Attached files

file filename
EX-21.1 - SUBSIDIARIES OF HECKMANN CORPORATION - Nuverra Environmental Solutions, Inc.dex211.htm
EX-32.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 906 - Nuverra Environmental Solutions, Inc.dex321.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Nuverra Environmental Solutions, Inc.dex311.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Nuverra Environmental Solutions, Inc.dex312.htm
EX-23.1 - CONSENT OF GHP HORWATH, P.C. - Nuverra Environmental Solutions, Inc.dex231.htm
EX-32.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 906 - Nuverra Environmental Solutions, Inc.dex322.htm
EX-10.42 - FIRST SUPPLEMENTAL AND AMENDED AGREEMENT FOR FIRM DISPOSAL OF SALTWATER - Nuverra Environmental Solutions, Inc.dex1042.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2009

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-33816

 

 

HECKMANN CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   26-0287117

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification No.)
75080 Frank Sinatra Drive  
Palm Desert, CA   92211
(Address of principal executive offices)   (Zip Code)

(760) 341-3606

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Units

  New York Stock Exchange

Common Stock, $0.001 par value

  New York Stock Exchange

Common Stock Purchase Warrants

  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Exchange 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  ¨    No  x

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  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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 Company is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨     Accelerated filer  x
Non-accelerated filer  ¨   (Do not check if a smaller reporting company)   Smaller reporting company  ¨

Indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 30, 2009, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $377,503,624 based on the closing sale price on such date as reported on the New York Stock Exchange. Shares held by executive officers, directors and persons owning directly or indirectly more than 10% of the outstanding common stock have been excluded from the preceding number because such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the registrant’s common stock as of March 10, 2010 was 108,750,650.

Documents Incorporated by Reference

Portions of the registrant’s Proxy Statement for the 2010 Annual Meeting of Stockholders to be held on May 7, 2010 are incorporated by reference into Part III, Items 10-13 of this Annual Report on Form 10-K.

 

 

 


Table of Contents

HECKMANN CORPORATION

TABLE OF CONTENTS

 

          Page

Part I

     
Item 1.   

Business

   2
Item 1A.   

Risk Factors

   9
Item 1B.   

Unresolved Staff Comments

   22
Item 2.   

Properties

   23
Item 3.   

Legal Proceedings

   24
Item 4.   

Reserved

   24

Part II

     
Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

   25
Item 6.   

Selected Financial Data

   27
Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   28
Item 7A.   

Quantitative and Qualitative Disclosure About Market Risk

   43
Item 8.   

Financial Statements and Supplementary Data

   44
Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   44
Item 9A.   

Controls and Procedures

   44
Item 9B.   

Other Information

   49

Part III

     
Item 10.   

Directors, Executive Officers and Corporate Governance

   50
Item 11.   

Executive Compensation

   50
Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   50
Item 13.   

Certain Relationships and Related Transactions, and Director Independence

   50
Item 14.   

Principal Accounting Fees and Services

   50

Part IV

     
Item 15.   

Exhibits, Financial Statement Schedules

   51

Signatures

   52

Exhibit Index

  


Table of Contents

LOGO

 

 

Certain Terms

In this Annual Report on Form 10-K, unless the context indicates otherwise, the terms “the Company,” “we,” “us” and “our” refer to the combined company, which is Heckmann Corporation and its subsidiaries and operating entities.

Forward-Looking Statements

This Annual Report contains statements that are forward-looking and, as such, are not historical facts. Rather, these statements constitute projections, forecasts and forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of performance. They involve known and unknown risks, uncertainties, assumptions and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by these statements. Such statements can be identified by the fact that they do not relate strictly to historical or current facts. These statements use words such as “believe,” “expect,” “should,” “strive,” “plan,” “intend,” “estimate,” “anticipate” or similar expressions. When the Company discusses its strategies or plans, it is making projections, forecasts or forward-looking statements. Actual results and stockholders’ value will be affected by a variety of risks and factors, including, without limitation, continuing fallout from the recent crisis in worldwide financial markets, international, national and local economic conditions, organic growth plans, merger, acquisition and business combination risks, financing risks, geo-political risks, and acts of terror or war. Many of the risks and factors that will determine these results and stockholder values are beyond the Company’s ability to control or predict. These statements are necessarily based upon various assumptions involving judgment with respect to the future. You should carefully read the risk factor disclosure contained in “Item 1A. Risk Factors” of this Annual Report, where many of the important factors currently known to management that could cause actual results to differ materially from those in our forward-looking statements are discussed.

All such forward-looking statements speak only as of the date of this Annual Report. The Company is under no obligation to, nor does it intend to, release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Periodic Reporting and Financial Information

Our units, common stock and warrants are registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and each are listed and trade on the New York Stock Exchange (“NYSE”) under the symbols HEK.U, HEK, and HEK.WS, respectively. We have compliance and reporting obligations, including the requirement that we file annual and quarterly reports with the Securities and Exchange Commission (“SEC”), and comply with the NYSE’s listing policies and procedures. In accordance with the requirements of the Exchange Act, this Annual Report contains financial statements audited and reported on by our independent registered public accounting firm.

Where You Can Find Additional Information About Us

You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. We also maintain an internet site at http://www.heckmanncorp.com where you can find our filings with the SEC in the Investor Relations area of the site.

 

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HECKMANN CORPORATION

PART I

 

 

 

Item 1. Business

Heckmann Corporation (NYSE: HEK) is a holding company that was created to buy operating businesses, and our focus is on buying and building companies in the water sector. We have two operating segments, which, as of the date of this report, we refer to as domestic and international. Our domestic segment presently includes our water disposal, treatment, and pipeline transport facilities in Texas and Louisiana operated by our wholly-owned subsidiary Heckmann Water Resources Corporation (“HWR”); our joint venture with Energy Transfer Partners, L.P., to develop water pipeline infrastructure and treatment solutions for oil and gas producers in the Marcellus and Haynesville Shale fields, operated through our wholly-owned subsidiary HEK Water Solutions, LLC (“HWS”); and our minority interest investment in water infrastructure solutions and pipeline supplier Underground Solutions, Inc. (OTC: UGSI) (“UGSI’). Our international segment presently includes our bottled water business operated by our wholly-owned subsidiary China Water and Drinks, Inc., (“China Water”) and our minority investment in China Bottles, Inc., a bottling equipment manufacturer. As of December 31, 2009, we had approximately $250 million in invested cash and cash equivalents on our balance sheet. In 2010, we plan to continue building the businesses in our domestic and international segments, and we will also make additional acquisitions as we find attractive long-term opportunities for our stockholders.

Headquartered in Palm Desert, California, the Company was incorporated in Delaware on May 29, 2007. We began our corporate existence as a blank check development stage company. On November 16, 2007, we completed an initial public offering (“IPO”) of 54,116,800 units (each consisting of one share of common stock and one warrant exercisable for an additional share of common stock), including 4,116,800 units issued pursuant to the partial exercise of the underwriters’ over-allotment option, and received net proceeds of approximately $421 million. On the same date, we also completed a private placement of warrants to our founders at an aggregate purchase price of $7 million, or $1.00 per warrant.

On October 30, 2008, we completed our acquisition of China Water, subsequently consolidated its subsidiaries and affiliate entities, and now operate its eight bottled water facilities in the People’s Republic of China (“China”) with Coca-Cola and its subcontractors located in China, which we collectively refer to as “Coca-Cola China,” as our largest customer.

On July 1, 2009, we purchased all of the assets of Greer Exploration Corporation and the Silversword Partnerships, and all the membership interests of Charis Partners, LLC. The assets of these entities were consolidated into HWR together with the capital and operating resources necessary to build a pipeline and network of disposal wells and terminal facilities. HWR now operates a multi-modal water disposal, treatment and pipeline transportation business in Texas and Louisiana serving customers seeking to dispose of complex water flows including flowback water, frac fluids, and produced brine waters generated in their oil and gas operations. On January 30, 2010, we completed our 50-mile water transport pipeline. At full capacity, it is designed to treat and dispose up to 100,000 barrels of water per day and is supported by a network of deep injection disposal wells.

On February 9, 2010, we announced a joint venture with Energy Transfer Partners, L.P. (NYSE: ETP). The joint venture is a 50/50 partnership and will operate under the name Energy Transfer Water Solutions, JV, LLC, a joint venture of Heckmann Corporation and Energy Transfer. It will develop water pipeline infrastructure and treatment solutions for oil and gas producers in the Marcellus and Haynesville Shale fields, and potentially other areas within the states of New York, Pennsylvania, Ohio, West Virginia, Virginia, Tennessee, Kentucky, Texas, and Louisiana.

 

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Our Corporate Structure

As of the date of this report, our organizational structure, excluding subsidiaries of China Water and HWR, is as follows:

LOGO

We have two operating segments, which as of the date of this report, we refer to as domestic and international. Financial information regarding each segment and the geographic areas in which we do business is available in Note 13 to our consolidated financial statements included in this Annual Report on Form 10-K.

Our Domestic Segment

Our domestic segment presently includes the businesses of our subsidiaries HWR and HWS, and our strategic minority investment in UGSI.

Through HWR, we own and operate a network of water disposal, treatment, and pipeline transport facilities in Texas and Louisiana, including our recently completed 50-mile pipeline. HWR serves oil and natural gas exploration and production companies seeking to dispose of complex water flows including flowback water, frac fluids, and produced brine waters generated in their oil and gas operations. HWR does this in two ways. First, we directly connect customers from their field operations to our pipeline. Second, we provide terminal facilities where producers and independent truckers can deliver water to us for processing. All water is then treated and subsequently disposed of into our network of disposal wells.

Through HWS and our recently announced joint venture with Energy Transfer, L.P., we intend to develop water pipeline infrastructure and treatment solutions for oil and gas producers in the Marcellus and Haynesville Shale fields, and potentially other areas within the states of New York, Pennsylvania, Ohio, West Virginia, Virginia, Tennessee, Kentucky, Texas, and Louisiana. Our 50% interest in the joint venture is managed through HWS. The joint venture is designed to accomplish this by laying water transport pipelines alongside natural gas pipelines which may transport water in both directions—complex or fluid laden water from oil and natural gas drilling fields to treatment and disposal facilities, and fresh and/or remediated water to oil and natural gas drilling fields. Where applicable, our joint venture projects may also extend water transport and treatment services to mining companies and coal and electric utilities.

Our investment in UGSI is a strategic complement to HWR and HWS. Both are a potential customer of UGSI’s patented flexible fusion pipeline products and their fusion processes, technologies, and field know-how, which we believe are emerging as a leading product line for long-life pipeline installations.

The Convergence of Water and Energy, Market Opportunities & Competition

In North America, through HWR and HWS we are entering the water infrastructure and the oil and natural gas service sectors. Both are very large industry sectors comprised of competitors with longer industry tenure and

 

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greater resources than us. Our strategy is to participate in the newly emerging subsector that is experiencing a convergence of water and energy expertise and technologies that will provide the commercial solutions rapidly being demanded by oil and gas producers, mining companies, and utilities. Specifically, through HWR and HWS we are building products and service solutions for dealing with expanding complex water flows anticipated by increased exploration in unconventional shale gas fields. These large discoveries, known as Shale Plays (e.g. Marcellus Shale, Haynesville Shale, Barnett Shale, Eagle Ford Shale, Fayetteville Shale) refer to previously inaccessible or non-economical depth formations in the earth’s crust now being exploited by advances in drilling technology that utilize high water pressure methods (or hydraulic fracturing) combined with proppant fluids (sand grains or microscopic beads) to crack open and exploit new perforation depths and fissures to extract large quantities of natural gas, oil, and other hydrocarbon condensates. Complex water flows represent the largest waste stream from these methods of hydrocarbon exploration and production. The energy industry creates daily water production volumes 2.5 times greater than oil volumes, making it vital to deal effectively and efficiently with produced water volumes at the surface. The market for produced water management and handling is estimated at $9.8 billion dollars over the next five years, and the market for produced water treatment systems is estimated at $4.3 billion dollars over the same period, according to “The Produced Water Gamechanger Report 2010-2014,” an industry report of OTM Consulting and energy business analysts, Douglas-Westwood, as cited in a March 2010 article of Water Online Newsletter Magazine.

Our International Segment

Our international segment presently includes the business of our subsidiary China Water and its operating entities, and our minority investment in China Bottles, a bottling equipment manufacturer.

Through China Water, we produce bottled water products at facilities in the cities of X’ian (Shaanxi Province), Guangzhou (Guangdong Province), Changchun (Jilin Province), Feixian (Shandong Province), Nanning (Guangxi Province), Changsha (Hunan Province), and Harbin (Heilongjiang Province).

Our production plants have two types of production lines: one type produces hand-held sized (330 milliliters to 1.5 liters) bottled water (“Small Bottles”) and the other produces carboy-sized (11.4 to 18.9 liters, or 3 to 5 gallons) bottled water (“Carboy Bottles”). We produce a variety of bottled water products including natural mineral water, spring water, purified water, flavored water and oxygenated water.

We market our bottled water products in China using the brand names “Darcunk” (which translates to “Absolutely Pure”) and “Grand Canyon.” We also supply bottled water products to beverage companies and servicing companies, which we refer to as OEM customers, including Coca-Cola China, as well as Uni-President and Jian Li Bao. In addition, we provide private label bottled water products to companies in the service industry, such as hotels and casinos.

In 2009, we produced approximately 405 million Small Bottles and 3 million Carboy Bottles of bottled water products. We currently market and sell our bottled water products in multiple regions of China, including Beijing, Guangdong Province, Guangxi Province, Shandong Province, Heilongjiang Province, Jilin Province, Shanxi Province, Shaanxi Province, Gansu Province, Liaoning Province, Anhui Province, Sichuan Province, Hebei Province, Hunan Province and Macau.

The Bottled Water Industry in China

In China, consumption of bottled water has overtaken consumption of carbonated sweet drinks and China is one of the largest potential national markets for bottled water sales.

Although China is fast growing and represents one of the largest potential national markets for bottled water, consumption per person is still among the lowest in the world. According to Beverage Marketing Corporation, a consulting and market research firm, China’s bottled water consumption per capita represents less than one-half of the global per capita average, and only 11% of the per capita average of the top 20 national markets by volume.

 

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In China, the competitive landscape is shaped by two layers of companies: branding companies and production companies. The first layer consists of those companies that have marketing, distribution and branding capabilities. The second layer consists of those companies that actually produce bottled water. Although some branding companies also build plants themselves, we believe they still need production companies to address their production gaps and fill in the locations where their facilities do not cover. Because the China market is so large, we believe that no single branding company can cover all locations with their own plants.

In 2010, we believe that our water business in China will be influenced by the following factors:

 

   

Growth and evolution of China’s bottled water industry.    The bottled water industry in China is in a process of continuous growth, consolidation, and development. With the growth in demand and addition of new industry participants offering new and varied bottled water products, the Chinese bottled water industry is poised for continued growth and consolidation.

 

   

Health consciousness of Chinese individuals.    We believe that Chinese citizens are becoming increasingly health conscious. Given concerns with the quality and hygiene standards of available drinking water in China, we believe that consumers will increasingly purchase and consume bottled drinking water, teas, and juices that have been purified and treated to afford consumers greater health benefits.

 

   

Growing middle class in China.    According to research by McKinsey Global Institute, a market research firm, by 2011, the middle class in China will number more than 350 million people, representing more than 50% of the urban population. This group is likely to possess increased spending power and a desire and ability to consume products, including bottled water, teas, and juices.

 

   

Demand for greater product mix offerings.    Consumers are demanding specialty bottled water, tea, and juice products, such as flavored waters and nutrient-enriched water products. We believe that bottled water producers that have the resources to offer to consumers a variety of specialty water products will prosper.

Our Competitive Strengths in the Chinese Bottled Water Business

We believe that the following key competitive strengths enable us to compete effectively in China:

 

   

Strong Long-Term Relationship with Well Known Global Brands.    We have maintained stable and trusted long-term relationships with several globally recognized beverage companies and original equipment manufacturers involved in the bottled water production businesses in China, including Coca-Cola China, Uni-President and Jian Li Bao. We have expanded our own production capacity in order to leverage and capitalize upon Coca-Cola’s business plans in China.

 

   

Top Tier Production Capability and Quality Control.    As a long-term supplier to Coca-Cola China and other well known beverage companies, we are required to comply with their production requirements and rigid quality control standards. We have implemented these high standards in all of our manufacturing facilities. Our plants are audited by independent assessors for compliance with our customers’ procedures, quality control requirements and hygiene standards.

 

   

Production Cost Advantages.    The majority of our production processes are standardized and fully automated. We believe increased automation will increase production yields and efficiency as well as reduce labor costs and minimize the impact of any labor shortages.

 

   

Established Distribution Network.    We sell our bottled water products through an extensive distribution network of local and regional distributors, which help us establish a presence in each regional market we serve. We have maintained a stable long-term relationship with the majority of our distributors.

 

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Our International and Domestic Customers

For the year ended December 31, 2009, our total sales to our top five customers and distributors among both international and domestic segments is shown in the table below:

 

Top Five Customers/Distributors

   Year Ended
December 31, 2009
 

Coca Cola China (OEM/Private Label)

   57

Bai Chuan (distributor)

   6

Tang Xia (distributor)

   2

El Paso

   2

Shi Pai (distributor)

   2
      

Percentage of total sales to top five customers/distributors

   69
      

In the year ended December 31, 2009, approximately 63% of sales in China and 57% of our total sales were made to Coca-Cola China. Coca-Cola China resells our bottled water products. We believe that our relationship with Coca-Cola China provides consistent sales and credibility for us in our target markets. However, not all arrangements with Coca-Cola China impose minimum purchase commitments upon Coca-Cola China, nor are they all exclusive. If Coca-Cola China discontinues or reduces purchases and we are unable to generate replacement sales from new and existing customers, our revenue and net income would decline considerably. Also, because the margins on our sales to Coca-Cola China are generally lower than on our sales to other customers and through distributors, if sales to Coca-Cola China increase as a percentage of overall sales, then our margins would decline.

Our International Segment’s Sales Network of Distributors

In China, we market and sell our bottled water products to distributors that sell our bottled water products to end users under our own brands, and OEM and private label customers, which include major global drink and beverage companies such as Coca-Cola China, Uni-President and Jian Li Bao, which usually sell our bottled water products under their brand or brands. For the year ended December 31, approximately 21% of our revenue was derived from sales of our bottled water products to consumers directly under our own brands, and 79% of our revenue was derived from sales of our bottled water products to OEM and private label customers such as Coca-Cola China, which represented the largest customer for our OEM and private label sales.

Raw Materials and Principal Suppliers

The main raw materials for our international segment’s products are water, which is obtained from local municipal water systems and streams, lakes and wells, and PET (polyethylene terephthalate) bottling materials, such as PET plastic materials and containers, caps, oil byproducts and packaging materials. PET bottling materials account for a significant percentage of our product costs and are subject to a high degree of price volatility caused by the supply and demand, as well the price of oil. Our domestic segment does not have any material raw materials needs.

For the year ended December 31, 2009, our top five suppliers of raw materials are shown in the table below:

 

Top Five Suppliers

   Raw Material Supplied    Year Ended
December 31, 2009
 

Zhuhai Fuhongmao

   PET plastic material    26

Foshan Expanding Industry Trade

   PET plastic material    22

Shunde Yong Hui Plastic Products Co. Ltd.

   PET plastic material    13

Liao Yang Chemical

   PET plastic material    7

Zhongfu

   PET plastic material    5
         

Percentage of total purchases from top five suppliers

      73
         

 

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Competition

The bottled water industry in China is highly fragmented, consisting of several large Chinese and international competitors and a number of smaller local and regional manufacturers. We primarily compete with Chinese bottled water producers, including Hangzhou Wahaha Group, Nongfu Spring Company Ltd., and Guandong Robust Corp. In addition to local Chinese producers, we compete with global beverage companies and brands including Nestle S.A., the leading company in the global bottled water market, as well as Coca-Cola, C’est Bon, Danone, Tingyi Master Kong, and Uni-President. Many of these competitors have substantially greater resources in China than we have and pose significant competition to us. Nevertheless, we believe that we can compete effectively in our markets given the fragmentation of the market, the heavily regional aspect of bottled water in China, our strong brand recognition and established distributorships and customer relationships, and our strong balance sheet, which may allow us to seize on appropriately valued acquisition and new facilities manufacturing opportunities without accessing credit markets. We also believe that we can effectively compete based on price, quality and hygiene standards.

The water treatment and produced water handling industries, even if nascent in respect of competing for customers in the expanding oil and gas shale fields, are serviced by many large international and domestic competitors including GE Water, Siemens, Veolia, Schlumberger, Baker-Hughes, BJ Services, Key Energy Services, and Basic Energy Services. We believe we can compete effectively in the emerging subsector of water handling and closed loop treatment, recycling, and reuse as a result of our strong balance sheet, water industry experience, water transport pipeline experience, and industry alliances.

Seasonality and Commodity Fluctuations

Our sales in China are subject to seasonality factors. We typically experience higher sales of bottled water in the summer time in coastal cities while sales remain constant throughout the entire year in some inland cities. In general, our sales are higher in the second and third quarters of the year when the weather is hot and dry, and lower in the first and fourth quarters when the weather is cold and wet. Sales can also fluctuate throughout the year for a number of other reasons, including the timing of advertising and promotional campaigns, and unforeseen circumstances, such as production interruptions.

Our domestic water handling sales are subject to seasonality factors and the fluctuation of commodity futures. Extreme weather has historically reduced our total handling volumes because a portion of the water we receive is delivered via overland trucking, although we expect that, going forward, extreme weather will have less of an impact on our sales as we accept a greater portion of our total water deliveries directly into pipelines connected to the operational sites of customers. We are negatively leveraged to fluctuating natural gas prices in the sense that our customers could alter drilling and capital expense plans if long term futures turned down substantially. We are favorably leveraged to oil and diesel prices in the sense that our pipeline displaces water transport by trucks when diesel prices rise and fuel surcharges influence our customers to consider pipeline transport.

Government Regulation

Our China operations are heavily regulated. Like other bottled water manufacturers within China, we are subject to compliance with China’s food hygiene, tax, licensing, and environmental laws and regulations. Our domestic operations are subject to environmental laws and regulations.

Food and Hygiene Regulatory System of China.    The Food Hygiene Law sets out the hygiene standards for the production of bottled water, water additives, water packaging and containers, and the prescribed contents of water packaging labels. It also stipulates hygiene requirements in respect of premises, facilities and equipment for the production, transport and sale of bottled water.

