ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
SPECIAL
NOTE ABOUT FORWARD-LOOKING STATEMENTS
Management’s Discussion and Analysis of
Financial Condition and Results of Operations (“MD&A”) is intended to help
the reader understand the results of operations and financial condition of
Southwest Water Company. This MD&A
also contains “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. All statements contained herein
that are not clearly historical in nature are forward-looking, and the words “anticipate,”
“believe,” “belief,” “expect,” “estimate,” “project,” “plan,” “intend,” “continue,”
“predict,” “may,” “will,” “should, “strategy,” “will likely result,” “will
likely continue,” and similar expressions are generally intended to identify
forward-looking statements.
Forward-looking statements are subject to risks and uncertainties that
could cause actual results to differ materially from our historical experience
and our present expectations or projections.
A detailed discussion of these and other risks and uncertainties that
could cause actual results and events to differ materially from such
forward-looking statements is included in the section entitled “Item 1A. Risk Factors” in our 2006 Annual Report on
Form 10-K. Caution should be taken not
to place undue reliance on any such forward-looking statements since such
statements speak only as of the date when made.
Other than as required by applicable law, we undertake no obligation to
publicly update or revise forward-looking statements whether as a result of new
information, future events, or otherwise.
The MD&A is intended to help the reader
understand the results of operations, financial condition and cash flows of
Southwest Water Company and is provided as a supplement to, and should be read
in conjunction with, our condensed consolidated financial statements and the
accompanying notes to the financial statements included in this report.
OVERVIEW
Southwest Water Company provides a broad
range of services including water production, treatment and distribution;
wastewater collection and treatment; utility billing and collection; utility
infrastructure construction management; and public works services. We own regulated public utilities and also
serve cities, utility districts and private companies under contract. Our subsidiaries are segmented into two
operating groups: our Utility Group and our Services Group.
Utility Group
Our Utility Group owns public water and
wastewater utilities in Alabama, California, New Mexico, Oklahoma and Texas
and, beginning in February 2007, Mississippi.
Except for our California utility, our utilities are operated by
companies in our Services Group. State
and federal agencies issue regulations regarding standards of water quality,
safety, environmental and other matters which affect these operations. The rates that our regulated utility
subsidiaries charge for water and wastewater usage are established by state or
local authorities.
Utility Group revenues reflect fees earned
for the production and distribution of water and the collection and treatment
of sewage for residential, business, industrial and public authority use. The group’s operating expenses reflect the
costs associated with purchasing, producing and distributing water, collecting
and treating wastewater, salaries, wages and employee benefits, facilities
costs, supplies and equipment, repairs and maintenance, professional fees and
other costs.
We grow our Utility Group by:
•
increasing the number of customers we
serve;
•
increasing the rate customers pay for
our services through rate case filings with state regulatory commissions;
•
creating new utilities by partnering
with the development community in high growth markets; and
•
acquiring utilities from cities,
municipalities and private owners in high growth markets.
23
In our pursuit of long-term Utility Group
growth, during 2006 we acquired two small water utilities and the rights to
provide water and wastewater utility service in developing areas located near
Austin, Texas, in February 2007, we acquired a small water and wastewater
utility located in northern Mississippi, just south of Memphis, Tennessee and,
in May 2007, acquired two water and wastewater utilities near San Antonio,
Texas. While these acquisitions are
insignificant to our financial results, both individually and in the aggregate,
they are strategically important as they expand our utility ownership in areas
that are currently experiencing significant population growth.
In 2007, the Albuquerque Bernalillo County
Water Utility Authority and the City of Rio Rancho, New Mexico, filed a
Petition for Condemnation (the “Petition”) against our New Mexico regulated
utility, New Mexico Utilities, Inc. (“NMUI”).
The Petition seeks to acquire, by condemnation, all of the assets of
NMUI, including all real property, through the alleged power of eminent
domain. The Petition also alleges that
the Petitioners need to acquire the utility assets for the public purposes of
providing water and wastewater services to customers and that the acquisition
of NMUI is necessary, appropriate and in the public interest. We believe we have defenses to the Action
which we intend to vigorously assert. If
we do not prevail, the Petitioners must pay fair market value as determined by
the court, based on appraisals. NMUI and
the Petitioners do not agree on the value of the assets which the Petitioners
seek to condemn. While it is too early
to predict the outcome of this matter, we believe that the fair market value of
the NMUI utility exceeds its recorded net book value as of September 30, 2007.
Services Group
Our Services Group operates our contract
service businesses in which we operate and maintain water and wastewater
facilities owned by cities, public agencies, municipal utility districts,
private entities and investor-owned utilities, including most of our own
utilities. Our Services Group operates
primarily in Alabama, California, Colorado, Georgia, Mississippi, New Mexico
and Texas. While state and federal
agencies issue regulations regarding standards of water quality, safety,
environmental and other matters which affect these operations, our Services
Group’s pricing is not subject to regulation.
Services Group revenues reflect fees earned
for water and wastewater facility operations and maintenance services,
equipment maintenance and repair, sewer pipeline video inspections and
cleaning, billing and collection services, public works and state-certified
water and wastewater laboratory analysis.
Our Services Group also facilitates the design, construction, project
management and operating aspects of various water and wastewater projects. The group’s operating expenses reflect
salaries, wages and employee benefits, fleet and facilities costs, supplies and
equipment, repairs and maintenance, professional fees and other costs. Most work performed by the Services Group is
required to be performed by state licensed and certified technicians.
Some companies in our Services Group provide
construction, operations and maintenance services to our Utility Group and
recognize a profit on those services. In
accordance with SFAS No. 71,
Accounting for the Effects
of Certain Types of Regulation
(“SFAS 71”), we do not eliminate the
Services Group’s profit because management believes the sales price is
reasonable and it is probable that, through the rate making process, future
Utility Group revenue approximately equal to the sales price will result from
the regulated utilities’ use of the services.
We do, however, eliminate revenues to the extent of the related costs in
the consolidated financial statements in accordance with the guidance provided
in SFAS 71.
We grow our Services Group by:
•
increasing the number of clients we
have contracts with;
•
increasing the customer base for our
existing contracts;
•
providing additional services to
clients to enhance the value of our contracts; and
•
acquiring strategically located,
well-established service contract businesses in high growth markets.
The relationships we build with our service
contract clients can position us for additional growth when a client decides to
sell their utility. Our 2006
acquisitions of small water and wastewater utilities near Austin, Texas are
examples of this growth strategy, as they were operated by our Services Group
prior to the utilities being sold to us.
24
Selling,
General and Administrative Expenses
Selling, general and administrative expenses
consist of costs related to personnel, facilities, insurance, consulting and
professional services, which support our sales, marketing, human resources,
finance and administration functions for the entire company.
RESULTS
OF OPERATIONS
Three Months
Ended September 30, 2007 Compared to 2006
Revenues.
Revenues decreased $1.6 million, or 2.7%, to
$57.4 million for the three months ended September 30, 2007 from $58.9 million
for the same period during the prior year.
