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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   ----------

                                    FORM 10-K

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

                          COMMISSION FILE NO. 001-15065

                                   ----------

                                  AZURIX CORP.
             (Exact name of registrant as specified in its charter)

                  DELAWARE                           76-0589114
      (State or other jurisdiction of             (I.R.S. Employer
       incorporation or organization)              Identification
                                                        No.)
              333 CLAY STREET
                 SUITE 1000
               HOUSTON, TEXAS                          77002
  (Address of principal executive offices)           (Zip Code)

       Registrant's telephone number, including area code: (713) 646-6001

        Securities Registered Pursuant to Section 12(b) of the Act: NONE

        Securities Registered Pursuant to Section 12(g) of the Act: NONE

    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 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. [X]

    All shares of registrant's common equity are held by affiliates of
registrant. As of March 29, 2001, there were three shares of registrant's common
stock outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

                                      NONE

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                                TABLE OF CONTENTS


<TABLE>
<CAPTION>

                                                                                                     Page
                                                                                                     ----
PART I
<S>        <C>                                                                                       <C>
  Item 1.  Business
              General.................................................................................  1
              Our Business............................................................................  2
              Existing Azurix Assets..................................................................  3
              Regulatory Matters...................................................................... 13
              Factors that may Affect Future Results and Accuracy of Forward-Looking Statements....... 26
  Item 2.  Properties................................................................................. 31
  Item 3.  Legal Proceedings.......................................................................... 31
  Item 4.  Submission of Matters to a Vote of Security Holders........................................ 32

PART II

  Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters...................... 33
  Item 6.  Selected Financial Data.................................................................... 33
  Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations...... 35
  Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................. 43
  Item 8.  Financial Statements and Supplemental Data................................................. 45
  Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....... 91


PART III

  Item 10. Directors and Executive Officers of the Registrant........................................  91
  Item 11. Executive Compensation....................................................................  92
  Item 12. Security Ownership of Certain Beneficial Owners and Management............................  97
  Item 13. Certain Relationships and Related Transactions............................................  98

PART IV

  Item 14. Financial Statement Schedules and Reports on Form 8-K..................................... 102

SIGNATURES........................................................................................... 105
</TABLE>

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                                     PART I

ITEM 1. BUSINESS

GENERAL

    Azurix is a global water company engaged in the business of owning,
operating and managing water and wastewater assets, providing water and
wastewater related services and developing and managing water resources. We are
a holding company and conduct substantially all of our operations through our
subsidiaries.

    Azurix was formed by Enron Corp., one of the world's leading electricity,
natural gas and communications companies, in 1998. In December 1998, Enron
contributed our company to Atlantic Water Trust, a Delaware business trust. In
connection with Enron's contribution, Marlin Water Trust acquired a 50% voting
interest in Atlantic Water Trust. In June 1999, we completed our initial public
offering of 38,563,468 shares of common stock. Following the offering, Atlantic
Water Trust owned approximately 67% of our common stock, with public
shareholders owning the remainder.

    On March 16, 2001, our shareholders approved and adopted an agreement and
plan of merger whereby an indirect, wholly owned subsidiary of Enron was merged
into Azurix with Azurix being the surviving corporation. The merger took effect
later the same day, immediately following the close of trading on the New York
Stock Exchange. In the merger:

    o    each issued and outstanding share of Azurix common stock, other than
         those shares held by Atlantic Water Trust, was cancelled and converted
         automatically into the right to receive $8.375 per share (rounding up
         the aggregate cash to be paid to each such shareholder, to the extent
         necessary, to the next $.01);

    o    the aggregate shares of Azurix common stock held by Atlantic Water
         Trust were cancelled and converted into two shares of common stock of
         the surviving corporation in the merger;

    o    the shares of stock of the Enron merger subsidiary were cancelled and
         converted into one share of common stock of the surviving corporation
         in the merger;

    o    all treasury shares were cancelled; and

    o    shares of Azurix common stock held by shareholders who had perfected
         their appraisal rights became subject to appraisal in accordance with
         Delaware law.

 Therefore, Atlantic Water Trust owns two-thirds, and Enron through a wholly
owned subsidiary owns one-third of our issued and outstanding common stock.
Enron and Marlin Water Trust each continue to own a 50% voting interest in
Atlantic Water Trust. Upon completion of the merger, our shares of common stock
were delisted from the New York Stock Exchange and are no longer publicly
traded.

    In addition, under the agreement and plan of merger, Azurix retired $180
million of borrowings outstanding under our credit agreement with Enron through
the issuance to Enron of 11% cumulative mandatorily redeemable preferred stock
with an initial liquidation preference of $180 million and the credit agreement
was cancelled. We may not redeem the preferred stock prior to the date that all
of our senior notes due 2007 and 2010 have been redeemed. We must redeem the
preferred stock on or before the second anniversary of the date that the senior
notes are no longer outstanding. Dividends will accrue, but will not be paid
until all of our senior notes have been redeemed.

    As disclosed in the proxy statement that we mailed to our shareholders in
connection with the merger, Enron does not view Azurix as a core strategic
asset. While no definitive plans have been made, we intend to pursue the
potential disposal of certain of our assets provided favorable prices for those
assets can be obtained.

    Our largest asset is Wessex Water Ltd, a water and wastewater company based
in southwestern England, which we acquired in October 1998. Our asset portfolio
also includes the following:


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    o    interests in long-term water and wastewater concessions in the
         Provinces of Buenos Aires and Mendoza, Argentina and in Cancun, Mexico

    o    Azurix North America, a water and wastewater services company with
         operations in the United States and Canada

    o    a 49% interest in Industrias del Agua, a company that provides water
         and wastewater related services in a portion of Mexico City, Mexico,
         and participates in water and wastewater projects elsewhere in Mexico

    o    Geoplan, a water and wastewater services company that provides water
         drilling, water supply and water and wastewater treatment services in
         Brazil

    o    Lurgi Bamag, a water and wastewater engineering services company with
         offices in Germany, Brazil, Egypt and the United Kingdom

    o    property in Madera County, California, on which we are developing the
         Madera Water Bank, a ground water storage project

    As of December 31, 2000, concessions in which we own an interest and water
and wastewater systems that we operate served an aggregate population of
approximately 9.6 million for water and approximately 7.7 million for
wastewater. The businesses in our asset portfolio currently employ approximately
5,400 individuals worldwide, with approximately 35 employees on our corporate
staff in Houston.

    During the fourth quarter of 2000, due to events that occurred with respect
to our Argentine assets, we reevaluated our investments in Argentina and as a
result wrote down the net carrying value of our Argentine assets to their fair
value. See Note 17 to the Consolidated Financial Statements.

    Azurix was incorporated in Delaware on January 29, 1998. Our principal
executive offices are located at 333 Clay Street, Suite 1000, Houston, Texas
77002 and our telephone number is (713) 646-6001. Azurix maintains an internet
site at www.azurix.com. Unless the context otherwise requires, when we refer to
"we" or "Azurix" in this Annual Report, we mean Azurix Corp. and all of our
consolidated subsidiaries.

OUR BUSINESS

    Our business is focused on the following complementary areas in the global
water industry:

    o    owning, operating and managing water and wastewater assets

    o    providing water and wastewater related services, including resource,
         operational and residuals services

OWNING, OPERATING AND MANAGING WATER AND WASTEWATER ASSETS

    We own interests in water and wastewater systems in the United Kingdom,
Argentina, Mexico, the United States and Canada. These assets are described more
fully under "Existing Azurix Assets." We are not currently pursuing ownership of
additional water and wastewater systems.

PROVIDING WATER AND WASTEWATER RELATED SERVICES

    We provide a broad range of cost-effective services to owners of water and
wastewater systems and to municipal and industrial customers, including services
in each principal area of the water value chain: resource services, operational
services and residuals services.

    Resource Services. We believe the growing demand for drinking water has
generated a need for better management of water resources. We believe that there
are significant capital, technical and operational needs for this area of the
water industry and that governments are increasingly turning to the private
sector to manage and meet these needs. This "upstream" end of the water value
chain includes the following services to water distribution systems and
industrial and agricultural customers:


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    o    Raw water resources -- Locating, drilling and extracting water supply,
         developing reservoir management projects and using desalinization and
         other techniques to develop new supplies

    o    Conveyance and storage systems -- Developing transportation and storage
         projects, including pipelines, aqueducts and underground storage

    Operational Services. Services for the operation of a water and wastewater
system or industrial or agricultural business can involve:

    o    water treatment processes

    o    distribution of water

    o    retail services, including billing, metering, collection and customer
         care

    o    wastewater collection

    o    wastewater treatment

    Our water related services business is currently targeting municipal and
industrial customers, especially in North America, that are seeking to outsource
the management of their systems or particular services. These customers
generally desire a service provider with the operating experience to provide
reliable water supply and wastewater treatment services and the ability to
comply with more stringent regulatory requirements for water quality and
environmental protection.

    Residuals Services. We provide residuals management and disposal services in
various parts of the United States and Canada through land application and
dewatering.

    Detail of our operating revenues and long-lived assets by geographic area is
included in the Notes to Consolidated Financial Statements (see Note 20).

    The following table represents the operating revenues contributed by each of
the service categories of our business for the periods indicated, although all
of the operating revenues occurred after the date of the Wessex acquisition:

<TABLE>
<CAPTION>

                                               JANUARY 29,
                                                 1998 TO       YEAR ENDED   YEAR ENDED
                                               DECEMBER 31,   DECEMBER 31,  DECEMBER 31,
                                                   1998          1999          2000
                                               ------------   ------------  ------------
                                                              (IN MILLIONS)
<S>                                            <C>            <C>           <C>
Water supply ...............................      $ 35.0         $186.0        $208.9
Wastewater services ........................        73.1          320.3         316.5
Residuals management .......................         7.2           27.1          62.5
Other ......................................         4.4           84.6         169.4
                                                  ------         ------        ------
     Total .................................      $119.7         $618.0        $757.3
                                                  ======         ======        ======
</TABLE>

EXISTING AZURIX ASSETS

EUROPE

    Wessex. Wessex's principal business is providing water supply and wastewater
services in parts of southwestern England through Wessex Water Services Limited,
a wholly owned subsidiary. Wessex has a virtual monopoly over water supply and
wastewater services in its region, with the exception of extensive areas around
and including the cities of Bristol and Bournemouth and a small area of rural
Wiltshire, where three other companies provide only water services and Wessex
provides wastewater services.

    The Wessex region covers approximately 10,000 square kilometers and is
predominantly rural. There are two major urban areas in the region, with Bristol
and Bath in the north and Bournemouth and Poole in the south. The largest town
for which Wessex provides water is Poole with a population of approximately
102,000, and the


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largest town for which Wessex provides wastewater services is Bristol, with a
population of approximately 400,000 (approximately 800,000 including the
surrounding area). For the year ended December 31, 2000, Wessex had operating
revenues of approximately $415.4 million and earnings before interest, income
tax, depreciation and amortization, impairment of long-lived assets and
investment in unconsolidated affiliate, and minority interest of approximately
$278.2 million.

    o    Water Supply Services. Wessex supplies approximately 375 million liters
         of water per day to a population of approximately 1.2 million using its
         water infrastructure. The system includes approximately 138 water
         sources, 128 water treatment plants, 320 pumping stations, 360 storage
         reservoirs and 11,130 kilometers of water mains. Wessex serves
         approximately 519,000 domestic and commercial locations. Wessex's
         customer base is approximately 55% residential and 45% commercial by
         volume of supply.

         Wessex withdraws 78% of its water from underground sources and the
         remainder from reservoirs (21%) and rivers (1%). Wessex has a
         comprehensive network of storage reservoirs (interlinked by a regional
         grid), which facilitates water management during periods of low
         rainfall. As a result of its strong water resources, internal grid
         network and water management, Wessex has not enforced any restrictions
         on water usage in the past 24 years.

         During the year ended December 31, 2000, Wessex tested approximately
         35,000 drinking water samples and achieved 99.9% compliance with the
         strict U.K. and European Union standards. The Office of Water Service,
         the industry regulator for England and Wales commonly called Ofwat,
         repeatedly has ranked Wessex as the most efficient operator of the
         privatized U.K. water and wastewater companies.

         As of December 31, 2000, Wessex had invested approximately $780 million
         in capital projects related to improvements in its water infrastructure
         since its privatization in 1989, of which over $450 million had been
         invested since 1993. Wessex's water supply network continues to require
         further investment.

    o    Wastewater Services. Wessex treats on average 480 million liters of
         wastewater per day from a population of approximately 2.5 million
         through its infrastructure of approximately 360 wastewater treatment
         plants, 1,300 pumping stations and 15,400 kilometers of sewers.
         Residential customers account for approximately 86% of the volume of
         wastewater retrieved and commercial customers account for approximately
         14%.

         Wessex's wastewater treatment plants perform above industry standards.
         Wastewater is collected in the wastewater system and pumped or
         gravitated to wastewater treatment plants where the wastewater passes
         through processes designed to remove biosolids and purify the
         wastewater. Following further processes, Wessex disposes of 70% of its
         biosolids to agricultural land, uses 10% in landscaping and land
         reclamation work and disposes of 20% in landfills. Approximately 10% of
         biosolids are subjected to an advanced heated drying treatment at
         Wessex's major wastewater treatment facility at Avonmouth, near
         Bristol. During 2000, Wessex commissioned similar drying facilities,
         referred to as biodriers, at Weston-super-Mare and is currently
         commissioning a biodrier at Bournemouth.

         During the year ended March 31, 2000, Wessex's wastewater treatment
         plants were in substantial compliance with applicable U.K. and European
         Union discharge standards and 99% of these plants were in 100%
         compliance with applicable discharge standards.

         As of December 31, 2000, Wessex had invested approximately $1.5 billion
         in capital projects related to improvements in its wastewater
         infrastructure since its privatization in 1989, of which approximately
         $870 million had been invested since 1993. Wessex has been upgrading
         many of its wastewater treatment plants to comply with European Union
         legislation. At some of its treatment facilities, Wessex has introduced
         advanced filtration technology using membranes, ultraviolet
         disinfection and fully enclosed underground plants in connection with
         the treatment of wastewater. Wessex's wastewater treatment plant at
         Swanage in Dorset, which was commissioned in 2000, is the largest
         operational plant in the world to use membrane filtration technology to
         process domestic wastewater to a state that is virtually bacteria and
         virus free.



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    o    Properties. Wessex manages over 2,500 installations. These include
         approximately 138 water sources, 128 water treatment plants, 320 clean
         water pumping stations, 360 storage reservoirs, 1,300 wastewater
         pumping stations and 358 wastewater treatment plants. The following is
         a list of the five largest water treatment plants operated by Wessex:

<TABLE>
<CAPTION>

                                                                  CAPACITY
              LOCATION                                    (MILLION LITERS PER DAY)
              --------                                    ------------------------
<S>                                                       <C>
               Maundown ...............................             72
               Upton Scudamore ........................             36
               Corfe Mullen ...........................             33
               Sturminster Marshall ...................             30
               Durleigh ...............................             30
</TABLE>


    The following is a list of the five largest wastewater treatment plants
operated by Wessex:

<TABLE>
<CAPTION>

                                                     ESTIMATED EQUIVALENT
               LOCATION                               POPULATION SERVED
               --------                              --------------------
<S>                                                   <C>
               Bristol (Avonmouth) .................      897,000
               Holdenhurst .........................      180,000
               Poole ...............................      159,000
               Bath (Saltford) .....................      109,000
               Bridgwater ..........................      107,000
</TABLE>

    o Customer Charges. The U.K. Director General of Water Services sets limits
      on the rates Wessex may charge for its regulated water supply and
      wastewater treatment businesses, including the extent of annual rate
      increases.

      Charges for water supply and wastewater services are calculated separately
      based on the average costs of providing each service for each class of
      customers. Currently, approximately 82% of household bills are calculated
      in part on the basis of the ratable value of the property rather than on
      water usage. The remaining 18% of household customers pay based on metered
      water usage. Where a customer receives a metered water supply, wastewater
      services charges are based on the volume of water supplied. Wessex offers
      a free meter installation service to all its customers and, as a result,
      the level of metering in Wessex's territory is above the industry average
      in the United Kingdom. New properties will be subject to metering.

      Charges are generally set on a standard tariff basis. Charges for bulk
      supplies of water are usually determined on an individual basis, as are
      charges for some larger commercial water supplies and some industrial
      wastewater. The charging basis for bulk supplies in some cases provides
      for annual recalculation by reference to the expenditure associated with
      the supply. Wastewater from industrial users is normally charged on a
      formula basis taking account of the volume of wastewater, its strength and
      costs of removal and treatment.

      In 1999, the Director issued new price limits for Wessex and other U.K.
      water and wastewater companies that applied from April 1, 2000. As a
      result, Wessex's prices were reduced by 12.0% beginning April 1, 2000,
      before adjustment for inflation. Current pricing limits will remain level
      through March 2003 with price increases effective April 1, 2003 of 3.8%
      and April 1, 2004 of 4.7%, before adjustment for inflation. Companies are
      required to implement certain policies in their charging schemes that
      must, for example, deal with tariffs for vulnerable groups,
      cost-reflective charging, the balance between water and wastewater
      charges, metered and unmetered tariff differentials, large user tariffs,
      timing and methods of payment and optional metering. See Note 19 to the
      Consolidated Financial Statements and "Regulatory Matters -- U.K.
      Regulatory Matters -- Tariff Rates."

      The Water Industry Act 1999 became effective on April 1, 2000. It grants
      household customers the right:

      o  to resist water metering in their current homes if they are not using
         water for non-essential purposes

      o  to have a free meter installed if they wish to have one, where this is
         practicable

      o  where they have taken up the right to have a free meter installed, to
         revert to an unmetered basis of charging within 12 months if they so
         choose

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    Prior to this legislation, Wessex already had implemented a free metering
    program with a right to revert to unmetered service. In addition, two new
    regulations under the Water Industry Act 1991, as amended by the Water
    Industry Act 1999, became effective on April 1, 2000. These regulations:

    o  protect vulnerable customers with high essential water use, who live in
       homes with meters, from higher than average water bills

    o  prevent water companies from disconnecting domestic customers and other
       protected premises for non-payment

    o  grant new powers for the Director to approve charging schemes annually,
       taking account of guidance from the Secretary of State

    In the meantime, the U.K. government continues to review the provisions
    dealing with vulnerable customers and will consider whether it is necessary
    to introduce amendments to meet the needs of customers facing severe
    hardship over their water bills. The Director will also consult on whether
    to impose widespread metering in areas where water resources are under
    stress. The structure for setting water companies' charges under the Water
    Industry Acts 1991 and 1999 and regulations thereunder provides for
    adjustments to the charges from the entirety of Wessex's customers so that
    the total amount of income to Wessex is not affected by reductions in
    charges to vulnerable customers.

    Following the introduction of the new legislation, the Secretary of State
    has given guidance to the Director that highlighted a number of key
    objectives, including providing a fair distribution of costs between
    customers, affordability, taking into account environmental considerations,
    ensuring stability and predictability of charges and providing transparent
    and customer-focused services.

    Lurgi Bamag. On October 18, 1999, we acquired Lurgi Bamag GmbH, a water and
wastewater engineering services company. Lurgi Bamag and its subsidiaries have
offices in Germany, Brazil, Egypt and the United Kingdom. Lurgi Bamag serves
industrial customers in the refining, pulp and paper, petrochemicals and iron
and steel industries that require cost-efficient, high quality water and
wastewater treatment.

NORTH AMERICA

    Azurix North America. On May 18, 1999, we acquired Philip Utilities
Management Corporation, a water and wastewater services company headquartered in
Hamilton, Ontario, Canada. Following our acquisition of this business, now
called Azurix North America, we have expanded it through the acquisition of
several water and wastewater companies in the United States and Canada. Azurix
North America conducts operations in Canada and the United States, with a
concentration of operations in the province of Ontario and in the states of
Alabama, Arizona, Florida, Georgia, Louisiana, Maine, New Jersey, Texas and
Washington. For the year ended December 31, 2000, Azurix North America had
operating revenues of approximately $157.0 million and earnings before interest,
income tax, depreciation and amortization, impairment of long-lived assets and
investment in unconsolidated affiliate, and minority interest of approximately
$13.1 million.

    Azurix North America operates through six business divisions, described
below:

    o  Operations and Maintenance (O&M). Azurix North America's O&M division
       operates a wide range of municipal water and wastewater treatment
       facilities, from small rural plants to large-scale treatment facilities.
       O&M provides management, operations and maintenance of all water and
       wastewater infrastructure and a full range of customer management
       services, including billing, collection and customer service. Our O&M
       division serves approximately 700 water and 300 wastewater facilities
       throughout the United States and Canada. Azurix North America's largest
       O&M projects are in Hamilton-Wentworth, Ontario and Seattle, Washington.

       In 1994, Philip Utilities was awarded the contract to operate and
       maintain the 192 million gallon per day water treatment facility and the
       110 million gallon per day wastewater treatment facility of the regional
       municipality of Hamilton-Wentworth. Under the operations agreement, we
       receive an adjustable flat fee plus a portion of any cost savings
       realized under the contract. Services provided under the operations
       agreement include the day-to-day operation, maintenance, repair and
       permitting and compliance of the water and


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       wastewater treatment facilities, as well as several remote plants and
       pumping stations. Under the terms of the plant operations agreement,
       Hamilton-Wentworth pays an annual fee to us equal to an agreed upon base
       budget, adjusted for inflation, salary and wage increases, insurance
       costs, ash, sludge and grit disposal costs and increases in cost of
       corporate overhead. In addition, Hamilton-Wentworth shares in
       approximately 40% of actual annual costs savings over the base budget
       amount by reducing the annual fee due to us.

       Azurix North America's second largest contract operation project is the
       design-build-operate contract with Seattle Public Utilities for the 120
       million gallon per day Tolt Treatment Facility located outside of
       Seattle, Washington. In 1996, Philip Utilities teamed with the
       engineering firm of Camp Dresser & McKee, Inc. to win this 20-year
       contract, which is renewable by the City of Seattle for two additional
       periods of five years each. Azurix CDM, Inc., an 80%-owned subsidiary of
       Azurix North America, received approximately $70.7 million in design and
       construction fees. Azurix CDM subcontracted the design-build portion of
       the contract for approximately $63 million. Construction of the Tolt
       plant was completed in December 2000 and the facility commenced
       operations in February 2001. Under the contract, Azurix CDM is entitled
       to receive an annual service fee of approximately $2.0 million, subject
       to modification for incentive bonuses, pass-through costs and other
       adjustments.

    o  Engineering Services. Azurix North America provides plant design,
       construction, project management and process design and engineering
       services primarily for municipal customers and other Azurix North America
       operations. Azurix North America also provides process automation and
       instrumentation services including design, testing and installation of
       supervisory control and data acquisition systems and other computer
       control technologies primarily for municipal customers.

    o  Residuals Management. The residuals management division transports,
       dewaters, treats and disposes of residuals and provides regulatory
       compliance services to municipal and industrial customers across North
       America, with significant concentrations in Ontario and Florida and
       Texas.

    o  Underground Infrastructure Remediation and Development. Azurix North
       America's underground infrastructure division (UID) repairs,
       rehabilitates, and maintains the collection and distribution systems used
       to transport water and wastewater to and from treatment facilities and
       industrial and residential users. To this end, the division offers a wide
       range of underground asset management services to customers in the United
       States and Canada, including closed circuit television inspection and
       location mapping, as well as pipeline repair and rehabilitation. Since
       1996, Azurix North America and its predecessor, Philip Utilities, have
       been migrating from traditional pipe rehabilitation to trenchless
       technologies. Azurix North America employs a variety of trenchless
       technologies for which it holds licenses in various geographic
       territories. Among these licensed products are epoxy resins, polyurethane
       fold-and-form pipe, a roll-down pipe product, two cured-in-place products
       and a spot repair system.

    o  Carbon Services. Azurix North America operates its carbon services
       division through its wholly owned subsidiary, Azurix North America Carbon
       Services Corp., and through its majority-owned subsidiary, Horseshoe
       Carbons Inc. Azurix North America Carbon Services Corp. installs,
       transports, removes, and supplies granular activated carbons for water
       treatment facilities. Horseshoe Carbons, which is 80% owned by Azurix
       North America and 20% owned by PICA SA, a French-based manufacturer of
       activated carbons, regenerates the spent granular activated carbons for
       customers.

    o  Investor Owned Utilities. In addition to its outsourcing operations,
       Azurix North America owns three small regulated utilities in North
       America. Southwest Utilities, Inc. and Walker Water Works, Inc. are
       located near Houston, Texas, while Horseshoe Valley Resort, Inc. is
       situated in Ontario, Canada. Together, these utilities serve
       approximately 4,000 customers.

    Madera Water Bank Project. On October 4, 1999, we purchased approximately
13,600 acres of land in Madera County, California. We currently are seeking
permits to construct, own and operate the Madera Water Bank Project, a 400,000
acre-foot ground water storage project in the aquifer beneath the land for use
by municipal, industrial and agricultural customers. The aquifer on the property
will be used to store surplus water from local, state and federal water
customers during wet years in an effort to make this water available for use
throughout the region and state during drier years or as the market dictates.
The property is located 25 miles northwest of Fresno and is strategically
located near existing state and federal canals and aqueducts and the San Joaquin
River, all of which could provide a number of alternative conveyance systems to
move water to and from


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the site. We are required to make additional payments to the seller, contingent
upon our ability to successfully obtain the required water bank permits and our
commencement of operations of the water bank.

    Completion of the Madera Water Bank Project will require various
governmental permits and, if permits are obtained, construction expenditures
that we currently estimate to be in the range of $35 to $40 million. We will
also need to satisfy local property owner and county concerns regarding the
impact the project will have on local water resources prior to starting
construction. If the project is constructed, we intend to sell a majority of the
storage capacity of the proposed water bank on a long-term basis. Although we
are working to obtain the necessary permits and satisfy local community concerns
in a timely manner, we cannot yet be assured these efforts will be successful.

LATIN AMERICA

    Azurix Buenos Aires. On July 1, 1999, we assumed operation of a 30-year
concession to operate the water and wastewater systems in two regions of the
Province of Buenos Aires, Argentina, previously operated by Administracion
General de Obras Sanitarias de la Provincia Buenos Aires. Azurix currently owns
90% of Azurix Buenos Aires, with a 10% interest in Azurix Buenos Aires being
held by employees. For the year ended December 31, 2000, Azurix Buenos Aires had
operating revenues of approximately $89.5 million and earnings before interest,
income tax, depreciation and amortization, impairment of long-lived assets and
investment in unconsolidated affiliate, and minority interest of approximately
$(11.6) million.

    The Province of Buenos Aires surrounds the Argentine capital city. It is the
country's largest province, with a total population of approximately 13.5
million. The two regions included in our concession have a total population of
approximately 2.1 million. They include the provincial capital of La Plata and
the large industrial city of Bahia Blanca.

    Azurix Buenos Aires supplies approximately 976 million liters of water per
day through a system that includes approximately 504 extraction wells, 16 water
treatment plants, 63 storage tanks, 30 cisterns and 7,301 kilometers of water
mains. Azurix Buenos Aires treats approximately 205 million liters of wastewater
through its infrastructure of approximately 43 wastewater treatment plants, 48
pumping stations and 4,280 kilometers of sewers. The aggregate capacity of its
water treatment plants is approximately 616 million liters per day and the
aggregate capacity of its wastewater treatment plants is approximately 250
million liters per day.

    The concession contract requires Azurix Buenos Aires to develop and complete
a specified investment plan to improve water quality, recondition the
distribution and collection network, expand customer metering and water and
wastewater connections and reduce water losses. Additionally, the concession
contract requires Azurix Buenos Aires to provide for the expansion,
reconditioning and construction of wastewater treatment plants. At the time we
assumed operation of the concession, we anticipated incurring capital
expenditures of approximately $350 million during the first five years, but as
discussed below, this program is currently being renegotiated with the Province.
The concession also obligates Azurix Buenos Aires to maintain minimum
requirements regarding stated capital, contract guarantees and insurance.

    Administracion General de Obras Sanitarias de la Provincia de Buenos Aires
transferred 1,098 employees to Azurix Buenos Aires. The employees transferred to
Azurix Buenos Aires were mostly hourly operational personnel, requiring us to
hire most of our managerial level staff. Azurix Buenos Aires has entered into a
collective bargaining agreement with the union since taking over the concession.
Labor expenses accounted for approximately 70% of the operational expenses of
the provincial operator prior to the take over by Azurix Buenos Aires, and this
level is not expected to change during the term of the concession. The board of
directors of Azurix Buenos Aires has the authority to appoint the key technical
and managerial positions at the company.

    Initially, the tariff has remained the same as was in effect prior to
privatization. Under the concession contract, the first ordinary tariff review
is expected around 2004. The tariff then is to be reviewed every five years in
light of changes to the five-year program of investment. Azurix Buenos Aires or
the regulator may at any time ask for an increase or reduction in the tariff if
consumer cost indices change by more than 3% or if there are material changes in
Argentine tax law, other than value added tax or income tax, changes in water
quality standards or environmental regulations or substantial changes in the
condition of the concession. Both the concession contract and the governing law
provide that tariff modifications may not be used to penalize Azurix Buenos
Aires if it operates more efficiently than expected. Azurix Buenos Aires is
required to provide lower rates to specified users,


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including retired persons with low income, care centers for the elderly and for
physically challenged children, public schools, public sports facilities and
libraries.

    Azurix Buenos Aires has not been performing to expectations. The Province
has not allowed the concession company to charge rates in accordance with the
tariff set by the concession contract, thereby affecting the concession
company's ability to raise capital and to serve its customers. Further, we did
not receive complete billing and customer records when we took over the
concession, which has impeded collection efforts and adversely affected our
operating revenues derived from this concession to date. We have embarked on a
program to improve billing and debt collection procedures and increase the
number of accounts billed, which we believe will improve collections. In
addition, the Province did not transfer some of the assets that the concession
agreement required it to transfer, including some accounts receivable; has not
completed some work projects that the concession agreement obligates it to
perform; and has not paid some pre-takeover costs that we now have paid.

    Negotiations with the Province thus far have failed to result in resolution
of disputed items, despite oral assurances from provincial officials to Azurix
Buenos Aires management that various matters would be resolved by the end of
2000, including allowing Azurix to charge rates at levels consistent with the
concession contract. In addition, during the last week of December 2000, some
prominent officials in the Province publicly advocated cancellation of the
contract. Azurix does not believe the Province has grounds for cancellation
without compensation and is vigorously challenging the Province's actions and
will continue to do so; however, the lack of resolution on rates by the end of
2000, and a shift in the political environment during the last week of 2000
caused us to revise our expectation of future cash flows from this concession,
including collection rates from customers, and to evaluate the recoverability of
related tax assets. Accordingly, during the fourth quarter of 2000, we wrote
down the carrying value of these assets to their fair value. See Note 17 to the
Consolidated Financial Statements.

    On February 15, 2001, the Province and Azurix Buenos Aires entered into a
Memorandum of Understanding regarding a variety of issues between them. The
Memorandum of Understanding, among other things, set an investment program for
2001 at a lower level than previously required and established a framework for
negotiating issues associated with tariff levels and the remaining capital
program. There is no assurance, however, that these negotiations will result in
a resolution satisfactory to Azurix or the Province.

    Mendoza, Argentina. In May 1998, Enron, in a consortium co-led by SAUR, a
French water company, successfully bid to acquire a controlling interest in
Obras Sanitarias Mendoza S.A., a privatized company that holds a 95-year
exclusive concession to provide water and wastewater services to the majority of
the Province of Mendoza, Argentina. In December 1998, Enron contributed to
Azurix its 32.1% interest in Obras Sanitarias Mendoza. SAUR also owns a 32.1%
interest in the concession holder, local private investors own a 3.3% interest,
Italgas owns a 2.5% interest, employees own a 10.0% interest and the Province of
Mendoza owns the remaining 20.0%. Obras Sanitarias Mendoza is currently operated
by SAUR under an operations agreement and is governed by a five-member board of
directors, two of whom have been appointed by Azurix.

    Obras Sanitarias Mendoza is charged with operating, maintaining and
upgrading its nine drinking water plants and 20 wastewater treatment plants as
well as associated distribution and collection networks to Mendoza. Its service
territory covers 17 municipalities. Obras Sanitarias Mendoza serves over one
million water customers and has approximately 245,000 water connections. Obras
Sanitarias Mendoza provides wastewater services to approximately 900,000 people
and has approximately 150,000 wastewater connections. The concession contract
requires Obras Sanitarias Mendoza to expand the water and wastewater connections
in the concession area over the next 10 to 15 years. Through 2015, approximately
$180 million is expected to be spent on new connections, new water and
wastewater treatment facilities and system improvements. Obras Sanitarias
Mendoza's assets include raw water transportation pipelines and aqueducts,
drinking water treatment plants and other general assets.

    The concession is located in western Argentina in the desert bordering Chile
at the base of the Andes mountains. Water supply comes primarily from the
regional river, Rio Mendoza. The surface water feeds by gravity to treatment
plants. The remaining ground water comes from approximately 120 wells. Obras
Sanitarias Mendoza uses four large lagoon systems to provide the majority of
wastewater treatment within the concession area.


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<PAGE>   12


    Obras Sanitarias Mendoza must pay the Province a yearly royalty based on net
operating revenues collected. This royalty is equal to 3.85% of net operating
revenues collected in the first five years of the concession and 9.98%
thereafter.

    As a result of the recent events in the Province of Buenos Aires, we have
also reevaluated the fair value of our investment in Obras Sanitarias Mendoza
and determined that the fair value was less than its carrying value and, during
the fourth quarter of 2000, wrote down the carrying value accordingly. See Note
17 to the Consolidated Financial Statements.

    Brazil. On September 24, 1999, we acquired from an affiliate of AMX-Acqua
Management Inc. 100% of three Brazilian companies, Geoplan-Assessoria,
Planejamento e Perfuracoes Ltda., Aguacerta-Sistemas de Abastecimento Ltda. and
Aguacerta Saneamento Ltda., which provide water drilling, water supply and water
and wastewater treatment services in Brazil. We may be required to make
additional payments to an affiliate of AMX-Acqua Management that are contingent
on the future performance of the business. During 2000, the other two of these
companies were consolidated into Geoplan.

    Geoplan primarily provides resource development and management services,
including the exploration, sourcing and storage of water. Geoplan also provides
water and wastewater treatment services and serves a broad base of Brazilian
customers ranging from large industrial companies and small commercial companies
to municipalities. Geoplan has a portfolio of more than 100 risk contracts.
Under a risk contract, Geoplan takes on the responsibility for obtaining water
for the owner or occupant of land and is paid only if water is delivered. For
example, under one risk contract, Geoplan has drilled a well on privately owned
property to replace other sources of water, such as municipal water systems, and
provides wastewater treatment services for the owner, including recycling of
wastewater for irrigation. Geoplan expends the capital to drill the well and
bears all drilling risk, construction costs and operating costs and receives a
fee for water and other services provided over a fixed contract term, often
10-15 years.

    Geoplan currently operates principally in the States of Rio de Janeiro and
Sao Paulo, but also provides services in northeastern Brasil and plans to expand
its business to other parts of Brazil. Although competitors may enter this
business in the future, the market appears large enough, and aquifers appear to
have sufficient water, to permit substantial growth. Prices for risk contracts
currently are not regulated.

    Mexico. During 1999, we acquired several interests in Mexico, including the
following:

    o  Cancun. On March 24, 1999, we acquired a 49.9% economic interest in and
       the right to manage and operate the water and wastewater treatment
       concession for Cancun and Isla Mujeres, Mexico. Desarrollos Hidraulicos
       de Cancun, S.A. de C.V. is the concessionaire that holds the concession.
       Affiliates of one of the former shareholders, Grupo Mexicano de
       Desarrollo, S.A., own an aggregate 50.1% economic interest in the
       concessionaire. The concessionaire serves a population of approximately
       430,000 through approximately 87,084 connections. An estimated 65% of the
       concession's operating revenues are derived from the supply of drinking
       water to tourist hotels, whose operating revenues are primarily U.S.
       dollar based.

       In May 2000, the concessionaire completed the construction of a new
       wastewater treatment plant, which increased the percentage of collected
       wastewater that is being treated in the Cancun urban zone from
       approximately 40% to approximately 85%.

       The concession was initially granted on the condition that the
       concessionaire would invest capital in projects to provide services under
       the concession. The cost to the concessionaire for these investments is
       estimated at $44 million through 2003. On February 25, 1999, we loaned
       the concessionaire $15.0 million to permit it to retire a portion of its
       indebtedness. We also agreed to make additional loans of up to $10
       million. The balance of the loans outstanding to the Cancun
       concessionaire at December 31, 2000 was $20.1 million. The concessionaire
       is required to pay to the State of Quintana Roo an annual concession fee
       of 7.5 million pesos (in 1993 pesos), adjusted annually in accordance
       with changes in the Mexican consumer price index.

       The operations and tariffs for water and wastewater systems in the State
       of Quintana Roo are regulated by Comision de Agua Potable y
       Alcantarillado, referred to as CAPA. The water tariff paid by the hotels
       and commercial and industrial customers is adjusted monthly according to
       the change in Mexico's consumer price index as published by the Mexican
       government. In addition, the concession provides that the rate paid by
       the


                                       10
<PAGE>   13


       hotels will be increased in the event of a variation of the Mexican
       peso/U.S. dollar exchange rate in excess of 15% due to a short-term
       event. The remainder of operating revenues come from residential and
       public services drinking water supply and from wastewater services.
       Residential drinking water rates are adjusted annually with changes in
       the Mexican minimum wage established by the minimum wage commission.

       The concession expires in October 2023, unless extended. At the end of
       the concession term the concessionaire will be required to deliver to the
       government at their residual equity value the facilities and equipment
       used to provide services under the concession.

       We have three seats on the board of directors of the concessionaire,
       while the 50.1% shareholder has two. We have the right to appoint the
       chief executive officer, the chief financial officer and the chief
       operating officer of the concessionaire. The 50.1% shareholder has the
       right to appoint the chairman of the concessionaire's board and the
       non-voting board secretary. Resolutions concerning major corporate
       actions and governance issues require supermajority approval.

    o  Industrias del Agua, S.A. de C.V. On September 24, 1999, we acquired 49%
       of the capital stock of IASA Holdings, S.A. de C.V. IASA Holdings owns
       100% of Industrias del Agua, S.A. de C.V., a water and wastewater
       services company that provides water and wastewater services within
       Mexico City, Mexico. The remaining 51% of the capital stock of IASA
       Holdings is owned by a privately-held Mexican company. We have the right
       to appoint two members of the board of directors, and the 51% shareholder
       has the right to appoint three members. Contemporaneous with our purchase
       of the capital stock of IASA Holdings, we entered into separate
       agreements that result in our having effective control over IASA
       Holdings.

       Under a contract with the Water Commission of the Federal District of
       Mexico, Industrias del Agua provides metering, billing, collections,
       operations and maintenance services for an area covering approximately
       one quarter of the Federal District within Mexico City, a service area
       with a population of approximately two million people. Industrias del
       Agua has provided these services since 1993, when it signed a 10-year
       contract with the Water Commission of the Federal District. All recourse
       by the Water Commission of the Federal District of Mexico is to the
       company that is a party to the contract, a subsidiary of Industrias del
       Agua.

       The volume of work Industrias del Agua is required to perform every year
       is not fixed under the contract and depends on the requests made by the
       Water Commission of the Federal District. Industrias del Agua's revenues
       for providing services under the contract are based on unit prices
       adjusted for inflation. Only minor ongoing capital commitments remain
       related to increased activities under the contract.

       In August 1999, a consortium in which Industrias del Agua participated
       with FYPASA Construcciones, S.A. de C.V. was awarded a public bid by the
       Sistema Municipal de Aguas y Saneamiento de Torreon, Coahuila, known as
       SIMAS, for a concession to build, operate and transfer an approximately
       $20 million wastewater treatment plant for the City of Torreon, Coahuila.
       Project revenues are backed by a revolving line of credit to be provided
       by BANOBRAS, which is Mexico's national public works bank. Funding of the
       project is being provided by federal and state grants from FINFRA and CAN
       (Water Commission), BANOBRAS' equity investment arm, and equity
       contributions from IASA and FYPASA, the shareholders of the project
       company. The contract requires that the plant be built and certain
       start-up tests be successfully completed within 18 months after initial
       conditions to construction are met, and then provides for an operating
       period of 18.5 years. The contract was signed on November 12, 1999 and
       the conditions to construction were met in December 2000. Construction of
       the plant has begun and is expected to be completed during the summer of
       2002. Industrias del Agua owns 90% of the consortium company.

    Through a joint venture, Azurix holds a 49% interest in an approximately $25
million municipal wastewater treatment plant for Leon. Construction of the plant
was completed in September 2000. We also are participating in a smaller
wastewater treatment plant in Matamoros, whose primary customers are industrial
parks.

COMPETITION

    Participants in the global water market face significant challenges,
including qualifying for the bidding process, obtaining and demonstrating
operating experience and management depth, accessing capital, obtaining and
demonstrating expertise in managing international infrastructure projects,
identifying and evaluating transactions and assessing and mitigating risks,
especially operational, political and regulatory risks. As a result,


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<PAGE>   14


only a small number of companies currently compete globally in the water and
wastewater privatization market. We face significant competition from companies
larger than we are, companies with longer operating histories and greater
experience in securing water and wastewater projects than we have, companies
with greater access to capital, often on better terms, and other new entrants to
the global water industry.

    Two French companies, Vivendi Environment and Suez (formerly known as
Suez-Lyonnaise des Eaux), currently are recognized as the leading competitors in
the international water and wastewater market. According to their published
data, Vivendi Environment serves more than 100 million water and wastewater
customers worldwide and Suez serves approximately 110 million water and
wastewater customers worldwide. These two companies are significantly larger
than the next group of international competitors. These smaller competitors
include privatized water and wastewater companies from the United Kingdom and
some smaller French and Spanish companies. Some construction companies also bid
on water and wastewater projects, more often on build-own-transfer projects than
on concessions.

    Concessions in which we own interests and systems that we operate currently
serve an aggregate population of approximately 9.6 million for water and
approximately 7.7 million for wastewater. The larger companies, due to their
longer operating histories and financial strength from stable concessions and
contracts, may be better able to demonstrate their expertise. Further, our
competitors may be able to obtain capital at a lower cost and be willing to bid
more aggressively than we can, which would give them an advantage in bidding on
projects and other competitive situations. This competition, along with the
delay in concessions coming to market and our capital constraints, led us to
decide not to pursue further concession investments at this time.

    In the United States, the water and wastewater industry is highly
fragmented, with over 55,000 public and private water entities serving
approximately 90% of the nation's population. Of this number, the majority are
investor owned and the rest are publicly owned, generally by local
municipalities. Most of these entities serve only a single community or region.
Several of these publicly traded companies, and others that have been acquired
by foreign entities, have become active consolidators by acquiring the small
private and public investor owned utilities that operate in markets contiguous
to or near their own. In addition, several electric utilities have begun to
acquire municipally owned water distribution companies in the United States.
Many companies compete in the United States for municipal service contracts and
industrial outsourcing opportunities.

    In the United Kingdom, the water industry has achieved approximately 98%
population coverage. The 10 water and wastewater authorities in England and
Wales were privatized in 1989 to form 10 water and wastewater companies
operating in geographically discrete regions. Wessex has a virtual monopoly over
water supply and wastewater services in its licensed region, with the exception
of extensive areas around and including the cities of Bristol and Bournemouth
and a small area of rural Wiltshire, where three companies provide water
services and Wessex provides wastewater services.

    Although water and wastewater concessions, once awarded, historically are
virtual monopolies for their terms, some forms of competition are arising. For
example, in the United Kingdom other suppliers may apply to the industry
regulator for an "inset appointment" to serve particular areas within Wessex's
or any other licensee's service area. Inset appointments may be granted for the
supply of water and wastewater services to Wessex's customers using in excess of
100 megaliters of water per year. Inset appointments may also be granted for
"greenfield sites," which are areas previously not served by existing companies,
or where an incumbent water company consents to change its boundary to allow
part of its area to be transferred to another company. Historically, very few
inset appointments have been granted in England and Wales, although a number of
applications are currently being considered. This may change in the future as
the U.K. Government and the Director General of Water Services seek to increase
competition. Certain new initiatives are underway or being considered. These
include allowing premises to be combined to meet the consumption limit for a
large user inset; promoting competition in new connections; extending the
obligation on companies to allow connections to their water mains from outside
their areas in response to requests by non-residential customers as well as
residential customers (currently, water and wastewater companies are only
obliged to make such supplies outside their areas when requested by residential
customers); facilitating common carriage, for example, by developing access
codes to set out fair terms for common carriage using others' networks;
liberalizing trade in abstraction licenses; and using the new competition law
powers under the Competition Act 1998 to prevent abuses of a dominant position
and anti-competitive behavior. The Director's objective is to encourage
competition by giving competitors access to the monopoly inherent in water and
wastewater services. Wessex, as well as the other U.K. water companies, have
prepared and published access codes to facilitate common carriage competition.
The Director recognizes that


                                       12
<PAGE>   15


competition is currently focused on large users and considers that measures such
as the development of common carriage and the right to optional metering as well
as the installation of meters on new properties will open up competition to
household customers. It is considered unlikely that these changes will have a
material adverse impact on the profitability of existing water companies,
particularly if entrants continue to use the incumbent's asset network. One
inset appointment was granted within Wessex's territory resulting from the
privatization of water supply activities formerly provided by the Ministry of
Defence. Wessex chose not to pursue this project because of unacceptable
contract terms. Wessex was awarded another appointment to operate water and
wastewater services formerly provided by the Ministry of Defence.

