Consolidated Water Co. Ltd. - Quarter Report: 2004 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

Commission File Number: 0-25248

CONSOLIDATED WATER CO. LTD.

Registrant’s telephone number, including area code: (345) 945-4277

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

As at July 31, 2004, there were 5,748,855 of the registrant’s ordinary shares of common stock, with CI$ 1.00 par value, outstanding.

EXCHANGE RATES

Unless otherwise indicated, all dollar amounts are in United States Dollars and references to “$”, “U.S.”, or “U.S. $” are to United States Dollars.

The official fixed exchange rate for conversion of CI$ into U.S.$, as determined by the Cayman Islands Monetary Authority, has been fixed since April 1974 at U.S. $1.20 per CI$1.00.

The official fixed exchange rate for conversion of BZE$ into U.S.$, as determined by the Central Bank of Belize, has been fixed since 1976 at U.S.$ 0.50 per BZE$ 1.00.

The official fixed exchange rate for conversion of BAH$ into U.S.$, as determined by the Central Bank of The Bahamas, has been fixed since 1973 at U.S. $1.00 per BAH $1.00.

The official fixed exchange rate for conversation of BDS$ into U.S.$ as determined by the Central Bank of Barbados has been fixed since 1975 at U.S.$ 0.50 per BDS$ 1.00.

The British Virgin Islands’ currency is U.S.$.

TABLE OF CONTENTS

Forward-Looking Statements

This Form 10-Q for Consolidated Water Co. Ltd. (the “Company”) includes statements that may constitute “forward-looking” statements, usually containing the words “believe,” “estimate,” “project,” “intend,” “expect” or similar expressions. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences include, but are not limited to, continued acceptance of the Company’s products and services in the marketplace, changes in its relationship with the governments of the jurisdictions in which it operates, the ability to successfully secure contracts for water projects in other countries, the ability to develop and operate such projects profitably, and other risks detailed in the Company’s other periodic report filings with the Securities and Exchange Commission. By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this Form 10-Q.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED WATER CO. LTD.

The accompanying information and notes are an
integral part of these condensed consolidated financial statements.

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CONSOLIDATED WATER CO. LTD.

The accompanying information and notes are an
integral part of these condensed consolidated financial statements.

2

CONSOLIDATED WATER CO. LTD.

The accompanying information and notes are an
integral part of these condensed consolidated financial statements.

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CONSOLIDATED WATER CO. LTD.

1. Presentation of Financial Information

The accompanying unaudited Condensed Consolidated Financial Statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. All adjustments that are, in the opinion of management, of a normal recurring nature and are necessary for a fair presentation of the interim financial statements have been included. The results of operations for the period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.

The accompanying consolidated financial statements of the Company should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10–K for the year ended December 31, 2003.

Certain of the prior period’s figures have been reclassified to conform to the current period’s presentation. The Company has reallocated various expenses in cost of sales, general and administrative expenses and interest expense, as management has determined it more appropriate to reflect these amounts in its current allocations. There is no impact to net income of the Company as a result of these reclassifications.

2 Principles of Consolidation

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of the Company’s wholly-owned subsidiaries, Cayman Water Company Limited, Belize Water Limited, Ocean Conversion (Cayman) Limited, DesalCo Limited, DesalCo (Barbados) Limited, and its majority owned subsidiary Waterfields Company Limited. All intercompany balances and transactions have been eliminated in consolidation.

3. Stock Based Compensation

The Company currently has four stock compensation plans. The Company accounts for stock–based compensation plans for employees and directors using the intrinsic value method. Under this method, the Company records no compensation expense for stock options granted when the exercise price of options granted is equal to or greater than the fair market value of the Company’s common stock on the date of grant.

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CONSOLIDATED WATER CO. LTD.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Stock Based Compensation (continued)

The following table presents the effect on net income and earnings per share if the Company had applied a fair value recognition method:

4. Segment Information

Under the Statements of Financial Accounting Standards 131, “Disclosure about Segments of an Enterprise and Related Information”, management considers; (i) the operations to supply water to retail customers, (ii) the operations to supply water to bulk customers, and (iii) the provision of engineering and management services as separate business segments.