By segment, revenues changed as follows:
|
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
26,041
|
|
$
|
25,839
|
|
$
|
202
|
|
45.4
|
%
|
43.8
|
%
|
|
Services Group
|
|
31,317
|
|
33,105
|
|
(1,788
|
)
|
54.6
|
%
|
56.2
|
%
|
|
Total
|
|
$
|
57,358
|
|
$
|
58,944
|
|
$
|
(1,586
|
)
|
100.0
|
%
|
100.0
|
%
|
Utility
Group.
Revenues increased $0.2 million, or 0.8%, to $26.0 million for the three
months ended September 30, 2007, from $25.8 million for the same period during
the prior year. The increase was primarily
due to the following:
•
a $0.1 million increase at our
California utility related to a $0.5 million increase in rates that went into
effect on July 1st of 2006, which was partially offset by decreased consumption
as a result of milder September weather; and
•
a $0.7 million increase at our Texas
utilities primarily resulting from a San Antonio, Texas and Mississippi area
utility acquisitions, an increase in customer connections, a fourth quarter
2006 rate increase at one of our other Texas utilities, and a rate increase at
our Alabama waste water treatment facility; offset by
•
a $0.6 million decrease due to lower
consumption attributable to the wet weather in the Texas region during the
third quarter of 2007.
Services
Group.
Revenues
decreased $1.8 million, or 5.4%, to $31.3 million for the three months ended
September 30, 2007 from $33.1 million for the same period during the prior
year. The decrease in revenues was
primarily due to the following:
|
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
|
Percent of Revenues
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from unaffiliated customers
|
|
$
|
30,562
|
|
$
|
31,711
|
|
$
|
(1,149
|
)
|
81.0
|
%
|
77.6
|
%
|
|
Intersegment revenues
|
|
7,161
|
|
9,158
|
|
(1,997
|
)
|
19.0
|
%
|
22.4
|
%
|
|
Total revenues
|
|
37,723
|
|
40,869
|
|
(3,146
|
)
|
100.0
|
%
|
100.0
|
%
|
|
Intersegment cost eliminations
|
|
(6,406
|
)
|
(7,764
|
)
|
1,358
|
|
|
|
|
|
|
Total
|
|
$
|
31,317
|
|
$
|
33,105
|
|
$
|
(1,788
|
)
|
|
|
|
|
Revenues from unaffiliated customers
decreased $1.1 million, or 3.6%, to $30.6 million for the three months ended
September 30, 2007 from $31.7 million for the same period during the prior
year. The decrease in revenues was
primarily due to the following:
•
a $2.9 million decrease in contract
operations, maintenance, public works and construction work in our southeast
region due to contracts not renewed or canceled; offset by
•
a $1.8 million increase related to
new contracts combined with our successful efforts to increase prices on some
of our current contracts.
25
Intersegment revenues from our Utility Group
decreased by $2.0 million, or 21.8%, to $7.2 million for the three months ended
September 30, 2007 from $9.2 million for the same period during the prior
year. The decrease in revenues resulted
from a decrease in construction projects performed for our New Mexico and Texas
utilities due to a slow down in housing construction as well as a reduction in
capital expenditures by our Texas utilities.
Direct Operating
Expenses.
Direct operating expenses decreased
$0.2 million, or 0.4%, to $43.6 million for the three months ended September
30, 2007 from $43.8 million for the same period during the prior year as
follows:
|
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
15,030
|
|
$
|
14,539
|
|
$
|
491
|
|
57.7
|
%
|
56.3
|
%
|
|
Services Group
|
|
28,608
|
|
29,272
|
|
(664
|
)
|
91.3
|
%
|
88.4
|
%
|
|
Total
|
|
$
|
43,638
|
|
$
|
43,811
|
|
$
|
(173
|
)
|
76.1
|
%
|
74.3
|
%
|
(1)
Utility Group and Services
Group direct operating expenses are computed as a percent of their respective
revenues. Total direct operating
expenses are computed as a percentage of total revenues.
Utility
Group.
Direct operating expenses increased $0.5 million, or 3.4%, to $15.0
million for the three months ended September 30, 2007, from $14.5 million for
the same period during the prior year.
The increase in direct operating expenses was primarily due to the
following:
•
a $0.4 million increase in expenses
at our New Mexico and Texas utilities resulting from a San Antonio, Texas and
Mississippi area utility acquisitions, an increase in depreciation expense, an
increase in contract operation fees, and higher sewage treatment expenses; and
•
a $0.1 million net increase in direct
operating expenses at our California utility principally resulting from an
increase in depreciation expense.
Direct operating expenses were 57.7% and 56.3%
of related revenues for the three months ended September 30, 2007 and 2006,
respectively, primarily as a result of increased costs at our New Mexico and
Texas facilities as mentioned above.
Services
Group.
Direct operating expenses decreased $0.7 million, or 2.3%, to $28.6
million for the three months ended September 30, 2007 from $29.3 million for
the same period during the prior year.
The decrease in direct operating expenses was due to the following:
•
a $3.5 million decrease related to
contracts not renewed or canceled in our southeast region; offset by
•
a $2.1 million increase in direct
costs associated with higher insurance costs and increased business activity;
and
•
a $0.7 million charge in anticipation
of a settlement for our share of potential fines and penalties imposed by a
water quality control board.
Direct operating expenses as a percentage of
the related revenues increased 2.9% to 91.3% for the three months ended
September 30, 2007 compared to 88.4% for the same period during the prior
year. Excluding the one-time $0.7
million charge, the operating expense percentage is 89.3% for the three months
ended September 30, 2007.
Gross Profit.
Gross
profit, which we define as the difference between revenues and the related
direct operating expenses, decreased $1.4 million, or 9.3%, to $13.7 million
for the three months ended September 30, 2007 from $15.1 million for the same
period during the prior year as follows:
26
|
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
11,011
|
|
$
|
11,300
|
|
$
|
(289
|
)
|
42.3
|
%
|
43.7
|
%
|
|
Services Group
|
|
2,709
|
|
3,833
|
|
(1,124
|
)
|
8.7
|
%
|
11.6
|
%
|
|
Total
|
|
$
|
13,720
|
|
$
|
15,133
|
|
$
|
(1,413
|
)
|
23.9
|
%
|
25.7
|
%
|
(1)
Utility Group and Services
Group gross profit is computed as a percent of their respective revenues after
intersegment eliminations. Total gross
profit is computed as a percentage of total revenues.
Utility
Group.
Gross profit was 42.3% and 43.7% of related revenues for the three
months ended September 30, 2007 and 2006, respectively, primarily related to
the wet weather in our Texas region as mentioned above.
Services
Group.
Gross
profit for the three months ended September 30, 2007 and 2006 was comprised of
the following:
|
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit on sales to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated customers
|
|
$
|
1,954
|
|
$
|
2,439
|
|
$
|
(485
|
)
|
6.4
|
%
|
7.7
|
%
|
|
Affiliated customers (intersegment)
|
|
755
|
|
1,394
|
|
(639
|
)
|
10.5
|
%
|
15.2
|
%
|
|
Total
|
|
$
|
2,709
|
|
$
|
3,833
|
|
$
|
(1,124
|
)
|
7.2
|
%
|
9.4
|
%
|
(1)
Gross profit is computed as a
percent of the respective revenues before intersegment eliminations.
