UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2008
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from to
Commission file number: 000-51991
Basin Water, Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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20-4736881
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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9302 Pittsburgh Avenue, Suite 210
Rancho Cucamonga, California
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91730
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(Address of principal executive offices)
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(Zip Code)
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(909) 481-6800
(Registrant’s telephone number, including area code)
Securities registered pursuant to
Section 12(b) of the Act:
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Title of each class
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Name of exchange on which registered
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Common Stock, $0.001 par value
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The NASDAQ Stock Market LLC
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Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
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No
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes
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No
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
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No
x
Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K.
¨
Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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(Do not check if a smaller reporting company)
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Smaller reporting company
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes
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No
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The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $93.4 million based upon the closing price of the Registrant’s common stock on
the NASDAQ Global Market on June 30, 2008. On March 23, 2009, there were 22,223,364 shares of common stock, par value $0.001, outstanding.
Documents Incorporated by Reference
Portions of the Proxy Statement to be delivered to stockholders in connection with the
Registrant’s 2009 Annual Meeting of Stockholders to be filed on or before 120 days after the end of the Registrant’s fiscal year end are incorporated by reference into Part III of this Annual Report on Form 10-K. With the exception of
those portions that are specifically incorporated in this Annual Report on Form 10-K, such Proxy Statement shall not be deemed filed as part of this Report or incorporated by reference herein.
TABLE OF CONTENTS
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “Safe Harbor” created by those sections. Any such forward-looking statements would be contained principally in “Business”,
“Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements include information concerning our possible or assumed future results of operations,
business strategies, financing plans, competitive position, industry environment, potential growth opportunities, the effects of regulation our ability to continue as a going concern or the results of a strategic alternative review process.
Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,”
“may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions.
Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or
achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in greater detail in “Item 1A. Risk Factors.” Given these
uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Annual Report on Form 10-K
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You should read this Annual Report on Form 10-K completely and with the understanding that our actual future results may be materially different from what we expect.
We assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from
those anticipated in these forward-looking statements, even if new information becomes available in the future.
PART I
Overview
Basin Water, Inc. designs, builds and implements systems for the treatment of contaminated groundwater, industrial process water, and air streams from
municipal and industrial sources. It provides reliable sources of drinking water for many communities, and the ability to comply with environmental standards and recover valuable resources from process and waste water streams.
In 2008 and 2007, we derived most of our revenues from designing, assembling and servicing our proprietary ion-exchange systems for the treatment of
contaminated groundwater for use as drinking water. Also, in 2008, we continued initiatives, both external and internal, to facilitate our transformation into a water services company focused on development of our technology+services business model.
Using this model, we seek opportunities to combine proprietary or specialized technologies with long-term relationships built through performance-based service agreements to meet groundwater treatment, industrial water and wastewater treatment and
resource recovery needs. By expanding the array of technologies we offer through our technology+services model beyond our proprietary ion-exchange technology, we believe we can expand the potential pool of customers, markets and geographic areas for
our services.
In 2008, we derived substantially all of our revenues from our proprietary, ion-exchange, onsite regenerable treatment
system. That system reduces groundwater contaminant levels in what we believe is an efficient, flexible and cost-effective manner. Our system produces what we believe are very low waste rates, can effectively treat medium-to-high volume requirements
and is capable of removing multiple chemical contaminants at a single site. These systems regenerate the resin by using a salt brine solution to remove the contaminants from the resin so that it can be used again in the ion-exchange process. We
market these systems to utilities, cities, municipalities, special districts, real estate developers and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of
chemical contaminants.
We are defining our municipal market opportunities in targeted geographic regions and our industrial market
opportunities on a national basis. We believe that concerns over specific contaminants throughout the country may also provide opportunities for our technology and services, such as for treatment of chemical contaminants.
We are taking steps to become a next generation water services company that succeeds by combining the strengths of our existing businesses and employees
with the offering of cutting edge technology and site-tailored solutions. We plan to employ this model across a broad range of treatment scenarios in municipal and industrial markets for the treatment of water and air streams.
We make available free of charge through our internet website our press releases, this Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q,
our Current Reports on Form 8-K and all other required filings with the Securities and Exchange Commission (SEC) and amendments thereto as soon as reasonably practical after they are electronically filed with, or furnished to, the SEC. Our internet
website also contains our Code of Ethics. Our principal executive offices are located at 9302 Pittsburgh Ave., Suite 210, Rancho Cucamonga, California 91730, and our telephone number is (888) 481-6811. Our website address is
www.basinwater.com.
The information on our website is neither part of nor incorporated by reference into this Annual Report on Form 10-K.
Company History
Originally incorporated in California in 1999, Basin Water reincorporated in Delaware in connection with
our initial public offering which was completed in May 2006. Our operations from 1999 until 2001 consisted
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primarily of research and development activities, as we developed our proprietary ion-exchange process. Also during this time, we developed a groundwater
treatment system for commercialization of our proprietary process and increased our personnel to include additional engineers and sales and marketing personnel. We successfully completed a prototype for our groundwater treatment system in May 2002,
and shortly thereafter we assisted one of our customers in submitting an application with the California Department of Health Services (DHS) for a permit to operate our system for treatment of nitrate. In June 2002, our customer received the first
permit from DHS for operation of our system to treat groundwater. We also received our first revenues in 2002 from sales of our groundwater treatment system and operations.
From 2002 through 2006, we focused our efforts on developing systems that could treat other contaminants, increasing our engineering workforce,
developing our sales and marketing force, obtaining patents, and improving our internal finance and accounting capabilities.
Beginning in
the last quarter of 2006, and continuing throughout 2008, we focused our efforts on becoming a more diversified and predictable growth company by developing our technology+services business model and also implementing internal and external
initiatives.
Our internal initiatives included:
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Recruiting top personnel with an emphasis on people with experience in the water and wastewater industries or in combining technology with performance-based service
agreements;
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Expanding beyond our base of municipal customers (such as utilities, special districts, municipalities and other similar organizations) to include potential
customers in the industrial marketplace (such as oil and gas, power, mining and chemical companies);
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Installing business and financial systems to accommodate our growth and new system and service initiatives;
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Developing regional sales, process engineering and field service groups aligned with both our municipal and industrial marketplace customers; and
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Developing our technology+services offering to include the treatment of a variety of organic and inorganic contaminants.
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Our external initiatives included the Mobile Process Technology, Co. acquisition, and entering into a strategic alliance with Rohm and Haas Chemicals
LLC, among others. In addition, we acquired the assets of a bioreactor and biofilter business, which we refer to as Envirogen, from Shaw Environmental, Inc. and its affiliates, which we refer to as Shaw.
Market Opportunity
Demand for drinking water
treatment technologies and services.
Population growth has resulted in increased demand for drinking water in much of the United States. This is a problem throughout the United States but is particularly acute in California and other states
in the Southwest United States, which we refer to as the arid West, where population growth and chronic shortages of drinking water have resulted in rapidly increasing demand for drinking water.
Though we believe groundwater is a cost-effective and advantageous source of water supply, it is at substantial risk of contamination from a number of
chemical contaminants; such as arsenic, nitrate, perchlorate, radium, chromium VI, uranium and radionuclides, as well as organic contaminants, such as methyl tertiary-butyl ether (MTBE), trichloroethylene (TCE) and perchloroethylene (PCE), which
have been linked to various cancers, diseases, metabolic disorders and other health problems. Because of these health concerns, the Environmental Protection Agency, or EPA, and state regulatory agencies have been active in establishing and lowering
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maximum containment levels, or MCLs, for contaminants in drinking water to ensure that the public has access to a safe drinking water supply. In addition,
improvements in water testing and treatment technologies have allowed the EPA and state regulatory agencies to lower the MCL for certain contaminants.
We believe that a market opportunity exists in providing a solution for treatment of groundwater for drinking water. There are few economically attractive alternatives for treating groundwater at the wellhead.
Customarily, water providers either shut down a contaminated well or blend the water with non-contaminated water to meet an MCL. Ion-exchange technology is acknowledged as a leading technology for groundwater treatment, including being designated by
the DHS and EPA as a “best available technology” for treating groundwater for removal of contaminants. As compared to our ion-exchange technology, we believe many existing contaminant treatment technologies are costly, produce large
amounts of waste, or are generally designed for large industrial installations rather than for wellhead treatment. We are actively pursuing opportunities to introduce our groundwater treatments systems across the United States where the opportunity
exists to provide our technology+services offerings.
Demand for technology+services.
We believe our technology+services
offerings can be valuable to municipal and industrial customers. We believe there is demand by our customers for an offering that includes our technology combined with a long-term services agreement to provide services and maintenance with our
performance guarantee for the life of the agreement.
Demand for treatment of wastewater and air streams, water reuse and the
recovery of valuable commodities.
We also believe there is demand for treatment of wastewater and air streams, water reuse and metals and commodities recovery systems and services. Many industrial facilities face increasingly
stringent discharge requirements for industrial wastewater, driving demand for technological solutions like ours for wastewater treatment. We also believe that demand exists for applications through which our customers can reuse and recycle
wastewater for process water needed for manufacturing or other industrial uses. Furthermore, we believe there is demand for technologies that are able to recover valuable commodities from wastewater streams.
Our Solution and Strengths
Basin Water onsite
regenerable ion-exchange.
Our proprietary onsite regenerable ion-exchange system is designed to treat groundwater contamination at the wellhead. We believe our multiple-bed system provides a safe, reliable and sustainable source of drinking
water to our customers. Our system effectively treats water resulting in low waste rates, can be scaled to meet a customer’s requirements and has a small footprint. These systems are installed with telemetry to allow independent functionality.
Approximately 58% of our revenues in 2008 were derived from sales and service related to these systems.
Our expanded
technologies.
We have made concerted efforts to expand our technology portfolio beyond proprietary onsite regenerable ion-exchange technology. While our ion-exchange technology continues to have potential in a variety of applications in the
groundwater treatment market, we believe that additional opportunities exist for ion-exchange and absorptive media systems utilizing alternative methods of regeneration or media handling, and also technologies that can remove organic contaminants
from water. Therefore, during 2007 we sought out and acquired the rights to ion-exchange technologies and other technologies that would enable us to address these opportunities through our September 2007 acquisition of Mobile Process Technology Co.,
which we refer to as MPT (see Note 3 to our consolidated financial statements), our November 2007 strategic alliance with a wholly owned subsidiary of Rohm and Haas Company named Rohm and Haas Chemicals, LLC, which we refer to as Rohm and Haas, and
our 2007 agreement with Purifics ES Inc., which we refer to as Purifics, a licensed engineering firm headquartered in Ontario, Canada. In 2008, we acquired Envirogen, providing us with a bioreactor and biofilter business that includes the design and
supply of fluidized bed, membrane, and suspended carrier bioreactors for the treatment of groundwater, wastewater and air streams in industrial, municipal and federal applications.
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We believe these expanded technologies will enable us to address a large market of potential customers.
Our experienced management team.
One of our developing strengths is our management team. Beginning in late 2006 and
continuing into 2008, we bolstered our existing management team by hiring veterans from the water industry as well as other leading industries that have experience with technology and service offering business models. Most notably, our President and
Chief Executive Officer joined Basin Water in October 2006 and brought the knowledge and experience to develop our business model. In addition, we have hired five senior managers all of whom had past experience in the water, wastewater and other
related industries. We believe the management team we have assembled has significantly strengthened our ability to achieve our goal to develop and implement our technology+services business model.
Our Strategy
Next generation water services
company.
Our goal is to define, test and then implement the strategies necessary to become a “next generation” water services company—a company that can profitably offer predictable, competitive life-cycle costs. To do that we
believe we must develop offerings and select opportunities that will generally involve pairing a proprietary or specialized technology with a service agreement to meet a defined set of customer needs. To date we continue to make progress as a
provider of groundwater treatment systems and services to our customers throughout the United States, with an initial focus on the arid West. We plan to achieve these goals through the following strategies:
Develop and implement our technology+services model
.
We have developed and will now implement our technology+services business model
that combines proprietary or specialized technologies with long-term relationships built through performance-based service agreements to meet groundwater treatment, industrial water and wastewater treatment, and resource recovery needs. Over time,
we may also seek to offer this technology+services model to the technologies acquired in our Envirogen acquisition.
Extend our
business and geographic reach throughout the United States
.
We have expanded our business reach beyond the arid West into other areas of the United States. In 2007, we began an internal organizational change and expansion through the
assignment of dedicated management, sales, marketing, and technical support create five regions (West, Southwest, Southeast, Great Lakes and Northeast). In addition to our West regional office in Rancho Cucamonga, we developed a footprint in the
Southeast with our facility in Memphis, a Southwest regional office in Houston and a sales presence in the Great Lakes. In 2008 we continued to expand our business reach through our Envirogen acquisition, which provided us with a footprint in the
Northeast. We believe sales and marketing teams at the local level will be more effective because of their knowledge of and relationships with the municipalities within their region.
Expand our business by continuing to develop strategic relationships with companies serving and supplying the water industry on a national
basis
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We have identified and will continue to identify companies servicing and supplying the water industry on a national basis that can provide strategic benefits to the marketing of our groundwater treatment system. As part of this
strategy, we have entered into a strategic alliance agreement with Rohm and Haas. We believe that by partnering with companies like Rohm and Haas, we can efficiently leverage their existing infrastructure to provide our technology+services offering
in new markets.
Our Technology and Services
Our ion-exchange treatment systems.
Our groundwater treatment services generally utilize our ion-exchange technology. To treat contaminated groundwater, the water is pumped from the wellhead into our system which contains a
bed of ion-exchange resin. Through the ion-exchange process, the contaminants remain on the resin while the clean water exits the system and enters the drinking water distribution system. This process continues until the resin inside the bed is
saturated with contaminants. We offer our customers three types of ion-exchange treatment systems—onsite regenerable systems, offsite regeneration systems, and disposable resin systems. The primary difference among these three types of systems
is how resin is used in the treatment process.
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For our onsite regenerable system, once the resin bed is saturated with contaminants, sometimes referred to as being spent or exhausted, a saturated salt
brine solution is pumped into the tank which regenerates the resin onsite. For our offsite regeneration systems, we remove the spent resin to be regenerated offsite, and replenish the system with regenerated resin. The spent resin is transported for
processing, such as at our Memphis central regeneration facility. There the resin is regenerated to be returned to service at the customer’s site. For some contaminants, such as radionuclides, regeneration is not feasible. In those situations
we use a disposable resin system whereby we dispose of the resin in accordance with the particular regulation applicable to the contaminant being removed.
Our ion-exchange treatment systems are assembled on a build-to-order basis using raw materials from suppliers typically located in the United States and from predominantly “off-the-shelf” components for
which there are generally multiple suppliers. In the past, we assembled our onsite regenerable and disposable ion-exchange treatment systems at our facility in Rancho Cucamonga, California and our offsite regenerable systems at our facility in
Memphis, Tennessee. In 2008, we closed our assembling facility in Rancho Cucamonga, and we plan to outsource all future assembly operations that were previously conducted at our Rancho Cucamonga location.
Our customers must obtain a license and/or a permit from the applicable state regulatory agency in order to operate each system that we install at their
wellheads. We work with our customers to secure required licenses and permits from state regulatory agencies, including assisting with the completion of the license or permit application and responding to inquiries or requests from these regulators
regarding our system.
Our onsite regenerable, and certain disposable resin systems, use a multiple-bed system design, providing
flexibility to meet different volume requirements. These systems allow resin beds to be sequenced in and out of service to optimize performance and offer users a wide range of production rates up to 12,000 gpm.
Typically our systems are installed adjacent to a wellhead. The systems use the well pump’s pressure to move water through the ion-exchange process.
Our onsite regenerable systems require at least one waste brine tank to be placed onsite. The brine tank is connected to a waste line that allows for a contracted waste removal company to remove the brine without entering the well site. For our
offsite regenerable systems, which service low flow wells, there is no onsite brine tank. Instead, we remove the resin vessel from the customer’s site for regeneration at our facility.
All of our onsite regenerable systems and some of our offsite regenerable systems and disposable resin systems are fully automatic and use a Program
Logic Controller, or PLC, that runs advanced control programs to maximize treatment system performance and reliability while also minimizing waste products.
Our technology+services offering.
The exact technology+services offering we use in a given situation is dependent upon the customer’s needs. Our most frequently offered technology to date is our
onsite regenerable ion-exchange system, which we incorporate into our offering by combining our treatment system with an ongoing services agreement. This agreement incorporates a variety of services requested by our customers. For our offsite
regenerable systems and disposable resin systems, our service component might include such services as replacing media, conducting vessel exchanges on a periodic basis as the resin becomes exhausted, performing regeneration services at our central
facility in Memphis, periodic testing of the system and ongoing support as required to optimize system operations.
We anticipate that
service contracts for our expanded technology portfolio may include services similar to those listed above, and may also include the management of site-based operations involving a treatment system.
Customers
Historically, we have marketed our
ion-exchange treatment systems and services to groundwater customers that included utilities, municipalities, cities and other organizations that supply drinking water. By enhancing our
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technology+services offerings to include smaller ion-exchange treatment systems, offsite regeneration and organic removal capabilities, we believe we have
expanded our potential customer base in the municipal market.
This expansion of our offerings also addresses industrial customers’
needs for wastewater treatment, air treatment, water reuse and the recovery of valuable commodities from wastewater streams including for oil and gas, power, mining and chemical companies.
At December 31, 2008 and 2007, respectively, we had 77 and 88 systems under binding contracts as follows:
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Year Ended December 31, 2008
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Quantity at
Beginning
of Year
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Systems
Commenced
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Systems
Placed in
Service
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Demo
Systems
Returned
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Systems
Returned
or Cancelled
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Quantity at
End
of Year
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Systems installed and generating revenue under
water service agreements
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46
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—
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4
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—
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(1
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49
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Systems installed under interim demonstration agreements
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2
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—
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—
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(2
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)
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—
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—
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Systems in various stages of deployment
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40
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—
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(4
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—
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(8
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28
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Total systems
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88
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—
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—
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(2
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(9
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77
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Year Ended December 31, 2007
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Quantity at
Beginning
of Year
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Systems
Commenced
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Systems
Placed in
Service
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Demo
Systems
Returned
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Systems
Returned
or Cancelled
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Quantity at
End
of Year
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Systems installed and generating revenue under
water service agreements
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33
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—
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13
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—
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—
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46
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Systems installed under interim demonstration agreements
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5
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—
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—
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(3
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)
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—
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2
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Systems in various stages of deployment
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29
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24
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(13
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—
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—
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40
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Total systems
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67
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24
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—
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(3
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)
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—
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88
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In addition, we had 22 systems in progress in our Industrial and Envirogen business at
December 31, 2008, which are for system sales only and do not involve related water service agreements:
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Systems under contract and in progress
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19
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Systems under contract not yet started
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3
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Total
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22
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The following customers accounted for more than 10% of our revenues in the periods indicated:
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Year Ended December 31,
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2008
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2007
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2006
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East Valley Water District
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17
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%
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*
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*
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Baldy Mesa Water District
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*
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24
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%
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38
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%
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California Water Service Group
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*
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12
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%
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*
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Shaw Environmental, Inc.
(1)
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*
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*
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21
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%
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Totals
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17
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%
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36
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%
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59
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%
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*
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Indicates a less than 10% customer during such period.
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(1)
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We were formerly parties to an arrangement pursuant to which Shaw provided site work, bonding and other services to Coachella Valley Water District.
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As of December 31, 2008, our revenues backlog, assuming no further renewal of our long-term
contracts, was $41.7 million, compared to our revenues backlog of $38.4 million at December 31, 2007.
Competition
We believe successful competition in our industry and markets is dependent on the following factors: (1) superior technology and (2) customer
relationships.
Superior technology is an important factor for competition in our industry. The EPA has reviewed and accepted certain
well-established technologies for use in drinking water applications and designated them as “best available technology.” Ion-exchange technology has already been designated as a “best available technology” by the EPA and by many
state regulatory agencies. Ion-exchange technology is also frequently sought for industrial applications. We believe our rights to proprietary technologies provide us a competitive advantage in the municipal and industrial markets.
There are significant competitive challenges even for companies relying on superior and cost-effective technologies. There are a large number of
established and well-capitalized companies that already implement cost-effective technologies such as ion exchange in their solutions, and many of these large companies have strong and longstanding relationships with customers in the marketplace. We
believe these relationships are critical in establishing credibility and in maintaining steady business. This is particularly true in the municipal market where a local presence and knowledge of the region contributes to a company’s ability to
effectively market its services to municipalities. We are developing relationships with municipal customers on a local basis by implementing our regional structure.
We believe our geographic expansion plans, placing our marketing and sales force closer to our customer locations, coupled with the ongoing interactions between our field service force and customers, also provide us
with a competitive advantage. For those existing customers, our field services staff is often our onsite ambassadors who are able to spot and kindle future opportunities to increase the number of systems, or expand on our existing services at a
customer site.
Finally, many of our current and potential competitors have significantly stronger financial resources, larger marketing
and service organizations and significantly greater market expertise than we have. However, we believe that we can compete favorably based on the efficacy of our proprietary technology, our newly acquired technological expertise, our
technology+services business model, and our significant relationships with our customers.
Sales and Marketing
We market our technology+services offerings through a direct sales force, independent contractors and strategic relationships. In addition, members of our
management team leverage their numerous business contacts to capitalize on opportunities to sell our technology+services offerings. Regulatory changes also trigger sales opportunities. For example, in 2006 and 2007, changes in MCLs, especially
arsenic and radium, have caused customers to seek solutions such as ours to assist in their efforts to keep their groundwater supplies in compliance with regulatory standards. As a result, we periodically receive inquiries and are asked for
referrals about our systems and services. Finally, our existing client base refers our services to other water providers. We also secure business through a procurement bid process in which we compete with others in qualification and proposal
processes.
We have expanded our sales and marketing efforts beyond the arid West into other geographic areas of the United States.
Beginning in late 2007 and continuing in 2008, we made organizational changes to assign dedicated management, sales and service, marketing, and technical support to create five regions (West, Southwest, Southeast, Great Lakes and Northeast). In
addition to our West regional office in Rancho
8
Cucamonga, California, we developed a footprint in the Southeast with our facility in Memphis, Tennessee, a Southwest regional office in Houston, Texas in
mid-2008, and a sales presence in the Great Lakes area. In 2008, we continued to expand our business reach through our Envirogen acquisition, which provided us with a footprint in the Northeast. We believe sales and marketing teams at the local
level will be more effective because of their knowledge of and relationships with the municipalities within their region.
We have expanded
our sales and marketing efforts through strategic relationships, including the Rohm and Haas alliance and the agreement with Purifics. Our sales team plans to use Rohm and Haas’ expertise and contacts in the water treatment industry to develop
and manage our relationships with customers and our strategic relationships.
Other Significant Transactions
Rohm and Haas Alliance
Rohm
and Haas Company is a global company that develops advanced materials for customers around the world. Its business spans the world: North America, Latin America, Europe, Middle East, Africa, and Asia-Pacific, with more than 100 manufacturing,
technical research and customer service sites in 27 countries. It had annual sales of approximately US $9.5 billion in 2008. It is a publicly owned company whose stock is traded under the “ROH” symbol on the New York Stock Exchange.
On November 14, 2007, we entered into an exclusive alliance with Rohm and Haas to provide technology solutions and service offerings
in both the drinking water market and certain areas of the industrial market. We expect the alliance to also develop new technologies to address other groundwater treatment issues, such as produced water from oil and gas operations and emerging
water recovery applications. Each member of the alliance will contribute its respective core strengths to the alliance: Rohm and Haas its research and development capabilities, global infrastructure and ion exchange resins and our company its
systems designs, channels to market and service capabilities. We expect the alliance to initially market offerings in the United States and Canada using our technology+services business model to provide guaranteed performance and guaranteed costs
over the lifetime of a project. As part of the alliance, we have exclusive access to Rohm and Haas ion-exchange resin technology for certain selected markets.
The initial term of the alliance is five years. The parties agreed to renew the alliance agreement if at the end of the initial term the alliance has met projected budget, earnings and growth projections.
Investment in Empire Water Corporation (Empire)
In May 2007, we entered into an agreement to acquire certain water rights and related assets. In December 2007, we sold to Empire the rights to purchase certain collective assets from unrelated parties including
(a) a canal located in San Bernardino and Riverside counties in Southern California that is approximately eighteen miles in length, (b) rights to pump water from the San Bernardino Basin, and (c) other equipment and tangible and
intangible personal property of the sellers. As consideration for the sale of these assets, we received 6,000,000 shares of Empire common stock, which represents an ownership interest of approximately 32% in Empire as of December 31, 2008. See
Note 11 to our consolidated financial statements included in this report for additional detail.
In conjunction with the February 2009
settlement of a claim by one of our customers, we transferred 150,000 shares of Empire common stock to this customer as partial consideration of this claim (see Notes 11 and 25 to our consolidated financial statements). After the transfer of this
common stock in 2009, we now own approximately 31% of the outstanding stock of Empire.
Envirogen Acquisition
On September 18, 2008, we acquired Envirogen, Shaw’s bioreactor and biofilter business, for approximately $1.5 million cash (subject to
adjustment for working capital) plus the settlement of a disputed claim against Shaw for amounts we claimed to be owed by Shaw. The bioreactor and biofilter business includes the design and supply of fluidized bed, membrane, and suspended carrier
bioreactors for the treatment of groundwater and wastewater streams in industrial, municipal and federal applications. The business also includes the design and supply of biofilters for the treatment of air streams from municipalities and industry
for the removal of odor-causing and other contaminants. See Note 3 to our consolidated financial statements included in this report for additional detail.
9
Government Regulation
Our customers are subject to extensive environmental laws and regulations concerning emissions to the air, discharges to waterways and the generation, handling, storage, transportation, treatment and disposal of waste
materials and also are subject to other federal and state laws regarding health and safety matters. Under the contracts with our customers, we assist them in meeting these regulations and obtaining any required permits and/or licenses in order to
implement our systems. These laws and regulations are constantly evolving, and it is difficult to predict the effect these laws and regulations may have on us or our customers in the future.
In the United States, many different federal, state and local laws and regulations govern the treatment of contaminated groundwater, wastewater, air
streams, disposal of attendant wastes, and distribution of potable water. Changes in such laws and regulations could have a material adverse effect on our business. The increased interest in the treatment of contaminated groundwater due to increased
attention to the adverse health effects from contaminated drinking water may result in intervention by governmental regulatory agencies in the United States or elsewhere under existing or newly enacted legislation and in the imposition of
restrictions, fees or charges on users and providers of products and services in this area. Conversely, the failure of the EPA or state regulatory agencies to act on a timely basis to set interim or permanent standards for pollutants, or to delay
effective dates for standards for pollutants, grant waivers of compliance with such standards or take other discretionary actions not to enforce these standards, may decrease demand for our systems and services and thus harm our business
significantly.
Each groundwater treatment solution, including our contaminant treatment systems, must be permitted by applicable state
regulatory agencies prior to use of such systems by our customers. Typically, our customers apply for a permit from the applicable state regulatory agency to use our systems, and we assist our customers in completion of the permit application
process. The application process for our system is time consuming and often involves several information requests to our customers by the regulatory agencies with respect to our systems.
Furthermore, we cannot predict the impact of changing drinking water standards on the approval of our technology for groundwater treatment. The MCLs for
contaminants are subject to review and revision by the EPA and applicable state regulatory agencies. The MCLs may be changed to levels below that which our systems can treat on a cost-effective basis, and if we are unable to design systems that
remove contaminants below the designated MCL, then the state regulatory agencies will fail to approve our systems. Without regulatory approval, our systems could not be used by our customers, and we would be required to develop technology that meets
any revised MCLs.
Although our customers retain title to the brine waste generated by our systems, we facilitate the removal of the waste
with a licensed waste disposal service and in some cases contract directly with the waste transporter on behalf of our customers. As such, we may become subject to the provisions of the Comprehensive Environmental Response, Compensation and
Liability Act of 1980, as amended, or CERCLA. CERCLA, which is also known as Superfund, addresses problems created by the release or threatened release of hazardous substances (as defined in CERCLA) into the environment. CERCLA imposes strict, joint
and several liability for remediation of certain disposal sites on: current owners and operators of the site, on former site owners and operators at the time of disposal, on parties who arranged for disposal or treatment or arranged for
transportation for disposal or treatment of hazardous substances at the site, and on parties that transport hazardous substances to a site. Because CERCLA liability is joint and several, the costs of a CERCLA cleanup can be substantial. Because
liability under CERCLA is strict, it is not premised upon the violation of any law, statute, rule or regulation but is rather based upon a party’s status as an owner, operator, transporter or arranger (as those terms are described above). Such
liability can therefore be based upon the release or threatened release, even as a result of lawful, unintentional and non-negligent action, of any one of the more than 700 “hazardous substances” listed by the EPA, even in small amounts.
10
Our Memphis Facility
. Our facility in Memphis supports services that include catalyst
recovery, service exchange programs for containers of spent filtration media, and media processing and regeneration of ion-exchange media for other water service providers and end users that have applied the media to capture or recover various
metals, organics, or inorganic compounds. Because our facility does not accept or receive materials that have been profiled as hazardous wastes, it does not maintain environmental permits as a treatment, storage, and disposal facility for hazardous
wastes as defined by the EPA and the State of Tennessee. The Memphis facility performs its own independent waste stream profiling and acceptance criteria review to ensure that all materials received for processing and regeneration are applicable to
the Memphis facility processes and are in accordance with the facility’s environmental permits.
The Memphis facility’s
environmental permits include a National Pollutant Discharge Elimination System (NPDES) wastewater discharge permit to discharge process wastewater to the City of Memphis, Tennessee’s publicly owned treatment works (POTW), an NPDES Stormwater
Discharge permit issued by the State of Tennessee, and Special Solid Waste Disposal Permits issued by the facility’s solid waste disposal contractor for the land disposal of certain non-hazardous special waste streams.
Since the Memphis facility is also a Small Quantity Generator (SQG) of hazardous waste, we maintain an EPA generator registration and identification
number for their hazardous waste disposal activities.
We are also pursuing business opportunities involving the removal of radionuclides
from groundwater and/or industrial wastewater streams. Our plans are to sell or lease the removal systems to third party customers, with an associated service contract for removal and disposal of the resin material upon exhaustion. We would use
a licensed subcontractor for transportation and disposal of the media. These activities would fall under regulations governed by the Nuclear Regulatory Commission (NRC). All subcontractors, transporters, and disposal facilities would be
required to possess the required NRC permits and licenses to engage in these roles. However, should any of the spent radionuclide-containing resins also contain characteristic or listed hazardous wastes, the resins would be classified as “mixed
wastes” and would no longer be regulated by the NRC, but, would be subject to the EPA’s Resource Conservation and Recovery Act (RCRA) hazardous waste regulations.
Given our Memphis facility’s onsite chemical inventory and disposal and/or release of chemical substances / wastes / residues as a part of
doing business, the Memphis facility is subject to annual reporting requirements as specified by the EPA Superfund Amendment and Reauthorization Act (SARA) (specifically the SARA 312, Tier II Hazardous Chemical Inventory, and SARA 313, Toxic
Release Inventory, regulations).
To the extent we do not comply with the various laws and regulations applicable to our activities, we may
be subject to fines, regulatory action or private litigation that may adversely affect our business.
Research and Development
Product development activities focus on lab and project related field work that includes 1) the design and evaluation of experimental ion-exchange
processes and groundwater treatment systems for the removal of various contaminants, and 2) the development of processes involving an array of technologies useful in our expansion from an ion-exchange company to a commercial water treatment company.
These development activities include piloting efforts on applications related to the removal of nitrate, arsenic and radionuclides from groundwater from groundwater. Additional activities include the piloting of media-based, and other, treatment
technologies for the removal of synthetic and naturally occurring organic contaminants.
As a result of our acquisition of Envirogen in
September 2008, we have enhanced our internal research and development capabilities to include process development related to laboratory and field scale pilot capabilities for the treatment of water and wastewater for the removal of both organic and
inorganic constituents for groundwater remediation, wastewater treatment and potable water applications. We also acquired through Envirogen development capabilities for treatment methods for air streams containing odor-causing and other
contaminants.
11
We had a sponsored research arrangement with the
University of Nevada Las Vegas (UNLV) under which they were researching and testing certain aspects related to the regeneration of exchange resins that may be useful in a technology for biologically removing and destroying perchlorate load from
spend ion-exchange resins, which we refer to as the BIONExchange
™
process. Any intellectual property developed by us under the agreement is owned by us, any intellectual property developed
by UNLV under the agreement is owned by UNLV, and intellectual property developed jointly will be jointly owned by the parties. Due to uncertainties surrounding the future commercial viability of this technology, we wrote off certain related costs
totaling approximately $0.7 million during the quarter ended September 30, 2008 (see Note 12 to our consolidated financial statements). Our arrangement with UNLV was discontinued in the fourth quarter of 2008.
Our total research and development expenses were $1.2 million in 2008 and $0.6 million in both 2007 and 2006, respectively. In 2008, such costs included
the write-off of certain assets related to the development of our proprietary BionExchange technology. Management determined this impairment was required due to uncertainties regarding the future commercial viability of the technology, which were in
part, due to the economics of competing technologies with respect to biological processes intended to reduce the costs of treatment of contaminated water.
We intend to continue our active development efforts internally and through our existing strategic alliances and our Envirogen operations to strengthen the position of our groundwater and other treatment technologies
through the development of new and improved processes. The principal goals of our program are maintaining our position as a technological leader in solving customers’ problems with technology+services, and acquiring access to and developing new
products and services.
Intellectual Property
Our intellectual property is the result of many years of research and development efforts as well as strategic acquisitions and contract relationships. We have pursued a broad strategy of protecting our developed and owned intellectual
property, including seeking patent protection, safeguarding trade secrets, registering trademarks and using non-disclosure and other contractual agreements to protect other intellectual property rights.
We have developed what we believe to be an innovative process design that significantly improves
the economics of using ion exchange for groundwater treatment. As of December 31, 2008, we have two issued United States patents directed to a system and process for the removal of arsenic, one issued United States patent directed to a process
for the removal of nitrate, one issued patent directed to a system and process for the removal of chromium, and two issued United States patents directed to processes for the removal of perchlorate. We also have three issued patents in the United
States and in five European countries directed to our BIONExchange
™
system and process, a proprietary process for biologically removing and destroying perchlorate load from used
ion-exchange resins and alternatively from perchlorate-laden ion-exchange resin regeneration brines. We currently are developing a process through which we hope to remove radium from potable water sources, and for which we may seek patent
protection.
In addition, we hold five pending United States utility patent applications, two pending United States provisional patent
applications, nine pending foreign patent applications and one PCT on various aspects of our treatment processes. Our patents and patent applications as a group are related to ion exchange and the treatment of one or more of the following
contaminants:
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We employ the Basin Water IX
™
software program for the operation of our system. We also use this software program for the design of our system to determine the most efficient operating parameters for our system based upon
the contaminant profile of the water source being treated. We own federal trademark registrations for the marks Basin Water
®
and Basin Water IX
®
.
As part of our business procedures, we typically enter into confidentiality and invention assignment
agreements, or have confidentiality provisions in agreements with our employees, independent contractors and consultants, and non-disclosure agreements with our customers, partners, independent contractors and consultants.
MPT, which we acquired in September 2007, holds five United States patents and eleven foreign patents related to various chemical manufacturing
processes. These patents relate to 1) an improved process for the recovery of ethylene glycol from spent glycol generated in the manufacture of polyethylene terephthalate, 2) an improved separation process for the continuous catalytic oxidation of
aromatic alkyls for the production of aromatic carboxylic acids in a liquid solvent medium, 3) an apparatus and method for the purification of waste wash water derived from the production of aromatic acids, 4) a method of polyester manufacturing
using cross flow membrane filtration, and 5) a process for the recovery of molybdenum catalyst from the epoxidation reaction product of olefins with organic hydroperoxides.
MPT also has three pending United States patent applications related to processes for the treatment of the following contaminants: ammonia, arsenic and
radium. MPT also has a pending patent application for the treatment of various contaminants using electrocoagulation.
The pending patent
applications related to the treatment of radium, arsenic and ammonia have been assigned to us pursuant to our acquisition of MPT. In 2009, we plan to have the other patents and pending patent applications assigned to us.
MPT also holds trademark registrations for Hypersorb
®
, Hyperflux
®
and Chromasep
®
.
In 2008, with the Envirogen acquisition, we acquired rights to a patent portfolio relating generally to bioreactors, biofiltration systems, and related
technologies useful for the treatment of wastewater and the reduction of contaminants. That patent portfolio includes 12 United States patents and 10 foreign patents related to technologies including, for example, mechanically mixed packed bed
bioreactors, biomass separation apparatus and methods, biofiltration apparatus and methods, systems and methods for withdrawing permeate through a filter and for cleaning the filter
in situ
, fluidized bed reactors, systems and methods for
inoculating biological reactors, and apparatus and methods for controlling biomass growth in suspended carrier bioreactors. That portfolio also includes 8 pending United States patent applications, 6 foreign patent applications and 3 PCTs related to
these technologies.
Employees
As of
December 31, 2008, we employed 83 full-time employees, one part-time employee and 20 employees leased from Shaw pursuant to our Envirogen acquisition. These leased employees became employees of the Company effective January 1, 2009. None
of our employees are represented by a collective bargaining agreement. There are no pending labor-related legal actions against us filed with any state or federal agency. We believe our employee relations are good.
Risks Related to the Restatement
The restatement of our consolidated financial statements has had a material adverse impact on us, including increased costs and the increased
possibility of legal or administrative proceedings.
Our consolidated financial statements for the years ended December 31, 2006
and 2007 and for the first quarter of 2008 were restated. As a result, we have become subject to a number of additional risks and uncertainties.
We have incurred substantial unanticipated costs for accounting and legal fees in 2008 in connection with the restatement of our consolidated financial statements. We filed an amendment to our Annual Report on
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Form 10-K/A to restate our consolidated financial statements for the years ended December 31, 2007 and 2006, and we filed an amendment to our
Quarterly Report on Form 10-Q/A to restate our consolidated financial statements for the quarter ended March 31, 2008. The restatement has caused and may continue to cause a significant diversion of management’s time and attention.
We have been named in a number of lawsuits that began in December 2007. As a result of the restatement of our 2007 and 2006, the
plaintiffs in these lawsuits have made additional claims, expanded existing claims and expanded the time periods covered by the complaints. Other plaintiffs may bring additional actions with other claims, based on the restatement. As a result, we
may incur additional substantial defense costs regardless of their outcome. Likewise, such events might cause an additional diversion of our management’s time and attention. If we do not prevail in any such actions, we could be required to pay
substantial damages or settlement costs.
The Securities and Exchange Commission (SEC) has instituted an investigation with respect to the
Company’s accounting and related disclosure and other matters. The Company is cooperating with the SEC. This investigation has diverted and will likely divert more of our management’s time and attention and cause us to incur substantial
costs. Such investigation could result in the SEC seeking various penalties and relief, including, without limitation, civil injunctive relief and/or civil monetary penalties or administrative relief. The nature of the relief or remedies the SEC may
seek, if any, cannot be predicted at this time and can lead to further substantial costs and diversion of management time and attention.
Failure to
satisfy the listing requirements of the Nasdaq Global Market could result in our common stock being delisted, which may have an adverse effect on our stock price.
Timely filing of annual and periodic reports with the SEC is required for continued listing under Nasdaq Marketplace Rule 4310(c) (14). In addition, the Nasdaq Global Market imposes, among other requirements, minimum
bid and public float requirements. The price of our common stock must close at or above $1.00 to comply with Nasdaq’s minimum bid requirement for continued listing on the Nasdaq Global Market. Our common stock has been trading at a price below
$1.00 per share. On October 16, 2008, The Nasdaq Stock Market announced the immediate suspension of its enforcement of the rules requiring a minimum $1.00 closing bid price and that it will not take any action to delist any security traded on
the Nasdaq Global Market that fails to comply with the minimum $1.00 closing bid price requirement until January 19, 2009. On March 23, 2009, The Nasdaq Stock Market announced further suspension of its enforcement of these rules until July
2009. Consequently, for as long as Nasdaq’s rule suspension remains in effect, Nasdaq will not delist our stock if the closing bid price for our common stock falls below $1.00 per share during the rule suspension period. If the closing bid
price of our common stock continues to fail to meet Nasdaq’s minimum closing bid price requirement at any time on or after July 20, 2009, or if we otherwise fail to meet all other applicable Nasdaq requirements, Nasdaq may make a
determination to delist our common stock.