For purposes of segment information, the accounts of Ocean Conversion (BVI) Ltd. have been proportionally consolidated into the Bulk water segment. An adjustment has been made in reconciling items to account for the investment under the equity method. Also included in reconciling items are corporate expenses including interest expense that do not relate to any specific operating segment.

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CONSOLIDATED WATER CO. LTD.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

4. Segment Information (continued)

As at June 30 and for the three months then ended

As at June 30 and for the six months then ended

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CONSOLIDATED WATER CO. LTD.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5. Earnings Per Share

Basic earnings per common share (“EPS”) is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. The computation of diluted EPS assumes the issuance of common shares for all dilutive-potential common shares outstanding during the reporting period. In addition, the dilutive effect of stock options is considered in earnings per common share calculations, if dilutive, using the treasury stock method.

The following summarizes information related to the computation of basic and diluted earnings per share for the three and six month period ended June 30, 2004 and 2003.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Our objective is to provide water services in areas where the supply of potable water is scarce and where the use of reverse osmosis technology to produce potable water is economically feasible. By focusing on this market, we believe that we can provide a superior financial return to our investors. To increase share value and maintain dividend payouts in accordance with current company policy, we need to expand our revenues by developing new business opportunities both within our current service areas, and in new areas. We need to maintain our high operating efficiencies by adhering to our strict equipment maintenance and water loss mitigation programs in order to achieve gross profit margins that have historically been between 40% and 45%. We further believe that many Caribbean basin and adjacent countries, while being water scarce, also present opportunities for operation of our plants in limited regulatory settings which are less restrictive than the highly regulated markets of North America, which promotes cost effective operation of our equipment.

Our business operations and activities are conducted in five countries: the Cayman Islands, Belize, Barbados, the British Virgin Islands and the Bahamas.

Critical Accounting Policies

The preparation of our condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to trade accounts receivable, goodwill and other intangible assets. Our company bases its estimates on historical experience and on various other assumptions that are believed 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. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies are the most important to the portrayal of our financial condition and results and require management’s more significant judgments and estimates in the preparation of our company’s consolidated financial statements.

Trade accounts receivable: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Management continuously evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts based on estimates of the level of actual write-offs which might be experienced. These estimates are based on, among other things, comparisons of the relative age of accounts and consideration of actual write-off history.

Goodwill and other intangible assets: Goodwill represents the excess costs over fair value of the assets of an acquired business. Goodwill and intangible assets acquired in a business combination accounted for as a purchase and determined to have an indefinite useful life are not amortized, but are tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimatable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”. The Company periodically evaluates the possible impairment of goodwill. Management identifies its reporting units and determines the carrying value of each reporting unit by assigning the assets and liabilities, including the existing

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goodwill and intangible assets, to those reporting units. The Company determines the fair value of each reporting unit and compares it to the carrying amount of the reporting unit. To the extent the carrying amount of the reporting unit exceeds the fair value of the reporting unit, the Company is required to perform the second step of the impairment test, as this is an indication that the reporting unit goodwill may be impaired. In this step, the Company compares the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to all the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation, in accordance with SFAS No. 141, “Business Combinations”. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. If the implied fair value is less than its carrying amount, the impairment loss is recorded.

Revenue

Revenue is comprised of retail water sales via pipeline to individual customers, bulk water sales to large commercial or municipal customers, and fees for management and engineering services.

Expenses

Expenses include the cost of sales (“direct expenses’’) and indirect, or general and administrative, expenses. Direct expenses include royalty payments to the Cayman Islands government, electricity and chemicals expenses, production equipment and facility depreciation costs, equipment maintenance expenses, operational staff costs and amortization of intangible assets. Indirect, or general and administrative, expenses consist primarily of salaries and employee benefits for administrative personnel, stock compensation expenses, office lease payments, depreciation on fixed assets used for administrative purposes and legal and professional fees. There are no income taxes in the Cayman Islands, and we are currently exempt from taxes in the British Virgin Islands and Belize. We pay an annual business license fee in the Bahamas. We pay income tax in Barbados.