China’s Ministry of Health is responsible for the regulation and supervision of bottled water hygiene in China. The Food Hygiene Law requires all enterprises proposing to be involved in bottled water production and

 

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processing to obtain a hygiene license from the relevant local department of the Ministry of Health before they can register their enterprise with the relevant Local Administration for Industry and Commerce, which is responsible for issuing business licenses. Enterprises cannot begin bottled water production and processing activities without first obtaining a hygiene license.

Regulation of Production in China.    China’s Administration of Production Licenses for Industrial Products requires us to maintain a production license for manufacturing bottled water products. Spot tests and product inspection, as well as periodic supervisory inspections are conducted. To date, we have passed spot tests and product inspections, but have yet to be selected for any supervisory inspections.

Environmental Protection Laws and Regulations.    The environmental protection laws of the United States and China establish a basic legal framework for environmental protection. The environmental protection laws of the individual states where we operate pipelines and disposal wells also represent a regulatory framework requiring compliance. In Texas, we are also subject to rules and regulations promulgated by the Texas Railroad Commission and the Texas Commission on Environmental Quality, including those designed to protect the environment and monitor compliance with water quality.

Government authorities can impose various types of penalties on persons or enterprises who are in violation of environmental and water quality laws depending on the circumstances and extent of pollution or surface and subsurface impact. Penalties can include issuing a warning notice, imposing fines, setting a time limit for rectification, suspending production, ordering, reinstallation and operation of environmental protection facilities that have been dismantled or left unused, imposing administrative sanctions against management in charge, or ordering the termination and closure of enterprises or institutions conducting such operations.

We believe we are in material compliance with all applicable environmental protection laws and regulations in the United States and China. We have completed the required environmental assessments and, where applicable, our environmental assessment reports have been approved by the local environmental administration or authority. Also, we have installed the necessary environmental protection equipment, adopted advanced environmental protection technologies, established responsibility systems for environmental protection, and reported to and registered with the relevant local environmental protection departments.

Employees

As of December 31, 2009, we had 1,074 full-time employees, of which 358 were executive, managerial, sales, general administrative and accounting staff, and 716 were manufacturing and field workers. We also hire temporary manufacturing workers in China to supplement our manufacturing capabilities during periods of high demand. None of our employees are under collective bargaining agreements. We believe that we maintain a satisfactory working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.

 

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Item 1A. Risk Factors

You should carefully consider the following risk factors, together with all of the other information included in this Annual Report. We are subject to a number of risks. The market price of our common stock and warrants could decline due to any of the risks discussed below, in which case you could lose all or part of your investment. In assessing these risks, you should also refer to the other information included in this Annual Report, including our financial statements and accompanying notes. We face risks common to newly acquired or newly built operations in the United States. Separately, because we operate in China, we are subject to legal and regulatory environments that differ in many respects from those of the United States. Our business, financial condition or results of operations could be affected materially and adversely by any of the risks discussed below.

Risks Related to Our Company

We are involved in litigation with Xu Hong Bin, China Water’s former president and chairman, related to our intended cancellation of approximately 5.3 million shares of our common stock held by Xu, the outcome of which cannot be predicted with certainty.

As more fully described in Part I, Item 3—Legal Proceedings, of this Annual Report, Xu Hong Bin has filed a lawsuit against us claiming that our intended cancellation of his shares is a breach of an escrow resolution and transition agreement that we entered into with him. We filed a vigorous countersuit expanding our claims against Xu and seeking recovery of not only the stock at issue, but also cash paid to Xu in connection with our acquisition of China Water and cash misappropriated by Xu. Although we believe that we will prevail in our countersuit, no assurance can be given that the outcome of the litigation will be in our favor or, in the event that it is, that a court will award us the full amount of damages that we are seeking. Also, we may determine that it is in the best interests of the Company to settle our claims against Xu for less than the amount of damages we are seeking in our countersuit. The resolution of this litigation could have a material effect on our financial condition.

A business strategy of making acquisitions subjects us to all of the risks inherent in identifying, acquiring and operating newly acquired businesses.

We face all the risks associated with such a strategy, including, but not limited to:

 

   

the potential disruption of our existing businesses, including the diversion of management attention and the redeployment of resources;

 

   

entering new markets or industries in which we have limited prior experience;

 

   

failure to identify in due diligence key issues specific to the businesses we seek to acquire or the industries or other environments in which they operate, or, failure to protect against contingent liabilities arising from those issues;

 

   

difficulties in integrating, aligning and coordinating organizations which will likely be geographically separated and may involve diverse business operations and corporate cultures;

 

   

difficulties in integrating and retaining key management, sales, research and development, production and other personnel;

 

   

difficulties in incorporating the acquired business into our organization;

 

   

the potential loss of customers, distributors or suppliers;

 

   

difficulties in integrating or expanding information technology systems and other business processes to accommodate the acquired businesses;

 

   

risks associated with integrating financial reporting and internal control systems;

 

   

the potential for future impairments of goodwill if the acquired business does not perform as expected;

 

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the inability to obtain necessary government approvals for the acquisition, if any; and

 

   

successfully operating the acquired business.

If we cannot overcome these challenges, we may not realize actual benefits from past and future acquisitions, which will impair our overall business results. If we complete an investment or acquisition, we may not realize the anticipated benefits from the transaction.

The process of targeting, selecting, acquiring, and operating newly acquired businesses is time consuming and potentially expensive. We may be unable to identify other suitable investment or acquisition candidates or may be unable to make these investments or acquisitions on commercially reasonable terms, if at all.

If we use stock as consideration, this would have a dilutive effect on existing stockholders. If we use cash, this would reduce our liquidity and impact our financial flexibility. We may seek debt financing for particular acquisitions, which may not be available on commercially reasonable terms, or at all.

Future charges due to possible impairments of acquired assets may have a material adverse effect on our financial condition and results of operations.

A portion of our assets is comprised of goodwill and other intangible assets, which may be subject to future impairment that would result in financial statement write-offs. Goodwill and other intangible assets represent approximately 10% of our total assets at December 31, 2009. If there is a material change in our business operations or prospects, the value of the intangible assets we have acquired or may acquire in the future could decrease significantly. On an ongoing basis and at least annually, we will evaluate, partially based on discounted expected future cash flows, whether the carrying value of such intangible assets may no longer be recoverable, in which case a charge to earnings may be necessary. Any future determination requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition, results of operations and stock price.

Fallout from the global financial crisis could have a negative impact on our results of operations.

Overall consumption was reduced following the global financial and credit crisis, and we expect continued cautious spending in 2010 relating to consumer consumption of bottled water products in China, and consumer and industrial consumption of natural gas in the United States. Our international operations could be impacted in 2010 as a result of cautious spending or if Chinese consumer consumption is flat or lower than estimated. Our domestic operations could be impacted if consumer and industrial consumption of natural gas is reduced to the point of causing our energy customers to reduce drilling and exploration expenditures and thereby reduce their demand for our water handling services. Separately, the global financial and credit crisis has negatively impacted returns on our cash and investments, and we expect this to continue through 2010.

We do not believe that the estimates provided to us by China Water in connection with our acquisition will be achieved in 2010.

During our due diligence investigation of China Water in connection with its acquisition by us, we were presented with estimated levels of pro forma annualized revenue and net income that China Water could achieve by the end of 2008 and forward. This forward-looking information pre-dated the worldwide crisis in financial and credit markets and was based on our review of internal financial projections prepared by China Water, general due diligence, and anticipated benefits from plant expansions and acquisitions. Also, after taking over, we discovered financial irregularities, misdirected funds, receivables overstatements, deposit overstatements, and operating and accounting deficiencies that caused us to take substantial impairment charges to goodwill, write downs of purported acquisition deposits, receivables reserve adjustments, and write offs of receivables. We expect that our revenues and net income for 2010 will be lower than we originally forecast. The consequences of this determination could include a decline in our stock price.

 

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We are subject to litigation risks, which may be costly to defend and the outcome of which is uncertain.

All industries, including those businesses in our domestic and international segments, are subject to legal claims. As a public company we are particularly susceptible to securities and derivative lawsuits. These claims may be costly to defend and divert the attention of our management and our resources in general. Defense and settlement costs can be substantial, even with respect to claims that have no merit. Due to the inherent uncertainty of the litigation process, the resolution of any particular legal claim or proceeding could have a material effect on our business, financial condition, results of operations or cash flows.

Our ability to succeed will largely depend upon the efforts of our directors and officers, and in particular our chief executive officer, Mr. Richard J. Heckmann. The loss of Mr. Heckmann could affect our ability to operate.

Our ability to succeed is largely dependent upon the efforts of our officers and directors, especially Mr. Heckmann, our Chairman and Chief Executive Officer. Even though we believe that our success depends on the continued services of Mr. Heckmann, we have not entered into an employment agreement with Mr. Heckmann, nor obtained “key man” life insurance. Accordingly, we cannot be sure that Mr. Heckmann will remain with the company for the immediate or foreseeable future. In addition, though Mr. Heckmann has expressed a commitment of his full time to our success, he is not required to commit any specified amount of time to the company’s affairs and, as a result, he may have conflicts of interest in allocating management time among various business activities, including identifying more potential business acquisitions and monitoring the related due diligence and closing process. The loss of the services of Mr. Heckmann or any other of our other executive officers and directors could have a material adverse effect on our ability to successfully achieve our business objectives.

There are material weaknesses in our internal control over financial reporting that could cause investors to lose confidence in our reported financial information and thereby cause a decline in our stock price.

We inherited, and have undertaken to fix and remediate certain previously reported and currently reported weaknesses in China Water’s internal controls over financial reporting. See “Item 9A. Controls and Procedures.”

We continue efforts toward remediation of China Water’s control deficiencies. However, if we are unable to address these or other material weaknesses in our internal control over financial reporting, this might result in errors in our financial statements that could result in a restatement of our financial statements, cause us to fail to meet our reporting deadlines, and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

The results of China Water during the 10 month pre-acquisition period ended October 30, 2008 have not been audited.

We have included in this report pro forma operating results of China Water for the ten months ended October 31, 2008, which is based in part on unaudited information of China Water for the year ended December 31, 2008. Changes could be required to this information if it were to be audited, and there can be no assurance those changes will not be material. Further, China Water’s actual operating results may differ, and those differences may be material, from the pro forma operating results.

Changes to the fair market or carrying value of our investments in China Bottles, Inc. and UGSI could affect the value of our investment and any potential recordable income from the investments, which could result in a substantial write down.

We own 48% of the outstanding equity of China Bottles, Inc. (“China Bottles”), a manufacturer of bottling equipment and provider of contract manufacturing and finished product services. At December 31, 2009, our investment in China Bottles totaled $4.0 million, and our ability to estimate the market value of our shares of

 

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China Bottles common stock is limited to management’s estimate only since China Bottles is no longer providing data to the Over-the-Counter Bulletin Board or similar system for observable market value.

We own 7% of UGSI, a supplier of water infrastructure pipeline products. In 2009, through two separate purchases, we acquired shares of their common and convertible preferred stock for a total investment of $7.2 million dollars. At December 31, 2009, the market value of our shares was approximately $12.4 million (based on the closing market price on the Over-the-Counter Bulletin Board).

China Bottles has a significant insider ownership, the observable market price of UGSI’s stock has been volatile, and there is no liquidity in either stock. Changes to the fair market or carrying value of our investment in China Bottles or UGSI could affect the value of our investments and any potential recordable income from the investments, which could result in a substantial write down.

Risks Related to our Domestic Segment’s Business Operations

We have operated our recently acquired water disposal and pipeline business for just two quarters, and we may not achieve all the benefits anticipated.

On July 1, 2009, we purchased the assets underlying the business of HWR. The purchase could subject us to a number of risks and uncertainties, including, but not limited to, geopolitical events affecting the expansion plans of our customers, domestic political issues affecting the energy industry generally such as energy and tax legislation unfavorable to our customers that directly influences their capital expenditure and exploration plans, fluctuations in commodity prices that impact our customers’ expansion plans, near term integration and management challenges typical to acquisitions, and unforeseen interruptions in our newly operational pipeline. We have operated HWR’s business for just two quarters and continue to evaluate and determine the risks to which it is subject and therefore we can offer no assurance that we will achieve all the benefits anticipated.

Our new pipeline operations and expansion plans could be delayed.

We recently constructed a new pipeline and we are expanding our existing disposal capacity in order to accommodate much greater volumes of disposed water. Construction of our new pipeline in the Haynesville Play was substantially completed on January 30, 2010. Successful consistent operation could be impacted by inclement weather, land use and right of way disputes, equipment breakdowns, delays common to start up of complex construction and engineering equipment and systems, pipe, and measurement devices, installation interruptions, and operational safety, testing and troubleshooting of interdependent systems. Although we believe we have allocated all the necessary resources to insure consistent operation, any unforeseen interruptions could delay or negatively impact the realization of our business plans and have a material impact on our anticipated new pipeline revenues.

Our initial anticipated revenue from new pipeline operations is currently from three principal customers.

HWR has pre-sold approximately 46% of our new pipeline capacity to three principal customers under multi-year contracts with guaranteed minimum volumes and guaranteed minimum prices that reflect early adoption rates. These customers (Exco Production Company, El Paso E&P Company, and Encana Oil & Gas USA Inc.) are large, well capitalized public companies that we anticipate doing business with for the full term of these contracts. Even so, any unforeseen reduction or interruption concerning the operations of these initial principal customers that results in reduced water volume deliveries to us, or their refusal to make the minimum contractually agreed payments, could have a material impact on our initial anticipated pipeline revenues. Separately, we intend to sell the remaining 54% of the pipeline capacity over time to a larger group of customers under a combination of short and long term volume guarantees and at differing prices. If we do not sell the remaining capacity as soon as it is available, or if we sell it at rates different than anticipated, there could be a material impact on our anticipated new pipeline revenues.

 

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A portion of our domestic business will be operated through a joint venture in which our rights to control business decisions are limited.

A portion of our domestic business going forward will be generated through Energy Transfer Water Solutions JV, LLC, our joint venture with Energy Transfer Partners, L.P. (“ETP”) in which we hold a 50% ownership interest. We have less control over business decisions affecting this joint venture than we have in our wholly-owned businesses. In particular, we generally cannot act on major business initiatives for Energy Transfer Water Solutions JV, LLC without the consent of ETP. As a result, for this joint venture to operate efficiently, we and ETP must be in agreement on strategic, operational, funding and other matters. There is a significant risk that, as a result of differing views and priorities, there will be occasions when we do not agree on various matters related to the operation of the joint venture which could result in delays or changes in operations that could materially harm our prospects or even lead to dissolution of the joint venture.

Our joint venture has not commenced operations.

On February 9, 2010, we announced a joint venture with ETP to develop water pipeline infrastructure and treatment solutions for oil and gas producers in the Marcellus and Haynesville Shale fields, and potentially other areas within the states of New York, Pennsylvania, Ohio, West Virginia, Virginia, Tennessee, Kentucky, Texas and Louisiana. The joint venture is designed to accomplish this by laying water transport pipelines alongside natural gas pipelines which may transport water in both directions—complex or fluid laden water from oil and natural gas drilling fields to treatment and disposal facilities, and fresh and/or remediated water to oil and natural gas drilling fields. Where applicable, our joint venture projects may also extend water transport and treatment services to mining companies and coal and electric utilities.

Our joint venture has not commenced operations and does not have any agreements with any customers. The process of identifying a new potential customer, negotiating and entering into a services agreement, and constructing related pipelines and treatment and disposal facilities will require a significant investment of time and capital. If we are unable to complete this process efficiently, we may not achieve our goals for our joint venture and the price of our stock could decline.

Any interruption in our services due to pipeline breakdowns or necessary maintenance could impair our financial performance and negatively affect our brand.

Our current and future water transport pipelines are susceptible to breakdown and require ongoing maintenance. We may experience difficulties in maintaining the operation of our pipelines, thereby causing downtime and delays. Any interruption in our services due to pipeline breakdowns or necessary maintenance could reduce sales revenues and earnings. If there are interruptions, even if only temporary, our business and reputation could be severely harmed.

Our domestic segment’s operations may fluctuate due to seasonality and commodity fluctuations.

Our domestic water handling sales are subject to seasonality factors and the fluctuation of commodity futures. Extreme weather has historically reduced our total handling volumes because a portion of the water we receive is delivered via overland trucking. Also, we are negatively leveraged to fluctuating natural gas prices in the sense that our customers could alter drilling and capital expense plans if long term futures turned down substantially.

Changes to the existing environmental laws and regulations governing the transport and disposal of produced water may cause us to incur additional costs that could have an adverse impact on our financial position, and we may not be able to comply with such laws and regulations.

Our domestic segment operations are subject to federal and state environmental laws and regulations. If we fail to comply with these laws and regulations, we could face substantial fines, suspension of operations and loss of necessary permits. There can be no assurance that we will be able to comply with such laws and regulations. There also can be no assurance that there will not be changes to existing laws or regulations, compliance with which may cause us to incur significant additional costs that we cannot pass on to customers through higher prices.

 

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Risks Related to Our International Segment’s Business Operations

We face risks associated with recent acquisitions by China Water and if we fail to successfully integrate these acquired businesses our operating results will be negatively affected.

Within the past three years, our China Water subsidiary acquired outright control or a controlling interest in several businesses through acquisition. The ongoing process of integrating these businesses is distracting, time consuming, expensive, and requires continuous optimization and allocation of resources. Geographic distance between business operations, the compatibility of the technologies and operations being integrated, and combining disparate corporate cultures also present significant challenges. The acquired businesses also have different standards, controls, contracts, procedures, and policies, making it difficult to implement and harmonize company-wide financial, accounting, billing, information, and other systems. Continuing the successful integration of the recently acquired companies will require us to integrate and retain key management and other personnel, incorporate the acquired products or capabilities into our product offerings from an engineering, sales and marketing perspective, coordinate research and development efforts, integrate and support pre-existing supplier, distribution and customer relationships, and combine or centralize back office accounting, order processing, purchasing, and support functions. China Water’s focus on integrating operations may also distract attention from China Water’s day-to-day business and may disrupt key research and development, marketing, or sales efforts. If China Water cannot overcome these challenges, we may not realize actual benefits from past and future acquisitions, which will impair our overall business results.

Part of our strategy for China Water involves the development of new products and if we fail to timely develop new products or incorrectly gauge the potential market for new products, our financial results may suffer.

We are developing new bottled water products, such as flavored water, juices, teas, oxygenated water and nutrient-enriched bottled water products that could become new sources of revenue for us in the future and help us to diversify our revenue base. Part of our future development efforts will be focused on expanding our product offerings. If we fail to timely develop new products or if we miscalculate market demand for new products in development, we may not be able to grow our sales revenue sufficiently to outpace our product development expenses.

The revenues of our China business are highly concentrated in a single customer, Coca-Cola China, and we would be harmed if Coca-Cola China reduces its orders.

In the year ended December 31, 2009, approximately 63% of sales in China and 57% of our total sales were made to Coca-Cola China. Coca-Cola China resells our bottled water products. We believe that our relationship with Coca-Cola China provides consistent sales and credibility for us in our target markets. However, the arrangements with Coca-Cola China do not impose minimum purchase commitments upon Coca-Cola China, and they are not exclusive. If Coca-Cola China discontinues or reduces purchases and we are unable to generate replacement sales from new and existing customers, our revenue and net income would decline considerably. Also, because the margins on our sales to Coca-Cola China are generally lower than on our sales to other customers and through distributors, if sales to Coca-Cola China increase as a percentage of overall sales, then our margins would decline.

We face increasing competition which may negatively impact our market share and profit margins.

The bottled water industry in China is highly competitive, and we anticipate it will become even more competitive in the future. We compete with domestic Chinese bottled water producers including Hangzhou Wahaha Group, Nongfu Spring Company Ltd., and Guangdong Robust Corp., and with global beverage companies and brands including Nestle S.A, Coca-Cola, C’est Bon, Danone, Tingyi Master Kong, and Uni-President. Some of our competitors have been in business longer, some have substantially greater financial and other resources, and some are better established in their markets. Some may also benefit from raw material sources or production facilities that are closer to their markets, thereby giving them a competitive advantage in terms of cost and proximity to consumers.

 

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Currently, there are several thousand water brands in China, including those offered by domestic and foreign-invested enterprises. Our ability to compete against these enterprises will depend on our continuing ability to leverage our brand recognition and to distinguish our products by providing quality products at reasonable prices that appeal to wide consumer tastes and preferences.

Some of our competitors may provide products comparable or superior to ours, or adapt more quickly to consumer trends or changing market requirements. Significant consolidation among our competitors is also possible. Increased competition may lead our competitors to substantially increase their advertising expenditures and promotional activities or to engage in irrational or predatory pricing behavior. Third parties may actively engage in activities, whether legal or illegal, designed to undermine our brand name and product quality or to influence consumer confidence in our products. These activities may result in price reductions, reduced margins, and loss of market share, any of which could have a material adverse effect on our profit margins. As a result, we may not be able to compete effectively against current and future competitors.

Any interruption in our production could impair our financial performance and negatively affect our brand.

We produce bottled water products at eight facilities in China. Our manufacturing operations are complicated and integrated, involving the coordination of sourcing of water and other raw materials from third parties, internal production processes, and external distribution processes. While these operations are modified on a regular basis in an effort to improve manufacturing and distribution efficiency and flexibility, we may experience difficulties in coordinating the various aspects of our manufacturing processes, thereby causing downtime and delays. We may encounter interruptions in our manufacturing processes due to events beyond our control, such as fires, explosions, labor disturbances or violent weather conditions. Any interruptions in production could reduce sales revenue and earnings. If there are interruptions at any of our production facilities, even if only temporary, or delays in delivery times to our customers, our business and reputation could be severely harmed. Any significant delays in deliveries to our distributors or customers could also lead to increased returns or cancellations and cause us to lose future sales.

Limitations on or the unavailability of natural resources or energy resources needed to operate our business in China would impair our profitability.

In order to produce our bottled water products in China, we need a readily available supply of water and electricity. We depend mainly on municipal water supplies to provide the water used in our products and on regulated electric companies to provide us with the electricity needed for our production facilities. In the year ended December 31, 2009 approximately 66% of our water was sourced from municipal water supplies and the remaining 34% was sourced from ground water. It is possible that municipal governments could put usage limits on these water resources in situations when water reserves for their cities are low or curtail electricity usage when the demand for energy resources is high relative to supply. Our business operations, income, and profits would be highly impaired if such limits are imposed.

