FINANCIAL REVIEW MAKE WAVES 113

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1 FINANCIAL REVIEW MAKE WAVES 113

2 MANAGEMENT S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following management s discussion and analysis ( MD&A ) of Manila Water Company Inc. and subsidiaries ( Group ) financial condition and results of operations should be read in conjunction with the Group s audited financial statements, including related notes. This report may contain forward-looking statements that involve risks and uncertainties. The actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to, economic, regulatory, socio-political, financial and other risk factors. Any references in this MD&A to our, us, we, MWCI or the Group shall refer to Manila Water Company, Inc., including its subsidiaries. Any reference to Manila Water Company, Manila Water, MWC or the Company shall refer to the parent company only. This report contains a discussion on Core Income that is not a measure of performance under Philippine Financial Reporting Standards (PFRS). Users of this report should not consider Core Income in isolation or as alternative to net income as an indicator of the Group s operating performance or to cash flow from operating, investing and financing activities as a measure of liquidity, or any other measures of performance under PFRS. Additional information about the Group, including recent disclosures of material events and annual/ quarterly reports, are available at our corporate website at OVERVIEW OF THE BUSINESS Manila Water Company holds the exclusive right to provide water and used water services to the eastern side of Metro Manila ( Manila Concession or East Zone ) under a Concession Agreement ( CA ) entered into between the Company and Metropolitan Waterworks and Sewerage System ( MWSS ) in August The original term of the concession was for a period of 25 years to expire in The Company s concession was extended by another 15 years by MWSS and the Philippine Government in 2009, thereby extending the term from May 2022 to May The Company provides water treatment, water distribution, sewerage and sanitation services to more than six million people in the East Zone, comprising a broad range of residential, semi-business, commercial and industrial customers. The East Zone encompasses 23 cities and municipalities spanning a 1,400-square kilometer area that includes Makati, Mandaluyong, Pasig, Pateros, San Juan, Taguig, Marikina, most parts of Quezon City, portions of Manila, as well as the following towns of Rizal: Angono, Antipolo, Baras, Binangonan, Cainta, Cardona, Jala-Jala, Morong, Pililia, Rodriguez, San Mateo, Tanay, Taytay, and Teresa. Under the terms of the CA, the Company has the right to the use of land and operational fixed assets, and the exclusive right, as agent of MWSS, to extract and treat raw water, distribute and sell water, and collect, transport, treat and dispose used water, including reusable industrial effluent discharged by the sewerage system in the East Zone. The Company is entitled to recover over the concession period its operating, capital maintenance and investment expenditures, business taxes, and concession fee payments, and to earn a rate of return on these expenditures for the remaining term of the concession. Aside from the Manila Concession, the Group has a holding company for all its domestic operating subsidiaries in Manila Water Philippine Ventures, Inc. ( MWPV ). Currently under MWPV are Laguna AAA Water Corporation ( Laguna Water ), Boracay Island Water Company ( Boracay Water ), Clark Water Corporation ( Clark Water ), Manila Water Consortium, Inc. ( MW Consortium ), Bulacan MWPV Development Corporation ( BMDC ), Obando Water Company, Inc. ( Obando Water ), Estate Water and Aqua Centro MWPV Corporation ( Aqua Centro MWPV ), where the latter two operate and manage the water systems of townships developed by property developers such as Ayala Land, Inc. and SM Group, respectively. A subsidiary of MW Consortium is Cebu Manila Water Development, Inc. ( Cebu Water ) that provides bulk water in the province of Cebu. The Group has other projects in its portfolio including the Zamboanga City performance-based non-revenue water reduction project under Zamboanga Water Company, Inc. ( Zamboanga Water ), Tagum City bulk water supply project under Tagum Water Company, Inc. ( Tagum Water ), and Calasiao Water District water supply project under Calasiao Water Company, Inc. ( Calasiao Water ) Integrated Report

3 The holding company for its international ventures is Manila Water Asia Pacific Pte. Ltd. ( MWAP ). Under MWAP are two affiliated companies in Vietnam, namely Thu Duc Water B.O.O Corporation ( Thu Duc Water ) and Kenh Dong Water Supply Joint Stock Company ( Kenh Dong Water ), both supplying treated water to Saigon Water Corporation ( SAWACO ) under a take-or-pay arrangement. Also under MWAP are Saigon Water Infrastructure Corporation ( Saigon Water ), a holding company listed in the Ho Chi Minh City Stock Exchange, Cu Chi Water Supply Sewerage Company, Ltd. ( Cu Chi Water ) and another company tasked to pursue non-revenue water reduction projects in Vietnam called Asia Water Network Solutions ( Asia Water ). Lastly, Manila Water Total Solutions Corporation ( MWTS ), a wholly-owned subsidiary, handles after-the-meter products and services. Its current offerings include pipelaying, integrated used water services, and the sale of Healthy Family Purified Water as five-gallon and 500-ml purified water in selected areas in Metro Manila. CONSOLIDATED FINANCIAL PERFORMANCE The Group s key financial performance indicators are discussed below: For the years ended December 31 (in thousand Pesos) Increase/ (Decrease) % Total operating revenues 18,515,772 17,711, ,861 5% Total cost and expenses (excluding 7,360,379 6,192,585 1,167,794 19% depreciation and amortization) Other income (expense) - net 540, ,165 88,815 20% Equity share in net income of associates 457, ,830 88,378 24% Others 83,772 83, % EBITDA 11,696,373 11,971,491 (275,118) -2% Depreciation and amortization 2,556,999 2,866,043 (309,044) -11% Income before other income/expenses 9,139,374 9,105,448 33,926 0% Interest income (expense) - net (1,057,498) (1,172,083) 114,585-10% Income before income tax 8,081,876 7,933, ,511 2% Provision for income tax 1,941,929 1,746, ,554 11% Net income 6,139,947 6,186,990 (47,043) -1% Non-controlling interest (6,661) 121,769 (128,430) -105% Reported net income attributable to MWC 6,146,608 6,065,221 81,387 1% Non-recurring expense 352, , % Core net income 6,498,845 6,065, ,624 7% Consolidated operating revenues grew by 5% to P18,516 million in 2017 from P17,712 million the previous year driven by the billed volume growth of the Manila Concession, expansion of the domestic operating subsidiaries and higher supervision fees recognized by Estate Water. MAKE WAVES 115