Results of Operations

Three and Six Months Ended June 30, 2004 Compared to Three and Six Months Ended June 30, 2003

Revenue

Total revenue increased by 34.9% from $4,750,381 to $6,409,364 for the three months ended June 30, 2004 and by 45.4% from $8,769,106 to $12,747,061 for the six months ended June 30, 2004 when compared to the same three and six month period in 2003.

Revenue from our retail water (“Retail”) operations increased by 23.5% from $2,862,424 to $3,536,311 for the three months ended June 30, 2003 and 2004, respectively, and by 25.2% from $5,681,376 to $7,111,387 for the six months ended June 30, 2003 and 2004, respectively. For the three and six months ended these increases were due to higher water sales in our primary market in the Cayman Islands due to increased demand in both our tourist and residential markets. Published tourist air arrivals records show a 17.6% increase for the three months ended June 30, 2004 and a 12.7% increase for the six months ended June 30, 2004 over the same periods in the prior year. Residential markets increased due to increased residential development.

Revenue from our bulk water (“Bulk”) operations increased by 76.4% from $1,505,716 to $2,655,693 for the three months ended June 30, 2003 and 2004, respectively, and by 105.7% from $2,510,857 to

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$5,163,872 for the six months ended June 30, 2003 and 2004, respectively. For the three month period this increase was due to the additional three months of revenue from our acquisition of Waterfields Company Limited when compared to the same three month period in 2003. For the six months periods these increases were due to an additional month of revenue from our acquisition of Ocean Conversion (Cayman) Limited operations and six months of revenue from our acquisition of Waterfields Company Limited operations when compared to the same six month period in 2003. Revenues from our Belize operations declined by 26% and 32%, respectively during the same three and six month periods due to the reduced water rates in the new long term contract which was signed in September 2003 and has come into full effect on June 1, 2004 now that all conditions precedent have been met or waived. These reduced prices will be offset by the reduced amortization costs on the intangible asset which is being amortized over 23 years. The new contract also makes us the exclusive producer of potable water for our customer on Ambergris Caye for the term of the agreement.

Revenue from services (“Service”) decreased by 43.1% from $382,241 to $217,360 for the three months ended June 30, 2003 and 2004, respectively, and by 18.2% from $576,873 to $471,802 for the six months ended June 30, 2003 and 2004, respectively. For the three and six month periods these decreases were due to fewer construction projects and the related decrease in engineering fees that are charged on labour and material costs associated with these projects. During the three and six month periods, we substantially completed our existing construction projects and have not commenced any new construction projects. We are in the process of bidding for one plant in BVI and are awaiting the results of three other bids which we submitted earlier this year on projects in the Bahamas, Barbados and Mexico.

Other Income (Expenses)

Total other income increased from a net expense of $140,461 to a net income of $314,255 for the three months ended June 30, 2003 and 2004, respectively, and from a net expense of $129,615 to a net income of $470,046 for the six months ended June 30, 2003 and 2004, respectively. These increases were due primarily to decreased interest expense because we repaid our bridge loan facility with proceeds from our 2003 equity offering on July 8, 2003 and due to the full amortization of our bridge financing fees in the prior year. Our profit sharing and equity income from our investment in Ocean Conversion (BVI) Ltd. also contributed to the increase.

Cost of Sales

Total cost of sales increased by 34.8% from $2,641,400 to $3,559,819 for the three months ended June 30, 2004 and by 43.4% from $4,874,863 to $6,990,769 for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003. During these same periods in 2004, our total revenue increased by 34.9% and 45.4%, respectively.

Cost of sales of our Retail operations increased by 17.0% from $1,214,120 to $1,420,869 for the three months ended June 30, 2003 and 2004, respectively, and by 14.7% from $2,433,996 to $2,791,151 for the six months ended June 30, 2003 and 2004, respectively, while our Retail revenue increased by 23.5% and 25.2% for the same period. For the three and six month periods, these increases in cost of sales resulted primarily from additional variable costs related to the production of the additional water sold.