If our common stock is delisted from the Nasdaq Global Market, our common stock would be traded
over-the-counter, more commonly known as OTC. OTC transactions involve risks in addition to those associated with transactions in securities traded on the Nasdaq Global Market. Many OTC stocks trade less frequently and in smaller volumes than
securities traded on the Nasdaq Global Market. Accordingly, our common stock would be less liquid than it would otherwise be, and the value of our common stock could decrease. Finally, any such delisting could also adversely affect our ability to
obtain financing for the continuation of our operations and/or result in the loss of confidence by investors, customers, suppliers and employees.
Material weaknesses or deficiencies in our internal control over financial reporting could harm stockholder and business confidence on our financial reporting, our ability to obtain financing and other aspects of our business.
Maintaining an effective system of internal control over financial reporting is necessary for us to provide reliable financial reports.
As of and for the years ended December 31, 2007 and December 31, 2006, we have restated our consolidated financial statements, including each of the quarterly periods in 2007 and 2006, and we
14
filed an amendment to our Quarterly Report on Form 10-Q/A to restate our consolidated financial statements for the first quarter of 2008. As previously
reported, we identified a material weakness in our internal control over financial reporting that resulted from certain control deficiencies stemming from several significant changes within our Company, including changes in the organization
structure, new information systems and our acquisition of MPT in the third quarter of 2007. In connection with the restatement of our consolidated financial statements, we have identified the following additional material weaknesses in our internal
control over financial reporting:
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A lack of sufficient personnel with appropriate knowledge, experience and training in applying GAAP to transactions and the correct application of revenue
recognition principles required under GAAP;
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A lack of effective checks and balances between the former CFO and accounting and legal functions with respect to the negotiation, structuring and accounting for
transactions, including water treatment unit sales and water service agreements;
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A failure to maintain adequately organized business records and complete documentation for sales contracts, many of which lacked execution dates, signatures by
Company or counterparty representatives; the use of draft or non-standard arrangements; and the lack of adequate written agreements to memorialize significant transactions;
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Insufficient information systems and processes to accumulate information to timely identify and address business and accounting issues;
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A lack of sufficiently detailed written accounting policies and procedures with respect to the timing and recognition of sales transactions and an insufficient
process at the time of the transactions to monitor compliance with such policies and procedures; and
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A failure to maintain an effective internal audit function.
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As a result of these material weaknesses, management’s assessment concluded that our internal controls over financial reporting continue to be ineffective. Some of the identified material weaknesses have not been
fully addressed. It is also possible that additional material weaknesses will be identified in the future. Until we remediate the remaining material weaknesses, we have the risk of another restatement.
We have incurred and expect to incur substantial expenses relating to the remediation of the material weaknesses in our internal control over financial
reporting. The effectiveness of our internal control over financial reporting may in the future be limited by a variety of factors including without limitation:
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failure of the effectiveness of our policies, procedures and information systems and processes;
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delay in upgrading financial software system; and
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the possibility that any enhancements to disclosure controls and procedures or internal controls may still not be adequate to assure timely and accurate financial
information.
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Because we have concluded that our internal control over financial reporting is not effective and our
independent registered public accountants issued an adverse opinion on the effectiveness of our internal controls, and to the extent we identify future weaknesses or deficiencies, there could be material misstatements in our consolidated financial
statements and we could fail to meet our financial reporting obligations. As a result, our ability to obtain additional financing, or obtain additional financing on favorable terms, could be materially and adversely affected, which, in turn, could
materially and adversely affect our business, our financial condition and the market value of our securities. In addition, perceptions of us could also be adversely affected among customers, lenders, investors, securities analysts and others.
Current material weaknesses or any future weaknesses or deficiencies could also hurt confidence in our business and consolidated financial statements and our ability to do business with these groups.
15
Risks Related to Our Business
We will need additional capital to continue to operate our business, and if we cannot obtain additional financing, we may not be able to continue operations.
As of December 31, 2008, we had approximately $11.5 million in cash and cash equivalents and as of March 30, 2009, we had approximately $8.5 million in
cash and cash equivalents (excluding cash balances resulting from the consolidation of VL Capital, which funds of VL Capital are not available to us to support our liquidity needs). We have experienced significant negative cash flows from operating
and investing activities between 2006 and 2008, and we expect to use additional cash for such activities for the foreseeable future. Our net losses incurred during the past two fiscal years ended December 31, 2008 and 2007 amounted to
$32.5 million and $18.3 million, respectively. Unless and until we are able to generate sufficient revenues from our system sales and contract services, we expect such losses to continue in the future. Therefore, our ability to continue to
operate our business over the next 12 months is highly dependent on the amount of cash and cash equivalents on hand combined with our ability to raise capital to support our future operations.
Additional capital, whether obtained through financial markets (in the form of public or private debt or equity) or collaborative or other arrangements
with water providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to us. If additional funds are raised through the issuance of additional common stock, other equity securities or
indebtedness, the percentage ownership of our then-current stockholders may be diluted substantially and the equity or debt securities issued to new investors may have rights, preferences or privileges senior to those of the holders of our
then-existing capital stock.
The U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which
have caused spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the
unavailability of certain types of debt financing. These events in the credit markets as well as deteriorating market conditions have also had an adverse effect on other financial markets in the United States, including the equity markets, which we
expect will make it very difficult and costly for us to raise capital through the issuance of common stock or other equity securities. If adequate funds are not available or are not available on acceptable terms, we may not be able to continue
operations, resulting in significant harm to our financial condition and prospects and a decline in our stock price. This raises substantial doubt as to our ability to continue as a going concern.
Our independent auditors’ report for the year ended December 31, 2008 includes an explanatory paragraph stating that our recurring losses from
operations and negative cash flows raise substantial doubt about our ability to continue as a going concern. If we are unable to obtain additional financing on commercially reasonable terms, our business, financial condition and results of
operations will be materially and adversely affected and we may be unable to continue as a going concern. The question about our ability to continue as a going concern may also limit our ability to obtain financing on acceptable terms or at all, and
may limit our ability to obtain new business due to potential customers’ concern about our ability to provide water treatment and other services. If we are unable to continue as a going concern, we may elect or be required to seek protection
from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. In such a case, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our
financial statements, and it is likely that investors will lose all or a part of their investment.
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We have a limited operating history, have incurred significant operating losses in our first few years of operation
and have not consistently achieved profitability on an annual basis.
We have a limited operating history and limited revenues derived
from our operations. We began our business operations in December 1999 and did not generate our first revenues until 2002. Our revenues grew from $12.2 million in 2005 to $13.9 million in 2006, followed by a decline to $9.7 million in 2007 and an
increase to $11.8 million in 2008. We have incurred significant net losses since our inception, including net losses of $1.3 million in 2003, $0.6 million in 2004, $13.5 million in 2006, $18.3 million in 2007 and $32.5 million in 2008. Our net
loss in 2006 resulted in part from reserves we recorded in connection with certain of our contracts which have ongoing operating costs in excess of our contract revenues. In addition, our net loss in 2007 resulted in part from additional reserves we
recorded in the third quarter of 2007. We took these reserves in connection with certain older legacy contracts when it became apparent that these projects would be operating at a loss for some period of time. In addition, we may find that
additional contracts have ongoing operating costs in excess of revenues, which could have an adverse effect on future results of operations. Though we have taken steps in an effort to improve our business processes, we cannot assure you that these
improved processes will positively impact our results of operations. At December 31, 2008, we had an accumulated deficiency of approximately $68.4 million. Even if these improved processes do positively impact our results of operations, we
may not have sufficient capital to continue as a going concern.
Our operations prior to 2006 primarily focused on development of our
technology and onsite regenerable ion exchange treatment systems, building our sales and marketing capabilities, commencing the commercial launch of these systems and developing and maintaining customer relationships. In late 2006 and throughout
2007 and 2008, we implemented several initiatives to improve our business model, but we cannot assure you that any of these initiatives will result in increased revenues or positively impact our financial results. In addition, our ability to
successfully sell our systems and services depends on, among other things, the level of demand for contaminated groundwater treatment, which is an evolving market, and the demand for our technology and services in those geographic areas and markets
into which we are expanding.
In 2008 and 2007, we had significant net losses and expect to continue to have significant net losses from
our operations in the foreseeable future. Even if we do achieve significant revenues from our business operations, increased operating expenses associated with any expansion of our business may result in future operating losses in the near term as
we, among other things:
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market our technology+services offering to our customers;
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seek to acquire new customers in the markets in which we are currently active;
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expand our technology offering to broaden our reach into new markets, such as the industrial marketplace;
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expand geographically throughout the United States pursuant to our regional structure;
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make significant capital expenditures to support our ability to provide services under our recurring revenue contracts;
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expand our internal sales force and develop strategic relationships with companies serving the water, wastewater, waste reduction, and resource recovery industries
on a national basis;
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fund development costs for our systems and technology;
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incur costs associated with our litigation matters; and
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incur increased general and administrative expenses, including increased costs as a result of being a public company.
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As a result of these and other factors, we may not achieve, sustain or increase our profitability on an ongoing basis. If we are not able to achieve
profitability, then we may be unable to continue as a going concern. Our independent auditors’ report for the year ended December 31, 2008 includes an explanatory paragraph stating that our recurring losses from operations and negative
cash flows raise substantial doubt about our ability to continue as a going concern. If we are unable to continue as a going concern, we may elect or be required to seek protection from creditors by filing a voluntary petition in bankruptcy or may
be subject to an involuntary petition in bankruptcy. In such a case, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all
or a part of their investment.
Our future operating results will likely fluctuate significantly from reporting period to reporting period.
We expect our future revenues and operating results to fluctuate significantly from period to period due to a number of factors,
including:
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customer budgets or commitments for our systems and/or services, including availability of Federal and state funding to our customers;
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the effectiveness of our internal sales and marketing organization;
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demand for our systems and/or services;
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demand for low life-cycle cost solutions among our current and potential customers;
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our ability to develop and market new and enhanced technology and our technology+services business model in a cost-effective manner;
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our product and price competition in our market;
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length of our sales cycle;
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our ability to enter into third-party financing arrangements where a customer selects a long-term capital contract, thus recognizing revenue over longer periods of
time;
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general economic conditions;
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ability to control our costs, including labor and the cost of materials included in our systems;
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increases in the costs of salt, resin, chemicals, waste disposal and other materials necessary to fulfill our obligations under our recurring revenue contracts;
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our ability to pass through increased operating costs to our customers under our recurring revenue contracts;
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our ability to work with companies with whom we enter into strategic alliances and relationships in a cost-effective manner; and
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our ability to build and install systems and provide services on a timely and low life-cycle cost basis.
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Any of the foregoing factors, some of which are not within our control, may cause our operating expenses
to be disproportionately high or cause our revenues and operating results to fluctuate, which could prevent us from maintaining or increasing our business or could harm our results of operations or result in our inability to continue as a going
concern. In addition, our future revenues or our future operating expenses may not be consistent with our past results, which could adversely affect our stock price.
Our financial success will depend in part on the efforts of strategic relationships we may work with in the future.
In November 2007, we announced the formation of an exclusive, service-based alliance with Rohm and Haas. This alliance provides us with exclusive access in selected markets to the Rohm and Haas ion-exchange resin
technology which we intend to deploy as part of our business model. Our alliance also provides us access to technology for the removal of organic contaminants from water, support for our business model through access to the Rohm and Haas scientific
and laboratory resources and Rohm and Haas’ developed channels to the specified markets. In late 2007, we entered into an agreement with Purifics to provide us with unique engineered systems, solutions and products effective in removing organic
contaminants from groundwater. Under this agreement, we can exclusively market the Purifics photocatalysis technology in certain areas of the United States, and we have access to the technology on a non-exclusive basis in a larger market area. We
may enter into other such strategic relationships with other companies focused on the water, wastewater, waste reduction and resource recovery industries on a national basis. Our financial success and our anticipated growth will depend in part on
the efforts of these strategic relationships as we market and sell our treatment systems and solutions. If Rohm and Haas, Purifics or any other strategic relationships fail to perform satisfactorily under their respective agreements with us, or if
we fail to maintain these relationships, or establish new relationships as required, then we may lose our access to their technologies, and our ability to market our treatment systems and our technology+services offering will likely suffer. In
addition, our revenues resulting from these strategic relationships may not grow as anticipated, and we could be subject to additional costs which could negatively impact our operating results and financial condition significantly.
Our long sales cycles make predicting our financial results difficult.
Many of our service contracts have a term of five or more years, and some contain an option either to purchase the system or to renew the contract at the end of the initial contract term. Since most of our sales are
based on long-term contracts, our customers generally take a longer time to decide to purchase our system and/or services, thus creating a lengthy sales cycle. Other reasons for our long sales cycle include:
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the size of the capital outlay to be incurred by our customers;
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the budget constraints of municipal and industrial customers that may cause delays in project selection;
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extensive contract negotiations over the specific terms of the sale of our system and/or services;
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the unfamiliarity of some of our customers with utilizing third parties for water and wastewater treatment, waste reduction and resource recovery services;
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our customer’s perception of our financial capability;
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the resistance by customers to granting control of support functions such as water treatment to external parties;
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the availability of many competitive alternatives that may be considered by our customers in the municipal market, including water importation, water blending,
coagulation microfiltration (a process of destabilizing charges on contaminants in water by adding chemical coagulants that can then be filtered and removed), reverse osmosis (a pressure-driven separation process that removes contaminants from water
by forcing them through a membrane barrier), electrodialysis reversal (a
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process that transfers contaminants by direct electric current flow through membranes thus removing them from water) and ion exchange processes of our
competitors;
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the availability of competitive alternatives to our existing and developing technology+services offerings;
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the availability of competitive alternatives to our existing and developing offerings in the wastewater treatment, waste reduction and resource recovery industries;
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the long approval procedures imposed by government agencies; and
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the lengthy approval process of many customers’ equipment/contract procurement procedures due to multiple approvals that may be required by, for example,
municipal boards, public bidding or state public utility commission requirements, which is sometimes exacerbated by the capital outlay needed to enter into and support contracts for our systems and services.
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In addition, to the extent we expand our service to international markets, we may face additional factors that contribute to long sales cycles, including
additional time required for travel to foreign locations as well as potential problems caused by language barriers, cultural differences, differing business practices, differing contracting practices, and varying regulatory requirements. Our long
sales cycles, as well as the placement of large orders with short lead times on an irregular and unpredictable basis, may cause our revenues and operating results to vary significantly and unexpectedly from period to period. Since our operating
expenses are largely based on anticipated revenue trends and a significant portion of our expenses are, and will continue to be, fixed, any delay in generating or recognizing revenues could harm our operating results or financial condition
significantly.
Our ion-exchange treatment systems and the technologies upon which they are based may not achieve widespread market acceptance among our
customers which may impact demand for our system and services.
We have developed our proprietary ion-exchange technology and processes
for groundwater treatment based on ion-exchange technology that competes with other forms of groundwater treatment technologies that currently are in operation throughout the United States. This proprietary technology is used in our onsite
regenerable and disposable resin treatment systems. Through our acquisition of MPT, we have expanded our capabilities into central regeneration for ion exchange, smaller ion-exchange systems and technologies to serve customers in the industrial
markets. These treatment systems and the technologies on which they are based may not achieve widespread market acceptance. Our success will depend on our ability to market our systems and services to businesses and customers on terms and conditions
acceptable to us and to establish and maintain successful relationships with municipal and industrial customers.
We believe that market
acceptance of our systems and technology and our related success will depend on many factors including:
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the perceived advantages of our systems over competing treatment solutions;
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the actual and perceived safety and efficacy of our systems;
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the availability and success of alternative treatment solutions;
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the pricing and cost effectiveness of our systems;
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our ability to market effectively to municipal and industrial customers that may use our systems;
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the permitting of our technology by regulatory agencies;
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the willingness of potential customers to enter into long-term service contracts;
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publicity concerning our systems and technologies or competitive solutions;
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timeliness in assembling and installing our systems on customer sites;
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whether or not our existing customers continue to use our system and services and/or renew service contracts after their expiration;
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our customer’s perception of our financial viability and ability to fulfill our obligations under our long term service contracts;
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our ability to respond to changes in the regulatory standards for maximum contaminant levels of various contaminants;
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the ability of our strategic relationships to provide necessary support to our efforts to market their technologies now available to us from our strategic alliance
and other agreements;
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our ability to provide effective service and maintenance of our system to our customers’ satisfaction; and
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our ability to control operating costs.
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If our systems or technologies fail to achieve or maintain market acceptance or if new technologies are introduced by others that are more favorably received than our technology, are more cost effective or otherwise render our technologies
obsolete, we may experience a decline in demand for our systems and services. If we are unable to market and sell our systems and services successfully, our revenues would decline and our operating results and prospects would suffer.
We may be unable to attract and retain qualified personnel which could harm our business, operating results, financial condition and prospects significantly.
Our future success also will depend, in large part, on our ability to identify, attract and retain sufficient numbers of highly skilled
employees, particularly qualified sales, marketing and engineering personnel. As of December 31, 2008, we had 83 full-time employees, one part-time employee and 20 employees leased from Shaw pursuant to our Envirogen acquisition. These leased
employees became employees of the Company effective January 1, 2009. Although we have expanded our sales force somewhat, we have a limited number of sales and marketing employees and consultants, as well as service employees who provide field
and other services to our treatment systems. We may not succeed in identifying, attracting and retaining individuals who qualify for these positions. Further, competitors and other companies may attempt to recruit our employees. If we are unable to
hire and retain adequate staffing levels, it may be difficult to increase sales of our systems or services or adequately support our installed systems, which could harm our business and prospects.
Our future success also depends on the experience and expertise of our President and CEO, whose talents, efforts and relationships within the water
industry have been, and continue to be, critical to our success. We have an employment agreement with our CEO that provides for “at will” employment. However, we cannot prevent our CEO from leaving our employ if he chooses to do so. We do
not currently carry “key man” insurance upon the life of our CEO or the lives of any of our employees or officers. The loss of our CEO’s services and access to his abilities and relationships could adversely affect our ability to
maintain or increase our customer base and could harm our operating results and prospects significantly.
The current geographic concentration of our
customers in California and Arizona and the location of our headquarters in California make our business particularly vulnerable to adverse conditions affecting these markets.
Currently, our customers are concentrated geographically, primarily in the states of California and Arizona. Our revenues and operating results are
therefore subject to local regulatory, economic, demographic and weather conditions in those areas. A change in any of these conditions could make it more costly or difficult for us to conduct our business or decrease demand for our treatment
systems. The current economic climate in California
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has resulted in a decrease in new home development and population migration to California. Additionally, in December 2008, the California Department of
Public Health, Division of Drinking Water and Environmental Management was directed by the State of California to cease entering into any new construction related to the expenditure of state bond funds, which may impair the ability of municipalities
and other governmental entities to pay for capital expenditures. As a result of these events, we may experience lower sales of our water treatment units to developers, municipalities and other governmental entities in California.
In addition, we are subject to greater risk of loss from earthquakes and wildfires because our headquarters, where we assembled our onsite regenerable
systems and most of the well locations that utilize our system are concentrated in California. Either of these occurrences could result in increased costs and a disruption in our operations, which would harm our operating results and financial
condition significantly.
Due to our current client concentration, a loss of one of our significant customers could harm our business, operating
results, financial condition and prospects.
As of December 31, 2008, we had approximately 59 customers, including approximately 22
customers resulting from our acquisition of Envirogen in September 2008. This excludes approximately 140 small customers we added as a result of our acquisition of MPT. We had one customer who accounted for 17% of our revenues during 2008. Our
customers may, upon the occurrence of certain circumstances, elect to terminate their contracts with us prior to their contractual expiration date and seek services from our competitors. In addition, upon the expiration of these contracts, our
customers may decide not to renew such contracts with us. If we were to lose one or more of these significant customers for any reason, our revenues would decline significantly and our business, operating results and prospects would suffer.
We may face risks associated with our geographic expansion.
Our ability to expand our offering geographically will depend on our ability to recruit, hire, train and motivate sales, operations and field services personnel. If we are unsuccessful in gathering a critical mass of
projects in a regional office, we may find it additionally difficult to leverage our overhead costs or to achieve and maintain the profitability of such regional office. Our operations in our regional offices, including our industrial operations
office, will be far from our Southern California headquarters and will require additional management time and attention. Failure to properly supervise the personnel in these offices could result in loss of new business and potentially harm future
sales prospects. In addition, as our systems and services for industrial customers become accepted in North America, these customers may require us to support their international activities which will require additional time and resources.
Supporting the marketing, development, process design, and operations of potentially distant operations will further challenge our management team and operations and could cause harm to our business or operating results.
Most of our operations are conducted in our facilities in Southern California and our facility in Memphis, Tennessee. Disruptions at these facilities could increase
our expenses.
Our headquarters are located in Southern California. Our central resin regeneration operations for our offsite
regenerable treatment systems and our base of our operations servicing the industrial markets are located at our facility in Memphis, Tennessee. We take precautions to safeguard our facilities, including obtaining insurance, maintaining health and
safety protocols, and using off-site storage of computer data. However, a natural disaster, such as an earthquake, fire or flood in Southern California or a tornado, flood or earthquake in Memphis, could cause a substantial interruption in our
operations, damage or destroy our resin regeneration facility or inventory and cause us to incur additional expenses. The insurance we maintain against natural disasters may not be adequate to cover our losses in any particular case, which would
require us to expend significant resources to replace any destroyed assets, thereby harming our financial condition and prospects significantly.
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We face risks associated with the historical and current operations at our Memphis facility.
We acquired our Memphis facility in September 2007 and have limited operating experience with this facility. From our Memphis facility, we regenerate the
ion-exchange resins associated with our offsite regenerable treatment systems and for other customers that have not purchased one of our systems but who require resin. Any problems we face in shipping or transporting resins to our Memphis facility
for regeneration, the inability to regenerate certain resins, or any other problems at our Memphis facility that would prevent us from timely providing regeneration services on a cost-effective basis would adversely affect our relationships with our
customers, our business and our results of operations.
In connection with our acquisition of MPT, we obtained indemnification from the MPT
stockholders for any violations of environmental laws that occurred prior to the acquisition date. We cannot assure you that there are no environmental risks associated with the Memphis facility or that indemnification obligations of the MPT
stockholders with respect to any such problems will adequately protect us from any liability we may face. In addition, we cannot be certain that the materials characterization procedures at our Memphis facility are adequate to properly identify and
dispose of hazardous waste. If these procedures are deficient, then we may be in violation of certain environmental laws which could result in potential liability or disruptions in our operations.
Our Memphis facility is over 50 years old and may also contain latent defects or other damage of which we are unaware. In the future, this facility may
also lack the capacity to meet our needs for central regeneration of resins or for conducting our industrial market operations. Any of these occurrences could require us to make substantial investment in this facility so that it meets our needs, or
require us to relocate our operations from this facility, which would result in significant disruptions in our operations at this facility.
Also in connection with our acquisition of MPT, we assumed certain legacy contracts and other arrangements to which MPT was a party. Some of these contracts may have terms that we do not find to be favorable or compatible with our business
plans, including our ability to expand and/or penetrate markets. We may be unable to renegotiate these contracts on more favorable terms or at all, which may adversely impact our business and results of operations.
We face risks associated with the design and operation of our systems which may prevent us from increasing our revenues.
We take responsibility for the design, construction, initial maintenance and installation of our ion exchange systems. However, we cannot predict whether
we will be able to design our systems for every particular contaminant. Thus, we may be required to turn away customers that require treatment of chemical contaminants that our systems do not treat. We also cannot guarantee that once constructed,
our systems will operate according to their design or be free from defects. Because many of our systems treat groundwater for dangerous contaminants, if our systems fail to operate properly, it could cause significant public harm, especially for
drinking water applications.
Following installation, testing and regulatory certification of a system, actual day-to-day operation of our
groundwater treatment systems is transitioned to our customer’s personnel. Though we retain ownership of many of our systems, our customers take responsibility for operation of some of these systems. We, however, continue to be responsible for
the maintenance of the installed systems in most cases. We may not be able to provide sufficient employees for the maintenance of those systems. In addition, because our systems are located at our customers’ sites, we will not always be
physically present should problems arise.
If there are defects in our system or if significant reliability, quality or performance
problems develop with respect to our system or services, this may have a number of negative effects on our business, operating results, financial condition and prospects, including:
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failure to attract new customers and achieve market acceptance;
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delays in collecting accounts receivable;
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diversion of management and development resources and the attention of engineering personnel;
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significant customer relations problems and loss of existing customers;
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high service, support, repair, warranty and insurance expenses;
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removal of our systems from service by state regulatory agencies for failure to operate properly; and
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legal actions for damages by our customers.
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order to operate our business successfully, we must meet evolving municipal customer requirements for groundwater treatment and invest in the development of our technology.
If we fail to develop or enhance our system and services to satisfy evolving municipal customer demands, our business, operating results, financial
condition and prospects may be harmed significantly. The market for groundwater treatment in the municipal markets is characterized by changing technologies, periodic new product introductions and evolving customer and industry standards. For
instance, competitors in the groundwater treatment industry are continuously searching for methods of groundwater treatment that are more cost-effective and more efficient. Our current and prospective municipal customers may choose future
groundwater treatment solutions and/or services that might be offered at a lower price than our system and/or services. To achieve market acceptance for our system and services, we must effectively and timely anticipate and adapt to customer
requirements and offer products and services that meet customer demands. Our municipal customers may require us to provide water treatment solutions for new contaminants or higher volumes of water or to decrease the presence of contaminants well
below an applicable MCL which may increase our operating costs for those systems and harm our results of operations. We also may experience design, engineering and other difficulties that could delay or prevent the development, introduction or
marketing of any modifications to our system or our new services. Our failure to successfully develop and offer systems or services that satisfy customer requirements would likely cause a decrease in our financial performance. In addition, if our
competitors introduce solutions and/or services based on new or alternative water treatment technologies, our existing and future systems and/or services could become obsolete, which would also weaken demand for our systems or services, thereby
decreasing our revenues and harming our operating results.
Serving customers in industrial markets presents numerous risks.
We face numerous risks as we expand our services to customers in the industrial markets. We have limited experience in serving industrial market customers
and have never provided systems or services to customers in the oil, gas or mining industries. Industrial customers have different requirements and goals than our municipal customers. Our industrial customers may choose treatment solutions and/or
services that are offered on a low life-cycle cost basis or that give them an advantage from a technological standpoint. They also require us to tailor our systems to meet their specific business needs, which often results in additional development
and design costs. We may have difficulty in developing technologies and services that address the needs of these customers and in hiring the appropriate engineering or other talent that can develop such technologies. In some cases, we may be
required to conduct a pilot project to address an industrial market customer’s needs. We may expend significant time and resources in building and conducting the pilot project, and there can be no assurance that the pilot will successfully
uncover all key process variables required to successfully scale up a particular process or meet the customer’s requirements. Since these processes have not been successfully commercialized, more extensive or other pilot testing may be
required.
Even if we meet the customer’s treatment requirements at the pilot stage, when we build the full-scale treatment system,
positive results from a pilot test might not provide an accurate indication of the treatment capabilities of and the cost of operation of a full-scale treatment system, and thus, we may have problems
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meeting the relevant treatment requirements on an economically feasible basis or at all. Additionally, startup of new industrial process facilities could
cause increased safety risks until processes and procedures for normal operation, upset conditions and emergency conditions are established and well understood by our employees. To the extent we are unable to meet these customers’ demands and
requirements, our expansion into these markets may not be successful which would adversely affect our business, operating results, financial condition and prospects. The economics of the systems for some of our industrial customers may rely on the
recovery of a valuable resource from waste streams. Should the underlying economics of the resource deteriorate significantly, demand for these types of our systems and services may decline which could have an adverse effect on our business and
operating results.
Industrial market customers may pose credit risks that we do not necessarily face to the same degree with our municipal
market customers. Our industrial market customers may not be economically viable, might be newly formed without adequate capitalization and/or may be highly dependent on commodity prices, such as companies in the oil, gas and mining industries.
Changes in commodity prices will particularly impact the viability of our business in recovery of valuable materials. Finally, when we install our treatment system onsite for an industrial customer, we must take into account the location which our
customer provides us for the installation. We, our systems or the hazardous chemicals we use in our systems, may damage the property or harm our customer’s personnel that may be in proximity to our systems, or we may adversely impact our
customer’s operations while we install, service and/or repair our systems. In addition, our employees may be injured by hazardous chemicals, machinery or other dangers at our customer’s site during the installation, operation and/or
servicing of our systems. Because of our unfamiliarity with building systems for the industrial markets, we may not understand all of the safety and other risks associated with these systems until we have more experience servicing this industry. Any
of these risks could have an adverse effect on our ability to address the industrial market.
Our reliance on third party suppliers and manufacturers
poses significant risks to our business and prospects.
We contract for all of the components in our system and for all of the
commodities necessary to fulfill our service obligations, including salt, chemicals and replacement resin, with third-party suppliers. We plan to rely on third party suppliers and manufacturers for systems we market to our customers. We are subject
to substantial risks because of our reliance on these suppliers and manufacturers. For example:
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our suppliers may increase prices for these commodities that exceed contract provisions to recover such costs;
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our suppliers may not provide components that meet our specifications in sufficient quantities;
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our suppliers and manufacturers may face a reduction or an interruption of supply of our components;
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our manufacturers may lack the capacity and resources to continue to manufacture our systems or supply them in sufficient quantity to meet our demands;
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our suppliers and manufacturers may face production delays due to natural disasters or strikes, lock-outs or other such actions;
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one or more suppliers or manufacturers could make strategic changes in its or their product lines;
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there may be a lack of alternative suppliers for certain product lines; and
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many of our suppliers and manufacturers are small companies which are more likely to experience financial and operational difficulties than larger, well-established
companies, because of their limited financial and other resources.
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As a result of any of these factors, we may be
required to find alternative suppliers for the components of our system or alternative manufacturers for our systems marketed to industrial customers. It may take considerable amounts of time to identify and qualify such alternative suppliers. In
addition, we may be required
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to redesign our system to conform to the components provided by these alternative suppliers. As a result of these factors, we may experience delays in
obtaining raw materials and components on a timely basis and in sufficient quantities from our suppliers, which could result in delays in the production and installation of our system. We may also face delays in the manufacture and assembly of our
systems from third party manufacturers. These delays could impact our ability to sell our systems, enter into recurring revenue contracts or profitably execute our service agreements, which would cause our revenues and operating results to decline.
In addition, we have lacked the leverage or have otherwise been unable to negotiate consistently long-term contracts for the supply of components and commodities necessary to build our systems and fulfill our service obligations. As a result, rising
component or commodity prices could increase our expenses and adversely affect our results of operations.
We often place our systems through a party
other than the party with whom we enter into a long-term contract which may cause difficulties in selling our systems and offering our services.
When we sell a system to a municipal or industrial customer, we often contract with a general contractor as opposed to our actual customer. We often enter into a separate long-term contract for servicing the system directly with our
municipal or industrial customer. Contracting with different parties can create difficulties for us, including having inconsistent terms between the two contracts which makes it more difficult to successfully close the transaction and could harm our
relationships with our customers. These difficulties may adversely affect our business and results of operations.
The revenues from certain of our
long-term contracts for onsite regenerable treatment systems are moderately seasonal, with higher processing fees received in the summer months and lower processing fees received in the winter months.
Our business, particularly the revenues we receive from our long-term contracts, is moderately seasonal due to the impact of summer and hot weather
conditions on the water requirements of our customers. In the summer and warmer months, our customers have a higher demand for water and generally increase the utilization of their groundwater resources resulting in a higher volume of groundwater
treated during a period and thus higher revenues from our long-term contracts. However, this increased utilization results in increased operating costs for us, which could adversely affect our profit margins and results of operations. Conversely,
our customers experience lower demand in cooler months in the first and fourth calendar quarters, resulting in lower revenues from our long-term contracts during those periods. This seasonality in processing fees has resulted in fluctuations in our
revenues and operating results. These moderate seasonal trends can cause some reductions in our profit margin and variations in our financial condition.
Impairment of our significant long-lived assets may reduce our profitability.
Our long-lived assets consist of property,
equipment, acquired intellectual property, patents, trademarks and other intangible assets and goodwill. We regularly review the carrying amount of our long-lived assets. Some factors we consider important in assessing whether or not impairment
exists include performance relative to expected historical or projected future operating results, significant changes in the manner of our use of the assets or the strategy for our overall business and significant negative industry or economic
trends. If the carrying value of the asset exceeds projected undiscounted cash flows, the asset will be written down to its fair value, which could result in an impairment of our long-lived assets. Any impairment of our long-lived assets in the
future may reduce our profitability and have a material adverse effect on our results of operations and financial condition. In 2008, we recorded an impairment charge in the approximate amount of $5.0 million to reduce the recorded goodwill
resulting from our MPT acquisition. See Notes 3 and 9 to our consolidated financial statements for additional details. We may be required to record further impairment charges related to these or other assets in the future.
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We own a large stake in Empire Water Corporation, and to the extent that it does not succeed, the value of our
investment in Empire Water Corporation may decline further.
In 2007, we disposed of our rights to purchase certain water assets to
Empire Water Corporation, or Empire, in exchange for approximately 32% of the outstanding stock of Empire. To the extent that Empire does not succeed in its operations or business or Empire experiences any material adverse event, the value of
Empire’s common stock will likely decline, which would cause the value of our investment in Empire to decline. Because we record our investment in Empire under the equity method, a decline in the value of our investment would have an adverse
effect on our financial position and results of operations.
In the quarter ended September 30, 2008, we determined that the value of
our investment in Empire had declined and, as a result, we recorded a reduction of our investment and a related reduction in deferred revenue-affiliate through a charge to earnings in the approximate amount of $1.2 million. Any further decline in
the value of our investment in Empire would require us to record additional charges to our earnings.
In conjunction with the February 2009
settlement of a claim by one of our customers, we transferred 150,000 shares of Empire common stock to this customer as partial consideration of this claim (see Notes 11 and 25 to our consolidated financial statements). After the transfer of this
common stock in 2009, we now own approximately 31% of the outstanding stock of Empire.
We have been named as a party to lawsuits, including class
action and derivative action lawsuits, and we may be named in additional litigation, all of which could require time and attention from certain members of management and result in significant legal expenses. An unfavorable outcome in one or more of
these lawsuits could have a material adverse effect on our business, financial condition, results of operations and cash flows.
On
December 27, 2007 and January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against our Company, Peter L. Jensen, Michael M. Stark and Thomas
C. Tekulve (collectively referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned
Poulos v. Basin Water, et al
., Case No. CV 07-8359 GW (FFMx) and
Nofer v.
Basin Water, et al
., Case No. CV 08-0002 SGL (JCRx). The lawsuits were subsequently consolidated, and on October 3, 2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the Company deliberately understated the reserves
it took for certain unprofitable contracts, and committed various intentional violations of GAAP during a putative class period between November 14, 2006 and August 8, 2008 (the Federal Lawsuit). The suit does not state a specific amount
of damages.
On February 19, 2009, we and our insurance carriers reached an agreement in principle to settle the class action with
representatives of the class. The settlement is still subject to preparation of a final settlement agreement, following which we would intend to seek preliminary approval from the Court so that class members can receive notice of the settlement,
providing them with the opportunity to accept its terms or to opt out and choose whether to pursue their own individual claims. Following a fair period of notice to the class, it would be our intention to seek final Court approval of the settlement
and the dismissal of all claims against us. We deny all of the allegations in the lawsuit and believe that our disclosures were appropriate under the law. Nevertheless, we have agreed to settle the litigation in order to avoid costly and
time-consuming litigation. We do not expect a cash effect of the settlement on our Company as the entire settlement amount is expected to be paid by our liability insurers.
On January 31, 2008, Loren Charif, a purported stockholder of our company, filed a shareholder derivative lawsuit in the Superior Court of the State
of California, County of San Bernardino, against certain of our current and former executive officers and our current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in
connection with those allegations alleges, among
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other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to
allegations of improper selling. The suit does not state a specific amount of damages. On November 12, 2008, we obtained an order staying this action until a final determination occurs in the Federal Lawsuit.
On March 10, 2009, Demetrice Ledbetter, III, a purported shareholder of our company, filed a shareholder derivative lawsuit in the United States District
Court for the Central District of California against certain current and former executive officers and directors. The complaint assumes the truth of the aforementioned federal securities class action lawsuits and in connection with those allegations
alleges, among other things, breaches of fiduciary duty, waste of corporate assets, abuse of control, gross mismanagement, unjust enrichment, and claims for contribution and indemnification. The suit does not state a specific amount of damages.
From time to time, we are involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which
we believe are not material to the conduct of our business.
We are subject to risks related to our international operations.
We currently serve some international customers. We may serve additional international customers or expand our operations internationally. As we expand
our international operations, we will be increasingly susceptible to the following risks associated with international operations:
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import and export license requirements;
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changes in tariffs and taxes;
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restrictions on repatriating foreign profits back to the United States;
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the imposition of foreign and domestic governmental controls;
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unfamiliarity with foreign laws and regulations and ability to enforce obligations of foreign partners;
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difficulties in staffing and managing international operations;
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product registration, permitting and regulatory compliance;
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significant, time-consuming and expensive travel to foreign locations;
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fluctuations in foreign currencies;
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language and cultural barriers;
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thefts and other crimes; and
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geopolitical conditions, such as terrorist attacks, war or other military action.
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In addition, we may develop formal and informal relationships with existing and new local business partners who can provide local expertise and sales and
distribution infrastructure to support our expansion in our target international markets, which will be time-consuming and costly. Several of the risks associated with our international business may be within the control (in whole or in part) of
these local business partners with whom we have established relationships or may be affected by the acts or omissions of these local business partners. No assurances can be provided that these local business partners will effectively help us in
their respective markets and the inability to do so would adversely affect our business, prospects, financial condition and results of operations.
Risks Related to Our Intellectual Property
Failure to protect, or uncertainty regarding the validity, enforceability or scope of,
our intellectual property rights could impair our competitive position.
Our treatment systems and services utilize a variety of
proprietary rights that are important to our competitive position and success. Because the intellectual property associated with our technology is evolving
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and rapidly changing, our current intellectual property rights may not protect us adequately. We rely on a combination of patents, trademarks, trade secrets
and contractual restrictions to protect the intellectual property we use in our business. In addition, we generally enter into confidentiality or license agreements, or have confidentiality provisions in agreements, with our employees, consultants,
strategic relationships and customers and control access to, and distribution of, our technology, documentation and other proprietary information. Our pending patent applications may not be granted or, if granted, the resulting patent may be
challenged or invalidated by our competitors or by other third parties. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our intellectual property. In addition, monitoring
unauthorized use of our intellectual property is difficult, and we cannot be certain the steps we have taken to protect our intellectual property will prevent unauthorized use of it.
Because legal standards relating to the validity, enforceability and scope of protection of patent and intellectual property rights in new technologies
are uncertain and still evolving, the future viability or value of our intellectual property rights is uncertain. Furthermore, our competitors independently may develop similar technologies that limit the value of our intellectual property or design
around patents issued to us. If competitors or third parties are able to use our intellectual property or are able to successfully challenge, circumvent, invalidate or render unenforceable our intellectual property, we likely would lose a
significant portion of our competitive advantage in the market. We may not be successful in securing or maintaining proprietary or patent protection for the technology used in our systems or services, and protection that is secured may be challenged
and possibly lost. We may have to prosecute unauthorized uses of our intellectual property and the expense, time, delay and burden on management of such litigation could prevent us from maintaining or increasing our business. Our inability to
protect our intellectual property adequately for these and other reasons could result in weakened demand for our systems or services, which would result in a decline in our revenues.