4 A breakdown of the revenue drivers is shown below: For the years ended December 31 (in thousand Pesos) Increase/ (Decrease) % Water 14,269,066 13,670, ,637 4% Environmental charges 2,481,248 2,420,227 61,021 3% Sewer 455, ,943 41,663 10% Other operating income 1,309,852 1,207, ,540 8% Total operating revenues 18,515,772 17,711, ,861 5% The Group derived 77% of its operating revenues from the sale of water, while 16% came from environmental and sewer charges. Other revenues, which accounted for the balance of 7%, were from after the meter services, connection fees and septic sludge disposal, among others. On the other hand, consolidated operating costs and expenses (excluding depreciation and amortization) rose by 19% to P7,360 million in 2017 led by the 67% growth in overhead costs to P1,524 million. Of the total overhead costs, provision for uncollectible receivables accounted for 38% during the period. The other driver of operating costs and expenses was direct costs which increased by 12%, primarily due to higher power and light charges from the higher consumption of new facilities, as well as an increase in power rates. Below is a summary of the operating expenses incurred during the period: For the years ended December 31 (in thousand Pesos) Increase/ (Decrease) % Salaries, wages and employee benefits 2,059,203 1,906, ,096 8% Non-personnel costs 4,830,377 3,852, ,890 25% Direct costs 2,976,165 2,660, ,919 12% Overhead 1,523, , ,777 67% Premises 330, ,381 51,194 18% Other expenses 470, ,991 36,808 8% Total operating expenses 7,360,379 6,192,585 1,167,794 19% Meanwhile, other income (net of expense) grew by 20% to P541 million in 2017 from P452 million in 2016, largely due to higher equity share in net income of associates. The two bulk water companies in Vietnam, Thu Duc Water and Kenh Dong Water, together with Saigon Water, contributed P457 million in net income, growing by 24% from the previous year. The movements in operating revenues and expenses as well as other income resulted in a consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) of P11,696 million in 2017, declining by 2% from EBITDA margin was recorded at 63%. Depreciation and amortization dropped by 11% to P2,557 million as the Parent Company, Laguna Water, Boracay Water, and Clark Water shifted from a straight line method of depreciation to units of production beginning May 1, 2017 to align with industry practice. Interest expense likewise dropped by 10% to P1,057 million as a result of loan payments the previous year. Provision for income tax however increased by 11% to P1,942 million due to the higher taxable base of the Group. These offset the slightly lower EBITDA, leading to a reported net income growth of 1% to P6,147 million in Taking out the nonrecurring expense related to the provision for uncollectible receivables, core income grew by 7% to P6,499 million Integrated Report

