UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
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Annual
Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
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For
the fiscal year ended December 31, 2007
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or
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o
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Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
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For
the transition period from to
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Commission File Number 0-8176
(Exact name of
registrant as specified in its charter)
Delaware
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95-1840947
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(State or other jurisdiction of
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(I.R.S. Employer
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incorporation or organization)
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Identification Number)
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One Wilshire Building
624 South Grand Avenue, Suite 2900
Los Angeles, California 90017-3782
(Address of principal executive offices, including zip code)
(213) 929-1800
(Registrants telephone, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act. Yes
o
No
x
Indicate
by a check mark if the registrant is not required to file reports pursuant to Section 13
or Section 15(d) of the Act. Yes
o
No
x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes
x
No
o
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 registrants 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.
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of large accelerated filer, accelerated filer, and smaller
reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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Smaller reporting company
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(Do not check if a
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smaller reporting company)
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Act). Yes
o
No
x
The
aggregate market value of the voting common equity held by non-affiliates of
the registrant was $308.3 million based on the closing sale price of such
common equity as of June 29, 2007 as reported by The NASDAQ Stock Market
LLC. The registrant is unable to estimate the aggregate market value of its
preferred shares held by non-affiliates of the registrant because there is no
public market for such shares.
On
March 20, 2008, there were 24,435,213 common shares outstanding.
Documents Incorporated by Reference
Portions
of the Definitive Proxy Statement to be delivered to stockholders in connection
with the Annual Meeting of Stockholders to be held on May 20, 2008
are incorporated by reference into Part II and Part III of this
report.
FORWARD-LOOKING STATEMENTS
This Annual Report 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 in this
Annual Report on Form 10-K 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, including those set forth
under Item 1A. Risk Factors below, 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 of this report. 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.
PART I
ITEM 1.
BUSINESS
OVERVIEW
SouthWest Water Company and its subsidiaries provide
a broad range of services including water production, treatment and
distribution; wastewater collection and treatment; utility operations and
maintenance services; and utility infrastructure construction. We own regulated
public utilities and also serve cities, utility districts and private companies
under contract, serving a combined total of more than two million people. Our
subsidiaries are segmented into two operating groups: our Utility Group and our
Services Group.
Within our Utility Group, we own and manage the
operations of rate-regulated public water and/or wastewater utilities in
Alabama, California, Mississippi, New Mexico, Oklahoma and Texas, through which
we serve water or provide wastewater services to residential, commercial and
public authority customers. State and federal agencies issue regulations
regarding standards of water quality, safety, environmental and other matters
which affect these operations. The rates that we can charge for water and
wastewater service are established and approved by state or local government
agencies.
Our Services Group provides water and wastewater
facility operations and maintenance services, equipment maintenance and repair,
sewer pipeline cleaning, billing and collection services, and state-certified
water and wastewater laboratory analysis on a contract basis. The facilities
operated by the Services Group are owned by cities, public agencies, municipal
utility districts and private entities primarily in Alabama, California, Colorado,
Georgia, Mississippi, New Mexico, South Dakota and Texas. While state and
federal agencies issue regulations regarding standards of water quality,
safety, environmental and other matters which affect our Services Group
operations, the pricing of the services provided by our Services Group is not
subject to government regulation.
SouthWest Water Company was incorporated in
California in 1954 and reincorporated in Delaware in 1988. We maintain our
corporate offices in Los Angeles, California.
1
OUR BUSINESS STRATEGY
Our primary objective is to
provide an essential product or service in such a way as to generate value for
our clients, customers, employees and stockholders. We apply two principal strategies
in our efforts to continue growing our business and improving our financial
performance.
We work to enhance organic revenue growth.
We grow our
revenue organically in two principal ways. First, our operations are largely
located in high population-growth states where the number of water and
wastewater connections we serve increase as a factor of real estate
development. We strategically look to operate in small to medium size cities
that are experiencing population growth. Second, we also look to increase the
number of contract services clients we serve as well as increasing the number
of services performed under each contract. Our offerings include:
·
Water and wastewater system
management;
·
construction management of
water and wastewater systems;
·
water and wastewater
certified laboratory services;
·
pipeline inspections;
·
refurbishment of manholes and
sewer lines;
·
water meter replacement;
·
non-regulated wholesale water
sales;
·
wastewater treatment
services; and
·
municipal public works
services and/or management.
We pursue selected acquisitions.
We pursue selected
acquisitions that fit our long-term growth goals in both the Utility and
Services Groups. To pursue this strategy, we seek acquisitions that:
·
increase our operating
results;
·
expand our business within
our geographic footprint;
·
provide access to high
population growth markets;
·
promote operating
efficiencies through sharing of overhead costs and employee competencies in the
region; and
·
facilitate the Services Groups
ability to supply needed services to Utility Group operations in the region.
In recent years, we have completed several Utility
Group acquisitions as a direct result of our long-term relations built by our
Services Group. For example, in February 2007, we acquired our first water
and wastewater utility in northern Mississippi where our Services Group has
operated for several years, providing us access to a new, high population
growth market. In 2006, we acquired two utilities in the Austin, Texas area
that had been operated by our Services Group for several years, thereby
broadening our utility ownership and leveraging our existing resources in that region.
In 2005, our Services Group acquired a contract operations company in Alabama
which led to our Utility Groups acquisition of one of its clients, a
wastewater collection and treatment system. These acquisitions expanded our
presence in the Southeastern United States and introduced us to the Birmingham,
Alabama area. In January 2008, we acquired another wastewater collection
and treatment system located directly adjacent to our existing system, further
leveraging our resources in the Birmingham, Alabama area.
For additional information about our acquisition
activities, see Acquisitions and Dispositions.
2
BUSINESS SEGMENTS
Revenues and gross profit, which we define as
revenues less the related direct operating expenses, for the three years ended December 31,
2007 were as follows:
Revenues and
Gross Profit by Business Segment
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Years Ended December 31,
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2007
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2006
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2005
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(In thousands, except percentage data)
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Amount
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Percent
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Amount
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Percent
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Amount
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Percent
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Revenues:
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Utility Group
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$
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93,370
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43
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%
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$
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86,321
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39
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%
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$
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78,884
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40
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%
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Services Group
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123,977
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57
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%
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132,481
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61
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%
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118,720
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60
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%
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Total revenues
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$
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217,347
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100
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%
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$
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218,802
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100
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%
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$
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197,604
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100
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%
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Gross Profit:
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Utility Group
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$
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40,605
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72
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%
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$
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37,781
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67
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%
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$
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34,057
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69
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%
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Services Group
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16,093
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28
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%
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18,565
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33
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%
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15,173
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31
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%
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Total gross profit
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$
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56,698
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100
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%
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$
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56,346
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100
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%
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$
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49,230
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100
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%
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You can find complete information about our business
segments in Note 15 accompanying our consolidated financial statements included
in this report.
UTILITY GROUPDEVELOPMENT OF
BUSINESS, SERVICES AND REGULATION
California
Our regulated water utility in California, Suburban
Water Systems, produces and supplies water for residential, business,
industrial and public authority use under the jurisdiction of the California
Public Utilities Commission (CPUC). We do not provide wastewater collection
or treatment services in California. Our California utility service area
contains a population of more than 300,000 people in an area of approximately
42 square miles within Los Angeles and Orange counties. Our California utility,
or its predecessor entities, have supplied water since approximately 1907. From
the mid-1950s to the late 1960s, our operations expanded rapidly as most of our
service area was converted from agricultural use to residential, business and
industrial use. In recent years, the growth of our California utility has been
limited to extensions into new subdivisions along the periphery of its service
area. There is little undeveloped land available for new business, industrial
construction or residential growth in our service area. As a result, we do not
anticipate a significant increase in the number of connections in our current
service area.
The following table indicates, by classification, the
number of water connections that our California utility served as of the end of
each of the past three years.
California
UtilityNumber of Water Connections by Classification
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As of December 31,
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2007
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2006
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2005
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Residential
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70,968
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70,921
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70,955
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Commercial and industrial
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3,076
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3,018
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2,994
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Public authority and other
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1,278
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1,247
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1,221
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Total water connections
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75,322
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75,186
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75,170
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During 2007, 73% of our California utilitys annual
revenues were derived from sales to residential connections, 18% from sales to
commercial and industrial connections and 9% from sales to public authority and
other connections. Our California utility owns 18 wells and 32 reservoirs. We
believe that we are able to purchase or produce adequate water to serve our
current customer base and manage reasonable growth from new customers.
3
Our California utility obtains water by both pumping
water from our own wells and by purchasing water from the Metropolitan Water
District of Southern California (MWD), a governmental agency, or other
sources. The wells owned and operated by our California utility pump water from
two of the major groundwater basins in the Southern California coastal
watershed: the Main San Gabriel Basin (the Main Basin) and the Central Basin.
Our rights to pump water from the Main and Central Basins are fully adjudicated
under California law, and these adjudications establish our right to produce
water at levels and at a cost prescribed each year by the respective
Watermaster Boards (the Watermasters) that manage the Main and Central
Basins. Our California utility is also allowed to produce water from the Main
and Central Basins in excess of the amount prescribed by the Watermasters, but
when such excess production occurs, an additional payment is required to
provide for the replenishment of the water supply. As the water levels in the
Main and Central Basins increase or decrease, the Watermasters may adjust the
prescribed production levels beyond which we are required to make payments for
replenishment of the water supply.
In mid-year 2001, we removed some of our wells in the
Main Basin from service due to environmental matters more fully described in Environmental
Matters below. This resulted in our California utility purchasing greater
amounts of water from the MWD and other sources. We purchased 46% of our supply
from external sources in 2001 but those purchases increased to 72% in 2002 as a
result of the lost groundwater production caused by the Main Basin
contamination. Our purchases from external sources have decreased in subsequent
years to 43% in 2007 as we have gradually replaced the lost groundwater
production. Under an agreement made in early 2002, we have been reimbursed for
the incremental costs of purchasing water needed to replace the lost
groundwater production. We expect such reimbursement to continue until
completion of remediation. See Environmental Matters below for additional
information.
Even though our utility service areas in California
are not likely to experience significant connection growth, our California
utility operations require significant capital expenditures for the renovation
and replacement of our infrastructure. Cash for capital expenditures is
generated internally by California utility operations, periodic debt financings
and bank lines of credit extended to SouthWest Water. Our California utility
also receives contributions in aid of construction from developers,
governmental agencies, municipalities or individuals to assist in the cost of
facility development. For the years ended December 31, 2007, 2006 and
2005, capital expenditures in California were $13.5 million, $10.7 million and
$9.5 million, respectively. Our California utility received capital
contributions and advances from developers of $2.0 million, $3.7 million and
$1.0 million in 2007, 2006 and 2005, respectively, to assist in providing
funding for these capital expenditures.
The CPUC regulates the rates and operations of our
California utility. Under current CPUC practices, California customer water
rates may be changed through general rate cases or by offsets for certain rate
base and expense items. Since September 30, 2002, the California Public
Utilities Code has required that CPUC-regulated water utilities file general
rate cases every three years. General rate cases require formal proceedings
with the CPUC in which overall rate structure, expenses and rate base are
examined by CPUC staff. Historically, rate proceedings have required
approximately 12 months from the time an application is filed to the CPUCs
authorization of new rates. Our California utility made a general rate case
filing in June 2005 and was granted an average 6.4% increase in rates
effective July 1, 2006. In May 2007, the CPUC modified its rate case
plan for water utilities. The revised schedule required our California utility
to file its next general rate case six months early, on January 1, 2008.
That filing was made on a timely basis and requests a 13.57% rate increase on January 1,
2009, a 2.97% rate increase on January 1, 2010 and a 2.12% increase on January 1,
2011.
In addition to a general rate increase, the CPUC
typically provides for step increases in the second and third years following
the general rate increase. The step increases are intended to compensate for
projected expense increases. Prior to June 2004, allowable step increases
were predetermined by the CPUC in general rate case decisions. Under the CPUCs
interim rate case plan adopted in June 2004, step increases, now referred
to as escalation year increases, are no longer predetermined, but rather are
partly subject to inflationary indices in those later years. As with step
increases, escalation year increases are also subject to verification that pro
forma
4
earnings levels have not exceeded the amounts
authorized in the general rate proceeding. In connection with the general rate
case that went into effect July 1, 2006, the CPUC subsequently authorized
a 1.6% escalation year increase on July 1, 2007. That general rate case
also provided for an estimated additional escalation year increase of 2.6%
effective July 1, 2008, subject to CPUC verification.
In December 2005, the CPUC adopted a Water
Action Plan which identified policy objectives for guiding the CPUC in
regulating investor-owned water utilities. It also highlighted actions that the
CPUC anticipates taking to implement those objectives. A key objective of the
plan is to strengthen water conservation programs to a level comparable to
those of energy utilities. In pursuing that goal, in January 2007 the CPUC
opened an Order Instituting Investigation (OII) concerning conservation
objectives for water utilities. That OII consolidated pending conservation rate
design applications by four utilities, inclu
ding one that our California utility had been required
to file as a condition of the final decision in its recent general rate case
filing. In February 2008, as part of the first phase of that proceeding, the
CPUC issued a decision relating to three of the utilities, including our
California utility. The decision approves eight settlements, including four
settlements that were entered into by our California utility. Those four
settlements establish a conservation rate design, a low income ratepayer
assistance program, a customer outreach, education, data collection and
reporting program, and a resolution of return on equity issues.
Texas
Our regulated public water utilities in Texas serve
water and provide sewage collection and treatment services for residential,
commercial and irrigation use under the jurisdiction of the Texas Commission on
Environmental Quality (TCEQ). We also own a small public water utility in
Oklahoma, which is regulated by the Oklahoma Corporation Commission (OCC),
that we operate as part of our Texas utilities. Our service areas in Texas are
broadly dispersed geographically throughout the state covering about 4,000
square miles, encompassing the Dallas-Fort Worth, Houston, Austin and San
Antonio areas. Our service areas are highly fragmented and are comprised of 105
separate water systems serving a population of about 116,000 people in an area
of approximately 51 square miles, most of which is largely undeveloped. These
service areas are experiencing ongoing real estate development, and we expect
the number of connections in our service areas to continue growing in future
years.
The following table indicates, by classification, the
number of water and wastewater connections served by our Texas utilities as of
the end of each of the most recent three years:
Texas
UtilitiesNumber of Water and Wastewater Connections by Classification
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Years Ended December 31,
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2007
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2006
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2005
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Water
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Wastewater
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Water
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Wastewater
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Water
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Wastewater
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Residential
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36,251
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11,794
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33,126
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11,622
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32,460
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11,388
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Business and commercial
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490
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181
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393
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167
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375
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160
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Total connections
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36,741
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11,975
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33,519
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11,789
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32,835
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11,548
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|
We established our utility ownership presence in
Texas in 2000 when we acquired our first water utility near Austin, Texas. We
significantly expanded our presence in Texas in 2004 when we acquired 86 water
and 14 wastewater collection and treatment systems which we operate as Monarch
Utilities. We continue to make strategic acquisitions of utilities within our
geographic footprint, thereby expanding our presence in the region and gaining
economies of scale. For example, since our 2004 acquisition of Monarch, we have
acquired five smaller utilities serving a combined total of approximately 600
connections in proximity to our existing service areas.
Our Texas utilities own or have rights to 253 wells
and 386 reservoirs in addition to distribution, collection and treatment
facilities. We expect customer growth to continue in our Texas service areas
and, as a result, we may have to increase the water supply capacity of our
Texas utilities through a combination of outside water purchases and the
construction of additional wells. We have long-term agreements to purchase
water from the cities of Austin and Pflugerville, Texas, the Lower Colorado
River Authority and other water producers in the Dallas-Fort Worth and Houston
areas.
5
Our Texas utilities are capital intensive because
they are older systems and therefore require infrastructure upgrades to
remediate regulatory compliance issues inherited from the previous owners. They
also require additional capital for expansion to support population growth.
Cash for capital expenditures is generated from our Texas utilities
operations, periodic debt financing, bank lines of credit extended to SouthWest
Water, and contributions and advances received from developers. For the years
ended December 31, 2007, 2006 and 2005, our capital expenditures in Texas
were $16.3 million, $25.9 million, and $19.8 million, respectively. Our Texas
utilities received contributions from developers of $0.4 million, $4.5 million
and $1.7 million during 2007, 2006 and 2005, respectively.
The TCEQ regulates the rates and environmental
quality of our Texas utilities. Monarch Utilities received authorization for a
phased water and sewer rate increase in October 2004 and October 2005.
Monarch Utilities filed for another rate increase in 2007 and preliminary rates
went into effect fully in the fourth quarter of 2007. In February 2008 we
received a letter from the TCEQ questioning the amount of our 2007 rate
increase. We are working with the TCEQ to address their concerns and believe we
will be able to agree on an equitable increase. We also believe that any rate
adjustments will be made prospectively from when an agreement is reached.
Windermere Utility, another one of our Texas
utilities, filed for a rate increase in 2006 and those rates were approved by
the TCEQ in 2007. Windermere will also benefit from a step increase in 2008. In
addition we filed for a rate increase for a smaller utility in the Austin area
that we acquired in 2006 and those rates went into effect and were approved by
the TCEQ in 2007. We also expect to file for a rate increase during 2008 for
another one of our utilities in the Austin area. The remainder of our Texas
utilities are not currently seeking increased rates; however, regulatory
changes concerning water quality, future construction expenditures and
increased operating expenses may result in future requests for rate increases.
New Mexico
Our regulated public water utility in New Mexico
serves water and supplies wastewater collection services for residential,
commercial and irrigation use. The wastewater we collect through our system of
collection lines and lift stations is processed at a municipal treatment
facility. Our New Mexico utility is under jurisdiction of the New Mexico Public
Regulation Commission (NMPRC). Our New Mexico utility service area is located
in the northwest part of the City of Albuquerque and in the northern portion of
Bernalillo County, and contains a population of approximately 53,000 people in
an area of approximately 34 square miles. Approximately 40% of the area has
been developed.
The following table indicates, by classification, the
number of water and wastewater connections served by our New Mexico utility as
of the end of each of the most recent three years:
New
Mexico UtilityNumber of Water and Wastewater Connections by Classification
|
|
Years Ended December 31,
|
|
|
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2007
|
|
2006
|
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2005
|
|
|
|
Water
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|
Wastewater
|
|
Water
|
|
Wastewater
|
|
Water
|
|
Wastewater
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
16,183
|
|
16,054
|
|
16,030
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|
15,875
|
|
14,889
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|
14,729
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|
Business and commercial
|
|
1,135
|
|
523
|
|
866
|
|
325
|
|
782
|
|
306
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|
Other
|
|
|
|
11
|
|
|
|
11
|
|
|
|
11
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|
Total connections
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17,318
|
|
16,588
|
|
16,896
|
|
16,211
|
|
15,671
|
|
15,046
|
|
Our New Mexico utility has grown from approximately
800 water connections at the time of its acquisition in 1969 to over 17,300
connections today. Most of this growth has resulted from the extension of water
services and sewage collection services into new residential subdivisions and
new commercial development. During 2007, we added 422 new water connections and
377 new wastewater connections in our service area, which was at a lower rate
than prior years due to the nationwide housing construction slowdown. There is
continuing real estate development in our service area therefore we expect
continued connection growth in 2008 however the growth will
6
be at a reduced rate of increase from levels we have
experienced historically. During 2007, 77% our revenues in New Mexico were from
sales to residential connections and 23% of our revenues were from sales to
commercial and industrial connections.
Our New Mexico utility owns eight wells and five
reservoirs, and we believe that we have adequate water capacity to serve our
current customer base as well as reasonable growth from new customers. The
wells that we own and operate in New Mexico produce water from the Rio Grande
Underground Basin. We have purchased, and plan to continue evaluating
opportunities to purchase, additional water rights in New Mexico.
As we expect customer growth to continue in our New
Mexico service area, we may have to increase our water supply capacity through
additional well construction. Our New Mexico utility has established an
emergency supply of water available through an interconnection with another
water purveyor, for use in the case of a temporary interruption in our New
Mexico water supply.
Because our New Mexico utility service area has
continued to experience customer growth, our operations are capital intensive.
Cash for capital expenditures is generated by New Mexico utility operations,
periodic debt financing, bank lines of credit extended to SouthWest Water, and
contributions and advances received from developers. For the years ended December 31,
2007, 2006 and 2005, our capital expenditures in New Mexico were $11.1 million,
$13.7 million, and $11.9 million, respectively. Our New Mexico utility received
capital contributions from developers of $7.2 million, $7.3 million and $5.6
million in 2007, 2006 and 2005, respectively.
The NMPRC regulates the rates and operations of our
utility subsidiary in New Mexico. Requests for rate increases, typically based
on historical costs, must be submitted to the NMPRC. We have not requested a
general water rate increase during the past several years and at this time we
do not expect to do so in the near future.
Our New Mexico utility has an agreement with the
Albuquerque Bernalillo County Water Utility Authority (the Water Authority)
whereby the Water Authority treats the effluent from our New Mexico wastewater
collection system for a fee. The treated effluent is returned to the Rio Grande
Underground Basin, creating return flow credits. Return flow credits supplement
our existing water rights, enabling us to pump additional water from the basin.
In August 2004, the Water Authority increased
the fee it charges, using a different formula than had been used to calculate
fee increases in prior years. Subsequently, the Water Authority also claimed
ownership of the return flow credits. In January 2007, the Water Authority
filed a lawsuit in New Mexico District Court to condemn our New Mexico utility
in accordance with the provisions of the New Mexico Eminent Domain Code. Under
prevailing law, condemning agencies must pay fair market value for property
they take through eminent domain. While we intend to vigorously contest the
eminent domain proceedings, we are exposed to the risk of losing our New Mexico
utility if the condemnation proceedings succeed. See Item 3. Legal Proceedings
for additional information.
Alabama
In Alabama we supply wastewater collection and
treatment services to residential and commercial customers. In 2005 we acquired
a wastewater collection and treatment system in an area located south of
Birmingham, in Shelby County and in 2007 we acquired another collection and
treatment system in Madison County. Our service areas contain a population of
approximately 14,500 people in an area of approximately 19 square miles. Our
Alabama utilities are regulated at the county level. The rates we charge are set
by contract and contain provisions for recovery of operating costs and capital
recovery increases.
7
The following table indicates, by classification, the
number of wastewater connections served by our Alabama utilities as of the end
of each of the most recent three years:
Alabama
UtilitiesNumber of Wastewater Connections by Classification
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Residential
|
|
4,195
|
|
4,048
|
|
3,973
|
|
Business and commercial
|
|
198
|
|
195
|
|
195
|
|
Total connections
|
|
4,393
|
|
4,243
|
|
4,168
|
|
In January 2008, we acquired another wastewater
collection and treatment system that services approximately 4,100 residential
and commercial connections in 18 square miles of additional service area
directly adjacent to our existing Shelby County collection and treatment
system.
Mississippi
During 2007, we acquired a small water utility and four
wastewater collection and treatment systems in northern Mississippi, just south
of Memphis, Tennessee. The Mississippi utilities are under jurisdiction of the
Mississippi Public Service Commission (MPSC). These utilities serve 279
residential water connections and service 387 wastewater connections. Our
Services Group has operated in the area for several years and will operate this
utility for our Utility Group. This acquisition augments our existing
operations in Mississippi and corresponds with our strategy of expanding into
geographic markets with high population growth rates.
Seasonality
Our Utility Group water revenues are seasonal because
rainfall and weather conditions affect water sales. The second and third
quarters of each year typically account for the highest volume of water
consumption when weather tends to be hot and dry. Utility Group wastewater
revenues are generally not seasonal.
The results of operations for one quarter do not
indicate results to be expected in another quarter. Drought conditions may
result in consumer conservation efforts or water shortages, which can reduce
consumption. Drought conditions may also result in increased water costs to us,
which could adversely affect our profitability. Conversely, unusually wet conditions
may result in decreased customer demand, lower revenues and lower profit in our
utility operations.
Environmental Matters
Some of our groundwater sources for our California
water utility have been affected by the presence of certain groundwater contaminants.
These contaminants consist mainly of chemicals disposed of by various
industrial companies in the 1940s and 1950s. In 2001 and 2002, this
contamination necessitated the shutdown of a number of our wells, and we
purchased replacement water at a cost substantially higher than the cost of
water pumped from our own wells. Prior to May 2002, these costs were
recorded as operating expenses and reduced our operating income.
In May 2002, a settlement agreement was reached
between some of the parties allegedly responsible for the contamination (Cooperating
Respondents) and certain water entities, including our California water
utility. As a result of this settlement agreement, we have received payments
during the last several years, and we expect to continue to receive payments
until completion of remediation. These payments represent the incremental cost
of purchasing water over the cost that would have been incurred by us to pump
water from our wells had they not been shut down as a result of contamination
and excluded costs covered in the $1.7 million settlement discussed above. The
settlement agreement provided for ongoing reimbursement of our excess water
costs and we bill and collect this reimbursement monthly. These monthly
reimbursements are recorded as a reduction to operating
8
expenses. The reimbursements were $3.4 million, $3.1
million, $3.4 million, $3.3 million and $4.0 million during 2007, 2006, 2005,
2004 and 2003, respectively.
The settlement agreement also provides for
contributions by the Cooperating Respondents for construction of new wells and
interconnections with nearby water sources. These contributions were $0.8
million, $1.6 million, $0.5 million, $0.7 million and $2.5 million for
2007, 2006, 2005, 2004 and 2003, respectively, and were recorded as
contributions in aid of construction.
Water Quality Regulation
Potable
Water
The water supplies available to all of our utilities
are subject to regulation by the United States Environmental Protection Agency
(EPA) under the 1996 Federal Safe Drinking Water Act (US Act). The US Act
establishes uniform minimum national water quality standards, as well as
specification of the types of treatment processes to be used for public
drinking water. The EPA, as mandated under the US Act, issues regulations that
require, among other things, disinfection of drinking water, specification of
maximum contaminant levels (MCLs) and filtration of surface water supplies.
Our water supplies are also subject to regulation by the following:
·
In California, the California
Department of Public Health (DPH) under the California Safe Drinking Water
Act (Cal Act);
·
In Mississippi, the
Mississippi Department of Health ServicesWater Supply Division.
·
In New Mexico, the State of
New Mexico Environment Department Drinking Water Bureau (NMDWB);
·
In Oklahoma, the Department
of Environmental Quality (DEQ), and
·
In Texas, the Texas
Commission on Environmental Quality (TCEQ).
The Cal Act and the rules of the DPH are similar
to the US Act and the mandates of the EPA, except that in many instances the
requirements of the DPH are more stringent than those of the EPA. In addition
to the EPA and the DPH water quality regulations, our California water utility
is also subject to water quality standards that may be set by the CPUC. The
California Supreme Court has ruled that the CPUC has the authority to set
standards that are more stringent than those set by the EPA and the DPH.
In February 2002, the EPA lowered the arsenic
standard in drinking water from 50 parts per billion to 10 parts per billion.
We were required to comply with the more stringent standard by January of
2006. Currently, our water sources in California, Mississippi, Oklahoma and
Texas are in compliance with the new standard. The DPH is holding discussions
that could result in more stringent arsenic standards. We cannot predict the
impact that such changes in the arsenic standard would have on our California
and Texas water utility operations. If the arsenic standard remains at 10 parts
per billion, we do not expect it to have a material adverse impact on our
consolidated financial position or results of operations.
To meet this new standard in New Mexico, we have
constructed three arsenic removal treatment plants. Capital expenditures
totaling $3.6 million have been required to date at our New Mexico facilities
in order to comply with the new arsenic standard and we expect that the cost of
water will increase as a result of the treatment requirements. If the cost of
complying with this new standard has an adverse impact on our New Mexico
operations, we will consider making a request to the NMPRC for recovery of
these costs. While the NMPRC has previously allowed the recovery of similar
costs through higher rates, we cannot assure you that costs incurred or capital
spent will ultimately be recoverable from the ratepayers.
Costs associated with testing of our water supplies
have increased and are expected to further increase as regulatory agencies
adopt additional monitoring requirements. We believe that costs associated with
the additional monitoring and testing of our water supplies will be recoverable
from ratepayers through future rate increases.
9
However, we cannot assure you that water sources
currently available to our utilities will meet future EPA, or state regulatory
requirements, that recovery of additional costs will be allowed, or that new or
revised monitoring requirements will not necessitate additional capital expenditures
in the future. We believe that future incremental costs of complying with
governmental regulations, including capital expenditures, will be recoverable
through increased rates. However, we cannot assure you that recovery of such
costs will be allowed.
Both the EPA and the state regulatory agencies have
put into effect regulations and other pronouncements that require periodic
testing and sampling of water to ensure that only permissible levels below the
prescribe MCLs of organic and volatile and semi-volatile organic compounds (VOCs),
herbicides, pesticides, radionuclides, and inorganic substances are present in
water supplied to the public. Our water utilities operators regularly sample
and monitor the quality of water being distributed throughout the system. Our
utility personnel conduct sampling, testing and inspections at the intervals,
locations and frequencies required by EPA and state regulations. Water samples
from throughout our water systems are tested regularly by state-certified laboratories
for bacterial contamination, chemical contaminant content and for the presence
of pollutants and contaminants for which MCLs have been put into effect. The
test results are sent to the respective state regulatory agencies. Disinfection
and other types of treatment are applied to water supplies as required or
needed to safeguard against bacteriological, chemical and other water
contaminants. In addition, each of our utilities provides its customers with an
annual water quality report that, among other matters, informs them of the
sources and quality of the water being provided.
In California, in addition to water sampling and
testing performed by our utility personnel, independent engineers retained by
the Watermasters conduct sampling and testing for certain pollutants such as
VOCs. The results of the sampling and testing are made available to the DPH and
all water purveyors that produce water from the Main Basin. The cost of such
sampling and testing is covered by assessments to the producers in this basin.
Several water systems at our Texas utilities are in
violation of MCLs and other state regulatory requirements, which has resulted,
in some cases, in citations and fines from the TCEQ. Our Texas utilities are
older systems and therefore require infrastructure upgrades to remediate
regulatory compliance issues, many of which were inherited from the previous
owners at the time of acquisition. We have entered into agreements with the
TCEQ, many prior to acquiring the utilities, under which we have committed to
make certain improvements to achieve compliance. These agreements are intended
to provide the TCEQ with assurance that problems covered by these agreements
will be addressed, and the agreements generally provide protection to us from
fines, penalties and other actions while corrective measures are being
implemented. The customers in affected areas have been advised of the
violations and the corrective actions taken, as required by the TCEQ. We have
constructed new treatment facilities, changed water sources and/or taken other
steps during the past year to address these compliance issues. We are actively
working with the TCEQ and outside consultants to address the remaining issues
and bring the affected systems into full compliance. We do not expect the
ultimate resolution of these compliance issues will have a material adverse
impact on our consolidated financial position or results of operations.
Drinking water systems have been identified as
critical infrastructures and potential terrorist targets. In compliance with
the Public Health Security and Bioterrorism Response Act of 2002, PL 107-88,
our Utility Group assessed the vulnerability of our water systems to terrorist
attack. This vulnerability assessment was used to determine the risks posed to
the water supply system operations, treatment, and distribution systems;
identify the water systems vulnerabilities; provide a prioritized plan for
security upgrades, modifications of operational procedures, and/or policy
changes to mitigate identified risks to critical assets; and provide a basis
for comparing the cost of protection against the risks posed. While it is
impossible to protect or eliminate the vulnerability of all of our drinking
water systems, our utilities considered and are implementing improvements in
security that we believe can make it more difficult for attacks to succeed and
can lessen the impact of attacks that may occur.
We believe that water supplied by our California
utility meets all current requirements of the US Act, the Cal Act and the
regulations put into effect under the related legislation and CPUC standards.
We also believe that water
10
supplied by our Mississippi, New Mexico and Texas
utilities complies with all current requirements of the US Act and the
respective state regulatory agencies, except as noted above. However, we cannot
assure you that water sources currently available to our water utilities will
meet existing and future federal or state regulatory requirements or that such
future requirements will not necessitate future capital expenditures by our
water utilities. It is not possible at this time to reasonably project the
potential impact on future capital requirements, if any, resulting from these
regulatory requirements, but the effect is not expected to have a material
impact on our results of operations or financial condition because amounts
expended are expected to be recoverable through rates. We also cannot assure
you that our systems will not be fined or receive citations for past failures
although the amounts, if any, are not expected to have a material impact on our
consolidated financial condition or results of operations.
Wastewater
The water discharged from our wastewater facilities
are subject to regulations imposed by the EPA under the Clean Water Act of
1972, as amended. We currently have wastewater operations in Alabama,
Mississippi, Oklahoma and Texas. The discharge water is also regulated by the
Alabama Department of Environmental Management, the Mississippi Department of
Environmental Quality and the Oklahoma Department of Environmental Quality.
In Texas, discharge water is also subject to
regulation under the TCEQ Texas Clean Water Act, as amended. These regulations
establish MCLs for discharging contaminates into natural water bodies. We hold
several discharge permits as required by the TCEQ and are complying with all
monitoring and reporting requirements related to the quality of the discharged
water.
When we acquired our Texas-based Monarch Utilities in
2004, its wastewater facilities were not in compliance with TCEQ regulations
and, as a result, some discharge violations have occurred that resulted in
citations and fines. We have been cooperatively working with the TCEQ and have
entered into agreements with them under which we have committed to make certain
improvements to achieve compliance. These agreements are intended to provide
the TCEQ with assurance that problems covered by these agreements will be
addressed, and the agreements generally provide protection to us from fines,
penalties and other actions while corrective measures are being implemented. We
are addressing these violations by constructing new treatment facilities,
changing existing treatment and/or modifying operations. We are continuing to
work with the TCEQ and outside consultants to address the remaining issues and
bring the affected systems into full compliance. We do not expect the ultimate
resolution of these compliance issues will have a material adverse impact on our
consolidated financial position or results of operations.