In addition, we have entered into an alliance agreement with Rohm and Haas and an agreement with Purifics, pursuant to which we have access to certain of
their technologies. In connection with our acquisition of Envirogen, we are in the process of obtaining the rights to a number of patents relating to the bioreactor and biofilter business. To the extent that each of these parties faces a challenge
to its intellectual property rights in those technologies, it could have an adverse effect on our ability to market our systems and/or services that incorporate those technologies which would result in a decline in our revenues.
We could become subject to litigation regarding intellectual property rights, which could harm our business significantly.
Our commercial success will continue to depend in part on our ability to make and sell our systems or provide our services without infringing the patents
or proprietary rights of third parties. We face these risks with respect to intellectual property that we have developed internally, as well as with respect to intellectual property rights we have acquired from third parties. For example, pursuant
to our alliance agreement with Rohm and Haas and our agreement with Purifics, we have access to the technologies owned by each of these companies. To the extent either of these parties has failed to adequately protect the technologies upon which we
rely or if these technologies infringe upon the patents or proprietary rights of third parties, we may be unable to continue using such technologies or we may face lawsuits related to our past use of these technologies. In addition, our competitors,
many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make or sell
our systems or provide our services.
If we are unsuccessful in any challenge to our rights to market and sell our systems, our rights to
use third party technologies or to provide our services, we may, among other things, be required to:
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pay actual damages, royalties, lost profits and/or increased damages and the third party’s attorneys’ fees, which may be substantial;
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cease the development, manufacture and/or marketing of our systems or services that use the intellectual property in question through a court-imposed sanction
called an injunction;
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expend significant resources to modify or redesign our systems or other technology or services so that they do not infringe others’ intellectual property
rights or to develop or acquire non-infringing technology, which may not be possible; or
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obtain licenses to the disputed rights, which could require us to pay substantial upfront fees and future royalty payments and may not be available to us on
acceptable terms, if at all.
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Even if we successfully defend any infringement claims, the expense, time, delay and burden
on management of litigation could prevent us from maintaining or increasing our business. Further, negative publicity could decrease demand for our systems and services and cause our revenues to decline, thus harming our operating results
significantly.
If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology, systems and
services could be harmed significantly.
We also rely on trade secrets, know-how and other proprietary information in operating our
business. We seek to protect this information, in part, through the use of confidentiality agreements with employees, consultants, advisors and others upon commencement of their relationships with us. These agreements require that all confidential
information developed by the individual or made known to the individual by us during the course of the individual’s relationship with us be kept confidential and not disclosed to third parties. Our agreements with employees also provide that
any inventions conceived by the individual in the course of rendering services to us are our exclusive property. Nonetheless, those agreements may not provide adequate protection for our trade secrets, know-how or other proprietary information and
prevent their unauthorized use or disclosure. In the event of unauthorized use or disclosure of our trade secrets or proprietary information, these agreements may not provide meaningful protection, particularly for our trade secrets or other
confidential information.
To the extent that consultants, key employees or other third parties apply technological information
independently developed by them or by others to our proposed products, disputes may arise as to the proprietary rights to such information which may not be resolved in our favor. The risk that other parties may breach confidentiality agreements or
that our trade secrets become known or independently discovered by competitors, could harm us by enabling our competitors, who may have greater experience and financial resources, to copy or use our trade secrets and other proprietary information in
the advancement of their products, methods or technologies. The disclosure of our trade secrets would impair our competitive position, thereby weakening demand for our systems or services and harming our ability to maintain or increase our customer
base.
In addition, to the extent that we do not fulfill our contractual or other obligations to adequately protect the technologies to
which we have been granted access by Rohm and Haas or Purifics, we could be liable to either of them for any resulting harm to their businesses or could lose further access to those technologies, which could harm our business, operating results or
financial condition.
Risks Related to Our Industry
We are subject to environmental risks that may prevent us from selling our systems and, if such risks are realized, may subject us to clean-up costs or litigation that could adversely affect our business, operating results, financial
condition and prospects.
We are subject to a number of governmental regulations with respect to our business activities and operations.
See “Business—Government Regulation.” For example, our onsite regenerable ion-exchange technology generates a byproduct known as brine waste, which may contain hazardous contaminants such as arsenic. Any waste materials or byproducts
from our treatment process are required to be disposed of in a manner mandated by the EPA or state regulatory agencies. The EPA or state regulatory agencies may consider these or other byproducts of the ion-exchange process to be hazardous, and in
such cases, our customers will be subject to
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additional requirements relating to the treatment, storage, disposal and transportation of hazardous substances. With respect to our onsite regenerable
treatment systems, though our customers take title to all brine waste, together with all other byproducts of the ion-exchange technology process, we generally contract with third parties to secure waste disposal services on our customers’
behalf. We cannot predict whether any new laws, statutes, ordinances, rules or regulations will be enacted that may require significant modification to our system or our services, which may weaken demand for our system or services and harm our
business significantly.
In addition, we cannot predict whether any third party will assert against us any claims for violations of any
federal, state or local statute, ordinance, law, rule or regulation relating to hazardous or toxic substances in connection with the brine waste or groundwater treatment process or as a result of any actions of the third-party waste disposal
services with whom we contract on behalf of our customers who use our onsite regenerable treatment systems. We face similar risks with respect to resins containing contaminants that we transport to our Memphis facility for regeneration, as these
resins may contain hazardous substances with our knowledge. CERCLA and analogous state laws provide for the remediation of certain contaminated facilities and impose strict, joint and several liability for remediation costs on current and former
owners or operators of a facility at which there has been a release or a threatened release of a “hazardous substance.” This liability is also imposed on persons who arrange for the disposal or transportation of such substances, and on
those who transport such substances to the facility. Because we generally contract for waste disposal and transport on our customers’ behalf, we may be subject to liability as an arranger of the disposal or transportation of hazardous
substances, and our contracts with our customers may not adequately protect us from this liability. Hundreds of substances are defined as “hazardous” under CERCLA and analogous state laws and their presence, even in small amounts, can
result in substantial liability. The expense of conducting a cleanup can be significant. The actual costs for these liabilities could be significantly greater than the amounts that we might be required to accrue on our financial statements from time
to time. In addition to the costs of complying with environmental regulations, we may incur costs to defend against litigation brought by government agencies and private parties. As a result, we may be required to pay fines to governmental agencies
if we are found to have violated these environmental laws. In addition, we may in the future be a defendant in lawsuits brought by private parties who assert claims alleging environmental damage, natural resource damages, personal injury, property
damage and/or violations of permits and licenses by us. If such claims are asserted against us, and if we do not prevail in defending such claims, we may be required to pay significant damages, causing our financial condition to suffer. Even if we
successfully defend against such claims, we may devote significant time and resources to litigation, which would likely prevent us from maintaining or increasing our customer base and business.
We face additional environmental risks related to the parties with whom we do business, particularly those parties that send resin to our Memphis
facility for regeneration. Our customers may not be in compliance with federal, state or local statutes, ordinances, laws, rules or regulations relating to hazardous or toxic substances and to the extent we assist them with water and wastewater
treatment services, offsite regeneration of resins or waste reduction or resource recovery services, we could be subject to liability under these various laws and regulations. In addition, our contracts with these customers may not adequately
protect us from these liabilities, and even if our contracts provide these legal protections, these customers may not have the financial resources to provide us with the protection to which we are legally entitled such as the ability to pay
indemnity obligations to which they are contractually obligated.
We also face environmental risks associated with our operations targeted
to serve industrial customers. These operations involve wastewater treatment, water reuse and the recovery of valuable commodities and often require the discharge of wastewater and other materials. We plan for these activities to take place at our
Memphis facility. These activities subject us to numerous stringent permitting requirements as well as numerous federal, state or local statutes, ordinances, laws, rules or regulations relating to hazardous or toxic substances. For example, our
Memphis facility’s environmental permits include a NPDES wastewater discharge permit and Special Solid Waste Disposal Permits. In addition, this facility is required to maintain an EPA generator registration and identification number for its
hazardous waste disposal activities. Additionally, to the extent these activities involve radionuclides, they would be subject to regulations governed by the NRC. If we do not comply
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with the applicable environmental laws and regulations applicable to our activities or obtain and maintain the appropriate permits necessary to conduct these
activities, we would be subject to numerous legal and administrative disputes and proceedings.
Changes in governmental regulation and other legal
uncertainties could adversely affect our customers or decrease demand for our systems, and thus harm our business, operating results and prospects.
In the United States, many different federal, state and local laws and regulations govern the treatment and distribution of contaminated groundwater and disposal of attendant wastes. The increased interest in the
treatment of contaminated groundwater due to increased media attention on the adverse health effects from contaminated drinking water may result in intervention by the EPA or state regulatory agencies under existing or newly enacted legislation and
in the imposition of restrictions, fees or charges on users and providers of products and services in this area. These restrictions, fees or charges could adversely affect our customers, which could negatively affect our revenues. Conversely, the
failure of the EPA or state regulatory agencies to act on a timely basis to set interim or permanent standards for pollutants such as MCLs, or to delay effective dates for standards for pollutants, grant waivers of compliance with such standards or
take other discretionary actions not to enforce these standards, may decrease demand for our systems and services because our customers would not be required to bring their water into compliance with such regulatory standards. Changes in regulations
affecting treatment of air streams, wastewater treatment or water reuse processes could also impact their need for our systems and/or services. We cannot predict whether there will be future legislation regarding the treatment and distribution of
contaminated groundwater, the disposal of attendant wastes, wastewater treatment or water reuse processes. If there are significant changes in such laws and regulations, particularly if such laws and regulations become less stringent, such changes
could weaken demand for our systems or services and cause our revenues to decline, thus harming our operating results and prospects.
Each groundwater
treatment solution must be permitted by a regulatory agency prior to its use by our customers, and changing drinking water standards and other factors could affect the approval process with respect to our system by such regulatory agencies.
Each groundwater treatment solution, including our groundwater treatment system and those of our competitors, must be permitted by
applicable state regulatory agencies prior to use of such systems by our customers. We cannot assure you when or whether the various regulatory agencies will approve our systems for use by our customers. The application process for our systems is
time consuming and often involves several information requests by the regulatory agencies with respect to our systems. Any long waiting periods or difficulties faced by our customers in the application process could cause some of our customers to
use competing technologies, products, services or sources of drinking water, rather than use our technology.
Also, we cannot predict the
impact of changing drinking water standards on the approval of our technology for groundwater treatment. Our systems currently treat groundwater so that it meets the MCL for several different contaminants. MCLs are set by the EPA and/or state
regulatory agencies that regulate drinking water contaminants. However, the MCL for any contaminant is subject to review and revision by the EPA or state regulatory agencies. MCLs may be changed to levels below that which our systems can treat,
resulting in state regulatory agencies failing to approve our systems. Without regulatory approval, our systems could not be used by our customers, and we may be required to develop technology that meets any revised MCLs, and to the extent we cannot
do so, sales of our systems will suffer. The development of such technology may require increased expenditures, and during this development, we could be delayed in selling our systems, which would cause our revenues to decline, thus harming our
operating results significantly.
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Demand for our groundwater treatment systems would be adversely affected by a downturn in government spending related
to groundwater treatment solutions, or in the cyclical residential or non-residential building markets.
Our municipal market business
is dependent upon spending on groundwater treatment solutions by utilities, municipalities and other organizations that supply water, which in turn is often dependent upon residential construction, population growth, continued contamination of
groundwater sources and regulatory responses to this contamination. As a result, demand for our water treatment systems could be impacted adversely by general budgetary constraints on our governmental or regulated customers, including government
spending cuts, the inability of government entities to issue debt to finance any necessary groundwater treatment projects, difficulty of our customers in obtaining necessary permits or changes in regulatory limits associated with the chemical
contaminants we seek to address with our groundwater treatment system. It is not unusual for the implementation of water treatment solutions to be delayed and rescheduled for a number of reasons, including changes in project priorities and
difficulties in complying with environmental and other government regulations. We cannot assure you that economic conditions will continue such that state and local governments will address groundwater contaminant needs and consider purchasing or
entering into long-term contracts for our systems. In addition, although in past years our target markets have experienced population growth in recent years along with related residential building market growth, we have recently witnessed a
significant slowdown in the residential building industry and a decrease in new home development and population migration to California. A slowdown of growth in residential and non-residential building has reduced demand for groundwater treatment
solutions such as our systems. The residential and non-residential building markets are generally cyclical, and, historically, down cycles have typically lasted a number of years. Because of the dramatic declines in the housing market in the past
few years and the significant deterioration of the economic climate, this down cycle may be significantly longer than past down cycles, which could affect the demand for drinking water and water treatment services. Any significant decline in the
governmental spending on groundwater treatment solutions or residential or non-residential building markets could weaken demand for our systems or services, thus harming our operating results and prospects significantly.
We operate in a competitive market, and if we are unable to compete effectively, our business, operating results and prospects could suffer.
The market environment in which we operate is dynamic and is characterized by evolving standards, the development of new technology, regulations which
continually reduce the acceptable levels for contaminants and affect the means, methods and costs of disposing of wastes derived from groundwater treatment. Though barriers to entry in this market are arguably high, we expect that competition will
intensify in the future. We believe that in a changing market, key competitive factors include:
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development and use of technology;
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cost and effectiveness of treatment and waste disposal methods;
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changing requirements of the EPA or state regulatory agencies;
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changing requirements of customers in the industrial markets; and
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availability of capital to meet evolving customer needs and requirements for the treatment of contaminated water.
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We compete with large groundwater treatment companies, such as Severn Trent PLC, GE Water and Siemens AG, in our business aimed at the municipal markets.
We compete with large industrial market companies, such as GE Water and Layne Christensen, in our business aimed at the industrial markets. Many of our current and potential competitors have technical and financial resources, marketing and service
organizations and market expertise significantly greater than ours. Many of our competitors also have longer operating histories, greater name recognition and larger customer bases. Moreover, our competitors may forecast the course of market
developments more accurately and could in the future develop new technologies that compete with our
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systems and/or services or even render our system and/or services obsolete. Due to the evolving markets in which we compete, additional competitors with
significant market presence and financial resources may enter those markets, thereby further increasing competition. These competitors may be able to reduce our market share by adopting more aggressive pricing policies than we can or by developing
technology and services that gain wider market acceptance than our system and/or services. Existing and potential competitors also may develop relationships with distributors of our systems and services or third parties with whom we have strategic
relationships in a manner that could harm our ability to sell, market and develop our systems and services significantly. If we do not compete successfully we may never achieve significant market penetration and we may be unable to maintain or
increase our business or revenues, causing our operating results and prospects to suffer.
We could become subject to litigation as a result of claims
brought against our customers, which could harm our operating results and financial condition significantly.
Our municipal customers
are water providers that supply drinking water treated by our system to the general public. If our customers faced claims from consumers related to the quality of the drinking water, such consumers also may bring claims against any other party with
whom the customer contracted in the groundwater treatment process. Even if our system treated the groundwater successfully for the contaminants it was designed to remove, we still may be subject to claims from such consumers. Our industrial
customers may also face liability from consumers or regulatory agencies with respect to their wastewater treatment or waste reduction activities. These parties may also bring claims or actions against us because our systems and services were
utilized in our customer’s activities. Despite any success in defending such claims, the expense, time, delay and burden on management of litigation would likely prevent us from maintaining or increasing our business and negative publicity
could weaken demand for our services, cause our revenues to decline and harm our operating results and financial condition significantly.
Risks
Related to our Finances and Capital Requirements
We may incur indebtedness that contains terms that place restrictions on the operation of our
business; our failure to comply with these terms could put us in default, which would harm our business and operations.
We may incur
indebtedness in the future that contains a number of significant covenants. These covenants may limit our ability to, among other things, do the following:
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incur additional indebtedness;
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merge, consolidate or dispose of our assets;
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pay dividends or repurchase our capital stock;
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change our line of business;
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accept any prepayments under or otherwise modify contracts with our customers;
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enter into transactions with our affiliates; and
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grant liens on our assets.
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If we
were to incur such indebtedness, a material breach of any of these covenants would result in a default under this indebtedness which could result in significant harm to our business and operations.
Our customers may need financing to purchase our systems, which exposes us to additional business and credit risks.
Availability and cost of financing are significant factors that affect demand for our systems and services. Many of our customers can purchase our systems
only when financing is available at a reasonable cost. Some customers
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seek to acquire our systems and services through a long-term contract. We may rely on third parties to purchase the systems that are then subject to
long-term contracts with our customers. In certain cases, we may indemnify the third party for any financial damages caused by our default under our long-term services agreement with our customer. This exposes us to potential additional costs in the
event of our failure to perform. In addition, if we are unable to contract with third parties to purchase our systems in connection with the placement of our systems with municipal or industrial customers, we would be faced with either keeping these
systems on our balance sheet or requiring our customers to purchase the equipment outright. Our ability to continue to lease systems to our customers may be impacted by our liquidity situation. Requiring customers to purchase our systems outright
may delay or prevent the sale to our customer, which could adversely affect our business and operating results.
We have recorded and will record
non-cash expense in future periods that result in a decrease in our net income for a given period.
As required by the Financial
Accounting Standards Board, or FASB, we record expense for the fair value of stock options and restricted stock granted and this expense is reflected in our operating results. We rely on stock options to motivate current employees and attract new
employees. As a result of the requirement to expense stock options, we may choose to reduce our reliance on stock options as a motivation tool. If we reduce our use of stock options, it may be more difficult for us to attract and retain qualified
employees. However, if we do not reduce our reliance on stock options, our reported net loss may increase or our reported net income may decrease.
We have also applied the provisions of SFAS No. 123(R),
Share-Based Payment
, to warrants issued to lenders and other third parties including Cross Atlantic Partners, Aqua America and BWCA. The fair value of these warrants is
expensed over the period of the related agreements, as appropriate. As a result, we recognized expense in 2005 and 2006 which affected our interest expense or selling, general and administrative expense, depending upon the nature of the underlying
transaction. In May 2006 and May 2007, we repaid certain of our indebtedness. The remaining fair value of the associated warrants attributed to the debt was charged to interest expense during that period. In connection with the restatement of our
financial statements, we determined to recognize the fair value of the warrants issued to Aqua America as interest expense at the time of the repayment of our indebtedness to Aqua America in 2007.
We face a number of risks related to our acquisitions.
Our growth strategy included several acquisitions. Acquisitions involve a number of risks, including the following:
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we may experience adverse short-term effects on our operating results;
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we may be unable to successfully and rapidly integrate the new businesses, personnel and products with our existing business, including financial reporting,
management and information technology systems;
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we may experience higher than anticipated costs of integration and unforeseen operating difficulties and expenditures;
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an acquisition may be in a market or geographical area in which we have little experience;
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we may have difficulty in retaining key employees, including employees who may have been instrumental to the success or growth of the acquired business; and
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we may use a substantial amount of our cash, common stock and other financial resources to consummate an acquisition.
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In September 2007, we acquired MPT, which is located in Tennessee, for approximately $12.2 million, consisting of $6.9 million in cash and 462,746 shares
of our common stock with a fair value of $5.3 million. In September 2008, we acquired Envirogen from Shaw. There can be no assurance that we will achieve higher
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revenues or benefit from any synergies as a result of these acquisitions. In 2008, we recorded an impairment charge related to the MPT assets we acquired.
In addition, we may require additional debt or equity financing for future acquisitions, and such financing may not be available or on
favorable terms, if available at all. We may not be able to successfully integrate or profitably operate any new business we acquire, and we cannot assure you that any such acquisition will meet our expectations. Finally, in the event we decide to
discontinue pursuit of a potential acquisition, we will be required to immediately expense all costs incurred in pursuit of the possible acquisition which may have an adverse effect on our results of operations in the period in which the expense is
recognized.
Risks Related to Our Common Stock
We expect that the price of our common stock may fluctuate substantially.
The price of our common stock may decline, and
the price of our common stock that prevails in the market may be higher or lower than the price you pay, depending on many factors, some of which are beyond our control. Factors that could cause fluctuations in the trading price of our common stock
include:
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the effects of the restatement of our financial statements;
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our ability to continue as a going concern;
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failure of our systems or technology to achieve commercial success;
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announcements of the introduction of new products or services by us or our competitors;
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market conditions in our industry sectors;
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developments concerning product development results or intellectual property rights of others;
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litigation or public concern about the safety of our systems and services;
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fluctuations in our quarterly operating results;
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|
securities analysts coverage of our common stock;
|
|
|
•
|
|
deviations in our operating results from estimates;
|
|
|
•
|
|
additions or departures of key personnel;
|
|
|
•
|
|
price and volume fluctuations in the overall stock market from time to time;
|
|
|
•
|
|
the outcome of litigation;
|
|
|
•
|
|
general economic trends; or
|
|
|
•
|
|
sales of large blocks of our stock.
|
In addition, the equity markets in general, and the Nasdaq Global Market in particular, have experienced extreme price and volume fluctuations that have often appeared to be unrelated or disproportionate to the operating performance of
those companies. Further, the market prices of securities of water-related companies have been particularly volatile. These broad market and industry factors may affect the market price of our common stock adversely, regardless of our operating
performance.
36
Anti-takeover provisions in our charter documents, as amended and restated, and under Delaware law could delay or
discourage a takeover that stockholders may consider favorable.
Provisions in our amended and restated certificate of incorporation and
bylaws may have the effect of delaying or preventing a change of control or changes in our management. Some of these provisions include:
|
|
•
|
|
a board of directors divided into three classes serving staggered three-year terms;
|
|
|
•
|
|
a prohibition on stockholder action through written consent;
|
|
|
•
|
|
a requirement that special meetings of stockholders be called only by the chairman of our board of directors, the chief executive officer, the president or by a
majority of the total number of authorized directors;
|
|
|
•
|
|
advance notice requirements for stockholder proposals and nominations;
|
|
|
•
|
|
a requirement of approval of not less than 66
2
/
3
% of all outstanding shares of our capital stock entitled to vote to amend any bylaws by stockholder action, or to amend specific provisions of our certificate of incorporation; and
|
|
|
•
|
|
the authority of our board of directors to issue preferred stock on terms determined by our board of directors without stockholder approval.
|
In addition, because we are a Delaware corporation, we are governed by the provisions of Section 203 of the
Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, amended and
restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including to delay or
impede a merger, tender offer, or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.
|
ITEM 1B.
|
UNRESOLVED STAFF COMMENTS
|
On October 23,
2008, we received comments from the Staff of the Division of Corporation Finance (the Staff) of the Securities and Exchange Commission (the SEC) with respect to our Annual Report on Form 10-K for the year ended December 31, 2007 (the 2007 Form
10-K), our Form NT 10-Q for the period ended June 30, 2008 and our Form 8-K dated August 11, 2008. We provided responses to these comments on November 6, 2008 and January 23, 2009. On February 10, 2009, we filed our Annual
Report on Form 10-K/A for the year ended December 31, 2007 (the 2007 Form 10-K/A), our Quarterly Report on Form 10-Q/A for the period ended March 31, 2008, our Quarterly Report on Form 10-Q for the period ended June 30, 2008 and our
Quarterly Report on Form 10-Q for the period ended September 30, 2008, which filings included disclosure to address the Staff’s comments in its October 23, 2008 letter.
On March 6, 2009, we received additional comments from the Staff with respect to our 2007 Form 10-K/A and our Quarterly Report on Form 10-Q/A for
the period ended March 31, 2008. On March
30
, 2009, we sent a letter to the Staff responding to these comments. The Staff’s unresolved comments that we believe are material relate primarily to the following:
|
|
•
|
|
Our disclosure with respect to the number of systems on order pursuant to binding contracts for sale or lease and the number are installed and under contract;
|
|
|
•
|
|
Our contracts that allow for renegotiation of terms to recover increased costs and the number of contracts under which systems are operational;
|
|
|
•
|
|
The difference in capital commitments in the 2007 Form 10-K and the 2007 Form 10-K/A;
|
37
|
|
•
|
|
Our analysis of the facts and circumstances that led to the application of FIN 46(R) and the consolidation of VL Capital (VLC) and Water Services Solutions (WSS) as
well as why VLC and WSS were not separate reportable segments and the scheduled lease payments assigned to VLC and WSS;
|
|
|
•
|
|
Our unbilled receivables and revenues under the percentage of completion method;
|
|
|
•
|
|
Our determination of the market value of our shares of Empire Water Corporation (Empire), the accounting treatment of our equity in the net assets of the Empire and
our gain with respect to the transaction with Empire;
|
|
|
•
|
|
Estimates with respect to our contract loss reserves and consideration of reserves for renewal periods; and
|
|
|
•
|
|
Our analysis in determining that there has been an impairment with respect to our investment in Empire.
|
We have considered the Staff’s comments in the preparation of this Annual Report on Form 10-K. The Staff may have further comments to this Annual
Report on Form 10-K or our other filings, which may require us to amend this Annual Report on Form 10-K or other filings.
Facilities
Our corporate headquarters, finance and administration offices are located in Rancho Cucamonga, California where we occupy approximately 10,000 square
feet under a lease expiring on February 14, 2013 at an initial annual cost of approximately $0.3 million with annual escalations. We have an option to extend the lease for an additional three years. Our rental expense in 2008 was
approximately $0.3 million for this facility. This facility became our headquarters in November 2008. Prior to October 2008, we also occupied approximately 35,000 square feet under an additional lease expiring on March 31, 2011 comprising our
former engineering and manufacturing facilities. In October 2008, we outsourced our production operations and vacated that facility. We are currently attempting to secure a sublease on this property.
We lease our Memphis facility from a limited liability company owned by the former stockholders of MPT. The facility is approximately 55,000 square feet.
The lease provides for an annual base rent of $81,900 and an initial lease term of five years, with three 5-year options to extend the lease term. In 2008, we also leased warehouse and office space in Pasadena, California and outside Phoenix,
Arizona, respectively. We terminated the Pasadena lease in the fourth quarter of 2008.
In March 2008 we leased approximately 6,400 square
feet for our Southwest Region office and certain executives in Kingwood, Texas under a lease expiring on April 30, 2012 at an initial annual cost of approximately $130,000 with periodic escalators. Additionally, in September 2008, in connection
with our acquisition of the Envirogen business, we entered into subleases with Shaw for facilities in Lawrenceville, New Jersey and Milwaukee, Wisconsin. The subleases expire no later than July 31, 2009 at an annual cost of approximately
$0.2 million.
38
Property and Equipment
Property and equipment, net of accumulated depreciation, consisted of the following as of December 31, 2008 (in thousands):
|
|
|
|
|
|
Water treatment facilities
|
|
$
|
14,812
|
|
Office furniture and equipment
|
|
|
680
|
|
Vehicles and trailers
|
|
|
451
|
|
Software and other
|
|
|
1,145
|
|
Machinery and equipment
|
|
|
2,945
|
|
Leasehold improvements
|
|
|
303
|
|
Construction in progress
|
|
|
11,558
|
|
|
|
|
|
|
|
|
|
31,894
|
|
Less: accumulated depreciation
|
|
|
3,640
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
28,254
|
|
|
|
|
|
|
ITEM 3.
|
LEGAL PROCEEDINGS
|
On December 27, 2007 and
January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against the Company, Peter L. Jensen, Michael M. Stark and Thomas C. Tekulve (collectively
referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned
Poulos v. Basin Water, et al
., Case No. CV 07-8359 GW (FFMx) and
Nofer v. Basin Water, et al
.,
Case No. CV 08-0002 SGL (JCRx). The lawsuits were subsequently consolidated, and on October 3, 2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the Company deliberately understated the reserves it took for certain
unprofitable contracts, and committed various intentional violations of GAAP during a putative class period between November 14, 2006 and August 8, 2008 (the Federal Lawsuit). The suit does not state a specific amount of damages.
On February 19, 2009, we and our insurance carriers reached an agreement in principle to settle the class action with representatives
of the class. The settlement is still subject to preparation of a final settlement agreement, following which we would intend to seek preliminary approval from the Court so that class members can receive notice of the settlement, providing them with
the opportunity to accept its terms or to opt out and choose whether to pursue their own individual claims. Following a fair period of notice to the class, it would be our intention to seek final Court approval of the settlement and the dismissal of
all claims against us. We deny all of the allegations in the lawsuit and believe that our disclosures were appropriate under the law. Nevertheless, we have agreed to settle the litigation in order to avoid costly and time-consuming litigation. We do
not expect a cash effect of this settlement on our Company as the entire settlement amount is expected to be paid by our liability insurers.
On January 31, 2008, Loren Charif, a purported stockholder of our Company, filed a shareholder derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of our current and former
executive officers and our current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of
fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to allegations of improper selling. The suit does not state a specific amount of damages. On November 12, 2008, we obtained
an order staying this action until a final determination occurs in the Federal Lawsuit.
On March 10, 2009, Demetrice Ledbetter, III, a
purported shareholder of our Company, filed a shareholder derivative lawsuit in the United States District Court for the Central District of California against certain current and former executive officers and directors. The complaint assumes the
truth of the aforementioned federal
39
securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duty, waste of corporate assets,
abuse of control, gross mismanagement, unjust enrichment, and claims for contribution and indemnification. The suit does not state a specific amount of damages.
From time to time, we are involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which we believe are not material to the conduct of our business. With respect to
these ordinary matters, management believes that we have adequate accruals for related costs, and we may also have effective legal defenses.
|
ITEM 4.
|
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
No matters were submitted to a vote of security holders during the fourth quarter of 2008.
40
PART II
|
ITEM 5.
|
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|
Market Information
The following table shows the
range of market prices of Basin Water’s common stock for the last two fiscal years. Our common stock is traded on the Nasdaq Global Market under the symbol “BWTR”. There were 5,479 stockholders as of March 11, 2009.
|
|
|
|
|
|
|
|
|
|
|
Stock Price Range
|
|
|
|
High
|
|
Low
|
|
Year ended December 31, 2007
|
|
|
|
|
|
|
|
First Quarter 2007
|
|
$
|
8.00
|
|
$
|
6.18
|
|
Second Quarter 2007
|
|
$
|
8.70
|
|
$
|
6.20
|
|
Third Quarter 2007
|
|
$
|
12.50
|
|
$
|
8.70
|
|
Fourth Quarter 2007
|
|
$
|
13.06
|
|
$
|
5.66
|
|
|
|
|
|
Year ending December 31, 2008
|
|
|
|
|
|
|
|
First Quarter 2008
|
|
$
|
9.00
|
|
$
|
4.10
|
|
Second Quarter 2008
|
|
$
|
6.47
|
|
$
|
3.49
|
|
Third Quarter 2008
|
|
$
|
4.75
|
|
$
|
1.29
|
|
Fourth Quarter 2008
|
|
$
|
1.97
|
|
$
|
0.41
|
Dividend Policy
We have never declared or paid any cash dividend on our capital stock. We currently intend to retain all future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any
cash dividends in the foreseeable future. Consequently, stockholders will need to sell shares of our common stock to realize a return on their investments, if any. Any future determination related to dividend policy will be made at the discretion of
our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements, contractual restrictions and such other factors as our board of directors deems relevant.
Repurchases of Securities
In May 2007, our Board of
Directors authorized management to repurchase up to $10.0 million of shares of our common stock in the market from time to time. The shares could be repurchased at times and prices as determined by management, and may be completed through open
market or privately negotiated transactions. The repurchase program provides that repurchases must be made in accordance with the terms and subject to the restrictions of Rule 10b-18 under the Securities Exchange Act of 1934, as amended. There were
no share repurchases in the fourth quarter of 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period
|
|
(a) Total
Number of
Shares
Purchased
|
|
(b) Average
Price Paid
per Share
|
|
(c) Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or
Programs
|
|
(d) Maximum Number
(or Approximate
Dollar Value) of
Shares that May Yet
be Purchased Under
the
Plans or Programs
|
|
October 2007 (October 1 through October 31)
|
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
November 2007 (November 1 through November 30)
|
|
85,000
|
|
|
6.45
|
|
|
85,000
|
|
|
9,451,750
|
|
December 2007 (December 1 through December 31)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Totals
|
|
85,000
|
|
$
|
6.45
|
|
|
85,000
|
|
$
|
9,451,750
|
41
|
ITEM 6.
|
SELECTED FINANCIAL DATA
|
The following selected
financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and the accompanying notes included elsewhere in this
Annual Report on Form 10-K.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
(1)
|
|
|
2007
(1)
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
|
(In thousands, except per share data)
|
|
|
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
11,778
|
|
|
$
|
9,660
|
|
|
$
|
13,890
|
|
|
$
|
12,231
|
|
|
$
|
4,307
|
|
|
Cost of revenues
|
|
|
12,240
|
|
|
|
19,527
|
|
|
|
18,692
|
|
|
|
7,130
|
|
|
|
2,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (loss)
(2)
|
|
|
(462
|
)
|
|
|
(9,867
|
)
|
|
|
(4,802
|
)
|
|
|
5,101
|
|
|
|
1,745
|
|
|
Research and development expense
|
|
|
1,167
|
|
|
|
564
|
|
|
|
634
|
|
|
|
651
|
|
|
|
316
|
|
|
Selling, general and administrative expense
(3)
|
|
|
28,989
|
|
|
|
12,827
|
|
|
|
6,445
|
|
|
|
3,334
|
|
|
|
1,765
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(30,618
|
)
|
|
|
(23,258
|
)
|
|
|
(11,881
|
)
|
|
|
1,116
|
|
|
|
(336
|
)
|
|
Other income (expense)
(4)
|
|
|
(1,559
|
)
|
|
|
5,066
|
|
|
|
(1,571
|
)
|
|
|
(553
|
)
|
|
|
(220
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
(32,177
|
)
|
|
|
(18,192
|
)
|
|
|
(13,452
|
)
|
|
|
563
|
|
|
|
(556
|
)
|
|
Income tax provision (benefit)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before noncontrolling interest
|
|
|
(32,177
|
)
|
|
|
(18,192
|
)
|
|
|
(13,452
|
)
|
|
|
563
|
|
|
|
(556
|
)
|
|
Less: net income attributable to noncontrolling interest
|
|
|
(348
|
)
|
|
|
(84
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(32,525
|
)
|
|
$
|
(18,276
|
)
|
|
$
|
(13,452
|
)
|
|
$
|
563
|
|
|
$
|
(556
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(1.49
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.84
|
)
|
|
$
|
0.06
|
|
|
$
|
(0.06
|
)
|
|
Diluted
|
|
$
|
(1.49
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.84
|
)
|
|
$
|
0.04
|
|
|
$
|
(0.06
|
)
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
21,798
|
|
|
|
20,185
|
|
|
|
16,048
|
|
|
|
9,924
|
|
|
|
9,586
|
|
|
Diluted
|
|
|
21,798
|
|
|
|
20,185
|
|
|
|
16,048
|
|
|
|
12,849
|
|
|
|
9,586
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
11,954
|
|
|
$
|
36,038
|
|
|
$
|
54,567
|
|
|
$
|
2,724
|
|
|
$
|
1,704
|
|
|
Total assets
|
|
$
|
61,176
|
|
|
$
|
92,367
|
|
|
$
|
87,458
|
|
|
$
|
23,798
|
|
|
$
|
11,723
|
|
|
Total long-term liabilities
|
|
$
|
7,933
|
|
|
$
|
9,157
|
|
|
$
|
2,825
|
|
|
$
|
7,357
|
|
|
$
|
4,264
|
|
|
Redeemable convertible preferred stock
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
8,779
|
|
|
$
|
8,183
|
|
|
Stockholders’ equity (deficiency)
|
|
$
|
43,797
|
|
|
$
|
73,817
|
|
|
$
|
77,335
|
|
|
$
|
3,809
|
|
|
$
|
(2,290
|
)
|
|
(1) —Includes
|
the results of operations of Mobile Process Technology Co. (MPT) acquired in September 2007 and the Envirogen business acquired in September 2008 (see Note 3 to our consolidated
financial statements).
|
|
(2) —For
|
years 2008, 2007 and 2006, includes additions to reserves for future contract losses of approximately $0.1 million, $6.8 million and $3.7 million, respectively, offset by actual
contract losses charged against reserves of approximately $1.2 million and $1.4 million for years 2008 and 2007, respectively (see Note 15 to our consolidated financial statements).
|
|
(3) —For
|
2008, includes a goodwill impairment charge of approximately $5.0 million (see Notes 3 and 9 to our consolidated financial statements).
|
|
(4) —For
|
2007, includes a $3.1 million gain related to our transaction with Empire Water Corporation (see Note 11 to our consolidated financial statements). Also, for 2008, includes an
impairment charge of approximately $1.2 million related to our investment in Empire Water Corporation (see Note 11 to our consolidated financial statements).
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ITEM 7.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the
notes to those statements included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties
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See
“Forward-Looking Statements” elsewhere in this Annual Report on Form 10-K. As a result of many factors, such as those set forth under “Item 1A. Risk Factors”, our actual results may differ materially from those
anticipated in such forward-looking statements.
Overview
We design, build and implement systems for the treatment of contaminated groundwater, industrial process water and air streams from municipal and industrial sources. We provide reliable sources of drinking water for
many communities, and the ability to comply with environmental standards and recover valuable resources from process and waste water streams. We were initially incorporated in December 1999 and during our first two years of operations primarily
focused on the development of our ion-exchange regenerable, onsite treatment system. The first permit to be issued by the California Department of Health Services, or DHS, to one of our customers for the operation of our system was issued in 2002.
As of December 31, 2008, we had 77 systems on order or under contract with an aggregate installed capacity of approximately 115,000 acre-feet per year, or approximately 37.4 billion gallons per year.
At December 31, 2008 and 2007, respectively, we had 77 and 88 systems under binding contracts as follows:
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December 31,
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2008
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2007
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Systems installed and generating revenue under water service agreements
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Systems installed under interim demonstration agreements
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2
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Systems in various states of deployment
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28
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40
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Total systems
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77
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88
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In addition, we had 22 systems in progress in our Industrial and Envirogen business at December
31, 2008, which are for system sales only and do not involve related water service agreements.
In 2008, we marketed our treatment systems
and services primarily to utilities, cities, municipalities, special districts, real estate developers and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence
of chemical contaminants. We marketed our treatment systems and services through our direct sales force, independent contractors and strategic relationships. As of December 31, 2008, our customers include Arizona American Water, California Water
Service Group and American States Water Company, three of the largest investor-owned water utilities in the United States based on population served.
Our operations necessitate a significant investment in receivables and property and require significant working capital. In the case of sales of ion-exchange regenerable, onsite treatment systems, we must expend all
of the costs to build and deliver our systems to the customer, and we receive payment for the system primarily when the delivery is completed and the system has been placed into service. For systems that we deliver to customers under our long-term
contract arrangements, we must incur the costs to build and deliver our treatment systems, and we receive payment over a typical period of five or more years.
In May 2006, we completed our initial public offering which resulted in the issuance of 6,900,000 shares of our common stock at a price of $12.00 per share for net proceeds of approximately $75.2 million.
On September 14, 2007, we completed the acquisition of Mobile Process Technology Co. (MPT), a provider of technology and services to the water
treatment and industrial process markets. This acquisition provides us
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with additional capabilities including expanded technological solutions, geographic presence and expanded customer base. It provides the ability to service
and treat smaller capacity water systems than our previous product offering. In addition, in September 2008, we also acquired Envirogen from Shaw Environmental, Inc. and its affiliates.
Outlook
We believe that the following trends and uncertainties, among others, may impact our
revenues, income, liquidity and cash flows:
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The success of our internal marketing and sales organization in developing new customers and placing our treatment systems through sales or long-term contracts,
which would increase our revenues;
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Our success in placing our treatment systems throughout the nation pursuant to strategic relationships, efforts of our marketing and sales organization, expansion
of our regional structure which would increase our revenues and may decrease our customer concentration and associated risk;
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Public awareness of the effects of groundwater contamination, which may increase demand for our groundwater treatment systems;
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Our ability to renegotiate our long-term contracts to mitigate our contract losses;
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The outcome of our litigation, including our securities class action and shareholder derivative litigation;
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The effects of the restatement of our financial statements;
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Changes in federal and state government regulation with respect to drinking water standards which may impact demand for our water treatment systems;
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The potential increase in demand for placement of our systems through long-term contracts rather than sales, which will likely require higher capital expenditures
and adversely affect our liquidity;
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Changes in federal and state government regulation of discharge requirements for wastewater may impact our demand for wastewater treatment systems and services;
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Changes in commodity prices, particularly commodities that might be recoverable from waste streams, may impact the demand for our resource recovery system and
services;
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Changes in general economic conditions and the current significant economic decline, which may affect capital expenditures in our markets and demand for our
treatment systems and services;
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Availability of federal and state funding to our potential customers;
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Acceptance by potential customers to utilize third parties for water and wastewater treatment, waste reduction and resource recovery services, including through
long-term service agreements; and
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Increased utilization and productivity of our personnel, which we anticipate will positively impact our gross profit under our contract revenues.