5 BUSINESS UNITS FINANCIAL AND OPERATING PERFORMANCE Manila Concession For the years ended December Increase/ (Decrease) % Operating Highlights Billed volume (in million cubic meters) % Domestic % Semi-Commercial % Commercial % Industrial % Number of billed connections 961, ,089 31,574 3% Non-revenue water 11.6% 10.8% (0.8% pt) Financial Highlights (in thousand Pesos) Revenues 15,071,923 14,980,143 91,781 1% Cost and expenses 4,222,422 4,197,510 24,912 1% EBITDA 10,876,410 10,836,660 39,750 0% Net income 5,923,338 5,569, ,342 6% The Manila Concession s billed volume increased by 2% in 2017 to million cubic meters ( mcm ), despite coming from a high base in 2016 that was partly due to the one day advantage of 2016 being a leap year. Billed water connections (net of permanent disconnections) grew by 3% to 961,663 customers at the end of the period, mostly from the expansion areas of Marikina, Pasig, Rizal, and Taguig. Average consumption slightly contracted by 1% to 43.0 cubic meters per connection, while average effective tariff likewise decreased by 1% to P29.90 per cubic meter. Billed volume growth was driven by the improvement in domestic and semi-commercial accounts by 2% and 8%, respectively, with the latter due to the reclassification of certain accounts from industrial and commercial to semi-commercial accounts. Commercial accounts likewise grew by 1% but these were offset by the decline in industrial accounts by 5% due to the completion of construction projects. The level of system losses, as measured by the non-revenue water ( NRW ) ratio, rose to 11.6% at the end of December 2017 from 10.8% during the same period in 2016 due to the ongoing pipeline replacement and repair as assets reach the end of their useful life. Meanwhile, collection efficiency in 2017 was almost 100%, with average accounts receivable days maintained at 19 days. The third and final tranche of the Rate Rebasing adjustment for the period 2013 to 2017 was implemented on January 1, 2017 equivalent to a negative P0.55 per cubic meter and a CPI adjustment of 1.9% equivalent to P0.47 per cubic meter. This is following the decision of the Appeals Panel in the arbitration proceedings between the Company and MWSS that set the adjustment of the basic water charge at a negative 11.05% from Manila Water s 2012 average basic water charge of P25.07 per cubic meter, translating to a decrease of P2.77 per cubic meter in the basic water charge for implementation on a staggered basis. The first tranche of negative P1.66 per cubic meter adjustment was implemented on June 1, 2015 together with a CPI adjustment of 4.19% on top of the basic water charge equivalent to P1.08 per cubic meter. The second tranche of negative P0.55 per cubic meter adjustment was implemented on January 1, 2016, together with a CPI adjustment of 0.8% equivalent to P0.20 per cubic meter. With the 2% billed volume growth and slight decline in tariff, revenues grew by 1% to P15,072 million in Cost and expenses, on the other hand, rose by 1% to P4,222 million due to higher power as a result of new used water facilities and additional septic sludge activities. This resulted in an EBITDA of P10,876 million and an EBITDA margin of 72%. Net income was recorded at P5,923 million in 2017, growing by 6% from the same period last year. MAKE WAVES 117

6 Boracay Island Water Company (Boracay Water) Clark Water Corporation (Clark Water) For the years ended December Increase/ (Decrease) % Operating Highlights Billed volume (in % million cubic meters) Number of billed 6,267 6,475 (208) -3% connections Non-revenue water 22.5% 13.0% (9.5% pts) Financial Highlights (in thousand Pesos) Revenues 600, ,026 86,167 17% Cost and expenses 282, ,302 48,591 21% EBITDA 317, ,724 37,576 13% Net income 142, ,530 20,904 17% Boracay Water posted a billed volume growth of 13% in 2017 to 5.5 mcm from 4.9 mcm in The growth was driven by the 16% growth in tourist arrivals that reached more than two million during the year, and the sale of bulk water to the Malay Water District beginning in the second quarter of NRW, however, rose to 22.5% at the end of December 2017, as it continued to embark on various meter replacement and leak detection activities. Boracay Water spent capital expenditures of P464 million in 2017, mostly for pipelaying and the expansion of used water services. The 13% growth in billed volume and 4% higher average tariff at P92.86 per cubic meter led to a 17% improvement in total revenues in 2017 to P600 million. Meanwhile, cost and expenses increased by 21% to P283 million due to higher power and manpower costs, resulting in a 13% improvement in EBITDA to P317 million. With the lower depreciation, net income grew by 17% to P142 million in 2017 despite higher taxes due to the expiration of its income tax holiday. For the years ended December 31 Increase/ (Decrease) % Operating Highlights Billed volume (in million cubic meters) % Number of billed connections 2,050 1, % Non-revenue water 3.9% 4.5% 0.6% pt Financial Highlights (in thousand Pesos) Revenues 459, ,919 44,336 11% Cost and expenses 250, ,497 35,797 17% EBITDA 208, ,422 8,539 4% Net income 94,200 81,387 12,813 16% Clark Water posted a billed volume growth of 8% to 14.5 mcm in 2017, driven by the higher consumption of commercial accounts and the sale of bulk water to residential subdivisions outside the Clark Freeport Zone in nearby Angeles City, Pampanga. Average tariff was maintained at P30.16 per cubic meter, while NRW improved to 3.9% at the end of Clark Water posted capital expenditures of P263 million in 2017 mostly for the expansion of water supply and used water services. The increase in billed volume and other income together with flat average tariff led to a revenue growth of 11% to P459 million in Meanwhile, cost and expenses rose by 17% to P250 million due to higher direct costs on the back of higher power expenses. These developments resulted in a 4% improvement in EBITDA to P209 million. Coupled with lower depreciation expense, net income of Clark Water grew by 16% to P94 million in On June 14, 2017, Boracay Water received the approval of its new rates from the Tourism Infrastructure and Enterprise Zone Authority (TIEZA) Regulatory Office for implementation beginning July 1, The approved tariff adjustment is to be implemented over three years from 2017 to 2019, where upward adjustments on the basic charge per cubic meter are as follows: 2017 P30.00; 2018 P15.33; and 2019 P Integrated Report