Services Group gross profit on revenues from
unaffiliated customers decreased by $0.5 million, or 19.9%, to $2.0 million for
the three months ended September 30, 2007 from $2.4 million for the same period
during the prior year. Gross profit as a
percent of revenues for 2007 was 6.4%, compared to 7.7% for 2006. The decrease in gross margin percent is
primarily related to a slowdown in the housing market, less project work due to
wet weather and the $0.7 million one-time charge, partially offset by our
ongoing efforts to increase prices on our existing contracts.
Services Group gross profit on revenues from
our Utility Group decreased by $0.6 million, or 45.8% to $0.8 million for the
three months ended September 30, 2007 from $1.4 million for the same period
during the prior year. The decrease is
related to a reduction in construction projects for our Texas and New Mexico
utilities due to a slow down in housing construction as well as a reduction in
capital expenditures by our Texas utilities.
The Services Group supports three distinctly
different customer bases; Texas Municipal Utility Districts or MUD’s, municipal
clients through operations and maintenance contracts, and Southwest Water’s own
Utility Group. We need to accelerate our
performance improvements and therefore we plan to refocus this Group in early
2008 along these business lines to better serve the unique demands of each
customer base, to focus our business development efforts for each market and to
eliminate structural redundancies that may exist today.
Selling,
General and Administrative Expenses.
Selling, general and administrative expenses
increased $1.3 million, or 18.6%, to $8.4 million for the three months
ended September 30, 2007 compared to $7.1 million for the same period during
the prior year as follows:
|
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
1,852
|
|
$
|
1,787
|
|
$
|
65
|
|
7.1
|
%
|
6.9
|
%
|
|
Services Group
|
|
2,964
|
|
2,650
|
|
314
|
|
9.5
|
%
|
8.0
|
%
|
|
Corporate
|
|
3,621
|
|
2,678
|
|
943
|
|
—
|
|
—
|
|
|
Total
|
|
$
|
8,437
|
|
$
|
7,115
|
|
$
|
1,322
|
|
14.7
|
%
|
12.1
|
%
|
(1)
Utility Group and Services
Group expenses are computed as a percent of their respective revenues. Total expenses are computed as a percentage
of total revenues.
27
Selling, general and administrative expenses
are relatively fixed in nature and do not fluctuate significantly with changes
in revenues. The Utility Group increase
is primarily caused by legal costs incurred in connection with the condemnation
proceedings against our New Mexico utility.
In accordance with New Mexico statute, costs incurred during the quarter
aggregating $0.1 million ($0.4 million incurred to date) are expected to be
reimbursed to us by the parties seeking condemnation should we prevail in the
action. The Services Group expense
increase resulted from higher salary, wages and related benefits attributable
to upgrades in management and staff positions.
The Corporate increase is a result of $0.4 million related to higher
salary, wages and related benefits attributable to new and upgraded management
positions and $0.5 million of costs related to our Cornerstone project incurred
during the third quarter of 2007.
The Cornerstone project is a company-wide
initiative to reengineer our business processes and integrate our information
systems onto a single platform across the entire company utilizing
state-of-the-art systems and technology.
Our existing systems are inefficient because, for the most part, they
are standalone legacy systems that were in place when we acquired many of our
companies. These individual standalone
systems are costly to operate and maintain and make the consolidation and
sharing of data between the various platforms labor intensive and
time-consuming.
We are investing in this new technology to
enable us to gather and disseminate information on a more timely basis at reduced
costs thereby improving customer service and enhancing operational
efficiencies. Although expenditures
related to the information technology hardware and software portions of this
initiative are capitalized, certain costs are expensed as incurred. We expect
to recover a portion of our Cornerstone investment through the rates of our
owned utility portfolio due to the customer service enhancements and we also
believe the rest of the investment will result in cost savings in the Services
Group, resulting in improved margins.
Impairment
of Goodwill.
During the three months ended September 30, 2006, we recorded impairment
charges totaling $0.3 million, related to our water and wastewater testing
laboratory.
Other Income
(Expense).
Other expense decreased $0.1 million, or 1.5%, to $1.9 million for the
three months ended September 30, 2007, compared to $2.0 million for the same
period during the prior year as follows:
|
|
|
Three Months Ended
|
|
|
|
|
|
|
September 30,
|
|
(Increase)
|
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
Decrease
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
$
|
(2,182
|
)
|
$
|
(2,081
|
)
|
$
|
(101
|
)
|
|
Interest income
|
|
291
|
|
108
|
|
183
|
|
|
Other, net
|
|
(41
|
)
|
11
|
|
(52
|
)
|
|
Total
|
|
$
|
(1,932
|
)
|
$
|
(1,962
|
)
|
$
|
30
|
|
Interest
Expense.
Interest expense increased $0.1 million, or 4.9%, to $2.2 million for
the three months ended September 30, 2007, from $2.1 million for the same
period during the prior year. The major
components of interest expense were as follows:
|
|
|
Three Months Ended
|
|
|
|
|
|
|
September 30,
|
|
|
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage bonds and bank term loans
|
|
$
|
1,188
|
|
$
|
1,215
|
|
$
|
(27
|
)
|
|
Revolving lines of credit
|
|
875
|
|
647
|
|
228
|
|
|
Convertible subordinated debentures
|
|
208
|
|
221
|
|
(13
|
)
|
|
Other indebtedness
|
|
153
|
|
202
|
|
(49
|
)
|
|
Total interest incurred
|
|
2,424
|
|
2,285
|
|
139
|
|
|
Less capitalized interest
|
|
(242
|
)
|
(204
|
)
|
(38
|
)
|
|
Total interest expense
|
|
$
|
2,182
|
|
$
|
2,081
|
|
$
|
101
|
|
28
The change in total interest incurred is
primarily due to an increase in borrowing levels on our revolving line of
credit, offset by reduced borrowings related to our other indebtedness as well
as higher levels of capitalized interest on long-term capital projects,
including the Cornerstone project. The
average balance of interest bearing debt outstanding increased to $144.9
million during the three months ended September 30, 2007 compared to $130.4
million for the prior year. The
additional borrowings were used to fund capital expenditures and acquisitions
as well as to fund the capital and expense portions of the Cornerstone
project. The weighted average interest
rate on total borrowings was approximately 6.0% for the three months ended
September 30, 2007 and 6.4% for the same period last year.
Interest
Income.
Interest income increased $0.2 million for the three months ended
September 30, 2007 principally as a result of receiving $0.2 million of
interest with the final contract retainage payment on the Capistrano Valley
Water District construction project.
Provision for Income
Taxes.
Our
effective consolidated income tax rate increased to 38.1% for the three months
ended September 30, 2007 compared to 36.6% for the prior year as a result of an
increase in our effective state income tax rate attributable to changes in
state apportionment factors.