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We will need to raise additional funds through public or private financings, debt financings, strategic relationships,
or other arrangements and cannot assure that the funding will be available on attractive terms, or at all. Additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. If we are
unsuccessful in our efforts to raise sufficient additional funds, we may be required to reduce or curtail our operations and costs, and we may be unable to continue as a going concern.
Restatement of Historical Financial Statements
In February 2009, we restated our financial
statements for fiscal years ended December 31, 2006 and December 31, 2007 and for the fiscal quarter ended March 31, 2008. See our Annual Report on Form 10-K/A for the years ended December 31, 2007 and 2006 and our Quarterly
Report on Form 10-Q/A for the fiscal quarter ended March 31, 2008 for additional details.
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Financial Operations Review
We evaluate our business using a variety of key financial measures:
Revenues
Our revenues tend to vary from period to period, because customers can choose between purchasing our groundwater treatment systems and entering into
long-term contract arrangements for our treatment systems. If a customer chooses to purchase a system, we recognize revenues over a much shorter period of time, generally within one or two quarters, than we would recognize for the same system if the
customer chose a long-term contract arrangement for the system. Thus, our revenues will tend to be higher in periods in which we sell rather than place our systems under long-term contracts. For any customers selecting a long-term capital
arrangement, we may enter into third-party financing arrangements.
Sales
For treatment systems sold to customers which are sold under fixed-price contracts, or that we enter into a sale under a third-party financing
arrangement, we recognize revenues using the percentage-of-completion method. This method takes into account the cost, estimated earnings and revenues to date on systems not yet completed. This method is used because management considers total cost
to be the best available method of measuring progress on systems sold to customers. In general, financial statements based on the percentage-of-completion method present the economic substance of production-type activities more clearly than the
completed-contract method, and present the relationships between sales, cost of sales and related period costs more accurately. Because of inherent uncertainties in estimating costs, estimates used may change in the near term. Such estimates are
adjusted under the cumulative-catch-up method. Unless contractually agreed to otherwise, the sales contract is deemed to be substantially complete when the treatment system has been physically completed and a performance test has been passed.
Historically, our sales consisted of large system sales and standard system sales. Our large systems consisted of large site regenerable treatment systems that we constructed at our customer’s site as opposed to standard systems which are
fabricated at our facilities.
Contract Revenues
Our recurring contract revenues are generated from three sources. The first source of recurring contract revenues is from long-term fixed contracts under which we install our system at the customer’s site and
treat the customer’s water. We retain ownership of the installed system. Under this contract we recognize monthly revenues on a straight-line basis over the life of the contract, which represents a return of the capital value of the installed
system. The amount of this fixed monthly revenue is based on both the capacity of the system and the type of contaminant(s) being treated. The straight-line method best reflects the value of having the system’s capacity available to the
customer at all times and is similar to the method used for calculating depreciation.
The second source of recurring revenues is from
long-term contracts for the treatment of the water produced from installed treatment systems, which we also refer to as service revenues. Service revenues are recognized based on the actual volume of water treated each month. Such water-treatment
revenues bear a direct relationship to the variable costs for the purchase and delivery of salt, chemicals and resin used in the system, the removal of waste and the cost to maintain and service the system. This revenue stream is generated both by
systems that were purchased by our customers and by systems in which we retain ownership and recognize revenue for the monthly capital component.
The third source of contract revenues relates to providing other services for the processing of water, replacement of resins or equipment parts and other water treatment related services.
Under each of the long-term contracts, the customer is typically obligated to pay us for the treatment of its water—not for specific hours worked,
supplies purchased or waste-hauls provided.
Under the criteria set forth in EITF 00-21, we have determined that the multiple deliverables
of each of our long-term contracts specifically, the capital component and the volume-related service charge, qualify for
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separate accounting treatment. The three criteria required for separate accounting treatment are: 1) that each deliverable has a stand-alone value to the
customer, 2) that there is objective and reliable evidence of fair value of each deliverable and 3) that there are no general refund rights for the deliverables.
In the case of contracts under which we own the system, the customer is obligated to pay us the fixed capital component of the system on a monthly basis. These arrangements are classified and treated as operating
leases under Statement of Financial Accounting Standards (SFAS) No. 13,
Accounting for Leases,
because they meet the four criteria of an operating lease: 1) there is no transfer of title; 2) there is not a bargain purchase option;
3) the lease term is substantially shorter than the economic life of the system; and 4) the present value of the capital component payments is less than 90% of the fair value of the water treatment system at the inception of the contract. For
water treatment systems which are owned by us and leased to our customers, the capital recovery portion of the payment stream from the customer is determined at the outset of the lease contract based on capital value and the lease term.
Consequently, these payments, and the recoverability of the related assets, are not affected by the operating losses sustained under the water services agreements, as described below.
In connection with long-term contracts, we may receive payments from our customers prior to the system being placed in service. Such payments are
recorded as deferred revenues. In addition, we may receive payments from our customers in excess of that which can be recognized on a straight-line basis. These payments are also recorded as deferred revenues. All deferred revenues amounts are
recognized as revenues in the periods in which services are rendered to the customer.
In each of these arrangements, the contract term is
typically five or more years, provided our customers may elect to terminate their contract with us prior to the expiration upon the occurrence of certain circumstances. In the case of the long-term water treatment contracts, they generally contain a
purchase option at the end of the agreement.
Cost of Revenues
Our cost of revenues varies based on the type of revenues as follows:
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Cost of Systems Sold
. Our cost of revenues for a sold system includes our cost of materials included in such system plus costs associated with deploying the
system, warranty costs, payroll and payroll related costs for our manufacturing personnel and other manufacturing overhead costs. These costs are recorded under the percentage-of-completion method of accounting. This method takes into account the
cost, estimated earnings and revenues to date on systems not yet completed.
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Cost of Contract Revenues.
Cost of revenues in connection with contract revenues consist of costs associated with the processing of waters, including the
cost of salt and other consumables used in our systems, waste removal on behalf of our customers, maintenance and other service costs of our systems. Cost of revenues in connection with contract revenue that includes capital for systems Basin
retains ownership under a water treatment contract includes depreciation expense using a 20-year life under the straight-line method.
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The cost of revenues for a system also varies by the contaminant(s) that the system is designed to address. We purchase components and raw materials from third party vendors which are then assembled into our treatment
systems in our manufacturing facilities or assembled at our customers’ site. We are not dependent on any sole source suppliers and generally have multiple vendors for each of our components and raw materials, all of which are located within the
United States.
Contract Loss Reserves
During the latter half of 2006 and in 2007, improvements to our management controls and accounting systems enabled us to more thoroughly analyze operating results for each water service agreement (WSA) and determine that certain, generally
older contracts were operating at net cash flow losses. Under the WSAs, we
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provide to our customers operations and maintenance services for water treatment units previously sold or leased to our customers. These contracts have
sustained increasing operating costs such as waste disposal and salt purchase costs as the direct result of higher fuel, salt and other third-party costs. Many of these contracts did not allow for the renegotiation of terms to recover such increased
costs (see Water Service Agreements below). Management determined that these contracts would continue to generate net operating cash flow losses through the end of the contract period, and those additional contracts that were not yet operational,
but which were scheduled to go on-line thereafter could have similar problems. Accordingly, we recorded a reserve for future contract losses in the amount of $3.7 million in the fourth quarter of 2006. This amount represented the losses which we
expected to incur during the initial period of these contracts and does not include renewal periods, if any, related to such contracts. Actual losses on the underlying contracts are being charged against the reserve as incurred.
During 2007, as these contracts progressed and as additional older legacy contracts became operational and were operated during the busy, higher volume
summer months, it became apparent by the third quarter of 2007 that the original reserve was not adequate. Management reviewed each contract’s financial performance and identified the future expected losses for these contracts, resulting in an
approximate $6.8 million increase to the reserve (offset by approximately $1.4 million of actual contract losses charged against the reserve during 2007) for future contract losses, which was charged to cost of contract revenues during the third
quarter of 2007. The increased contract loss reserve as of December 31, 2007 amounted to approximately $9.1 million (see Note 15 to our consolidated financial statements).
As part of its customary process and in connection with the preparation of its financial statements for the quarter ended June 30, 2008, the Company
conducted its review of the adequacy of its reserve for contract losses. Based on the results of that review, which included the benefit of additional operating history, the Company determined that the overall contract loss reserve as of that date
required only minor adjustment. As part of the process, certain adjustments were necessary to reallocate the total contract loss reserve to specific contracts to give effect to current estimates of future losses for such contracts. Included in the
total contract loss reserve at December 31, 2008 is approximately $1.2 million related to service contracts for water treatment systems which have not yet become operational but are anticipated to go online in the future.
In December 2007, other than in contracts that had been previously negotiated, we began including provisions in our WSAs that allowed for us to pass
through certain increased costs (primarily costs related to salt and waste transportation) to our customers.
Water Service Agreements
As of December 31, 2007, we had approximately 45 WSAs. This figure includes all WSAs to that date whether active or
anticipated to become active once water treatment systems are installed. As of December 31, 2007, we were actively providing services pursuant to our WSAs for approximately 46 wells. As of December 31, 2007, we had approximately 28 wells
expected to become operational at some time in the future. Some WSAs memorialize contract terms for multiple wells, and sometimes such multiple-well WSAs include wells that a) are active, b) will become active and c) were removed from the contract
before becoming active. For those WSAs active as of December 31, 2007, the average remaining initial term in months is approximately 63 months. The services and fee structure for at least two WSAs is on a time and materials basis, while certain
other WSAs are interim contracts under which the long-term WSAs are currently under negotiation, so their terms of service are not included in this calculation because they are more comparable to month-to-month service agreements. Of our
approximately 45 WSAs, 38 allow us to increase fees based upon increases in consumer price index, 16 allow us to increase fees based upon increases in waste disposal costs (only three of which include specific reference to transportation costs), and
one allows us to increase fees based upon increases in salt costs. Until the end of 2006, we did not have management controls and accounting systems to determine costs on a contract-by-contract basis, and thus we were unable to determine which
individual wells and WSAs were experiencing increased costs beyond our initial cost assumptions as well as the amount by which we should
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increase our water treatment fees for any specific customer. These management controls and accounting systems continued to be developed and expanded
throughout 2007, which enabled us to more fully assess the performance of individual wells and the specific causes for operating losses on a well-by-well basis, especially potential future operating losses for newly-contracted wells which were not
yet operating. At the time of renewal of a long-term contract, we will either renegotiate the terms of the project by increasing our fees to take into account any increased costs for providing the services, or we will decline to renew the contract.
As of December 31, 2008, we had approximately 44 WSAs in effect. This figure includes all WSAs to that date whether active or
anticipated to become active once water treatment systems are installed. As of December 31, 2008, we were actively providing services pursuant to our WSAs for approximately 52 wells. As of December 31, 2008, we had approximately 21 wells
expected to become operational at some time in the future. Some WSAs memorialize contract terms for multiple wells, and sometimes such multiple-well WSAs include wells that a) are active, b) will become active and c) were removed from the contract
before becoming active. For those WSAs active as of December 31, 2008, the average remaining initial term in months is approximately 49 months. The services and fee structure for at least two WSAs are on a time and material basis, while certain
other WSAs are interim contracts under which the long-term WSAs are currently under negotiation, so their terms of service are not included in this calculation because they are more comparable to month-to-month service agreements. Of our
approximately 44 WSAs, 40 allow us to increase fees based on increases in consumer price index, 19 allow us to increase fees based on increases in waste disposal costs (only five of which included specific reference to transportation costs), three
allow us to increase fees based on increases in salt costs, and two allow us to increase fees based on increases in bag filters costs. At the time of renewal of a long-term contract, we will either renegotiate the terms of the project by increasing
our fees to take into account any increased costs for providing the services, or we will decline to renew the contract.
Research and Development
Expense
Research and development expense consists primarily of research material costs, payroll and payroll related costs for our
research and development personnel and outside sponsored research and consulting expenses associated with the design, development and testing of new and existing technologies and systems.
Selling, General and Administrative Expense
Selling, general and administrative expense consists primarily of payroll and payroll related costs for our corporate management, finance, accounting, sales, marketing and administrative personnel, including commissions for our sales and
marketing personnel. Also included in selling, general and administrative expense are overhead costs associated with these activities, marketing and promotion expenses, public company costs, director fees, audit and legal expenses, and charges for
goodwill impairment.
Other Income (Expense)
Other income (expense) included in the statements of operations includes interest income, partially offset by interest and other expense. Additionally, other income (expense) includes certain transactions with Empire,
an affiliate. Such transactions include the gain on sale to Empire in 2007, our equity in losses of Empire, and impairment losses with respect to our investment in Empire.
Net Income Attributable to Noncontrolling Interest
In 2007, the Company entered into
agreements with two special-purpose entities, or SPEs (VL Capital, or VLC, and Water Services Solutions, or WSS) which were formed and owned by an outside third party to hold and facilitate financing of water systems leased our customers. We have
concluded that, under FIN 46(R), we are the primary beneficiary of these SPEs because we are exposed to a majority of the expected losses through our interest in notes receivable from the SPEs. Because we are deemed to be the primary
beneficiary of the SPEs, in
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accordance with FIN 46(R), the financial statements of the SPEs have been included in our consolidated financial statements. As of December 31,
2008, assets with a carrying amount of approximately $3.6 million are included in Property and Equipment and are collateral for debt of approximately $0.2 million included in Notes Payable. The holders of the SPE’s debt have no recourse to our
general credit.
Because we have no ownership interest in VLC, and no control over its management or business operations, we have recorded
the net income of VLC as attributable to a noncontrolling interest in our consolidated financial statements commencing with the sale of certain equipment to VLC in June 2007. The results of WSS were not material to our consolidated financial
statements.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based upon our audited financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. The
preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate these estimates,
including those related to revenue recognition, long-lived assets, accrued liabilities, and income taxes. These estimates are based on historical experience, information received from third parties and on various other assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Predicting future events is inherently an imprecise
activity and, as such, requires the use of assumptions. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be based on assumptions about matters that are highly uncertain at the time the estimate is made, and different estimates that reasonably could have been
used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements.
We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our financial statements:
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Revenue Recognition.
Our revenues are recognized in two different ways. For groundwater treatment systems that we sell to our customers, revenues are
recognized under the percentage-of-completion method by comparing actual costs incurred to total estimated costs to complete each system. The percentage-of-completion method recognizes revenues and associated costs as work progresses on a system,
based on the expected total system revenues and costs. In general, financial statements based on the percentage-of-completion method present the economic substance of production-type activities more clearly than the use of the completed-contract
method, and present the relationships between sales, cost of sales and related period costs more accurately. For all other groundwater treatment systems delivered to our customers under various contractual arrangements, we recognize revenues for a
periodic fee we receive over the life of the contract using the straight-line method and recognize a processing fee as our systems treat the customer’s contaminated water.
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Property and Equipment.
Property and equipment is stated at cost less accumulated depreciation and amortization. Property consists primarily of
groundwater treatment systems which we place with customers under various arrangements. For our groundwater treatment systems placed with our customers under long-term contracts, we capitalize materials, labor, overhead and interest. Depreciation is
calculated using the straight-line method over the estimated useful lives of the related assets. We capitalize expenditures for major renewals and betterments that extend the useful lives of property and equipment. We charge expenditures for
maintenance and repairs to expense as incurred.
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Estimated useful lives are generally as follows: vehicles and trailers—three to five years; furniture and fixtures—three to seven years; other
equipment—three to 10 years, and groundwater treatment systems—20 years. Judgments and estimates made by us related to the expected useful lives of these assets are affected by factors such as changes in operating performance and
fluctuations in economic conditions. If our assumptions change in the future, we may be required to record impairment charges for these assets.
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Intangible Assets and Goodwill.
In conjunction with our September 2007 acquisition of MPT, we engaged an independent third party to assess the fair
value of the assets acquired in this transaction. The purchase price was allocated to net tangible and intangible assets acquired based on their estimated fair values, with approximately $4.2 million allocated to intangible assets with a
weighted-average useful life of approximately 11 years. Such intangible assets consist of a covenant not to compete in the amount of $0.3 million (three year useful life), trade name in the amount of $0.2 million (two year useful life), service
agreements and contracts in the amount of $1.3 million (six year useful life), customer relationships in the amount of $0.6 million (15 year useful life) and patents in the amount of $1.8 million (17 year useful life). The excess of the net purchase
price over the estimated fair value of assets acquired was approximately $6.3 million, which was recorded as non-tax deductible goodwill.
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In conjunction with our September 2008 acquisition of Envirogen, we also engaged an independent third party to assess the fair value of the assets acquired in this transaction. The purchase price was allocated to net
tangible and intangible assets acquired based on their estimated fair values, with approximately $1.2 million allocated to intangible assets with a weighted-average useful life of approximately nine years and approximately $0.3 million allocated to
intangible assets with an indefinite useful life. Such intangible assets consist of a trade name in the amount of $0.3 million (indefinite useful life), distribution network in the amount of $0.1 million (six year useful life), backlog in the amount
of $0.1 million (one year useful life) and patents in the amount of $1.0 million (10 year useful life). The excess of the net purchase price over the estimated fair value of assets acquired was approximately $1.1 million which was recorded as tax
deductible goodwill.
During the third quarter of 2008, we recorded a charge to earnings of approximately $5.0 million to reduce the
carrying value of the goodwill related to the MPT acquisition, which was included in selling, general and administrative expense. See Note 9 to our consolidated financial statements for a further discussion of this impairment charge.
Judgments and estimates made by us related to the expected useful lives of the intangible assets are affected by factors such as changes in operating
performance, loss of existing customers or service contracts, failure to obtain final approval for patents, fluctuations in economic conditions and expected future performance. If our assumptions change in the future, we may be required to record
impairment charges for these assets, including goodwill.
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Inventory.
Inventory consists primarily of raw materials and supplies used in the fabrication of our groundwater treatment units, as well as the
reprocessing and conditioning of resins. Inventory items are stated at the lower of cost, on a first-in, first-out basis, or market. Physical counts of inventory items are conducted periodically to help verify the balance of inventory. A reserve is
maintained for obsolete inventory, if appropriate. We consider inventory to be obsolete when it is no longer usable as a system component.
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Stock-based Compensation.
Effective January 1, 2006, we adopted the provisions of SFAS No. 123(R),
Share-Based Payment
. This
statement requires the recognition of the fair value of stock-based compensation awards in financial statements. Under the provisions of SFAS No. 123(R), stock-based compensation expense is measured at the date of grant, based on the calculated
fair value of the stock-based award, and is recognized as expense over the employee’s requisite service period (generally the vesting period of the award). We elected to adopt the modified prospective transition method as provided under SFAS
No. 123(R). This method applies to all new awards or awards modified, repurchased or cancelled on or after January 1, 2006. Accordingly, financial statement
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amounts for the periods prior to 2006 presented elsewhere in this Annual Report on Form 10-K have not been restated to reflect the fair value method of
expensing share-based compensation.
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The adoption of SFAS No. 123(R) resulted in approximately $2.5 million, $1.5
million and $0.7 million of expense in 2008, 2007 and 2006, respectively, and we anticipate that the adoption of SFAS No. 123(R) will result in approximately $1.7 million of expense in 2009 and approximately $0.7 million of expense
thereafter, based upon options and other stock-based awards outstanding as of December 31, 2008.
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Deferred Charges:
During the first quarter of 2006 and the fourth quarter of 2005, we recorded deferred charges in an amount equal to the excess of
the deemed fair value of our common stock over the exercise price of warrants issued during these periods. During these same two quarters, we also recorded deferred charges in an amount equal to the excess of the deemed fair value of our common
stock over the exercise price of stock options issued during these periods. Such deferred charges have been or will be amortized as charges to the appropriate income statement classification over the period of the underlying transaction for which
the warrants were issued in accordance with SFAS No. 150,
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
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FIN 46(R):
As discussed previously, in 2007, we entered into four transactions with respect to the sale of water treatment units to two special
purpose entities, or SPEs (VL Capital, or VLC, and Water Services Solutions, or WSS). These sales were to be funded by third-party financial institutions. In addition to the sale of these units, the underlying agreements provided that the special
purpose entity would have the right to receive the scheduled lease payments from the customers subject to the WSAs. VLC issued us a secured note as consideration for the water treatment units and related scheduled lease payments. We have concluded
that the financial statements of these special purpose entities should be included in our consolidated financial statements in accordance with FIN 46(R), as we retained the majority of the risks underlying these transactions.
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Investments in Unconsolidated Entity:
We have a 32% ownership investment in Empire Water Corporation (Empire). This investment is evaluated under the
requirements of FASB Interpretation No. (FIN) 46(R
), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,
Accounting Principles Board Opinion No. (APB) 18,
The Equity Method of Accounting for Investments in
Common Stock
, and other applicable guidance to determine the appropriate accounting treatment, including whether we must consolidate the investee company. Our 32% ownership investment in Empire is accounted for using the equity method of
accounting since the investment gives us the ability to exercise significant influence, but not control, over the investee as outlined under APB 18. Significant influence is generally deemed to exist if we have an ownership interest of between 20%
and 50%, although other factors are considered in determining whether the equity method of accounting is appropriate.
|
This investment is classified as an “investment in affiliate” on our consolidated balance sheet. We monitor this investment for impairment and will make appropriate reductions in carrying values if we determine that an impairment
charge is required based primarily on the near-term prospects and financial condition of Empire. Any significant intervening events relating to Empire in the period since the latest available financial statements will be disclosed in future filings.
51
Results of Operations
The following table sets forth key components of our results of operations for the years indicated, both in dollars and as a percentage of revenues.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
2008
|
|
|
% of
Revenue
|
|
|
2007
|
|
|
% of
Revenue
|
|
|
2006
|
|
|
% of
Revenue
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System sales
|
|
$
|
3,612
|
|
|
31
|
%
|
|
$
|
3,980
|
|
|
41
|
%
|
|
$
|
10,593
|
|
|
76
|
%
|
|
Contract revenues
|
|
|
8,166
|
|
|
69
|
%
|
|
|
5,680
|
|
|
59
|
%
|
|
|
3,297
|
|
|
24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
11,778
|
|
|
100
|
%
|
|
|
9,660
|
|
|
100
|
%
|
|
|
13,890
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of system sales
|
|
|
3,533
|
|
|
30
|
%
|
|
|
6,443
|
|
|
67
|
%
|
|
|
10,707
|
|
|
77
|
%
|
|
Cost of contract revenues
|
|
|
7,773
|
|
|
66
|
%
|
|
|
12,545
|
|
|
130
|
%
|
|
|
7,562
|
|
|
54
|
%
|
|
Depreciation expense
|
|
|
934
|
|
|
8
|
%
|
|
|
539
|
|
|
6
|
%
|
|
|
423
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
12,240
|
|
|
104
|
%
|
|
|
19,527
|
|
|
203
|
%
|
|
|
18,692
|
|
|
134
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loss
|
|
|
(462
|
)
|
|
-4
|
%
|
|
|
(9,867
|
)
|
|
-103
|
%
|
|
|
(4,802
|
)
|
|
-34
|
%
|
|
Research and development expense
|
|
|
1,167
|
|
|
10
|
%
|
|
|
564
|
|
|
6
|
%
|
|
|
634
|
|
|
5
|
%
|
|
Selling, general and administrative expense
|
|
|
28,989
|
|
|
246
|
%
|
|
|
12,827
|
|
|
133
|
%
|
|
|
6,445
|
|
|
46
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(30,618
|
)
|
|
-260
|
%
|
|
|
(23,258
|
)
|
|
-242
|
%
|
|
|
(11,881
|
)
|
|
-85
|
%
|
|
Other income (expense)
|
|
|
(1,559
|
)
|
|
-13
|
%
|
|
|
5,066
|
|
|
52
|
%
|
|
|
(1,571
|
)
|
|
-11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(32,177
|
)
|
|
-273
|
%
|
|
|
(18,192
|
)
|
|
-190
|
%
|
|
|
(13,452
|
)
|
|
-96
|
%
|
|
Income tax benefit
|
|
|
—
|
|
|
|
|
|
|
—
|
|
|
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss before noncontrolling interest
|
|
|
(32,177
|
)
|
|
-273
|
%
|
|
|
(18,192
|
)
|
|
-190
|
%
|
|
|
(13,452
|
)
|
|
-96
|
%
|
|
Less: net income attributable to noncontrolling interest
|
|
|
(348
|
)
|
|
-3
|
%
|
|
|
(84
|
)
|
|
-1
|
%
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(32,525
|
)
|
|
-276
|
%
|
|
$
|
(18,276
|
)
|
|
-191
|
%
|
|
$
|
(13,452
|
)
|
|
-96
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
52
Years Ended December 31, 2008 and 2007
Revenues, Cost of Revenues and Gross Loss
The following table summarizes the significant
components of revenues, cost of revenues and gross profit (loss) for the year ended December 31, 2008 compared to the prior year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase
(Decrease)
|
|
|
|
|
(In thousands)
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large system sales
|
|
$
|
—
|
|
|
$
|
1,927
|
|
|
$
|
(1,927
|
)
|
|
Standard system sales
|
|
|
3,612
|
|
|
|
2,053
|
|
|
|
1,559
|
|
|
Contract operations
|
|
|
8,166
|
|
|
|
5,680
|
|
|
|
2,486
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenues
|
|
|
11,778
|
|
|
|
9,660
|
|
|
|
2,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large system sales
|
|
|
—
|
|
|
|
4,274
|
|
|
|
(4,274
|
)
|
|
Standard system sales
|
|
|
3,533
|
|
|
|
2,169
|
|
|
|
1,364
|
|
|
Contract operations
|
|
|
8,915
|
|
|
|
7,158
|
|
|
|
1,757
|
|
|
Net change in contract loss reserve
|
|
|
(1,142
|
)
|
|
|
5,387
|
|
|
|
(6,529
|
)
|
|
Depreciation expense
|
|
|
934
|
|
|
|
539
|
|
|
|
395
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Cost of Revenues
|
|
|
12,240
|
|
|
|
19,527
|
|
|
|
(7,287
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit (Loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large system sales
|
|
|
—
|
|
|
|
(2,347
|
)
|
|
|
2,347
|
|
|
Standard system sales
|
|
|
79
|
|
|
|
(116
|
)
|
|
|
195
|
|
|
Contract operations
|
|
|
(1,683
|
)
|
|
|
(2,017
|
)
|
|
|
334
|
|
|
Reserve for future contract operations
|
|
|
1,142
|
|
|
|
(5,387
|
)
|
|
|
6,529
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Loss
|
|
$
|
(462
|
)
|
|
$
|
(9,867
|
)
|
|
$
|
9,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
Revenues increased by $2.1 million, or 22%, to $11.8 million in 2008 from $9.7 million in 2007. Revenues recognized for sales of water treatment systems totaled approximately $3.6 million in 2008 compared to
approximately $4.0 million in 2007. We acquired Envirogen in September 2008, which increased our 2008 system sales revenues by approximately $1.0 million. This partially offset a decrease of approximately $1.4 million in sales of water treatment
systems from our existing operations. Revenues from system sales represented 31% and 41% of our total revenues during 2008 and 2007, respectively. Contract revenues increased to $8.2 million in 2008 from $5.7 million in 2007, an increase of
$2.5 million, or 44%, as the number of systems placed in service with customers increased in 2008 compared to 2007. In addition, we acquired MPT in September of 2007 which increased our contract revenues.
Cost of Revenues
Cost of revenues decreased
by $7.3 million, or 37% to $12.2 million in 2008 from $19.5 million in 2007. This decrease was primarily due to decreased sales of large groundwater treatment systems, which had generated a negative gross margin of $2.3 million in 2007. The cost of
systems sold in 2007 was $6.5 million compared to $3.6 million in 2008. This decrease in cost is due to the unanticipated costs associated with a large system sale in 2007, as well as the small decrease in sales of water treatment systems as
indicated above. Operating costs for our contract revenues increased by $1.8 million, or 25%, to $8.9 million in 2008 from $7.1 million in 2007. The increase in operating costs was primarily due to higher costs of waste disposal, salt, chemicals and
increased field service labor expense, all as a result of having more systems placed in service with customers in 2008 compared
53
to 2007. During 2008, we recorded approximately $1.1 million of net charges against the reserve for contract losses. As a result of management’s
evaluations of certain loss contracts we recorded approximately $6.8 million reserve for future contract losses in 2007, offset by approximately $1.4 million of charges against the reserve (see “Management’s Discussion and Analysis of
Financial Condition—Financial Operations Review” for a further discussion of this reserve).
Gross Loss
Our gross loss decreased to $0.5 million in 2008 from $9.9 million in 2007. Our gross loss as a percentage of revenue was negative 4% compared to negative
102% in 2007. This decrease in gross loss was primarily the result of an increase of $2.5 million in our gross margins on system sales. In addition, as noted above, in 2007, we recorded an increase to the reserve for future contract losses of
approximately $6.8 million (offset by approximately $1.4 million of actual contract losses charged against the reserve) which severely impacted our operating profit. In addition to this reserve, the 2008 gross loss on our contract operations was
$1.7 million prior to applying any charges against the contract loss reserve; this compared to a $2.0 million gross loss from contract operations in the prior year. In 2007, we experienced unanticipated increased costs on our large system sales, and
we did not have similar unanticipated costs in 2008. In addition, we had MPT for the full year compared to three months in 2007 and this contributed to our gross margin. Finally, we had improved margins on our contract revenues due to the increase
in some water service agreements and the containment of costs.
Research and Development Expense
Research and development expense was approximately $1.2 million and $0.6 million in 2008 and 2007, respectively. The increase in research and development
expense during 2008 is primarily due to a charge to earnings of approximately $0.7 million to write off certain assets related to the development of our BionExchange technology. See Note 12 to the consolidated financial statements for further
discussion. We also incurred research and development costs for outside consultant expense, research material costs and personnel costs.
Selling,
General and Administrative Expense
The following table summarizes the significant changes in selling, general and administrative
expense for the year ended December 31, 2008 compared to the prior year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
2007
|
|
Increase
(Decrease)
|
|
|
|
|
(In thousands)
|
|
|
Compensation and benefits
|
|
$
|
7,728
|
|
$
|
5,126
|
|
$
|
2,602
|
|
|
Professional fees
|
|
|
5,025
|
|
|
1,619
|
|
|
3,406
|
|
|
Goodwill impairment
|
|
|
4,998
|
|
|
—
|
|
|
4,998
|
|
|
Restricted stock expense
|
|
|
1,407
|
|
|
875
|
|
|
532
|
|
|
Travel and entertainment
|
|
|
1,402
|
|
|
605
|
|
|
797
|
|
|
Stock-based compensation expense
|
|
|
1,080
|
|
|
831
|
|
|
249
|
|
|
Directors’ fees and public company costs
|
|
|
1,185
|
|
|
614
|
|
|
571
|
|
|
Severance, consulting and stock-based compensation— former Chairman and CEO
|
|
|
990
|
|
|
—
|
|
|
990
|
|
|
Building rent and occupancy costs
|
|
|
1,120
|
|
|
407
|
|
|
713
|
|
|
Amortization—intangibles
|
|
|
620
|
|
|
145
|
|
|
475
|
|
|
Bad debt expense
|
|
|
818
|
|
|
243
|
|
|
575
|
|
|
Outside selling, marketing & promotion
|
|
|
748
|
|
|
1,062
|
|
|
(314
|
)
|
|
Restructure charges
|
|
|
598
|
|
|
—
|
|
|
598
|
|
|
Insurance
|
|
|
373
|
|
|
329
|
|
|
44
|
|
|
Sarbanes Oxley 404 expense
|
|
|
155
|
|
|
442
|
|
|
(287
|
)
|
|
Other SG&A expense
|
|
|
742
|
|
|
529
|
|
|
213
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SG&A Expense
|
|
$
|
28,989
|
|
$
|
12,827
|
|
$
|
16,162
|
|
|
|
|
|
|
|
|
|
|
|
|
|
54
Selling, general and administrative expense increased by $16.2 million, or 127%, to $29.0 million in 2008
from $12.8 million in 2007. The increase was primarily due to the $5.0 million goodwill impairment charge related to MPT, recognized during the third quarter of 2008; an increase in compensation expense and related employee benefits of $2.6 million
attributable to additional executive and management personnel and related costs to support planned growth (including approximately $0.5 million and $0.9 million added expense as a result of the September 2008 acquisition of Envirogen and the
September 2007 acquisition of MPT, respectively); an increase in professional fees of $3.4 million, primarily due to higher legal fees incurred in connection with various litigation and the restatement of the Company’s financial statements;
approximately $1.0 million of costs associated with the resignation of our former Chairman and CEO, which included a cash severance payment, stock-based compensation expense associated with options awarded in prior periods and consulting payments to
be made over a two-year period; an increase of $0.8 million in travel expense due primarily to the expansion of our operations as a result of our acquisitions of MPT in September 2007 and Envirogen in September 2008; the accrual of $0.6 million in
restructuring charges, representing the future operating lease obligations for the manufacturing facilities in California which were shut down during the fourth quarter of 2008; an increase in restricted stock expense of $0.5 million, primarily for
restricted stock granted in October 2007; an increase in bad debt expense of $0.5 million because we recorded a 50% reserve against one of our outstanding system sale receivable which we believe had become a risk for collection. We recorded an
increase of $0.5 million in directors fees and public company costs (as 2007 was our first full year as a public company); and a decrease of $0.4 million in outside selling, marketing and promotion.
Other Income (Expense)
The following table
summarizes the significant changes in other expense for the year ended December 31, 2008 compared to the prior year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Expense
(Increase)
Decrease
|
|
|
|
|
(In thousands)
|
|
|
Interest income
|
|
$
|
714
|
|
|
$
|
2,738
|
|
|
$
|
(2,024
|
)
|
|
Interest expense
|
|
|
(101
|
)
|
|
|
(774
|
)
|
|
|
673
|
|
|
Gain on sale to affiliate
|
|
|
—
|
|
|
|
3,094
|
|
|
|
(3,094
|
)
|
|
Equity in loss of affiliate
|
|
|
(946
|
)
|
|
|
—
|
|
|
|
(946
|
)
|
|
Impairment of investment in affiliate
|
|
|
(1,231
|
)
|
|
|
—
|
|
|
|
(1,231
|
)
|
|
Other income
|
|
|
5
|
|
|
|
8
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Other Income (Expense)
|
|
$
|
(1,559
|
)
|
|
$
|
5,066
|
|
|
$
|
(6,625
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We recorded other expense of $1.6 million in 2008 compared to other income of $5.1 million in
2008. The overall decrease in other income when compared to 2007 is primarily due to a gain on sale to an affiliate of $3.1 million recorded in the fourth quarter of 2007 as the result of the assignment to Empire of our contract to purchase
certain water assets in exchange for Empire common stock (see Note 11 to our consolidated financial statements). Interest income decreased by $2.0 million, or 74%, from $2.7 million in 2007 to $0.7 million in 2008, as cash balances and interest
rates declined throughout 2008 when compared to 2007. In the third quarter of 2008, we recorded a charge to earnings of approximately $1.2 million to write down the carrying value of our investment in Empire. Equity in loss of affiliate in 2008
represents our share of the net loss of Empire, an affiliate in which we have own an approximate 32% interest.
55
Years Ended December 31, 2007 and 2006
Revenues, Cost of Revenues and Gross Loss
The following table summarizes the significant
components of revenues, cost of revenues and gross profit (loss) for the year ended December 31, 2007 compared to the prior year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Increase
(Decrease)
|
|
|
|
|
(In thousands)
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large system sales
|
|
$
|
1,927
|
|
|
$
|
5,694
|
|
|
$
|
(3,767
|
)
|
|
Standard system sales
|
|
|
2,053
|
|
|
|
4,899
|
|
|
|
(2,846
|
)
|
|
Contract operations
|
|
|
5,680
|
|
|
|
3,297
|
|
|
|
2,383
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenues
|
|
|
9,660
|
|
|
|
13,890
|
|
|
|
(4,230
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large system sales
|
|
|
4,274
|
|
|
|
6,400
|
|
|
|
(2,126
|
)
|
|
Standard system sales
|
|
|
2,169
|
|
|
|
4,307
|
|
|
|
(2,138
|
)
|
|
Contract operations
|
|
|
7,158
|
|
|
|
3,838
|
|
|
|
3,320
|
|
|
Net change in contract loss reserve
|
|
|
5,387
|
|
|
|
3,724
|
|
|
|
1,663
|
|
|
Depreciation expense
|
|
|
539
|
|
|
|
423
|
|
|
|
116
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Cost of Revenues
|
|
|
19,527
|
|
|
|
18,692
|
|
|
|
835
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit (Loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large system sales
|
|
|
(2,347
|
)
|
|
|
(706
|
)
|
|
|
(1,641
|
)
|
|
Standard system sales
|
|
|
(116
|
)
|
|
|
592
|
|
|
|
(708
|
)
|
|
Contract operations
|
|
|
(2,017
|
)
|
|
|
(964
|
)
|
|
|
(1,053
|
)
|
|
Reserve for contract operations
|
|
|
(5,387
|
)
|
|
|
(3,724
|
)
|
|
|
(1,663
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Loss
|
|
$
|
(9,867
|
)
|
|
$
|
(4,802
|
)
|
|
$
|
(5,065
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
Revenues decreased by $4.2 million, or 30%, to $9.7 million in 2007 from $13.9 million in 2006. This occurred primarily as a result of a decrease in our revenues from system sales. Revenues recognized for sales of
groundwater treatment systems decreased from $10.6 million in 2006 to $4.0 million in 2007, a decrease of $6.6 million, or 62%, primarily due to decreased groundwater treatment systems sales volume. Revenues from system sales represented 41%
and 76% of our total revenues during 2007 and 2006, respectively. The decrease in system sales revenue was partially offset by (i) our acquisition of MPT in September 2007 and (ii) growth in our contract revenues. Contract revenues
increased to $5.7 million in 2007 from $3.3 million in 2006, an increase of $2.4 million, or 73%, as the number of systems placed in service with customers increased in 2007 compared to 2006.
Cost of Revenues
Cost of revenues increased
by $0.8 million, or 5% to $19.5 million in 2007 from $18.7 million in 2006. This decrease was primarily due to decreased sales of groundwater treatment systems. The cost of systems sold in 2006 was $10.7 million compared to $6.5 million in 2007.
This decrease in cost is consistent with the decreased sales of groundwater treatment systems. Operating costs for our contract revenues increased by $3.3 million, or 87%, to $7.1 million in 2007 from $3.8 million in 2006. The increase in operating
costs was primarily due to higher costs of waste disposal, salt, chemicals and increased field service labor expense, all as a result of having more systems placed in service with customers in 2007 compared to 2006. During 2007, we recorded an
additional $6.8 million reserve for future contract losses (offset by approximately $1.4 million of charges against
56
the reserve for actual contract losses during 2007) as a result of management’s evaluations of certain loss contracts, compared to a $3.7 million
reserve for future contract losses recorded in 2006 (see “Management’s Discussion and Analysis of Financial Condition—Financial Operations Review” for a further discussion of this reserve).
Gross Loss
Our gross loss increased to $9.9
million in 2007 from $4.8 million in 2006. Our gross loss as a percentage of revenue was negative 102% compared to negative 35% in 2006. This increase in gross loss was primarily the result of a decrease of $2.4 million in our gross margins on
system sales.