Costs associated with monitoring and complying with
the Clean Water Act have increased and are expected to further increase as
regulatory agencies adopt additional monitoring and discharge requirements. We
believe that costs associated with the additional monitoring and testing of the
discharge water will be recoverable from ratepayers through future rate
increases. However, we cannot assure you that existing discharges will meet
existing or future EPA, or TCEQ regulatory requirements, that recovery of
additional costs will be allowed, or that new or revised monitoring
requirements will not necessitate additional capital expenditures in the
future. We believe that future incremental costs of complying with governmental
regulations, including capital expenditures, will be recoverable through
increased rates. However, we cannot assure you that recovery of such costs will
be allowed.
Competition
Our regulated utilities in California, Mississippi,
New Mexico, Oklahoma and Texas each operate under a Certificate of Public
Convenience and Necessity granted by the respective regulators in their state.
Our water utilities and Alabama wastewater utilities are also regulated by
other state and local governmental authorities having jurisdiction over water
and wastewater service and other aspects of our water utility businesses. Our
Utility Group
11
water businesses are dependent upon maintaining these
certificates and upon various governmental and court decisions affecting our
water rights and service areas.
All of the states in which our regulated utilities
operate have state laws which provide that no public or private agency can
install facilities within the service area of another public utility in order
to compete with it, except upon payment of just compensation for all damages
incurred by the public utility. Under the state laws of California and New
Mexico, municipalities and certain other public agencies have the right to
acquire private water utility plants and systems within their territorial
limits by condemnation but must pay fair value for the condemned system.
On January 19, 2007, the Albuquerque Bernalillo
County Water Authority and the City of Rio Rancho, New Mexico filed a petition
in New Mexico District Court seeking to acquire, by condemnation, our New
Mexico utility through the alleged power of eminent domain. While we intend to
vigorously contest the condemnation proceedings, we are exposed to the risk of
being required to sell our New Mexico utility if the condemnation proceedings
succeed. See Item 3. Legal Proceedings for additional information.
SERVICES GROUPDEVELOPMENT OF
BUSINESS, SERVICES AND REGULATION
Our Services Group has over 700 contracts as of December 31,
2007, with the majority of these contracts falling into one of three
categories:
·
Municipal Utility District
contracts;
·
Operations and maintenance
contracts; and
·
Construction management
contracts.
Municipal Utility District (MUD)
Contracts
A Municipal Utility District (MUD) is created
either administratively or legislatively to operate under the rules of the
TCEQ to provide water supply, wastewater treatment and drainage services to
areas where existing municipal services are not available. Our Services Group
has contracts with MUDs in the suburbs of Houston, Austin, Dallas and El Paso,
Texas. Under a typical MUD contract, we bill a monthly base fee to the MUD to
provide a specified level of services. We typically provide water and/or
wastewater facility operations and maintenance services, equipment maintenance
and repair, billing and collection services. We also provide state-certified
water and wastewater laboratory analysis for an additional fee. We usually bill
for any additional services provided beyond the basic contract on a
time-and-materials basis as such services are rendered. Most contracts provide
for an increase in the monthly base fee as the number of customer connections
increases and generally include inflation adjustments. Changes in prices are
negotiated on a contract-by-contract basis. Generally, MUD contracts are
cancelable with 30 to 60 day prior notice by either party. Our experience
indicates that, with high-quality service and strong focus on client
satisfaction, MUD relationships can last for many years. For example, many of
our MUD contracts have been in existence for over ten years.
Operations and Maintenance (O&M)
Contracts
Operations and maintenance (O&M) contracts are
agreements with cities, private entities and investor-owned utilities
(including some of our own Utility Group affiliates) that provide specific
services such as facility operation and maintenance, meter reading, customer
billing and collection, municipal pubic works services and/or management, or
management of entire water or wastewater systems. Under a typical O&M
contract, our Services Group subsidiaries charge a fee that covers a specified
level of services. Services are typically provided evenly throughout the
contract period and are billed on a monthly basis. Our O&M contracts limit
our liability in the event of a major system failure or catastrophic event. If
we provide services beyond the scope of a contract, we bill for the additional
services. For example, if a major system failure or catastrophic event occurred
as the result of
12
flooding, hurricanes, earthquakes, electrical strikes
or vandalism, the facility owner usually asks us to provide additional services
on a time-and-materials basis.
Most O&M contracts provide for annual increases
based upon inflation and we typically have the right to increase our fixed
operations fee if the system experiences customer connection growth beyond a
specified level. We may pay certain costs, such as chemical or power expenses.
However, the contracts usually provide for reimbursement of these costs.
In most cases, O&M contracts are cancelable by
either party only upon the occurrence of specified events defined as a breach
of contract. O&M contracts have terms ranging from month-to-month to up to
20 years, with the typical duration being three to five years. We have a strong
focus on customer service and client satisfaction and our experience has been
that over 95% of our O&M contracts are renewed upon expiration.
Construction and Construction
Management Projects
Our Services Group enters into construction and
construction management services contracts for water and wastewater facility
development, improvement and expansion projects. Under the terms of certain of
these contracts, we may bear all or a significant portion of the risk of cost
overruns, or incur additional costs or penalties for failing to meet project
completion deadlines or minimum performance standards.
We also bid on full-scale design, build, and operate
contracts. In September 2002, we successfully bid a project to design,
build and operate a $23.0 million reverse osmosis water treatment plant in the
city of San Juan Capistrano, California, for the Capistrano Valley Water
District (CVWD). We also assisted the CVWD with obtaining financing for the
project. The project included the drilling of several new wells and the
installation of associated water lines. After completion of construction, we
began the 20-year $20.0 million contract to operate and maintain the treatment
plant.
Services Group Contracts With
Our Own Utilities
Many Services Group contracts are with our own
Alabama, Mississippi, New Mexico, Oklahoma and Texas utilities to perform
operating services, normal maintenance and construction work and management of
capital projects for these utilities. These contracts are established utilizing
terms and conditions equivalent to prevailing industry rates for similar work
performed by our Services Group for non-affiliated customers. In accordance
with Statement of Financial Accounting Standards (SFAS) No. 71,
Accounting for the Effects of Certain Types of Regulation
(SFAS 71),
we recognize a profit on sales to regulated affiliates and do not eliminate the
intercompany profit because we believe the sales price is reasonable and it is
probable that, through the rate making process, future revenue approximately
equal to the sales price will result from the regulated affiliates use of the
services. Historically, state regulators have approved the services provided
and rates charged by the Services Group to our Utility Group and permitted
those charges as a component of utility rates. However, we cannot assure you
that state regulators will approve those services and rates in the future.
Growth and Contractual Service
Backlog
During the past three years, our Services Group has
increased revenues and service areas by adding new contracts and construction
projects, pursuing renewal and expansion of existing contracts and by making
acquisitions.
Revenues included in backlog are generally realized
over a multi-year period. O&M contracts typically have durations of three
to five years, and the uncompleted remaining portion of these contracts is
reflected in backlog. MUD contracts, which are generally cancelable with 30 to
60 days prior notice, are assumed to have a 36-month remaining term, consistent
with our experience, and are included in the backlog computation using an
assumed 36-month term. As of December 31, 2007, our Services Group
contractual base service fee backlog was $188.4 million
13
compared to $185.3 million as of December 31,
2006. Base service fee backlog totaling approximately $141.4 million as of December 31,
2007 is expected to be earned during 2009 and beyond.
Seasonality
Our Services Group operations are generally not
seasonal but can be affected by severe weather and rainfall. In general, heavy
rainfall or storm conditions may limit our ability to perform certain billable
work such as pipeline maintenance, manhole rehabilitation and other outdoor services.
Severe weather conditions may also result in additional labor and material
costs to us that may not necessarily be recoverable from our various firm price
contracts.
Revenues from our billing and collection services
business are generally not subject to seasonal fluctuations.
Competition
Competition in the MUD, O&M and construction
management portions of our business includes a number of significantly larger
companies that provide services on a national and international basis, as well
as regional and local competitors. New contracts are awarded based on a
combination of customer relationships, service levels, competitive pricing,
references and technical expertise.
Cities themselves are also competitors in O&M
operations, since we must overcome reluctance on the part of some city
officials to outsource their water and wastewater services. Although industry
renewal rates tend to be high, the contract water and wastewater management
business is very competitive, and we cannot assure you that our Services Group
will be able to increase or sustain its market share.
Regulation
Our Services Group prices are not subject to
regulation. However, because we provide contract services which include the
operation and maintenance of water supply and wastewater facilities owned by
cities, public agencies, municipal utility districts and private entities
(including our own Utility Group affiliates), we are subject to state and
federal regulations regarding standards of water quality, safety, environmental
and other matters.
ACQUISITIONS AND DISPOSITIONS
Acquisitions
During the five years ended December 31, 2007
and in 2008 through the date of this report, we have acquired the stock or
assets of several businesses that fit our long-term growth goals for our Utility
and Services Groups. Those acquisitions are summarized below.
Utility
Group Acquisitions
Monarch Utilities.
In July 2004, we
acquired a Texas utility consisting of a collection of rural regulated water
systems and wastewater collection and treatment systems serving approximately
21,000 water connections and 3,500 wastewater connections from Tecon Water
Holdings, L.P. and renamed the utility Monarch Utilities, Inc. The
acquisition expanded our regulated operations in the state of Texas. Monarch is
operated by our Services Group, allowing us to obtain operating efficiencies by
sharing overhead costs and employee competency in this region. The aggregate
purchase price was $66 million, comprised of $48 million in cash and the
assumption of $18 million in debt.
Shelby County Alabama Wastewater System.
In September 2005,
we acquired the assets of a wastewater collection and treatment system
servicing approximately 4,000 connections in Shelby County, Alabama, for $8.6
million in cash. The acquisition allowed us to expand our regulated utility
footprint into Alabama. Novus Utilities,
14
the contract operations company in Birmingham Alabama
we acquired in March 2005, has operated this facility since 1992 and was instrumental
in the acquisition process. This synergy creates operating efficiencies by
sharing overhead costs and employee competency in this region.
Denton Texas Water System.
In October 2005, we
acquired all of the stock of Midway Water Utilities, a small water utility
serving approximately 370 connections located in Denton County, Texas, for $0.5
million in cash and $0.2 million of assumed liabilities. Midway will be
combined with Monarch Utilities, one of our other Texas-based utilities,
allowing us to achieve operating efficiencies by sharing overhead costs and
employee competency in this region.
Windermere Minority Interest.
We have owned 80% of
Windermere Utility Company since October 2000. Windermere is our largest
water and wastewater utility located in the Austin, Texas area. Pursuant to a
shareholder agreement we entered into with the minority stockholder at the time
of acquisition, we acquired the remaining 20% of Windermere in December 2005
by issuing 450,644 shares of our common stock which had an aggregate market
value of $6.0 million as stipulated in the rights agreement.
Austin Texas Water and Wastewater Systems.
During 2006, we
acquired two small water utilities serving 244 connections and the rights to
serve water and provide wastewater utility service in developing areas located
near Austin, Texas. The aggregate purchase price for these acquisitions was
$1.4 million in cash; liabilities assumed in connection with the acquisitions
were negligible. These utilities will be combined with our other utilities in
the region allowing us to achieve operating efficiencies by sharing overhead
costs and employee competency in this region.
Mississippi Water and Wastewater Systems
. In February 2007, we
acquired the assets of a small water utility serving 275 connections and four
wastewater collection systems servicing 355 connections in a high growth area
of northern Mississippi, just south of Memphis Tennessee. The aggregate
purchase price for these acquisitions was $0.6 million in cash; liabilities assumed
in connection with these acquisitions were negligible. These utilities are
operated by our Services Group, which has operated in the area for several
years, allowing us to achieve operating efficiencies in this developing region.
San Antonio Texas Water Systems.
In May 2007, we acquired
all of the stock of two water utilities comprised of 13 separate systems
serving an aggregate 2,600 connections in a high population growth area
northwest of San Antonio, Texas. The aggregate purchase price for these acquisitions
was $5.8 million in cash and $0.9 million of assumed liabilities. These
utilities will be combined with Monarch Utilities, one of our other Texas-based
utilities, allowing us to achieve operating efficiencies by sharing overhead
costs and employee competency in this region.
Madison County Alabama Wastewater System.
In November 2007,
we acquired the assets of a wastewater collection and treatment system
servicing approximately 120 connections in an area north of Huntsville in
Madison County, Alabama, for $1.7 million in cash; no liabilities were assumed
in the transaction. The acquisition allowed us to expand our regulated utility
footprint into Alabama. Novus Utilities, the contract operations company in
Birmingham Alabama we acquired in March 2005, has operated this facility
for several years and was instrumental in the acquisition process. This synergy
creates operating efficiencies by sharing overhead costs and employee
competency in this region.
Shelby County Alabama Wastewater System.
In January 2008, we
purchased the assets of another wastewater collection and treatment system that
services approximately 4,100 residential and commercial connections in a
service area directly adjacent to our existing Shelby County collection and
treatment system. The purchase price was $22.5 million in cash at closing.
15
Services
Group Acquisitions
ACE Technologies.
In September 2004, our
SouthWest Environmental Laboratories subsidiary acquired the assets of Houston,
Texas-based ACE Technologies, Inc., a water and wastewater testing
laboratory for $1.2 million in the form of a promissory note payable to the
former owner. The promissory note was paid during 2005. This acquisition
allowed us to expand our capacity and expertise in the water and wastewater
quality testing field.
Novus Utilities.
In March 2005, we acquired the assets of
a Birmingham, Alabama-based contract operations company we operate as Novus
Utilities, Inc. This acquisition increased our market presence in the
southeastern United States and introduced us to the Birmingham, Alabama area.
We paid $2.7 million in cash and assumed $1.1 million of liabilities, which
includes $0.6 million of debt, in connection with this acquisition.
OpTech Minority Interest.
We have owned 90% of
Operations Technology, Inc. since August 2001. OpTech is a provider
of contract water, wastewater and public works services in the southeastern
United States. Pursuant to a shareholder agreement we entered into with the
minority stockholder at the time of acquisition, we acquired the remaining 10%
of OpTech in for $1.0 million in cash on March 21, 2006.
Disposition of Master Tek
In June 2005, we sold Master Tek International,
Inc, our subsidiary that provided utility submetering and billing and
collection services to multi-family residential properties. We elected to sell
Master Tek because of changes in the submetering market which would have
required significant capital investments in future years. We believe growth
opportunities involving our core competencies of operating and managing water
and wastewater facilities exceed those of the submetering business.
We sold Master Tek for $12.2 million in cash. We
received $11.1 million in cash at closing and $1.1 million was placed into an
escrow account which was released upon final determination of customary
representations and warranties. We used the proceeds from the sale to acquire
the assets of a wastewater collection and treatment system located in Shelby
County, Alabama, and to repay borrowings under our bank line of credit.
Master Tek contributed $8.4 million of revenue during
2004 and $3.7 million during the first six months of 2005 prior to the sale. As
a result of the sale, Master Tek is reflected as a discontinued operation in
our consolidated financial statements included in this report. The sale of this
business, which was part of our Services Group, did not adversely affect the
operations of our remaining businesses in the Services Group or our Utility
Group.
OTHER INFORMATION
Credit Concentration
We have no individual customers who accounted for 10%
or more of our consolidated revenues during each of the years in the three-year
period ended December 31, 2007, or whose loss would have a material
adverse effect on our consolidated or operating segment revenues.
Intellectual Property
The primary focus of the water and wastewater
management industry is customer service, and the industry does not rely heavily
on technological or proprietary manufacturing processes. We do not conduct
significant research and development activities. Except for certain logos,
trademarks and artwork used in marketing, we have no other patents, licenses or
trademarks.
16
Employees
At December 31, 2007, we employed approximately
1,400 people. Approximately 1,250 people were employed in our Services Group,
120 were employed in our Utility Group and 30 people in our corporate office.
None of our employees are represented under a collective bargaining agreement.
We believe relations with our employees are positive.
COMPANY INFORMATION
We make available free of charge through our internet
website our press releases, annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and all amendments to those
reports as soon as reasonably practicable after they are electronically filed
with, or furnished to, the Securities and Exchange Commission. Our internet
website also contains our Code of Ethical Conduct for all employees and our
Code of Ethics for Directors and Executive Officers. Our address is: SouthWest
Water Company; 624 South Grand Avenue, Suite 2900, Los Angeles, California
90017-3782. Our telephone number is (213) 929-1800 and our Internet website
address is www.swwc.com.
Information about our executive officers can be found
in Item 10. Directors, Executive Officers and Corporate GovernanceExecutive
Officers of the Registrant and is incorporated herein by reference.
ITEM 1A.
RISK FACTORS
We operate in two business
segments: our Utility Group and our Services Group. There are separate risk
factors associated with each.
UTILITY GROUP OPERATIONS
Weather Conditions
Rainfall and weather conditions affect the financial
results of our Utility Group.
·
Most water use occurs during
the second and third quarters of each year when weather tends to be hot and
dry. Depending on the degree of heat and lack of rain, our marginal costs of
water may exceed our marginal revenues as we use higher-cost purchased water to
meet customer demand. Therefore, while our revenues may increase, we may
experience lower profit margins during periods of peak demand.
·
Drought, or conversely,
unusually wet conditions, may also adversely impact our revenues and
profitability. During a drought, we may experience both lower revenues due to
consumer conservation efforts and higher water costs due to supply shortages.
Since a relatively high percentage of our water is used for residential
landscape irrigation, unusually wet conditions could result in decreased
customer demand, lower revenues and lower profit. Consequently, the results of
operations for one quarter should not be used to predict the results of future
quarters.
Regulatory Environment
Changes in the regulatory environment, including
restrictions on the rates we are allowed to charge customers, may adversely
affect our results of operations.
·
Our utility subsidiaries are
subject to regulation by governmental agencies which establish the rates that
we may charge our customers. These rates are intended, in concept, to permit
our utilities to recover operating costs and earn a rate of return on our
investment in utility plant and equipment. Each state regulatory agency sets
the rules and policies that allow our utilities to file applications to
increase rates as expenses or investment needs increase. These rules and
policies may require that we estimate future expenses or may require that we
incur specific expenses before there can be a change in rates. As a
17
result, our revenues and earnings may
fluctuate depending on the accuracy of our estimates, timing of our investments
or expenses, or other factors. For example, in many instances we rely on
electric pumps to pump and move water to our customers. Electric power costs in
California have been volatile. While we intend to use energy-efficient
techniques and appropriate equipment, we may seek an increase in rates. If we
were unable to obtain a rate increase that completely offsets the affect of
higher power costs, we would realize a decrease in our profitability.
·
The regulatory agencies may
change their rules and policies which may adversely impact our
profitability. In some states, regulators are elected by popular vote, and the
results of elections may change the rules and policies of the agency.
Changes in the rules and policies, including policies allowing our
Services Group to provide operations and maintenance, construction and
construction management services to our regulated utilities at fair market
value, may adversely impact our operating results.
Water Contamination
Contamination of our water sources by third parties
may adversely affect our operations.
·
Our water sources are
susceptible to contamination. We may not be able to recover costs incurred or
revenues lost due to such contamination. Additionally, contamination exposes us
to environmental liabilities, claims and litigation costs.
Natural Disasters or Terrorist
Activities
We own assets in areas that historically have
experienced natural disasters or that may be disrupted by terrorist activities.
·
Some of our utility
operations are located in areas that historically have experienced earthquakes
and hurricanes as well as other natural disasters. While we maintain insurance
policies to help reduce our financial exposure, a significant event could
adversely impact our ability to deliver water.
·
Our utility assets could be
targeted by terrorists seeking to disrupt services to our customers.
Environmental Risks
We are subject to environmental risks and may not be
able to provide an adequate supply of water to our customers.
·
Improved detection
technology, increasingly stringent regulatory requirements and heightened
consumer awareness of water quality issues contribute to an environment of
increased focus on water quality.
·
We cannot assure you that we
will be able in the future to reduce contaminants in our wells to acceptable
levels at a commercially reasonable cost or at all.
·
Standards that we must meet
are constantly changing and becoming more stringent. For example, in February 2002,
the EPA lowered the arsenic standard in drinking water from 50 parts per
billion to 10 parts per billion. To meet this new standard, we took actions
that included constructing three arsenic removal treatment plants costing $3.6
million and we expect that the resulting treatment requirements will increase
our cost of the water we provide. While we may request rate increases to
recover these additional costs and the cost of complying with standards that
may be enacted in the future, we cannot assure you that we will be successful
in obtaining those rate increases.
18
Water Sources
We have no assured access to
water.
·
Each of our utilities obtains
its water from various sources. The preferred source is pumping water from
aquifers within our service areas. In the event that our wells cannot meet the
customer demand, we have the ability to purchase water from surrounding
municipalities, agencies and other utilities. However, it usually costs us more
to purchase water than to produce it. Furthermore, these alternative sources
may not always have an adequate supply to sell us.
·
To date, we have been able to
produce and purchase enough water to meet our current customer requirements in
California. However, we cannot assure you that we will be able to produce or
purchase enough water to fully satisfy future customer demand in our California
service area. For example, our California utility purchases some water from the
MWD, especially during times of peak consumption, which in turn receives water
from both the California aqueduct system and the Colorado River. In 2003, the
US Department of the Interior restricted the amount of water that California
may receive from the Colorado River. In August 2007, the California
Department of Water Resources, the operator of the California aqueduct system,
was issued a court order to reduce by one-third the amount of water it draws
from the Sacramento-San Joaquin Delta to protect endangered fish. Additionally,
the aqueduct levees have recently come under scrutiny and there is a risk of
failure in the event of a natural disaster. These events may impact the amount
of water that the MWD can sell to our California utility in the future. We are
currently examining various options to increase our available water supply in
California. These options include drilling new wells, adding connections to our
existing MWD supply lines and constructing water treatment facilities. We
cannot assure you that the results of drilling the wells will be successful,
that we will be able to obtain necessary permits to add new supply lines and
connections, or that we will be able to obtain regulatory or legislative
approval to operate new water treatment facilities.
·
We can make no guarantee that
we will always have access to an adequate supply of water that will meet all
quality standards, or that the cost of our water will not adversely affect our
operating results.
SERVICES GROUP OPERATIONS
Competition
We operate in a competitive market.
·
Our Services Group competes
with several larger companies whose size, financial resources, customer base
and technical expertise may restrict our ability to compete successfully for
certain operations and maintenance contracts.
·
Due to the nature of our
contract operations business, and to the very competitive nature of the market,
we must accurately estimate the cost and profitability of each project while,
at the same time, maintaining prices at a level low enough to compete with
other companies. Our inability to achieve this balance could adversely impact
our results of operations.
Revenue Growth
Our revenue growth depends upon our ability to obtain
new operating contracts as well as to renew existing contracts with cities,
municipal utility districts and other agencies.
·
Because we are selling our
services in a political environment, we are subject to changing trends and
municipal preferences. Recent terrorist acts have affected some political
viewpoints relative to outsourcing water or wastewater utility services. In the
United States, municipalities own and municipal employees operate the majority
of water and wastewater systems. A significant portion of our Services Groups
marketing and sales efforts is spent demonstrating the benefits of contract
operations to elected officials
19
and municipal authorities. The existing
political environment means that decisions are based on many factors, not just
economic factors.
Weather Conditions
Events such as heavy rain, hurricanes, tornadoes and
floods may affect our results of operations.
·
Our Services Group contract
operations can be impacted by heavy rainfall which may limit our ability to
perform certain billable work such as pipeline maintenance, manhole
rehabilitation and other outdoor services.
·
Severe weather conditions,
such as hurricanes, tornadoes and floods, may result in additional labor and
material costs that may not necessarily be recoverable under our firm,
fixed-price O&M contracts, and therefore may adversely impact our results
of operations.
Construction Contract
Performance Risk
Services Group contracts for the design and
construction of water and wastewater projects may expose us to certain
completion and performance risks.
·
We have entered into, and may
continue to enter into, design and construction contracts for water and
wastewater facilities. These construction activities involve potential risks,
including shortages of materials and labor, work stoppages, labor relations
disputes, weather interference, engineering, environmental, permitting or
geological problems and unanticipated cost increases for reasons beyond our
control. These issues could give rise to delays, cost overruns or performance
deficiencies, or otherwise adversely affect the design, construction or
operation of the project.
·
Certain of our contracts are
fixed-price contracts, where we may bear all, or a significant portion of, the
risk for cost overruns. Under these fixed-price contracts, our contract pricing
is established in part based on fixed, firm subcontractor quotes or contracts
and on cost and scheduling estimates. These estimates may be based on a number
of assumptions, including assumptions about prices and availability of labor,
equipment and materials, and other issues. If these subcontractor quotations or
cost estimates prove inaccurate, or if circumstances change, cost overruns may
occur, and we could experience reduced profits or, in some cases, a loss for
that project. There can be no assurance that we can avoid additional costs
under these types of contracts.
·
See Item 7. Managements
Discussion and Analysis of Financial Condition and Results of OperationCertain
Contractual Commitments and Indemnities for additional information.
Environmental and Water Quality
Risks
Our Services Group is subject to environmental and
water quality risks.
·
We operate facilities on
behalf of our clients under contract. These facilities must be operated in
accordance with various federal and state water quality standards. We also
handle certain hazardous materials at these facilities, such as chlorine gas
and hydrogen sulfide. Any failures of our operation of the facilities,
including sewage spills, noncompliance with water quality standards, hazardous
material leaks and spills, and similar events, could expose us to environmental
liabilities, claims and litigation costs. We cannot assure you that we will
successfully manage these issues, and failure to do so could have a material
adverse effect on future results of operations.
20
Escalating Costs
Our operating costs,
construction costs and costs of providing services may rise faster than our
revenues.
·
Many of our contracts with
municipalities include contractual price increases tied to national consumer
price indices. However, our costs are subject to market conditions and other
factors, which may increase significantly higher than a generalized price
index. The largest component of our operating costs is made up of salaries and
wages. These costs are affected by the local supply and demand for qualified
labor. Other large components of our costs are general liability insurance,
workers compensation insurance, employee benefits and health insurance costs.
These costs may increase at rates higher than the applicable general price
index based on our actual claims incurred experience and therefore may result
in a material adverse effect on our future results of operations.
Contract Cancellations
Our operations and maintenance contracts may be
canceled, reducing our revenues and service backlog. Also, we may not secure
new construction and construction management projects on a consistent basis,
leading to fluctuations in revenues and backlog.
·
Our Service Group revenue
backlog consists of new and existing contracts. We include new contracts in the
backlog when we have a signed contract. Revenues included in our backlog may be
realized over a multi-year period. The contracts signed by our Services Group
typically have durations of three to five years and some are cancelable with 30
to 60 days prior notice. The uncompleted portion of base revenue for these
existing contracts is reflected in the backlog. Although our Services Group
tends to experience high renewal rates, municipalities and cities periodically
change operators or terminate outsourcing at the end of a contract. The
inability to renew existing contracts could have a material adverse impact on
our Services Group. In addition, a municipality could cancel a long-term
contract without notice. This would result in loss of revenues and operating
profits and may result in litigation if a breach of contract occurs.
Regulatory Environment
Changes in the regulatory
environment may adversely affect our results of operations.
·
Our utility subsidiaries are
subject to regulation by governmental agencies. In some states, regulators are
elected by popular vote, and the results of elections may change the rules and
policies of the agency. Changes in rules and policies, including policies
allowing our Services Group to provide operations and maintenance, construction
and construction management services to our regulated utilities at fair market
value, may adversely impact our operating results.
OTHER RISK FACTORS
Capital Resources
Our capital resources may restrict our ability to
operate and expand our business.
·
We may be unable to renew our
credit facilities when they expire. We may be unable to execute additional
financing alternatives at terms that we find acceptable. If we are unable to
renew our existing lines of credit, or if we are unable to execute additional
financing alternatives, our capital spending would be reduced or delayed and
any future acquisitions would also be delayed or eliminated, which could
negatively impact our revenues, revenue growth and profitability.
·
See Item 7. Managements
Discussion and Analysis of Financial Condition and Results of OperationCertain
Contractual Commitments and Indemnities for additional information.
21
Debt Covenants
We are subject to debt covenants.
·
We are obligated to comply
with specified debt covenants under some of our loan and debt agreements.
Failure to maintain compliance with these covenants could limit future
borrowing, and we could face penalties, increased borrowing costs, litigation,
acceleration of maturity schedules and cross default issues. Such actions by
our creditors could have a material adverse effect on our results of
operations.
Geographic Diversity
Our operations are subject to certain risks due to
their location.
·
We own or operate water and
wastewater facilities in numerous locations in numerous states and,
consequently, we are subject to widely differing weather, political, water
supply, labor supply, utility cost, regulatory, economic and other risks in the
areas we service. We cannot control these risks.
Internal Control Weaknesses
Internal control weaknesses
could have an adverse effect on us.
·
Insufficient
internal controls could result in lack of compliance with contractual
agreements, misstatements in our financial statements in amounts that could be
material and could cause investors to lose confidence in our reported financial
information, which could have a negative effect on the trading price of our
stock.
·
Controls that function
effectively today may become inadequate due to changes in conditions.
Information Technology
We rely on a number of complex business systems that
could malfunction.
·
Our businesses are dependent
on several complex business systems that must function reliably in order for us
to operate effectively. Among other things, system malfunctions could prevent
us from operating or monitoring our facilities, billing accurately and timely
analyzing financial results. Our profitability and cash flow could be impacted
negatively in the event these systems do not operate effectively. We are
working on migrating all of the legacy applications to a single integrated
software and hardware platform. We may also experience malfunctions during this
migration process.
Uninsured Risks
We retain certain risks not covered by our insurance
policies.
·
We evaluate our risks and
insurance coverage annually. Our evaluation considers the costs, risks and
benefits of retaining versus insuring various risks as well as the availability
of certain types of insurance coverage. Retained risks are associated with
deductible limits, partial self-insurance programs and insurance policy
coverage ceilings. We cannot assure you that we will not face uninsured losses
pertaining to the risks we have retained or that such uninsured losses will not
affect our financial condition, liquidity and results of operations.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
22
ITEM 2.
PROPERTIES
FACILITIES
Administrative Offices and
Warehouse Space
We lease administrative office and warehouse space at
22 locations in Alabama, California, Colorado, Georgia, Mississippi, New Mexico
and Texas. These office and warehouse facilities total approximately 227,000
square feet. In addition, we own administrative and warehouse space at three
locations in Alabama and Texas. The facilities we own total approximately
38,600 square feet of office space. We believe that these facilities are
adequate to meet the needs of our existing operations and provide reasonable
space for growth. The majority of our operations do not require uniquely
specialized facilities, and we believe that additional or alternative space is
available, if required, at reasonable prices. We may relocate some of our
facilities as leases terminate to improve the location or size of the facility,
or to provide better coordination among our operating units.
Property, Plant and Equipment
Our Utility Group utilizes
the majority of our property, plant and equipment. Property, plant and
equipment, net of accumulated depreciation, as of December 31, 2007, was
as follows:
Property, Plant
and Equipment, Net
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
|
|
|
|
Utility Group:
|
|
|
|
California
|
|
$
|
113,456
|
|
Texas
|
|
171,674
|
|
New Mexico
|
|
102,344
|
|
Alabama
|
|
10,452
|
|
Mississippi
|
|
574
|
|
Oklahoma
|
|
646
|
|
Total Utility Group
|
|
399,146
|
|
|
|
|
|
Services Group
|
|
8,090
|
|
Corporate
|
|
10,667
|
|
Total property, plant and equipment, net
|
|
$
|
417,903
|
|
Water Production and
Distribution Systems
Our Utility Group subsidiaries own and operate water
production and distribution systems including well pumping plants, booster
pumping stations, water treatment facilities, reservoir storage facilities,
transmission and distribution mains, and service connections to individual customers.
Our utilities have rights-of-way and easements in their service areas necessary
to provide water services. Water production and distribution facilities held by
our utilities as of December 31, 2007 were as follows:
23
Water Production
and Distribution Systems
|
|
California
|
|
Texas (1)
|
|
New Mexico
|
|
Mississippi
|
|
|
|
|
|
|
|
|
|
|
|
Transmission and
distribution mains (in miles)
|
|
852
|
|
1,013
|
|
237
|
|
7
|
|
Storage reservoirs
|
|
32
|
|
386
|
|
5
|
|
1
|
|
Storage reservoir capacity
(in million of gallons)
|
|
74
|
|
13
|
|
12
|
|
|
|
Active wells
|
|
18
|
|
250
|
|
6
|
|
2
|
|
Approximate pumping
capacity (in gallons per minute)
|
|
39,600
|
|
22,800
|
|
17,700
|
|
700
|
|
(1)
Includes the small utility we own in Oklahoma which
we operate as part of our Texas utilities.
Wastewater Facilities
We also own and operate wastewater collection and
sewage treatment systems. These utilities also have rights-of-way and easements
in their service areas necessary to provide their services. Wastewater
collection and sewage treatment facilities held by our utilities as of December 31,
2007 were as follows:
Wastewater
Collection and Sewage Treatment Systems
|
|
Texas (1)
|
|
New Mexico (2)
|
|
Alabama
|
|
Mississippi
|
|
|
|
|
|
|
|
|
|
|
|
Interceptor and collection
lines (in miles)
|
|
205
|
|
184
|
|
107
|
|
7
|
|
Lift stations
|
|
45
|
|
5
|
|
59
|
|
2
|
|
(1)
Consists of 15 separate collection and treatment
systems.
