gains and losses in instances when the Company purchases inventory, equipment, and services from businesses in countries where the currency used is not the U.S. dollar. During the years ended December 31, 2019, 2018 and 2017, the Company incurred a foreign currency transaction gain (loss) of $(43) thousand, $(155) thousand and $190 thousand, respectively, which was recorded in other income (expense) in the consolidated statements of operations and comprehensive income.
For its operations where the functional currency is the local currency, the Company records foreign currency translation adjustments which are recorded in other comprehensive income in the consolidated statements of operations and comprehensive income. Assets and liabilities are translated at the exchange rate in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates for the period. Foreign currency translation gain (loss) recorded in other comprehensive income for the years ended December 31, 2019, 2018 and 2017 was $271 thousand $(404) thousand and $(17) thousand, respectively.
Business Combinations
When accounting for business combinations, the Company allocates the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill. The Company’s purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. The Company estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses. Unanticipated events or circumstances may occur which could affect the accuracy of the Company’s fair value estimates.
If an acquisition does not meet the definition of a business combination, the Company accounts for the transaction as an asset acquisition. In an asset acquisition, goodwill is not recognized, but rather any excess consideration transferred over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable net assets. In addition, transaction-related expenses are capitalized and allocated to the net assets acquired on a relative fair value basis.
Adoption of New Accounting Pronouncements
In June 2016, the FASB issued authoritative guidance regarding implementation of measurement of credit losses on financial instruments. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company adopted this guidance on a modified retrospective basis on January 1, 2019 with the cumulative effect of transition as of the effective date of adoption. The Company considered relevant information about past events, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount, resulting in recognition of lifetime expected credit losses for certain financial instruments within the scope of this pronouncement. The Company re-established its allowance for credit losses and there was no material impact to the consolidated financial statements as a result of this adoption.
In March 2019, the FASB issued authoritative guidance regarding targeted changes to lessor accounting. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company adopted this guidance on a retrospective basis as of January 1, 2019 (the original adoption date of the lease pronouncement). With respect to the changes around the fair value of the underlying leased asset for lease classification purposes, in instances in which the Company is not considered a dealer, the Company now includes contract acquisition costs in this calculation. In instances in which the Company is a dealer, the Company now excludes these costs from this calculation. There were no changes to the consolidated financial statements as a result of this adoption.
In February 2016, the Financial Accounting Standards Board, or FASB, issued authoritative guidance regarding leases that requires lessees to recognize a lease liability and right-of-use asset for operating leases, with the exception of short-term leases. In addition, lessor accounting was modified to align, where necessary, with lessee accounting modifications and the authoritative guidance regarding revenue from contracts with customers. During 2018, the FASB issued additional authoritative guidance which, among other things, provided an option to apply transition provisions under the standard at adoption date rather than the earliest comparative period presented as well as added a practical expedient that would permit lessors to not separate non-lease components from the associated lease components if certain conditions are met. These amendments are effective, in conjunction with the new lease standard, for annual reporting periods beginning on or after December 15, 2018, including interim periods within those annual periods.
The Company adopted this guidance on a modified retrospective basis on January 1, 2019 with the cumulative effect of the transition as of the date of adoption.
The Company has elected the package of practical expedients provided for within the authoritative guidance which exempts the Company from having to reassess: (i) whether expired or existing contracts contain leases, (ii) the lease classification for expired or existing leases, and (iii) initial direct costs for existing leases. In addition, the Company has elected the practical expedient that permits lessors to not separate non-lease components from the associated lease components if certain conditions are met. Lastly, the Company has utilized the short-term exemption for lessees and established an accounting policy to not recognize a right-of-use asset or lease liability for any lease with a term of less than 12 months. The Company did not elect to utilize any of the other practical expedients.
The impacts of the new lease standard are as follows:
Lessee accounting - The adoption has had a material impact on the consolidated balance sheets, including an increase to both assets and liabilities, as a result of the recognition of a right-of-use asset and corresponding lease liability for operating leases. As the Company has made a policy election for the short-term lease exemption, a right-of-use asset and corresponding lease liability are only recorded for leases with expected terms of more than 12 months. The adoption did not have a material impact on the consolidated statements of operations and comprehensive income for situations in which the Company is a lessee.
Lessor accounting - As the Company has elected the transitional practical expedients for leases, there are not any material impacts to the consolidated financial statements for leases in situations which the Company is a lessor and the lease commenced prior to January 1, 2019. To conform with the guidance, the Company has updated its policies for costs incurred for the acquisition and fulfillment of the lease contracts, including commissions and installation costs.
Adoption of the new lease standard did not impact our historically reported results. On January 1, 2019, the Company recorded $8.7 million of right-of-use assets and $8.9 million of operating lease liabilities, including the classification of $0.2 million from straight-line rent liabilities to operating lease liabilities, in the consolidated balance sheets.
New Accounting Pronouncements to be Adopted
In August 2018, the FASB issued authoritative guidance regarding implementation costs incurred in a cloud computing arrangement that is a service contract. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company adopted this guidance on January 1, 2020 on a prospective basis. Although certain implementation costs incurred by the Company going forward may now be capitalizable, there is no material impact expected to the consolidated financial statements as a result of this adoption.
In August 2018, the FASB issued authoritative guidance regarding fair value measurements. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company adopted this guidance on January 1, 2020 on a prospective basis. Beginning with all periods subsequent to the adoption date, the Company will prepare the enhanced disclosures within the consolidated financial statements as a result of this adoption.
3. Business Combinations and Asset Acquisitions
Business Combinations
Jonli Water Services, Inc.
On December 16, 2019, we acquired substantially all of the assets and assumed certain liabilities of Jonli Water Services, Inc. (“Jonli”), a POU water filtration company based in Quebec, Canada pursuant to an asset purchase agreement (the “Jonli Acquisition”). The estimated aggregate purchase price, subject to adjustments, was $0.4 million, which was paid in cash. In addition, the asset purchase agreement includes contingent payments with the ultimate payout based upon the future performance of the acquired assets. The contingent payments are automatically forfeited if the employment of certain selling shareholders terminates. As a result, the Company has determined that the contingent payments will be accounted for as post combination compensation expense, which will be accreted to its estimated payout amount of $0.1 million throughout the substantive service period. The undiscounted range of outcomes for the post combination compensation payout amount is $0 to $0.1 million. The assets acquired consist primarily of in-place maintenance agreements in Canada.
Acquisition-related costs incurred by the Company related to the Jonli Acquisition during the year ended December 31, 2019 were $50 thousand, which were expensed as incurred within SG&A expenses in the consolidated statements of operations and comprehensive income.
The Quench business completed the Jonli Acquisition to expand its maintenance services in Canada.
The following table summarizes the preliminary purchase price allocated to the fair value of assets acquired, including intangibles recorded in conjunction with the business combination, and liabilities assumed (in thousands):
As of December 31, 2019, the purchase price allocated to the fair value of assets acquired, including intangibles, and liabilities assumed recorded in conjunction with the Jonli Acquisition remains preliminary. The preliminary purchase price allocation has been developed based on estimates with assumptions made by management. Although the Company does not expect the final allocation to vary significantly, there may be adjustments made to the preliminary purchase price allocation that could result in changes to the preliminary fair values allocated, assigned useful lives and associated amortization recorded. The assets and liabilities in the preliminary purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships. The final valuation of the intangibles identified is dependent upon certain valuation and other studies that have not yet been finalized. Accordingly, the preliminary purchase price allocation is subject to further adjustment as additional information becomes available and as additional analyses and final valuations are completed. There can be no assurances that these additional analyses and final valuations will not result in material changes to the estimates of fair value set forth above.
The Company has initially determined the weighted average useful life at the date of valuation for the customer relationships to be 15 years.
Goodwill for this acquisition is composed of synergies not valued, is deductible for tax purposes and is recorded within the Quench reportable segment.
The results of the operations of the acquired Jonli assets are included in the Quench reportable segment from and after the date of acquisition. The resulting amount of revenues and net loss included in the consolidated statements of operations and comprehensive income since acquisition were $15 thousand and $3 thousand, respectively.
Pure Health Solutions, Inc.
On December 18, 2018, Quench USA, Inc. (“Quench”), a wholly-owned subsidiary of AquaVenture Holdings Limited, acquired all of the issued and outstanding shares of Pure Health Solutions, Inc. (“PHSI”) pursuant to a stock purchase agreement (the “PHSI Acquisition”). PHSI, which is based outside of Chicago, is a leading provider of filtered water coolers and related services through direct and indirect sales channels. The Company paid approximately $56.6 million, in the aggregate, which included approximately $39.1 million of cash related to the purchase price of PHSI, net of adjustments to reduce the purchase price by $1.6 million, and approximately $17.5 million of cash accounted for as a post-combination payoff of factored contract liabilities which had been classified as a secured borrowing. The factored contract liabilities were adjusted to fair value as of the acquisition date based on the present value of the factored contract liabilities using a discount rate of approximately 7% and any penalties associated with the payoff.
Acquisition-related costs incurred by the Company related to the PHSI Acquisition during the years ended December 31, 2019 and 2018 were $0.1 million and $1.8 million, respectively, which were expensed as incurred within SG&A expenses in the consolidated statements of operations and comprehensive income.
The Quench business completed the asset acquisition to expand its installed base of POU systems and to be able to participate more broadly in the global POU market through the PHSI distribution network. In addition, the acquisition enhances Quench’s ability to develop, source and manufacture exclusive coolers and purification offerings. Lastly, it offers the Company the opportunity to develop relationships with POU dealers that could lead to future acquisitions.
The following table summarizes the purchase price allocated to the fair value of assets acquired, including intangibles recorded in conjunction with the business combination, and liabilities assumed (in thousands):
The purchase price allocated to the fair value of assets acquired, including intangibles, recorded in conjunction with the PHSI Acquisition is considered final. During the third quarter of 2019, the Company updated its preliminary allocation of the purchase price to the assets acquired and liabilities assumed. The assets and liabilities in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships, trade names and non-compete agreements. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 15.8%. The fair value of the trade names was determined using the relief from royalty method which is based on the present value of royalty fees derived from projected revenues using a discount rate of 15.8%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue loss using a discount rate of 15.8%.
The estimated weighted average useful life for customer relationships, trade names, and non-compete agreements is 15 years, 12 years, and 5 years, respectively.
As a result of the measurement period adjustments made to the purchase price allocation during the third quarter of 2019, the Company recorded additional amortization expense, as reflected in SG&A, of $1.1 million. For the year ended December 31, 2019, the Company’s loss from operations and net loss in the consolidated statements of operations were approximately $1.1 million higher as a result of the measurement period adjustments. For the year ended December 31, 2019, the Company’s net loss per share increased by $0.04 per share as a result of the measurement period adjustments.
Goodwill is composed of the acquired workforce and synergies not valued and is not deductible for tax purposes. Goodwill for the PHSI Acquisition is recorded within the Quench reportable segment.
The results of the operations of the acquired PHSI assets are included in the Quench reportable segment after the date of the PHSI Acquisition.
The Company identified certain liabilities, including tax matters that existed prior to December 18, 2018. The Company believes the liabilities are indemnified pursuant to the stock purchase agreement for the PHSI Acquisition. As a result, as of the date of acquisition, the Company recorded a liability in the amount of $0.8 million, which was recorded in accrued liabilities, and a corresponding indemnification receivable in the amount of $0.8 million, which was recorded in prepaids and other current assets in the consolidated balance sheet. The amounts were reflected within the purchase price allocation.
Commencing on December 18, 2018, the Company initiated a restructuring of the PHSI organization which included the reduction of headcount for PHSI executive management and other employee positions determined to be duplicative with those at Quench (the “PHSI Restructuring Plan”). Certain of the positions were backfilled with additional positions at Quench depending on the needs of the business. The expected net effect of the restructuring allowed Quench to recognize synergies of reduced employee costs subsequent to the PHSI Acquisition. The restructuring was determined to be a post-combination transaction. During the years ended December 31, 2019 and 2018, the Company incurred an incremental restructuring-related charge related to severance, termination benefits and related taxes of $0.1 million and $0.9 million, respectively, which was recorded within SG&A expenses in the consolidated statements of operations and comprehensive income. As of December 31, 2019 and 2018, the Company had accrued approximately $0 and $0.8 million, respectively, within accrued liabilities on the consolidated balance sheets. The Company completed the PHSI Restructuring Plan during the second quarter of 2019
FB Global Development, Inc., d/b/a Bluline
On December 3, 2018, Quench acquired substantially all the assets and assumed certain liabilities of FB Global Development, Inc., d/b/a Bluline (“Bluline”) pursuant to an asset purchase agreement (“Bluline Acquisition”). Bluline, based in South Florida, is a provider of filtered water coolers and related services through direct and indirect sales channels. The aggregate purchase price, subject to adjustments, of the Bluline Acquisition was $2.5 million in cash and $0.3 million payable, which was paid in full in January 2020.
There were no acquisition-related costs incurred by the Company related to the Blueline Acquisition during the year ended December 31, 2019. Acquisition-related costs incurred by the Company related to the Bluline Acquisition during the year ended December 31, 2018 were $9 thousand, which were expensed as incurred within SG&A expenses in the consolidated statements of operations and comprehensive income.
The Quench business completed the Bluline Acquisition to expand its installed base of POU systems and to be able to participate more broadly in the global POU market through its indirect sales channel.
The following table summarizes the purchase price allocated to the fair value of assets acquired, including intangibles recorded in conjunction with the business combination, and liabilities assumed (in thousands):
The purchase price allocated to the fair value of assets acquired, including intangibles, and liabilities assumed recorded in conjunction with the Bluline Acquisition is considered final. The assets and liabilities in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions
management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships and non-compete agreements. The fair value of the customer relationships were developed using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a weighted average discount rate of 20.0%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue loss using a weighted average discount rate of 20.0%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships and non-compete agreements to be 20 years and 5 years, respectively.
Goodwill for this acquisition is composed of synergies not valued, is deductible for tax purposes and is recorded within the Quench reportable segment.
The results of the operations of the acquired Bluline assets are included in the Quench reportable segment from and after the date of acquisition
AUC Acquisition Holdings
On November 1, 2018, AquaVenture Holdings Inc., a wholly owned subsidiary of AquaVenture, acquired all of the issued and outstanding membership interests of AUC Acquisition Holdings (“AUC”), a provider of wastewater treatment and water reuse solutions based in Houston, Texas, pursuant to a membership interest purchase agreement (the “AUC Acquisition”). The aggregate purchase price was $130.9 million, including $127.0 million cash (including net working capital adjustments of $0.4 million), approximately 122 thousand ordinary shares of AquaVenture, or $2.0 million, and $1.9 million of acquisition contingent consideration. The acquisition contingent consideration is recorded at its estimated fair value with the ultimate payout based upon the future collection of assumed receivables. The undiscounted range of outcomes for the acquisition contingent consideration is $0 to $2.0 million.
Acquisition-related costs incurred by the Company related to the AUC Acquisition during the years ended December 31, 2019 and 2018 were $0.1 million and $1.3 million, respectively, which were expensed as incurred within SG&A expenses in the consolidated statements of operations and comprehensive income.
The Company completed the AUC Acquisition to expand its WAAS offerings in the wastewater treatment and water reuse businesses and broaden the Company’s existing portfolio in the United States.
The following table summarizes the purchase price allocated to the fair value of assets acquired, including intangibles recorded in conjunction with the business combination, and liabilities assumed (in thousands):
The purchase price allocated to the fair value of assets acquired, including intangibles, and liabilities assumed recorded in conjunction with the AUC Acquisition is considered final. During 2019, the Company updated its allocation of the purchase price to the assets acquired and liabilities assumed. The fair value of the property, plant and equipment was determined using a combination of the indirect cost approach, direct cost approach and market approach, depending on asset type. The assets and liabilities (excluding property, plant and equipment) in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships, trade names, non-compete agreements and backlog. The fair value of customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 10.9%. The fair value of the trade names was determined using the relief from royalty method which is based on the present value of royalty fees derived from projected revenues using a discount rate of 10.9%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue loss using a discount rate of 10.9%. The fair value of the backlog, which represents revenues and the related profit for contracts executed but not yet completed, was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 10.9%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships, trade names, non-compete agreements and backlog is 19 years, 15 years, 4.9 years, and 0.7 years, respectively.
As a result of the adjustments made to the purchase price allocation during 2019, the Company recorded additional depreciation expense of $0.7 million, as reflected in cost of revenues, and a reduction of amortization expense of $0.1 million, as reflected in SG&A. Upon obtaining new information, the Company also recorded additional goodwill of $0.5 million and a corresponding reduction in the deferred tax liability of $0.5 million. For the year ended December 31, 2019, the Company’s loss from operations and net loss in the consolidated statements of operations were approximately $0.6 million higher as a result of these adjustments. For the year ended December 31, 2019, the Company’s net loss per share increased by $0.02 per share as a result of these adjustments.
Goodwill is composed of the acquired workforce and synergies not valued and is not deductible for tax purposes. Goodwill for the AUC Acquisition is recorded within the Seven Seas Water reportable segment.
The results of the operations of the acquired AUC assets are included in the Seven Seas Water reportable segment after the date of acquisition.