    The Chancellor of the Exchequer announced in March 1999 that the U.K.
Government intends to study ways to increase competition in the United Kingdom's
water sector. The Director has announced that comparative competition will
continue to be the principal tool of regulation and has confirmed that he will
not support consolidation of the UK water industry unless substantial benefits
to consumers can be demonstrated. We cannot predict what changes, if any, the
U.K. Government will adopt to promote competition. Competition may open up
profitable opportunities to efficient operators.

SUPPLIERS

    Our operating subsidiaries depend upon electricity, chemical and
telecommunication suppliers for their operations. Wessex's only significant
supplier of goods or services is Yorkshire Electricity plc, a subsidiary of
American Electric Power Corporation, which supplies electricity to approximately
1,100 of Wessex's sites. Wessex pays Yorkshire Electricity plc approximately
$9.55 million per year, which represents approximately 5.5% of Wessex's annual
operating costs. The contract was effective October 1, 1999 and runs for two
years. The price is based upon a negotiated pence amount per kilowatt hour for
each site. Wessex is not dependent on any single supplier, including Yorkshire
Electricity, because its supplies are readily available from alternative sources
at market rates and on similar terms. Except for Enron, which provides services
under agreements with Azurix, none of Azurix's suppliers is affiliated with it.

EMPLOYEES

    As of December 31, 2000, we had approximately 98 employees, excluding
employees of our operating subsidiaries. This number decreased to approximately
35 as of March 29, 2001. As of December 31, 2000, Wessex had approximately 1,384
employees, which included approximately 60 employees at SC Technology worldwide.
As of December 31, 2000, Azurix Buenos Aires had approximately 1,229 employees,
Azurix North America had approximately 984 employees, Geoplan had approximately
225 employees and Lurgi Bamag had approximately 190 employees.

    In addition, the Cancun concession employed approximately 565 people and
Industrias del Agua employed approximately 475 people, as of December 31, 2000.
All or a significant portion of the work forces at Wessex, Azurix Buenos Aires,
Azurix North America, Cancun, Industrias del Agua and Geoplan are represented by
unions.

INSURANCE

    We believe that our insurance arrangements, including self-insurance, are
customary for the industry and are adequate. We have established a global
insurance program covering our property, employers' liability, public and
products liability, excess public and products liability and our motor fleets
worldwide.

REGULATORY MATTERS

    The following is a summary of regulatory matters relating to water and
wastewater operations in the United Kingdom, the United States, Canada,
Argentina, Brazil and Mexico.

    In general, most countries where we have invested, or may consider
investments, have drinking water quality and environmental laws and regulations.
Because the supply of clean drinking water and the treatment of wastewater are
essential societal needs, we anticipate that these activities will be subject to
at least some form of regulation wherever we do business. The nature and extent
of environmental laws and regulations vary from country to country, and there
may be wide disparities in the requirements from one part of the world where we
do


                                       13
<PAGE>   16


business to another. Generally speaking, compliance with these laws and
regulations is mandatory and penalties, as well as injunctive and other relief,
are usually available in the event of noncompliance. Moreover, these laws and
regulations may require improvements to water and wastewater systems that will
require additional capital and operating costs for us to remain in compliance.

    Changes in the nature of these laws and regulations, or in the level of
their enforcement, also have the potential to impact adversely our financial
results during the relevant period. These adverse impacts could cause our actual
financial results to differ materially from those we project, forecast, estimate
or budget. Moreover, changes in these laws and regulations may require
improvements in order to remain in compliance that can result in additional
capital and operating costs.

    Wessex has established a comprehensive environmental auditing program that
is designed to provide early identification of potential environmental problems
associated with its activities and to provide reasonable assurance that all
identified problems are properly and promptly addressed. We are using these
capabilities to monitor environmental and other regulatory compliance in all
water and wastewater systems, companies and concessions in which Azurix or one
of its subsidiaries takes an active management role. Despite the demonstrated
effectiveness of this environmental auditing program with respect to Wessex's
operations, we cannot assure you that this approach will be adequate to address
and manage all such risks associated with our business.

    Particularly in jurisdictions where we operate water or wastewater companies
serving end-users, we can expect to be subject to regulation on the rates we may
charge. The regulatory regime will vary from jurisdiction to jurisdiction, but
can be expected to resemble in some respects the regime in place in the United
Kingdom, the United States, Canada, Argentina, Brazil and Mexico.

U.K. REGULATORY MATTERS

    The economic aspects of the water industry in England and Wales are
principally regulated under the provisions of the Water Industry Act 1991.
Following privatization of the water industry in England and Wales, each of the
water and wastewater companies became regulated through a license and the
regulatory provisions of the Water Industry Act 1991 and regulations and orders
thereunder. The license designates the relevant company as a water and/or
wastewater undertaker in its own area and provides for the monitoring of the
company's performance by the Director General for Water Services and the
Secretary of State for the Environment. The Water Industry Act 1991 imposes
duties on the Secretary of State and the Director as to how and when they should
exercise their functions under the Act. In particular, their primary duties are
to exercise their functions in the manner each considers best calculated to
secure that licensees properly carry out and are able to finance their
functions, including by securing reasonable returns on their capital. Subject to
these primary duties, the Secretary of State and the Director have other duties,
including protecting customers' interests, promoting efficiency and economy by
licensees and facilitating competition. Therefore, in setting limits on the
prices that water and wastewater companies may charge, the Director is currently
required to allow companies a projected rate of return sufficient to finance
their operations and attract the capital necessary for investments in
infrastructures required to meet environmental and other regulatory standards.
The actual rates of return achieved by individual companies can vary
significantly from the projected rates of return assumed by the Director in
setting prices.

    Each water company is under a general duty to develop and maintain an
efficient and economical system of water supply within its license area and is
subject to duties of water supply. Each wastewater company is under a general
duty to provide, improve and extend a system of public sewers and to maintain
those sewers to ensure that its wastewater region is effectively drained. In
addition, discharges from wastewater treatment plants must be licensed by the
Environment Agency, and wastewater companies are responsible for regulating
discharges of industrial wastewater into sewers. Contamination caused by
wastewater discharged from a treatment plant may subject the wastewater company
to liability, including clean-up costs.

    Among his functions, the Director has powers to determine terms if Wessex
and the customer cannot agree. These include terms for, and requiring, bulk
supplies of water, the provision of water for non-domestic purposes and the
connection of sewers and the reception, treatment and disposal of industrial
wastewater to public sewers. The Director is responsible for ensuring that water
and wastewater companies comply with their license conditions and has
enforcement powers under the Water Industry Act to secure compliance. Subject to
a power of veto by the Secretary of State for the Environment, conditions may be
modified by the Director with the consent of the licensee. Before making the
modifications, the Director must publish the proposed modifications as part of


                                       14
<PAGE>   17


a consultation process, giving third parties the opportunity to make
representations and objections that the Director must consider. In the absence
of consent, the only means by which the Director currently can secure a
modification is following a modification reference by him to the U.K.
Competition Commission. The Commission is required to investigate and report on
whether matters specified in the reference operate or may be expected to operate
against the public interest and, if so, whether the adverse public interest
effect of those matters could be remedied or prevented by modification of the
conditions of the license. If the Commission gives an adverse finding, it will
state in its report whether any adverse effects on the public interest could be
remedied or prevented by modification of the license. The Director must then
make such modifications as appear to him necessary for the purpose of preventing
the adverse effects specified in the report after giving due notice and
consideration to any representations or objections. The Secretary of State would
have the power, among others, to modify the conditions of the license if, on
investigation, under the Fair Trading Act 1973, the Commission concluded that
matters investigated by it in relation to water or wastewater services operated
against the public interest.

Wessex Water Services' License

    Wessex's license continues indefinitely, or until such time as the Secretary
of State revokes Wessex's license after 10 years' advance notice. The effective
date of revocation, under the terms of Wessex's license, cannot occur prior to
2014 without Wessex's consent. If at any time Wessex becomes insolvent or it is
determined that Wessex has committed such a serious violation of its duties so
as to make it inappropriate for it to continue to hold the license, the
Secretary of State or, with his consent, the Director may seek a special
administration order, under the terms of which Wessex's affairs, business and
property may be transferred to another company to ensure that Wessex's appointed
functions can be carried out. In either event, the legislation provides for
Wessex's assets to be transferred to the new replacement appointee on terms
approved by the Director or the Secretary of State, including the consideration
to be paid by the new appointee. The special administration provisions in effect
subordinate members' and creditors' rights to the achievement of the purposes of
the special administration order. The license sets out the charging formula
imposed on Wessex, which is subject to review every five years. The formula is
tied to the retail price index plus an adjustment factor, which can be positive,
zero or negative. The adjustment factor is set by the Director on a case-by-case
basis for each company at the review to bring the companies in line with the
target rate of return set by the Director. The license also regulates the fees
that Wessex may charge new customers upon connecting them to the water or
wastewater network for the first time. Wessex must fix and publicize its rates
for the provision of water and wastewater services and for first-time provision
of water supply and wastewater services and must not discriminate against any
individual or class of customer with respect to charges.

    Wessex is required to maintain sufficient financial and managerial resources
to carry out the appointed business and necessary investment. The license
requires it to publish separate accounts showing its regulated business
separately from all other businesses and activities and additional accounts
prepared on a current-cost basis with respect to the same period. Regulated
businesses, such as Wessex, are subject to business practices limitations, such
as restrictions on cross-subsidies, that restrict affiliate dealings and promote
competitive contracting. The license also requires Wessex to put in place
financial structures protecting a sufficient amount of its assets so that its
water and wastewater services could still be provided in the event of Wessex's
insolvency.

    Wessex's license includes service targets that are monitored by the industry
regulator. The license also requires Wessex to pay annual fees, based on
Wessex's revenues, which are intended to cover the costs of the regulation of
the water industry. In 2000, Wessex paid approximately L.550,000 ($834,000) in
such fees.

    The license was modified as a condition of regulatory clearance of Azurix's
acquisition of Wessex to address regulatory concerns arising out of the
acquisition. In particular, the modifications strengthened the financial
independence and independent management of Wessex Water Services' regulated
business, providing water supply and wastewater services, by imposing the
following:

    o    restrictions on transfers of assets, guarantees, intercompany loans and
         loans containing cross-default provisions

    o    a requirement that transactions with associated companies must be
         entered into on an arm's length basis at market rates

    o    a requirement to maintain an investment grade rating for corporate debt
         of Wessex Water Services


                                       15
<PAGE>   18


    o    a requirement that Wessex issue a variable-coupon bond and use its
         reasonable efforts to list these bonds on the London Stock Exchange

    o    a requirement that information be published similar to that of a public
         company

We have complied with each of these requirements.

    The license as modified also requires a dividend policy to be agreed upon
with the Director that ensures that Wessex Water Services retains sufficient
funds to finance its core activities and that should be expected to reward
efficiency and the management of economic risk. The license also requires Wessex
Water Services to conduct its regulated business as if a separate public limited
company. In addition, Wessex is obligated to obtain undertakings from its
ultimate parent company. If those undertakings are not, at any time, in place or
if there is an unremedied breach of them, then, in addition to potential
enforcement action, Wessex may not, without the Director's consent, enter into
any contract with its parent. To comply with this obligation, Azurix Europe and
Atlantic Water Trust have given a holding company undertaking that requires,
among other things, that Azurix Europe and Atlantic Water Trust give Wessex
Water Services all information necessary for it to carry out its obligations and
refrain from action that would cause Wessex Water Services to breach its
obligations. This undertaking also provides that the board of Wessex Water
Services must include at least three independent non-executive directors of
standing and relevant experience.

Tariff Rates

    The Director regulates prices and service levels. Price controls applicable
to each water and wastewater company are subject to reviews by the Director
every five years, known as periodic reviews, but, in limited circumstances, both
the Director and the individual company may seek an interim determination to
adjust price limits between the periodic reviews.

    Unlike "rate of return" economic regulation, such as exists for many U.S.
industries, regulation in the United Kingdom generally uses forms of "price
limitation." This is intended to reward companies for efficiency and quality of
service to customers. The U.K. regulatory system generally allows companies to
retain for a period any savings attributable to efficiencies that they are able
to achieve. These are then passed on to customers in lower price limits or
additional investment in the next periodic review. The main instrument of
economic regulation is a price limitation formula set out in each company's
license. This formula limits average charges made by water and wastewater
companies for a basket of principal regulated services. The limit is expressed
as a percentage change by reference to the retail price index. This adjustment
can be positive, zero or negative and is determined in light of past operational
efficiencies, assumed future operational efficiencies, investments to meet water
quality standards, expenditures to enhance security of supply and service levels
and maintain assets and an appropriate return on capital.

    On November 25, 1999, the Director announced the results of his latest
periodic review to establish price limits for the period April 1, 2000 through
March 31, 2005. Customers that use over 100 megaliters per year are excluded
from the tariff basket with the effect, among others, that companies will not be
able to recover from other customers lost revenue arising from reduced charges
to their large users. The Director imposed a 12.0% price cut for Wessex for
2000-2001, before adjustment for inflation. The announcement included level
prices through March 2003 with price increases effective April 1, 2003 of 3.8%
and April 1, 2004 of 4.7%, before adjustment for inflation.

    These price limits make allowances for the investments the Director
considers necessary to meet obligations to improve service and drinking water
quality and to ensure higher environmental standards under the proposed
five-year program of mandatory capital expenditures by the water companies. This
program is expected to cost the industry L.15.6 ($23.3) billion in aggregate
through March 31, 2005. In Wessex's case, the Director did not include L.109.0
($163.0) million in capital expenditure requirements initially proposed in
connection with the periodic review process under the company's quality
improvement program. If the Director determines to require these capital
expenditures in the future, this requirement could trigger an interim
determination to adjust Wessex's price limits.


                                       16
<PAGE>   19


    In the final determinations, the Director assumed the following cost
reductions by 2004-2005 for Wessex: a reduction in operating expenditures of 11%
for water service and 7% for wastewater service; a reduction in capital
maintenance of 11% for both water and wastewater service; and a reduction in
capital enhancement of 9% for water service and 7% for wastewater service. In
connection with Wessex's recent periodic review of price limits, the Director
has estimated that the cost of the capital expenditures that Wessex will be
required to make over the five years of the price review will be approximately
L.764 ($1,143) million. The determination assumed an after-tax cost of capital
for Wessex of 4.75%. Because Wessex has been recognized as one of the most
efficiently operated water and wastewater companies, it has been given
efficiency targets at the lower end of the range.

Changes to Regulatory Regime

    Since 1997 the U.K. Government has been carrying out a review of the
regulation of all utilities. At the end of 2000, the U.K Government published
new proposals for a revised water bill. The key features of this new bill are:

       o   The regulator would be given a new primary duty to protect consumer
           interests. This can include promoting competition where effective, so
           long as it does not conflict with wider social and environmental
           objectives

       o   Competition would be reviewed in its entirety in light of industry
           proposals on restructuring

       o   An independent national consumer council would be set up

       o   A new water advisory panel would be created, and the regulator would
           be required to refer certain matters to this panel

       o   The government would be given right to issue statutory guidance on
           social and environmental matters

       o   The level of fines would be increased

       o   Companies would be required to provide consumers with comparative
           performance data

       o   Licenses for abstracting water would be reformed, including placing
           time limits on licenses, allowing civil actions for damages caused by
           abstraction and ending compensation for removal of a license after
           2012

       o   Companies would be required to publish the link between the
           Director's salary and standards of service to consumers

The final contents of this legislation and the timing of its enactment are
uncertain, but it is unlikely to take effect prior to 2002.

    In his March 1999 Budget Speech, the Chancellor of the Exchequer announced
that the Deputy Prime Minister would review competition in the water industry
and published a consultation paper in March 2000. This review is ongoing.

    Separately, the Competition Act 1998 became effective in March 2000. This
law, among other things, increases the ability of the U.K. regulatory
authorities, including the Director, in relation to water and wastewater
services, to investigate and take action against anti-competitive agreements and
conduct. In particular, companies found to have violated the new prohibitions of
anti-competitive agreements and abuse of a dominant position may be fined up to
10% of their U.K. turnover. The Director has announced that he intends to
actively pursue potential breaches of the Competition Act by identifying areas
where companies may be restricting competition. U.K. competition law, in the
Fair Trading Act 1973, also enables monopoly situations, as defined in the Act,
to be investigated by the Competition Commission. Where these are found to
operate contrary to the public interest, the Secretary of State has extensive
powers to take action to remedy or prevent those adverse effects, including the
power to order businesses to be divested.


                                       17
<PAGE>   20


    The Director has indicated that he intends to seek public comment before the
end of 2002 on the rules and policies that should be developed in relation to
license renewal and termination. The Director has suggested that, in considering
license termination after 2004, the Secretary of State should not regard the
present structure of the industry as sacrosanct and that a less vertically
integrated industry would be more conducive to the development of competition.
The Director has stated that continuity of services to customers would be the
industry regulator's primary concern in developing any rules or policies with
respect to termination of licenses.

    In August 1999, the U.K. Government announced proposals for radical reform
of U.K. merger control under the Fair Trading Act that would give responsibility
to the independent competition authorities for decisions on most mergers and
would focus more clearly on competition and the consumer. A special merger
regime operates in relation to the water industry in England and Wales. The
Secretary of State has a duty to refer to the Competition Commission mergers or
proposed mergers between two or more water enterprises where the value of the
gross assets taken over and those of the acquirer each exceed L.30 ($45)
million. There are also specific appraisal criteria for mergers between water
enterprises. These require the Competition Commission to determine whether the
merger will operate against the public interest. In determining whether this is
the case the Competition Commission must have regard to the risk that the number
of water enterprises under independent control should not be reduced so as to
prejudice the ability of the Director to make comparisons between different
water enterprises in order to determine their efficiency. The Director announced
in January 2000 that, in the case of water-to-water mergers, the detriment of
the loss of a comparator in the industry might be offset if the merger were to
bring about the development of market competition, especially if companies were
prepared to see a loss in market share in their own areas. As far as the special
merger regime for the water industry in England and Wales is concerned, the U.K.
Government will consider that regime in light of the review it is conducting of
competition in the water industry, but does not anticipate at this stage that
major changes will be necessary to that regime. However, the Director has stated
that, until market competition has developed, he has no intention of abandoning
comparative competition. Furthermore, in evaluating the competitive position of
U.K. water companies in the future, he intends to extend the comparisons to
include comparable suppliers in Scotland and Northern Ireland, as well as in
other countries, including France, Australia and the United States, as well as
the suppliers in England and Wales.

Drinking Water Quality and Environmental Regulation

    The water and wastewater industries in England and Wales are subject to
numerous U.K. environmental regulatory requirements principally under the Water
Industry Act 1991, the Water Resources Act 1991, the Environmental Protection
Act 1990, the Environment Act 1995 and the Pollution Prevention and Control Act
1999.

    The Water Industry Act 1991 established a new, more extensive and more
stringent quality regime for the water and wastewater industry through the
creation of the National Rivers Authority, since replaced by the Environment
Agency, and the Drinking Water Inspectorate. Under the Water Industry Act 1991,
water supplied for domestic or food production must be wholesome at the time of
supply. The Drinking Water Inspectorate is responsible for ensuring that water
supplies meet this standard as well as the standards set out in the U.K. Water
Quality Regulations. Breach of these requirements can lead to regulatory or
criminal liability, and if the water supplied causes loss or damage, the breach
may lead to civil liability. Water companies are required to carry out statutory
sampling of water supplied to customers and must provide public information on
drinking water quality. The Inspectorate conducts technical audits to assess
annually the quality of the drinking water supplied by the licensed companies.
If a company fails to meet the relevant water quality standards, the
Inspectorate may require it to take any necessary remedial action.

    Under the Water Resources Act, the Environment Agency may require persons to
take precautions against pollution, may prohibit or restrict activities likely
to cause pollution in areas designated by the Secretary of State for the
Environment and may require persons to hold a consent to discharge matter from a
drain or sewer. When reviewing existing consents and issuing new ones, the
stated practice of the Environment Agency is to seek to set conditions at the
level required to at least maintain and, where appropriate, improve the quality
of the receiving waters. The Water Resources Act 1991 makes it an offense to
abstract water without a license.

    The activities of the U.K. water and wastewater companies are also affected
by the requirements of European Union directives, including the Drinking Water
Directive, the Bathing Waters Directive and the Urban Wastewater Treatment
Directive, each of which has been, or will be, brought into force in the United
Kingdom. The environmental systems that Wessex has in place are designed to
comply with European Union and U.K. requirements.


                                       18
<PAGE>   21


    The Pollution Prevention and Control Act 1999 implements the European Union
Directive on Integrated Pollution Prevention and Control. Future regulations
under the Act will set out permitting obligations for certain plants and
activities. The regulations could impose additional requirements under an
integrated pollution prevention and control license on Wessex's operations.

    In view of the age and history of many sites owned by Wessex, Wessex may
incur liability for sites that are found to be contaminated, resulting in
increased costs of managing or cleaning up such sites. Environmental legislation
requires the polluter (or if the polluter cannot be found, the owner or
occupant) of contaminated land to clean up any contamination that causes, or is
likely to cause, significant harm to the environment. Polluters are also
required to clean up any pollution of water sources. Other proposals that may
impose strict liability for environmental damage are also under consideration by
the European Union. Wessex expects that the direction of future changes will be
towards further tightening of controls. However, Wessex does not believe that
any liability that it may incur under environmental legislation or published
European Union directives will have a materially adverse effect on its results
of operations, financial position or liquidity.

    The Drinking Water Inspectorate has issued guidance on the water quality
aspects of common carriage. The guidance, although not legally binding, covers
drinking water quality aspects and suggested contractual arrangements for all
parties considering common carriage operations. A new entrant will not be
regulated by the Inspectorate, unless it is already a statutory undertaker.
Rather, a new entrant will be treated as a contractor to the existing
undertaker. The existing undertaker will have total responsibility for itself
and the new entrant complying with the Water Supply (Water Quality) Regulations
1989, and other legal requirements. The guidance also provides that both the
undertaker and the new entrant must carry out a prior assessment of the likely
impact of the proposed arrangement for common carriage on water quality and the
distribution system before entering into such an arrangement.

U.S. REGULATORY MATTERS

    Azurix North America has operations in the United States. The business
sectors in which we operate, or intend to operate, in the United States are
generally highly regulated by national, state and local laws and regulations.

Tariff Rates

    In the United States, the rates for retail water and wastewater services are
generally subject to state and local laws and regulation. Although the system is
highly fragmented among jurisdictions, most jurisdictions in the United States
utilize "rate of return" economic regulation in setting water and wastewater
rates. Under rate of return economic regulation, the service provider is allowed
to recover its reasonable and necessary operations and maintenance expenses, and
a recovery of and a reasonable return on its invested capital. In most
jurisdictions, a water or wastewater service provider is required to keep a
current set of tariffs on file with the governing regulatory authority. A
limited portion of our business in the United States involves charging retail
customers for water or wastewater services, and therefore we are not subject to
significant tariff regulation.

Drinking Water Quality

    The Safe Drinking Water Act directs the EPA to set drinking water standards
for the approximately 55,000 community water supply systems in the United
States. The Safe Drinking Water Act Amendments of 1996 bring important changes
to the regulation and financing of water systems. The amendments have several
potentially significant regulatory initiatives, which include the following:

    o Recent adoption of two rules that may require more sophisticated
      treatment. First, the disinfectants and disinfection by-products rule
      establishes maximum residual disinfectant levels for chlorination and
      maximum contaminant level goals for potentially harmful disinfection
      by-products. Second, the enhanced surface water treatment rule focuses on
      treatment requirements for waterborne pathogens, particularly
      cryptosporidium.


                                       19
<PAGE>   22


    o A requirement that the EPA list 30 previously unregulated contaminants for
      monitoring, risk assessment and potential regulation at least once every
      five years. Such a program poses the risk of additional contaminants being
      regulated as the EPA implements this research, with the attendant risks of
      potentially increased capital and operational costs.

    o Adoption of regulations to reduce lead and copper in drinking water. Water
      providers that exceed specified levels of lead and copper in drinking
      water may be required to perform additional monitoring and develop
      measures to reduce the lead and copper content.

    The EPA has other long-term plans to develop regulations governing the
treatment of drinking water, such as the recycling of filter backwash into
influent streams at public utilities and additional ground water disinfection.
It is unclear what precise form these and other regulations will take, so
potential regulatory risks and costs of compliance cannot be evaluated at this
time. As is true for any drinking water provider, by operating water assets in
the United States, we face the risk that water we will provide could be
contaminated, including for reasons outside our control, and such contamination
could expose us to regulatory sanctions and potential liability for injury to
persons and property.

Environmental Matters

    Among other things, environmental laws and regulations in the United States
generally set requirements for:

    o the quality of the discharges from treatment facilities

    o the handling and disposal of biosolids from treatment facilities

    o the management of associated materials and wastes

    o good housekeeping practices for the management and monitoring of the
      operations

    Changes in environmental laws and regulations, or in the level of their
enforcement, may adversely impact our financial results. These adverse impacts
could cause our actual financial results to differ materially from those we
project, forecast, estimate or budget. Moreover, changes in these laws and
regulations may require improvements in order to remain in compliance that can
result in additional capital and operating costs. Environmental protection
statutes in the United States typically provide for the imposition of
substantial civil and criminal penalties, as well as the possibility of permit
revocation and corrective action orders, for violations of their requirements.
These laws may also provide for retroactive, strict liability without regard to
a party's negligence or fault.

    The Federal Water Pollution Control Act, known as the Clean Water Act,
establishes a system of standards, permits and enforcement procedures for the
discharge of pollutants from industrial and municipal wastewater sources. The
law requires permits for discharges from water treatment facilities and sets
treatment standards for industries and wastewater treatment plants. Discharge
permits issued under the Clean Water Act are subject to renewal once every five
years. When discharge permits are renewed and reissued, it is customary for the
EPA or the state agency issuing the permit to impose more stringent discharge
limitations in the new permit. In addition, the EPA and the states have been
establishing new standards for bodies of water that receive wastewater treatment
plant discharges and these new standards may result in the imposition of more
stringent effluent limitations as discharge permits are renewed. Compliance with
these requirements is monitored closely and the Clean Water Act provides the EPA
with an array of enforcement mechanisms for companies that fail to comply,
including penalties and injunctive relief. Additionally, the EPA has published
regulations of the use and disposal of biosolids when they are applied to land
or incinerated.


                                       20
<PAGE>   23


    Other U.S. environmental laws and regulations may also impact Azurix. These
include the Clean Air Act, the Resource Conservation and Recovery Act, referred
to as RCRA, the Emergency Planning and Community Right-to-Know Act, referred to
as EPCRA, and the Comprehensive Environmental Response, Compensation and
Liability Act, referred to as CERCLA. Generally speaking, responsibility for
implementing and enforcing the regulations promulgated by the EPA under the
Clean Air Act and the RCRA rests with individual states, whereas the EPCRA and
CERCLA are administered by the EPA itself. In some instances, state regulations
have established standards that are more demanding than the federal standards.
Although we anticipate that our industrial wastewater treatment services
business will focus primarily on the operation and management of on-site
wastewater treatment facilities, we may also operate and manage facilities that
receive and treat third party industrial wastewater that is generated at an
off-site location. Biosolids and other residues resulting from the treatment of
industrial wastewater, particularly wastewater from third party off-site
generators, may be subject to classification as "hazardous waste" under the RCRA
and consequently become subject to more stringent handling and disposal
requirements imposed under the RCRA.

CANADIAN REGULATORY MATTERS

    Azurix North America has operations in Canada. Water and wastewater
treatment operations in Canada are subject to comprehensive federal, provincial
and local laws, regulations and guidelines pertaining to the provision of
drinking water and wastewater treatment services, as well as protection of the
environment. These laws and implementing regulations and guidelines establish
standards for the quality and quantity of effluent discharged from wastewater
treatment facilities, the handling and disposal of biosolids and other generated
wastes and materials, and the treatment and distribution of drinking water to
customers. Water and wastewater treatment facilities may only be constructed
after required environmental permits, certificates and approvals have been
obtained from appropriate governmental agencies. These facilities must then be
operated in compliance with the terms and conditions found in those permits,
certificates and approvals. Some Canadian provinces also regulate and control
the quality of drinking water, using standards relating to the design,
construction and operation of water facilities that may be more burdensome than
federal requirements. Moreover, there are extensive federal and provincial laws,
regulations and guidelines relating to the proper management and safe control of
biosolids and other wastes and materials that are accumulated at water or
wastewater treatment facilities and require proper disposal. The failure to
comply with these laws, regulations and guidelines or any applicable permits,
certificates and approvals may result in the assessment of fines, penalties or
administrative orders. A limited portion of our business in Canada involves
charging retail customers for water or wastewater services, and therefore we are
not subject to significant tariff regulation.

ARGENTINE REGULATORY MATTERS

General Regulation of Water

    Argentina has a federal system of government that delegates significant
regulatory powers to the provinces. Under the Argentine Constitution, each
province has jurisdiction over its own natural resources, including water, and
the legal power to create standards to protect those resources.

    Federal laws apply to areas within national jurisdiction, such as the
federal capital, and to matters that affect the nation as a whole and not merely
one province. At the national level, the recently organized Ministry of Social
Development and Environment is principally responsible for the protection of the
environment, including water supply, wastewater and sanitation service, and the
Ministry of Health and Social Action is principally responsible for the
protection of public health. The recently organized Ministry of Infrastructure
and Housing is responsible for the development and implementation of national
water policy and for establishing priorities of uses for multiple-use water
resources.

    Under the Argentine Constitution, the provision of water services at the
local level generally is within either provincial or municipal authority. In the
Province of Mendoza, for example, the Ministry of Public Works and the
Environment is granted general authority over all non-agricultural water
services, and environmental regulation. Concessions for the provision of water
services are granted by the provincial government by statute and decree, with
oversight vested in the Ministry of Public Works and in a special purpose
regulatory body known as EPAS. Decisions of EPAS may be reviewed by the Minister
of the Ministry of Public Works and the Governor of the Province of Mendoza. In
the Province of Buenos Aires, these duties are being carried out by the
Organismo


                                       21
<PAGE>   24


Regulador de Aguas Bonaerenses, an independent agency operating within the
province's Ministry of Public Works and Services, and by the Water Authority,
created by the provincial Water Code.

Regulation of Water Service and Tariff Rates

    In Argentina, provision of local water service and tariff rates are
generally controlled by provincial regulatory authorities, through a framework
established by statute and concession contracts. Governmental acts are subject
to judicial review in Argentine courts, but there is no general right to appeal
provincial decisions setting tariffs to the Argentine federal government. Where
a water service concession is held by a company substantially owned by a U.S.
company, however, recourse may be available through international arbitration
under the Bilateral Investment Treaty between the United States and Argentina,
which provides for fair and nondiscriminatory treatment of investments.

    In Mendoza, tariffs are proposed by EPAS, and then submitted to the Minister
of the Ministry of Public Works, the provincial legislature and the Governor for
approval. EPAS must recommend rate regimes with an aim to reflect efficient
costs of operations, maintenance and expansion and renewal of the water system,
including debt service. EPAS also strives to promote rational and efficient use
of services and resources leading to a balance of supply and demand, and to
address sanitation and social objectives. EPAS is authorized to establish tariff
rates that require some users to pay rates that subsidize the cost of providing
service to other users. Argentine law provides that, in setting tariffs, EPAS
must take into account costs of operations, maintenance, amortization of
services and a "reasonable" rate of return for the concessionaire in the context
of an efficient level of operation. The basic tariff regime is to be reviewed
every five years.

    The current tariff schedule imposes a fixed monthly charge per customer,
based on a formula that takes into account the customer's land area, types and
size of structures and uses of the land, that normally will remain unchanged
until the new tariff regime is implemented. Changes in current tariffs are
allowed for several enumerated reasons, including if operating costs increase or
decrease by 4% as reflected in official national indices, if there is a change
in the national "convertibility law" which establishes a 1:1 exchange rate of
the peso with the dollar, if there are changes in the capital program due to
government or regulatory reasons or if there are changes in taxes, other than
income taxes.

    A new tariff regime is to be implemented in Mendoza within the next several
years based on a metered charge per liter of water used. The concession contract
contains assurances that Obras Sanitarias Mendoza will receive the same level of
revenue as under the prior regime, thus allowing Obras Sanitarias Mendoza to
retain efficiency gains and pass through changes in costs. The contract contains
no provision for direct pass-through for inflation or revisions in tariffs for
capital expenditures. Obras Sanitarias Mendoza may request adjustments to the
new tariff if any of the following occurs:

    o  the new tariff lowers consumption significantly

    o  Obras Sanitarias Mendoza shows that the new tariff does not promote
       rational use of the assets and capital employed for the operations of the
       company or does not allow it to carry out the obligations of the company

    o  Obras Sanitarias Mendoza shows that most of the benefits of cost
       reductions are inuring to consumers

    The Province of Buenos Aires employs a similar regime. Initially, the tariff
has remained the same as was in effect prior to privatization. The first
ordinary tariff review is expected around 2004. The tariff then is to be
reviewed every five years in light of changes to the five-year program of
investment. Azurix Buenos Aires or the regulator may ask at any time for an
increase or reduction in the tariff if consumer cost indices change by more than
3% or if there are material changes in Argentine tax law, other than value added
tax or income tax, changes in water quality standards or environmental
regulations or substantial changes in the condition of the concession. Both the
concession contract and the governing law provide that tariff modifications may
not be used to penalize Azurix Buenos Aires if it operates more efficiently than
expected. Azurix Buenos Aires is required to provide lower rates to specified
users, including retired persons with low income, care centers for the elderly
and for physically challenged children, public schools, public sports facilities
and libraries. Azurix is currently negotiating with the Province for an earlier
tariff adjustment. There can be no assurance, however, that such an adjustment
will occur. See "Existing Azurix Assets - Latin America - Azurix Buenos Aires"
above.


                                       22
<PAGE>   25


Environmental Matters

    Beginning in the early 1990s, Argentina began addressing environmental
matters systematically at the federal level. For instance, in 1991 the Argentine
government enacted a law establishing the Secretariat of the Environment and
calling for a balancing of economic development with the conservation of natural
resources, the improvement of the environment and the prevention and
amelioration of the effects of pollution. In August 1994, the Argentine
Constitution was amended to assure the right of all residents of Argentina to a
healthy environment and granted the Argentine government authority to establish
minimum standards of environmental protection which are to be implemented by the
provinces. The 1994 amendments to the Constitution also provide that damage to
the environment must be repaired immediately in accordance with applicable law,
and prohibit the importation of actually or potentially toxic or radioactive
waste. In 1995, the Argentine government initiated a program to protect the
environment by promulgating rules regarding water, land, air and noise pollution
and hazardous substances.

    Throughout Argentina, the provinces take the lead in regulating discharges
of pollutants into waterways. The provinces typically set permissible standards
for pollutant levels in the discharges, issue permits and enforce them. In
Mendoza, wastewater discharges are regulated at the provincial level by the
Ministry of Public Works, which has adopted laws respecting water quality. As in
most provinces in Argentina, the Ministry of Public Works issues permits and
regulates discharges of pollutants into water bodies. In addition, the
concessionaire is required to comply with the drinking water quality standards
set by the concession contract and enforced by EPAS. In the Province of Buenos
Aires, Organismo Regulador de Aguas Bonarense regulates wastewater disposal,
including industrial wastewater discharges, while the Secretariat of
Environmental Policy is in charge of environmental issues. In both provinces,
the Argentine government can enforce the provisions of the Argentine Civil and
Criminal Codes against the concessionaire.

    Most provinces in Argentina have also adopted their own regulations for air
and water. The various provincial laws establish different compliance and
enforcement requirements.

BRAZILIAN REGULATORY MATTERS

    Geoplan provides water well drilling, water supply and water and wastewater
treatment services in Brazil. Water well drilling and water supply services are
most commonly provided under a "risk contract," pursuant to which Geoplan drills
a water well or provides a source of water supply to a private property owner
and receives a fee based on the amount of water delivered to the customer. The
contract is called a risk contract because Geoplan does not receive any payment
unless it is able to deliver water to the customer. Under Brazilian law, no one
can render public services, such as water supply and water and wastewater
treatment services, without first obtaining a concession from the appropriate
governmental entity.

Regulation of Water Rights and Risk Contracts

    Federal law 9.433/97, the Federal Water Rights Law, establishes a permitting
system for the right to extract water from underground aquifers or to divert and
remove surface water from streams, rivers or lakes. A permit must be obtained
from either the federal government or the state government before a water well
is drilled or a diversion of surface water occurs. A federal permit is required
if the affected body of water is located in more than one state, such as a river
passing through multiple states or a lake or aquifer that is on the border of
two states, and a state permit is required if the affected body of water is
located wholly within a single state. The decision on whether to issue a permit
is usually based on technical factors because water is plentiful in most areas
of Brazil.

    For a typical risk contract project, a permit must be obtained from the
state government before a water well is drilled. Although the owner of the
property on which the well is to be drilled is responsible under law for
obtaining the permit, Geoplan will frequently agree to obtain the necessary
permit on behalf of the customer. Although permits can be granted for a term of
up to 30 years, most states limit the duration of ground water well permits to
five years. If a permit expires and is not renewed, the owner of the property
might loose the right to withdraw ground water through the well and Azurix might
then loose its right to receive payment under the risk contract.


                                       23
<PAGE>   26

Regulation of Concessions

    Article 175 of the Federal Constitution of Brazil provides that it is the
responsibility of the government to render all public services, including water
supply and water and wastewater treatment. State and local governments may
fulfill this responsibility directly or by granting concessions to private
companies to provide public services on behalf of the state or local government.
Federal law 8.987/95, the Federal Concessions Law, authorizes state and local
governments to award concessions to private entities through a public bidding
process. The Federal Concessions Law establishes a variety of requirements
relating to the terms of any concession that may be granted by a state or local
governmental entity.

    The Federal Administration has submitted to the Brazilian Congress a bill
aimed at regulating the sanitation industry and providing access to water and
wastewater services to the country's population. The proposed bill establishes
responsibility as between the states and municipalities for the provision of
sanitation services. Under the proposed bill, each municipality would be
responsible for the sanitation systems that are located within its territory,
including water and wastewater treatment facilities. Sanitation systems that are
shared by more than one municipality would be the responsibility of the state.

Health and Environmental Regulation

    A variety of federal, state and local laws establish standards for the
quality of water supplied for public consumption and the quality of wastewater
discharged into public bodies of water. When Geoplan provides water supply
services, sampling is performed at least monthly during the life of the contract
to ensure that the water complies with applicable standards. Since the quality
of water supplied depends heavily on the quality of the source of water, Geoplan
typically does not provide water quality guarantees in its risk contracts.
However, if Geoplan is successful in obtaining public water supply concessions,
the water supplied pursuant to the concession will have to meet all applicable
standards.

    Wastewater discharge quality standards are based on the quality and
designated use of the body of water into which the wastewater is discharged. The
federal government has established minimum water quality standards for all major
bodies of water in Brazil. In addition, some Brazilian states have established
supplemental water quality standards that exceed the federal minimum standards.
In the event of a conflict, the more restrictive standards apply. Permits issued
for wastewater discharges establish minimum standards for a variety of
pollutants and substances, such as oil, solids, fecal coliform,
ammonia-nitrogen, and various toxic substances, all of which are based on the
quality and designated use of the body of water receiving the discharge. Permits
for discharges into bodies of water that are already highly polluted or that
have a special designated use, such as public recreation or drinking water
supply, will contain more stringent limitations than other wastewater discharge
permits.

    Under Brazilian law, the permit is issued to the wastewater generator or
treatment plant owner, and the permit holder is responsible for complying with
wastewater discharge permit limits. Fines and penalties can be imposed for
noncompliance with permit limits. Geoplan provides operational services for some
wastewater treatment plants and may seek concessions to operate wastewater
treatment plants that provide service to the general public. Under operational
service contracts or concessions, Geoplan may agree to be responsible for
compliance with permit limits provided that the customer (for an operational
contract) or the governmental entity (for a concession) does not act negligently
or in a manner that would cause the wastewater treatment plant to be incapable
of complying with applicable permit limits.

MEXICAN REGULATORY MATTERS

Water Provision Issues

    Article 27 of the Mexican Constitution reserves water resources to the
nation. Article 115 of the Mexican Constitution places responsibility for
providing public services, including water and wastewater treatment, on the
municipalities with the participation of the corresponding state at the request
of the municipality. The Ministry of Environment, Natural Resources and
Fisheries, through the National Water Commission, is responsible for:

    o  assigning water rights and discharge rights to users and assessing the
       relevant fees

    o  enforcing water related environmental regulations


                                       24
<PAGE>   27


    o  planning the efficient development of water resources

    o  developing regulatory, legal and financial structures for water
       concessions at the municipal level with an emphasis on private
       participation

    o  providing technical assistance to local water authorities and advising on
       project feasibility

    o  providing financial support for priority water projects, particularly in
       low-income areas

    The Water Commission of the Federal District of Mexico is responsible for
the provision of water and wastewater services within the Federal District of
Mexico. The Water Commission has contracted with Industrias del Agua to provide
services relating to the water and wastewater system. These services are to be
provided in accordance with the terms of the contract and reimbursed according
to the rate schedule set forth in the contract.

    For areas outside the Federal District, the states and municipalities are
responsible for setting conditions for concessions and for establishing a tariff
structure for all customer groups, collecting payments from customers and paying
the National Water Commission for use of water rights. The Cancun concession is
regulated by Comision de Agua Potable y Alcantarillado, referred to as CAPA, an
agency of the State of Quintana Roo. The Governor of the State of Quintana Roo
appoints the members of CAPA. One of the requirements of the concession is that
the concessionaire achieve and maintain a 95% connection rate for water and
wastewater for the population. Changes to the connection rate requirement will
be subject to the mutual consent of both CAPA and the concessionaire.

Tariff Rates for the Cancun Concession

    The tariff rates for the Cancun concession are set by CAPA and are based on
the principle of full recovery of operations and maintenance costs and can be
revised to maintain the economic equilibrium of the concession. There is no
provision that tariffs should provide a return on equity or permit the
concessionaire to earn a profit.

    Initial tariffs were set when the concessionaire was first awarded the
concession in October 1993. At current levels, the tariffs are sufficient to
cover cost of operations, capital expenditures required under the concession and
return on investment. These expenditures should not necessitate a real tariff
increase at the present time, but over the term of the concession a tariff
increase will be necessary due to growth in the domestic sector, which does not
pay for its costs. In addition, should significant, unexpected capital
expenditures be required, the concessionaire can propose to CAPA a tariff
increase.

    The concessionaire and CAPA are currently negotiating to change the tariff
rate to eliminate the cross-subsidy between water and wastewater. Currently,
wastewater service is charged a flat rate of 20% of the water bill, regardless
of actual usage. If the concessionaire wants to increase rates in real terms, it
will be required to submit a rate case to CAPA, with supporting economic and
financial documents explaining the reason for the increase. In all cases, the
real rate for the residential and communal customer classes shall not exceed the
combined operation and maintenance costs of supplying those customers. The
concession will be evaluated every five years to determine whether real tariff
increases are justified. However, the concessionaire may propose real increases
at any time, though CAPA's consent must still be obtained.

Environmental Matters

    A variety of federal, state and local laws establish standards for the
quality of water supplied for public consumption and the quality of wastewater
discharged into public bodies of water. The Constitution of Mexico provides that
all navigable bodies of water are subject to federal jurisdiction and
regulation. The federal government has adopted the General Law of Ecological
Balance and Environmental Protection, also known as the Federal Environmental
Law, to establish uniform standards for protection of all bodies of water
subject to federal jurisdiction and regulation. The Federal Environmental Law
authorizes individual state governments to adopt and enforce environmental
protection standards that meet or exceed minimum requirements established by the
federal government. The State of Quintana Roo, in which the Cancun concession is
located, has adopted its own state environmental laws and regulations. Both
state and federal governmental agencies possess the authority to impose fines
and penalties for violations of applicable environmental requirements.


                                       25
<PAGE>   28


    Industrias del Agua, which operates primarily in the Federal District of
Mexico, is subject primarily to federal environmental quality standards, whereas
the Cancun concession is subject to environmental rules and regulations
established by the State of Quintana Roo.

    CAPA is the agency responsible for enforcing environmental regulations
relating to water quality and wastewater discharges within the State of Quintana
Roo. The environmental laws adopted by the State of Quintana Roo also authorize
local governments, such as the municipal county governments of Benito Juarez and
Isla Mujeres, to adopt and enforce regulations pertaining to the operation of
potable water systems and the discharge of treated wastewater. These local
governmental entities monitor water consumption and regulate effluent quality
for the Cancun area, in cooperation with CAPA.