(2)
Wastewater is treated at a city-owned facility.
CAPITAL EXPENDITURES, REPAIRS AND
MAINTENANCE
We believe that our properties are maintained in good
condition and in accordance with current standards of good industry practice.
We believe that the facilities used in the operation of our business are in
good condition in terms of suitability, adequacy and utilization. We intend to
continue our capital expenditure programs of constructing and replacing
reservoirs, wells and transmission and distribution lines in future years as
needed and as approved by the regulating authorities. Our employees perform
normal maintenance and construction work on these facilities while major
construction projects are normally performed by general contractors. Ongoing
repairs and maintenance expenses for our Utility Group, expressed in dollars
spent as well as the related percentage of Utility Group revenue, for the three
years ended December 31, 2007 were as follows:
Utility
GroupRepairs and Maintenance Expenses
(In thousands, except percentage data)
|
|
Amount
|
|
Percent
|
|
|
|
|
|
|
|
Repairs and maintenance
expense:
|
|
|
|
|
|
2007
|
|
$
|
5,763
|
|
6.2
|
%
|
2006
|
|
$
|
5,864
|
|
6.8
|
%
|
2005
|
|
$
|
5,116
|
|
6.5
|
%
|
MORTGAGES AND LIENS
Virtually all of our California utilitys property is
subject to the lien of an Indenture of Mortgage and Deed of Trust dated October 1,
1986, as amended (the California Indenture), securing our California utilitys
First Mortgage Bonds. The California Indenture contains certain restrictions
common to such types of instruments regarding the disposition of property and
includes various covenants and restrictions, including limitations on the
amount of cash dividends that our California utility may pay to its parent
company, SouthWest Water. Our California utility pays regular quarterly
dividends to SouthWest Water. As of December 31, 2007, our California
utility was in compliance with the dividend limitations mandated by the
California Indenture.
24
Virtually
all of our New Mexico utilitys property is subject to the lien of an Indenture
of Mortgage and Deed of Trust dated February 14, 1992, as amended (the New
Mexico Indenture), securing our New Mexico utilitys First Mortgage Bonds. The
New Mexico Indenture contains certain restrictions common to such types of
instruments regarding the disposition of property and includes various
covenants and other restrictions, including limitations on the amount of cash
dividends that our New Mexico utility may pay to SouthWest Water. Our utility
in New Mexico pays regular quarterly dividends to SouthWest Water. As of December 31,
2007, our New Mexico utility was in compliance with dividend limitations
mandated by the New Mexico Indenture.
In
addition, substantially all of the assets of our Texas-based Monarch Utilities
are pledged as security for its bank term loans and a wastewater treatment
facility owned and operated by ECO Resources is pledged as security for
economic development bonds issued by the city of Keystone, South Dakota, to
finance the construction of that facility.
For
additional information, see our consolidated financial statements and the
accompanying notes to the financial statements included in this report.
ITEM 3.
LEGAL PROCEEDINGS
NEW MEXICO UTILITIES, INC.
New
Mexico Utilities, Inc. (NMUI), one of SouthWest Waters wholly-owned
regulated utilities, has an agreement with the Albuquerque Bernalillo County
Water Utility Authority, a political subdivision of the State of New Mexico
(the Water Authority), whereby the Water Authority treats the effluent from
NMUIs wastewater collection system for a fee. The treated effluent is returned
to the Rio Grande Underground Basin, creating return flow credits. Return flow
credits supplement NMUIs existing water rights, enabling it to pump additional
water from the basin.
In
August 2004, the Water Authority increased the fee charged to NMUI, using
a different formula than had been used to calculate fee increases in prior
years. The Company believes the increase violates the terms of a written
agreement between the parties. Subsequently, the Water Authority also claimed
ownership of the return flow credits. The Company filed a Complaint for
Declaratory Judgment in the Second Judicial District Court, County of
Bernalillo, State of New Mexico, requesting that the Court settle these
disputes. In a letter ruling dated May 2, 2007, the Court ruled that the
Water Authority could use a new formula to set fees for NMUI. SouthWest Water
filed a motion for reconsideration and that motion was denied on October 2,
2007. The matter has now been set for trial in the fall of 2008. The Court has
not ruled on whether the new rate was appropriate; has made no determination as
to any amount NMUI may owe to the Water Authority, or ruled on the ownership of
the return flow credits.
Although
we cannot give any assurances as to the ultimate resolution of this matter, we
do not believe that it is probable we will be required to pay the disputed fees
and related late payment penalties, which totaled $4.9 million as of December 31,
2007, and have not recognized a reserve for any potential liabilities in the
accompanying consolidated financial statements. In addition, should the Court rule against
NMUI, the New Mexico Public Regulation Commission has indicated its support of
NMUIs proposal that it be permitted to establish a regulatory asset for any
amounts paid, including late payment penalties, and recover that asset
prospectively through a rate surcharge to its customers. We are unable to
predict the impact the resolution of the return flow credits ownership dispute
will have on the consolidated financial statements.
In
September 2007, NMUI received a $0.7 million retroactive billing
adjustment from the Water Authority covering the period from August 2003
through April 2006 for the volume of wastewater it believes NMUI
discharged into the treatment system versus the amount reported by NMUI. The
amounts reported by NMUI were based on a calculation methodology that had been
agreed to by both parties and used for approximately 30 years. NMUI is
contesting the billing adjustment. Although we cannot give any assurances as to
the ultimate resolution of this
25
matter,
we do not believe that it is probable we will be required to pay the
retroactive billing and therefore have not recognized a reserve for any
potential liability for this amount in the accompanying consolidated financial
statements.
On
February 26, 2008, we were made aware of a Claim of Lien filed by the Water
Authority against NMUI in the sum of $5.8 million, allegedly for delinquent
sewer charges. This lien is related to the above described matters currently
being litigated in New Mexico State Court.
In
addition, on January 19, 2007, the Water Authority and the City of Rio
Rancho, a home-rule municipal corporation, as Petitioners, filed a
Petition for Condemnation against NMUI and others, as Defendants, in the Second
Judicial District Court, County of Bernalillo, State of New Mexico (the Petition).
The Petition seeks to acquire, by condemnation, all of the assets of NMUI,
including all real property, through the stated power of eminent domain. The
Petition also alleges that the Petitioners need to acquire the NMUI assets for
the public purposes of providing water and wastewater services to NMUI
customers and that the acquisition of NMUI is necessary, appropriate and in the
public interest. SouthWest Water is contesting the Petition and the matter is
scheduled for trial in the fall of 2008. If SouthWest Water does not prevail,
the Petitioners must pay fair market value for the utility 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
NMUI exceeds its recorded net book value as of December 31, 2007.
SUBURBAN WATER SYSTEMS
Suburban
Water Systems, one of the Companys wholly owned subsidiaries, and the Company
were named as defendants in several lawsuits alleging various injuries as a
result of water contamination in the San Gabriel Valley Main Basin. The
California Supreme Court ruled in February 2002 that the plaintiffs could
not challenge the adequacy of the water quality standards established by
California Department of Health Services. In August 2004, the case against
SouthWest Water and its subsidiary was dismissed; however, the plaintiffs
appealed the dismissal to the Court of Appeals for the State of California,
First Appellate District (1DCA Civil No. B178283). Oral arguments for the
appeal were presented on June 20, 2007 and the Company (and the other
defendants) prevailed at the appellate level. The Court ruled that the only
time a regulated water utility or public water company can be held liable in
tort for water quality issues is when they have violated a numerical standard
set by the Department of Health Services or other similar regulatory agency.
Liability insurance carriers have absorbed all costs related to the lawsuits
and appeals. The parties have entered into a settlement agreement which
provides, in part, that no further appeals will be filed, effectively ending
this litigation.
INVESTIGATIONS
On
May 5, 2005, ECO Resources, Inc. (ECO), one of SouthWest Waters
operating subsidiaries, received a subpoena to provide records to a grand jury.
The requested records relate to the operations of the San Simeon wastewater
treatment plant in California for the period January 2002 to the date of
the subpoena. ECO has operated this facility since September 2004. The
facility was also served with search warrants executed by the EPA. We
cooperated fully with the investigation and the investigation was closed without
further action in February 2008.
SouthWest
Water received a letter dated January 28, 2008 from the California State
Water Resources Control Board Office of Enforcement (the Board). The letter
indicates that the Board has conducted an investigation of the operations of
ECO with respect to various California wastewater treatment facilities which
are operated, but not owned, by ECO. The Board alleges that ECO has violated
certain provisions of the California Water Code and may be subject to civil
administrative liability in excess of $15.0 million, and possible
26
administrative
action against ECOs status as a contract operator in California. While we
believe that the summary allegations cannot be substantiated, we cannot
currently predict what, if any, actions may be taken by the Board or the effect
those actions may have on our financial position, results of operations or cash
flows. We intend to aggressively defend against this action. No amounts have been
accrued related to any potential fines, penalties or other liabilities.
On
May 18, 2005, the EPA executed a search warrant at SouthWest Waters
Texas-based testing laboratory and on July 20, 2006 the laboratory
received a subpoena to provide additional records and information to a grand
jury. We have cooperated fully with the investigation and have provided the
records requested. There have been no further significant developments since July 20,
2006.
OTHER MATTERS
SouthWest
Water and our subsidiaries are also involved in other routine legal and
administrative proceedings arising during the ordinary course of business. We
believe the ultimate disposition of such matters will not have a material
adverse effect on our consolidated financial position, results of operations or
cash flows.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to a vote of security holders during the fourth quarter
of fiscal year 2007.
27
PART II
ITEM 5.
MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION
The
following table shows the range of market prices of SouthWest Waters common
stock. Our common stock is traded on The NASDAQ Stock Market LLC under the
symbol SWWC. There were 3,305 stockholders of record as of March 20, 2008.
The
prices shown reflect the high and low sales prices for our common stock. The
price ranges shown in the table, as well as cash dividends declared in each
quarter, have been adjusted to reflect 5% stock dividends on January 2,
2006.
|
|
Stock Price Range
|
|
Cash
|
|
|
|
High
|
|
Low
|
|
Dividend
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
$
|
19.07
|
|
$
|
13.98
|
|
$
|
0.0524
|
|
Second Quarter
|
|
16.49
|
|
10.75
|
|
0.0524
|
|
Third Quarter
|
|
13.96
|
|
11.24
|
|
0.0524
|
|
Fourth Quarter
|
|
14.44
|
|
11.84
|
|
0.0576
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
15.25
|
|
12.10
|
|
0.0576
|
|
Second Quarter
|
|
15.06
|
|
12.21
|
|
0.0576
|
|
Third Quarter
|
|
16.41
|
|
12.35
|
|
0.0576
|
|
Fourth Quarter
|
|
13.10
|
|
11.53
|
|
0.0600
|
|
|
|
|
|
|
|
|
|
|
|
|
DIVIDEND POLICY
Since
1960, our practice has been to pay common stock cash dividends quarterly. The
amount and timing of future dividends depends on our growth, results of
operations, profitability and financial condition, as well as other factors
deemed relevant by our Board of Directors. Our current quarterly dividend rate
is $0.06 per share of common stock.
STOCK PERFORMANCE GRAPH
The
following graph compares the cumulative total return to holders of the Companys
common stock during the five most recent fiscal years versus the cumulative
total return during the same period achieved by the 11 publicly held water
utilities listed in the A.G. Edwards Water Utility Index and that achieved by
the Standard & Poors 500 Stock Index on December 31st of each
year. The comparison assumes an initial investment of $100 made on December 31,
2002 in each of the Companys common stock, the A.G. Edwards Water Utility
Index and the Standard & Poors 500 Stock Index. The cumulative total
returns assume the reinvestment of all dividends. The historical stock
performance reflected in the graph is not necessarily indicative of future
stock performance.
28
|
|
Current
Value of a
|
|
|
|
|
|
|
|
December 31,
2002 Investment in:
|
|
Price
of:
|
|
|
|
|
|
|
|
A.G.
Edwards
|
|
|
|
|
|
|
|
|
|
S&P
500
|
|
Water
Utility
|
|
|
|
|
|
|
|
SWWC
|
|
Composite
|
|
Index
|
|
SWWC
|
|
S&P 500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2002
|
|
$
|
100.00
|
|
$
|
100.00
|
|
$
|
100.00
|
|
$
|
9.01
|
|
$
|
880
|
|
December 31, 2003
|
|
122.50
|
|
128.68
|
|
129.07
|
|
10.86
|
|
1,112
|
|
December 31, 2004
|
|
146.78
|
|
142.69
|
|
149.99
|
|
12.81
|
|
1,212
|
|
December 31, 2005
|
|
166.60
|
|
149.68
|
|
203.79
|
|
14.31
|
|
1,248
|
|
December 31, 2006
|
|
162.76
|
|
173.32
|
|
204.62
|
|
13.76
|
|
1,418
|
|
December 31, 2007
|
|
150.74
|
|
182.84
|
|
193.64
|
|
12.52
|
|
1,468
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes:
(1)
Assumes that dividends are
reinvested.
(2)
Includes the impact of stock
splits and stock dividends.
(3)
A.G. Edwards Water Utility
Index includes ARTNA, AWR, BIW, CTWS, CWT, MSEX, PNNW, SWWC, SJW, WTR and YORW,
weighted for market capitalization.
SECURITIES AUTHORIZED FOR
ISSUANCE UNDER EQUITY COMPENSATION PLANS
Information
relating to securities authorized for issuance under equity compensation plans
will be set forth under the caption Equity Compensation Plan Information in
our Proxy Statement for our 2008 Annual Meeting of Stockholders. Such
information is incorporated herein by reference.
29
ITEM 6.
SELECTED FINANCIAL DATA
|
|
Years Ended December 31, (1)
|
|
(In thousands, except ratio and
per share data)
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Summary of Income Statement
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
217,347
|
|
$
|
218,802
|
|
$
|
197,604
|
|
$
|
179,420
|
|
$
|
166,683
|
|
Operating income (2)
|
|
2,859
|
|
22,419
|
|
18,474
|
|
11,394
|
|
14,179
|
|
Other income (expense) (2)
|
|
(6
|
)
|
58
|
|
(2
|
)
|
105
|
|
658
|
|
Income (loss) from
continuing operations
|
|
(5,020
|
)
|
10,009
|
|
7,971
|
|
5,004
|
|
7,204
|
|
Loss from discontinued
operations
|
|
(3,026
|
)
|
(681
|
)
|
(5,572
|
)
|
(470
|
)
|
(11
|
)
|
Net income (loss)
|
|
(8,046
|
)
|
9,399
|
|
2,399
|
|
4,534
|
|
7,193
|
|
Net income (loss)
applicable to common stockholders
|
|
(8,070
|
)
|
9,375
|
|
2,375
|
|
4,510
|
|
7,166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of earnings to fixed
changes (3)
|
|
|
|
|
|
|
|
|
|
|
|
Ratio
|
|
|
|
2.36
|
x
|
2.37
|
x
|
2.02
|
x
|
2.58
|
x
|
Deficiency
|
|
$
|
5,151
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Common Share Data (4):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per common
share:
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations:
|
|
|
|
|
|
|
|
|
|
|
|
Basic (2)
|
|
$
|
(0.21
|
)
|
$
|
0.44
|
|
$
|
0.38
|
|
$
|
0.27
|
|
$
|
0.47
|
|
Diluted (2)
|
|
(0.21
|
)
|
0.43
|
|
0.37
|
|
0.26
|
|
0.44
|
|
Discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
(0.12
|
)
|
(0.03
|
)
|
(0.27
|
)
|
(0.03
|
)
|
|
|
Diluted
|
|
(0.12
|
)
|
(0.03
|
)
|
(0.26
|
)
|
(0.03
|
)
|
|
|
Applicable to common
stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
Basic (2)
|
|
(0.33
|
)
|
0.41
|
|
0.11
|
|
0.24
|
|
0.47
|
|
Diluted (2)
|
|
(0.33
|
)
|
0.40
|
|
0.11
|
|
0.23
|
|
0.44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividends per common
share
|
|
0.23
|
|
0.21
|
|
0.20
|
|
0.18
|
|
0.16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, (1)
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet and Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions to property,
plant and equipment
|
|
$
|
41,348
|
|
$
|
43,253
|
|
$
|
32,640
|
|
$
|
22,975
|
|
$
|
16,741
|
|
Total assets
|
|
516,409
|
|
491,693
|
|
444,725
|
|
404,809
|
|
296,222
|
|
Total debt (5)
|
|
147,290
|
|
130,047
|
|
127,095
|
|
118,560
|
|
75,799
|
|
Stockholders equity
|
|
159,194
|
|
166,527
|
|
145,253
|
|
126,198
|
|
79,667
|
|
(1)
Reflects historical selected consolidated financial
statement data derived from the audited consolidated financial statements and
related notes, reclassified to present Master Tek, which was sold during 2005,
as a discontinued operation. Also reflects the results of operations and
financial position of companies acquired for all periods subsequent to their
respective acquisition dates. See Item 1. BusinessSignificant Acquisitions
and Dispositions for additional information.
(2)
Operating income for the five years ended December 31,
2007 includes reimbursement of incremental costs pursuant to a 2002 settlement
agreement. As a result of the settlement agreement, we have received, and we
expect to continue receiving, monthly reimbursement from the allegedly
responsible parties for the incremental costs until completion of remediation.
For 2007, 2006, 2005, 2004 and 2003 the reimbursements were $3.4 million, $3.1
million, $3.4 million, $3.3 million and $4.0 million, respectively ($0.09,
$0.09, $0.10, $0.10 and $0.16 per share, respectively, net of tax).
(3)
For the purposes of calculating the ratio of earnings
to fixed charges, earnings represent income or loss from continuing operations
before income taxes and fixed charges, minus interest capitalized. Fixed
charges consist of:
·
interest, both expensed and
capitalized;
30
·
amortization of debt expense
and discount or premium relating to any indebtedness; and
·
one-third of rental expenses
under operating leases which is considered to be a reasonable approximation of
the interest portion of such expense.
(4)
All earnings and cash dividends per common share have
been retroactively adjusted to reflect stock dividends and stock splits
occurring in prior periods.
(5)
Total debt is defined as total borrowings under bank
lines of credit and long-term debt, including current maturities.
ITEM 7
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Managements Discussion and Analysis of Financial
Condition and Results of Operations (the MD&A) is intended to help the
reader understand the results of operations and financial condition of
SouthWest Water Company. The MD&A is provided as a supplement to, and
should be read in conjunction with, our consolidated financial statements and
the accompanying notes to the financial statements included in this report. The
MD&A also contains forward-looking statements. See Forward-Looking
Statements on page 1 of this report for additional information.
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, which we describe
below. 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 groups
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.
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, South Dakota 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 Groups 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 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
groups
31
operating expenses reflect salaries, wages and
employee benefits, 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 Groups 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.
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.
Effects of Inflation
For our Utility Group, recovery for the effects of
inflation through higher rates is dependent upon receiving adequate and timely
rate increases. For our Service Group, most of our contacts have provisions for
rate increases tied to the rate of inflation. However, rate increases are not
retroactive and often lag increases in costs caused by inflation. During
periods of moderate inflation, as has been experienced in 2007 and 2006, the
effects of inflation have had an impact on our results of operations.
Acquisitions, Assets Held for
Sale and Dispositions
Our
financial position, results of operations and cash flows have been affected by
our history of acquisitions and, in 2005, a disposition. Our most recent
significant acquisitions, which affect the comparability of the historical
financial condition and results of operations described in the MD&A, are:
Utility Group:
·
a Shelby County,
Alabama-based wastewater collection and treatment system servicing
approximately 4,000 connections in September 2005;
·
a Denton County, Texas-based
water utility serving approximately 370 connections in October 2005;
·
two Austin, Texas-based water
utilities serving 244 connections in 2006;
·
a northern Mississippi-based
water and wastewater utility serving approximately 275 water connections and
servicing approximately 355 wastewater connections through four collection
systems in February 2007;
·
two San Antonio, Texas-based
water utilities serving approximately 2,600 connections in May 2007;
·
a Madison County,
Alabama-based wastewater collection and treatment system servicing
approximately 120 connections in November 2007; and
Services Group:
·
a Birmingham, Alabama-based
contract operations company in March 2005.
In January 2008, we also acquired another
Birmingham, Alabama-based wastewater collection and treatment system that
services approximately 4,100 residential and commercial connections in a
service area directly adjacent to our existing Shelby County collection and treatment
system.
32
During 2007, we elected to sell a wholesale water and
wastewater operation in Texas and believe the sale can be consummated during
2008. As a result of this decision, the operation is classified as a
discontinued operation in our consolidated financial statements and the
discussion below reflects only continuing operations for all periods.
In June 2005 we sold Master Tek International, Inc.,
our submetering business that provided multi-family residential utility
metering, billing and collection services for residential properties. The sale
of this business, which was part of our Services Group, has not affected the
operations of our remaining businesses in the Services Group or our Utility Group.
As a result of the sale, the business we sold is also reflected as a
discontinued operation in our consolidated financial statements for 2005 and
the discussion below reflects only continuing operations.
New Mexico Eminent Domain
Condemnation Proceedings
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 December 31, 2007. See Item 3. Legal Proceedings
for additional information.
BUSINESS OUTLOOK
The water and wastewater industry generates annual
revenues in excess of $70 billion in the United States. Both services are
primarily owned by government municipalities. Growing regulatory complexity and
escalating water quality awareness has led to a dwindling supply of low-cost
potable water. The market is characterized by an aging and deteriorating
municipal infrastructure and there is minimal state and federal government
funding available to upgrade these systems to meet the higher standards. The
EPA estimates that an investment of $750 billion to $1.0 trillion may be needed
over the next 20 years to meet the higher standards. These factors lead us to a
very positive outlook for growth in our industry as more government entities
look to the private sector to help them meet these challenges.
We intend to grow our market share of this industry
by focusing on both increasing the number of utilities we own and on increasing
the dollars generated by operating and maintaining government-owned utilities.
Our long-term strategic plan is to increase our profitability through
acquisitions and organic growth in both our Utility Group and our Services
Group.
The Utility Group growth strategy focuses on
strategically located acquisitions, organic customer growth and actively
managed rate proceedings. We look to acquire strategic utilities located within
our geographic footprint, thereby expanding our presence in a region and
gaining economies of scale. We also look to acquire utilities in population
growth areas. Historically, our utilities in population growth areas experience
new development in their service areas which generates organic growth through
increased customer connections. To ensure a reasonable rate of return on
investments in our capital assets, we manage rate proceedings through our
relationships with public utility commissions.
The Services Group growth strategy focuses on
expanding our client base, making strategic acquisitions and providing
peripheral services such as construction of infrastructure, billing and
collection services, customer care/call centers, meter replacement and
laboratory analysis of water and wastewater samples. By pursuing new
33
operations and maintenance contracts with cities,
municipalities and private owners of water and wastewater utilities within our
geographic footprint, we expand our presence in a region and gain economies of
scale. We look to expand the scope of our contracts with current clients by
adding additional services such as billing and collections and providing
capital improvement project management services. An opportunity unique to our
business model is that it includes an integrated strategy in which the Services
Group provides construction and operation and maintenance services to our
Utility Group. This provides us with economies of scale. We also continue to
pursue acquisitions of small, strategic service companies that expand our
geographic presence and give us knowledge of the regions water and wastewater
needs. This local knowledge positions us for growth both in the service as well
as the utility side of the business as municipalities look to form
public/private partnerships or to sell their utility assets. This was
demonstrated in March 2005 by our acquisition of Novus Utilities, a
contract operations business in Alabama which gave us local knowledge and
relationships in the region. This positioning in turn led to the acquisition of
three wastewater utilities, one in September 2005, a second in November 2007
and the third in January 2008.
RESULTS OF OPERATIONS
Change in Presentation
Effective January 1, 2007, we elected to
allocate a portion of the Services Groups operating expense overhead between
affiliated and unaffiliated customers for segment reporting purposes. In prior
periods, all operating expense overhead was reflected as operating expenses
attributable to unaffiliated customers. This change in allocation methodology
increased the gross profit from sales to unaffiliated customers and decreased
the gross profit from sales to affiliated customers by the same amount. In accordance
with SFAS No. 131,
Disclosures about Segments
of an Enterprise and Related Information
, prior year amounts have
been reclassified to conform to the 2007 presentation.
In accordance with SFAS No. 71,
Accounting for the Effects of Certain Types of Regulation
(SFAS
71), we do not eliminate the intersegment profit recognized on sales to
affiliated customers because we believe 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 the Services Groups revenues
from affiliated customers to the extent of its cost. Consequently, this change
resulted in a decrease in the Services Groups revenues and direct operating
expenses reported in 2006 and 2005 by the same amounts. Consolidated gross
profit, operating income and net income are unchanged.
In 2006, we centralized many of our common business
functions into a shared services departmental structure and the related
expenses were classified as selling, general and administrative expenses.
Effective January 1, 2007 we concluded that these expenses were more
operational in nature and elected to classify these expenses as direct
operating expenses. As a result, 2006 amounts have also been reclassified to
conform to the 2007 presentation.
2007 Compared to 2006
Revenues.
Revenues
decreased $1.5 million, or 0.7%, to $217.3 million for year ended December 31,
2007 from $218.8 million for the same period during the prior year. By segment,
revenues changed as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues
|
|
(In thousands, except
percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
93,370
|
|
$
|
86,321
|
|
$
|
7,049
|
|
43.0
|
%
|
39.5
|
%
|
Services Group
|
|
123,977
|
|
132,481
|
|
(8,504
|
)
|
57.0
|
%
|
60.5
|
%
|
Total
|
|
$
|
217,347
|
|
$
|
218,802
|
|
$
|
(1,455
|
)
|
100.0
|
%
|
100.0
|
%
|
34
Utility Group.
Revenues
increased $7.0 million, or 8.2%, to $93.4 million for the year ended December 31,
2007, from $86.3 million for the same period during the prior year. The
increase was primarily due to the following:
·
a $3.7 million increase at
our California utility related to increased consumption and an increase in
rates that went into effect on July 1, 2006; and
·
a $3.4 million increase
primarily resulting from a fourth quarter 2006 rate increase at one of our
Texas utilities, a fourth quarter 2007 rate increase at one of our other Texas
Utilities, a rate increase at our Alabama wastewater treatment facility and an
increase in customer connections at our Texas and New Mexico Utilities; and
·
a $1.1 million increase
resulting from utility acquisitions in San Antonio, Texas and northern
Mississippi; offset by
·
a $1.2 million decrease due
to lower consumption attributable to the wet weather in the Texas region during
the year.
Services Group.
Revenues
decreased $8.5 million, or 6.4%, to $124.0 million for the year ended December 31,
2007 from $132.5 million for the same period during the prior year. The
decrease in revenues was primarily due to the following:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues
|
|
(In thousands, except
percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from unaffiliated
customers
|
|
$
|
119,254
|
|
$
|
125,558
|
|
$
|
(6,304
|
)
|
79.1
|
%
|
75.6
|
%
|
Intersegment revenues
|
|
31,467
|
|
40,424
|
|
(8,957
|
)
|
20.9
|
%
|
24.4
|
%
|
Total revenues
|
|
150,721
|
|
165,982
|
|
(15,261
|
)
|
100.0
|
%
|
100.0
|
%
|
Intersegment cost eliminations
|
|
(26,744
|
)
|
(33,501
|
)
|
6,757
|
|
|
|
|
|
Total
|
|
$
|
123,977
|
|
$
|
132,481
|
|
$
|
(8,504
|
)
|
|
|
|
|
Revenues from unaffiliated customers decreased $6.3
million, or 5.0%, to $119.3 million for the year ended December 31, 2007
from $125.6 million for the same period during the prior year. The decrease in
revenues was primarily due to the following:
·
a $7.6 million decrease in
contract operations, maintenance, public works and construction work in our
southeast region due to contracts not renewed or canceled; and
·
a $2.0 million decrease
related to lower revenues in Texas from new housing construction due to a
slowdown in housing starts as well as inclement weather compared to the prior
year; offset by
·
a $3.3 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 $9.0 million, or 22.2%, to $31.5 million for the year ended December 31,
2007 from $40.4 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 $1.8 million, or 1.1%, to $160.6 million for the year ended December 31,
2007 from $162.5 million for the same period during the prior year as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
52,765
|
|
$
|
48,540
|
|
$
|
4,225
|
|
56.5
|
%
|
56.2
|
%
|
Services Group
|
|
107,884
|
|
113,916
|
|
(6,032
|
)
|
87.0
|
%
|
86.0
|
%
|
Total
|
|
$
|
160,649
|
|
$
|
162,456
|
|
$
|
(1,807
|
)
|
73.9
|
%
|
74.2
|
%
|
(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.
35
Utility Group.
Direct operating
expenses increased $4.2 million, or 8.7%, to $52.8 million for the year ended December 31,
2007, from $48.5 million for the same period during the prior year. The
increase in direct operating expenses was primarily due to the following:
·
a $1.8 million increase in
expenses resulting from our San Antonio, Texas and northern Mississippi utility
acquisitions, and increases at our Texas and New Mexico utilities in
depreciation expense, contract operation fees, and sewage treatment expenses;
·
a $1.6 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 56.5% and 56.2% of
related revenues for the year ended December 31, 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 57.2% for the year ended December 31,
2006.
Services Group.
Direct operating
expenses decreased $6.0 million, or 5.3%, to $107.9 million for the year ended December 31,
2007 from $113.9 million for the same period during the prior year. The
decrease in direct operating expenses was due to the following:
·
a $8.0 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 $1.5 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 $2.8 million increase in
direct costs associated with increased business activity; and
·
a $0.7 million charge in 2007
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 1.0% to 87.0% for the year ended December 31,
2007 compared to 86.0% for the same period during the prior year. Excluding the
nonrecurring $0.7 million charge, the operating expense percentage is 86.5% for
the year ended December 31, 2007.
Gross Profit.
Gross profit,
which we define as the difference between revenues and the related direct
operating expenses, increased $0.4 million, or 0.6%, to $56.7 million for the
year ended December 31, 2007 from $56.3 million for the same period during
the prior year as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
40,605
|
|
$
|
37,781
|
|
$
|
2,824
|
|
43.5
|
%
|
43.8
|
%
|
Services Group
|
|
16,093
|
|
18,565
|
|
(2,472
|
)
|
13.0
|
%
|
14.0
|
%
|
Total
|
|
$
|
56,698
|
|
$
|
56,346
|
|
$
|
352
|
|
26.1
|
%
|
25.8
|
%
|
(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
43.5% and 43.8% of related revenues for the year ended December 31, 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 42.8% for the year ended December 31,
2006. The decrease is primarily attributable to higher depreciation and other
operating expenses.
36
Services Group.
Gross profit for
the year ended December 31, 2007 and 2006 was comprised of the following:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit on sales to:
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated customers
|
|
$
|
11,370
|
|
$
|
11,642
|
|
$
|
(272
|
)
|
9.5
|
%
|
9.3
|
%
|
Affiliated customers (intersegment)
|
|
4,723
|
|
6,923
|
|
(2,200
|
)
|
15.0
|
%
|
17.1
|
%
|
Total
|
|
$
|
16,093
|
|
$
|
18,565
|
|
$
|
(2,472
|
)
|
10.7
|
%
|
11.2
|
%
|
(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 $0.3 million, or 2.3%, to $11.4 million for
the year ended December 31, 2007 from $11.6 million for the same period
during the prior year. Gross profit as a percent of revenues for 2007 was 9.5%,
compared to 9.3% for the same period for the prior year. The decrease in gross
margin dollars is primarily related to the slowdown in the housing market as
mentioned above, partially offset by an increase in contract prices.
Services Group gross profit on revenues from our
Utility Group decreased by $2.2 million, or 31.8% to $4.7 million for the year
ended December 31, 2007 from $6.9 million for the same period during the
prior year. The decrease is related to a slow down in housing construction, wet
weather in Texas, 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 MUDs, municipal
clients through operations and maintenance contracts, and SouthWest Waters own
Utility Group. We need to accelerate our performance improvements and therefore
we refocused 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 $3.6 million, or 11.0%, to $36.6 million
for the year ended December 31, 2007 compared to $33.0 million for the
same period during the prior year as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
8,050
|
|
$
|
7,609
|
|
$
|
441
|
|
8.6
|
%
|
8.8
|
%
|
Services Group
|
|
12,680
|
|
12,006
|
|
674
|
|
10.2
|
%
|
9.1
|
%
|
Corporate
|
|
15,894
|
|
13,383
|
|
2,511
|
|
|
|
|
|
Total
|
|
$
|
36,624
|
|
$
|
32,998
|
|
$
|
3,626
|
|
16.9
|
%
|
15.1
|
%
|
(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.
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 $0.5
million through December 31, 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 primarily from a restructuring charge
associated with the workforce realignment. Corporate expenses increased as
result of $1.9 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 $0.9 million of CEO relocation expenses incurred in 2006.
37
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 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. The financial module of the integrated platform became operational
on January 1, 2008 and is performing as expected.
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 2007, charges totaling $17.2 million were
recorded to reflect the impairment of goodwill in accordance with SFAS No. 142.
As required by SFAS 142, we test goodwill annually for impairment at the
reporting unit level, or when events or circumstances indicate the carrying
values may not be recoverable. We evaluate goodwill for impairment using
discounted cash flow methodologies, transaction values for comparable
companies, and other valuation techniques for reporting units with goodwill
balances. The realization of long-lived assets, including goodwill, is
dependent on expected future cash flows from the underlying operations.
Forecasted revenues and capital expenditures, which include forecasted customer
connection growth and the timing and amount of regulated rate increases, are
key components of the discounted cash flow projections.