Increases in raw material prices that we are unable to pass on to our customers would reduce profit margins.

The principal raw materials used in our production, including water, bottled water containers, caps and packaging materials, are subject to a high degree of price volatility caused by external conditions. In particular, the PET we use to manufacture our bottles is petroleum based, and therefore subject to significant price fluctuations. In the year ended December 31, 2009 PET accounted for approximately 52% of our cost of goods sold. Oil prices have fluctuated at record velocity in recent years and the prices we pay for oil products and other raw materials may escalate in the future. Price changes to our raw materials may result in unexpected increases in production, packaging, and distribution costs, and we may be unable to increase the prices of our products to offset these increased costs. If so, we would suffer a reduction in our profit margins.

 

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Any difficulties or delays in delivery or poor handling by distributors and third party transport operators may affect our sales and damage our reputation.

In China, we sell our own brands of bottled water through distributors. In the year ended December 31, 2009, our three largest distributors accounted for approximately 10% of total sales. The delivery of our products by distributors to retailers could be delayed or interrupted in the case of unforeseen events and disruptions that occur for various reasons beyond our control, including poor handling by distributors or third party transport operators, transportation bottlenecks, natural disasters, and labor strikes. Poor handling by distributors and third-party transport operators could also result in damage to our products. If our products are not delivered to retailers on time, or are delivered damaged, we could lose business and our reputation could be harmed.

We may ineffectively allocate and balance the supply of our bottled water products among our distribution channels.

We market and sell our bottled water products to distributors that sell them to end users under our own brands, to major global drink and beverage companies, and to other corporations, hotels, and casinos on a private label basis. Like any other manufacturer or producer of products, we have limited production capacity and there are times when we are resource and capacity constrained. As our production capacity reaches its limit, it becomes more difficult for us to produce, balance, and allocate our bottled water products for sales through our various distribution and sales channels.

If we fail to strike an appropriate balance in producing and delivering our products for sale through our network of sales and distribution channels, we may be unsuccessful in meeting the relative demands of our distributors and the consumer market, which would hurt our sales, reputation, and relationships with distributors and customers.

Our products may become subject to recall in the event of defects or other performance related issues.

Our bottled water products have never been the subject of an open recall. However, like many other bottled water producers in China, we are at risk for product recall costs if a product is recalled due to a known or suspected contamination or other health or performance related defect. Costs typically include the cost of the product being replaced, the cost of the recall borne by our distributors, and the cost of removing our products from the market. If a recall decision is made, we will need to estimate the cost of the recall and record a charge to earnings. In making this estimate, judgment is required as to the quantity or volume to be recalled, the total cost of the recall campaign, and the ultimate negotiated sharing of the cost between us and our customers. Excessive recall costs or our failure to adequately estimate these costs may negatively affect our operating results. Recalls could also create reputational damage that materially affects our business.

Our results of operations may fluctuate due to seasonality.

Our sales in China are subject to seasonality factors. We typically experience higher sales of bottled water in the summer time in coastal cities while sales remain constant throughout the entire year in some inland cities. In general, our sales are higher in the second and third quarters of the year when the weather is hot and dry, and lower in the first and fourth quarters when the weather is cold and wet.

Sales can fluctuate throughout the year for a number of other reasons, including the timing of advertising and promotional campaigns, and unforeseen circumstances, such as production interruptions.

Changes to the existing environmental and food and hygiene laws and regulations in China may cause us to incur additional costs that could have an adverse impact on our financial position, and we may not be able to comply with such laws and regulations.

As a China based bottled water producer, we are subject to the environmental and food and hygiene laws and regulations of China. If we fail to comply with these laws and regulations, we could face substantial fines,

 

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suspension of operations by China’s government, loss of necessary licenses and, in the case of serious noncompliance with China’s food and hygiene laws, we and our management may be subject to criminal proceedings. There can be no assurance that we will be able to comply with such laws or regulations. There can also be no assurance that the Chinese government will not change the existing laws or regulations or impose additional or stricter laws or regulations, compliance with which may cause us to incur significant additional costs that we cannot pass on to customers through higher prices.

Risks Related to Doing Business in China

Adverse changes in political and economic policies of China’s government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.

We conduct operations and generate a portion of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects will be affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:

 

   

the higher level of government involvement in commercial activities;

 

   

the early stage of development of the market-oriented sector of the economy;

 

   

the rapid growth rate;

 

   

the higher level of control over foreign exchange; and

 

   

the allocation of resources.

As China’s economy has been transitioning from a planned economy to a more market-oriented economy, China’s government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall Chinese economy, they may also have a negative effect on our China business.

Although China’s government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, China’s government continues to exercise significant control over economic growth in China through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways. Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of investments and expenditures in China, which in turn could lead to a reduction in demand for China Water’s products and consequently have a material adverse effect on our business and prospects.

Uncertainties with respect to China’s legal system could limit the legal protections available to the Company and its stockholders.

We conduct business through China Water’s operating subsidiaries in China. China Water’s operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. China’s legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new Chinese laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since China’s legal system continues to evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to us and our stockholders. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

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China’s government exerts substantial influence over the manner in which we must conduct our business activities.

China’s government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in China’s laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that China Water’s bottled water production operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which China Water operates may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require the Company to divest itself of any interest it then holds in Chinese properties or joint ventures.

Past or future violations of complicated Chinese regulations governing merger and acquisition activity involving domestic Chinese companies could materially adversely affect our business.

Our past and any future acquisitions of Chinese operating companies are subject to complicated Chinese regulations governing merger and acquisition activity. On August 8, 2006, six Chinese regulatory agencies, including the China Securities Regulatory Commission, promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006. This new regulation, among other things, governs the approval process by which a Chinese company may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, the new regulation will require the Chinese parties to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to the new regulation, business combination transactions in China became significantly more complicated, time consuming and expensive.

In October 2005, China’s State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75. Circular 75 requires Chinese residents to register with an applicable branch of SAFE before establishing or acquiring control over an offshore special purpose company for the purpose of engaging in an equity financing outside of China that is supported by domestic Chinese assets originally held by those residents. Following the issuance of Circular 75, SAFE issued internal implementing guidelines for Circular 75 in June 2007. These implementing guidelines, known as Notice 106, effectively expanded the reach of Circular 75 by:

 

   

purporting to regulate the establishment or acquisition of control by Chinese residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership;

 

   

adding requirements relating to the source of the Chinese resident’s funds used to establish or acquire the offshore entity;

 

   

regulating the use of existing offshore entities for offshore financings;

 

   

purporting to regulate situations in which an offshore entity establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China;

 

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making the domestic affiliate of the offshore entity responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds; and

 

   

requiring that the registrant establish that all foreign exchange transactions undertaken by the offshore entity and its affiliates were in compliance with applicable laws and regulations.

No assurance can be given that our stockholders who are Chinese residents as defined in Circular 75, and who owned China Water or any of its China based subsidiaries prior to our acquisition of China Water, have fully complied with, and will continue to comply with, all applicable registration and approval requirements of Circular 75 in connection with their equity interests in the Company and the Company’s acquisition of equity interests in its China based subsidiaries by virtue of our acquisition of China Water. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to the Company following the China Water acquisition, we cannot predict how it will affect our business operations or future strategies. For example, the ability of our present and prospective China subsidiaries to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our Chinese resident beneficial holders. In addition, such Chinese residents may not always be able to complete the necessary registration procedures required by Circular 75. We have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. If our Chinese stockholders or the Chinese stockholders of the target companies we acquired in the past or acquire in the future fail to comply with Circular 75, if SAFE requires it, they may be subject to fines or legal sanctions, and Chinese authorities could restrict our investment activities in China, limit our subsidiaries’ ability to make distributions or pay dividends, or even unwind the transaction and revoke the right of our subsidiaries to do business in China.

If our Chinese stockholders or the Chinese stockholders of the target companies we acquired in the past or acquire in the future fail to obtain any required Chinese governmental approvals in connection with our acquisition of such companies, they may be subject to fines or legal sanctions, and Chinese authorities could restrict our investment activities in China, limit our subsidiaries’ ability to make distributions or pay dividends, or even unwind the transaction and revoke the right of our subsidiaries to do business in China.

China Water’s business will suffer if it loses its land use rights.

There is no private ownership of land in China and all land ownership is held by the government of China, its agencies, and collectives. Land use rights can be obtained from the government for a period up to 70 years, and are typically renewable. Land use rights can be transferred upon approval by the land administrative authorities of China (State Land Administration Bureau) upon payment of the required land transfer fee. China Water holds land use rights for some of its occupied properties and leases property from third parties that it believes have proper land use rights, but no assurance can be given that these land use rights will be renewed or that China Water’s lessors will maintain their land use rights. If China Water or any of its lessors lose their land use right certificates, China Water may lose production facilities that would be difficult or impossible to replace. Should it have to relocate, China Water’s workforce may be unable or unwilling to work in the new location and its operations will be disrupted during the relocation. The relocation or loss of facilities could cause China Water to lose sales and/or increase its costs of production, which would negatively impact our financial results.

Any failure to fully comply with China’s labor laws could cause potential liability.

Companies operating in China must comply with a variety of labor laws. Certain of these labor laws require Chinese companies to have an executed labor contract with employees and make certain pension, housing, and other welfare-oriented payments. For a period of time in 2007, most of China Water’s operating subsidiaries failed to have in place effective labor contracts with each of their employees and failed to make related payments in violation of applicable Chinese labor laws. In 2008, China Water took corrective actions by entering into the required labor contracts and made the payments as required under China’s labor laws. Although China Water

 

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believes these actions are sufficient to ensure that it is currently in compliance with applicable Chinese labor laws and are the appropriate remediative measures, no assurance can be given that China’s governmental authorities will concur with such a view and will not impose additional penalties.

Accounting laws in China mandate accounting practices which may not be consistent with United States generally accepted accounting principles and therefore our financials and their interpretation involve uncertainties.

China’s accounting laws require an annual “statutory audit” to be performed in accordance with China’s accounting standards and the books of foreign invested enterprises to be maintained in accordance with Chinese accounting laws. These Chinese accounting practices may not be consistent with United States generally accepted accounting principles, or GAAP. Article 14 of China’s Wholly Foreign-Owned Enterprise Law requires a wholly foreign-owned enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities. China Water’s China based operating subsidiaries are all considered wholly foreign-owned enterprises and, as such, must maintain financial statements in accordance with Chinese accounting practices in order to meet its filing obligations under China’s Wholly Foreign-Owned Enterprise Law. The translation of these financial statements from the requirements of China to United States GAAP requires interpretation and exercise of judgment. This may increase costs, cause inaccuracies or misstatements that could negatively impact our ability to get a clean audit opinion in the United States or may lead to fines by certain governmental bodies, which would negatively impact our financial performance and/or stock price.

Restrictions on currency exchange may limit our ability to receive and use sales revenue effectively.

Substantially all of our international segment sales revenue and expenses is denominated in RMB. Under Chinese law, the RMB is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, China Water’s China based operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to the Company, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant Chinese government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our international segment future revenue will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China that are denominated in foreign currencies.

Foreign exchange transactions by China operating subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with Chinese government authorities, including SAFE. In particular, if our China operating subsidiaries borrow foreign currency through loans from the Company or other foreign lenders, these loans must be registered with SAFE, and if the Company finances the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or MOFCOM, or their respective local counterparts. These limitations could affect China Water’s ability to obtain foreign exchange through debt or equity financing.

Fluctuations in exchange rates could adversely affect our business and the value of our securities.

The value of our common stock is indirectly affected by the foreign exchange rate between United States dollars and RMB and between those currencies and other currencies in which sales may be denominated. Because substantially all of our earnings and cash assets are denominated in RMB, appreciation or depreciation in the value of the RMB relative to the United States dollar would affect our financial results reported in United States dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend China Water may issue to the Company that will be exchanged into United States dollars and earnings from, and the value of, any United States dollar-denominated investments we make in the future.

 

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Since July 2005, the RMB has no longer been pegged to the United States dollar at a constant exchange rate. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate within a flexible peg range against the United States dollar in the medium to long term. Moreover, it is possible that in the future Chinese authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

Very limited hedging transactions are available in China to reduce exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by China’s exchange control regulations that restrict our ability to convert RMB into foreign currencies.

Currently, some of China Water’s raw materials and major equipment are imported. In the event that the United States dollar or other currencies appreciate against RMB, costs of such materials and equipment will increase. If China Water cannot pass-through the resulting cost increases on to its customers, profitability and operating results will suffer.

Risks Related to Our Common Stock

Our stockholders would experience substantial dilution in their investment as a result of subsequent exercises of outstanding warrants and the issuance of additional shares of common stock.

We have approximately 70.8 million shares subject to outstanding warrants, the exercise of which will dilute the investment of our existing stockholders. We may also issue shares in future acquisitions that would also be dilutive.

Our stock price could be affected because a substantial number of shares of our common stock will be available for sale in the future.

As of March 10, 2010, we had 108,750,650 shares of our common stock outstanding, all of which have been listed for trading according to the rules of the New York Stock Exchange. We had outstanding, as of March 10, 2010, 68.1 million public warrants and 2.7 million private warrants to acquire an additional approximately 70.8 million shares of our common stock. The public warrants are exerciseable at a strike price of $6.00 through November 9, 2011 and we are required to reserve sufficient common stock to support actual exercise. If a significant number of our warrants are exercised for shares of our common stock, our stock price could decline due to the increase in our number of common shares outstanding.

Our stock price may be volatile, which could result in substantial losses for investors in our securities.

The stock markets in general and the markets for stock of companies with significant operations in China in particular, have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock.

The market price of our common stock may also fluctuate significantly in response to the following factors, some of which are beyond our control:

 

   

variations in our quarterly operating results;

 

   

changes in securities analysts’ estimates of our financial performance;

 

   

changes in market valuations of similar companies;

 

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announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures, capital commitments, new products or product enhancements;

 

   

loss of a major customer or failure to complete significant transactions; and

 

   

additions or departures of key personnel.

The trading price of our common stock since our IPO has ranged from a high of $10.44 on the New York Stock Exchange on September 3, 2008 to a low of $3.38 on July 10, 2009. The last reported price of our common stock on the New York Stock Exchange on March 10, 2010 was $6.19 per share.

We currently do not intend to pay any dividends on our common stock.

We currently do not intend to pay any dividends on our common stock. While we may declare dividends at some point in the future, we cannot assure you that you will ever receive cash dividends as a result of ownership of our common stock and any gains from investment in our common stock may only come from increases in our stock prices, if any.

We are subject to anti-takeover effects of certain charter and bylaw provisions and Delaware law, as well as of our substantial insider ownership.

We have provisions in our certificate of incorporation and bylaws that:

 

   

make it more difficult for a third party to acquire control of us, and discourage a third party from attempting to acquire control of us;

 

   

may limit the price some investors are willing to pay for our common stock;

 

   

enable us to issue preferred stock without a vote of our stockholders or other stockholder action;

 

   

provide for a classified Board of Directors (the “Board”) and regulate nominations for the Board;

 

   

make it more difficult for stockholders to take certain corporate actions; and

 

   

may delay or prevent a change of control.

These and other provisions of our charter documents, certain provisions of Delaware law and our substantial insider ownership could delay or make more difficult certain types of transactions involving a change of control of the Company or our management. As a result, the price of our common stock may be adversely affected.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

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Item 2. Properties

We lease our executive offices in Palm Desert, California, and additional office space in Hong Kong and Tyler, Texas. We have extra capacity in Hong Kong and are currently subleasing excess space to a third party. We also lease warehouses and production facilities in China. We own one office space in Joaquin, Texas and one land use right in China. The following table summarizes our current land use right, owned property and leases:

 

Address

  

Leased/Owned

   Expires
No. 2 Zhu Ji Road, Ji Shan Village, Zhu Ji Street, Dong Pu, Tian He District, Guangzhou, Guangdong Province, China    Leased    2012
449 Kao Shan Village, Economic and Technology Development District, Changchun, Jilin Province, China    Leased    2011
Dong Jiu Road South, Shang Ye County, Feixian, Shandong Province, China    Land Use Right    2023
District 9, Ke Yuan Xi Shi Road, Nanning, Guangxi Province, China    Leased    2011
Zhuan Qiao Xi, Bei Er Cun Road, Sha He Zen, Chang Ping District, Beijing, China    Leased    2012
No. 1848 Yuan Da San Road, Huang Hua Zhen, Changsha, China    Leased    2012
1/F, Block A, Dong Feng Industrial Park, Zhu Cun Dong Huan Road, Guangzhou, Guangdong Province, China    Leased    2010
Ju Ji Warehouse, Tu Bei Industrial Park, Zhu Cun Dong Huan Road, Guangzhou, Guangdong Province, China    Leased    2010
Changchun Taoda, #204 of Block one, #205 of Block 15, Caizheng Small Town, Jingkai District, Changchun, Jilin Province, China    Leased    2010
#314, No. 10, Yongan Garden, Liwan Road, Guangzhou, Guangdong Province, China    Leased    2010
No. 1 Building, 1/F of No. 2 Buiding, Dormitory Building, Huazhou Road 82, Haizhu District, Guangzhou, Guangdong Province, China    Leased    2011
Harbin Taoda, No. 9 Tielu Street, Lalin Town, Wu Chang City, Heilongjiang, Harbin, China    Leased    2011
China Water Investment Management, 2/F., Block 2, No. 2005, Hong Mei Road, Shanghai, China    Leased    2014
China Water Investment Management, No. 7 West Axis, West Warehouse Building, Puning Road, Tangwan Village, Minxing District, Shanghai, China    Leased    2011
China Water Investment Management, Unit 405, 4/F., SenBen Plaza, 567 Tianyaoqiao Road, Xuhui District, Shanghai, China    Leased    2010
China Water Investment Management, Unit 7B06, No. 1915 North Jing, Sichuan, Shanghai, China    Leased    2011
Olympic Forward Trading, Units 3, 5 and 6, 12A/F., One Peking, No. 1 Peking Road, Tsimshatsui, Kowloon, Hong Kong    Leased    2011
210 South Broadway, Tyler, Texas    Leased    2010
202 CR 37, Joaquin, Texas    Owned    N/A
75080 Frank Sinatra Drive, Palm Desert, California    Leased    2010

There is no private ownership of land in China and all land ownership is held by the government of China, its agencies and collectives. Land use rights can be obtained from the government for a period of up to 70 years,

 

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and are typically renewable. Land use rights can be transferred upon approval of the land administrative authorities of China (State Land Administration Bureau) upon payment of the required land transfer fee. We have received the necessary land use right certificates for the facilities in the table above for which it is indicated that we possess a land use right, and we believe that the lessors of our leased properties in China have similarly obtained appropriate land use right certificates. Once the land use rights expire, the properties will be acquired by the Chinese government under China’s laws.

For the year ended December 31, 2009, the total cost associated with our properties, land use rights, and leased properties was approximately $1,442,000.

 

Item 3. Legal Proceedings

On June 1, 2009, Xu Hong Bin, the former president and chairman of China Water and his affiliated entity, Kotex Development Corp. (collectively “Xu”), filed a lawsuit in the Delaware Court of Chancery (the “Court”) making various claims against the Company and our directors and executive officers. Xu’s lawsuit makes claims allegedly arising out of our intended cancellation of approximately 5.3 million shares of Company common stock held by Xu. Xu claims that our intended cancellation of his 5.3 million shares is a breach of the general release in an escrow resolution and transition agreement that we entered into with him, which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2008. On June 8, 2009, the Court denied Xu’s request for expedited scheduling but indicated that pending resolution of the Xu litigation we may not cancel the 5.3 million Xu shares at issue. On June 22, 2009, we filed a vigorous answer and countersuit expanding our claims against Xu and seeking recovery of not only the stock at issue, but also cash paid to Xu, and cash misappropriated by Xu. Our affirmative defenses and our countersuit contend that the general release in the escrow resolution and transition agreement is infected with fraud and therefore voidable.

In response to our affirmative defenses and countersuit, Xu tried to circumvent the emerging evidence with a technical motion for partial judgment. It failed. On October 26, 2009, the Court denied Xu’s motion. Xu also asked the Court for an order of specific performance of the general release provisions of the escrow resolution and transition agreement. That also failed. The Court rejected Xu’s arguments as premature. The Court ruled that evidentiary questions of fraud and the voidabilty of contract will remain for later proceedings and trial. The Court also denied Xu’s motion to dismiss our counterclaims for his breach of the fiduciary duties of care and loyalty as a member of the Company’s Board of Directors. Although our fraud defenses and countersuit for breach of fiduciary duties remains, the Court has trimmed the pleadings by dismissing our counterclaims for contract breach and conversion. Our evidence of Xu’s wrongdoing raises serious issues for trial. Our countersuit for Xu’s breach of fiduciary duties and our affirmative defenses to his claims are going forward. In light of the pending litigation, disputed shares will continue to be included in our outstanding shares until the litigation is finally resolved.

In a companion action also filed in the Delaware Court of Chancery, Xu is seeking an order for legal fee expense reimbursement as a former director for now having to defend against our countersuit. On December 29, 2009, the Court ruled that reasonable conditions set by our Board of Directors must be met before Xu is entitled to any expense reimbursement, including the condition that Xu provide an irrevocable $900,000 letter of credit in favor of the Company should Xu ultimately not be entitled to reimbursement. As of March 10, 2010, Xu had not posted the letter of credit and the Company has not advanced any monies for legal fee expense reimbursement.

Separately, we are subject to claims and litigation in the ordinary course of business, the outcome of which is not material and cannot be predicted with certainty.

 

Item 4. Reserved.

 

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HECKMANN CORPORATION

PART II

 

 

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Price Range of Common Stock

Our units, which consist of one share of our common stock and one warrant to purchase a share of our common stock, trade on the New York Stock Exchange under the symbol “HEK.U.” Our common stock trades separately on the New York Stock Exchange under the symbol “HEK.” Certain of our warrants trade separately on the New York Stock Exchange under the symbol “HEK.WS.” Each public warrant entitles the holder to purchase from us one share of our common stock at an exercise price of $6.00. These public warrants will expire on November 9, 2011, or earlier upon redemption.

The following table sets forth, for the calendar quarters indicated, the high and low closing sale prices for our units, common stock and publicly traded warrants, respectively, as reported on the American Stock Exchange through May 22, 2008 and the New York Stock Exchange since May 23, 2008.