Cost of sales of our Bulk operations increased by 54.1% from $1,284,141 to $1,978,442 for the three months ended June 30, 2003 and 2004, respectively, and by 78.6% from $2,180,160 to $3,894,501 for the six months ended June 30, 2003 and 2004, respectively, while our Bulk revenue increased by 76.4% and 105.7% for the same periods. For the three month period this increase was due to the additional three months of cost of sales from our acquisition of Waterfields Company Limited when compared to the same three month period in 2003. For the six months periods these increases in cost of sales were due to

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an additional month of expenses from our Ocean Conversion (Cayman) Limited operations and six months of expenses from our Waterfields Company Limited operations when compared to the same six month periods in 2003. This increase was also affected by increased maintenance costs in our Belize operations due to the unscheduled rebuild of our diesel engines. We have changed management of our Belize operations and are working on reducing these unscheduled repair costs by improving the capabilities of our staff and preventative maintenance.

Cost of sales from our Service operations increased by 12.1% from $143,139 to $160,508 for the three months ended June 30, 2003 and 2004, respectively, and by 17.0% from $260,707 to $305,117 for the six months ended June 30, 2003 and June 30, 2004, respectively, while our Service revenue decreased by 43.1% and 18.2% for the same periods. For the three and six month periods these increases were due to additional labour expense because certain permanent staff were not charged out to construction projects. In addition for the six month period the increase in cost of sales is due to an additional month of operations from both DesalCo Limited and its wholly-owned subsidiary DesalCo (Barbados) Ltd. For the three and six month periods our Barbados operation also experienced increased maintenance when compared to the same periods is 2003.

Gross Profit

Overall gross profit margin increased from 44.4% to 44.5% for the three months ended June 30, 2004 and from 44.4% to 45.1% for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003, for the reasons explained below.

Gross profit margin for our Retail operations increased from 57.6% to 59.8% for the three months ended June 30, 2004 and from 57.2% to 60.8% for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003. The primary reasons for these increases are that our Retail cost of sales decreased as a result of the cancellation of the Governor’s Harbour plant operating contract in February 2003, and our Cayman water production equipment produced more water to meet increased customer demand and we incurred no additional fixed overhead costs.

Gross profit margin for our Bulk operations increased from 14.7% to 25.5% for the three months ended June 30, 2004 and from 13.2% to 24.6% for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003. The primary reason for these increases is due to the addition of the operations of Waterfields Company Limited which is producing water at a higher gross margin than our other bulk operations. The reason Waterfields Company Limited is able to operate at higher gross profit margins than some of our other Bulk operations is because Waterfields does not incur the amortization expense that our other Bulk operations incur. Various intangible assets were recognized in Ocean Conversion (Cayman) Limited when we acquired that company in February 2003, and in Belize Water Limited when we acquired that company in June 2000. Amortization expense of $428,502 and $420,961 was taken during each of the six month ended June 30, 2003 and 2004, respectively in our Bulk operations.

Gross profit margin for our Service reporting segment decreased from 62.6% to 26.2% for the three months ended June 30, 2004 and from 54.8% to 35.3% for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003. The primary reason for these decreases is because we did not have any new construction projects in 2004 from which we earn engineering revenues and to which we charge out certain labour costs. In addition, we carried out certain intermittent maintenance work in Barbados which increased our costs.

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General and Administrative Expenses

Total general and administrative expenses increased by 46.4% from $939,959 to $1,376,510 for the three months ended June 30, 2004 and by 44.5% from $1,711,950 to $2,473,198 for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003. General and administrative expenses were at 19.8% and 21.5% of total revenue for the three months ended June 30, 2003 and 2004, respectively and at 19.5% and 19.4% of total revenue for the six months ended June 30, 2003 and 2004, respectively.

General and administrative expenses for our Retail operations increased by 83.4% from $651,672 to $1,195,080 for the three months ended June 30, 2003 and 2004, respectively, and by 72.7% from $1,223,652 to $2,112,795 for the six months ended June 30, 2003 and 2004, respectively. These increases are comprised of additional 2003 audit costs related to the work performed on the 2003 acquisitions, increased 2004 audit and legal fees, consulting fees related to the new internal control review and testing processes, increases in salaries and bonuses, costs relating to a new purchasing department, additional administration staff, increases in director fees and higher insurance premiums.

