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Investment in OC-BVI
 6 Months Ended
Jun. 30, 2012
Equity Method Investments and Joint Ventures [Abstract]  
Equity Method Investments Disclosure [Text Block]

7. Investment in OC-BVI

 

The Company owns 50% of the outstanding voting common shares and a 43.5% equity interest in the profits of Ocean Conversion (BVI) Ltd. (“OC-BVI”). The Company also owns certain profit sharing rights in OC-BVI that raise its effective interest in the profits of OC-BVI to approximately 45%. Pursuant to a management services agreement, OC-BVI pays the Company monthly fees for certain engineering and administrative services. OC-BVI’s sole customer is the Ministry of Communications and Works of the Government of the British Virgin Islands (the “Ministry”) to which it sells bulk water.

 

Substantially all of the water sold by OC-BVI to the Ministry was initially supplied under a Water Supply Agreement dated May 1990 (the “1990 Agreement”) and was produced by one desalination plant with a capacity of 1.7 million gallons per day located at Baughers Bay, Tortola (the “Baughers Bay plant”). As discussed later in this Note (see “Baughers Bay dispute”), the BVI government assumed the operating responsibilities for the Baughers Bay plant in March 2010. During 2007, OC-BVI completed, for a total cost of approximately $8 million, the construction of a desalination plant with a capacity of 720,000 gallons per day located at Bar Bay, Tortola (the “Bar Bay plant”). OC-BVI began selling water to the Ministry from this plant in January 2009 and on March 4, 2010, OC-BVI and the BVI government executed a definitive seven-year contract for the Bar Bay plant (the “Bar Bay Agreement”). Under the terms of the Bar Bay Agreement, OC-BVI delivers up to 600,000 U.S. gallons of water per day to the BVI government from the Bar Bay plant. The Bar Bay Agreement includes a seven-year extension option exercisable by the BVI government and required OC-BVI to complete a storage reservoir on the BVI government site by no later than March 4, 2011. OC-BVI has not commenced construction of this storage reservoir due to the BVI government’s failure to pay (i) the invoices for the water provided by the Bar Bay plant on a timely basis; and (ii) the full amount ordered pursuant to a court ruling relating to the Baughers Bay dispute (see discussion that follows).

 

The Company provided OC-BVI with a $3 million loan to fund part of the construction costs for the Bar Bay plant. Principal on this loan was payable in quarterly installments of $125,000 with a final balloon payment due on August 31, 2009 and interest on the loan was due quarterly at the rate of LIBOR plus 3.5%. In August 2009, the Company amended the terms of this loan with OC-BVI, increasing its balance to $2.8 million by converting $800,000 in trade receivables due to the Company from OC-BVI. Under the terms of this amendment, the interest rate on the loan was increased to LIBOR plus 5.5% and the maturity date for the amended final balloon payment of $1,550,000 was extended to August 31, 2011. The Company and OC-BVI further amended this loan in January 2010 to increase the interest rate to LIBOR plus 7.5%. This loan was fully repaid in August 2011.

Summarized financial information for OC-BVI is presented as follows:

 

    June 30,     December 31,  
    2012     2011  
Current assets   $ 2,428,112     $ 2,726,046  
Non-current assets     7,123,025       7,436,845  
Total assets   $ 9,551,137     $ 10,162,891  

 

    June 30,     December 31,  
    2012     2011  
Current liabilities   $ 2,112,154     $ 2,109,284  
Non-current liabilities     2,089,390       2,218,519  
Total liabilities   $ 4,201,544     $ 4,327,803  

  

    Three Months Ended June 30,     Six Months Ended June 30,  
    2012     2011     2012     2011  
Water sales   $ 1,118,504     $ 988,807     $ 2,153,413     $ 2,938,948  
Gross profit   $ 377,549     $ 351,614     $ 661,290     $ 1,697,299  
Income from operations   $ 50,597     $ 184,729     $ 141,058     $ 1,308,092  
Net income   $ 102,932     $ 204,407     $ 238,455     $ 1,328,504  

 

The Company’s investment in OC-BVI:

 

    June 30,     December 31,  
    2012     2011  
Equity investment (including profit sharing rights)   $ 6,342,459     $ 6,634,598  

 