 

     Common Stock    Warrants    Units
     High    Low    High    Low    High    Low

2008

                 

First Quarter

   $ 7.45    $ 7.26    $ 0.79    $ 0.60    $ 8.16    $ 7.935

Second Quarter

   $ 10.09    $ 7.37    $ 3.70    $ 0.58    $ 13.89    $ 7.92

Third Quarter

   $ 10.44    $ 8.04    $ 4.35    $ 1.87    $ 15.08    $ 10.85

Fourth Quarter

   $ 8.36    $ 5.35    $ 2.60    $ 0.95    $ 11.50    $ 6.65

2009

                 

First Quarter

   $ 6.31    $ 4.31    $ 1.48    $ 0.60    $ 7.75    $ 5.20

Second Quarter

   $ 5.27    $ 3.75    $ 0.95    $ 0.55    $ 6.00    $ 4.70

Third Quarter

   $ 4.75    $ 3.38    $ 0.59    $ 0.35    $ 5.50    $ 5.00

Fourth Quarter

   $ 5.10    $ 4.17    $ 0.93    $ 0.50    $ 6.42    $ 4.99

Holders

As of March 10, 2010, our common stock was held by approximately 3,650 record holders.

Dividends

We have not paid any dividends on our common stock to date. The payment of dividends in the future will be contingent upon our revenues and earnings, if any, capital requirements and general financial condition. The payment of any dividends will be within the discretion of our board of directors. It is the present intention of our board of directors to retain all earnings, if any, for use in our business operations and, accordingly, our board does not anticipate declaring any dividends in the foreseeable future.

 

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Performance Graph

The following graphs compare the cumulative total return for our common stock from November 20, 2007, the date our common stock first became separately tradable, through December 31, 2009 with the comparable cumulative return of two indices, the S&P 500 Index and the Dow Jones Industrial Average Index. The graphs assume $100 invested on November 20, 2007 in our common stock and $100 invested at that same time in each of the two indices.

LOGO

LOGO

 

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Item 6. Selected Financial Data

The following table summarizes the relevant financial data for our business and should be read in conjunction with our consolidated financial statements, and the notes and schedules related thereto, which are included in this Annual Report on Form 10-K. The following discussion includes the operating results of China Water since October 30, 2008 and the operating results of HWR since July 1, 2009, the date HWR acquired all of the assets of Greer Exploration Corporation and the Silversword Partnerships, and all of the membership interests of Charis Partners, LLC. Prior to our October 30, 2008 acquisition of China Water, we were a blank check company with no operations. Accordingly, the results of operations for the year ended December 31, 2009 do not provide a meaningful comparison with the year ended December 31, 2008 or for the period May 29, 2007 (inception) through December 31, 2007.

Income Statement Data

 

In thousands, except share and per share data

   Year ended
December 31,
2009
    Year ended
December 31,
2008
    For the Period
29-May-07
(Inception)
through
December 31,
2007

Net sales

   $ 35,975      $ 10,507      $ —  

Gross profit

     9,241        3,260        —  

Operating expenses

     408,754        3,907        169

Other income (expense), net

     3,973        (10,383     2,486

(Benefit) provision for income taxes

     (2     3,710        1,171

Net (loss) income

     (395,538     (14,740     1,146

Net (loss) income attributable to the Company

     (395,395     (14,917     1,146

Net (loss) income per share:

      

Basic and diluted

     (3.61     (0.20     0.03

Weighted average shares outstanding

      

Basic and diluted

     109,575,057        74,853,651        25,305,415

Balance Sheet Data

      
     December 31,
2009
    December 31,
2008
    December 31,
2007

Total current assets

   $ 176,091      $ 333,668      $ 430,647

Total assets

     364,989        763,093        430,647

Total current liabilities

     38,995        14,483        20,838

Total liabilities

     43,959        16,489        20,838

Common stock, subject to possible redemption, 16,235,039 shares at $7.91 per share (*)

     —          —          128,419

Deferred interest income attributable to common stock subject to possible redemption (net of taxes of $182)

     —          —          265

Noncontrolling interest

     2,162        2,845        —  

Total equity of the Company

     318,868        743,759        281,125

 

(*) These shares were redeemable because they were issued in our IPO and, under the terms of our IPO prospectus, their holders had the right to vote against our acquisition of China Water and exercise their right to convert these shares into cash. Of the 16,235,039 shares of our common stock that were subject to possible redemption, only 1,021,695 shares were redeemed.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.

Company Overview

We are a holding company that was created to buy operating businesses, and our focus is on buying and building companies in the water sector. We have two operating segments: (1) domestic and (2) international. Our domestic segment presently includes (a) our water disposal, treatment, and pipeline transport facilities in Texas and Louisiana operated by our wholly-owned subsidiary HWR, (b) our joint venture with Energy Transfer Partners, L.P., to develop water pipeline infrastructure and treatment solutions for oil and gas producers in the Marcellus and Haynesville Shale rock formations containing oil and gas located in the eastern United States, and northwest Louisiana and northeast Texas respectively, which we maintain through our wholly-owned subsidiary HWS, and (c) our minority interest investment in water infrastructure solutions and pipeline supplier UGSI. (OTC: UGSI). Our international group presently includes (a) our bottled water business operated by our wholly-owned subsidiary China Water and (b) our minority investment in China Bottles, a bottling equipment manufacturer. As of December 31, 2009, we had approximately $250 million in invested cash and cash equivalents on our balance sheet. In 2010, we plan to continue building the businesses in our domestic and international segments, and we will also make additional acquisitions as we find attractive long-term opportunities for our stockholders.

Headquartered in Palm Desert, California, the Company was incorporated in Delaware on May 29, 2007. We began our corporate existence as a blank check development stage company. On November 16, 2007, we completed an IPO of 54,116,800 units (each consisting of one share of common stock and one warrant exercisable for an additional share of common stock), including 4,116,800 units issued pursuant to the partial exercise of the underwriters’ over-allotment option, and received net proceeds of approximately $421 million. On the same date, we also completed a private placement of warrants to our founders at an aggregate purchase price of $7 million, or $1.00 per warrant.

On October 30, 2008, we completed our acquisition of China Water, consolidated its subsidiaries and affiliate entities, and now operate its eight bottled water facilities in China with Coca Cola China as our largest customer.

On July 1, 2009, we purchased of all the assets of Greer Exploration Corporation and the Silversword Partnerships, and all the membership interests of Charis Partners, LLC. The assets of these entities were consolidated into HWR together with the capital and operating resources necessary to build a pipeline and network of disposal wells and terminal facilities. HWR now operates a multi-modal water disposal, treatment and pipeline transportation business in Texas and Louisiana serving customers seeking to dispose of complex water flows including flowback water, frac fluids, and produced brine waters generated in their oil and gas operations. On January 30, 2010, we completed our 50-mile water transport pipeline and treatment facility network in the Haynesville Shale field. It is designed to treat and dispose up to 100,000 barrels of water per day and is supported by a network of deep injection disposal wells.

On February 9, 2010, we announced a joint venture with Energy Transfer Partners, L.P. The joint venture is a 50/50 partnership and will operate under the name Energy Transfer Water Solutions, JV, LLC. It will develop water pipeline infrastructure and treatment solutions for oil and gas producers in the Marcellus and Haynesville Shale fields, and potentially other areas within the states of New York, Pennsylvania, Ohio, West Virginia, Virginia, Tennessee, Kentucky, Texas, and Louisiana. Our 50% interest in the joint venture is held through HWS.

Operations Overview

China Water produces bottled water products at facilities throughout China. China Water uses two types of production lines, one which produces hand-held sized (330 milliliters to 1.5 liters) bottled water (“Small

 

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Bottles”) and the other which produces carboy-sized (11.4 to 18.9 liters, or 3 to 5 gallons) bottled water (“Carboy Bottles”). China Water produces a variety of bottled water products including purified water, mineralized water, and oxygenated water.

China Water supplies bottled water products to beverage companies and servicing companies, including Coca-Cola China, Uni-President and Jian Li Bao. China Water also markets its bottled water products in China using the brand names “Absolutely Pure” and “Grand Canyon.” In addition, China Water provides private label bottled products to companies in the service industry, such as hotels and casinos.

HWR’s saltwater disposal and transport business presently includes eight disposal wells and approximately 50 miles of interconnecting pipeline which, at full capacity, is capable of disposing of approximately 100,000 barrels of saltwater and frac fluid each day. HWR enters into saltwater disposal agreements with oil and gas producers and independent trucking companies that need to dispose of saltwater and frac fluid used in drilling operations. HWR accepts trucking company deliveries of saltwater, condensate, and frac fluid at its filtration terminals, and takes delivery of saltwater and frac fluid directly into its filtration facilities and pipeline network from the oil and gas wells of area operators. The saltwater and frac fluid is pumped through the pipeline and into deep injection disposal wells. HWR is in the process of expanding its operations to include up to four additional disposal wells and several miles of new interconnecting pipeline, which, when completed and operating at full capacity, will raise HWR’s daily receiving and disposal capacity to approximately 120,000 barrels.

HWR currently has multi-year forward contracts with three principal customers, pursuant to which HWR has installed pipeline connecting these customers’ oil and gas wells to HWR’s disposal wells. The agreements provide that, upon connection of the new pipeline, the customers will have an obligation to dispose of a minimum firm quantity of saltwater and frac fluid into HWR’s network and, in return, HWR will receive fixed fee payments. In addition, HWR currently has agreements with approximately 15 other customers, pursuant to which these customers have the right, but not the obligation, to dispose of saltwater and frac fluid into HWR’s network and are obligated to make payments to HWR based upon the volume of saltwater and frac fluid actually delivered.

As of December 31, 2009, we had operated our China Water subsidiary for fourteen months. Based upon our recent operating results, and evaluations performed by our management team at China Water and our management team at Heckmann Corporation, we believe the following:

 

   

The global water business remains an excellent long-term business opportunity.

 

   

China presents a sizable and growing market, and is and will continue to be a key market for us.

 

   

Through China Water, we have the capacity to produce up to 1.1 billion bottles of water annually in China.

 

   

Our relationship with Coca-Cola in China is strong, and we have completed construction of a new facility near Xi’An, Shaanxi Province, to serve Coca-Cola in this market.

 

   

The business we acquired in China is not currently as strong as we had anticipated. Sales for the year ended December 31, 2009 were disappointing. We continue to evaluate whether there are other issues that affect current and future operation of the business.

 

   

In addition, the financial reporting systems we inherited, which we knew were deficient at the time of the acquisition, continue to be a challenge.

 

   

We are executing on our intended cancellation of approximately 15.5 million shares issued to former China Water management and insiders, and approximately 1.5 million shares underlying warrants issuable to them. To date 3,361,000 shares have been cancelled pursuant to the previously disclosed settlement agreement with Chen Xinghua, China Water’s former Chief Executive Officer, and we intend to complete the cancellation process for the remainder of the shares through additional settlement agreements or litigation.

 

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We have evaluated the goodwill recorded on acquisition, and have reduced it from an initial estimate of approximately $315.0 million to $6.3 million (See Note 3 to our consolidated financial statements included in this Annual Report on Form 10-K), reflecting (1) a reduction of approximately $28.0 million relating to the Chen Xinghua settlement agreement mentioned above, (2) an increase of approximately $47.1 million from adjusting certain acquired assets and assumed liabilities to recoverable amounts at the date of acquisition, (3) an increase of approximately $34.7 from finalizing the valuations related to the purchase price allocation and (4) approximately $362.5 million related to non-cash impairment charges. In connection with finalizing the Company’s purchase price allocation related to China Water, the Company corrected the allocation of its purchase price related to certain tangible assets and assumed liabilities by $47.1 million. Pursuant to Staff Accounting Bulletin (SAB) 99, Materiality, (SAB 99), and SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, the Company evaluated the quantitative and qualitative aspects of these corrections and determined the corrections were not material, as there was no impact on the Company’s results of operations or cash flow statements for the year ended December 31, 2008, or for the periods reported within the Company’s quarterly Form 10-Q filings for 2009.

As of December 31, 2009, HWR had operated our salt water disposal and transport business for six months. Based upon our recent operating results, and evaluations performed by our management team, we believe the following:

 

   

HWR’s existing business including eight disposal wells and approximately 50 miles of interconnecting pipeline is operating profitably and has contributed net earnings to our consolidated operating results. Capital expenditures will be invested by HWR in 2010 to acquire, permit, and operate additional disposal wells and install interconnecting pipeline into an integrated closed loop system capable of receiving and disposing up to 120,000 barrels per day.

 

   

Construction of HWR’s new 50-mile pipeline into the Haynesville Shale in east Texas and northwest Louisiana is complete and began commercial operations in January 2010.

 

   

HWR has firm multi-year disposal contracts for approximately 46% of current capacity for the new Haynesville pipeline.

Our balance sheet remains strong and we continue to actively evaluate potential acquisitions.

The following discussion includes the operating results of China Water for all periods after the acquisition date, October 30, 2008 and the operating results of HWR since July 1, 2009, the respective acquisition date of these businesses. Prior to our acquisition of China Water, we were a blank check company with no operations. Accordingly, the results of operations for 2009 do not provide a meaningful comparison with 2008.

Results of Operations for the Year Ended December 31, 2009 Compared to the Year Ended December 31, 2008

 

(in thousands)

   Year Ended
December 31,
2009
    Year Ended
December 31,
2008
 

Net sales

   $ 35,975      $ 10,507   

Cost of goods sold

     26,734        7,247   
                

Gross profit

     9,241        3,260   

Operating expenses

     408,754        3,907   
                

Operating loss

     (399,513     (647

Interest income, net

     3,928        10,940   

Other income (expense)

     45        (21,323
                

Loss before income taxes

     (395,540     (11,030

Provision for income taxes

     2        (3,710
                

Net (loss) income

   $ (395,538   $ (14,740
                

 

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Net Sales

Our net sales for the year ended December 31, 2009 were $35.9 million, which represents $32.1 of sales of bottled water made by the Company’s China Water subsidiary and $3.8 million of revenues from water disposal, as compared to $10.5 million for the year ended December 31, 2008, all of which was generated from sales of bottled water by the Company’s China Water subsidiary.

Cost of Goods Sold and Gross Profit

The cost of goods sold for the year ended December 31, 2009 was $26.7 million, resulting in total gross profit of $9.2 million, or 25.7% of sales. Gross profit of $7.5 million, or 23.4%, was attributable to bottled water sales and a gross profit of $1.7 million, or 45.0%, was attributable to water disposal revenues. The cost of goods sold for the year ended December 31, 2008 was $7.2 million, resulting in total gross profit of $3.3 million, or 31.0% of sales, all of which was attributable to sales of bottled water by the Company’s China Water subsidiary.

Operating Expenses

Operating expenses for the year ended December 31, 2009 totaled $408.8 million, compared to $3.9 million for the year ended December 31, 2008. The operating expenses for the year ended December 31, 2009 included a $357.5 million goodwill impairment charge based upon finalizing our goodwill impairment analysis as of September 30, 2009 (see Note 3 to our consolidated financial statements included in this Annual Report on Form 10-K). In addition, we recorded impairments to the carrying value of our fixed assets of approximately $6.8 million for the year ended December 31, 2009 primarily related to exiting the Beijing factory and writing off $2.2 million of Beijing factory leasehold improvements and $3.8 million of write-offs for construction in progress at the Changchun and Shandong factories.

General and administrative expense for the year ended December 31, 2009 were $41.3 million which included approximately $2.0 million of stock based compensation and amortization expense of approximately $2.6 million. Also included in general and administrative expense are approximately $5.3 million of expenses regarding the deconsolidation of a bottled water production factory (see Note 4 to our consolidated financial statements included in this Annual Report on Form 10-K). China Water management determined that the Company cannot support a greater than fifty percent ownership of the outstanding equity of the owner of this factory and accordingly, has deconsolidated the net assets and minority interests as of September 30, 2009. General and administrative expense also includes a $4.5 million expense for reimbursements made to Xu Hong Bin, the former president and chairman of China Water, that were previously capitalized, a $9.3 million expense to write off bad debts, a $3.9 million expense to write off other assets, and provisions for liabilities of $1.3 million.

In addition, during the first quarter of 2009, we adopted the Financial Accounting Standard Board’s (“FASB”) revised authoritative guidance for business combinations, which requires that acquisition related costs be expensed in the period in which the costs are incurred. This differs from previous accounting treatment in that the acquisition related expenses were included as part of the purchase price of the acquired company. We incurred approximately $0.2 million in acquisition related costs in connection with our acquisition by HWR of our saltwater disposal and transport business in the year ended December 31, 2009, with no comparable expense during the same periods in 2008.

Loss from Operations

We had operating losses of $399.5 million and $0.6 million for the year ended December 31, 2009 and 2008, respectively, as a result of the items mentioned above.

 

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Interest Income, net

During the year ended December 31, 2009, we recorded interest income of approximately $3.9 million compared to approximately $10.9 million for the year ended December 31, 2008. The decrease was due to lower interest rates for invested funds and lower investment balances in the year ended December 31, 2009 when compared to the same period in 2008.

Income from Equity Method Investment

During the year ended December 31, 2009, we recorded approximately $47,000 of equity income from our 48% equity method investment in China Bottles, Inc. Subsequent to management and its independent valuation advisor finalizing the report on the fair value of the Company’s 48% equity method investment in China Bottles, Inc., the 48% equity investment was written down to $4.0 million.

Other Income (Expense), net

We recorded other expense of approximately $0.2 million for the year ended December 31, 2009 primarily related to a $0.5 million restructuring reserve to exit the Bejing factory offset by other income at China Water from the sale of pre-form plastic bottles.

Income Taxes

The income tax benefit for the year ended December 31, 2009 was $2,000 compared with $3.7 million income tax expense for the year ended December 31, 2008.

Net (Loss) Income

Our net loss for the year ended December 31, 2009 was $395.5 million compared to a net loss of $14.7 million for the year ended December 31, 2008. The change relates primarily to the $357.5 million non-cash goodwill impairment loss and other items mentioned above.

Results of Operations for the Year Ended December 31, 2008 Compared to the Period from Inception (May 29, 2007) to the Year Ended December 31, 2007

 

(in thousands)

   Year Ended
December 31,
2008
    Inception
(May 29, 2007) to
December 31,
2007
 

Net sales

   $ 10,507      $ —     

Cost of goods sold

     7,247        —     
                

Gross profit

     3,260        —     

Operating expenses

     3,907        169   
                

Operating loss

     (647     (169

Interest income, net

     10,940        2,486   

Other expense

     (21,323     —     
                

(Loss) income before income taxes

     (11,030     2,317   

Provision for income taxes

     3,710        1,171   
                

Net (loss) income

   $ (14,740   $ 1,146   
                

Net Sales

Our net sales for the year ended December 31, 2008 were $10.5 million, which represents sales of bottled water made after the acquisition of China Water.

 

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Cost of Goods Sold

The cost of goods sold for the year ended December 31, 2008 was $7.2 million, which represents the cost of sales made after the acquisition of China Water, resulting in a gross profit of $3.3 million, or 31.4% of net sales.

Operating Expenses

Total operating expenses for the year ended December 31, 2008 were $3.9 million compared to $0.2 million for the corresponding period in 2007. Operating expenses for 2008 included selling, marketing, and general and administrative expenses of $2.4 million incurred after the date of acquisition of China Water. For the year ended December 31, 2008 and for the period from inception (May 29, 2007) to December 31, 2007, we incurred expenses related to the formation and operation of the Company of $1.5 million and $0.2 million, respectively.

Income (Loss) from Operations

We had operating losses of $0.6 and $0.2 million for the year ended December 31, 2008 and for the period from inception (May 29, 2007) through December 31, 2007, respectively, as a result of the items mentioned above.

Interest Income, net

During the fiscal year ended December 31, 2008, we recorded interest income of approximately $10.9 million compared to approximately $2.5 million for the period from inception (May 29, 2007) to December 31, 2007. The increase consists primarily of the full year impact of interest earned on the trust account, which, prior to our acquisition of China Water, contained a substantial portion of the proceeds of our IPO. Due to declining interest rates and a reduction in our cash and investment balances in light of our acquisition of China Water, interest income is expected to be less significant going forward.

Other Income (Expense), net

We incurred other expenses of approximately $21.3 million for the year ended December 31, 2008. These expenses relate primarily to transaction costs incurred by China Water that we paid concurrent with the closing of our acquisition of China Water. There was no reimbursement agreement in place between the Company and China Water at the time China Water incurred these costs, therefore, they were charged to expense in conjunction with the closing of the acquisition.

Income Taxes

The provision for income taxes for the year ended December 31, 2008 was $3.7 million compared with a provision of $1.2 million for the period from inception (May 29, 2007) through December 31, 2007. The 2008 provision is based on a pretax loss of $11.0 million, which includes approximately $21.2 million of transaction costs that are permanent differences for purposes of the tax provision.

Net Income (Loss)

Our net loss for the year ended December 31, 2008 was $14.7 million compared to net income of $1.1 million in the period from inception (May 29, 2007) through December 31, 2007. The change primarily relates to transaction costs incurred by China Water in connection with our acquisition of China Water.

Liquidity and Capital Resources

We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures, strategic acquisitions and investments, repurchases of our securities, and lease payments. Our principal sources of liquidity are cash on hand and cash generated from operations. Cash generated from operations is a function of such factors as changes in demand for our products and services, competitive pricing pressures, effective management of our manufacturing capacity, our ability to achieve reductions in operating

 

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expenses, and the impact of integration on our productivity. As of December 31, 2009, we had cash and cash equivalents of approximately $136.1 million, and approximately $113.2 million of short and long-term investments, for an aggregate of approximately $249.2 million in invested cash, cash equivalents and marketable securities.

Our primary strategy is to grow by expansion and acquisition. The Company believes that its cash, cash equivalents and investments will be sufficient to fund operations, facilitate plant expansions and complete any acquisitions it may undertake for the foreseeable future.

China Bottles, Inc. Investment

We own 48% of the outstanding equity of China Bottles, a manufacturer of bottling equipment and provider of contract manufacturing and finished product services. At December 31, 2009, our investment in China Bottles totaled $4.0 million. For the years ended December 31, 2009 and 2008, we recorded equity income of $47,000 and $4,000, respectively, based on the interim financial reports of China Bottles’ management. China Bottles has a significant insider ownership and there is no liquidity in the stock. Subsequent to management and its independent valuation advisor finalizing the report on the fair value of the Company’s 48% equity method investment in China Bottles the 48% equity investment was written down to $4.0 million.