Alpine Water Systems, LLC
On August 6, 2018, Quench acquired substantially all the assets and assumed certain liabilities of Alpine Water Systems, LLC (“Alpine”), a POU water filtration company based in Las Vegas, Nevada, pursuant to an asset purchase agreement (the “Alpine Acquisition”). The aggregate purchase price of the Alpine Acquisition was $15.0 million, including $14.5 million in cash (including final working capital adjustment of $0.1 million which was received during the three months ended March 31, 2019), $0.4 million payable on August 6, 2020, and $0.1 million of acquisition contingent consideration. The acquisition contingent consideration is recorded at its estimated fair value with the ultimate payout based upon the future performance of the acquired assets. The undiscounted range of outcomes for the acquisition contingent consideration is $0 to $0.3 million. In addition, the asset purchase agreement includes contingent payments with the ultimate payout based upon the future performance of the acquired assets. The contingent payments are automatically forfeited if the employment of certain selling shareholders terminates. The Company has determined that the contingent payments will be post-combination compensation expense, which will be accreted to their estimated payout amount of $0.4 million throughout the substantive service period. The undiscounted range of outcomes for the post-combination compensation payout amount is $0 to $1.1 million. Payments related to the final acquisition contingent consideration and post-combination expense were made during the third quarter of 2019. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States and Canada.
There were no acquisition-related costs incurred by the Company related to the Alpine Acquisition during the year ended December 31, 2019. Acquisition-related costs incurred by the Company related to the Alpine Acquisition during the year ended December 31, 2018 were $0.6 million, which were expensed as incurred within SG&A expenses in the consolidated statements of operations and comprehensive income.
The Quench business completed the asset acquisition to expand its installed base of POU systems.
The following table summarizes the purchase price allocated to the fair value of assets acquired, including intangibles recorded in conjunction with the business combination, and liabilities assumed (in thousands), subject to measurement period adjustments:
The purchase price allocated to the fair value of assets acquired, including intangibles, and liabilities assumed recorded in conjunction with the Alpine Acquisition is considered final. During the first quarter of 2019, the Company updated its allocation of the purchase price to the assets acquired and liabilities assumed. The assets and liabilities in the
purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships and non-compete agreements. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 13.4%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue loss using a discount rate of 13.4%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships and non-compete agreements to be 15 years and 5 years, respectively.
Goodwill is composed of synergies not valued, is deductible for tax purposes and is recorded within the Quench reportable segment.
The results of the operations of the acquired Alpine assets are included in the Quench reportable segment from and after the date of acquisition.
Wa-2 Water Company Ltd.
On March 1, 2018, Quench Canada, Inc., a wholly-owned subsidiary of the Company, acquired substantially all of the water filtration assets and assumed certain liabilities of Wa-2 Water Company Ltd. (“Wa-2”), pursuant to an asset purchase agreement for an aggregate purchase price of $5.1 million in cash, including a final working capital adjustment of approximately $5 thousand which was paid in June 2018 (the “Wa-2 Acquisition”). Approximately $0.3 million of the aggregate purchase price was held in escrow for a period of one year by a third party for seller indemnifications. Wa-2 is a POU water filtration company based in Vancouver, British Columbia. The assets acquired consist primarily of in-place lease agreements and the related POU systems.
There were no acquisition-related costs incurred by the Company related to the Wa-2 Acquisition during the year ended December 31, 2019. Acquisition-related costs incurred by the Company related to the Wa-2 Acquisition during the year ended December 31, 2018 were $0.1 million, which were expensed as incurred within SG&A expenses in the consolidated statements of operations and comprehensive income.
The Quench business completed the Wa-2 Acquisition to expand its installed base of POU systems in Canada.
The following table summarizes the purchase price allocated to the fair value of assets acquired, including intangibles recorded in conjunction with the business combination, and liabilities assumed (in thousands):
The purchase price allocated to the fair value of assets acquired, including intangibles, and liabilities assumed recorded in conjunction with the Wa-2 Acquisition is considered final. During the second quarter of 2018, the Company
updated its allocation of the purchase price to the assets acquired and liabilities assumed. The assets and liabilities in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships, trade names and non-compete agreements. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 12.9%. The fair value of the trade names was determined using the relief from royalty method which is based on the present value of royalty fees derived from projected revenues using a discount rate of 12.9%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue and cash flow loss using a discount rate of 12.9%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships, trade names and non-compete agreements to be 20 years, 12 years, and 5 years, respectively.
Goodwill is composed of synergies not valued, is deductible for tax purposes and is recorded within the Quench reporting segment.
The results of the operations of the acquired Wa-2 assets are included in the Quench reportable segment from and after the date of acquisition.
Wellsys USA Corporation
On September 8, 2017, Quench acquired substantially all of the assets and assumed certain liabilities of Wellsys USA Corporation (“Wellsys”) pursuant to an asset purchase agreement for an aggregate purchase price of $6.9 million in cash, including a final working capital adjustment of $165 thousand (“Wellsys Acquisition”) which was received from the escrow agent in October 2017. Wellsys is a supplier of high-quality branded and private-labeled POU water coolers and purifications systems. Headquartered in the greater Phoenix, Arizona area, Wellsys sells its products to networks of dealers in the United States, Canada, Mexico and South Africa.
There were no acquisition-related costs incurred by the Company related to the Wellsys Acquisition during the years ended December 31, 2019 and 2018. Acquisition-related costs incurred by the Company related to the Wellsys Acquisition during the year ended December 31, 2017 were $31 thousand, which were expensed as incurred within SG&A in the consolidated statements of operations and comprehensive income.
The Quench business completed the Wellsys Acquisition to be able to participate more broadly in the global POU market through the Wellsys distribution network. In addition, the acquisition provides an opportunity to develop, source and distribute Quench-exclusive innovative coolers and purification offerings, and to develop relationships with Wellsys dealers that could ultimately lead to potential acquisitions.
Pro Forma Financial Information
The following unaudited pro forma financial information (in thousands, except for per share amounts) for the Company gives effect to the acquisitions of: (i) Jonli, which occurred on December 16, 2019; (ii) PHSI, which occurred on December 18, 2018; (iii) Bluline, which was acquired on December 3, 2018; (iv) AUC, which occurred on November 1, 2018; (v) Alpine, which occurred on August 6, 2018; (vi) Wa-2, which occurred on March 1, 2018; and (vii) Wellsys, which occurred on September 8, 2017, as if each had occurred on January 1, 2017. These unaudited pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisitions occurred on the date indicated, or that may result in the future.
Asset Acquisitions
The following acquisitions did not meet the definition of a business combination, so the Company accounted for these transactions as asset acquisitions. In an asset acquisition, goodwill is not recognized, but rather any excess consideration transferred over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable net assets. In addition, related transaction expenses are capitalized and allocated to the net assets acquired on a relative fair value basis.
Mirex AquaPure Solutions L.P., d/b/a Mirex AquaPure Solutions
On October 1, 2019, we acquired substantially all of the assets and assumed certain liabilities of Mirex AquaPure Solutions L.P., d/b/a Mirex AquaPure Solutions (“Mirex”), a POU water filtration company based in Houston, Texas, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $11.6 million, which included approximately $10.3 million of cash, $0.9 million payable on the one-year anniversary of the transaction, $0.3 million payable on the two-year anniversary of the transaction and approximately $0.1 million of acquisition contingent consideration payable to the seller on or before the one-year anniversary of the transaction. The acquisition contingent consideration is recorded at its estimated fair value with the ultimate payout based upon the receipt of certain receivables as set forth in the asset purchase agreement. The undiscounted range of outcomes for the acquisition contingent considerations is $0 to $0.1 million. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
The revenues and related expenses from the acquired in-place lease agreements are included in the Quench reportable segment from the date of acquisition. The Quench business completed the Mirex acquisition to expand its installed base of POU systems in the United States.
Acquisition-related costs incurred by the Company in connection with this acquisition during the year ended December 31, 2019 were $12 thousand.
The following table summarizes the amounts for the Mirex acquisition which were allocated to the fair value of aggregated net assets acquired (in thousands):
The assets in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships and non-compete agreements. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 11.3%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue and cash flow loss using a discount rate of 11.3%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships and non-compete agreements to be 15 years and 5 years, respectively.
Carolina Pure Water Systems, LLC
On July 15, 2019, Quench acquired substantially all of the assets and assumed certain liabilities of Carolina Pure Water Systems, LLC (“Carolina Pure”), a POU water filtration company based in Raleigh, North Carolina, pursuant to an asset purchase agreement. The aggregate purchase price, subject to adjustments, was $7.3 million, which included approximately $6.8 million of cash and $0.5 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
The revenues and related expenses from the acquired in-place lease agreements are included in the Quench reportable segment from the date of acquisition. The Quench business completed the Carolina Pure acquisition to expand its installed base of POU systems in the United States.
Acquisition-related costs incurred by the Company in connection with this acquisition during the year ended December 31, 2019 were $13 thousand.
The following table summarizes the amounts for the Carolina Pure acquisition which were allocated to the fair value of aggregated net assets acquired (in thousands):
The assets in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. Intangibles identified and valued related to the transaction include customer relationships and non-compete agreements. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of
expected cash flows generated by the revenues under the contract with the customer using a discount rate of 11.8%. The fair value of the non-compete agreements was determined using the comparative business valuation method which is based on the present value of potential revenue and cash flow loss using a discount rate of 11.8%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships and non-compete agreements to be 15 years and 5 years, respectively.
Aguaman, Inc.
On June 1, 2019, Quench acquired substantially all of the water filtration assets and assumed certain liabilities of Aguaman, Inc. (“Aguaman”), a POU water filtration company based in Miami, Florida, pursuant to an asset purchase agreement. The aggregate purchase price, subject to adjustments, was $1.5 million, which included approximately $1.1 million of cash, $0.2 million payable on the one-year anniversary of the transaction and $0.2 million acquisition contingent consideration payable to the seller on or before the one-year anniversary of the transaction. The acquisition contingent consideration is recorded at its estimated fair value with the ultimate payout based upon the future performance of the acquired assets and the resolution of certain matters as set forth in the asset purchase agreement. The undiscounted range of outcomes for the acquisition contingent considerations is $0 to $0.2 million. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
The revenues and related expenses from the acquired in-place lease agreements are included in the Quench reportable segment from the date of acquisition. The Quench business completed the Aguaman acquisition to expand its installed base of POU systems in the United States.
Acquisition-related costs incurred by the Company in connection with this acquisition during the year ended December 31, 2019 were $8 thousand.
The following table summarizes the amounts for the Aguaman acquisition which were allocated to the fair value of aggregated net assets acquired (in thousands):
The assets in the purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer using a discount rate of 13.0%.
The Company determined the weighted average useful life at the date of valuation for the customer relationships to be 12 years.
Other Asset Acquisitions
On October 1, 2019, we acquired substantially all of the assets and assumed certain liabilities of 1920277 Alberta Inc., d/b/a Flowline Canada (“Flowline”), a POU water filtration company based in Edmonton, Canada, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.9 million, which included approximately $0.8 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in Canada.
On December 2, 2019, we acquired substantially all of the assets and assumed certain liabilities of Pure Planet Water, Inc. (“Pure Planet”), a POU water filtration company based in Palm Desert, California, pursuant to an asset
purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $0.2 million, which included approximately $0.1 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
Aggregated acquisition-related costs incurred by the Company in connection with these acquisitions during the year December 31, 2019 were $27 thousand, respectively.
The following table summarizes the aggregate amounts for the Flowline and Pure Planet acquisitions which were allocated to the fair value of aggregated net assets acquired (in thousands):
The assets in the aggregated purchase price allocation are stated at fair value based on estimates of fair value using available information and making assumptions management believes are reasonable. The fair value of the customer relationships was determined using the multi-period excess earnings method which is based on the present value of expected cash flows generated by the revenues under the contract with the customer.
The Company determined the weighted average useful life at the date of valuation for the customer relationships to be 15 years.
4. Revenue
Disaggregation of Revenue
The following table represents a disaggregation of revenue for the years ended December 31, 2019, 2018 and 2017, along with the reportable segment for each category (in thousands):
Contract Assets and Liabilities
Contract assets include amounts related to our contractual right to consideration for completed performance obligations not yet invoiced. Contract liabilities include payments received in advance of performance under the contract or for differences between the amount billed to a customer and the revenue recognized for the completed performance obligation.
The following table provides information about contract assets and contract liabilities from contracts with customers (in thousands) at December 31, 2019 and December 31, 2018:
Significant changes in the contract asset and the contract liability balances during the period are as follows (in thousands):
The Company had no contract asset impairment charges related to contract assets during the years ended December 31, 2019 and 2018.
Transaction Price Allocated to the Remaining Performance Obligation
The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of the reporting period (in thousands). The estimated revenue does not include amounts of variable consideration, including revenues based on changes to consumer price indices that are constrained. In addition, the estimated revenue is based on current contracts with customers and does not take into consideration contract terms not legally enforceable with the customer.
The amounts presented in the table above primarily consist of bulk water sales and service, service concession arrangements and construction revenues for certain product sales contracts. The amounts presented in the table above do not include the rental of equipment accounted for as operating leases as these are included within the disclosure in Note 6-Leases. The transaction price for bulk water sales and service and service concession arrangements are based on contractual minimum monthly charges and the expected amount of variable consideration related to the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied and the contractual rates. The remaining performance obligations to be performed generally include the delivery of bulk water or performance of O&M services with revenues being recognized as the remaining performance obligations are delivered to the customer. The transaction price for the construction revenues are based on the contractual price with the customer. The remaining performance obligations to be performed generally include the completed construction of the infrastructure.
5. Property, Plant and Equipment and Construction in Progress
Property, plant and equipment and construction in progress consisted of the following (in thousands):
During the years ended December 31, 2019, 2018 and 2017, the Company capitalized interest expense of $0.3 million, $0.1 million and $0.1 million, respectively. Total depreciation expense for the years ended December 31, 2019, 2018 and 2017 was $26.2 million, $18.4 million and $16.5 million, respectively, of which $25.4 million, $15.8 million and $14.4 million, respectively, was recorded in cost of revenues in the consolidated statements of operations.
Included in rental equipment are assets on lease and held for lease. As of December 31, 2019 and 2018, assets on lease were $83.7 million and $69.3 million, respectively, net of accumulated depreciation of $30.7 million and $21.9 million, respectively. As of December 31, 2019 and 2018, assets on hold for lease were $3.6 million and $1.8 million respectively, net of accumulated depreciation of $3.1 million and $1.5 million, respectively.
On December 31, 2019, our water supply agreement in Curaçao expired and our customer exercised its right to purchase the desalination facilities pursuant to the terms of the water supply agreement for $3.5 million. At the time of sale, the net book value of the property, plant and equipment sold was approximately $1.0 million and existing asset retirement obligations were approximately $0.7 million. Upon receipt of the cash payment of $3.5 million from the customer, the Company wrote off the related property, plant and equipment, released the related asset retirement obligations and recorded a resulting net gain on sale of property, plant and equipment of approximately $3.2 million, which is reflected within SG&A in the consolidated statements of operations during the year ended December 31, 2019.
6. Leases
Lessee accounting
The Company leases space and operating assets, including offices, office equipment, warehouses, storage yards and storage units under non-cancelable operating leases expiring at various dates with some containing escalation in rent clauses, rent concessions and/or renewal options. Minimum lease payments under operating leases are recognized on a straight-line basis over the term of the lease, including any periods of free rent.
The components of lease cost were as follows (in thousands):
The weighted-average remaining lease term and weighted-average discount rate for operating leases as of December 31, 2019 is 6.7 years and 10.0%, respectively. Cash paid for operating leases that are included in the measurement of lease liabilities for the year ended December 31, 2019 was $2.4 million.
As of December 31, 2019, the maturities of the Company’s operating lease liabilities were as follows (in thousands):
As of December 31, 2018, future minimum lease payments under non-cancelable operating leases are summarized as follows (in thousands):
Lessor accounting
The components of lease income were as follows (in thousands):
Future minimum rental revenues to be generated from the leased assets under non-cancelable operating leases are summarized as follows (in thousands):
Included in long-term receivables, current and long-term receivables in the consolidated balance sheets are sales-type lease receivables for the Company’s sales-type leases. As of December 31, 2019, the maturities of the Company’s sales-type lease receivables are as follows (in thousands):
7. Income Taxes
For income tax purposes, the domestic and foreign components of income (loss) before income tax were as follows (in thousands):
The provision for income tax expense (benefit) consisted of the following (in thousands):
As of December 31, 2019 and 2018, income tax payable was $5.2 million and $4.3 million, respectively, and was recorded in accrued liabilities in the consolidated balance sheets.
The provision for income taxes shown above varied from the “expected” U.S. statutory federal income tax rate for those periods as follows:
Deferred income tax assets and liabilities are composed of the following (in thousands):
As of December 31, 2019, the Company estimated $129.1 million, $126.9 million and $39.1 million of federal, state and foreign net operating loss carryforwards, respectively. As of December 31, 2018, the Company estimated $123.6 million, $88.0 million and $45.2 million of federal, state and foreign net operating loss carryforwards, respectively. The federal loss carryforwards will begin to expire in 2028. Federal loss carryforwards generated in 2019 and 2018 of $1.3 million and $27.9 million, respectively, do not expire. Certain of the state loss carryforwards began expiring at various times in 2019. The foreign loss carryforwards of $7.1 million, in the aggregate, for Trinidad, Chile, Peru and the United Kingdom do not expire. The remaining foreign loss carryforwards will begin to expire in 2021.