7 Laguna AAAWater Corporation (Laguna Water) Estate Water For the years ended December Increase/ (Decrease) % Operating Highlights Billed volume (in % million cubic meters) Number of billed 98,056 96,534 1,522 2% connections Non-revenue water 18.2% 21.4% 3.2% pts Financial Highlights (in thousand Pesos) Revenues 1,212, , ,663 23% Cost and expenses 1,226, , , % EBITDA (13,405) 494,936 (508,341) -103% Net income (300,511) 248,452 (548,963) -221% Billed volume of Laguna Water grew by 12% to 44.1 mcm in 2017, brought about by additional billed service connections of close to 2,000 that raised billed volume in the base business to 24.1 mcm, growing by 10% year-onyear. The balance of 17.6 mcm came from the 187 industrial customers of Laguna Technopark, Inc. (LTI), growing by 10% from the previous year, and an additional 2.4 mcm from new businesses outside the original concession area that grew by 57%. NRW improved by 3.2% points to 18.2% at the end of December 2017 from 21.4% at the end of 2016 as a result of leak detection and repair activities. Laguna Water spent P955 million in capital expenditures in 2017, mostly for the expansion of water and used water networks. Revenues grew by 23% in 2017 to P1.21 billion as a result of the higher billed volume and 14% improvement in average effective tariff to P21.06 per cubic meter. On the other hand, cost and expenses ended at P1.23 billion as Laguna Water recorded a non-recurring provision for uncollectible receivables, while aligning its provisioning policies with the Company. The movements resulted in an EBITDA of negative P13 million. Laguna Water recorded a net loss of P301 million in 2017 from a net income of P248 million the previous year. For the years ended December 31 Increase/ (Decrease) % Operating Highlights Billed volume (in % million cubic meters) Number of billed connections. 10,153 6,753 3,400 50% Financial Highlights (in thousand Pesos) Revenues 637, , ,039 41% Cost and expenses 274, , ,196 94% EBITDA 362, ,578 51,843 17% Net income 254, ,941 38,026 18% Estate Water posted a billed volume growth of 117% to 4.5 mcm in 2017 from 2.1 mcm in 2016 on the back of a 50% increase in billed connections to 10,153 from the 63 brownfield Ayala Land developments it has taken over since last year. It spent P481 million in capital expenditures, mostly for the development of water and used water networks in the new estates being developed by Ayala Land, growing by 8% from the previous year. Revenues reached P637 million in 2017 brought about by supervision fees, income from O&M contracts, and water and used water revenues from the billed volume of customers, growing by 41% from On the other hand, cost and expenses was P275 million, resulting in an EBITDA of P362 million. Estate Water posted a net income of P255 million in 2017, rising by 18% from the previous year. On June 30, 2015, Laguna Water signed an amendment to its Concession Agreement with the Provincial Government of Laguna expanding the scope of its concession from the cities of Biñan, Cabuyao and Sta. Rosa to cover all cities and municipalities in the entire Province of Laguna. The amendment likewise included the provision of used water services and the establishment of an integrated sewage and septage system in the province. To date, Laguna Water has finalized the takeover of the water distribution in the municipalities of Calauan and Victoria. MAKE WAVES 119

8 Thu Duc Water B.O.O Corporation (Thu Duc Water) For the years ended December Increase/ (Decrease) % Operating Highlights Billed volume (in million cubic meters) % Financial Highlights (in million VND) Revenues 329, ,158 9,349 3% Cost and expenses 110, ,821 2,802 3% EBITDA 218, ,337 6,547 3% Net income 104, ,411 3,645 4% in PFRS (in thousand Pesos) Net income (49% contribution) 241, ,970 12,976 6% Thu Duc Water sold a total of mcm in 2017, rising slightly from mcm billed volume in the same period last year. The growth was due to the higher water intake of Saigon Water Corporation ( SAWACO ). Under Vietnamese Accounting Standards ( VAS ), revenues grew by 3% to VND330 billion while cost and expenses increased by a similar 3% to VND111 billion due to higher general and administrative expenses. This led to a 3% improvement in EBITDA and a 4% increase in net income to VND104 billion. In peso terms, the PFRS-translated income reflected in the consolidated financial statements as equity share in net income of associates amounted to P242 million, equivalent to Manila Water s 49% stake in Thu Duc Water. Kenh Dong Water Supply Joint Stock Company (Kenh Dong Water) For the years ended December 31 Increase/ (Decrease) % Operating Highlights Billed volume (in million cubic meters) % Financial Highlights (in million VND) Revenues 217, ,252 (58) 0% Cost and expenses 69,511 68,047 1,464 2% EBITDA 147, ,205 (1,522) -1% Net income 78,250 64,854 13,396 21% in PFRS (in thousand Pesos) Net income (47% contribution) 148, ,458 20,929 16% Kenh Dong Water registered a billed volume growth of 2% in 2017 to 57.8 mcm despite having additional billed volume from flushing activities in Under VAS, Kenh Dong Water posted revenues of VND217 billion and an EBITDA of VND148 billion. With lower interest expense, this led to a net income of VND78 billion, growing by 21% in Similar to Thu Duc Water, income from Kenh Dong Water is translated into PFRS and is reported as equity share in net income of associates in the consolidated financial statements. In peso terms, the PFRS-translated income of Manila Water s 47.35% stake in Kenh Dong Water amounted to P148 million. Aside from Thu Duc Water and Kenh Dong Water, its investment in Saigon Water, the listed holding company in Vietnam, recorded a net income of P69 million in 2017, up by 475% from the previous year, due mainly to a government grant recognized in Integrated Report