In addition, as noted above, in both 2007 and 2006, we recorded a reserve for future contract losses of $6.8 million
(net of $1.4 million of charges against the reserve for actual contract losses during 2007) and $3.7 million, respectively, which severely impacted our operating profit. In addition to this reserve, the gross loss on our contract operations was
$2.0 million prior to applying any charges against the contract loss reserve; this compared to $1.0 million gross loss in the prior year. The increased gross loss was due primarily to the certain legacy contracts booked in prior periods that became
operational in 2007 that included, among other things, poor pricing and inadequate contract terms.
Research and Development Expense
Research and development expense was approximately $0.6 million in both 2007 and 2006. We incurred research and development costs
for outside consultant expense, research material costs and personnel costs.
Selling, General and Administrative Expense
The following table summarizes the significant changes in selling, general and administrative expense for the year ended December 31, 2007 compared
to the prior year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
Increase
(Decrease)
|
|
|
|
(In thousands)
|
|
Compensation and benefits
|
|
$
|
5,126
|
|
$
|
2,535
|
|
$
|
2,591
|
|
Professional fees
|
|
|
1,619
|
|
|
726
|
|
|
893
|
|
Outside selling, marketing & promotion
|
|
|
1,062
|
|
|
666
|
|
|
396
|
|
Restricted stock expense
|
|
|
875
|
|
|
93
|
|
|
782
|
|
Stock-based compensation expense
|
|
|
831
|
|
|
744
|
|
|
87
|
|
Directors’ fees and public company costs
|
|
|
614
|
|
|
174
|
|
|
440
|
|
Travel and entertainment
|
|
|
605
|
|
|
400
|
|
|
205
|
|
Sarbanes Oxley 404 expense
|
|
|
442
|
|
|
—
|
|
|
442
|
|
Insurance
|
|
|
329
|
|
|
263
|
|
|
66
|
|
Bad debt expense
|
|
|
243
|
|
|
65
|
|
|
178
|
|
Amortization—intangibles
|
|
|
145
|
|
|
—
|
|
|
145
|
|
Building rent and occupancy costs
|
|
|
407
|
|
|
286
|
|
|
121
|
|
Other SG&A expense
|
|
|
529
|
|
|
493
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SG&A Expense
|
|
$
|
12,827
|
|
$
|
6,445
|
|
$
|
6,382
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expense increased by $6.4 million, or 100%, to $12.8 million
in 2007 from $6.4 million in 2006. The increase was primarily due to an increase in compensation expense and related employee benefits of $2.6 million attributable to additional executive and management personnel and related costs to support planned
growth (including approximately $0.8 million added expense as a result of the September 2007 acquisition of MPT); an increase in professional fees of $0.9 million, primarily due to higher
57
legal fees incurred in connection with various litigation; an increase in restricted stock expense of $0.8 million, primarily for restricted stock granted in
October 2006; approximately $0.4 million of increased expense incurred in connection with the development and implementation of internal controls over financial reporting to comply with Section 404 of the Sarbanes Oxley Act of 2002; an increase
of $0.4 million in directors fees and public company costs (as 2007 was our first full year as a public company); and an increase of $0.4 million in outside selling, marketing and promotion.
Other Income (Expense)
The following table
summarizes the significant changes in other expense for the year ended December 31, 2007 compared to the prior year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Expense
(Increase)
Decrease
|
|
|
|
|
(In thousands)
|
|
|
Interest income
|
|
$
|
2,738
|
|
|
$
|
2,061
|
|
|
$
|
677
|
|
|
Interest expense
|
|
|
(774
|
)
|
|
|
(674
|
)
|
|
|
(100
|
)
|
|
Gain on sale to affiliate
|
|
|
3,094
|
|
|
|
—
|
|
|
|
3,094
|
|
|
Amortization—fair value of warrants
|
|
|
—
|
|
|
|
(1,083
|
)
|
|
|
—
|
|
|
Write off fair value of warrants
|
|
|
—
|
|
|
|
(1,524
|
)
|
|
|
—
|
|
|
Write off loan acquisition costs
|
|
|
—
|
|
|
|
(357
|
)
|
|
|
—
|
|
|
Other income
|
|
|
8
|
|
|
|
6
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Other Income (Expense)
|
|
$
|
5,066
|
|
|
$
|
(1,571
|
)
|
|
$
|
3,673
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We recorded other income of $5.1 million in 2007 compared to other expense of $1.6 million in
2006. The overall increase in other income is primarily due to a gain on sale to an affiliate of $3.1 million recorded in the fourth quarter of 2007 as the result of the assignment to Empire of our contract to purchase certain water assets in
exchange for Empire common stock (see Note 11 to our consolidated financial statements) and an increase in interest income of $0.7 million, or 33%, to $2.7 million in 2007 from $2.1 million in 2006.
In addition, during 2006, the write-off of approximately $1.5 million in unamortized fair value of warrants and the write-off of approximately $0.4
million in unamortized loan costs in connection with the repayment of amounts outstanding under our BWCA loan and our XACP Notes, as well as the amortization of fair value of warrants outstanding under our Aqua Note, all of which are more fully
discussed below under “Liquidity and Capital Resources,” resulted in higher interest expense.
Liquidity and Capital Resources
From our inception until our initial public offering in May 2006, we financed our growth and operations primarily with proceeds from the issuance of
preferred stock and common stock, as well as the incurrence of indebtedness under the BWCA loan, our subordinated notes payable to The Co-Investment 2000 Fund, LP, Cross Atlantic Technology Fund II, LP and Catalyst Basin Water, LLC (the XACP Notes),
and our $2.0 million subordinated note to Aqua America, Inc. (the Aqua Note).
In connection with our initial public offering in May 2006,
we received net cash proceeds of approximately $75.2 million, of which $11.0 million was used to repay the $4.0 million BWCA loan, $5.0 million in XACP Notes and the $2.0 million Aqua Note.
At December 31, 2008, we had approximately $11.5 million and as of March 30, 2009, we had approximately $8.5 million in cash and cash equivalents
(excluding cash balances resulting from the consolidation of VL Capital, which funds of VL Capital are not available to us to support our liquidity needs).
58
We have experienced significant negative cash flows from operating and investing activities between 2006 and 2008, and we expect to use additional cash for
such activities for the foreseeable future. Our net losses incurred during the past two fiscal years ended December 31, 2008 and 2007 amounted to $32.5 million and $18.3 million, respectively. Unless and until we are able to generate sufficient
revenues from our system sales and contract services, we expect such losses to continue in the future. Therefore, our ability to continue to operate our business over the next 12 months is highly dependent on the amount of cash and cash equivalents
on hand combined with our ability to raise capital to support our future operations.
Additional capital, whether obtained through
financial markets (in the form of public or private debt or equity) or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to us. If
additional funds are raised through the issuance of additional common stock, other equity securities or indebtedness, the percentage ownership of our then-current stockholders may be diluted substantially and the equity or debt securities issued to
new investors may have rights, preferences or privileges senior to those of the holders of our then-existing capital stock.
The U.S.
credit markets have recently experienced significant dislocations and liquidity disruptions which have caused spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets,
making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt financing. These events in the credit markets as well as deteriorating market conditions have also had an adverse
effect on other financial markets in the United States, including the equity markets, which we expect will make it very difficult and costly for us to raise capital through the issuance of debt, common stock or other equity securities. If adequate
funds are not available or are not available on acceptable terms, we may not be able to continue operations, resulting in significant harm to our financial condition and prospects and a decline in our stock price. This raises substantial doubt as to
our ability to continue as a going concern.
Our independent auditors’ report for the year ended December 31, 2008 includes an
explanatory paragraph stating that our recurring losses from operations and negative cash flows raise substantial doubt about our ability to continue as a going concern. If we are unable to obtain additional financing on commercially reasonable
terms, our business, financial condition and results of operations will be materially and adversely affected and we may be unable to continue as a going concern. The question about our ability to continue as a going concern may also limit our
ability to obtain financing on acceptable terms or at all, and may limit our ability to obtain new business due to potential customers’ concern about our ability to provide water treatment and other services. If we are unable to continue as a
going concern, we may elect or be required to seek protection from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. In such a case, we may have to liquidate our assets and may receive
less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or a part of their investment.
As previously announced, our Board of Directors has engaged Canaccord Adams to conduct a review of the Company’s strategic alternatives. These alternatives include the sale of some or all of our assets or stock,
a merger or other business combination involving the Company, third party investment and other strategic alternatives. At this time, we believe that if a transaction occurs, the most likely will be a sale of substantially all of our assets (which
may occur under Section 363 of the Bankruptcy Code) that is intended to result in a continuation of the Company’s current business. The Company and Canaccord Adams have engaged in confidential discussions with a number of potential
counterparties regarding a strategic transaction, including a potential asset sale. However, there can be no assurance that these efforts will result in any specific transaction or that any transaction that is consummated will be favorable to our
stockholders. We do not expect to disclose further developments regarding the process until the completion of the strategic alternatives review and a decision by the Board of Directors regarding a transaction or course of action.
We have invested substantially all of our available cash funds in money market funds placed with reputable institutions for which credit loss is not
anticipated.
59
The following table summarizes our primary sources of cash in the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
(in thousands)
|
|
|
Net cash provided by (used in):
|
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
(19,070
|
)
|
|
$
|
(9,734
|
)
|
|
Investing activities
|
|
|
(5,193
|
)
|
|
|
(14,905
|
)
|
|
Financing activities
|
|
|
179
|
|
|
|
6,110
|
|
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
$
|
(24,084
|
)
|
|
$
|
(18,529
|
)
|
|
|
|
|
|
|
|
|
|
|
Operating Activities
Net cash used by operating activities was $19.1 million during 2008 compared to net cash used in operating activities of $9.7 million during 2007. In
addition to our 2008 net loss of $32.5 million compared to our 2007 net loss of $18.3 million, this increase in net cash used by operating activities was primarily attributable to a $2.6 million net change in accounts receivable (including
unbilled receivables), a $6.8 million net change in contract loss reserves and a $2.6 million net change in accounts payable, offset in part by a $2.1 million net change in accrued liabilities. Our 2008 net loss included non-cash charges of $5.0
million for goodwill impairment, $1.2 million for impairment of our investment in an affiliate and $0.9 million representing equity in the loss of an affiliate. See Notes 9 and 11 to our consolidated financial statements for an additional
explanation of these non-cash charges.
In general, accounts receivable arising from systems sales to customers are due in accordance with
the provisions of the sales contract, which typically provide for payment terms of a few months. Historically, the Company frequently granted more liberal payment terms of up to one year or more for a significant portion of the contract price. In
contrast, accounts receivable from systems placed under long-term operating contracts with customers are usually due within a much shorter period, generally within one month after the date services have been performed and the customer has been
billed.
Investing Activities
Net cash used in investing activities was $5.2 million in 2008 compared to $14.9 million in 2006. The decrease in cash used in investing activities was due primarily to $6.2 million in cash paid as partial
consideration for the acquisition of MPT, net of cash acquired compared to the $2.0 million in cash paid as consideration for the acquisition of Envirogen in September of 2008. Our capital expenditures were $5.6 million higher in 2007 compared to
2008. This decrease in capital expenditures was the result of more systems placed with customers under long-term contracts during 2007 than during 2008 since more customers chose to pay us under long term contracts rather than purchase systems, as
well as the buildup of partially constructed treatment systems in 2007.
Financing Activities
Net cash provided by financing activities was $0.2 million in 2008 compared to cash provided by financing activities of $6.1 million in 2007. During 2007,
net cash provided by financing activities included $8.1 million in net proceeds from exercise of common stock warrants offset by a decrease of $2.1 million in repayments of notes payable and capital lease obligations.
Capital Expenditures
Our capital expenditures are
primarily for groundwater treatment systems that we build and then contract to customers under long-term contracts. Capital expenditures totaled $3.2 million, $8.7 million, and $4.7 million during the years ended December 31, 2008, 2007 and
2006, respectively. Our future capital expenditures will fluctuate depending on the number of our systems we place with customers under long-term contracts.
60
Depending on the availability of additional cash resources, we anticipate cash requirements of
approximately $4.0 million to $5.0 million for capital expenditures during 2009 including expenditures for treatment systems delivered to customers under long-term contract arrangements.
Outstanding Indebtedness
At December 31, 2008, we had no outstanding indebtedness except for
approximately $0.2 million in notes payable to a finance company, resulting from the consolidation of VL Capital, and a contract payable to a finance company of approximately $0.3 million. See Note 13 to our consolidated financial statements for
further discussion.
Warrants Issued in connection with Indebtedness and other Transactions
In connection with the BWCA loan (which was repaid in full in May 2006), we issued to the lender warrants to purchase an aggregate of 717,450 shares of
our common stock at an exercise price of $4.00 per share. These warrants expired in November 2008.
On August 13, 2007, we entered
into an Omnibus Amendment to Business Loan Agreement and Warrants dated October 3, 2003, April 30, 2004 and February 10, 2006 (Omnibus Amendment) with BWCA I, LLC. Pursuant to the terms of the Omnibus Amendment, the prepayment
penalty associated with the May 2006 repayment of the loans previously outstanding and owed to BWCA I, LLC was reduced from 5.0% to 2.5%, and each of the warrants previously issued to BWCA I, LLC was amended to allow the holder thereof to effect a
“net” or “cashless” exercise of the warrant.
Subsequent to the Omnibus Agreement, during the last two quarters of
2007, holders of 56,066 warrants exercised such warrants through cashless exercises, and received 38,995 shares of our common stock. The remaining warrants outstanding under the Omnibus Agreement expired in November 2008.
In connection with the XACP Notes (which were repaid in full in May 2006), we issued to the purchasers warrants to purchase an aggregate of 750,000
shares of our common stock at an exercise price of $5.50 per share and warrants to purchase an aggregate of 250,000 shares of our common stock at an exercise price of $7.00 per share. During the third and fourth quarters of 2007, the holders of the
XACP warrants exercised 725,000 warrants at an exercise price of $5.50 per share and 225,000 warrants at an exercise price of $7.00 per share, resulting in the issuance of 950,000 shares of our common stock and net proceeds to us of approximately
$5.6 million.
In connection with the issuance of the Aqua Note (which was repaid in full in May 2007), we granted to Aqua America a
warrant to purchase 300,000 shares of our common stock at an exercise price of $6.00 per share and a warrant to purchase 100,000 shares of our common stock at an exercise price of $7.00 per share. During the fourth quarter of 2007, the holders of
the Aqua warrants exercised all of their warrants, resulting in the issuance of 400,000 shares of our common stock and net proceeds to us of $2.5 million.
In addition, in connection with the consent granted by BWCA I, LLC with respect to our issuance of the Aqua Note, we granted to BWCA I, LLC a warrant to purchase 50,000 shares of our common stock at an exercise price
of $8.00 per share.
Pursuant to our December 2005 binding commitment letter with Shaw, Shaw committed to purchase a total of $5.0 million
of our groundwater treatment systems prior to December 31, 2006. As part of that commitment letter, we granted to Shaw a warrant to purchase 300,000 shares of our common stock at an exercise price of $7.00 per share in connection with its
purchase of our groundwater treatment systems. As of December 31, 2007, no shares had vested under the Shaw warrant. Subsequently, as part of our September 18, 2008 acquisition of Envirogen from Shaw, we entered into a settlement agreement
with Shaw which cancelled the Shaw warrants.
61
We have applied the provisions of SFAS No. 123 and SFAS No. 123(R) to the warrants issued in
connection with these transactions. Accordingly, the total fair value of the warrants issued has been calculated using the Black-Scholes method. In accordance with the provisions of SFAS No. 150,
Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity
, the fair values of those warrants primarily related to indebtedness have been or will be recorded as a discount to notes payable, with a corresponding increase in common stock. The fair value
of such warrants is being amortized through the end of each respective loan term under the interest method.
Off-Balance Sheet Arrangements
In 2007, the Company entered into four transactions with respect to the sale of water treatment units to two special purpose entities
(VL Capital, or VLC, and Water Services Solutions, or WSS) that were to be funded by third-party financial institutions. The underlying agreements provided that the Company would sell VLC and WSS water treatment units subject to water service
agreements (WSAs) between the Company and its customers. The special purpose entities would then have the right to receive the scheduled lease payments from the customers subject to the WSAs. The Company has concluded that the financial statements
of VLC and WSS should be consolidated with those of the Company in accordance with FIN 46(R). This analysis is based on the fact that the structure of the transactions with VLC and WSS did not effectively transfer sufficient risk to the other
parties to the transactions, leaving the Company with the majority of the risks.
Other than as described above, as of December 31,
2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market
or credit risk that could arise if we had engaged in these relationships. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties.
Contractual Obligations
The following table
summarizes our significant contractual obligations as of December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
Less than
1 Year
(2009)
|
|
1 to 3
Years
(2010-2011)
|
|
3 to 5
Years
(2012-2013)
|
|
More than
5 Years
(After 2013)
|
|
Total
|
|
|
|
(In thousands)
|
|
Long-term debt obligations
|
|
$
|
408
|
|
$
|
11
|
|
$
|
52
|
|
$
|
46
|
|
$
|
517
|
|
Capital lease obligations
|
|
|
10
|
|
|
5
|
|
|
—
|
|
|
—
|
|
|
15
|
|
Operating lease obligations
|
|
|
886
|
|
|
1,301
|
|
|
292
|
|
|
—
|
|
|
2,479
|
|
Capital commitments
(1)
|
|
|
5,030
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
5,030
|
|
Purchase commitments
(2)
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
6,334
|
|
$
|
1,317
|
|
$
|
344
|
|
$
|
46
|
|
$
|
8,041
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) —
|
Represents estimated costs to complete groundwater treatment systems under current contracts with customers.
|
|
(2) —
|
There were no minimum purchase arrangements with vendors.
|
Effect of
Inflation and Seasonality
We do not believe that inflation will have a material impact on our financial condition or results of
operations. We believe current contracts and pricing policies will allow for these costs to be appropriately passed on to our customers. We identified certain older contracts where we did not provide for the ability to offset cost increases and
recorded a $3.7 million reserve in 2006 for these future losses.
During 2007, as these contracts progressed and as additional older legacy
contracts became operational and were operated during the busy, higher volume summer months, it became apparent by the third quarter of 2007 that the original reserve was not adequate. Management reviewed each contract’s financial performance
and
62
identified the future expected losses for these contracts, resulting in an approximate $6.8 million increase to the reserve for future contract losses
(offset by approximately $1.4 million of actual contract loss charges against the reserve during 2007) which was charged to cost of contract revenues during the third quarter of 2007. During 2008, we reversed approximately $1.1 million of actual
contract losses against the reserve. The reserve for future contract losses included on our balance sheet, both short- and long-term, as of December 31, 2008 was approximately $8.0 million.
Our business, particularly the revenues we receive from our long-term contracts, is moderately seasonal due to the impact of summer and hot weather
conditions on the water requirements of our customers. In the summer and warmer months, our customers have a higher demand for water and must increase the utilization of their groundwater resources resulting in a higher volume of groundwater treated
during these periods and thus higher revenues from our long-term contracts. Our net sales and net income have historically been lowest in the three-month periods ending December 31 and March 31, when the arid West generally faces cooler
weather that reduces the utilization of groundwater sources, which in turn reduces the processing fees we receive from our long-term contracts. Historically, the impact of seasonality has been mitigated through the impact of the sales of our systems
in certain periods.
Recently Issued Accounting Standards
In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109
(FIN 48). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109
, Accounting for Income Taxes
. FIN 48 also prescribes a recognition threshold and measurement standard for the financial
statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure
and transition. The provisions of FIN 48 became effective for the Company on January 1, 2007. The provisions of FIN 48 are to be applied to all tax positions upon initial application of this standard. Only tax positions that meet the
more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption. The cumulative effect of applying the provisions of FIN 48, if any, must be reported as an adjustment to the opening
balance of retained earnings or other appropriate components of equity for the fiscal year of adoption. The adoption of FIN 48 had no material impact on our financial statements.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
. This statement establishes a single authoritative definition of
fair value, sets out framework for establishing fair value, and requires additional disclosures about fair value measurements. This statement applies only to fair value measurements that are already required or permitted by other accounting
standards and is expected to increase the consistency of those measurements. We were required to adopt SFAS No. 157 for our fiscal year beginning on January 1, 2008, prospectively applied, except for the provisions of SFAS No. 157 relating to
nonfinancial instruments, which will be required to be adopted by us for our fiscal year beginning January 1, 2009. The adoption of SFAS No. 157 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment
of FASB Statement No. 115
. This statement permits companies to choose to measure many financial instruments and other specified items at fair value. We were required to adopt SFAS No. 159 for our fiscal year beginning on January 1, 2008,
prospectively applied. The adoption of SFAS No. 159 did not have a material impact on our consolidated financial statements.
In December
2007, the FASB issued SFAS No. 141(R),
Business Combinations
(SFAS 141(R)). This statement replaces SFAS No. 141 in its entirety and retains the fundamental requirements in SFAS 141, including that the purchase method be used
for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the
acquisition date as the date that the acquirer achieves
63
control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business
combination, including business combinations achieved in states (step acquisition), to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values of
that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. SFAS 141(R)
applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first reporting period beginning on or after December 15, 2008, and may not be applied before that date. We are currently
evaluating the impact SFAS 141(R) could have on our consolidated financial statements.
In December 2007, the FASB issued SFAS
No. 160,
Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51
(SFAS 160), which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. This statement is effective for the fiscal year beginning January 1, 2009 and will be applied prospectively. We do not expect adoption of SFAS 160 to have a material impact on our consolidated financial
statements.
|
ITEM 7A.
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. At December 31, 2008, we had no outstanding indebtedness except for $0.4 million of notes payable to a finance company
through VL Capital. The amount of our outstanding debt at any time may fluctuate and we may from time to time be subject to refinancing risk. A hypothetical 100 basis point increase in interest rates would not have a material effect on our annual
interest expense, our results of operations or financial condition. We derive substantially all of our revenues from sales within the United States. Since transactions in foreign currencies are immaterial to us as a whole because we do not currently
have any significant foreign customers nor do we enter into contracts with foreign entities except contracts denominated in United States currency, we do not consider it necessary to hedge against currency risk.
|
ITEM 8.
|
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
Our
financial statements, supplementary financial data and financial statement schedules are included in a separate section at the end of this Report. The financial statements, supplementary data and schedules are listed in the index on page F-1 of this
Report and are incorporated herein by reference.
|
ITEM 9.
|
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|
None.
|
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
our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure
that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer (CEO) and chief financial officer (CFO), as
appropriate to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
64
Management, with participation by our CEO and CFO, has designed the Company’s disclosure controls
and procedures to provide reasonable assurance of achieving the desired objectives. As required by SEC Rule 13a-15(b), in connection with filing this Annual Report on Form 10-K, management conducted an evaluation, with the participation of our CEO
and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act, as of December 31, 2008, the end of the period covered by this
report.
Based upon the evaluation conducted by management in connection with the audit of the Company’s financial statements for the
year ended December 31, 2008, and, in connection with the restatement of our financial statements for the years ended December 31, 2007 and 2006, we identified material weaknesses in our internal control over financial reporting that
existed as of December 31, 2008. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or
interim financial statements will not be prevented or detected on a timely basis.
As a result of these material weaknesses, our CEO and
CFO concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of December 31, 2008.
(b)
Management’s Evaluation of Internal Control over Financial Reporting
Our management is responsible for establishing and
maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting refers to a process designed by, or under the supervision of, our CEO and CFO,
and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles (GAAP) and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and disposition of our assets;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of
our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Our management performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 based upon
the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management concluded that our internal control over financial reporting was not effective as of
December 31, 2008 as a result of the material weaknesses described below.
Our independent registered public accounting firm has
issued an attestation report on our internal control over financial reporting, which is included in Item 8 of this Report.
The
ineffectiveness of internal control over financial reporting as of December 31, 2008 stemmed from several significant factors. The organization structure was changing as we hired additional management, and we were establishing new accounting
processes and procedures. Additionally, the integration of recently-acquired businesses, namely MPT in late 2007 and Envirogen in late 2008, caused additional changes to our organization structure and accounting systems. This placed additional
stress on the organization and our internal controls as these new structures were being instituted within the Company. These changes in our management, reporting structure and our accounting systems and processes resulted in a material weakness in
our internal control over financial reporting.
65
In connection with the restatement of our consolidated financial statements, we have identified the
following material weaknesses in our internal control over financial reporting that continued to exist as of December 31, 2008:
|
|
•
|
|
A lack of sufficient personnel with appropriate knowledge, experience and training in applying GAAP to transactions and the correct application of revenue
recognition principles required under GAAP;
|
|
|
•
|
|
A lack of effective checks and balances between the former CFO and accounting and legal functions with respect to the negotiation, structuring and accounting for
transactions, including water treatment unit sales and water service agreements;
|
|
|
•
|
|
A failure to maintain adequately organized business records and complete documentation for sales contracts, many of which lacked execution dates, signatures by
Company or counterparty representatives; the use of draft or non-standard arrangements; and the lack of adequate written agreements to memorialize significant transactions;
|
|
|
•
|
|
Insufficient information systems and processes to accumulate information to timely identify and address business and accounting issues;
|
|
|
•
|
|
A lack of sufficiently detailed written accounting policies and procedures with respect to the timing and recognition of sales transactions and an insufficient
process at the time of the transactions to monitor compliance with such policies and procedures; and
|
|
|
•
|
|
A failure to maintain an effective internal audit function.
|
In light of these material weaknesses, we performed additional analyses and procedures in order to conclude that our consolidated financial statements for the year ended December 31, 2008 included in this Annual
Report on Form 10-K were fairly presented in accordance with GAAP. Accordingly, management believes that despite our material weaknesses, our financial statements for the year ended December 31, 2008 are fairly presented in accordance with
GAAP.
Based on our remediation efforts described below, we expect to enhance our internal control over financial reporting with the goal
of remediating the foregoing material weaknesses by December 31, 2009. The effectiveness of the measures we implement in this regard will be subject to ongoing management review supported by confirmation and testing by management and by our
internal auditors, as well as audit committee oversight. As a result, we expect that additional changes could be made to our internal control over financial reporting and our disclosure controls and procedures. In addition, we may in the future
identify additional material weaknesses in our internal control over financial reporting that we have not identified as of the date of this report.
(c)
Plan for Remediation of Material Weaknesses
We have implemented a number of changes designed to improve our internal control over
financial reporting such as:
|
|
•
|
|
We hired a new CFO in June 2008;
|
|
|
•
|
|
We retained an experienced consultant to assist us in our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002;
|
|
|
•
|
|
We have developed and are implementing our accounting policies and procedures with enhanced controls surrounding expenditures, cutoff dates and payroll processing
and procedures;
|
|
|
•
|
|
With respect to revenue recognition, we now require the CFO and either the General Counsel or the CEO to provide formal written or electronic approval of all sales
contracts;
|
|
|
•
|
|
We have developed procedures and internal documentation to reduce the risks associated with non-routine transaction documents;
|
66
|
|
•
|
|
We have developed policies and procedures designed to ensure that the appropriate authorized officers receive on a timely basis information regarding proposed
transactions prior to execution and approval of such transactions;
|
|
|
•
|
|
With respect to non-routine transactions, we have adopted additional procedures designed to ensure the correct accounting treatment of such transactions including,
where appropriate, retention of outside accounting specialists where additional expertise is determined to be advisable based upon the nature of the transaction; and
|
|
|
•
|
|
We have implemented new financial systems designed to enhance our financial reporting process.
|
Subject to the availability of resources in light of our liquidity situation, we intend to take the following additional remediation efforts:
|
|
•
|
|
increase our accounting and finance resources and/or the accounting qualifications of current personnel;
|
|
|
•
|
|
conduct additional employee training relating to existing and newly implemented policies and procedures;
|
|
|
•
|
|
realign our internal audit review and internal reporting function in a manner designed to ensure compliance with written accounting and revenue recognition
procedures;
|
|
|
•
|
|
adopt additional procedures with respect to monitoring and internal communication within the organization; and
|
|
|
•
|
|
implement new policies and procedures designed to improve cutoff, reporting and processing functions.
|
We believe these remediation efforts will continue to improve our internal control over financial reporting.
We have incurred, and expect to continue to incur, substantial expenses relating to the remediation of the material weaknesses in our internal control
over financial reporting. The effectiveness of our internal control over financial reporting may in the future be limited by:
|
|
•
|
|
failure of the effectiveness of our policies, procedures and information systems and processes;
|
|
|
•
|
|
delays in upgrading financial software systems; and
|
|
|
•
|
|
the possibility that enhancements to our disclosure controls and procedures or internal control over financial reporting may not adequately assure timely and
accurate financial information.
|
(d) Changes in Internal Control over Financial Reporting
Other than as described above, there were no changes in our internal control over financial reporting during the quarter ended December 31, 2008 that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
|
ITEM 9B.
|
OTHER INFORMATION
|
None.
67
PART III
|
ITEM 10.
|
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|
Directors
Information relating to the officers and directors of the Company, other corporate governance matters and other
information required under this Item 10 will either be set forth in our Proxy Statement for our 2009 Annual Meeting of Stockholders (Proxy Statement) and incorporated herein by reference or will be included in an amendment to this Annual Report
on Form 10-K to be filed on or prior to 120 days after the end of our fiscal year.
Executive Officers
Michael M. Stark
has served as our President and Chief Executive Officer since February 2008, and as our President and Chief Operating Officer from
October 2006 to February 2008. Mr. Stark served from 1997 to 2005 as President of Veolia Water North America, previously known as USFilter, a water services company. From 2005 to 2006, Mr. Stark has been an independent consultant to
companies in the water industry. From 1992 to 1997, Mr. Stark served as President and Chief Executive Officer of Mobley Environmental Services, a company specializing in non-hazardous hydrocarbon recycling. Prior to that time, Mr. Stark
has held executive positions at a variety of companies, and has been in the water, environmental and specialty chemical industry since 1965. Mr. Stark holds a B.S. in Biology from Marietta College.
W. Christopher Chisholm
has served as our Vice President and Chief Financial Officer since June 2008. From 2003 to 2008, Mr. Chisholm served
as Executive Vice President, Finance & Administration and Chief Financial Officer of Veolia Water North America. Subsequent to the 1999 acquisition of USFilter by Veolia Environment, Mr. Chisholm served as Executive Vice President,
Finance of US Filter until 2003. In 1997, Mr. Chisholm joined US Filter (prior to it becoming Veolia Water) as its Vice President and Group Controller for North American operations and later served as Vice President and Chief Financial Officer
of USFilter’s Water & Wastewater Group until 1999. From 1991 to 1997, Mr. Chisholm served as Vice President and Chief Financial Officer of Mobley Environmental Services, which was acquired in 1997 by USFilter. Prior to his career
in the environmental services and water industries, Mr. Chisholm spent 11 years in the audit practice of KPMG, an international public accounting and consulting firm, serving clients in a wide variety of industries. Mr. Chisholm is an
accounting graduate of the University of Louisiana at Monroe and obtained his certification as a Certified Public Accountant in 1981.
Scott B. Hamilton
has served as the Company’s General Counsel since July 2007 and as the Company’s Secretary since August 2007. From 2005 to 2007, Mr. Hamilton served as Associate General Counsel of Veolia Water North
America Operating Services, LLC, previously known as USFilter Operating Services, Inc., a water services company, and from 1999 to 2004, served as Senior Counsel of the same company. From 1998 to 1999, Mr. Hamilton served as the Vice President,
General Counsel and Assistant Secretary of USFilter Operating Services, Inc., and Regional Counsel of USFilter, before its acquisition by Veolia Water North America. From 1992 to 1998, Mr. Hamilton served in the enforcement division of the
Securities and Exchange Commission, and prior to that was involved in the private practice of law for several years. Mr. Hamilton holds a B.A. in Comparative Area Studies and History from Duke University and a J.D. from the University of
Illinois College of Law.
Richard A. Reese
joined Basin Water in September of 2007 as the Marketing Vice President, and was named an
Executive Officer in January of 2008. From 1997 to 2008, Mr. Reese served in management roles within Siemens Water Technologies, Inc., previously known as USFilter. These roles included Vice President, General Manager of Aftermarket within the
Services & Products segment (2003 – 2007), Senior Vice President, Marketing within the Services Group of USFilter/Veolia Water (2002 – 2003), Vice President, Customer Service & Satisfaction (2000 – 2002) for
USFilter, and Vice President, General Manager of the Recovery Services Southwest business unit of USFilter (1997 – 2000). Prior to joining USFilter, Mr. Reese served in
68
Regional Vice President and Business Development roles with Mobley Environmental Services, Inc., as an Operations manager for Browning Ferris Waste
Management Systems Inc., and as an engineer for R.J. Brown and Associates of America and J.P. Kenny Offshore Engineering. Mr. Reese holds a B.S. in Ocean Engineering from Texas A&M University and an MBA from the University of Texas.
Code of Ethics
We have adopted the
Basin Water, Inc. Code of Business Conduct and Ethics (Code of Ethics). The Code of Ethics applies to all of our directors, officers and employees, including our chief executive officer and chief financial officer (who is also our principal
accounting officer), and is available to the public in the Investor Relations section of our website at
www.basinwater.com.
|
ITEM 11.
|
EXECUTIVE COMPENSATION
|
Information relating to
executive compensation and director compensation and other information required under this Item 11 will either be set forth in our Proxy Statement and incorporated herein by reference, except for the information set forth under the caption
“Compensation Committee Report” which specifically is not incorporated herein by reference, or will be included in an amendment to this Annual Report on Form 10-K to be filed on or prior to 120 days after the end of our fiscal year.
|
ITEM 12.
|
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|
Information concerning ownership of our common stock and other securities by certain persons and other information required under this Item 12 will
either be set forth in our Proxy Statement and incorporated herein by reference or will be included in an amendment to this Annual Report on Form 10-K to be filed on or prior to 120 days after the end of our fiscal year.
|
ITEM 13.
|
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|
The information concerning certain relationships and related transactions and director independence and other information required under this Item 13 will either be set forth in our Proxy Statement and
incorporated herein by reference or will be included in an amendment to this Annual Report on Form 10-K to be filed on or prior to 120 days after the end of our fiscal year.
|
ITEM 14.
|
PRINCIPAL ACCOUNTING FEES AND SERVICES
|
Information
regarding principal accounting fees and services and other information required under this Item 14 will either be set forth in our Proxy Statement and incorporated herein by reference or will be included in an amendment to this Annual Report on
Form 10-K to be filed on or prior to 120 days after the end of our fiscal year.
69
PART IV
|
ITEM 15.
|
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|
(A)
Documents filed as part of this report.
1. The following consolidated financial statements of Basin Water, Inc. and subsidiaries and
Reports of SingerLewak LLP, independent registered public accounting firm, are included in this report:
|
|
•
|
|
Report of SingerLewak LLP, Independent Registered Public Accounting Firm
|
|
|
•
|
|
Consolidated Balance Sheets as of December 31, 2008 and 2007
|
|
|
•
|
|
Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006
|
|
|
•
|
|
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2008, 2007 and 2006
|
|
|
•
|
|
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006
|
|
|
•
|
|
Notes to Consolidated Financial Statements
|
2. List of financial statement schedules-Schedule II—Valuation and Qualifying Accounts.
3. List of exhibits required by
Item 601 of Regulation S-K. See part (B) below.
(B) Exhibits.