Utilization of net operating loss carryforwards may be subject to annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss carryforwards before their utilization. The events that may cause ownership change include, but are not limited to, a cumulative stock ownership change of greater than 50% over a three-year period. Also, net operating loss and credit carryforwards of one subsidiary are not currently available to offset income generated by another subsidiary, which will affect the future benefit from and utilization of these carryforwards.
As of December 31, 2019 and 2018, the Company had approximately $264.6 million and $245.5 million of undistributed earnings, respectively. These earnings are either (i) not available for distribution due to outstanding payables, which will be paid down first, (ii) indefinitely reinvested to grow the business in the current jurisdiction or (iii) if distributed, will not incur taxes as the earnings are in non-taxing jurisdictions. If in the future this income is repatriated or if the Company determines that the earnings will be remitted in the foreseeable future, additional tax provisions may be required. Management believes the amount of unrecognized deferred income tax liabilities on the undistributed earnings is immaterial.
On December 22, 2017, the United States enacted tax reform legislation known as the H.R. 1, commonly referred to as the “Tax Cuts and Jobs Act” (“TCJ Act”), resulting in significant modifications to existing law. Among other changes, the TCJ Act permanently lowers the corporate federal income tax rate to 21% from the existing maximum rate of 35% effective for tax years beginning after December 31, 2017. As a result of the reduction of the corporate federal income tax rate, we revalued our net deferred tax assets and recorded an income tax expense of approximately $7.9 million in the affected jurisdictions as of December 31, 2017. In addition, we recorded an $8.0 million income tax benefit for a corresponding reduction in the valuation allowance on the net deferred tax assets that were subject to the revaluation. For the year ended December 31, 2017, the Company recorded an estimated income tax benefit of approximately $0.1 million related to the TCJ Act. The other provisions of the TCJ Act did not have a material impact
on the consolidated financial statements. During the year ended December 31, 2018, the company completed its accounting for the effects of the TCJ Act resulting in an immaterial impact to the initial adjustment recorded in 2017.
GAAP requires a valuation allowance to reduce the deferred income tax assets recorded if, based on the weight of the evidence, it is more likely than not, that some portion or all of the deferred income tax assets will not be realized. After consideration of all the evidence, the Company has determined that a valuation allowance of approximately $28.5 million and $25.1 million is necessary at December 31, 2019 and 2018, respectively. The Company recognized a net increase in the valuation allowance of $3.4 million during the year ended December 31, 2019.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, various state jurisdictions and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal assessments by tax authorities for years before 2015 and state and local and non-U.S. income tax examinations by tax authorities before 2013. To the extent net operating loss carryforwards are utilized, the tax years in which those net operating loss carryforwards were generated may be subject to adjustment by tax authorities during the examination of a tax return in which those net operating loss carryforwards are utilized.
Uncertain Income Tax Positions
GAAP requires the evaluation of tax positions taken or expected to be taken in the course of preparing tax returns to determine whether the tax positions are “more likely than not” to be sustained by the Company upon challenge by the applicable tax authority. Tax positions not deemed to meet the “more likely than not” threshold and that would result in a tax benefit or expense to the Company would be recorded as a tax benefit or expense in the current period. As of December 31, 2019 and 2018, the Company had unrecognized tax benefits of $0.7 million and $4.6 million, respectively. Of these amounts, $0.1 million and $3.9 of the Company’s unrecognized tax benefits at December 31, 2019 and 2018, respectively, have been recorded as a reduction to the related deferred tax asset for the net operating loss in accordance with the FASB issued authoritative guidance relating to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists for all periods. The remaining $0.6 million and $0.7 million of the Company’s unrecognized tax benefits at December 31, 2019 and 2018, respectively, are fully indemnified pursuant to purchase agreements for business combinations and, if realized, would impact the effective tax rate. In addition, the amount of accumulated penalties and interest related to the unrecognized tax benefit was $0.2 million and $0.3 million, respectively, as of December 31, 2019 and 2018. As of December 31, 2019 and 2018, the Company recorded, in the aggregate, an accrued liability of $0.9 million and $1.0 million, respectively, and a corresponding indemnification receivable of $0.9 million and $1.0 million, respectively, related to the uncertain tax benefits and contractual indemnifications.
For the years ended December 31, 2019, 2018 and 2017, the Company recognized income tax expense on interest and penalties of $0.1 million, $0.1 million and $0.2 respectively, due to the accrual of current year interest on existing uncertain tax positions offset by the lapse of the statute of limitations for certain tax contingencies. The total amount of unrecognized tax benefits is expected to decrease by approximately $0.2 million within 12 months of the reporting date.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2019 and 2018 is as follows (in thousands):
8. Goodwill and Other Intangible Assets
Goodwill
The following table contains a disclosure of changes in the carrying amount of goodwill in total and for each reportable segment for the years ended December 31, 2019 and 2018 (in thousands):
During 2019, the Company updated its preliminary allocations of the purchase price to the assets acquired and liabilities assumed for the Alpine, AUC and PHSI acquisitions. See Note 3- ‘Business Combinations” for further information on the impact that these adjustments had on the consolidated financial statements.
The Company performed its annual impairment assessment of the carrying value of goodwill during the fourth quarters of 2019 and 2018 for each of its reporting units.
For the years ended December 31, 2019 and 2018, the Company assessed the qualitative factors and determined it was more likely than not that the fair value exceeded carrying values for each reporting unit. As such, a quantitative assessment was not performed for any of the reporting units during 2019 or 2018.
There were no goodwill impairment charges recorded for the years ended December 31, 2019, 2018 and 2017.
There have been no goodwill impairment charges recognized for the reporting units within the Seven Seas Water segment and, as such, the carrying value of goodwill at December 31, 2019 and 2018 represents the gross amount of goodwill attributable to the reporting units contained within. A reconciliation of the gross amount of goodwill and the carrying value of goodwill attributable to the Quench reporting unit for the years ended December 31, 2019 and 2018 are as follows (in thousands):
Other Intangible Assets
The gross and net carrying values of other intangible assets by major intangible asset class, are as follows (in thousands):
Amortization expense for these intangible assets for the years ended December 31, 2019, 2018 and 2017 was $22.6 million, $13.4 million and $8.3 million, respectively, of which $2.6 million, $2.6 million and $2.6 million respectively, was recorded as contra-revenue within the consolidated statements of operations and comprehensive income.
Amortization expense for these intangible assets for 2020, 2021, 2022, 2023 and 2024 is expected to be $23.2 million, $21.6 million, $20.2 million, $19.3 million and $17.1 million, respectively.
There was no impairment expense related to other intangible assets recorded during the years ended December 31, 2019, 2018 and 2017.
9. Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
10. Long-Term Debt
As of December 31, 2019 and 2018, long-term debt included the following (in thousands):
Corporate Credit Agreement
On August 4, 2017, the Company, AVH Peru and Quench USA, Inc. (collectively the “Borrowers”) entered into a $150.0 million senior secured credit agreement (the “Corporate Credit Agreement”) with a syndicate of lenders. The Credit Agreement is non-amortizing, matures in August 2021, at the time it was incurred, bore interest at LIBOR plus 6.0% with a LIBOR floor of 1.0%. Interest only payments are due quarterly with principal due in full upon maturity.
On November 17, 2017, the Corporate Credit Agreement was amended to convert the interest rate applicable to 50% of the then-outstanding principal balance, or $75.0 million, from a variable interest rate of LIBOR plus 6.0% with a LIBOR floor of 1.0% to a fixed rate of 8.2%. The remaining 50% of the then-outstanding principal balance, of $75.0 million, continued to bear interest at LIBOR plus 6.0% with a LIBOR floor of 1.0%. All other material terms of the original credit agreement remained substantially unchanged.
On August 28, 2018, the Corporate Credit Agreement was amended to modify certain agreement definitions and non-financial covenants. All other material terms of the original credit agreement remained substantially unchanged.
On November 1, 2018, the Corporate Credit Agreement was amended to: (i) add AquaVenture Holdings Inc., a wholly-owned subsidiary of the Company, as a borrower under the Amended Corporate Credit Agreement, (ii) increase net borrowings by $110.0 million to an aggregate principal amount of $260.0 million, (iii) reduce the interest rate for the original $150.0 million borrowings by 50 basis points on both the variable and fixed interest portions and (iv) amend certain financial covenant requirements. Of the incremental net borrowing of $110.0 million, $70.0 million bears interest at a variable rate of LIBOR plus 5.5% with a LIBOR floor of 1.0%, and the remaining $40.0 million bears interest at a fixed rate of 8.7%. In the aggregate, including the aforementioned interest rate reduction, $145.0 million of borrowings bear interest at a variable rate of LIBOR plus 5.5% with a LIBOR floor of 1.0% and the remaining $115.0 million of borrowings bear interest at a weighted average fixed rate of 8.0%. A declining prepayment fee on the incremental borrowing was due upon repayment if it occurred prior to November 1, 2019. All other material terms of the Corporate Credit Agreement remained substantially unchanged.
On December 20, 2018, the Corporate Credit Agreement was amended to increase its borrowings by $40 million to an aggregate principal amount of $300 million. The incremental borrowings bear interest at a variable rate of LIBOR plus 5.5% with a LIBOR floor of 1.0%. A prepayment fee on the incremental borrowing, which declines over time, was due upon repayment if it occurred prior to December 20, 2019. These additional borrowings are non-amortizing and mature in August 2021. All other terms of the Corporate Credit Agreement remained substantially unchanged.
On December 10, 2019, the Corporate Credit Agreement was amended to modify certain covenants. All other material terms of the original credit agreement remained substantially unchanged.
As of December 31, 2019, the weighted-average interest rate was 7.7%.
The Corporate Credit Agreement is guaranteed by AquaVenture Holdings Limited along with certain subsidiaries and contains financial and nonfinancial covenants. The financial covenants include minimum interest coverage ratio and maximum leverage ratio requirements, as defined in the Corporate Credit Agreement, and are calculated using consolidated financial information of AquaVenture Holdings Limited excluding the results of AquaVenture (BVI) Holdings Limited and its subsidiary Seven Seas Water (BVI) Limited. In addition, the Corporate Credit Agreement contains customary negative covenants limiting, among other things, indebtedness, investments, liens, dispositions of assets, restricted payments (including dividends), transactions with affiliates, prepayments of indebtedness, capital expenditures, changes in nature of business and amendments to documents. As of December 31, 2019, the Company was in compliance with, or received waivers for breaches of, all such covenants.
The Company may prepay in whole or in part, the outstanding principal and accrued unpaid interest under the Corporate Credit Agreement. We did not make repayment on the original $150.0 million borrowing prior to August 4, 2018, and thus did not incur any prepayment fee. The Corporate Credit Agreement is collateralized by certain of the assets of the Borrowers and stated guarantors.
In connection with the refinancing of certain debt agreements in exchange for the Corporate Credit Agreement, the Company recorded a loss on debt extinguishment of $1.4 million during the year ended December 31, 2017 related to prepayment fees, breakage costs and accelerated amortization of debt financing fees, which was recorded in other expense within the consolidated statements of operations and comprehensive income.
BVI Loan Agreement
In connection with the acquisition of the capital stock of AquaVenture (BVI) Holdings Limited (“BVI Acquiree”), in June 2015, the Company assumed the $43.0 million credit facility of its subsidiary, Seven Seas Water (BVI) Ltd., arranged by a bank (the “BVI Loan Agreement”). The BVI Loan Agreement closed on November 14, 2013 and was arranged to finance the construction of a desalination facility at Paraquita Bay in Tortola, BVI and other contractual obligations. The BVI Loan Agreement is project financing with recourse only to the stock, assets and cash flow of Seven Seas Water (BVI) Ltd. and is not guaranteed by the Company or any of its other subsidiaries. The BVI Loan Agreement is guaranteed by United Kingdom Export Finance. As of the acquisition date of June 11, 2015, $40.8 million remained outstanding. In addition, approximately $820 thousand remained available for draw through October 2016. The BVI Loan Agreement was amended on May 7, 2014 and June 11, 2015 to reflect extensions in milestone dates and the acquisition of Seven Seas Water (BVI) Ltd. The BVI Loan Agreement is collateralized by all shares and underlying assets of Seven Seas Water (BVI) Ltd.
Prior to the amendment on August 4, 2017, the BVI Loan Agreement provided for interest on the outstanding borrowings at LIBOR plus 3.5% per annum and interest was paid quarterly. The loan principal is repayable quarterly beginning in March 31, 2015 in 26 quarterly installments that escalate over the term of the loan.
On August 4, 2017, Seven Seas Water (BVI) Ltd. amended the BVI Loan Agreement to extend the amortization on principal to May 2022 and reduce the spread applied to the LIBOR base rate used in the calculation of interest by 50 basis points to LIBOR plus 3.0% per annum. The United Kingdom Export Finance also extended its participation in the project to match the extended term of the amended BVI Loan Agreement. All other material terms of the original loan agreement remained unchanged.
As of December 31, 2019, the weighted-average interest rate was 5.1%. Seven Seas Water (BVI) Ltd. may prepay the principal amounts of the loans at par prior to the maturity date, in whole or in part.
The BVI Loan Agreement includes both financial and nonfinancial covenants, limits the amount of additional indebtedness that Seven Seas Water (BVI) Ltd. can incur and places annual limits on capital expenditures for this subsidiary. The BVI Loan Agreement also places restrictions on distributions made by Seven Seas Water (BVI) Ltd. which is only permitted to make distributions to shareholders and affiliates of AquaVenture Holdings Limited if specified debt service coverage and loan life coverage ratios are met and it is in compliance with all loan covenants. The BVI Loan Agreement contains a number of negative covenants restricting, among other things, indebtedness, investments, liens, dispositions of assets, restricted payments (including dividends), mergers and acquisitions,
accounting changes, transactions with affiliates, prepayments of indebtedness, capital expenditures, and changes in nature of business and joint ventures. In addition, Seven Seas Water (BVI) Ltd is subject to quarterly financial covenant compliance, including minimum debt service and loan life coverage ratios, and must maintain minimum debt service reserve and maintenance reserve funds with the bank in addition to other minimum balance requirements as set forth in the agreement. As of December 31, 2019, Seven Seas Water (BVI) Ltd. was in compliance with, or received waivers for breaches of, all such covenants.
Other Debt
The Company primarily finances its vehicles under three-year terms with interest rates per annum ranging from 3.0% to 4.5%.
Maturities of Long-Term Debt
Maturities of long-term debt were as follows as of December 31, 2019 (in thousands):
Restricted Net Assets
The Corporate Credit Agreement contains no restrictions on the transfer of net assets in the form of loans, advances or cash dividends to the ultimate parent company.
In accordance with the negative covenants as defined within the BVI Loan Agreement, Seven Seas Water (BVI) Ltd. is restricted from declaring dividends unless certain criteria, including financial ratios and operational commitments, under the BVI Loan Agreement have been met. Seven Seas Water (BVI) Ltd. met all the requirements as of December 31, 2019 and 2018 and thus, there were no net asset restrictions for 2019 or 2018.
As of December 31, 2019 and 2018, there were no restricted net assets of the Company.
Deferred Financing Fees
The Company incurred debt financing fees in relation to long-term debt arrangements. These fees are amortized over the term of the related debt using the effective interest method. At December 31, 2019, 2018 and 2017, deferred financing fees, net of amortization, were $1.6 million, $2.6 million and $3.3 million, respectively, and were recorded in long-term debt in the consolidated balance sheets. Amortization expense related to debt financing fees for the years ended December 31, 2019, 2018 and 2017 was $1.0 million, $1.0 million, $1.0 million respectively, and was included in interest expense in the consolidated statements of operations and comprehensive income.
11. Fair Value Measurements
At December 31, 2019 and 2018, the Company had the following assets and liabilities measured at fair value on a recurring basis in the consolidated balance sheets:
·
U.S. Treasury securities are measured on a recurring basis and are recorded at fair value based on quoted market value in an active market, which is considered a Level 1 input.
·
Money market funds are measured on a recurring basis and are recorded at fair value based on each fund’s quoted market value per share in an active market, which is considered a Level 1 input.
·
Acquisition contingent consideration is measured on a recurring basis and is recorded at fair value based on a probability-weighted discounted cash flow model which utilizes unobservable inputs such as the forecasted achievement of performance targets throughout the earn-out period, which is considered a Level 3 input.
There were no transfers into or out of Level 1, 2 or 3 assets during the years ended December 31, 2019 and 2018. Transfers between levels are deemed to have occurred if the lowest level of input were to change.
The Company’s fair value measurements as of December 31, 2019 and 2018 were as follows (in thousands):
See Note 15- “Commitments and Contingencies” for changes in the estimated fair value and additional information on the acquisition contingent consideration.
12. Share-based Compensation
AquaVenture Equity Awards
On September 22, 2016, the Company approved and adopted the AquaVenture Holdings Limited 2016 Share Option and Incentive Plan (“2016 Plan”), which allows for the issuance of incentive share options, non-qualified share options, share appreciation rights, restricted share units, restricted share awards, unrestricted share awards, cash-based awards, performance share awards and dividend equivalent rights to officers, employees, managers, directors and other key persons, including consultants to the Company. The aggregate number of ordinary shares initially authorized for issuance, subject to adjustment upon a change in capitalization, under the 2016 Plan was 5.0 million shares. The shares authorized for issuance increase annually by 4% of the number of ordinary shares issued and outstanding on the immediately preceding December 31. As of December 31, 2019, the number of ordinary shares authorized for issuance under the 2016 Plan was 8.2 million shares.