Nine Months
Ended September 30, 2007 Compared to 2006
Revenues.
Revenues decreased $2.4 million, or 1.5%, to
$160.4 million for nine months ended September 30, 2007 from $162.8 million for
the same period during the prior year.
By segment, revenues changed as follows:
|
|
|
Nine
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
69,629
|
|
$
|
64,602
|
|
$
|
5,027
|
|
43.4
|
%
|
39.7
|
%
|
|
Services Group
|
|
90,778
|
|
98,232
|
|
(7,454
|
)
|
56.6
|
%
|
60.3
|
%
|
|
Total
|
|
$
|
160,407
|
|
$
|
162,834
|
|
$
|
(2,427
|
)
|
100.0
|
%
|
100.0
|
%
|
Utility
Group.
Revenues increased $5.0 million, or 7.8%, to $69.6 million for the nine
months ended September 30, 2007, from $64.6 million for the same period during
the prior year. The increase was
primarily due to the following:
•
a $4.3 million increase at our
California utility related to increased consumption and an increase in rates
that went into effect on July 1st of 2006; and
•
a $1.6 million increase at our Texas
utilities primarily resulting from a San Antonio, Texas and Mississippi area
utility acquisitions, an increase in customer connections, a fourth quarter
2006 rate increase at one of our other Texas utilities, and a rate increase at
our Alabama waste water treatment facility; offset by
•
a $0.9 million decrease due to lower
consumption attributable to the wet weather in the Texas region during the
third quarter of 2007.
Services
Group.
Revenues
decreased $7.5 million, or 7.6%, to $90.8 million for the nine months ended
September 30, 2007 from $98.2 million for the same period during the prior
year. The decrease in revenues was
primarily due to the following:
|
|
|
Nine
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
|
Percent of Revenues
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from unaffiliated customers
|
|
$
|
87,794
|
|
$
|
93,783
|
|
$
|
(5,989
|
)
|
81.0
|
%
|
78.2
|
%
|
|
Intersegment revenues
|
|
20,645
|
|
26,217
|
|
(5,572
|
)
|
19.0
|
%
|
21.8
|
%
|
|
Total revenues
|
|
108,439
|
|
120,000
|
|
(11,561
|
)
|
100.0
|
%
|
100.0
|
%
|
|
Intersegment cost eliminations
|
|
(17,661
|
)
|
(21,768
|
)
|
4,107
|
|
|
|
|
|
|
Total
|
|
$
|
90,778
|
|
$
|
98,232
|
|
$
|
(7,454
|
)
|
|
|
|
|
29
Revenues from unaffiliated customers decreased
$6.0 million, or 6.4%, to $87.8 million for the nine months ended September 30,
2007 from $93.8 million for the same period during the prior year. The decrease in revenues was primarily due to
the following:
•
a $7.4 million decrease in contract
operations, maintenance, public works and construction work in our southeast
region due to contracts not renewed or canceled; and
•
a $1.4 million decrease related to
lower revenues from new housing construction due to a slowdown in housing
starts as well as inclement weather compared to the prior year; offset by
•
a $2.8 million increase related to
increased business activity combined with our ongoing efforts to review our
contracts and increase prices.
Intersegment revenues from our Utility Group
decreased by $5.6 million, or 21.3%, to $20.6 million for the nine months ended
September 30, 2007 from $26.2 million for the same period during the prior
year. The decrease in revenues resulted
from a decrease in construction projects performed for our New Mexico and Texas
utilities due to a slow down in housing construction as well as a reduction in
capital expenditures by our Texas utilities.
Direct Operating
Expenses.
Direct operating expenses decreased
$1.1 million, or 0.9%, to $120.4 million for the nine months ended September
30, 2007 from $121.5 million for the same period during the prior year as
follows:
|
|
|
Nine
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
39,619
|
|
$
|
35,442
|
|
$
|
4,177
|
|
56.9
|
%
|
54.9
|
%
|
|
Services Group
|
|
80,733
|
|
86,021
|
|
(5,288
|
)
|
88.9
|
%
|
87.6
|
%
|
|
Total
|
|
$
|
120,352
|
|
$
|
121,463
|
|
$
|
(1,111
|
)
|
75.0
|
%
|
74.6
|
%
|
(1)
Utility Group and Services
Group direct operating expenses are computed as a percent of their respective
revenues. Total direct operating
expenses are computed as a percentage of total revenues.
Utility
Group.
Direct operating expenses increased $4.2 million, or 11.8%, to $39.6
million for the nine months ended September 30, 2007, from $35.4 million for
the same period during the prior year.
The increase in direct operating expenses was primarily due to the
following:
•
a $1.7 million increase in expenses
at our New Mexico and Texas utilities resulting from a San Antonio, Texas and
Mississippi area utility acquisitions, an increase in depreciation expense, an
increase in contract operation fees, and higher sewage treatment expenses;
•
a $1.7 million net increase in direct
operating expenses at our California utility principally resulting from higher
water usage related to increased consumption and higher depreciation rates
adopted under the rate case that went into effect on July 1, 2006; and
•
a $0.8 million increase resulting
from the one-time recognition of a balancing account receivable in 2006 by our
California utility pursuant to a CPUC decision which was recognized as a
reduction of operating expenses.
Direct operating expenses were 56.9% and
54.9% of related revenues for the nine months ended September 30, 2007 and
2006, respectively, primarily as a result of the recognition of a balancing
account receivable in 2006 as mentioned above.
Excluding the balancing account, direct operating expenses as a percent
of revenue were 56.1% for the nine months ended September 30, 2006.
Services
Group.
Direct operating expenses decreased $5.3 million, or 6.1%, to $80.7
million for the nine months ended September 30, 2007 from $86.0 million for the
same period during the prior year. The
decrease in direct operating expenses was due to the following:
30
•
a $7.8 million decrease related to
contracts not renewed or canceled in our southeast region net of cost increases
to correct past performance issues in that region; and
•
a $1.1 million decrease primarily
related to lower revenues from new housing construction-related work compared
to the prior year due to inclement weather and a slowdown in the housing market
in Texas; partially offset by
•
a $2.9 million increase in direct
costs associated with increased business activity; and
•
a $0.7 million charge in anticipation
of a settlement for our share of potential fines and penalties imposed by a
water quality control board.
Direct operating expenses as a percentage of
the related revenues increased 1.3% to 88.9% for the nine months ended
September 30, 2007 compared to 87.6% for the same period during the prior
year. Excluding the one-time $0.7
million charge, the operating expense percentage is 88.2% for the nine months
ended September 30, 2007.
Gross Profit.
Gross
profit, which we define as the difference between revenues and the related
direct operating expenses, decreased $1.3 million, or 3.2%, to $40.1 million
for the nine months ended September 30, 2007 from $41.4 million for the same
period during the prior year as follows:
|
|
|
Nine
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
30,010
|
|
$
|
29,160
|
|
$
|
850
|
|
43.1
|
%
|
45.1
|
%
|
|
Services Group
|
|
10,045
|
|
12,211
|
|
(2,166
|
)
|
11.1
|
%
|
12.4
|
%
|
|
Total
|
|
$
|
40,055
|
|
$
|
41,371
|
|
$
|
(1,316
|
)
|
25.0
|
%
|
25.4
|
%
|
(1)
Utility Group and Services
Group gross profit is computed as a percent of their respective revenues after
intersegment eliminations. Total gross
profit is computed as a percentage of total revenues.