Cash Flows for Year Ended December 31, 2009

Net cash used in operating activities was $6.0 million for the year ended December 31, 2009. Cash used by operating activities was primarily driven by working capital changes, which were principally increases in accounts receivable of $8.1 million, inventories of $1.4 million, prepaid expenses of $1.4 million offset by increases to accounts payable and accrued expenses of $7.9 million.

Net cash used in investing activities was $122.8 million for the year ended December 31, 2009. Of this amount, $148.2 million was invested in high grade corporate notes, $85.2 million was received from the sale of securities, $34.8 million was used to purchase machinery and equipment, $7.2 million was used to purchase approximately 7% of UGSI, (see Note 5 to our consolidated financial statements included in this Annual Report on Form 10-K), $1.2 million (net of $.2 million) was used to purchase 67% of Harbin Taoda and $16.6 million was used to consummate HWR’s acquisition of our saltwater disposal and transport business. (See Note 3 to our consolidated financial statements included in this Annual Report on Form 10-K).

Net cash used in financing activities was $16.7 million for the year ended December 31, 2009. Of this amount, $4.4 million was used by management under the discretionary program to buy back 6,166,696 previously issued warrants and $14.0 million was used to purchase 13,032,100 shares from Xu Hong Bin, and $1.9 million was borrowed under a China Water revolving credit facility with $0.3 million of repayments made during 2009.

Cash Flows for Year Ended December 31, 2008

Cash used in operating activities was $19.3 million for the year ended December 31, 2008. For the year ended December 31, 2008, we had a net loss of $14.7 million primarily due to cash payments of approximately $21.5 million for transaction costs paid in conjunction with the China Water acquisition and cash payments of approximately $5.3 million for income taxes, offset by approximately $10.9 million of cash interest earnings.

Cash provided by investing activities totaled approximately $305.3 million reflecting the release of approximately $403.2 million from the trust account, in which a substantial portion of the net proceeds from our

 

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IPO were held, in conjunction with consummating the business combination with China Water on October 30, 2008. Approximately $48.3 million of cash was paid to acquire China Water, net of approximately $1.7 million of cash acquired. Approximately $48.5 million of cash was used to purchase short- and long-term interest bearing investments and approximately $1.1 million of cash was used by China Water to purchase machinery and equipment.

Cash used in financing activities was approximately $5.3 million and was primarily attributable to cash paid for equity issuance costs in conjunction with our acquisition of China Water.

Cash Flows for Year Ended December 31, 2007

Through December 31, 2007, our efforts were limited to organizational activities, activities relating to our IPO, activities relating to identifying and evaluating prospective acquisition candidates, and activities relating to general corporate matters. We neither engaged in any operations nor generated any revenues other than interest income earned on the proceeds of our private placement and IPO. For the period-ended December 31, 2007, we earned approximately $2.5 million in interest income, all of which was received into the trust account in which a substantial portion of the net proceeds from our IPO were held.

As of December 31, 2007, we had approximately $1.5 million of unrestricted cash available to us for our activities in connection with identifying and conducting due diligence of a suitable business combination, and for general corporate matters. For the period-ended December 31, 2007, we paid or incurred an aggregate of approximately $0.2 million in expenses for general corporate matters.

Contractual Obligations

The following table summarizes contractual obligations and borrowings as of December 31, 2009 and the timing and effect that these commitments are expected to have on our liquidity and capital requirements in future periods. We expect to fund other commitments primarily with operating cash flows generated in the normal course of business.

 

Payments Due by Period

     Less than
1 Year
   1 to 3
Years
   3 to 5
Years
   More than
5 Years
   Total
     (Amounts in Thousands)

Debt obligations

   $ 1,837    $ —      $ —      $ —      $ 1,837

Quarterly obligation under purchase agreement (Note 3)

     700      1,050      —        —        1,750

Operating Lease Obligations

     1,919      1,768      4      —        3,691
                                  

Total

   $ 4,456    $ 2,818    $ 4    $ —      $ 7,278
                                  

Off Balance Sheet Arrangements

We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “variable interest entities.”

Discussion of Results on an Operating Basis

Our financial information prepared in accordance with United States generally accepted accounting principles (“GAAP”) includes the operating results of China Water for all periods after the acquisition date of October 30, 2008 and the operating results of HWR since July 1, 2009, the date our saltwater disposal and transport business was acquired, and therefore, are not necessarily comparable to the prior periods presented. To supplement our consolidated financial statements presented in accordance with GAAP, the Company uses certain measures defined as non-GAAP by the SEC. The presentation of these non-GAAP financial measures is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in

 

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accordance with GAAP. We use non-GAAP financial measures to gain an understanding of our Company’s comparative operating performance when comparing such results with previous periods. Non-GAAP financial measures are also used by the Company’s management in their financial and operational decision-making, because management believes they reflect the Company’s ongoing business in a manner that allows meaningful period-to-period comparisons. The Company’s management believes that these non-GAAP financial measures provide useful information to investors to understand and evaluate the Company’s current operating performance in the same manner as management does, and to compare in a consistent manner the Company’s current financial results with the past financial results. We further believe these non-GAAP financial measures provide useful and meaningful supplemental information to both management and investors regarding the Company’s performance by excluding certain items that are not expected to result in future cash payments or that may not be indicative of the Company’s core operating results and business outlook. These non-GAAP financial measures should be evaluated considering, among other things, the non-cash goodwill impairment charges recorded by the Company.

For the year ended December 31, 2009, our GAAP results excluded the results of HWR prior to July 1, 2009. For the year ended December 31, 2008, our GAAP results exclude the results of China Water prior to October 30, 2008 and the GAAP loss from operations includes certain non-cash expenses related to the release of performance based shares from an escrow established in 2007 relating to a private placement of China Water, merger related expenses, and non-cash increases to the allowances for bad debts, deposits and other receivables. In order to provide a more meaningful comparison of operating performance during the periods presented in our financial statements, we have removed those items from the 2008 operating basis results set forth below and we have added the pre-acquisition results of China Water and HWR’s business for all periods prior to the respective acquisition date. Furthermore, in 2008, the loss from operations for Heckmann Corporation, without the results of China Water or HWR, consisted largely of formation costs and other expenses incurred in seeking and evaluating potential business combinations. We have disregarded these expenses. China Water and HWR incurred their own operating expenses for these periods, and the inclusion of Heckmann Corporation’s expenses prior to the date of acquisition would make it difficult to compare operating results period to period. In addition, we have removed acquisition related costs paid by the Company that were incurred by China Water, amortization of a beneficial conversion feature, and interest expense on 5% convertible notes to make the income before income tax results more comparable period over period. With the information set forth below, we believe management and stockholders are better able to determine whether or not revenues, gross profit, income from operations or income before income taxes of the acquired business have improved in 2009 compared to 2008, and in 2008 compared to 2007. The information set forth below is intended to assist the reader in comparing the performance of the China Water and HWR businesses we acquired, for the periods before and after the acquisitions. However, they do not indicate what actual consolidated results would have been had we acquired China Water and HWR on January 1, 2007 in accordance with GAAP.

 

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The following operating basis results should not be viewed in isolation or as a substitution for GAAP results:

(in millions)

  As Reported
Form 10-K
    Add China
Water Results
Prior to
Acquisition
    Heckmann
Water
Resources
Prior to
Acquisition
    Adjustments     Adjusted
Combined
 
          (unaudited) (a)     (unaudited)     (unaudited)     (unaudited)  

Year Ended December 31, 2009

         

Revenue

  $ 36.0        —          3.7        —        $ 39.7   
                                       

Gross profit

    9.2        —          1.6        —          10.8   
                                       

% of Revenue

    25.6     —          43.2     —          27.3
                                       

(Loss) income from operations

    (399.5     —          1.0        —          (398.5
                                       

Interest income

    3.9        —          —          —          3.9   

Other income (expense), net

    0.1        —          —          —          0.1   
                                       

(Loss) income before income taxes

  $ (395.5     —          1.0        —        $ (394.5
                                       

Year Ended December 31, 2008

         

Revenue

  $ 10.5      $ 45.9      $ 7.0        —        $ 63.4   
                                       

Gross profit

    3.3        16.1        3.0        (0.2 )(b)      22.2   
                                       

% of Revenue

    31.4     35.1     42.9     —          35.0
                                       

(Loss) income from operations

    (0.6     (73.8     2.0        (0.8 )(c)      (73.2
                                       

Stock based compensation

    —          —          —          46.6 (d)      46.6   

Merger related expenses and other

      —          —          4.8 (e)      4.8   

Non-cash increases to allowances for bad debts, deposits, and other receivables

    —          —          —          23.2 (f)      23.2   

Income (loss) from operations excluding non-cash stock based compensation expense, parent company pre-acquisition expenses, merger related expenses, and non-cash increases to the allowance for bad debts, deposits, and other receivables

    (0.6     (73.8     2.0        73.8        1.4   
                                       

Interest income

    10.9        —          —          —          10.9   
                                       

Interest expense

    —          (14.5       14.5 (g)      —     
                                       

Acquisition costs

    (21.2     —            21.2 (h)      —     
                                       

Other income (expense), net

    (0.1     3.4        —          —          3.3   
                                       

(Loss) income before income taxes

  $ (11.0   $ (84.9   $ 2.0      $ 109.5      $ 15.6   
                                       

% of Revenue

            24.6
               

Year Ended December 31, 2007

         

Revenue

  $ —        $ 56.8      $ 7.0      $ —        $ 63.8   
                                       

Gross profit

    —          19.4        3.0        (0.2 )(b)      22.2   
                                       

% of Revenue

    —          34.2     42.9     —          34.8
                                       

(Loss) income from operations

    (0.2     (38.4     1.9        (2.1 )(c)      (38.8
                                       

Stock based compensation

    —          —            55.9 (d)      55.9   

Income (loss) from operations excluding non-cash stock based compensation expense and parent company pre-acquisition expenses

    (0.2     (38.4     1.9        53.8        17.1   
                                       

Interest income

    2.5        —          —          —          2.5   
                                       

Other income (expense), net

    —          2.2        —          —          2.2   
                                       

Income (loss) before income taxes

  $ 2.3      $ (36.2   $ 1.9      $ 53.8      $ 21.8   
                                       

% of Revenue

            34.2
               

 

(a) The results presented are unaudited. The Company is in the process of having the pre-acquisition period audited and will provide those audited results as soon as practicable.

 

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(b) These adjustments were made to record utilization of inventory step-up in both 2008 and 2007 related to acquired inventory in the China Water acquisition from the beginning of each respective year.

 

(c) These adjustments were made to remove 2008 and 2007 pre-acquisition expenses of Heckmann Corporation (without China Water) of $1.5 million and $0.2 million, respectively, and to record additional amortization expense of $2.1 million in 2008 and 2007 related to intangible assets acquired in the China Water acquisition from the beginning of each respective year. Heckmann Corporation expenses incurred beginning October 31, 2008 remain included in operating basis results.

 

(d) These adjustments were made to remove approximately $46.6 million and $55.9 million of stock-based compensation pursuant to a make good escrow agreement entered into in connection with an equity financing transaction consummated by China Water in 2007.

 

(e) These adjustments were made to remove merger-related expenses incurred by China Water in connection with its acquisition by the Company that would not have been incurred had the acquisition taken place at the beginning of the periods presented.

 

(f) These adjustments were made to remove approximately $23.2 million of non-cash increases to the allowance for bad debts, deposits and other receivables.

 

(g) These adjustments were made to remove approximately $12.4 million of beneficial conversion future amortization and approximately $2.1 million of interest on 5% convertible notes payable that would not have been incurred had the merger taken place at the beginning of the periods presented.

 

(h) These adjustments were made to remove approximately $21.2 million of transaction costs incurred by China Water that were paid by the Company in connection with the merger.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008 (Non-GAAP, Unaudited Operating Results)

Net Sales

Net sales are derived from sales of bottled water products and revenues from water disposal. Net sales decreased 37.4% to $39.7 million in 2009 from $63.4 million in 2008. The decrease was primarily due to weak performance by our China Water subsidiary, competitive pressures, as well as integration difficulties we have faced with the former management of China Water.

Gross Profit

Gross profits for 2009 decreased $11.4 million to $10.8 million from $22.2 million in 2008. Gross profit as a percentage of sales decreased to 27.3% for 2009 from 35.0% in 2008. The reduction was due to lower sales of bottled water products, competitive pressures, an adjustment to depreciation expense of $0.4 million and $0.8 million of inventory write-offs and inventory reserves recorded in the twelve months ended December 31, 2009.

Operating Expenses

Operating expense for the year ended December 31, 2009 totaled $409.3 million, compared to $95.4 million for the year ended December 31, 2008. Operating expenses for the year ended December 31, 2009 include a $357.5 million goodwill impairment charge based upon finalizing our goodwill impairment analysis as of September 30, 2009. Also included in operating expense is a $6.8 million charge for the impairment of fixed assets.

General and administrative expense for the year ended December 31, 2009 were $41.3 million which included approximately $2.0 million of stock based compensation and amortization expense of approximately $2.6 million. Also included in general and administrative expense are approximately $5.3 million of expenses

 

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regarding the deconsolidation of ShenYang Aixin, a $4.5 million expense for reimbursements made to Xu Hong Bin that were previously capitalized, a $9.3 million expense to write off bad debts, a $3.9 million expense to write off other assets, and a provision for liabilities of $1.3 million.

Loss from Operations

We had a loss from operations of $398.5 million for the year ended December 31, 2009 compared to operating income of $1.4 million for the year ended December 31, 2008 as a result of the items mentioned above.

Interest Income, net

For the year ended December 31, 2009 we recorded interest income of approximately $3.9 million compared to approximately $10.9 million for the year ended December 31, 2008. The decrease was due to lower interest rates for invested funds and lower investment balances for the year ended December 31, 2009 when compared to the year ended December 31, 2008.

Net (Loss) Income

Our net loss for the year ended December 31, 2009 was $394.5 million compared to net income of $15.6 million for the year ended December 31, 2008. The change related primarily to the $357.5 million non-cash goodwill impairment loss and the other items mentioned above.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 (Non-GAAP, Unaudited Operating Results)

Net Sales

Net sales are derived from sales of China Water bottled water products and revenues from water disposal. Net sales decreased $0.4 million to $63.4 million in 2008, from $63.8 million in 2007.

Gross Profit

Gross profit was unchanged in 2008 and remained at the $22.2 million level for 2007. Gross profit as a percentage of net sales increased to 35.0% in 2008 from 34.8% in 2007, primarily due to production process and other automated functions which China Water introduced in the second half of 2007 that boosted its efficiencies in all product categories.

Income (Loss) from Operations

Operating income for 2008, excluding non-cash stock-based compensation expense, parent company pre-acquisition expenses, merger related expenses, and non-cash increases to the allowances for bad debts, deposits, and other receivables, decreased $15.7 million to $1.4 million from $17.1 million in 2007 due, in part, to additional marketing efforts and expenses to promote China Water’s branded products.

Income (Loss) before Income Taxes

Income before income taxes for 2008 decreased $6.2 million to $15.6 million from $21.8 million due primarily to the lower sales and gross profits mentioned above.

Recent Accounting Pronouncements

Adopted Accounting Standards

Effective January 1, 2009, the Company implemented the Financial Accounting Standard Board’s (“FASB”) revised authoritative guidance for business combinations. This revised guidance requires an acquiring company to measure all assets acquired and liabilities assumed, including contingent considerations and all contractual

 

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contingencies, at fair value as of the acquisition date. In addition, an acquiring company is required to capitalize in-process research and development and either amortize it over the life of the product, or write it off if the project is abandoned or impaired. Previously, post-acquisition adjustments related to business combination deferred tax asset valuation allowances and liabilities for uncertain tax positions were generally required to be recorded as an increase or decrease to goodwill. The revised guidance does not permit this accounting and, generally, requires any such changes to be recorded in current period income tax expense. Thus, all changes to valuation allowances and liabilities for uncertain tax positions established in acquisition accounting, regardless of the guidance used to initially account for the business combination, will be recognized in current period income tax expense. The Company accounted for its acquisition of the Salt Water Disposal business on July 1, 2009 and Harbin Taoda on April 11, 2009 in accordance with this guidance (Note 3). Therefore, the adoption of the revised guidance had an impact on the Company’s consolidated financial statements for the year ended December 31, 2009. The nature and magnitude of the specific effects in future periods will depend upon the nature, terms and size of the acquisitions consummated after the authoritative guidance’s effective date of January 1, 2009.

Effective January 1, 2009, the Company adopted the revised authoritative guidance for the accounting treatment afforded preacquisition contingencies in a business combination. Under the revised guidance, an acquirer is required to recognize at fair value an “asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of the liability can be determined during the measurement period.” If the acquisition-date fair value cannot be determined, the acquirer must apply the authoritative guidance used to evaluate contingencies to determine whether the contingency should be recognized as of the acquisition date or after the acquisition date. The adoption of the revised guidance will have an impact on the Company’s consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions consummated after the authoritative guidance’s effective date of January 1, 2009.

Effective January 1, 2009, we implemented FASB’s revised authoritative guidance for consolidation, which addresses the accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The guidance also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The adoption of the revised guidance impacted the Company’s consolidated financial statements, and resulted in the Company reclassifying financial statement line items within its consolidated balance sheets, statements of operations, and statements of stockholders equity for prior periods to conform to this standard.

Effective January 1, 2009, we adopted the FASB’s revised authoritative guidance which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance requires enhanced disclosures concerning a company’s treatment of costs incurred to renew or extend the term of a recognized intangible asset. The adoption of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.

Effective April 1, 2009, we adopted FASB’s revised authoritative guidance for fair value measurements which clarifies the measurement of fair value in a market that is not active, and is effective as of the issue date, including application to prior periods for which financial statements have not been issued. The Company also adopted additional authoritative guidance for determining whether a market is active or inactive, and whether a transaction is distressed, is applicable to all assets and liabilities (financial and nonfinancial) and which requires enhanced disclosures. The adoption of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.

Effective April 1, 2009, we adopted authoritative guidance which provides additional guidance to provide greater clarity about the credit and noncredit component of an other-than-temporary impairment event and to more effectively communicate when an other-than-temporary impairment event has occurred. The adoption of

 

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this guidance, which applies to investments in debt securities, did not have a material impact on our consolidated financial position, results of operations or cash flows.

In June 2009, the FASB approved its Accounting Standards Codification (“Codification”) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification is effective for interim or annual financial periods ending after September 15, 2009 and impacts the Company’s financial statements as all future references to authoritative accounting literature will be referenced in accordance with the Codification. There have been no changes to the content of the Company’s financial statements or disclosures as a result of implementing the Codification during the quarter ended September 30, 2009.

Recently Issued Accounting Standards

In June 2009, the FASB issued revised authoritative guidance that, among other things, requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity (“VIE”), which amends previous guidance for consideration of related party relationships in the determination of the primary beneficiary of a VIE, amends certain guidance for determining whether an entity is a VIE, requires continuous assessments of whether an enterprise is the primary beneficiary of a VIE, and requires enhanced disclosures about an enterprise’s involvement with a VIE. This guidance is effective for years beginning January 1, 2010. We are currently evaluating the impact the adoption will have on its consolidated financial statements.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the most significant judgments and estimates in the preparation of our financial statements, including the following:

Basis of Consolidation

The consolidated financial statements of the Company and its subsidiaries are prepared in accordance with accounting principles generally accepted in the United States and include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. The Company maintains bank accounts in the United States, China, and Hong Kong, with a majority of those balances maintained in US dollars. Balances at financial institutions or Chinese state-owned banks are not covered by insurance. The Company has not experienced any historical losses in such accounts and believes that the risk of any loss is minimal. A majority of the funds held in the United States are invested in one or more institutional money market funds.

Accounts Receivable and Allowance for Doubtful Accounts

Substantially all of our receivables are related to providing bottled water products. Accounts receivable are reduced by an allowance for amounts that could become uncollectible in the future. Our estimate for allowance for doubtful accounts is based upon management’s assessment of expected net collections. Due to the continuing changes in the economy, it is possible that management’s estimates could change in the near term, which could have an impact on our financial position, results of operations, and cash flows.

 

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Goodwill

Goodwill is tested annually for impairment in the fourth quarter of each year or more frequently if events or changes in circumstances indicate that impairment may have occurred. The impairment analysis for goodwill includes a comparison of our carrying value of our investment (including goodwill) to our estimated fair value. If the fair value does not exceed its carrying value, then an additional analysis will be performed to allocate the fair value to all assets and liabilities as if it had been acquired in a business combination and the fair value was its purchase price. If the fair value of our identifiable assets and liabilities is less than the carrying value of recorded goodwill, an impairment charge is recorded for the difference. During the year ended December 31, 2009, impairment losses were recorded as a result of this analysis; see Note 3 to the financial statements for further discussion.

Stock-Based Compensation

The estimated fair value of share-based awards exchanged for employee and non-employee director services are expensed over the requisite service period. Option awards issued to non-employees (excluding non-employee directors) are recorded at their fair value as determined in accordance with authoritative guidance, and are periodically revalued as the options vest and are recognized as expense over the related service period.

For purposes of calculating stock-based compensation, we estimate the fair value of stock options and shares issued under the Equity Incentive Plan using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option-pricing model incorporates various and highly sensitive assumptions including expected volatility, expected term and interest rates. Stock-based compensation related to stock options is recognized and amortized on an accelerated basis in accordance with authoritative guidance. If there is a difference between the assumptions used in determining stock-based compensation expense and the actual factors which become known over time, specifically with respect to anticipated forfeitures, we may change the input factors used in determining stock-based compensation costs for future grants. These changes, if any, may materially impact our results of operations in the period such changes are made.

Long-Lived Assets

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset to the expected undiscounted future net cash flows generated by the asset. If it is determined that the asset may not be recoverable and if the carrying amount of an asset exceeds its estimated fair value, an impairment charge is recognized to the extent of the difference.

Revenue Recognition

The Company recognizes revenues in accordance with Staff Accounting Bulletin No. 104 and, accordingly, all of the following criteria must exist for revenues to be recognized: pervasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed and determinable; and collectibility is reasonably assured. The majority of the Company’s revenue results from sales contracts with direct customers and revenues are generated upon shipment of the goods.

Foreign Currency Translation

The functional currency of the Company’s operating subsidiaries is the RMB, which is not freely convertible into foreign currencies. The company maintains its consolidated financial statements in the functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet date. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the

 

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exchange rates prevailing at the dates of the translations. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures for contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those estimates.

Income Taxes

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance on our net deferred tax assets as of December 31, 2009 due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future.