On October 4, 2016, the outstanding equity awards of the AquaVenture Holdings LLC Amended and Restated Equity Incentive Plans were converted to equity awards of AquaVenture Holdings Limited, with the underlying security being ordinary shares of the AquaVenture Holdings Limited. In addition, the Quench USA Holdings LLC 2014 Equity Incentive Plan and Quench USA, Inc. 2008 Stock Plan (“Quench Equity Plans”) were assumed by AquaVenture Holdings Limited on October 4, 2016. All outstanding awards of the Quench Equity Plans were also converted to equity awards of AquaVenture Holdings Limited, with the underlying security being ordinary shares of the AquaVenture Holdings Limited. The authority to grant additional equity awards under the AquaVenture Holdings LLC Amended and Restated Equity Incentive Plan, Quench USA Holdings LLC 2014 Equity Incentive Plan and Quench USA, Inc. 2008 Stock Plan ceased effective October 5, 2016 at the time of the initial public offering. As a result, no additional equity award grants may be made under these plans.
Options to Purchase Ordinary Shares
Options to purchase ordinary shares granted by the Company contains time-based vesting terms ranging from two to four years. The exercise price of the option to purchase ordinary shares will be equal to the closing share price of Company’s ordinary shares on the date of grant. The contractual term of options to purchase ordinary shares awarded is ten years. Upon the termination of the recipient’s business relationship, unvested options to purchase ordinary shares are
forfeited while vested options to purchase ordinary shares will remain eligible for exercise for a period of 90 days from the recipient’s termination date. Generally, after 90 days from the recipient’s termination date, the vested options to purchase ordinary shares expire.
The Company uses the Black-Scholes option pricing model to determine the fair value of the options to purchase ordinary shares under the plan. There were no options to purchase ordinary shares granted during the years ended December 31, 2019 and December 31, 2018. The following weighted average assumptions were used to determine such fair values of the option awards granted during the year ended December 31, 2017:
The simplified method was used to determine the expected term assumptions as the Company does not have sufficient history to make more refined estimates of the expected term. The risk-free rate assumption was based on U.S. Treasury yields with similar terms. Expected volatility is based on the historical volatility of a selected peer group over a period equivalent to the expected term. The expected dividend yield is 0% because the Company does not have a history of paying dividends or future plans of doing so.
The following table presents the activity of options to purchase ordinary shares for the years ended December 31, 2019, 2018 and 2017 (in thousands, except per share amounts):
As mentioned above, there were no options to purchase ordinary shares granted during the year ended December 31, 2019. The remaining weighted-average contractual term for options to purchase ordinary shares outstanding as of December 31, 2019 was 6.7 years. The remaining weighted-average contractual term for options to purchase ordinary shares exercisable as of December 31, 2019 was 6.7 years. The aggregate intrinsic value of options to
purchase ordinary shares outstanding as of December 31, 2019 was $30.1 million. The aggregate intrinsic value of options to purchase ordinary shares exercisable as of December 31, 2019 was $28.9 million.
As of December 31, 2019, total unrecognized compensation expense related to the options to purchase ordinary shares was $0.6 million, which will be recognized over a weighted-average remaining period of 0.6 years.
Restricted Awards
Restricted awards include restricted share units and restricted share awards. Restricted share units are settled in ordinary shares upon the satisfaction of stated restrictions and conditions at the time of grant while restricted share awards are considered issued and outstanding ordinary shares, subject to trading restrictions until satisfaction of stated restrictions and conditions, at the time of grant and shall have the same rights as a shareholder of the Company, including voting and dividend rights. Restricted awards granted by the Company contain time-based vesting terms ranging from one to four years and have no contractual term. Generally, unvested restricted awards will be forfeited on the termination of the recipient’s business relationship.
The following table presents the activity of restricted awards for the years ended December 31, 2019, 2018 and 2017 (in thousands, except per share amounts):
During the year ended December 31, 2019, the Company granted 0.4 million restricted share units to employees, non-employee consultants and certain members of the Company’s board of directors. Restricted share units granted to employees and non-employee consultants typically have a time-based vesting schedule of four years, primarily with 25% vesting on the first anniversary of the date of grant and the remaining 75% vesting quarterly over the remaining three years. Restricted share units granted to certain members of the Company’s board of directors typically vest in full on the first anniversary of the date of the grant. The fair market value of restricted share units is determined based on the closing share price of the Company’s ordinary shares on the date of grant and is amortized on a straight-line basis over the requisite service period. The aggregate grant date fair value of the awards granted during the year ended December 31, 2019 was $8.5 million.
As of December 31, 2019, total unrecognized compensation expense related to the restricted share units was $9.6 million, which will be recognized over a weighted-average remaining period of 1.5 years.
Employee Stock Purchase Plan
Under the 2016 Employee Share Purchase Plan (“2016 ESPP”), the Company offers eligible employee participants the right to purchase the Company’s ordinary shares at a price equal to the lesser of 85% of the closing market price on the first or last day of an established offering period. Under the 2016 ESPP, 24 thousand shares were sold to eligible employees during the year ended December 31, 2019. Share-based compensation expense is recognized based on the fair value of the employees’ purchase rights under the 2016 ESPP and is amortized on a straight-line basis
over the offering period. The shares authorized for issuance under the 2016 ESPP increase annually on January 1, through 2021, by the lesser of: (i) 1% of the number of shares issued and outstanding on the immediately preceding December 31, (ii) 200,000 shares, or (iii) such number of shares as determined by the administrator of the 2016 ESPP. As of December 31, 2019, the number of ordinary shares authorized for issuance under the 2016 ESPP was 0.9 million shares.
Independent Directors’ Deferred Compensation Program
Under the Independent Directors' Deferred Compensation Program (the “Deferred Compensation Program”), which was established under the 2016 Plan, eligible members of the Company’s board of directors (“Eligible Directors”) are able to defer all or a portion of the cash compensation or equity awards which they are due in the form of phantom share units. Each phantom share unit is the economic equivalent of one ordinary share of the Company. The number of phantom share units credited to the Eligible Director’s deferred account is equal to 120% of the aggregate deferred cash fees that would otherwise be payable on such date divided by the closing price of the Company’s ordinary shares on the award date. No premium is given to the directors for deferral of their equity awards. Phantom share units shall be settled in ordinary shares upon the earlier of the Eligible Director’s death, disability, separation from the board, sale event, or end of the first full fiscal year after the grant date. The phantom share units issued in lieu of the cash retainers have no vesting period and cannot be forfeited. The phantom share units issued in lieu of the restricted units will have a stated vesting period but will then have a deferred delivery once vested.
Share-based compensation expense for the phantom share units issued in lieu of the cash retainers is recognized on the date of grant, while share-based compensation expense for the phantom share units issued in lieu of the restricted units is recognized over the requisite service period, which is typically 12 months.
During the year ended December 31, 2019, the Company granted 25 thousand phantom share units to Eligible Directors, including 17 thousand phantom share units subject to a 12 month vesting period and 8 thousand phantom shares that are immediately vested. The aggregate grant date fair value of the awards granted during the year ended December 31, 2019 was $0.5 million.
During the year ended December 31, 2019, approximately 9 thousand phantom share units were forfeited pursuant to the terms in the Deferred Compensation Program. During the year ended December 31, 2019, 12 thousand phantom share units were converted to 12 thousand ordinary shares of the Company pursuant to the terms in the Deferred Compensation Program.
At December 31, 2019, 52 thousand phantom shares remained outstanding.
Share-Based Compensation Expense
Total share-based compensation expense recognized for all equity awards during the years ended December 31, 2019, 2018 and 2017 was $5.0 million, $11.2 million and $12.1 million, respectively. For the year ended December 31, 2019, $4.8 million and $0.2 million were recorded in SG&A and cost of revenues, respectively, within the consolidated statements of operations and comprehensive income. For the year ended December 31, 2018, $11.0 million and $0.2 were recorded in SG&A and cost of revenues, respectively, within the consolidated statements of operations and comprehensive income. For the year ended December 31, 2017, $11.7 million and $0.4 were recorded in SG&A and cost of revenues, respectively, within the consolidated statements of operations and comprehensive income.
There was no related tax benefit for the years ended December 31, 2019, 2018 and 2017.
13. Loss per Share
Basic earnings (loss) per share is computed by dividing net earnings (loss) attributable to ordinary shareholders for the period by the weighted-average number of ordinary shares outstanding during the same period. Basic weighted-average shares outstanding excludes unvested shares of restricted share awards. Diluted earnings (loss) per share is computed by dividing net earnings (loss) attributable to ordinary shareholders for the period by the weighted-average number of ordinary shares outstanding adjusted to give effect to potentially dilutive securities using the treasury stock method, except where the effect of including the effect of such securities would be anti-dilutive.
The following table reconciles net loss to net loss applicable to ordinary shareholders for the periods presented (in thousands, except per share amounts):
Given that the Company had a net loss for the periods presented, the calculation of diluted loss per share is computed using basic weighted average ordinary shares outstanding.
For the years ended December 31, 2019, 2018 and 2017, approximately 4.1 million, 4.1 million and 3.9 million weighted-average outstanding share awards, respectively, were excluded from the calculation of diluted earnings per share because their effect was antidilutive.
14. Employee Benefit Plans
On April 1, 2013, the Company began offering a defined contribution 401(k) plan to its Seven Seas Water employees in the United States (“SSW Plan”). During the year ended December 31, 2017, the Company contributed 3% of each employee’s compensation to the SSW Plan. As of January 1, 2018, the SSW Plan was amended and the Company now matches 50% of the first 6% of the employee’s compensation deferred under the plan.
On June 6, 2014 in connection with the acquisition of Quench, the Company assumed the Quench USA, Inc. 401(K) Profit Sharing Plan and Trust (“Quench Plan”) which covers substantially all of the employees of Quench. The Company matches 50% of the first 6% of the employee’s compensation deferred in the Quench Plan.
The Company’s expense for both the plans for the years ended December 31, 2019, 2018 and 2017 was $1.0 million, $0.8 million and $0.7 million, respectively.
15. Commitments and Contingencies
Asset Retirement Obligations
ARO liabilities, which arise from contractual requirements to perform certain asset retirement activities and is generally recorded when the asset is constructed, is based on the Company’s engineering estimates of future costs to dismantle and remove equipment from a customer’s plant site and to restore the site to a specified condition at the conclusion of a contract. As appropriate, the Company revises certain of its liabilities based on changes in the projected costs for future removal and shipping activities. These revisions, along with accretion expense, are included in cost of revenues in the consolidated statements of operations and comprehensive income.
During the years ended December 31, 2019, 2018 and 2017, the Company recorded accretion expense of $52 thousand, $50 thousand and $49 thousand, respectively. During the year ended December 31, 2019, the Company performed certain asset retirement activities and settled ARO liabilities of $3 thousand upon the conclusion of certain of its contracts. During the year ended December 31, 2019, the Company released certain ARO liabilities of $0.9 million as it no longer had an obligation under certain contracts due to the amendment of the underlying contract or sale of underlying equipment. The Company recorded a valuation adjustment of $24 thousand during the year ended December 31, 2019, respectively, which was recorded in cost of revenues in the consolidated statements of operations and comprehensive income. No valuation adjustments were recorded during the years ended December 31, 2018 and 2017.
At December 31, 2019 and 2018, the current portion of the ARO liabilities was $0 and $0.7 million, respectively, and was recorded in accrued liabilities in the consolidated balance sheets. At December 31, 2019 and 2018, the long-term portion of the ARO liabilities was $0.3 million and $0.5 million, respectively, and was recorded in other long-term liabilities in the consolidated balance sheets.
As of December 31, 2019, the Company estimated remaining payments (undiscounted) for the ARO liability to be $0.5 million.
Acquisition Contingent Consideration
Acquisition contingent consideration represents the additional purchase price that was derived in connection with certain acquisitions.
A reconciliation of the beginning and ending amounts of the acquisition contingent consideration for the periods presented is as follows (in thousands):
Acquisition contingent consideration liabilities consist of (i) payments held for potential adjustments or claims as set forth in the purchase agreements which are recorded at fair value based on collectability and a discount factor, (ii) payments contingent on the future collection of certain acquired receivables which are recorded at fair value based on collectability and a discount factor and (iii) payments that are contingent on the future performance of the acquired business and are recorded at fair value based on a Monte Carlo Simulation which utilizes unobservable inputs, including forecasted revenues.
The Company recorded interest accretion expense within the consolidated statements of operations and comprehensive income of $140 thousand, $13 thousand and $0, respectively, for the years ended December 31, 2019, 2018 and 2017.
The Company recorded a valuation adjustments of $136 thousand for the change in fair value during the year ended December 31, 2019, which was composed of (i) $191 thousand which was recorded in SG&A in the consolidated statements of operations and comprehensive income and (ii) $(55) thousand that was part of final purchase price allocation adjustments. The Company recorded a valuation adjustment of ($40) thousand for the change in fair value during the year ended December 31, 2018, which was recorded in SG&A in the consolidated statements of operations and comprehensive income. There were no valuation adjustments for the year ended December 31, 2017.
At December 31, 2019 and 2018, $3.1 million and $2.7 million, respectively, was deemed current and was recorded in accrued liabilities in the consolidated balance sheets. At December 31, 2019 and 2018, $0.3 million and $0.4 million, respectively, was deemed long-term and was recorded in other long-term liabilities in the consolidated balance sheets.
Litigation
The Company, may, from time to time, be a party to legal proceedings, claims, and administrative matters that arise in the normal course of business. The Company has made accruals with respect to certain of these matters, where appropriate, that are reflected in the consolidated financial statements but are not, individually or in the aggregate, considered material. For other matters for which an accrual has not been made, the Company has not yet determined that a loss is probable or the amount of loss cannot be reasonably estimated. While the ultimate outcome of the matters cannot be determined, the Company currently does not expect that these proceedings and claims, individually or in the aggregate, will have a material effect on its consolidated financial position, results of operations, or cash flows. The
outcome of any litigation is inherently uncertain, however, and if decided adversely to the Company, or if the Company determines that settlement of particular litigation is appropriate, the Company may be subject to liability that could have a material adverse effect on its consolidated financial position, results of operations, or cash flows. The Company maintains liability insurance in such amounts and with such coverage and deductibles as management believes is reasonable. The principal liability risks that the Company insures against are customer lawsuits caused by damage or nonperformance, workers’ compensation, personal injury, bodily injury, property damage, directors’ and officers’ liability, errors and omissions, employment practices liability and fidelity losses. There can be no assurance that the Company’s liability insurance will cover any or all events or that the limits of coverage will be sufficient to fully cover all liabilities. As of December 31, 2019 and 2018, the Company determined there are no matters for which a material loss is reasonably possible or the Company has either determined that the range of loss is not reasonably estimable or that any reasonably estimable range of loss is not material to the consolidated financial statements.
Since the announcement of the Merger Agreement on December 23, 2019, three putative class actions have been filed in connection with the proposed Merger. On February 4, 2020, in connection with the merger, a putative class action lawsuit, Post v. AquaVenture Holdings Ltd., et al., 1:20-cv-174, was filed by purported shareholder Joseph Post against our Company and our directors in the United States District Court for the District of Delaware. On February 12, 2020, in connection with the merger, a lawsuit, Hamilton v. AquaVenture Holdings Ltd., et al., 1:19-cv-01227, was filed as an individual action by purported shareholder Peter Hamilton against our Company and our directors in the United States District Court for the Southern District of New York. On February 20, 2020, purported shareholder Christopher Jagt filed an individual lawsuit against the Company and its directors in the United States District Court for the Eastern district of New York, captioned Jagt v. AquaVenture Holdings Ltd., et. al. 1:20-cv-931. These complaints allege that, because the proxy statement concerning the Merger is materially deficient in certain respects, all of the defendants violated Sections 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder, and that the directors additionally violated Section 20(a) of the Exchange Act. The complaints seek, among other things, (1) injunctive relief preventing consummation of the Merger, (2) rescissory damage or rescission of the Merger if it has already occurred; and (3) costs and fees, including attorney and expert fees, related to the actions. The defendants believe that the respective allegations asserted against them in the lawsuits are without merit and intend to defend against the lawsuits vigorously. Similar cases may also be filed in connection with the merger. These legal proceedings could delay or prevent the Merger from becoming effective.
16. Supplemental Cash Flow Information
Supplemental cash flow information is as follows for the years ended December 31 (in thousands):
The components of total ending cash for the periods presented in the consolidated statement of cash flows are as follows (in thousands):
17. Segment Reporting
The Company has two operating and reportable segments, Seven Seas Water and Quench. This determination is supported by, among other factors, the existence of individuals responsible for the operations of each segment and who also report directly to the Company’s chief operating decision maker (“CODM”), the nature of the segment’s operations and information presented to the Company’s CODM.
Seven Seas Water provides outsourced desalination solutions and wastewater treatment and water reuse solutions for governmental, municipal (including utility districts), industrial, property developers and hospitality customers in the Caribbean region, the United States and in South America. Quench rents and sells bottleless filtered water coolers and other products that use filtered water as an input, such as ice machines, sparkling water dispensers and coffee brewers, to customers throughout the United States and Canada.