The Company recognized $44,823 and $101,761 in earnings from its equity investment in OC-BVI for the three and six months ended June 30, 2012, respectively.  The Company recognized $88,978 and $632,472 in earnings from its equity investment in OC-BVI for the three and six months ended June 30, 2011, respectively.  For the three and six months ended June 30, 2012, the Company recognized $148,856 and $242,238, respectively, in revenues from its management services agreement with OC-BVI. For the three and six months ended June 30, 2011, the Company recognized $85,671 and $222,071, respectively, in revenues from its management services agreement with OC-BVI. In addition to the Company’s equity investment in OC-BVI of $6,342,459 as of June 30, 2012 and $6,634,598 as of December 31, 2011, respectively, the Company’s recorded value of the OC-BVI management services agreement, which is reflected as an intangible asset on the Company’s condensed consolidated balance sheet, was approximately $499,000 and $571,000 as of June 30, 2012 and December 31, 2011, respectively.

 

Baughers Bay dispute:

 

In October 2006, OC-BVI notified the Company that the Ministry had asserted a purported right of ownership of the Baughers Bay plant pursuant to the terms of the 1990 Agreement.

 

Under the terms of the 1990 Agreement, upon the expiration of the initial seven-year term in May 1999, the agreement would automatically be extended for another seven-year term unless the Ministry provided notice, at least eight months prior to such expiration, of its decision to purchase the plant from OC-BVI for approximately $1.42 million. In correspondence between the parties from late 1998 through early 2000, the Ministry indicated that the BVI government was prepared to exercise the option to purchase the plant but would be amenable to negotiating a new water supply agreement, and that it considered the 1990 Agreement to be in force on a monthly basis until negotiations between the BVI government and OC-BVI were concluded. Occasional discussions were held by the parties since 2000 without resolution of the matter. OC-BVI continued to supply water to the Ministry and expended approximately $4.7 million to significantly expand the production capacity of the plant beyond that contemplated in the 1990 Agreement.

 

Early in 2007, the Ministry unilaterally took the position that until such time as a new operating agreement was negotiated for the Baughers Bay plant, the Ministry would only pay that amount of OC-BVI’s billings that the Ministry purported constituted OC-BVI’s costs of producing the water. Payments made by the Ministry to OC-BVI since the Ministry’s assumption of this reduced price became sporadic. In November 2007, the BVI government filed a lawsuit with the Eastern Caribbean Supreme Court (the “Court”) seeking ownership of the Baughers Bay plant. OC-BVI counterclaimed that it was entitled to continued possession and operation of the Baughers Bay plant until the BVI government paid OC-BVI approximately $4.7 million, which it believed represented the value of the Baughers Bay plant at its expanded production capacity. OC-BVI took the legal position that since the BVI government never paid the $1.42 million to purchase the Baughers Bay plant, the 1990 Agreement terminated on May 31, 1999, which was eight months after the date that the Ministry provided written notice of its intention to purchase the plant.

 

OC-BVI filed a claim with the Court in July 2008, and in April 2009 amended and increased this claim, seeking payment for water sold and delivered to the BVI government through May 31, 2009 at the contract prices in effect before the BVI government asserted its purported right of ownership of the plant.

 

The Court issued a preliminary ruling with respect to this litigation on September 17, 2009. The Court determined that the BVI government was entitled to immediate ownership and possession of the Baughers Bay plant and dismissed OC-BVI’s claim for compensation of approximately $4.7 million for the expenditures made to expand the production capacity of the plant. However, the Court determined that OC-BVI was entitled to full payment of water invoices issued up to December 20, 2007, which had been calculated under the terms of the original 1990 Agreement, and ordered the BVI government to make an immediate interim payment of $5.0 million to OC-BVI. The Court deferred deciding the entire dispute between the parties until it could conduct a hearing to determine the reasonable rate for water produced by OC-BVI for the period subsequent to December 20, 2007.

 

In October 2009, the Court ordered the BVI government to pay OC-BVI the amount of $10.4 million for water produced by OC-BVI from the Baughers Bay plant subsequent to December 20, 2007. The BVI government made a payment of $2 million to OC-BVI under the Court order during the fourth quarter of 2009, a second payment of $2 million under the Court order during July 2010 and a third payment under the Court order of $1 million in February 2011.