    The federal wastewater discharge standard for effluent from sewage treatment
plants in coastal areas is 70 milligrams per liter of total suspended solids and
biochemical oxygen demand. Although the State of Quintana Roo, CAPA, and the
municipal county governments of Benito Juarez and Isla Mujeres have not
established more stringent discharge requirements, the wastewater treatment
plants for the Cancun concession are designed to discharge an effluent
containing no more than 30 milligrams per liter of total suspended solids and
biochemical oxygen demand. The new facilities being constructed to serve the
Cancun concession will generate an increased volume of biosolids that will
require additional on-site management and off-site disposal, but we expect that
the Cancun concession will be able to handle the increase in compliance with all
environmental requirements. Azurix believes that the Cancun concession and
Industrias del Agua are conducting their operations in substantial compliance
with all applicable environmental laws.

FACTORS THAT MAY AFFECT FUTURE RESULTS AND ACCURACY OF FORWARD-LOOKING
STATEMENTS

    Certain statements contained in this Annual Report may constitute
"forward-looking statements" as such term is defined in the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. We may also
make forward-looking statements in other reports filed with the Securities and
Exchange Commission, in materials delivered to securityholders and in press
releases. In addition, our executive officers and those of our direct and
indirect shareholders may from time to time make oral forward-looking
statements. The forward-looking statements are based on management's current
expectations and beliefs and are subject to a number of factors and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements. Words such as "anticipates,"
"believes," "expects," "estimates," "intends," "plans," "projects" and similar
expressions, may identify such forward-looking statements.

    The following factors, among others, could cause actual results to differ
materially from those described in the forward-looking statements. Readers
should carefully review these factors, in addition to other factors discussed
elsewhere in this Annual Report and in our filings with the Securities and
Exchange Commission, as they identify certain important factors that could cause
actual results to differ materially from those in the forward-looking
statements.

WE HAVE A SHORT OPERATING HISTORY. OUR FUTURE FINANCIAL OR OPERATING RESULTS ARE
DIFFICULT TO FORECAST AND MAY BE MATERIALLY DIFFERENT FROM THOSE PRESENTED IN
THIS REPORT.

    We were formed in 1998 and, therefore, have a short operating history. We
acquired Wessex and our interest in Mendoza in late 1998 and most of our other
assets in 1999. As a consequence, there is limited historical information
available regarding our businesses. Our limited operating history and the
unpredictable results of our business strategy make it difficult to forecast our
future operating results.

WATER AND WASTEWATER COMPANIES FACE PRICE, COMPETITION AND OTHER REGULATIONS
THAT COULD REDUCE OUR OPERATING REVENUES.

    Governments generally regulate the prices that water and wastewater
companies may charge their customers and the competitive environment in which
they operate. Regulatory regimes vary from country to country and at times can
give great discretion to the regulatory authority. Moreover, the regulatory
authorities in countries where we currently operate, or may operate in the
future, could change, as could the regulations they promulgate. These changes
could cause reductions in our operating revenues.


                                       26
<PAGE>   29


WE FACE SIGNIFICANT COMPETITION.

    Participants in the global water industry must compete with each other when
bidding or negotiating for concessions, contracts and other projects. We face
significant competition from companies larger than we are, companies with longer
operating histories and greater experience in securing water and wastewater
projects than we have and other new entrants to the global water industry. Our
limited operating history may make it difficult for us to qualify for, or be
successful in, bidding against these more experienced competitors. We may be at
a disadvantage in competing for concessions, contracts and other projects when
we have no history operating in a particular country or region, or when we have
no history operating a water or wastewater facility or system comparable in size
to the facility or system being privatized or built. Further, our competitors
may be able to obtain capital at a lower cost and be willing to bid more
aggressively than we can, which would give them an advantage in bidding on
projects and other competitive situations. This competition, along with the
delay in concessions coming to market and our capital constraints, led us to
decide not to pursue further concession investments at this time.

OUR PROFITABILITY AND PROSPECTS FOR GROWTH ARE HIGHLY DEPENDENT ON OUR
SUCCESSFULLY OBTAINING CONTRACTS, COMPLETING ACQUISITIONS AND DEVELOPING
PROJECTS, AND WE MAY NOT BE ABLE TO OBTAIN CONTRACTS, COMPLETE ACQUISITIONS AND
DEVELOP PROJECTS SUCCESSFULLY.

    We may not be able to obtain contracts, complete acquisitions of water and
wastewater assets and develop projects successfully because these transactions
involve many complexities. These complexities include, among other things,
negotiation of satisfactory water supply and wastewater treatment services
agreements with local governments and industrial customers, receipt of required
governmental consents and permits and obtaining financing for our operations,
acquisitions and projects. In addition, in evaluating and negotiating water
service projects and contracts, we may encounter difficulties in determining the
status and condition of existing systems or developing accurate forecasts of
material factors such as the rate of population growth, particularly in
developing countries. In privatization transactions, we are unable to predict
with certainty the timing of a privatization or the commitment level of a
government to completing a privatization. Most privatizations are competitively
bid, and there is no assurance as to what proportion of the projects on which we
bid, if any, we ultimately will acquire. To the extent we are unsuccessful in
completing acquisitions and development projects, expenses we incur in pursuing
these transactions will not be absorbed by income associated with those
acquisitions and development projects and will decrease our net income.

RESTRICTIONS IN OUR DEBT AGREEMENTS COULD LIMIT OUR GROWTH AND OUR ABILITY TO
RESPOND TO CHANGING CONDITIONS.

    Some of the debt agreements to which we or our subsidiaries are a party,
including the indenture governing our senior notes and the Azurix Europe and the
Wessex credit facilities, contain covenants that could restrict our future
business operations. These operating and financial covenants could hinder our
flexibility in planning for, and reacting to, changes in our business. Our
ability to satisfy these covenants and the other requirements imposed by our
credit facilities and the indenture could be adversely affected by events beyond
our control. An event of default under our credit agreements or the occurrence
of a change of control or an event of default under the indenture, if not cured
or waived, could permit acceleration of the relevant debt and acceleration of
debt and other obligations under other instruments. We are not certain whether
we would have, or be able to obtain, sufficient funds to make these accelerated
payments.

FAILURE TO IDENTIFY AND ASSESS ACCURATELY THE RISKS RELATED TO AN ACQUISITION OR
TRANSACTION COULD ADVERSELY AFFECT OUR OPERATING RESULTS.

    In evaluating potential transactions, we make assumptions and projections
based on the potential for increased returns, future regulatory and rate case
changes and the engineering, operations, financing, economic, structuring,
insurance, tax, environmental, legal and accounting risks relating to each
transaction. Forecasts, estimates and information provided by local governments
and other sources used to bid for public tenders can prove to be materially
inaccurate or incomplete, resulting in projections for capital expenditures to
improve or build water systems that are below what is ultimately required. If
the assumptions on which we base our decision to acquire assets, develop a
project or provide a service prove to be incorrect in any material respect, then
our operating results, including earnings, could be materially adversely
affected.


                                       27
<PAGE>   30


BECAUSE OUR BUSINESS REQUIRES SUBSTANTIAL CAPITAL, DIFFICULTY FINANCING OUR
OPERATIONS, ACQUISITIONS AND PROJECTS COULD LIMIT OUR GROWTH AND OUR
PROFITABILITY.

    With respect to commitments under our existing businesses, we expect to
incur capital expenditures of approximately $1.4 billion over the next five
years. We intend to finance our projected capital expenditures for our existing
businesses principally with internally generated funds and proceeds under
existing long-term and short-term borrowing arrangements and future financing
arrangements. The water and wastewater assets and projects in which we have
invested and may invest in the future may also require substantial capital
expenditures, especially early in the life of our investments. We intend to
finance our investments and projects using various techniques and instruments
such as debt financing, project financing and equity investments. We engage in
leveraged transactions, and we may pledge all or substantially all of our
assets.

    There is a risk that financing may not be readily available to finance our
operations, acquire water and wastewater assets or develop projects. Our ability
to arrange financing will be affected by general economic and capital market
conditions, credit availability from banks or other lenders and the risks
inherent in particular concessions, projects or countries. In particular
projects, we may have a co-owner with limited resources or that may default on
its obligations to contribute capital to a project.

IF WE DO NOT HAVE OPERATIONAL CONTROL, OUR OPERATING REVENUES AND EARNINGS COULD
BE REDUCED.

    We have invested in water and wastewater projects and assets in which we do
not own a majority of the project or assets, and may do so in the future. In
addition, we have invested in or own projects and assets with partners,
co-venturers and other parties, including governmental entities, and may do so
in the future. Some jurisdictions require participation of employees or other
stakeholders in company management. In these cases, major decisions may require
the consent of other equity owners or stakeholders.

    We may also invest in projects and assets where we do not serve as operator.
For example, we do not have operational control of the concession in Mendoza,
Argentina in which we own a 32.1% interest. In these cases, our ability to
direct the outcome of matters with respect to the operations of the project or
assets could be limited. A lack of operational control in a project could
materially and adversely affect our interest in the project and, as a result,
our operating revenues and earnings from the project.

ENVIRONMENTAL AND HEALTH FACTORS AND CHANGES IN REGULATIONS COULD INCREASE OUR
COSTS OR OUR LIABILITIES.

    Changes in environmental, health and other regulations applying to the water
supply or wastewater treatment services industry or new, revised or inconsistent
interpretations of these regulations may adversely affect our financial
condition and results of operations. Water companies are subject to water
quality risks related to contamination of drinking water supplies or
environmental danger from effluent discharges. The occurrence of these or other
risks could have a material adverse effect on our financial position and results
of operations.

    In addition, many countries have recently developed, or are in the process
of developing, new regulatory and legal structures that regulate the delivery of
drinking water and wastewater services and accommodate private and foreign-owned
water businesses. In some instances, these regulatory and legal structures and
their interpretation and application by administrative agencies are relatively
new and incomplete. The interpretation of existing rules can be expected to
evolve over time and may have an unpredictable impact on our business. We
anticipate future changes in, or decisions affecting, regulatory regimes that
will serve to expand or tighten regulatory controls. Some of these changes or
decisions could have a material adverse effect on our financial position and
results of operations.

    In our industrial services business, we may handle hazardous substances in
addition to biological waste. Stringent environmental laws provide for serious
penalties and sometimes impose strict liability on those who handle these
substances or find them on their property. Accordingly, if we handle hazardous
substances in our industrial services business in the future, there is a risk
that we will incur significant liabilities and expenses. Although we maintain
insurance against many of these risks, we cannot be certain that insurance
proceeds received under our policies would adequately cover all liabilities we
may incur.


                                       28
<PAGE>   31


LIABILITY FOR WATER SUPPLY CONTAMINATION COULD RESULT IN MATERIAL LOSSES AND
COSTS.

    Our business, in particular the supply of water to end-users, is subject to
risks of contamination of the water supply, which could result in disease or
even death or otherwise endanger the public health. As a result of
contamination, we could be subject to civil, criminal or regulatory enforcement
actions, private suits and cleanup obligations, which could have a material
adverse effect on our financial condition and results of operations. Drinking
water contamination can be caused by, among other things, wastewater effluent,
stormwater runoff from farms and industrial sites, materials used in the
construction or rehabilitation of water supply pipes, harmful nitrates
attributable to modern farming practices and various other pathogens from a
variety of sources entering the drinking water supply. Accordingly, we cannot
assure you that our water supply will remain at all times free of contaminants.
Although we maintain insurance against many of these risks, we cannot be certain
that insurance proceeds received under our policies would adequately cover all
liabilities we may incur.

POLITICAL AND ECONOMIC CHANGES IN COUNTRIES IN WHICH WE OPERATE COULD ADVERSELY
AFFECT OUR OPERATING RESULTS.

    The success of our strategy in many countries will depend on a political and
economic environment that will accommodate foreign investment and project
development. Our operations will be subject to political and economic risks,
including risks of war, terrorism, expropriation, nationalization, renegotiation
or nullification of existing contracts, changes in rates and methods of
taxation, implementation of subsidies or other protections for disadvantaged
groups and foreign exchange controls or governmental restrictions on the
repatriation of hard currency. We operate in countries whose economies differ in
many respects from the economies of the United States, Canada and most Western
European countries, including their structure, levels of capital reinvestment,
growth rate, governmental involvement, resource allocation, self-sufficiency,
rate of inflation and balance of payments position. In many of these countries,
the government retains significant control over the economy. Thus, there is a
risk that future government actions, especially with respect to nationally
important facilities such as water systems, could have a material adverse effect
on our financial condition and results of operations.

WORK STOPPAGES AND OTHER LABOR RELATIONS MATTERS COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.

    We are subject to a risk of work stoppages and other labor relations matters
because we have invested and may invest in the future in assets and projects
utilizing a workforce that in many cases will be unionized. A significant
portion of the work forces at almost all of our operating subsidiaries are
represented by unions. Our ability to obtain an adequate return on an investment
will often depend on our success in optimizing the labor force through voluntary
and sometimes involuntary staff reductions. There is a risk that layoffs, where
implemented, could trigger community or union problems. We cannot assure you
that issues with our labor forces will be resolved favorably to us, or that we
will not experience work stoppages. Work stoppages could lead not only to
reduced revenues, but also, in some cases, to defaults under concession,
operating or other contracts.

CHANGES IN CURRENCY EXCHANGE RATES, LIMITATIONS ON SENDING FUNDS OUT OF A
FOREIGN COUNTRY AND FOREIGN CURRENCY RESTRICTIONS OR SHORTAGES COULD ADVERSELY
AFFECT OUR OPERATING RESULTS.

    Because we conduct operations outside the United States, limitations on the
right to convert currency or to take it out of a foreign country and the
capacity of currency exchange markets may adversely affect our ability to
repatriate profits, and changes in exchange rates may adversely affect the U.S.
dollar equivalent of the profits to be repatriated. For the year ended December
31, 2000, 84.7% of our operating revenues were not U.S. dollar denominated.
Legal restrictions or shortages in currencies in countries outside the United
States may prevent us from converting sufficient local currency to enable us to
comply with our currency payment obligations not denominated in local currency
or to meet our operating needs and debt service requirements.

OPERATING IN COUNTRIES WITHOUT ADEQUATE REVENUE COLLECTION SYSTEMS COULD REDUCE
OUR OPERATING REVENUES.

    We operate in countries without established or well-enforced revenue
collection mechanisms for water supply and wastewater treatment services or
encounter other difficulties in the collection process. For example, we did not
receive complete billing and customer records when we took over our concession
in Buenos Aires, which has impeded collection efforts and adversely affected our
operating revenues derived from this concession to date. Also, customers in some
countries may not be able or willing to pay for water services. This could have
a material adverse effect on our financial condition and results of operations.
We cannot assure you that government subsidies or taxes and other concessions
will sufficiently compensate private parties that provide these services for


                                       29
<PAGE>   32


the economic consequences of such conditions. Where initially available, there
is a risk that such subsidies and concessions could be reduced or eliminated
before reliable revenue sources and collection mechanisms can be established.

INTERACTION OF DIFFERENT TAX JURISDICTIONS COULD LOWER OUR RETURNS AND DIRECTLY
AFFECT OUR BUSINESS STRATEGY.

    In the United States, if our operating revenues from future U.S. operations
do not exceed the expenses we incur in the United States in supporting our
worldwide operations, the potential tax benefits associated with these expenses
may not be realizable. If these amounts were determined to not be realizable
within specified expiration periods in accordance with applicable U.S.
accounting and tax regulations, the impact could materially reduce future
consolidated net earnings. The future realization of these tax benefits in the
U.S. could therefore have a direct impact on our strategic emphasis in expanding
our U.S. operating base.

    In addition, tax laws in various countries treat differently the taxability
of various aspects of income and gain and the deductibility of expenses and
losses. Income earned in one jurisdiction also may be taxable in another,
including the United States. Although in many instances U.S. tax laws will
permit us to credit amounts paid in taxes in other countries against our U.S.
tax obligations, the rules allowing credits are complex and do not allow credits
in many circumstances. Moreover, if we incur expenses in one jurisdiction that
benefit a project in another, they may not be deductible against income in the
jurisdiction where the expenses were incurred.

OPERATING IN COUNTRIES WITH UNDEVELOPED LEGAL SYSTEMS COULD ADVERSELY AFFECT OUR
BUSINESS BECAUSE WE MAY ENCOUNTER DIFFICULTIES ENFORCING OUR CONTRACTUAL RIGHTS.

    Developing countries in which we may pursue opportunities may not have well
established legal systems and may lack a well-developed, consolidated body of
laws governing foreign investment enterprises. The uncertainty of the legal
environment in these countries could make it difficult for us to enforce our
rights, or those of our operating companies, under agreements relating to our
operations. In addition, the administration of laws and regulations by
government agencies in such countries may be subject to considerable
discrimination or prejudice against foreigners or private investors. As these
legal systems develop, foreign investors may be adversely affected by new laws
and changes to existing laws. In addition, in countries where adequate laws and
well-developed legal systems do exist, it may not be possible to obtain swift
and equitable enforcement of such laws.

OUR SUCCESS DEPENDS ON KEY MEMBERS OF OUR MANAGEMENT, THE LOSS OF WHOM COULD
DISRUPT OUR BUSINESS OPERATIONS.

    We depend on the continued employment of key management personnel. If these
officers resign or become unable to continue in their present role and if they
are not adequately replaced, our business operations could be materially
adversely affected.

CHANGES IN OUR RELATIONSHIP WITH ENRON COULD INCREASE OUR COSTS BECAUSE WE RELY
ON ENRON FOR CORPORATE STAFF AND SUPPORT SERVICES.

    We have entered into an agreement with Enron pursuant to which Enron
provides various corporate staff and support services to us. These services
include information technology, office space, building maintenance, security and
other office services as well as employee development, training and maintenance
of compensation and other benefits programs. We also may utilize Enron's
regulatory affairs, marketing affairs, treasury and risk assessment and control
departments. Our services agreement with Enron is for an indefinite term, but
may be terminated on 180 days' notice. If our agreement is terminated we expect
that we would be able to arrange alternate suppliers for all the services
important to our business. We expect that these services would be available from
third parties at costs similar to those we pay Enron.

OUR BUSINESS OPPORTUNITIES COULD BE LIMITED BECAUSE ENRON AND ITS AFFILIATES MAY
COMPETE WITH AZURIX IN WATER RELATED ACTIVITIES AND BECAUSE AZURIX MAY ONLY
ENGAGE IN ACTIVITIES GENERALLY IDENTIFIED IN THIS REPORT, INCIDENTAL ACTIVITIES
AND OTHER ACTIVITIES AS ATLANTIC WATER TRUST OR ENRON MAY APPROVE.

    Enron and Azurix have entered into an agreement that limits the scope of
Azurix's business and provides that Enron and its affiliates may engage in water
related businesses, even if those businesses have a competitive impact on
Azurix. In general, Enron is permitted to engage in any business whatsoever,
including water,


                                       30
<PAGE>   33


wastewater and other businesses competing with Azurix, and may compete in public
tenders against Azurix, provided the business is conducted and opportunities are
identified and developed through Enron's own personnel and not through Azurix.
If an opportunity in the water industry is presented to a person who is an
officer or director of both Enron and Azurix, the opportunity must first be
offered to Azurix, unless water constitutes a minority of the fair market value
of the opportunity, as determined by that officer or director in good faith
based on information available at the time. Azurix has agreed to indemnify Enron
and its officers, directors and employees against any claim that Enron's pursuit
of any water business was a breach of any duty owed by Enron to Azurix, provided
Enron has followed the rules described above. Were Enron to decide to pursue
activities in the water or wastewater industry, its size, access to capital and
experience in developing products and markets could make it a strong competitor.

    The agreement requires Azurix to limit its purpose, in its certificate of
incorporation, to the businesses generally identified in this report, activities
incidental to those businesses and such other businesses as Enron may approve in
its sole discretion. Azurix has agreed not to amend its certificate of
incorporation to expand its purpose clause without Enron's prior written
consent. The agreement thus limits our ability to pursue potentially profitable
activities that are not primarily in the water and wastewater sector, even
though those opportunities come to our attention on account of our activities in
water and wastewater. For example, some jurisdictions may choose to privatize
their water and wastewater and other utility assets together. As a result of
this agreement, we would need Enron's consent to pursue the privatization if the
water and wastewater assets were not expected to represent a majority of the
value.

    The agreement expires on the first date on which Enron and its affiliates do
not individually or collectively, directly or indirectly, own or have the power
to vote at least one-third of the shares of Azurix ordinarily entitled to vote
for the election of directors, and fewer than one-third of the directors of
Azurix are persons who are employees, officers or directors of Enron or any
affiliate of Enron.

OUR DIRECTORS MAY HAVE CONFLICTS OF INTEREST BECAUSE THEY ARE ALSO ENRON
OFFICERS.

    Currently, all of our directors are also officers of Enron, a situation that
may create conflicts of interest. The officers of Enron have fiduciary duties to
manage Enron, including its investments in subsidiaries and affiliates such as
Azurix, in a manner beneficial to Enron and its shareholders. Similarly, as
directors of Azurix, they have fiduciary duties to manage Azurix in a manner
beneficial to Azurix and its shareholders. In some circumstances, the duties of
these officers of Enron may conflict with their duties as directors of Azurix.

ITEM 2. PROPERTIES

    Information regarding our properties is set forth in "Item 1 -- Business."

ITEM 3. LEGAL PROCEEDINGS

    As previous reported in Azurix's Annual Report on Form 10-K for the year
ended December 31, 1999 and other filings, on November 1, 1999, Synagro filed a
lawsuit against us styled Synagro Technologies, Inc. v. Azurix Corp., in the
270th Judicial District Court of Harris County, Texas. The lawsuit relates to
various agreements between the parties regarding potential business transactions
and the possible acquisition by Azurix of two subsidiaries of Waste Management,
Inc., commonly called BioGro. On May 9, 2000, Synagro filed its First Amended
Petition in the District Court seeking (i) damages in excess of $57 million
resulting from the alleged breach by Azurix to purchase up to $23 million of
Synagro convertible preferred stock and (ii) unspecified damages resulting from
Azurix's alleged breach of confidentiality and standstill agreements. On August
4, 2000, Azurix filed its First Amended Answer and Counterclaim (i) denying all
of the material allegations contained in Synagro's First Amended Petition and
(ii) seeking damages in excess of $175 million for misrepresentations by Synagro
that induced Azurix to agree to restrictions on its ability to purchase BioGro
and to enter into negotiations with Synagro and Synagro's interference with
Azurix's acquisition of BioGro. The parties have agreed to a trail date in
September 2001. Azurix intends to continue to vigorously defend itself against
Synagro's claims and to continue to pursue its claims for damages resulting from
Synagro's conduct regarding BioGro. Although no assurances can be given, Azurix
believes that the ultimate resolution of this litigation will not have a
material adverse effect on its financial position or results of operations.


                                       31
<PAGE>   34


    On October 6, 2000, a lawsuit was filed in the United States District Court
for the Southern District of Texas, Houston Division, by Irving Rosenzweig, on
behalf of himself and others similarly situated, against Azurix Corp., Enron
Corp. and certain of their officers and directors. The suit is a purported class
action filed on behalf of those persons who purchased the common stock of Azurix
during the period from June 9, 1999, the date of Azurix's initial public
offering, through and including August 8, 2000. The suit generally alleges that
the defendants violated Sections 11, 12(a) and 15 of the Securities Act of 1933,
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5.
The plaintiff contends that the defendants issued and disseminated materially
false and misleading information to the plaintiff and the investing public in
connection with Azurix's initial public offering and during the class period.
The plaintiff seeks rescissory and/or compensatory damages, interest and costs,
including attorneys and experts fees. The plaintiff also seeks extraordinary
and/or injunctive relief, including attaching, impounding, imposing a
constructive trust upon or otherwise restricting the proceeds of defendants'
trading activities or their other assets so as to assure that plaintiffs have an
effective remedy. Several similar actions have been filed in the United States
District Court for the Southern District of Texas and have been consolidated.
These lawsuits are subject to the Private Securities Litigations Reform Act of
1995 and in each case the plaintiff seeks to have the action certified as a
class action with plaintiff as the class representative. Azurix intends to deny
the allegations in each complaint and defend these cases vigorously. At this
early stage of the litigation, it is not possible to estimate potential damages,
if any. If liability were established, an unfavorable judgment or settlement
could have a material adverse effect on Azurix's financial position and results
of operations.

    On October 27, 2000, a lawsuit was filed in the Court of Chancery in the
State of Delaware, New Castle County, by Thomas Turberg against Azurix Corp.,
Enron Corp., and certain of their officers and directors. The suit is a
purported class action filed on behalf of Azurix's public shareholders for the
purpose of enjoining a transaction proposed by Enron for taking Azurix private
at a price of $7.00 for each of Azurix's publicly held shares. The letter from
Enron making this proposal and the related press release issued by Azurix were
filed with the Securities and Exchange Commission on October 27, 2000, as
exhibits to Azurix's Current Report on Form 8-K. The suit generally alleged that
the buy-out price of $7.00 per share was unconscionable and unfair and grossly
inadequate and that the defendants have breached their duties of loyalty and
care with respect to Azurix's public shareholders. The plaintiff sought a
judgment (i) enjoining the acquisition under the terms proposed in the letter;
(ii) to the extent the transaction is consummated prior to a final judgment,
rescinding the transaction or awarding rescissory damages to the class; (iii)
directing that the defendants account to the plaintiff and the class for all
damages caused to them and account for all profits and any special benefits
obtained by the defendants as a result of their alleged unlawful conduct; (iv)
awarding to the plaintiff the costs and disbursements of the lawsuit, including
a reasonable allowance for attorney fees and expenses; and (v) granting such
other and further relief as the court deems appropriate. Six similar actions
were subsequently filed in the Court of Chancery in the State of Delaware, New
Castle County and all Delaware actions have been consolidated into a single
action. In addition, a similar action was filed in the 55th Judicial District
Court of Harris County, Texas. Certain of the actions filed in the Delaware
court have added Atlantic Water Trust as a defendant. On December 13, 2000, the
parties to the litigation executed a Memorandum of Understanding that settled
both the Delaware and Texas actions in principle. Under the proposed settlement,
the defendants acknowledged that the prosecution of the litigation was a
material factor in causing Enron to increase the merger consideration from $7.00
to $8.375 per share. The proposed settlement provides that the defendants will
not oppose plaintiffs' application for attorneys' fees and expenses up to $2.25
million, which Enron has agreed to pay. The proposed settlement is subject to
the execution of definitive settlement documents, confirmatory discovery, and
court approval.

    Azurix's subsidiaries are parties to other legal proceedings as part of
their operations. We do not believe that any of these other legal proceedings
would, if adversely determined, have a material adverse effect on our financial
position or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    No matter was submitted to a vote of our shareholders, through the
solicitation of proxies or otherwise, during the fourth quarter of fiscal year
2000.


                                       32
<PAGE>   35

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

    Our common stock was traded on the New York Stock Exchange under the symbol
"AZX" since its initial public offering in June 1999 through March 16, 2001, the
date on which Azurix merged with an indirect, wholly owned subsidiary of Enron.
The table below sets forth the high and low closing sales prices for shares of
the common stock, as reported on the New York Stock Exchange for the periods
listed.

<TABLE>
<CAPTION>

                                                              HIGH          LOW
                                                            --------      ---------
<S>                                                         <C>           <C>
           YEAR ENDED DECEMBER 31, 1999
           Second Quarter (beginning June 9, 1999).......   $20 1/4       $19
           Third Quarter ................................    24 1/4        13 3/4
           Fourth Quarter ...............................    17 1/16        6 9/16
           YEAR ENDED DECEMBER 31, 2000
           First Quarter ................................    11 1/16        6 13/16
           Second Quarter ...............................     9 3/8         6
           Third Quarter ................................     9 1/16        3 1/2
           Fourth Quarter ...............................     8 3/16        3 3/8
           YEAR ENDED DECEMBER 31, 2001
           First Quarter (through March 16, 2001) .......     8 3/8         8 3/16
</TABLE>

HOLDERS

    As of March 29, 2001, there were two holders of record of our common stock.
Of the three shares of common stock outstanding, a wholly owned subsidiary of
Enron holds one share and Atlantic Water Trust holds the other two. Enron and
Marlin Water Trust each owns a 50% voting interest in Atlantic Water Trust.

DIVIDENDS

    We have never declared or paid cash dividends on our common stock. We do not
anticipate paying any dividends in the foreseeable future because we intend to
retain all earnings for use in our business. Furthermore, the payment of
dividends or other distributions on, or with respect to, the common stock is
limited by provisions of the indenture covering the senior notes we issued in
February 2000, which contains certain covenants that restrict our ability to pay
dividends. Further, Azurix Europe's revolving credit facility prohibits the
payment of dividends or other distributions of capital from Azurix Europe to us,
which restricts our ability to fund dividends. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and Notes 6 and 7 of the Notes to the Consolidated Financial
Statements.

ITEM 6. SELECTED FINANCIAL DATA

    The tables on the following page present selected historical consolidated
financial data for Azurix and for Wessex, the predecessor of Azurix, for the
periods and dates indicated.

    The financial data for Azurix are derived from Azurix's audited consolidated
financial statements included elsewhere in this report and include the impact of
the Wessex acquisition from the date of acquisition. All of Azurix's 1998
results of operations occurred in the fourth quarter of 1998, subsequent to the
acquisition of Wessex. The income statement and other financial data for Wessex
for the six months ended October 2, 1998 are derived from Wessex's audited
financial statements included elsewhere in this report. The balance sheet data
for Wessex as of March 31, 1998 and the income statement and other financial
data for the year ended March 31, 1998 are derived from Wessex's audited
consolidated financial statements included in Azurix's Annual Report on Form
10-K for the year ended December 31, 1999. Wessex's income statement and other
financial data for the year ended March 31, 1997 are derived from Wessex's
audited consolidated financial statements included in Azurix's Form S-1, filed
with the Securities and Exchange Commission on June 9, 1999. The balance sheet
data for Wessex as of March 31, 1997 was derived from unaudited financial
statements prepared in accordance with


                                       33
<PAGE>   36


U.S. generally accepted accounting principles that were derived from Wessex's
audited financial statements prepared in accordance with U.K. generally accepted
accounting principles.

    The merger of Azurix Corp. and a wholly owned indirect subsidiary of Enron
Corp. resulted in Azurix Corp. ceasing to have publicly held common stock or
potential common stock on March 16, 2001 (see Note 21 to the Consolidated
Financial Statements). In addition, on that date, the outstanding shares of
Azurix Corp. were reduced to three shares. Statement of Financial Accounting
Standards No. 128 requires disclosure of earnings per common share for entities
with publicly held common stock or potential common stock. Because Azurix has
ceased to have publicly held common stock, earnings per share disclosures are
not presented below.




<TABLE>
<CAPTION>


                                                     WESSEX (PREDECESSOR COMPANY)                    AZURIX
                                                 -------------------------------------  -------------------------------------
                                                                           SIX MONTHS   JANUARY 29,
                                                  YEAR ENDED MARCH 31,        ENDED      1998 TO      YEAR ENDED DECEMBER 31,
                                                 ---------------------     OCTOBER 2,   DECEMBER 31,  -----------------------
                                                   1997         1998          1998         1998           1999         2000
                                                 --------     --------     ----------   ------------  ---------     ---------
                                                                         (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S>                                              <C>          <C>          <C>          <C>           <C>          <C>
STATEMENT OF INCOME (LOSS) DATA:
Operating revenues ..........................    $  403.1     $  436.6     $  233.8     $  119.7      $  618.0     $  757.3
Operations and maintenance expense ..........       102.4        110.9         61.7         31.6         224.7        376.2
General and administrative expense ..........        32.2         29.1         36.4         20.3         117.8        154.1
Depreciation and amortization ...............        58.0         64.3         35.2         22.2         104.8        132.3
Impairment of long-lived assets .............          --           --           --           --            --        401.8
Restructuring charge ........................          --           --           --           --          34.2           --
Operating income (loss) .....................       210.5        232.3        100.5         45.6         136.5       (307.1)
Equity in earnings (loss) of
  affiliates(1) .............................        14.7         13.3          5.8         (0.8)          2.0          5.6
Impairment of investment in
  unconsolidated affiliate ..................          --           --           --           --            --        (55.0)
Gain on sale of assets ......................          --           --           --           --            --          2.5
Interest expense (income), net ..............       (10.2)         8.6          6.1         15.1          73.6        122.4
Other expense ...............................          --           --           --          1.2            --           --
Income (loss) before minority
  interest, income tax and
  utility tax and extraordinary loss ........       235.4        237.0        100.2         28.5          64.9       (476.4)
Minority interest ...........................          --           --           --           --          (1.1)        (3.0)
Income tax expense ..........................        82.4         58.0         28.4         18.3          21.5         17.6
Utility tax expense(2) ......................          --        162.3           --           --            --           --
Income (loss) before extraordinary loss .....       153.0         16.7         71.8         10.2          44.5       (491.0)
Extraordinary loss, net of tax ..............          --           --           --           --           6.8           --
Net income (loss) ...........................       153.0         16.7         71.8         10.2          37.7       (491.0)
Preference share dividends ..................        13.5         15.1          7.7           --            --           --
Net income (loss) available to common
  stockholders ..............................       139.5          1.6         64.1         10.2          37.7       (491.0)
Dividends declared per common share(3) ......        0.26         0.31         0.23           --            --           --
OTHER FINANCIAL DATA:
Net cash provided by operating
  activities ................................       246.3        125.0        132.2          4.4         158.3         77.8
Net cash used in investing activities .......       (97.8)      (195.0)      (108.4)    (1,982.6)     (1,076.8)      (363.5)
Net cash (used in) provided by
  financing activities ......................      (373.0)         6.8        (23.6)     1,977.5         940.0        299.3
</TABLE>


<TABLE>
<CAPTION>

                                                  WESSEX (PREDECESSOR COMPANY)                   AZURIX
                                                  ----------------------------   -----------------------------------------
                                                          AT MARCH 31,                       AT DECEMBER 31,
                                                  ----------------------------   -----------------------------------------
                                                      1997           1998          1998            1999          2000
                                                  ------------    -----------   ----------     ----------     ----------
                                                                          (IN MILLIONS)
<S>                                               <C>             <C>           <C>            <C>            <C>
BALANCE SHEET DATA:
Working capital .............................      $    (95.5)    $   (307.0)    $   (129.6)    $   (239.6)    $   (433.1)
Total assets ................................         2,258.0        2,372.3        3,358.3        4,850.4        4,101.4
Long-term debt (including affiliates) .......           203.9          169.7        1,033.5        1,481.9        1,464.7
Redeemable preference shares ................           254.7          259.0             --             --             --
Stockholders' equity ........................         1,251.5        1,229.5        1,645.5        1,941.8        1,324.2
</TABLE>


    (1)  Equity in earnings of affiliates for all periods presented for Wessex
         is related primarily to Wessex's interest in UK Waste, which was sold
         in November 1998.


                                       34
<PAGE>   37


    (2)  The year ended March 31, 1998 includes a windfall tax of $162.3
         million, which has been described by the U.K. Government as a one-time
         tax. Excluding the effect of this tax, for the year ended March 31,
         1998, Wessex's net income would have been $179.0 million.

    (3)  Wessex shareholders were given the option to elect dividends declared
         to be paid in cash or the issuance of additional ordinary shares. Of
         the dividends declared per share for the years ended March 31, 1997 and
         1998 and for the six months ended October 2, 1998, shareholders elected
         stock dividends equal to $0.02, $0.05 and $0.18 per share,
         respectively.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

    The following information should be read in conjunction with the information
contained in the Consolidated Financial Statements of Azurix and Wessex and
related notes thereto contained herein.

BUSINESS ACQUISITIONS

    On October 2, 1998, Azurix, through its indirect wholly owned subsidiary,
Azurix Europe Ltd., acquired over 90% of the outstanding ordinary share capital
of Wessex. On that same date, Azurix Europe issued notices to the remaining
Wessex ordinary shareholders, informing them that it intended to exercise its
rights under the English Companies Act to acquire compulsorily all of the
outstanding ordinary shares not held by Azurix Europe. The compulsory share
acquisition was completed in November 1998. The per share price paid to Wessex
shareholders was L.6.30. The total cost of the Wessex acquisition, including
transaction costs, was $2.4 billion, plus the assumption of $481.5 million of
existing Wessex debt. The cost included cash consideration paid to Wessex
shareholders, net of $1.7 million cash acquired, and the issuance of loan notes
to Wessex shareholders in the face amount of $119.8 million. The acquisition was
financed through capital contributions from Azurix's parent company totaling
$1.6 billion and the issuance of $0.8 billion in debt by Azurix Europe. Wessex
had cumulative mandatorily redeemable preference shares outstanding when it was
acquired. Wessex redeemed these shares in December 1998 for a cash payment of
$106.4 million.

    On March 24, 1999, Azurix acquired, for $13.5 million, a 49% economic
interest in the company holding the water and wastewater treatment concession
for Cancun and Isla Mujeres, Mexico, along with the right to manage and operate
its business. On February 25, 1999, Azurix lent the concession company $15.0
million to permit it to retire a portion of its indebtedness. Azurix also agreed
to make additional loans of up to $10.0 million. The balance of the loans
outstanding to the Cancun concession at December 31, 2000 was $20.1 million.

    On May 18, 1999, Azurix acquired 100% of the stock of Canadian-incorporated
Philip Utilities Management Corporation for $107.4 million, including
transaction costs. This business subsequently was renamed Azurix North America.
Azurix North America is a water and wastewater services company that provides
operations and management, engineering, residuals management and underground
infrastructure development services for municipal water and wastewater
facilities in the U.S. and Canada. Subsequent to its acquisition by Azurix,
Azurix North America has expanded through the acquisition of several water and
wastewater service companies for an aggregate purchase price of $17.7 million.

    During the second quarter of 1999, Azurix was the successful bidder in a
tender for a 30-year concession to operate the water and wastewater systems in
two regions of the Province of Buenos Aires, Argentina, previously operated by
Administracion General de Obras Sanitarias Buenos Aires. On June 30, 1999,
Azurix, through Azurix Buenos Aires S.A., an indirect wholly owned subsidiary,
entered into a concession contract with the provincial government covering the
two regions and paid the government $438.6 million. On July 1, 1999, Azurix
assumed operation of the water and wastewater systems.

    In connection with the funding of the Buenos Aires concession acquisition,
Azurix made an equity investment in Azurix Buenos Aires of $45.0 million, and
Azurix Buenos Aires borrowed $394.0 million under a new credit agreement. This
loan was secured by cash and other short-term liquid investments, which Azurix
deposited into a cash collateral account and pledged as security for the loan.
Azurix used $230.6 million of the proceeds from its initial public offering,
$208.0 million in funds drawn under the senior credit facility of its indirect
wholly owned subsidiary, Azurix Europe Ltd., and interest on those funds and
other funds of Azurix, to fund the equity investment in Azurix Buenos Aires and
the deposit into the cash collateral account. Under the concession


                                       35
<PAGE>   38


contract, a 10% interest in Azurix Buenos Aires was subsequently transferred to
the employees of Azurix Buenos Aires.

    On September 24, 1999, Azurix acquired 49% of the capital stock of IASA
Holdings, S.A. de C.V. for $22.5 million, excluding transaction costs. IASA
Holdings owns 100% of Industrias del Agua, S.A. de C.V., a water and wastewater
services company based in Mexico City, Mexico that provides metering, billing,
collections, operations and maintenance services for one quarter of the Federal
District within Mexico City, a service area with a population of approximately
two million people. Industrias del Agua has provided these services since 1993,
when it signed a 10-year contract with the Water Commission of the Federal
District. In addition to holding an interest in Industrias del Agua, Azurix
provides technical services and serves as a technical participant under the
Federal District contract. Contemporaneous with its purchase of the common stock
of IASA Holdings, Azurix entered into separate agreements that resulted in
Azurix having effective control over IASA Holdings. Accordingly, IASA Holdings
is consolidated for financial statement purposes.

    On September 24, 1999, Azurix acquired from an affiliate of AMX-Acqua
Management Inc. 100% of three Brazilian companies, Geoplan-Assessoria,
Planejamento e Perfuracoes Ltda., Aguacerta-Sistemas de Abastecimento Ltda. and
Aguacerta Saneamento Ltda., which provide water drilling, water supply and
wastewater treatment services in Brazil, for $55.6 million in cash, excluding
transaction costs. Azurix has contingent payment obligations to a former owner
under certain negotiated formulas that depend on the future performance of the
business and has retained a former affiliate as a consultant to its Brazilian
operations.

    On October 4, 1999, Azurix purchased 13,600 acres of property in Madera
County, California, for $31.5 million, excluding transaction costs, with plans
of developing, owning and operating the Madera Water Bank Project, a ground
water storage project in the aquifer beneath it. The aquifer on the property
will be used to store surplus water from local, state and federal water
customers during wet years in an effort to make this water available for use
throughout the region and state during drier years or as the market dictates.
The Madera property is strategically located near existing state and federal
canals and aqueducts and the San Joaquin River, all of which could provide a
number of alternative conveyance systems to move water to and from the site.
Azurix is required to make additional payments to the seller contingent upon its
ability to successfully obtain the required water bank permits and commencement
of operations of the water bank.

    On October 18, 1999, Azurix acquired Lurgi Bamag GmbH, a water and
wastewater engineering services company, for $30.2 million, excluding
transaction costs. Lurgi Bamag and its subsidiaries have offices in Germany,
Brazil, Egypt and the United Kingdom.

RECENT DEVELOPMENTS

MERGER

    On March 16, 2001, shareholders of Azurix Corp. approved and adopted the
Agreement and Plan of Merger by and among Enron Corp., Enron BW Corp., a wholly
owned indirect subsidiary of Enron, and Azurix dated as of December 15, 2000.
The merger was consummated on March 16, 2001, at which time Enron BW Corp. was
merged into Azurix with Azurix being the surviving corporation.

    Under the Agreement and Plan of Merger, each issued and outstanding share of
Azurix Corp. common stock, other than those shares held by Atlantic Water Trust,
Enron Corp., Enron BW Corp., Azurix and any of their wholly owned subsidiaries,
was cancelled and converted into the right to receive $8.375 per share. On the
date of the merger, Enron BW Corp. had $325.9 million of cash that was used to
pay consideration to the public shareholders whose shares were cancelled. As a
result of the merger and effective on the merger date, Azurix Corp. had three
shares of common stock outstanding and Azurix Corp. common stock ceased to be
publicly held.

    Pursuant to the terms of the Agreement and Plan of Merger, on March 16,
2001, all Azurix stock options and unvested restricted stock outstanding were
cancelled. Holders of the options received a cash payment, less applicable
withholding taxes, for both vested and unvested options, based on the excess of
$8.375 over the exercise price per share. Holders of unvested restricted stock
received a cash payment of $8.375 per share, less applicable withholding taxes.
These payments resulted in Azurix recognizing a pre-tax charge of approximately
$4.3 million in the first quarter of 2001.


                                       36
<PAGE>   39


    In addition, under the Agreement and Plan of Merger, Azurix Corp. retired
$180 million of borrowings outstanding on March 16, 2001 under the Enron credit
agreement through the issuance to Enron of 11% cumulative mandatorily redeemable
preferred stock with an initial liquidation preference of $180 million. The
preferred stock may not be redeemed by Azurix Corp. prior to the date that all
of its senior notes due 2007 and 2010 have been redeemed. The preferred stock
must be redeemed on or before the second anniversary of the date that the senior
notes are no longer outstanding. Dividends will accrue, but will not be paid
until all of its senior notes have been redeemed.

    The definitive proxy statement that Azurix mailed to its shareholders in
connection with the merger stated that Enron does not view Azurix as a core
strategic asset. While no definitive plans have been made, Azurix intends to
pursue the potential disposal of certain of its assets provided favorable prices
for those assets can be obtained. Such asset disposals, should they occur, may
result in Azurix incurring losses in future periods.

ASSET IMPAIRMENTS

    In 1999, Azurix, through its subsidiary Azurix Buenos Aires S.A., was
awarded and assumed operations of a water and wastewater concession in the
Province of Buenos Aires, Argentina. In addition to the $438.6 million paid to
the provincial government to acquire the concession contract, under the terms of
the concession contract, Azurix is required to complete an investment program
which it began in 1999. Azurix currently owns 90% of Azurix Buenos Aires.

    Azurix believes that the provincial government has violated the terms of the
concession contract through such acts as limiting the amount Azurix can charge
customers to levels below those specified in the concession contract and failing
to complete and deliver infrastructure and other assets, including algae
treatment works at Bahia Blanca (see "Results of Operations"). Azurix notified
the provincial government of these and other violations in 2000. These
violations have negatively impacted concession cash flows, ability to raise
capital to fund the investment program of the concession and ability to provide
services to the concession customers.

    Failure by the provincial government to comply with the terms of the
concession contract, lack of progress in reaching resolution on these issues,
despite oral assurances from provincial officials to reach resolution by
year-end 2000, and prominent government officials publicly stating that Azurix
should be removed as operator of the concession during the last week of 2000,
resulted in Azurix evaluating its investment in the concession and related
property, plant and equipment for impairment. Based on this review, in the
fourth quarter of 2000, Azurix adjusted the carrying values of the concession
intangible and related property, plant and equipment to their fair value by
recording an impairment of $389.5 million (pre-tax and after-tax) which is
included in "Impairment of long-lived assets" in the Consolidated Statements of
Income (Loss). Fair value was determined based on the present value of expected
future cash flows from the concession, discounted using a risk-adjusted rate.