 

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Foreign Exchange Risk

The value of the RMB against the United States dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. Since July 2005, the RMB has no longer been pegged to the United States dollar at a constant exchange rate. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate within a flexible peg range against the United States dollar in the medium to long term. Moreover, it is possible that in the future, China’s governmental authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

Because substantially all of the earnings from our Chinese subsidiary are denominated in RMB, but our reporting currency is the United States dollar, fluctuations in the exchange rate between the United States dollar and the RMB will affect our balance sheet and our earnings per share in United States dollars. In addition, appreciation or depreciation in the value of the RMB relative to the United States dollar would affect our financial results reported in United States dollar terms without giving effect to any underlying change in our business or results of operations.

Inflation

Inflationary factors, such as increases in the cost of our products and overhead costs, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of sales revenue if the selling prices of our products do not increase with these increased costs.

Certain Company Operations are in Foreign Countries

Our international segment operations conducted in China are subject to various political, economic, and other risks and uncertainties inherent in conducting business in China. Among other risks, the Company and China Water subsidiary operations are subject to the risks of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.

 

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Interest Rates

Our exposure to market risk for changes in interest rates relates to our cash investments. Our cash investments policy emphasizes the preservation of principal over other portfolio considerations. If market interest rates increased by one percent from December 31, 2009, the fair value of our portfolio would decline approximately $1.1 million.

 

Item 8. Financial Statements and Supplementary Data

The financial statements and supplementary data required by Regulation S-X are included in Part IV, Item 15 of this Annual Report on Form 10-K.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

In 2009, there were no disagreements with accountants on accounting and financial disclosures.

 

Item 9A. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Annual Report, our management, under the supervision and with the participation of our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), performed an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based upon, and as of the date of that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective to provide reasonable assurance that the information required to be disclosed in our reports filed with the SEC under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and are accumulated and communicated to our management, including the Chief Executive Officer, as appropriate to allow timely decisions regarding required disclosure.

In making this evaluation, our Chief Executive Officer and Chief Financial Officer considered the material weaknesses of China Water discussed below in “Management’s Report on Internal Control over Financial Reporting.” Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of December 31, 2009 because of the identification of material weaknesses in China Water’s internal control over financial reporting that have not yet been fully remediated and which continue to exist at December 31, 2009.

(b) Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. The Exchange Act defines internal control over financial reporting as a process designed by, or under the supervision of, a Company’s principal executive and principal financial officers and effected by a Company’s 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 accounting principles generally accepted in the United States of America and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States generally accepted accounting principles, or US GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) 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.

 

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There are inherent limitations in the effectiveness of any system of internal controls, including the possibility of human error and the circumvention or overriding of controls, such that 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 and procedures may deteriorate. A material weakness is a deficiency, or a combination of deficiencies, in internal controls 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. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of our financial reporting.

Management, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. Management excluded from this assessment two businesses that we acquired in 2009 because it was not possible to conduct an assessment of the two acquired businesses’ internal control over financial reporting in the period between the consummation date and the date of management’s assessment. With respect to excluding these companies, we are required to (1) formally note that management is excluding these acquired businesses from management’s report on internal control over financial reporting; (2) clearly identify the acquired businesses excluded and have indicated the significances of the acquired businesses in our consolidated financial statements; and (3) disclose material changes, if any, to our internal control over financial reporting due to the acquisition of these businesses. We have excluded Harbin Taoda (“Harbin”), a subsidiary of China Water, and HWR, from our assessment of internal control over financial reporting as of December 31, 2009 because Harbin and the assets underlying the business of HWR were acquired on April 1, 2009 and July 1, 2009, respectively, and qualified under current SEC interpretive guidance for exclusion from our assessment of internal control over financial reporting. Harbin and HWR’s financial statements constitute 7% and less than 1%, respectively, of our total assets, 11% and 13% respectively of total revenues, and less than 1% of net loss of our consolidated financial statements amounts, as of and for the year ended December 31, 2009. In assessing the effectiveness of our internal controls over financial reporting as of December 31, 2009, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on our assessment, we determined that, for the reasons disclosed below, as of December 31, 2009, our internal controls over financial reporting were not effective based on those criteria.

GHP Horwath P.C. (“GHP”), our independent registered public accounting firm, has performed an audit of the effectiveness of our company’s internal control over financial reporting as of December 31, 2009, and, as part of its audit, has issued its attestation report on the effectiveness of our company’s internal control over financial reporting herein as of December 31, 2009. GHP’s attestation report is included in this Annual Report on Form 10-K under Item 9A(d). This audit is required to be performed in accordance with the standards of the Public Company Accounting Oversight Board (United States).

The material weaknesses indentified related to China Water’s internal controls over financial reporting as of December 31, 2009. Decentralized management in China combined with inadequate headcount in the accounting and finance department led to our local PRC businesses operating autonomously, which increased the risk of management override, noncompliance with corporate policies and untimely preparation and filing of our financial statements. These conditions contributed to the following material weaknesses in internal control over financial reporting:

 

   

ineffective supervision and monitoring of the financial statement close, preparation and review processes;

 

   

ineffective procedures relating to the identification, documentation and review of various account reconciliations and related supporting documentation; and

 

   

ineffective procedures relating to the safeguarding of assets against unauthorized or improper use.

 

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Remediation Measures of Material Weaknesses

We announced our proposed business combination with China Water on May 20, 2008 and consummated that business combination on October 30, 2008. Until the consummation of such business combination, we were a blank check company. As a blank check company, our activities were limited to managing the working capital funds outside of the trust account, in which a substantial portion of our IPO proceeds were held prior to consummating the China Water acquisition and related expenses associated with our efforts to identify a target business and consummate a business combination. China Water’s management assessed the effectiveness of its internal control over financial reporting as of December 31, 2007. Based on that evaluation, China Water’s management concluded that its internal control over financial reporting was not effective as of December 31, 2007 due to the existence of several material weaknesses.

The material weaknesses in China Water’s internal controls over financial reporting as of December 31, 2007 related to:

 

   

Its failure to maintain effective internal controls over the financial closing process to ensure the accurate and timely preparation of local financial statements and financial data which is necessary for preparation of consolidated financial statements due to an insufficient complement of local financial and accounting staff with knowledge of local accounting and US GAAP financial reporting rules to support the size of the company’s then current organizational structure. During the course of the preparation of December 31, 2007 consolidated financial statements, China Water discovered accounting errors in some of its transactions, and management subsequently reevaluated the transactions and recorded the necessary period-end adjustments. These adjustments reflected a material weakness in China Water’s internal controls over accounting and financial reporting. This restatement reflected a material weakness in China Water’s policies and procedures related to its review of complex accounting transactions; and

 

   

Its failure to adequately design and operate internal controls in a manner to effectively support the requirements of the financial reporting and period-end close process, including the proper cut-off of revenues and expenses and the proper accounting for value added taxes, due to the aggregate deficiencies in internal control activities.

Prior to the consummation of our business combination with China Water, its chief financial officer resigned. In conjunction with the consummation of the business combination on October 30, 2008, China Water’s audit committee and its chief executive officer resigned their positions. As a result of the turnover in China Water’s senior management and audit committee and China Water’s inability to make a management assessment of its internal controls, as well as the fact that the acquisition of China Water occurred during the fourth quarter of 2008, our Chief Executive Officer and Chief Financial Officer determined that it was impractical for our Company to make an assessment of China Water’s internal controls as of December 31, 2008. The control deficiencies discussed above continued into 2008 and 2009. Part of our efforts to remediate these control deficiencies included the selection of an enterprise resource management system (the “ERP System”) from Oracle to replace our existing financial reporting and information systems at China Water. Over the next twelve months, we were anticipating being in the process of implementing this system, including testing the system in a controlled environment, training our personnel in the use of the system and documenting and testing the control environment in preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. Our planned “go-live” date for the new system was October 1, 2009. However, due to the work performed to finalize the allocation of the China Water purchase price and the subsequent goodwill impairment charges that we encountered in the first and third quarters of 2009, we experienced delays in integrating the ERP System. As a result of these delays we elected to postpone implementation of the ERP System until after the end of the fiscal year ended December 31, 2009 as we did not believe it would be prudent to implement the new system so close to our fiscal year-end. We have made a substantial investment to ensure that the ERP System will provide effective internal control over financial reporting, and we have evaluated our controls that are not intended to change with the implementation of the ERP System. Because we initially anticipated that the “go-live” date of the ERP System would be prior to December 31, 2009, we did not, however, fully evaluate the effectiveness of

 

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the existing controls that were to be replaced by the ERP System. With the delay in implementing the ERP System, we did not have sufficient time to fully document, test and remediate (where applicable) those controls that we previously planned to replace prior to December 31, 2009. As a result, we believe our inability to fully test the legacy China Water internal controls over financial reporting contributes to the material weaknesses in our internal control over financial reporting. Not being able to test the remediated controls in a manner that would enable us to conclude that such controls are effective have caused management to conclude that, as of December 31, 2009, our internal controls over financial reporting were not effective.

In connection with our acquisition of China Water, we began to address the internal control weaknesses as described above. We have implemented, or plan to implement, the measures described below under the supervision and guidance of our executive management as well as the Audit Committee of our Board of Directors.

Key elements of the remediation effort include, but are not limited to the following initiatives, which have been implemented, or are in the process of implementation as of the date of filing:

 

   

Implementation of the ERP System, a computer based application for the financial process, including an integrated general ledger and financial reporting system for all business centers of our China Water subsidiary.

 

   

A new President of our China Water subsidiary was appointed, effective January 2009.

 

   

A new Manager of Internal Audit for our China Water subsidiary was appointed, effective April 2009.

 

   

A new Vice President of Finance for our China Water subsidiary was appointed, effective June 2009.

 

   

A new PRC Finance Manager for our China Water subsidiary was appointed, effective June 2009.

 

   

A new Manager of Information Technology for our China Water subsidiary was appointed, effective September 2009.

 

   

Improving the training programs for the financial accounting staff of our China Water subsidiary and recruiting qualified executive operations management for our China Water subsidiary.

 

   

We have substantially revised and emphasized to our employees our Code of Business Conduct and Ethics.

 

   

We have established policy statements and process overviews in appropriate areas of accounting and financial reporting controls, as well as continuing to develop implementation procedures under each policy statement.

 

   

We have directed significant time of our Manager of Internal Audit to reviewing, testing and documenting financial controls and have used external consultants to supplement these efforts.

When implemented, management believes that these proposed controls will operate effectively for a sufficient period of time to reduce to a less than reasonably possible likelihood the possibility of a material misstatement and remediate the material weaknesses reported by both management and our independent registered public accounting firm.

Our management does not believe that the material weaknesses discussed above had a material effect on our financial condition or results of operations or caused our financial statements as of and for the year ended December 31, 2008 to contain a material misstatement.

(c) Changes in Internal Controls over Financial Reporting

Except as described above, there were no changes in our internal control over financial reporting, during the fiscal quarter ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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(d) Audit Report of the Independent Registered Public Accounting Firm

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Heckmann Corporation

We have audited Heckmann Corporation and subsidiaries’ (the “Company’s”) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). 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 Report on 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) (“PCAOB”). 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, testing and evaluating the design and operating effectiveness of internal control over financial reporting based on that risk, and 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: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 (3) 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 the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include two business acquisitions which were completed during 2009 because it was not possible to conduct an assessment of the acquired businesses’ internal control over financial reporting in the period between the acquisition date and the date of management’s assessment. The two businesses’ comprise 8%, 24%, and less than 1% of total assets, total revenue and net loss, respectively, included in the consolidated financial statements of Heckmann Corporation as of December 31, 2009 and for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of these two acquired businesses.

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

 

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interim financial statements will not be prevented or detected on a timely basis. Material weaknesses have been identified related to the Company’s subsidiary, China Water and Drinks, Inc., including ineffective supervision and monitoring of the financial statement close, preparation and review processes; ineffective procedures relating to the identification, documentation and review of various account reconciliations and related supporting documentation necessary to prepare financial statements in accordance with US GAAP; and ineffective procedures relating to the safeguarding of assets against unauthorized or improper use. These material weaknesses are discussed in Management’s Report on Internal Control over Financial Reporting.

These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the Company’s consolidated financial statements as of December 31, 2009 and 2008 and for each of the years ended December 31, 2009 and 2008, and for the period from May 29, 2007 (inception) through December 31, 2007, and this report does not affect our report on such consolidated financial statements.

In our opinion, because of the effects of the material weaknesses identified above on the achievement of the objectives of the control criteria, the Company did not maintain effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission COSO.

We have also audited, in accordance with the standards of the PCAOB, the consolidated financial statements of the Company as of December 31, 2009 and 2008 and for each of the years ended December 31, 2009 and 2008, and for the period from May 29, 2007 (inception) through December 31, 2007, and our report dated March 11, 2010 expressed an unqualified opinion on those consolidated financial statements.

/s/    GHP Horwath, P.C.

Denver, Colorado

March 11, 2010

 

Item 9B. Other Information

None.

 

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HECKMANN CORPORATION

PART III

 

 

 

Item 10. Directors, Executive Officers and Corporate Governance

The information required by this item is incorporated by reference from our proxy statement to be filed pursuant to Regulation 14A within 120 days after our year ended December 31, 2009 in connection with our 2009 Annual Meeting of Stockholders (“Proxy Statement”).

 

Item 11. Executive Compensation

The information required by this item is incorporated by reference from our Proxy Statement.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item is incorporated by reference from our Proxy Statement.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this item is incorporated by reference from our Proxy Statement.

 

Item 14. Principal Accounting Fees and Services

The information required by this item is incorporated by reference from our Proxy Statement.

 

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HECKMANN CORPORATION

PART IV

 

 

 

Item 15. Exhibits, Financial Statement Schedules

 

(a) The following documents are filed as part of this Annual Report on Form 10-K:

 

  (1) Audited Consolidated Financial Statements

 

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Balance Sheets

   F-3

Consolidated Statements of Operations

   F-4

Consolidated Statements of Comprehensive (Loss) Income

   F-5

Consolidated Statements of Changes in Equity

   F-6

Consolidated Statements of Cash Flows

   F-8

Notes to Consolidated Financial Statements

   F-10

 

  (2) Financial Statement Schedules

All financial statement schedules have been omitted since they are not required, not applicable, or the information is otherwise included in the audited consolidated financial statements.

 

(b) The Exhibit Index is included following the audited consolidated financial statements.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    HECKMANN CORPORATION

Date: March 11, 2010

  By:  

/s/    RICHARD J. HECKMANN        

  Name:   Richard J. Heckmann
  Title:   Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Date: March 11, 2010

  By:  

/s/    RICHARD J. HECKMANN        

  Name:   Richard J. Heckmann
  Title:   Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)

Date: March 11, 2010

  By:  

/s/    BRIAN R. ANDERSON        

  Name:   Brian R. Anderson
  Title:   Chief Financial Officer (Principal Financial Officer and
Principal Accounting Officer)

Date: March 11, 2010

  By:  

/s/    LOU HOLTZ          

  Name:   Lou Holtz
  Title:   Director

Date: March 11, 2010

  By:  

/s/    DR. ALFRED E. OSBORNE, JR.        

  Name:   Dr. Alfred E. Osborne, Jr.
  Title:   Director

Date: March 11, 2010

  By:  

/s/    DAN QUAYLE          

  Name:   Dan Quayle
  Title:   Director

Date: March 11, 2010

  By:  

/s/    ANDREW D. SEIDEL          

  Name:   Andrew D. Seidel
  Title:   Director

Date: March 11, 2010

  By:  

/s/    EDWARD A. BARKETT          

  Name:   Edward A. Barkett
  Title:   Director

 

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Index to Financial Statements

 

     Page

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Balance Sheets

   F-3

Consolidated Statements of Operations

   F-4

Consolidated Statements of Comprehensive (Loss) Income

   F-5

Consolidated Statements of Changes in Equity

   F-6

Consolidated Statements of Cash Flows

   F-8

Notes to Consolidated Financial Statements

   F-10

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Heckmann Corporation

We have audited the accompanying consolidated balance sheets of Heckmann Corporation and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, comprehensive income (loss), changes in equity and cash flows for the years ended December 31, 2009 and 2008, and for the period from May 29, 2007 (inception) through December 31, 2007. These financial statements 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 audits 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 Heckmann Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years ended December 31, 2009 and 2008, and for the period from May 29, 2007 (inception) through December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 11, 2010 expressed an adverse opinion on the effectiveness of the Company’s internal control over financial reporting because of material weaknesses.

As discussed in Notes 2 and 3 to the consolidated financial statements, during 2009 the provisions of new accounting standards relating to business combinations and noncontrolling interests were adopted.

/s/    GHP Horwath, P.C.

Denver, Colorado

March 11, 2010

 

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HECKMANN CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

     December 31,  
     2009     2008  

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 136,050      $ 281,683   

Certificates of deposit

     10,513        10,000   

Marketable securities

     16,020        —     

Accounts receivable, net of allowance of $946 and $10,601 at December 31, 2009 and 2008, respectively

     5,873        26,460   

Inventory, net

     2,896        2,241   

Prepaid expenses

     865        8,842   

Other receivables

     3,596        1,548   

Due from related party

     —          1,381   

Income tax receivable

     —          969   

Other current assets

     278        544   
                

Total current assets

     176,091        333,668   
                

Property, plant and equipment, net

     53,520        15,901   

Marketable securities

     86,638        38,717   

Deposits for acquisitions

     —          16,608   

Investment in unconsolidated equity investee

     4,047        12,964   

Investment in UGSI

     7,182        —     

Intangible assets, net

     23,507        29,879   

Goodwill

     13,598        315,018   

Other

     406        338   
                

TOTAL ASSETS

   $ 364,989      $ 763,093   
                

LIABILITIES AND EQUITY

    

Current Liabilities

    

Accounts payable

   $ 19,501      $ 9,550   

Deferred revenues

     3,003        1,209   

Accrued expenses

     13,443        2,208   

Current portion of long term debt

     1,398        36   

Income taxes payable

     —          440   

Due to related parties

     1,472        963   

Deferred income taxes

     178        77   
                

Total current liabilities

     38,995        14,483   

Acquisition consideration payable

     1,910        1,910   

Long-term debt, less current portion

     439        96   

Other long term liabilities

     2,615        —     

Commitments and contingencies

    

Equity

    

Preferred stock, $0.001 par value, 1,000,000 shares authorized; no shares issued or outstanding

     —          —     

Common stock, $0.001 par value, 500,000,000 and 250,000,000 shares authorized at December 31, 2009 and 2008, respectively: 125,282,740 shares issued and 108,750,650 shares outstanding at December 31, 2009; 126,606,323 shares issued and 110,074,223 outstanding as of December 31, 2008

     124        126   

Additional paid-in capital

     746,077        757,720   

Purchased warrants

     (4,810     (405

Treasury stock

     (14,000     —     

Accumulated other comprehensive income

     643        89   

(Accumulated deficit) retained earnings

     (409,166     (13,771
                

Total Equity of the Company

     318,868        743,759   
                

Noncontrolling interests

     2,162        2,845   
                

TOTAL EQUITY

     321,030        746,604   
                

TOTAL LIABILITIES AND EQUITY

   $ 364,989      $ 763,093   
                

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

 

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HECKMANN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except share and per share data)

 

     Year ended December 31,     May 29, 2007
(inception) through
December 31, 2007
 
     2009     2008    

Revenue

   $ 35,975      $ 10,507      $ —     

Cost of goods sold

     26,734        7,247        —     
                        

Gross profit

     9,241        3,260        —     

Operating expenses:

      

Selling and marketing expenses

     3,141        322        —     

General and administrative expenses

     41,287        3,585        169   

Goodwill impairment

     357,545        —          —     

Fixed asset impairment

     6,781        —          —     
                        

Total operating expenses

     408,754        3,907        169   
                        

Loss from operations

     (399,513     (647     (169

Interest income, net

     3,928        10,940        2,486   

Acquisition costs

     —          (21,153     —     

Income from equity method investment

     47       4        —     

Other, net

     (2     (174     —     
                        

(Loss) income before income taxes

     (395,540     (11,030     2,317   

Income tax (benefit) expense

     (2     3,710        1,171   
                        

Net (loss) income

     (395,538     (14,740     1,146   

Net income (loss) attributable to noncontrolling interest

     143       (177     —     
                        

Net (loss) income attributable to the Company

     (395,395     (14,917     1,146   

Deferred interest income, net of taxes, attributable to common stock subject to possible redemption

     —          265        (265
                        

Net (loss) income attributable to common stockholders

   $ (395,395   $ (14,652   $ 881   
                        

Net (loss) earnings attributable to common stockholders per share:

      

Basic and diluted

   $ (3.61   $ (0.20   $ 0.03   
                        

Weighted average number of shares outstanding:

      

Basic and diluted

     109,575,057        74,853,651        25,305,415   
                        

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

 

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Table of Contents

Heckmann Corporation

Consolidated Statements of Comprehensive (Loss) Income

(In thousands)

 

     Year ended December 31,
     2009     2008     2007

Net (loss) income attributable to common stockholders

   $ (395,395   $ (14,652   $ 881

Add back: comprehensive (loss) income attributable to the noncontrolling interest

     (143     177       —  

Deferred interest income, net of taxes, attributable to common stockholders subject to possible redemption

     —          (265     265
                      

Net (loss) income

     (395,538     (14,740     1,146

Other comprehensive income, net of tax:

      

Foreign currency translation gain

     31        (1 )     —  

Unrealized gain on available-for-sale securities

     523        90       —  
                      

Total other comprehensive income, net of tax

     554        89       —  
                      

Comprehensive (loss) income, net of tax

     (394,984     (14,651     1,146

Comprehensive loss (income) attributable to noncontrolling interest

     143        (177 )     —  
                      

Comprehensive (loss) income attributable to the Company

   $ (394,841   $ (14,828   $ 1,146
                      

The accompanying notes are an integral part of these financial statements.