In addition to the Seven Seas Water and Quench segments, the Company records certain general and administrative costs that are not allocated to either of the reportable segments within “Corporate and Other” for the CODM and for segment reporting purposes. These costs include, but are not limited to, professional service fees and other expenses to support the activities of the registrant holding company. Corporate and Other does not include any labor allocations from the Seven Seas Water and Quench segments. The Company believes this presentation more accurately portrays the results of the core operations of each of the operating and reportable segments to the CODM. The Corporate and Other administration function is not treated as a segment.
As part of the segment reconciliation below, intercompany interest expense and the associated intercompany interest income are included but are eliminated in consolidation.
The following table provides information by reportable segment and a reconciliation to the consolidated results for the year ended December 31, 2019 (in thousands):
The following table provides information by reportable segment and a reconciliation to the consolidated results for the year ended December 31, 2018 (in thousands):
The following table provides information by reportable segment and a reconciliation to the consolidated results for the year ended December 31, 2017 (in thousands):
Revenues earned by major geographical region were (in thousands):
Revenues earned from major customers, which are all included within the Seven Seas Water reportable segment, were (in thousands):
See Note 4-“Revenue” for revenues from external customers for each product and service by segment.
Long-lived assets, which include property, plant and equipment, net and construction in process, by major geographic region were (in thousands):
18. Significant Concentrations, Risks and Uncertainties
The Company is exposed to interest rate risk resulting from its variable rate loans outstanding that adjust with movements in LIBOR.
For the year ended December 31, 2019, a significant portion of the Company’s revenues were derived from territories and countries in the Caribbean region. Demand for water in the Caribbean region is impacted by, among other things, levels of rainfall, natural disaster or other catastrophic events, the tourism industry and demand from our industrial clients. Destruction caused by tropical storms and hurricanes, high levels of rainfall, downturn in the level of tourism and demand for real estate could all adversely impact the future performance of the Company as well as cause delays in collections from the Company’s customers.
At December 31, 2019, a significant portion of the Company’s property, plant and equipment is located in the Caribbean region. The Caribbean islands are situated in a geography where tropical storms and hurricanes occur with regularity, especially during certain times of the year. The Company designs its plant facilities to withstand such conditions; however, a major storm could result in plant damage or periods of reduced consumption or unavailability of electricity or source seawater needed to produce water in one or more of our locations. It is the Company’s policy to maintain adequate levels of property and casualty insurance; however, the Company only insures certain of its plants for wind damage.
The operation of desalination plants requires significant amounts of electricity which typically is provided by the local utility of the jurisdiction in which the plant is located. A shortage of electricity supply caused by force majeure or material increases in electricity costs could adversely impact the Company’s operating results. To mitigate the risk of electricity cost increases, the Company has generally contracted with major customers for those cost increases to be borne by the customers and has invested in energy efficient technology. Management believes that rising energy costs and availability of its supply of electricity would not have a material adverse effect on its future performance.
19. Quarterly Financial Data (Unaudited)
The following tables provides quarterly information for the years ended December 31, 2019 and 2018 (in thousands, except per share amounts):
20. Subsequent Events
The Company has evaluated subsequent events through the date of issuance of the consolidated financial statements for the year ended December 31, 2019. The subsequent events included the following:
·
On January 13, 2020, Quench acquired substantially all of the assets and assumed certain liabilities of Smart Water Solutions, LLC (“Smart Water Solutions”), a POU water filtration company based in Butler, New Jersey, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $1.2 million, which included approximately $1.1 million of cash and $0.1 million payable on the one-year anniversary of the transaction. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
Due primarily to the timing of the acquisition and the complexities involved with determining fair value of assets acquired, the Company has not yet completed the allocation of the net assets acquired.
The revenues and related expenses from the acquired in-place lease agreements will be included in the Quench reportable segment from the date of acquisition. The Quench business completed the acquisition of Smart Water Solutions to expand its installed base of POU systems in the United States.
·
On February 5, 2020, effective February 3, 2020, Quench acquired substantially all of the assets and assumed certain liabilities of Krystal Kleer LLC (“Krystal Kleer”), a POU water filtration company based in Meridian, Connecticut, pursuant to an asset purchase agreement. The estimated aggregate purchase price, subject to adjustments, was $8.9 million, which included approximately $7.1 million of cash, $0.8 million payable on the one-year anniversary of the transaction and $1.0 million of acquisition contingent consideration. The assets acquired consist primarily of in-place lease agreements and the related POU systems in the United States.
Due primarily to the timing of the acquisition and the complexities involved with determining fair value of assets acquired, the Company has not yet completed the allocation of the net assets acquired.
The revenues and related expenses from the acquired in-place lease agreements will be included in the Quench reportable segment from the date of acquisition. The Quench business completed the acquisition of Krystal Kleer to expand its installed base of POU systems in the United States.
			 		
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to our management, including our Chief Executive Officer, who is our principal executive officer, and our Chief Financial Officer, who is also our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
As of December 31, 2019, our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Our principal executive officer and principal financial officer have concluded, based upon the evaluation described above, that, as of December 31, 2019, our disclosure controls and procedures were effective at the reasonable assurance level.
(b) Report of Management on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. Management evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (the 2013 Framework). Management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2019 and concluded that it was effective.
(c) Inherent Limitations of Internal Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of control can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. In addition, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations, misstatements due to error or fraud may occur and not be detected.
(d) Changes in Internal Control over Financial Reporting
In connection with the adoption of guidance regarding leases, we have implemented additional preventative and detective controls around the recording and disclosure of leases, including but not limited to the accumulation of accurate information, review of critical assumptions, the calculation of right-of-use assets and lease liabilities for the period and the completeness and accuracy of new disclosure requirements. There were no other changes in our internal
control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the year ended December 31, 2019 that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Ofﬁcers and Corporate Governance.
(1)
Member of Compensation Committee.
(2)
Member of Audit Committee.
(3)
Member of the Nominating and Corporate Governance Committee
Executive Officers
Anthony Ibarguen, 60, has served as our Chief Executive Officer since January 2019. He has served as a member of our Board and President since June 2014 and as the Chief Executive Officer of Quench since October 2010. Mr. Ibarguen has also served on the board of directors of the Federal Reserve Bank of Philadelphia since January 2018 and on the board of directors of Insight Enterprises, Inc. (NASDAQ: NSIT), a Fortune 500 information technology business, since July 2008. He served as Insight’s interim Chief Executive Officer in 2009. From 2004 to 2008, he was the Chief Executive Officer of Alliance Consulting Group, a privately held information technology consulting firm. During that time, he also served on the board of directors of CCOR Inc., a global on-demand network solutions provider (NASDAQ: ARRS). He holds a B.A. in Marketing from Boston College and an M.B.A. from Harvard Business School. We believe Mr. Ibarguen is qualified to serve on our Board because of his experience as an executive officer of the Company and Quench, as well as his extensive experience as a business leader, board member and investor.
Lee Muller, 59, has served as our Senior Vice President and Chief Financial Officer since October 2014. Mr. Muller has been Senior Vice President and Chief Financial Officer of our Seven Seas Water business since December 2013. From October 2005 to December 2012, Mr. Muller served in various executive capacities, including Executive Vice President and Chief Financial Officer, at ContourGlobal plc, a developer, owner and operator of electric power businesses. Mr. Muller was also an investment banker with Goldman Sachs for over 10 years where he specialized in international
project finance. Mr. Muller holds a B.S. in Accounting and Finance from Boston University and an M.B.A. from the University of Chicago.
Douglas Brown, 65, founded the Company in December 2006 and has served as our Chairman of the Board since January 2007. Mr. Brown served as our Chief Executive Officer from January 2007 to October 2012 and from October 2014 to December 2018. Mr. Brown has also served as Chief Executive Officer of the Seven Seas Water business from January 2007 to October 2012 and from October 2014 through December 2018. From 2003 to 2005 Mr. Brown served as the Chief Executive Officer of Ionics, Incorporated (NYSE: ION), a water purification technology company that was sold to General Electric in 2005. Together with his prior experience at Ionics, he has more than 20 years of experience in the water industry. Before joining Ionics, Mr. Brown spent 17 years at Advent International Corporation, a global private equity firm, the last seven years of which he was chief executive officer. He also serves as an operating partner and senior advisor of Element Partners, a private equity firm. Mr. Brown received a B.S. in Chemical Engineering from Massachusetts Institute of Technology and an M.B.A. from Harvard Business School where he was designated a Baker Scholar and a Loeb Rhodes Fellow in Finance. We believe Mr. Brown is qualified to serve on our Board because of his experience as an executive officer of our company, his extensive business, management and executive experience and his experience as a seasoned investor.
Olaf Krohg, 58, has served as the Chief Executive Officer of Seven Seas Water since January 2019. Mr. Krohg served as the Vice President of Mergers and Acquisitions of Seven Seas Water from June 2016 to December 2018. Previously, Mr. Krohg served as President and Chief Executive Officer of Scallop Imaging LLC from 2014 to 2015. From 2004 to 2013, Mr. Krohg served in various leadership roles, including Chairman and Chief Executive Officer, of Dimensional Photonics International, Inc., which was acquired by Danaher Corporation (NYSE: DHR) in 2010. Prior to 2004, Mr. Krohg served in partner and director roles for various private equity firms and their portfolio companies, including Advent International from 1992 to 2001. He has also served as a management consultant with McKinsey & Company. Mr. Krohg holds a B.S. in Business Administration from Boston University and an M.B.A. from Harvard Business School.
Brian Miller, 54, has served as Senior Vice President and General Counsel since May 2019. Previously, Mr. Miller served in various leadership positions with AES Corporation, a Fortune 200 global power company, from July 2001 to March 2018. His leadership positions included Executive Vice President, General Counsel and Corporate Secretary from 2005 to 2018 in addition to co-head of Business Development, Deputy General Counsel, Chief Compliance Officer, Corporate Secretary, General Counsel for North America and Assistant General Counsel. He also was responsible at times for the management of other teams, including cyber security, stakeholder management, internal audit and independent review, and served as Chair or member of numerous AES subsidiary and/or joint venture Boards. During his tenure at AES, Mr. Miller was recognized with numerous awards including “Distinguished General Counsel” by the New York Stock Exchange in 2015. From 1990 to 2001, Mr. Miller served as counsel in the New York office of Chadbourne and Parke, LLP. Mr. Miller holds a B.A. in History and Economics from Boston College and a juris doctorate degree from the University of Connecticut School of Law.
Directors
Debra Coy, 62, has served as a member of our Board of Directors since February 2019. Ms. Coy has served as a partner with XPV Water Partners, the largest water-focused growth equity fund in North America, since 2015 and as an advisor to the firm from 2010 to 2015. From 2010 to 2015, she served as a principal of Svanda & Coy Consulting, providing strategic capital markets advisory services for water sector investors, corporations and municipal utilities. Before 2010, she led coverage of the global water sector as Managing Director of the capital markets group at Janney Montgomery Scott and held senior equity research positions at the Stanford Washington Research Group, Schwab Capital Markets, HSBC Securities and National Westminster Bank. In addition, Ms. Coy has served on the Board of Directors of Global Water Resources, Inc. (NASDAQ: GWRS) since May 2018 and Willdan Group, Inc. (NASDAQ: WLDN) since March 2018. From 2013 until 2016, Ms. Coy served as a non-executive director for Headworks International, Inc., a wastewater treatment technology firm. Ms. Coy has also served as co-chair of the Water Environment Federation’s Global Water Strategies Council. She received a B.A. in English and Journalism from Southern Adventist University in Tennessee and an M.A. in Journalism from the University of Maryland. We believe Ms. Coy is qualified to serve on our Board because of her board membership, water market and investor experience.
Hugh Evans, 53, has served as a member of our Board of Directors since 2013. Mr. Evans is currently Director of Capital Markets at CollPlant Biotechnologies. Mr. Evans previously managed corporate development activities for 3D
Systems Corporation, a leading 3D printing company, from March 2013 through January 2019. He also held an operating role leading its digitization business unit during that time. Prior to 3D Systems, Mr. Evans served as an analyst and portfolio manager at T. Rowe Price Associates for more than 20 years. He holds a B.A. from the University of Virginia and an M.B.A. from Stanford University. We believe Mr. Evans is qualified to serve on our Board because of his executive and investment experience.
Paul Hanrahan, 62, has served as a member of our Board of Directors since 2012. Mr. Hanrahan served as Chief Executive Officer of Globeleq Africa Ltd, a United Kingdom company developing, owning and operating electric power businesses in Africa, from September 2017 to January 2020. He also served as Chief Executive Officer and co-founder of American Capital Energy & Infrastructure, a private equity firm that invests in energy infrastructure assets, from September 2012 to December 2016. Prior to establishing American Capital Energy & Infrastructure, from June 2002 to September 2011, Mr. Hanrahan served as the Chief Executive Officer and President of The AES Corporation (NYSE: AES), one of the largest global energy infrastructure companies in the world. Mr. Hanrahan serves on the board of Ingredion Incorporated (NYSE: INGR). He has also served on the boards of other major publicly listed utilities in Latin America and was twice appointed by the White House to serve on the US India CEO Forum. Mr. Hanrahan holds a B.S. in Mechanical Engineering from the United States Naval Academy and an M.B.A. from Harvard Business School. We believe Mr. Hanrahan is qualified to serve on our Board because of his extensive executive experience and board membership in several publicly traded companies.
David Lincoln, 63, has served as a member of our Board of Directors since 2016. Mr. Lincoln is a founder of and has served as managing partner at Element Partners LP, a sustainability and industrial technology investment firm, since 2004. Mr. Lincoln has been a prominent investor in renewable and alternative energy and industrial technology companies for over 25 years. Mr. Lincoln currently serves as a member of the board of directors of numerous private companies. Mr. Lincoln holds a B.A. with honors from Colgate University and an M.S. from the University of Pennsylvania. We believe Mr. Lincoln is qualified to serve on our Board because of his experience as a seasoned investor, operator and business advisor in the energy and technology industry.
Timothy J. Whall, 58, has served as a member of our Board of Directors since August 2019. Mr. Whall has served on the Board of Directors of ADT, Inc. (NYSE: ADT), formerly ADT Corporation, formerly ADT Corporation, since May 2016. Previously, Mr. Whall served as Chief Executive Officer of ADT, Inc. from September 2017 until his retirement in November 2018 and President from April 2016 to September 2017. In addition, he was President of Prime Borrower from July 2015 to March 2018. From June 2010 to March 2017, Mr. Whall served as President, Chief Executive Officer, and a member of the Board of Directors of Protection One, Inc. Mr. Whall joined SecurityLink in 1990 as a Service Manager. He served as a General Manager before joining the senior management team in various capacities and ultimately became the President and Chief Operating Officer. After SecurityLink was acquired by GTCR in 2000, Mr. Whall continued to serve as President and Chief Operating Officer. Following SecurityLink’s sale to Tyco in 2001, Mr. Whall was ADT, Inc.’s Senior Vice President of Business Operations from 2001 to 2004. In 2004, Mr. Whall partnered with GTCR to acquire Honeywell’s Security Monitoring division (“HSM”). At HSM he served as President and Chief Operating Officer. Following the sale of HSM to Stanley Black & Decker, Mr. Whall served as Chief Operating Officer of StanleyWorks’ Convergent Security Solutions division for one year. In 2008, he left Stanley to pursue opportunities with GTCR. That partnership led to GTCR’s acquisition of the Protection One business in June 2010. Mr. Whall received a Bachelor’s degree in Personnel Management from Michigan State University.
Cyril Meduña, 62, has served as a member of our Board of Directors since 2013. In 1989, Mr. Meduña founded Advent Morro Equity Partners, Puerto Rico’s first and largest private equity and venture capital firm. Advent-Morro’s portfolio companies operate in the United States, the Caribbean and Latin America. Since 2008, Mr. Meduña has served as Honorary Consul of Chile in Puerto Rico and the U.S. Virgin Islands. He obtained a B.S. in Mechanical Engineering from Rensselear Polytechnic Institute and an M.B.A. from George Washington University. We believe Mr. Meduña is qualified to serve on our Board because of his experience as a seasoned investor and experience with multiple operating companies in the Caribbean and Latin America.
Richard Reilly, 72, has served as a member of our Board of Directors since 2014. For 28 years prior to his retirement in 2009, Mr. Reilly served as a senior audit partner at KPMG LLP. Since July 2010, Mr. Reilly has served on the board of directors and as chair of the audit committee of Aspen Aerogels, Inc. (NYSE: ASPN), a leader in the energy insulation market. Mr. Reilly also serves as a member of the as a member of the finance and audit committee for the Clergy Health and Retirement Trust Funds of the Archdiocese of Boston. From September 2009 to December 2018, Mr. Reilly served as a trustee and chair of the audit committee of Perkins School for the Blind. From November 2012 to December 2013,
Mr. Reilly served as a consultant to a Fortune 500 company related to finance, controls and governance issues at its subsidiary in India. Mr. Reilly holds a B.S. in Business Administration from Northeastern University and is a Certified Public Accountant. We believe Mr. Reilly is qualified to serve on our Board because of his experience in business, accounting and finance.