The following exhibits are filed as part of, or incorporated by reference into, this report:
|
|
|
|
|
|
|
Exhibit
Number
|
|
|
|
Exhibit Description
|
|
2.1
|
|
(1)
|
|
Agreement and Plan of Merger, dated August 31, 2007, by and among the Registrant, BW Acquisition Merger Sub, Inc., Basin Water-MPT, Inc., Mobile Process Technology, Co. and the stockholders
of Mobile Process Technology, Co.
|
|
|
|
|
|
2.2
|
|
†(3)
|
|
Asset Purchase Agreement, dated as of September 18, 2008, by and among Shaw Environmental & Infrastructure, Inc., Shaw Environmental, Inc., Envirogen Inc. and the
Registrant
|
|
|
|
|
|
3.1
|
|
(3)
|
|
Amended and Restated Certificate of Incorporation of the Registrant
|
|
|
|
|
|
3.2
|
|
(3)
|
|
Amended and Restated Bylaws of the Registrant
|
|
|
|
|
|
4.1
|
|
(3)
|
|
Form of the Registrant’s Common Stock Certificate
|
|
|
|
|
|
4.2
|
|
(3)
|
|
Registration Rights Agreement, dated June 28, 2005, among the Registrant and holders of Preferred Stock
|
|
|
|
|
|
4.3
|
|
(3)
|
|
Form of Common Stock Warrant
|
|
|
|
|
|
10.1
|
|
#(4)
|
|
Form of Amended and Restated Indemnification Agreement for Directors and Executive Officers
|
|
|
|
|
|
10.2
|
|
#(3)
|
|
2001 Stock Option Plan, as amended and restated and form of option agreement hereunder
|
|
|
|
|
|
10.3
|
|
#(5)
|
|
Amended and Restated Director Compensation Policy, dated March 27, 2007
|
|
|
|
|
|
10.4
|
|
#(3)
|
|
2006 Equity Incentive Award Plan and forms of option and restricted stock agreements hereunder
|
|
|
|
|
|
10.5
|
|
#(3)
|
|
2006 Employee Stock Purchase Plan
|
70
|
|
|
|
|
|
|
Exhibit
Number
|
|
|
|
Exhibit Description
|
|
10.6
|
|
(3)
|
|
Standard Industrial/Commercial Single-Tenant Lease, dated June 7, 2002 between the Registrant and White Oak, LLC for the property located at 8731 Prestige Court, Rancho Cucamonga, California
91730
|
|
|
|
|
|
10.7
|
|
(3)
|
|
First Amendment to Standard Industrial/Commercial Single-Tenant Lease—Gross, dated August 4, 2004, between the Registrant and White Oak, LLC
|
|
|
|
|
|
10.8
|
|
(3)
|
|
Second Amendment to Standard Industrial/Commercial Single-Tenant Lease-Gross, dated February 15, 2006, between the Registrant and White Oak, LLC
|
|
|
|
|
|
10.9
|
|
#(6)
|
|
Employment Agreement, dated October 27, 2006, between Michael Stark and Registrant
|
|
|
|
|
|
10.10
|
|
#(7)
|
|
Amendment No. 1 to 2006 Equity Incentive Award Plan dated May 10, 2007
|
|
|
|
|
|
10.11
|
|
#(8)
|
|
Employment Agreement, dated June 29, 2007, between Scott Hamilton and Registrant
|
|
|
|
|
|
10.12
|
|
(9)
|
|
Omnibus Amendment to Business Loan Agreement and Warrants dated October 3, 2003, April 30, 2004, October 26, 2004 and February 10, 2006 between Registrant and
BWCA I, LLC
|
|
|
|
|
|
10.13
|
|
(10)
|
|
Escrow Agreement, dated September 14, 2007, among Registrant, Mobile Process Technology, Co., the Stockholders’ Representative and Computershare Trust Company, N.A.
|
|
|
|
|
|
10.14
|
|
(10)
|
|
Lease Agreement, dated September 14, 2007, by and between Basin Water-MPT, Inc. and Craft Real Property, LLC
|
|
|
|
|
|
10.15
|
|
(10)
|
|
Form of Non-Compete and Non-Solicitation Agreement, dated September 14, 2007, by and between Registrant and the other parties thereto
|
|
|
|
|
|
10.16
|
|
†(4)
|
|
Alliance Agreement, dated November 14, 2007, between Rohm and Haas Chemicals LLC and Registrant
|
|
|
|
|
|
10.17
|
|
(11)
|
|
Assignment and Amendment Agreement, dated December 21, 2007, among Empire Water Corporation, Basin Water Resources, Inc. and Indian Hills Water Conservation Corporation, West Riverside Canal
Company, West Riverside 350 Inch Company, Henry Cox and John L. West
|
|
|
|
|
|
10.18
|
|
(11)
|
|
Stock Purchase Agreement between Empire Water Corporation and Basin Water Resources, Inc., dated as of December 21, 2007
|
|
|
|
|
|
10.19
|
|
#(12)
|
|
Employment Transition and Consulting Agreement, dated February 19, 2008, between Peter L. Jensen and Registrant
|
|
|
|
|
|
10.10
|
|
(13)
|
|
Agreement to Sell and Purchase, dated September 14, 2007, between VL Capital LLC and Registrant
|
|
|
|
|
|
10.21
|
|
(13)
|
|
Term Loan Agreement, dated September 2007, and amendment, between VL Capital LLC and Registrant
|
|
|
|
|
|
10.22
|
|
(13)
|
|
Security Agreement, dated September 14, 2007 between VL Capital LLC and Registrant
|
|
|
|
|
|
10.23
|
|
(14)
|
|
Release of All Claims dated February 13, 2008 between the Registrant and GBM Newco, LLC
|
|
|
|
|
|
10.24
|
|
(15)
|
|
Employment Agreement between W. Christopher Chisholm and Registrant dated June 17, 2008
|
|
|
|
|
|
10.25
|
|
(16)
|
|
Basin Water, Inc. 2008 Annual Incentive Plan adopted on April 23, 2008
|
|
|
|
|
|
10.26
|
|
(16)
|
|
Second Amended and Restated Director Compensation Policy, effective as of May 6, 2008
|
71
|
|
|
|
|
|
|
Exhibit
Number
|
|
|
|
Exhibit Description
|
|
10.27
|
|
(17)
|
|
Settlement Agreement, dated as of September 18, 2008, by and among Shaw Environmental & Infrastructure, Inc., Shaw Environmental, Inc. and Registrant
|
|
|
|
|
|
10.28
|
|
†(17)
|
|
Biological Materials Sales Agreement, dated as of September 18, 2008, by and between Shaw Environmental, Inc. and Registrant
|
|
|
|
|
|
10.29
|
|
#(18)
|
|
Resignation Letter Agreement, dated October 13, 2008, between the Registrant and Thomas C. Tekulve
|
|
|
|
|
|
10.30
|
|
(19)
|
|
Standard Multi-Tenant Office Lease, dated June 1, 2007, between the Registrant and Sixth & Pittsburgh, LLC
|
|
|
|
|
|
10.31
|
|
#(20)
|
|
Amended and Restated Employment Agreement, dated December 16, 2008, between Michael M. Stark and the Registrant
|
|
|
|
|
|
10.32
|
|
#(20)
|
|
Amended and Restated Employment Agreement, dated December 16, 2008, between Scott B. Hamilton and the Registrant
|
|
|
|
|
|
10.33
|
|
#(20)
|
|
Amended and Restated Employment Agreement, dated December 16, 2008, between Richard A. Reese and the Registrant
|
|
|
|
|
|
10.34
|
|
(21)
|
|
Settlement Agreement and Release, effective as of December 8, 2008, by and among Process Water Solutions, LLC, Veolia Water North America Operations Services, LLC, Clean Water Technologies,
LLC, Dr. Phosphate, Inc., Basin Water-MPT, Inc., Registrant, Robert Gorgol, Robert Stark and Michael Stark
|
|
|
|
|
|
10.35
|
|
(21)
|
|
Settlement Agreement and Mutual General Release, effective as of February 5, 2009, by and among Registrant, BionBasin, Inc., Opus Trust, Inc. and Martin A. Benowitz, individually and as
Trustee of the Martin A. Benowitz Qualified Profit Sharing Plan
|
|
|
|
|
|
23.1
|
|
|
|
Consent of SingerLewak LLP, independent registered public accounting firm (filed herewith)
|
|
|
|
|
|
31.1
|
|
|
|
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
|
|
|
|
|
|
31.2
|
|
|
|
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
|
|
|
|
|
|
32.1
|
|
*
|
|
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to the Sarbanes-Oxley Act of 2002 (filed herewith)
|
|
|
|
|
|
32.2
|
|
*
|
|
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to the Sarbanes-Oxley Act of 2002 (filed herewith)
|
|
(1)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K/A filed on September 6, 2007.
|
|
(2)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K/A filed on September 22, 2008.
|
|
(3)
|
Incorporated by reference to the Registrant’s Registration Statement on Form S-1 filed on February 13, 2006, as amended.
|
|
(4)
|
Incorporated by reference to the Registrant’s Annual Report on Form 10-K filed on March 17, 2008.
|
|
(5)
|
Incorporated by reference to the Registrant’s Annual Report on Form 10-K filed on April 2, 2007.
|
|
(6)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on October 30, 2006.
|
|
(7)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on May 16, 2007.
|
|
(8)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on July 6, 2007.
|
|
(9)
|
Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2007.
|
|
(10)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on September 17, 2007.
|
|
(11)
|
Incorporated by reference to the Schedule 13D/A filed by the Registrant with respect to Empire Water Corporation on January 10, 2008.
|
72
|
(12)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on February 25, 2008.
|
|
(13)
|
Incorporated by reference to the Registrant’s Annual Report on Form 10-K/A filed on February 10, 2009.
|
|
(14)
|
Incorporated by reference to the Registrant’s Quarterly Report Form 10-Q/A for the quarter ended March 31, 2008, filed on February 10, 2009.
|
|
(15)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on June 23, 2008.
|
|
(16)
|
Incorporated by reference to the Registrant’s Quarterly Report Form 10-Q for the quarter ended June 30, 2008, filed on February 10, 2009.
|
|
(17)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on September 22, 2008.
|
|
(18)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on October 14, 2008.
|
|
(19)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on November 18, 2008.
|
|
(20)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on December 19, 2008.
|
|
(21)
|
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on February 10, 2009.
|
|
#
|
Indicates management contract or compensatory plan.
|
|
†
|
Confidential treatment has been requested for portions of this exhibit.
|
|
*
|
These certifications are being furnished solely to accompany this Annual Report on Form 10-K pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of
Section 18 of the Securities Exchange Act of 1934 and are not being incorporated by reference into any filing of Basin Water, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.
|
73
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 and in the capacities indicated.
|
|
|
|
|
|
|
|
|
|
|
Basin Water, Inc. (Registrant)
|
|
|
|
|
|
|
|
|
|
|
|
BY:
|
|
/
S
/ M
ICHAEL
M. S
TARK
|
|
|
|
BY:
|
|
/
S
/ W. C
HRISTOPHER
C
HISHOLM
|
|
|
|
Michael M. Stark
Chief Executive Officer and Director
(Principal Executive Officer)
|
|
|
|
|
|
W. Christopher Chisholm
Chief Financial Officer
(Principal Financial and Accounting Officer)
|
Date: March 31, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities indicated and on the date indicated.
|
|
|
|
|
|
|
|
BY:
|
|
/s/ S
COTT
A. K
ATZMANN
|
|
|
|
Scott A. Katzmann
|
|
|
|
Chairman of the Board of Directors
|
|
|
|
|
BY:
|
|
/s/ R
OGER
S. F
AUBEL
|
|
|
|
Roger S. Faubel
|
|
|
|
Director
|
|
|
|
|
BY:
|
|
/s/ V
ICTOR
J. F
RYLING
|
|
|
|
Victor J. Fryling
|
|
|
|
Director
|
|
|
|
|
BY:
|
|
/s/ S
TEPHEN
A. S
HARPE
|
|
|
|
Stephen A. Sharpe
|
|
|
|
Director
|
|
|
|
|
BY:
|
|
/s/ S
USAN
H. S
NOW
|
|
|
|
Susan H. Snow
|
|
|
|
Director
|
|
|
|
|
BY:
|
|
/s/ K
EITH
R. S
OLAR
|
|
|
|
Keith R. Solar
|
|
|
|
Director
|
Date: March 31, 2009
74
BASIN WATER, INC.
INDEX TO FINANCIAL STATEMENTS
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Basin Water, Inc. and
subsidiaries
Rancho Cucamonga, California
We
have audited the consolidated balance sheets of Basin Water, Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the
three years in the period ended December 31, 2008. Our audits also included the financial statement schedule of the Company listed in Item 15 (A). These financial statements and financial statement schedules are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our
audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2007, and the results of their
operations and their cash flows for each of the three years in the period ended December 31,2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered
in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our report dated March 31, 2009 expressed an opinion that the Company had not maintained
effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note
1 to the financial statements, the Company has suffered recurring losses from operations. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also
described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ SINGERLEWAK LLP
Irvine, California
March 31, 2009
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Basin Water, Inc. and
Subsidiaries
Rancho Cucamonga, California
We
have audited Basin Water Inc.’s (the Company) internal control over financial reporting as of December 31, 2008, based on criteria established in
Internal Control—Integrated Framework
issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting
included in the accompanying Management’s Evaluation of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s
internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that
(a)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company;
(b)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(c)
provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material
weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not
be prevented or detected on a timely basis.
As of December 31, 2008, the Company lacked an effective internal control environment.
Material weaknesses have been identified in the following transaction cycles:
|
|
•
|
|
Treasury and cash management
|
|
|
•
|
|
Cash disbursements cycle including payment for inventory purchases, fixed assets and payment for services.
|
|
|
•
|
|
Human resource management relating to payroll processing
|
|
|
•
|
|
Stockholders’ equity which includes the process of managing equity instruments issued by the Company
|
|
|
•
|
|
Financial control and reporting which includes monthly, quarterly and annual closing processes as well as communicating reporting requirements and proper disclosure
requirements
|
F-3
|
|
•
|
|
Revenue recognition cycle relating to sales of water treatment units
|
|
|
•
|
|
Information technology controls and related systems such as non-integrated “manual” sub-ledgers
|
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2008 financial
statements, and this report does not affect our report dated March 31, 2009 on those financial statements.
In our opinion, because of
the effect of the material weakness described above on the achievement of the objectives of the control criteria, Basin Water Inc has not maintained effective internal control over financial reporting as of December 31, 2008, based on criteria
established in
Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets and consolidated statements of operations, stockholders’ equity and cash flows of
the Company for each of the three years in the period ended December 31, 2008 of Basin Water Inc and our report dated March 31, 2009 expressed an unqualified opinion.
/s/ SINGERLEWAK LLP
Irvine, California
March 31, 2009
F-4
BASIN WATER, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
11,954
|
|
|
$
|
36,038
|
|
|
Accounts receivable trade, net of $190 and $92 allowance for doubtful accounts
|
|
|
1,464
|
|
|
|
2,458
|
|
|
Accounts receivable under long-term contracts
|
|
|
3,776
|
|
|
|
709
|
|
|
Unbilled receivables, net of $544 and $208 allowance for doubtful accounts
|
|
|
2,234
|
|
|
|
7,357
|
|
|
Inventory, net of $246 and $79 reserves
|
|
|
1,387
|
|
|
|
975
|
|
|
Prepaid expenses and other
|
|
|
1,030
|
|
|
|
1,163
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
21,845
|
|
|
|
48,700
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
31,894
|
|
|
|
24,885
|
|
|
Less: accumulated depreciation
|
|
|
3,640
|
|
|
|
2,235
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
28,254
|
|
|
|
22,650
|
|
|
|
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
2,490
|
|
|
|
6,323
|
|
|
Unbilled receivables, net of current portion
|
|
|
—
|
|
|
|
3,653
|
|
|
Intangible assets, net
|
|
|
2,382
|
|
|
|
2,468
|
|
|
Patent costs, net
|
|
|
3,233
|
|
|
|
2,274
|
|
|
Investment in affiliate
|
|
|
1,857
|
|
|
|
4,632
|
|
|
Other assets
|
|
|
1,115
|
|
|
|
1,667
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other assets
|
|
|
11,077
|
|
|
|
21,017
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
61,176
|
|
|
$
|
92,367
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,485
|
|
|
$
|
3,553
|
|
|
Current portion of notes payable
|
|
|
408
|
|
|
|
239
|
|
|
Current portion of capital lease obligations
|
|
|
10
|
|
|
|
11
|
|
|
Current portion of deferred revenue and advances
|
|
|
1,280
|
|
|
|
266
|
|
|
Current portion of contract loss reserve
|
|
|
1,542
|
|
|
|
2,109
|
|
|
Accrued expenses and other
|
|
|
3,289
|
|
|
|
3,131
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
9,014
|
|
|
|
9,309
|
|
|
|
|
|
|
Notes payable, net of current portion
|
|
|
109
|
|
|
|
113
|
|
|
Capital lease obligations, net of current portion
|
|
|
5
|
|
|
|
15
|
|
|
Deferred revenue, net of current portion
|
|
|
257
|
|
|
|
391
|
|
|
Deferred revenue—affiliate
|
|
|
797
|
|
|
|
1,456
|
|
|
Contract loss reserve, net of current portion
|
|
|
6,428
|
|
|
|
7,003
|
|
|
Other long-term liabilities
|
|
|
337
|
|
|
|
179
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
16,947
|
|
|
|
18,466
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncontrolling interest
|
|
|
432
|
|
|
|
84
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value—100,000,000 shares authorized, 22,205,923 and
21,948,704 shares issued and outstanding
|
|
|
22
|
|
|
|
22
|
|
|
Additional paid-in capital
|
|
|
112,698
|
|
|
|
110,193
|
|
|
Treasury stock
|
|
|
(552
|
)
|
|
|
(552
|
)
|
|
Accumulated deficiency
|
|
|
(68,371
|
)
|
|
|
(35,846
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders’ equity
|
|
|
43,797
|
|
|
|
73,817
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
61,176
|
|
|
$
|
92,367
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Independent Registered Public Accountant’s Report.
The accompanying notes are an integral part of these consolidated financial statements.
F-5
BASIN WATER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System sales
|
|
$
|
3,612
|
|
|
$
|
3,980
|
|
|
$
|
10,593
|
|
|
Contract revenues
|
|
|
8,166
|
|
|
|
5,680
|
|
|
|
3,297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
11,778
|
|
|
|
9,660
|
|
|
|
13,890
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of system sales
|
|
|
3,533
|
|
|
|
6,443
|
|
|
|
10,707
|
|
|
Cost of contract revenues
|
|
|
7,773
|
|
|
|
12,545
|
|
|
|
7,562
|
|
|
Depreciation expense
|
|
|
934
|
|
|
|
539
|
|
|
|
423
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
12,240
|
|
|
|
19,527
|
|
|
|
18,692
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross loss
|
|
|
(462
|
)
|
|
|
(9,867
|
)
|
|
|
(4,802
|
)
|
|
Research and development expense
|
|
|
1,167
|
|
|
|
564
|
|
|
|
634
|
|
|
Selling, general and administrative expense
|
|
|
28,989
|
|
|
|
12,827
|
|
|
|
6,445
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(30,618
|
)
|
|
|
(23,258
|
)
|
|
|
(11,881
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
714
|
|
|
|
2,738
|
|
|
|
2,061
|
|
|
Interest expense
|
|
|
(101
|
)
|
|
|
(774
|
)
|
|
|
(3,638
|
)
|
|
Gain on sale to affiliate
|
|
|
—
|
|
|
|
3,094
|
|
|
|
—
|
|
|
Equity in loss of affiliate
|
|
|
(946
|
)
|
|
|
—
|
|
|
|
—
|
|
|
Impairment charge—investment in affiliate
|
|
|
(1,231
|
)
|
|
|
—
|
|
|
|
—
|
|
|
Other income (expense)
|
|
|
5
|
|
|
|
8
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other income (expense)
|
|
|
(1,559
|
)
|
|
|
5,066
|
|
|
|
(1,571
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(32,177
|
)
|
|
|
(18,192
|
)
|
|
|
(13,452
|
)
|
|
Income tax benefit
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before noncontrolling interest
|
|
|
(32,177
|
)
|
|
|
(18,192
|
)
|
|
|
(13,452
|
)
|
|
Less: net income attributable to noncontrolling interest
|
|
|
(348
|
)
|
|
|
(84
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(32,525
|
)
|
|
$
|
(18,276
|
)
|
|
$
|
(13,452
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(1.49
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.84
|
)
|
|
Diluted
|
|
$
|
(1.49
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.84
|
)
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
21,798
|
|
|
|
20,185
|
|
|
|
16,048
|
|
|
Diluted
|
|
|
21,798
|
|
|
|
20,185
|
|
|
|
16,048
|
|
See accompanying Independent Registered Public Accountant’s Report.
The accompanying notes are an integral part of these consolidated financial statements.
F-6
BASIN WATER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Additional
Paid-in Capital
|
|
Treasury
Stock
|
|
|
Accumulated
Deficiency
|
|
|
Totals
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
|
Balance—January 1, 2006
|
|
10,303
|
|
|
$
|
7,927
|
|
|
$
|
—
|
|
$
|
—
|
|
|
$
|
(4,118
|
)
|
|
$
|
3,809
|
|
|
Issuance of common stock for services
|
|
213
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Reincorporation at time of initial public offering
|
|
—
|
|
|
|
(7,917
|
)
|
|
|
7,917
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Net proceeds from sale of common stock in the initial public offering
|
|
6,900
|
|
|
|
7
|
|
|
|
75,171
|
|
|
—
|
|
|
|
—
|
|
|
|
75,178
|
|
|
Conversion of preferred stock to common
|
|
2,362
|
|
|
|
3
|
|
|
|
8,776
|
|
|
—
|
|
|
|
—
|
|
|
|
8,779
|
|
|
Stock options exercised
|
|
110
|
|
|
|
—
|
|
|
|
163
|
|
|
—
|
|
|
|
—
|
|
|
|
163
|
|
|
Stock-based compensation expense
|
|
—
|
|
|
|
—
|
|
|
|
676
|
|
|
—
|
|
|
|
—
|
|
|
|
676
|
|
|
Fair value of options issued
|
|
—
|
|
|
|
—
|
|
|
|
495
|
|
|
—
|
|
|
|
—
|
|
|
|
495
|
|
|
Fair value of warrants issued
|
|
—
|
|
|
|
—
|
|
|
|
1,687
|
|
|
—
|
|
|
|
—
|
|
|
|
1,687
|
|
|
Net loss
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
|
(13,452
|
)
|
|
|
(13,452
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance—December 31, 2006
|
|
19,888
|
|
|
|
20
|
|
|
|
94,885
|
|
|
—
|
|
|
|
(17,570
|
)
|
|
|
77,335
|
|
|
Stock options exercised
|
|
225
|
|
|
|
—
|
|
|
|
527
|
|
|
—
|
|
|
|
—
|
|
|
|
527
|
|
|
Warrants exercised
|
|
1,389
|
|
|
|
2
|
|
|
|
8,058
|
|
|
—
|
|
|
|
—
|
|
|
|
8,060
|
|
|
Stock-based compensation expense
|
|
—
|
|
|
|
—
|
|
|
|
1,457
|
|
|
—
|
|
|
|
—
|
|
|
|
1,457
|
|
|
Deferred stock compensation
|
|
70
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Fair value of stock issued for acquisition
|
|
462
|
|
|
|
—
|
|
|
|
5,266
|
|
|
—
|
|
|
|
—
|
|
|
|
5,266
|
|
|
Repurchase of common stock
|
|
(85
|
)
|
|
|
—
|
|
|
|
—
|
|
|
(552
|
)
|
|
|
—
|
|
|
|
(552
|
)
|
|
Net loss
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
|
(18,276
|
)
|
|
|
(18,276
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance—December 31, 2007
|
|
21,949
|
|
|
|
22
|
|
|
|
110,193
|
|
|
(552
|
)
|
|
|
(35,846
|
)
|
|
|
73,817
|
|
|
Stock options exercised
|
|
29
|
|
|
|
—
|
|
|
|
25
|
|
|
—
|
|
|
|
—
|
|
|
|
25
|
|
|
Stock-based compensation expense
|
|
—
|
|
|
|
—
|
|
|
|
2,480
|
|
|
—
|
|
|
|
—
|
|
|
|
2,480
|
|
|
Deferred stock compensation
|
|
228
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Net loss
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
|
(32,525
|
)
|
|
|
(32,525
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance—December 31, 2008
|
|
22,206
|
|
|
$
|
22
|
|
|
$
|
112,698
|
|
$
|
(552
|
)
|
|
$
|
(68,371
|
)
|
|
$
|
43,797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Independent Registered Public Accountant’s Report.
The accompanying notes are an integral part of these consolidated financial statements.
F-7
BASIN WATER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(32,525
|
)
|
|
$
|
(18,276
|
)
|
|
$
|
(13,452
|
)
|
|
Adjustments to reconcile net loss to net cash provided by operating activities, net of effect of acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,966
|
|
|
|
798
|
|
|
|
748
|
|
|
Stock-based compensation expense
|
|
|
2,480
|
|
|
|
1,457
|
|
|
|
676
|
|
|
Amortization of deferred compensation
|
|
|
119
|
|
|
|
188
|
|
|
|
256
|
|
|
Bad debt expense
|
|
|
818
|
|
|
|
243
|
|
|
|
65
|
|
|
Gain on sale to affiliate
|
|
|
—
|
|
|
|
(3,094
|
)
|
|
|
—
|
|
|
Equity in loss of affiliate
|
|
|
946
|
|
|
|
—
|
|
|
|
—
|
|
|
Net income attributable to noncontrolling interest
|
|
|
348
|
|
|
|
84
|
|
|
|
—
|
|
|
Impairment of goodwill
|
|
|
4,998
|
|
|
|
—
|
|
|
|
—
|
|
|
Impairment of investment in affiliate
|
|
|
1,231
|
|
|
|
—
|
|
|
|
—
|
|
|
Issuance of warrants for services
|
|
|
—
|
|
|
|
—
|
|
|
|
95
|
|
|
Write off of loan acquisition costs
|
|
|
—
|
|
|
|
—
|
|
|
|
401
|
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(2,491
|
)
|
|
|
530
|
|
|
|
2,296
|
|
|
Unbilled receivables
|
|
|
4,311
|
|
|
|
2,520
|
|
|
|
(8,783
|
)
|
|
Inventory
|
|
|
(251
|
)
|
|
|
145
|
|
|
|
(329
|
)
|
|
Prepaid expenses and other
|
|
|
200
|
|
|
|
(472
|
)
|
|
|
(445
|
)
|
|
Accounts payable
|
|
|
(1,068
|
)
|
|
|
1,560
|
|
|
|
(548
|
)
|
|
Deferred revenues
|
|
|
215
|
|
|
|
(22
|
)
|
|
|
(501
|
)
|
|
Accrued expenses and other
|
|
|
103
|
|
|
|
(1,762
|
)
|
|
|
2,235
|
|
|
Contract loss reserve
|
|
|
(1,142
|
)
|
|
|
5,387
|
|
|
|
3,725
|
|
|
Other assets and other liabilities
|
|
|
672
|
|
|
|
980
|
|
|
|
1,931
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(19,070
|
)
|
|
|
(9,734
|
)
|
|
|
(11,630
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property, plant and equipment
|
|
|
(3,176
|
)
|
|
|
(8,705
|
)
|
|
|
(4,667
|
)
|
|
Acquisition of business, net of cash acquired
|
|
|
(1,997
|
)
|
|
|
(6,169
|
)
|
|
|
—
|
|
|
Collection of notes receivable
|
|
|
—
|
|
|
|
—
|
|
|
|
100
|
|
|
Patent costs
|
|
|
(20
|
)
|
|
|
(31
|
)
|
|
|
(99
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(5,193
|
)
|
|
|
(14,905
|
)
|
|
|
(4,666
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
|
—
|
|
|
|
—
|
|
|
|
75,178
|
|
|
Repurchase of common stock
|
|
|
—
|
|
|
|
(552
|
)
|
|
|
—
|
|
|
Proceeds from stock option exercises
|
|
|
25
|
|
|
|
527
|
|
|
|
163
|
|
|
Proceeds from warrant exercises
|
|
|
—
|
|
|
|
8,060
|
|
|
|
—
|
|
|
Proceeds from notes payable
|
|
|
457
|
|
|
|
500
|
|
|
|
2,000
|
|
|
Loan origination fees
|
|
|
—
|
|
|
|
—
|
|
|
|
(100
|
)
|
|
Repayments of notes payable and capital lease obligations
|
|
|
(303
|
)
|
|
|
(2,425
|
)
|
|
|
(9,102
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
179
|
|
|
|
6,110
|
|
|
|
68,139
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(24,084
|
)
|
|
|
(18,529
|
)
|
|
|
51,843
|
|
|
Cash and cash equivalents, beginning of period
|
|
|
36,038
|
|
|
|
54,567
|
|
|
|
2,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
11,954
|
|
|
$
|
36,038
|
|
|
$
|
54,567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Independent Registered Public Accountant’s Report.
The accompanying notes are an integral part of these consolidated financial statements.
F-8
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
Note 1—Business Activity and Basis of Presentation
Basin Water, Inc. and its subsidiaries (the Company) design, build and implement systems for the treatment of contaminated groundwater,
industrial process water, and air streams from municipal and industrial sources. Customers can choose between purchasing the Company’s systems and entering into long-term contracting arrangements for the Company’s systems.
The Company markets its treatment systems and services primarily to utilities, cities, municipalities, special districts, real estate developers and
other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of chemical contaminants. The Company markets its treatment systems and services through its direct sales
force, independent contractors and strategic relationships.
In May 2006, the Company registered for sale and sold 6,900,000 shares of
$0.001 par value common stock at a price of $12.00 per share in its initial public offering. After underwriting discounts and commissions and offering expenses in the amount of $7,600, the net proceeds from the Company’s initial public offering
were approximately $75,200.
In connection with the initial public offering, all 2,361,625 shares of Series A and Series B preferred stock
were converted into shares of common stock. After the initial public offering, the Company’s amended and restated certificate of incorporation provides for a total of 100,000,000 authorized shares of common stock, $0.001 par value. Also,
immediately prior to the initial public offering, the Company reincorporated in Delaware.
On September 14, 2007, the Company
completed the acquisition of Mobile Process Technology Co. (MPT), a provider of technology and services to the water and wastewater treatment and industrial process markets. This acquisition provides additional capabilities including expanded
technological solutions, geographic presence and customer base. Additional services the new Company provides include: (1) central regeneration for ion-exchange, in which we replace the resin vessel on a periodic basis and regenerate the resin
offsite, (2) smaller ion exchange systems permitting the servicing of low-flow wells, and (3) technologies to treat process water and to provide resource recovery from wastewater. The new company also provides the ability to service
and treat smaller capacity water systems than the Company’s current product offering.
In 2007, the Company entered into transactions
with respect to the sale of water treatment systems to two special purpose entities (VL Capital, or VLC and Water Services Solutions, or WSS) that were to be funded by third-party financial institutions. In accordance with the provisions of
Financial Accounting Standards Board Interpretation No. 46,
Consolidation of Variable Interest Entities—Deferral for Certain Interests, Revised December 2003
(FIN 46 (R)), the Company has concluded that the financial statements of
VLC and WSS should be consolidated with those of the Company. Accordingly, the Company’s consolidated financial statements for the periods presented herein include these entities.
In September 2008, the Company acquired the bioreactor and biofilter business (Envirogen) of Shaw Environmental & Infrastructure, Inc. (Shaw)
for $1,500 cash (subject to adjustment for working capital) plus the settlement of a previously disputed claim against Shaw for amounts the Company claimed to be owed by Shaw. The dispute involved an ion exchange unit purchase agreement executed by
the Company and Shaw in December 2005 which was structured as a $5,000 sale of water treatment units by the Company to Shaw in two parts. In the settlement, Shaw relinquished its claims or rights under the 2005 purchase agreement generally, and in
particular to the ion exchange unites that were the subject of the agreement. In the transactions, the Company acquired the assets of Envirogen, which include the design and supply of fluidized bed, membrane and suspended carrier
F-9
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 1—Business Activity and Basis of Presentation (continued)
bioreactors for the treatment of groundwater and wastewater streams in industrial, municipal and federal applications. The business also includes the design
and supply of biofilters for the treatment of air streams from municipalities and industry for the removal or odor-causing and other contaminants.
Capital Resources
The accompanying consolidated financial statements have been prepared by the Company on a going
concern basis, which contemplates the realization of amounts and satisfaction of obligations in the normal course of business. As of December 31, 2008, the Company had approximately $11,500 in cash and cash equivalents (excluding cash balances
resulting from the consolidation of VL Capital, which funds of VL Capital are not available to us to support our liquidity needs). The Company has experienced significant negative cash flows from operating and investing activities between 2006 and
2008, and expects to need additional cash for such activities for the foreseeable future. The Company’s net losses incurred during the fiscal years ended December 31, 2008 and 2007 amounted to $32,500 and $18,300, respectively. Unless and
until the Company is able to generate sufficient revenues from its system sales and contract services, it expects such losses to continue in the future. Therefore, the Company’s ability to continue to operate as a going concern is highly
dependent on the amount of cash and cash equivalents on hand combined with its ability to raise capital to support future operations. Additional capital, whether obtained through financial markets or collaborative or other arrangements with water
providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to the Company. This raises substantial doubt as to the Company’s ability to continue as a going concern.
The Company’s independent auditors’ report for the year ended December 31, 2008 includes an explanatory paragraph stating that these
recurring losses from operations and negative cash flows raise substantial doubt about the Company’s ability to continue as a going concern. If the Company is unable to continue as a going concern, it may elect or be required to seek protection
from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. In such a case, the Company may have to liquidate its assets and may receive less than the value at which those assets are
carried on its financial statements, and it is likely that investors will lose all or a part of their investment.
Note 2—Summary of Significant
Accounting Policies
Basis of Presentation and Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect certain reported amounts of assets, liabilities, revenues and expenses, and related disclosures. Accordingly, actual results could differ from those estimates.
Certain reclassifications have been made to prior years’ financial statement presentation to conform to the current year presentation.
Revenue Recognition
The Company recognizes
revenues in two different ways. For groundwater treatment systems that are sold to customers, revenues are recognized under the percentage-of-completion method by comparing actual costs incurred to total estimated costs to complete each system. The
percentage-of-completion method recognizes revenues and associated costs as work progresses on a system, based on the expected total system revenues and
F-10
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
costs. In general, financial statements based on the percentage-of-completion method present the economic substance of production-type activities more
clearly than the use of the completed-contract method, and present the relationships between sales, cost of sales and related period costs more accurately. For all other groundwater treatment systems delivered to customers under various contractual
arrangements, the Company recognizes revenues for a periodic fee received over the life of the contract using the straight-line method and recognizes a processing fee as the Company’s systems treat the customer’s contaminated water.
The Company recognizes revenues either from a sale of a system or as recurring revenues from a long-term contract under which a system is
placed.
Sale.
For treatment systems which are sold to customers under fixed-price contracts, the Company recognizes revenues
using the percentage-of-completion method. This method takes into account the cost, estimated earnings and revenues to date on systems not yet completed. This method is used because management considers total cost to be the best available method of
measuring progress on systems sold to customers. In general, financial statements based on the percentage-of-completion method present the economic substance of production-type activities more clearly than the completed-contract method, and present
the relationships between sales, cost of sales and related period costs more accurately. Because of inherent uncertainties in estimating costs, estimates used may change within the near term. Such estimates are adjusted under the cumulative-catch-up
method. Unless contractually agreed to otherwise, the sales contract is deemed to be substantially complete when the treatment system has been physically completed and a performance test has been passed.
Contract Revenue
.
The Company generates recurring contract revenues from three sources. The first source of recurring contract
revenues is from long-term contracts under which the system is installed at the customer’s site and treats the customer’s water. We retain ownership of the installed system. Under this contract, the Company recognizes monthly revenues, on
a straight-line basis over the life of the contract, which represents a return of the capital value of the installed system. The amount of this fixed monthly revenue is based on both the capacity of the system and the type of contaminant(s) being
treated. The straight-line method best reflects the value of having the system’s capacity available to the customer at all times and is similar to the method used for calculating depreciation.
The second source of recurring revenues is from long-term contracts for the treatment of the water produced from installed treatment systems, also
referred to as service revenues. Service revenues are recognized based on the actual volume of water treated each month. Such water-treatment revenues bear a direct relationship to the variable costs for the purchase and delivery of salt, chemicals
and resin used in the system, the removal of waste and the cost to maintain and service the system. This revenue stream is generated both by systems that were purchased by the Company’s customers and by systems in which the Company retains
ownership and recognizes revenue for the monthly capital component.
The third source of contract revenues relates to providing other
services for the processing of water, replacement of resins or equipment parts and other water treatment related services, including the services provided by MPT described previously.
Under each of the long-term contracts, the customer is obligated to pay the Company for the treatment of its water—not for specific hours worked,
supplies purchased or waste-hauls provided. Certain of the Company’s long-term contracts allow it to recover increased operating costs, including costs for salt, resin and removal of
F-11
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
waste. Under the criteria set forth in Emerging Issues Task Force (EITF) 00-21, the Company has determined that the multiple deliverables of each of its
long-term contracts, specifically the capital component and the volume-related service charge, qualify for separate accounting treatment. The three criteria required for separate accounting treatment are: 1) that each deliverable has a standalone
value to the customer, 2) that there is objective and reliable evidence of fair value of each deliverable and 3) that there are no general refund rights for the deliverables.
In the case of contracts under which the Company owns the system, the customer is obligated to pay the Company the fixed capital component of the system
on a monthly basis. These arrangements are classified and treated as operating leases under Statement of Financial Accounting Standards (SFAS) No. 13,
Accounting for Leases
, because they meet the four criteria of an operating lease: 1)
there is no transfer of title; 2) there is not a bargain purchase option; 3) the lease term is substantially shorter than the economic life of the system; and 4) the present value of the capital component payments is less than 90% of the fair value
of the water treatment system at the inception of the contract. For water treatment systems which are owned by the Company and leased to its customers, the capital recovery portion of the payment stream from the customer is determined at the outset
of the lease contract based on capital value and the lease term. Consequently, these payments, and the recoverability of the related assets, are not affected by the operating losses sustained under the water service agreements, as described in Note
15.
Accounts Receivable
In
general, accounts receivable arising from systems sales to customers are due in accordance with the provisions of the sales contract, which may provide for extended payment terms ranging from several months to one year or more for a significant
portion of the sales price. In contrast, accounts receivable from systems placed under long-term contracts with customers are usually due within a much shorter period of time, generally within one month after the date services have been performed
and the customer has been billed. Accordingly, in periods in which the Company’s revenues from system sales are higher relative to revenues from long-term contracts, the collection of accounts receivable will be much slower due to the nature of
the sales contracts. Management has assessed the collectability of accounts receivable and recorded an allowance for doubtful accounts of $734 and $300 based upon this assessment at the end of December 31, 2008 and 2007, respectively.
Unbilled receivables generally arise from the recording of revenue under the percentage-of-completion method. As such, unbilled revenues
are reclassified as accounts receivable when the invoice is sent to the customer in accordance with contractual terms.
Inventory
Inventory consists primarily of raw materials and supplies. Inventory items are stated at the lower of cost, on a first-in, first-out (FIFO) basis, or
market. Physical counts of inventory are conducted periodically to help verify the balance of inventory. A reserve is maintained for obsolete inventory, if appropriate. During the years ended December 31, 2008 and 2007, the Company recorded
increases to its reserves for slow-moving inventory of $167 and $41, respectively. The Company considers inventory to be obsolete when it is no longer usable as a system component.
F-12
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and amortization. Property consists primarily of treatment systems which the Company places with customers under various arrangements. For
groundwater treatment systems placed with customers under long-term contracts, the Company capitalizes materials, labor, overhead and interest. Depreciation is calculated using the straight-line method over the estimated useful lives of the related
assets.
The Company capitalizes expenditures for significant renewals and betterments that extend the useful lives of property and
equipment. The Company charges expenditures for maintenance and repairs to expense as incurred. Estimated useful lives are generally as follows: vehicles and trailers—three to five years; furniture and fixtures—five to seven years, other
equipment—five to 10 years, and groundwater treatment systems—20 years. Judgments and estimates made by the Company related to the expected useful lives of these assets are affected by factors such as changes in operating performance and
fluctuations in economic conditions.
Construction in progress is recorded when costs related to the construction of water treatment
systems are incurred.
The Company evaluates long-lived assets for impairment in accordance with SFAS No. 144,
Accounting for the
Impairment or Disposal of Long-Lived Assets
, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When the undiscounted future net cash flows expected to result from the use of the
asset and its eventual disposition is less than its carrying amount, the Company would measure an impairment loss in an amount equal to the excess of the carrying amount over the discounted cash flows. Other than the impairment charge related to the
Company’s investment in Empire Water recorded in the year ended December 31, 2008 (see Note 11), no impairment losses were recorded for the years ended December 31, 2008, 2007 and 2006.
Deferred Revenues
In connection with
long-term contracts, the Company may receive payments from its customers prior to the system being placed in service. Such payments are recorded as deferred revenues. In addition, the Company may receive payments from its customers in excess of that
which can be recognized on a straight-line basis. These payments are also recorded as deferred revenues. All deferred revenues amounts are recognized as revenues in the periods in which services are rendered to the customer. The Company also
recorded “deferred revenue- affiliate” which represents the Company’s deferral of a portion of the gain on the sale to Empire equal to its proportional 32% interest in Empire.
Income Taxes
The Company accounts for income
taxes pursuant to the asset and liability method under SFAS No. 109,
Accounting for Income Taxes
, which requires deferred income tax assets and liabilities to be computed annually for temporary differences between the financial statement
and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted laws and rates applicable to the periods in which the temporary differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
F-13
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
Valuation of Intangible Assets and Goodwill
The Company assesses intangible assets, excluding goodwill, for recoverability in accordance with the provisions of SFAS No. 144,
Accounting for
the Impairment or Disposal of Long-Lived Assets
(SFAS 144). Such intangible assets are assessed for recoverability whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable through
the estimated future discounted cash flows arising from the use of such assets. If the Company determines that the carrying value of intangible assets may not be recoverable, the amount of impairment expense is determined by using the projected
discounted cash flow method in accordance with SFAS 144.
The Company tests goodwill for impairment in accordance with SFAS
No. 142,
Goodwill and Other Intangible Assets
(SFAS 142). SFAS 142 requires annual testing for impairment, or more frequent testing if events or circumstances indicate that carrying value of goodwill may not be recoverable. The
Company evaluates goodwill for impairment using discounted cash flow methods, transaction values for comparable companies, and other recognized valuation techniques.
Patents
At December 31, 2008 and 2007, the Company had incurred cumulative legal fees in
the amount of $620 and $495, respectively, as a result of application for a series of patents. At the time the patents are received, all costs incurred in obtaining the patents are then amortized over their estimated useful lives of 17 years. In
addition, the Company acquired patents with a fair value of $1,812 as a result of the acquisition of MPT in September 2007, and also acquired patents with a fair value of $966 as a result of the acquisition of Envirogen in September 2008. These
acquired patents have estimated remaining useful lives of 10 to 17 years. The amount of patent amortization expense was $612, $29 and $3 for the years ended December 31, 2008, 2007 and 2006, respectively.
Research and Development Expenses
Research
and development expenses are charged to operations in the year incurred. Research and development expenses totaled $1,167, $564 and $634 for the years ended December 31, 2008, 2007 and 2006, respectively.
Investments in Unconsolidated Entity
The
Company has a 32% ownership investment in Empire Water Corporation (Empire). This investment is evaluated under the requirements of FASB Interpretation No. (FIN) 46(R
), Consolidation of Variable Interest Entities, an interpretation of ARB
No. 51,
Accounting Principles Board Opinion No. (APB) 18,
The Equity Method of Accounting for Investments in Common Stock
, and other applicable guidance to determine the appropriate accounting treatment, including whether the Company
must consolidate the investee company. The Company’s 32% ownership investment in Empire is accounted for using the equity method of accounting since the investment gives the Company the ability to exercise significant influence, but not
control, over the investee as outlined under APB 18. Significant influence is generally deemed to exist if the Company has an ownership interest of between 20% and 50%, although other factors are considered in determining whether the equity method
of accounting is appropriate.
Empire has a fiscal year end of June 30 while the fiscal year end of the Company is December 31.
The Company does not control the management or accounting functions of Empire and thus cannot control the
F-14
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
determination of the June 30 fiscal year end. In accordance with paragraph 19 of APB 18, the Company records its share of the earnings or losses of
Empire from the most recent available financial statements. For the quarterly period ended March 31, 2008, the Company recorded an estimate of its share of Empire’s net loss. For the quarterly periods ended June 30, 2008,
September 30, 2008, and December 31, 2008, the Company recorded its share of Empire’s loss based upon Empire’s actual financial results. After the quarter ended December 31, 2008, the Company expects to record its equity in
the income or loss of Empire three months in arrears, which will be calculated based upon the most recently available financial statement published by Empire in accordance with APB 18.