    During 2000, there were water supply and quality problems experienced by
areas within the concession, which Azurix attributes to failure of the Province
to meet the terms of the concession agreement. In addition, there was negative
publicity generated from growing political opposition as discussed above. Azurix
recorded an additional charge of $11.0 million (pre-tax and after-tax) in the
fourth quarter of 2000 to reflect the impact of these items on accounts
receivable collections. This amount is included in "Operations and maintenance"
expense in the Consolidated Statements of Income (Loss).

    As a result of the review of future cash flows discussed above, Azurix
believes that sufficient uncertainty exists regarding the realizability of
Argentine tax loss carryforwards such that a valuation allowance was appropriate
at December 31, 2000 (see Note 9 to the Consolidated Financial Statements). This
resulted in an additional tax expense of $18.5 million in the fourth quarter
of 2000.

    Azurix has a 32.1% equity method investment in Obras Sanitarias Mendoza
S.A., which owns a water and wastewater concession in the Province of Mendoza,
Argentina. As a result of events related to its investment in the concession in
the Province of Buenos Aires, Argentina, discussed above, Azurix evaluated the
fair value of its investment in the Mendoza concession. Fair value was
determined based on the present value of expected future cash flows from the
concession, discounted using a risk-adjusted rate. The resulting fair value was
less than Azurix's carrying value and this loss in value was determined to be
other than a temporary decline. Accordingly, Azurix recorded an impairment of
$55.0 million (pre-tax and after-tax) in the fourth quarter of 2000. This amount


                                       37
<PAGE>   40


is included in "Impairment of investment in unconsolidated affiliate" in the
Consolidated Statements of Income (Loss).

    On February 15, 2001, the Province and Azurix Buenos Aires entered into a
Memorandum of Understanding regarding a variety of issues between them. The
Memorandum of Understanding, among other things, set an investment program for
2001 at a lower level than previously required and established a framework for
negotiating issues associated with tariff levels and the remaining capital
program. There is no assurance, however, that these negotiations will result in
a resolution satisfactory to Azurix or the Province.

    During 2000, Azurix decided to sell its investment in its e-business
marketplace WaterDesk.com(TM). An initial attempt to sell WaterDesk as a public
marketplace solution for the water and wastewater industry was terminated in the
fourth quarter of 2000. Azurix is currently attempting to sell WaterDesk as a
private marketplace or an internal procurement tool for one or several companies
to conduct inter-company commerce. Azurix believes the fair market value of
WaterDesk used in this latter capacity has a lower value than if it were
utilized as a public marketplace solution for the entire water and wastewater
industry. As a result, Azurix recorded in the fourth quarter of 2000, a $12.3
million pre-tax impairment of its long-lived assets that comprise WaterDesk.
This amount is included in "Impairment of long-lived assets" in the Consolidated
Statements of Income (Loss).

RECENT ACCOUNTING PRONOUNCEMENTS

    In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which was subsequently amended by Statement of
Financial Accounting Standards No. 137 and No. 138. Statement of Financial
Accounting Standards No. 133 must be applied to all derivative instruments and
certain derivative instruments embedded in hybrid instruments and requires that
such instruments be recorded in the balance sheet either as an asset or
liability measured at their fair value through earnings, with special accounting
allowed for certain qualifying hedges. Azurix adopted Statement of Financial
Accounting Standards No. 133 as of January 1, 2001. Due to its adoption, Azurix
will recognize an after-tax non-cash gain of approximately $1.5 million in
earnings and an after-tax non-cash loss in "Accumulated other comprehensive
loss," a component of stockholders' equity, of approximately $0.5 million, both
from the cumulative effect of a change in accounting principle.

RESULTS OF OPERATIONS

    Approximately 70% of Azurix's operating revenues for the year ended December
31, 2000 are derived from water supplied and wastewater treated for residential,
commercial and industrial customers. Services can be charged on a metered or
unmetered basis.

    Azurix also has operating revenues derived from outsourced services,
including operating and maintaining water and wastewater treatment facilities
and related services, such as metering, billing and collections for municipal
and industrial customers and providing residuals management and biosolid
dewatering and disposal services. In connection with these outsourced services,
additional revenues result from plant design and construction project
management, process design and engineering services as well as installation of
automated control systems. Azurix also provides services relating to the
construction, repair and maintenance of collection and distribution systems both
to water and wastewater treatment facilities owned and operated by Azurix and to
third parties.

    Operations and maintenance expense consists of the costs of supplying water
and treating wastewater, including the costs of maintaining and operating the
plant and equipment used in these processes, and the cost of purchasing bulk
potable water. The main categories of cost include labor, power, rent, real
estate taxes, chemicals, transport, equipment, grounds maintenance and
tankering. Costs of projects relating to selling and managing the construction
of plants consist of the construction and delivery of the plant being installed,
including the cost of equipment, civil engineering, building and labor.

    General and administrative expense includes personnel costs, transaction
expenses relating to due diligence and overhead associated with Azurix's pursuit
of acquisitions and development projects, in addition to support functions such
as billing and customer services, quality and scientific services, regulation,
finance, human resources, public relations and marketing and sales activities.


                                       38
<PAGE>   41


    During April 2000, residents of the city of Bahia Blanca, Argentina and
surrounding areas began noticing unpleasant taste and odor in their water
supply, which is provided by Azurix Buenos Aires, S.A. The taste and odor were
traced to a substance released by algae that had grown to higher than normal
levels in a reservoir operated by an agency of the Province of Buenos Aires and
that had entered the local water supply. On becoming aware of the cause of the
unpleasant taste and odor, Azurix Buenos Aires instituted measures that restored
the taste and odor to acceptable levels. Tests performed by government
officials, as well as Azurix Buenos Aires, have shown that there were no harmful
biological or toxic substances in the water supply, and provincial officials
have stated publicly that there was no danger to public health. However, algae
continue to be present in the reservoir, and therefore issues of taste, odor and
color may recur.

    Before the situation was corrected, at the request of government officials,
Azurix Buenos Aires acquired water from other sources for delivery in trucks and
bottles to residents in Bahia Blanca. Azurix Buenos Aires agreed with the
provincial regulatory agency not to bill residential customers for water
services for a 50-day period during which the taste and odor of supplied water
were allegedly unsatisfactory, although the regulatory agency approved billing
industrial customers for water and all customers for wastewater services during
this time. Azurix's second quarter 2000 results of operations included $3.3
million of operations and maintenance expense and $0.6 million of general and
administrative expense that were incurred in responding to this situation, in
addition to foregoing approximately $1.5 million in revenues for the 50-day
period. Azurix also incurred $0.2 million of related capital expenditures. Under
the concession contract, the provincial regulatory agency may impose penalties;
however, none have been assessed as of this date.

    Under the Azurix Buenos Aires concession agreement with the province, an
agency of the province was required to construct works to remove algae from the
water. The algae-removing works had not been completed or tested before this
incident occurred. International experts have advised Azurix Buenos Aires that
conventional algae removal facilities and reservoir operations would have
prevented the algae from entering the water system. Azurix Buenos Aires believes
the events in Bahia Blanca resulted directly from the provincial agency's
failure to deliver functioning algae removal works as required under the
agreement and is seeking reimbursement or other compensation from the province
for all costs, including any penalties that may be assessed, and forgone
revenues.

    For the years ended December 31, 1999 and 2000, 73% and 53%, respectively,
of Azurix's operating revenues were denominated in U.K. pound sterling. The
average U.S. dollar to pound sterling exchange rate for the year ended December
31, 1999 was 1.62, compared to the year ended December 31, 2000 of 1.52. These
rates represent a decrease from 1999 to 2000 of 6%. The decrease in the pound
sterling exchange rates reduced current period net income by approximately $5.9
million.

    Azurix was incorporated on January 29, 1998 (date of inception), but had no
operations prior to September 30, 1998. As a result, the 1999 and 1998 results
of operations are not presented on a comparative basis.

AZURIX -- YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31,
1999

    Operating revenues for the year ended December 31, 2000 of $757.3 million
increased $139.3 million, or 23%, when compared to the year ended December 31,
1999. The increase included $184.8 million from acquisitions that occurred
during 1999, partially offset by the Wessex rate cut (see Note 19 to the
Consolidated Financial Statements) and the lower current period pound sterling
exchange rate, which decreased current period revenues by $24.1 million and
$26.8 million, respectively.

    Operations and maintenance expense for the year ended December 31, 2000 of
$376.2 million increased $151.5 million, or 67%, when compared to the year ended
December 31, 1999. The increase included $137.2 million from acquisitions that
occurred during 1999, $4.1 million related to new processes and climatic
conditions at Wessex, $11.0 million related to an increase in the bad debt
allowance at Azurix Buenos Aires (see "Recent Developments - Asset
Impairments"), partially offset by the effect of the lower current period pound
sterling exchange rate, which resulted in a $6.1 million decrease from the prior
period.

    General and administrative expense for the year ended December 31, 2000 of
$154.1 million increased $36.3 million, or 31%, when compared to the year ended
December 31, 1999. The increase included $38.5 million from acquisitions that
occurred during 1999. This increase was offset partially by the effect of the
lower current period pound sterling exchange rate and a reduction in costs
associated with the pursuit and support of worldwide water


                                       39
<PAGE>   42


and wastewater privatization projects that was implemented in the fourth quarter
of 1999, which decreased the current period general and administrative expense
by $2.0 million and $14.6 million, respectively.

    In 1998, Azurix adopted a business strategy focused on growth through
acquisitions and development projects around the world. During the fourth
quarter of 1998 and the first half of 1999, Azurix initiated a business
development effort requiring increased personnel to pursue and support
acquisition and privatization activities worldwide. The initiative was based on
Azurix's expectations as to the size, number, location and timing of
privatization projects that would be awarded in 1999, 2000 and beyond. During
the second half of 1999, several large privatization projects were postponed or
cancelled. In the fourth quarter of 1999, Azurix reevaluated its cost structure
in relation to its business development efforts. As a result, Azurix announced a
plan to restructure its operations, which resulted in Azurix recording a
one-time pre-tax expense totaling $34.2 million in the fourth quarter of 1999.
The restructuring plan included reducing personnel, reducing leased office space
and eliminating other costs relating to the pursuit of concessions in certain
regions. The restructuring liability was being funded through cash provided by
operating activities and borrowings under credit agreements. See Note 15 to the
Consolidated Financial Statements.

    Depreciation and amortization expense for the year ended December 31, 2000
of $132.3 million increased $27.5 million, or 26%, when compared to the year
ended December 31, 1999. The increase included $14.0 million from acquisitions
that occurred during 1999 and $16.0 million from capital expenditure additions
at Wessex, Azurix Buenos Aires and corporate headquarters. These increases were
offset partially by the effect of the lower current period pound sterling
exchange rate, which accounted for a decrease of approximately $6.4 million.

    During the year ended December 31, 2000, Azurix recorded $401.8 million,
pre-tax ($397.5 million after-tax), of impairments of long-lived assets. See
"Recent Developments - Asset Impairments." There were no similar impairments
during the year ended December 31, 1999.

    Equity in earnings of unconsolidated affiliates for the year ended December
31, 2000 of $5.6 million increased $3.6 million when compared to the year ended
December 31, 1999. The increase resulted primarily from higher earnings from
Azurix's investment in the entity which manages and operates the water and
wastewater concession for Cancun and Isla Mujeres, Mexico.

    During the year ended December 31, 2000, Azurix recorded a $55.0 million,
pre-tax and after-tax, impairment of its equity method investment in the entity
which owns the water and wastewater concession in the Province of Mendoza,
Argentina. See "Recent Developments - Assets Impairments." There were no similar
impairments during the year ended December 31, 1999.

    Interest income for the year ended December 31, 2000 of $19.4 million
increased $3.6 million, or 23%, when compared to the year ended December 31,
1999. The increase primarily resulted from higher average funds on deposit in
interest bearing restricted cash accounts during the current period.

    Interest expense for the year ended December 31, 2000 of $141.8 million
increased $52.4 million, or 59%, when compared to the year ended December 31,
1999. Higher cost of borrowings during the current period, primarily resulting
from the senior notes issued in February 2000, and higher current period average
borrowings outstanding, resulted in higher current period interest expense of
$35.0 million and $26.7 million, respectively. This was partially offset by the
lower current period pound sterling exchange rate which lowered current period
interest expense by $4.5 million and higher current period capitalized interest
of $4.9 million. As of December 31, 2000, approximately 62% of Azurix's debt was
denominated in pound sterling.

    During the year ended December 31, 2000, Wessex recorded a $2.5 million gain
on the sale of real estate which was included in "Other income (expense)" on the
Consolidated Statements of Income (Loss). There were no asset sales during the
year ended December 31, 1999.

    Income tax expense for the year ended December 31, 2000 of $17.6 million
decreased $3.9 million, or 18%, when compared to the year ended December 31,
1999. The effective tax rate for the year ended December 31, 2000 was impacted
by the impairment of the equity method investment of the Mendoza concession
company of $55.0 million and the impairment of long-lived assets at the Buenos
Aires concession of $389.5 million, neither of which were tax benefited. In
addition, based on events that occurred during the fourth quarter of 2000,
Azurix


                                       40
<PAGE>   43


reevaluated future cash flows from its Argentine entities and determined that a
valuation allowance on its Argentine deferred tax assets was required which
resulted in a deferred tax expense of $18.5 million. Excluding the effect of
these items, the effective tax rate for the year ended December 31, 2000 was 3%.
The effective tax rate for the year ended December 31, 1999 included the effect
of a reversal of a $5.1 million U.S. deferred tax valuation allowance that was
recorded during 1998. During the second quarter of 1999, Azurix determined that
the available evidence indicated that it was more likely than not that the
deferred tax asset would be realized. Accordingly, the valuation allowance was
reversed in the second quarter of 1999. Excluding the effect of the valuation
allowance reversal, the effective tax rate for the year ended December 31, 1999
was 40%. The decrease in the effective tax rate from 1999 to 2000 was due
primarily to the impact of non-deductible goodwill amortization relative to
lower current period pre-tax income (loss).

    In May 1999, Azurix retired borrowings under its former senior credit
facility and terminated the facility prior to its maturity. Unamortized deferred
financing fees related to this facility of $9.8 million ($6.8 million net of tax
benefit) were charged to income as an extraordinary loss.

AZURIX -- DATE OF INCEPTION TO DECEMBER 31, 1998

    Operating revenues of $119.7 million were derived from Wessex. Approximately
90% of these revenues were derived from the sale of metered and unmetered water
and wastewater services. Operating revenues from SC Technology, a subsidiary of
Wessex, and other unregulated activities accounted for 6% and 4%, respectively,
of total operating revenues.

    Operations and maintenance expense totaled $31.6 million. Of this amount,
$21.8 million related to the cost of supplying water and treating wastewater,
including the costs of maintaining and operating plant and equipment used in
these processes, and $7.1 million related to the costs of the plants being
installed by SC Technology.

    General and administrative expense of $20.3 million included $7.7 million
related to Wessex's operations and $12.3 million related to the pursuit of
acquisition and development projects. The expenses related to acquisition and
development projects resulted from a business strategy initiated in the fourth
quarter of 1998. See "Results of Operations" discussion above.

    Depreciation and amortization expense of $22.2 million included $5.5 million
for the amortization of goodwill incurred by Azurix in the acquisition of
Wessex. All of the depreciation expense was derived from depreciation on the
property, plant and equipment of Wessex.

    Interest expense was related to the Wessex acquisition financing, existing
Wessex debt and funds borrowed in the fourth quarter to redeem the outstanding
preference shares.

    The effective tax rate for the period was 64.2%. The difference between the
effective tax rate and the U.S. statutory rate of 35% (U.K. statutory rate of
31%) was primarily related to a valuation allowance recognized on a U.S.
deferred tax asset generated from general and administrative expenses incurred
in the United States, a valuation allowance recognized on a U.K. deferred tax
asset relating to non-deductible interest expense prior to achieving a
consolidated tax position and non-deductible amortization of goodwill resulting
from the acquisition of Wessex.

WESSEX (PREDECESSOR COMPANY) -- SIX MONTHS ENDED OCTOBER 2, 1998

    Operating revenues for the six months ended October 2, 1998 were $233.8
million. Approximately 91% of these revenues related to the sale of metered and
unmetered water and wastewater services. Operating revenues from SC Technology
and other unregulated activities accounted for 5% and 4%, respectively, of total
operating revenues.

    Operations and maintenance expense for the six months ended October 2, 1998
was $61.7 million. Of this amount, $46.8 million related to the cost of
supplying water and treating wastewater, including the costs of maintaining and
operating plant and equipment used in these processes. In addition, $10.9
million related to the cost of the plants being installed by SC Technology.

    General and administrative expenses of $36.4 million for the six months
ended October 2, 1998 included $20.7 million incurred by Wessex in connection
with its acquisition by Azurix.


                                       41
<PAGE>   44


    Income tax expense for the six months ended October 2, 1998 was $28.4
million, which resulted in a 28% effective book tax rate compared to a statutory
tax rate of 31%. The primary reason for the variance from the statutory rate was
the effect of an enacted change in the statutory tax rate during the period from
31% to 30%, effective April 1, 1999. This was partially offset by the effect of
non-tax deductible expenses that were incurred during the period.

LIQUIDITY AND CAPITAL RESOURCES

    Azurix's cash provided by operating activities for the year ended December
31, 2000 was $77.8 million. Cash used in investing activities for the period was
$363.5 million which included capital expenditures of $297.1 million. Cash
provided by financing activities for the period was $299.3 million and primarily
resulted from net borrowings during the period.

    As of December 31, 2000, Azurix had a working capital deficit of $433.1
million. Of this amount, $392.7 million was related to borrowings outstanding or
secured by the Azurix Europe credit facility which terminates in May 2002. The
Azurix Europe credit facility contains a provision permitting banks, with
two-thirds or more of the commitments, to terminate at an earlier time if, in
their reasonable opinion, changes have occurred resulting in a material adverse
effect on the borrower's ability to repay the outstanding debt. Azurix has no
knowledge of the lenders' intent to exercise this right; however, the existence
of this provision requires amounts outstanding under the facility to be
classified as short-term debt under generally accepted accounting principles.

    In addition, at December 31, 2000, $43.3 million of the working capital
deficit related to funds received from customers in advance of providing
services that are reflected on the Consolidated Balance Sheet as deferred
income. This component of the working capital deficit does not require the use
of cash, but is recognized in income over the period in which the services are
provided. Azurix, and Wessex, its predecessor company, have during the past
several years operated with a working capital deficit as part of its normal
business practice.

    Under the terms of the Azurix Europe credit facility, Azurix Europe is
restricted from paying dividends. Azurix does not anticipate that this will have
an impact on liquidity for the remainder of the Azurix consolidated group. In
February 2000, the Azurix Europe credit facility was amended so that Azurix
Europe may borrow a portion of the facility capacity in a manner allowing for
its use by Azurix for general corporate purposes. Such capacity is denominated
in U.K. pound sterling and at December 31, 2000 was equivalent to $358.9
million. Borrowings under that portion of the facility capacity were repaid in
its entirety with a portion of the proceeds from the senior notes issued in
February 2000. As of December 31, 2000, Azurix had outstanding borrowings of
$156.0 million under that portion of the facility available for use by Azurix
for general corporate purposes. These borrowings were used primarily to fund
capital expenditures, acquisitions and other general corporate purposes.

    In February 2000, Azurix issued U.S. dollar and U.K. pound sterling senior
notes with a U.S. dollar equivalent face value at December 31, 2000 of $589.6
million. The senior notes consisted of $240.0 million and L.100.0 million, each
due in 2007 and bearing an interest rate of 10.375%, and $200.0 million due in
2010 and bearing an interest rate of 10.75%. Net proceeds after underwriters'
discount and other offering costs were $583.1 million. Of this amount, $150.0
million was used to pay down the Azurix revolving credit facility, $386.0
million was used to pay down the Azurix Europe credit facility and $18.1 million
was used to pay down amounts outstanding under the credit agreement with Enron.
In addition, $11.5 million was used to pay accrued interest on the three credit
facilities. The remaining proceeds were made available for general corporate
purposes. The senior notes were issued under an indenture that contains certain
covenants that limit Azurix's ability to incur additional debt, pay dividends or
make other distributions, incur liens on its assets, enter into sale/leaseback
transactions, enter into transactions with affiliates, or sell assets to, or
merge with, another entity.

    Azurix's credit agreement with Enron provided $180 million of liquidity to
fund general, administrative and operating expenses through December 2001. As of
December 31, 2000, $103.1 million was outstanding under this credit agreement.
The principal amount outstanding under the credit agreement was limited to no
more than $60 million, $120 million and $180 million at any time during calendar
years 1999, 2000 and 2001, respectively.

    In January 2001, Azurix borrowed $40.0 million under the Enron credit
agreement and paid down that portion of the Azurix Europe credit facility that
can be used by Azurix for general corporate purposes. In addition, on March 16,
2001, the then outstanding balance of the Enron credit agreement of $180 million
was retired through


                                       42
<PAGE>   45


the issuance to Enron of mandatorily redeemable preferred stock and the credit
agreement was terminated. See "Recent Developments - Merger."

    As of December 31, 2000, Azurix through Wessex, had among other credit
facilities, committed credit facilities with major commercial banks providing
for an aggregate of $224.3 million of borrowing capacity. Of this capacity, 50%
expires in October 2001 and the remainder expires in April 2002. As of December
31, 2000, outstanding borrowings consisted of $62.8 million under the facilities
that expire in 2002.

    Azurix estimates that required capital expenditures, primarily related to
its ownership of water and wastewater concessions, will be approximately $1.4
billion for the period 2001 to 2005. Azurix intends to finance its projected
capital expenditures for its existing businesses principally with internally
generated funds and proceeds under existing long-term and short-term borrowing
arrangements and future financing arrangements.

    Azurix's short-term debt, net of restricted cash which secures such debt,
was $194.0 million as of December 31, 2000. In addition, it had approximately
$190.9 million of long-term debt and $109.2 million of long-term debt with
affiliates, excluding amounts outstanding under the Enron credit agreement which
were converted to mandatorily redeemable preferred stock in 2001, that mature
before the end of 2004. Included in these amounts are the Wessex committed bank
facilities and the Azurix Europe credit facility which mature in April 2002 and
May 2002, respectively. As of March 16, 2001, these two facilities along with
existing cash, cash flows from operations and uncommitted bank facilities are
Azurix's primary sources of liquidity. Azurix anticipates that it will need to
renew, refinance or replace these borrowings and credit facilities before they
mature. Azurix cannot assure that such additional capital needed to replace
maturing borrowings and credit facilities can be obtained at reasonable costs,
and if Azurix is not successful in these efforts, it will need to raise capital
through other means, which may include disposing of assets. Azurix intends to
pursue the potential disposal of certain of its assets to improve its long-term
liquidity, provided favorable prices can be obtained for those assets.

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

    This Annual Report includes forward looking statements. See "Factors That
May Affect Future Results and Accuracy of Forward-Looking Statements" in Item 1.
Business.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    Azurix is exposed to market risks, particularly changes in U.S. and
international interest rates and changes in currency exchange rates as measured
against the functional currencies in which it operates. Azurix engages in
hedging programs aimed at limiting the impact of significant and sudden
fluctuations, but there can be no assurance that such an approach will be
successful. Factors that could impact the effectiveness of its hedging programs
include the accuracy of revenue forecasts, volatility of the currency and
interest rate markets and the availability of hedging instruments. Azurix
utilizes swap contracts to manage interest rate risk. Currency exchange rate
risk is the result of transactions that are denominated in a currency other than
the functional currencies in which Azurix operates. The primary purpose of
Azurix's foreign currency hedging activities is to manage the volatility
associated with currency exchange rates. Azurix manages these risks by utilizing
derivative financial instruments for non-trading purposes. Azurix enters into
foreign currency contracts, forward contracts or interest rate contracts for the
sole purpose of hedging an existing or anticipated exposure, not for
speculation. Azurix's accounting policies for, and the significant terms of,
derivative financial instruments are described in Note 1 and Note 8,
respectively, to the Consolidated Financial Statements.

    Azurix uses J.P. Morgan's RiskMetrics(TM) system to estimate the
value-at-risk of its financial instruments. Value-at-risk is a statistical
estimate of the loss that would result from changes in market prices.
Value-at-risk is based on volatility and correlation data provided by
J.P. Morgan, a statistical confidence level and an estimate of the time period
required to liquidate the positions in the various financial instruments. The
value-at-risk estimate was based on normal market conditions, a 95% confidence
level and a liquidation period between 30 days and 60 months, depending on the
type of financial instrument. At December 31, 1999, the value-at-risk estimate
for foreign currency and interest rate exposure was $0.1 million and $19,000,
respectively. At December 31, 2000, the value-at-risk estimate for foreign
currency and interest rate exposure was $0.1 million and approximately $0.2
million, respectively. The value-at-risk estimate includes only the risk related
to the financial instruments that serve as hedges and does not include the
related underlying hedged item. Judgment is required in interpreting


                                       43
<PAGE>   46


market data and the use of different market assumptions or estimation
methodologies that will affect the estimated value-at-risk amount.


                                       44
<PAGE>   47


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                  AZURIX CORP.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

                                                                                                           PAGE
                                                                                                           -----
<S>                                                                                                        <C>
AZURIX CORP. - CONSOLIDATED FINANCIAL STATEMENTS:

   Report of Independent Public Accountants ..........................................................      46

   Consolidated Statements of Income (Loss) for the period from January 29, 1998
     (Date of Inception) to December 31, 1998 and for the years ended December 31, 1999 and 2000 .....      47

   Consolidated Statements of Comprehensive Loss for the period from January 29, 1998
      (Date of Inception) to December 31, 1998 and for the years ended December 31, 1999 and 2000 ....      48

   Consolidated Balance Sheets at December 31, 1999 and 2000 .........................................      49

   Consolidated Statements of Cash Flows for the period from January 29, 1998 (Date of Inception)
       to December 31, 1998 and for the years ended December 31, 1999 and 2000 .......................      50

   Consolidated Statements of Changes in Stockholders' Equity for the period from January 29, 1998
      (Date of Inception) to December 31, 1998 and for the years ended December 31, 1999 and 2000 ....      51

   Notes to the Consolidated Financial Statements ....................................................      52

WESSEX WATER PLC (NOW RENAMED WESSEX WATER LTD) (PREDECESSOR COMPANY) -
CONSOLIDATED FINANCIAL STATEMENTS:

   Report of Independent Accountants .................................................................      76

   Consolidated Statement of Income for the six months ended October 2, 1998 .........................      77

   Consolidated Statement of Cash Flows for the six months ended October 2, 1998 .....................      78

   Consolidated Statement of Changes in Stockholders' Equity for the six months ended
     October 2, 1998 .................................................................................      79

   Notes to the Consolidated Financial Statements ....................................................      80
</TABLE>



                                       45

<PAGE>   48

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Azurix Corp.:

    We have audited the accompanying consolidated balance sheets of Azurix Corp.
(a Delaware corporation) and subsidiaries as of December 31, 2000 and 1999, and
the related consolidated statements of income (loss), comprehensive loss, cash
flows and changes in stockholders' equity for the years ended December 31, 2000
and 1999 and for the period from January 29, 1998 (Date of Inception) to
December 31, 1998. These financial statements are the responsibility of Azurix
Corp.'s management. Our responsibility is to express an opinion on these
financial statements based on our audits.

    We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit 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 financial statements referred to above present fairly,
in all material respects, the financial position of Azurix Corp. and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and cash flows for the years ended December 31, 2000 and 1999, and
for the period from January 29, 1998 (Date of Inception) to December 31, 1998,
in conformity with accounting principles generally accepted in the United
States.



ARTHUR ANDERSEN LLP

Houston, Texas
March 26, 2001


                                       46
<PAGE>   49


                                  AZURIX CORP.

                    CONSOLIDATED STATEMENTS OF INCOME (LOSS)
                                  (IN MILLIONS)


<TABLE>
<CAPTION>


                                                               JANUARY 29, 1998
                                                             (DATE OF INCEPTION) YEAR ENDED DECEMBER 31,
                                                                TO DECEMBER 31,  -----------------------
                                                                     1998          1999           2000
                                                                  --------       --------       --------
<S>                                                               <C>            <C>            <C>
Operating revenues .........................................      $  119.7       $  618.0       $  757.3
Operating expenses:
  Operations and maintenance ...............................          31.6          224.7          376.2
  General and administrative ...............................          20.3          117.8          154.1
  Depreciation and amortization ............................          22.2          104.8          132.3
  Impairment of long-lived assets ..........................            --             --          401.8
  Restructuring charge .....................................            --           34.2             --
                                                                  --------       --------       --------
     Total operating expenses ..............................          74.1          481.5        1,064.4
                                                                  --------       --------       --------
Operating income (loss) ....................................          45.6          136.5         (307.1)
                                                                  --------       --------       --------
Other income (expense):
  Equity in earnings (loss) of unconsolidated affiliates ...          (0.8)           2.0            5.6
  Impairment of investment in unconsolidated
      affiliate ............................................            --             --          (55.0)
  Interest income ..........................................           1.3           15.8           19.4
  Interest expense .........................................         (16.4)         (89.4)        (141.8)
  Other income (expense) ...................................          (1.2)            --            2.5
                                                                  --------       --------       --------
Income (loss) before minority interest, income taxes and
      extraordinary loss ...................................          28.5           64.9         (476.4)
                                                                  --------       --------       --------
Minority interest ..........................................            --           (1.1)          (3.0)
Income tax expense .........................................          18.3           21.5           17.6
                                                                  --------       --------       --------
Income (loss) before extraordinary loss ....................          10.2           44.5         (491.0)
                                                                  --------       --------       --------
Extraordinary loss, net of income tax benefit ..............            --            6.8             --
                                                                  --------       --------       --------
Net income (loss) ..........................................      $   10.2       $   37.7       $ (491.0)
                                                                  ========       ========       ========
</TABLE>



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


                                       47
<PAGE>   50



                                  AZURIX CORP.

                  CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
                                  (IN MILLIONS)


<TABLE>
<CAPTION>


                                                                 JANUARY 29, 1998
                                                               (DATE OF INCEPTION)   YEAR ENDED DECEMBER 31,
                                                                 TO DECEMBER 31,     -----------------------
                                                                       1998             1999          2000
                                                               -------------------   ---------      --------
<S>                                                            <C>                      <C>          <C>
Net income (loss) ............................................         $ 10.2           $ 37.7      $(491.0)
Other comprehensive loss, net of tax:
         Foreign currency translation adjustment .............          (36.7)           (41.4)      (128.1)
         Unrealized loss on available for sale securities ....             --             (0.8)        (0.3)
                                                                       ------           ------      -------
Comprehensive loss ...........................................         $(26.5)          $ (4.5)     $(619.4)
                                                                       ======           ======      =======
</TABLE>





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


                                       48
<PAGE>   51


                                  AZURIX CORP.

                           CONSOLIDATED BALANCE SHEETS
                        (IN MILLIONS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>


                                     ASSETS
                                                                                DECEMBER 31,
                                                                          -----------------------
Current assets:                                                             1999           2000
                                                                          --------       --------
<S>                                                                       <C>            <C>
  Cash and cash equivalents ........................................      $   27.2       $   30.0
  Restricted cash and cash equivalents (Note 3) ....................         464.2          108.0
  Trade receivables (net of allowance for doubtful
     accounts of $40.7 and $66.9, respectively) ....................         115.7          128.9
  Unbilled receivables .............................................          32.5           42.0
   Other ...........................................................          69.7           75.2
                                                                          --------       --------
      Total current assets .........................................         709.3          384.1
                                                                          --------       --------
Property, plant and equipment, at cost .............................       2,559.1        2,691.7
Less accumulated depreciation ......................................         (90.4)        (228.2)
                                                                          --------       --------
      Property, plant and equipment, net ...........................       2,468.7        2,463.5
                                                                          --------       --------
Investments in and advances to unconsolidated affiliates ...........         110.4           60.5
Concession intangibles, net ........................................         451.3           86.4
Goodwill, net ......................................................       1,029.6          971.4
Other assets .......................................................          81.1          135.5
                                                                          --------       --------
      Total Assets .................................................      $4,850.4       $4,101.4
                                                                          ========       ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable and accruals ....................................      $  236.0       $  275.9
  Deferred income ..................................................          54.6           43.3
  Accrued taxes ....................................................          21.1            9.4
  Short-term debt ..................................................         602.2          298.7
  Current maturities of long-term debt .............................          35.0           80.7
  Current maturities of long-term debt - affiliates ................            --          109.2
                                                                          --------       --------
      Total current liabilities ....................................         948.9          817.2
                                                                          --------       --------
Long-term debt .....................................................       1,301.9        1,346.1
Long-term debt - affiliates ........................................         180.0          118.6
Deferred income taxes ..............................................         443.3          457.8
Other long-term liabilities ........................................          31.2           32.9
                                                                          --------       --------
      Total liabilities ............................................       2,905.3        2,772.6
                                                                          --------       --------
Commitments and contingencies (Note 19)
Minority interest ..................................................           3.3            4.6
Stockholders' equity:
  Preferred stock, $0.01 par value, 50,000,000 shares authorized....            --             --
  Common stock, $0.01 par value, 500,000,000 shares authorized,
    2 shares issued and outstanding ................................            --             --
  Additional paid-in capital .......................................       1,973.4        1,974.8
  Retained earnings (deficit) ......................................          47.9         (443.1)
  Unearned compensation ............................................          (0.6)          (0.2)
  Accumulated other comprehensive loss .............................         (78.9)        (207.3)
                                                                          --------       --------
      Total stockholders' equity ...................................       1,941.8        1,324.2
                                                                          --------       --------
      Total Liabilities and Stockholders' Equity ...................      $4,850.4       $4,101.4
                                                                          ========       ========

</TABLE>





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


                                       49
<PAGE>   52


                                  AZURIX CORP.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (IN MILLIONS)

<TABLE>
<CAPTION>


                                                                                 JANUARY 29, 1998
                                                                                (DATE OF INCEPTION)  YEAR ENDED DECEMBER 31,
                                                                                   TO DECEMBER 31,   -----------------------
                                                                                       1998            1999           2000
                                                                                -------------------  ----------     ---------
<S>                                                                             <C>                  <C>            <C>
Operating Activities:
   Net income (loss) ...........................................................      $   10.2       $   37.7       $ (491.0)
   Adjustments to reconcile net income (loss) to cash provided by
          operating activities:
      Depreciation and amortization ............................................          22.2          104.8          132.3
      Impairment of long-lived assets and investment in unconsolidated
          affiliate ............................................................            --             --          456.8
      Accretion and amortization of debt expenses and write-off of deferred
          financing costs ......................................................           0.6           12.2            7.3
      Deferred income taxes ....................................................          13.4            6.2            9.5
      Equity in (earnings) loss of unconsolidated affiliates ...................           0.8           (2.0)          (5.6)
      Minority interest ........................................................            --           (1.1)          (3.0)
      Gain on sale of asset ....................................................            --             --           (2.5)
      Changes in operating assets and liabilities:
          (Increase) decrease in trade receivables and other current assets ....         (17.1)           7.9          (37.2)
          Increase (decrease) in current liabilities, excluding debt ...........         (25.7)           6.1           24.8
          Increase in other assets .............................................          (2.5)          (6.1)         (15.6)
          Increase (decrease) in other long-term liabilities ...................           1.3           (7.4)           2.0
          Other ................................................................           1.2             --             --
                                                                                      --------       --------       --------
Net cash provided by operating activities ......................................           4.4          158.3           77.8
                                                                                      --------       --------       --------
Investing Activities:
    Capital expenditures .......................................................         (63.2)        (287.3)        (297.1)
    Investments in and advances to unconsolidated affiliates ...................            --          (34.5)          (3.2)
    Business acquisitions, net of cash acquired ................................      (2,270.8)        (698.5)         (15.5)
    Proceeds from sale of asset ................................................            --             --            5.4
    Proceeds from sale of equity investment ....................................         337.9             --             --
    Other ......................................................................          13.5          (56.5)         (53.1)
                                                                                      --------       --------       --------
Net cash used in investing activities ..........................................      (1,982.6)      (1,076.8)        (363.5)
                                                                                      --------       --------       --------
Financing Activities:
   Proceeds from long-term borrowings ..........................................         550.8        1,176.7          599.2
   Repayments of long-term borrowings ..........................................        (226.2)        (254.6)        (573.0)
   Net proceeds from (repayments of) short-term borrowings .....................         160.8           80.7         (183.5)
   (Deposit to) withdrawal from restricted cash and cash equivalents
          accounts..............................................................            --         (407.7)         394.0
   Advances from affiliates, net of repayments .................................            --           44.4           56.6
   Redemption of subsidiary preference shares ..................................        (106.4)            --             --
   Dividends paid on subsidiary preference shares ..............................          (1.7)            --             --
   Issuance of common stock and capital contributed ............................       1,600.2          300.5            1.7
   Contribution to subsidiary from minority shareholder ........................            --             --            4.3
                                                                                      --------       --------       --------
Net cash provided by financing activities ......................................       1,977.5          940.0          299.3
                                                                                      --------       --------       --------
Effect of exchange rate changes on cash ........................................           6.0            0.4          (10.8)
                                                                                      --------       --------       --------
Change in cash and cash equivalents ............................................           5.3           21.9            2.8
                                                                                      --------       --------       --------
Cash and cash equivalents, beginning of period .................................            --            5.3           27.2
                                                                                      --------       --------       --------
Cash and cash equivalents, end of period .......................................      $    5.3       $   27.2       $   30.0
                                                                                      ========       ========       ========
</TABLE>



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




                                       50
<PAGE>   53



                                  AZURIX CORP.

           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                        (IN MILLIONS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                           ACCUMULATED
                                                                   ADDITIONAL    RETAINED                     OTHER
                                            PREFERRED   COMMON      PAID-IN      EARNINGS     UNEARNED    COMPREHENSIVE
                                              STOCK      STOCK      CAPITAL     (DEFICIT)   COMPENSATION       LOSS       TOTAL
                                            ---------   --------   ---------     --------   ------------  -------------  --------
<S>                                         <C>         <C>        <C>           <C>        <C>           <C>            <C>
Balance at January 29, 1998
  (Date of Inception) ....................  $     --    $     --    $     --     $     --     $     --      $     --     $     --
   Issuance of two shares of
    common stock .........................        --          --         1.0           --           --            --          1.0
   Capital contributions .................        --          --     1,599.2           --           --            --      1,599.2
   Subsidiary stock contributed ..........        --          --        71.8           --           --            --         71.8
   Foreign currency translation
    adjustment ...........................        --          --          --           --           --         (36.7)       (36.7)
   Net income ............................        --          --          --         10.2           --            --         10.2
                                            --------    --------    --------     --------     --------      --------     --------
Balance at December 31, 1998 .............        --          --     1,672.0         10.2           --         (36.7)     1,645.5
                                            --------    --------    --------     --------     --------      --------     --------
   Issuance of common stock ..............        --          --       300.5           --           --            --        300.5
   Issuance of restricted common
    stock to employees ...................        --          --         0.9           --         (0.6)           --          0.3
   Unrealized loss on available for
    sale securities ......................        --          --          --           --           --          (0.8)        (0.8)
   Foreign currency translation
    adjustment ...........................        --          --          --           --           --         (41.4)       (41.4)
   Net income ............................        --          --          --         37.7           --            --         37.7
                                            --------    --------    --------     --------     --------      --------     --------
Balance at December 31, 1999 .............        --          --     1,973.4         47.9         (0.6)        (78.9)     1,941.8
                                            --------    --------    --------     --------     --------      --------     --------
   Issuance of common stock from
    exercise of employee stock options....        --          --         1.7           --           --            --          1.7
   Forfeiture of employee restricted
    stock ................................        --          --        (0.3)          --          0.2            --         (0.1)
   Amortization of unearned compensation..        --          --          --           --          0.2            --          0.2
   Unrealized loss on available for
    sale securities ......................        --          --          --           --           --          (0.3)        (0.3)
   Foreign currency translation
    adjustment ...........................        --          --          --           --           --        (128.1)      (128.1)
   Net loss ..............................        --          --          --       (491.0)          --            --       (491.0)
                                            --------    --------    --------     --------     --------      --------     --------
Balance at December 31, 2000 .............  $     --    $     --    $1,974.8     $ (443.1)    $   (0.2)     $ (207.3)    $1,324.2
                                            ========    ========    ========     ========     ========      ========     ========
</TABLE>




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


                                       51
<PAGE>   54


                                  AZURIX CORP.
                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS

    Azurix is engaged in the business of acquiring, owning, operating and
managing water and wastewater assets, providing water and wastewater related
services and managing and developing resources in the global water industry.

    Azurix Corp. was incorporated on January 29, 1998, and as a result, the
Consolidated Statements of Income (Loss), Consolidated Statements of
Comprehensive Loss, Consolidated Statements of Cash Flows and Consolidated
Statements of Changes in Stockholders' Equity reflect the years ended December
31, 1999 and 2000, and the period from Date of Inception to December 31, 1998.
Substantially all of Azurix's 1998 results of operations, cash flows and equity
transactions occurred during the fourth quarter of 1998, subsequent to the
Wessex acquisition.

    On March 16, 2001, shareholders of Azurix Corp. approved and adopted the
Agreement and Plan of Merger by and among Enron Corp., Enron BW Corp., a wholly
owned indirect subsidiary of Enron, and Azurix dated as of December 15, 2000.
The merger was consummated on March 16, 2001, at which time Enron BW Corp. was
merged into Azurix with Azurix being the surviving corporation (see Note 21).

CONSOLIDATION POLICY AND USE OF ESTIMATES

    The consolidated financial statements include the accounts of all majority
owned subsidiaries and those affiliates over which Azurix has the ability to
control and are prepared in accordance with generally accepted accounting
principles in the United States. All significant intercompany balances and
transactions have been eliminated in consolidation. Azurix uses the equity
method of accounting for all investments where it owns less than a majority of
the voting stock, and cannot control, but is able to exercise significant
influence over the operating and financial policies of the investee.

    The preparation of the financial statements in conformity with U.S.
generally accepted accounting principles 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. Actual results could differ from those estimates.

REVENUE RECOGNITION

    Operating revenues represent income earned in the ordinary course of
business, excluding value added tax. Water and wastewater revenue for metered
customers is recognized based on actual usage and accrued based on the estimated
amount of water sold but not billed as of the balance sheet date. Water and
wastewater revenue for non-metered customers, who pay an annual fixed charge
based on the ratable value of their property, is recognized uniformly over the
year. Revenue for water and wastewater related services is recognized as
services are provided. Revenues derived from services provided under fixed-price
contracts are recognized on the percentage-of-completion basis.

DERIVATIVE FINANCIAL INSTRUMENTS

    Azurix utilizes derivative financial instrument contracts for non-trading
purposes to manage exposure to fluctuations in interest rates and foreign
currency exchange rates. Hedge accounting is utilized in non-trading activities
where there is a high correlation of price movements in the derivative and the
contract is designated as a hedge. In instances where the anticipated
correlation of price movements no longer exists, hedge accounting is terminated
and future changes in the value of the derivative financial instruments are
recognized as gains or losses to net income.

    Interest rate swaps involve the exchange of amounts based on a fixed
interest rate for amounts based on variable interest rates over the life of the
contract without an exchange of the notional amount upon which payments are
based. The difference to be received or paid is recognized in income over the
life of the contracts as adjustments to interest expense.


                                       52
<PAGE>   55


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    Currency swap contracts are denominated in one foreign currency and are to
be repaid in another currency. These contracts are designated as hedges of firm
commitments to pay interest and principal on debt, which would otherwise expose
Azurix to foreign currency risk.

    The fair values of the swap contracts are not recognized in the financial
statements. The income and cash flow impact of financial instruments is
reflected as an adjustment of the hedged item. Gains and losses on terminations
of interest rate and currency swap contracts are deferred as an adjustment to
the carrying amount of the outstanding obligation and amortized as an adjustment
to interest expense related to the obligation using the effective interest
method over the remaining term of the original contract life of the terminated
swap contract. In the event of early extinguishment of the obligation, any
realized or unrealized gain or loss from the swap would be recognized in net
income at the time of extinguishment. See Note 1 -- Recent Accounting
Pronouncements.

INCOME TAXES

    Azurix accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under the
asset and liability method of Statement of Financial Accounting Standards No.
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. For U.S. tax purposes, Azurix was a member of Enron's consolidated group
through June 8, 1999 and accordingly is included in Enron's consolidated federal
income tax return through that date. Members of the consolidated group are
charged with the amount of income tax expense (benefit) determined as if they
filed separate federal income tax returns. For periods subsequent to June 9,
1999, Azurix will file its own consolidated tax return.

EARNINGS PER COMMON SHARE

    Statement of Financial Accounting Standards No. 128, "Earnings Per Share,"
requires disclosure of earnings per common share on the face of the income
statement for entities with publicly held common stock or potential common
stock. The merger of Azurix Corp. and a wholly owned indirect subsidiary of
Enron Corp. (see Note 21), resulted in Azurix Corp. ceasing to have publicly
held common stock or potential common stock on March 16, 2001. Because Azurix
has ceased to have publicly held common stock, this report does not contain
earnings per share disclosures.