Utility
Group.
Gross profit was 43.1% and 45.1% of related revenues for the nine months
ended September 30, 2007 and 2006, respectively, primarily related to the
recognition of a balancing account receivable in 2006 as mentioned above. Excluding the balancing account, gross profit
as a percent of revenue was 43.9% for the nine months ended September 30, 2006.
Services
Group.
Gross
profit for the nine months ended September 30, 2007 and 2006 was comprised of
the following:
|
|
|
Nine
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September
30,
|
|
Increase
|
|
Percent
of Revenues (1)
|
|
|
(In thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit on sales to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated customers
|
|
$
|
7,061
|
|
$
|
7,762
|
|
$
|
(701
|
)
|
8.0
|
%
|
8.3
|
%
|
|
Affiliated customers (intersegment)
|
|
2,984
|
|
4,449
|
|
(1,465
|
)
|
14.5
|
%
|
17.0
|
%
|
|
Total
|
|
$
|
10,045
|
|
$
|
12,211
|
|
$
|
(2,166
|
)
|
9.3
|
%
|
10.2
|
%
|
(1)
Gross profit is computed as a
percent of the respective revenues before intersegment eliminations.
Services Group gross profit on revenues from
unaffiliated customers decreased by $0.7 million, or 9.0%, to $7.1 million for
the nine months ended September 30, 2007 from $7.8 million for the same period
during the prior year. Gross profit as a
percent of revenues for 2007 was 8.0%, compared to 8.3% for 2006. The decrease in gross margin percent is
primarily related to the slowdown in the housing market as mentioned above.
31
Services Group gross profit on revenues from
our Utility Group decreased by $1.5 million, or 32.9% to $3.0 million for the
nine months ended September 30, 2007 from $4.4 million for the same period
during the prior year. The decrease is
related to a slow down in housing construction as well as a reduction in
capital expenditures by our Texas utilities.
The Services Group supports three distinctly
different customer bases; Texas Municipal Utility Districts or MUD’s, municipal
clients through operations and maintenance contracts, and Southwest Water’s own
Utility Group. We need to accelerate our
performance improvements and therefore we plan to refocus this Group in early
2008 along these business lines to better serve the unique demands of each
customer base, to focus our business development efforts for each market and to
eliminate structural redundancies that may exist today.
Selling,
General and Administrative Expenses.
Selling, general and administrative expenses
increased $1.6 million, or 6.4%, to $26.3 million for the nine months
ended September 30, 2007 compared to $24.7 million for the same period during
the prior year as follows:
|
|
|
Nine
Months Ended
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
Increase
|
|
Percent of Revenues (1)
|
|
|
(In
thousands, except percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
6,241
|
|
$
|
5,870
|
|
$
|
371
|
|
9.0
|
%
|
9.1
|
%
|
|
Services Group
|
|
9,213
|
|
8,692
|
|
521
|
|
10.1
|
%
|
8.8
|
%
|
|
Corporate
|
|
10,828
|
|
10,146
|
|
682
|
|
—
|
|
—
|
|
|
Total
|
|
$
|
26,282
|
|
$
|
24,708
|
|
$
|
1,574
|
|
16.4
|
%
|
15.2
|
%
|
(1)
Utility Group and Services
Group expenses are computed as a percent of their respective revenues. Total expenses are computed as a percentage
of total revenues.
Selling, general and administrative expenses
are relatively fixed in nature and do not fluctuate significantly with changes
in revenues. The Utility Group increase
is caused primarily by legal costs incurred in connection with the condemnation
proceedings against our New Mexico utility.
In accordance with New Mexico statute, costs incurred aggregating $0.4
million through September 30, 2007 are expected to be reimbursed to us by the
parties seeking condemnation should we prevail in the action. The Services Group expense increase resulted
from higher salary, wages and related benefits attributable to upgrades in
management and staff positions.
Corporate expenses increased as result of $0.9 million of costs incurred
related to our Cornerstone project which commenced in the second quarter of
2007 and higher salary, wages and related benefits attributable to upgrades in
management and staff positions, partially offset by $0.7 million of CEO
relocation expenses incurred in 2006.
The Cornerstone project is a company-wide
initiative to reengineer our business processes and integrate our information
systems onto a single platform across the entire company utilizing
state-of-the-art systems and technology.
Our existing systems are inefficient because, for the most part, they
are standalone legacy systems that were in place when we acquired many of our
companies. These individual standalone
systems are costly to operate and maintain and make the consolidation and
sharing of data between the various platforms labor intensive and time-consuming.
We are investing in this new technology to
enable us to gather and disseminate information on a more timely basis at
reduced costs thereby improving customer service and enhancing operational
efficiencies. Although expenditures
related to the information technology hardware and software portions of this
initiative are capitalized, certain costs are expensed as incurred. We expect
to recover a portion of our Cornerstone investment through the rates of our
owned utility portfolio due to the customer service enhancements and we also
believe the rest of the investment will result in cost savings in the Services
Group, resulting in improved margins.
Impairment
of Goodwill.
During the nine months ended September 30, 2006, we recorded impairment
charges totaling $0.9 million, primarily related to our water and wastewater
testing laboratory.
32
Other Income
(Expense).
Other expenses were $6.0 million for the nine months ended September 30,
2007 and 2006 as follows:
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
September 30,
|
|
(Increase)
|
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
Decrease
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
$
|
(6,376
|
)
|
$
|
(6,333
|
)
|
$
|
(43
|
)
|
|
Interest income
|
|
507
|
|
363
|
|
144
|
|
|
Other, net
|
|
(102
|
)
|
—
|
|
(102
|
)
|
|
Total
|
|
$
|
(5,971
|
)
|
$
|
(5,970
|
)
|
$
|
(1
|
)
|
Interest
Expense.
Interest expense was flat for the nine months ended September 30, 2007
compared to the same period during the prior year. The major components of interest expense were
as follows:
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
September 30,
|
|
|
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage bonds and bank term loans
|
|
$
|
3,581
|
|
$
|
3,648
|
|
$
|
(67
|
)
|
|
Revolving lines of credit
|
|
2,324
|
|
1,776
|
|
548
|
|
|
Convertible subordinated debentures
|
|
636
|
|
726
|
|
(90
|
)
|
|
Other indebtedness
|
|
492
|
|
610
|
|
(118
|
)
|
|
Total interest incurred
|
|
7,033
|
|
6,760
|
|
273
|
|
|
Less capitalized interest
|
|
(657
|
)
|
(427
|
)
|
(230
|
)
|
|
Total interest expense
|
|
$
|
6,376
|
|
$
|
6,333
|
|
$
|
43
|
|
The change in total interest incurred is
primarily due to an increase in borrowing levels on our revolving line of
credit, offset by a decrease in borrowing levels related to our other
indebtedness as well as higher levels of capitalized interest on long-term
capital projects, including the Cornerstone project. The average balance of interest bearing debt
outstanding increased to $142.3 million during the nine months ended September
30, 2007 compared to $130.9 million for the prior year.