General and administrative expenses for our Bulk operations decreased by 3.6% from $176,444 to $170,086 for the three months ended June 30, 2003 and 2004, respectively, and increased by 14.6% from $297,432 to $340,979 for the six months ended June 30, 2003 and 2004, respectively. The three month decrease was due to the assimilation of the general and administrative functions of Ocean Conversion (Cayman) Limited. This decrease was offset by an additional six months of expenses from our Waterfields Company Limited operations when compared to the same six month period in 2003.

General and administrative expenses for our Service reporting segment decreased by 89.9% from $111,843 to $11,344 for the three months ended June 30, 2003 and 2004, respectively, and by 89.8% from $190,866 to $19,424 for the six months ended June 30, 2003 and 2004, respectively. In June 2003, we closed our Bermuda office and relocated those operations to the Cayman Islands. These decreases are the result of our assimilation of the general and administrative functions of that office.

Net Income

Net income increased by 74.1% from $1,013,041 to $1,764,040 for the three months ended June 30, 2004 and by 81.6% from $2,031,165 to $3,687,958 for the six months ended June 30, 2004 when compared to the same three and six month periods in 2003 as the result of factors explained above.

Dividends

On January 31, 2004, we paid a dividend of $0.105 per share to shareholders of record on December 31, 2003, and on April 30, 2004, we paid a dividend of $0.115 per share to shareholders of record on March 31, 2004 and on July 31, 2004, we paid a dividend of $0.115 per share to shareholders of record on June 30, 2004. We have consistently paid dividends to owners of our ordinary and redeemable preferred shares since we began declaring dividends in 1985. Our board of directors has established a policy, but not a binding obligation, that we will seek to maintain a dividend pay out ratio in the range of 50% to 60% of net income. While this policy is subject to modification by our board of directors, we expect to continue increasing our dividends, if our earnings grow. Our payment of any future cash dividends, however, will depend upon our earnings, financial condition, capital demand and other factors, including the condition in our loan agreement with Scotiabank (Cayman Islands) Ltd. that dividends be paid only from current cash flows.

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Liquidity and Capital Resources

Overview

For the three and six months ended June 30, 2004, we generated cash primarily from our various business segments in the Cayman Islands, the Bahamas, Belize and Barbados and from dividends and profit sharing rights from our equity investment in the British Virgin Islands. Cash flow is affected by the timely receipt of customer payments, by operating expenses, the timeliness and adequacy of rate increases (excluding automatic adjustments to our rates for inflation and electricity costs), and various factors affecting tourism in the areas in which we operate, such as weather conditions and the world economy. We use cash to fund our various business segments in the Cayman Islands, the Bahamas, Belize and Barbados, to fund capital projects, to expand our infrastructure, to pay dividends, to repay principal on our loans, to repurchase our shares when appropriate and to take advantage of new investment opportunities which expand our operations.

Operating Activities

Cash generated from operating activities for the six months ended June 30, 2003 and 2004 was $3,330,998 and $3,509,382, respectively. We generate cash through the utilization of our existing plants, equipment and resources in all segments of the business, minimization of water losses and operating efficiencies created by our management team.

Investing Activities

Cash used in investing activities during the six months ended June 30, 2003 and 2004 was $21,323,161 and $390,761, respectively. During the six months ended June 30, 2004, we used cash to make capital purchases and improvements to our water production plant and equipment in our Bulk and Retail segments and to our existing distribution system in our Retail segment. This was offset by cash provided by the collection of our loans receivable and from our investment in affiliates through receipt of profit sharing and dividends. During the same period in 2003, cash in the amount of $23,955,837 was used for acquisitions. We also continued to make minor expansions to our water distribution system in our Retail segment by constructing additional pipelines to service new developments within our exclusive licensed area. In 2004, we intend to complete the upgrade of our Britannia reverse osmosis plant in our Retail segment. This upgrade will allow us to produce more water to meet expected demand increases in 2005.