CASH EQUIVALENTS

    Azurix considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.

PROPERTY, PLANT AND EQUIPMENT

    Property, plant and equipment is stated at cost. Cost of acquired property,
plant and equipment includes an allocation of the purchase price based on the
asset's fair market value. Cost of property, plant and equipment placed in
service includes direct charges for material, labor and services and indirect
charges related to construction, such as engineering, supervision, payroll taxes
and employee benefits. Additions, replacements, modifications and enhancements
to units of property are capitalized. Major improvements to leasehold properties
are amortized over the shorter of the asset life or the life of the respective
lease. Repairs, maintenance and minor replacements are charged to operations and
maintenance expense as incurred. Interest capitalized is based on the average
value of construction work in progress at Azurix's average borrowing rate during
the period. The amount of interest capitalized during 1998, 1999 and 2000 was
approximately $2.3 million, $8.6 million and $13.5 million, respectively.

    Azurix's infrastructure assets comprise a network of systems of mains and
sewers, impounding and pumped raw water storage reservoirs, dams, sludge
pipelines and infrastructure investigations and studies.



                                       53
<PAGE>   56

                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    The cost of property, plant and equipment, excluding land, is charged to
depreciation using the straight-line method over the estimated useful lives of
the assets. Depreciation is computed based on estimated useful lives as follows:

<TABLE>
<CAPTION>

                                                  YEARS
                                                 --------
<S>                                              <C>
     Buildings and operational structures ...    5 to  80
     Infrastructure .........................    5 to 115
     Plant machinery and vehicles ...........    3 to  30
     Other assets ...........................    3 to  15
</TABLE>

    Azurix's accounting policy for the costs of computer software (all of which
is for internal use only) is to capitalize direct costs of materials and
services consumed in developing or obtaining software, including payroll and
payroll-related costs for employees who are directly associated with and who
devote time to the software project. Costs begin to be capitalized once the
application development stage has begun. All other costs are expensed as
incurred. Azurix amortizes the costs on a straight-line basis over the useful
life of the software. Impairment is evaluated based on changes in the expected
usefulness of the software.

LONG-LIVED ASSETS

    In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," long-lived assets held and used by Azurix are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. For purposes of evaluating
the recoverability, a test is performed comparing the estimated future
undiscounted cash flows associated with the asset to the asset's carrying
amount, including allocated goodwill, to determine if a write-down to fair value
is required.

GOODWILL

    Goodwill represents the excess of purchase price and related costs over the
value assigned to the net assets of businesses acquired (see Note 2) and is
presented on the Consolidated Balance Sheets net of accumulated amortization.
Goodwill is amortized on a straight-line basis over the estimated useful life,
not to exceed 40 years. Accumulated amortization of goodwill at December 31,
1999 and 2000 was $28.8 million and $51.9 million, respectively.

CONCESSION INTANGIBLES

    Concession intangible assets represent prepaid amounts for the rights as the
concession holder and operator of public water and wastewater facilities to
provide service and charge a tariff in the service area subject to the
concession and is presented on the Consolidated Balance Sheets net of
accumulated amortization and accumulated impairments.

    The total costs associated with retaining concession rights, including
prepaid amounts and amounts payable in the future, are allocated among the
service areas awarded by the concession agreement and amortized on a
straight-line basis over the life of the concession for each service area
commencing when access is attained. Accumulated amortization of concession
intangibles at December 31, 1999 and 2000 was $5.4 million and $13.4 million,
respectively, and accumulated impairments of concession intangible assets at
December 31, 2000 was $357.2 million (see Note 17).

OTHER ASSETS

    Other assets consist primarily of deferred tax assets, deferred pension
assets and deferred charges, such as financing costs and external costs of
acquisition activities. Deferred financing charges are amortized to interest
expense over the lives of the related debt issuances using the effective
interest method and external acquisition costs are capitalized as a cost of
successful acquisitions or expensed during the period in which it is determined
that the project is unsuccessful or the pursuit is terminated.


                                       54
<PAGE>   57


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


DEFERRED INCOME

    Azurix bills certain customers in advance of providing water and wastewater
services and classifies these amounts as "Deferred income" on the Consolidated
Balance Sheets until earned.

PENSION BENEFITS

    The pension plans maintained by Wessex, Azurix Buenos Aires and Lurgi Bamag
(see Note 12) are of the defined benefit type, and are valued by an independent
actuary. Current service costs for the plans are accrued in the period to which
they relate. Prior service costs and actuarial gains and losses, if any,
relating to amendments to the plans, are recognized on a basis designed to
spread the costs over the remaining average service lives of employees.

    Azurix North America has defined contribution plans for a number of its
employees and makes contributions to a multi-employer pension plan for certain
employees. Azurix's contributions to these plans are based on various
percentages of compensation, years of service and, in some instances, are based
upon the amount of the employees' contributions to the plans (see Note 12).

FOREIGN CURRENCY TRANSLATION

    The functional currency for Azurix's foreign operations is the applicable
local currency. The translation from the applicable foreign currencies to U.S.
dollars is performed for balance sheet accounts using the current exchange rates
in effect at the balance sheet date and for revenue and expense accounts, using
the weighted average exchange rate during the period or, where known or
determinable, at the rate on the date of the transaction for significant items.
The resulting translation adjustments are recorded in accumulated other
comprehensive loss as a component of stockholders' equity and are included in
income only upon the sale or liquidation of the underlying investments.

ENVIRONMENTAL COSTS

    Environmental expenditures that relate to current operations are expensed as
incurred. Expenditures providing a future benefit are capitalized as
appropriate. Remediation costs that relate to an existing condition caused by
past operations are accrued when it is probable that these costs will be
incurred and can be reasonably estimated.

RECENT ACCOUNTING PRONOUNCEMENTS

    In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which was subsequently amended by Statement of
Financial Accounting Standards No. 137 and No. 138. Statement of Financial
Accounting Standards No. 133 must be applied to all derivative instruments and
certain derivative instruments embedded in hybrid instruments and requires that
such instruments be recorded in the balance sheet either as an asset or
liability measured at their fair value through earnings, with special accounting
allowed for certain qualifying hedges. Azurix adopted Statement of Financial
Accounting Standards No. 133 as of January 1, 2001. Due to its adoption, Azurix
will recognize an after-tax non-cash gain of approximately $1.5 million in
earnings and an after-tax non-cash loss in "Accumulated other comprehensive
loss," a component of stockholders' equity, of approximately $0.5 million, both
from the cumulative effect of a change in accounting principle.

SEGMENT REPORTING

    Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information," establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports. Operating segments are defined as components of an enterprise about
which separate financial information is available and evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The operating subsidiaries of
Azurix operated in one segment for all periods presented in this report and
therefore such disclosures are not applicable.


                                       55
<PAGE>   58


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


RECLASSIFICATIONS

    Certain reclassifications have been made to the consolidated financial
statements for prior years to conform with the current presentation.

NOTE 2 -- BUSINESS ACQUISITIONS

    On October 2, 1998, Azurix, through its indirect wholly owned subsidiary
Azurix Europe Ltd., acquired over 90% of the outstanding ordinary share capital
of Wessex Water Plc. Azurix completed the acquisition of the ordinary share
capital of Wessex in November 1998. The cost of the Wessex acquisition,
including transaction costs, was $2.4 billion. The purchase method of accounting
was utilized and the results of operations of Wessex have been included in the
consolidated financial statements since the date of acquisition.

    The following unaudited pro forma information summarizes consolidated
results of operations of Azurix as if the Wessex acquisition had occurred as of
January 1, 1998:

<TABLE>
<CAPTION>
                                       YEAR ENDED
                                      DECEMBER 31,
                                          1998
                                      ------------
                                      (IN MILLIONS)
                                       (UNAUDITED)
<S>                                   <C>
         Operating revenues ......      $  464.2
         Net income ..............          87.2
</TABLE>

    These unaudited pro forma results of operations have been prepared for
illustrative purposes only and include adjustments in addition to the
pre-acquisition historical results of Wessex, such as additional amortization
expense as a result of goodwill, increased depreciation expense resulting from
allocation of fair market value to fixed assets acquired, increased interest
expense on acquisition debt and preference share redemption and the sale of
Wessex's interest in Wessex Waste Management Ltd. The unaudited pro forma
financial information is not necessarily indicative of the results of operations
that would have occurred had the Wessex acquisition occurred on the date
indicated, and should not be viewed as indicative of operations in future
periods.

    Azurix entered into an agreement on December 19, 1998 to purchase 49.9% of
an entity whose principal asset is the water concession for the city of Cancun,
Mexico. This agreement was not binding until specific material conditions were
met, and these conditions were met subsequent to December 31, 1998. As a result,
the Cancun concession is not reflected in Azurix's 1998 financial statements.
The purchase price was $13.5 million and Azurix agreed to provide up to $25.0
million in debt financing. The balance of the loans outstanding to the Cancun
concession at December 31, 2000 was $20.1 million. The Cancun concession
acquisition closed on March 24, 1999. The results of the Cancun concession
acquisition are reflected in the financial statements as of the acquisition
closing date utilizing the equity method of accounting.

    On May 18, 1999, Azurix acquired 100% of the stock of Canadian-incorporated
Philip Utilities Management Corporation for $107.4 million, including
transaction costs. This business subsequently was renamed Azurix North America.
Azurix North America is a water and wastewater services company that provides
operations and management, engineering, residuals management and underground
infrastructure development services for municipal water and wastewater
facilities in the U.S. and Canada. Subsequent to its acquisition by Azurix,
Azurix North America has expanded through the acquisition of several water and
wastewater service companies for an aggregate purchase price of $17.7 million.

    During the second quarter of 1999, Azurix was the successful bidder in a
tender for a 30-year concession to operate the water and wastewater systems in
two regions of the Province of Buenos Aires, Argentina, previously operated by
Administracion General de Obras Sanitarias Buenos Aires. On June 30, 1999,
Azurix, through Azurix Buenos Aires S.A., an indirect wholly owned subsidiary,
entered into a concession contract with the provincial government covering the
two regions and paid the government $438.6 million. On July 1, 1999, Azurix
assumed operation of the water and wastewater systems and risk of ownership of
the concession.

    In connection with the funding of this acquisition, Azurix made an equity
investment in Azurix Buenos Aires of $45.0 million, and Azurix Buenos Aires
borrowed $394.0 million under a new credit agreement. This loan was secured by
cash and other short-term liquid investments which Azurix deposited into a cash
collateral account and


                                       56
<PAGE>   59


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


pledged as security for the loan (see Note 3). Azurix used $230.6 million of the
proceeds from its initial public offering, $208.0 million in funds drawn under
the senior credit facility of its indirect wholly owned subsidiary, Azurix
Europe Ltd., and interest on those funds and other funds of Azurix, to fund the
equity investment in Azurix Buenos Aires and the deposit into the cash
collateral account. Under the concession contract, a 10% interest in Azurix
Buenos Aires was subsequently transferred to the employees of Azurix Buenos
Aires.

    On September 24, 1999, Azurix acquired 49% of the capital stock of IASA
Holdings, S.A. de C.V. for $22.5 million, excluding transaction costs. IASA
Holdings owns 100% of Industrias del Agua, S.A. de C.V., a water and wastewater
services company based in Mexico City, Mexico that provides metering, billing,
collections, operations and maintenance services for one quarter of the Federal
District within Mexico City, a service area with a population of approximately
two million people. Industrias del Agua has provided these services since 1993,
when it signed a 10-year contract with the Water Commission of the Federal
District. In addition to holding an interest in Industrias del Agua, Azurix
provides technical services and serves as a technical participant under the
Federal District contract. Contemporaneous with its purchase of the common stock
of IASA Holdings, Azurix entered into separate agreements that resulted in
Azurix having effective control over IASA Holdings. Accordingly, IASA Holdings
is consolidated for financial statement purposes.

    On September 24, 1999, Azurix acquired from an affiliate of AMX-Acqua
Management Inc. 100% of three Brazilian companies, Geoplan-Assessoria,
Planejamento e Perfuracoes Ltda., Aguacerta-Sistemas de Abastecimento Ltda. and
Aguacerta Saneamento Ltda., which provide water drilling, water supply and
wastewater treatment services in Brazil, for $55.6 million in cash, excluding
transaction costs. Azurix has contingent payment obligations to a former owner
under certain negotiated formulas that depend on the future performance of the
business and has retained a former affiliate as a consultant to its Brazilian
operations.

    On October 4, 1999, Azurix purchased 13,600 acres of property in Madera
County, California, for $31.5 million, excluding transaction costs, with plans
of developing, owning and operating a ground water storage project in the
aquifer beneath it.

    On October 18, 1999, Azurix acquired Lurgi Bamag GmbH, a water and
wastewater engineering services company, for $30.2 million, excluding
transaction costs. Lurgi Bamag and its subsidiaries have offices in Germany,
Brazil, Egypt and the United Kingdom.

    For each 1999 acquisition that is consolidated in Azurix's financial
statements, the purchase method of accounting was utilized, and accordingly, the
assets and liabilities have been recorded at their estimated fair values on the
date of each acquisition. The excess of the purchase price over the fair values
of the net assets acquired for each acquisition has been recorded as goodwill,
and is being amortized on a straight-line basis over 40 years. The results of
operations of the acquisitions have been included in the consolidated financial
statements since the date of each acquisition.

NOTE 3 -- RESTRICTED CASH AND CASH EQUIVALENTS

    At December 31, 1999, Azurix had restricted cash and cash equivalents of
$407.7 million, on deposit in a cash collateral account that secured a $394.0
million bank loan to an Azurix subsidiary that was used to fund the Buenos Aires
concession acquisition (see Note 2). The amount payable under the loan at
December 31, 1999 is included in "Short-term debt" on the Consolidated Balance
Sheets (see Note 6). In April 2000, Azurix used the proceeds from this account
to repay the loan and related interest. In addition, at December 31, 1999 and
2000, Azurix had other restricted cash on deposit of $56.5 million and $108.0
million, respectively, that primarily secured borrowings under the Azurix Europe
credit facility (see Note 6).


                                       57
<PAGE>   60


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


NOTE 4 -- OTHER CURRENT ASSETS

    Other current assets is comprised of the following:

<TABLE>
<CAPTION>
                                          DECEMBER 31,
                                        ----------------
                                        1999       2000
                                        -----      -----
                                         (IN MILLIONS)
<S>                                     <C>        <C>
         Prepayments .............      $20.0      $21.5
         Other receivables .......       34.4       23.5
         Other ...................       15.3       30.2
                                        -----      -----
                                        $69.7      $75.2
                                        =====      =====
</TABLE>


NOTE 5 -- PROPERTY, PLANT AND EQUIPMENT

    Property, plant and equipment is comprised of the following:

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                            -----------------------
                                                              1999           2000
                                                            --------       --------
                                                                (IN MILLIONS)
<S>                                                         <C>            <C>
         Land ........................................      $   42.7       $   41.4
         Buildings and operational structures ........         500.4          595.8
         Infrastructure ..............................       1,269.7        1,231.7
         Plant machinery and vehicles ................         489.2          650.9
         Construction work-in-progress ...............         216.0           84.7
         Other assets ................................          41.1           87.2
                                                            --------       --------
                                                             2,559.1        2,691.7
         Less accumulated depreciation ...............         (90.4)        (228.2)
                                                            --------       --------
             Property, plant and equipment, net ......      $2,468.7       $2,463.5
                                                            ========       ========

</TABLE>

    Included in accumulated depreciation at December 31, 2000 are accumulated
impairments of $44.6 million which were recorded in 2000 (see Note 17).

NOTE 6 -- SHORT-TERM DEBT

    As of December 31, 1999 and 2000, Azurix, through Wessex, had committed
credit facilities with major commercial banks providing for an aggregate of
$121.1 million and $224.3 million, respectively, of availability for general
corporate purposes. These facilities expire in October 2001 and April 2002. As
of December 31, 1999, no amounts were outstanding under these credit facilities.
As of December 31, 2000, outstanding borrowings consisted of $62.8 million under
the facilities that expire in 2002. Borrowings are for a period of less than one
year but may be refinanced through 2002. Therefore, amounts outstanding at
December 31, 2000 were reclassified to long-term debt. The facilities accrue
interest at the London interbank offered rate plus 0.275% to 0.35% per annum.
Wessex pays an annual commitment fee equal to 0.15% of the unused portion of
committed lines of credit.

    On May 10, 1999, Azurix Europe entered into a credit facility. At December
31, 1999 and 2000, the maximum capacity of the facility was $686.4 million and
$635.6 million, respectively. At December 31, 1999 and 2000, $298.8 million and
$276.7 million, respectively, of the facility capacity could be used to
refinance indebtedness of Azurix Europe, $101.3 million and $80.8 million,
respectively, of such capacity was reserved to provide for the refinancing of
outstanding Azurix Europe loan notes. At December 31, 1999, the remaining $387.6
million of capacity could be used for acquisitions of water and wastewater
related assets or businesses. In February 2000, the facility was amended so that
as of December 31, 2000, Azurix Europe may borrow $358.9 million of the facility
capacity in a manner allowing for its use by Azurix for general corporate
purposes. At December 31, 1999, $474.8 million was outstanding under the
facility. In February 2000, Azurix issued long-term debt (see Note 7) and used a
portion of the proceeds to repay $386.0 million outstanding under the portion of
this facility that had been borrowed for acquisitions. Accordingly, this amount
was reclassified to long-term at December 31, 1999. At December 31, 2000, $156.0
million was outstanding under that portion of the facility that can be used by
Azurix for general corporate purposes and $95.7 million was outstanding under
that portion of the facility that can be used to refinance the indebtedness of
Azurix Europe. In January 2001, Azurix borrowed $40.0 million under its credit
agreement with Enron (see Note 7) and repaid borrowings that were outstanding at
December 31, 2000


                                       58
<PAGE>   61


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


under the Azurix Europe credit facility. In March 2001, borrowings outstanding
under the Enron credit agreement, including the $40.0 million borrowed and used
to repay borrowings outstanding under the Azurix Europe credit facility, were
retired through the issuance of long-term mandatorily redeemable preferred stock
(see Note 21). Accordingly, $40 million of the balance outstanding was
reclassified as long-term at December 31, 2000.

    The Azurix Europe credit facility bears interest at the London interbank
offered rate plus 0.75% or 1.0%, depending on the level of utilization of the
borrowing capacity. The weighted average interest rates on the U.S. dollar and
U.K. pound sterling borrowings outstanding at December 31, 1999 were 6.9% and
6.8%, respectively, and at December 31, 2000 were 7.5% and 6.8%, respectively.
Azurix incurs commitment fees of 0.375% on the unused borrowing capacity of this
facility. The facility terminates on May 10, 2002, but contains a clause
permitting banks, with two-thirds or more of the commitments, to terminate at an
earlier time if, in their reasonable opinion, changes have occurred resulting in
a material adverse effect on the borrower's ability to repay the outstanding
debt. Therefore, amounts outstanding under this facility are classified as
short-term debt, except amounts refinanced subsequent to December 31, 1999 and
2000 through the issuance of long-term debt and long-term mandatorily redeemable
preferred stock. The facility contains restrictive covenants that include
limitations on borrowings, maintenance of financial ratios such as interest
coverage and debt to equity and contracts to perform or refrain from undertaking
certain acts. The facility includes customary events of default, including
non-payment, cross-defaults and insolvency and prohibits Azurix Europe from
paying dividends.

    As of December 31, 1999 and 2000, Azurix, through Wessex, had $15.8 million
and $6.0 million, respectively, outstanding under credit facilities with major
commercial banks on an uncommitted basis. Interest accrues on the uncommitted
facilities based on the market rate plus a negotiated margin. The interest rate
on the uncommitted bank borrowings outstanding as of December 31, 1999 and 2000
was 5.2% and 5.5%, respectively.

    In connection with the funding of the Buenos Aires concession acquisition
(see Note 2), Azurix, through its indirect wholly owned subsidiary, Azurix
Buenos Aires S.A., entered into a credit agreement and borrowed $394.0 million
in June 1999. The agreement was between Azurix Buenos Aires and Westdeutsche
Landesbank Girozentrale, a German bank, as the agent and lender. The loan was
secured by cash and other short-term liquid investments in the aggregate amount
of $407.7 million as of December 31, 1999, which Azurix deposited into a cash
collateral account, including interest earned on amounts deposited, and pledged
as security for the loan (see Note 3). In April 2000, Azurix used proceeds from
the cash collateral account to repay the $394.0 million bank loan and related
interest of $19.7 million (see Note 3).

    On September 29, 1999, Azurix Corp. entered into a 364-day $150.0 million
unsecured revolving credit facility with a group of banks. The facility, as
subsequently amended, was scheduled to mature in September 2000. As of December
31, 1999, $150.0 million was outstanding under the facility and the borrowings
were primarily used to reduce other debt obligations and finance acquisitions.
The weighted average interest rate on borrowings outstanding under this facility
at December 31, 1999 was 7.7%. Azurix used a portion of the proceeds from the
long-term senior notes issued in February 2000 to repay all amounts outstanding
under this facility (see Note 7). Accordingly, the borrowings under this
facility at December 31, 1999 were reclassified as long-term. Azurix terminated
the facility in March 2000.

    Azurix, through Azurix Europe, had outstanding U.K. pound sterling
denominated loan notes as of December 31, 1999 and 2000 of $101.3 million and
$80.8 million, respectively. The loan notes were issued to Wessex shareholders
in lieu of cash consideration for the ordinary shares purchased in the Wessex
acquisition (see Note 2). The loan notes are redeemable, at the option of the
holder, semiannually beginning September 30, 1999, with final redemption
occurring September 30, 2005. The loan notes may be redeemed at the holders'
option within one year, and therefore, are potential current obligations. At
December 31, 1999 and 2000, the loan notes are secured by the Azurix Europe
credit facility. As a result of a subjective acceleration clause contained in
that facility as discussed above, the loan notes are classified as short-term at
December 31, 1999 and 2000. Interest on the loan notes accrues at the London
interbank offered rate and is payable semiannually. The interest rates for the
period the loan notes were outstanding during 1999 and 2000 was 5.9% and 6.3%,
respectively.

    At December 31, 1999 and 2000, Azurix, through various subsidiaries, had
other short-term borrowings outstanding of $2.3 million and $0.2 million,
respectively.


                                       59
<PAGE>   62

                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)



NOTE 7 -- LONG-TERM DEBT AND LONG-TERM DEBT -- AFFILIATES

    The components of long-term debt are as follows:

<TABLE>
<CAPTION>
                                                                                  DECEMBER 31,
                                                                           -----------------------
                                                                             1999              2000
                                                                           --------       --------
                                                                                (IN MILLIONS)
<S>                                                                        <C>            <C>
         Amounts reclassified from short-term debt (see Note 6) .....      $  536.0       $  102.8
         Azurix Corp. senior notes ..................................            --          589.6
         Wessex senior unsecured bonds ..............................         479.2          444.3
         Wessex European Investment Bank credit facilities ..........         223.1          201.7
         Capital lease obligations ..................................          86.3           61.9
         Other ......................................................          12.3           26.5
                                                                           --------       --------
                                                                            1,336.9        1,426.8
         Less current maturities ....................................         (35.0)         (80.7)
                                                                           --------       --------
             Total long-term debt ...................................      $1,301.9       $1,346.1
                                                                           ========       ========
</TABLE>

    In February 2000, Azurix issued U.S. dollar and U.K. pound sterling senior
notes with a U.S. dollar equivalent face value at December 31, 2000 of $589.6
million. The senior notes consisted of $240.0 million and L.100.0 million, each
due in 2007 and bearing an interest rate of 10.375%, and $200.0 million due in
2010 and bearing an interest rate of 10.75%. Net proceeds after underwriters'
discount and other offering costs were $583.1 million. Of this amount, $150.0
million was used to pay down the Azurix revolving credit facility, $386.0
million was used to pay down the Azurix Europe credit facility and $18.1 million
was used to pay down amounts outstanding under the credit agreement with Enron.
In addition, $11.5 million was used to pay accrued interest on the three credit
facilities. The remaining proceeds were made available for general corporate
purposes. The senior notes were issued under an indenture that contains certain
covenants that limit Azurix's ability to incur additional debt, pay dividends or
make other distributions, incur liens on its assets, enter into sale/leaseback
transactions, enter into transactions with affiliates, or sell assets to, or
merge with, another entity.

    In March 1999, Azurix, through a wholly owned subsidiary of Wessex, issued
U.K. pound sterling denominated senior unsecured bonds with a face value of
$484.5 million and $448.7 million as of December 31, 1999 and 2000,
respectively. The net proceeds were primarily used to refinance all short-term
bank borrowings that were outstanding on the date of issue. The bonds mature on
March 30, 2009 and bear interest at a rate of 5.875% payable annually.

    The European Investment Bank credit facilities consist of four separate
loans. The U.S. dollar denominated loan has a floating interest rate based on
the London interbank offered rate less 0.25%, is due October 2001 and had an
outstanding balance of $48.5 million and $44.9 million at December 31, 1999 and
2000, respectively. The weighted average interest rate on the U.S. dollar loan
was 5.1% and 6.2% for the years ended December 31, 1999 and 2000, respectively.
The Italian lire denominated loan bears interest at 11.6% per annum, is payable
in semiannual installments through June 2002 and had an outstanding balance of
$13.1 million and $7.3 million at December 31, 1999 and 2000, respectively. The
other two obligations are U.K. pound sterling denominated and were entered into
in 1999. Interest on one of the U.K. pound sterling denominated obligations is
based on the London interbank offered rate less 0.13%, is payable in full in
December 2005 and had an outstanding balance of $126.6 million and $117.2
million at December 31, 1999 and 2000, respectively. Interest on this loan was
5.9% for the period outstanding in 1999 and 6.0% in 2000. The other U.K. pound
sterling denominated obligation bears interest based on the London interbank
offered rate less 0.10%, is payable in full in December 2009 and had an
outstanding balance of $34.9 million and $32.3 million at December 31, 1999 and
2000, respectively. The interest rate on this loan was 5.9% for the period
outstanding in 1999 and 6.1% in 2000.

    At December 31, 2000, future minimum lease payments under capital leases
total $69.4 million, including $7.5 million representing interest. At December
31, 2000, $150.7 million of historical cost and $26.5 million of related
accumulated depreciation are recorded under capital leases and included in
property, plant and equipment.

    At December 31, 1999 and 2000, Azurix, through various subsidiaries, had
other long-term debt outstanding of $12.3 million and $26.5 million,
respectively.

    Each of these financing agreements contains certain restrictive covenants,
including among other things, limitations on borrowings, the maintenance of
certain financial ratios such as interest coverage, net worth and debt


                                       60
<PAGE>   63


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

to equity and contracts to perform or refrain from undertaking certain acts. The
financing contracts include standard events of default, including non-payment,
cross-defaults and insolvency. Azurix is currently in compliance with these
covenants.

    At December 31, 2000, long-term debt and capital lease obligation maturities
over the next five years were $80.7 million in 2001, $101.8 million in 2002,
$4.7 million in 2003, $3.7 million in 2004 and $120.1 million in 2005.

    Azurix has entered into interest rate and currency swap contracts related to
certain outstanding debt instruments (see Note 8).

    Effective May 1, 1999, Azurix entered into a credit agreement with Enron,
which was amended as of January 24, 2000. Under this agreement, Enron loaned
funds to Azurix for general, administrative and operating expenses. As of
December 31, 1999 and 2000, $53.3 million and $103.1 million, respectively, was
outstanding under this credit agreement. The credit agreement originally
terminated on the earlier of December 15, 2001 or 90 days following the date
that Enron does not own or have the power to vote at least one-third of Azurix's
capital stock ordinarily entitled to vote for the election of directors and
fewer than one-third of Azurix's directors are officers, directors or employees
of Enron. The total commitment under the credit agreement would not exceed $60
million, $120 million and $180 million at any time during calendars years 1999,
2000 and 2001, respectively. Advances under the credit agreement bore interest
at the federal funds rate plus 1.50%. The effective interest rate on these
borrowings in 1999 and 2000 was 6.8% and 8.1%, respectively. In January 2001,
Azurix borrowed $40.0 million under the Enron credit agreement and paid down
that portion of the Azurix Europe credit facility that can be used by Azurix for
general corporate purposes. Interest expense recorded for 1999 and 2000 was $2.2
million and $7.6 million, respectively. In addition, on March 16, 2001, the then
outstanding balance of the Enron credit agreement of $180 million was retired
through the issuance to Enron of mandatorily redeemable preferred stock and the
credit agreement was terminated. As a result, the balance outstanding at
December 31, 2000 under the credit agreement was classified as long-term debt -
affiliates and not as current maturities of long-term debt - affiliates.

    During 1998, Azurix, though Azurix Europe, entered into a U.K. pound
sterling denominated senior loan agreement with a subsidiary of a shareholder.
The note accrues interest at 6.25% per annum. Under the note agreement maturing
December 2001, prepayment is allowed in whole or in part at any time. The
principal balance outstanding at December 31, 1999 and 2000 was $117.9 million
and $109.2 million, respectively. Interest expense recorded for 1998, 1999 and
2000 was $1.9 million, $7.4 million and $6.9 million, respectively.

    In June 1999, a loan agreement was entered into with a shareholder. The
principal amount is limited to $25.0 million and the balance outstanding at
December 31, 1999 and 2000 was $8.8 million and $15.5 million, respectively.
Individual loans made under the agreement mature in 2009 and are non-interest
bearing.

NOTE 8 -- FINANCIAL INSTRUMENTS

    Azurix uses derivative financial instruments in the normal course of its
business for purposes other than trading. These financial instruments include
interest rate, currency swap and forward foreign exchange contracts. At December
31, 2000, Azurix had U.K. pound sterling interest rate swap contracts having a
total notional principal amount of $272.4 million. Interest rate swap contracts
relating to notional principal amounts of $179.4 million and $93.0 million
terminate in 2001 and 2002 through 2009, respectively. At December 31, 2000,
Azurix had cross-currency swap contracts to exchange U.S. dollars of $51.0
million to U.K. pound sterling of L.30.0 million, which expires in 2001, and
Italian lire of 10.7 billion to U.K. pound sterling of L.4.9 million, which
expires in 2002. At December 31, 2000, Azurix had forward foreign exchange
contracts having a total notional principal amount of $5.5 million which
terminate in 2001.

    The carrying amount of cash and cash equivalents, trade accounts receivable
(net of an allowance for doubtful accounts), accounts payable and accruals and
short-term debt approximates their fair value due to their short-term nature.
The fair value of long-term debt and affiliate long-term debt is based on the
quoted market prices for the same or similar issues or on the current rates
offered to Azurix for debt of the same remaining maturities. The fair value of
currency swap, forward exchange and interest rate swap contracts shown below was
determined based on a model which estimates the fair value of these contracts
using market rates in effect at each respective date or was based on quoted
market prices for similar instruments with similar maturities. Judgment is
necessarily required in interpreting market data and the use of different market
assumptions or estimation methodologies may


                                       61
<PAGE>   64


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


affect the estimated fair value amounts. The comparison of estimated fair value
and carrying amount are as follows:


<TABLE>
<CAPTION>

                                                                          DECEMBER 31,
                                                                     -----------------------
                                                                       1999           2000
                                                                     --------       --------
                                                                         (IN MILLIONS)
<S>                                                                  <C>            <C>
Long-term debt (including current maturities) (1)
         Estimated fair value .................................      $1,219.8       $1,136.6
         Carrying amount ......................................       1,338.1        1,430.9
Long-term debt - affiliates (including current maturities)
         Estimated fair value .................................         168.5          209.7
         Carrying amount ......................................         180.0          227.8
Derivatives:
     Interest rate swap contracts
         Estimated fair value .................................           7.2            2.7
         Carrying amount ......................................            --             --
     Currency swap contracts (1)
         Estimated fair value .................................          (2.8)           2.9
         Carrying amount ......................................          (1.2)          (4.1)
     Forward exchange contracts
         Estimated fair value .................................          (0.8)          (0.3)
         Carrying amount ......................................            --             --
</TABLE>

----------

(1) The sum of the carrying amount for long-term debt and the currency swaps, as
    indicated above, equals long-term debt including current maturities (see
    Note 7).

    Azurix is exposed to certain risks due to the nature of derivative financial
instruments. In the event of non-performance by third parties, the amounts of
interest rate, forward exchange and currency swap contracts are potentially
subject to credit risk. Third parties to these contracts are major commercial
banks with high-quality credit ratings. Accordingly, Azurix does not anticipate
non-performance by any of these counterparties on these financial instruments.
Azurix is exposed to market risk in the form of foreign exchange rate and
interest rate risks. Several variable and fixed rate loans in foreign currencies
are hedged through a combination of cross-currency swaps, forward exchange
contracts and interest rate swaps.

NOTE 9 -- INCOME TAXES

    The components of income before income taxes are as follows:

<TABLE>
<CAPTION>

                     JANUARY 29, 1998
                         (DATE OF
                        INCEPTION)    YEAR ENDED DECEMBER 31,
                     TO DECEMBER 31,  -----------------------
                           1998          1999         2000
                     ---------------   -------      -------
                                    (IN MILLIONS)
<S>                       <C>          <C>          <C>
United States ....        $(14.7)      $(86.5)      $(121.6)
Foreign ..........          43.2        152.5        (351.8)
                          ------       ------       -------
                          $ 28.5       $ 66.0       $(473.4)
                          ======       ======       =======
</TABLE>



                                       62

<PAGE>   65

                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    Total income tax expense is summarized as follows:

<TABLE>
<CAPTION>



                                          JANUARY 29, 1998
                                         (DATE OF INCEPTION)             YEAR ENDED DECEMBER 31,
                                           TO DECEMBER 31,     -----------------------------------------
                                                1998                  1999                  2000
                                        --------------------   -------------------   -------------------
                                                                 (IN MILLIONS)
<S>                                     <C>                    <C>                   <C>
Current tax expense:
  Federal ...........................      $      --              $     0.9                $      --
  State .............................             --                    0.3                      0.2
  Foreign ...........................            4.9                   14.1                      7.9
                                           ---------              ---------                ---------
                                                 4.9                   15.3                      8.1
                                           ---------              ---------                ---------
Deferred tax expense (benefit):
  Federal ...........................             --                  (33.1)                   (39.3)
  State .............................             --                    0.1                       --
  Foreign ...........................           13.4                   39.2                     48.8
                                           ---------              ---------                ---------
                                                13.4                    6.2                      9.5
                                           ---------              ---------                ---------
      Total income tax expense ......      $    18.3              $    21.5                $    17.6
                                           =========              =========                =========


    Income tax benefit for the components of other comprehensive loss was $0.3 million and $0.1 million for the years ended
December 31, 1999 and 2000, respectively.

    The differences between taxes computed at the U.S. federal statutory tax rate and Azurix's effective income tax rate are
as follows:
</TABLE>


<TABLE>
<CAPTION>

                                               JANUARY 29, 1998
                                              (DATE OF INCEPTION)                     YEAR ENDED DECEMBER 31,
                                                TO DECEMBER 31,          ----------------------------------------------
                                                     1998                       1999                       2000
                                              -------------------        -------------------        -------------------
                                              AMOUNT      PERCENT        AMOUNT      PERCENT        AMOUNT      PERCENT
                                              ------      -------        ------      -------        ------      -------
                                                                   (IN MILLIONS, EXCEPT PERCENTAGES)
<S>                                           <C>         <C>            <C>         <C>            <C>         <C>
Statutory federal income tax
   provision ...........................      $ 10.0         35.0%       $ 23.1         35.0%       $(165.7)       35.0%
U.S. loss not benefited (valuation
   allowance reversal) .................         5.1         17.9          (5.1)        (7.7)           --           --
Foreign subsidiary company losses
   not benefited .......................         2.4          8.4            --           --         166.9        (35.3)
Nondeductible goodwill amortization ....         1.7          6.0           6.3          9.5           7.1         (1.5)
Consolidated foreign earnings
   taxed at other than the U.S. rate....        (1.8)        (6.3)         (2.5)        (3.8)         (7.1)         1.5
Equity income (loss) of foreign
   investment ..........................         0.4          1.4          (0.5)        (0.8)         13.6         (2.9)
Minority interest ......................          --           --          (0.3)        (0.4)         (1.1)         0.2
Other ..................................         0.5          1.8           0.5          0.8           3.9         (0.7)
                                              ------       ------        ------       ------        ------       ------
   Total income tax expense ............      $ 18.3         64.2%       $ 21.5         32.6%       $ 17.6         (3.7)%
                                              ======       ======        ======       ======        ======       ======
</TABLE>



                                       63
<PAGE>   66


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


The principal components of Azurix's net deferred income tax liability are as
follows:


<TABLE>
<CAPTION>


                                                                                DECEMBER 31,
                                                                          -----------------------
                                                                             1999           2000
                                                                           --------       --------
                                                                                (IN MILLIONS)
<S>                                                                         <C>          <C>
Deferred income tax assets:
   U.K. Advance Corporation Tax (ACT) carryforward .................      $   67.8       $   23.2
   U.S. tax loss and start-up expenditure carryforwards ............          36.3           80.6
   Foreign net operating loss carryforwards ........................          13.0            9.7
   Tax credits in foreign jurisdictions ............................           2.8            7.4
   Basis differences concession intangibles, property, plant and
       equipment and Other .........................................           7.9          163.4
   Valuation allowance .............................................          (4.8)        (180.5)
                                                                          --------       --------
       Total deferred tax assets ...................................         123.0          103.8
                                                                          --------       --------
Deferred income tax liabilities:
   Basis differences in property, plant and equipment ..............        (515.1)        (466.8)
   Liabilities not recognized for tax purposes
       and Other ...................................................          (1.6)          (6.0)
                                                                          --------       --------
       Total deferred tax liabilities ..............................        (516.7)        (472.8)
                                                                          --------       --------
       Net deferred tax liabilities ................................      $ (393.7)      $ (369.0)
                                                                          ========       ========
</TABLE>

    Azurix's results of operations for the year ended December 31, 2000 included
the impairment of the equity method investment of the Mendoza concession company
of $55.0 million and the impairment of long-lived assets at the Buenos Aires
concession of $389.5 million. Due to the significant uncertainty regarding the
Argentine investments (see Note 17), no deferred tax benefits were recorded for
these impairments. In addition, at December 31, 2000, Azurix determined that a
valuation allowance on its prior and current year Argentine deferred tax assets
was required, resulting in a fourth quarter tax expense of $18.5 million (see
Note 17).

    Azurix had U.K. Advance Corporation Tax credit carryforwards at December 31,
2000 of approximately $23.2 million that can be used to offset U.K. taxes
payable in future years. At December 31, 2000, the U.K. ACT credit had an
indefinite carryforward period. At December 31, 2000, Azurix had foreign
subsidiary company loss carryforwards of approximately $27.6 million. Due to
restrictions on the use of such loss carryforwards and uncertainty as to their
ultimate usage, the related tax benefits have not been reflected in Azurix's
results of operations.

    At December 31, 2000, Azurix had carryforwards of U.S. tax losses and
start-up expenditures of approximately $230.2 million that will begin to expire
in 2019. During 1998, Azurix recorded a valuation allowance on a deferred tax
asset of approximately $5.1 million related to losses incurred in the United
States. During the second quarter of 1999, Azurix determined that the available
evidence attributable to the increased level of 1999 business activities
(including consideration of the proceeds generated from the initial public
offering and available U.S. tax planning strategies) indicated that it is more
likely than not that the deferred tax asset associated with the 1998 U.S. losses
will be realized. Accordingly, the valuation allowance of approximately $5.1
million was reversed in the second quarter of 1999. Management has determined
that no valuation allowance is necessary for the U.S. losses generated through
the year ended December 31, 2000 due to expected future income and available tax
planning strategies.

    U.S. and foreign income taxes have been provided for earnings of foreign
subsidiary and affiliate companies that are expected to be remitted to the U.S.
Foreign subsidiaries' and affiliates' cumulative undistributed earnings of
approximately $277.7 million are considered to be indefinitely reinvested
outside the United States and, accordingly, no U.S. income taxes have been
provided thereon. In the event of a distribution of those earnings in the form
of dividends, Azurix may be subject to both foreign withholding taxes and U.S.
income taxes net of allowable foreign tax credits.



                                       64
<PAGE>   67


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


NOTE 10 -- SUPPLEMENTAL CASH FLOW INFORMATION

    Cash paid for income taxes and interest expense is as follows:

<TABLE>
<CAPTION>

                                                          JANUARY 29, 1998
                                                         (DATE OF INCEPTION)       YEAR ENDED DECEMBER 31,
                                                           TO DECEMBER 31,         -----------------------
                                                                1998                   1999          2000
                                                         -------------------       ------------    -------
                                                                                   (IN MILLIONS)
<S>                                                      <C>                       <C>           <C>
Utility taxes(1) .................................           $ 81.7                    $   --      $   --
Income taxes .....................................               --                      29.6         7.8
Interest expense (net of amounts capitalized) ....              9.6                      47.7       115.7
</TABLE>

----------

(1) One-time tax levied on private utilities by the U.K. Government. This amount
    was recorded to Wessex's net income in 1997.

NON-CASH TRANSACTIONS

    During 1998, Azurix issued $117.2 million of debt in the form of loan notes
in connection with the Wessex acquisition. During 1998, Azurix received a
capital contribution from Enron of the outstanding stock of a subsidiary that
holds an interest in Obras Sanitarias Mendoza. The transfer was recorded at the
book value of Enron of $71.8 million. During 2000, Azurix acquired assets by
entering into capital leases totaling $5.4 million.

NOTE 11 -- RELATED PARTY TRANSACTIONS

    Enron and Azurix have entered into an agreement that limits the scope of
Azurix's business and provides that Enron and its affiliates may engage in water
related businesses, even if those businesses have a competitive impact on
Azurix. In general, Enron is permitted to engage in any business whatsoever,
including water, wastewater and other businesses competing with Azurix, provided
the business is conducted and opportunities are identified and developed through
Enron's own personnel and not through those of Azurix. If an opportunity in the
water industry is presented to a person who is an officer or director of both
Enron and Azurix, the opportunity must first be offered to Azurix, unless water
constitutes a minority of the fair market value of the opportunity, as
determined by that officer or director in good faith based on information
available at the time.

    During 1998, 1999 and 2000, Enron provided various services to Azurix. In
1999, Azurix signed agreements with Enron pursuant to which Enron will continue
to provide such services which include among other things, information
technology, office space, building maintenance, security and other office
services as well as employee development, training, maintenance of compensation
and other benefits programs and the use of Enron-owned aircraft. Azurix may
utilize Enron's regulatory affairs, marketing affairs, treasury and risk
assessment and control departments. In addition, Azurix may continue to
participate in Enron's corporate insurance program. The agreement provides that
Azurix may use the international offices of Enron and its affiliates for
projects, subject to mutual agreement with Enron or its affiliates on a
project-by-project basis. The agreement provides that Azurix will reimburse
Enron for direct charges related to Enron services and facilities that it
utilizes. Azurix is also allocated an amount for overhead charges related to
Enron corporate staff and support services which it utilizes. This overhead
charge is allocated based upon factors such as employee headcount, payroll and
square footage. The agreement is for an indefinite term, but either party may
terminate the agreement on 180 days' notice. During 1998, 1999 and 2000, the
expense recorded for these services was approximately $1.5 million, $6.6 million
and $2.9 million, respectively.

    Employees of Azurix Corp. are covered by various employee benefit plans of
Enron such as medical, dental, life insurance and other benefit plans. These
costs are allocated to Azurix based upon Enron's costs of administering and
providing the benefit plans. During 1998, 1999 and 2000, the expense recorded
under the plan arrangements was approximately $1.4 million, $2.3 million and
$1.4 million, respectively.

    Management believes the above allocation methods and costs are reasonable.


                                       65
<PAGE>   68


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    During 1998 and 1999, Enron advanced to Azurix $17.7 million and $53.4
million, respectively, related to office space and other services provided by
Enron and the cost of various benefit plans for certain employees, each
described above, and to fund Azurix's investment in and advances to its Cancun
affiliate. The entire amount of the advances were repaid in June 1999 with the
proceeds from Azurix's initial public offering of its common stock.

    A former director of a subsidiary of Wessex owns certain assets utilized in
the subsidiary's operations. The subsidiary was charged $0.1 million and $0.2
million for the use of those assets during 1998 and the period in 1999 while
serving as a director, respectively.

    Enron has made available letters of credit on behalf of Azurix's
subsidiaries in the aggregate amount of approximately $16 million as of December
31, 1999. Azurix paid, or reimbursed Enron for, the fees associated with these
letters of credit. There were no letters of credit made available by Enron on
behalf of Azurix as of December 31, 2000.

    During 1999, and through March 31, 2000, Enron guaranteed debt and letter of
credit obligations of up to $25 million on behalf of Azurix North America to a
bank under terms of the bank credit facilities in exchange for, among other
things, the elimination of requirements for various assets to be pledged. As of
December 31, 1999, $16.4 million of letter of credit obligations were
outstanding under this credit facility, and thus guaranteed by Enron. While the
guarantee was outstanding, Azurix paid a fee to Enron of $0.3 million per annum.