The additional borrowings were used to fund
capital expenditures and acquisitions as well as to fund the capital and
expense portions of the Cornerstone project.
The weighted average interest rate on total borrowings was approximately
6.0% for the nine months ended September 30, 2007 and 6.4% for the same period
in the prior year.
Interest
Income.
Interest income increased $0.1 million for the nine months ended
September 30, 2007 principally as a result of receiving $0.2 million of
interest with the final contract retainage payment on the Capistrano Valley
Water District construction project.
Provision for Income
Taxes.
Our
effective consolidated income tax rate increase to 37.0% for the nine months
ended September 30, 2007 compared to 36.6% for the prior year as a result of an
increase in our effective state income tax rate attributable to changes in
state apportionment factors.
NEW
ACCOUNTING GUIDANCE AND PRONOUNCEMENTS ADOPTED DURING 2007
SFAS No. 158
In September 2006, the Financial Accounting
Standards Board (“FASB”) issued SFAS No. 158,
Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans – an
amendment of FASB Statements No. 87, 88, 106, and 132(R)
(“SFAS 158”). This statement requires balance sheet
recognition of the funded status of pension and postretirement benefit
plans. Under SFAS 158, actuarial gains
and losses, prior service costs or credits, and any remaining transition assets
or obligations that have not been recognized under previous accounting
standards must be recognized in accumulated other comprehensive income (loss),
net of tax effects, until they are amortized as a component of net periodic
benefit cost. The balance sheet
recognition provisions of SFAS 158 were effective for our fiscal year ended
December 31, 2006 and, as a result, we began recognizing the unamortized portion
of actuarial gains and prior service costs in accumulated other comprehensive
income. The adoption of SFAS 158 did not
have a material effect on our consolidated financial statements.
33
FIN No. 48
On January 1, 2007, we adopted the provisions
of FASB Interpretation No. 48,
Accounting for Uncertainty
in Income Taxes
(“FIN 48”).
This interpretation clarifies the accounting for uncertainty in income
taxes recognized in a company’s financial statements in accordance with SFAS
No. 109,
Accounting for Income Taxes
(“SFAS 109”). FIN 48 requires companies to recognize
the financial statement benefit of a tax position only after determining the
relevant tax authority would “more likely than not” sustain the position
following an examination by the taxing authority. For tax positions meeting the
more-likely-than-not threshold, the amount recognized in the financial
statements is the largest benefit that has a greater than 50% likelihood of
being realized upon settlement with the relevant taxing authority.
As of December 31, 2006 and September 30,
2007, our liabilities for uncertain tax positions were not significant. Our policy is to recognize interest and
penalties related to liabilities for uncertain tax benefits in the income tax
expense line-item of the consolidated statements of income. Net interest and penalties incurred during
the three months and nine months ended September 30, 2007 and 2006 were
insignificant.
We are subject to federal and various state
and local income taxes. Tax regulations
within each jurisdiction are subject to the interpretation of related tax laws
and regulations and require significant judgment to apply. We are no longer subject to federal, state
and local income tax return examinations by taxing authorities for years before
2002. Our federal income tax returns for
the 2002 through 2004 tax years were recently examined by the Internal Revenue
Service. The examination was concluded
in February 2007 and resulted in no net change for the tax years examined. State and local income tax returns from 2002
to the present and federal income tax returns from 2005 to the present are
still subject to examinations by taxing authorities.
RECENT
ACCOUNTING PRONOUNCEMENTS
SFAS No. 157
In September 2006, the FASB issued SFAS No.
157,
Fair Value Measurements
(“SFAS 157”). This statement establishes a single
authoritative definition of fair value, sets out framework for establishing
fair value, and requires additional disclosures about fair value measurements. This statement applies only to fair value
measurements that are already required or permitted by other accounting
standards and is expected to increase the consistency of those
measurements. Adoption of SFAS 157 is
required for our fiscal year beginning January 1, 2008, and will be applied
prospectively under most circumstances.
While we are still evaluating the impact this statement will have on our
consolidated financial statements, we currently believe the impact will not be
material.
SFAS No. 159
In February 2007, the FASB issued SFAS No.
159,
The Fair Value Option for Financial Assets and
Financial Liabilities – Including an amendment of FASB Statement No. 115
(“SFAS 159”). This statement permits
companies to choose to measure many financial instruments and other specified
items at fair value. This statement is
effective for our fiscal year beginning January 1, 2008 and will be applied
prospectively. While we are still
evaluating the impact this statement will have on our consolidated financial
statements, we currently believe the impact will not be material.
34
LIQUIDITY
AND CAPITAL RESOURCES
Our overall objectives with respect to
liquidity and capital resources are to:
•
generate sufficient operating cash
flows to service our debt and tax obligations, fund capital improvements and
organic growth, and pay dividends to our stockholders;
•
utilize our credit facility for major
capital improvements and to manage seasonal cash needs;
•
obtain external financing for major
acquisitions; and
•
maintain approximately equal levels
of debt and equity consistent with the investor-owned water utility industry.
Our statements of cash flows are summarized
as follows:
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
September 30,
|
|
|
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in):
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
17,995
|
|
$
|
17,861
|
|
$
|
134
|
|
|
Investing activities
|
|
(36,458
|
)
|
(32,094
|
)
|
(4,364
|
)
|
|
Financing activities
|
|
16,588
|
|
14,695
|
|
1,893
|
|
|
Increase (decrease) in cash and cash
equivalents
|
|
$
|
(1,875
|
)
|
$
|
462
|
|
$
|
(2,337
|
)
|
Cash Flows From Operating Activities.
Net cash provided by operating activities was
comparable between periods. Operational
aspects of our businesses that affected working capital in 2007 versus 2006 are
highlighted below:
•
increased level of vendor payments in
2007 for goods and services used during the fourth quarter of 2006; offset by
•
increased revenues generated by our
California and Texas utilities resulting from rate increases.
Cash Flows From Investing Activities.
Cash used in investing activities totaled
$36.5 million for the nine months ended September 30, 2007 compared to $32.1
million for the same period during the prior year as follows:
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
September 30,
|
|
|
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows (used in) provided by investing
activities:
|
|
|
|
|
|
|
|
|
Additions to property, plant and equipment
|
|
$
|
(29,953
|
)
|
$
|
(29,699
|
)
|
$
|
(254
|
)
|
|
Acquisition of businesses, net of cash
acquired
|
|
(6,547
|
)
|
(1,809
|
)
|
(4,738
|
)
|
|
Purchase of minority interest
|
|
—
|
|
(1,013
|
)
|
1,013
|
|
|
Proceeds from sales of land
|
|
42
|
|
427
|
|
(385
|
)
|
|
Net cash used in investing activities
|
|
$
|
(36,458
|
)
|
$
|
(32,094
|
)
|
$
|
(4,364
|
)
|
The following table summarizes additions to
property, plant and equipment additions for 2007 and 2006.