Code of Business Conduct and Ethics
Our Board has adopted a Code of Business Conduct and Ethics that applies to all of our employees, officers and directors, including our Chief Executive Officer, and other executive and senior financial officers. A copy of the code is posted on the Governance section of our website, which is located at http://aquaventure.com/investors/governance/governance-documents. If we make any substantive amendments to, or grant any waivers from, the Code of Business Conduct and Ethics for any officer or director, we will disclose the nature of such amendment or waiver on our website or in a current report on Form 8-K.
Board Committees
Our Board has established an Audit Committee, a Compensation Committee and a Nominating and Corporate Governance Committee. The composition and responsibilities of each of the committees of our Board are described below. Members will serve on these committees until their resignation or until as otherwise determined by our Board.
Audit Committee
Our Audit Committee is a standing committee of the Board and consists of Messrs. Whall, Meduña, Reilly and Ms. Coy, with Mr. Reilly serving as chairman. The composition of our Audit Committee meets the requirements for independence under current New York Stock Exchange, or NYSE, listing standards and SEC rules and regulations and the Audit Committee was established in accordance with Section 3(a)(58)(A) of the Exchange Act. Each member of our Audit Committee meets the financial literacy requirements of the NYSE listing standards. In addition, our Board has determined that Mr. Reilly is an audit committee financial expert within the meaning of Item 407(d) of Regulation S-K under the Securities Act. Our Audit Committee will, among other things:
·
select a qualified firm to serve as the independent registered public accounting firm to audit our financial statements;
·
help to ensure the independence and performance of the independent registered public accounting firm;
·
discuss the scope and results of the audit with the independent registered public accounting firm, and review, with management and the independent registered public accounting firm, our interim and year-end operating results;
·
develop procedures for employees to submit concerns anonymously about questionable accounting or audit matters;
·
review our policies on risk assessment and risk management;
·
review related party transactions;
·
obtain and review a report by the independent registered public accounting firm at least annually, that describes our internal control procedures, any material issues with such procedures and any steps taken to deal with such issues; and
·
approve (or, as permitted, pre-approve) all audit and all permissible non-audit services to be performed by the independent registered public accounting firm.
The Audit Committee is responsible for appointing the independent auditor, approving engagement fees and engagements, and reviewing the independence and quality of the independent auditor. The Audit Committee is also responsible for reviewing audit plans, audit reports, recommendations of the independent auditor and the internal audit
function. The Audit Committee reviews systems of internal accounting controls and audit results. The Audit Committee also reviews and discusses with management the Company’s financial statements, earnings releases and earnings guidance. In addition, the Audit Committee reviews the Company’s compliance with regulatory requirements and our Code of Business Conduct and Ethics.
The Audit Committee met five times during the fiscal year ended December 31, 2019. Our Audit Committee operates under a written charter that satisfies the applicable rules of the SEC and the listing standards of the NYSE. A complete copy of the Audit Committee Charter is available on the Governance page of our website at, http://aquaventure.com/investors/governance/governance-documents.
Compensation Committee
Our Compensation Committee is a standing committee of the Board and consists of Messrs. Evans, Hanrahan, Lincoln and Whall, with Mr. Hanrahan serving as chairman. The composition of our Compensation Committee meets the requirements for independence under NYSE listing standards and SEC rules and regulations. Each member of the Compensation Committee is also a non-employee director (as defined pursuant to Rule 16b-3 promulgated under the Exchange Act) and an outside director (as defined pursuant to Section 162(m) of the United States Internal Revenue Code of 1986, (the “Code”)). The purpose of our Compensation Committee is to discharge the responsibilities of our Board relating to compensation of our executive officers. Our Compensation Committee, among other things:
·
reviews, approves and determines, or makes recommendations to our Board regarding the compensation of our executive officers;
·
evaluates the performance of our Chief Executive Officer in light of corporate goals and objectives and based on such evaluation: recommends to the Board the compensation for the Chief Executive Officer, including base salary, short-term and long-term incentive compensation and compensation under equity-based plans;
·
administers our share and equity incentive plans;
·
reviews, approves and makes recommendations to our Board regarding incentive compensation and equity plans;
·
establishes and reviews general policies relating to compensation and benefits of our employees;
·
produces a Compensation Committee report to be included in the Company’s proxy statement relating to its annual meeting of stockholders or annual report on Form 10-K in accordance with applicable rules and regulations.
The Compensation Committee establishes executive compensation policies and reviews and approves senior executive compensation. The Chief Executive Officer recommends to the Compensation Committee the form and level of compensation for each named executive officer other than himself. The Compensation Committee reviews corporate goals and objectives relevant to the Chief Executive Officer’s compensation, evaluates the Chief Executive Officer’s performance against those objectives, and makes recommendations to the Board regarding the Chief Executive Officer’s compensation. The Compensation Committee does not delegate authority to perform any of the foregoing functions with respect to the compensation of any named executive officer. In addition, the Compensation Committee reviews director compensation periodically and makes recommendations regarding director compensation to the Board for approval.
During 2019, the Compensation Committee met six times and acted by written consent three times. Our Compensation Committee operates under a written charter that satisfies the applicable rules of the SEC and the listing standards of the NYSE. A complete copy of the Compensation Committee Charter is available on the Governance page of our website at, http://aquaventure.com/investors/governance/governance-documents.
Nominating and Corporate Governance Committee
Our Nominating and Corporate Governance Committee is a standing committee of the Board and consists of Messrs. Lincoln, Meduña, Evans and Ms. Coy, with Mr. Lincoln serving as chairman. The composition of our
Nominating and Corporate Governance Committee meets the requirements for independence under NYSE listing standards and SEC rules and regulations. Our Nominating and Corporate Governance Committee, among other things:
·
identifies, evaluates and selects, or make recommendations to our Board regarding, nominees for election to our Board and its committees;
·
evaluates the performance of our Board and of individual directors;
·
considers and make recommendations to our board of directors regarding the composition of our Board and its committees;
·
reviews developments in corporate governance practices;
·
evaluates the adequacy of our corporate governance practices and reporting; and
·
develops and make recommendations to our Board regarding corporate governance guidelines and matters.
During 2019, the Nominating and Corporate Governance Committee met two times and acted once by written consent. The Nominating and Corporate Governance Committee operates under a written charter that satisfies the applicable listing requirements and rules of the NYSE. A complete copy of the Nominating and Corporate Governance Committee Charter is available on the Governance page of our website at, http://aquaventure.com/investors/governance/governance-documents.
Identifying and Evaluating Director Nominees
The Board has delegated the director selection and nomination process to the Nominating and Corporate Governance Committee, with the expectation that other members of the Board, and of management, will be requested to take part in the process as appropriate.
Generally, the Nominating and Corporate Governance Committee is responsible for identifying candidates for director nominees in consultation with management, through the use of search firms or other advisors, through the recommendations submitted by shareholders or through such other methods as the Nominating and Corporate Governance Committee deems to be helpful to identify candidates. Once candidates have been identified, it is our policy that the Nominating and Corporate Governance Committee confirm that the candidates meet all of the minimum qualifications for director nominees established by the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee may gather information about the candidates through interviews, detailed questionnaires, comprehensive background checks or any other means that the Nominating and Corporate Governance Committee deems to be appropriate in the evaluation process. The Nominating and Corporate Governance Committee would then meet as a group to discuss and evaluate the qualities and skills of each candidate, both on an individual basis and taking into account the overall composition and needs of the Board. Based on the results of the evaluation process, the Nominating and Corporate Governance Committee would recommend candidates for the Board’s approval as director nominees for election to the Board.
Director Nominee Minimum Qualifications
In evaluating proposed director candidates, the Nominating and Corporate Governance Committee may consider all facts and circumstances that it deems appropriate or advisable, including, among other things, the skills of the proposed director candidate, his or her depth and breadth of professional experience or other background characteristics, his or her independence, the current size and composition of our Board and the needs of our Board and its respective committees. The Nominating and Corporate Governance Committee actively seeks highly qualified men and women from diverse racial and ethnic groups to include in the pool from which new candidates are selected so that a diverse set of experiences and perspectives is represented on the Board.
At a minimum, the nominee must have the highest personal and professional integrity, have demonstrated exceptional ability and judgment, and be most effective, in conjunction with the other nominees to the Board, in collectively serving the long-term interests of our shareholders. In addition, our Nominating and Corporate Governance
Committee shall recommend that the Board select persons for nomination to help ensure that a majority our Board is "independent" under NYSE Rules and that the members of the committees of our Board are "independent." Some of the additional qualifications that our Nominating and Corporate Governance Committee may consider include diversity of experience, expertise, business acumen, understanding of our business and industry, potential conflicts of interest and other commitments. Our Nominating and Corporate Governance Committee may also consider whether director nominees have proven achievement and competence in their field and the ability to provide guidance to our management team and make significant contributions to our success, and an understanding of the fiduciary responsibilities that are required of a director. Our Nominating and Corporate Governance Committee also considers whether our director candidates have sufficient time available to perform all board of director and committee responsibilities. Members of our Board are expected to prepare for, attend, and participate in all board of director and applicable committee meetings.
Our Policy Governing Director Qualifications and Nominations provides that, in addition to any other standards our Nominating and Corporate Governance Committee may deem appropriate from time to time for the overall structure and composition of the Board, the committee may consider whether the nominee, if elected, assists in achieving a mix of Board members that represents a diversity of background and experiences.
Shareholder Recommendations and Communications
Shareholders may submit recommendations for director candidates to our Nominating and Corporate Governance Committee by sending the individual’s name and qualifications to Conyers Corporate Services (BVI) Limited, Secretary, AquaVenture Holdings Limited, Wickhams Cay 1, P.O. Box 3140, Road Town, Tortola, British Virgin Islands VG1110, with a copy to Lee Muller, Assistant Secretary, Seven Seas Water Corporation, 14400 Carlson Circle, Tampa, Florida 33626, who will forward all recommendations to the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee will evaluate any candidates recommended by shareholders against the same criteria and pursuant to the same policies and procedures applicable to the evaluation of candidates proposed by directors or management.
Shareholders may communicate with the members of the Board, either individually or collectively, by writing to the Board at Conyers Corporate Services (BVI) Limited, Secretary, AquaVenture Holdings Limited, Wickhams Cay 1, P.O. Box 3140, Road Town, Tortola, British Virgin Islands VG1110, with a copy to Lee Muller, Assistant Secretary, Seven Seas Water Corporation, 14400 Carlson Circle, Tampa, Florida 33626. These communications will be reviewed by the Lee Muller, Assistant Secretary, as agent for the non-employee directors in facilitating direct communication to the Board. The Assistant Secretary will disregard communications that are bulk mail and solicitations to purchase products or services not directly related either to us or the non-employee directors’ roles as members of the Board, sent other than by shareholders in their capacities as such or from particular authors or regarding particular subjects that the non-employee directors may specify from time to time. The Assistant Secretary will summarize all shareholder communications directly relating to our business operations, the Board, our officers, our activities or other matters and opportunities closely related to us. This summary and copies of the actual shareholder communications will then be circulated to the Board.
Item 11.
Item 11. Executive Compensation.
OVERVIEW
Our executive compensation program historically has reflected our growth and corporate goals. To date, the compensation of the executive officers identified in the summary compensation table below, whom we refer to as our named executive officers, has consisted of a combination of base salary, performance-related bonuses and long-term incentive compensation in the form of equity awards. Our executive officers are also eligible to receive retirement, health and welfare benefits.
We review executive compensation annually with input from our Compensation Committee’s independent compensation consultants, if and when determined by the Compensation Committee. As part of this review process, our Board and the Compensation Committee apply our compensation philosophy when considering the compensation levels needed to ensure our executive compensation program remains competitive. We review whether we are meeting our retention objectives and the potential cost of replacing a key employee. We engaged Willis Towers Watson and Pearl Meyer to perform a review of executive compensation during 2019, which consisted of a market comparison of
executive compensation to peer companies with a similar market capitalizations, revenues, industries and growth strategies, targeting executive compensation at the 50th percentile.
The compensation provided to certain of our named executive officers for 2019 is detailed in the 2019 Summary Compensation Table and accompanying footnotes and narrative that follows this section.
Our named executive officers for the year ended December 31, 2019 were:
·
Anthony Ibarguen, our President and Chief Executive Officer;
·
Lee Muller, our Chief Financial Officer, Treasurer and Assistant Secretary;
·
Douglas Brown, our Chairman of the Board;
·
Olaf Krohg, our Chief Executive Officer of Seven Seas Water; and
·
Brian Miller, our Senior Vice President and General Counsel.
On December 31, 2018, Mr. Brown, Chairman of the Board and Chief Executive Officer of both the Company and Seven Seas Water, resigned his positions as Chief Executive Officer of the Company and Seven Seas Water. Mr. Brown remains with the Company following the transition date, focusing on mergers and acquisitions, and has also continued as a director and the Chairman of the Board. On January 1, 2019, Mr. Ibarguen was named to the role of Chief Executive Officer of the Company. Mr. Ibarguen will also continue to serve as a member of the Board and President of the Company, as well as Chief Executive Officer of Quench. In addition, Olaf Krohg was named the Chief Executive Officer of our Seven Seas Water business, and became an executive officer of the Company, on January 1, 2019.
2019 Summary Compensation Table
The following table provides information regarding the total compensation for services rendered in all capacities that was earned by the individuals who served as our principal executive officer during fiscal years 2019 and 2018, and our two other most highly compensated executive officers during fiscal year 2019. These individuals were our named executive officers for fiscal year 2019 and are listed here with the titles each held during the fiscal year 2019.
(1)
Represents each named executive officers’ salary earned during the respective year.
(2)
The amounts reported in the Bonus column for 2019 for Mr. Brown represent a discretionary bonus for his operational achievements.
(3)
The amounts reported in the Share Awards column represent the grant date fair value of the restricted share units granted during 2019 and 2018 as described below, computed in accordance with ASC Topic 718.
(4)
Amounts include annual performance-based bonuses earned by our named executive officers for performance in 2019 and 2018.
(5)
All other compensation for Messrs. Ibarguen and Muller includes the following:
·
Mr. Ibarguen-The amounts reported in 2019 and 2018 represents payments for certain health insurance premiums and 401(k) matching contributions.
·
Mr. Muller-The amounts reported in 2019 and 2018 represents 401(k) matching contributions.
Narrative to 2019 Summary Compensation Table
During 2019, we engaged Willis Towers Watson and Pearl Meyer to assist in determining levels of market compensation for the executive officers using a broad group of companies. Executive compensation for 2019 primarily consisted of base salary, non-equity incentive plan compensation and long-term incentive compensation.
Base Salary
Base salary was included as a component of the executive compensation program to ensure each named executive officer is rewarded for his service to the Company. A fixed component of compensation also ensures the named executive officer continues to focus on long-term objectives to maximize shareholder value as compared to only focusing on shorter-term objectives and the related incentives.
The base salaries for Messrs. Ibarguen, Brown and Muller that were established for 2019 were $500,000, $450,000 and $325,000, respectively. The base salaries for Messrs. Ibarguen, Brown and Muller that were established for 2018 were $340,000, $371,000 and $305,000, respectively. The base salary for Mr. Ibarguen described in this paragraph are not directly comparable to the amount listed in the Summary Compensation Table for 2018 because it commenced in February 2018 and represents a weighted-average of his then-current and then-prior year base salaries. The base salaries for Mr. Muller described in this paragraph are not directly comparable to the amounts listed in the Summary Compensation Table for 2019 and 2018 because they commenced in February 2019 and 2018, respectively, and represents a weighted-average of his then-current and then-prior year base salaries.
Non-Equity Incentive Plan Compensation
Annual performance-based bonuses ("Performance Bonus"), which are paid in cash, were included as a component of the executive compensation to motivate our executive officers to achieve key corporate and segment-level financial and strategic goals. For each of 2018 and 2019, the potential payment for the Performance Bonus for Messrs. Ibarguen and Muller ranged from zero to 200% of a target award based on the actual attainment of specified financial metrics in addition to evaluating individual performance in the context of the achievement of management business objectives (“MBOs”). For 2018 and 2019, the potential payment for the Performance Bonus for Mr. Brown ranged from zero to 200% of a target award based on the actual attainment of specified financial metrics in addition to evaluating individual performance in the context of the achievement of MBOs. Mr. Brown no longer had a target bonus in 2019. The target bonuses for Messrs. Ibarguen and Muller for 2019 were $350,000 and $115,000 respectively. The target bonuses for Messrs. Ibarguen, Brown and Muller for 2018 were $235,000, $530,000 and $123,600, respectively.
For 2019, 33.3% of each named executive officer’s Performance Bonus was based on targeted annual consolidated Adjusted EBITDA plus cash collected on the Peru construction contract from operations in existence as of January 1, 2019, as defined by the Compensation Committee; 33.3% of their Performance Bonus was based on targeted annual consolidated Adjusted EBITDA plus cash collected on the Peru construction contract from new businesses or assets acquired or new operations commenced, as defined by the Compensation Committee, subsequent to January 1, 2019; and 33.3% of their Performance Bonus was based on individual performance and the achievement of individual MBOs. For 2018, 75% of each named executive officer’s Performance Bonus was based on targeted annual consolidated Adjusted EBITDA plus cash collected on the Peru construction contract and 25% of their Performance Bonus was based on individual performance and the achievement of individual MBOs.