9 BALANCE SHEET The consolidated balance sheet as of end 2017 reflected the Company s substantial asset base expansion. Total assets rose by 20% to P billion as the Company continued to lay additional capital investments. Liabilities also rose by 31% to P53.92 billion. Strong cash inflows attributable to the high collection efficiency and loan drawdowns brought cash and cash equivalents to P9.02 billion. The Group continued to be compliant with its loan covenants. Debt to equity ratio stood at 0.98x, excluding concession obligations, while net bank debt to equity registered at 0.65x. Under the Company s cash dividend policy, common shares are entitled to annual cash dividends equivalent to 35% of the prior year s net income, payable semi-annually. On March 1, 2017 and October 3, 2017, the Company declared cash dividends for the first half and second half of the year, respectively, with dividend rates at P per common share and P per preferred share, amounting to approximately P1.0 billion at each pay-out period. CAPITAL EXPENDITURES The Group ended 2017 with total capital expenditures of P13.03 billion, posting a growth of 48% over the previous year. Manila Concession spent a total of P10.63 billion (inclusive of concession fee payments) for capital expenditures in 2017, 64% more than the P6.46 billion spent in the same period the previous year. Of the total amount, 91% was spent on wastewater expansion, network reliability and water supply projects, while the balance of 9% was accounted for by concession fees paid to MWSS. Meanwhile, total capital expenditures of the domestic subsidiaries grew by 3% to P2.41 billion from the P2.34 billion spent in Of the total amount, P955 million was used by Laguna Water for its development of new water sources and network expansion, while Boracay Water and Clark Water disbursed P464 million and P263 million, respectively. Estate Water spent P481 million for its greenfield and brownfield projects while the balance was spent by Cebu Water, Tagum Water, Zamboanga Water and MWTS. MAKE WAVES 121

10 REPORT OF THE AUDIT COMMITTEE TO THE BOARD OF DIRECTORS FOR THE YEAR ENDED DECEMBER 31, 2017 The Audit Committee s roles, responsibilities and authority are defined in the Audit Committee Charter approved by the Board of Directors. The Committee provides assistance to the Board of Directors in fulfilling their oversight responsibility to the shareholders relating to the: a) integrity of Manila Water Company, Inc. s ( Company s ) financial statements and the financial reporting process; b) appointment, remuneration, independence and performance of internal audit and of the independent auditors, and integrity of the audit process c) effectiveness of the systems of internal controls and enterprise risk management process d) compliance with applicable legal and regulatory requirements and other reporting standards e) performance and leadership of the internal control function f) preparation of a year-end report of the Committee for approval of the Board and to be included in the annual report. In compliance with the Audit Committee Charter, the Committee confirms that: An independent director chairs the Audit Committee. The Committee has three out of four members who are independent directors. The Committee had four meetings during the year with the following attendance rate: Directors No. of Meetings Attended/Held Percent Present Oscar S. Reyes 4/4 100% Jose L. Cuisia Jr. 4/4 100% Jaime C. Laya 4/4 100% Gerardo C. Ablaza Jr. 3/4 75% The Committee reviewed and approved the quarterly unaudited consolidated financial statements and the annual audited consolidated financial statements of Manila Water Company, Inc. and subsidiaries, including Management s Discussion and Analysis of Financial Condition and Results of Operations as of and for the year ended December 31, 2017, with the Company s Management, internal auditors, and SGV & Co. These activities were conducted in the following context: - Management has the primary responsibility for the financial statements and the reporting process - SGV & Co. is responsible for expressing an opinion on the conformity of the Company s audited consolidated financial statements with the Philippine Financial Reporting Standards. The Committee discussed and approved the overall scope and the respective audit plans of the Company s internal auditors and of SGV & Co., the results of their audits and their assessment of the Company s internal controls, and the overall quality of the financial reporting process. The Committee discussed the reports of the internal auditors, and ensured that Management is taking appropriate actions in a timely manner, including addressing internal control and compliance issues. All the activities performed by Internal Audit were conducted in conformance with the International Standards for the Professional Practice of Internal Auditing. The Audit Committee, through the audits conducted by SGV & Co. and Internal Audit, has reviewed Management s system of internal controls and the Committee found the internal control system to be adequate and effective. The Committee discussed with Management the adequacy and effectiveness of the Enterprise Risk Management process, including significant risk exposures, the related risk-mitigation efforts and initiatives, and the status of the mitigation plans. The review was undertaken in the context that Management is primarily responsible for the risk management process. The Committee reviewed and confirmed that the existing Audit and Internal Audit Charters are sufficient to accomplish the Committee s and Internal Audit s objectives. The Audit Committee Charter is in compliance with the Securities and Exchange Commission Memo Circular No. 04 (2012). The Committee conducted a self-assessment of its performance to confirm that the Committee continues to meet the expectations of the Board, Management, and shareholders. Based on the reviews and discussions undertaken, and subject to the limitations on our roles and responsibilities referred to above, the Audit Committee recommended to the Board of Directors the inclusion of the Company s audited consolidated financial statements in the Company s Annual Report to the Stockholders for the year ended December 31, 2017 and the filing thereof with the Securities and Exchange Commission. February 27, 2018 OSCAR S. REYES Chairman, Audit Committee The Committee reviewed and approved the Management representation letter before submission to the Company s independent external auditors. The Committee recommended to the Board of Directors the re-appointment of SGV & Co. as independent external auditors for 2018 based on its review of SGV s performance and qualifications, including consideration of Management s recommendation. The Committee reviewed and approved all audit and auditrelated services provided by SGV & Co. to the Company and the related fees for such services. JOSE L. CUISIA JR. Independent Director GERARDO C. ABLAZA JR. Member JAIME C. LAYA Independent Director Integrated Report