 

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HECKMANN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Equity

For the period from May 29, 2007 (inception) through December 31, 2009

(In thousands, except share data)

 

    Total     Common Stock     Additional
Paid-In
Capital
    Purchased
Warrants
    Treasury Stock   Retained
Earnings
(Accumulated
deficit)
    Accumulated
Other
Comprehensive
Income
    Non-controlling
Interests
    Shares     Amount       Number   Amount     Shares   Amount      

Balance at May 29, 2007 (inception)

    —        —          —          —        —       —        —         —          —        —  

Initial capital from founding stockholders’

  $ 72      14,375,000      $ 14      $ 58          —          —         —        —  

Sale of 54,116,800 units, net of underwriters’ discount and offering expenses (including 16,235,039 shares subject to possible redemption)

    401,595      54,116,800        54        401,541          —          —         —        —  

Sale of private placement warrants

    7,000            7,000          —          —         —        —  

Net proceeds subject to possible redemption of 16,235,039 shares

    (128,419         (128,419       —          —         —        —  

Redemption of founding stockholders’ shares

    (4   (845,000     (1     (3       —          —         —        —  

Net income

    1,146                    $ 1,146        —  

Deferred interest income, net of taxes, attributable to common stock subject to possible redemption

    (265                   (265     —  
                                                                     

Balance at December 31, 2007

    281,125      67,646,800        67        280,177      —       —        —     —       881        —        —  

Repurchase of shares from dissenting stockholders, net of tax

    (8,119   (1,021,695     (1     (8,118               —  

Deferred interest income, net of taxes, attributable to common stock subject to possible redemption

    265                      265        —  

Issuance of common stock related to the China Water and Drinks Inc. acquisition, net of offering costs (including 16,532,100 shares issued and held in escrow see Note 3)

    359,971      59,981,218        60        357,243                  2,668

Common stock previously subject to possible redemption

    128,418            128,418                  —  

Purchase of warrants

    (405         405,400   $ (405           —  

Comprehensive loss:

                     

Net (loss) income

    (14,740                   (14,917     177

Unrealized gains from available for sale securities

    90                      $ 90      —  

Foreign currency translation loss

    (1                     (1   —  
                           

Comprehensive loss

    (14,651                     —  
                                                                     

 

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HECKMANN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Equity—(Continued)

For the period from May 29, 2007 (inception) through December 31, 2009

(In thousands, except share data)

 

    Total     Common Stock     Additional
Paid-In
Capital
    Purchased
Warrants
    Treasury Stock     Retained
Earnings
(Accumulated
deficit)
    Accumulated
Other
Comprehensive
Income
  Non-controlling
Interests
 
    Shares     Amount       Number   Amount     Shares   Amount        

Balance at December 31, 2008

    746,604      126,606,323        126        757,720      405,400     (405   —       —          (13,771     89     2,845  

Purchase of treasury stock

    (14,000             13,032,098   $ (14,000         —     

3,361,000 common shares canceled in connection with Settlement and Release Agreement (Note 12)

    (28,031   (3,361,000     (3     (28,028   —       —        —       —          —          —       —     

1,576,577 common shares issued in connection with the Charis/Greer/Silversword acquisition (Note 3)

    6,101      1,576,577        1        6,100      —       —        —         —          —       —     

Issuance of stock to employees and consultants (Note 10)

    1,567      260,840        —          1,567      —       —        —         —          —       —     

Purchase of warrants

    (4,405   —          —          —        6,166,696     (4,405   —         —          —       —     

Contingent consideration to be issued in common stock in connection with Charis/Greer/Silversword acquisition (Note 3)

    7,887      —          —          7,887      —       —        —       —          —          —       —     

Noncontrolling interest in acquired company (Note 3)

    672      —          —          —        —       —        —       —          —          —       672  

Deconsolidation of Shen Yang Aixin (Note 4)

    (1,212   —          —          —        —       —        —       —          —          —       (1,212 )

Issuance of 200,000 common shares in connection with Settlement and Release Agreement (Note 12)

    831      200,000          831      —       —        —         —          —       —     

Comprehensive loss:

                     

Net loss

    (395,538   —          —          —        —       —        —       —          (395,395     —       (143 )

Unrealized gains from available for sale securities

    523      —          —          —        —       —        —       —          —          523     —     

Foreign currency translation loss

    31      —          —          —        —       —        —       —          —          31     —     
                           

Comprehensive loss

    (394,984                    
                                                                           

Balance at December 31, 2009

  $ 321,030      125,282,740      $ 124      $ 746,077      6,572,096   $ (4,810   13,032,098   $ (14,000   $ (409,166   $ 643   $ 2,162   
                                                                           

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

 

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HECKMANN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

 

     For the year ended
December 31,
    May 29, 2007
(inception) through
December 31, 2007
 
     2009     2008    

Operating activities

      

Net (loss) income

   $ (395,538   $ (14,740   $ 1,146   

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

      

Interest earned on cash and cash equivalents held in trust

     —          (1,256     (1,489

Deferred taxes

     —          312        (72

Depreciation

     2,674        212        —     

Amortization

     2,576        397        —     

Stock-based compensation

     2,894        —          —     

Goodwill impairment

     357,545        —          —     

Write off of other assets

     3,933        —          —     

Impairment of property, plant and equipment

     6,781        —          —     

Loss on deconsolidation of Shen Yang (Note 4)

     5,341        —          —     

Bad debt expense

     9,346        —          —     

Provision for obsolete inventory

     837        —          —     

Restructuring costs

     540        —          —     

Income from equity method investment

     (47     (4     —     

Other

     79        (3     —     

Changes in operating assets and liabilities, net of business acquisitions and purchase price adjustments (Note 3):

      

Accounts receivable

     (8,098     (2,116     —     

Inventory

     (1,362     95        —     

Deposits

     494        (147     —     

Other receivables

     9        (1,497     —     

Prepaid expenses

     (1,451     2,291        (142

Accounts payable and accrued expenses

     7,943        (1,934     113   

Deferred revenues

     (878     694     

Acquisition consideration payable

     —          (1,060     —     

Due to related parties

     1,277        858        —     

Income tax payable

     114        (1,381     —     

Other assets

     (1,057     —          1,243   
                        

Net cash (used in) provided by operating activities

     (6,048     (19,279     799   
                        

Investing activities

      

Payments made in connection with acquisition of China Water (Note 3)

     —          (48,337     —     

Payments made in connection with HWR acquisition, no cash acquired (Note 3)

     (16,566     —          —     

Cash paid for equity investment

     (7,182     —          —     

Payments made in connection with Harbin acquisition, net of cash acquired of $168 (Note 3)

     (1,193     —          —     

Purchase of available-for-sale securities

     (148,194     (38,501     —     

Proceeds from sale of available-for-sale securities

     85,153        —          —     

Purchase of certificates of deposit

     —          (10,000     —     

Purchase of property plant and equipment

     (34,802     (1,109     —     

Cash released from trust account

     —          403,215        —     

Cash held in trust account

     —          —          (428,071
                        

Net cash (used in) provided by investing activities

     (122,784     305,268        (428,071
                        

 

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HECKMANN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows—(Continued)

(In thousands)

 

     For the year ended
December 31,
    May 29, 2007
(inception) through
December 31, 2007
 
     2009     2008    

Financing activities

      

Payment on long term debt agreements

     (278     (5     —     

Borrowings under revolving credit facility

     1,983        —          —     

Cash paid to repurchase warrants

     (4,405     (405     —     

Cash paid to purchase treasury stock

     (14,000     —          —     

Cash paid for equity offering costs

     —          (4,859     —     

Proceeds from note to stockholder

     —          —          258   

Repayment of note to stockholder

     —          —          (258

Proceeds from public offering, net

     —          —          421,077   

Proceeds from issuance of warrants

     —          —          7,000   

Proceeds from issuance of securities to initial stockholders, net

     —          —          67   
                        

Net cash (used in) provided by financing activities

     (16,700     (5,269     428,144   
                        

Net (decrease) increase in cash

     (145,532     280,720        872   

Cash and cash equivalents—beginning of period

     281,683        872        —     

Effect of change in foreign exchange rate on cash and cash equivalents

     (101     91        —     
                        

Cash and cash equivalents—end of period

   $ 136,050      $ 281,683      $ 872   
                        

Non-cash investing and financing activities

      

Deferred underwriting discounts and commissions paid from Trust account

   $ —        $ (19,482   $ 19,482   

Redemption of founding stockholders’ shares

   $ —        $ —        $ 4   

Repurchase of shares from dissenting shareholders paid from Trust account

   $ —        $ (8,119  

Supplemental cash flow information:

      

Cash paid for interest

   $ (17 )   $ —        $ 4   

Cash paid for income taxes

   $ (143   $ (5,377   $ —     

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

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1—Organization and Nature of Business Operations

Heckmann Corporation (the “Company”) was incorporated in Delaware on May 29, 2007 as a blank check company whose objective was to acquire, through a merger, stock exchange, asset acquisition, reorganization or similar business combination, one or more operating businesses. On May 19, 2008, Heckmann Corporation and Heckmann Acquisition II Corp., a Delaware corporation and the Company’s wholly-owned subsidiary (“Acquisition Sub”), entered into an agreement and plan of merger and reorganization with China Water and Drinks, Inc., a Nevada corporation (“China Water”). China Water and subsidiaries is engaged in the manufacture of bottled water products and operates eight bottled water production plants in the People’s Republic of China (“PRC” or “China”). China Water produces and markets bottled water products under the brand name “Darcunk” and “Grand Canyon” to distributors throughout China, and supplies bottled water products to beverage and servicing companies in the industry. On October 30, 2008, the Company and Acquisition Sub completed the acquisition of China Water pursuant to a merger agreement, as amended, with Acquisition Sub remaining as the surviving entity. Substantially all activities through October 30, 2008 related to the Company’s formation, initial public offering (the “Offering”) and efforts to identify prospective target businesses. Prior to October 30, 2008 the Company was in the development stage. For accounting purposes the acquisition has been treated as a business purchase combination, with the results of China Water included in the consolidated financial statements subsequent to the acquisition date (Note 3).

On July 1, 2009, the Company’s wholly-owned subsidiary, Heckmann Water Resources Corporation, a Texas corporation (“HWR”), completed the purchase of the limited liability company interests of Charis Partners, LLC, a Texas limited liability company, and substantially all of the assets of Greer Exploration Corporation, a Louisiana corporation, and Silversword Partnerships, each a Texas limited partnership, pursuant to an asset purchase agreement dated April 22, 2009. The business acquired under the agreement is a multi-modal saltwater disposal, treatment and pipeline transportation business in Texas and Louisiana serving customers seeking to dispose of saltwater and frac fluid generated in their oil and gas operations (the “Saltwater Disposal and Transport Business”) (Note 3).

Effective with the July 1, 2009 acquisition of the Saltwater Disposal and Transport Business, the Company has two reportable segments, which as of December 31, 2009 were referred to as China Water and HWR.

Note 2—Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts, transactions, and profits are eliminated in consolidation.

Economic and Political Risks

A significant portion of the Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.

The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation.

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Equity Method Investments

Investee entities in which the Company can exercise significant influence, but not control, are accounted for under the equity method of accounting. Whether the Company exercises significant influence with respect to an investee depends on an evaluation of several factors, including, among others, representation on the company’s board of directors and an ownership level of, generally, 20% to 50% of the voting securities of the company, including voting rights associated with the Company’s holdings in common, preferred and other convertible instruments of the company. Under the equity method of accounting, the Company’s share of the earnings or losses of these companies is included in the equity income (loss) section of the consolidated statements of operations. A loss in value of an investment that is other than a temporary decline is recognized as a charge to operations. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. The Company holds a 48% equity investment in China Bottles Inc. (“China Bottles”) (formerly Hutton Holdings Corporation) through its subsidiary China Water.

Investments

Equity investments in companies over which the Company has no ability to exercise significant influence are accounted for under the cost method. Equity investments in companies over which the Company has the ability to exercise significant influence but does not hold a controlling interest are accounted for under the equity method and the Company’s income or loss on these investments is recorded in non-operating income or expense.

Use of Estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include revenue recognition, allowance for doubtful accounts, valuation of long-lived assets including identifiable intangibles and goodwill, contingencies and litigation. In the future, the Company may realize actual results that differ from the current reported estimates and if the estimates that the Company has used change in the future, such changes could have a material impact on the Company’s consolidated financial statements.

Foreign Currency Translation

The functional currency of the Company’s PRC subsidiaries is the Chinese Renminbi, (“RMB”). The RMB is not freely convertible into foreign currencies. The functional currency of the Company’s BVI subsidiary and its Hong Kong subsidiaries is the Hong Kong Dollar (“HKD”). The Company’s PRC, BVI and Hong Kong subsidiaries’ financial statements are maintained in their functional currency.

Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet date. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

The Company has adopted the United States dollar as its reporting currency. The financial statements of the Company’s foreign subsidiaries are translated into United States Dollars (“USD”) using year-end rates of exchange for assets and liabilities and rates of exchange that approximate the rates in effect at the transaction date for revenues, expenses, gains and losses. Amounts classified in stockholders’ equity are translated at historical exchange rates. The resulting translation adjustments are not included in determining net income, but

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

are included in foreign exchange adjustment recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity.

Translation rates applied are as follows:

 

     December 31,
2009
   December 31,
2008

Year end RMB : USD exchange rate

   6.863    6.854

Year average RMB : USD exchange rate

   6.841    6.854

Year end HKD : USD exchange rate

   7.755    7.750

Year average HKD : USD exchange rate

   7.752    7.751

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.

Subsequent to December 31, 2009, the RMB foreign exchange rates continued to experience a rise against the USD. Through March 1, 2010, the RMB: USD ratio ranged from a high of 6.877 to a low of 6.771, closing at 6.797 at March 1, 2010 with an average of 6.716.

Concentrations of Customer and Supplier Risk

None of the Company’s customers comprise 10% or more of accounts receivable at December 31, 2009 or 2008.

One customer comprised 57% of revenues for the year ended December 31, 2009 and two customers comprised 12% and 10% of post-acquisition revenues for the period from October 31, 2008 through December 31, 2008, respectively. The Company did not have any customers prior to its acquisition of China Water.

The Company purchased 73% and 47% of its raw materials from five vendors during the year ended December 31, 2009 and the post-acquisition period from October 31, 2008 through December 31, 2008, respectively. The Company believes that alternative vendors could be secured without interruption to operations. The Company did not make raw materials purchases prior to its acquisition of China Water. Both of these concentrations are within the Company’s bottled water products segment.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. The Company maintains bank accounts in the United States, China and Hong Kong, with a majority of those balances maintained in USD. Balances at financial institutions or PRC state-owned banks are not covered by insurance. The Company has not experienced any historical losses in such accounts and believes that the risk of any loss is minimal. A majority of the funds held in the United States are invested in one or more institutional money market funds.

Marketable Securities

All of the Company’s investments in marketable securities are classified as available-for-sale. These marketable securities are stated at fair value with any unrealized gains or losses recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity, until realized. Other-than-temporary declines in market value from original cost are included in the current year’s operations. In determining whether an other-than-temporary decline in the market value has occurred, our Company considers the duration that, and extent to which, fair value of the investment is below its cost. Realized gains and losses are also included in non-operating income and expense on the consolidated statements of operations.

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Accounts Receivable, net

Accounts receivable are recognized and carried at the original invoice amount less an allowance for any uncollectible amounts. The Company provides an allowance for doubtful accounts to reflect the expected uncollectibility of trade receivables. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates including, among others, the customer’s willingness or ability to pay, the effect of general economic conditions and the ongoing relationship with the customer. Accounts with outstanding balances longer than the payment terms are considered past due. The Company writes off trade receivables when they become uncollectible. As of December 31, 2009, the allowance for doubtful accounts was approximately $0.9 million.

Inventories, net

Inventories consist of raw materials to produce plastic bottles, caps and labels, work in progress and finished goods, and are stated at the lower of cost or net realizable value. Cost is determined on a weighted-average cost method. Finished goods are comprised of direct materials, direct labor and a portion of overhead. Net realizable value is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale. As of December 31, 2009, gross inventories were comprised of approximately $2.6 million of raw materials, $0.5 million of work in process, and $0.6 million of finished goods. As of December 31, 2008, inventories were comprised of approximately $1.8 million of raw materials and $0.4 million of finished goods. The Company performs an analysis of slow-moving or obsolete inventory periodically and any necessary valuation reserves, which could potentially be significant, are included in the period in which the evaluations are completed. Management determined that a reserve for obsolescence of approximately $0.8 million was necessary as of December 31, 2009. No reserve for obsolescence was necessary as of December 31, 2008.

Property, Plant and Equipment, net

Property, plant and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Additions and major replacements or betterments are added to the assets at cost. Maintenance and repair costs and minor replacements are charged to expense when incurred. When assets are replaced or otherwise disposed, the cost and accumulated depreciation are removed from the accounts and the gains or losses, if any, are reflected in the consolidated statement of operations. Gains or losses on the disposal of such assets are included in the consolidated statements of operations.

Depreciation is computed using the following estimated useful lives:

 

Buildings

   20-25 years

Motor vehicles

   5-10 years

Office equipment

   5-10 years

Machinery and equipment

   3-15 years

Goodwill and Other Intangible Assets, net

Goodwill represents the excess of the purchase price over the fair value of the net assets of the businesses acquired (Note 3). Authoritative guidance requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests when circumstances indicate that the recoverability of the carrying amount of goodwill may be in doubt. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

value. Significant judgments are required to estimate the fair value of a reporting unit including estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions or the occurrence of one or more confirming events in future periods could cause the actual results or outcomes to materially differ from such estimates and could also affect the determination of fair value and/or goodwill impairment at future reporting dates. The Company performs its impairment annually during the third quarter of each fiscal year.

However, based on the work performed in connection with the Company’s filing of its quarterly report on Form 10-Q for the quarterly period ended March 31, 2009, management concluded that an impairment loss was probable and could be reasonably estimated. Accordingly, effective March 31, 2009, the Company recorded a $184.0 million non-cash goodwill impairment charge, representing management’s best estimate of the impairment loss at that time. As of March 31, 2009, the purchase price allocation was not considered final, as management, along with the Company’s independent valuation advisors, were still reviewing all of the underlying assumptions and calculations used in the allocation. In October 2009, the Company finalized the assumptions and calculations used in the preliminary purchase price allocation. Management then completed the Company’s second step of its goodwill impairment test, which was begun in April 2009, as disclosed in previous Form 10-Q filings.

As a result of the completion of the second step of the goodwill impairment test, management determined that the implied fair value of goodwill was less than the carrying value of goodwill by approximately $178.5 million, which was recorded as a non-cash goodwill impairment charge in the third quarter of 2009. As of December 31, 2009, remaining goodwill of our China Water reporting unit is $6.3 million (Note 3).

The Company’s amortizable intangible assets include registered trademarks, customer relationships and distribution networks acquired in the acquisition of China Water and HWR (Note 8). These costs are being amortized using the straight-line method over a weighted average estimated useful life of approximately 14 years.

Accounting for the Impairment of Long-Lived Assets

In accordance with authoritative guidance, the Company reviews the carrying value of intangibles and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is measured by comparison of their carrying amounts to the undiscounted cash flows that the asset or asset group is expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset, if any, exceeds its fair market value. During the third quarter of 2009, the Company determined that certain of its long-lived assets were impaired resulting in a charge to operations of approximately $6.2 million (Note 7).

Income Taxes

Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that will more likely than not be realized.

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company does not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense related to unrecognized tax benefits recognized for the years ended December 31, 2009, 2008 or for the period from May 29, 2007 (inception) through December 31, 2007.

Retirement Benefits

PRC regulations mandate companies to contribute funds into the national retirement system managed by the government, which benefits qualified employees based on where they were born within the country. The Company records any required contribution as payroll tax expense. The Company provides no other retirement benefits to its employees. The Company recorded approximately $136,000 and $23,000 of retirement benefits expense for the year ended December 31, 2009 and the post-acquisition period from October 31, 2008, the date the Company acquired China Water, through December 31, 2008, respectively. The Company did not have any retirement benefits expense prior to its acquisition of China Water.

Revenue Recognition

Revenues are recognized when finished products are delivered to customers and all of the following have occurred (i) both title and the risks and benefits of ownership are transferred; (ii) persuasive evidence of an arrangement with the customer exists; (iii) the price is fixed and determinable; and (iv) collection is reasonably assured.

Taxes Collected From Customers and Remitted to Governmental Authorities

Revenues are recorded net of taxes collected from customers and remitted to governmental authorities.

Shipping and Handling Costs

In accordance with authoritative guidance, shipping and handling costs incurred in bringing finished products or raw materials to our warehouses are capitalized as part of inventory and relieved in cost of sales when a sale occurs. The Company does not bill customers for shipping and handling costs. Shipping and handling costs related to the movement of finished goods from the Company’s warehouses to the customer locations are reflected in selling, general and administrative expenses. Shipping and handling costs amounted to approximately $1,206,500 and $137,500 for the year ended December 31, 2009 and the post-acquisition period from October 31, 2008, the date of the Company’s acquisition of China Water, through December 31, 2008, respectively. Prior to the Company’s acquisition of China Water, its shipping and handling costs were de minimis.

Earnings Per Share

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income (loss) applicable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS is based upon the weighted average number of common shares outstanding during the period plus the additional weighted average common equivalent shares during the period. Common equivalent shares result from the assumed exercises of outstanding warrants, the proceeds of which are then assumed to have been used to repurchase outstanding shares of common stock (the “treasury stock method”). Inherently, stock warrants are deemed to be anti-dilutive when the average market price of the common stock during the period exceeds the exercise prices of the stock warrants. At December 31, 2009, 2008 and 2007, the Company’s dilutive securities

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

include 71,493,593, 76,973,621, and 76,646,800 warrants and options exercisable for common stock. These dilutive securities have been omitted from the computation of dilutive loss per share for the years ended December 31, 2009 and 2008 because the effect would be anti-dilutive. For the period from May 29, 2007 through December 31, 2007, the dilutive securities have been omitted from the computation of dilutive income per share since their exercisability as of December 31, 2007 was contingent upon the latter of November 9, 2008 or the successful completion of a business combination. Also excluded from the computation of EPS are 3,500,000 and 16,532,100 shares held in escrow as of December 31, 2009 and 2008, respectively, pursuant to the majority stockholder consent agreement entered into on May 19, 2008, as amended, in connection with the acquisition of China Water between the Company and Mr. Xu Hong Bin. On March 13, 2009, 13,032,100 of those shares were released from escrow pursuant to an escrow resolution and transition agreement among the Company, China Water, Mr. Xu Hong Bin and his affiliate, and are subject to cancellation by the Company as of May 4, 2009 (Note 12).

For the purpose of the computation of net income per share, shares issued in connection with acquisitions that are returnable are considered contingently returnable shares and although classified as issued, are not included in the basic weighted average number of shares outstanding until all necessary conditions are met that no longer cause the shares to be contingently returnable. These contingently returnable shares are included in the diluted weighted average number of shares as of the beginning of the period in which the conditions were satisfied (or as of the date of the agreement, if later).