This investment is classified as an “investment in affiliate” in the Company’s consolidated balance sheet. The Company monitors this
investment for impairment and will make appropriate reductions in carrying values if the Company determines that an impairment charge is required based primarily on the near-term prospects and financial condition of Empire. Any significant
intervening events relating to Empire in the period since the latest available financial statements will be disclosed in future filings.
The long-term liability “deferred revenue—affiliate” represents the Company’s deferral of the gain on sale to Empire of its proportional 32% interest in Empire.
Special Purpose Entities
In 2007, the Company
entered into agreements with two special-purpose entities, or SPEs (VL Capital, or VLC, and Water Services Solutions, or WSS) which were formed and owned by an outside third party to hold and facilitate financing of water systems leased to the
Company’s customers. The Company has concluded that, under FIN 46(R), it is the primary beneficiary of these SPEs because the Company is exposed to a majority of the expected losses through its interest in notes receivable from the SPEs.
Because the Company is the primary beneficiary of the SPEs, in accordance with FIN 46(R), the financial statements of both SPEs have been consolidated with those of the Company. As of December 31, 2008, assets with a carrying amount of
$3,565 are included in Property and Equipment and are collateral for debt of $155 included in Notes Payable. The holders of the SPE’s debt have no recourse to the general credit of the Company.
Net Income Attributable to Noncontrolling Interest
Because it has no ownership interest in VLC and no control over its management or business operations, the Company has recorded the net income of VLC as attributable to a noncontrolling interest in the consolidated financial statements
commencing with the sale of certain equipment to VLC in June 2007. The results of WSS were not material to the Company’s consolidated financial statements.
F-15
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
Stock-based Compensation
2006 Equity Incentive Award Plan
In May 2006, the Company adopted the Basin Water 2006 Equity Incentive Award Plan,
or 2006 Equity Plan. The 2006 Equity Plan replaces the 2001 Stock Option Plan, and became effective immediately prior to the completion of the initial public offering in May 2006. Under the 2006 Equity Plan, 2,500,000 shares of the Company’s
common stock were reserved for issuance. This replaces the 2,100,000 shares of common stock initially reserved under the 2001 Stock Option Plan.
2001 Stock Option Plan
On August 27, 2001, the Company established the Basin Water 2001 Stock Option Plan.
Under the plan, 900,000 shares of Company common stock were initially reserved for issuance upon exercise of options pursuant to the plan. In June 2005, the plan was amended to increase the number of shares of Company common stock reserved for
issuance to 2,100,000. In May 2006, the 2001 Stock Option Plan was replaced by the 2006 Equity Plan.
Redeemable Convertible Preferred Stock
The Company sold 149,250 shares of no par value Series B preferred stock for $4.00 per share during the year ended December 31, 2005.
Also, at December 31, 2004, the Company had committed to issue an additional 37,500 shares of Series B preferred stock for which it had received proceeds of $4.00 per share as of that date. Such stock was issued in January 2005. Costs of the
offering totaled $2 in 2005. Additionally, as part of the offering, the Company issued seven-year warrants to purchase 78,488 shares of Series B convertible stock at an exercise price of $4.40 per share. The estimated fair value of the warrants
granted was determined to be approximately $61 based on the Black-Scholes valuation model. The warrants are fully exercisable and expire in 2010. In connection with the initial public offering in May 2006, all 2,361,625 shares of Series A and Series
B preferred stock outstanding were converted into shares of common stock.
Recent Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162,
The Hierarchy of
Generally Accepted Accounting Principles
, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented
in conformity with US GAAP. SFAS No. 162 becomes effective in the third quarter of 2009 and is not expected to have a material impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS
No. 133
, which requires enhanced disclosures for derivative and hedging activities. SFAS No. 161 becomes effective in the first quarter of 2009 and is not expected to have a material impact on the Company’s consolidated financial
statements.
Other than the above, there have been no recent accounting pronouncements issued which would impact the Company’s
consolidated financial statements.
Impact of Recent Accounting Pronouncements
In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109
(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109
, Accounting for
F-16
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 2—Summary of Significant Accounting Policies (continued)
Income Taxes
. FIN 48 also prescribes a recognition threshold and measurement standard for the financial statement recognition and measurement of an
income tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48
became effective for the Company on January 1, 2007. The provisions of FIN 48 are to be applied to all tax positions upon initial application of this standard. Only tax positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized upon adoption. The cumulative effect of applying the provisions of FIN 48, if any, must be reported as an adjustment to the opening balance of retained earnings or other appropriate
components of equity for the fiscal year of adoption. The adoption of FIN 48 had no material impact on the Company’s financial statements.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
. This statement establishes a single authoritative definition of fair value, sets out a framework for establishing fair value, and requires additional
disclosures about fair value measurements. This statement applies only to fair value measurements that are already required or permitted by other accounting standards and is expected to increase the consistency of those measurements. The Company was
required to adopt SFAS No. 157 for its fiscal year beginning on January 1, 2008, prospectively applied, except for the provisions of SFAS No. 157 relating to nonfinancial instruments, which will be required to be adopted by
the Company for its fiscal year beginning January 1, 2009. The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment
of FASB Statement No. 115
. This statement permits companies to choose to measure many financial instruments and other specified items at fair value. The Company was required to adopt SFAS No. 159 for its fiscal year beginning on
January 1, 2008, prospectively applied. The adoption of SFAS No. 159 did not have a material impact on the Company’s consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R),
Business Combinations
(SFAS 141 (R)). This statement replaces SFAS 141 in its entirety and
retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that
obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an
acquirer in a business combination, including business combinations achieved in steps (step acquisition), to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at
their fair values of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair
values. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first reporting period beginning on or after December 15, 2008, and may not be applied before that date.
The Company is currently evaluating the impact SFAS 141(R) could have on its consolidated financial statements.
In December 2007, the FASB
issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51
(SFAS 160) which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary
and for the deconsolidation of a subsidiary. This statement is effective for the fiscal year beginning January 1, 2009 and will be applied prospectively. The Company does not expect adoption of SFAS 160 to have a material impact on its
consolidated financial statements.
F-17
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 3—Acquisitions
Mobile Process Technology
On September 14, 2007, a newly formed subsidiary of the Company acquired 100% of the business of Mobile Process Technology Co., an Arkansas corporation based in Memphis, Tennessee, through the means of a merger
agreement, and upon completion of the merger and acquisition, the business was renamed Basin Water-MPT, Inc. (MPT). MPT is a provider of technology and services to the water treatment and industrial process markets.
The aggregate purchase price was approximately $12,200, consisting of approximately $6,900 of cash and 462,746 shares of Company common stock with a fair
value of approximately $5,300. The fair value of the common stock issued was determined based on the average closing market price of the Company’s common stock over the period beginning five business days before and ending five business days
after the terms of the acquisition were agreed upon and announced. The following table presents the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
|
|
|
|
|
|
|
Current assets
|
|
$
|
2,631
|
|
|
Property, plant and equipment
|
|
|
2,191
|
|
|
Goodwill
|
|
|
6,323
|
|
|
Intangible assets
|
|
|
4,238
|
|
|
|
|
|
|
|
|
Total assets acquired
|
|
|
15,383
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
(2,754
|
)
|
|
Long-term debt
|
|
|
(266
|
)
|
|
Other liabilities
|
|
|
(179
|
)
|
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
(3,199
|
)
|
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
12,184
|
|
|
|
|
|
|
|
The net assets acquired in the table above represent cash consideration of approximately $6,200
(net of cash acquired), approximately $700 of cash acquired included in current assets above and common stock consideration of approximately $5,300. The purchase price was allocated to net tangible and intangible assets acquired based on their
estimated fair values, with approximately $4,200 allocated to intangible assets with a weighted-average useful life of approximately 11 years.
As of December 31, 2007, approximately $1,250 of the cash portion of the purchase price was placed into an escrow account as a reserve for unidentified liabilities of the acquired business. This balance was subsequently released in
full to the former shareholders of MPT during the quarter ended December 31, 2008.
In addition, $750 of the cash portion of the
purchase price was placed into an escrow account until the working capital of MPT at the date of acquisition was finalized. In February 2008, $326 was released from the escrow account to the Company, reducing the purchase price, and the balance of
the working capital escrow account was released to the former shareholders of MPT.
Acquired intangible assets consist of a covenant not to
compete in the amount of $322 (three year useful life), trade name in the amount of $180 (two year useful life), service agreements and contracts in the amount of $1,355 (six year useful life), customer relationships in the amount of $569 (15 year
useful life) and patents in the amount of $1,812 (17 year useful life). The excess of the net purchase price over the estimated fair value of assets acquired was approximately $6,300, which was recorded as non-tax deductible goodwill.
F-18
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 3—Acquisitions (continued)
During the quarter ended September 30, 2008, the Company determined that the goodwill related to
the MPT acquisition was impaired, and recorded a charge to earnings of approximately $5,000 to reduce the carrying value of goodwill. See Note 9 for a further discussion of this impairment charge.
The results of MPT’s operations have been included in the Company’s consolidated financial statements since it was acquired on
September 14, 2007.
Envirogen
On September 18, 2008, the Company acquired the bioreactor and biofilter businesses (Envirogen) from Shaw Environmental and Infrastructure, Inc. (Shaw) through an asset purchase agreement.
The Company previously sold to Shaw water treatment systems for a total purchase price of approximately $4,800, including installation, of which the
Company recognized revenues of approximately $3,000 and approximately $1,600 during the years ended December 31, 2006 and 2005, respectively. Under the terms of the sale, Shaw made a down payment of $227 and was to pay an additional $2,048 of
the total amount due not later than December 31, 2007 and the remaining balance of approximately $2,300 not later than December 31, 2008.
The aggregate purchase price for Envirogen was approximately $4,100, consisting of cash consideration of approximately $2,000 (including adjustments and transaction costs) of cash and the satisfaction of approximately $4,700 of accounts
receivable and accrued interest owed to the Company by Shaw (as described in the previous paragraph), less approximately $2,600 representing the fair value of the water treatment systems returned by Shaw to the Company. The fair value of the water
treatment systems was determined by management through an evaluation of the current replacement cost of equivalent systems, less the expected costs to sell such systems.
A valuation of Envirogen’s property and intangible assets is in the process of being developed; accordingly, the allocation of the purchase price is subject to refinement. The following table presents the
estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.
|
|
|
|
|
|
|
Current assets
|
|
$
|
890
|
|
|
Property, plant and equipment
|
|
|
1,132
|
|
|
Goodwill
|
|
|
1,140
|
|
|
Intangible assets
|
|
|
1,524
|
|
|
|
|
|
|
|
|
Total assets acquired
|
|
|
4,686
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
(584
|
)
|
|
Other liabilities
|
|
|
—
|
|
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
(584
|
)
|
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
4,102
|
|
|
|
|
|
|
|
The purchase price was allocated to net tangible and intangible assets acquired based on their
estimated fair values, with approximately $1,100 allocated to intangible assets with a weighted-average useful life of approximately nine years and approximately $400 allocated to intangible assets with indefinite useful lives.
Acquired intangible assets consist of contract backlog in the amount of $83 (one year useful life), distribution network in the amount of $112 (six year
useful life), patents in the amount of $966 (10 year useful life) and trade name in the amount of $363 (indefinite useful life). The excess of the net purchase price over the estimated fair value of assets acquired was approximately $1,100 which was
recorded as tax deductible goodwill.
The results of Envirogen’s operations have been included in the consolidated financial
statements since it was acquired on September 18, 2008.
F-19
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 3—Acquisitions (continued)
The unaudited pro forma condensed combined statements of operations table below reflects the results
of operations of the Company and Envirogen for the years ended December 31, 2008, 2007 and 2006 as if the acquisition of Envirogen had occurred at the inception of each of the periods presented. Unaudited pro forma condensed combined statements of
operations are not necessarily indicative of the results that would have been achieved had the transaction been consummated as of the date indicated or had the entities been a single entity during these periods. The unaudited pro forma condensed
combined statements of operations are not necessarily indicative of the results that may be achieved in the future.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
|
(Unaudited pro forma)
|
|
|
Revenues
|
|
$
|
17,756
|
|
|
$
|
16,841
|
|
|
$
|
26,981
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(33,279
|
)
|
|
$
|
(20,448
|
)
|
|
$
|
(15,215
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(1.53
|
)
|
|
$
|
(1.01
|
)
|
|
$
|
(0.95
|
)
|
|
Diluted
|
|
$
|
(1.53
|
)
|
|
$
|
(1.01
|
)
|
|
$
|
(0.95
|
)
|
Note 4—Earnings Per Share
In accordance with the provisions of SFAS No. 128,
Earnings Per Share
, the Company reports earnings per share (EPS) by computing both basic
and diluted EPS. Basic EPS measures the Company’s performance for a reporting period by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted EPS
measures the Company’s performance for a reporting period by dividing net income available to common stockholders by the weighted average number of shares of common stock plus common stock equivalents outstanding during the period. Common stock
equivalents consist of all potentially dilutive common shares, such as stock options and warrants, which are convertible into shares of common stock.
The Company incurred a net loss for the years ended December 31, 2008, 2007 and 2006. As a result, approximately 62,000, 529,000 and 719,000 shares issuable upon exercise of outstanding stock options, as well as
131,000, 823,000 and 1,034,000 warrants and 0, 0 and 908,000 shares of redeemable convertible preferred stock have been excluded from the computation of diluted EPS in 2008, 2007 and 2006, respectively, due to the antidilutive effect of such common
stock equivalents.
Also, approximately 1,602,000, 271,000 and 414,000 stock options and 611,000, 25,000 and 50,000 warrants have been
excluded from the computation of diluted EPS for 2008, 2007 and 2006, respectively, have been excluded from the computation of diluted EPS as the exercise prices of such options and warrants were higher than the weighted average price of the
Company’s common stock during those years. The following tables contain a reconciliation of the numerators (net income or loss) and denominators (weighted average shares) used in both basic and diluted EPS calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
Net loss per share
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss applicable to common shares
|
|
$
|
(32,525
|
)
|
|
$
|
(18,276
|
)
|
|
$
|
(13,452
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
21,798
|
|
|
|
20,185
|
|
|
|
16,048
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share
|
|
$
|
(1.49
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.84
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-20
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 4—Earnings Per Share (continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Net loss per share—assuming dilution
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss applicable to common shares
|
|
$
|
(32,525
|
)
|
|
$
|
(18,276
|
)
|
|
$
|
(13,452
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
21,798
|
|
|
|
20,185
|
|
|
|
16,048
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share—diluted
|
|
$
|
(1.49
|
)
|
|
$
|
(0.91
|
)
|
|
$
|
(0.84
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 5—Concentrations of Risk
Cash
Financial instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash and cash equivalents and accounts receivable. The Company considers all highly liquid debt instruments with an original maturity of three months or less when purchased to be cash equivalents. The Company maintains its
cash and cash equivalents with high-credit quality financial institutions. At times, such amounts may exceed federally insured limits. At December 31, 2008 and 2007, the Company had cash balances of $11,454 and $35,975, respectively, in excess
of the FDIC insured limit. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on its cash equivalent accounts.
Major Customers
In 2008, the Company had one customer from which it received approximately
17% of revenues. In 2007, the Company had two customers from which it received approximately 36% of revenues. The largest customer represented 24% of revenues and the second largest customer represented 12% of revenues. In 2006, the Company had two
customers from which it received 59% of its revenues. The largest customer represented 38% of revenues and the second largest customer represented 21% of revenues. As of December 31, 2008, the Company had two customers that represented 36% of
accounts receivable. At December 31, 2007, the Company’s accounts receivable from its two largest customers amounted to 12% of total accounts receivable.
Note 6—Inventory
Inventory consists primarily of raw materials and supplies used in the fabrication of the
Company’s groundwater treatment units, as well as the reprocessing and conditioning of resins. Inventory items are stated at the lower of cost, on a first-in, first-out basis, or market. Physical counts of inventory items are conducted
periodically to help verify the balance of inventory. A reserve is maintained for obsolete inventory, if appropriate. The Company considers inventory to be obsolete when it is no longer usable as a system component. As of December 31, 2008 and
2007, the value of the Company’s inventory was $1,387 and $975, respectively, net of reserves for slow moving and obsolete inventory of $246 and $79, respectively.
F-21
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 7—Property and Equipment
Property and equipment consists of the following:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
Water treatment facilities
|
|
$
|
14,812
|
|
$
|
11,437
|
|
Office furniture and equipment
|
|
|
680
|
|
|
514
|
|
Vehicles and trailers
|
|
|
451
|
|
|
501
|
|
Software and other
|
|
|
1,145
|
|
|
704
|
|
Machinery and equipment
|
|
|
2,945
|
|
|
1,921
|
|
Leasehold improvements
|
|
|
303
|
|
|
169
|
|
Construction in progress
|
|
|
11,558
|
|
|
9,639
|
|
|
|
|
|
|
|
|
|
|
|
|
31,894
|
|
|
24,885
|
|
Less: accumulated depreciation
|
|
|
3,640
|
|
|
2,235
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
28,254
|
|
$
|
22,650
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense for property and equipment was $1,224, $766, and $538 for
the years ended December 31, 2008, 2007 and 2006, respectively.
Note 8—Equipment Placed with Customers
As discussed in Note 2, for those systems not sold to customers, the Company retains ownership of such systems and bills the customers a fixed monthly
amount, which represents a return of the capital value of the installed system. These long-term contract arrangements are classified as operating leases, and the systems are depreciated over their estimated useful lives, typically 20 years.
Generally, the Company’s long-term contracts are renewable by mutual consent of the parties, with one exception in which the customer has the right to renew the arrangement or purchase the equipment at the end of the term. Equipment under such
long-term arrangements and the related accumulated depreciation were as follows:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
Equipment on long-term contracts
|
|
$
|
11,045
|
|
$
|
11,437
|
|
Less: accumulated depreciation
|
|
|
1,371
|
|
|
1,047
|
|
|
|
|
|
|
|
|
|
Equipment on long-term contracts, net
|
|
$
|
9,674
|
|
$
|
10,390
|
|
|
|
|
|
|
|
|
Depreciation expense for the systems placed under these long-term arrangements was $438, $508 and
$407 for the years ended December 31, 2008, 2007 and 2006, respectively.
The Company’s long-term contract arrangement terms are
generally for five to ten years, with an option to renew or to purchase the system. The purchase option is not a bargain purchase. As of December 31, 2008, scheduled minimum future contract revenues on these operating lease arrangements with
original terms of one year or longer are as follows:
|
|
|
|
|
|
Year Ending December 31,
|
|
Amount
|
|
2009
|
|
$
|
1,467
|
|
2010
|
|
|
1,115
|
|
2011
|
|
|
808
|
|
2012
|
|
|
618
|
|
2013
|
|
|
230
|
|
|
|
|
|
|
Total
|
|
$
|
4,238
|
|
|
|
|
|
F-22
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 8—Equipment Placed with Customers (continued)
The Company had no contingent long-term contract revenues during any of the years ended
December 31, 2008, 2007 and 2006.
Note 9—Goodwill and Intangible Assets
Goodwill
Goodwill represents the excess of the cost of an acquired entity over the net fair
value of identifiable assets acquired and liabilities assumed. The following table summarizes the changes in the carrying amount of goodwill for the year ended December 31, 2008:
|
|
|
|
|
|
|
Balance at December 31, 2007
|
|
$
|
6,323
|
|
|
Acquisition of Envirogen business during the period
|
|
|
1,140
|
|
|
Adjustments to MPT goodwill
|
|
|
25
|
|
|
Impairment of MPT goodwill
|
|
|
(4,998
|
)
|
|
|
|
|
|
|
|
Balance at December 31, 2008
|
|
$
|
2,490
|
|
|
|
|
|
|
|
During the third quarter of 2008, the Company recorded a charge to earnings of approximately
$5,000 to reduce the carrying value of goodwill related to the MPT acquisition, which was included in selling, general and administrative expense. The primary factors impacting management’s assessment of value included slower-than-anticipated
growth rates and a decline in the customer base of MPT, both of which have resulted in a significant decline in MPT’s future revenues and cash flows since its acquisition in September 2007.
The Company’s goodwill at December 31, 2008 increased due to the acquisition of Envirogen, as discussed in Note 3.
Intangible Assets
Net intangible assets are
as shown in the following table as of the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred stock-based compensation
|
|
$
|
—
|
|
|
$
|
157
|
|
|
Service agreements and contracts
|
|
|
1,438
|
|
|
|
1,355
|
|
|
Customer relationships
|
|
|
681
|
|
|
|
569
|
|
|
Covenant not to compete
|
|
|
322
|
|
|
|
322
|
|
|
Trade name
|
|
|
543
|
|
|
|
180
|
|
|
Accumulated amortization
|
|
|
(602
|
)
|
|
|
(115
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets, net
|
|
$
|
2,382
|
|
|
$
|
2,468
|
|
|
|
|
|
|
|
|
|
|
|
The amortization periods of intangible assets are as follows: customer relationships—15
years; covenant not to compete—three years; trade name—two years; service agreements and contracts—six years; and deferred stock-based compensation—three years.
Patent Costs
The Company capitalizes costs of patent applications. As a result of the
September 2007 acquisition of MPT, the Company recorded an additional $1,812 representing the fair value of patents acquired. As a result of the September 2008 acquisition of Envirogen, the Company recorded an additional $966 representing the fair
F-23
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 9—Goodwill and Intangible Assets (continued)
value of patents acquired. When patents are issued, the Company amortizes the patent cost over the life of the patent, usually 17 years. Future amortization
of patent costs at December 31, 2008 is $206 per year for each of the five years ending December 31, 2009 through 2013, and an aggregate of $1,627 thereafter. If a patent is denied, capitalized patent costs are written off in the period in
which a patent application is denied.
Note 10—Unbilled Receivables
Long-term Unbilled Receivables
The Company has two customer system sales agreements which
provide for payment terms ranging from two to five years, unless certain conditions are met, in which case the payment terms are accelerated. As of December 31, 2007, four systems sold to one of these customers were substantially completed,
except for delivery, deployment and testing costs which were yet to be incurred as of that date. In accordance with the terms and conditions of the 2006 sale of these systems, payment from the customer was due not later than December 31, 2008.
As of December 31, 2007, two systems sold to another customer in 2005 were substantially completed. In accordance with the terms and
conditions of the sale of these systems, the remaining 80% payment for these systems was due as follows: 30% upon final approval and California Department of Health Services (DHS) permitting of the systems and introduction of drinking water into the
end user’s distribution system, and the remaining 50% upon the earlier of (a) the approval by DHS of the Company’s BIONExchange process or (b) two years from the date of deployment of the systems.
At December 31, 2007, the amount of long-term unbilled receivables was $3,653, which represents the balance due from these two customers under the
extended payment terms. There were no long-term unbilled receivables at December 31, 2008.
In 2004, in connection with the sale of a
system, the Company received a $300 unsecured note that provides for interest at a rate of 3% per annum. The Company received a payment of $200 in connection with this note in 2005. The final principal payment of $100 became due in 2006, and as
such, the note has been classified as current. The Company has recorded an allowance for doubtful accounts of $65 of this note as of December 31, 2007 and 2006. Both the note and the related allowance for doubtful accounts have been classified
as current assets and are included in the accounts receivable balance at December 31, 2007 and 2006.
Systems Underlying Unbilled Receivables
The following table summarizes the number of systems underlying unbilled receivables (both current and long-term) as of the dates
indicated:
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
Systems not completed (including passing a performance test and permitting)
|
|
11
|
|
18
|
|
Completed systems for which contract terms did not yet provide for billing to the customer
|
|
—
|
|
1
|
|
Completed systems—contract dispute with customer (settled in 2008)
|
|
—
|
|
3
|
|
|
|
|
|
|
|
Total systems underlying unbilled receivables
|
|
11
|
|
22
|
|
|
|
|
|
|
F-24
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 11—Investment in Empire Water Corporation (Empire)
In May 2007, the Company entered into an agreement to acquire certain water rights and related
assets. In December 2007, the Company sold to Empire its rights to purchase certain collective assets from unrelated parties including (a) a canal located in San Bernardino and Riverside counties in Southern California that is approximately
eighteen miles in length, (b) rights to pump water from the San Bernardino Basin, and (c) other equipment and tangible and intangible personal property of the sellers. As consideration for the sale of the rights to purchase these assets,
the Company received 6,000,000 shares of Empire common stock, which represents an ownership interest of approximately 32% in Empire as of December 31, 2007 and 2008.
The Company recorded the transaction under the equity method; therefore, under EITF 01-2 the Company recorded a partial gain of approximately $3,100 on the transaction. The Company determined the gain of $3,094 by
(a) estimating the fair value of such stock based upon concurrent sales of Empire common stock to third parties, less a discount for risk and illiquidity and including a reimbursement of certain due diligence costs pursuant to the terms of the
agreement with Empire, which amounted to an estimated fair value of approximately $4,904; (b) subtracting the Company’s basis in the assets sold, amounting to approximately $354, and (c) reducing the resulting gain of $4,550 by the
Company’s 32% ownership interest in Empire, for a reduction of $1,456
.
These reductions of approximately $800 and $1,500 have been recorded as deferred revenue—affiliate in the consolidated balance sheet of the Company at
December 31, 2008 and 2007, respectively.
At December 31, 2007, the Company recorded its investment in Empire at approximately
$4,500 based upon its assessment of the fair value of the Empire common stock it received in the transaction. At the same time, the Company performed an evaluation of the underlying assets and liabilities of Empire as of that same date, and
determined that the assets and liabilities of Empire were stated at fair value as of December 31, 2007, since a) the assets consisted primarily of cash and the water rights and related assets acquired from the Company only a few days prior to
the end of 2007 and b) Empire was a company in the development stage, and did not have any elements of an ongoing business as of that date which might give rise to intangible assets on Empire’s balance sheet. The Company’s 32% share of the
underlying net assets of Empire as of December 31, 2007 totaled approximately $3,000. The difference between the $4,500 recorded investment and the $3,000 representing the Company’s share of the underlying assets of Empire is approximately
$1,500, which is an element of goodwill.
In addition, the Company has concluded that the assets sold under the agreement did not
constitute the sale of a business as contemplated by EITF 98-3, as the rights conveyed to Empire were not an integrated set of activities and assets conducted and managed for the purpose of providing a return or other economic benefits. The Company
also does not believe the transaction was covered under SAB Topic 5.U., as 1) Empire is not a highly leveraged entity; 2) the underlying assets sold to Empire have historically produced cash flows; 3) substantial capital has been raised by
Empire from outside investors; and 4) the Company does not have any actual or implied commitment to support Empire. According to Empire’s Quarterly Report on Form 10-Q for the six months ended December 31, 2008, Empire raised a total of
$4,750 in financing through June 2008 and had $202 in cash as of December 31, 2008. Empire also disclosed that it needed to raise an additional $16,000 or joint venture its assets with a municipal or financial partner to fully implement its
plan of operation. Empire further stated that in light of the current economic recession it is unlikely that it would be able to raise this capital in the short run and gave no assurance that it would be able to raise the additional capital needed
to implement its plan of operation. The Company is not aware of any parties obliged to provide Empire with financial support in the future.
During the quarter ended September 30, 2008, the Company assessed its investment in Empire. Based upon current market conditions, Empire’s financial condition, and the Company’s understanding of Empire’s business
F-25
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 11—Investment in Empire Water Corporation (Empire) (continued)
prospects, the Company determined that the carrying value of its investment in Empire should be reduced by approximately $1,900 at September 30, 2008.
As part of this assessment, the Company determined that a portion of the impairment was attributable to the deferred revenue recorded at the date that the Company sold assets to Empire, as the Company has evaluated the underlying assets associated
with the deferred revenue and concluded that such assets are impaired to the extent of the Company’s 32% ownership interest in Empire. Accordingly, the Company reduced deferred revenue-affiliate by $659 at September 30, 2008. The
difference between the $1,890 impairment of investment in affiliate and the $659 reduction of deferred revenue-affiliate, or $1,231, was recorded as other expense in the statement of operations for the year ended December 31, 2008.
As of December 31, 2008, the Company has recorded its investment in Empire at approximately $1,900, while the amount of underlying equity in the
net assets of Empire is approximately $2,700. The difference of approximately $800 represents the excess of the Company’s 32% interest in the net assets of Empire over the market value of the Company’s investment in Empire.
The quoted market price for Empire’s common stock as of March 6, 2009 was $1.01 per share. To the Company’s knowledge, there have been no
significant intervening events relating to Empire since its last available financial statements. As of December 31, 2008, Empire had assets of $9,023 and liabilities of $203. For the twelve months ended December 31, 2008, Empire reported
revenues of $72 and net losses of $2,956.
The following table presents summarized information as to the assets and liabilities for Empire
at December 31, 2008:
|
|
|
|
|
|
|
|
December 31,
2008
|
|
|
|
(Unaudited)
|
|
Current assets
|
|
$
|
251
|
|
Land and water rights
|
|
|
3,870
|
|
Property and equipment, net
|
|
|
4,353
|
|
Other assets
|
|
|
549
|
|
|
|
|
|
|
Total assets
|
|
$
|
9,023
|
|
|
|
|
|
|
Current liabilities
|
|
$
|
203
|
|
Shareholders’ equity
|
|
|
8,820
|
|
|
|
|
|
|
Total liabilities and shareholders’ equity
|
|
$
|
9,023
|
|
|
|
|
|
Note 12—Bion Impairment
During the third quarter of 2008, the Company recorded a charge to earnings of $740, classified in the accompanying statement of operations as research and development expense, to write off certain assets related to
the development of the Company’s proprietary Bion Exchange technology. Management determined this impairment charge was required due to uncertainties regarding the future commercial viability of the technology which were, in part, due to the
economics of competing technologies with respect to biological processes intended to reduce the costs of treatment of contaminated water.
F-26
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 13—Notes Payable
The following table summarizes notes payable as of December 31, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Note payable to a financing company, non-interest bearing, imputed interest rate of 68.9% per annum, payable in 80 monthly installments
beginning on August 1, 2008 and ending on March 1, 2014
|
|
$
|
155
|
|
|
$
|
352
|
|
|
Contract payable to a financing company in nine monthly installments including interest at 4.6% per annum
|
|
|
362
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Total notes payable
|
|
|
517
|
|
|
|
352
|
|
|
Less: current portion of notes payable
|
|
|
(408
|
)
|
|
|
(239
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Notes payable, net of current portion
|
|
$
|
109
|
|
|
$
|
113
|
|
|
|
|
|
|
|
|
|
|
|
Notes Payable to Finance Companies
In June 2007, the Company sold 10 of its water treatment systems to a special purpose entity, VL Capital (VLC). The total sales price was $3,853,
consisting of $500 in cash to be paid to the Company plus notes issued by VLC to the Company payable in 72 monthly installments of $56 beginning April 2008, with a net present value of $3,353, calculated using an imputed interest rate of
5.0% per annum.VLC, in turn, received a loan of $500 from a finance company to fund the cash payment to the Company. This non-interest bearing loan is due in nine monthly installments of $63 plus 71 monthly installments of $7 beginning August
2008.
The Company has determined that, in accordance with the provisions of FIN 46(R), the financial statements of VLC should be included
in the consolidated financial statements of the Company. Accordingly, both the sale of equipment to VLC and the notes receivable from VLC have been eliminated in consolidation, and the Company has included in its consolidated financial statements
the notes payable by VLC to the finance company. As of December 31, 2008, there was $155 outstanding under these notes payable.
The
Company also has a contract payable to a financing company for a portion of its insurance premiums, payable in nine monthly installments of $51 beginning in November 2008 and ending in July 2009.
Repayment of Notes Payable
In February 2006,
the Company issued a $2,000 subordinated note to Aqua America, Inc. (the Aqua Note). The Aqua Note was secured by substantially all of the Company’s assets, including its water contracts and water services agreements. The Aqua Note accrued
interest at a rate of 7.0% per annum, payable on a semiannual basis beginning July 1, 2006. The Aqua Note matured on May 11, 2007 and was repaid in full, including all accrued interest.
In connection with an anticipated nationwide strategic relationship with Aqua America and issuance of the Aqua Note, the Company issued to Aqua America a
warrant to purchase 300,000 shares of the Company’s common stock at an exercise price of $6.00 per share and a warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $7.00 per share. These warrants are
immediately exercisable and expire on the earliest of November 11, 2008 and immediately prior to a change in control of the Company. The Company
F-27
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 13—Notes Payable (continued)
has applied the provisions of SFAS No. 123(R),
Share-Based Payment
, to the warrants issued to Aqua America. Accordingly, the total fair value of
the warrants issued is approximately $406. The fair value of these warrants was amortized over the term of the Aqua Note.
Pursuant to the
terms of a business loan agreement with BWCA I, LLC (the BWCA loan), after completion of the Company’s initial public offering in May 2006, the Company repaid the $4,000 BWCA loan, plus all accrued interest. In addition, the remaining
unamortized fair value of warrants issued to the lender in connection with the BWCA loan in the amount of $400 was written off in the second quarter of 2006, as the principal on the loan was repaid in full.
In accordance with the terms of the $5,000 in subordinated notes payable to The Co-Investment 2000 Fund, L.P., Cross Atlantic Technology Fund II, L.P.
and Catalyst Basin Water, LLC (the XACP Notes), after completion of the Company’s initial public offering in May 2006, the Company repaid in full the XACP Notes, plus all accrued interest. In addition, the remaining unamortized fair value of
warrants issued in connection with the XACP Notes in the amount of $1,100 was written off in the second quarter of 2006, as these notes were repaid in full.
Also, the remaining unamortized loan costs of $400 for the BWCA loan and the XACP Notes were written off in the second quarter of 2006, as the principal amount of these debt instruments was repaid in full.
Note 14—Capital Lease Obligations
The
Company leases vehicles and certain office equipment under capital leases. The economic substance of the leases is that the Company is financing the acquisitions of vehicles and equipment through leases and, accordingly, they are recorded in the
Company’s assets and liabilities. Included in depreciation expense is amortization of vehicles and equipment held under capital leases. At December 31, 2008, the net book value of assets subject to capital leases was $15. The following is
a schedule by year of the future minimum lease payments required under capital leases as of December 31, 2008:
|
|
|
|
|
|
Year Ending December 31,
|
|
Amount
|
|
2009
|
|
$
|
10
|
|
2010
|
|
|
5
|
|
|
|
|
|
|
Total future capital lease payments
|
|
$
|
15
|
|
|
|
|
|
Note 15—Contract Loss Reserve
During the latter half of 2006 and in 2007, the Company analyzed operating results for each water service agreement (WSA) and determined that certain,
generally older contracts were operating at net cash flow losses. Under the WSAs, the Company provides to its customers operations and maintenance services for water treatment units previously sold or leased to those customers. These contracts have
sustained increasing operating costs such as waste disposal and salt purchase costs as the direct result of higher fuel, salt and other third-party costs. These contracts did not allow for the renegotiation of terms to recover such increased costs.
Management determined that these contracts would continue to generate net operating cash flow losses through the end of the contract period, and those additional contracts that were not yet operational, but which were scheduled to go online
thereafter, could have similar problems. Accordingly, the Company recorded a reserve for future contract losses in the amount of approximately $3,700 in the fourth quarter of 2006. This amount represented the losses expected over the remaining
F-28
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 15—Contract Loss Reserve (continued)
term of the initial period of these contracts and does not include renewal periods, if any, related to such contracts. Actual losses on the underlying
contracts are being charged against the reserve as incurred.
During 2007, as these contracts progressed and additional older legacy
contracts became operational and were operated during the busy, higher volume summer months it became apparent by the third quarter of 2007 that the original reserve was not adequate. Based on the new operating history, especially during the third
quarter of 2007, the Company determined that the original reserve was not adequate. Management reviewed each contract’s financial performance and identified the future expected losses for these contracts, resulting in an approximate $6,800
increase to the reserve (offset by approximately $1,400 of actual contract losses charged against the reserve) which was charged to cost of contract revenues during the third quarter of 2007. The Company’s contract loss reserve relates only to
water service agreements.
As part of its customary process and in connection with the preparation of its financial statements for the
quarter ended June 30, 2008, the Company conducted its review of the adequacy of the reserve for contract losses. Based on the results of that review, which included the benefit of additional operating history, the Company determined that the
overall contract loss reserve as of that date required only minor adjustment. As part of the process, certain adjustments were necessary to reallocate the total contract loss reserve to specific contracts to give effect to current estimates of
future losses for such contracts. Included in the total contract loss reserve at December 31, 2008 is approximately $1,200 related to service contracts for water treatment systems which have not yet become operational but are anticipated to go
online in the future.
In December 2007, other than in contracts that had been previously negotiated, the Company began including
provisions in its WSAs that allowed for the pass-through of certain increased costs (primarily costs related to salt and waste transportation) to its customers. At the time of renewal of a loss contract, the Company would renegotiate the terms of
the project by increasing its payments to eliminate its losses under the contract or it would decline to renew the contract.
These reserve
amounts are being reversed (or applied) as actual losses are incurred on the underlying contracts. The reserve for contract losses included in the consolidated balance sheet as of December 31, 2008 was approximately $8,000. The changes in the
reserve for contract losses are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Beginning balance
|
|
$
|
9,112
|
|
|
$
|
3,725
|
|
|
Additions to contract loss reserve
|
|
|
40
|
|
|
|
6,777
|
|
|
Actual contract losses charged against the reserve
|
|
|
(1,182
|
)
|
|
|
(1,390
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance
|
|
|
7,970
|
|
|
|
9,112
|
|
|
Less: current portion
|
|
|
(1,542
|
)
|
|
|
(2,109
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Long-term portion
|
|
$
|
6,428
|
|
|
$
|
7,003
|
|
|
|
|
|
|
|
|
|
|
|
The Company is in ongoing discussions with several customers in an effort to reduce the current
and expected operating losses associated with certain water services agreements. While the ultimate outcome of such discussions cannot be predicted with certainty, it is reasonably possible that such negotiations may result in amendments to existing
contracts or new contracts which will result in reduced future operating losses and a reduction in the amount of the required reserve for contract losses. However, at this time, such contract amendments or new contracts have not yet been finalized.
F-29
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 16—Income Taxes
The components of the provision for income taxes consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
(7,662
|
)
|
|
$
|
(2,013
|
)
|
|
$
|
(2,096
|
)
|
|
State
|
|
|
(1,884
|
)
|
|
|
(556
|
)
|
|
|
(547
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,546
|
)
|
|
|
(2,569
|
)
|
|
|
(2,643
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(869
|
)
|
|
|
(2,910
|
)
|
|
|
(2,087
|
)
|
|
State
|
|
|
(417
|
)
|
|
|
(771
|
)
|
|
|
(581
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,286
|
)
|
|
|
(3,681
|
)
|
|
|
(2,668
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: valuation allowance
|
|
|
10,832
|
|
|
|
6,250
|
|
|
|
5,311
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax provision (benefit)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A reconciliation of the U.S. statutory federal income tax rate to the effective income tax rate is
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
U.S. federal statutory income tax rate
|
|
34.0
|
%
|
|
34.0
|
%
|
|
34.0
|
%
|
|
State taxes, net of federal income tax impact
|
|
4.7
|
%
|
|
5.4
|
%
|
|
5.5
|
%
|
|
Impairment charge—goodwill
|
|
(5.3
|
)%
|
|
0.0
|
%
|
|
0.0
|
%
|
|
Other
|
|
(0.1
|
)%
|
|
(0.3
|
)%
|
|
(0.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33.3
|
%
|
|
39.1
|
%
|
|
39.3
|
%
|
|
Less: impact of valuation allowance
|
|
(33.3
|
)%
|
|
(39.1
|
)%
|
|
(39.3
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate
|
|
0.0
|
%
|
|
0.0
|
%
|
|
0.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2008, the Company has Federal and state income tax net operating loss
carryforwards of approximately $47,300 and $46,800, respectively. The Federal net operating losses begin to expire in 2020. The California net operating losses have been suspended for two years and will begin to expire in 2010.