The Performance Bonus amounts approved and paid to Messrs. Ibarguen, Brown and Muller were $500,000, $0 and $143,750, respectively, for 2019 and $304,138, $685,928 and $157,904, respectively, for 2018 and were included in the "Non-Equity Incentive Plan Compensation" column of the summary compensation table above. During 2019, Mr. Brown no longer had a bonus target and instead received a discretionary bonus of $187,500 for his operational achievements which is included in the “Bonus” column of the summary compensation table above.
Long-term Incentive Compensation
In January 2019, the Compensation Committee recommended, and the Board approved, a grant of restricted share units to employees, including grants of 47,960, 43,160 and 15,010 restricted share units to Messrs. Ibarguen, Brown and Muller, respectively. The restricted share units vest over four years with 25% of the award vesting on the first anniversary of the grant date and the remainder vesting in equal quarterly installments over the remaining three years. These grants were made in connection with the Compensation Committee’s annual review of employee compensation. The Compensation Committee expects that annual equity grants will constitute part of certain employees’ annual compensation. Such grants will be composed of grants of options to purchase shares, restricted share units, or a combination thereof. For Mr. Ibarguen, his long-term incentive grant was in connection with his appointment as Chief Executive Officer of the Company.
In January 2018, the Compensation Committee recommended, and the Board approved, a grant of restricted share units to employees, including grants of 29,464, 59,514 and 19,976 restricted share units to Messrs. Ibarguen, Brown and Muller, respectively. The restricted share units vest over four years with 25% of the award vesting on the first anniversary of the grant date and the remainder vesting in equal quarterly installments over the remaining three years. These grants were made in connection with the Compensation Committee’s annual review of employee compensation. The Compensation Committee expects that annual equity grants will continue to constitute part of certain employees’ annual compensation. Such grants will be composed of grants of options to purchase shares, restricted share units, or a combination thereof.
Outstanding Equity Awards at Fiscal 2019 Year-End
The following table sets forth information regarding outstanding equity awards held by our named executive officers at the end of 2019.
(1)
These options to purchase ordinary shares for Mr. Muller vest over four years with 25% of the award vesting on the first anniversary of the grant date and the remainder vesting in equal quarterly installments over the following three years.
(2)
The restricted share units vest over four years with 25% of the award vesting on the first anniversary of the grant date and the remainder vesting in equal quarterly installments over the following three years.
(3)
The market value shown was determined by multiplying the number of shares that have not vested by $27.12, which was the closing price of our ordinary shares on December 31, 2019.
Compensation Risk Assessment
We believe that although a portion of the compensation provided to our executive officers and other employees is performance-based, our executive compensation program does not encourage excessive or unnecessary risk taking.
This is primarily due to the fact that our compensation programs are designed to encourage our executive officers and other employees to remain focused on both short-term and long-term strategic goals, in particular in connection with our pay-for-performance compensation philosophy. As a result, we do not believe that our compensation programs are reasonably likely to have a material adverse effect on us.
Compensation Committee Interlocks and Insider Participation
None of our executive officers currently serves, or in the past year has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our Board of Directors or Compensation Committee. None of the members of our Compensation Committee is an officer or employee of our company, and none of the members of our Compensation Committee has ever been an officer or employee of our Company.
Agreements with Named Executive Officers
We have entered into an employment agreement or an offer letter with each of Messrs. Ibarguen, Brown and Muller in connection with his employment with us. Except as noted below, these employment agreements and offer letters provide for "at will" employment.
Anthony Ibarguen
On April 16, 2019, the Company and its Quench USA, Inc. subsidiary entered into an amended and restated employment agreement dated as of January 1, 2019 with Mr. Ibarguen, the Chief Executive Officer and President of the Company and Chief Executive Officer of Quench USA, Inc., which replaced his existing employment agreement in its entirety.
Mr. Ibarguen’s base salary is required to be reviewed at least annually by the Board and may be increased but not decreased without his prior written consent. His target bonus for a specific year is required to be at least 70% of his base salary for that year and is payable in accordance with the metrics, terms and conditions established and determined by the Board after consultation with him.
His employment agreement provides that upon his death or disability, Mr. Ibarguen or his estate will be entitled to receive his base salary and vested benefits through the date of termination and a portion of his target bonus for the year in which the date of termination occurs, prorated for the portion of the year through the date of termination.
In addition, his employment agreement provides that if we terminate his employment without “cause” or he resigns with “good reason,” in each case other than during the 24 months after a “change in control” (as each such quoted term is defined in his employment agreement), Mr. Ibarguen will be entitled to receive, subject to the execution and delivery of an effective release of claims in favor of the Company, (i) a lump sum cash payment equal to his base salary and target bonus for the year in which the date of termination occurs, (ii) a monthly cash payment equal to Quench’s contribution towards health insurance for up to 12 months after the date of termination, and (iii) 12 months of additional vesting of all outstanding and unvested stock options and other stock-based awards held by him, with any performance conditions of such awards being deemed satisfied at the target levels specified in the applicable award agreements.
His employment agreement also provides that if we terminate his employment without “cause” or he resigns with “good reason,” in each case during the 24 months after a “change in control,” Mr. Ibarguen will be entitled to receive, in lieu of the payments and benefits described above and subject to the execution and delivery of an effective release of claims in favor of the Company, (i) a lump sum cash payment equal to (a) two times his base salary and target bonus for the year in which the date of termination occurs and (b) a portion of his target bonus for the year in which the date of termination occurs (prorated for the portion of the year through the date of termination), (ii) a monthly cash payment equal to Quench’s contribution towards health insurance for up to 24 months after the date of termination, and (iii) full accelerated vesting of all outstanding and unvested stock options and other stock-based awards held by him, with any performance conditions of such awards being deemed satisfied at the target levels specified in the applicable award agreements.
The payments and benefits provided under his employment agreement in connection with a change in control may not be eligible for a federal income tax deduction by us pursuant to Section 280G of the Internal Revenue Code. These payments and benefits may also subject him to an excise tax under Section 4999 of the Internal Revenue Code. If the payments or benefits payable to him in connection with a change in control would be subject to the excise tax imposed under Section 4999 of the Internal Revenue Code, those payments or benefits will be reduced if such reduction would result in a higher net after-tax benefit to him.
In addition, Mr. Ibarguen’s employment agreement contains, among other things, non-competition and non-solicitation provisions that apply during the term of Mr. Ibarguen’s employment and for either (i) 12 months thereafter, or (ii) if his employment is terminated during the 24 months after a “change in control,” 24 months thereafter.
Douglas Brown
On April 17, 2019, the Company and its Seven Seas Water Corporation subsidiary entered into an amendment dated as of January 1, 2019 to the offer letter with Mr. Brown, the Company’s Chairman and a continuing executive focusing on business development activities. His base salary will be determined by the Company’s Board of Directors (or the Compensation Committee thereof). Mr. Brown is also eligible to receive discretionary bonuses as, and payable when, determined by the Board in its discretion.
Pursuant to his offer letter, in the event his employment is terminated by us other than for “cause” (as defined in the Key Executive Severance Plan described below), Mr. Brown will be entitled to receive salary continuation for the 12-month period following the termination of his employment, and any stock options and other stock-based awards he holds will vest as if he had completed an additional 12 months of service. In addition, all outstanding and unvested stock options and other stock-based awards held by him vest in full immediately prior to the occurrence of a “change in control” (as defined in the Key Executive Severance Plan described below). In addition, Mr. Brown is entitled to a tax “gross-up payment” (as defined in his existing offer letter) in the event he receives any payments in connection with a change in control that would be subject to the excise tax imposed by Section 4999 of the Code.
In addition, Mr. Brown has entered into a new employee non-competition, non-solicitation, confidentiality and assignment agreement, with restrictive covenants that apply during the term of his employment and for 12 months thereafter.
Lee Muller
Seven Seas Water Corporation entered into an offer letter with Mr. Muller that provides for his at-will employment and sets forth his initial base salary, bonus opportunity, initial equity award, and eligibility for our benefit plans. Pursuant to his offer letter, in the event Mr. Muller’s employment is terminated by us other than for "cause", and subject to his execution of a release of claims, Mr. Muller will be entitled to receive salary continuation for the 12-month period following the termination of his employment and the stock incentive awards he holds will continue to vest during such 12-month period. In Mr. Muller’s offer letter, "cause" is defined as (i) a willful and material breach of any obligations under the offer letter or other contract with us or our subsidiaries or affiliates, (ii) fraud or dishonesty, (iii) competition with us or our subsidiaries or affiliates in violation of any noncompetition or non-solicitation obligation to us or any of our subsidiaries or affiliates, (iv) unauthorized use of any of our trade secrets or confidential information or those of our subsidiaries or affiliates or any breach of any obligations to us or our subsidiaries or affiliates with respect to trade secrets or confidential information, or (v) Mr. Muller’s failure to attend to duties assigned to him that are customary for his position and material to the success of our operations that remains unremedied for 30 days after written notice to Mr. Muller. Mr. Muller is not entitled to a tax "gross-up payment" in the event he receives any payments in connection with a change in control that would be subject to the excise tax imposed by Section 4999 of the Code.
In addition, Mr. Muller has entered into a proprietary information and inventions assignment agreement that contains, among other things, non-competition and non-solicitation provisions that apply during the term of Mr. Muller’s employment and for one year thereafter.
Key Executive Severance Plan
On April 14, 2019, our Board of Directors adopted the Key Executive Severance Plan (the “Severance Plan”), which provides severance benefits to key executives who are designated by the Board of Directors or the Compensation Committee thereof. Eligible participants include Lee Muller, our Chief Financial Officer, Treasurer and Assistant Secretary, and Olaf Krohg, the Chief Executive Officer of our Seven Seas Water business, but not Messrs. Brown and Ibarguen. As a condition to an eligible participant’s participation in the Severance Plan, such participant is required to (i) terminate all existing employment agreements and offer letters and (ii) enter into a new employee non-competition, non-solicitation, confidentiality and assignment agreement, with restrictive covenants that apply during the term of such participant’s employment and for 12 months thereafter. In connection with their participation in the Severance Plan, Messrs. Muller and Krohg each agreed to terminate his existing offer letter and entered into the new employee non-competition, non-solicitation, confidentiality and assignment agreement.
The Severance Plan provides that, upon an eligible participant’s death or “disability” (as defined in the Severance Plan), such participant or such participant’s estate will be entitled to receive such participant’s base salary and vested benefits through the date of termination and a portion of such participant’s target bonus for the year in which the date of termination occurs, prorated for the portion of the year through the date of termination.
In addition, the Severance Plan provides that if we terminate an eligible participant’s employment without “cause” or such participant resigns with “good reason,” in each case other than during the 12 months after a “change in control” (as each such quoted term is defined in the Severance Plan), such participant will be entitled to receive, subject to the execution and delivery of an effective release of claims in favor of the Company, (i) a lump sum cash payment equal to such participant’s base salary and target bonus for the year in which the date of termination occurs, (ii) a monthly cash payment equal to our contribution towards health insurance for up to twelve months after the date of termination, and (iii) 12 months of additional vesting of all outstanding and unvested stock options and other stock-based awards held by such participant, with any performance conditions of such awards being deemed satisfied at the target levels specified in the applicable award agreements.
The Executive Severance Plan also provides that if we terminate an eligible participant’s employment without “cause” or such participant resigns with “good reason,” in each case during the 12 months after a “change in control,” an eligible participant will be entitled to receive, in lieu of the payments and benefits described above and subject to the execution and delivery of an effective release of claims in favor of the Company, (i) a lump sum cash payment equal to (a) such participant’s base salary and target bonus for the year in which the date of termination occurs and (b) a portion of such participant’s target bonus for the year in which the date of termination occurs (prorated for the portion of the year through the date of termination), (ii) a monthly cash payment equal to our contribution towards health insurance for up to 12 months after the date of termination, and (iii) full accelerated vesting of all outstanding and unvested stock options and other stock-based awards held by such participant, with any performance conditions of such awards being deemed satisfied at the target levels specified in the applicable award agreements.
The payments and benefits provided under the Severance Plan in connection with a change in control may not be eligible for a federal income tax deduction by us pursuant to Section 280G of the Internal Revenue Code. These payments and benefits may also subject an eligible participant, including the named executive officers, to an excise tax under Section 4999 of the Internal Revenue Code. If the payments or benefits payable to an eligible participant in connection with a change in control would be subject to the excise tax imposed under Section 4999 of the Internal Revenue Code, those payments or benefits will be reduced if such reduction would result in a higher net after-tax benefit to such participant.
401(k) Plans
We maintain two tax-qualified retirement plans that provide eligible employees with an opportunity to save for retirement on a tax-advantaged basis: the Seven Seas Water Corporation 401(k) Plan (the "SSW 401(k) Plan") and the Quench USA, Inc. 401(k) Profit Sharing Plan and Trust (the "Quench 401(k) Plan"). All participants’ interests in their contributions are 100% vested when contributed. Participants in both the Seven Seas Water Corporation 401(k) Plan and Quench 401(k) Plan receive a matching contribution from us equal to 50% of the first 6% of the employee’s compensation deferred under the plan. Pre-tax contributions are allocated to each participant’s individual account and are then invested in selected investment alternatives according to the participants’ directions. Participants in the SSW
401(k) Plan are also eligible to make contributions on a post-tax basis. Both retirement plans are intended to qualify under Sections 401(a) and 501(a) of the Code.
Non-Employee Director Compensation
Our Board has adopted a director compensation structure for directors who are not our employees and not affiliated with our institutional investors that is designed to provide a total compensation package that enables us to attract and retain, on a long-term basis, high caliber directors and to align the directors’ interests with the long-term interests of our shareholders. Our policy has been and will continue to be to reimburse our directors for their travel, lodging and other reasonable expenses incurred in attending meetings of our Board and committees of the Board.
In connection with the completion of our initial public offering in October 2016, our Board adopted a compensation policy for directors who are neither employees nor affiliated with our institutional investors that is designed to provide a total compensation package that enables us to attract and retain, on a long-term basis, high caliber nonemployee directors. The table below shows the cash retainers our directors are eligible to receive under our current nonemployee director compensation policy.
In addition, on an annual basis, each such director is eligible to receive a grant of restricted share units having a fair market value of $125,000, which vest in full on the one-year anniversary of the grant date.
In April 2017, we implemented a deferred compensation program for such directors to permit them to defer compensation awarded to them under our director compensation policy. In advance of an award and in compliance with the program’s requirements and applicable tax law, a director may elect to defer the receipt of his or her cash compensation and/or the settlement of his or her restricted share unit award until the earliest of his or her death, disability, sale event, separation from service or December 31 of the year following the year in which the compensation is otherwise vested. In addition, in the event a director elects to defer his cash compensation, the director’s account will be credited with a number of share units equal to 120% of the quotient obtained by dividing the aggregate deferred cash fees that would otherwise be payable on such date by the fair market value of an ordinary share on that date.
2019 Non-Employee Director Compensation
The following table presents the total compensation for each person who served as a non-employee member of our Board during 2019. Mr. Brown, who serves as Chairman of the Board, and Mr. Ibarguen, who is our President and Chief Executive Officer receive no compensation for their services as directors and, consequently, neither of them is included in this table. In addition, Messrs. Lincoln, Lovell and Meduña are affiliated with our institutional investors and, consequently, received no compensation for their service as members of our Board in 2019. The compensation received by each of Messrs. Brown and Ibarguen as our employees during 2019 is set forth in the section of this Annual Report on Form 10-K captioned "Executive Compensation-Summary Compensation Table."
(1)
The amounts reported in the Share Awards column represent the grant date fair value of restricted share units and phantom share units granted during 2019, computed in accordance with ASC Topic 718.
(2)
The amounts reported in the Share Awards column include 5,540 phantom share units granted during 2019 to each of Messrs. Evans, Hanrahan and Reilly related to their annual equity compensation for their 2019 services. Each of Messrs. Evans, Hanrahan and Reilly elected to defer their annual equity compensation to receive phantom share units. All of the phantom share units granted during 2019 vested on February 24, 2020. The grant date fair value of such awards for each Messrs. Evans, Hanrahan and Reilly was $124,982.
For Ms. Coy, the amounts reported in the Share Awards column include 5,540 restricted share units granted during 2019 related to her annual equity compensation for her 2019 services. The restricted share units vested on February 24, 2020. The grant date fair value of such award was $124,982.
For Mr. Whall, the amounts reported in the Share Awards column include 7,631 restricted share units granted during 2019 related to his annual equity compensation for his 2019 services. The restricted share units vest on August 5, 2020. The grant date fair value of such award was $124,996.
In addition, Messrs. Evans, Hanrahan, Whall and O’Neill elected to defer their cash compensation during 2019 and were credited with a number of phantom share units equal to 120% of the quotient obtained by dividing the aggregate deferred cash fees that would otherwise be payable on such date by the fair market value of an ordinary share on that date. The phantom share units granted during 2019 were deemed fully vested upon the respective grant dates when the related cash fees were otherwise payable. The aggregate grant date fair value of such awards for each of Messrs. Evans, Hanrahan, Whall and O’Neill was $57,300, $58,800, $30,115 and $13,500, respectively.
As of December 31, 2019, Messrs. Evans, Hanrahan, Whall and O’Neill had a balance of 17,739, 17,813, 1,631 and 0, respectively, phantom share units in their respective deferred accounts.
(3)
On February 19, 2019, Mr. O’Neill resigned from the Board of Directors of the Company.