Restructuring and exit activities

Restructuring and exit activities generally include significant actions involving employee-related termination costs, contract termination charges and other charges associated with such actions. Employee-related termination charges are based upon distributed employment policies and substantive severance plans and are reflected in the quarter in which management approves the associated actions. Employee-related amounts for which affected employees are required to render service in order to receive benefits at their termination dates are measured at the date such benefits were communicated to the applicable employees and recognized as expense over the employees’ remaining service periods. Contract termination and other charges primarily reflect costs to terminate a contract before the end of its term (measured at fair value at the time the Company provides notice to the counterparty) or costs that will continue to be incurred under the contract for its remaining term without economic benefit to the Company. During the third quarter of 2009, management approved and committed to undertake certain restructuring actions relating to its Beijing facility. These plans were undertaken, in part, to improve the operational capabilities of China Water. Costs expected to be incurred relating to these actions primarily include employee-related termination costs of $0.1 million and contract termination costs of $0.4 million. The workforce reductions were completed as of December 31, 2009. The Company expects to recognize approximately $0.2 million subsequent to the year ended December 31, 2009.

Reclassifications and Comparability

Certain reclassifications have been made to prior periods’ financial statements in order to conform them to the current period’s presentation.

Comprehensive Income

Unrealized gains and losses on the Company’s available-for-sale securities and foreign currency translation adjustments are included in comprehensive income (loss).

 

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HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Fair Value of Financial Instruments

The carrying amounts of the Company’s cash and cash equivalents, certificates of deposit, marketable securities, accounts receivable, accounts payable, and customer deposits approximate fair value due to the short-term nature of these instruments. The Company’s long-term debt, secured by various properties, bears interest at rates commensurate with market rates and therefore management believes carrying values approximate fair values. The fair value of amounts due from and to related parties is not practicable to estimate due to the related party nature of the underlying transactions (Note 6).

Recently Issued Accounting Pronouncements

Adopted Accounting Standards

Effective January 1, 2009, the Company implemented the Financial Accounting Standard Board’s (“FASB”) revised authoritative guidance for business combinations. This revised guidance requires an acquiring company to measure all assets acquired and liabilities assumed, including contingent considerations and all contractual contingencies, at fair value as of the acquisition date. In addition, an acquiring company is required to capitalize in-process research and development and either amortize it over the life of the product, or write it off if the project is abandoned or impaired. Previously, post-acquisition adjustments related to business combination deferred tax asset valuation allowances and liabilities for uncertain tax positions were generally required to be recorded as an increase or decrease to goodwill. The revised guidance does not permit this accounting and, generally, requires any such changes to be recorded in current period income tax expense. Thus, all changes to valuation allowances and liabilities for uncertain tax positions established in acquisition accounting, regardless of the guidance used to initially account for the business combination, will be recognized in current period income tax expense. The Company accounted for its acquisition of the Salt Water Disposal business on July 1, 2009 and Harbin Taoda on April 11, 2009 in accordance with this guidance (Note 3). Therefore, the adoption of the revised guidance had an impact on the Company’s consolidated financial statements for the year ended December 31, 2009. The nature and magnitude of the specific effects in future periods will depend upon the nature, terms and size of the acquisitions consummated after the authoritative guidance’s effective date of January 1, 2009.

Effective January 1, 2009, the Company adopted the revised authoritative guidance for the accounting treatment afforded preacquisition contingencies in a business combination. Under the revised guidance, an acquirer is required to recognize at fair value an “asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of the liability can be determined during the measurement period.” If the acquisition-date fair value cannot be determined, the acquirer mustl apply the authoritative guidance used to evaluate contingencies to determine whether the contingency should be recognized as of the acquisition date or after the acquisition date. The adoption of the revised guidance will have an impact on the Company’s consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions consummated after the authoritative guidance’s effective date of January 1, 2009.

Effective January 1, 2009, the Company implemented the FASB’s revised authoritative guidance for consolidation, which addresses the accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The guidance also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The adoption of the revised guidance impacted the Company’s consolidated financial statements, and resulted in the Company reclassifying financial statement line items within its consolidated balance sheets, statements of operations, and statements of stockholders equity for prior periods to conform to this standard.

 

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Table of Contents

HECKMANN CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Effective January 1, 2009, the Company adopted the FASB’s revised authoritative guidance which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance requires enhanced disclosures concerning a company’s treatment of costs incurred to renew or extend the term of a recognized intangible asset. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Effective April 1, 2009, the Company adopted the FASB’s revised authoritative guidance for fair value measurements which clarifies the measurement of fair value in a market that is not active, and is effective as of the issue date, including application to prior periods for which financial statements have not been issued. The Company also adopted additional authoritative guidance for determining whether a market is active or inactive and whether a transaction is distressed. This guidance is applicable to all assets and liabilities (financial and nonfinancial) and requires enhanced disclosures. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Effective April 1, 2009, the Company adopted authoritative guidance which provides additional guidance to provide greater clarity about the credit and noncredit component of an other-than-temporary impairment event and to more effectively communicate when an other-than-temporary impairment event has occurred. The adoption of this guidance, which applies to investments in debt securities, did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In June 2009, the FASB approved its Accounting Standards Codification (“Codification”) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification is effective for interim or annual financial periods ending after September 15, 2009 and impacts the Company’s financial statements as all future references to authoritative accounting literature will be referenced in accordance with the Codification. There have been no changes to the substance of the Company’s consolidated financial statements or disclosures as a result of implementing the Codification during the quarter ended September 30, 2009.

Recently Issued Accounting Standards

In June 2009, the FASB issued revised authoritative guidance that, among other things, requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity (“VIE”), which amends previous guidance for consideration of related party relationships in the determination of the primary beneficiary of a VIE, amends certain guidance for determining whether an entity is a VIE, requires continuous assessments of whether an enterprise is the primary beneficiary of a VIE, and requires enhanced disclosures about an enterprise’s involvement with a VIE. This guidance is effective for years beginning January 1, 2010. The Company is currently evaluating the impact the adoption will have on its consolidated financial statements.

Note 3—Business Acquisitions

Acquisition of Charis Partners, LLC, Greer Exploration Corporation, and Silversword Partnerships

On July 1, 2009 (the “Closing Date”), the Company, through HWR, completed the purchase of all the limited liability company interests of Charis Partners, LLC and all of the assets of Greer Exploration Corporation and Silversword Partnerships pursuant to an asset purchase agreement, dated April 22, 2009, for an initial payment of approximately $23 million consisting of cash totaling $17 million and the issuance of 1,576,577 shares of its common stock (valued at approximately $6.1 million based on the market price of the Company’s

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

common stock as of July 1, 2009) to the various sellers. These assets underlie a multi-modal saltwater disposal, treatment and pipeline transportation business in Texas and Louisiana serving customers seeking to dispose of saltwater and frac fluid generated in their oil and gas operations.

In addition to the initial payment, the Company will make quarterly cash payments of $175,000 from July 2009 through April 2012 (totaling $2,100,000) and may be obligated to make additional payments of $10 million upon the achievement of certain financial performance targets in 2010 and 2011. To the extent earned, this contingent consideration will be paid in Company common stock.

Purchase Price

The acquisition was recorded using the acquisition method of accounting in accordance with the authoritative guidance for business combinations.

The estimated purchase price was determined as follows (in thousands):

 

Cash paid to sellers

   $ 16,566

Market value of Company common stock issued on the Closing Date

     6,101

Cash to be paid to sellers in quarterly installments, fair value

     1,784

Acquisition consideration payable

     900

Contingent consideration, due on achieving milestones

     7,887
      

Total purchase price

   $ 33,238
      

The contingent consideration arrangement requires the Company to pay an additional amount not to exceed $10 million in common stock in the event that specified profitability targets are achieved. As of December 31, 2009, the total number of shares that would be issued under this arrangement would be approximately 2.0 million shares based on the quoted market price of the Company’s common stock. The fair value of the contingent consideration at the Closing Date was determined to be approximately $7.9 million using a probability-weighted discounted cash flow model. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement as defined in the authoritative guidance for fair value measurements. (Note 6). The key assumptions in applying this approach were the discount rate and the probability assigned to the performance targets being achieved. In accordance with the authoritative guidance for business combinations, the contingent consideration is considered to be equity and accordingly was included in additional paid-in capital.

The allocation of the purchase price is based on management’s and its independent valuation advisors’ determination of the fair value of tangible and intangible assets acquired and liabilities assumed as of the Closing Date. The following table summarizes the allocation of the purchase price (in thousands):

 

     Estimated
Fair Value
    Estimated
Useful Life

Inventory

   $ 1,102     

Fixed Assets

     6,106      Various

Customer relationships

     1,741      9 years

Customer contracts

     17,352      15-17 years

Disposal permits

     110     

Goodwill

     7,259     

Deferred income tax liabilities

     (432 )  
          

Total estimated initial purchase price allocation

   $ 33,238     
          

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The goodwill related to the acquisition was approximately $7.3 million as of December 31, 2009. Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and relates to the economies of scale expected from the acquisition. Of the $7.3 million recorded as goodwill, none is expected to be deductible for tax purposes.

The accompanying consolidated statements of operations for the year ended December 31, 2009 reflect the operating results of the HWR assets since the date of the acquisition. The amount of revenue and net income attributable to the acquisition included in the Company’s consolidated statements of operations from the acquisition date to December 31, 2009 are approximately $3.8 million and approximately $0.9 million, respectively. For the year ended December 31, 2009, the Company’s consolidated results of operations include acquisition-related expenses of approximately $0.2 million, which are included in general and administrative expenses.

The Company has prepared the following unaudited pro forma financial statement information to compare results of the periods presented assuming the acquisition had occurred as of the beginning of each period presented. These unaudited pro forma results have been prepared for comparative purposes only and do not purport to be an indicator of the results of operations that would have actually resulted had the acquisition occurred at the beginning of each of the periods presented, or of future results of operations. Assuming the HWR acquisition occurred as of the beginning of each period presented, the pro forma unaudited results of operations would have been as follows for the years ended December 31, 2009 and 2008.

 

     Year ended
December 31,
 
     2009     2008  

Revenue

   $ 39,675      $ 17,507   

Net loss

     (394,538     (12,740

Net income (loss) per share—basic and diluted

   $ (3.60   $ (0.17

Acquisition of China Water

On October 30, 2008, the Company acquired China Water via a merger transaction. The results of China Water’s operations have been included in the consolidated financial statements of the Company since that date. The aggregate purchase price was approximately $412.5 million, including approximately $45.2 million of cash, common stock valued at approximately $362.3 million and acquisition costs of approximately $5 million. The value of the Company common stock issued to effect the business combination was determined based on the five day trading range beginning two days before a material change to the terms of the China Water acquisition were agreed to and announced on September 26, 2008. The primary reasons leading to the acquisition of China Water are the growth opportunities in the consumption of bottled water in China and China Water’s well-established bottled water platform in the PRC.

In connection with the acquisition of China Water and in order to secure Mr. Xu Hong Bin’s (“the Consenting Shareholder”) obligations under the terms of a majority stockholder consent agreement entered into by the Consenting Shareholder and the Company in connection with the China Water acquisition, the Company placed 16,532,100 shares of the Company’s common stock, issued to the Consenting Shareholder, into escrow. These contingently returnable shares were excluded from the calculation of the purchase price because, as of December 31, 2008, the outcome of the representations and warranties was not determinable beyond a reasonable doubt. Under the terms of the majority shareholder consent agreement, and amendments thereto, the escrow period was originally to extend until March 30, 2010.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

A preliminary allocation of the purchase price of China Water to the estimated fair values of the assets acquired and liabilities assumed was made and recorded during the period ended December 31, 2008. The preliminary allocation of the purchase price, including the evaluation and allocation to identifiable intangible assets and allocation to goodwill resulting from the acquisition, was made by the Company’s management and its independent valuation advisor.

In the third quarter of 2009 the Company finalized the assumptions and calculations used in its preliminary purchase price allocation.

The following table summarizes the preliminary and final allocation of the fair value of the assets acquired and liabilities assumed in the acquisition of China Water, including the goodwill impairment charge of $357,545,000 recorded in the nine months ended September 30, 2009. (in thousands):

 

     Preliminary Purchase
Price allocation at
October 31, 2008
   Final Purchase
Price allocation at

September 30, 2009

Cash

   $ 1,741    $ 1,741

Accounts receivable, net

     24,344      7,692

Inventories

     2,336      2,336

Prepaid expenses

     11,275      4,342

Other assets

     2,489      1,263

Property plant and equipment

     15,537      13,089

Deposits

     16,461      1,520

Investment in equity investee

     12,960      4,000

Intangible assets

     30,513      7,269

Goodwill

     315,260      6,341
             

Total assets

   $ 432,916    $ 49,593
             

Accounts payable and accrued liabilities

   $ 13,358    $ 16,036

Other liabilities

     7,050      7,050
             

Total liabilities assumed

   $ 20,408    $ 23,086
             

Total fair value of the net assets acquired

   $ 412,508    $ 26,507
             

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company’s goodwill balance and changes in the carrying amount of goodwill are as follows (in thousands):

 

Ending balance, December 31, 2008

   $ 315,018   

Purchase price adjustment to record a reduction to deposits for acquisitions

     10,811   

Purchase price adjustment in connection with cancelling 12,027,900 shares issued in connection with the China Water acquisition

     (100,313

Preliminary estimated impairment loss

     (184,000

Other

     (182
        

Ending balance, March 31, 2009

     41,334   

Adjustment in connection with cancelling 12,027,900 shares issued in connection with the China Water acquisition reflecting 3,361,000 shares actually cancelled (Note 13)

     72,282   

Carrying value in excess of fair value of certain acquired assets and assumed liabilities

     31,618   

Carrying value in excess of fair value of property plant and equipment and intangible assets

     25,692   

Carrying value in excess of fair value of investment in equity investee

     8,960   

Non-cash impairment loss

     (173,545
        

Goodwill in connection with the acquisition of China Water

     6,341   

Goodwill recorded in connection with the acquisition of the Saltwater Disposal Business

     7,257   
        

Ending balance, December 31, 2009

   $ 13,598   
        

In March 2009, the Company recorded a purchase accounting adjustment of approximately $100.0 million to reflect approximately 12.0 million shares of Company common stock previously issued in connection with its acquisition of China Water that are now subject to cancellation (although the Company intends to cancel a total of approximately 15.5 million shares of common stock issued in connection with the merger, the purchase price adjustment was only affected by the cancellation of 12.0 million shares because the remaining 3.5 million shares subject to cancellation were originally excluded from the purchase price as escrowed contingently returnable shares). Consequently, the Company reduced equity by approximately $100.0 million for the value of the shares as of the date of acquisition and reduced goodwill by the same amount. In March 2009, the Company also recorded a purchase accounting adjustment of approximately $10.8 million to reduce deposits for acquisitions and increase goodwill by the same amount. The Company recorded these deposits in its initial purchase price allocation, however subsequent to the issuance of its December 31, 2008 consolidated financial statements the Company determined that these deposits were not recoverable at the date of acquisition. Based on the work performed in connection with filing of the Company’s quarterly report on Form 10-Q for the quarterly period ended March 31, 2009, management concluded that an impairment loss was probable and could be reasonably estimated. Accordingly, effective March 31 2009, the Company recorded a $184.0 million non-cash goodwill impairment charge, representing management’s best estimate of the impairment loss. As of March 31, 2009, the purchase price allocation was not considered final as management, along with the Company’s independent valuation advisors, were still reviewing all of the underlying assumptions and calculations used in the allocation.

In October 2009, the Company finalized the assumptions and calculations used in the preliminary purchase price allocation. In the process of finalizing the preliminary allocation management considered further declines in projected sales volumes and cash flow projections, a revised lower outlook for China Water’s operating results, and pending litigation between the Company and Xu Hong Bin (Note 12), the former President and Chairman of China Water. As a result, management determined that its initial purchase price allocation for certain acquired assets and assumed liabilities, were not recoverable at the date of acquisition. In addition, management, along with the Company’s independent valuation advisors, finalized the valuations of property, plant and equipment intangible assets, and the investment in equity investee. Accordingly, the Company reduced estimated values for certain acquired assets and assumed liabilities, property plant and equipment and intangible assets, and the

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

investment in equitee investee by, approximately $36.6 million, $25.7 million, and $9.0 million, respectively and increased goodwill. Management then completed the Company’s second step of its goodwill impairment test, which was begun in April 2009, as disclosed in previous Form 10-Q filings. The second step of the goodwill impairment test involved determining the implied fair value of goodwill by allocating the fair value to all assets and liabilities other than goodwill and comparing it to the carrying amount of goodwill.

Management determined that the implied fair value of goodwill was less than the carrying value of goodwill by approximately $178.5 million, which was recorded as a non-cash goodwill impairment charge in the third quarter of fiscal 2009. As of September 30, 2009, remaining goodwill of our China Water reporting unit is $6.3 million. The goodwill impairment charge was recorded in operating expenses during the third quarter of fiscal 2009.

Acquisition of Harbin Taoda Drinks, Ltd.

The Company acquired 67% of Harbin Taoda, a bottled water manufacturer located in Harbin Province, China, on April 1, 2009. The results of Harbin Taoda are included in the Company’s consolidated financial statements from the date of acquisition. The aggregate purchase price of $1.3 million consisted primarily of accounts receivable and property and equipment. There was no goodwill associated with the acquisition.

Note 4—Deconsolidation

In August 2007, Pilpol, a Hong Kong company and an indirect wholly-owned subsidiary of China Water, entered into a stock purchase agreement with Haoyang Bian, pursuant to which Mr. Bian agreed to sell to Pilpol 67% of the equity interests of ShenYang Aixin Company Limited, a company formed in accordance with the laws of the PRC (“ShenYang Aixin”). In September 2007, Shenyang Yuchinchuan Economic and Trade Limited, a company formed in accordance with the laws of the PRC (“Yuchinchuan”), became the sole equity holder of ShenYang Aixin. At such time, Haoyang Bian owned 90% of the equity of Yuchinchuan. In October 2007, ShenYang Aixin was converted into a Sino-foreign equity joint venture company and Pilpol and Yuchinchuan entered into a cooperative joint venture agreement (the “CJV Agreement”). In December 2007, Pilpol, Haoyang Bian and Yuchinchuan entered into an amendment to the stock purchase agreement to, among other things, memorialize the foregoing and to confirm the sale by Yuchinchuan to Pilpol of 67% of the equity interests of ShenYang Aixin.

The CJV Agreement provided Pilpol with the right to 67% of the profits of ShenYang Aixin and with financial and operational control of ShenYang Aixin’s factory, provided that such right to profits and control would expire if, by an agreed date, Pilpol had not directly purchased 67% of ShenYang Aixin. As of September 30, 2009, management made the decision not to directly purchase the interest in ShenYang Aixin and, consequently, Pilpol no longer has financial and operational control of ShenYang Aixin.

As a result, and effective September 30, 2009, the Company deconsolidated ShenYang Aixin. The deconsolidation was attributable to other than a nonreciprocal transaction and accordingly a loss of $5.3 million was recorded in the twelve months ended December 31, 2009 that represents the aggregate of the carrying amount of the noncontrolling interest and the carrying amount of ShenYang Aixin’s net assets as of the date of deconsolidation, which is included in general and administrative expenses in the statement of operations. The fair value of the retained non-controlling interest in ShenYang Aixin was determined to be zero as of the date of deconsolidation (Note 6).

 

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Note 5—Investments

The amortized cost, gross unrealized holding gains and losses, and fair value of held-to-maturity and available-for sale securities as of December 31, 2009 and 2008 are as follows (in thousands):

 

     Contractual
Maturity (in years)
   Amortized
Cost
   Gross Unrealized Holding    Fair
Value
             Gains            Losses       

December 31, 2009

              

Held-to-maturity:

              

Certificates of deposit

   1    $ 10,513      —        —      $ 10,513
                              

Available-for-sale:

              

Current:

              

U.S. Government Agencies

   1    $ 605    $ 1      —      $ 606

Corporate Notes

   1      15,213      201         15,414
                              
      $ 15,818    $ 202      —      $ 16,020
                              

Noncurrent:

              

U.S. Government Agencies

   2-3    $ 48,570    $ 67    $ 54    $ 48,583

U.S. Government Securities

   2-3      1,023      10      —        1,033

Corporate Notes

   2-3      36,209      813         37,022
                              
      $ 85,802    $ 890    $ 54    $ 86,638
                              
      $ 101,620    $ 1,092    $ 54    $ 102,658
                              

December 31, 2008

              

Held-to-maturity:

              

Certificates of deposit

   1    $ 10,000      —        —      $ 10,000
                              

Available-for-sale:

              

Noncurrent:

              

U.S. Government Agencies

   2    $ 28,288    $ 85      —      $ 28,373

Corporate Notes

   2      10,339      5         10,344
                              
      $ 38,627    $ 90      —      $ 38,717
                              

Scheduled maturities of available-for-sale and held to maturity securities as of December 31, 2009 are as follows (in thousands):

 

     Amortized
Cost
   Fair Value

2010

   $ 26,331    $ 26,533

2011

     73,251      74,122

2012

     12,551      12,516
             
   $ 112,133    $ 113,171
             

Investment in Underground Solutions, Inc.

On May 6, 2009, the Company purchased approximately 7% of the equity of Underground Solutions, Inc., (“UGSI”), a water infrastructure and pipeline supplier located in Poway, California for approximately $6.8 million in cash. On December 10, 2009, the Company purchased 1.0 million preferred shares of UGSI for approximately $0.4 million in cash. Equity investments in companies over which the Company has no ability to exercise significant influence are accounted for under the cost method. Accordingly, this investment is accounted for under the cost method. The Chief Executive Officer of UGSI serves as a member of the Board of Directors of the Company.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 6—Fair Value Measurements

Effective January 1, 2008, the Company adopted the authoritative guidance for fair value measurements, which defines fair value, establishes a framework for measuring fair value under United States generally accepted accounting principles, and expands disclosures about fair value measurements. The Company measures certain assets at fair value and thus there was no impact on the Company’s consolidated financial statements upon adoption of the guidance, other than the additional disclosure requirements. The guidance requires fair value measurements be classified and disclosed in one of the following three categories:

 

   

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities.

 

   

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

 

   

Level 3: Unobservable inputs are used when little or no market data is available.

The following table presents information about the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2009, and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value (in thousands):

 

     December 31,
2009
   Significant Other
Observable

Inputs
(Level 1)
   Significant Other
Observable

Inputs
(Level 2)
   Significant
Unobservable

Inputs
(Level 3)

Assets: