Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2019

Summary of Significant Accounting Policies

The unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, certain information and footnotes normally required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as amended. In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair presentation of the Company’s unaudited condensed consolidated balance sheet as of September 30, 2019, the unaudited condensed consolidated statements of operations and comprehensive income for the three and nine months ended September 30, 2019 and 2018, the unaudited condensed consolidated statements of changes in equity for the three and nine months ended September 30, 2019 and 2018, and the unaudited condensed consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018. The unaudited condensed consolidated balance sheet as of December 31, 2018 was based on the audited consolidated balance sheet as of December 31, 2018, as presented in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as amended, but restated for adoption of new accounting guidance which is further explained in the “Adoption of New Accounting Pronouncements” section below.

The unaudited condensed consolidated financial statements include the accounts of AquaVenture Holdings Limited and its subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include: accounting for revenue from contracts with customers and the determination of transaction prices and allocation of revenues to remaining performance obligations; accounting for leases and the determination of operating lease liabilities and right-of-use assets; accounting for goodwill and identifiable intangible assets and any related impairment; property, plant and equipment and any related impairment; contract costs and any related impairment; share‑based compensation; allowance for doubtful accounts; obligations for asset retirement; acquisition contingent consideration; and valuation of deferred income taxes. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.

Lessee accounting

The Company leases space and operating assets, including offices, office equipment, warehouses, storage yards and storage units under non-cancelable operating leases. The Company accounts for these leases in accordance with the authoritative guidance adopted as of January 1, 2019. Please see “Adoption of New Accounting Pronouncements” section below for information regarding this adoption.

At the time of contract inception, the Company determines if an arrangement is or contains a lease. If the arrangement contains a lease, the Company recognizes a right-of-use asset and an operating lease liability at the lease commencement date. Lease expense for lease payments made is recognized on a straight-line basis over the lease term.

The operating lease liability is initially measured at the present value of the unpaid lease payments at the lease commencement date. The current portion of the Company’s operating lease liabilities are recorded within accrued liabilities in the consolidated balance sheets.

The right-of-use asset is initially measured at cost, which is comprised of the initial amount of the operating lease liability adjusted for lease payments made at or before the lease commencement date, plus any initial direct costs incurred less any lease incentives received. The right-of-use asset is subsequently measured throughout the lease term at the carrying amount of the operating lease liability, plus initial direct costs, plus (minus) any prepaid (accrued) lease payments, less the unamortized balance of lease incentives received. Right-of-use assets are periodically reviewed for impairment whenever events or changes in circumstances arise. During the three and nine months ended September 30, 2019, the Company had incurred no impairment charges related to right-of-use assets.

Key estimates and judgments in determining both the operating lease liability and right-of-use asset include the determination of (i) the discount rate it uses to discount the unpaid lease payments to present value, (ii) the lease term and (iii) the lease payments.

The discount rate applied to the unpaid lease payments is the interest rate implicit in the lease or, if that rate cannot be readily determined, the Company’s incremental borrowing rate. Generally, the Company cannot determine the interest rate implicit in the lease because it does not have access to the lessor’s estimated residual value or the amount of the lessor’s deferred initial direct costs. Therefore, the Company generally derives an incremental borrowing rate as the discount rate for the lease. The Company’s incremental borrowing rate for a lease is the rate of interest it would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms.

The lease term for the Company’s leases includes the noncancelable period of the lease, plus any additional periods covered by either a Company option to extend (or not to terminate) the lease that the Company is reasonably certain to exercise, or an option to extend (or not to terminate) the lease controlled by the lessor.

Lease payments included in the measurement of operating lease liabilities are comprised of the following:

fixed payments;

variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date; and

the exercise price of a Company option to purchase the underlying asset if the Company is reasonably certain to exercise the option.

In certain instances, the Company's leases include non-lease components, such as equipment maintenance or common area maintenance. As part of its adoption of authoritative guidance on leases on January 1, 2019, the Company has not elected the practical expedient to account for the lease and non-lease components as a single lease component and has elected (for all classes of underlying assets) to account for these components separately. The Company allocates the consideration in the contract to the lease and non-lease components based on each component's relative standalone price. The Company determines standalone prices for the lease components based on the prices for which other lessors lease similar assets on a standalone basis. The Company determines standalone prices for the non-lease components based on the prices that suppliers might charge for those types of services on a standalone basis. If observable standalone prices are not readily available, the Company estimates the standalone prices maximizing the use of observable information.

The Company has elected to utilize the short-term lease exemption and not recognize a right-of-use asset and corresponding operating lease liability for leases with expected terms of 12 months or less. The Company recognizes the lease payments associated with its short-term leases on a straight-line basis over the lease term.