(4)
On April 18, 2019, Evan Lovell informed the Company that he would not stand for re-election to our Board when his term expired at the 2019 Annual Meeting.
The following table shows the aggregate number of unvested restricted share awards and options to purchase our ordinary shares held, if any, by our non-employee directors at December 31, 2019:
Item 12.
Item 12. Security Ownership of Certain Beneﬁcial Owners and Management and Related Stockholder Matters.
The following table sets forth certain information regarding the beneficial ownership of our ordinary shares as of February 13, 2020 by:
·
each person known to us to beneficially own more than five percent of our outstanding ordinary shares based solely on our review of SEC filings;
·
each of our named executive officers;
·
each of our directors; and
·
all directors and executive officers as a group.
Beneficial ownership is based upon 31,963,449 ordinary shares outstanding as of February 13, 2020 unless otherwise indicated in the footnotes to the table. In addition, ordinary shares issuable upon exercise of share options or other derivative securities that are exercisable currently or will become exercisable within 60 days of February 13, 2020 are deemed outstanding for computing the percentage of the person holding such options or other derivative securities, but are not deemed outstanding for purposes of computing the percentage owned by any other person. All of the ordinary shares listed in the table below are entitled to one vote per share and each of the persons described below has sole voting power and sole investment power with respect to the shares set forth opposite his, her or its name, except as otherwise noted. Unless otherwise indicated, the address of each beneficial owner listed in the table below is c/o AquaVenture Holdings Limited, Commerce House, Wickhams Cay 1, P.O. Box 3140, Road Town, Tortola, British Virgin Islands VG1110.
*Indicates beneficial ownership of less than one percent.
(1)
A "beneficial owner" of a security is determined in accordance with Rule 13d-3 under the Exchange Act and generally means any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, has or shares: voting power which includes the power to vote, or to direct the voting of, such security; and/or investment power which includes the power to dispose, or to direct the disposition of, such security.
Based upon a Schedule 13D filed January 2, 2020 by Advent International Corporation (for purposes of this footnote, "Advent"), Culligan International Corporation, Amberjack Merger Sub Limited and the Advent Entities (as defined herein) may be deemed to have beneficial ownership of 11,269,104 ordinary shares of AquaVenture. The ownership consists of 7,872,596 shares indirectly owned by GPE VIII GP S.À R.L. ("Advent GP Luxembourg"), 469,922 shares indirectly owned by AP GPE VIII GP Limited Partnership ("Advent GP AP"), 2,926,586 shares indirectly owned by GPE VIII GP Limited Partnership ("Advent GP Cayman"), 614,166 shares indirectly owned by Advent International GPE VIII Limited Partnership, 753,903 shares indirectly owned by Advent International GPE VIII-B-1 Limited Partnership, 562,328 shares indirectly owned by Advent International GPE VIII-B-2 Limited Partnership, 877,863 shares indirectly owned by Advent International GPE VIII-B-3 Limited Partnership, 2,124,226 shares indirectly owned by Advent International GPE VIII-B Limited Partnership, 345,961 shares indirectly owned by Advent International GPE VIII-C Limited Partnership, 296,377 shares indirectly owned by Advent International GPE VIII-D Limited Partnership, 87,899 shares indirectly owned by Advent International GPE VIII-F Limited Partnership, 777,568 shares indirectly owned by Advent International GPE VIII-H Limited Partnership, 722,350 shares indirectly owned by Advent International GPE VIII-I Limited Partnership, 709,954 shares indirectly owned by Advent International GPE VIII-J Limited Partnership (collectively, the "Advent Luxembourg Funds"), 30,427 shares indirectly owned by Advent Partners GPE VIII-A Limited Partnership, 253,555 shares indirectly owned by Advent Partners GPE
VIII-B Cayman Limited Partnership, 141,991 shares indirectly owned by Advent Partners VIII Cayman Limited Partnership, 19,157 shares indirectly owned by Advent Partners GPE VIII-A Cayman Limited Partnership, 24,792 shares indirectly owned by Advent Partners GPE VIII Limited Partnership (collectively, the "Advent AP Funds"), 1,440,191 shares indirectly owned by Advent International GPE VIII-A Limited Partnership, 330,185 shares indirectly owned by Advent International GPE VIII-E Limited Partnership, 558,948 shares indirectly owned by Advent International GPE VIII-G Limited Partnership, 294,124 shares indirectly owned by Advent International GPE VIII-K Limited Partnership, 303,139 shares indirectly owned by Advent International GPE VIII-L Limited Partnership (collectively, the "Advent Cayman Funds", and together with Advent, Advent GP Luxembourg, Advent GP AP, GP Cayman, the Advent Luxembourg Funds and the Advent AP Funds, the "Advent Entities"). The Advent Entities disclaim any beneficial ownership of these shares.
(2)
Based upon a Schedule 13G/A filed February 13, 2018 by Element Partners II L.P., Element Partners II Intrafund, L.P., Element Partners II-A, L.P. DFJ Element, L.P. and DFJ element Intrafund L.P. (collectively, the "Element Entities"). The Schedule 13G/A provides that, as of December 31, 2017, (i) Element Partners II L.P. held 6,696,669 ordinary shares, (ii) Element Partners II Intrafund, L.P. held 101,975 ordinary shares, (iii) Element Partners II-A, L.P. held 133,973 ordinary shares, (iv) DFJ Element, L.P. held 2,566,686 ordinary shares, and (v) DFJ Element Intrafund L.P. held 69,515 ordinary shares. The general partner of Element Partners II, L.P. and Element Partners II Intrafund, L.P. is Element Partners II G.P., L.P. The general partner of Element Partners II G.P., L.P. is Element II G.P., LLC. The general partner of DFJ Element, L.P. and DFJ Element Intrafund, L.P. is DFJ Element Partners, LLC. The general partner of DFJ Element Partners, LLC is Element Venture Partners LP. The general partner of Element Partners II-A, L.P. is Element Partners II-A, GP LP. The general partners of Element Partners II-A, GP LP are Element II-A GP, LLC and Element Venture Partners LP. Each of Mr. Lincoln, a member of the board of directors, Michael Bevan and Michael DeRosa is a managing member of Element II G.P., LLC, Element II-A, GP, LLC and Element Venture Partners LP. Collectively, Element II G.P., L.P., Element II-A, GP, LLC and Element Venture Partners LP have decision-making power over the disposition and voting of shares of portfolio investments of each of the Element Entities. Since Element II G.P., L.P., Element II-A, GP, LLC and Element Venture Partners LLC have decision-making power over the Element Entities, each of Messrs. Bevan, Lincoln and DeRosa may be deemed to beneficially own the shares that the Element Entities hold of record or may deemed to beneficially own. Messrs. Bevan, Lincoln and DeRosa, Element II G.P., L.P., Element II-A, GP, LLC and Element Venture Partners LLC disclaim beneficial ownership over the shares held by the Element Entities. The address for the Element Entities is 565 E. Swedes Lord Road, Suite 207, Wayne, PA 19087. The number of ordinary shares beneficially owned by Mr. Lincoln includes 27,543 shares held directly by him.
(3)
Consists of 56,279 ordinary shares held directly by Mr. Ibarguen, 500,185 shares subject to purchase pursuant to currently exercisable options and options exercisable or restricted share units vesting within 60 days of February 13, 2020.
(4)
Consists of 26,916 ordinary shares held directly by Mr. Muller, 215,349 shares subject to purchase pursuant to currently exercisable options and options exercisable or restricted share units vesting within 60 days of February 13, 2020 and 70,000 ordinary shares held by his spouse.
(5)
Consists of 8,303 ordinary shares held directly by Mr. Krohg, 42,725 shares subject to purchase pursuant to currently exercisable options and options exercisable or restricted share units vesting within 60 days of February 13, 2020 and 3 ordinary shares held by his son.
(6)
Consists of 1,562,636 ordinary shares held directly by Mr. Brown, 660,496 shares subject to purchase pursuant to currently exercisable options and options exercisable or restricted share units vesting within 60 days of February 13, 2020 and 148,449 ordinary shares held by his spouse.
(7)
Consists of restricted share units vesting within 60 days of February 13, 2020.
(8)
Consists of 53,148 ordinary shares held directly by Mr. Evans, 6,615 shares subject to purchase pursuant to currently exercisable options or options exercisable within 60 days of February 13, 2020 and 18,261 phantom share units within Mr. Evan's deferred account with respect to the deferred compensation program.
(9)
Consists of 22,837 ordinary shares held directly by Mr. Hanrahan, 11,654 shares subject to purchase pursuant to currently exercisable options or options exercisable within 60 days of February 13, 2020 and 18,357 phantom share units within Mr. Hanrahan's deferred account with respect to the deferred compensation program.
(10)
Consists of 33,218 shares held personally by Mr. Meduña and 970,389 ordinary shares held by Guayacan Private Equity Fund Limited Partnership II, 15,772 ordinary shares held by Guayacan Private Equity Fund Limited Partnership II-A LLC and 144,885 ordinary shares held by Venture Capital Fund, Inc. The general partner of Guayacan Private Equity Fund Limited Partnership II and Guayacan Private Equity Fund Limited Partnership II-A LLC (the "Guayacan Funds") is Advent-Morro Equity Partners GP II, LLC. Mr. Meduña acts as managing member of Advent-Morro Equity Partners GP II, LLC and is President and a director of Venture Capital Fund, Inc. Advent-Morro Equity Partners GP II, LLC has decision-making power over the disposition and voting of shares of portfolio investments of the Guayacan Funds. Mr. Meduña has decision-making power over the disposition and voting of shares of portfolio investments of the Venture Capital Fund, Inc. Since Advent-Morro Equity Partners GP II, LLC and Mr. Meduña personally have decision-making power over the Guayacan Funds and Venture Capital Fund, Inc. (together, the "Advent-Morro Entities"), Mr. Meduña may be deemed to beneficially own the shares that the Advent-Morro Entities hold of record or may deemed to beneficially own. Mr. Meduña and Advent-Morro Equity Partners GP II, LLC disclaim beneficial ownership over the shares held by the Advent-Morro Entities. The address for the Advent-Morro Entities is 206 Calle Tetuan, Suite 903, San Juan, Puerto Rico 00902.
(11)
Consists of 9,754 ordinary shares held directly by Mr. Reilly, 7,560 shares subject to purchase pursuant to currently exercisable options or options exercisable within 60 days of February 13, 2020 and 14,785 phantom share units within Mr. Reilly's deferred account with respect to the deferred compensation program.
(12)
Consists of phantom share units within Mr. Whall’s deferred account with respect to the deferred compensation program.
For information regarding the Company's equity compensation plans, see Item 5 “Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Securities authorized for issuance under equity compensation plans” elsewhere in this Annual Report on Form 10-K.
Indemnification of Officers and Directors
We have agreed to indemnify our directors and executive officers in certain circumstances. See “Certain Relationships and Related Transactions, and Director Independence - Limitation of Liability and Indemnification of Officers and Directors.”
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Related Party Transactions
Other than compensation arrangements for our directors and named executive officers, which are described elsewhere in the "Executive Compensation" of this Annual Report on Form 10-K , below we describe transactions since January 1, 2019 to which we were a party or will be a party, in which:
·
the amounts involved exceeded or will exceed $120,000; and
·
any of our directors, executive officers or holders of more than 5% of our share capital, or any member of the immediate family of, or person sharing the household with, the foregoing persons, had or will have a direct or indirect material interest.
Our Audit Committee has the primary responsibility for reviewing and approving or disapproving "related party transactions," which are the transactions described above. Our Code of Business Conduct and Ethics and our Audit Committee charter provide that the Audit Committee shall review and approve or disapprove any related party transactions.
Since the beginning of January 1, 2019, there have not been, nor is there currently proposed, any related party transactions, except for the compensation and other arrangements described in the sections titled "Executive Compensation" and "2019 Non-Employee Director Compensation" of this Part III of this Annual Report on Form 10-K.
Registration Rights
We are party to an investors’ rights agreement with certain of our shareholders. The investors’ rights agreement grants such shareholders certain registration rights, which include demand registration rights, piggyback registration rights and short-form registration rights, with respect to our ordinary shares.
Limitation of Liability and Indemnification of Officers and Directors
Our memorandum and articles of association contain provisions that limit the liability of our directors for monetary damages to the fullest extent permitted by the law of the British Virgin Islands. Further, we have entered into indemnification agreements with each of our directors and executive officers that may be broader than the specific indemnification provisions contained under the law of the British Virgin Islands. These indemnification agreements require us, among other things, to indemnify our directors and executive officers against liabilities that may arise by reason of their status or service. These indemnification agreements also require us to advance all expenses incurred by the directors and executive officers in investigating or defending any such action, suit, or proceeding. We believe that these agreements are necessary to attract and retain qualified individuals to serve as directors and executive officers.
Employment Agreements and Offer Letters
Each of our executive officers is employed with us under the terms of their employment agreement or offer letter, as applicable. For more information regarding these employment agreements, see the section titled “Executive Compensation- Agreements with Named Executive Officers.”
Director Independence
Our Board has undertaken a review of the independence of each director. Based on information provided by each director concerning his background, employment and affiliations, our Board has determined that Ms. Coy and Messrs. Evans, Hanrahan, Lincoln, Whall, Meduña, and Reilly are “independent” and as such, do not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and that each of these directors is "independent" as that term is defined under the applicable rules and regulations of the SEC and the listing standards of the NYSE. Furthermore, the Board has determined that each member of each of the committees of our Board is independent within the meaning of the NYSE’s, the SEC’s, and our applicable committees’ independence standards, including Rule 10a-3(b)(1) under the Exchange Act. In making these determinations, our Board considered the current and prior relationships that each non-employee director has with our company and all other facts and circumstances our Board deemed relevant in determining their independence, including the beneficial ownership of our shares by each non-employee director, and the transactions involving them described in the section titled "Certain Relationships and Related Party Transactions."
At least annually, our Board evaluates all relationships between our company and each director in light of relevant facts and circumstances for the purposes of determining whether a material relationship exists that might signal a potential conflict of interest or otherwise interfere with such director’s ability to satisfy his or her responsibilities as an independent director. Based on this evaluation, the Board will make an annual determination of whether each director is independent within the meaning of the NYSE’s, the SEC’s and our applicable committees’ independence standards.
Item 14.
Item 14. Principal Accounting Fees and Services.
Audit Fees
Fees for audit services totaled $1,263,121 and $1,051,818 for 2019 and 2018, respectively. For 2019 and 2018, audit services included professional services provided in connection with the audit of our financial statements and audits of certain of our subsidiaries, and the reviews of our quarterly financial statements for the applicable year.
Audit-Related Fees
Fees for audit-related services totaled $0 and $165,027 for 2019 and 2018, respectively. For 2018, audit-related services included attestation services performed on the financial statements of a potential acquisition.
Tax Fees
There were no fees for tax services for 2019 and 2018.
All Other Fees
There were no other services performed for 2019 or 2018 other than as discussed above.
Pre-Approval Policies and Procedures
It is the policy of the Audit Committee to pre-approve all services, audit and non-audit, to be provided to us by our independent registered public accounting firm. Under the policy, the Audit Committee is generally required to pre-approve the provision by our independent registered public accounting firm of specific audit, audit-related, tax and other non-audit services, subject to the fee limits established from time to time by the Audit Committee, as being consistent with auditor independence.
Since the adoption of our pre-approval policy, all services provided by KPMG LLP as our independent registered public accounting firm were pre-approved by the Audit Committee.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements.
The response to this portion of Item 15 is set forth under Item 8 Part II above.
(a)(2) Financial Statement Schedules.
All schedules have been omitted because they are not required or because the required information is given in the Consolidated Financial Statements or Notes thereto set forth under Item 8 Part II above.
(a)(3) Exhibits.
The exhibits listed on the accompanying Exhibit Index are filed, furnished or incorporated by reference as part of this report, and such Exhibit Index is incorporated herein by reference.
Item 16. Form 10-K Summary
Not applicable.
EXHIBIT INDEX
*Filed herewith.
#Indicates management contract or compensatory plan, contract or agreement.
+Portions of this agreement have been redacted pursuant to a request for confidential treatment granted by the SEC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby makes, constitutes and appoints Anthony Ibarguen and Lee S. Muller with full power to act without the other, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities to sign any or all amendments to this Form 10-K, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agents of any of them, or any substitute or substitutes, lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ ANTHONY IBARGUEN
Anthony Ibarguen
Chief Executive Officer, President and Director
(Principal executive officer)
March 5, 2020
/s/ LEE S. MULLER
Lee S. Muller
Chief Financial Officer, Treasurer and Secretary
(Principal financial and accounting officer)
March 5, 2020
/s/ DOUGLAS R. BROWN
Douglas R. Brown
Chairman of the Board
March 5, 2020
/s/ TIMOTHY J. WHALL
Timothy J. Whall
Director
March 5, 2020
/s/ HUGH EVANS
Hugh Evans
Director
March 5, 2020
/s/ PAUL HANRAHAN
Paul Hanrahan
Director
March 5, 2020
/s/ DEBRA COY
Debra Coy
Director
March 5, 2020
Signature
Title
Date
/s/ CYRIL MEDUÑA
Cyril Meduña
Director
March 5, 2020
/s/ RICHARD REILLY
Richard Reilly
Director
March 5, 2020
/s/ DAVID LINCOLN
David Lincoln
Director
March 5, 2020