During recent impairment testing, we determined that
revenue growth for our Texas Utilities was likely to be slower than originally
projected due to downturns in overall economic conditions and new housing
construction as well as a slower rate of regulated rate increases. Additionally
we determined that higher levels of capital expenditures than previously
projected were necessary to bring the systems into regulatory compliance and to
continue improving the quality of service for our customers. These factors
resulted in significantly lower discounted cash flow projections than
previously forecast. Based on these projections, the entire $17.2 million of
goodwill associated with the Texas Utilities was found to be impaired and was
charged to expense in 2007.
Other Income (Expense).
Other expenses
increased $0.1 million, or 0.9% to $7.1 million for the year ended December 31,
2007, compared to $7.0 million for the same period during the prior year as
follows:
|
|
|
|
|
|
(Increase)
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
Decrease
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
$
|
(7,696
|
)
|
$
|
(7,536
|
)
|
$
|
(160
|
)
|
Interest income
|
|
618
|
|
456
|
|
162
|
|
Other, net
|
|
(6
|
)
|
58
|
|
(64
|
)
|
Total
|
|
$
|
(7,084
|
)
|
$
|
(7,022
|
)
|
$
|
(62
|
)
|
Interest Expense.
Interest expense
increased by $0.2 million, or 2.1% to $7.7 million for the year ended December 31,
2007 from $7.5 compared to the same period during the prior year. The major
components of interest expense were as follows:
(In thousands
)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
Mortgage bonds and bank
term loans
|
|
$
|
4,731
|
|
$
|
4,836
|
|
$
|
(105
|
)
|
Revolving lines of credit
|
|
3,229
|
|
2,382
|
|
847
|
|
Convertible subordinated
debentures
|
|
843
|
|
950
|
|
(107
|
)
|
Other indebtedness
|
|
702
|
|
834
|
|
(132
|
)
|
Total interest incurred
|
|
9,505
|
|
9,002
|
|
503
|
|
Less capitalized interest
|
|
(914
|
)
|
(630
|
)
|
(284
|
)
|
Less interest related to discontinued operations
|
|
(895
|
)
|
(836
|
)
|
(59
|
)
|
Total interest expense
|
|
$
|
7,696
|
|
$
|
7,536
|
|
$
|
160
|
|
38
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 $140.9 million during the year ended December 31,
2007 compared to $130.0 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 6.8% for the year ended December 31,
2007 and 6.9% for the same period in the prior year.
Interest Income.
Interest income
increased $0.2 million for the year ended December 31, 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 on combined continuing and discontinued operations
was 11% for the year ended December 31, 2007 compared to 35% for 2006. The
decrease from the 34% federal statutory rate in 2007 was primarily caused by
$5.6 million of non-deductible goodwill impairment charges recorded during the
year.
Loss from Discontinued
Operations.
Net loss from discontinued operations, which pertains
to our wholesale water and wastewater business we elected to sell, was $3.0
million for the year ended December 31, 2007. Included in the net loss is
a $3.4 million charge ($2.2 million net of tax) to reduce the carrying value of
the assets to expected net realizable value.
2006 Compared to 2005
Revenues.
Revenues increased
$21.2 million, or 10.7%, to $218.8 million for year ended December 31,
2006 from $197.6 million for the year ended December 31, 2005. By segment,
revenues increased as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues
|
|
(In thousands, except percentages)
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
86,321
|
|
$
|
78,884
|
|
$
|
7,437
|
|
39.5
|
%
|
39.9
|
%
|
Services Group
|
|
132,481
|
|
118,720
|
|
13,761
|
|
60.5
|
%
|
60.1
|
%
|
Total
|
|
$
|
218,802
|
|
$
|
197,604
|
|
$
|
21,198
|
|
100.0
|
%
|
100.0
|
%
|
Utility Group.
Revenues increased
$7.4 million, or 9.4%, to $86.3 million for the year ended December 31,
2006, from $78.9 million for the prior year. The increase was primarily due to
the following:
·
a $2.8 million increase at
our California utility related to increased consumption and an increase in
rates that went into effect on July 1st of 2006;
·
a $2.7 million increase at
our New Mexico and Texas utilities primarily resulting from an increase in the
number of connections, a fourth quarter 2005 rate increase at one of our Texas
utilities and, to a lesser extent, increased consumption; and
·
a $1.9 million increase
related to our acquisition of a wastewater treatment facility in Alabama at the
end of the third quarter of 2005.
Services Group.
Revenues
increased $13.8 million, or 11.6%, to $132.5 million for the year ended December 31,
2006 from $118.7 million for the same period during the prior year. The
increase in revenues was primarily due to the following:
39
|
|
|
|
|
|
Increase
|
|
Percent of Revenues
|
|
(In thousands, except
percentages)
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from unaffiliated
customers
|
|
$
|
125,558
|
|
$
|
114,515
|
|
$
|
11,043
|
|
75.6
|
%
|
78.5
|
%
|
Intersegment revenues
|
|
40,424
|
|
31,324
|
|
9,100
|
|
24.4
|
%
|
21.5
|
%
|
Total revenues
|
|
165,982
|
|
145,839
|
|
20,143
|
|
100.0
|
%
|
100.0
|
%
|
Intersegment cost eliminations
|
|
(33,501
|
)
|
(27,119
|
)
|
(6,382
|
)
|
|
|
|
|
Total
|
|
$
|
132,481
|
|
$
|
118,720
|
|
$
|
13,761
|
|
|
|
|
|
Revenues from unaffiliated customers increased $11.0
million, or 9.6%, to $125.6 million for the year ended December 31, 2006
from $114.5 million for the same period during the prior year. The increase in
revenues was primarily due to the following:
·
a $4.1 million increase in
contract operations, maintenance, public works and construction due to new
contracts;
·
a $6.3 million increase
related to growth in the customer base under existing contracts as a result of
increased housing starts; and
·
a $1.4 million increase
resulting from the acquisition of an Alabama-based contract operations company
in March 2005; offset by
·
a $0.8 million decrease in
revenues at our testing laboratory operation.
Services Group revenues
received from our Utility Group increased by $9.1 million, or 29.1%, to $40.4
million for the year ended December 31, 2006 from $31.3 million for the
prior year. The increase in revenues results from a $7.0 million increase in
construction projects performed for our New Mexico and Texas utilities, as well
as an increase in operations and maintenance work of $2.1 million, primarily
related to the acquisition of our Alabama wastewater facility.
Direct Operating Expenses.
Direct operating
expenses increased $14.1 million, or 9.5%, to $162.5 million for the year ended
December 31, 2006 from $148.4 million for the prior year as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
48,540
|
|
$
|
44,827
|
|
$
|
3,713
|
|
56.2
|
%
|
56.8
|
%
|
Services Group
|
|
113,916
|
|
103,547
|
|
10,369
|
|
86.0
|
%
|
87.2
|
%
|
Total
|
|
$
|
162,456
|
|
$
|
148,374
|
|
$
|
14,082
|
|
74.2
|
%
|
75.1
|
%
|
(1)
Utility Group and Services Group direct operating
expenses are computed as a percent of their respective revenues. Total direct
operating expenses is computed as a percentage of total revenues.
Utility Group.
Direct
operating expenses increased $3.7 million, or 8.3%, to $48.5 million for the
year ended December 31, 2006, from $44.8 million for the prior year. The
increase in direct operating expenses was primarily due to the following:
·
a $2.5 million increase in
expenses at our New Mexico and Texas utilities resulting from an increase in
the number of connections we serve which caused higher costs related to water
production, chemicals, lab fees and sludge hauling;
·
a $2.8 million net increase
in direct operating expenses at our California utility principally resulting
from higher water production costs related to increased consumption; and
·
a $1.0 million increase
related to our acquisition of a wastewater treatment facility in Alabama at the
end of the third quarter of 2005; offset by
40
·
a $2.2 million decrease
resulting from our California utility recording a balancing account receivable
pursuant to a CPUC decision which eliminated a required earnings test; and
·
a $0.4 million reduction in
expenses at our California utility resulting from a gain on the sale of land
that was no longer used or useful to its operations.
Direct operating expenses
were 56.2% and 56.8% of related revenues for the years December 31, 2006
and 2005, respectively. Direct operating expenses as a percent of related
revenues for 2006 were 59.2% excluding the effect of the favorable CPUC
decision and the gain on the sale of land. The adjusted increase is primarily
due to higher direct operating costs at our California and Texas utilities.
Services Group.
Direct
operating expenses increased $10.4 million, or 10.0%, to $113.9 million for the
year ended December 31, 2006 from $103.5 million for the prior year. The
increase in direct operating expenses was due to the following:
·
an $10.0 million increase
related to the cost of serving new contacts and the growth in customer base
under existing contracts, including the impact of rising fuel and fleet-related
expenses; and
·
a $1.1 million increase from
our acquisition of an Alabama-based contract operations company in March 2005;
offset by
·
a $0.7 million decrease in
our testing laboratorys 2006 direct operating expenses as a result of reducing
the scope of its operations to focus on bottom line performance.
Direct operating expenses as
a percentage of the related revenues of 86.0% for the year ended December 31,
2006 is comparable to 87.2% for the prior year.
Gross Profit.
Gross profit,
which we define as the difference between revenues and the related direct
operating expenses, increased $7.1 million, or 14.5%, to $56.3 million for the
year ended December 31, 2006 from $49.2 million for the prior year as
follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
37,781
|
|
$
|
34,057
|
|
$
|
3,724
|
|
43.8
|
%
|
43.2
|
%
|
Services Group
|
|
18,565
|
|
15,173
|
|
3,392
|
|
14.0
|
%
|
12.8
|
%
|
Total
|
|
$
|
56,346
|
|
$
|
49,230
|
|
$
|
7,116
|
|
25.8
|
%
|
24.9
|
%
|
(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 43.8% and 43.2% of related revenues for the years December 31, 2006
and 2005, respectively. Gross profit as a percent of related revenues for 2006
was 40.8% excluding the effect of the favorable CPUC decision and the gain on
the sale of land. The adjusted decrease is primarily due to higher direct
operating costs at our California and Texas utilities.
Services Group.
Gross profit for
the years ended December 31, 2006 and 2005 was comprised of the following:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit on sales to:
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated customers
|
|
$
|
11,642
|
|
$
|
10,968
|
|
$
|
674
|
|
9.3
|
%
|
9.6
|
%
|
Utility Group (intersegment)
|
|
6,923
|
|
4,205
|
|
2,718
|
|
17.1
|
%
|
13.4
|
%
|
Total
|
|
$
|
18,565
|
|
$
|
15,173
|
|
$
|
3,392
|
|
11.2
|
%
|
10.4
|
%
|
(1)
Gross profit is computed as a percent of the
respective revenues before intersegment eliminations.
41
Services Group gross profit
on revenues from unaffiliated customers increased by $0.7 million, or 6.1%, to
$11.6 million for the year ended December 31, 2006 from $11.0 million for
the prior year. Gross profit as a percent of revenues for 2006 was 9.3%, compared
to 9.6% for 2005. During 2006, we began focusing our efforts on improving this
profit margin and began the process of evaluating our performance under each of
our more than 600 individual contacts. We determined that many contracts had
old rate structures that had not been updated in recent years as permitted
under most of our contracts. We began negotiating new rates with our customers
in 2006 that provide an appropriate return for the services we provide. We
continued this effort in 2007 and showed additional improvement.
Services Group gross profit
on revenues from our Utility Group increased by $2.7 million, or 64.6%, to $6.9
million for the year ended December 31, 2006 from $4.2 million for the
prior year. The increase is related to an increase in construction projects for
our Texas and New Mexico utilities as well as an increase in operations and
maintenance work related to our September 2005 acquisition of our Alabama
wastewater collection and treatment operations.
Selling, General
and Administrative Expenses.
Selling, general and
administrative expenses increased $2.2 million, or 7.3%, to $33.0 million
for the year ended December 31, 2006 compared to $30.8 million for the
same period during the prior year as follows:
|
|
|
|
|
|
Increase
|
|
Percent of Revenues (1)
|
|
(In thousands, except
percentages)
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
7,609
|
|
$
|
7,448
|
|
$
|
161
|
|
8.8
|
%
|
9.4
|
%
|
Services Group
|
|
12,006
|
|
10,779
|
|
1,227
|
|
9.1
|
%
|
9.1
|
%
|
Corporate
|
|
13,383
|
|
12,529
|
|
854
|
|
|
|
|
|
Total
|
|
$
|
32,998
|
|
$
|
30,756
|
|
$
|
2,242
|
|
15.1
|
%
|
15.6
|
%
|
(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 increase in selling, general and administrative expenses was
primarily due to the following:
·
a $0.9 million increase
related to nonrecurring charges for relocation assistance extended to our new
CEO;
·
a $0.4 million increase
attributable to acquisitions which occurred in 2005;
·
a $0.2 million increase in
salaries, wages and related benefits resulting from workforce increases to
support our business growth; and
·
a $1.0 million increase in
legal and other professional fees, relating to certain litigation and other
routine legal and administrative proceedings arising during the ordinary course
of business; offset by
·
a $0.3 million decrease in
Sarbanes-Oxley compliance-related costs.
Impairment of Goodwill and
Other Long-Lived Assets.
During 2006, charges
totaling $0.9 million have been recorded to reflect the impairment of goodwill
in accordance with SFAS 142. As required by SFAS 142, we test
goodwill annually for impairment at the reporting unit level, as of October 31st
of each year, or when events or circumstances indicate the carrying values may
not be recoverable. We evaluate goodwill for impairment using discounted cash
flow methodologies, transaction values for comparable companies, and other
valuation techniques for reporting units with goodwill balances. The
realization of the Companys long-lived assets, including goodwill, is
dependent on expected future cash flows from the underlying operations.
During the second quarter of
2006, we reviewed the business strategy for our water and wastewater testing
laboratory reporting unit. This review resulted in our decision to realign the
operations by reducing the size and scope of its business activities and
focusing on its core operations and customers. This realignment is intended to
42
create a strong foundation
for providing high-quality laboratory testing and reporting services to
municipal utility districts and targeted commercial customers, enhancing future
growth and performance. The carrying value of the entity was tested for
impairment using the revised cash flow projections and it was determined that
carrying values were not fully recoverable. As a result, $0.5 million of
goodwill associated with the laboratory reporting unit was deemed to be
impaired and was charged to expense in the second quarter of 2006. During the
third quarter of 2006, a significant contract at the testing laboratory was not
renewed. The carrying value of the entity was tested again for impairment using
the revised cash flow projections and it was determined that carrying values
were not recoverable. As a result, the remaining $0.3 million of goodwill
associated with the laboratory reporting unit was deemed to be impaired and was
charged to expense in the third quarter of 2006.
Additionally, in the second
quarter of 2006 we determined that the renewal of a primary contract for
another reporting unit was not likely to occur, significantly reducing future
estimated cash flows of the reporting unit. As a result, $0.1 million of
goodwill associated with this reporting unit was deemed to be impaired and was
charged to expense during that period.
Other Income (Expense).
Other expense
increased $1.0 million, or 15.7%, to $7.0 million for the year ended December 31,
2006 from $6.1 million for the same period during the prior year as follows:
(In thousands)
|
|
2006
|
|
2005
|
|
Change
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
$
|
(7,536
|
)
|
$
|
(6,501
|
)
|
$
|
(1,035
|
)
|
Interest income
|
|
456
|
|
434
|
|
22
|
|
Other
|
|
58
|
|
(2
|
)
|
60
|
|
Total
|
|
$
|
(7,022
|
)
|
$
|
(6,069
|
)
|
$
|
(953
|
)
|
Interest Expense.
Interest
expense increased $1.0 million, or 15.9%, for the year ended December 31,
2006 compared to the same period during the prior year. The major components of
interest expense were as follows:
(In thousands)
|
|
2006
|
|
2005
|
|
Change
|
|
|
|
|
|
|
|
|
|
Revolving lines of credit
|
|
$
|
2,382
|
|
$
|
1,763
|
|
$
|
619
|
|
Mortgage bonds and bank
term loans
|
|
4,836
|
|
4,391
|
|
445
|
|
Convertible subordinated
debentures
|
|
950
|
|
1,157
|
|
(207
|
)
|
Other indebtedness
|
|
834
|
|
623
|
|
211
|
|
Total interest incurred
|
|
9,002
|
|
7,934
|
|
1,068
|
|
Less capitalized interest
|
|
(630
|
)
|
(689
|
)
|
59
|
|
Less interest related to discontinued operations
|
|
(836
|
)
|
(744
|
)
|
(92
|
)
|
Total interest expense
|
|
$
|
7,536
|
|
$
|
6,501
|
|
$
|
1,035
|
|
The increase in total
interest incurred is primarily due to an increase in borrowings levels on our
mortgage bonds and bank term loans and an increase in interest rates related to
our revolving line of credit. Average balances of interest bearing debt
outstanding increased to $130.0 million in 2006 compared to $126.0 million in
2005. The added borrowings were used to fund capital expenditures and
acquisitions. The weighted average interest rate on our borrowings increased to
6.9% for the year ended December 31, 2006 from 6.3% for the prior year.
Provision for Income Taxes.
Our effective
consolidated income tax rate was 35.0% for the year ended December 31,
2006 and is comparable to 35.7% for the prior year (based on combined pre-tax
income and related income taxes for both continuing and discontinued
operations). Our effective tax rate for 2006 reflects the $0.2 million reversal
of a capital loss carryforward deferred tax asset valuation allowance as
further described below.
During the year ended December 31,
2005, we recognized a capital loss of $4.0 million for income tax purposes upon
the sale of Master Tek, our discontinued operation. We were able to carry back
the capital loss to the prior three years and partially offset it against
capital gains realized during those years. The remaining $3.3 million of
43
capital loss was carried
forward to future years to offset any future capital gains. The $1.2 million
tax benefit of the capital loss carryforward was fully offset by a valuation
allowance as of December 31, 2005 because management did not believe it is
more likely than not we will generate future capital gains prior to the
expiration date of the loss carryforward. During 2006, we were able to utilize
a portion of the capital loss carryforward to offset taxable gains on the sale
land. As a result, a portion of the valuation allowance was reversed in 2006
equal to the tax benefit realized. The remaining capital loss carryforward is
fully offset by a valuation allowance as of December 31, 2006 because
management continues to believe it is more likely than not we will not generate
future capital gains sufficient to fully utilize the carryforward prior to the
expiration date of the loss carryforward. The capital loss carryforward expires
in 2010.
Cumulative Effect of Change in
Accounting Principle.
Effective January 1, 2006, we adopted
the provisions of SFAS No. 123 (revised 2004),
Share-Based
Payment
(SFAS 123(R)). The adoption of SFAS 123(R) required
us to change from recognizing the effect of forfeitures as they occur to
estimating the number of outstanding instruments for which the requisite
service is not expected to be rendered. As required by SFAS 123(R) we
recorded a $0.07 million (net of tax) benefit on January 1, 2006 to
reflect the reduction in compensation expense that would have resulted had we
been estimating the effect of forfeitures in prior periods.
Loss from Discontinued
Operations.
Loss from discontinued operations was $0.7 million for
the year ended December 31, 2006 compared to $5.6 million during the prior
year and is comprised of two businesses, our wholesale water and wastewater
business and our submetering business which we sold in the second quarter of
2005 as follows:
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Submetering business:
|
|
|
|
|
|
Net loss from operations through June 30, 2005, the date of sale
|
|
$
|
|
|
$
|
(1,278
|
)
|
Loss on sale, net of tax benefit
|
|
|
|
(3,624
|
)
|
Wholesale water and
wastewater business net loss from operations
|
|
(681
|
)
|
(670
|
)
|
Total additions to property, plant and equipment
|
|
$
|
(681
|
)
|
$
|
(5,572
|
)
|
NEW ACCOUNTING GUIDANCE AND
PRONOUNCEMENTS ADOPTED
SFAS No. 158
In September 2006, the 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 the consolidated financial statements.
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 companys financial
statements in accordance with SFAS No. 109,
Accounting
for Income Taxes
. FIN 48 requires companies to recognize the
financial statement benefit of a tax position only after determining the
relevant tax
44
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 January 1, 2007, our liabilities for uncertain tax
positions were not significant and therefore adoption of FIN 48 did not
have a material effect on the consolidated financial statements.
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:
|
|
Years Ended December 31,
|
|
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used
in):
|
|
|
|
|
|
|
|
Continuing operations:
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
30,548
|
|
$
|
26,796
|
|
$
|
3,752
|
|
Investing activities
|
|
(49,368
|
)
|
(45,558
|
)
|
(3,810
|
)
|
Financing activities
|
|
16,228
|
|
20,329
|
|
(4,101
|
)
|
Total continuing operations
|
|
(2,592
|
)
|
1,567
|
|
(4,159
|
)
|
Discontinued operations:
|
|
|
|
|
|
|
|
Operating activities
|
|
1,565
|
|
1,250
|
|
315
|
|
Investing activities
|
|
(317
|
)
|
(1,287
|
)
|
970
|
|
Total continuing operations
|
|
1,248
|
|
(37
|
)
|
1,285
|
|
Increase (decrease) in cash and cash equivalents
|
|
$
|
(1,344
|
)
|
$
|
1,530
|
|
$
|
(2,874
|
)
|
Cash Flows From Operating Activities.
Net cash provided by
operating activities increased by $3.8 million in 2007 compared to the prior
year. Operational aspects of our businesses that affected working capital in
2007 versus 2006 are highlighted below:
·
the benefit from increased
water rates at our California and Texas utilities; and
·
collection of the final $2.3
million on a long-term construction project upon final acceptance by the
customer in 2007.
Cash Flows From Investing Activities.
Cash used in investing
activities totaled $49.4 million in 2007 compared to $45.6 million during 2006
as follows:
|
|
Years Ended December 31,
|
|
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
Cash flows (used in)
provided by investing activities:
|
|
|
|
|
|
|
|
Additions to property, plant and equipment
|
|
$
|
(41,348
|
)
|
$
|
(43,253
|
)
|
$
|
1,905
|
|
Acquisition of businesses, net of cash acquired
|
|
(8,069
|
)
|
(1,719
|
)
|
(6,350
|
)
|
Purchase of minority interest
|
|
|
|
(1,013
|
)
|
1,013
|
|
Proceeds from sales of land and equipment
|
|
49
|
|
427
|
|
(378
|
)
|
Net cash used for investing activities
|
|
$
|
(49,368
|
)
|
$
|
(45,558
|
)
|
$
|
(3,810
|
)
|
45
The following table
summarizes additions to property, plant and equipment additions for 2007 and
2006.
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Company-financed additions
|
|
$
|
35,375
|
|
$
|
35,396
|
|
Capital improvement
reimbursements
|
|
1,931
|
|
4,300
|
|
Cash contributions received
in aid of construction
|
|
4,042
|
|
3,557
|
|
Total cash additions to property, plant and equipment
|
|
41,348
|
|
43,253
|
|
Non-cash contributions in aid of construction
|
|
6,355
|
|
12,605
|
|
Capital expenditures financed with capital lease obligations
|
|
4,582
|
|
|
|
Total additions to property, plant and equipment
|
|
$
|
52,285
|
|
$
|
55,858
|
|
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, starting in 2007, 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.
During 2007, we invested $5.5 million in cash for
capital assets related to our Cornerstone project as well as financed an
additional $4.6 million of our capital investment with capital leases. We have
invested a total of $10.1 million in the project since its inception.
In 2008, we expect to spend approximately $29.2
million on cash additions, principally within our Utility Group, expect to
receive $0.4 million of CIAC and expect to finance an additional $14.0 million
of Cornerstone-related expenditures with our capital lease facility resulting
in total expected additions to property, plant and equipment of approximately
$43.6 million.
During 2007, we acquired a small water and wastewater
utility located in northern Mississippi, just south of Memphis, Tennessee, two
water and wastewater utilities near San Antonio, Texas and a wastewater
collection and treatment system in Alabama for an aggregate $8.1 million in
cash plus $2.5 million of liabilities assumed.
In January 2008, we also purchased the assets of
a wastewater collection system and related treatment plant for $22.5 million in
cash at closing and we expect we will continue to make substantial investments
in acquisitions in the future.
Cash Flows From Financing Activities.
During 2007, we financed our
growth through a broad range of capital initiatives:
·
borrowed $15.0 million under
our revolving line of credit;
·
received $5.1 million of
capital improvement reimbursements and contributions in aid of construction;
and
·
received $3.5 million of
proceeds from our share-based equity incentive plans and stock purchase plans.
Aggregate borrowings under our revolving lines of
credit increased by a net $9.0 million during 2007 compared to 2006 primarily
due to our acquisition activities and to fund our capital expenditure programs.
During 2007, we paid $5.7 million of cash dividends
to our common and preferred stockholders. In the fourth quarter of 2007, we
increased our quarterly common stock dividend rate by 4.2% to $0.06 per share.
Our borrowing availability under our $100.0 million
credit facility was $47.0 million as of December 31, 2007. Availability
was subsequently reduced by $22.5 million in January 2008 as a result of a
borrowing to close our wastewater treatment plant acquisition described above.
46
In February 2008, we entered into a new credit
agreement with several lenders including Bank of America, as lender and
Administrative Agent, KeyBank, CoBank, U.S. Bank, JPMorgan Chase Bank, Comerica
Bank, Bank of the West, Citibank and Union Bank of California. The credit
agreement provides for a $150.0 million revolving credit facility. We may elect
to increase the amount of the credit facility by an amount not to exceed $75.0
million during the term of the agreement provided certain conditions are met. The
new credit agreement is more fully described in Note 17 to the consolidated
financial statements included in this report.
The new revolving line of credit commitment ends on February 15,
2013 and our $100.0 million credit facility was cancelled upon repayment with
an initial borrowing under the $150.0 million facility.
CONTRACTUAL OBLIGATIONS
The following table summarizes our known contractual
obligations to make future cash payments as of December 31, 2007, as well
as an estimate of the periods during which these payments are expected to be
made. The table also shows, on a pro forma basis, the effect our January 2008
acquisition and new credit agreement would have had as of December 31,
2007 had they occurred as of that date.
|
|
Years Ended December 31, (1)
|
|
|
|
|
|
|
|
2009
|
|
2011
|
|
2013
|
|
|
|
|
|
|
|
and
|
|
and
|
|
and
|
|
(In thousands)
|
|
Total
|
|
2008
|
|
2010
|
|
2012
|
|
Beyond
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt (1):
|
|
|
|
|
|
|
|
|
|
|
|
Bank line of credit (2)
|
|
$
|
51,000
|
|
$
|
|
|
$
|
51,000
|
|
$
|
|
|
$
|
|
|
Mortgage bonds (3)
|
|
45,000
|
|
|
|
|
|
|
|
45,000
|
|
Bank term loans (4)
|
|
31,796
|
|
823
|
|
1,646
|
|
1,645
|
|
27,682
|
|
Convertible subordinated debentures (5)
|
|
12,053
|
|
|
|
|
|
|
|
12,053
|
|
Capital lease obligations (6)
|
|
4,582
|
|
837
|
|
1,790
|
|
1,955
|
|
|
|
Economic development revenue bonds (7)
|
|
1,925
|
|
115
|
|
245
|
|
280
|
|
1,285
|
|
Notes payable (8)
|
|
176
|
|
162
|
|
14
|
|
|
|
|
|
Total long-term debt
|
|
146,532
|
|
1,937
|
|
54,695
|
|
3,880
|
|
86,020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayment of advances for
construction (9)
|
|
10,486
|
|
1,276
|
|
1,366
|
|
864
|
|
6,980
|
|
Water purchase commitment
(10)
|
|
7,627
|
|
460
|
|
920
|
|
920
|
|
5,327
|
|
Lease assignment
obligations (11)
|
|
1,059
|
|
1,059
|
|
|
|
|
|
|
|
Operating lease obligations
|
|
30,831
|
|
6,729
|
|
9,434
|
|
5,207
|
|
9,461
|
|
Total obligations as of December 31, 2007 (12)
|
|
196,535
|
|
11,461
|
|
66,415
|
|
10,871
|
|
107,788
|
|
Borrowing for 2008 acquisition
(13)
|
|
22,500
|
|
|
|
22,500
|
|
|
|
|
|
Credit facility borrowing
(repayment) (14)
|
|
|
|
|
|
(73,500
|
)
|
|
|
73,500
|
|
Pro forma total obligations (12)
|
|
$
|
219,035
|
|
$
|
11,461
|
|
$
|
15,415
|
|
$
|
10,871
|
|
$
|
181,288
|
|
(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.
(2)
The bank line 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 5.74% as of December 31, 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 6.53% and is payable semiannually.
(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 capital lease
obligations is imputed at a weighted-average annual interest rate of 4.43% and
is payable monthly.
(7)
Interest on the economic
development bonds is fixed at a weighted-average annual interest rate of 5.97%
and is payable semiannually.
(8)
Interest is payable either monthly or quarterly at
rates ranging from 5.15% to 8.0% per year.
47
(9)
Advances for construction are non-interest bearing.
(10)
Reflects the minimum annual contractual commitments
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.
(11)
Interest on the lease assignment obligations is fixed
at an interest rate of 7.74% and is payable monthly.
(12)
Excludes preferred stock dividend obligations.
Preferred stockholders are entitled to receive annual dividends of $2.625 per
share and there are 9,156 shares of preferred stock outstanding as of December 31,
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.
(13)
Reflects the borrowing under the $100.0 million
credit facility to fund the acquisition of a wastewater treatment plant in January 2008.
(14)
Reflects the pro forma repayment of borrowings outstanding
under the $100.0 million credit facility, which was due in 2010, with an
initial borrowing under the $150.0 million credit facility which is due in
2013.
FINANCIAL CONDITION AND LIQUIDITY
As of December 31, 2007, we had $15.4 million of
working capital and $6.7 million of operating lease obligations payable during
2008. As of December 31, 2007, after adjusting for our 2008 acquisition
and the new $150.0 million credit facility described above, we also had $74.5
million of additional borrowings available under our line of credit facility,
which expires on February 15, 2013. In addition to our line of credit, we
also have $25.4 million of capital available under our $30.0 million capital
lease facility. Our California and New Mexico mortgage bond indentures also
permit the issuance of an additional $91.2 million of first mortgage bonds as
of December 31, 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
$4.2 million to $5.2 million per year and are less than the aggregate
cumulative dividend restriction threshold by $50.4 million as of December 31,
2007. We were in compliance with all loan agreement covenants during the year
ended December 31, 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 December 31, 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 ($74.5 million of which was
available as of December 31, 2007 (on a pro forma basis) and expires on February 15,
2013) and $25.4 million available under our capital lease facility 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, the Company was 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, the Company obtained a $3.4 million standby
letter of credit as collateral to insure its 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. The Company 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
48
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 December 31, 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.
In connection with the sale of Master Tek, 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 us or our subsidiaries.
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.
49
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States (GAAP).
These accounting principles require us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. We believe that the
estimates and judgments are reasonable based upon information available to us
at the time that these estimates and judgments are made and they are evaluated
and updated on an ongoing basis. To the extent our estimates and judgments are
different than actual results, our financial statements will be affected. We
believe the following are the more critical accounting policies we use in
preparing our financial statements and are important to fully understanding and
evaluating our reported financial position and results of operations.
Accounting for Regulated Businesses
Our regulated businesses, which include our utilities
in Alabama, California, Mississippi, New Mexico and Texas, are accounted for
under the provisions of SFAS No. 71,
Accounting
for the Effects of Certain Types of Regulation
(SFAS 71),
which specifies certain revenue, expense and balance sheet treatment as
required by each states regulatory authority. Each state authority establishes
rates which are intended to permit each utility to recover its costs and earn a
reasonable rate of return.
Our Services Group provides construction, operations
and maintenance services to our utilities in Alabama, Mississippi, New Mexico
and Texas and recognizes a profit on those services. In accordance with
SFAS 71, we do not eliminate the Services Groups profit recognized on
these services 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. Since the regulators that govern our
utilities have historically approved the services provided and rates charged by
our Services Group to our utilities as a component of rates, we believe we have
met the requirements of SFAS 71 to recognize profit on such services.
During the years ended December 31, 2007, 2006 and 2005, we have
recognized profit of $4.7 million, $6.9 million and $4.2 million, respectively.
Over the years, the CPUC, the regulator of Suburban,
our California utility, has had various policies with respect to accounting for
the difference between Suburbans actual water production costs incurred and
CPUC-adopted water production costs. In the water industry, those costs consist
of expenditures for purchased water, purchased power and pump taxes. At times,
the CPUC has allowed balancing accounts in the financial statements of water
utilities whereby the difference between actual and CPUC-adopted costs are
recorded as either a receivable, for under-collections of costs from customers,
or as a liability, for over-collections of costs from customers, as permitted by
SFAS 71. Under these procedures, the utility would apply for the
dispensation of balancing accounts and amounts would either be refunded to or
recovered from utility customers through future CPUC-authorized rate
adjustments, once certain balancing thresholds were achieved.
Prior to November 29, 2001, the CPUC allowed the
recording of the difference between actual costs incurred and the CPUC-adopted
volume related costs to balancing accounts. The CPUC changed their methodology
in 2001 and required an earnings test to accompany annual submissions of
memorandum accounts where these volume-related differences would be tracked.
Once submitted to the CPUC, the utility would subsequently be directed by the
CPUC as to what portion of their memorandum account could be added to or
subtracted from its balancing account. As a result of this change and the
uncertainties the earnings test created with respect to the collections of
under-collections, Suburban elected to record in its financial statements only
over-collections of volume related costs until recovery of under-collections
was assured. Suburban followed this practice from December 2001 until April 2006.
50
In April 2006, the CPUC issued a decision which
eliminated the required earnings test, removing the uncertainty associated with
the recovering balancing account under-collections. As a result, in 2006 we
recorded $0.7 million of receivables related to balancing account
under-collections attributable to 2005 and $1.5 million and $1.8 million
attributable to 2006 and 2007, respectively. In October 2007, the CPUC
issued a ruling that our California utility could collect the net amount of its
balancing accounts from 2002 through 2006 over a one year period.
Future CPUC policy changes could have an impact on
recording under-collections in future periods.
Revenue Recognition
Water utility revenues are recognized when water is
delivered to customers. At the end of an accounting period, estimated amounts
for unbilled revenues are accrued for water usage since the previous billing
period.
Revenues for contract operations are recognized and
billed at the end of the month based on a monthly fee to provide a specific
level of service as outlined in each individual contract. We generally bill for
additional services provided beyond the scope of the base contract on a
time-and-materials basis as such services are rendered.
Revenues for construction projects for unaffiliated
third parties are recorded using the percentage-of-completion method of
accounting. The percentage-of-completion method recognizes revenue and income
as work progresses on a project based on the expected total project costs and
the expected total project revenues. We estimate the percentage of completion using
total contract price, actual costs incurred to date and an estimate of the
completion costs for each contract. Revenues for construction projects for
utilities within our Utility Group are recorded using the completed contract
method of accounting under which all revenues and costs are recognized upon
completion of the project. If management anticipates we will ultimately suffer
a loss on a construction project, the entire estimated loss is recorded in the
period such a determination is made.
For contracts involving the provision of a single
product or service (single-element contracts), revenue is generally recognized
when the product or service is provided and the amount becomes billable. If
services are provided evenly during the contract term but service billings are
irregular, revenue is recognized on a straight-line basis over the contract
term. For contracts involving the provision of multiple products or services
(elements), total estimated contract revenue is allocated to each element based
on the relative fair value of each service in accordance with Emerging Issues
Task Force Issue No. 00-21,
Revenue Arrangements with
Multiple Deliverables
.
Certain non-refundable activation fees in our
non-regulated wholesale water operations are recognized over the expected
period of performance.
Valuation of Long-Lived and
Intangible Assets
In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets
(SFAS 144),
we assess intangible assets and other long-lived assets, excluding goodwill,
for recoverability whenever events or changes in circumstances indicate that
their carrying value may not be recoverable through the estimated undiscounted
future cash flows resulting from the use of the assets. If we determine that
the carrying value of intangible assets or other long-lived assets may not be
recoverable, we measure impairment by using the projected discounted cash-flow
method in accordance with SFAS 144. For example, during the year ended December 31,
2007, we recorded a $3.4 million charge to reduce the carrying value of
long-lived assets held for sale to estimated realizable value in accordance
with SFAS 144. Net long-lived assets and intangible assets, excluding
goodwill, amounted to $453.2 million as of December 31, 2007.
Goodwill
In accordance with SFAS No. 142,
Goodwill and Other Intangible Assets
(SFAS 142), we
test goodwill and indefinite-lived intangible assets for impairment at least
annually, on October 31
st
of each year, or when events or
51
circumstances indicate carrying values may not be
recoverable. We evaluate goodwill for impairment using discounted cash flow
methodologies, transaction values for comparable companies, and other valuation
techniques for all of our reporting units with goodwill balances; we do not
have any indefinite-lived intangible assets. Forecasted revenues and capital
expenditures, which include forecasted customer connection growth and the
timing and amount of regulated rate increases, are key components of the
discounted cash flow projections.
During recent impairment testing, we determined that
revenue growth for our Texas Utilities was likely to be slower than originally
projected due to downturns in overall economic conditions and new housing
construction as well as a slower rate of regulated rate increases. Additionally
we determined that higher levels of capital expenditures than previously
projected were necessary to bring the systems into regulatory compliance and to
continue improving the quality of service for our customers. These factors
resulted in significantly lower discounted cash flow projections than
previously forecast. Based on these projections, the entire $17.2 million of
goodwill associated with our Texas Utilities was found to be impaired and was
charged to expense in 2007.
Goodwill with an aggregate book value of $17.3
million remains as of December 31, 2007, $16.9 million of which pertains
to our Services Group and $0.4 million pertains to our Utilities Group. This goodwill will be subject to impairment
testing on October 31, 2008, or sooner, if additional events occur or
circumstances change such that it is reasonably possible further impairment may
have occurred.
Share-Based Compensation
We use the Black-Scholes option valuation model to
estimate the fair value of our stock options. This option valuation model was
developed for use in estimating the fair value of traded options that do not
have vesting restrictions and that are fully transferable. Option valuation
models require subjective assumptions such as the expected future volatility of
the stock price. Because the stock options we grant have characteristics that
are significantly different from those of traded options, and because changes
in the subjective input assumptions can materially affect the calculated
results, in managements opinion, the stock option valuation models, including
Black-Scholes, may not necessarily provide an exact measure of the fair value
of employee stock options. During the years ended December 31, 2007, 2006
and 2005, we recognized stock compensation expense of $1.9 million, $1.1
million and $1.0 million, respectively, using the Black-Scholes option
valuation model.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 141(R)
In December 2007, the FASB issued Statement No. 141
(revised 2007),
Business Combinations
(SFAS 141(R)).
SFAS 141(R) changes the accounting for acquisitions specifically
eliminating the step acquisition model, changing the recognition of contingent
consideration at the time of acquisition, disallowing the capitalization of
transaction costs and changes when restructurings related to acquisitions can
be recognized. The statement is effective for fiscal years beginning on or
after December 15, 2008 and will only impact the accounting for
acquisitions that are made after adoption. Adoption of SFAS 141(R) will
impact our accounting for future business combinations in that all transactions
costs will be expensed as incurred and contingent consideration, if present,
will be recorded upon acquisition.
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
52
the consistency of those measurements. Adoption of
SFAS 157 was required to begin with our fiscal year beginning January 1,
2008 with prospective adoption under most circumstances.
On February 12, 2008, the FASB issued FASB Staff
Position No. 157-2,
Effective Date of FASB
Statement No. 157
(FSP 157-2) that amends SFAS 157 to
delay the effective date for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (that is, at least annually).
FSP 157-2 defers the effective date of SFAS 157 to our fiscal years
beginning January 1, 2009. We believe the adoption of this new statement
will not have a material impact on our consolidated financial statements.
However, we believe we will likely be required to provide additional
disclosures in future financial statements beginning after the effective date
of the new standard.
SFAS No. 159
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial LiabilitiesIncluding 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. We believe the adoption of this new statement will not
have a material impact on our consolidated financial statements.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2007, we had $147.3 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 $51.0 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 5.74% as of December 31,
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
$96.3 million, has a fair value of $96.1 million as of December 31, 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 December 31,
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 $5.9
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 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, supplementary
financial data and financial statement schedules are included in a separate
section at the end of this report. The financial statements, supplementary data
and schedules are listed in the index on page F-1 of this report and are
incorporated herein by reference.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
53
ITEM 9A.
CONTROLS AND PROCEDURES
MANAGEMENTS EVALUATION OF DISCLOSURE CONTROLS AND
PROCEDURES
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms, and that such information is accumulated and
communicated to management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives. Management also recognizes it is required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
As of December 31, 2007, the end of the fiscal year covered by this
report, we carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures. Based on the foregoing, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective at the reasonable assurance level.
MANAGEMENTS REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING
Management is also responsible for establishing and maintaining
adequate internal control over financial reporting. As part of that process, as
of December 31, 2007, the end of the fiscal year covered by this report, we
carried out an evaluation of our internal control over financial reporting. The
evaluation was conducted following the criteria established in
Internal Control Integrated Framework
issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
assessment did not identify any material weaknesses in our internal control
over financial reporting and management concluded that our internal control
over financial reporting was effective. Our independent registered public
accounting firm that audited our financial statements contained in this annual
report has issued an audit report on the effectiveness of our internal control
over financial reporting.
CHANGES IN INTERNAL CONTROL OVER
FINANCIAL REPORTING
There were no changes in our internal control over
financial reporting during the quarter ended December 31, 2007 that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
54
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Board of Directors and Stockholders
SouthWest Water Company:
We have audited SouthWest Water Companys internal
control over financial reporting as of December 31, 2007, based on criteria
established in
Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). SouthWest Water Companys management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting
, included in the accompanying
Managements Report on Internal Control Over Financial Reporting appearing
under Item 9A
.
Our
responsibility is to express an opinion on the effectiveness of the Companys
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on assessed risk. Our audit
also included performing such other procedures as we considered necessary in
the circumstances. We believe that our audit provides a reasonable basis for
our opinion.
A companys internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. A companys
internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control
over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
In our opinion, SouthWest Water Company maintained,
in all material respects, effective internal control over financial reporting
as of December 31, 2007, based on
Internal
ControlIntegrated Framework
issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of SouthWest Water Company and subsidiaries as of December 31,
2007 and 2006, and the related consolidated statements of income, changes in
stockholders equity, and cash flows for each of the years in the three-year
period ended December 31, 2007, and our report dated March 27, 2008,
expressed an unqualified opinion on those consolidated financial statements and
financial statement schedule.
/s/ KPMG LLP
Los
Angeles, California
March 27,
2008
55
ITEM 9B. OTHER
INFORMATION
None.
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
DIRECTORS
Information relating to the directors of the Company
will be set forth under the caption Proposal 2Election of Directors in our
Proxy Statement for our 2008 Annual Meeting of Stockholders (Proxy Statement).
Such information is incorporated herein by reference.
COMPLIANCE WITH SECTION 16A
OF THE EXCHANGE ACT
Information regarding compliance by our directors and
executive officers and owners of more than 10% of the Companys common stock
with the reporting requirements of Section 16a of the Securities Exchange
Act of 1934, as amended, will be set forth under the caption Section 16(a) Beneficial
Ownership Reporting Compliance in the above-referenced Proxy Statement.
EXECUTIVE OFFICERS OF THE
REGISTRANT
Our Board of Directors elects executive officers each
year at the first meeting following the Annual Meeting of Stockholders. There
are no family relationships among any of the executive officers of SouthWest
Water Company, and there are no agreements or understandings between any such
officer and another person pursuant to which he or she was elected as an
officer. There are no legal proceedings that involve any executive officer of the
type requiring disclosure pursuant to the instructions to this item. The
executive officers of SouthWest Water Company as of March 1, 2008 were as
follows:
Mark A. SwatekChief Executive
Officer
Mr. Swatek (Age: 54) joined SouthWest Water
Company as Chief Executive Officer in May 2006. From 2005 until joining
SouthWest Water, Mr. Swatek was President of MWH Municipal and State
Services, the largest operating division of MWH Global. In this capacity, he
managed municipal operations, primarily involving water/wastewater engineering,
program management, and facility design-build activities for city, county and
state governments throughout the U.S. From 2000 to 2005, Mr. Swatek was
President of MWH Constructors, the design-build construction subsidiary of MWH
Global. Mr. Swatek also served as a member of the Board of Directors of
MWH Global from 2003 to 2006, MWH Constructors from 2000 to 2006 and MWH
Americas from 2005 to 2006. Mr. Swatek started his professional career in
the mid 1970s and provided engineering and management expertise to a number of
companies, including Camp Dresser & McKee, Versar Architects &
Engineers and CDM Engineers & Constructors. Mr. Swatek earned
both his Bachelor of Science and Master of Science degrees in civil engineering
from Purdue University. A registered professional civil engineer, he has served
as a director on a number of boards of engineering and construction companies.
David StantonChief Operating
Officer
Mr. Stanton (Age: 42) joined SouthWest Water
Company in November 2006 as its Executive Vice President of Corporate
Development and in December 2007 was appointed to the position of Chief
Operating Officer. From 2001 to 2006, Mr. Stanton held a variety of
positions with Earth Tech, a division of Tyco International, Inc., an
international environmental water and wastewater service provider. From 2003 to
2006, Mr. Stanton served as an Executive Vice President overseeing the
international water and asset management business. From 2002 to 2003, he served
as Earth Techs Chief Financial Officer. From 2001 to 2002 he served as Senior
Vice President of Corporate Development, where he was responsible for all
financial functions and acquisition growth strategies with
56
a focus on water technology and service companies.
Earlier, Mr. Stanton held senior management positions with a number of
companies in the water and wastewater industry, including Waterlink, Inc.,
ITEQ, Inc. and Wheelabrator Technologies, Inc. Mr. Stanton has a
Bachelor of Science degree in Electrical Engineering from Cornell University,
New York.
Cheryl L. ClaryChief Financial
Officer
Ms. Clary (Age: 52) joined SouthWest Water
Company as Vice President Finance in October 2004 and in April 2005
was appointed to the position of Chief Financial Officer. From 2002 to 2004,
she served as Chief Financial Officer of Del Richardson and Associates, a
professional services firm. From 2000 to 2001, she was Managing Director of the
Los Angeles office of Jefferson Wells International, a management consulting
firm. From 1981 to 2000, she held various senior level finance and operational
management positions at Atlantic Richfield Company, an oil and gas company,
including business manager at three different operating units. Ms. Clary
began her career in 1977 in public accounting. Ms. Clary has a Bachelor of
Science degree in Business Administration with an emphasis in Accounting from
California State University, Northridge. Ms. Clary is Certified Public
Accountant in the state of California.
Michael O. QuinnPresident,
SouthWest Water Company Utility Group
Mr. Quinn (Age: 61) has held a variety of
positions with SouthWest Water Company and its subsidiaries since 1970. He is
President of the Utility Group of SouthWest Water Company and has been
President of Suburban Water Systems since 1996. From 1992 to 1996, he was Chief
Operating Officer for Suburban Water Systems. From 1985 to 1992, he was
President of ECO Resources, Inc. Prior to that, he was
Controller/Treasurer at Suburban Water Systems. Mr. Quinn holds a Bachelor
of Arts in Business Management from California State University at Fullerton.
Among his water industry affiliations, Mr. Quinn is past president of the
California Water Association, is past president of the National Association of
Water Companies and serves on the boards of the Citrus Valley Health
Foundation, California Domestic Water Company and Covina Irrigating Company.
Stephen C. HeldPresident,
SouthWest Water Company Services Group
Mr. Held (Age: 57) served as President of
SouthWest Water Company Services Group from April 2006 until his
resignation on December 31, 2007. Mr. Held was responsible for
overseeing all of the Services Group subsidiaries and the work they perform
under contract with cities, municipal utility districts and other government
entities. From 1992 through 2006, Mr. Held served in a variety of
positions at ECO Resources, Inc., the largest operating subsidiary in
SouthWest Waters Services Group, most recently as Regional Vice President-Central
Region, from 1997 to 2006. With over 30 years of experience in management and
business development, Mr. Helds career has included regional shopping
center development, oilfield development, financial consulting and planning,
and municipal management. Mr. Held is a graduate of Alabamas Auburn
University where he earned a Bachelor of Science Degree in Business
Administration.
William K. DixVice President,
General Counsel and Secretary
William K. Dix (51) was appointed Vice President,
General Counsel and Secretary in May 2007. From 2002 to May 2007, Mr. Dix
had a corporate transactional practice representing a variety of companies in
Southern California. From 2001 to 2002 Mr. Dix was Vice President and
General Counsel of Genetronics Biomedical Corporation. Mr. Dix is a 1987
graduate of The Georgetown University Law Center.
CODE OF ETHICS
We have adopted the SouthWest Water Company Code of
Ethics for Directors and Executive Officers (the D&O Code of Ethics) and
the SouthWest Water Company Code of Ethical Conduct (the Ethics Code). The
D&O Code of
57
Ethics and the Ethics Code apply to the Chief
Executive Officer, Chief Financial Officer, Corporate Controller and other
executive officers of the Company. The D&O Code of Ethics and the Ethics
Code are available to the public on our website www.swwc.com under Governance
and Management in the Investor Relations section.
ITEM 11.
EXECUTIVE COMPENSATION
Information relating to executive compensation will
be set forth under the caption Executive Compensation in our Proxy Statement.
Such information is incorporated herein by reference, except for the
information set forth under the captions Executive CompensationReport of the
Compensation and Organization Committee which specifically is not so
incorporated by reference. Information related to director compensation will be
set forth under the caption Director Compensation in our Proxy Statement
referred to in Item 10 above. Such information is incorporated herein by
reference.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
Information regarding ownership of our securities by
certain persons is set forth under the caption Proposal 2Election of
Directors in the Companys Proxy Statement referred to in Item 10 above. Such
information is incorporated herein by reference.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information set forth under the caption Governance
of the CompanyCertain Relationships and Related Transactions in our Proxy
Statement referred to in Item 10 above. Such information is incorporated herein
by reference.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accountant fees and
services is set forth under the caption Notification of Selection of Principal
Accountant in the Companys Proxy Statement referred to in Item 10 above. Such
information is incorporated herein by reference.
PART IV
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENTS AND
SCHEDULES
The consolidated financial statements and financial
statement schedules filed with this report are included in a separate section
at end of this report and are listed in an index on page F-1.
EXHIBIT LISTING
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
3.1
|
|
Restated Certificate of Incorporation of SouthWest Water
Company dated May 24, 2005 (incorporated by reference to
Exhibit 3.1 included in the Companys Form 10-Q for the quarterly
period ended June 30, 2005)
|
58
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
3.2.1
|
|
Amended and Restated Bylaws of SouthWest Water Company
dated May 18, 2001, (incorporated by reference to Exhibit 3.2D included
in the Companys Form 10-K for the year ended December 31, 2001)
|
|
|
|
3.2.2
|
|
Amendment No. 2 to Amended and Restated Bylaws of
SouthWest Water Company effective February 12, 2004 (incorporated by
reference to Exhibit 10.1 included in the Companys Form 10-Q for
the quarter ended June 30, 2004)
|
|
|
|
3.2.3
|
|
Amendment No. 3 to Amended and Restated Bylaws of
SouthWest Water Company effective May 16, 2006 (incorporated by
reference to Exhibit 3.2 included in the Companys Form 8-K filed
with the Commission on May 19, 2006)
|
|
|
|
3.2.4
|
|
Amendment No. 4 to Amended and Restated Bylaws of
SouthWest Water Company effective December 11, 2006 (incorporated by
reference to Exhibit 3.3 included in the Companys Form 8-K filed
with the Commission on December 15, 2006)
|
|
|
|
4.1.1
|
|
Indenture of Mortgage and Deed of Trust between Suburban
Water Systems and U.S. Bank National Association, formerly First Trust of
California, N.A. dated October 1, 1986 (incorporated by reference to
Exhibit 4.3 included in the Companys Form 10-K for the year ended
December 31, 1986)
|
|
|
|
4.1.2
|
|
First Amendment and Supplement to Indenture of Mortgage and
Deed of Trust between Suburban Water Systems and U.S. Bank National
Association, formerly First Trust of California, N.A. dated February 7, 1990
(incorporated by reference to Exhibit 4.2A included in the Companys
Form 10-K for the year ended December 31, 1989)
|
|
|
|
4.1.3
|
|
Second Amendment and Supplement to Indenture of Mortgage
and Deed of Trust between Suburban Water Systems and U.S. Bank National
Association, formerly First Trust of California, N.A. dated January 24,
1992 (incorporated by reference to Exhibit 4.2B included in the
Companys Form 10-K for the year ended December 31, 1991)
|
|
|
|
4.1.4
|
|
Third Amendment and Supplement to Indenture of Mortgage
dated October 9, 1996, between Suburban Water Systems and U.S. Bank
National Association, formerly First Trust of California, N.A. (incorporated
by reference to Exhibit 4.2C included in the Companys Form 10-K
for the year ended December 31, 1996)
|
|
|
|
4.1.5
|
|
Fourth Amendment and Supplement to Indenture of Mortgage
and Deed of Trust between Suburban Water Systems and U.S. Bank National
Association, formerly First Trust of California, N.A., dated October 19,
2004 (incorporated by reference to Exhibit 4.1E included in the
Companys Form 10-K for the year ended December 31, 2004)
|
|
|
|
4.1.6
|
|
Fifth Amendment and Supplement to Indenture of Mortgage and
Deed of Trust between Suburban Water Systems and U.S. Bank National
Association, dated October 20, 2006 (incorporated by reference to
Exhibit 4.1.6 included in the Companys Form 10-Q for the quarter
ended September 30, 2006)
|
|
|
|
4.2
|
|
Bond Purchase Agreement dated February 20, 1992, for
Suburban Water Systems (incorporated by reference to Exhibit 4.3A included
in the Companys Form 10-K for the year ended December 31, 1991)
|
59
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
4.3
|
|
Bond Purchase Agreement dated October 21, 1996, for
Suburban Water Systems (incorporated by reference to Exhibit 4.3B
included in the Companys Form 10-K for the year ended December 31,
1996)
|
|
|
|
4.4
|
|
Bond Purchase Agreement dated October 19, 2004, for
Suburban Water Systems (incorporated by reference to Exhibit 4.5
included in the Companys Form 10-K for the year ended December 31,
2004)
|
|
|
|
4.5
|
*
|
Bond Purchase Agreement dated October 20, 2006, for
Suburban Water Systems
|
|
|
|
4.6
|
|
Bond Purchase Agreement dated December 15, 2004, for
New Mexico Utilities, Inc. (incorporated by reference to
Exhibit 4.8 included in the Companys Form 10-K for the year ended
December 31, 2004)
|
|
|
|
4.7
|
|
Stockholders Rights Plan dated April 6, 1998
(incorporated by reference to Exhibit 4 included in the Companys
Form 8-K filed with the Commission on April 24, 1998)
|
|
|
|
4.8
|
|
Shareholders Agreement by and among Operations
Technology, Inc., SouthWest Water Company, Robert W. Monette, dated
August 31, 2001 (incorporated by reference to Exhibit 4.12 included
in the Companys Form 10-K for the year ended December 31, 2004)
|
|
|
|
4.9
|
|
Indenture dated as of July 20, 2001 between SouthWest
Water Company and Chase Manhattan Bank and Trust Company, as Trustee
(incorporated by reference to Exhibit 4 included in the Companys
Registration Statement of Form S-3 (Amendment No. 2), File
No. 333-63196, filed with the Commission on July 13, 2001)
|
|
|
|
4.10.1
|
**
|
SouthWest Water Company 2006 Equity Incentive Plan
(incorporated by reference as Exhibit 4.13.1 included in the Companys
Registration Statement on Form S-8, File No. 333-134575, filed with
the Commission on May 31, 2006)
|
|
|
|
4.10.2
|
**
|
SouthWest Water Company 2006 Equity Incentive Plan Notice
of Restricted Stock Award and Restricted Stock Agreement (incorporated by
reference as Exhibit 4.13.2 included in the Companys Registration
Statement on Form S-8, File No. 333-134575, filed with the
Commission on May 31, 2006)
|
|
|
|
4.10.3
|
**
|
SouthWest Water Company 2006 Equity Incentive Plan Notice
of Restricted Stock Unit Award and Restricted Stock Unit Agreement
(incorporated by reference as Exhibit 4.13.3 included in the Companys
Registration Statement on Form S-8, File No. 333-134575, filed with
the Commission on May 31, 2006)
|
|
|
|
4.10.4
|
**
|
SouthWest Water Company 2006 Equity Incentive Plan Stock
Option Agreement (incorporated by reference as Exhibit 4.13.4 included
in the Companys Registration Statement on Form S-8, File
No. 333-134575, filed with the Commission on May 31, 2006)
|
|
|
|
4.10.5
|
**
|
SouthWest Water Company 2006 Equity Incentive Plan SAR
Agreement (incorporated by reference as Exhibit 4.13.5 included in the
Companys Registration Statement on Form S-8, File No. 333-134575,
filed with the Commission on May 31, 2006)
|
|
|
|
10.1.1
|
**
|
Second Amended and Restated Stock Option Plan, dated
May 23, 2000, as amended (incorporated by reference to Exhibit 10.1
included in the Companys Form 10-K for the year ended December 31,
2003)
|
60
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
10.1.2
|
**
|
Form of Employee Non-Qualified Stock Option Agreement
pursuant to Second Amended and Restated Stock Option Plan, as amended
(incorporated by reference to Exhibit 10.1B included in the Companys
Form 10-K for the year ended December 31, 2003)
|
|
|
|
10.1.3
|
**
|
Certificate of Amendment to Second Amended and Restated
Stock Option Plan, dated May 8, 2003 (incorporated by reference to
Exhibit 10.1B1 included in the Companys Form 10-K for the year
ended December 31, 2003)
|
|
|
|
10.2.1
|
|
Amended and Restated Stock Option Plan for Non-Employee
Directors dated May 23, 2000 (incorporated by reference to
Exhibit 10.1B1 included in the Companys Form 10-K for the year
ended December 31, 2003)
|
|
|
|
10.2.2
|
|
Certificate of Amendment for Option Plan for Non-Employee
Directors dated May 13, 2004 (incorporated by reference to
Exhibit 10.4 included in the Companys Form 10-Q for the quarter
ended June 30, 2004)
|
|
|
|
10.2.3
|
**
|
Form of Non-Qualified Stock Option Agreement pursuant
to Option Plan for Non-Employee Directors, as amended (incorporated by
reference to Exhibit 10.3 included in the Companys Form 10-Q for
the quarter ended June 30, 2004)
|
|
|
|
10.3
|
**
|
Amended and Restated Employee Stock Purchase Plan dated
May 28, 1998 (incorporated by reference to Appendix B included in the
Companys 1998 Proxy Statement filed with the Commission on April 20,
1998)
|
|
|
|
10.4
|
**
|
Amended and Restated Dividend Reinvestment and Stock
Purchase Plan dated April 8, 2005 (incorporated by reference to the
Companys Form S-3/A Registration Statement filed with the Commission on
April 5, 2005)
|
|
|
|
10.5
|
**
|
Deferred Compensation Plan dated January 1, 2002
(incorporated by reference to Exhibit 10.6 included in the Companys
Form 10-K for the year ended December 31, 2004)
|
|
|
|
10.6
|
**
|
Supplemental Executive Retirement Plan dated May 8,
2000 (incorporated by reference to Exhibit 10.7 included in the
Companys Form 10-K for the year ended December 31, 2004)
|
|
|
|
10.7
|
|
Tolling Agreement between Suburban Water Systems and
Aerojet dated June 20, 2000 (incorporated by reference to
Exhibit 10.7 included in the Companys Form 10-Q for the quarter
ended June 30, 2000)
|
|
|
|
10.8.1
|
**
|
Severance Compensation Agreement between SouthWest Water
Company and certain executive officers approved by the Compensation Committee
of the Board of Directors on August 5, 1998 (incorporated by reference
to Exhibit 10.9A included in the Companys Form 10-K for the year
ended December 31, 1998)
|
|
|
|
10.8.2
|
**
|
First Amendment to Severance Compensation Agreement, dated
July 22, 2005, between SouthWest Water Company and Anton C. Garnier
(incorporated by reference to Exhibit 10.1 included in the Companys
Form 8-K filed with the Commission on July 28, 2005)
|
|
|
|
10.9
|
**
|
Severance Compensation Agreement between SouthWest Water
Company and a certain executive officer approved by the Compensation
Committee of the Board of Directors on August 31, 2001 (incorporated by
reference to Exhibit 10.9B included in the Companys Form 10-Q for
the quarter ended June 30, 2002)
|
61
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
10.10
|
|
Credit Agreement dated as of April 1, 2005 among
SouthWest Water Company, as borrower, the several lenders parties thereto,
Bank of America, N.A., as administrative agent, swing line lender and letter
of credit issuer, Banc of America Securities LLC and Union Bank of
California, N.A., as co-lead arrangers and co-book managers, and Union Bank
of California, N.A., as syndication agent (incorporated by reference to
Exhibit 10.1 included in the Companys Form 8-K filed with the
Commission on April 6, 2005)
|
|
|
|
10.11.1
|
|
Amended and Restated Master Loan Agreement dated
September 12, 2005 (MLA No. RX 0936) between Monarch Utilities I
L.P. and CoBank, ACB (incorporated by reference to Exhibit 10.4 included
in the Companys Form 10-Q for the quarter ended September 30,
2005)
|
|
|
|
10.11.1.1
|
|
First Amendment of Amended and Restated Master Loan
Agreement (MLA No. 0936) dated November 6, 2006 between Monarch
Utilities I L.P. and CoBank, ACB (incorporated by reference to
Exhibit 10.17.1.1 included in the Companys Form 10-Q for the
quarter ended September 30, 2006)
|
|
|
|
10.11.2
|
|
Promissory Note and Supplement dated May 1, 2002 (Loan
No. ML0936T1) between Tecon Water Company, L.P. (now Monarch Utilities I
L.P.) and CoBank, ACB (incorporated by reference to Exhibit 10.4.1
included in the Companys Form 10-Q for the quarter ended
September 30, 2005)
|
|
|
|
10.11.3
|
|
First Amendment to Promissory Note and Supplement dated
September 12, 2005 (Loan No. ML0936T1) between Monarch Utilities I
L.P. (formerly known as Tecon Water Company, L.P.) and CoBank, ACB
(incorporated by reference to Exhibit 10.4.2 included in the Companys
Form 10-Q for the quarter ended September 30, 2005)
|
|
|
|
10.11.4
|
|
Promissory Note and Supplement dated May 1, 2002 (Loan
No. ML0936T2 between Tecon Water Company, L.P. (now Monarch Utilities I
L.P.) and CoBank, ACB (incorporated by reference to Exhibit 10.4.3
included in the Companys Form 10-Q for the quarter ended
September 30, 2005)
|
|
|
|
10.11.5
|
|
First Amendment to Promissory Note and Supplement dated
September 12, 2005 (Loan No. ML0936T2) between Monarch Utilities I
L.P. (formerly known as Tecon Water Company, L.P.) and CoBank, ACB
(incorporated by reference to Exhibit 10.4.4 included in the Companys
Form 10-Q for the quarter ended September 30, 2005)
|
|
|
|
10.11.6
|
|
Promissory Note and Supplement dated September 12,
2005 (Loan No. RX0936T3) between Monarch Utilities I L.P. and CoBank,
ACB (incorporated by reference to Exhibit 10.4.5 included in the
Companys Form 10-Q for the quarter ended September 30, 2005)
|
|
|
|
10.12
|
|
Official Statement for $31,555,000 of San Juan Basin
Authority Lease Revenue Bonds (Ground Water Recovery Project) Issue of 2002
containing descriptions and summaries of various documents relating to the
project, including the Service Contract for the Design, Construction,
Financing and Operation of the San Juan Basin Desalter Project by and among
ECO Resources, Inc., SouthWest Water Company, and the Capistrano Valley
Water District, Orange County, California, dated as of September 3,
2002. (incorporated by reference to Exhibit 10.24 included in the
Companys Form 10-K for the year ended December 31, 2002)
|
|
|
|
10.13.1
|
|
Investors Rights Agreement, dated February 25, 2000,
among SouthWest Water Company and the investors named therein (incorporated
by reference to Exhibit 10.24.1 included in the Companys Form 10-K
for the year ended December 31, 2005)
|
62
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
10.13.2
|
|
Common Stock Purchase Warrant, dated October 6, 2003,
from SouthWest Water Company to Guaranty & Trust Co. TTEE, FBO:
William L. McIntyre, Jr., covering 30,000 shares of common stock of
SouthWest Water Company (incorporated by reference to Exhibit 10.24.2
included in the Companys Form 10-K for the year ended December 31,
2005)
|
|
|
|
10.13.3
|
|
Common Stock Purchase Warrant, dated October 6, 2003,
from SouthWest Water Company to William L. McIntyre, Jr., covering
18,837 shares of common stock of SouthWest Water Company (incorporated by
reference to Exhibit 10.24.3 included in the Companys Form 10-K
for the year ended December 31, 2005)
|
|
|
|
10.14
|
**
|
Employment Agreement dated March 16, 2006 Anton C.
Garnier and SouthWest Water Company (incorporated by reference to
Exhibit 10.25 included in the Companys Form 8-K filed with the
Commission on March 17, 2006)
|
|
|
|
10.15
|
**
|
Executive Employment Agreement dated April 17, 2006,
between Mark A. Swatek and SouthWest Water Company (incorporated by reference
to Exhibit 10.2 included in the Companys Form 8-K filed with the
Commission on April 18, 2006)
|
|
|
|
10.16
|
**
|
Executive Employment Agreement dated April 28, 2006,
between Cheryl L. Clary and SouthWest Water Company (incorporated by
reference to Exhibit 10.1 included in the Companys Form 8-K filed
with the Commission on May 3, 2006)
|
|
|
|
10.17
|
**
|
Change of Control Agreement dated April 28, 2006,
between Cheryl L. Clary and SouthWest Water Company (incorporated by
reference to Exhibit 10.3 included in the Companys Form 8-K filed
with the Commission on May 3, 2006)
|
|
|
|
10.18
|
**
|
Executive Employment Agreement dated April 28, 2006,
between Michael O. Quinn and SouthWest Water Company (incorporated by
reference to Exhibit 10.2 included in the Companys Form 8-K filed
with the Commission on May 3, 2006)
|
|
|
|
10.19
|
**
|
Change of Control Agreement dated April 28, 2006,
between Michael O. Quinn and SouthWest Water Company (incorporated by
reference to Exhibit 10.4 included in the Companys Form 8-K filed
with the Commission on May 3, 2006)
|
|
|
|
10.20
|
**
|
Change of Control Agreement dated as of May 15, 2006,
between SouthWest Water Company and Mark A. Swatek, the Companys Chairman of
the Board and Chief Executive Officer (incorporated by reference to
Exhibit 10.1 included in the Companys Form 8-K filed with the
Commission on May 19, 2006)
|
|
|
|
10.21
|
|
Lease Agreement effective December 28, 2007 between
the Company, as lessee and Fidelity National Capital, Inc. as lessor
(incorporated by reference to Exhibit 10.1 included in the Companys
Form 8-K filed with the Commission on January 3, 2008)
|
|
|
|
10.22
|
|
Credit Agreement dated as of February 15, 2008 among
the Company, as borrower, the several lenders parties thereto, Bank of
America, N.A., as Administrative Agent, Swing Line Lender and Letter of
Credit Issuer, Banc of America Securities LLC, as Sole Lead Arranger and Sole
Book Manager, Keybank National Association, as Syndication Agent, and CoBank
ACB, U.S. Bank National Association and JPMorgan Chase Bank, N.A., as
Documentation Agents (incorporated by reference to Exhibit 10.1 included
in the Companys Form 8-K filed with the Commission on
February 22, 2008)
|
63
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
12
|
*
|
Computation of Earnings to Fixed Charges Ratios
|
|
|
|
21.1
|
*
|
Subsidiaries of the Registrant
|
|
|
|
23.1
|
*
|
Consent of Independent Registered Public Accounting Firm
|
|
|
|
31.1
|
*
|
Certification of Principal Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
|
31.2
|
*
|
Certification of Principal Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
|
32.1
|
*
|
Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
32.2
|
*
|
Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
|
*
Filed herewith
**
Indicates a management
contract or compensatory plan or arrangement.
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of
the Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereto duly authorized.
SOUTHWEST WATER COMPANY (REGISTRANT)
BY:
|
/s/ MARK A. SWATEK
|
|
Mark A. Swatek
|
|
Chief Executive Officer
|
|
|
Date:
|
March 31, 2008
|
Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
BY:
|
/s/ H. FREDERICK CHRISTIE
|
|
BY:
|
/s/ WILLIAM D. JONES
|
|
H. Frederick Christie
|
|
|
William D. Jones
|
|
Director
|
|
|
Director
|
|
|
|
|
|
BY:
|
/s/ ANTON C. GARNIER
|
|
BY:
|
/s/ MAUREEN A. KINDEL
|
|
Anton C. Garnier
|
|
|
Maureen A. Kindel
|
|
Director
|
|
|
Director
|
|
|
|
|
|
BY:
|
/s/ LINDA GRIEGO
|
|
BY:
|
/s/ RICHARD G. NEWMAN
|
|
Linda Griego
|
|
|
Richard G. Newman
|
|
Director
|
|
|
Director
|
|
|
|
|
|
BY:
|
/s/ DONOVAN D. HUENNEKENS
|
|
BY:
|
/s/ MARK A. SWATEK
|
|
Donovan D. Huennekens
|
|
|
Mark A. Swatek
|
|
Director
|
|
|
Director and Chief Executive Officer
|
|
|
|
|
|
BY:
|
/s/ THOMAS IINO
|
|
BY:
|
/s/ CHERYL L. CLARY
|
|
Thomas Iino
|
|
|
Cheryl L. Clary
|
|
Director
|
|
|
Chief Financial Officer
|
|
|
|
|
|
Date:
|
March 31, 2008
|
|
|
|
65
All other schedules are omitted because they are
either not applicable or the required information is shown in the consolidated
financial statements or note thereto.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
SouthWest Water Company:
We have audited the accompanying consolidated balance
sheets of SouthWest Water Company and subsidiaries as of December 31, 2007
and 2006, and the related consolidated statements of income, changes in
stockholders equity, and cash flows for each of the years in the three-year
period ended December 31, 2007. In connection with our audits of the
consolidated financial statements, we also have audited the related financial
statement schedules as listed in the index on page F-1. These consolidated
financial statements and financial statement schedules are the responsibility
of the Companys management. Our responsibility is to express an opinion on
these consolidated financial statements and financial statement schedules based
on our audits.
We conducted our audits in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the 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 consolidated financial statements
referred to above present fairly, in all material respects, the financial
position of SouthWest Water Company and subsidiaries as of December 31,
2007 and 2006, and the results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 2007, in
conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
As
discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for uncertain income tax positions in 2007 and
for share-based compensation, defined benefit pension plans and method of
quantifying errors in 2006.
We also have audited, in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
effectiveness of SouthWest Water Companys internal control over financial
reporting as of December 31, 2007, based on criteria established in
Internal ControlIntegrated Framework
issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and
our report dated March 27, 2008, expressed an unqualified opinion on the
effectiveness of the Companys internal control over financial reporting.
/s/
KPMG LLP
|
|
|
|
Los
Angeles, California
|
|
March 27,
2008
|
|
F-2
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
|
|
December 31,
|
|
(In thousands, except per share data)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
2,950
|
|
$
|
4,294
|
|
Accounts receivable, net
|
|
26,005
|
|
27,512
|
|
Assets held for sale
|
|
16,013
|
|
|
|
Other current assets
|
|
16,617
|
|
16,451
|
|
Total current assets
|
|
61,585
|
|
48,257
|
|
|
|
|
|
|
|
Property, Plant and
Equipment, Net:
|
|
|
|
|
|
Regulated utilities
|
|
399,146
|
|
378,260
|
|
Non-regulated operations
|
|
18,757
|
|
11,365
|
|
Total property, plant and equipment, net
|
|
417,903
|
|
389,625
|
|
|
|
|
|
|
|
Other Assets:
|
|
|
|
|
|
Goodwill
|
|
17,349
|
|
33,152
|
|
Intangible assets
|
|
2,539
|
|
2,844
|
|
Other assets
|
|
17,033
|
|
17,815
|
|
|
|
$
|
516,409
|
|
$
|
491,693
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS
EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
|
Accounts payable
|
|
$
|
14,930
|
|
$
|
12,746
|
|
Liabilities related to assets held for sale
|
|
4,297
|
|
|
|
Current portion of long-term debt
|
|
1,937
|
|
1,423
|
|
Other current liabilities
|
|
25,020
|
|
21,661
|
|
Total current liabilities
|
|
46,184
|
|
35,830
|
|
|
|
|
|
|
|
Other Liabilities and
Deferred Credits:
|
|
|
|
|
|
Long-term debt
|
|
145,353
|
|
128,624
|
|
Deferred income taxes
|
|
28,102
|
|
26,011
|
|
Advances for construction
|
|
9,210
|
|
8,413
|
|
Contributions in aid of construction
|
|
115,442
|
|
110,024
|
|
Other liabilities and deferred credits
|
|
12,924
|
|
16,264
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders Equity:
|
|
|
|
|
|
Preferred stock, $0.01 par value per share, 250 shares authorized,
9 shares issued and outstanding, at stated liquidation value
|
|
458
|
|
458
|
|
Common stock, $0.01 par value per share, 75,000 shares authorized, 24,268
and
23,802 shares issued and outstanding at December 31, 2007 and 2006,
respectively
|
|
243
|
|
238
|
|
Additional paid-in capital
|
|
145,072
|
|
138,728
|
|
Retained earnings
|
|
13,336
|
|
27,031
|
|
Accumulated other comprehensive income
|
|
85
|
|
72
|
|
Total stockholders equity
|
|
159,194
|
|
166,527
|
|
|
|
|
|
|
|
|
|
$
|
516,409
|
|
$
|
491,693
|
|
See
accompanying notes to consolidated financial statements.
F-3
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
|
|
Years Ended December 31,
|
|
(In thousands, except per share data)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
Utility Group
|
|
$
|
93,370
|
|
$
|
86,321
|
|
$
|
78,884
|
|
Services Group
|
|
123,977
|
|
132,481
|
|
118,720
|
|
Total revenues
|
|
217,347
|
|
218,802
|
|
197,604
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
Utility Group operating expenses
|
|
52,765
|
|
48,540
|
|
44,827
|
|
Services Group operating expenses
|
|
107,884
|
|
113,916
|
|
103,547
|
|
Selling, general and administrative expenses
|
|
36,624
|
|
32,998
|
|
30,756
|
|
Impairment of goodwill
|
|
17,215
|
|
929
|
|
|
|
Total expenses
|
|
214,488
|
|
196,383
|
|
179,130
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
2,859
|
|
22,419
|
|
18,474
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
Interest expense
|
|
(7,696
|
)
|
(7,536
|
)
|
(6,501
|
)
|
Interest income
|
|
618
|
|
456
|
|
434
|
|
Other, net
|
|
(6
|
)
|
58
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
Income (loss) from
continuing operations before income taxes
|
|
(4,225
|
)
|
15,397
|
|
12,405
|
|
Provision for income taxes
|
|
795
|
|
5,388
|
|
4,434
|
|
|
|
|
|
|
|
|
|
Income (loss) from
continuing operations
|
|
(5,020
|
)
|
10,009
|
|
7,971
|
|
|
|
|
|
|
|
|
|
Loss from discontinued
operations, net of tax
|
|
(3,026
|
)
|
(681
|
)
|
(5,572
|
)
|
Cumulative effect of change
in accounting principle, net of tax
|
|
|
|
71
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
(8,046
|
)
|
9,399
|
|
2,399
|
|
|
|
|
|
|
|
|
|
Preferred stock dividends
|
|
(24
|
)
|
(24
|
)
|
(24
|
)
|
|
|
|
|
|
|
|
|
Net income (loss)
applicable to common stockholders
|
|
$
|
(8,070
|
)
|
$
|
9,375
|
|
$
|
2,375
|
|
|
|
|
|
|
|
|
|
Earnings per common share:
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
(0.21
|
)
|
$
|
0.44
|
|
$
|
0.38
|
|
Loss from discontinued operations
|
|
(0.12
|
)
|
(0.03
|
)
|
(0.27
|
)
|
Cumulative effect of change in accounting principle
|
|
|
|
|
|
|
|
Net income (loss) applicable to common stockholders
|
|
$
|
(0.33
|
)
|
$
|
0.41
|
|
$
|
0.11
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
(0.21
|
)
|
$
|
0.43
|
|
$
|
0.37
|
|
Loss from discontinued operations
|
|
(0.12
|
)
|
(0.03
|
)
|
(0.26
|
)
|
Cumulative effect of change in accounting principle
|
|
|
|
|
|
|
|
Net income (loss) applicable to common stockholders
|
|
$
|
(0.33
|
)
|
$
|
0.40
|
|
$
|
0.11
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
Basic
|
|
24,101
|
|
22,928
|
|
20,859
|
|
Diluted
|
|
24,101
|
|
23,363
|
|
21,611
|
|
See
accompanying notes to consolidated financial statements.
F-4
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Preferred
Stock
|
|
Common
Stock
|
|
Additional
|
|
|
|
Other
|
|
Total
|
|
|
|
Number
of
|
|
|
Number
of
|
|
|
Paid-in
|
|
Retained
|
|
Comprehensive
|
|
Stockholders
|
|
(In
thousands)
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Earnings
|
|
Income
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
9
|
|
$
|
461
|
|
20,365
|
|
$
|
204
|
|
$
|
101,499
|
|
$
|
24,034
|
|
$
|
|
|
$
|
126,198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issued to acquire minority interest in subsidiary
|
|
|
|
|
|
451
|
|
4
|
|
5,996
|
|
|
|
|
|
6,000
|
|
Dividend reinvestment and stock purchase plans
|
|
|
|
|
|
796
|
|
8
|
|
9,644
|
|
|
|
|
|
9,652
|
|
Proceeds from stock options exercised
|
|
|
|
|
|
469
|
|
5
|
|
2,474
|
|
|
|
|
|
2,479
|
|
Tax benefit from stock options exercised
|
|
|
|
|
|
|
|
|
|
703
|
|
|
|
|
|
703
|
|
Share-based compensation
|
|
|
|
|
|
|
|
|
|
966
|
|
|
|
|
|
966
|
|
Debenture conversions
|
|
|
|
|
|
104
|
|
1
|
|
1,076
|
|
|
|
|
|
1,077
|
|
5% stock dividend
|
|
|
|
|
|
|
|
|
|
10
|
|
(10
|
)
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
2,399
|
|
|
|
2,399
|
|
Cash dividends declared
|
|
|
|
|
|
|
|
|
|
|
|
(4,221
|
)
|
|
|
(4,221
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
9
|
|
461
|
|
22,185
|
|
222
|
|
122,368
|
|
22,202
|
|
|
|
145,253
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative effect of adjustment from the adoption of SAB 108
|
|
|
|
|
|
|
|
|
|
|
|
430
|
|
|
|
430
|
|
Dividend reinvestment and stock purchase plans
|
|
|
|
|
|
416
|
|
4
|
|
5,273
|
|
|
|
|
|
5,277
|
|
Proceeds from stock options exercised
|
|
|
|
|
|
884
|
|
9
|
|
5,312
|
|
|
|
|
|
5,321
|
|
Tax benefit from stock options exercised
|
|
|
|
|
|
|
|
|
|
1,478
|
|
|
|
|
|
1,478
|
|
Share-based compensation
|
|
|
|
|
|
|
|
|
|
1,079
|
|
|
|
|
|
1,079
|
|
Cumulative effect of change in accounting principle for share-based
compensation
|
|
|
|
|
|
|
|
|
|
(110
|
)
|
|
|
|
|
(110
|
)
|
Debenture conversions
|
|
|
|
|
|
317
|
|
3
|
|
3,327
|
|
|
|
|
|
3,330
|
|
Repurchase of preferred stock
|
|
|
|
(3
|
)
|
|
|
|
|
1
|
|
|
|
|
|
(2
|
)
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
9,399
|
|
|
|
9,399
|
|
Cash dividends declared
|
|
|
|
|
|
|
|
|
|
|
|
(5,000
|
)
|
|
|
(5,000
|
)
|
Adjustment to initially apply SFAS No. 158, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
72
|
|
72
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
9
|
|
458
|
|
23,802
|
|
238
|
|
138,728
|
|
27,031
|
|
72
|
|
166,527
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
(8,046
|
)
|
|
|
(8,046
|
)
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of actuarial net gain
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(44
|
)
|
(44
|
)
|
Amortization of prior service costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57
|
|
57
|
|
Comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,033
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend reinvestment and stock purchase plans
|
|
|
|
|
|
216
|
|
2
|
|
2,776
|
|
|
|
|
|
2,778
|
|
Proceeds from stock options exercised
|
|
|
|
|
|
172
|
|
2
|
|
765
|
|
|
|
|
|
767
|
|
Tax benfits from stock options exercised
|
|
|
|
|
|
|
|
|
|
414
|
|
|
|
|
|
414
|
|
Share-based compensation
|
|
|
|
|
|
27
|
|
|
|
1,861
|
|
|
|
|
|
1,861
|
|
Debenture conversions
|
|
|
|
|
|
51
|
|
1
|
|
528
|
|
|
|
|
|
529
|
|
Cash dividends declared
|
|
|
|
|
|
|
|
|
|
|
|
(5,649
|
)
|
|
|
(5,649
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007
|
|
9
|
|
$
|
458
|
|
24,268
|
|
$
|
243
|
|
$
|
145,072
|
|
$
|
13,336
|
|
$
|
85
|
|
$
|
159,194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
F-5
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
Years
Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Cash flows from operating
activities of continuing operations:
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(8,046
|
)
|
$
|
9,399
|
|
$
|
2,399
|
|
Adjustments to reconcile net income to net cash provided
by operating activities:
|
|
|
|
|
|
|
|
Cumulative effect of change in accounting principle, net of tax
|
|
|
|
(71
|
)
|
|
|
Loss from discontinued operations, net of tax
|
|
3,026
|
|
681
|
|
5,572
|
|
Depreciation and amortization
|
|
11,634
|
|
10,538
|
|
9,792
|
|
Deferred income taxes
|
|
(3,214
|
)
|
3,124
|
|
5,559
|
|
Share-based compensation expense
|
|
1,861
|
|
1,079
|
|
966
|
|
Impairment of goodwill
|
|
17,215
|
|
929
|
|
|
|
Gain on sales of land
|
|
|
|
(407
|
)
|
|
|
Changes in assets and liabilities, net of effects of acquisitions:
|
|
|
|
|
|
|
|
Accounts receivable
|
|
1,563
|
|
(1,250
|
)
|
(4,029
|
)
|
Other current assets
|
|
2,858
|
|
2,996
|
|
4,763
|
|
Other assets
|
|
(77
|
)
|
(1,675
|
)
|
1,181
|
|
Accounts payable
|
|
2,234
|
|
2,644
|
|
(2,243
|
)
|
Other current liabilities
|
|
3,019
|
|
(1,041
|
)
|
(694
|
)
|
Other liabilities
|
|
(1,712
|
)
|
(475
|
)
|
325
|
|
Other, net
|
|
187
|
|
325
|
|
162
|
|
Net cash provided by operating activities
|
|
30,548
|
|
26,796
|
|
23,753
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities of continuing operations:
|
|
|
|
|
|
|
|
Additions to property, plant and equipment
|
|
(41,348
|
)
|
(43,253
|
)
|
(32,640
|
)
|
Acquisition of businesses, net of cash acquired
|
|
(8,069
|
)
|
(1,719
|
)
|
(12,312
|
)
|
Purchase of minority interest
|
|
|
|
(1,013
|
)
|
|
|
Proceeds from the sale of discontinued operations
|
|
|
|
|
|
9,206
|
|
Proceeds from sales of land and equipment
|
|
49
|
|
427
|
|
|
|
Net cash used in investing activities
|
|
(49,368
|
)
|
(45,558
|
)
|
(35,746
|
)
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities of continuing operations:
|
|
|
|
|
|
|
|
Borrowings under lines of credit
|
|
15,000
|
|
6,000
|
|
6,965
|
|
Capital improvement reimbursements
|
|
5,089
|
|
4,300
|
|
949
|
|
Proceeds from share-based equity incentive plans and stock
purchase plans
|
|
3,545
|
|
10,598
|
|
12,131
|
|
Proceeds from issuance of long-term debt
|
|
|
|
10,000
|
|
20,000
|
|
Contributions in aid of construction
|
|
884
|
|
3,557
|
|
2,573
|
|
Excess tax benefit from stock options exercised
|
|
414
|
|
1,478
|
|
|
|
Dividends paid
|
|
(5,649
|
)
|
(5,000
|
)
|
(4,221
|
)
|
Payments on long-term debt
|
|
(2,214
|
)
|
(9,415
|
)
|
(17,932
|
)
|
Repayment of advances for construction
|
|
(841
|
)
|
(919
|
)
|
(973
|
)
|
Deferred financing costs
|
|
|
|
(268
|
)
|
(1,338
|
)
|
Repurchase of preferred stock
|
|
|
|
(2
|
)
|
|
|
Net cash provided by financing activities
|
|
16,228
|
|
20,329
|
|
18,154
|
|
|
|
|
|
|
|
|
|
Cash flows from discontinued operations:
|
|
|
|
|
|
|
|
Operating activities
|
|
1,565
|
|
1,250
|
|
150
|
|
Investing activities
|
|
(317
|
)
|
(1,287
|
)
|
(4,403
|
)
|
Financing activities
|
|
|
|
|
|
(532
|
)
|
Net cash provided by (used) in discontinued operations
|
|
1,248
|
|
(37
|
)
|
(4,785
|
)
|
|
|
|
|
|
|
|
|
Net increase (decrease) in
cash and cash equivalents
|
|
(1,344
|
)
|
1,530
|
|
1,376
|
|
Cash and cash equivalents
at beginning of year
|
|
4,294
|
|
2,764
|
|
1,388
|
|
Cash and cash equivalents
at end of year
|
|
$
|
2,950
|
|
$
|
4,294
|
|
$
|
2,764
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
F-6
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting
Policies
Description of
Business
SouthWest Water Company and its subsidiaries (SouthWest
Water or the Company) provide a broad range of operations, maintenance and
management services, including water production; treatment and distribution;
wastewater collection and treatment; customer service; and utility
infrastructure construction management. The Company owns regulated public
utilities and also serves cities, utility districts and private companies under
contract. The Companys businesses are segmented into two operating groups: the
Utility Group, which is comprised of the Companys regulated public utilities;
and the Services Group, which is comprised of the Companys non-regulated
operations.
Basis of
Presentation
The consolidated financial statements include
the accounts of SouthWest Water and its wholly owned and majority-owned
subsidiaries and partnerships. All significant intercompany accounts and
transactions have been eliminated, except where permitted for intercompany
transactions with the Companys regulated utilities as further described in Regulated
Utility Accounting.
Preparation of these financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions. The reported
amounts of assets and liabilities, 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 could be affected by changes
in such estimates. Actual results may differ from these estimates.
Change in
Presentation
Effective January 1, 2007, the Company
elected to allocate a portion of its Services Groups operating expense
overhead between affiliated and unaffiliated customers for segment reporting
purposes (Note 15). In prior periods, all operating expense overhead was
reflected as operating expenses attributable to unaffiliated customers. This
change in allocation methodology increased the gross profit from sales to
unaffiliated customers and decreased the gross profit from sales to affiliated
customers by the same amount. In accordance with SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information
,
prior year amounts have been reclassified to conform to the 2007 presentation.
In accordance with SFAS No. 71,
Accounting for the Effects of Certain Types of Regulation
(SFAS
71), the Company does not eliminate the intersegment profit recognized on
sales to affiliated customers because the Company 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. The Company does, however,
eliminate the Services Groups revenues from affiliated customers to the extent
of its cost. Consequently, this change resulted in a decrease in the Services
Groups revenues and direct operating expenses reported in 2006 and 2005 by the
same amounts. Consolidated gross profit, operating income and net income are
unchanged.
Reclassifications have also been made to prior
years financial statement presentation with respect to a component of the
business the Company is holding for sale as discontinued operations (Note 2).
F-7
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting
Policies (Continued)
In 2006, the Company centralized many of its
common business functions into a shared services departmental structure and the
related expenses were classified as selling, general and administrative
expenses. Effective January 1, 2007 the Company concluded that these
expenses were more operational in nature and elected to classify these expenses
as direct operating expenses. As a result, 2006 amounts have also been
reclassified to conform to the 2007 presentation.
Accounting
Guidance and Pronouncements Adopted
SAB No. 108
In 2006, the Company adopted the
provisions of Staff Accounting Bulletin No. 108,
Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements
(SAB 108). SAB 108 requires
companies to quantify misstatements using both a balance sheet and income
statement approach and then evaluate whether either method results in
quantifying an error that is material. Prior to SAB 108, the Company had used
the income statement method for quantifying misstatements in its financial
statements. The Company had previously identified computational errors in
measuring its deferred income taxes. The cumulative effect of these errors,
which occurred for the most part ratably over a 16 year period, resulted in a
$0.4 million overstatement of deferred tax liabilities as of December 31, 2005.
The impact of these errors was immaterial to each of the prior years under the
income statement approach. However, in applying the dual method approach under
SAB 108, the cumulative effect of correcting the errors would have been
material. As a result, the Company elected to record a $0.4 million adjustment
to its retained earnings balance as of January 1, 2006, in accordance with the
transition provisions of SAB 108.
SFAS No. 158
In September 2006, the 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 the Companys fiscal year ended December 31, 2006 and, as a
result, the Company 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 the consolidated
financial statements.
FIN No. 48
On January 1, 2007, the Company 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
companys financial statements in accordance with SFAS No. 109,
Accounting for Income Taxes
. 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 January 1, 2007, the Companys liabilities for uncertain
tax positions were not significant and therefore adoption of FIN 48 did
not have a material effect on the consolidated financial statements.
F-8
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting
Policies (Continued)
Regulated
Utility Accounting
The Companys utilities are regulated by
either the California Public Utilities Commission (CPUC), the Texas Commission
on Environmental Quality (TCEQ), the Mississippi Public Service Commission
(MPSC) the New Mexico Public Regulation Commission (NMPRC) or local county
governing bodies. The Companys
utilities record transactions in accordance with SFAS No. 71,
Accounting for the Effects of Certain Types of Regulation
(SFAS 71).
Regulatory assets and liabilities are recorded in accordance with SFAS 71
and include the following:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Regulatory
assets:
|
|
|
|
|
|
Regulatory tax assets
|
|
$
|
3,567
|
|
$
|
3,207
|
|
Supply cost balancing
accountNovember 29, 2001 and prior
|
|
2,985
|
|
3,009
|
|
Supply cost balancing account2005
|
|
750
|
|
710
|
|
Supply cost balancing account2006
|
|
1,520
|
|
1,459
|
|
Supply cost balancing account2007
|
|
1,806
|
|
|
|
Rate case filing expenses and other
|
|
1,118
|
|
702
|
|
Regulatory
liabilities:
|
|
|
|
|
|
Regulatory tax liability
|
|
(1,171
|
)
|
(1,214
|
)
|
Regulatory fees
|
|
(180
|
)
|
(161
|
)
|
Supply cost memorandum account2002
|
|
(122
|
)
|
(73
|
)
|
Supply cost memorandum account2003
|
|
(401
|
)
|
(359
|
)
|
Supply cost memorandum account2004
|
|
(325
|
)
|
(250
|
)
|
Collections
on net supply cost balancing and memorandum accounts:
|
|
|
|
|
|
November 29, 2001 and prior
|
|
(3,176
|
)
|
(2,702
|
)
|
January 1, 2002 to present
|
|
(405
|
)
|
|
|
Net regulatory assets
|
|
$
|
5,966
|
|
$
|
4,328
|
|
|
|
|
|
|
|
Balance sheet
classification:
|
|
|
|
|
|
Other current assets
|
|
$
|
1,986
|
|
$
|
765
|
|
Other long-term assets
|
|
5,331
|
|
5,620
|
|
Other current liabilities
|
|
(180
|
)
|
(161
|
)
|
Other long-term liabilities
|
|
(1,171
|
)
|
(1,896
|
)
|
Net regulatory assets
|
|
$
|
5,966
|
|
$
|
4,328
|
|
Regulatory income tax assets are included in
rate base and earn the Company a return. Conversely, regulatory income tax
liabilities are included in rate base and reduce the Companys return.
Over the years, the CPUC, the regulator of
Suburban, the Companys California utility, has had various policies with
respect to accounting for the difference between Suburbans actual water
production costs incurred versus CPUC-adopted water production costs. In the
water industry, those costs consist of expenditures for purchased water,
purchased power and pump taxes. At times, the CPUC has allowed balancing
accounts in the financial statements of water utilities whereby the difference
between actual and CPUC-adopted costs are recorded as either a receivable, for
under-collections of costs from customers, or as a liability, for
over-collections of costs from customers, as permitted by SFAS 71. Under
these procedures, the utility would apply for the dispensation of balancing
accounts and amounts would either be refunded to or recovered from utility
customers through future CPUC-authorized rate adjustments, once certain
balancing thresholds were achieved.
F-9
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting
Policies (Continued)
Prior to November 29, 2001, the CPUC
allowed the recording of the difference between actual costs incurred and the
CPUC-adopted volume related costs to balancing accounts. The CPUC changed their
methodology in 2001 and required an earnings test to accompany annual
submissions of memorandum accounts where these volume-related differences would
be tracked. Once submitted to the CPUC, the utility would subsequently be
directed by the CPUC as to what portion of their memorandum account could be
added to or subtracted from its balancing account. As a result of this change
and the uncertainties the earnings test created with respect to the collections
of under-collections, Suburban recorded in its financial statements only
over-collections of volume related costs until recovery of under-collections
was assured. Suburban followed this practice from December 2001 until April 2006.
In 2004, the CPUC issued a decision that
allowed Suburban to recover the supply cost balancing account pertaining to the
pre-November 29, 2001 period through a surcharge billed to its customers.
Pursuant to CPUC policy, this supply cost balancing account, while excluded
from rate base, earns interest for the years recorded once approved by the
CPUC.
In April 2006, the CPUC issued a decision
which eliminated the required earnings test, removing the uncertainty
associated with the recovering balancing account under-collections. As a
result, in 2006, the Company recorded $0.7 million of receivables related to
balancing account under-collections attributable to 2005 and $1.5 million and
$1.8 million attributable to 2006 and 2007, respectively. In October 2007,
the CPUC issued a ruling that Suburban could collect the net amount of its
balancing accounts from 2002 through 2006 over a one year period. As a result,
the net of these amounts is classified as a current asset as of December 31,
2007.
The Companys Services Group provides
construction, operations and maintenance services to the Companys Alabama, New
Mexico and Texas utilities and recognizes a profit on those services. In
accordance with SFAS 71, the Company does not eliminate the Services Groups
profit recognized on these services because the Company 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. The Company does, however,
eliminate revenues to the extent of the related costs in its consolidated
financial statements.
Cash and Cash
Equivalents
The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
The Company transfers cash into its bank
accounts to fund cash transactions on an as-needed basis as they clear the
bank. Book overdrafts, which represent cash transactions that have not cleared
the bank as of the end of a period, are reported as accounts payable and
changes in the book overdraft balances are reported as cash flows from
operating activities.
F-10
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting
Policies (Continued)
Property, Plant
and Equipment
The cost of additions to regulated utility
plant includes labor, material and capitalized interest. Capitalized interest
totaled $0.9 million in 2007, $0.6 million in 2006 and $0.7 million 2005.
Depreciation expense on utility plant is recorded using the straight-line
method over useful lives ranging from five to fifty years as prescribed by the
applicable regulatory authorities and as permitted by SFAS 71.
Depreciation expense on average gross depreciable plant was 2.7% in 2007, 2.6%
in 2006 and 2.5% in 2005.
Property, plant and equipment used in
non-regulated operations are depreciated using the straight-line method over
estimated useful lives ranging from twenty months to forty years. For both
regulated and non-regulated operations, maintenance costs are recognized in the
period in which they are incurred. The Company does not accrue for major
maintenance projects prior to the periods in which they are actually incurred.
Leased property meeting capital lease criteria
is capitalized and the present value of the lease payments is recorded as a
liability. Capitalized leased assets are depreciated using the straight-line
method over the shorter of the estimated useful life of the assets or the
initial lease term.
Valuation of
Long-Lived and Intangible Assets
The Company assesses finite-lived intangible
assets and other long-lived assets, excluding goodwill, for recoverability in
accordance with SFAS No. 144,
Accounting for the
Impairment or Disposal of Long-Lived Assets
(SFAS 144).
Intangible and other long-lived assets are assessed for
recoverability
whenever events or changes in
circumstances indicate that their carrying value may not be recoverable through
the estimated undiscounted future cash flows resulting from the use of the
assets. If it is determined that the carrying value of intangible assets or
other long-lived assets may not be recoverable, the impairment is measured by
using the projected discounted cash-flow method in accordance with
SFAS 144.
The Company tests goodwill and
indefinite-lived intangible assets for impairment in accordance with SFAS No. 142,
Goodwill and Other Intangible Assets
(SFAS 142)
.
SFAS 142 requires annual impairment testing or when
events or circumstances indicate carrying values may not be recoverable. The
Company evaluates goodwill for impairment using discounted cash flow
methodologies, transaction values for comparable companies, and other valuation
techniques for its reporting units with goodwill balances; the Company does not
have any indefinite-lived intangible assets.
As more fully described in Notes 2 and 5, the
Company has recorded impairment charges during 2006 and 2007 in connection with
its impairment testing procedures.
Other Assets
Identifiable finite-lived intangible assets
are amortized on a straight-line basis over their estimated useful lives,
ranging from three to thirty-four years. Deferred financing costs are amortized
using either the straight-line or effective interest method, depending on
nature of the debt instrument, over the term of the related debt.
F-11
Note 1. Summary of Significant Accounting
Policies (Continued)
Long-Term
Leases to Clients
The Company has entered into two long-term
agreements for the lease of various types of water production and distribution
systems to certain municipal agencies in Texas. Amounts due to the Company,
which represent receivables from the leases, have been accounted for as part of
the Companys investment in the direct financing leases (Note 5). The leases
expire in 2013.
The Companys rights, but not its obligations,
under one of the lease agreements have been assigned to a financial institution
in return for a cash payment. As the Company collects payments under the lease
agreement, it uses those funds to pay its obligations under the assignment
agreement with the financial institution. The Company is obligated to make the
payments to the financial institution under the assignment agreement. The
Companys payment obligation to the financial institution is secured by a
letter of credit from the lessee and the leased property.
Fair Value of
Financial Instruments
The Companys long-term debt with aggregate
book values of $147.3 million and $130.0 million had fair values of
approximately $147.1 million and $130.1 million at December 31, 2007 and
2006, respectively. The estimated fair values are based on current rates for
similar issues for debt of the same remaining maturities. The carrying value of
all other financial instruments, such as cash and cash equivalents, accounts
receivable and accounts payable, approximates fair value because of the short
maturity of the instruments. At December 31, 2007, the Company had no
derivative financial instruments, financial instruments with off-balance sheet
risk or financial instruments with concentrations of credit risks requiring
accounting or disclosure under SFAS No. 133,
Accounting
for Derivative Instruments and Hedging Activities,
as amended. All
financial instruments are held for purposes other than trading.
Income Taxes
Income taxes are accounted for using the asset
and liability method. Deferred tax assets and liabilities are recorded in order
to recognize future tax effects attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, as well as the recognition of operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are recorded
using enacted tax rates expected to apply to taxable income in the years in
which the temporary differences are recovered or settled. The effect of a
change in tax rates on deferred tax assets and liabilities is recognized in the
period that the enactment occurs. The Company files a consolidated U.S. federal
income tax return, which includes all of its subsidiaries.
Liabilities are recorded for
probable income tax assessments based on estimates of potential tax related
exposures. Accounting for these assessments requires significant judgment as
uncertainties often exist with respect to existing tax laws, new
interpretations of existing laws and rulings by taxing authorities. Differences
between actual results and assumptions, or changes in assumptions in future
periods, are recorded in the period they become known.
The Companys California and New Mexico
regulated utilities recorded additional deferred income taxes, as well as
corresponding regulatory assets and regulatory liabilities as permitted by the
CPUC and the NMPRC, respectively. In addition, unamortized investment tax
credits have been deferred and are amortized over the estimated productive
lives of the related assets as allowed by the CPUC and the NMPRC.