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
Company-financed additions
|
|
$
|
26,547
|
|
$
|
24,100
|
|
|
Capital improvement reimbursements
|
|
1,849
|
|
2,630
|
|
|
Cash contributions received in aid of
construction
|
|
1,557
|
|
2,969
|
|
|
Total cash additions to property, plant and
equipment
|
|
29,953
|
|
29,699
|
|
|
Non-cash contributions in aid of
construction
|
|
5,875
|
|
5,823
|
|
|
Total additions to property, plant and
equipment
|
|
$
|
35,828
|
|
$
|
35,522
|
|
35
Capital projects primarily relate to the
expansion, replacement and renovation of our water and wastewater systems,
particularly at our California, Texas and New Mexico utilities and, in 2007,
include $6.3 million of expenditures related to our Cornerstone project. Contributions in Aid of Construction (“CIAC”)
represent contributions in the form of cash, services or property received from
developers, governmental agencies, municipalities or individuals for the
purpose of constructing utility plant and is not refundable. In 2007, we expect to spend approximately
$37.0 million on cash additions, principally within our Utility Group, and
expect to receive $7.0 million of CIAC resulting in total expected additions to
property, plant and equipment of approximately $44.0 million.
During 2007, we have acquired a small water
and wastewater utility located in northern Mississippi, just south of Memphis,
Tennessee and two water and wastewater utilities near San Antonio, Texas for an
aggregate $6.5 million in cash. During
2006 we acquired two small water utilities and the rights to provide water and
wastewater utility service in developing areas located near Austin, Texas for
an aggregate $1.8 million in cash. In
2006, we also acquired the remaining 10% interest in Operations Technology,
Inc. that we did not already own for $1.0 million in cash. We expect we will continue to make
substantial investments in acquisitions in the future.
Cash Flows From Financing Activities.
During 2007 we have financed our growth
through a broad range of capital initiatives:
•
borrowed $16.0 million under our
revolving line of credit;
•
received $3.0 million of capital
improvement reimbursements and contributions in aid of construction; and
•
received $2.8 million of proceeds
from our direct stock purchase plan, our employee stock purchase and option
plans and our director option plan.
Revolving line of borrowings were primarily
used to fund our investing activities and, to a lesser extent, to fund
operations. Additional borrowing
availability under our revolving credit facility was $46.0 million as of
September 30, 2007.
During the nine months ended September 30,
2007, we paid dividends totaling $4.2 million and our quarterly dividend rate
is currently $0.0576 per common share.
36
CONTRACTUAL
OBLIGATIONS
The following table summarizes our known
contractual obligations to make future cash payments as of September 30,
2007, as well as an estimate of the periods during which these payments are
expected to be made.
|
|
|
Years Ending December 31,
|
|
|
|
|
|
|
Remainder
|
|
2008
|
|
2010
|
|
2012
|
|
|
|
|
|
|
of
|
|
and
|
|
and
|
|
and
|
|
|
(In
thousands)
|
|
Total
|
|
2007
|
|
2009
|
|
2011
|
|
Beyond
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank line of credit (2)
|
|
$
|
52,000
|
|
$
|
—
|
|
$
|
—
|
|
$
|
52,000
|
|
$
|
—
|
|
|
Mortgage bonds (3)
|
|
45,000
|
|
—
|
|
—
|
|
—
|
|
45,000
|
|
|
Bank term loans (4)
|
|
32,001
|
|
205
|
|
1,645
|
|
1,646
|
|
28,505
|
|
|
Convertible subordinated debentures (5)
|
|
12,060
|
|
—
|
|
—
|
|
—
|
|
12,060
|
|
|
Economic development revenue bonds (6)
|
|
2,030
|
|
105
|
|
235
|
|
260
|
|
1,430
|
|
|
Notes payable and other (7)
|
|
709
|
|
127
|
|
582
|
|
—
|
|
—
|
|
|
Total long-term debt
|
|
143,800
|
|
437
|
|
2,462
|
|
53,906
|
|
86,995
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayment of advances for construction (8)
|
|
8,975
|
|
518
|
|
1,538
|
|
928
|
|
5,991
|
|
|
Water purchase commitment (9)
|
|
7,742
|
|
115
|
|
920
|
|
920
|
|
5,787
|
|
|
Lease assignment obligations (10)
|
|
1,084
|
|
47
|
|
1,037
|
|
—
|
|
—
|
|
|
Operating lease obligations
|
|
26,937
|
|
1,639
|
|
8,367
|
|
5,436
|
|
11,495
|
|
|
Total obligations as of September 30, 2007
(11)
|
|
$
|
188,538
|
|
$
|
2,756
|
|
$
|
14,324
|
|
$
|
61,190
|
|
$
|
110,268
|
|
(1)
Excludes interest payments,
which are described in the following notes.
The terms of the long-term debt are more fully described in the notes to
the consolidated financial statements included in this report and our 2006
Annual Report on Form 10-K.
(2)
The bank lines of credit bear
interest at variable rates and therefore the amount of future interest payments
are uncertain. Borrowings bear interest,
at our option, based on a margin either: a) over the LIBOR rate; or b) under
the prime rate. The margins vary based
on our consolidated debt to equity ratio.
The weighted-average interest rate on our bank line of credit borrowings
was 6.32% as of September 30, 2007.
(3)
Interest on the mortgage
bonds is fixed at a weighted-average annual interest rate of 6.52% and is
payable semiannually.
(4)
Interest on the bank term
loans is fixed at a weighted-average annual interest rate of 6.54% and is
payable monthly.
(5)
Interest on the convertible
debentures is fixed at a 6.85% annual rate and is payable quarterly. The debentures are convertible, at the option
of the holder, into shares of our common stock at any time prior to their
maturity.
(6)
Interest on the economic
development bonds is fixed at a weighted-average annual interest rate of 5.95%
and is payable semiannually.
(7)
Interest is payable either
monthly or quarterly at rates ranging from 5.0% to 8.0% per year.
(8)
Advances for construction are
non-interest bearing.
(9)
Reflects the minimum annual
contractual commitment to purchase water through 2024. The amount is subject to increases in future
periods for production costs increases and may also increase, but not decrease,
if average actual usage exceeds a specified amount.
(10)
Interest on the lease
assignment obligations is fixed at a weighted-average interest rate of 8.39%
and is payable monthly.
(11)
Excludes preferred stock
dividend obligations. Preferred
stockholders are entitled to receive annual dividends of $2.625 per share and
there are 9,155 shares of preferred stock outstanding as of September 30,
2007. The preferred stock is redeemable
by the Company at any time for $52.00 per share and, from time to time, we have
elected to repurchase shares offered to us by preferred stockholders at prices
less than $52.00 per share.