 

OC-BVI filed an appeal with the Eastern Caribbean Court of Appeals (the “Appellate Court”) in October 2009 asking the Appellate Court to review the September 17, 2009 ruling by the Court as it related to OC-BVI’s claim for compensation for expenditures made to expand the production capacity of the Baughers Bay plant. In October 2009, the BVI government also filed an appeal with the Appellate Court, seeking the Appellate Court’s review of the September 17, 2009 ruling of the Court that the BVI government pay OC-BVI the reasonable rate for water produced by OC-BVI for the period subsequent to December 20, 2007. The BVI government requested a ruling from the Appellate Court that the BVI government should only pay OC-BVI the actual cost of water produced at the plant.

 

In February 2010, the BVI government announced that it had signed a 16-year contract with another company for the construction and operation of a water plant that will provide potable water to the greater Tortola area and (the Company believes) will replace the current production of the Baughers Bay plant. In March 2010, OC-BVI vacated the Baughers Bay plant and the BVI government assumed direct responsibility for the plant’s operations.

 

On April 18, 2012, the Appellate Court issued the latest ruling with respect to the Baughers Bay litigation, which dismissed the BVI government’s appeal against the judgment of the Supreme Court awarding $10.4 million for the water supplied. Furthermore, the Appellate Court awarded OC-BVI compensation for improvements made to the plant in the amount equal to the difference between (i) the value of the Baughers Bay plant at the date OC-BVI transferred possession of the plant to the BVI government and (ii) $1.42 million (the purchase price for the Baughers Bay plant under the 1990 Agreement). OC-BVI was also awarded all of its court costs at the trial level and two-thirds of such costs incurred on appeal.

 

Although it upheld the $10.4 million awarded by the Court, in the course of its ruling the Appellate Court stated that all issues concerning payment of the $10.4 million award had been settled prior to the hearing of the appeal. In fact both OC-BVI and the BVI government acknowledge that to date the BVI government has paid only $5.0 million of the $10.4 million award. The BVI government appears to have taken the position that, notwithstanding this fact, it will make no further payments on the $10.4 million award pending clarification or correction of the Appellate Court statement regarding the award. OC-BVI is taking steps to enforce payment of the outstanding amount, but has also taken the precaution of applying for leave to appeal to the Privy Council against this latter finding should it be necessary to do so.

 

Accordingly, the amounts awarded by the Appellate Court will not be recognized in the Company’s earnings from its investment in OC-BVI until such time as the BVI government pays OC-BVI such amounts.

 

The Company accounts for its investment in OC-BVI in accordance with the equity method of accounting for investments in common stock. This method requires recognition of a loss on an equity investment that is other than temporary, and indicates that a current fair value of an equity investment that is less than its carrying amount may indicate a loss in the value of the investment. To test for possible impairment of its investment in OC-BVI, the Company estimates its fair value periodically, based upon any significant change in circumstances. In making its estimates, the Company calculates the expected cash flows from its investment in OC-BVI by estimating the expected cash flows from (i) OC-BVI’s contract with the BVI government to supply water from its Bar Bay plant; and (ii) the resolution of the Baughers Bay litigation. The resulting sum represents the Company’s best estimate of future cash flows to be derived from its investment in OC-BVI, which are present-valued to estimate OC-BVI’s fair value.

 

Based upon the estimated fair value determined as of June 30, 2012, the Company concluded that no impairment loss was required to be recognized on its investment in OC-BVI for the six months ended June 30, 2012. This conclusion assumes that the BVI government will fulfill its obligations under the contract for the Bar Bay plant and that OC-BVI will collect all of the $10.4 million awarded by the Court (of which only $5.0 million has been received to date). Should OC-BVI ultimately be unable to collect all of this $10.4 million, the Company will be required to record an impairment charge that will reduce the carrying value of the Company’s investment in OC-BVI by approximately 44% of any shortfall in collecting the $10.4 million. If the BVI government fails to honor the terms of its agreement for water supplied by OC-BVI’s Bar Bay plant, the actual cash flows from OC-BVI could vary materially from the expected cash flows the Company used in determining OC-BVI’s fair value as of June 30, 2012 and the Company would be required to record an impairment charge to reduce the carrying value of its investment in OC-BVI. Such impairment charges would reduce the Company’s earnings and could have a material adverse impact on its results of operations and financial condition.