    During 2000, Azurix provided certain services that included arranging,
negotiating and structuring water supply arrangements for a project being
developed by an Enron subsidiary. Revenues earned and received during 2000
related to these services were $1.1 million. Under a separate agreement with the
Enron subsidiary, Azurix has agreed to provide future water supply and water
management services to the project for a period of approximately 25 years.
Future services to be provided under this agreement are contingent upon the
Enron subsidiary receiving certain government approvals to proceed with its
project.

    Azurix has long-term debt with affiliates (see Note 7).

NOTE 12 -- PENSION AND OTHER POSTRETIREMENT BENEFITS

    Azurix has various pension plans through its subsidiaries which include both
defined benefit and defined contribution plans.

    During 1999, Wessex maintained three defined benefit pension plans that
covered substantially all of its employees. On January 1, 2000, these plans were
merged into a single plan. The plan assets are held in separate trustee
administered funds and consist primarily of equity and debt securities. Wessex's
funding policy is to contribute to the plan sufficient to satisfy legal funding
requirements. Azurix Buenos Aires maintains a defined benefit plan and Lurgi
Bamag maintains a defined benefit plan and a postretirement benefit plan. These
plans have no assets because Azurix Buenos Aires and Lurgi Bamag have not
previously provided funding. The pension costs for these plans charged to the
Consolidated Statements of Income (Loss) have been determined on the advice of
independent qualified actuaries and are accrued over the service lives of the
employees expected to be eligible to receive such benefits.

    The weighted average assumptions used in the actuarial computations for the
defined benefit plans of Wessex, Azurix Buenos Aires and Lurgi Bamag and the
postretirement plan of Lurgi Bamag are shown below:


<TABLE>
<CAPTION>

                                                            PENSION BENEFITS             POSTRETIREMENT BENEFTIS
                                                         -----------------------         -----------------------
                                                         YEAR ENDED DECEMBER 31,         YEAR ENDED DECEMBER 31,
                                                         -----------------------         -----------------------
                                                           1999          2000              1999          2000
                                                         -------        --------         -------        --------
<S>                                                      <C>            <C>              <C>            <C>
Discount rate ...............................              5.8%           5.8%             6.0%             6.5%
Expected long-term rate of return on
   plan assets ..............................              6.5            6.8               --               --
Rate of compensation increase ...............              4.3            3.5              3.0              3.0
</TABLE>



                                       66
<PAGE>   69


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    For the measurement purposes of postretirement benefits, a 4.0% annual rate
of increase in healthcare costs was assumed for the years ended December 31,
1999 and 2000.

    The following represents the obligations, plan assets and funded status for
the defined benefit pension plans and postretirement plan:

<TABLE>
<CAPTION>

                                                            PENSION BENEFITS          POSTRETIREMENT BENEFITS
                                                        -----------------------       -----------------------
                                                        YEAR ENDED DECEMBER 31,       YEAR ENDED DECEMBER 31,
                                                        -----------------------       -----------------------
                                                          1999           2000           1999           2000
                                                        --------       --------       --------       --------
                                                                           (IN MILLIONS)
<S>                                                     <C>            <C>            <C>            <C>
Change in benefit obligation:
  Benefit obligation at beginning of period ......      $  246.2       $  289.3       $     --       $    0.7
     Obligation acquired from business
       acquisitions ..............................          11.9             --            0.7             --
     Service cost ................................           7.8            6.9             --             --
     Past service cost ...........................          13.9             --             --             --
     Interest cost ...............................          13.2           16.1             --             --
     Plan participants' contributions ............           3.5            3.8             --             --
     Actuarial loss (gain) .......................           8.4            7.4             --           (0.1)
     Benefits paid ...............................          (7.7)         (12.1)            --             --
     Exchange difference .........................          (7.9)         (21.6)            --             --
                                                        --------       --------       --------       --------
   Benefit obligation at end of period ...........      $  289.3       $  289.8       $    0.7       $    0.6
                                                        ========       ========       ========       ========
Change in plan assets:
     Fair value of plan assets at beginning of
       period ....................................      $  259.2       $  290.2       $     --       $     --
     Actual return on plan assets ................          40.4            1.0             --             --
     Employer contribution .......................           1.9           15.8             --             --
     Plan participants' contributions ............           3.6            3.8             --             --
     Benefits paid ...............................          (7.6)         (11.5)            --             --
     Exchange difference .........................          (7.3)         (21.6)            --             --
                                                        --------       --------       --------       --------
   Fair value of plan assets at end of period ....      $  290.2       $  277.7       $     --       $     --
                                                        ========       ========       ========       ========
  Funded Status:
     Fair value of plan assets ...................      $  290.2       $  277.7       $     --       $     --
     Projected benefit obligation ................         289.3          289.8            0.7            0.6
                                                        --------       --------       --------       --------
     Funded status ...............................           0.9          (12.1)          (0.7)          (0.6)
     Unrecognized past service cost ..............          13.8           11.8             --             --
     Unrecognized net actuarial gain (loss) ......         (22.5)           4.2             --           (0.1)
                                                        --------       --------       --------       --------
   Prepaid benefit cost (Accrued benefit
     liability) ..................................      $   (7.8)      $    3.9       $   (0.7)      $   (0.7)
                                                        ========       ========       ========       ========
</TABLE>

Net periodic benefit cost includes the following components:

<TABLE>
<CAPTION>

                                                  PENSION BENEFITS         POSTRETIREMENT BENEFITS
                                              -----------------------      ------------------------
                                              YEAR ENDED DECEMBER 31,       YEAR ENDED DECEMBER 31,
                                              -----------------------      ------------------------
                                                1999           2000           1999          2000
                                              --------       --------       --------      ---------
                                                                 (IN MILLIONS)
<S>                                           <C>            <C>            <C>           <C>
 Service cost ..........................      $    7.8       $    6.9       $     --      $     --
 Interest cost .........................          13.2           16.1             --            --
 Amortization of prior service costs ...            --            0.9             --            --
 Expected return on plan assets ........         (16.3)         (18.9)            --            --
                                              --------       --------       --------      --------
 Net periodic benefit cost .............      $    4.7       $    5.0       $     --      $     --
                                              ========       ========       ========      ========
</TABLE>



                                       67
<PAGE>   70


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    A 1% change in assumed healthcare cost trend rates would have the following
effects for the year ended December 31, 2000:

<TABLE>
<CAPTION>

                                                             1% INCREASE  1% DECREASE
                                                             -----------  -----------
                                                                   (IN MILLIONS)
<S>                                                          <C>          <C>
Effect on total service and interest cost components .....      $  --       $   --
Effect on post retirement benefit obligation .............        0.1          0.1
</TABLE>


    Azurix North America contributes to defined contribution plans for a number
of its employees in the U.S. and Canada. Contributions to these plans totaled
$0.4 million during the period in 1999 that Azurix owned Azurix North America
and $0.3 million in 2000. Contributions to the defined contribution plans are
based on percentages of compensation varying from 1% to 15% of compensation, and
in some instances are based upon the amount of the employees' contributions to
the plans. In any event, contributions are limited to $3,000 per employee per
annum.

    Azurix North America also contributes to a multi-employer union pension plan
for certain union employees. These contributions are based on amounts negotiated
between the union and the participating employers. There were no contributions
related to the multi-employer plan during 1999 or 2000 because the plan is
currently over funded.

NOTE 13 -- STOCK PLANS

    In February 1999, Azurix established a stock plan that provides for the
granting or awarding of stock options and restricted stock to directors,
officers and key employees of Azurix and members of the Azurix Board of
Directors. Options granted may be either incentive stock options or
non-qualified stock options and are granted at not less than the fair market
value of the stock on the date of grant. At any particular time, the number of
shares of common stock issued under the plan may not exceed 15% of the total
number of shares of common stock outstanding. These stock options generally vest
over three to five years and will be exercisable for 10 years after the date of
grant. On March 16, 2001, all options and unvested restricted stock outstanding
under the stock plan were cancelled (see Note 21).

    Azurix applies Accounting Principles Board Opinion No. 25, "Accounting For
Stock Issued To Employees," and related interpretations in accounting for stock
options issued under the plan. Accordingly, no compensation expense has been
recognized for the stock options granted. Had compensation cost been recognized
based on the fair value of options granted at the grant dates for awards under
the plan, Azurix's net income (loss), for the years ended 1999 and 2000 would
have been $21.9 million and $(487.1) million, respectively.

    The fair value of options granted in 1999 and 2000 was estimated on the date
of grant using the Black-Scholes option pricing model assuming no expected
dividend yield, weighted average expected life of 3.8 years and 4.2 years,
respectively, expected volatility of 82.6% and 57.4%, respectively, and a
weighted average risk-free interest rate of 5.4% and 6.4%, respectively.

    Summarized information for Azurix's stock option plan is as follows:

<TABLE>
<CAPTION>

                                                                 1999                            2000
                                                        ----------------------          ----------------------

                                                                      WEIGHTED                        WEIGHTED
                                                                      AVERAGE                         AVERAGE
                                                                      EXERCISE                        EXERCISE
     (OPTIONS IN THOUSANDS)                             OPTIONS        PRICE             OPTIONS       PRICE
                                                        -------      ----------         -------       --------
<S>                                                     <C>          <C>                <C>           <C>
Options outstanding, beginning of year ...........          --                           10,253       $ 13.79
Granted ..........................................      12,374       $    14.31           2,016          7.49
Exercised ........................................          --               --            (251)         6.94
Forfeited ........................................      (2,121)           16.81          (4,917)        14.42
                                                        ------                           ------
Options outstanding, end of year .................      10,253            13.79           7,101         11.82
                                                        ======                           ======
Weighted average fair value of options granted ...                         8.58                          3.85
</TABLE>




                                       68
<PAGE>   71


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

    The following table summarizes information about stock options outstanding
at December 31, 2000 (options in thousands):

<TABLE>
<CAPTION>
                                                  WEIGHTED
                                                   AVERAGE            WEIGHTED
                                                  REMAINING           AVERAGE
    RANGE OF EXERCISE           OPTIONS          CONTRACTUAL          EXERCISE
          PRICES              OUTSTANDING           LIFE               PRICE
  --------------------        -----------        -----------         -----------
<S>                           <C>                <C>                 <C>
      $4.00 to $7.63             3,742              9.4 years        $     7.17
      14.25 to 21.56             3,359              8.1 years             16.99
</TABLE>


NOTE 14 -- EXTRAORDINARY LOSS

    In May 1999, Azurix Europe retired borrowings under its former senior credit
facility and terminated the facility prior to its maturity. Unamortized deferred
financing fees related to this facility of $9.8 million ($6.8 million net of tax
benefit) were charged to income as an extraordinary loss.

NOTE 15 -- RESTRUCTURING CHARGE

    In 1998, Azurix adopted a business strategy focused on growth through
acquisitions and development projects around the world. During the fourth
quarter of 1998 and the first half of 1999, Azurix initiated a business
development effort requiring increased personnel to pursue and support
acquisition and privatization activities worldwide. The initiative was based on
Azurix's expectations as to the size, number, location and timing of
privatization projects that would be awarded in 1999, 2000 and beyond. During
the second half of 1999, several large privatization projects were postponed or
cancelled. In the fourth quarter of 1999, Azurix reevaluated its cost structure
in relation to its business development efforts. As a result, Azurix announced a
plan to restructure its operations, which resulted in Azurix recording a
one-time, pre-tax expense totaling $34.2 million in the fourth quarter of 1999.
The restructuring plan included reducing personnel, reducing leased office space
and eliminating other costs relating to the pursuit of concessions in certain
regions.

    The restructuring plan was completed in the fourth quarter of 2000 and
involved the elimination of 213 employee positions working in the concession
acquisition effort. Certain employee contracts allowed Azurix to make payments
for up to five years. The restructuring liability of $5.4 million at December
31, 2000 is related to these long-term severance agreements and $2.7 million has
been classified in "Accounts payable and accruals" and $2.7 million has been
classified in "Other long-term liabilities" on the Consolidated Balance Sheet.
There were no adjustments necessary to the restructuring liability during the
year ended December 31, 2000.

NOTE 16 -- STOCKHOLDERS' EQUITY

    During 1998, Azurix issued 1,000 shares of $1.00 par value common stock. On
February 2, 1999, Azurix effected a 100,000-for-one stock split and restated the
par value to $0.01.

    During 1998, Azurix received cash contributions of approximately $1.6
billion. In addition, Azurix received a capital contribution from Enron of the
outstanding stock of a subsidiary that holds a 32.1% ownership interest in
Mendoza. The transfer was recorded at Enron's book value of $71.8 million.

    On June 9, 1999, Azurix's Registration Statement on Form S-1 relating to its
initial public offering was declared effective. The offering of 36.6 million
shares of common stock was priced at $19.00 per share. Azurix sold 17.1 million
shares and Atlantic Water Trust, the former 100% parent of Azurix, sold 19.5
million shares. The proceeds to Azurix, after deducting expenses associated with
the offering, were $300.5 million. The proceeds were used to repay an advance
from Enron, which holds a 50% voting interest in Atlantic Water Trust, and to
partially fund the Buenos Aires concession acquisition (see Note 2).
Approximately 68.7% of Azurix's common stock was held by Atlantic Water Trust
and the remaining 31.3% was held by the public until July 8, 1999, on which date
the underwriters exercised their over-allotment option in connection with the
initial public offering of Azurix's common stock. As a result, Atlantic Water
Trust sold an additional 1,963,468 shares of Azurix's common stock, reducing its
ownership percentage in Azurix to approximately 67.1%.

    In December 2000, Azurix Corp. entered into an Agreement and Plan of Merger
by and among Enron Corp., Enron BW Corp., a wholly owned indirect subsidiary of
Enron, and Azurix. The merger was consummated on March 16, 2001, and Azurix
Corp. was the surviving corporation (see Note 21). As a result of the merger and


                                       69
<PAGE>   72


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

effective on the merger date, Azurix Corp. cancelled the 78,536,532 shares held
by Atlantic Water Trust and issued two shares to Atlantic Water Trust. The
remaining 38,919,149 shares outstanding at the time of the merger that were held
by the public were cancelled and converted into the right to receive $8.375 per
share. Share data for all periods presented herein has been adjusted to give
effect to the cancellation of pre-merger shares and re-issuance of shares.

NOTE 17 -- ASSET IMPAIRMENTS

    In 1999, Azurix, through its subsidiary Azurix Buenos Aires S.A., was
awarded and assumed operations of a water and wastewater concession in the
Province of Buenos Aires, Argentina. In addition to the $438.6 million paid to
the provincial government to acquire the concession contract, under the terms of
the concession contract, Azurix is required to complete an investment program
which it began in 1999. Azurix currently owns 90% of Azurix Buenos Aires.

    Azurix believes that the provincial government has violated the terms of the
concession contract through such acts as limiting the amount Azurix can charge
customers to levels below those specified in the concession contract and failing
to complete and deliver infrastructure and other assets, including algae
treatment works at Bahia Blanca. Azurix notified the provincial government of
these and other violations in 2000. These violations have negatively impacted
concession cash flows, ability to raise capital to fund the investment program
of the concession and ability to provide services to the concession customers.

    Failure by the provincial government to comply with the terms of the
concession contract, lack of progress in reaching resolution on these issues,
despite oral assurances from provincial officials to reach resolution by
year-end 2000, and prominent government officials publicly stating that Azurix
should be removed as operator of the concession during the last week of 2000,
resulted in Azurix evaluating its investment in the concession and related
property, plant and equipment for impairment. Based on this review, in the
fourth quarter of 2000, Azurix adjusted the carrying values of the concession
intangible and related property, plant and equipment to their fair value by
recording an impairment of $389.5 million (pre-tax and after-tax) which is
included in "Impairment of long-lived assets" in the Consolidated Statements of
Income (Loss). Fair value was determined based on the present value of expected
future cash flows from the concession, discounted using a risk-adjusted rate.

    During 2000, there were water supply and quality problems experienced by
areas within the concession, which Azurix attributes to failure of the Province
to meet the terms of the concession agreement. In addition, there was negative
publicity generated from growing political opposition as discussed above. Azurix
recorded an additional charge of $11.0 million (pre-tax and after-tax) in the
fourth quarter of 2000 to reflect the impact of these items on accounts
receivable collections. This amount is included in "Operations and maintenance"
expense in the Consolidated Statements of Income (Loss).

    As a result of the review of future cash flows discussed above, Azurix
believes that sufficient uncertainty exists regarding the realizability of
Argentine tax loss carryforwards such that a valuation allowance was appropriate
at December 31, 2000 (see Note 9). This resulted in an additional tax expense
of $18.5 million in the fourth quarter of 2000.

    Azurix has a 32.1% equity method investment in Obras Sanitarias Mendoza
S.A., which owns a water and wastewater concession in the Province of Mendoza,
Argentina. As a result of events related to its investment in the concession in
the Province of Buenos Aires, Argentina discussed above, Azurix evaluated the
fair value of its investment in the Mendoza concession. Fair value was
determined based on the present value of expected future cash flows from the
concession, discounted using a risk-adjusted rate. The resulting fair value was
less than Azurix's carrying value and this loss in value was determined to be
other than a temporary decline. Accordingly, Azurix recorded an impairment of
$55.0 million (pre-tax and after-tax) in the fourth quarter of 2000. This amount
is included in "Impairment of investment in unconsolidated affiliate" in the
Consolidated Statements of Income (Loss).

    During 2000, Azurix decided to sell its investment in its e-business
marketplace WaterDesk.com(TM). An initial attempt to sell WaterDesk as a public
marketplace solution for the water and wastewater industry was terminated in the
fourth quarter of 2000. Azurix is currently attempting to sell WaterDesk as a
private marketplace or an internal procurement tool for one or several companies
to conduct inter-company commerce. Azurix believes the fair market value of
WaterDesk used in this latter capacity has a lower value than if it were
utilized as a public


                                       70
<PAGE>   73


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


marketplace solution for the entire water and wastewater industry. As a result,
Azurix recorded in the fourth quarter of 2000, a $12.3 million pre-tax
impairment of its long-lived assets that comprise WaterDesk. This amount is
included in "Impairment of long-lived assets" in the Consolidated Statements of
Income (Loss).

NOTE 18 -- RESTRICTED NET ASSETS OF SUBSIDIARIES

    Certain subsidiaries of Azurix Corp. have governmental and regulatory
restrictions or approvals required in order to pay dividends or to make
intercompany loans and advances to it. The amount of restricted net assets of
Azurix Corp. subsidiaries at December 31, 1999 and 2000 is approximately $1.6
billion.

NOTE 19 -- COMMITMENTS AND CONTINGENCIES

COMMITMENTS

    Azurix leases office space from Enron (see Note 11). Azurix has no
contractual obligation under these office lease agreements but pays to Enron the
amount determined in the lease or the contract rate applied to square footage
occupied. Azurix incurred rent expense to Enron for office space totaling $0.3
million, $1.7 million and $1.8 million in 1998, 1999 and 2000, respectively.

    Azurix leases property under various operating leases. Rental expense
related to these leases for the years ended December 31, 1998, 1999 and 2000
were $0.2 million, $2.1 million and $7.4 million, respectively. Future minimum
operating lease payments as of December 31, 2000, in the aggregate and for each
of the five succeeding fiscal years, are as follows:

<TABLE>
<CAPTION>
                                                    (IN MILLIONS)
<S>                                                 <C>
   2001............................................   $    4.7
   2002............................................        4.0
   2003............................................        3.1
   2004............................................        1.7
   2005............................................        0.3
   2006 and beyond.................................        0.2
                                                     ---------
      Total minimum lease payments.................  $    14.0
                                                      ========
</TABLE>

    Azurix, through Wessex and Azurix Buenos Aires, as owner of government
regulated water and wastewater concessions, is required to undertake a
significant capital investment program to meet statutory water quality and
environmental standards. It is currently estimated that the capital expenditure
programs at Wessex and Azurix Buenos Aires, along with the capital expenditure
commitments of other Azurix subsidiaries, will require expenditures over the
next five years of approximately $1.4 billion.

    The former parent of Lurgi Bamag had guaranteed reimbursement obligations
for approximately $27 million of letters of credit issued on behalf of Lurgi
Bamag. Azurix has agreed to indemnify the former parent of any payments under
that guarantee.

    Azurix has contingent payment obligations to former owners of acquired
entities under certain negotiated formulas. Currently, Azurix cannot assess the
likelihood that payments under these obligations will occur.

LITIGATION

    Azurix is involved in various claims and lawsuits, the significant items of
which are discussed below. Although no assurances can be given, Azurix believes,
after considering appropriate reserves that have been established and except
where noted below, that the ultimate resolution of such items will not have a
material adverse effect on its financial position or results of operations.

    As previous reported in Azurix's Annual Report on Form 10-K for the year
ended December 31, 1999 and other filings, on November 1, 1999, Synagro filed a
lawsuit against Azurix styled Synagro Technologies, Inc. v. Azurix Corp., in the
270th Judicial District Court of Harris County, Texas. The lawsuit relates to
various agreements between the parties regarding potential business transactions
and the possible acquisition by Azurix of two subsidiaries of Waste Management,
Inc., commonly called BioGro. On May 9, 2000, Synagro filed its First


                                       71
<PAGE>   74


                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


Amended Petition in the District Court seeking (i) damages in excess of $57
million resulting from the alleged breach by Azurix to purchase up to $23
million of Synagro convertible preferred stock and (ii) unspecified damages
resulting from Azurix's alleged breach of confidentiality and standstill
agreements. On August 4, 2000, Azurix filed its First Amended Answer and
Counterclaim (i) denying all of the material allegations contained in Synagro's
First Amended Petition and (ii) seeking damages in excess of $175 million for
misrepresentations by Synagro that induced Azurix to agree to restrictions on
its ability to purchase BioGro and to enter into negotiations with Synagro and
Synagro's interference with Azurix's acquisition of BioGro. The parties have
agreed to a trial date in September 2001. Azurix intends to continue to
vigorously defend itself against Synagro's claims and to continue to pursue its
claims for damages resulting from Synagro's conduct regarding BioGro. Although
no assurances can be given, Azurix believes that the ultimate resolution of this
litigation will not have a material adverse effect on its financial position or
results of operations.

    On October 6, 2000, a lawsuit was filed in the United States District Court
for the Southern District of Texas, Houston Division, by Irving Rosenzweig, on
behalf of himself and others similarly situated, against Azurix Corp., Enron
Corp. and certain of their officers and directors. The suit is a purported class
action filed on behalf of those persons who purchased the common stock of Azurix
during the period from June 9, 1999, the date of Azurix's initial public
offering, through and including August 8, 2000. The suit generally alleges that
the defendants violated Sections 11, 12(a) and 15 of the Securities Act of 1933,
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5.
The plaintiff contends that the defendants issued and disseminated materially
false and misleading information to the plaintiff and the investing public in
connection with Azurix's initial public offering and during the class period.
The plaintiff seeks rescissory and/or compensatory damages, interest and costs,
including attorneys and experts fees. The plaintiff also seeks extraordinary
and/or injunctive relief, including attaching, impounding, imposing a
constructive trust upon or otherwise restricting the proceeds of defendants'
trading activities or their other assets so as to assure that plaintiffs have an
effective remedy. Several similar actions have been filed in the United States
District Court for the Southern District of Texas and have been consolidated.
These lawsuits are subject to the Private Securities Litigations Reform Act of
1995 and in each case the plaintiff seeks to have the action certified as a
class action with plaintiff as the class representative. Azurix intends to deny
the allegations in each complaint and defend these cases vigorously. At this
early stage of the litigation, it is not possible to estimate potential damages,
if any. If liability were established, an unfavorable judgment or settlement
could have a material adverse effect on Azurix's financial position and results
of operations.

    On October 27, 2000, a lawsuit was filed in the Court of Chancery in the
State of Delaware, New Castle County, by Thomas Turberg against Azurix Corp.,
Enron Corp., and certain of their officers and directors. The suit is a
purported class action filed on behalf of Azurix's public shareholders for the
purpose of enjoining a transaction proposed by Enron for taking Azurix private
at a price of $7.00 for each of Azurix's publicly held shares. The letter from
Enron making this proposal and the related press release issued by Azurix were
filed with the Securities and Exchange Commission on October 27, 2000, as
exhibits to Azurix's Current Report on Form 8-K. The suit generally alleged that
the buy-out price of $7.00 per share was unconscionable and unfair and grossly
inadequate and that the defendants have breached their duties of loyalty and
care with respect to Azurix's public shareholders. The plaintiff sought a
judgment (i) enjoining the acquisition under the terms proposed in the letter;
(ii) to the extent the transaction is consummated prior to a final judgment,
rescinding the transaction or awarding rescissory damages to the class; (iii)
directing that the defendants account to the plaintiff and the class for all
damages caused to them and account for all profits and any special benefits
obtained by the defendants as a result of their alleged unlawful conduct; (iv)
awarding to the plaintiff the costs and disbursements of the lawsuit, including
a reasonable allowance for attorney fees and expenses; and (v) granting such
other and further relief as the court deems appropriate. Six similar actions
were subsequently filed in the Court of Chancery in the State of Delaware, New
Castle County and all Delaware actions have been consolidated into a single
action. In addition, a similar action was filed in the 55th Judicial District
Court of Harris County, Texas. Certain of the actions filed in the Delaware
court have added Atlantic Water Trust as a defendant. On December 13, 2000, the
parties to the litigation executed a Memorandum of Understanding that settled
both the Delaware and Texas actions in principle. Under the proposed settlement,
the defendants acknowledged that the prosecution of the litigation was a
material factor in causing Enron to increase the merger consideration from $7.00
to $8.375 per share. The proposed settlement provides that the defendants will
not oppose plaintiffs' application for attorneys' fees and expenses up to $2.25
million, which Enron has agreed to pay. The proposed settlement is subject to
the execution of definitive settlement documents, confirmatory discovery, and
court approval.


                                       72
<PAGE>   75



                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

    Issues regarding water quality or quantity have arisen in various areas
served by Azurix Buenos Aires. Azurix believes these episodes for the most part
are due to failures by the Province to deliver infrastructure that it committed
to deliver under the concession contract. In a few instances, customers of
Azurix Buenos Aires have filed claims for damages due to allegedly inadequate
water quality. Although to date these claims have not been for material amounts,
other claims regarding quality or quantity may be filed in the future, the
amount of which Azurix cannot predict. Azurix would defend any such claims
vigorously, if made, and would seek to have the Province of Buenos Aires brought
in as a defendant and reimbursement from the Province for any liability, if
assessed. Because no material claims have been asserted to date, Azurix is not
in a position to assess the likelihood of assertion or of Azurix Buenos Aires
prevailing on those claims.

REGULATION

    Azurix is subject to extensive federal, foreign, state and local
environmental laws and regulations. Azurix anticipates future changes in, or
decisions affecting, regulatory regimes that will serve to expand or tighten
regulatory controls. Some of these changes or decisions could have a material
adverse effect on its financial position and results of operations.

    Most of Azurix's revenues are subject to governmental regulation of the
rates that it charges to its customers. On November 25, 1999, the U.K. water
regulator, the Director General of Water Services, announced price limits for
U.K. water companies for the period April 1, 2000 through March 31, 2005. Wessex
was notified of a determination of a 12.0% price cut effective April 1, 2000,
before adjustment for inflation. The announcement included level prices through
March 2003 with annual price increases effective April 1, 2003 of 3.8% and April
1, 2004 of 4.7%, before adjustment for inflation. Wessex's regulated operating
revenues represented approximately 53% of Azurix's total operating revenues for
the year ended December 31, 2000. The outcome of the periodic review is expected
to reduce Wessex's regulated operating revenues from 1999-2000 to 2000-2001 by
12.0%, before adjustment for inflation (or by approximately 10% after
adjustments for inflation and other factors), and thus materially reduce
Azurix's cash flow and earnings. However, Azurix does not expect this will have
a material adverse effect on its financial position.

    Wessex currently has a virtual monopoly over water supply and wastewater
services within its service region, with the exception of the areas around and
including the cities of Bristol and Bournemouth and a small area of rural
Wiltshire, where three other companies provide only water and Wessex provides
wastewater services. This may change in the future, however, as the U.K.
Government and the Director are seeking to increase competition in the water
sector.

    At the end of 2000, the U.K. government published new proposals. The key
features include, among other things, that the Director would have the primary
duty to protect consumer interests, which can include promoting competition,
that competition would be reviewed in light of industry proposals on
restructuring, increased level of fines, that companies would be required to
provide consumers with comparative performance data and licenses for abstracting
water would be reformed, including placing time limits on licenses, allowing
civil actions for damages caused by abstraction and ending compensation for
removal of a license after 2012. The final contents of this legislation and the
timing of its enactment are uncertain, but it is unlikely to take effect prior
to 2002.

    In connection with Wessex's most recent periodic review of price limits, the
Director has estimated that the cost of the capital expenditures that Wessex
will be required to make during the period 2000 to 2004, will be approximately
L.764 ($1,143) million. The determination assumed an after-tax cost of capital
for Wessex of 4.75%.

    Azurix believes that the provincial government of Buenos Aires has failed to
permit Azurix Buenos Aires to charge rates in accordance with the tariff set by
the concession contract and to deliver infrastructure and other assets as
required by the concession contract, thereby affecting its ability to raise
capital and to serve its customers. Negotiations with the province thus far have
failed to result in resolution of disputed items, despite oral assurances from
provincial officials to Azurix Buenos Aires management that various matters
would be resolved by the end of 2000, including allowing Azurix to charge rates
at levels consistent with the concession contract. In addition, during the last
week of December 2000, some prominent officials in the Province publicly
advocated canceling the concession. Azurix does not believe the Province has
grounds for cancellation without compensation and is vigorously challenging the
Province's actions and will continue to do so; however, the lack


                                       73
<PAGE>   76
                                  AZURIX CORP.
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

of resolution on rates by December 31, 2000, and a shift in the political
environment during the last week of 2000 caused Azurix to revise its expectation
of future cash flows from this concession, including collection rates from
customers, and to evaluate the recoverability of related tax assets.
Accordingly, Azurix has written down the carrying value of the concession
intangible and related property, plant and equipment to its fair value. In
addition it has recorded an increase in bad debt expense and recorded a
valuation allowance against its Argentine tax loss carryforwards (see Note 17).

    On February 15, 2001, the Province and Azurix Buenos Aires entered into a
Memorandum of Understanding regarding a variety of issues between them. The
Memorandum of Understanding, among other things, set an investment program for
2001 at a lower level than previously required and established a framework for
negotiating issues associated with tariff levels and the remaining capital
program. There is no assurance, however, that these negotiations will result in
a resolution satisfactory to Azurix or the Province.

NOTE 20 -- GEOGRAPHIC INFORMATION

    Financial information by geographic area is as follows:

<TABLE>
<CAPTION>
                                                    OPERATING REVENUES
                                   -------------------------------------------------------
                                    JANUARY 29, 1998                   YEAR ENDED
                                   (DATE OF INCEPTION)                DECEMBER 31,
                                         TO               --------------------------------
                                    DECEMBER 31, 1998         1999                2000
                                   -------------------    -------------          ---------
                                                         (IN MILLIONS)
<S>                                <C>                   <C>                    <C>
   United States ........               $   --               $ 57.9              $107.7
   United Kingdom .......                112.5                453.9               407.2
   Canada ...............                   --                 30.6                53.9
   Argentina ............                   --                 39.5                90.3
   Mexico ...............                   --                  8.3                19.9
   Other ................                  7.2                 27.8                78.3
                                        ------               ------              ------
          Total .........               $119.7               $618.0              $757.3
                                        ======               ======              ======
</TABLE>


<TABLE>
<CAPTION>
                                                    LONG-LIVED ASSETS(1)
                                   -------------------------------------------------------
                                    JANUARY 29, 1998                   YEAR ENDED
                                   (DATE OF INCEPTION)                DECEMBER 31,
                                         TO               --------------------------------
                                    DECEMBER 31, 1998         1999                2000
                                   -------------------    -------------          ---------
                                                         (IN MILLIONS)
<S>                                <C>                   <C>                    <C>
   United States ........               $    2.3             $   84.6            $   73.9
   United Kingdom .......                2,249.9              2,363.7             2,302.4
   Canada ...............                     --                 13.4                26.7
   Argentina ............                   73.6                529.4               114.9
   Mexico ...............                     --                 26.2                67.0
   Other ................                    2.9                 13.1                25.5
                                        --------             --------            --------
          Total .........               $2,328.7             $3,030.4            $2,610.4
                                        ========             ========            ========
</TABLE>

------------

(1) Long-lived assets represents property, plant and equipment, net of
    accumulated depreciation, concession intangibles, net of accumulated
    amortization and investments in and advances to unconsolidated affiliates.

NOTE 21 -- SUBSEQUENT EVENTS

    On March 16, 2001, shareholders of Azurix Corp. approved and adopted the
Agreement and Plan of Merger by and among Enron Corp., Enron BW Corp., a wholly
owned indirect subsidiary of Enron, and Azurix dated as of December 15, 2000.
The merger was consummated on March 16, 2001, at which time Enron BW Corp. was
merged into Azurix with Azurix being the surviving corporation.

    Under the Agreement and Plan of Merger, each issued and outstanding share of
Azurix Corp. common stock, other than those shares held by Atlantic Water Trust,
Enron Corp., Enron BW Corp., Azurix and any of their wholly owned subsidiaries,
was cancelled and converted into the right to receive $8.375 per share. On the
date of the merger, Enron BW Corp. had $325.9 million of cash that was used to
pay


                                       74
<PAGE>   77

                                  AZURIX CORP.
           NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



consideration to the public shareholders whose shares were cancelled. As a
result of the merger and effective on the merger date, Azurix Corp. had three
shares of common stock outstanding and Azurix Corp. common stock ceased to be
publicly held.

    Pursuant to the terms of the Agreement and Plan of Merger, on March 16,
2001, all Azurix stock options and unvested restricted stock outstanding were
cancelled. Holders of the options received a cash payment, less applicable
withholding taxes, for both vested and unvested options, based on the excess of
$8.375 over the exercise price per share. Holders of unvested restricted stock
received a cash payment of $8.375 per share, less applicable withholding taxes.
These payments resulted in Azurix recognizing a pre-tax charge of approximately
$4.3 million in the first quarter of 2001.

    In addition, under the Agreement and Plan of Merger, Azurix Corp. retired
$180 million of borrowings outstanding on March 16, 2001 under the Enron credit
agreement through the issuance to Enron of 11% cumulative mandatorily redeemable
preferred stock with an initial liquidation preference of $180 million. The
preferred stock may not be redeemed by Azurix Corp. prior to the date that all
of its senior notes due 2007 and 2010 have been redeemed. The preferred stock
must be redeemed on or before the second anniversary of the date that the senior
notes are no longer outstanding. Dividends will accrue, but will not be paid
until all of its senior notes have been redeemed.

    The definitive proxy statement that Azurix mailed to its shareholders in
connection with the merger stated that Enron does not view Azurix as a core
strategic asset. While no definitive plans have been made, Azurix intends to
pursue the potential disposal of certain of its assets provided favorable prices
for those assets can be obtained. Such asset disposals, should they occur, may
result in Azurix incurring losses in future periods.



                                       75
<PAGE>   78

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the stockholder of Wessex Water Ltd (formerly Wessex Water Plc):

     We have audited the accompanying consolidated statements of income, changes
in stockholders' equity and cash flows of Wessex Water Plc (now renamed Wessex
Water Ltd) (predecessor company) (the "Company") and subsidiaries for the period
from April 1, 1998 to October 2, 1998. 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 audit.

     We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 audit provides a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations, cash flows and changes in
stockholders' equity of Wessex Water Plc (now renamed Wessex Water Ltd)
(predecessor company) and subsidiaries for the period from April 1, 1998 to
October 2, 1998 in conformity with generally accepted accounting principles.

ARTHUR ANDERSEN

London, England
March 12, 1999

                                        76
<PAGE>   79

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

                        CONSOLIDATED STATEMENT OF INCOME
                    FOR THE SIX MONTHS ENDED OCTOBER 2, 1998
                      (TRANSLATED INTO USD -- SEE NOTE 1)

<TABLE>
<CAPTION>
                                                                SIX MONTHS
                                                                   ENDED
                                                                OCTOBER 2,
                                                                   1998
                                                              ---------------
                                                              IN MILLIONS USD
                                                                (EXCEPT FOR
                                                              PER SHARE DATA)
<S>                                                           <C>
Operating revenues..........................................      $233.8
Operating expenses:
  Operations and maintenance................................        61.7
  General and administrative................................        36.4
  Depreciation and amortization.............................        35.2
                                                                  ------
Operating income............................................       100.5
                                                                  ------
Other income (expense):
  Interest income...........................................         0.2
  Interest expense..........................................        (6.3)
  Equity earnings...........................................         5.8
                                                                  ------
Income before taxes.........................................       100.2
                                                                  ------
Taxation on ordinary activities.............................        28.4
Utility tax.................................................          --
                                                                  ------
Net income..................................................        71.8
Dividends on preference shares..............................         7.7
                                                                  ------
Net income attributable to common stockholders..............      $ 64.1
                                                                  ======
Basic earnings per share....................................      $ 0.30
                                                                  ======
Diluted earnings per share..................................      $ 0.30
                                                                  ======
</TABLE>

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

                                        77
<PAGE>   80

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                    FOR THE SIX MONTHS ENDED OCTOBER 2, 1998
                      (TRANSLATED INTO USD -- SEE NOTE 1)

<TABLE>
<CAPTION>
                                                                SIX MONTHS
                                                                   ENDED
                                                                OCTOBER 2,
                                                                   1998
                                                              ---------------
                                                              IN MILLIONS USD
<S>                                                           <C>
Operating Activities:
Net income..................................................      $  71.8
Adjustments required to reflect cash flows from operating
  activities:
Income and expense items not involving cash flows:
  Share in profits of equity method investee, net of related
     taxes..................................................         (3.1)
  Depreciation and amortization.............................         35.2
  Deferred taxes............................................         23.2
  Loss on disposal of fixed assets..........................          0.8
  Other.....................................................          0.1
                                                                  -------
                                                                    128.0
                                                                  -------
Changes in operating asset and liability items:
  (Increase) decrease in trade accounts receivable..........          6.9
  (Increase) in prepayments.................................         (0.3)
  (Increase) decrease in other current assets...............         (8.3)
  Increase (decrease) in advances from customers............          2.5
  Increase in accounts payable and accruals.................          3.4
                                                                  -------
                                                                      4.2
                                                                  -------
Net cash provided by operating activities...................        132.2
                                                                  -------
Investing Activities:
  Purchase of fixed assets..................................       (108.9)
  Decrease in short-term investments........................           --
  Other.....................................................          0.5
                                                                  -------
Net cash used in investing activities.......................       (108.4)
                                                                  -------
Financing Activities:
  Repurchase of ordinary shares.............................           --
  Repurchase of preference shares...........................       (143.4)
  Short-term loans received.................................        177.5
  Repayment of lease obligations............................         (8.7)
  Dividends paid............................................        (51.4)
  Other.....................................................          2.4
                                                                  -------
Net cash (used in) provided by financing activities.........        (23.6)
                                                                  -------
Effect of exchange rate changes on cash balances............         (0.3)
                                                                  -------
Decrease in cash and cash equivalents.......................         (0.1)
Balance of cash and cash equivalents at beginning of
  period....................................................          1.8
                                                                  -------
Balance of cash and cash equivalents at end of period.......      $   1.7
                                                                  =======
Supplemental Cash Flow Items:
  Interest paid (net of amounts capitalized)................      $   8.6
  Income taxes paid.........................................          5.3
  Utility tax paid..........................................           --
Non-Cash Investing and Financing Activities:
  Scrip dividends...........................................         37.4
</TABLE>

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

                                        78
<PAGE>   81

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

           CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
                    FOR THE SIX MONTHS ENDED OCTOBER 2, 1998
                      (TRANSLATED INTO USD -- SEE NOTE 1)
                               (IN MILLIONS USD)

<TABLE>
<CAPTION>
                                                               ACCUMULATED
                                                 ADDITIONAL       OTHER
                                        COMMON    PAID-IN     COMPREHENSIVE   RETAINED              COMPREHENSIVE
                                        STOCK     CAPITAL        INCOME       EARNINGS    TOTAL        INCOME
                                        ------   ----------   -------------   --------   --------   -------------
<S>                                     <C>      <C>          <C>             <C>        <C>        <C>
Balance at March 31, 1998.............  $188.3     $ 80.6        $182.0        $778.6    $1,229.5
  Net income..........................                                           71.8        71.8       $71.8
  Other comprehensive income:
     Translation differences..........                             18.8                      18.8        18.8
     Unrealized gain on listed
       investment.....................                             (0.2)                     (0.2)       (0.2)
                                                                                                        -----
          Total comprehensive
            income....................                                                                  $90.4
                                                                                                        =====
  Shares issued.......................    5.1        33.8                                    38.9
  Dividends...........................                                          (57.1)      (57.1)
                                        ------     ------        ------        ------    --------
Balance at October 2, 1998............  $193.4     $114.4        $200.6        $793.3    $1,301.7
                                        ======     ======        ======        ======    ========
</TABLE>

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

                                        79
<PAGE>   82

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

     The accompanying consolidated financial statements include the operations
of Wessex Water Plc (now renamed Wessex Water Ltd) and its subsidiaries
("Wessex"). On October 2, 1998, Wessex was purchased by Azurix Europe Ltd, a
wholly owned subsidiary of Azurix Corp. ("Azurix"). The financial statements of
Wessex have been prepared for the purpose of presenting the financial statements
of the predecessor company of Azurix.

     These financial statements have been prepared in accordance with generally
accepted accounting principles in the United States ("US GAAP"). The functional
currency of Wessex is pounds sterling ("GBP"). These accounts have been
presented using US dollars ("USD") as the reporting currency by translating the
functional currency financial statements using the current rate methodology
described in the Statement of Financial Accounting Standard ("SFAS") 52,
"Foreign Currency Translation."

     The period from April 1 to October 2, 1998 will hereafter be referred to as
the "six months ended October 2, 1998."

NATURE OF OPERATIONS

     Wessex Water Plc was incorporated on April 1, 1989. On September 1, 1989,
Wessex Water Plc acquired the entire issued share capital of Wessex Water
Services Ltd, a company formed to continue the business of Wessex Water
Authority, as a result of the privatization by the UK government of the water
industry in England and Wales. The acquisition was effected through the issue of
49,998 Wessex shares to the Secretary of State for the Environment which were
credited as fully paid. The assets and liabilities acquired by Wessex were
recorded at book value as Wessex was owned by the UK government at the date of
the transfer making the transaction an exchange between entities under common
control. Wessex's principal activity is the provision of water supply and
wastewater services in southwestern England through its wholly owned subsidiary,
Wessex Water Services Ltd. Wessex's other business activities include SC
Technology AG ("SC Technology"), which does business as Swiss Combi and sells
and operates sludge drying plants.

     Wessex Water Services Ltd is licensed to operate as a water and sewerage
company in its region, subject to regulation of its water supply and wastewater
treatment services by government agencies including the Office of Water Services
and the Drinking Water Inspectorate. Wessex is subject to regulation of the
rates it may charge for its regulated water supply and wastewater treatment
businesses.

BASIS OF CONSOLIDATION

     The consolidated financial statements include the financial statements of
Wessex Water Plc and all its majority owned and controlled subsidiaries. All
inter-company transactions are eliminated as part of the consolidation process.

     Investments in companies in which Wessex owns 20 percent to 50 percent of
the voting stock and has significant influence are accounted for using the
equity method with Wessex's share of profits and losses included in the
consolidated income statement. Wessex's share of post-acquisition retained
profits/losses is added to/deducted from the cost of the investee in the
consolidated balance sheet.

USE OF ESTIMATES

     Preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets

                                        80
<PAGE>   83
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. Actual results could differ from those estimates.

FOREIGN CURRENCIES

     On consolidation, assets and liabilities of subsidiaries denominated in
foreign currencies, where the local currency is the functional currency, have
been translated at year-end rates. Income and expense items are translated using
the annual weighted average rates of exchange or, where known or determinable,
at the rate on the date of the transaction for significant items. Adjustments
arising from the translation have been recorded in other comprehensive income
and are included in income only upon sale or liquidation of the underlying
investments.

     Transactions in currencies other than the functional currency are recorded
at the rate of exchange at the date of the transaction. Assets and liabilities
in currencies other than the functional currency are translated at year-end
rates. Any resulting exchange differences are taken to the consolidated income
statement.

     The exchange rates used to translate the GBP functional currency financial
statements to USD were:

<TABLE>
<CAPTION>
                                                                         USD PER GBP
                                                                         -----------
<S>                                                           <C>        <C>
Period from April 1 to October 2, 1998......................  Average      1.6536
</TABLE>

CASH AND CASH EQUIVALENTS

     Cash and cash equivalents represent cash and short-term highly liquid
investments with original maturities of three months or less.

PROPERTY, PLANT AND EQUIPMENT

     Property, plant and equipment assets are stated at historical cost, less
accumulated depreciation. Depreciation is charged on a straight-line basis over
the estimated useful lives of the respective assets, based on the following
useful lives:

<TABLE>
<CAPTION>
                                                               YEARS
                                                              -------
<S>                                                           <C>
Buildings and operational structures.......................   15 - 80
Infrastructure assets......................................     85
Plant, machinery and vehicles..............................   3 - 30
Other assets...............................................   4 - 15
</TABLE>

     Major improvements to leasehold properties are amortized over the shorter
of the asset life and the life of the respective lease.