F-12
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting
Policies (Continued)
Advances for
Construction and Contributions in Aid of Construction
Developers, builders, governmental agencies
and municipalities will provide the Company with cash, or in some cases
property, to extend its water and wastewater service to their properties.
Advances for construction represent amounts advanced to the Company that are
repaid in cash, generally on a straight-line basis over periods ranging from
five to forty years. Nonrefundable contributions are recorded as contributions
in aid of construction (CIAC) and are amortized as a reduction of the
depreciation expense associated with the contributed asset.
Revenue
Recognition
Water utility revenues are recognized when
water is delivered to customers. At the end of an accounting period, estimated
amounts for unbilled revenues are accrued for water usage since the previous
billing period.
Revenues for contract operations are
recognized and billed at the end of the month based on a monthly fee to provide
a specific level of service as outlined in each individual contract. The
Company generally bills for additional services provided beyond the scope of
the base contract on a time-and-materials basis as such services are rendered.
Revenues for construction projects are
recorded using the percentage-of-completion method of accounting. The
percentage-of-completion method recognizes revenue and income as work
progresses on a project based on the expected total project costs and the
expected total project revenues. The Company estimates the percentage of
completion using total contract price, actual costs incurred to date and an
estimate of the completion costs for each contract. If the Company expects it
will ultimately suffer a loss on a construction project, the entire estimated
loss is recorded in the period such determination is made.
For contracts involving the provision of a
single product or service (single-element contracts), revenue is generally
recognized when the product or service is provided and the amount becomes
billable. If services are provided evenly during the contract term but service
billings are irregular, revenue is recognized on a straight-line basis over the
contract term. For contracts involving the provision of multiple products or
services (elements), total estimated contract revenue is allocated to each
element based on the relative fair value of each service in accordance with
Emerging Issues Task Force Issue No. 00-21,
Revenue
Arrangements with Multiple Deliverables
.
Non-refundable activation fees in the Companys
non-regulated wholesale water operations are recognized over the expected
period of performance.
Share-Based
Compensation
For periods prior to January 1, 2006, the
Company applied SFAS No. 123,
Accounting for Share-Based
Compensation
(SFAS 123), when accounting for stock option
grants under its option plans. Accordingly, compensation expense was recognized
for stock options over the vesting period based on the fair value of the stock
options on the date of grant.
F-13
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting
Policies (Continued)
Effective January 1, 2006, the Company
adopted the provisions of SFAS No. 123 (revised 2004),
Share-Based Payment
(SFAS 123(R)), using the modified
prospective application method. Generally, SFAS 123(R) is similar in
approach to SFAS 123, which the Company adopted in 2002, and requires that
compensation cost relating to share-based payments be recognized in the
financial statements based on the fair value of the equity or liability instruments
issued. Because the Company has been recognizing compensation cost related to
share-based payments since its 2002 adoption of SFAS 123, the 2006
adoption of SFAS 123(R) did not have a material effect on the
consolidated financial statements. The adoption of SFAS 123(R) did
require the Company to change from recognizing the effect of forfeitures as
they occur to estimating the number of outstanding instruments for which the
requisite service is not expected to be rendered. See Note 13 for additional
information.
Comprehensive
Income (Loss)
SFAS No. 130,
Reporting
Comprehensive Income
(SFAS 130), requires us to display
comprehensive income (loss) and its components as part of our financial
statements. Comprehensive income (loss) is comprised of net income (loss) and
other comprehensive income (loss). Other comprehensive income (loss) includes
changes in equity that are excluded from net income (loss), such as the
unfunded amount of our postretirement and pension plans. These changes in
equity are reflected net of tax, as appropriate.
Earnings per
Share
Basic earnings per share measures the
performance of the Company over the reporting period by dividing net income applicable
to common stockholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share measures the performance of the
Company over the reporting period after giving effect to all potentially
dilutive common shares that would have been outstanding if those shares had
been issued. The Company has stock options and warrants outstanding that give
rise to potentially dilutive common shares. The Company also has convertible
subordinate debentures outstanding that are convertible into common stock. When
the assumed conversion of the debentures has a dilutive effect on earnings per
share, the debentures will be included in the calculation of diluted earnings
per share after adjusting net income for the after-tax effect of the debenture
interest expense
Recent
Accounting Pronouncements
SFAS No. 141(R)
In December 2007, the FASB issued
Statement No. 141 (revised 2007),
Business Combinations
(SFAS 141(R)). SFAS 141(R) changes the accounting for
acquisitions specifically eliminating the step acquisition model, changing the
recognition of contingent consideration at the time of acquisition, disallowing
the capitalization of transaction costs and changes when restructurings related
to acquisitions can be recognized. The statement is effective for fiscal years
beginning on or after December 15, 2008 and will only impact the
accounting for acquisitions that are made after adoption. Adoption of
SFAS 141(R) will impact the Companys accounting for future business
combinations in that all transactions costs will be expensed as incurred and
contingent consideration, if present, will be recorded upon acquisition.
F-14
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1. Summary of Significant Accounting Policies
(Continued)
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 was required to begin with the
Companys fiscal year beginning January 1, 2008 with prospective adoption
under most circumstances.
In February 2008, the FASB issued FASB
Staff Position No. 157-2,
Effective Date of FASB
Statement No. 157
(FSP 157-2) that amends SFAS 157 to
delay the effective date for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (that is, at least annually).
FSP 157-2 defers the effective date of SFAS 157 to the Companys
fiscal years beginning January 1, 2009. The Company believes the adoption
of this new statement will not have a material impact on its consolidated
financial statements. However, the Company believes it will likely be required
to provide additional disclosures in future financial statements beginning
after the effective date of the new standard.
SFAS No. 159
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial LiabilitiesIncluding 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 the Companys fiscal year beginning January 1, 2008 and
will be applied prospectively. The Company believes the adoption of this new
statement will not have a material impact on its consolidated financial
statements.
SFAS No. 160
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51
(SFAS 160). SFAS 160
introduces significant changes in the accounting and reporting for business
acquisitions and noncontrolling interest in a subsidiary. SFAS 160 also changes
the accounting for and reporting for the deconsolidation of a subsidiary.
Companies are required to adopt the new standard for fiscal years beginning
after January 1, 2009. The Company is evaluating the impact of this standard
and currently does not expect it to have a significant impact on its financial
position, results of operations or cash flows.
F-15
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2. Acquisitions, Assets Held for Sale and
Dispositions
Acquisitions
During the three years ended December 31,
2007, the Company has acquired several regulated utilities and non-regulated
businesses. All of the acquisitions were accounted for as purchases and the
assets acquired and liabilities assumed have been recorded at their estimated
fair values with the difference between the aggregate purchase price and the
fair value of the identifiable net assets recorded as goodwill. The
consolidated financial statements reflect the financial position and results of
operations of the acquired utilities and businesses subsequent to their
respective acquisition dates. The acquisitions are summarized below.
2007
Acquisitions
During 2007, the Company acquired:
·
substantially
all of the assets of a small water and wastewater collection utility in a high
growth area of northern Mississippi, just south of Memphis, Tennessee in February 2007;
·
all
of the common stock of two water utilities in a high population growth area
northwest of San Antonio, Texas in May 2007; and
·
substantially
all of the assets of a wastewater collection and treatment system with a
service area located in Madison County, Alabama, just north of Huntsville,
Alabama in November 2007.
The aggregate purchase price for these
acquisitions was $8.1 million in cash plus $2.5 million of liabilities assumed.
Utility plant totaling $8.5 million, identifiable finite-lived intangible
assets (principally customer relationships) totaling $0.2 million and goodwill
totaling $1.7 million were recorded. Approximately $6.4 million, including
goodwill, is not deductible for income tax purposes. As a result, a $1.7
million deferred income tax liability was also recorded in connection with
these acquisitions. The intangible assets are being amortized on a
straight-line basis over a seven year estimated useful live.
The acquisitions were funded with borrowings
under the Companys revolving line of credit. These acquisitions are not
material, either individually or in the aggregate, to the Companys
consolidated financial statements.
2006
Acquisitions
During 2006, the Company acquired two small
water utilities and a company with the rights to provide water and wastewater
utility service in developing areas located near Austin, Texas. The aggregate
purchase price for these acquisitions was $1.4 million in cash; liabilities
assumed in connection with the acquisitions were negligible. Approximately $0.3
million of goodwill is not deductible for income tax purposes. The acquisitions
are not material, either individually or in the aggregate, to the Companys
consolidated results of operations. During 2006, the Company also recorded $0.3
million of contingent consideration payable to the sellers of businesses
acquired in prior years as additional goodwill.
F-16
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2. Acquisitions, Assets Held for Sale and
Dispositions (Continued)
On March 21, 2006, the 10% minority
interest stockholder in Operations Technology, Inc. (OpTech), a
Georgia-based non-regulated business in the Companys Services Group, exercised
its right to require the Company to purchase the remaining 10% of OpTech stock
that it did not already own for $1.0 million in cash (Note 10). In connection
with this acquisition, the Company has allocated $0.5 million of the purchase
price to finite-lived intangible assets and the remaining $0.5 million to
non-tax deductible goodwill. The intangible assets, principally customer
relationships and tradenames, are being amortized on a straight-line basis over
a weighted-average amortization period of 8.1 years.
The acquisitions were funded with borrowings
under the Companys revolving line of credit.
2005
Acquisitions
During the year ended December 31, 2005,
the Company acquired:
·
substantially
all of the assets of Novus Utility Services, Inc., a Shelby County,
Alabama-based contract operations company, on March 12, 2005;
·
substantially
all of the assets of Shelby County, Alabamas wastewater collection and
treatment system, on September 29, 2005; and
·
all
of the common stock of Midway Water Utilities, Inc., a Denton County,
Texas-based water utility, on October 5, 2005.
The aggregate purchase price for these
acquisitions was $12.3 million in cash plus $1.6 million of liabilities
assumed. Identifiable finite-lived intangible assets, principally customer
relationships, totaling $1.5 million were recorded and $1.3 million was
recorded as goodwill, $1.0 million of which is deductible for income tax
purposes. The intangible assets are being amortized on a straight-line basis
over their estimated useful lives, ranging from three to fifteen years. During
2005, the Company also recorded $0.6 million of contingent consideration earned
by the sellers of businesses acquired in prior years as additional tax
deductible goodwill.
The acquisitions are not material, either
individually or in the aggregate, to the Companys consolidated results of
operations. The acquisitions and contingent consideration payments were funded
with borrowings under the Companys revolving line of credit.
In December 2005, the 20% minority
interest stockholder in Windermere Utility Company, one of the Companys
Texas-based regulated utilities, exercised its right to require the Company to
purchase the remaining 20% of Windermere stock that it did not already own with
shares of the Companys common stock. On December 9, 2005, the Company
issued 450,644 shares of its common stock with an aggregate market value of
$6.0 million to the minority stockholder in exchange for the remaining shares.
In connection with this acquisition the Company has allocated the purchase
price to property, plant and equipment ($2.1 million), non-tax deductible
goodwill ($4.3 million) and deferred income tax liabilities ($0.8 million).
F-17
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2. Acquisitions, Assets Held for Sale and
Dispositions (Continued)
Assets Held for
Sale
The Company has elected to sell its wholesale
water and wastewater operations in Texas and believes it can consummate the
sales during 2008. As a result, the Company has classified the assets and
related liabilities as held for the sale in the accompanying consolidated
balance sheet as of December 31, 2007. The related results of operations
and cash flows are reflected as discontinued operations for all periods
presented. The following tables summarize the financial position and results of
operations of these operations included in the consolidated financial
statements.
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
|
|
|
|
Assets held for sale:
|
|
|
|
Accounts receivable
|
|
$
|
81
|
|
Other current assets
|
|
167
|
|
Property, plant and equipment, net
|
|
14,833
|
|
Other assets
|
|
932
|
|
Assets held for sale
|
|
16,013
|
|
|
|
|
|
Liabilities related to assets held for sale:
|
|
|
|
Accounts payable
|
|
31
|
|
Deferred revenue
|
|
4,266
|
|
Liabilities related to assets held for sale
|
|
4,297
|
|
Net assets held for sale
|
|
$
|
11,716
|
|
F-18
SOUTHWEST WATER
COMPANY AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2. Acquisitions, Assets Held for Sale and
Dispositions (Continued)
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
635
|
|
$
|
592
|
|
$
|
443
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
Operating expenses
|
|
1,128
|
|
777
|
|
752
|
|
Selling, general and administrative expenses
|
|
13
|
|
51
|
|
31
|
|
Impairment of goodwill and long-lived assets
|
|
3,400
|
|
|
|
|
|
Total expenses
|
|
4,541
|
|
828
|
|
783
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
(3,906
|
)
|
(236
|
)
|
(340
|
)
|
|
|
|
|
|
|
|
|
Other income
(expense):
|
|
|
|
|
|
|
|
Interest expense
|
|
(894
|
)
|
(836
|
)
|
(744
|
)
|
Interest income
|
|
23
|
|
25
|
|
41
|
|
|
|
|
|
|
|
|
|
Pretax loss
|
|
(4,777
|
)
|
(1,047
|
)
|
(1,043
|
)
|
Income tax
benefit
|
|
(1,751
|
)
|
(366
|
)
|
(373
|
)
|
|
|
|
|
|
|
|
|
Loss from
discontinued operations
|
|
$
|
(3,026
|
)
|
$
|
(681
|
)
|
$
|
(670
|
)
|
In accordance with EITF 87-24,
Allocation of Interest to Discontinued Operation
(EITF 87-24),
as amended, interest expense reflects interest on debt that the Company is
required to repay as a result of the sale. In addition, and also in accordance
with EITF 87-24, costs and expenses exclude the allocation of general corporate
overhead.
In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets
intangible
and other long-lived assets are assessed for recoverability
whenever
events or changes in circumstances indicate that their carrying value may not
be recoverable through the estimated undiscounted future cash flows resulting
from the use of the assets. The Company has determined that the carrying value
of the assets may not be recoverable through the sales process. As a result,
impairment charges aggregating $3.4 million were recorded to reduce the
carrying value of the long-lived assets to expected realizable value ($3.1
million of property, plant and equipment and $0.3 million of goodwill).
Disposition of
Master Tek
On June 30, 2005, the Company sold Master
Tek International, Inc., a subsidiary in its Services Group that provided
utility submetering and billing and collection services for multi-family
residential properties. The Company sold Master Tek for $12.2 million and
received $11.1 million in cash at closing; $1.1 million of the sales price was
placed into an escrow account that was released to the Company in 2006 at the
end of a specified representation and warranty period. The Company incurred
$1.9 million of expenses in connection with this transaction. The Company used
the proceeds from the sale to repay borrowings under its bank line of credit. The
sale of Master Tek did not affect the operations of the Companys remaining
operating subsidiaries.
In 2006, the Company released $0.6 million
from the escrow account to the buyer pursuant to the representation and
warranty provisions and the remaining escrow balance was released to the
Company. The $0.6 million released from escrow to the buyer was applied against
a liability established at closing for certain retained liabilities.
F-19
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 2. Acquisitions, Assets Held for Sale and
Dispositions (Continued)
As a result of the sale, the assets and liabilities,
results of operations and cash flows of Master Tek have been presented as
discontinued operations in the accompany consolidated financial statements for
all periods. The following tables summarize the results of operations of Master
Tek for the six months ended June 30, 2005 (the date of sale) included in
the consolidated financial statements.
(In thousands)
|
|
2005
|
|
|
|
|
|
Services Group revenues
|
|
$
|
3,679
|
|
|
|
|
|
Expenses:
|
|
|
|
Services Group operating expense
|
|
3,947
|
|
Selling, general and administrative
|
|
1,330
|
|
Total expenses
|
|
5,277
|
|
|
|
|
|
Operating income (loss)
|
|
(1,598
|
)
|
|
|
|
|
Other income (expense):
|
|
|
|
Interest expense
|
|
(369
|
)
|
Interest income
|
|
1
|
|
|
|
|
|
Income (loss) before income
taxes
|
|
(1,966
|
)
|
Provision (benefit) for
income taxes
|
|
688
|
|
|
|
|
|
Loss from operations
|
|
(1,278
|
)
|
Loss on sale, net of $345
tax benefit
|
|
(3,624
|
)
|
|
|
|
|
Loss from discontinued
operations
|
|
$
|
(4,902
|
)
|
F-20
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 3. Current Assets
Accounts Receivable
The Company maintains allowances for doubtful
accounts and generally such losses have been within managements expectations.
Accounts receivable are net of an allowance for doubtful accounts of $1.4
million and $1.8 million as of December 31, 2007 and 2006, respectively.
Other Current Assets
Other current assets consist of the following as of December 31,
2007 and 2006:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Deferred income tax asset
|
|
$
|
7,167
|
|
$
|
3,686
|
|
Prepaid expenses
|
|
3,706
|
|
6,613
|
|
Regulatory assets
|
|
1,986
|
|
765
|
|
Inventory
|
|
1,337
|
|
1,387
|
|
Other receivables
|
|
1,014
|
|
954
|
|
Income tax refunds
receivable
|
|
|
|
951
|
|
Other
|
|
1,407
|
|
2,095
|
|
Total other current assets
|
|
$
|
16,617
|
|
$
|
16,451
|
|
F-21
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 4. Property, Plant and Equipment
Property, plant and equipment consist of the
following at December 31, 2007 and 2006:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Regulated utilities:
|
|
|
|
|
|
Land and land rights
|
|
$
|
6,806
|
|
$
|
4,761
|
|
Source of supply
|
|
35,928
|
|
34,522
|
|
Pumping and purification
|
|
56,197
|
|
52,860
|
|
Transmission and distribution
|
|
332,957
|
|
319,214
|
|
General plant
|
|
14,582
|
|
15,340
|
|
Construction work-in-progress
|
|
42,856
|
|
32,853
|
|
Total cost
|
|
489,326
|
|
459,550
|
|
Accumulated depreciation and amortization
|
|
(90,186
|
)
|
(81,290
|
)
|
Net regulated utilities
|
|
399,146
|
|
378,260
|
|
|
|
|
|
|
|
Non-regulated operations:
|
|
|
|
|
|
Computer equipment and software
|
|
2,928
|
|
3,655
|
|
Machinery, automotive and office equipment
|
|
4,142
|
|
4,504
|
|
Construction work-in-progress
|
|
5,433
|
|
1,221
|
|
Leasehold improvements
|
|
3,835
|
|
3,657
|
|
Buildings, land, and other
|
|
10,263
|
|
5,497
|
|
Total cost
|
|
26,601
|
|
18,534
|
|
Accumulated depreciation and amortization
|
|
(7,844
|
)
|
(7,169
|
)
|
Net non-regulated operations
|
|
18,757
|
|
11,365
|
|
Net property, plant and equipment
|
|
$
|
417,903
|
|
$
|
389,625
|
|
Depreciation and amortization expense for regulated
utility and non-regulated property, plant and equipment totaled $14.3 million,
$12.7 million and $11.4 million in 2007, 2006 and 2005, respectively.
Depreciation and amortization expense for regulated utility property, plant and
equipment was reduced by the amortization of contributions in aid of
construction totaling $3.3 million, $2.9 million and $2.6 million in 2007,
2006 and 2005, respectively.
Computer equipment and software includes $4.6 million
of assets under capital leases. The five-year leases originated on December 28,
2007 and nominal amortization was recorded through December 31, 2007.
Substantially all of the Companys utility property,
plant and equipment as well as assets under capital leases are pledged as
collateral for various long-term debt obligations (Note 6).
F-22
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 5. Other Assets
Goodwill
The table below summarizes the changes in the
carrying amount of goodwill, by business segment (Note 15), during the two
years ended December 31, 2007.
|
|
Assets Held and Used
|
|
|
|
|
|
|
|
Utility
|
|
Services
|
|
|
|
Assets Held
|
|
(In thousands)
|
|
Group
|
|
Group
|
|
Total
|
|
For Sale
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2005
|
|
$
|
15,609
|
|
$
|
17,368
|
|
$
|
32,977
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
Businesses acquired during
the year
|
|
290
|
|
|
|
290
|
|
|
|
Acquisition of minority
interest
|
|
|
|
523
|
|
523
|
|
|
|
Contingent consideration
|
|
|
|
291
|
|
291
|
|
|
|
Impairment of goodwill
|
|
|
|
(929
|
)
|
(929
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2006
|
|
15,899
|
|
17,253
|
|
33,152
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Businesses acquired during
the year
|
|
1,733
|
|
|
|
1,733
|
|
|
|
Reclassified to assets held
for sale
|
|
|
|
(299
|
)
|
(299
|
)
|
299
|
|
Impairment of goodwill
|
|
(17,215
|
)
|
|
|
(17,215
|
)
|
(299
|
)
|
Adjustment to consideration
earned
|
|
|
|
(22
|
)
|
(22
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2007
|
|
$
|
417
|
|
$
|
16,932
|
|
$
|
17,349
|
|
$
|
|
|
The Company has acquired several businesses and a
minority interest during 2006 and 2007, all of which were accounted for as
purchases (Note 2). As a result, the assets acquired and liabilities assumed
have been recorded at their estimated fair values with the difference between
the aggregate purchase price and the fair value of the identifiable net assets
acquired recorded as goodwill. During 2006, the Company also recorded an
estimate of contingent consideration payable to the sellers of businesses
acquired which in 2007 was adjusted to reflect the final amount of contingent
consideration earned.
As more fully described in Note 1, the Company tests
goodwill annually each year for impairment at the reporting unit level, or when
events or circumstances indicate the carrying values may not be recoverable.
Discounted cash flow projections are one of the principal components used in
the impairment testing model. Forecasted revenues and capital expenditures,
which include forecasted customer connection growth and the timing and amount
of regulated rate increases, are key components of the discounted cash flow
projections.
During recent impairment testing, the Company
determined that revenue growth for its Texas Utilities was likely to be slower
than originally projected due to downturns in overall economic conditions and
new housing construction as well as a slower rate of regulated rate increases.
The Company also determined that higher levels of capital expenditures than
previously projected were necessary to bring the systems into regulatory
compliance and to continue improving the quality of service for its customers.
These factors resulted in significantly lower discounted cash flow projections
than previously forecast. Based on these projections, the entire $17.2 million
of goodwill associated with the Texas Utilities was found to be impaired and
was charged to expense in 2007.
F-23
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 5. Other Assets (Continued)
As described in Note 2, the Company also recorded a
$0.3 million impairment charge related to its decision to sell its wholesale
water and wastewater operations.
During 2006, management reviewed the business
strategy for its water and wastewater testing laboratory reporting unit. This
review resulted in managements decision to realign the operations by reducing
the size and scope of its business activities and focusing on its core
operations and customers. In addition, two significant contracts, one at the
testing laboratory and one at another reporting unit were not renewed. As a
result, $0.9 million of goodwill was found to be impaired and charged to
expense in 2006.
Intangible Assets
Intangible assets include purchased contracts,
acquired customer relationships and covenants not to compete and are amortized
on a straight-line basis over estimated useful lives ranging from three to
thirty-four years. Intangible assets amortization expense was $0.5 million,
$0.6 million and $0.8 million for the years ended December 31, 2007, 2006
and 2005, respectively. Estimated future annual amortization expense for all
identifiable intangible assets with finite useful lives for the five-year
period ending December 31, 2012 is as follows: 2008$0.4 million,
2009$0.3 million, 2010$0.2 million, 2011$0.2 million and 2012$0.2 million.
Other Long-Term Assets
Other long-term assets consist of the following as of
December 31, 2007 and 2006:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Regulatory assets
|
|
$
|
5,331
|
|
$
|
5,620
|
|
Investments in
Company-owned life insurance policies
|
|
3,131
|
|
3,040
|
|
Deferred financing costs,
net
|
|
2,765
|
|
3,092
|
|
Net investment in direct
financing leases
|
|
949
|
|
1,871
|
|
Other
|
|
4,857
|
|
4,192
|
|
Total other long-term assets
|
|
$
|
17,033
|
|
$
|
17,815
|
|
|
|
|
|
|
|
|
|
|
|
To assist in funding the liabilities related to its
supplemental executive retirement plan and deferred compensation liabilities,
the Company has invested in corporate-owned life insurance policies (Note 14).
F-24
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 6. Long-Term Debt
Long-term debt consists of the following as of December 31,
2007 and 2006:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
$100 million revolving
credit facility
|
|
$
|
51,000
|
|
$
|
36,000
|
|
|
|
|
|
|
|
6.85% convertible
subordinated debentures due 2021
|
|
12,053
|
|
12,610
|
|
|
|
|
|
|
|
$30 million capital lease
facility
|
|
4,582
|
|
|
|
|
|
|
|
|
|
Term Loans:
|
|
|
|
|
|
Monarch Utilities, Inc.:
|
|
|
|
|
|
7.37% fixed rate term loan due 2022
|
|
11,037
|
|
11,807
|
|
5.77% fixed rate term loan due 2022
|
|
759
|
|
811
|
|
6.10% fixed rate term loan due 2031
|
|
20,000
|
|
20,000
|
|
|
|
|
|
|
|
First Mortgage Bonds:
|
|
|
|
|
|
Suburban Water Systems:
|
|
|
|
|
|
9.09% series B first mortgage bond due 2022
|
|
8,000
|
|
8,000
|
|
5.64% series D first mortgage bond due 2024
|
|
15,000
|
|
15,000
|
|
6.30% series E first mortgage bond due 2026
|
|
10,000
|
|
10,000
|
|
New Mexico Utilities, Inc.:
|
|
|
|
|
|
6.10% series C first mortgage bond due 2024
|
|
12,000
|
|
12,000
|
|
|
|
|
|
|
|
Economic Development
Revenue Bonds:
|
|
|
|
|
|
ECO Resources, Inc.:
|
|
|
|
|
|
5.5% series 1998A due 2008
|
|
115
|
|
220
|
|
6.0% series 1998A due 2018
|
|
1,810
|
|
1,810
|
|
Acquisition-related
indebtedness and other
|
|
176
|
|
904
|
|
Total long-term debt payment obligations
|
|
146,532
|
|
129,162
|
|
Unamortized Monarch term loan fair value adjustments
|
|
758
|
|
885
|
|
Total long-term debt
|
|
147,290
|
|
130,047
|
|
Less current portion of long-term debt
|
|
(1,937
|
)
|
(1,423
|
)
|
Long-term debt, less current portion
|
|
$
|
145,353
|
|
$
|
128,624
|
|
In December 2007, the Company obtained a $30.0
million equipment leasing line of credit and the Company leased $4.6 million of
equipment pursuant to this agreement.
F-25
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 6. Long-Term Debt (Continued)
Revolving Lines of Credit
The $100 million revolving line of credit commitment
ends on April 1, 2010, at which time all borrowings must be repaid.
Borrowings under the credit facility bear interest, at the Companys option,
based on a margin either over the LIBOR rate or under the prime rate. The
margins vary depending upon the Companys consolidated debt to equity ratio.
Currently, the applicable margins are 0.875% over the LIBOR rate or 0.25% under
the prime rate. The weighted-average interest rate on all credit facility
borrowings outstanding was 5.74% as of December 31, 2007. The Company is
subject to commitment fees under the facility as well as the maintenance of
certain financial ratios, cash flow results and other restrictive covenants.
The Company was in compliance with all covenants during the year ended December 31,
2007.
The Company had irrevocable standby letters of credit
in the amount of $2.0 million issued and outstanding under the credit facility
as of December 31, 2007, reducing available borrowings under the credit
facility to $47.0 million as of that date.
In January 2008, the Company borrowed $22.5
million under the credit facility to fund the closing of an acquisition and in February 2008,
the Company entered into a new $150.0 million revolving credit facility and
used the initial borrowing under the new facility to repay borrowings
outstanding under the $100.0 million credit facility; the $100.0 million credit
facility was terminated upon repayment (Note 17).
Convertible Subordinated
Debentures
The Company has $12.1 million of 6.85% convertible
subordinated debentures issued and outstanding as of December 31, 2007
compared to $12.6 million as of the end of the prior year. The debentures are
convertible, at the option of the holder, into shares of the Companys common
stock at a conversion price of $11.018 per share and are convertible at any
time prior to maturity, unless previously redeemed. During the year ended December 31,
2007, debentures in the aggregate principal amount of $0.6 million were
converted into 50,542 shares of common stock. As of December 31, 2007, all
of the debentures outstanding are convertible into 1.1 million shares of common
stock and have a potentially dilutive effect on the computation of earnings per
share (Note 11).
The debentures are due on July 1, 2021 and
interest is payable quarterly on the first day of January, April, July and
October of each year. The debentures are unsecured general obligations of
the Company and are subordinated in right of payment to all existing and future
secured and senior debt. The Company may redeem the debentures at any time, in
whole or in part, at a redemption price of 105% beginning July 1, 2003 and
declining 1% annually to par (100% of face value) after June 30, 2008. The
Company is subject to financial covenants under the terms of the indenture and
was in compliance with all such covenants during the year ended December 31,
2007.
Capital Lease Facility
In December 2007, the Company obtained a $30.0
million equipment leasing line of credit commitment for an initial term of one
year with automatic annual extensions until terminated by either party. Leases
pursuant to the agreement have a five year term from each lease commencement
date and are structured as capital lease obligations. The lease rate is based
on the three year treasury rate in effect on each lease commencement date. On December 28,
2007, the Company leased $4.6 million of equipment pursuant to this agreement.
The weighted-average interest rate of all lease obligations outstanding was
4.43% as of December 31, 2007. The lease obligations are secured by the
leased assets.
F-26
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 6. Long-Term Debt (Continued)
Term Loans
When the Company acquired Monarch Utilities in 2004,
it assumed two fixed-rate term loans due in 2022. Principal is due in equal
monthly installments, plus interest, until maturity in 2022. Since the loans
acquired were at interest rates generally higher than prevailing market rates,
the historical carrying value of the acquired loans was increased by $1.2
million to fair value and such difference is being amortized as a reduction of
interest expense over the remaining term of the loans acquired, resulting in a
6.36% effective interest rate. The remaining unamortized fair value adjustment
is $0.8 million as of December 31, 2007 and is included in long-term debt.
The loans are secured by substantially all of the
assets of Monarch. Monarch is subject to the maintenance of certain financial
ratios and other restrictive covenants. Monarch was in compliance with all
covenants during the year ended December 31, 2007.
First Mortgage Bonds
Interest on the first mortgage bonds is payable
semiannually and bonds may be redeemed at any time prior to the maturity date
at a price of par plus a call premium. Additional mortgage bonds may be issued
subject to the provisions of the mortgage bond indentures and revolving credit
facility. Substantially all of the utility plant of Suburban Water Systems and
New Mexico Utilities, Inc. is pledged as collateral for these bonds. The
mortgage bond indentures limit the amount of cash and property dividends that
Suburban and New Mexico may pay to the Company. Dividends over the last three
years have ranged between $4.4 million to $5.2 million per year and are less
than the dividend restriction threshold by $50.4 million as of December 31,
2007. As of December 31, 2007, both companies were in compliance with the
dividend limitations mandated in their respective indentures.
Economic Development Revenue
Bonds
Economic Development Revenue Bonds of $1.8 million
are due in 2018 and bear interest at a fixed 6.0% annual rate; interest is
payable semi-annually. Annual principal payments commence in 2009 and continue
in increasing amounts until maturity. The bond in the amount of $0.1 million is
due in 2008, and bears interest at a fixed 5.5% annual rate, payable
semi-annually, and principal is payable annually until maturity. These bonds are
secured by wastewater treatment plant assets.
Acquisition-Related
Indebtedness and Other
Notes payable were issued in connection with
acquisitions made by the Company during 2001 and 2004, and are payable to the
former owners of the acquired entities. In general, these notes are not secured
and bear interest at fixed rates ranging from 5.15% to 8.0% per annum, with
interest payable either monthly or quarterly and with various contractual
principal payments required.
F-27
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 6. Long-Term Debt (Continued)
Aggregate Maturities
Total annual maturities of long-term debt outstanding
as of December 31, 2007 are as follows:
|
|
Annual
|
|
(In thousands)
|
|
Maturities
|
|
|
|
|
|
Year ending
December 31,:
|
|
|
|
2008
|
|
$
|
1,937
|
|
2009
|
|
1,832
|
|
2010
|
|
52,863
|
|
2011
|
|
1,914
|
|
2012
|
|
1,966
|
|
2013 and thereafter
|
|
86,020
|
|
Total annual maturities
|
|
146,532
|
|
Unamortized fair market value adjustment to acquired term loans
|
|
758
|
|
Total long-term debt
|
|
$
|
147,290
|
|
Maturities in 2010 include $51.0 million related to the Companys $100.0
million revolving credit facility. In February 2008, the Company entered into a
new $150.0 million revolving credit facility due in 2013 (Note 17). Proceeds
from the initial borrowing under the new credit facility were used to repay all
borrowings under the $100.0 million credit facility which was terminated upon
repayment.