Pursuant to the provisions of the Internal Revenue Code, the utilization of Federal net operating loss (NOL) carryforwards in future years may be subject
to substantial annual limitations if a change of more than 50% in the ownership of the Company occurs. The Company has determined that, through the year ended December 31, 2008, there has been no ownership change of more than 50%. Accordingly,
all NOL carryforwards are available to the Company.
F-30
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 16—Income Taxes (continued)
The following summarizes the Company’s net deferred tax assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
|
NOL carryforwards
|
|
$
|
20,017
|
|
|
$
|
10,521
|
|
|
Contract loss reserve
|
|
|
3,379
|
|
|
|
3,085
|
|
|
Stock-based compensation
|
|
|
1,237
|
|
|
|
277
|
|
|
Capital gain
|
|
|
1,151
|
|
|
|
1,151
|
|
|
Investment in affiliate
|
|
|
966
|
|
|
|
—
|
|
|
Deferred revenues
|
|
|
813
|
|
|
|
653
|
|
|
Accrued other liabilities
|
|
|
695
|
|
|
|
—
|
|
|
Other reserves and allowances
|
|
|
415
|
|
|
|
793
|
|
|
Accrued compensation
|
|
|
355
|
|
|
|
401
|
|
|
Other
|
|
|
166
|
|
|
|
204
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
29,194
|
|
|
|
17,085
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
|
Deferred state taxes
|
|
|
(1,740
|
)
|
|
|
(991
|
)
|
|
Intangible assets
|
|
|
(1,430
|
)
|
|
|
(1,664
|
)
|
|
Depreciation
|
|
|
(1,217
|
)
|
|
|
(1,300
|
)
|
|
Revenue recognition
|
|
|
(761
|
)
|
|
|
(938
|
)
|
|
Other
|
|
|
(185
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(5,333
|
)
|
|
|
(4,893
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Less: valuation allowance
|
|
|
(23,861
|
)
|
|
|
(12,192
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred income tax liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
F-31
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 17—Stockholders’ Equity
Common Stock
The Company is authorized to issue 100,000,000 common shares of $0.001 par value
common stock, of which approximately 22.2 million and 21.9 million shares were issued and outstanding as of December 31, 2008 and 2007, respectively. As of December 31, 2008, there were also options outstanding to purchase
2,167,351 shares of common stock, and warrants outstanding to purchase 419,238 shares of common stock. Also, as of December 31, 2008, there were approximately 5,600,000 shares of common stock reserved for issuance upon exercise of all options,
warrants and for future issuances under the 2006 Option Plan.
Initial Public Offering
In May 2006, the Company registered for sale and sold 6,900,000 shares of $0.001 par value common stock at a price of $12.00 per share in its initial
public offering. After underwriting discounts and commissions and offering expenses in the amount of $7,600, the net proceeds from the Company’s initial public offering were approximately $75,200.
After the initial public offering, the Company’s amended and restated certificate of incorporation provides for a total of 100,000,000 authorized
shares of common stock, $0.001 par value. Also, immediately prior to the initial public offering, the Company reincorporated in Delaware.
Issuance
of Non-Vested Stock
During the years ended December 31, 2008 and 2007, the Company issued non-vested common stock grants to
certain of its officers and management, as well as to the members of its Board of Directors. The grants to officers and management are generally subject to a three-year vesting period from date of grant, with one-third of the stock vesting on the
anniversary dates of the grants each year during the three-year period. The grants to directors are subject to a one-year vesting period.
The fair value of these non-vested stock grants is based on the grant date closing price of the Company’s common stock, and is recorded as stock-based compensation expense on a straight-line basis over the vesting period of each grant,
with a corresponding credit to common stock and additional paid-in capital.
The fair value of non-vested common stock granted in 2008 and
2007 was $956 and $641, respectively. The amount of stock-based compensation expense recognized was $1,335, $831 and $137 during the years ended December 31, 2008, 2007 and 2006, respectively. At December 31, 2008 and 2007, the amount of
unamortized grant date fair value of non-vested stock grants was $1,181 and $1,560, respectively. The unamortized amount of grant date fair value at December 31, 2008 will be amortized over a weighted average period of 0.9 years.
Repurchase of Common Stock
In May 2007, the
Company’s Board of Directors authorized management to repurchase shares of the Company’s common stock in the market from time to time. In November 2007, the Company repurchased 85,000 shares of its common stock at a price of $6.45 per
share. These repurchased shares have been classified as treasury stock on the Company’s balance sheets as of December 31, 2008 and 2007.
F-32
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 18—Related Party Transactions
The Company paid legal fees to a legal firm whose partner is a director. The total payments for legal fees to this firm were $173, $315 and $192 for the
years ended December 31, 2008, 2007 and 2006, respectively.
The Company also leases office space and equipment from an individual who
was a former employee in, under a month-to-month agreement. The total payments under these related party rental agreements were $44, $57 and $54 for the years ended December 31, 2008, 2007 and 2006, respectively.
In May 2007, the Company entered into an agreement to acquire certain water rights and related assets. In December 2007, the Company sold its rights to
purchase these assets to Empire. As consideration for the sale of these assets, the Company received 6,000,000 shares of Empire common stock, which represents an ownership interest of approximately 32% in Empire as of December 31, 2008 and
2007. The former chief executive officer of the Company is the current president and chief executive officer of Empire.
The Company
accounted for the December 2007 transaction under the equity method. Specifically, the Company recorded $3,094 as gain on sale to affiliate upon the receipt of the shares of Empire common stock by (1) estimating the fair value of such stock
based upon concurrent sales of Empire common stock to third parties; (2) subtracting the Company’s basis in the assets sold; and (3) reducing the resulting gain by the Company’s ownership interest in Empire.
In addition, Empire agreed to purchase one water treatment system from the Company concurrent with the December 2007 closing for a total price of $900.
As of December 31, 2007, the Company had a $600 receivable due from Empire associated with this system sale, which was subsequently paid to the Company during 2008 in accordance with its terms. During the years ended December 31, 2008 and
2007, the Company recorded $62 and $653 of system sales revenue and $27 and $287 of gross margin, respectively on this transaction under the percentage-of-completion method of revenue recognition. During the years ended December 31, 2008 and
2007, the Company recorded $14 and $87, respectively, as charges against other income under the equity method, which represent 32% of the Company’s gross margin on this system sale to a related party.
On February 19, 2008 (the Separation Date), the Company entered into an Employment Transition and Consulting Agreement (the Transition Agreement)
with its former chief executive officer. The Transition Agreement provides the former chief executive officer with the following benefits: (1) he will receive a cash lump sum payment of $423, (2) the Company will pay for his healthcare
insurance for 18 months following the Separation Date (or until he accepts employment with another employer providing comparable benefits), (3) he will be retained as a consultant to the Company for two years after the Separation Date for which
he will receive $200 per year (payable each year in 12 equal monthly installments), (4) he will be entitled to receive compensation for his services as a director in accordance with the Company’s Amended and Restated Director Compensation
Policy for non-employee directors, (5) he will be entitled to retain all Company personal property, including computer equipment, printers, cameras and a used Company truck, that is in his possession as of the Separation Date and (6) he
will not be entitled to any further benefits under his employment agreement in effect prior to the Separation Date except as provided in the Transition Agreement. On February 19, 2008, the Company’s former chief executive officer was
appointed as the principal executive officer of Empire.
F-33
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 19—Consolidated Statements of Cash Flows
The following information supplements the Company’s consolidated statements of cash flows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Supplemental disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
101
|
|
|
$
|
147
|
|
|
$
|
727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of assets acquired
|
|
$
|
2,531
|
|
|
$
|
9,369
|
|
|
$
|
—
|
|
Liabilities assumed
|
|
|
(534
|
)
|
|
|
(3,200
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for acquisition (net of cash acquired)
|
|
$
|
1,997
|
|
|
$
|
6,169
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issued for acquisition
|
|
$
|
—
|
|
|
$
|
5,266
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants issued for services and other
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,941
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Receivables satisfied for acquisition
|
|
$
|
4,727
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property returned from seller
|
|
$
|
(2,622
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 20—Stock-Based Incentive Compensation Plans
2006 Equity Incentive Award Plan
In May 2006,
the Company adopted the Basin Water 2006 Equity Incentive Award Plan, or 2006 Equity Plan. The 2006 Equity Plan became effective immediately prior to the completion of the initial public offering in May 2006. The 2006 Equity Plan replaces the 2001
Stock Option Plan. Under the 2006 Equity Plan, 2,500,000 shares of the Company’s common stock were initially reserved for issuance. During 2007, the authorized number of shares under the 2006 Equity Plan was increase by approximately 995,000
shares. As of December 31, 2008, there were 2,737,605 shares of common stock reserved for issuance under the 2006 Equity Plan. Options issued under the plan are issued at the closing price of the stock on the date of the grant. Option grants
are generally exercisable over three years, starting one year from the date of grant, and they expire 10 years from the date of grant.
Prior to becoming a publicly traded company in May 2006, the Company granted stock options with exercise prices equal to the estimated fair value of its common stock. However, to the extent that the deemed fair value of the common stock
exceeded the exercise price of stock options on the grant date, the Company recorded deferred stock-based compensation expense and amortizes the expense over the vesting period of the options. The fair value of the Company’s common stock was
determined by the Board. In the absence of a public trading market for the Company’s common stock, the Board considered both objective and subjective factors in determining the fair value of the Company’s common stock and related stock
options. Consistent with the guidance provided by the American Institute of Certified Public Accountants in its Technical Practice Aid (TPA) entitled
The Valuation of Privately Held Company Equity Securities Issued as Compensation
, such
considerations included, but were not limited to, the following factors:
|
|
•
|
|
The liquidation preference, anti-dilution and redemption rights of the preferred stock and the lack of such rights for the common stock;
|
F-34
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 20—Stock-Based Incentive Compensation Plans (continued)
|
|
•
|
|
The per share price for concurrent or recent sales of common stock and redeemable convertible preferred stock;
|
|
|
•
|
|
Historical performance and operating results at the time of the grant;
|
|
|
•
|
|
Expected future earnings performance;
|
|
|
•
|
|
Liquidity and future capital requirements;
|
|
|
•
|
|
Stage of development and business strategy;
|
|
|
•
|
|
Marketplace developments and major competition;
|
|
|
•
|
|
Market barriers to entry;
|
|
|
•
|
|
Strategic relationships with third parties;
|
|
|
•
|
|
Size of workforce and related skills;
|
|
|
•
|
|
The illiquidity of the common stock; and
|
|
|
•
|
|
The likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering or a sale.
|
Cheap Stock Amortization
In connection with
the Company’s initial public offering, the Company re-evaluated the historical fair value of its common stock. As a result of this re-evaluation, the Company recorded deferred stock-based compensation for the years ended December 31, 2006
and 2005 in the amount of $401 and $229, respectively, which represents the difference between the exercise price of stock options granted in the first quarter of 2006 and in the fourth quarter of 2005 and the revised fair value of the common stock
underlying such options on the date of grant.
Pursuant to FASB Interpretation (FIN) No. 28, the Company is amortizing these deferred
compensation amounts using both the graded attribution method and the straight-line attribution method over the vesting period of the options, which is generally three years. As a result of the amortization of these deferred compensation amounts,
the Company recorded $153, $189 and $256 of non-cash stock-based compensation expense for the years ended December 31, 2008, 2007 and 2006, respectively, all of which was included in selling, general and administrative expense for each year.
Method of Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with the provisions set forth in SFAS No. 123(R),
Share-Based Payment
(SFAS No. 123(R)). Under the provisions of SFAS No. 123(R),
stock-based compensation cost is measured at the date of grant, based on the calculated fair value of the stock-based award, and is recognized as expense over the employee’s requisite service period (generally the vesting period of the award).
The Company estimated the fair value of stock options granted during the years ended December 31, 2008, 2007 and 2006 using the
Black-Scholes method. Key assumptions used to estimate the fair value of stock options include the exercise price of the award, the fair value of the Company’s common stock on the date of grant, the expected option term, the risk free interest
rate at the date of grant, the expected volatility of the Company’s common stock over the expected option term, and the expected annual dividend yield on the Company’s common stock.
F-35
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 20—Stock-Based Incentive Compensation Plans (continued)
The fair value of each option grant during the years ended December 31, 2008, 2007 and 2006 was
estimated on the date of grant using the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
2007
|
|
2006
|
|
Expected option term in years
|
|
5.5 to 6.5
|
|
5.0 to 7.0
|
|
6.5 to 7.5
|
|
Risk free interest rate
|
|
4.5%
|
|
4.5% to 4.8%
|
|
4.3% to 5.0%
|
|
Expected volatility
|
|
28.4%
|
|
26.9% to 29.5%
|
|
28.3% to 29.6%
|
|
Expected dividend yield
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
The estimated forfeiture rate for stock option grants was 9.0%, 8.0% and 5.0% during the years
ended December 31, 2008, 2007 and 2006, respectively.
The expected option term in years was calculated using an average of the
vesting period and the option term, in accordance with the “simplified method” for “plain vanilla” stock options allowed under Staff Accounting Bulletin (SAB) 107. The risk free interest rate is the rate on a zero-coupon U.S.
Treasury bond with a remaining term equal to the expected option term. The expected volatility was derived from an industry-based index, in accordance with the calculated value method allowed under SFAS No. 123(R).
SFAS No. 123(R) requires entities to estimate the number of forfeitures expected to occur and record expense based upon the number of awards
expected to vest. Prior to adoption of SFAS No. 123(R), the Company accounted for forfeitures as they occurred, as permitted under SFAS No. 123. The cumulative effect of adopting the method change of estimating forfeitures is not material
to the Company’s financial statements for the year ended December 31, 2006.
Stock Option Activity
A summary of stock option activity for the years ended December 31, 2008 and 2007 is as follows:
|
|
|
|
|
|
|
|
|
(In thousands, except exercise prices)
|
|
Number
of Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
Options outstanding at December 31, 2006
|
|
1,528
|
|
|
$
|
4.72
|
|
Granted
|
|
466
|
|
|
|
8.18
|
|
Exercised
|
|
(224
|
)
|
|
|
2.36
|
|
Forfeited
|
|
(60
|
)
|
|
|
7.60
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2007
|
|
1,710
|
|
|
|
5.85
|
|
Granted
|
|
518
|
|
|
|
4.72
|
|
Exercised
|
|
(29
|
)
|
|
|
0.83
|
|
Forfeited
|
|
(32
|
)
|
|
|
4.91
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2008
|
|
2,167
|
|
|
$
|
5.66
|
|
|
|
|
|
|
|
|
F-36
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 20—Stock-Based Incentive Compensation Plans (continued)
The following table summarizes information about stock options outstanding and exercisable as of
December 31, 2008:
|
|
|
|
|
|
|
|
|
(In thousands, except exercise prices and years)
|
|
Outstanding
|
|
Exercisable
|
|
Number of shares
|
|
|
2,167
|
|
|
1,107
|
|
Weighted average remaining contractual life in years
|
|
|
7.3
|
|
|
6.0
|
|
Weighted average exercise price per share
|
|
$
|
5.66
|
|
$
|
4.63
|
|
Aggregate intrinsic value (at December 31, 2008 closing price of $0.52 per share)
|
|
$
|
—
|
|
$
|
—
|
The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value
(the difference between the Company’s closing stock price as of December 31, 2008 and the weighted average exercise price multiplied by the number of shares) that would have been received by the option holders had all option holders
exercised their options on December 31, 2008. This intrinsic value will vary as the Company’s stock price fluctuates.
The
weighted average grant-date fair value of options granted by the Company during the years ended December 31, 2008 and 2007 was $1.81 and $2.94 per share, respectively.
Compensation expense arising from stock option grants was $1,146, $626 and $539 for the years ended December 31, 2008, 2007 and 2006, respectively,
all of which expense was included in selling, general and administrative expense for each year. No related income tax benefit was recorded as the Company has significant net operating loss carryforwards (see Note 16).
As of December 31, 2008, approximately $1,174 of unrecognized compensation expense related to stock options is expected to be recognized over a
weighted average period of 1.1 years. The total fair value of options vested during the years ended December 31, 2008 and 2007 was $743 and $195, respectively.
Stock options outstanding and exercisable at December 31, 2008, and the related exercise price and remaining contractual life are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
Number of
Options
Outstanding
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Life of Options
Outstanding
|
|
Number of
Options
Exercisable
|
|
Weighted
Average
Exercise
Price
|
|
$0.83 - $1.33
|
|
217
|
|
$
|
1.03
|
|
2.7 yrs
|
|
218
|
|
$
|
1.03
|
|
$4.00 - $4.29
|
|
455
|
|
$
|
4.04
|
|
6.8 yrs
|
|
308
|
|
$
|
4.00
|
|
$5.00
|
|
673
|
|
$
|
5.00
|
|
8.1 yrs
|
|
334
|
|
$
|
5.00
|
|
$6.79 - $9.00
|
|
717
|
|
$
|
7.88
|
|
8.3 yrs
|
|
213
|
|
$
|
7.57
|
|
$9.87 - $12.29
|
|
105
|
|
$
|
11.33
|
|
8.6 yrs
|
|
34
|
|
$
|
11.34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,167
|
|
$
|
5.66
|
|
7.3 yrs
|
|
1,107
|
|
$
|
4.63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of stock options exercised during the years ended December 31, 2008
and 2007 was $99 and $1,736, respectively.
F-37
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 20—Stock-Based Incentive Compensation Plans (continued)
Non-vested Stock
Under the 2006 Equity Plan, the Company has granted non-vested common stock to management, officers and directors, which is subject only to a service condition. In general, such non-vested stock vests over three years
for management and one year for directors. The total cumulative number of shares of non-vested stock granted under the 2006 Equity Plan through December 31, 2008 is 510,514, of which 218,125 shares had vested as of December 31, 2008.
The fair value of non-vested stock is measured at the date of grant based upon the closing price of the Company’s common stock on
that date, and such fair value is recognized as stock-based compensation expense over the requisite vesting period. Compensation expense arising from grants of non-vested stock during the years ended December 31, 2008, 2007 and 2006 was $1,335,
$831 and $137, respectively, all of which expense was included in selling, general and administrative expense for each year. As of December 31, 2008, approximately $1,200 of unrecognized compensation expense related to non-vested stock grants
is expected to be recognized over a weighted average period of 0.9 years.
2001 Stock Option Plan
On August 27, 2001, the Company established the Basin Water 2001 Stock Option Plan. Under the plan, 900,000 shares of the Company’s common stock
were initially reserved for issuance upon exercise of options pursuant to the plan. In June 2005, the plan was amended to increase the number of shares of Company common stock reserved for issuance to 2,100,000. In May 2006, the 2001 Stock Option
Plan was replaced by the 2006 Equity Plan, and no further shares may be issued from the 2001 Stock Option Plan.
Note 21—Warrants
From time to time, the Company has issued common stock warrants to non-employees in connection with various transactions, primarily the issuance of
notes payable (see Note 12). During the year ended December 31, 2007, the holders of 1,350,000 warrants exercised such warrants, resulting in net proceeds to the Company of $8,060. In addition, during the year ended December 31, 2007, the
holders of 56,066 warrants elected cashless exercise of such warrants, and the Company issued 38,995 shares of common stock in these cashless exercises. During the year ended December 31, 2008, the Company cancelled 300,000 warrants in
connection with the acquisition of Envirogen from Shaw (see Note 3). In addition, there were 678,384 warrants with an exercise price of $4.00 per share which expired during the fourth quarter of 2008. A summary of common stock warrant activity
during the three years ended December 31, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
Warrants
Outstanding
|
|
|
Weighted
Average
Exercise Price
|
|
Balance—January 1, 2006
|
|
2,354
|
|
|
$
|
5.30
|
|
Warrants issued
|
|
450
|
|
|
$
|
6.44
|
|
|
|
|
|
|
|
|
|
Balance—December 31, 2006
|
|
2,804
|
|
|
$
|
5.48
|
|
Warrants issued
|
|
—
|
|
|
|
|
|
Warrants exercised
|
|
(1,406
|
)
|
|
$
|
5.87
|
|
|
|
|
|
|
|
|
|
Balance—December 31, 2007
|
|
1,398
|
|
|
$
|
5.10
|
|
Warrants issued
|
|
—
|
|
|
|
|
|
Warrants cancelled
|
|
(300
|
)
|
|
$
|
7.00
|
|
Warrants forfeited
|
|
(679
|
)
|
|
$
|
4.00
|
|
|
|
|
|
|
|
|
|
Balance—December 31, 2008
|
|
419
|
|
|
$
|
5.51
|
|
|
|
|
|
|
|
|
F-38
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 21—Warrants (continued)
The Company has applied the provisions of SFAS No. 123(R) to estimate the fair market value of
both the common stock and preferred stock warrants on the date of issuance using the Black Scholes option-pricing model with the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
2007
|
|
2006
|
|
Expected life in years
|
|
—
|
|
—
|
|
2.5
|
|
Risk free interest rate
|
|
—
|
|
—
|
|
3.8%
|
|
Volatility
|
|
—
|
|
—
|
|
30.0%
|
|
Dividend yield
|
|
—
|
|
—
|
|
0.0%
|
The expected life in years was calculated using an average of the vesting period and the option
term, in accordance with the “simplified” method for “plain vanilla” stock options allowed under SAB 107. The risk-free interest rate is the rate on a zero-coupon U.S. Treasury bond with a remaining term equal to the expected
life of the option. The volatility was derived from an industry-based index, in accordance with the calculated-value method allowed under SFAS No. 123(R).
As a result of these computations of the fair value of warrants issued, the following amounts have been recorded in the financial statements:
|
|
•
|
|
Warrants to purchase 717,450 shares of stock issued to the lender under the BWCA loan in 2003 and 2004 with an aggregate fair value of $435 have been recorded as a
discount to debt with a corresponding credit to common stock, and this discount was amortized to interest expense over the life of the BWCA loan until after completion of the Company’s initial public offering in May 2006, when the Company
repaid the BWCA loan in full pursuant to the terms of a business loan agreement with BWCA I, LLC. The remaining unamortized fair value of warrants in the amount of $392 was written off in the second quarter of 2006 (see Note 13).
|
|
|
•
|
|
Warrants to purchase 1,000,000 shares of stock issued to the purchasers of the XACP Notes in October 2005 with an aggregate fair value of $1,337 have been recorded
as a discount to debt with a corresponding credit to common stock, and this discount was being amortized to interest expense over the life of the XACP Notes until after completion of the Company’s initial public offering in May 2006, when the
Company repaid the XACP Notes in full pursuant to the terms of a business loan agreement with BWCA I, LLC. The remaining unamortized fair value of warrants in the amount of $1,132 was written off in the second quarter of 2006 (see Note 13).
|
|
|
•
|
|
Pursuant to a $1,500 binding commitment letter with a customer in September 2005, the customer committed to purchase two of the Company’s groundwater treatment
systems. As part of this transaction, the Company granted to the customer a warrant to purchase 180,000 shares of common stock at an exercise price of $5.50 per share. This warrant is fully vested upon issuance, and may be exercised for five years
after the date of grant. This warrant has a fair value of $168, which is being recorded as a charge to revenues as the related revenues are recognized. Such charges totaled $14 and $154 during the years ended December 31, 2006 and 2005,
respectively.
|
|
|
•
|
|
Pursuant to a binding commitment letter with Shaw Environmental, Inc. (Shaw) in December 2005, Shaw committed to purchase a total of $5,000 of the Company’s
groundwater treatment systems prior to December 31, 2006. As part of that commitment letter, the Company granted to Shaw a warrant to purchase 300,000 shares of common stock at an exercise price of $7.00 per share in connection with Shaw’s
purchase of the Company’s groundwater treatment systems. As of December 31, 2007, no
|
F-39
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 21—Warrants (continued)
|
|
shares had vested under the Shaw warrant. Subsequently, as part of its September 18, 2008 acquisition of Envirogen from Shaw, the Company entered into a
settlement agreement with Shaw which cancelled the Shaw warrants (see Note 3).
|
|
|
•
|
|
In February 2006, in connection with the consent granted by BWCA I, LLC with respect to the Company’s issuance of the Aqua Note, the Company granted to BWCA I,
LLC a warrant to purchase 50,000 shares of the Company’s common stock at an exercise price of $8.00 per share. This warrant is immediately exercisable and may be exercised for five years after the date of grant. This warrant has a fair value of
$91, and was written off with the repayment of the BWCA loan in the second quarter of 2006 (see Note 13).
|
|
|
•
|
|
Warrants to purchase 400,000 shares of stock issued to Aqua America in connection with an anticipated nationwide strategic relationship with Aqua America and
issuance of the Aqua Note in February 2006 with an aggregate fair value of $406 have been recorded as a discount to debt, and the related amortization to interest expense was $140 and $266 in the years ended December 31, 2007 and 2006,
respectively (see Note 13).
|
To the extent that the deemed fair value of the common stock exceeds the exercise price of
warrants on the date of the grant, the Company records deferred charges and amortizes such deferred charges over the life of the underlying transaction with which the warrants were issued. Prior to the Company’s initial public offering in May
2006, the fair value of the Company’s common stock was determined by the Board. In the absence of a public trading market prior to the initial public offering for the Company’s common stock, the Board considered both objective and
subjective factors in determining the fair value of the Company’s common stock and related warrants.
Consistent with the guidance
provided by the American Institute of Certified Public Accountants in its Technical Practice Aid (TPA) entitled
The Valuation of Privately Held Company Equity Securities Issued as Compensation
, such considerations included, but were not
limited to, the following factors:
|
|
•
|
|
The liquidation preference, anti-dilution and redemption rights of the preferred stock and the lack of such rights for the common stock;
|
|
|
•
|
|
The per share price for concurrent or recent sales of common stock and redeemable convertible preferred stock;
|
|
|
•
|
|
Historical performance and operating results at the time of the grant;
|
|
|
•
|
|
Expected future earnings performance;
|
|
|
•
|
|
Liquidity and future capital requirements;
|
|
|
•
|
|
Stage of development and business strategy;
|
|
|
•
|
|
Marketplace developments and major competition;
|
|
|
•
|
|
Market barriers to entry;
|
|
|
•
|
|
Strategic relationships with third parties;
|
|
|
•
|
|
Size of workforce and related skills;
|
|
|
•
|
|
The illiquidity of the common stock; and
|
|
|
•
|
|
The likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering or a sale.
|
F-40
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 21—Warrants (continued)
In connection with the Company’s initial public offering, the Company re-evaluated the
historical fair value of its common stock. As a result of this re-evaluation, the Company recorded deferred charges for warrants issued during the years ended December 31, 2006 and 2005 in the amounts of $925 and $60, respectively, which
represent the difference between the exercise price of warrants granted in the first quarter of 2006 and in the fourth quarter of 2005 and the revised fair value of the common stock underlying such warrants on the date of grant. Pursuant to FASB
Interpretation (FIN) No. 28, the Company is amortizing such deferred charges over the appropriate period of the underlying transaction.
The deferred charges recorded in the fourth quarter of 2005 related to the warrants granted to Shaw totaled $60. The Company recorded $39 and $18 of non-cash charges against revenues in the years ended December 31, 2006 and 2005
respectively. There was no amortization of these deferred charges during the year ended December 31, 2007. As of December 31, 2007, the remaining unamortized deferred charge related to the Shaw warrants was $3, which was written off in
connection with the cancellation of the warrants in 2008.
Deferred charges recorded in the first quarter of 2006 related to the warrants
granted to BWCA I, LLC totaled $25. The Company amortized this amount in full as non-cash interest expense during the year ended December 31, 2006.
Additionally, the Company recorded $900 as a discount to debt in the first quarter of 2006 related to the warrants granted to Aqua America. The Company amortized $309 and $591 of these deferred charges as non-cash
interest expense during the years ended December 31, 2007 and 2006, respectively.
Note 22—Commitments and Contingencies
Customer Contracts
The Company has long-term
water treatment contracts with various customers. Under the terms of these contracts, the Company is entitled to monthly standby fees from these customers for periods ranging from three to five years. Additionally, the Company has received
prepayments in conjunction with certain long-term treatment contracts. These prepayments are recorded as deferred revenues. As of December 31, 2008, deferred revenues are expected to be recognized as revenues in future years as follows:
|
|
|
|
|
|
Year Ending December 31,
|
|
Amount
|
|
2009
|
|
|
235
|
|
2010
|
|
|
169
|
|
2011
|
|
|
169
|
|
2012
|
|
|
164
|
|
2013
|
|
|
164
|
|
Thereafter
|
|
|
324
|
|
|
|
|
|
|
Total
|
|
$
|
1,225
|
|
|
|
|
|
F-41
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 22—Commitments and Contingencies (continued)
Operating Leases
The Company has entered into operating leases for office space, facilities and equipment. The office space lease agreements provide for extensions of the leases. The facility lease requires payment of common area
maintenance, insurance and property taxes in addition to rental payments. The total gross rental expense for all operating leases for the years ended December 31, 2008, 2007 and 2006 was $664, $441, and $254, respectively. As of
December 31, 2008, the minimum future payments under these operating leases are as follows:
|
|
|
|
|
|
Year Ending December 31,
|
|
Amount
|
|
2009
|
|
$
|
886
|
|
2010
|
|
|
746
|
|
2011
|
|
|
555
|
|
2012
|
|
|
292
|
|
|
|
|
|
|
Total
|
|
$
|
2,479
|
|
|
|
|
|
Litigation
On December 27, 2007 and January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against the Company, Peter L.
Jensen, Michael M. Stark and Thomas C. Tekulve (collectively referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned
Poulos v. Basin Water, et al
., Case No. CV
07-8359 GW (FFMx) and
Nofer v. Basin Water, et al
., Case No. CV 08-0002 SGL (JCRx). The lawsuits were subsequently consolidated, and on October 3, 2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the Company
deliberately understated the reserves it took for certain unprofitable contracts, and committed various intentional violations of GAAP during a putative class period between November 14, 2006 and August 8, 2008 (the Federal Lawsuit). The
suit does not state a specific amount of damages.
On February 19, 2009, the Company and its insurance carriers reached an agreement
in principle to settle the class action with representatives of the class. The settlement is still subject to preparation of a final settlement agreement, following which the Company would intend to seek preliminary approval from the Court so that
class members can receive notice of the settlement, providing them with the opportunity to accept its terms or to opt out and choose whether to pursue their own individual claims. Following a fair period of notice to the class, it would be the
Company’s intention to seek final Court approval of the settlement and the dismissal of all claims against us. The Company denies all of the allegations in the lawsuit and believes that its disclosures were appropriate under the law.
Nevertheless, management has agreed to settle the litigation in order to avoid costly and time-consuming litigation. Management does not expect a cash effect of the settlement on the Company as the entire settlement amount is expected to be paid by
the Company’s liability insurers.
On January 23, 2008, the Company received a letter dated January 17, 2008, from attorneys
representing a purported stockholder demanding that we investigate and remedy alleged breaches of fiduciary duty by certain unnamed officers and directors of the Company. In the demand letter, the attorneys allege that the unnamed officers and
directors violated their duties to the Company by, among other things, participating in or permitting the company to issue false and misleading statements regarding its business and financial results giving rise to the above named lawsuits.
F-42
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 22—Commitments and Contingencies (continued)
On January 31, 2008, Loren Charif, a purported stockholder of the Company, filed a shareholder
derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of the Company’s executive officers and its current directors. The complaint assumes the truth of the aforementioned allegations in
the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining
to allegations of improper selling. The suit does not state a specific amount of damages. On November 12, 2008, the Company obtained an order staying this action until a final determination occurs in the Federal Lawsuit.
From time to time, the Company is involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which
management believes are not material to the conduct of the Company’s business. With respect to these ordinary matters, management believes that the Company has adequate insurance coverage or has made adequate accruals for expected costs, and
the Company may also have effective legal defenses.
Note 23—Selected Quarterly Financial Information (Unaudited)
Selected unaudited quarterly consolidated financial information is presented in the following tables:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2008
|
|
|
|
|
1st
Quarter
|
|
|
2nd
Quarter
|
|
|
3rd
Quarter
|
|
|
4th
Quarter
|
|
|
Revenues
|
|
$
|
2,849
|
|
|
$
|
3,109
|
|
|
$
|
2,847
|
|
|
$
|
2,973
|
|
|
Gross profit (loss)
|
|
|
330
|
|
|
|
(377
|
)
|
|
|
(380
|
)
|
|
|
(35
|
)
|
|
Net loss
|
|
|
(5,184
|
)
|
|
|
(5,974
|
)
|
|
|
(14,653
|
)
|
|
|
(6,714
|
)
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.24
|
)
|
|
$
|
(0.27
|
)
|
|
$
|
(0.67
|
)
|
|
$
|
(0.31
|
)
|
|
Diluted
|
|
$
|
(0.24
|
)
|
|
$
|
(0.27
|
)
|
|
$
|
(0.67
|
)
|
|
$
|
(0.31
|
)
|
|
|
|
|
|
|
Year Ended December 31, 2007
|
|
|
|
|
1st
Quarter
|
|
|
2nd
Quarter
|
|
|
3rd
Quarter
|
|
|
4th
Quarter
|
|
|
Revenues
|
|
$
|
1,753
|
|
|
$
|
2,211
|
|
|
$
|
2,406
|
|
|
$
|
3,290
|
|
|
Gross profit (loss)
|
|
|
(293
|
)
|
|
|
(561
|
)
|
|
|
(9,058
|
)
|
|
|
45
|
|
|
Net loss
|
|
|
(2,345
|
)
|
|
|
(2,497
|
)
|
|
|
(11,981
|
)
|
|
|
(1,453
|
)
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.12
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.60
|
)
|
|
$
|
(0.07
|
)
|
|
Diluted
|
|
$
|
(0.12
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.60
|
)
|
|
$
|
(0.07
|
)
|
Note 24 —Exit Activities
In the third quarter of 2008, in response to a decline in water treatment system orders during the first half of 2008, the Company commenced a study of steps that could be taken to reduce costs related to its
production facilities. In October 2008, the Company decided to close down the production facilities located in two leased buildings in Rancho Cucamonga, California and to outsource future production and assembly of water treatment systems.
F-43
BASIN WATER, INC. AND SUBSIDIARIES
NOTES TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In
thousands, except share and per share data)
Note 24—Exit Activities (continued)
Concurrently, the Company decided to put into effect a reduction in force (RIF) which resulted in the
termination of several production and engineering positions during the fourth quarter of 2008.
These exit activities were completed during
the fourth quarter of 2008. The remaining 27 monthly lease payments and related costs due under the operating lease for the former production facilities in the amount of approximately $600 were accrued as of December 31, 2008. The severance and
related benefits associated with the RIF in the amount of approximately $340 were paid during the fourth quarter of 2008; therefore, no accrual for future termination benefits was necessary as of December 31, 2008.
Of the total remaining payments under the operating lease and the one-time termination benefits recorded during the year ended December 31, 2008,
approximately $100 was classified as cost of revenues and approximately $840 was classified as selling, general and administrative expense.
Note
25—Subsequent Events
Opus Trust Settlement
On February 5, 2009, the Company, BionBasin, Inc. (Bion), Opus Trust, Inc. (Opus Trust) and Martin Benowitz, individually and as Trustee of the Martin A. Benowitz Qualified Profit Sharing Plan (Benowitz), entered
into a Settlement Agreement and Mutual Release Agreement (the Settlement Agreement) to settle, among other things, certain claims related to (a) ion exchange units previously sold to Opus Trust by Bion, including a unit that was damaged by an
uninsured motorist, (b) Benowitz’ acquisition and sale of the Company’s common stock and (c) Opus Trust’s acquisition of Bion common stock (the Dispute). Pursuant to the terms of the Settlement Agreement, (a) the
Company paid $125,000 to Opus Trust and transferred to Opus Trust 150,000 shares of Empire Water Corporation common stock, (b) Opus Trust transferred to the Company all shares of Bion common stock (500,000 shares) held by Opus Trust and title
to the ion exchange units previously sold to Opus Trust, (c) Opus Trust and Benowitz released the Company and Bion from any and all claims and actions arising from the Dispute, (d) the Company and Bion released Opus Trust and Benowitz from
any and all claims and actions arising from the Dispute and (e) the parties agreed not to make negative references to the character or business reputation of the parties to the Settlement Agreement.
Derivative Class Action Suit
On March 10,
2009, Demetrice Ledbetter, III, a purported shareholder of the Company, filed a shareholder derivative lawsuit in the United States District Court for the Central District of California against certain current and former executive officers and
directors of the Company. The complaint assumes the truth of the federal securities class action lawsuits described in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2007 and in connection with those allegations
alleges, among other things, breaches of fiduciary duty, waste of corporate assets, abuse of control, gross mismanagement, unjust enrichment, and claims for contribution and indemnification. The suit does not state a specific amount of damages.
F-44
BASIN WATER, INC.
Schedule II—Valuation and Qualifying Accounts
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
Beginning
of Year
|
|
Valuation
Account
Increases
|
|
Valuation
Account
Decreases
|
|
|
Balance
at End of
Year
|
|
Valuation allowance for net deferred tax assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
1,552
|
|
$
|
5,596
|
|
$
|
—
|
|
|
$
|
7,148
|
|
Year ended December 31, 2007
|
|
$
|
7,148
|
|
$
|
5,044
|
|
$
|
—
|
|
|
|
12,192
|
|
Year ended December 31, 2008
|
|
$
|
12,192
|
|
$
|
11,669
|
|
$
|
—
|
|
|
$
|
23,861
|
|
|
|
|
|
|
|
|
|
Balance at
Beginning
of Year
|
|
Valuation
Account
Increases
|
|
Valuation
Account
Decreases
|
|
|
Balance
at End of
Year
|
|
Allowance for doubtful accounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
—
|
|
$
|
65
|
|
$
|
—
|
|
|
$
|
65
|
|
Year ended December 31, 2007
|
|
$
|
65
|
|
$
|
243
|
|
$
|
(8
|
)
|
|
$
|
300
|
|
Year ended December 31, 2008
|
|
$
|
300
|
|
$
|
818
|
|
$
|
(384
|
)
|
|
$
|
734
|
|
|
|
|
|
|
|
|
|
Balance at
Beginning
of Year
|
|
Valuation
Account
Increases
|
|
Valuation
Account
Decreases
|
|
|
Balance
at End of
Year
|
|
Contract loss reserve:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
—
|
|
$
|
3,725
|
|
$
|
—
|
|
|
$
|
3,725
|
|
Year ended December 31, 2007
|
|
$
|
3,725
|
|
$
|
6,777
|
|
$
|
(1,390
|
)
|
|
$
|
9,112
|
|
Year ended December 31, 2008
|
|
$
|
9,112
|
|
$
|
40
|
|
$
|
(1,182
|
)
|
|
$
|
7,970
|
|
|
|
|
|
|
|
|
|
Balance at
Beginning
of Year
|
|
Valuation
Account
Increases
|
|
Valuation
Account
Decreases
|
|
|
Balance
at End of
Year
|
|
Inventory reserve:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
—
|
|
$
|
38
|
|
$
|
—
|
|
|
$
|
38
|
|
Year ended December 31, 2007
|
|
$
|
38
|
|
$
|
41
|
|
$
|
—
|
|
|
$
|
79
|
|
Year ended December 31, 2008
|
|
$
|
79
|
|
$
|
167
|
|
$
|
—
|
|
|
$
|
246
|
|
|
|
|
|
|
|
|
|
Balance at
Beginning
of Year
|
|
Valuation
Account
Increases
|
|
Valuation
Account
Decreases
|
|
|
Balance
at End of
Year
|
|
Reserve for losses on system sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
—
|
|
$
|
600
|
|
$
|
(315
|
)
|
|
$
|
285
|
|
Year ended December 31, 2007
|
|
$
|
285
|
|
$
|
1,422
|
|
$
|
(587
|
)
|
|
$
|
1,120
|
|
Year ended December 31, 2008
|
|
$
|
1,120
|
|
$
|
—
|
|
$
|
(1,120
|
)
|
|
$
|
—
|
F-45
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