     Interest is capitalized on qualifying assets during the time required to
prepare the assets for their intended use using Wessex's weighted average
borrowing rate. The capitalized interest is amortized over the life of the
assets.

GOODWILL

     Goodwill is the excess of the purchase price over the fair value of the
identifiable assets acquired less the liabilities assumed of the acquired
company. Goodwill is capitalized and amortized over its estimated useful life
which ranges from twenty years (SC Technology) to forty years (Wessex Waste
Management Ltd).

                                        81
<PAGE>   84
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

LEASES

     Assets held under finance lease agreements are treated as tangible assets
and the present value of the related lease payments is recorded as a liability.
Costs for operating leases are charged to the income statement in the period
incurred.

LONG-LIVED ASSETS

     Wessex evaluates the carrying value of long-lived assets to be held and
used, including goodwill and other intangible assets, when events and
circumstances warrant such a review. The carrying value of a long-lived asset is
considered impaired when the estimated undiscounted cash flow from such an asset
is less than its carrying value. In that event, a loss is recognized based on
the amount by which the carrying value exceeds the estimated fair market value
of the long-lived asset. Fair market value is determined primarily using the
estimated cash flows discounted at a rate commensurate with the risk involved.

TAXATION

     Provision is made for all taxes payable in respect of profit earned in the
year. Deferred income tax is provided using the liability method for all
temporary differences arising between the tax basis of assets and liabilities
and their carrying value for financial reporting purposes, using the enacted tax
rate. Deferred tax assets are reduced by a valuation allowance to the extent
that it is more likely than not that all or part of the asset will not be
realized. No deferred tax liability has been recognized for undistributed
earnings of domestic subsidiaries since such earnings can be transferred to the
parent company without tax consequences.

REVENUE RECOGNITION

     For metered customers, Wessex recognizes revenue based on actual usage and
accrues revenue for the estimated amount of water sold but not billed as of the
balance sheet date. The revenue for non-metered customers, who pay an annual
fixed charge based on the rateable value of their property, is recognized
uniformly over the year.

PENSIONS

     Current service costs for defined benefit plans are accrued in the period
to which they relate. Prior service costs, if any, relating to amendments of the
plans, are recognized over the remaining average service lives of those
employees. The pension schemes are of the defined benefit type, which are
externally funded and valued by an independent actuary.

INVESTMENTS IN EQUITY SECURITIES

     Available-for-sale securities are reported at fair value and individual
securities are classified as a current or non-current asset, as appropriate.
Unrealized holding gains and losses for all available-for-sale securities are
reported net, as a separate component of other comprehensive income, a part of
stockholders' equity, until the gains and losses are realized.

DERIVATIVE FINANCIAL INSTRUMENTS

     Wessex uses cross-currency and interest rate swaps for the purpose of
hedging specific exposures as part of its risk management program and holds all
derivatives for purposes other than trading. Deferral (hedge) accounting is
applied only if the derivative reduces the risk of the underlying hedged item
and is designated at inception as a hedge with respect to the underlying hedged
item. Additionally, the derivative
                                        82
<PAGE>   85

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

must result in cash flows that are expected to be inversely correlated to those
of the underlying hedged item. Under hedge accounting, the changes in market
value of the derivatives and the hedged assets or liabilities are deferred and
recognized in net income in the same period. If Wessex's use of derivatives did
not qualify for hedge accounting treatment, the derivative would be recorded at
fair value with changes in fair value recognized in net income.

EARNINGS PER SHARE

     Basic earnings per share is based on the earnings from continuing
operations available to common stockholders divided by the weighted average
number of shares outstanding during each period. Diluted earnings per share is
calculated in the same manner as basic earnings per share except that the
numerator is increased by the amount of dividends payable to the holders of
convertible securities and the denominator is increased, using the treasury
stock method, to include the number of additional ordinary shares that would
have been outstanding, assuming the exercise of all employee stock options and
the conversion of all convertible securities that would have had a dilutive
effect on basic earnings per share.

ENVIRONMENTAL COSTS

     Environmental expenditures that relate to current operations are expensed.
Expenditures providing a future benefit are capitalized as appropriate.
Remediation costs that relate to an existing condition caused by past operations
are accrued when it is probable that these costs will be incurred and can be
reasonably estimated.

STOCK-BASED COMPENSATION

     Wessex follows Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), and related interpretations in accounting
for its employee stock options. Under APB 25, compensation expense is recorded
when the exercise price of employee stock options is less than the fair value of
the underlying stock on the measurement date.

ACCOUNTING STANDARDS ISSUED

     In June 1998, the FASB issued SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities. SFAS 133 requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet at fair value. SFAS 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. Wessex is currently evaluating, and
has not yet determined, the effect that the adoption of SFAS 133 will have on
its financial statements.

     In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities," which requires that costs for start-up activities and
organization costs be expensed as incurred and not capitalized as had previously
been allowed. SOP 98-5 is applicable to all financial statements for fiscal
years beginning after December 15, 1998 and initial adoption is required to be
reflected as a cumulative effect of an accounting change. The adoption of SOP
98-5 is not expected to have a material effect on Wessex's financial position or
results of operations.

                                        83
<PAGE>   86

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2 -- INTEREST EXPENSE

<TABLE>
<CAPTION>
                                                                 SIX MONTHS
                                                                   ENDED
                                                                 OCTOBER 2,
                                                                    1998
                                                              ----------------
                                                              (IN MILLIONS OF
                                                                US DOLLARS)
<S>                                                           <C>
Gross interest expense......................................       $11.3
Interest capitalized........................................        (5.0)
                                                                   -----
Net interest expense........................................       $ 6.3
                                                                   =====
</TABLE>

NOTE 3 -- INVESTMENT IN EQUITY METHOD INVESTEE

     During the six months ended October 2, 1998, Wessex had a 50.0% share of
Wessex Waste Management Ltd, holding Class B shares of L1 each. During this
period, Wessex's share of earnings of Wessex Waste Management Ltd was 50.0%.
Wessex Waste Management Ltd trades as UK Waste through its wholly owned
subsidiaries. UK Waste collects, recycles and disposes of waste from commercial
and domestic customers.

     Summarized financial information for Wessex Waste Management Ltd is
presented below.

<TABLE>
<CAPTION>
                                                               SIX MONTHS ENDED
                                                               OCTOBER 2, 1998
                                                               ----------------
                                                               (IN MILLIONS OF
                                                                 US DOLLARS)
<S>                                                            <C>
Revenues....................................................        $145.2
Operating profit............................................          10.6
Net income before tax.......................................          11.6
</TABLE>

NOTE 4 -- STOCKHOLDERS' EQUITY

STOCK OPTIONS

     Wessex applies APB 25 in accounting for its stock-based compensation plans
("share option plans"). Accordingly, compensation expense of $0.2 million was
recorded for the six months ended October 2, 1998.

     Details of the share option plans are summarized in the table below:

<TABLE>
<CAPTION>
                                                                              WEIGHTED
                                                                              AVERAGE
                                                                           EXERCISE PRICE
OPTIONS                                                         SHARES        (IN GBP)
-------                                                       ----------   --------------
<S>                                                           <C>          <C>
Outstanding at March 31, 1998...............................   3,129,581        2.68
Granted.....................................................     371,597        3.64
Exercised...................................................    (320,197)       2.62
Forfeited...................................................     (24,688)       2.73
                                                              ----------        ----
Outstanding at October 2, 1998..............................   3,156,293        2.80
                                                              ----------        ----
Exercisable at October 2, 1998..............................     629,674        3.10
</TABLE>

     The exercise price of the savings-related share options granted was 20%
below market price.

     If Wessex had elected to recognize compensation expense based on the fair
value of the stock options at the grant date in accordance with SFAS 123,
"Accounting for Stock Based Compensation," compensation

                                        84
<PAGE>   87

                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

expense of $0.3 million would have been recorded for the six months ended
October 2, 1998. Net income would have been reduced to the pro forma amount
indicated below:

<TABLE>
<CAPTION>
                                                                SIX MONTHS
                                                                   ENDED
                                                                OCTOBER 2,
                                                                   1998
                                                              ---------------
                                                              (IN MILLIONS OF
                                                                US DOLLARS,
                                                                EXCEPT PER
                                                              SHARE AMOUNTS)
<S>                                                           <C>
Net income:
  As reported...............................................       $71.8
  Pro forma.................................................        71.7
Basic earnings per share:
  As reported...............................................       $0.30
  Pro forma.................................................        0.30
</TABLE>

     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used for
grants for the six months ended October 2, 1998:

<TABLE>
<CAPTION>
                                                              SIX MONTHS
                                                                ENDED
                                                              OCTOBER 2,
                                                                 1998
                                                              ----------
<S>                                                           <C>
Dividend yield..............................................        4.1%
Expected volatility.........................................         21%
Risk-free interest rate.....................................        6.3%
Expected lives..............................................  4.9 years
Weighted average option price (GBP).........................       3.64
Weighted average fair market value at date of grant (GBP)...       1.24
</TABLE>

NOTE 5 -- REDEEMABLE PREFERENCE SHARES

     On September 7, 1995, a bonus issue of 308,984,402 fully paid 50p
cumulative redeemable preference shares was made to holders of record as of
August 31, 1995 of B and C ordinary shares on a one-for-one basis; 310,000,000
of these shares were authorized. The preference shares were originally
redeemable at par in four equal tranches on the dividend payment date in each of
the years 1998, 1999, 2000 and 2001. The preference dividend is paid annually in
arrears at a gross dividend rate, fixed in advance, of 12 month LIBOR plus 0.5%.
Preference shares have priority on winding up, but are non-voting unless a
resolution is passed to vary their rights.

     Beginning in September 1998, Wessex redeemed all of its 308,984,402
cumulative redeemable preference shares at the par value of 50p per share. This
was pursuant to resolutions passed by its stockholders on July 29, 1998 and
November 23, 1998 to cancel the preference shares by repaying capital to the
preference stockholders.

                                        85
<PAGE>   88
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 6 -- EARNINGS PER SHARE

     Reconciliation of the numerator and denominator as used in the calculation
of earnings per share:

<TABLE>
<CAPTION>
                                                              SIX MONTHS
                                                                ENDED
                                                              OCTOBER 2,
NUMERATOR (IN MILLIONS OF US DOLLARS)                            1998
-------------------------------------                         ----------
<S>                                                           <C>
Basic
  Net income attributable to ordinary stockholders..........    $ 64.1
  Dividends paid to convertible stockholders................        --
                                                                ------
Diluted
  Net income available to ordinary and convertible
     stockholders...........................................    $ 64.1
                                                                ======
</TABLE>

<TABLE>
<CAPTION>
                                                              SIX MONTHS
                                                                ENDED
                                                              OCTOBER 2,
DENOMINATOR (IN MILLIONS)                                        1998
-------------------------                                     ----------
<S>                                                           <C>
Basic
  Weighted average shares outstanding during year...........     213.0
  Effect of dilutive securities:
     Stock options..........................................       1.5
     Convertible securities.................................        --
                                                                ------
Diluted.....................................................     214.5
                                                                ======
</TABLE>

NOTE 7 -- INCOME TAXES

     Total income tax expense is summarized as follows:

<TABLE>
<CAPTION>
                                                                SIX MONTHS
                                                                   ENDED
                                                                OCTOBER 2,
                                                                   1998
                                                              ---------------
                                                              (IN MILLIONS OF
                                                                US DOLLARS)
<S>                                                           <C>
Current tax.................................................       $ 3.0
Deferred tax................................................        23.2
Share of tax of equity method investee......................         2.2
Utility tax.................................................          --
                                                                   -----
          Total income tax expense..........................       $28.4
                                                                   =====
</TABLE>

                                        86
<PAGE>   89
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The differences between taxes computed at the statutory tax rate and
Wessex's effective income tax rate are as follows:

<TABLE>
<CAPTION>
                                                       SIX MONTHS ENDED
                                                          OCTOBER 2,
                                                             1998
                                                      -------------------
                                                        (IN MILLIONS OF
                                                       US DOLLARS EXCEPT
                                                         PERCENTAGES)
<S>                                                   <C>
Tax at statutory tax rate 31%.......................         $31.1
Change in tax rate..................................         (12.7)
Non-deductible expenses.............................           7.9
Equity investee.....................................           0.5
Other...............................................           1.6
                                                             -----
          Total before utility tax..................          28.4
                                                             -----
Utility tax.........................................            --
                                                             -----
          Total.....................................         $28.4
                                                             =====
Effective rate before utility tax...................            28%
Effective rate after utility tax....................            28%
</TABLE>

     The change in the tax rate from 31% to 30% effective from April 1, 1999 was
enacted on July 31, 1998.

NOTE 8 -- PENSIONS

     The defined benefit schemes which cover the majority of staff are the
Wessex Water Pension Scheme ("WWPS"), the Wessex Water Mirror Image Pension
Scheme ("WWMIS") and the Wessex Water Executive Pension Scheme ("WWEPS"). The
assets are held in separate trustee-administered funds. The pension cost charged
to the income statement has been determined on the advice of independent
qualified actuaries and is accrued over the service lives of the employees
expected to be eligible to receive such benefits.

     The following assumptions were used in determining the pension charge for
the period, and are determined as of the beginning of the period:

<TABLE>
<CAPTION>
                                                            SIX MONTHS
                                                              ENDED
                                                            OCTOBER 2,
                                                               1998
                                                            ----------
<S>                                                         <C>
Discount rate...........................................       6.5%
Yield on government bonds...............................       6.0
Expected return on plan assets..........................       7.5
Rate of compensation increase...........................       5.0
Pension increases after April 5, 1997...................       3.0
</TABLE>

                                        87
<PAGE>   90
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Net periodic benefit cost includes the following components:

<TABLE>
<CAPTION>
                                                            SIX MONTHS
                                                               ENDED
                                                            OCTOBER 2,
                                                               1998
                                                          ---------------
                                                          (IN MILLIONS OF
                                                            US DOLLARS)
<S>                                                       <C>
Service cost............................................       $3.1
Interest cost...........................................        7.4
Expected return on plan assets..........................       (9.4)
Recognition of transition asset.........................       (0.5)
Amortization of prior service cost......................        0.3
Recognized actuarial gain...............................         --
Curtailments............................................         --
                                                               ----
Net periodic benefit cost...............................       $0.9
                                                               ====
</TABLE>

     The net periodic benefit cost is included within operating expenses in the
income statement.

NOTE 9 -- SEGMENT AND GEOGRAPHIC INFORMATION

     Wessex's principal business is the provision of water supply and wastewater
services in southwestern England. For management reporting purposes the
operations are divided into three service categories: regulated water services,
unregulated water services and SC Technology. Regulated water services accounted
for approximately 91% of revenues for the six months ended October 2, 1998.
Wessex's management regularly reviews financial information relating to these
three service categories. The financial information provided to and reviewed by
the chief operating decision maker does not include balance sheet information by
segment. The financial management information is prepared using UK generally
accepted accounting principles which differ in certain significant respects from
US generally accepted accounting principles.

<TABLE>
<CAPTION>
                                                                    SIX MONTHS ENDED
                                                                     OCTOBER 2, 1998
                                                              -----------------------------
                                                              REGULATED
                                                                WATER
                                                               SERVICES    OTHER     TOTAL
                                                              ----------   ------   -------
                                                               (IN MILLIONS OF US DOLLARS)
<S>                                                           <C>          <C>      <C>
External revenue............................................    $213.6     $20.2    $233.8
Intersegment revenue........................................        --       2.1       2.1
                                                                ------     -----    ------
Total revenue...............................................     213.6      22.3     235.9
Segment result..............................................      95.2       5.3     100.5
Depreciation................................................      27.4       0.5      27.9
</TABLE>

                                        88
<PAGE>   91
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Reconciliation of segment results to income before taxes:

<TABLE>
<CAPTION>
                                                                SIX MONTHS
                                                                   ENDED
                                                                OCTOBER 2,
                                                                   1998
                                                              ---------------
                                                              (IN MILLIONS OF
                                                                US DOLLARS)
<S>                                                           <C>
Total segment result for reportable segments................      $100.5
  Intersegment profit.......................................        (0.3)
  Head office charges.......................................        (2.8)
  US GAAP adjustments:
     Infrastructure renewals charge.........................         8.3
     Depreciation on infrastructure assets..................        (6.3)
     Other..................................................         1.1
                                                                  ------
  US GAAP operating profit..................................       100.5
  Share in results of equity method investee................         5.8
  Net interest income (expense).............................        (6.1)
                                                                  ------
  Income before tax.........................................      $100.2
                                                                  ======
</TABLE>

NOTE 10 -- RELATED PARTY TRANSACTIONS

     During the six months ended October 2, 1998, Wessex had a 50.0% interest in
Wessex Waste Management Ltd. This investment is further described in Note 3.
Waste Management (UK) Holdings Ltd, a subsidiary of Waste Management
International, is the other 50.0% owner of Wessex Waste Management Ltd. Related
party transactions with Wessex Waste Management Ltd and Waste Management
International group companies for the six months ended October 2, 1998 follow:

          (a) A director of SC Technology owns certain of the assets at the
     company's operation in Biel, Switzerland, for which a charge was made to SC
     Technology of $0.2 million for the six months ended October 2, 1998.

NOTE 11 -- COMMITMENTS AND CONTINGENCIES

LEASES

     Rent expense amounted to approximately $0.3 million for the six months
ended October 2, 1998.

GUARANTEES

     Wessex Water Plc has acted as guarantor for certain borrowing facilities
made available to Wessex Water Services Ltd. As part of the banking
arrangements, Wessex Water Plc has entered into a cross-undertaking with Wessex
Water Services Ltd in relation to the latter's overdraft and related facilities.

NOTE 12 -- SUBSEQUENT EVENTS

     On Friday July 24, 1998 Enron Corp. ("Enron") of Houston, Texas, United
States, made a cash offer of 630p per share for the shares of Wessex. This offer
was recommended to the stockholders by the Board of Directors of Wessex. The
offer ran to August 28, 1998, but was extended to September 18, 1998 to allow
the Secretary of State for Trade and Industry to consider if there should be an
investigation by the Monopolies and Mergers Commission ("MMC"). On September 10,
1998 it was announced that there would be no

                                        89
<PAGE>   92
                                WESSEX WATER PLC
                         (NOW RENAMED WESSEX WATER LTD)
                             (PREDECESSOR COMPANY)

         NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

reference to the MMC. On September 21, 1998 Enron announced that the offer had
become unconditional, having received by September 18, 1998 acceptances
representing 87.2 percent of all ordinary shares.

     On October 2, 1998 Enron announced that it had received acceptances
representing more than 90 percent of all ordinary shares. On that same date
notices were issued to the remaining Wessex ordinary shareholders, informing
them that Enron intended to exercise its rights under Section 429 of the
Companies Act 1985 to acquire compulsorily all of the outstanding ordinary
shares. The compulsory share acquisition was completed in November 1998. Offer
documents were also sent to the stock option holders in the Savings-Related
Share Option Scheme. The options outstanding under this scheme and the Executive
Share Option Scheme were either exercised and the shares acquired by Enron, or
compensation was paid to settle the liabilities under the schemes. All stock
option schemes are now closed.

     On November 30, 1998, Wessex sold its interest in Wessex Waste Management
Ltd to Waste Management International for $337.9 million.

     In December 1998, all of the remaining 128,339,909 redeemable preference
shares were redeemed and Wessex Water Plc changed its name to Wessex Water Ltd.

                                        90
<PAGE>   93



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS

J. Clifford Baxter                                     Director since March 2001
Vice Chairman, Enron Corp.                                                Age 42

     Mr. Baxter has served as Vice Chairman of Enron since October 2000 and
Chief Strategy Officer since June 2000. He served as Chairman and Chief
Executive Officer, Enron North America Corp., from June 1999 until June 2000,
Senior Vice President, Corporate Development, Enron Corp., from January 1997
until June 1999 and Managing Director, Enron Capital and Trade Resources Corp.
("ECT") in 1996 and as Vice President, Corporate Development, ECT in 1995 and
1996.

James V. Derrick, Jr.                                  Director since March 2001
Executive Vice President and General Counsel, Enron Corp.                 Age 56

     Mr. Derrick has served as Executive Vice President and General Counsel of
Enron since July 1999. He served as Senior Vice President and General Counsel of
Enron from June 1991 to July 1999. He was a Partner of Vinson & Elkins L.L.P.
from January 1977 until June 1991.

J. Mark Metts                                          Director since March 2001
Executive Vice President, Corporate Development, Enron Corp.              Age 42

     Mr. Metts has served as Executive Vice President, Corporate Development of
Enron since August 1999. He was a Partner of Vinson & Elkins L.L.P. from January
1991 until August 1999.

EXECUTIVE OFFICERS

John L. Garrison, Jr.
President and Chief Executive Officer                                     Age 40

     Mr. Garrison was elected President and Chief Executive Officer in August
2000. Mr. Garrison served as President and Chief Operating Officer from March
2000 to August 2000 and as President, Europe/South America from December 1999 to
March 2000. Mr. Garrison has served as an Executive Director of Azurix since
November 1999 and was a Managing Director from April 1999 to November 1999.
Prior to joining Azurix, Mr. Garrison served as Vice President and General
Manager of the North American Agricultural Group of Case Corp. from August 1995
to April 1999. Before joining Case Corp., Mr. Garrison served as a principal
with Enron Development Corp. from July 1992 to July 1995 and was responsible for
gas and power infrastructure development for the United States, Colombia and
Mexico.

Colin F. Skellett                                                         Age 55
Vice Chairman, Operations

     Mr. Skellett has served as Vice Chairman, Operations of Azurix since
November 1999. Mr. Skellett served as Executive Director, Technical and
Operating, Environmental and Safety Services of Azurix from October 1998 to
October 1999. Mr. Skellett has served as Chief Executive of Wessex since January
1995. Mr. Skellett served as Managing Director of Wessex from September 1989 to
January 1995. Mr. Skellett is also Chairman of Wessex Water Services Limited and
is the U.K. representative on the European Union of National Associations of
Water Suppliers and Waste Water Services.

                                       91

<PAGE>   94


Amanda K. Martin                                                          Age 40
Executive Director and President, North America

     Amanda K. Martin has served as Executive Director and President, North
America since December 1999. From September 1998 to December 1999, Ms. Martin
was Executive Director, Americas for Azurix. Commencing in 1991, Ms. Martin
served in various positions with Enron Capital & Trade Resources Corp.,
including President of Energy and Finance Services from January 1998 to
September 1998, Managing Director and Vice President of Business Ventures and
Asset Management from September 1996 to January 1998, Vice President of Business
Ventures and Asset Management from April 1994 to September 1996, and Senior
Counsel from March 1993 to April 1994.

John C. Ale                                                               Age 46
Executive Director and General Counsel

     Mr. Ale has served as Executive Director and General Counsel of Azurix
since December 1998. Prior to joining Azurix, Mr. Ale was with the law firm of
Vinson & Elkins L.L.P. for more than 17 years, and was a partner for more than
12 years. From December 1996 to October 1998, Mr. Ale served as managing partner
of the London office of Vinson & Elkins. From July 1993 to October 1998, he was
chairman of Vinson & Elkins' project finance and development practice. Prior to
joining Vinson & Elkins, Mr. Ale served as law clerk to the Honorable Warren E.
Burger, then Chief Justice of the United States.

J. Michael Anderson                                                       Age 38
Managing Director and Chief Financial Officer

     Mr. Anderson has served as Managing Director and Chief Financial Officer of
Azurix since May 2000. Mr. Anderson served as Senior Vice President, Corporate
Development from February 2000 until May 2000 and was Vice President, Corporate
Development from September 1999 until February 2000. Prior to joining Azurix,
Mr. Anderson spent 10 years with The Chase Manhattan Corporation, most recently
as Vice President in the Global Mergers and Acquisitions Group of Chase
Securities Inc. where he provided merger and acquisition advisory services to
clients in a broad range of industries.

ITEM 11. EXECUTIVE COMPENSATION

     With respect to the executive compensation information provided below, on
March 16, 2001, the date on which Azurix merged with an indirect, wholly owned
subsidiary of Enron, the Azurix stock incentive plan and all stock options
granted under the stock plan were cancelled. All stock options outstanding at
the effective time of the merger entitled the holder to receive a cash payment
equal to the product of (i) the number of shares subject to the option (without
regard to whether such option was vested or unvested) and (ii) the excess, if
any, of $8.375 over the exercise price per share. In addition, in connection
with the merger, all shares of restricted stock were vested and entitled the
holder to receive $8.375 per share.

                                       92

<PAGE>   95


SUMMARY COMPENSATION TABLE

     The following table sets forth compensation information for the fiscal
years ending December 31, 2000, 1999 and 1998, for our Chief Executive Officer,
our four other highest compensated executive officers who served in such
capacities as of December 31, 2000 and our former Chief Executive Officer who
left Azurix prior to the end of fiscal 2000.

<TABLE>
<CAPTION>
                                                                      ANNUAL COMPENSATION
                                                            ------------------------------------------
                                                                                          OTHER ANNUAL          ALL OTHER
NAME AND PRINCIPAL POSITION                         YEAR      SALARY         BONUS        COMPENSATION        COMPENSATION
---------------------------                         ----    ----------       -----        ------------        ------------

<S>                                                 <C>     <C>            <C>              <C>               <C>
John L. Garrison, Jr. ......................        2000    $  422,918     $     --         $    --           $   3,188 (1)
     President and Chief Executive Officer          1999       246,965      200,000(2)           --             103,467(3)(4)(5)

Colin F. Skellett...........................        2000       386,555           --              --                  --
     Vice Chairman, Operations                      1999       410,590           --              --                  --
                                                    1998       105,825       85,000(6)           --                  --

Amanda K. Martin (7)........................        2000       400,000           --              --               3,693(1)
 Executive Director and President, North            1999       400,000           --              --              24,281(4)(5)
 America                                            1998       106,999      181,250              --             350,000(8)

John C. Ale.................................        2000       340,000           --              --              89,300(9)
 Executive Director and General Counsel             1999       340,000           --              --             174,903(4)(10)
                                                    1998        19,318           --              --             312,638(11)

J. Michael Anderson.........................        2000       278,855      200,000              --               3,550(1)
  Managing Director and Chief Financial
  Officer

Rebecca P. Mark (7) (12)....................        2000        497,910       --              --                  3,400(1)
 Former Chairman and Chief Executive Officer        1999        710,000       --            122,446(13)          41,089(4)(5)
                                                    1998        145,306       --            65,653 (13)              --
</TABLE>

----------

(1)  Represents 2000 matching contributions paid by Azurix to Enron in
     connection with the employee's participation in the Enron Corp. Savings
     Plan.

(2)  Represents a sign-on bonus paid upon Mr. Garrison's employment with Azurix.

(3)  Includes $83,936 received in connection with Mr. Garrison's relocation to
     Houston, Texas.

(4)  Includes shares of restricted stock granted on December 17, 1999 in lieu of
     Azurix's continued participation in the Enron Cash Balance Plan as follows:
     Mr. Garrison, 2,690 shares vesting on December 31, 2000; Ms. Martin, 3,070
     shares vesting on December 31, 2000; Mr. Ale, 2,610 shares vesting on
     December 10, 2003; and Ms. Mark, 5,450 shares vesting on December 31, 2000.

(5)  Includes 1999 matching contributions paid by Azurix to Enron in connection
     with the employee's participation in the Enron Corp. Savings Plan as
     follows: Mr. Garrison, $533, Ms. Martin, $2,599 and Ms. Mark, $2,599.

(6)  Mr. Skellett joined Azurix in October 1998 in conjunction with the
     acquisition of Wessex Water Ltd. Mr. Skellett's bonus for 1998 was based on
     qualitative criteria and was awarded in relation to the formation of
     Azurix's technical and operational organization.

(7)  Ms. Mark and Ms. Martin were paid by Enron and/or its affiliates for the
     entire year ended December 31, 1998. The salary and bonus amounts for 1998
     shown in the table are the amounts of their total compensation received
     from Enron that were allocated by Enron to Azurix and paid by Azurix to
     Enron for services rendered to Azurix. The bonus amounts for 1998 allocated
     to Azurix by Enron for Ms.

                                       93

<PAGE>   96


     Martin were based on qualitative criteria and were awarded in relation to
     the Azurix's business development effort for the Americas.

(8)  Represents compensation paid to Ms. Martin for forgoing compensation from
     her previous employer, Enron Capital & Trade Resources Corp.

(9)  Represents a tax equalization payment received in connection with his
     overseas assignment.

(10) Includes $126,470 in compensation received in connection with his overseas
     assignment and $30,000 in connection with his relocation to Houston, Texas.

(11) Includes $312,638 in compensation paid to Mr. Ale for forgoing
     distributions of income from his previous employer.

(12) Ms. Mark resigned as Chairman, Chief Executive Officer and Director of
     Azurix and terminated her employment with Azurix on August 25, 2000. For a
     discussion of Ms. Mark's severance agreement please read "Severance
     Agreements" below.

(13) Includes $101,146 and $62,419 reported as income and paid by Azurix for Ms.
     Mark for personal airplane usage for 1999 and 1998, respectively.

OPTION GRANTS IN LAST FISCAL YEAR

     The following table sets forth information with respect to grants of stock
options to the named executive officers listed in the Summary Compensation
Table. On March 16, 2001, the date on which Azurix merged with an indirect,
wholly owned subsidiary of Enron, the Azurix stock incentive plan and all stock
options granted under the stock plan were cancelled. All stock options
outstanding at the effective time of the merger entitled the holder to receive a
cash payment equal to the product of (i) the number of shares subject to the
option (without regard to whether such option was vested or unvested) and (ii)
the excess, if any, of $8.375 over the exercise price per share.

<TABLE>
<CAPTION>
                                                         OPTION GRANTS IN 2000
                           NUMBER OF     PERCENT OF                                      POTENTIAL REALIZABLE VALUE AT
                           SHARES OF       TOTAL                                                   ASSUMED
                            COMMON        OPTIONS                                             RATES OF STOCK PRICE
                             STOCK       GRANTED TO                                               APPRECIATION
                           UNDERLYING     EMPLOYEES      EXERCISE                               FOR OPTION TERM(2)
                            OPTIONS          IN            PRICE        EXPIRATION      ------------------------------
       NAME                 GRANTED      FISCAL YEAR    ($/SHARE)(1)       DATE          0%          5%         10%
       ----                ----------    -----------    ------------    ----------       --       --------   ----------

<S>                            <C>             <C>          <C>            <C>           <C>      <C>        <C>
John L. Garrison, Jr..         100,000(3)      5.5%         $7.5625        3/23/10        0       $476,000   $1,205,000
                                74,410(4)      4.1%          7.5625        3/23/10        0        354,192      896,640

Colin F. Skellett.....          53,970(4)      3.0%          7.5625        3/23/10        0        256,897      650,338


Amanda K. Martin......          79,370(4)      4.4%          7.5625        3/23/10        0        377,801      956,408


John C. Ale...........          44,975(4)      2.5%          7.5625        3/23/10        0        214,081      541,949
                                26,500(3)      1.5%          7.5625        3/23/10        0        126,140      319,325

J. Michael Anderson...         200,000(3)     11.0%          7.5625        3/23/10        0        952,000    2,410,000
                                39,685(4)      2.2%          7.5625        3/23/10        0        188,900      478,204
Rebecca P. Mark (5)...              --          --               --             --       --             --           --
</TABLE>

----------

(1)  Options are granted at the market price of Azurix Common Stock on the date
     of grant.

                                       94

<PAGE>   97

(2)  The 0%, 5% and 10% assumed annual rates of compounded stock price
     appreciation are mandated by the rules of the Securities and Exchange
     Commission. There can be no assurance that the actual stock price
     appreciation over the 10-year option term will be at the assumed 0%, 5% or
     10% levels or at any other defined level. Unless the market price of the
     Common Stock appreciates over the option term, no value will be realized
     form the option grants. The potential realizable value is calculated by
     assuming that the fair market value of the Common Stock on the date of
     grant of the options appreciates at the indicated rate for the entire term
     of the option and that the option is exercised at the exercise price and
     sold on the last day at the appreciated price.

(3)  Options granted on March 23, 2000 which are subject to (a) 25% vesting upon
     the achievement in any year of financial performance measures established
     by the Board of Directors with respect to that year and (b) 100% vesting on
     March 23, 2006.

(4)  Options granted on March 23, 2000 which are subject to 100% vesting on the
     earlier of: (a) March 23, 2006 and (b) the achievement in any year of
     financial performance measures established by the Board of Directors with
     respect to that year.

(5)  Ms. Mark resigned as Chairman, Chief Executive Officer and Director of
     Azurix and terminated her employment with Azurix on August 25, 2000. For a
     discussion of Ms. Mark's severance agreement please read "Severance
     Agreements" below.

STOCK OPTION EXERCISES AND YEAR-END VALUE TABLE

     The following table discloses the options that were exercised by the named
executive officers during 2000 and sets forth the number and value of their
unexercised options as of December 31, 2000. On March 16, 2001, the date on
which Azurix merged with an indirect, wholly owned subsidiary of Enron, the
Azurix stock incentive plan and all stock options granted under the stock plan
were cancelled. All stock options outstanding at the effective time of the
merger entitled the holder to receive a cash payment equal to the product of (i)
the number of shares subject to the option (without regard to whether such
option was vested or unvested) and (ii) the excess, if any, of $8.375 over the
exercise price per share.

   AGGREGATED OPTION EXERCISES IN 2000 AND OPTION VALUES ON DECEMBER 31, 2000

<TABLE>
<CAPTION>
                                                                NUMBER OF SECURITIES             VALUE OF UNEXERCISED
                                                               UNDERLYING UNEXERCISED               IN-THE-MONEY
                                   SHARES                             OPTIONS AT                     OPTIONS AT
                                  ACQUIRED                        DECEMBER 31, 2000              DECEMBER 31, 2000(1)
                                     ON            VALUE    ---------------------------    -----------------------------
  NAME                            EXERCISE       REALIZED   EXERCISABLE   UNEXERCISABLE      EXERCISABLE   UNEXERCISABLE
  ----                            --------       --------   -----------   -------------    -------------   -------------


<S>                               <C>            <C>        <C>           <C>              <C>          <C>
  John L. Garrison, Jr..              0             0          100,000        659,410        $     0           $340,256
  Colin F. Skellett.....              0             0          200,000        578,970              0            189,981
  Amanda K. Martin......              0             0          250,000        984,370              0            243,356
  John C. Ale...........              0             0           62,500        313,975              0            113,422
  J. Michael Anderson...              0             0           31,461        308,355         29,464            206,053
  Rebecca P. Mark(2)....              0             0          500,000              0              0                  0
</TABLE>


----------

(1)  Based on December 29, 2000 Azurix Stock Price of $8.1875.

(2)  Ms. Mark resigned as Chairman, Chief Executive Officer and Director of
     Azurix and terminated her employment with Azurix on August 25, 2000. Under
     the terms of her severance agreement, Ms. Mark retained 500,000 Azurix
     vested stock options issued at $16.72 per share. For a discussion of Ms.
     Mark's severance agreement, please read "Severance Agreements" below.

PENSION PLANS

     Mr. Skellett participates in the contributory defined benefit pension plan
maintained by Wessex Water Ltd, a wholly owned subsidiary of Azurix. The plan
provides retirement benefits based on service and pension eligible compensation.
The standard accrual rate is one-sixtieth of an employee's annual compensation
for each year of

                                       95

<PAGE>   98


service, subject to a maximum of two-thirds of his annual compensation. Certain
senior executives of Wessex, including Mr. Skellett, are provided with a top-up
pension benefit allowing for an overall accrual rate of one-thirtieth of the
employee's annual compensation for each year of service, subject to the standard
maximum of two-thirds of his annual compensation. At December 31, 2000, Mr.
Skellett's credited years of service with Wessex was 37.6 years, his estimated
credited years of service at age 60 (normal retirement under the plan) was 42.2
years, his current eligible compensation under the plan was approximately
L.255,000 ($386,555) and his estimated annual benefit payable upon retirement
was approximately L.170,000 ($257,700).

EMPLOYMENT AGREEMENTS

     Mr. Skellett entered into an employment agreement with Wessex Water Ltd
that entitles Mr. Skellett to an annual salary of L.255,000 ($386,555). The
employment agreement may be terminated by either Wessex or Mr. Skellett upon
twelve months' notice. The agreement otherwise terminates on Mr. Skellett's 60th
birthday. The agreement provides that Mr. Skellett will participate in an annual
bonus plan. The agreement prohibits Mr. Skellett from competing with Wessex for
one year following termination of employment.

     Mr. Garrison entered into an employment agreement with Azurix, which runs
through April 26, 2003. The agreement entitles Mr. Garrison to receive an annual
salary of $450,000 and to participate in an annual incentive plan with a bonus
target of 100% of his annual base salary. If Mr. Garrison is involuntarily
terminated, which includes an involuntary termination by Azurix without cause,
then he will receive the greater of (i) monthly severance equal to 125% of his
monthly salary until the end of the term of the agreement and (ii) two years
annual base salary plus two times his annual bonus. In addition, Mr. Garrison
would be entitled to receive reimbursement for 75% of the cost of medical
insurance for himself and his family. The agreement also prohibits Mr. Garrison
from competing with Azurix until the later of April 26, 2003 and two years
following termination of his employment.

     Ms. Martin entered into an employment agreement with Enron Capital & Trade
Resources Corp., which subsequently was assigned to Azurix. The agreement runs
through August 31, 2003, and entitles Ms. Martin to an annual salary of
$400,000. In connection with the transfer of her agreement to Azurix, Ms. Martin
received a bonus of $350,000. The agreement provides that Ms. Martin will
participate in an annual incentive plan with a bonus target of between 100% and
200% of her annual base salary. If Ms. Martin is involuntarily terminated, which
includes a termination by Azurix without cause, then she will receive a monthly
severance payment equal to 100% of her monthly salary and unpaid annual bonuses
until the end of the term of the agreement as if she had not been terminated. In
order to receive these payments, Ms. Martin may not compete with Azurix during
the term of the agreement following an involuntary termination. The agreement
also prohibits Ms. Martin from competing with Azurix until six months after the
termination of employment or the expiration of the agreement.

     Mr. Ale entered into an employment agreement with Azurix, which runs
through December 10, 2001. The agreement entitles Mr. Ale to receive an annual
salary of $340,000 and to participate in an annual incentive plan with a bonus
target of 100% of his annual base salary for 2001. If Mr. Ale is involuntarily
terminated, which includes a termination by Azurix without cause, then he will
receive a monthly severance payment equal to 100% of his monthly salary and
annual bonus payments until the end of the term of the agreement as if he had
not been terminated. In addition, on termination of his employment, except in
the case of termination for cause, he will receive a cash bonus of $510,000. The
agreement prohibits Mr. Ale from competing with Azurix until the later of
December 10, 2001 and one year following termination of his employment.

     Mr. Anderson entered into an employment agreement with Azurix, which runs
through March 22, 2003. The agreement entitles Mr. Anderson to receive an annual
salary of $300,000 and to participate in an annual incentive plan with a bonus
target of 100% of his annual base salary. If Mr. Anderson is involuntarily
terminated, which includes a termination by Azurix without cause, then he will
receive one year's annual base salary plus his full 100% target bonus payable in
cash on a monthly basis for 12 months. The agreement prohibits Mr. Anderson from
competing with Azurix until one year after termination of his employment.

SEVERANCE AGREEMENTS

     Ms. Mark resigned as Chairman, Chief Executive Officer and Director of
Azurix on August 25, 2000. In connection with her resignation, Ms. Mark and
Azurix entered into a severance agreement that entitled Ms. Mark to receive a
lump sum payment of $441,601 on or before January 31, 2001. Ms. Mark was also
entitled to retain 500,000 vested Azurix stock options and 5,450 shares of
restricted stock. The agreement also prohibits Ms. Mark from competing with
Azurix through December 31, 2002, except with respect to water resource and
storage operations and services.

                                       96

<PAGE>   99


SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires officers and directors of Azurix and persons who
beneficially own more than 10% of the Common Stock to file reports of ownership
and changes in ownership concerning the Common Stock with the Securities and
Exchange Commission and to furnish Azurix with copies of all Section 16(a) forms
they file. Based upon Azurix's review of the Section 16(a) filings that have
been received by Azurix, Azurix believes that all filings required to be made
under Section 16(a) during 2000 were timely made.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

     The following table sets forth certain information concerning each person
known by Azurix to own beneficially more than 5% of the outstanding voting
shares of Azurix's Common Stock as of March 29, 2001.

<TABLE>
<CAPTION>
                                                                                BENEFICIAL OWNERSHIP
                                                                              ------------------------
                 NAME AND ADDRESS OF BENEFICIAL OWNERS                        SHARES           PERCENT
<S>                                                                           <C>              <C>
                 Atlantic Water Trust(1)(2)..................                     2              66.7
                   c/o Wilmington Trust Company
                   Rodney Square North
                   1100 North Market Street
                   Wilmington, Delaware 19890-0001

                 Marlin Water Trust(2).......................                     2              66.7
                   c/o Wilmington Trust Company
                   Rodney Square North
                   1100 North Market Street
                   Wilmington, Delaware 19890-0001

                 Enron Corp.(2)(3)...........................                     3             100.0
                   1400 Smith Street
                   Houston, Texas 77002

                 Enron BW Holdings Ltd.(3)...................                     1              33.3
                    1400 Smith Street
                    Houston, Texas  77002
</TABLE>


(1)  Atlantic Water Trust is a Delaware business trust. Atlantic Water Trust
     holds 66.7% of Azurix's Common Stock.

(2)  Each of Enron Corp., an Oregon corporation, and Marlin Water Trust, a
     Delaware business trust, has a 50% voting interest in Atlantic Water Trust,
     and each may be deemed to beneficially own all of the Azurix shares owned
     by Atlantic Water Trust because of certain shared voting and dispositive
     powers. Please read "Atlantic Water Trust."

(3)  Enron Corp. owns 100% of all of the outstanding shares of Enron BW Holdings
     Ltd.

ATLANTIC WATER TRUST

     Atlantic Water Trust, a Delaware business trust, currently owns two-thirds
of our outstanding common stock. Each of Enron and Marlin Water Trust owns a 50%
voting interest in Atlantic Water Trust. Each of Marlin Water Trust and Enron
currently has the right and power to appoint up to 50% of the members of the
board of directors of Atlantic Water Trust. Holders of Marlin Water Trust trust
certificates are entitled to exercise Marlin Water Trust's appointment rights.
If the Marlin Water Trust certificateholders defer exercising their appointment
rights, Enron has the right to appoint such members, but Marlin Water Trust has
the right, at any time, without cause, to remove any such members. To date,
Enron has appointed all of the directors of Atlantic Water Trust.

     Marlin Water Trust currently has the right to direct Atlantic Water Trust
to elect or replace half of Azurix's directors. In the event that Azurix were to
issue a class of preferred stock, then, in each case, Marlin Water Trust's






                                       97
<PAGE>   100

right to designate directors would be reduced by the number of directors that
may be elected by the Azurix preferred stock holders entitled to elect directors
as a class. Enron has the right to direct Atlantic Water Trust to elect or
replace the other half of Azurix's directors. In all other circumstances, the
board of directors of Atlantic Water Trust will direct the voting of Atlantic
Water Trust's shares of Common Stock. Under the terms of the Atlantic Water
Trust agreement, Enron can be prevented from appointing more than half of
Azurix's directors at any time.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     On March 16, 2001, our shareholders approved and adopted an agreement and
plan of merger whereby an indirect, wholly owned subsidiary of Enron was merged
into Azurix with Azurix being the surviving corporation. The merger took effect
later the same day, immediately following the close of trading on the New York
Stock Exchange. In the merger:

     o    each issued and outstanding share of our common stock, other than
          those shares held by Atlantic Water Trust, was cancelled and converted
          automatically into the right to receive $8.375 per share (rounding up
          the aggregate cash to be paid to each such shareholder, to the extent
          necessary, to the next $.01);

     o    the aggregate shares of Azurix common stock held by Atlantic Water
          Trust were cancelled and converted into two shares of common stock of
          the surviving corporation in the merger;

     o    the shares of stock of the Enron merger subsidiary were cancelled and
          converted into one share of common stock of the surviving corporation
          in the merger;

     o    all treasury shares were cancelled; and

     o    shares of Azurix common stock held by shareholders who had perfected
          their appraisal rights became subject to appraisal in accordance with
          Delaware law.

     Therefore, Atlantic Water Trust owns two-thirds, and Enron through a wholly
owned subsidiary owns one-third of our issued and outstanding common stock.
Enron and Marlin Water Trust each continue to own a 50% voting interest in
Atlantic Water Trust.

OTHER TRANSACTIONS

     Since its inception Azurix has entered into a variety of agreements and
transactions with Enron and certain of its subsidiaries. The following summaries
of these agreements discuss the material provisions of these agreements and are
qualified completely by reference to the full text of these agreements.