11 STATEMENT OF MANAGEMENT S RESPONSIBILITY FOR FINANCIAL STATEMENTS The management of Manila Water Company, Inc. (the Company ) and its subsidiaries (the Group ) is responsible for the preparation and fair presentation of the consolidated financial statements including the schedules attached therein, as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016, and 2015, in accordance with the prescribed financial reporting framework indicated therein, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated financial statements, management is responsible for assessing the Group s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or its subsidiaries, or to cease operations, or has no realistic alternative but to do so. The Board of Directors is responsible for overseeing the Group s financial reporting process. The Board of Directors reviews and approves the consolidated financial statements including the schedules attached therein, and submits the same to the stockholders or members. SyCip Gorres Velayo & Co., the independent auditors appointed by the stockholders, has audited the consolidated financial statements of the Group in accordance with Philippine Standards on Auditing, and in its report to the stockholders or members, has expressed its opinion on the fairness of presentation upon completion of such audit. FERNANDO ZOBEL DE AYALA Chairman of the Board FERDINAND M. DELA CRUZ President and Chief Executive Officer LUIS JUAN B. ORETA Chief Finance Officer MAKE WAVES 123

12 SyCip Gorres Velayo & Co Ayala Avenue 1226 Makati City Philippines Tel: (632) Fax: (632) ey.com/ph BOA/PRC Reg. No. 0001, December 14, 2015, valid until December 31, 2018 SEC Accreditation No FR-4 (Group A), November 10, 2015, valid until November 9, 2018 INDEPENDENT AUDITOR S REPORT The Board of Directors and Stockholders Manila Water Company, Inc. MWSS Administration Building, Katipunan Road Balara, Quezon City Opinion We have audited the consolidated financial statements of Manila Water Company, Inc. (the Parent Company) and its subsidiaries (collectively referred to as the Group ), which comprise the consolidated statements of financial position as at December 31, 2017 and 2016, and the consolidated statements of comprehensive income, consolidated statements of changes in equity and consolidated statements of cash flows for each of the three years in the period ended December 31, 2017, and notes to the consolidated financial statements, including a summary of significant accounting policies. In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Group as at December 31, 2017 and 2016, and its consolidated financial performance and its consolidated cash flows for each of the three years in the period ended December 31, 2017 in accordance with Philippine Financial Reporting Standards (PFRSs). Basis for Opinion We conducted our audits in accordance with Philippine Standards on Auditing (PSAs). Our responsibilities under those standards are further described in the Auditor s Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Group in accordance with the Code of Ethics for Professional Accountants in the Philippines (Code of Ethics) together with the ethical requirements that are relevant to our audit of the consolidated financial statements in the Philippines, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the Code of Ethics. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Key Audit Matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For each matter below, our description of how our audit addressed the matter is provided in that context. We have fulfilled the responsibilities described in the Auditor s Responsibilities for the Audit of the Consolidated Financial Statements section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the consolidated financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the accompanying consolidated financial statements. A member firm of Ernst & Young Global Limited Integrated Report

13 Revenue recognition for Manila Concession (East Zone) The Group s revenue from East Zone accounts for 86% of total consolidated revenue. The recognition process for the East Zone revenue requires processing of data from large number of customers classified as either residential, commercial, semi-business, or industrial within the Parent Company s concession area. The amounts billed to customers consist of a number of components, including basic charge, environmental charge and foreign currency differential adjustment and where applicable, sewer charge. These tariffs depend on the customer type and are determined based on a formula as prescribed by the Metropolitan Waterworks and Sewerage System Regulatory Office (MWSS RO). This matter is significant to our audit because the revenue recognized depends on the completeness of capture of water consumption based on the meter readings over the concession area taken on various dates; the propriety of rates applied across customer types; and the reliability of the systems involved in processing the billing transactions. Relevant disclosures related to this matter are provided in Notes 1, 2 and 6 to the consolidated financial statements. Audit response We obtained an understanding, evaluated the design and tested the controls over the read and bill process, which includes the capture of water consumption and calculation of billed fees, downloading of data from the billing system and uploading of data to the Parent Company s financial reporting system. We involved our internal specialist in the testing of the related controls over these processes. We performed test calculation of the billed amounts using the volume of water consumption and MWSS RO-approved rates and compared them with the amounts reflected in the billing statement. Provision and contingencies The Group is involved in legal proceedings and assessments for local and national taxes. This matter is significant to our audit because the estimation of the potential liability resulting from these tax assessments requires significant judgment by management. The inherent uncertainty over the outcome of these tax and legal matters is brought about by the differences in the interpretation and implementation of the laws and tax rulings. The Group s disclosure about provisions and contingencies are included in Note 29 to the consolidated financial statements. Audit response Our audit procedures include, among others, involvement of our tax specialists in reviewing the status of these assessments, the tax position of the Parent Company s legal counsels on the merits of the arguments against the assessments, previous court decisions, implementing rules and opinions issued by relevant government and regulatory bodies. In addition, we performed an independent calculation of the amount of the provisions and compared this with the outstanding provisions as of year-end. Amortization of Service Concession Assets Using the Units-of-production Method The service concession assets (SCA) of the Group is related to its concession agreements. In 2017, the Group changed the amortization method for SCA from straight-line method to units-of-production (UOP) method. As a result, the SCA is amortized based on the actual billed volume over the estimated billable water volume for the remaining period of the concession agreement. The UOP amortization method is a key audit matter as the method involves significant management judgment and estimates, particularly in determining the total estimated billable water volume over the remaining periods of the concession agreements. It considers different factors such as population growth, supply and consumption, and service coverage, including ongoing and future expansions. Refer to Notes 2, 3 and 10 to the consolidated financial statements for the relevant disclosures related to this matter. A member firm of Ernst & Young Global Limited MAKE WAVES 125