Lessor accounting

The Company generates revenues through the lease of its bulk water facilities, wastewater treatment and water reuse equipment, and filtered water and related systems equipment to customers. In certain instances, the Company enters into a contract with a customer but must construct the underlying asset, including bulk water facilities and wastewater treatment and water reuse equipment, prior to its lease.

At the time of contract inception, the Company determines if an arrangement is or contains a lease.

Customer contracts that contain leases, which can be explicit or implicit in the contract, are generally classified as either operating leases or sales-type leases and can contain both lease and non-lease components, including operating and maintenance services (“O&M”) of the Company-owned equipment. As part of its adoption of authoritative guidance on leases on January 1, 2019, the Company elected the practical expedient for all classes of underlying assets to not separate the lease and non-lease components if certain conditions are met, including the classification of the lease component as operating and the revenue recognition pattern of both the lease and non-lease components. The Company will account for the contract with the customer as a combined component under the respective authoritative guidance for the predominant element in the contract, the lease or non-lease component.

For leases classified as sales-type leases, the Company allocates the transaction price based on the relative standalone selling prices of the identified performance obligations.

If the customer contract contains or is accounted for as a lease, the key estimates and judgments used by the Company in accounting for the lease as a lessor include the following: (i) lease term, (ii) the economic life of the underlying leased asset, (iii) determination of lease payments and (iv) determination of the fair value at the time of contract inception and the residual value of the underlying leased asset.

The lease term for the Company’s leases includes the noncancelable period of the lease, plus any additional periods covered by either a lessee option to extend (or not to terminate) the lease that the lessee is reasonably certain to exercise, or an option to extend (or not to terminate) the lease controlled by the Company. Contracts entered into with customers can include either the option to renew or an auto-renewing provision that results in the automatic extension of the existing contract. In certain instances, key provisions such as the lease payment or term of the renewal are not stated and are subject to negotiation.

The economic life of the underlying leased asset is determined to be either the period over which the asset is expected to be economically usable, or where the benefits it can produce exceed the cost to replace or undertake major repairs. In certain instances, the economic life of the underlying leased asset can exceed the useful life assigned by the Company.

Lease payments that are accounted for as rental revenue are comprised of the following:

fixed payments;

variable lease payments that depend on an index or rate, initially measured using the index or rate at the lease commencement date;

the exercise price of a lessee option to purchase the underlying asset if the lessee is reasonably certain to exercise the option; and

payments for penalties for the termination of a lease if the term reflects the lessee terminating the lease.

The Company’s leases do not typically include a requirement for the customer to guarantee the residual value of the underlying leased asset. Variable lease payments that do not depend on an index or rate are excluded from the determination of lease payments.

The fair value of the underlying leased asset at contract inception and residual value of underlying leased asset at the end of the term of the lease are determined based on the price that would be received to sell an asset in an orderly transaction at the time of valuation. The Company’s risk management strategy for protecting the residual value of the underlying assets include the ongoing maintenance by the Company during the lease term as well as clauses and other protections within the lease agreements which require the lessee to return the underlying asset in working condition at the end of the lease term.

At contract inception, the Company determines the lease classification of the underlying asset. The Company considers inputs such as the lease term, lease payments, fair value of the underlying asset and residual value of the underlying asset when assessing the classification. The discount rate applied to the unpaid lease payments is the interest rate implicit in the lease. The rate implicit in the lease is the rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that the Company expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the Company and (2) any deferred initial direct costs of the Company.

In certain instances, contracts with customers may also include the option for the customer to purchase the underlying asset at the end of the lease term. When applicable and certain conditions are met, the Company will incorporate the stated purchase price into the determination of its implied interest rate.

Revenue Recognition

Through the Seven Seas Water and Quench operating platforms, the Company generates revenues from the following primary sources: (i) bulk water sales and services; (ii) service concession arrangements; (iii) rental of equipment; and (iv) product sales. The revenue recognition policy for each of the primary sources of revenue are as follows:

Bulk Water Sales and Services. Through the Seven Seas Water operating platform, the Company enters into contracts with customers with a single performance obligation to deliver bulk water or a series of performance obligations to perform substantially the same services with the same pattern of transfer, which can include the operations and maintenance (“O&M”) of a customer-owned or leased plant. The Company recognizes revenues from the delivery of bulk water or the performance of bulk water services at the time the water or services are delivered to the customers in accordance with the contractual agreements. Billings to the customer for both bulk water and the bulk water services are typically based on the volume of water supplied to a customer and typically contain a minimum monthly charge provision which allows the Company to invoice the customer for the greater of the water supplied or a minimum monthly charge. The volume of water supplied is based on meter readings performed at or near the end of the month. The transaction price calculated for bulk water sales and service can include, if applicable, contractual minimum monthly charges and the expected amount of variable consideration to the extent it is probable that a significant reversal of the cumulative revenue will not occur. The variable consideration generally includes the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied at contractually established rates. Estimates of revenue for unbilled water are recorded when meter readings occur at a time other than the end of a period. A contract asset or liability may be recognized in instances where there is a difference between the amount billed to a customer and the revenue recognized for the completed O&M performance obligations during the period. Revenues generated from both the delivery of bulk water and performance of services related to bulk water are recorded as bulk water revenue within the consolidated statements of operations and comprehensive income.

Certain contracts with customers which require the construction of facilities to provide bulk water to a specific customer include two performance obligations, including an implicit lease for the bulk water facilities and bulk water services, and a non-lease component related to O&M services. The implicit lease performance obligation is generally accounted for as an operating lease as a result of the provisions of the contract. As the bulk water services are deemed to be the more predominant element, the Company considers the arrangement to be a combined bulk water component. The calculated transaction price can include, if applicable, contractual minimum monthly charges and the expected amount of variable consideration to the extent it is probable that a significant reversal of the cumulative revenues will not occur. The variable consideration generally includes the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied and contractually established rates. The revenue recognition pattern for both the lease and non-lease components are the same, with revenues being recognized ratably over the contract period as water is delivered to the customer. Revenues generated from both the lease and non-lease performance obligations are recorded as bulk water revenue within the consolidated statements of operations and comprehensive income.

Service Concession Arrangements. Through the Seven Seas Water operating platform, the Company enters into contracts with customers that are determined to be service concession arrangements. Service concession arrangements are agreements entered into with a public sector entity which controls both (i) the ability to modify or approve the services and prices provided by the operating company and (ii) beneficial entitlement to, or residual interest in, the infrastructure at the end of the term of the agreement. Service concession arrangements typically include more than one performance obligation, including the construction of infrastructure for the customer and an obligation to provide O&M services for the infrastructure constructed for the customer. Billings to the customer for service concession arrangements are typically based on the volume of water supplied to a customer and typically contain a minimum monthly charge provision which allows the Company to invoice the customer for the greater of the water supplied or a minimum monthly charge. The volume of water supplied is based on meter readings performed at or near the end of the month. The transaction price calculated for service concession arrangements includes, if applicable, contractual minimum monthly charges and the expected amount of variable consideration to the extent it is probable that a significant reversal of the cumulative revenues will not occur. The variable consideration generally includes the amount of water in excess of contractual minimum volumes, if applicable, or the amount of water expected to be supplied at contractually established rates. The transaction price is allocated to the identified performance obligations based on the relative standalone selling prices of the identified performance obligations.

The transaction price allocated to the construction of infrastructure performance obligation is recognized as product sales within the consolidated statements of operations and comprehensive income. Product sales are recognized over time, using the input method based on cost incurred, which typically begins at commencement of the construction with revenue being fully recognized upon the completion of the infrastructure as control of the infrastructure is, or is deemed to be, transferred to the customer. In addition, service concession contracts typically include a difference in timing of when control is, or is deemed to be, transferred and the collection of cash receipts, which are collected over the term of the entire arrangement. The timing difference could result in a significant financing component for the construction performance obligations if determined to be a material component of the transaction price. If a significant financing component is identified, the future cash flows included in the transaction price allocated to the construction performance obligations are discounted using a discount rate comparable to a market-based borrowing rate specific to both the customer and terms of the contract. The resulting present value of the allocated future cash flows is recorded as construction revenue with a related long-term receivable as control of the infrastructure is, or is deemed to be, transferred to the customer while the discount amount is considered to be the significant financing component. Future cash flows received from the customer related to the construction performance obligations are bifurcated between principal repayment of the long-term receivable and the imputed interest income related to the customer financing. The interest income is recorded as financing revenue within the consolidated statements of operations and comprehensive income as providing financing to our customers is a core component of our business model.

The transaction price allocated to the O&M performance obligation is recorded as bulk water revenue within the consolidated statements of operations and comprehensive income as the services are provided to the customer. A contract asset or liability may be recognized in instances where there is a difference between the amount billed to a customer and the revenue recognized for the completed O&M performance obligations during the period.

Rental of Equipment. Through the Seven Seas Water and Quench operating platforms, the Company generates revenues through the rental of its wastewater treatment and water reuse equipment and filtered water and related systems to customers. Rental agreements classified as operating leases can contain both lease and non-lease components, including O&M services on Company-owned equipment. For rental agreements that meet all conditions of the elected practical expedient to not separate lease and non-lease components and where the lease component is determined to be the predominant element of the contract, the Company allocates all revenues under the contract to the lease component of the contract. Billings to the customer for the rental of this equipment, which generally occur either monthly or quarterly, are based on the rental rate as stated within the rental agreement. The transaction price is based on the minimum lease payment as stated within the rental agreement. Rental revenues, including revenues in connection with certain installation type activities are recognized ratably over the rental agreement term and amounts paid by customers in excess of recognizable revenue are recorded as a contract liability, or deferred revenue, in the consolidated balance sheets.

Certain revenues associated with shipping, delivery, installation or similar activities that occur prior to lease commencement do not provide a service to the lessee and are not a non-lease component of the contract. Payments for these activities are recorded as prepaid lease payments which are recognized ratably with the rental revenue over the lease term. Upon the expiration of the initial rental agreement term, the Company may enter into rental agreement extensions in which revenues are recognized ratably over the extension term.

Revenues generated under these rental agreements are recorded as rental revenue within the consolidated statements of operations and comprehensive income.

Product Sales. Through both the Seven Seas Water and Quench operating platforms, the Company enters into contracts to construct desalination and wastewater treatment and water reuse equipment and facilities and to sell customers water and related filtration equipment, coffee and consumables, which may include contracts accounted for as sales-type leases.

Contracts with customers to sell water and related filtration equipment and coffee and consumables typically include a single performance obligation. The Company recognizes revenues at the time the equipment, coffee or consumables is transferred to the customer, which can be upon either shipment or delivery to the customer. The transaction price is based on the contractual price with the customer. Shipping and handling costs paid by the customer are included in revenues. Billings to the customer for the sale of water and related filtration equipment, coffee and consumables occur at the time the product is transferred to the customer and are based on contract price.

Contracts with customers to construct desalination and wastewater treatment and water reuse equipment and facilities typically include a single performance obligation. Construction and equipment revenues are recognized over time, using the input method based on cost incurred, which typically begins at the later of commencement of the construction or at the time the infrastructure is, or is deemed to be, transferred to the customer with revenue being fully recognized upon the completion of the infrastructure. Billings to the customer to construct desalination and wastewater treatment and water reuse equipment and facilities can occur at contractual intervals throughout the construction period, at the time the equipment or facility is deemed transferred to the customer, or, in the case of sales-type leases, as stated within the rental agreement. The transaction price is based on the contractual price with the customer.

For contracts deemed to be, or that include a sales-type lease, the transaction price is based on the minimum lease payments as stated within the rental agreement. For contracts that contain both a lease and non-lease components, the transaction price is allocated based on the relative standalone selling prices of the lease and non-lease components. The transaction price, excluding variable lease payments, allocated to the lease component is discounted at the implicit rate of the contract and is recognized as revenue upon commencement of the lease.

Revenues generated under these contracts are recorded as product sales revenue within the consolidated statements of operations and comprehensive income.

Future cash flows received from sales-type leases are bifurcated between principal repayment of the long-term receivable and the related imputed interest income related to the customer financing. The interest income is recorded as financing revenue within the consolidated statements of operations and comprehensive income.

Contract Costs

Contract costs includes contract acquisition costs and contract fulfillment costs, which are all recorded within other assets in the consolidated balance sheets.

Contract Acquisition Costs. Prior to January 1, 2019, the Company accounted for initial direct costs incurred by the Company to originate leases as deferred lease costs. The costs capitalized were directly related to the negotiation and execution of leases and primarily consisted of internal compensation and benefits as lease origination activities were performed internally by the Company. Deferred lease costs capitalized prior to the adoption of the authoritative guidance on leases will be amortized on a straight-line basis over the remaining lease term.

For all leases originated on or after January 1, 2019, subsequent to the adoption of authoritative guidance on leases, the incremental costs incurred by the Company to originate contracts with customers are capitalized as contract acquisition costs. Contract acquisition costs, which generally include commissions and other costs that are only incurred as a result of obtaining a contract, are capitalized when the incremental costs are expected to be recovered over the contract period. All other costs incurred regardless of obtaining a contract are expensed as incurred. Contract acquisition costs are amortized over the period the costs are expected to contribute directly or indirectly to future cash flows, which is generally over the initial contract term, on a basis consistent with the transfer of goods or services to the customer to which the costs relate.

Contract acquisition costs, net as of September 30, 2019 and December 31, 2018 were $4.8 million and $3.7 million, respectively, and were recorded in other assets in the consolidated balance sheets.