     During 2000, Azurix provided certain services that included arranging,
negotiating and structuring water supply arrangements for a project being
developed by an Enron subsidiary. Revenues earned and received during 2000
related to these services were $1.1 million. Under a separate agreement with the
Enron subsidiary, Azurix has agreed to provide future water supply and water
management services to the project for a period of approximately 25 years.
Future services to be provided under this agreement are contingent upon the
Enron subsidiary receiving certain government approvals to proceed with its
project.

     Enron currently provides office space to Azurix and various services such
as computer hardware and software and support services such as risk management,
accounts payable, payroll and information technology services. Costs are
allocated to Azurix based upon usage, or where no direct method can be
efficiently applied due to administrative burden, upon factors such as
annualized payroll or employee headcount. Employees, other than employees of our
operating subsidiaries, are covered by various employee benefit plans of Enron
such as medical, dental, life insurance and other benefit plans. These costs are
allocated to Azurix based upon Enron's costs of administering and providing the
benefit plans.

AGREEMENT REGARDING BUSINESS OPPORTUNITIES AND RELATED MATTERS

     Enron and Azurix have entered into an agreement that limits the scope of
Azurix's business and provides that Enron and its affiliates may engage in water
related businesses, even if those businesses have a competitive impact on
Azurix. In general, Enron is permitted to engage in any business whatsoever,
including water,





                                       98
<PAGE>   101

wastewater and other businesses competing with Azurix, and may compete in public
tenders against Azurix, provided the business is conducted and opportunities are
identified and developed through Enron's own personnel and not through Azurix.
If an opportunity in the water industry is presented to a person who is an
officer or director of both Enron and Azurix, the opportunity must first be
offered to Azurix, unless water constitutes a minority of the fair market value
of the opportunity, as determined by that officer or director in good faith
based on information available at the time.

     In the agreement, Azurix acknowledges that Enron has fiduciary and
contractual obligations to other persons and entities under existing agreements
and relationships and has agreed that, in the event of a conflict between the
duties of Enron under the agreement and the duties of Enron to third parties
under agreements or relationships that exist on the date of execution of the
agreement, Enron will be entitled to perform its duties to such third parties
without any liability to Azurix.

     The agreement provides that any standard of care, any duty of loyalty and
any other duty imposed by the agreement or under Delaware law or any other
applicable law, rule or regulation shall be modified, waived or limited as
required in order to permit Enron to act under the agreement and to make any
decision pursuant to the authority prescribed in the agreement so long as such
action is reasonably believed by Enron to be in, or not inconsistent with, the
agreement or the interests of Azurix. Azurix has agreed to indemnify Enron and
its officers, directors and employees against any claim that Enron's pursuit of
any water business was a breach of any duty owed by Enron to Azurix, provided
Enron has followed the rules described above.

     Azurix's purpose clause contained in its certificate of incorporation
permits it to engage in the businesses of acquiring, owning, operating, and
managing water resources and activities incidental to those businesses, and such
other businesses as Enron may approve in its sole discretion. Azurix has agreed
not to amend its certificate of incorporation to expand its purpose clause
without Enron's prior written consent.

     The agreement restricts Enron and Azurix from taking action that might
cause either of them to violate any law or that would require either of them to
register as a public utility holding company under the Public Utility Holding
Company Act of 1935.

     The agreement states that whenever a potential conflict of interest exists
or arises between Enron and Azurix, any resolution or course of action in
respect of such conflict of interest shall be permitted and deemed approved, and
will not constitute a breach of any duty stated or implied by law or equity, if
the resolution or course of action is authorized by the agreement or, by
operation of the agreement, is deemed to be fair and reasonable to Azurix. The
agreement states that any conflict of interest and any resolution of such
conflict of interest shall be conclusively deemed fair and reasonable to Azurix
if such conflict of interest or resolution is (i) approved by special approval
(the approval by a majority of the directors of Azurix not associated with
Enron); (ii) on terms no less favorable to Azurix than those generally being
provided to or available from unrelated third parties; and (iii) fair to Azurix,
taking into account the totality of the relationships between the parties
involved, including other transactions that may be particularly favorable or
advantageous to Azurix.

     Enron may adopt a resolution or course of action that has not received
special approval. Enron and any person voting in connection with a special
approval will be authorized in connection with its determination of what is
"fair and reasonable" to Azurix and in connection with its resolution of any
conflict of interest to consider (i) the relative interests of any party to such
conflict, agreement, transaction or situation and the benefits and burdens
relating to such interest; (ii) any customary or accepted industry practices and
any customary or historical dealings with a particular person; (iii) any
applicable generally accepted accounting or engineering practices or principles;
and (iv) such additional factors as such person determines in its sole
discretion to be relevant, reasonable or appropriate under the circumstances.

     In the absence of bad faith by Enron, the resolution, action or terms so
made, taken or provided by Enron with respect to such matter shall not
constitute a breach of the agreement or a breach of any standard of care, any
duty of loyalty or any other duty imposed by the agreement or under Delaware law
or any other law, rule or regulation.

     Disputes under the agreement are to be resolved through arbitration. The
agreement will continue indefinitely, except that it will expire on the first
date on which both of the following occur (i) Enron and its affiliates do not
individually or collectively, directly or indirectly, own or have the power to
vote at least one-third of the shares of





                                       99
<PAGE>   102

Azurix ordinarily entitled to vote for the election of directors; and (ii) fewer
than one-third of the directors of Azurix are persons who are employees,
officers or directors of Enron or of any affiliate of Enron.

     The mutual covenants and agreements in the agreement will be the
consideration given by each party to the other in support of the agreement. In
addition, the agreement states that Enron's investment in Atlantic Water Trust
was predicated on the execution and delivery of an agreement containing
substantially the terms set forth in the agreement.

SERVICES AGREEMENT

     Effective May 1, 1999, Azurix and Enron entered into an agreement pursuant
to which Enron provides various corporate staff and support services to Azurix.
These services include information technology, office space, building
maintenance, security and other office services as well as employee development
and training and other benefits programs. Azurix may also utilize Enron's
regulatory affairs, marketing affairs, treasury and risk assessment and control
departments. In addition, Azurix may continue to participate in portions of
Enron's corporate insurance program. The agreement provides that Azurix may use
the international offices of Enron and its affiliates for projects, subject to
mutual agreement with Enron or its affiliates on a project-by-project basis. The
agreement provides that Azurix will reimburse Enron for direct charges related
to the Enron services and facilities that it utilizes. Azurix will also be
allocated an amount for overhead charges related to Enron's corporate staff and
support services that it utilizes. This overhead charge will be allocated based
upon factors such as employee headcount, payroll and square footage. Azurix
believes the allocation methods and costs are reasonable. Costs for services
used under the agreement were approximately $2.9 million in 2000. The services
agreement with Enron is for an indefinite term, but may be terminated on 180
days' notice. Azurix currently has a sublease arrangement, and intends to enter
into a sublease agreement, with Enron providing for the use of office space in
Houston, Texas.

CREDIT AGREEMENT AND PREFERRED STOCK

     Effective May 1, 1999, Azurix entered into a credit agreement with Enron,
which was amended as of January 4, 2000. Under this agreement, Enron provided
funds to Azurix for general, administrative and operating expenses, including
interest expenses. The total commitment under the credit agreement was $180
million. Advances under the facility bore interest at the U.S. federal funds
rate plus 1.50%. As of December 31, 2000, $103.1 million was outstanding under
this credit agreement.

     On March 16, 2001, as provided under the agreement and plan of merger,
Azurix retired $180 million of borrowings outstanding under the credit agreement
through the issuance to Enron of 11% cumulative mandatorily redeemable preferred
stock with an initial liquidation preference of $180 million and the credit
agreement was cancelled. The preferred stock may not be redeemed by Azurix prior
to the date that all of our senior notes due 2007 and 2010 have been redeemed.
The preferred stock must be redeemed on or before the second anniversary of the
date that the senior notes are no longer outstanding. Dividends will accrue, but
will not be paid until all of our senior notes have been redeemed.

LICENSE AGREEMENT

     Enron has licensed to Azurix the non-exclusive right to use the phrase "an
Enron Company" and its logo in identifying Azurix as part of the Enron
enterprise for use in its businesses permitted under the business opportunities
agreement described above, until the first date on which both of the following
occur (i) Enron and its affiliates do not individually or collectively, directly
or indirectly, own or have the power to vote at least one-third of the shares of
Azurix ordinarily entitled to vote for the election of directors and (ii) fewer
than one-third of the directors of Azurix are persons who are employees,
officers or directors of Enron or of any affiliate of Enron.

     The license is royalty free, although Azurix bears costs associated with
its use under a related cost sharing agreement. The license agreement is for a
term of one year, and renews automatically and repetitively for similar terms,
unless terminated by either party upon 30 days' notice or earlier upon uncured
default. Following termination, Azurix must phase out use of existing materials
within 90 days. The cost sharing agreement provides for a sharing of Enron's
costs incurred to develop, maintain, enhance, promote or defend the licensed
trademarks. Azurix's share of such costs will be pro rata based on its earnings
before interest and taxes. Azurix does not anticipate that its share of such
costs will be material.


                                      100
<PAGE>   103
LETTER OF CREDIT OBLIGATIONS

    Enron has made available letters of credit on behalf of Azurix's
subsidiaries in the aggregate amount of approximately $16 million as of December
31, 1999. Azurix paid, or reimbursed Enron for, the fees associated with these
letter of credit. There were no letters of credit made available by Enron on
behalf of Azurix as of December 31, 2000.

GUARANTEE OF AZURIX NORTH AMERICA DEBT

    During 1999, and through March 31, 2000, Enron guaranteed debt and letter of
credit obligations of up to $25 million on behalf of Azurix North America to a
bank under terms of the bank credit facilities in exchange for, among other
things, the elimination of requirements for various assets to be pledged. As of
December 31, 1999, $16.4 million of letter of credit obligations were
outstanding under this credit facility, and thus guaranteed by Enron. While the
guarantee was outstanding, Azurix paid a fee to Enron of $0.3 million per annum.



                                      101
<PAGE>   104

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) and (2) Financial Statements and Financial Statement Schedules. See
"Index to Consolidated Financial Statements" set forth on page 45 and "Index to
Financial Statement Schedules" set forth on page 106.

    (a)(3) Exhibits:

       EXHIBIT
       NUMBER:                          EXHIBIT

         3.1      Restated Certificate of Incorporation (incorporated by
                  reference to Exhibit 3.1 to the Registrant's Amendment No. 2
                  to Registration Statement on Form S-1(File No. 333-74739))

         3.2      Restated Bylaws, as amended on December 13, 1999 (incorporated
                  by reference to Exhibit 4.2 to the Registrant's Registration
                  Statement on Form S-8 (File No. 333-92709))

         3.3      Certificate of Merger of Enron BW Corp. into the Registrant,
                  dated March 16, 2001

         4.1      Indenture, dated February 18, 2000, between the Registrant and
                  Chase Bank of Texas, National Association, as Trustee
                  (incorporated by reference to Exhibit 4.1 to the Registrant's
                  Annual Report on Form 10-K for the year ended December 31,
                  1999)

         4.2      Certificate of Designations, Preferences and Rights of Series
                  A Preferred Stock, dated March 15, 2001

         4.3      Exchange Agreement, dated March 16, 2001, between the
                  Registrant and Enron Corp.

         4.4      Stock Restriction and Registration Rights Agreement, dated
                  June 9, 1999, between the Registrant and Atlantic Water Trust
                  (incorporated by reference to Exhibit 4.3 to the Registrant's
                  Annual Report on Form 10-K for the year ended December 31,
                  1999)

         10.1     Instrument of Appointment as a Water and Sewerage Undertaker,
                  dated August 1989, as amended, of Wessex Water Services
                  Limited (incorporated by reference to Exhibit 10.1 to the
                  Registrant's Registration Statement on Form S-1 (File No.
                  333-74739))

         10.2     L.425,000,000 Supplemental Agreement, dated February 25, 2000,
                  for Azurix Europe Ltd. arranged by Chase Manhattan Plc and
                  Westdeutsche Landesbank Griozentrale (incorporated by
                  reference to Exhibit 10.2 to the Registrant's Annual Report on
                  Form 10-K for the year ended December 31, 1999)

         10.3     L.73,000,000 Amended and Restated Credit Facility Agreement,
                  dated December 17, 1998, for Azurix Europe Ltd and Bristol
                  Water Trust (incorporated by reference to Exhibit 10.3 to the
                  Registrant's Registration Statement on Form S-1 (File
                  No. 333-74739))

         10.4     Amended and Restated Trust Agreement of Atlantic Water Trust,
                  dated December 17, 1998 (incorporated by reference to Exhibit
                  10.14 to the Registrant's Amendment No. 2 to Registration
                  Statement on Form S-1 (File No. 333-74739))

         10.5     Trust Deed, dated March 30, 1999, among Wessex Water Services
                  Finance Plc, Wessex Water Services Limited and Midland Bank
                  Plc (incorporated by reference to Exhibit 10.15 to the
                  Registrant's Amendment No. 2 to Registration Statement on Form
                  S-1 (File No. 333-74739))

         10.6     *Definitive Trust Deed and Rules of Wessex Water Executive
                  Pension Scheme, dated August 19, 1998 (incorporated by
                  reference to Exhibit 10.17 to the Registrant's Amendment No. 2
                  to Registration Statement on Form S-1 (File No. 333-74739))

         10.7     Concession Contract dated June 30, 1999, between the Executive
                  Authorities of the Province of Buenos Aires and Azurix Buenos
                  Aires S.A. (incorporated by reference to Exhibit 2 to the
                  Registrant's Amendment No. 1 to Current Report on Form 8-K/A
                  dated June 30, 1999)



                                      102
<PAGE>   105

         10.8     U.S.$394,000,000 Credit Agreement, dated as of June 24, 1999,
                  among Azurix Buenos Aires S.A., as Borrower, and the Initial
                  Lenders named therein, as Initial Lenders, and Westdentsche
                  Landestand Girozentrale, as Agent (incorporated by reference
                  to Exhibit 10.1 to the Registrant's Quarterly Report on Form
                  10-Q for the quarter ended June 30, 1999)

         10.9     Cash Collateral Agreement, dated as of June 25, 1999, among
                  the Registrant, as Pledgor, and The Chase Manhattan Bank, as
                  Collateral Agent and Collateral Securities Intermediary and
                  the other parties named therein (incorporated by reference to
                  Exhibit 10.2 to the Registrant's Quarterly Report on From 10-Q
                  for the quarter ended June 30, 1999)

         10.10    *Employment Agreement of Colin F. Skellett, dated February 24,
                  1995, and First Amendment, dated December 9, 1998, with Wessex
                  Water Plc (incorporated by reference to Exhibit 10.13 to the
                  Registrant's Amendment No. 1 to Registration Statement on Form
                  S-1 (File No. 333-74739))

         10.11    *Executive Employment Agreement of John L. Garrison, Jr.,
                  dated April 26, 1999, with the Registrant (incorporated by
                  reference to Exhibit 10.17 to Registrant's Annual Report on
                  Form 10-K for the year ended December 31, 1999)

         10.12    *First Amendment to Executive Employment Agreement of John L.
                  Garrison, Jr., dated June 1, 2000, with the Registrant
                  (incorporated by reference to Exhibit 10.2 to Registrant's
                  Quarterly Report on Form 10-Q for the quarter ended June 30,
                  2000)

         10.13    *Second Amendment to Executive Employment Agreement of John L.
                  Garrison, Jr. dated November 14, 2000, with the Registrant

         10.14    *Employment Agreement of Amanda K. Martin, effective January
                  1, 1998, with the Registrant and Enron Capital & Trade
                  Resources Corp. and Second Amendment, dated March 15, 1999,
                  with the Registrant (incorporated by reference to Exhibit
                  10.11 to the Registrant's Amendment No. 1 to Registration
                  Statement on Form S-1 (File No. 333-74739))

         10.15    *Executive Employment Agreement of John C. Ale, effective
                  December 10, 1998, with the Registrant (incorporated by
                  reference to Exhibit 10.19 to Registrant's Annual Report on
                  Form 10-K for the year ended December 31, 1999)

         10.16    *First Amendment to Executive Employment Agreement of John C.
                  Ale, effective October 10, 2000, with the Registrant
                  (incorporated by reference to Exhibit 10.6 to Registrant's
                  Quarterly Report on Form 10-Q for the quarter ended September
                  30, 2000)

         10.17    *Executive Employment Agreement of J. Michael Anderson,
                  effective March 23, 2000, with the Registrant, and First
                  Amendment dated October 10, 2000, with the Registrant

         10.18    *Severance Agreement of Rebecca P. Mark dated January 12,
                  2001, with the Registrant

         10.19    Cost Sharing Agreement, effective January 1, 1999, between the
                  Registrant and Enron (incorporated by reference to Exhibit
                  10.23 to the Registrant's Annual Report on Form 10-K for the
                  year ended December 31, 1999)

         10.20    Services Agreement, dated May 1, 1999, between the Registrant
                  and Enron (incorporated by reference to Exhibit 10.24 to the
                  Registrant's Annual Report on Form 10-K for the year ended
                  December 31, 1999)

         10.21    Non-Exclusive License Agreement, dated May 1, 1999, between
                  the Registrant and Enron (incorporated by reference to Exhibit
                  10.25 to the Registrant's Annual Report on Form 10-K for the
                  year ended December 31, 1999)

         10.22    Business Opportunity Agreement, dated June 9, 1999, among the
                  Registrant, Atlantic Water Trust and Enron (incorporated by
                  reference to Exhibit 10.26 to the Registrant's Annual Report
                  on Form 10-K for the year ended December 31, 1999)



                                      103
<PAGE>   106

         10.23    Memorandum of Understanding, dated February 15, 2000, among
                  the Ministry of Public Works and Utilities of the Province of
                  Buenos Aires, Azurix Buenos Aires S.A., the Secretary General
                  of SOSBA and the Secretary General of Fentos and Mayors

         10.24    Memorandum of Understanding filed in the Court of Chancery in
                  the State of Delaware in and for New Castle County under
                  Consolidated Civil Action 18463NC, In re: Azurix Shareholders
                  Litigation dated December 15, 2000

         21       Subsidiaries of the Registrant

         24       Powers of Attorney

*   Management contract or compensatory plan or arrangement required to be filed
    as an exhibit pursuant to Item 14(d) of Form 10-K.

    (b) Reports on Form 8-K:

    A Report on Form 8-K was filed on December 15, 2000, with respect to the
execution of an Agreement and Plan of Merger dated December 15, 2000 among the
Registrant, Enron BW Corp. and Enron Corp.



                                      104
<PAGE>   107

                                   SIGNATURES

    Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized, on March 29, 2001.

                                       AZURIX CORP.

                                       By: /s/ JOHN L. GARRISON, JR.
                                          ---------------------------
                                       Name: John L. Garrison, Jr.
                                       Title: President and Chief
                                              Executive Officer

    Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below on March 29, 2001 by the following persons on
behalf of the Registrant and in the capacities indicated:

<TABLE>
<CAPTION>
       SIGNATURE                                       TITLE                                         DATE
       ---------                                       -----                                         ----
<S>                                   <C>                                                       <C>
                                            President and Chief Executive
/s/ JOHN L. GARRISON,JR.                 Officer (Principal Executive Officer)                  March 29, 2001
------------------------
John L. Garrison, Jr.


/s/ J. MICHAEL ANDERSON               Managing Director and Chief Financial Officer             March 29, 2001
------------------------                    (Principal Financial Officer)
J. Michael Anderson


/s/ KENNETH R. BICKETT                  Vice President and Controller (Principal                March 29, 2001
------------------------                          Accounting Officer)
Kenneth R. Bickett


/s/ J. CLIFFORD BAXTER                                Director                                  March 29, 2001
------------------------
J. Clifford Baxter*


/s/ JAMES V. DERRICK, JR.                             Director                                  March 29, 2001
------------------------
James V. Derrick, Jr.*


/s/ J. MARK METTS                                     Director                                  March 29, 2001
------------------------
J. Mark Metts*
</TABLE>



*By: /s/ JOHN L. GARRISON, JR.
    --------------------------
    John L. Garrison, Jr.
    (Attorney-in-fact for
    persons indicated)



                                      105
<PAGE>   108


                                  AZURIX CORP.

                     INDEX TO FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
                                                                                                             PAGE
                                                                                                             ----


<S>                                                                                                           <C>
   Reports of Independent Public Accountants................................................................  107

   Schedule I - Condensed Financial Information of Registrant

   Statements of Income (Loss) for the period from January 29, 1998
      (Date of Inception) to December 31, 1998 and for the years ended December 31, 1999 and 2000...........  109
   Statements of Comprehensive Loss for the period from January 29, 1998
      (Date of Inception) to December 31, 1998 and for the years ended December 31, 1999 and 2000...........  110

   Balance Sheets at December 31, 1999 and 2000.............................................................  111

   Statements of Cash Flows for the period from January 29, 1998 (Date of Inception)
       to December 31, 1998 and for the years ended December 31, 1999 and 2000..............................  112

   Notes to the Financial Statements........................................................................  113

   Schedule II  - Valuation and Qualifying Accounts.........................................................  115
</TABLE>





                                      106
<PAGE>   109


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
                        ON FINANCIAL STATEMENT SCHEDULES


To Azurix Corp.:

    We have audited in accordance with auditing standards generally accepted in
the United States, the consolidated financial statements of Azurix Corp. and
subsidiaries included in this Form 10-K filing and have issued our report
thereon dated March 26, 2001. Our audits were made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedules listed
in Item 14(a) are the responsibility of Azurix Corp.'s management and are
presented for purposes of complying with the Securities and Exchange
Commission's rules and are not part of the basic financial statements. These
schedules have been subjected to the auditing procedures applied in the audits
of the basic financial statements and, in our opinion, fairly state in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.



ARTHUR ANDERSEN LLP

Houston, Texas
March 26, 2001





                                      107
<PAGE>   110


                        REPORT OF INDEPENDENT ACCOUNTANTS
                         ON FINANCIAL STATEMENT SCHEDULE

To Wessex Water Ltd (formerly Wessex Water Plc):

    We have audited in accordance with generally accepted auditing standards,
the consolidated statements of income, changes in stockholders' equity and cash
flows of Wessex Water Ltd (formerly Wessex Water Plc) and subsidiaries for the
period from April 1, 1998 to October 2, 1998 included in this Annual Report and
have issued our report thereon dated March 12, 1999. Our audit was made for the
purpose of forming an opinion on the basic financial statements taken as a
whole. Schedule II listed in Item 14(a) as related to Wessex Water Ltd (formerly
Wessex Water Plc) for the period from April 1, 1998 to October 2, 1998 is the
responsibility of the company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.

                                                     /s/ ARTHUR ANDERSEN
                                                     --------------------------
                                                          Arthur Andersen

London, England
March 12, 1999




                                      108
<PAGE>   111


          SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                  AZURIX CORP.

                           STATEMENTS OF INCOME (LOSS)
                                  (IN MILLIONS)


<TABLE>
<CAPTION>
                                                            JANUARY 29, 1998                  YEAR ENDED
                                                               (DATE OF                       DECEMBER 31,
                                                               INCEPTION)         --------------------------------
                                                             TO DECEMBER 31,
                                                                  1998                1999                2000
                                                            ----------------      ------------        ------------

<S>                                                        <C>                    <C>                 <C>
Operating revenues ....................................       $         --        $         --        $         --
Operating expenses:
  Operations and maintenance ..........................                2.3                  --                  --
  General and administrative ..........................               12.3                63.5                58.6
  Depreciation and amortization .......................                0.1                 1.2                 6.8
  Impairment of long-lived assets .....................                 --                  --                12.3
  Restructuring charge ................................                 --                29.1                  --
                                                              ------------        ------------        ------------
          Total operating expenses ....................               14.7                93.8                77.7
                                                              ------------        ------------        ------------
Equity in earnings of consolidated affiliates .........               26.0                96.6              (403.8)
Other expense .........................................               (1.1)                 --                  --
Interest expense, net .................................                 --                (0.2)              (51.3)
                                                              ------------        ------------        ------------
  Income before income taxes ..........................               10.2                 2.6              (532.8)
                                                              ------------        ------------        ------------
  Income tax benefit ..................................                 --               (35.1)              (41.8)
                                                              ------------        ------------        ------------
Net income (loss) .....................................       $       10.2        $       37.7        $     (491.0)
                                                              ============        ============        ============
</TABLE>




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



                                      109
<PAGE>   112




          SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                  AZURIX CORP.

                        STATEMENTS OF COMPREHENSIVE LOSS
                                  (IN MILLIONS)




<TABLE>
<CAPTION>
                                                            JANUARY 29, 1998                  YEAR ENDED
                                                               (DATE OF                       DECEMBER 31,
                                                               INCEPTION)         --------------------------------
                                                             TO DECEMBER 31,
                                                                  1998                1999                2000
                                                            ----------------      ------------        ------------

<S>                                                         <C>                   <C>                 <C>
Net income (loss) .....................................       $       10.2        $       37.7        $     (491.0)
Other comprehensive income, net of tax:
      Foreign currency translation adjustment .........              (36.7)              (41.4)             (128.1)
      Unrealized loss on available for sale securities
         held by subsidiary ...........................                 --                (0.8)               (0.3)
                                                              ------------        ------------        ------------
Comprehensive loss ....................................       $      (26.5)       $       (4.5)       $     (619.4)
                                                              ============        ============        ============
</TABLE>














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





                                      110
<PAGE>   113





           SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                  AZURIX CORP.

                                 BALANCE SHEETS
                                  (IN MILLIONS)

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                                       ------------------------
                                                                                         1999            2000
                                                                                       --------        --------
                                                   ASSETS
<S>                                                                                    <C>             <C>
Current assets:
  Restricted cash and cash equivalents .........................................       $   83.6        $    3.3
  Other ........................................................................            4.3            16.1
                                                                                       --------        --------
       Total current assets ....................................................           87.9            19.4
                                                                                       --------        --------
Property, plant and equipment, net .............................................           17.1            25.0
Investment in and advances to subsidiaries .....................................        2,033.4         1,958.4
Other assets ...................................................................           54.1            92.3
                                                                                       --------        --------
       Total Assets ............................................................       $2,192.5        $2,095.1
                                                                                       ========        ========

                                    LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable -- affiliates ...............................................       $    9.7        $   11.5
  Accounts payable and accruals ................................................           28.3            47.7
  Current maturities of long-term debt .........................................             --             0.1
                                                                                       --------        --------
       Total current liabilities ...............................................           38.0            59.3
                                                                                       --------        --------
Long-term debt .................................................................          150.0           590.3
Long-term debt -- affiliates ...................................................           62.7           118.6
Other long-term liabilities ....................................................             --             2.7
                                                                                       --------        --------
       Total liabilities .......................................................          250.7           770.9
                                                                                       --------        --------
Stockholders' equity:
  Preferred stock ..............................................................             --              --
  Common stock .................................................................             --              --
  Additional paid-in capital ...................................................        1,973.4         1,974.8
  Retained earnings (deficit) ..................................................           47.9          (443.1)
  Unearned compensation ........................................................           (0.6)           (0.2)
  Accumulated other comprehensive loss .........................................          (78.9)         (207.3)
                                                                                       --------        --------
       Total stockholders' equity ..............................................        1,941.8         1,324.2
                                                                                       --------        --------
       Total Liabilities and Stockholders' Equity ..............................       $2,192.5        $2,095.1
                                                                                       ========        ========
</TABLE>












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



                                      111
<PAGE>   114



           SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                  AZURIX CORP.

                            STATEMENTS OF CASH FLOWS
                                  (IN MILLIONS)







<TABLE>
<CAPTION>
                                                                             JANUARY 29, 1998
                                                                                (DATE OF
                                                                                INCEPTION)         YEAR ENDED DECEMBER 31,
                                                                              TO DECEMBER 31,     --------------------------
                                                                                   1998               1999         2000
                                                                              ----------------    ------------  ------------
<S>                                                                           <C>                 <C>           <C>
Cash used in operating activities .........................................       $         --    $      (82.6) $      (89.5)

Investing Activities:
    Investments in and advances to subsidiaries ...........................           (1,600.2)         (312.1)       (454.4)
    Capital expenditures ..................................................                 --           (16.7)        (26.1)
                                                                                  ------------    ------------  ------------
Net cash used in investing activities .....................................           (1,600.2)         (328.8)       (480.5)
                                                                                  ------------    ------------  ------------

Financing Activities:
    Proceeds from long-term borrowings ....................................                 --           149.4         583.1
    Repayments of long-term borrowings ....................................                 --              --        (150.0)
    Deposit to (withdrawal from) restricted cash and cash equivalents
     collateral accounts ..................................................                 --           (83.6)         78.6
    Issuance of common stock and capital contributed ......................            1,600.2           300.5           1.7
    Advances from affiliates, net of repayments ...........................                 --            45.1          56.6
                                                                                  ------------    ------------  ------------
Net cash provided by financing activities .................................            1,600.2           411.4         570.0
                                                                                  ------------    ------------  ------------
Change in cash and cash equivalents .......................................                 --              --            --
                                                                                  ------------    ------------  ------------
Cash and cash equivalents, beginning of period ............................                 --              --            --
                                                                                  ------------    ------------  ------------
Cash and cash equivalents, end of period ..................................       $         --    $         --  $         --
                                                                                  ============    ============  ============
</TABLE>







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


                                      112


<PAGE>   115

           SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                  AZURIX CORP.

                        NOTES TO THE FINANCIAL STATEMENTS

NOTE 1 -- GENERAL

    These condensed financial statements of Azurix reflect parent company only
financial information and should be read in conjunction with the consolidated
financial statements of Azurix Corp. presented elsewhere in this document.

NOTE 2 -- DEBT

    On September 29, 1999, Azurix Corp. entered into a 364-day $150.0 million
unsecured revolving credit facility with a group of banks. The facility, as
subsequently amended, was scheduled to mature in September 2000. As of December
31, 1999, $150.0 million was outstanding under the facility and the borrowings
were primarily used to reduce other debt obligations and finance acquisitions.
The weighted average interest rate on borrowings outstanding under this facility
at December 31, 1999 was 7.7%. Azurix used a portion of the proceeds from the
long-term notes issued in February 2000 to repay all amounts outstanding under
this facility. Accordingly, the borrowings under this facility at December 31,
1999 have been reclassified as long-term. Azurix terminated the facility in
March 2000.

    Effective May 1, 1999, Azurix entered into a credit agreement with Enron,
which was amended as of January 24, 2000. Under this agreement Enron, loaned
funds to Azurix for general, administrative and operating expenses. As of
December 31, 1999 and 2000, $53.3 million and $103.1 million, respectively, was
outstanding under this credit agreement. The credit agreement originally
terminated on the earlier of December 15, 2001 or 90 days following the date
that Enron does not own or have the power to vote at least one-third of Azurix's
capital stock ordinarily entitled to vote for the election of directors and
fewer than one-third of Azurix's directors are officers, directors or employees
of Enron. The total commitment under the credit agreement would not exceed $60
million, $120 million and $180 million at any time during calendars years 1999,
2000 and 2001, respectively. Advances under the credit agreement bore interest
at the federal funds rate plus 1.50%. The effective interest rate on these
borrowings in 1999 and 2000 was 6.8% and 8.1%, respectively. In January 2001,
Azurix borrowed $40.0 million under the Enron credit agreement and paid down
that portion of the Azurix Europe credit facility that can be used by Azurix for
general corporate purposes. Interest expense recorded for 1999 and 2000 was $2.2
million and $7.6 million, respectively. In addition, on March 16, 2001, the then
outstanding balance of the Enron credit agreement of $180 million was retired
through the issuance to Enron of mandatorily redeemable preferred stock and the
credit agreement was terminated. As a result, the balance outstanding at
December 31, 2000 under the credit agreement was classified as long-term debt -
affiliates and not as current maturities of long-term debt - affiliates.

    In June 1999, a loan agreement was entered into with a shareholder. The
principal amount is limited to $25.0 million and the balance outstanding at
December 31, 1999 and 2000, was $8.8 million and $15.5 million, respectively.
Individual loans made under the agreement mature in 2009 and are non-interest
bearing.

    In February 2000, Azurix issued U.S. dollar and U.K. pound sterling senior
notes with a U.S. dollar equivalent face value at December 31, 2000 of $589.6
million. The senior notes consisted of $240.0 million and L.100.0 million, each
due in 2007 and bearing an interest rate of 10.375%, and $200.0 million due in
2010 and bearing an interest rate of 10.75%. Net proceeds after underwriters'
discount and other offering costs were $583.1 million. Of this amount, $150.0
million was used to pay down the Azurix revolving credit facility, $386.0
million was used to pay down the Azurix Europe credit facility and $18.1 million
was used to pay down amounts outstanding under the credit agreement with Enron.
In addition, $11.5 million was used to pay accrued interest on the three credit
facilities. The remaining proceeds were made available for general corporate
purposes. The senior notes were issued under an indenture that contains certain
covenants that limit Azurix's ability to incur additional debt, pay dividends or
make other distributions, incur liens on its assets, enter into sale/leaseback
transactions, enter in transactions with affiliates, or sell assets to, or merge
with, another entity.



                                      113
<PAGE>   116

           SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                  AZURIX CORP.

                 NOTES TO THE FINANCIAL STATEMENTS - (CONTINUED)


NOTE 3 -- SUBSEQUENT EVENTS

    On March 16, 2001, shareholders of Azurix Corp. approved and adopted the
Agreement and Plan of Merger by and among Enron Corp., Enron BW Corp., a wholly
owned indirect subsidiary of Enron, and Azurix dated as of December 15, 2000.
The merger was consummated on March 16, 2001, at which time Enron BW Corp. was
merged into Azurix with Azurix being the surviving corporation.

    Under the Agreement and Plan of Merger, each issued and outstanding share of
Azurix Corp. common stock, other than those shares held by Atlantic Water Trust,
Enron Corp., Enron BW Corp., Azurix and any of their wholly owned subsidiaries,
was cancelled and converted into the right to receive $8.375 per share. On the
date of the merger, Enron BW Corp. had $325.9 million of cash that was used to
pay consideration to the public shareholders whose shares were cancelled. As a
result of the merger and effective on the merger date, Azurix Corp. had three
shares of common stock outstanding and Azurix Corp. common stock ceased to be
publicly held.

    Pursuant to the terms of the Agreement and Plan of Merger, on March 16,
2001, all Azurix stock options and unvested restricted stock outstanding were
cancelled. Holders of the options received a cash payment, less applicable
withholding taxes, for both vested and unvested options, based on the excess of
$8.375 over the exercise price per share. Holders of unvested restricted stock
received a cash payment of $8.375 per share, less applicable withholding taxes.
These payments resulted in Azurix recognizing a pre-tax charge of approximately
$4.3 million in the first quarter of 2001.

    In addition, under the Agreement and Plan of Merger, Azurix Corp. retired
$180 million of borrowings outstanding on March 16, 2001 under the Enron credit
agreement through the issuance to Enron of 11% cumulative mandatorily redeemable
preferred stock with an initial liquidation preference of $180 million. The
preferred stock may not be redeemed by Azurix Corp. prior to the date that all
of its senior notes due 2007 and 2010 have been redeemed. The preferred stock
must be redeemed on or before the second anniversary of the date that the senior
notes are no longer outstanding. Dividends will accrue, but will not be paid
until all of its senior notes have been redeemed.

    The definitive proxy statement that Azurix mailed to its shareholders in
connection with the merger stated that Enron does not view Azurix as a core
strategic asset. While no definitive plans have been made, Azurix intends to
pursue the potential disposal of certain of its assets provided favorable prices
for those assets can be obtained. Such asset disposals, should they occur, may
result in Azurix incurring losses in future periods.



                                      114
<PAGE>   117

                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                                  (IN MILLIONS)

<TABLE>
<CAPTION>
     AZURIX CORP.
                                                                  ADDITIONS
                                                     ADDITION     CHARGED TO                    CURRENCY
ALLOWANCE FOR DOUBTFUL                BEGINNING     RELATED TO    COSTS AND                     EXCHANGE
ACCOUNTS                              OF PERIOD    ACQUISITIONS    EXPENSES     WRITEOFFS      DIFFERENCE    END OF PERIOD
                                     ------------  ------------  ------------  ------------   ------------   -------------
<S>                                  <C>           <C>           <C>           <C>            <C>            <C>
January 29, 1998 (Date of
Inception) to
December 31, 1998 .................  $         --           4.9           1.7          (0.2)          (0.1)  $        6.3
Year Ended December 31, 1999 ......  $        6.3          25.0          13.3          (3.7)          (0.2)  $       40.7

Year Ended December 31, 2000 ......  $       40.7            --          29.1          (3.0)           0.1   $       66.9

     WESSEX WATER PLC (NOW RENAMED WESSEX WATER LTD.)

ALLOWANCE FOR DOUBTFUL
ACCOUNTS

Six months ended
October 2, 1998 ...................  $        5.9            --           1.7          (2.7)            --   $        4.9
</TABLE>



                                      115
<PAGE>   118

                                INDEX TO EXHIBITS

<TABLE>
<CAPTION>
       EXHIBIT
       NUMBER:                          DESCRIPTION
       -------                          -----------
<S>               <C>
         3.1      Restated Certificate of Incorporation (incorporated by
                  reference to Exhibit 3.1 to the Registrant's Amendment No. 2
                  to Registration Statement on Form S-1(File No. 333-74739))

         3.2      Restated Bylaws, as amended on December 13, 1999 (incorporated
                  by reference to Exhibit 4.2 to the Registrant's Registration
                  Statement on Form S-8 (File No. 333-92709))

         3.3      Certificate of Merger of Enron BW Corp. into the Registrant,
                  dated March 16, 2001

         4.1      Indenture, dated February 18, 2000, between the Registrant and
                  Chase Bank of Texas, National Association, as Trustee
                  (incorporated by reference to Exhibit 4.1 to the Registrant's
                  Annual Report on Form 10-K for the year ended December 31,
                  1999)

         4.2      Certificate of Designations, Preferences and Rights of Series
                  A Preferred Stock, dated March 15, 2001

         4.3      Exchange Agreement, dated March 16, 2001, between the
                  Registrant and Enron Corp.

         4.4      Stock Restriction and Registration Rights Agreement, dated
                  June 9, 1999, between the Registrant and Atlantic Water Trust
                  (incorporated by reference to Exhibit 4.3 to the Registrant's
                  Annual Report on Form 10-K for the year ended December 31,
                  1999)

         10.1     Instrument of Appointment as a Water and Sewerage Undertaker,
                  dated August 1989, as amended, of Wessex Water Services
                  Limited (incorporated by reference to Exhibit 10.1 to the
                  Registrant's Registration Statement on Form S-1 (File No.
                  333-74739))

         10.2     L.425,000,000 Supplemental Agreement, dated February 25, 2000,
                  for Azurix Europe Ltd. arranged by Chase Manhattan Plc and
                  Westdeutsche Landesbank Griozentrale (incorporated by
                  reference to Exhibit 10.2 to the Registrant's Annual Report on
                  Form 10-K for the year ended December 31, 1999)

         10.3     L.73,000,000 Amended and Restated Credit Facility Agreement,
                  dated December 17, 1998, for Azurix Europe Ltd and Bristol
                  Water Trust (incorporated by reference to Exhibit 10.3 to the
                  Registrant's Registration Statement on Form S-1 (File No.
                  333-74739))

         10.4     Amended and Restated Trust Agreement of Atlantic Water Trust,
                  dated December 17, 1998 (incorporated by reference to Exhibit
                  10.14 to the Registrant's Amendment No. 2 to Registration
                  Statement on Form S-1 (File No. 333-74739))

         10.5     Trust Deed, dated March 30, 1999, among Wessex Water Services
                  Finance Plc, Wessex Water Services Limited and Midland Bank
                  Plc (incorporated by reference to Exhibit 10.15 to the
                  Registrant's Amendment No. 2 to Registration Statement on Form
                  S-1 (File No. 333-74739))

         10.6     *Definitive Trust Deed and Rules of Wessex Water Executive
                  Pension Scheme, dated August 19, 1998 (incorporated by
                  reference to Exhibit 10.17 to the Registrant's Amendment No. 2
                  to Registration Statement on Form S-1 (File No. 333-74739))

         10.7     Concession Contract dated June 30, 1999, between the Executive
                  Authorities of the Province of Buenos Aires and Azurix Buenos
                  Aires S.A. (incorporated by reference to Exhibit 2 to the
                  Registrant's Amendment No. 1 to Current Report on Form 8-K/A
                  dated June 30, 1999)

         10.8     U.S.$394,000,000 Credit Agreement, dated as of June 24, 1999,
                  among Azurix Buenos Aires S.A., as Borrower, and the Initial
                  Lenders named therein, as Initial Lenders, and Westdentsche
                  Landestand Girozentrale, as Agent (incorporated by reference
                  to Exhibit 10.1 to the Registrant's Quarterly Report on Form
                  10-Q for the quarter ended June 30, 1999)
</TABLE>



                                      116
<PAGE>   119

<TABLE>
<S>               <C>
         10.9     Cash Collateral Agreement, dated as of June 25, 1999, among
                  the Registrant, as Pledgor, and The Chase Manhattan Bank, as
                  Collateral Agent and Collateral Securities Intermediary and
                  the other parties named therein (incorporated by reference to
                  Exhibit 10.2 to the Registrant's Quarterly Report on From 10-Q
                  for the quarter ended June 30, 1999)

         10.10    *Employment Agreement of Colin F. Skellett, dated February 24,
                  1995, and First Amendment, dated December 9, 1998, with Wessex
                  Water Plc (incorporated by reference to Exhibit 10.13 to the
                  Registrant's Amendment No. 1 to Registration Statement on Form
                  S-1 (File No. 333-74739))

         10.11    *Executive Employment Agreement of John L. Garrison, Jr.,
                  dated April 26, 1999, with the Registrant (incorporated by
                  reference to Exhibit 10.17 to Registrant's Annual Report on
                  Form 10-K for the year ended December 31, 1999)

         10.12    *First Amendment to Executive Employment Agreement of John L.
                  Garrison, Jr., dated June 1, 2000, with the Registrant
                  (incorporated by reference to Exhibit 10.2 to Registrant's
                  Quarterly Report on Form 10-Q for the quarter ended June 30,
                  2000)

         10.13    *Second Amendment to Executive Employment Agreement of John L.
                  Garrison, Jr. dated November 14, 2000, with the Registrant

         10.14    *Employment Agreement of Amanda K. Martin, effective January
                  1, 1998, with the Registrant and Enron Capital & Trade
                  Resources Corp. and Second Amendment, dated March 15, 1999,
                  with the Registrant (incorporated by reference to Exhibit
                  10.11 to the Registrant's Amendment No. 1 to Registration
                  Statement on Form S-1 (File No. 333-74739))

         10.15    *Executive Employment Agreement of John C. Ale, effective
                  December 10, 1998, with the Registrant (incorporated by
                  reference to Exhibit 10.19 to Registrant's Annual Report on
                  Form 10-K for the year ended December 31, 1999)

         10.16    *First Amendment to Executive Employment Agreement of John C.
                  Ale, effective October 10, 2000, with the Registrant
                  (incorporated by reference to Exhibit 10.6 to Registrant's
                  Quarterly Report on Form 10-Q for the quarter ended September
                  30, 2000)

         10.17    *Executive Employment Agreement of J. Michael Anderson,
                  effective March 23, 2000, with the Registrant, and First
                  Amendment dated October 10, 2000, with the Registrant

         10.18    *Severance Agreement of Rebecca P. Mark dated January 12,
                  2001, with the Registrant

         10.19    Cost Sharing Agreement, effective January 1, 1999, between the
                  Registrant and Enron (incorporated by reference to Exhibit
                  10.23 to the Registrant's Annual Report on Form 10-K for the
                  year ended December 31, 1999)

         10.20    Services Agreement, dated May 1, 1999, between the Registrant
                  and Enron (incorporated by reference to Exhibit 10.24 to the
                  Registrant's Annual Report on Form 10-K for the year ended
                  December 31, 1999)

         10.21    Non-Exclusive License Agreement, dated May 1, 1999, between
                  the Registrant and Enron (incorporated by reference to Exhibit
                  10.25 to the Registrant's Annual Report on Form 10-K for the
                  year ended December 31, 1999)

         10.22    Business Opportunity Agreement, dated June 9, 1999, among the
                  Registrant, Atlantic Water Trust and Enron (incorporated by
                  reference to Exhibit 10.26 to the Registrant's Annual Report
                  on Form 10-K for the year ended December 31, 1999)

         10.23    Memorandum of Understanding, dated February 15, 2000, among
                  the Ministry of Public Works and Utilities of the Province of
                  Buenos Aires, Azurix Buenos Aires S.A., the Secretary General
                  of SOSBA and the Secretary General of Fentos and Mayors

         10.24    Memorandum of Understanding filed in the Court of Chancery in
                  the State of Delaware in and for New Castle County under
                  Consolidated Civil Action 18463NC, In re: Azurix Shareholders
                  Litigation dated December 15, 2000
</TABLE>



                                      117
<PAGE>   120

<TABLE>
<S>               <C>
         21       Subsidiaries of the Registrant

         24       Powers of Attorney
</TABLE>

*   Management contract or compensatory plan or arrangement required to be filed
    as an exhibit pursuant to Item 14(d) of Form 10-K.



                                      118