14 Audit response We obtained an understanding of management s processes and controls in the estimation of billable water volume. We evaluated the competence, capabilities, and objectivity of management s specialist who estimated the total billable water volume. We also reviewed the report of the management s specialist and gained an understanding of the methodology and the basis of computing the forecasted volumes. Furthermore, we compared the billable water volume during the year against the data generated from the billing system. We recalculated the amortization expense for the year and the SCAs as of year-end based on the established billable water volume. Other Information Management is responsible for the other information. The other information comprises the information included in the SEC Form 20-IS (Definitive Information Statement), SEC Form 17-A and Annual Report for the year ended December 31, 2017, but does not include the consolidated financial statements and our auditor s report thereon. The SEC Form 20-IS (Definitive Information Statement), SEC Form 17-A and Annual Report for the year ended December 31, 2017 are expected to be made available to us after the date of this auditor s report. Our opinion on the consolidated financial statements does not cover the other information and we will not express any form of assurance conclusion thereon. In connection with our audits of the consolidated financial statements, our responsibility is to read the other information identified above when it becomes available and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audits, or otherwise appears to be materially misstated. Responsibilities of Management and Those Charged with Governance for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with PFRSs, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated financial statements, management is responsible for assessing the Group s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting, unless management either intends to liquidate the Group or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Group s financial reporting process Integrated Report

15 Auditor s Responsibilities for the Audit of the Consolidated Financial Statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with PSAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with PSAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Group s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor s report. However, future events or conditions may cause the Group to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. MAKE WAVES 127

16 From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor s report, unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. The engagement partner on the audit resulting in this independent auditor s report is Dhonabee B. Señeres. SYCIP GORRES VELAYO & CO. Dhonabee B. Señeres Partner CPA Certificate No SEC Accreditation No AR-1 (Group A) June 30, 2015, valid until June 29, 2018 Tax Identification No BIR Accreditation No February 2, 2018, valid until February 1, 2021 PTR No , January 9, 2018, Makati City March 1, Integrated Report

17 MANILA WATER COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION ASSETS December Current Assets Cash and cash equivalents (Notes 5, 21 and 27) P=9,020,744,089 P=4,065,700,122 Receivables (Notes 6, 21 and 27) 2,043,815,823 2,368,588,822 Concession financial receivable - current portion (Notes 10, 26 and 27) 197,043, ,252,687 Inventories (Note 7) 210,749, ,569,769 Other current assets (Note 8) 1,394,897,931 1,454,787,578 Total Current Assets 12,867,251,020 8,255,898,978 Noncurrent Assets Property, plant and equipment (Notes 9 and 21) 2,735,314,542 1,796,169,070 Service concession assets - net (Notes 10, 21 and 23) 74,150,945,381 64,653,247,094 Concession financial receivable - net of current portion (Notes 10, 26 and 27) 1,187,507,674 1,005,560,931 Investments in associates (Note 11) 6,796,037,256 6,199,517,193 Goodwill (Note 4) 132,755, ,319,465 Pension asset - net (Note 15) 16,111, ,010,000 Deferred tax assets - net (Note 18) 1,202,732,462 1,185,689,005 Other noncurrent assets (Notes 12, 26 and 27) 3,393,585,445 2,134,990,370 Total Noncurrent Assets 89,614,989,325 77,223,503,128 P=102,482,240,345 P=85,479,402,106 LIABILITIES AND EQUITY Current Liabilities Accounts and other payables (Notes 13, 21, 23 and 27) P=4,970,352,643 P=3,946,924,889 Current portion of: Long-term debt (Notes 14, 26 and 27) 4,614,057,448 2,287,380,591 Service concession obligations (Notes 10, 23, 26 and 27) 800,961, ,417,320 Income tax payable (Note 18) 441,002, ,783,876 Total Current Liabilities 10,826,374,003 7,481,506,676 Noncurrent Liabilities Noncurrent portion of: Long-term debt (Notes 14, 26 and 27) 35,110,322,008 25,331,120,889 Service concession obligations (Notes 10, 23, 26 and 27) 6,646,714,054 6,959,227,343 Pension liabilities - net (Note 15) 41,506,260 31,826,900 Deferred tax liabilities - net (Note 18) 111,542, ,584,175 Provisions (Note 29) 501,099, ,099,013 Other noncurrent liabilities (Notes 16, 26 and 27) 683,984, ,349,555 Total Noncurrent Liabilities 43,095,168,919 33,616,207,875 Total Liabilities 53,921,542,922 41,097,714,551 (Forward) MAKE WAVES 129