Contract Fulfillment Costs. Costs incurred by the Company to fulfill a contract with a customer are capitalized when the costs generate or enhance resources that will be used in satisfying future performance obligations of the contract and the costs are expected to be recovered. Capitalized contract fulfillment costs generally include contracted services, direct labor, materials, and allocable overhead directly related to resources required to fulfill the contract, including shipping and installation activities. Contract fulfillment costs are amortized over the period the costs are expected to contribute directly or indirectly to future cash flows, which is generally over the initial contract term, on a basis consistent with the transfer of good or services to the customer to which the costs relate.

Contract fulfillment costs, net as of September 30, 2019 and December 31, 2018 were $5.4 million and $1.5 million, respectively, and were recorded in other assets in the consolidated balance sheets.

Total contract costs amortization expense for the three and nine months ended September 30, 2019 were $1.5 million and $3.6 million, respectively. Total contract cost amortization expense for the three and nine months ended September 30, 2018 were $0.7 million and $2.0 million respectively.

Contract costs are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company had no impairment charges related to contract costs during the three and nine months ended September 30, 2019 and 2018.

Adoption of New Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board, or FASB, issued authoritative guidance regarding leases that requires lessees to recognize a lease liability and right‑of‑use asset for operating leases, with the exception of short‑term leases. In addition, lessor accounting was modified to align, where necessary, with lessee accounting modifications and the authoritative guidance regarding revenue from contracts with customers. During 2018, the FASB issued additional authoritative guidance which, among other things, provided an option to apply transition provisions under the standard at adoption date rather than the earliest comparative period presented as well as added a practical expedient that would permit lessors to not separate non-lease components from the associated lease components if certain conditions are met. These amendments are effective, in conjunction with the new lease standard, for annual reporting periods beginning on or after December 15, 2018, including interim periods within those annual periods.

The Company adopted this guidance on a modified retrospective basis on January 1, 2019 with the cumulative effect of the transition as of the date of adoption.

The Company has elected the package of practical expedients provided for within the authoritative guidance which exempts the Company from having to reassess: (i) whether expired or existing contracts contain leases, (ii) the lease classification for expired or existing leases, and (iii) initial direct costs for existing leases. In addition, the Company has elected the practical expedient that permits lessors to not separate non-lease components from the associated lease components if certain conditions are met. Lastly, the Company has utilized the short-term exemption for lessees and established an accounting policy to not recognize a right-of-use asset or lease liability for any lease with a term of less than 12 months. The Company did not elect to utilize any of the other practical expedients.

The impacts of the new lease standard are as follows:

Lessee accounting - The adoption has had a material impact on the consolidated balance sheets, including an increase to both assets and liabilities, as a result of the recognition of a right-of-use asset and corresponding lease liability for operating leases. As the Company has made a policy election for the short-term lease exemption, a right-of-use asset and corresponding lease liability are only recorded for leases with expected terms of more than 12 months. The adoption did not have a material impact on the consolidated statements of operations and comprehensive income for situations in which the Company is a lessee.

Lessor accounting - As the Company has elected the transitional practical expedients for leases, there are not any material impacts to the consolidated financial statements for leases in situations which the Company is a lessor and the lease commenced prior to January 1, 2019. To conform with the guidance, the Company has updated its policies for costs incurred for the acquisition and fulfillment of the lease contracts, including commissions and installation costs.

Adoption of the new lease standard did not impact our historically reported results. On January 1, 2019, the Company recorded $8.7 million of right-of-use assets and $8.9 million of operating lease liabilities, including the classification of $0.2 million from straight-line rent liabilities to operating lease liabilities, in the consolidated balance sheets.

New Accounting Pronouncements to be Adopted

In June 2016, the FASB issued authoritative guidance regarding implementation of measurement of credit losses on financial instruments. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company is currently evaluating the potential impact of the accounting and disclosure requirements on the consolidated financial statements.

In August 2018, the FASB issued authoritative guidance regarding implementation costs incurred in a cloud computing arrangement that is a service contract. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company is currently evaluating the potential impact of the disclosure requirements on the consolidated financial statements.

In August 2018, the FASB issued authoritative guidance regarding the disclosure requirements for fair value measurements. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company is currently evaluating the potential impact of the accounting and disclosure requirements on the consolidated financial statements.

In March 2019, the FASB issued authoritative guidance regarding targeted changes to lessor accounting. This guidance will be effective for annual reporting periods beginning on or after December 15, 2019, including interim periods within those annual periods, and early adoption is permitted. The Company is currently evaluating the potential impact of the accounting and disclosure requirements on the consolidated financial statements.