FINANCIAL
CONDITION AND LIQUIDITY
As of September 30, 2007, we had $7.8 million
of working capital and $1.8 million of operating lease and water purchase obligations
payable during the remainder of 2007. As
of September 30, 2007, we also had $46.0 million of additional borrowings
available under our line of credit facility, which expires on April 1, 2010. In addition to our line of credit, our
California and New Mexico mortgage bond indentures permit the issuance of an
additional $90.2 million of first mortgage bonds as of September 30,
2007. However, the terms of our credit
facility do not permit additional first mortgage bond indebtedness without
prior consent from the credit facility lenders.
The mortgage bond indentures also limit the amount of cash and property
dividends our California and New Mexico utilities may pay to the parent company
to fund its payment obligations.
Dividends have averaged $4.0 to $5.0 million per year and are
37
less than the aggregate cumulative dividend
restriction threshold by $49.8 million as of September 30, 2007. We were in compliance with all loan agreement
covenants during the nine months ended September 30, 2007.
We also have on file a registration statement
with the Securities and Exchange Commission, which is effective for the
issuance of up to $50.0 million aggregate principal amount of common stock,
debt securities and warrants. To date we
have issued approximately $43.6 million of common stock under the shelf
registration, and about $6.4 million remains available for issuance as of
September 30, 2007. We may offer any of
these securities for sale at any time and from time to time.
We believe that our expected operating cash
flows, together with borrowings under our credit facility ($46.0 million of
which was available as of September 30 2007 and expires on April 1, 2010) will
be sufficient to meet our operating expenses, working capital and capital
expenditure requirements as well as our debt service and other contractual
obligations for the next twelve months.
However, our ability to comply with debt financial covenants, pay principal
or interest and refinance our debt obligations will depend on our future
operating performance as well as competitive, legislative, regulatory, business
and other factors beyond our control.
CERTAIN
CONTRACTUAL COMMITMENTS AND INDEMNITIES
In 2002, we were retained to facilitate the engineering
and construction of a $23.0 million reverse osmosis water treatment plant in
the city of San Juan Capistrano, California for the Capistrano Valley Water
District (“CVWD”). In 2003, we obtained
a $3.4 million standby letter of credit as collateral to insure our performance
during the design and construction of the water treatment plant. Construction was completed during 2005 and
the $3.4 million standby letter of credit was released on May 3, 2007. We obtained final acceptance of the completed
project from the CVWD and payment of the final $2.3 million of the total
contract price in July 2007.
We now operate the completed plant under a
twenty-year operating agreement. The
CVWD service contract contains three guarantees related to our performance
during the term of the operating agreement.
The agreement provides for liquidated damages in the event we fail to
perform for reasons other than those caused by “uncontrollable circumstances,”
as such term is defined in the agreement.
During the term of the operating agreement,
we may be liable for liquidated damages relating to any lost payments from a
financial assistance agreement CVWD has with a state water agency, up to a
maximum of $1.4 million per contract year.
We have also made guarantees to CVWD with respect to the quantity of
finished water produced by the facility.
In the event the actual number of acre feet of finished water delivered
is less than the water delivery guarantee, we are required to pay liquidated
damages of approximately $600 per acre foot of shortfall, up to a maximum of
15.8 acre feet per day. Finally, we have
made guarantees with respect to seven measurable finished water quality
standards. Liquidated damages for
failure to meet these quality standards range from $100 to $400 per day per
failed quality standard (up to a maximum of $2,800 per day), depending on the
number of violations per contract year.
The CVWD has not asserted any claims for liquidated damages pursuant to
these guarantees through the date of this report.
As part of the financing for this project,
the CVWD sold insured municipal bonds.
We entered into an agreement with the bond insurer to guarantee our
performance under the service contract, subject to certain liability caps to
the bond insurer in the event of a default.
During the twenty-year operation of the facility, such liability caps
will not exceed an amount equal to $4.0 million plus an amount no greater than
the replacement cost of the actual reverse osmosis filtration unit within the
facility, estimated to be approximately $1.5 million.
As of September 30 2007, we had irrevocable
standby letters of credit in the amount of $2.0 million issued and outstanding
under our credit facility.
During our normal course of business, we have
entered into agreements containing indemnities pursuant to which we may be
required to make payments in the future.
These indemnities are in connection with facility leases and liabilities
and operations and maintenance and construction contracts entered into by our Services
Group. The duration of these
indemnities, commitments and guarantees varies, and in certain cases, is
indefinite. Substantially all of these
indemnities provide no limitation on the maximum potential future payments we
could be obligated to make and is not quantifiable. We have not recorded any liability for these
indemnities.
38
In connection with the sale of a subsidiary
in 2005, we made indemnities to the buyer with respect to a number of customary,
and certain other specific, representations and warranties. Our indemnities with respect to these matters
are limited in terms of duration to periods ranging from one year to the
expiration of the applicable statue of limitations.
OFF-BALANCE
SHEET ARRANGEMENTS
Through the date of this report, we did not
have any relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. In addition, we do not engage
in trading activities involving non-exchange traded contracts. We are not materially exposed to any financing,
liquidity, market or credit risk that could arise if we had engaged in these
relationships. We do not have
relationships or transactions with persons or entities that derive benefits
from their non-independent relationship with our subsidiaries or us.
We lease some of our equipment and office
facilities under operating leases which are deemed to be off-balance sheet
arrangements. Our future operating lease
payment obligations are more fully described under the caption “—Contractual
Obligations” above.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As of September 30, 2007, we had $144.6
million of long-term variable and fixed-rate debt. We are exposed to market risk based on
changes in prevailing interest rates.
Market risk related to our variable-rate debt
is estimated as the potential decrease in pre-tax earnings resulting from an
increase in interest rates. We have
$52.0 million of long-term debt that bears interest at variable rates based on
either the prime rate or LIBOR rate. Our
variable-rate debt had a weighted average interest rate of 6.32% as of
September 30, 2007. A hypothetical
one percent (100 basis points) increase in the average interest rates charged
on our variable-rate debt would reduce our pre-tax earnings by approximately
$0.5 million per year.
Our fixed-rate debt, which has a carrying
value of $92.6 million, has a fair value of $89.4 million as of
September 30, 2007. Market risk
related to our fixed-rate debt is deemed to be the potential increase in fair value
resulting from a decrease in prevailing interest rates. Our fixed-rate debt had a weighted average
interest rate of 6.5% as of September 30, 2007. A hypothetical ten percent decrease in
interest rates, from 6.5% to 5.9%, would increase the fair value of our
fixed-rate debt by approximately $6.1 million.
We do not use derivative financial
instruments to manage or reduce these risks although we may do so in the
future. We do not enter into derivatives
or other financial instruments for trading or speculative purposes.
ITEM 4.
CONTROLS AND PROCEDURES
Under the supervision and with the
participation of our management, including the Chief Executive Officer and
Chief Financial Officer, we have evaluated the effectiveness of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of the end
of the period covered by this report.
Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that these disclosure controls and procedures
are effective. There were no changes in
our internal control over financial reporting during the quarter ended
September 30, 2007 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
39