Financing Activities

Cash provided by financing activities during the six months ended June 30, 2003 was $21,462,292 and cash used in financing activities during the six months ended June 30, 2004 was $2,745,746. During the six months ended June 30, 2004 our primary financing activities were the payment of dividends and the repayment of long term debt. This was partially offset by the issuance of shares though the exercise of stock options by management. During the comparable six months ended June 30, 2003, our primary financing activity was to draw down $28,056,126 from our Scotiabank facilities. Also during that period, $2,214,286 was repaid on our Scotiabank facilities and $2,832,883 to repay our other credit facility.

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Material Commitments for Capital Expenditures and Contingencies

At June 30, 2004, we had committed approximately $680,000 for capital expenditures for the purchase, site preparation and construction of one water storage tank at our Ambergris Caye, Belize plant. We intend to finance this project using cash from our Belize Bulk operations.

We have guaranteed to Scotiabank 50% of the Ocean Conversion (BVI) Ltd. loan of $880,000. The Scotiabank loan is repayable in 6 equal semi-annual installments of $125,000 with the balance of principal due May 31, 2006, bearing interest at 3-month LIBOR plus 1.5%.

As a result of our acquisition of interests in Waterfields Company Limited, we guaranteed the performance of Waterfields Company Limited to the Water & Sewerage Corporation of the Bahamas in relation to the water supply contract between Waterfields Company Limited and the Water & Sewerage Corporation.

Through a performance and operation bond, the Royal Bank of Canada, Nassau, has made a guarantee in the amount of $1,910,775 to the Water & Sewerage Corporation of The Bahamas that we shall duly perform and observe all terms and provisions pursuant to the contract between the Water & Sewerage Corporation of The Bahamas and us. In the event of our default on our obligations, the Royal Bank of Canada, Nassau, shall satisfy and discharge any damages sustained by the Water & Sewerage Corporation of The Bahamas up to the guaranteed amount.

Impact of Inflation

Under the terms of our Cayman Islands license, Belize, Bahamas, British Virgin Islands and Barbados water sales agreements, there is an automatic price adjustment for inflation on an annual basis, subject to temporary exceptions. We, therefore, believe that the impact of inflation on our net income, measured in consistent dollars, will not be material.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Credit Risk

We are not exposed to significant credit risk on retail customer accounts in the Cayman Islands and Bimini, Bahamas, as our policy is to cease supply of water to customers whose accounts are more than 45 days overdue. Our main exposure to credit risk is from our bulk water sales customers in Belize, the Bahamas, the British Virgin Islands, Barbados and the Cayman Islands. In addition, the entire balance of our loans receivable are with one Bulk water customer, Water Authority-Cayman. These loans receivable are secured by assets which we hold until the receivable is paid in full.

Interest Rate Risk

As of June 30, 2004, we had loans outstanding totaling $18,454,829, all of which are based on various lending rates including LIBOR, Cayman Island’s Prime Rate or Nassau Prime Rate. We are subject to interest rate risk to the extent that any of these lending rates change.

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Foreign Exchange Risk

All of our foreign currencies have fixed exchange rates to the U.S. dollar. If any of these fixed exchange rates become a floating exchange rate, however, our results of operation could be adversely affected.

Item 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer (collectively, the “Certifying Officers”) are responsible for establishing and maintaining disclosure controls and procedures for us. Such officers have concluded (based upon their evaluation of these controls and procedures as of a date within 90 days of the filing of this report) that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in this report is accumulated and communicated to management, including our principal executive officers as appropriate, to allow timely decisions regarding required disclosure.

The Certifying Officers also have indicated that there were no significant changes in our internal controls or other factors that could significantly affect such controls subsequent to the date of their evaluation, and there were no corrective actions with regard to significant deficiencies and material weaknesses.

Our management, including each of the Certifying Officers, does not expect that our disclosure controls or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. The design of any systems of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of these inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II — OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

On June 9, 2003, we converted 2,388 shares of non-vested redeemable preferred stock for an equal number of ordinary shares under our Employee Share Incentive Plan. The issuance of the ordinary shares was exempt from registration under Regulation S promulgated under the Securities Act of 1933 (the “1933 Act”) because the ordinary shares were issued outside of the United States to non-U.S. persons (as defined in Regulation S) upon conversion of the redeemable preferred stock.

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Item 6. Exhibits and Reports on Form 8-K

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: August 13, 2004

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