18 December Equity Attributable to equity holders of Manila Water Company, Inc. Capital stock (Note 19): Common stock P=2,053,666,576 P=2,053,666,576 Preferred stock 400,000, ,000,000 2,453,666,576 2,453,666,576 Additional paid-in capital 4,230,508,417 4,221,712,962 Subscriptions receivable (235,693,873) (319,227,328) Total paid-up capital 6,448,481,120 6,356,152,210 Common stock options outstanding (Note 19) 28,700,622 25,325,260 Retained earnings (Note 19): Appropriated 28,698,000,000 21,100,000,000 Unappropriated 11,426,282,242 15,000,583,191 Remeasurement gain on defined benefit plans (Note 15) 3,251,651 60,812,693 Other equity reserves (Notes 1 and 19) 54,106,905 54,106,905 Cumulative translation adjustment (Notes 2 and 11) 895,910, ,422,320 47,554,733,022 43,384,402,579 Noncontrolling interests (Notes 1, 2 and 19) 1,005,964, ,284,976 Total Equity 48,560,697,423 44,381,687,555 P=102,482,240,345 P=85,479,402,106 See accompanying Notes to Consolidated Financial Statements Integrated Report

19 MANILA WATER COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December REVENUE Water (Note 21): East Zone P=12,123,443,381 P=12,034,756,289 P=11,897,119,383 Outside East Zone 2,145,622,488 1,635,673,199 1,323,110,432 Environmental charges (Note 21) 2,481,248,409 2,420,227,209 2,374,388,215 Sewer (Note 21): East Zone 226,593, ,006, ,456,863 Outside East Zone 229,012, ,936, ,292,277 Other operating income (Notes 16, 17, 21 and 22) 1,309,851,738 1,207,311, ,515,470 18,515,772,230 17,711,911,107 16,935,882,640 COST OF SERVICES Depreciation and amortization (Notes 9 and 10) 2,206,053,556 2,241,324,647 2,303,707,042 Power, light and water (Note 21) 1,183,196, ,000, ,444,002 Salaries, wages and employee benefits (Notes 15, 19 and 21) 1,063,651,691 1,315,751,741 1,183,972,052 Repairs and maintenance 379,544, ,526, ,645,322 Contractual services 316,447, ,677, ,550,207 Management, technical and professional fees (Note 21) 285,635, ,749, ,996,024 Regulatory costs (Note 1) 191,815, ,320, ,288,346 Cost of water service connections 190,849, ,761, ,904,080 Wastewater costs 162,923, ,909, ,063,441 Cost of packaged water (Note 7) 111,340,926 69,741,022 36,889,684 Collection fees 110,573, ,708, ,420,035 Water treatment chemicals 107,109,226 81,992,647 83,546,019 Occupancy costs (Notes 21, 24 and 28) 43,488,003 55,562, ,036,911 Other expenses 222,433, ,869, ,311,265 6,575,061,506 6,380,895,970 6,676,774,430 GROSS PROFIT 11,940,710,724 11,331,015,137 10,259,108,210 OPERATING EXPENSES (Note 17) 3,342,316,747 2,677,731,651 1,772,425,207 INCOME BEFORE OTHER INCOME (EXPENSES) 8,598,393,977 8,653,283,486 8,486,683,003 OTHER INCOME (EXPENSES) Revenue from rehabilitation works (Notes 1, 2 and 10) 11,672,137,031 6,804,908,377 5,219,358,277 Cost of rehabilitation works (Notes 1, 2 and 10) (11,672,137,031) (6,804,908,377) (5,219,358,277) Interest expense (Notes 14 and 17) (1,403,236,110) (1,429,206,868) (1,457,535,361) Equity share in net income of associates (Note 11) 457,208, ,829, ,514,812 Interest income (Note 17) 345,737, ,123, ,944,042 Foreign currency differentials (Note 1) 152,454, ,311, ,463,433 Foreign exchange losses (150,895,347) (761,789,202) (413,741,038) Gain on disposal of property and equipment - net 15,999,530 2,173,007 24,952,444 Amortization of deferred credits (Note 16) 11,142,247 9,814,745 8,432,177 Other income - net (Notes 4, 11 and 16) 55,071,907 36,825,155 42,250,317 (516,517,718) (719,919,094) (557,719,174) INCOME BEFORE INCOME TAX 8,081,876,259 7,933,364,392 7,928,963,829 PROVISION FOR INCOME TAX (Note 18) 1,941,928,572 1,746,374,542 1,794,923,838 NET INCOME 6,139,947,687 6,186,989,850 6,134,039,991 (Forward) MAKE WAVES 131