Note 7. Other Liabilities
Other Current Liabilities
Other current liabilities and deferred credits
consist of the following as of December 31, 2007 and 2006:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Accrued salaries, wages and
benefits
|
|
$
|
9,695
|
|
$
|
8,587
|
|
Deferred revenue and
customer deposits
|
|
2,582
|
|
2,504
|
|
Income taxes payable
|
|
1,882
|
|
|
|
Accrued interest payable
|
|
1,624
|
|
1,532
|
|
Dividends payable
|
|
1,462
|
|
1,377
|
|
Purchased water accrual
|
|
1,230
|
|
1,985
|
|
Franchise and other taxes
|
|
1,062
|
|
1,632
|
|
Regulatory liabilities
|
|
180
|
|
161
|
|
Other
|
|
5,303
|
|
3,883
|
|
Total other current liabilities
|
|
$
|
25,020
|
|
$
|
21,661
|
|
F-28
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 7. Other Liabilities (Continued)
Other Long-Term Liabilities
Other long-term liabilities consist of the following
as of December 31, 2007 and 2006
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Living unit equivalent and
impact fees
|
|
$
|
5,447
|
|
$
|
3,412
|
|
Supplemental retirement and
deferred compensation plan obligations
|
|
2,679
|
|
2,727
|
|
Deferred rent
|
|
1,270
|
|
1,274
|
|
Regulatory liabilities
|
|
1,171
|
|
1,896
|
|
Deferred revenue
|
|
|
|
3,619
|
|
Amounts payable under lease
assignment
|
|
|
|
1,037
|
|
Other
|
|
2,357
|
|
2,299
|
|
Total other long-term liabilities
|
|
$
|
12,924
|
|
$
|
16,264
|
|
Note 8. Income Taxes
The components of income before taxes are as follows:
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Income (loss) before income
taxes from:
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
(4,225
|
)
|
$
|
15,397
|
|
$
|
12,405
|
|
Discontinued operations
|
|
(4,777
|
)
|
(1,047
|
)
|
(3,009
|
)
|
Income (loss) before income taxes taxed at statutory rates
|
|
(9,002
|
)
|
14,350
|
|
9,396
|
|
Capital loss on sale of stock related to discontinued operations
|
|
|
|
|
|
(3,969
|
)
|
Income before income taxes
|
|
$
|
(9,002
|
)
|
$
|
14,350
|
|
$
|
5,427
|
|
F-29
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 8. Income Taxes (Continued)
The components of the provisions for income taxes
(benefits) are as follows:
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
Federal
|
|
$
|
1,560
|
|
$
|
1,942
|
|
$
|
(2,024
|
)
|
State
|
|
697
|
|
273
|
|
(180
|
)
|
Total current
|
|
2,257
|
|
2,215
|
|
(2,204
|
)
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
Federal
|
|
(2,416
|
)
|
2,875
|
|
5,081
|
|
State
|
|
(499
|
)
|
249
|
|
478
|
|
Total deferred
|
|
(2,915
|
)
|
3,124
|
|
5,559
|
|
|
|
|
|
|
|
|
|
Change in regulatory assets
and liabilities, net
|
|
(249
|
)
|
(268
|
)
|
(278
|
)
|
Investment tax credit
amortization
|
|
(49
|
)
|
(49
|
)
|
(49
|
)
|
Total provision (benefit) for income taxes
|
|
$
|
(956
|
)
|
$
|
5,022
|
|
$
|
3,028
|
|
|
|
|
|
|
|
|
|
Allocation of total
provision (benefit) for income taxes:
|
|
|
|
|
|
|
|
Income tax (benefit) at statutory rates:
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
795
|
|
$
|
5,388
|
|
$
|
4,434
|
|
Discontinued operations
|
|
(1,751
|
)
|
(366
|
)
|
(1,061
|
)
|
Total taxes at statutory rates
|
|
(956
|
)
|
5,022
|
|
3,373
|
|
Tax benefit from capital loss on sale of stock of Master Tek
|
|
|
|
|
|
(345
|
)
|
Net provision (benefit) for income taxes
|
|
$
|
(956
|
)
|
$
|
5,022
|
|
$
|
3,028
|
|
Current tax expense does not reflect benefits of $0.4
million, $1.5 million and $0.7 million for the years ended December 31,
2007, 2006 and 2005, respectively, related to the exercise of employee stock
options credited to additional paid-in capital in stockholders equity.
A reconciliation of the statutory federal income tax
rate to the Companys effective tax rate is as follows:
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Provision computed at
statutory rates
|
|
34
|
%
|
34
|
%
|
34
|
%
|
Goodwill impairment charges
not deductible for tax purposes
|
|
(21
|
)%
|
|
|
|
|
State income taxes, net of
federal tax benefit
|
|
(3
|
)%
|
3
|
%
|
3
|
%
|
Other, net
|
|
1
|
%
|
(2
|
)%
|
(1
|
)%
|
Effective tax rate
|
|
11
|
%
|
35
|
%
|
36
|
%
|
F-30
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 8. Income Taxes (Continued)
Deferred tax assets and liabilities consist of the
following as of December 31, 2007 and 2006:
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
Depreciation
|
|
$26,314
|
|
$22,522
|
|
Deferred revenue
|
|
3,023
|
|
5,218
|
|
Section 1031 like-kind property exchange gain
|
|
838
|
|
887
|
|
Production cost balancing accounts
|
|
893
|
|
547
|
|
Gains on condemnation of land
|
|
501
|
|
531
|
|
Other
|
|
807
|
|
1,615
|
|
Total deferred tax liabilities
|
|
32,376
|
|
31,320
|
|
Deferred tax (assets):
|
|
|
|
|
|
Goodwill and asset impairment charges
|
|
(4,565
|
)
|
|
|
Contributions in aid of construction and advances for construction
|
|
(1,826
|
)
|
(2,115
|
)
|
Allowances and other reserves
|
|
(2,458
|
)
|
(2,939
|
)
|
Net operating loss carryforwards
|
|
(115
|
)
|
(1,987
|
)
|
Capital loss carryforwards
|
|
(1,417
|
)
|
(1,010
|
)
|
Share-based compensation
|
|
(1,101
|
)
|
(606
|
)
|
Investment tax credits
|
|
(280
|
)
|
(303
|
)
|
Other
|
|
(1,096
|
)
|
(1,045
|
)
|
Total deferred tax (assets)
|
|
(12,858
|
)
|
(10,005
|
)
|
|
|
|
|
|
|
Net deferred tax
liabilities before valuation allowance
|
|
19,518
|
|
21,315
|
|
Deferred tax asset
valuation allowance
|
|
1,417
|
|
1,010
|
|
|
|
|
|
|
|
Net deferred tax liabilities
|
|
$20,935
|
|
$22,325
|
|
|
|
|
|
|
|
Balance sheet
classification:
|
|
|
|
|
|
Long-term deferred tax liabilities
|
|
$28,102
|
|
$26,011
|
|
Current deferred tax assets
|
|
(7,167
|
)
|
(3,686
|
)
|
Net deferred tax liabilities
|
|
$20,935
|
|
$22,325
|
|
As of December 31, 2006, the Company had federal
and state operating loss carryforwards in the amount of approximately $4.9
million and $3.0 million, respectively. The federal loss carryforwards were
fully utilized during 2007 and state operating loss carryforwards of
approximately $2.4 million remain as of December 31, 2007.
During 2005, the Company realized a capital loss of
$4.0 million on the sale of Master Tek, which is reflected as a discontinued
operation. The Company was able to carry back $0.7 million of the capital loss
to a prior year to offset capital gains. Also, the Company generated $0.4
million and $0.1 million of capital gains during 2006 and 2005, respectively,
which were offset by the capital loss. The remaining $2.8 million of capital
loss will be carried forward to future years to offset any future capital
gains. The capital loss carryforward expires in 2010. The $1.4 million capital
loss carryforward benefit has been fully offset by a valuation allowance as of December 31,
2007 because management does not believe it is more likely than not the Company
will generate future capital gains prior to the expiration date of the loss
carryforward.
F-31
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 8. Income Taxes (Continued)
Based upon the Companys current and historical
pre-tax earnings, management believes it is more likely than not that the
Company will realize the benefit of its remaining deferred income tax assets.
Management believes the existing net deductible temporary differences will
reverse during periods in which the Company generates net taxable income.
However, there can be no assurance that the Company will generate any earnings
or any specific level of continuing earnings in future years. Management
regularly reviews the recoverability of deferred income tax assets and has
determined that no additional valuation allowances are necessary as of December 31,
2007.
The Company is 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. The Company is no longer subject to federal, state and local
income tax return examinations by taxing authorities for years before 2003. The
Companys 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 2003 to the present and
federal income tax returns from 2005 to the present are still subject to examinations
by taxing authorities.
As of December 31, 2007 and 2006, the Companys
liabilities for uncertain tax positions were not significant. The Companys
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 years
ended December 31, 2007 and 2006 were insignificant.
Note 9. Stockholders Equity
Preferred Stock
The Company is authorized to issue 250,000 shares of
$0.01 par value preferred stock of which 10,373 shares are designated Series A
Preferred Stock. There are 9,156 and 9,158 Series A preferred shares
issued and outstanding as of December 31, 2007 and 2006, respectively. Series A
preferred stockholders are entitled to receive annual dividends of $2.625 per
share. Series A preferred shares may be redeemed by the Company at any
time for a price of $52.00 per share and have preference in liquidation of
$50.00 per share. During 2006, a stockholder offered to sell 60 shares of Series A
preferred stock back to the Company at $33.80 per share. The Company elected to
repurchase and cancel those shares.
Common Stock
The Company is authorized to issue 75,000,000 common
shares of $0.01 par value common stock, of which 24.3 million and 23.8
million shares are issued and outstanding as of December 31, 2007 and
2006, respectively. The current quarterly cash dividend rate is $0.06 per
share. As of December 31, 2007, there are also warrants to purchase
143,581 shares of common stock outstanding and exercisable. The warrants are
exercisable any time at $6.23 per share and expire in 2010. As of December 31,
2007, a total of 5.5 million common shares are reserved for issuance upon
exercise of all warrants and stock options, the conversion of the subordinated
debentures and stock purchase plans.
F-32
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 9. Stockholders Equity (Continued)
During 2005, the Company issued 450,644 unregistered
shares of common stock to acquire the remaining minority interest in Windermere
Utility Company (Note 2) and the shares issued are included in the number of
shares outstanding.
Common stockholders are entitled to one vote for each
share held on all matters voted on by stockholders, including the election of
directors. Upon liquidation or dissolution, the common stockholders will be
entitled to share ratably in the assets legally available for distribution to
stockholders after payment of liabilities and subject to the prior rights of
any preferred stockholders. Common stockholders do not have subscription,
sinking fund, preemptive, redemption or conversion privileges. The rights,
preferences and privileges of common stockholders are subject to the rights of
stockholders of any series of preferred stock that is issued, or that may be
issued, in the future.
The Company has a Stockholders Rights Plan (Rights
Plan) designed to preserve value for the Companys stockholders. The Rights
Plan is designed to deter coercive takeover tactics, to encourage third parties
interested in acquiring the Company to negotiate with the Board of Directors
and to reduce any adverse effects that significant stockholders of the Company
may have on the public market for the Companys common stock. In the event of
certain triggering events as specified in the Rights Plan (e.g., accumulation
of a significant block of shares by an acquiring person), the stockholders
become entitled to purchase additional shares of common stock at a significant
discount.
The rights under the Rights Plan may only become
exercisable under certain circumstances involving actual or potential
acquisitions of 15% or more of our common stock. Depending on the
circumstances, if the rights become exercisable, the holder is entitled to
purchase from us one one-hundredth of a share of Series B Junior
Participating Preferred Stock at an exercise price of $65.00, subject to
adjustment. The rights remain in existence until April 6, 2008 unless they
are earlier terminated, exchanged or redeemed.
Dividend Reinvestment and
Direct Stock Purchase Plan (DRIP / DSPP)
The Company has a dividend reinvestment and stock
purchase plan that gives common stockholders the option of receiving their
dividends in cash or in common stock at a discount from prevailing market
prices (DRIP). The plan also permits existing stockholders to purchase
additional common stock, up to a maximum of $10,000 per month, at a discount (DSPP);
new investors may participate in the plan, subject to a $250 minimum initial
investment. The Company may, at its sole discretion, permit purchases above the
$10,000 stated maximum. The discounts may range from 0% to 5%, as determined
from time to time by the Company. The DRIP and DSPP discounts offered by the
Company during 2007 were 5% for the DRIP and 0% for the DSPP. During 2006, the
Company registered an additional 1,200,000 shares of common stock that were
authorized to be issued under the plan. As of December 31, 2007, there are
3.7 million shares authorized for issuance under the plan of which 0.9 million
shares remain available for issuance.
F-33
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 10. Commitments and Contingencies
Lease Commitments
The Company leases equipment and office facilities
under operating and capital leases that expire through 2026. Aggregate rental
expense under all operating leases was $8.7 million, $8.1 million and $7.9
million in 2007, 2006 and 2005, respectively. At December 31, 2007, the
future minimum commitments under existing non-cancelable capital and operating
leases are as follows:
|
|
Operating
|
|
Capital
|
|
(In thousands)
|
|
Leases
|
|
Leases
|
|
|
|
|
|
|
|
Year ending
December 31,:
|
|
|
|
|
|
2008
|
|
$
|
6,729
|
|
$
|
938
|
|
2009
|
|
5,370
|
|
1,023
|
|
2010
|
|
4,064
|
|
1,023
|
|
2011
|
|
2,938
|
|
1,023
|
|
2012
|
|
2,269
|
|
1,024
|
|
2013 and thereafter
|
|
9,461
|
|
86
|
|
Total minimum payments required
|
|
$
|
30,831
|
|
5,117
|
|
Less amounts representing interest
|
|
|
|
(535
|
)
|
Total capital lease obligation
|
|
|
|
4,582
|
|
Less current portion of capital lease obligation
|
|
|
|
(837
|
)
|
Long-term capital lease obligation, net of current portion
|
|
|
|
$
|
3,745
|
|
The Company leases almost all of its vehicles under a
fleet leasing arrangement. Under this arrangement, vehicles must be leased for
a minimum of twelve months. After the initial twelve month period, vehicles may
be returned to the lessor or the lease may be continued on a month-to-basis.
Historically, the Company has replaced its fleet every three years. The lease
commitments in the table above include $7.5 million of vehicle lease
commitments assuming an initial three year lease term for each vehicle.
Water Supply Commitments
One of the Companys regulated utilities has a water
supply contract providing for the purchase of water to supplement its own water
supply. The agreement requires the Company to purchase minimum quantities of
water annually at a specified price. The price is subject to annual adjustment
for production cost increases incurred by the seller. The minimum quantity is
also subject to adjustment based on average actual water purchases over a
moving two-year period, but the minimum will not be reduced below a specified
threshold. As of December 31, 2007, the minimum annual purchase commitment
is $0.5 million through 2024.
F-34
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 10. Commitments and Contingencies (Continued)
Legal Proceedings
New Mexico Utilities, Inc.
New Mexico Utilities, Inc. (NMUI), one of the
Companys wholly-owned regulated utilities, has an agreement with the
Albuquerque Bernalillo County Water Utility Authority, a political subdivision
of the State of New Mexico (the Water Authority), whereby the Water Authority
treats the effluent from NMUIs wastewater collection system for a fee. The
treated effluent is returned to the Rio Grande Underground Basin, creating
return flow credits. Return flow credits supplement NMUIs existing water
rights, enabling it to pump additional water from the basin.
In August 2004, the Water Authority increased
the fee charged to NMUI, using a different formula than had been used to
calculate fee increases in prior years. The Company believes the increase
violates the terms of a written agreement between the parties. Subsequently,
the Water Authority also claimed ownership of the return flow credits. The
Company filed a Complaint for Declaratory Judgment in the Second Judicial
District Court, County of Bernalillo, State of New Mexico, requesting that the
Court settle these disputes. In a letter ruling dated May 2, 2007, the
Court ruled that the Water Authority could use a new formula to set fees for
NMUI. The Company filed a motion for reconsideration and that motion was denied
on October 2, 2007. The matter has now been set for trial in the fall of
2008. The Court has not ruled on whether the new rate was appropriate; has made
no determination as to any amount NMUI may owe to the Water Authority, or ruled
on the ownership of the return flow credits.
Although the Company cannot give any assurances as to
the ultimate resolution of this matter, the Company does not believe that it is
probable it will be required to pay the disputed fees and related late payment
penalties, which totaled $4.9 million as of December 31, 2007, and has not
recognized a reserve for any potential liabilities in the accompanying
consolidated financial statements. In addition, should the Court rule against
NMUI, the New Mexico Public Regulation Commission has indicated its support of
NMUIs proposal that it be permitted to establish a regulatory asset for any
amounts paid, including late payment penalties, and recover that asset
prospectively through a rate surcharge to its customers. The Company is unable
to predict the impact the resolution of the return flow credits ownership
dispute will have on its consolidated financial statements.
In September 2007, NMUI received a $0.7 million
retroactive billing adjustment from the Water Authority covering the period
from August 2003 through April 2006 for the volume of wastewater it
believes NMUI discharged into the treatment system versus the amount reported
by NMUI. The amounts reported by NMUI were based on a calculation methodology
that had been agreed to by both parties and used for approximately 30 years.
NMUI is contesting the billing adjustment. Although the Company cannot give any
assurances as to the ultimate resolution of this matter, the Company does not
believe that it is probable it will be required to pay the retroactive billing
and therefore has not recognized a reserve for any potential liability for this
amount in the accompanying consolidated financial statements.
On February 26, 2008, the Company was made aware of a
Claim of Lien filed by the Water Authority against NMUI in the sum of $5.8
million, allegedly for delinquent sewer charges. This lien is related to the
above described matters currently being litigated in New Mexico State Court.
F-35
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 10. Commitments and Contingencies (Continued)
In addition, on January 19, 2007, the Water
Authority and the City of Rio Rancho, a home-rule municipal corporation,
as Petitioners, filed a Petition for Condemnation against NMUI and others, as
Defendants, in the Second Judicial District Court, County of Bernalillo, State
of New Mexico (the Petition). The Petition seeks to acquire, by condemnation,
all of the assets of NMUI, including all real property, through the stated
power of eminent domain. The Petition also alleges that the Petitioners need to
acquire the NMUI assets for the public purposes of providing water and
wastewater services to NMUI customers and that the acquisition of NMUI is
necessary, appropriate and in the public interest. The Company is contesting
the Petition and the matter is scheduled for trial in the fall of 2008. If the
Company does not prevail, the Petitioners must pay fair market value for the
utility 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, the
Company believes that the fair market value of NMUI exceeds its recorded net
book value as of December 31, 2007.
Suburban Water Systems
Suburban Water Systems, one of the Companys wholly
owned subsidiaries, and the Company were named as defendants in several
lawsuits alleging various injuries as a result of water contamination in the
San Gabriel Valley Main Basin. The California Supreme Court ruled in February 2002
that the plaintiffs could not challenge the adequacy of the water quality
standards established by California Department of Health Services. In August 2004,
the case against SouthWest Water and its subsidiary was dismissed; however, the
plaintiffs appealed the dismissal to the Court of Appeals for the State of
California, First Appellate District (1DCA Civil No. B178283). Oral
arguments for the appeal were presented on June 20, 2007 and the Company
(and the other defendants) prevailed at the appellate level. The Court ruled
that the only time a regulated water utility or public water company can be
held liable in tort for water quality issues is when they have violated a
numerical standard set by the Department of Health Services or other similar
regulatory agency. Liability insurance carriers have absorbed all costs related
to the lawsuits and appeals. The parties have entered into a settlement
agreement which provides, in part, that no further appeals will be filed,
effectively ending this litigation.
Other Matters
The Company and its subsidiaries are also involved in
other routine legal and administrative proceedings arising during the ordinary
course of business. The Company believes the ultimate disposition of such
matters will not have a material adverse effect on its business, consolidated
financial position, results of operations or cash flows.
F-36
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 10. Commitments and Contingencies (Continued)
Investigations
On May 5, 2005, one of the Companys operating
subsidiaries received a subpoena to provide records to a grand jury. The
requested records relate to the operations of the San Simeon wastewater
treatment plant in California for the period January 2002 to the date of
the subpoena. The subsidiary has operated this facility since September 2004.
The facility was also served with search warrants executed by the EPA. The
Company cooperated fully with the investigation and the investigation was closed
without further action in February 2008.
On May 18, 2005, the EPA executed a search
warrant at the Companys Texas-based testing laboratory and on July 20,
2006 the laboratory received a subpoena to provide additional records and
information to a grand jury. The Company is cooperating fully with the
investigation and has provided the records requested. There have been no
further significant developments since July 20, 2006.
The Company received a letter dated January 28,
2008 from the California State Water Resources Control Board Office of
Enforcement (the Board). The letter indicates that the Board has conducted an
investigation of the operations of a subsidiary of the Company with respect to
various California wastewater treatment facilities which are operated, but not
owned, by the subsidiary. The Board alleges that the subsidiary has violated
certain provisions of the California Water Code and may be subject to civil
administrative liability in excess of $15.0 million, and possible
administrative action against the subsidiarys status as a contract operator in
California. While the Company believes that the summary allegations cannot be
substantiated, it cannot currently predict what, if any, actions may be taken
by the Board or the effect those actions may have on its financial position,
results of operations or cash flows. The Company intends to aggressively defend
against this action. No amounts have been accrued related to any potential
fines, penalties or other liabilities.
Settlement Agreement
Liability
In 2006, the Company negotiated a settlement
agreement with a municipality relating to possible fines and penalties for
specified violations occurring during the time the Company operated the
municipalitys wastewater system. The Companys maximum payment obligation is
capped at $0.7 million under the agreement provided that total fines and
penalties levied do not exceed a specified amount. The water quality control
board has levied fines and penalties exceeding the amount contemplated by the
settlement agreement.
The Company believes there are convincing arguments for
negotiating a reduction in the amounts levied but elected to accrue the $0.7
million maximum amount contemplated by the settlement agreement. The water
quality control board has preliminarily agreed that the fines and penalties may
be substantially reduced from the amounts originally levied however the Company
has not received final notice of this action. As a result, $0.7 million remains
accrued as of December 31, 2007.
F-37
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 10. Commitments and Contingencies (Continued)
Commitments Under Long-Term
Service Contracts
In 2002, the Company was 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, the Company obtained a $3.4 million standby
letter of credit as collateral to insure its 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. The Company 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.
The Company now operates the completed plant under a
twenty-year operating agreement. The CVWD service contract contains three
guarantees related to the performance of the Company and its subsidiary during
the term of the operating agreement. The agreement provides for the Company to
pay liquidated damages in the event it fails 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, the
Company 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. The Company has 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, the Company is 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, the Company has 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. The Company entered into an agreement with the
bond insurer to guarantee the Companys 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.
Performance Bonds
As part of its contract process, the Services Group
obtains bid bonds which secure, among other things, the Services Groups
willingness to participate in contract discussions. The bid bonds range in
value dependent upon the requirements of the potential client. Upon
consummation of the contract, or cancellation of the negotiating process, the
bid bond is canceled and the Services Group bears no further liability. The
aggregate amount of bid bonds outstanding is usually less than $0.5 million at
any given time. The Company also secures its performance under operating and
maintenance contracts with performance and completion bonds obtained from
surety companies. The aggregate amount of these bonds was approximately $3.1
million at December 31, 2007.
F-38
SOUTHWEST WATER COMAPNY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 11. Earnings per Share
The following table is a reconciliation of the
numerators (income or loss) and denominators (shares) used in both the basic
and diluted earnings per share calculations.
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
NumeratorsNet income
(loss) applicable to common stockholders:
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
(5,020
|
)
|
$
|
10,009
|
|
$
|
7,971
|
|
Less preferred stock dividends
|
|
(24
|
)
|
(24
|
)
|
(24
|
)
|
Income (loss) from continuing operations applicable
|
|
|
|
|
|
|
|
to common stockholders
|
|
(5,044
|
)
|
9,985
|
|
7,947
|
|
Loss from discontinued operations
|
|
(3,026
|
)
|
(681
|
)
|
(5,572
|
)
|
Cumulative effect of change in accounting principle
|
|
|
|
71
|
|
|
|
Net income (loss) applicable to common stockholders
|
|
$
|
(8,070
|
)
|
$
|
9,375
|
|
$
|
2,375
|
|
|
|
|
|
|
|
|
|
DenominatorsWeighted
average common shares outstanding:
|
|
|
|
|
|
|
|
Basic weighted average common shares outstanding
|
|
24,101
|
|
22,928
|
|
20,859
|
|
Plus shares issued on assumed exercise of stock options and warrants
|
|
|
|
435
|
|
752
|
|
Diluted weighted average common shares outstanding
|
|
24,101
|
|
23,363
|
|
21,611
|
|
The difference between reported basic and diluted
earnings per share is the effect of stock options that, under the treasury
share method, give rise to potentially dilutive common shares. The Company
incurred a loss during the year ended December 31, 2007. As a result,
options to purchase 318,000 shares of common stock are considered antidilutive
and therefore are not included in the computation of diluted loss per share for
this period.
As described in Note 6, the Company has $12.1 million
of 6.85% fixed-rate convertible subordinate debentures outstanding as of December 31,
2007. The debentures are convertible at any time prior to maturity, unless
previously redeemed, at a conversion price of $11.018 per share (1.1 million
shares as of December 31, 2007). At such time as the assumed conversion of
the debentures has a dilutive effect on earnings per share, the debentures will
be included in the calculation of diluted earnings per share after adjusting
net income for the after-tax effect of the debenture interest expense.
Approximately 610,000, 238,000 and 314,000 stock
options were excluded from the computation of diluted earnings per share in 2007,
2006 and 2005, respectively, due to their antidilutive effect.
F-39
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 12. Consolidated Statements of Cash Flows
The
following information supplements the Companys consolidated statements of cash
flows.
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Cash paid during the year
for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
8,616
|
|
$
|
8,343
|
|
$
|
7,513
|
|
Income taxes paid (refunded), net
|
|
(703
|
)
|
(1,956
|
)
|
(1,423
|
)
|
|
|
|
|
|
|
|
|
Components of cash paid for
acquisitions:
|
|
|
|
|
|
|
|
Fair value of assets acquired
|
|
$
|
10,580
|
|
$
|
1,798
|
|
$
|
13,931
|
|
Liabilities assumed
|
|
(2,511
|
)
|
(79
|
)
|
(1,619
|
)
|
Cash paid for acquisitions
|
|
$
|
8,069
|
|
$
|
1,719
|
|
$
|
12,312
|
|
|
|
|
|
|
|
|
|
Components of proceeds from
sale of discontinued operations:
|
|
|
|
|
|
|
|
Fair value of assets sold
|
|
$
|
|
|
$
|
|
|
$
|
12,748
|
|
Liabilities assumed by buyer
|
|
|
|
|
|
(598
|
)
|
Selling price
|
|
|
|
|
|
12,150
|
|
Transaction expenses
|
|
|
|
|
|
(1,874
|
)
|
Held in escrow and included in other receivables
|
|
|
|
|
|
(1,070
|
)
|
Net cash proceeds from sale of discontinued operations
|
|
$
|
|
|
$
|
|
|
$
|
9,206
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
Non-cash contributions in aid of construction and advances for
|
|
|
|
|
|
|
|
construction conveyed to Company by developers
|
|
$
|
6,355
|
|
$
|
12,605
|
|
$
|
5,738
|
|
Capital expenditures financed with capital lease obligations
|
|
4,582
|
|
|
|
|
|
Debentures converted into common stock
|
|
557
|
|
3,498
|
|
1,142
|
|
Common stock exchanged for 20% minority stockholders interest
|
|
|
|
|
|
6,000
|
|
F-40
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 13. Share-Based Incentive Compensation Plans
Adoption of SFAS No. 123(R)
Effective January 1, 2006, the Company adopted
the provisions of SFAS No. 123 (revised 2004),
Share-Based
Payment
(SFAS 123(R)), using the modified prospective
application method. Generally, SFAS 123(R) is similar in approach to
SFAS 123, which the Company adopted in 2002, and requires that
compensation cost relating to share-based payments be recognized in the
financial statements based on the fair value of the equity or liability
instruments issued. Because the Company has been recognizing compensation cost
related to share-based payments since its 2002 adoption of SFAS 123, the
2006 adoption of SFAS 123(R) did not have a material effect on the
consolidated financial statements.
The adoption of SFAS 123(R) required the
Company to change from recognizing the effect of forfeitures as they occur to
estimating the number of options for which the requisite service is not
expected to be rendered and reducing the periodic compensation cost recorded
accordingly. As a result, the Company recorded a benefit of $0.1 million ($0.07
million, net of tax) on January 1, 2006, which is reported as the
cumulative effect of a change in accounting principle, to reflect the amount of
compensation cost previously recognized related to outstanding options as of December 31,
2005 that are not expected to vest based on an estimate of forfeitures derived
from historical data. Additionally, SFAS No. 123(R) requires that the
tax benefit from the tax deduction related to share-based compensation that is
in excess of recognized compensation costs be reported as a financing cash flow
rather than an operating cash flow. Applying the provisions of SFAS 123(R) as
of January 1, 2005 would not have had a material effect on the Companys
consolidated financial statements.
Share-Based Equity Incentive
Plans
Prior to May 2006, the Company had two
share-based incentive compensation plans: a Stock Option Plan, and a Director
Stock Option Plan. At the May 2006 annual meeting of stockholders, the
stockholders approved a new Equity Incentive Plan, which incorporated the
previously existing Stock Option Plan and Director Stock Option Plan.
Equity Incentive Plan (EIP)
The stockholder-approved Equity Incentive Plan (EIP)
authorizes the Company to award up to 5.4 million shares of its common stock.
As of December 31, 2007, 1.1 million shares were available for granting
future awards under the plan which may be granted until May 16, 2016. The
Company has reserved a total of 2.8 million shares of its authorized common
shares for issuance upon exercise of options granted and for awards granted in
the future.
Under the EIP, the Company may award, either
qualified or non-qualified stock options, stock appreciation rights, restricted
stock, restricted stock units and other share-based awards to officers,
employees and non-employee directors. The EIP provides that the exercise price
may not be less than the fair market value of the stock on the date of grant.
The Compensation and Organization Committee of the Board of Directors
administers the EIP and establishes each awards vesting schedule and term at
the time of the award. The Committee has generally established straight-line
vesting schedules over periods of two to five years. An awards term may not
exceed ten years from date of grant and have generally been set at seven years
from date of grant. Options are forfeited when they expire or in the event a
participant terminates employment with the Company prior to the award vesting.
F-41
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 13. Share-Based Incentive Compensation Plans
(Continued)
Stock Option Plan (SOP)
Under the stockholder-approved Stock Option Plan (SOP),
as amended, the Company could grant non-qualified stock options to officers,
employees and consultants at an exercise price not less than the fair value of
the stock on the last trading date preceding the date of grant. The Company
could also grant non-qualified options to certain non-employee directors of the
Company. Options granted subsequent to December 31, 1999 vest equally over
a period of five years and expire seven years and one day from the date of
grant. Options granted prior to January 1, 2000 expire 10 years and one
day from the date of grant. Options are forfeited when they expire or in the
event a SOP participant terminates employment with the Company prior to the
options vesting.
Director Option Plan (DOP)
The stockholder-approved Director Option Plan (DOP),
as amended, authorized the Company to issue options to eligible non-employee
directors. The DOP provided for an automatic annual grant of options to
purchase 11,025 shares of the Companys common stock to eligible non-employee
directors of the Company on the date of the Companys annual meeting of
stockholders through 2014 at fair market value. New directors were initially
granted options to purchase 11,025 shares of common stock upon appointment to
the Board of Directors. DOP options granted after December 31, 1999 vest
equally over two years and expire seven years and one day after the date of
grant. Options granted prior to January 1, 2000 expire 10 years and one
day from the date of grant.
Warrants
In 2000 the Company issued warrants to consultants as
compensation for their assistance in connection with an acquisition. As of December 31,
2007, there are warrants to purchase 143,581 shares of common stock outstanding
and exercisable. The warrants are exercisable anytime at $6.23 per share and
expire in 2010.
Compensation Expense
The Company recognizes compensation cost in its
consolidated financial statements based on the fair value of an award on the
date of grant on a straight-line basis over the requisite service period for
each separately vesting portion of the award. The following table summarizes
the compensation expense and related income tax benefit related to share-based
compensation expense recognized during the periods:
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
$
|
1,710
|
|
$
|
1,079
|
|
$
|
966
|
|
Restricted stock awards
|
|
151
|
|
|
|
|
|
Share-based compensation expense
|
|
1,861
|
|
1,079
|
|
966
|
|
Income tax benefit
|
|
(689
|
)
|
(378
|
)
|
(345
|
)
|
Share-based compensation expense, net of tax
|
|
$
|
1,172
|
|
$
|
701
|
|
$
|
621
|
|
As of December 31, 2007, aggregate unrecognized
compensation costs was $1.4 million and is expected to be recognized over the
next five years (1.2 years on a weighted average basis).
F-42
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 13. Share-Based Incentive Compensation Plans
(Continued)
Stock Options
The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model. The Company
uses historical data to estimate expected option lives and employee termination
assumptions. In addition, groups of participants that have similar historical
exercise behavior are considered separately for valuation purposes. The
expected volatility of fair value is estimated based on historical volatility
of the Companys common stock. The expected dividends are based on the current
dividend yield of the Companys stock as of the date of the grant. The
risk-free rate for periods within the contractual life of the option is based
on the U.S. Treasury yield curve in effect at the time of grant. The
assumptions used are shown in the following table.
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Dividend yield
|
|
1.7
|
%
|
1.4
|
%
|
1.7
|
%
|
Expected volatility
|
|
34.4
|
%
|
33.6
|
%
|
24.3
|
%
|
Risk-free interest rate
|
|
4.6
|
%
|
4.8
|
%
|
4.1
|
%
|
Expected life in years
|
|
4.5
|
|
4.5
|
|
5.7
|
|
The weighted average grant date fair value per share
of options granted using these assumptions was $3.92, $4.90 and $3.01 per share
for the years ended December 31, 2007, 2006 and 2005, respectively. The
total fair value of options vested was $1.0 million, $0.9 million and $1.3
million for the years ended December 31, 2007, 2006 and 2005,
respectively.
The following table summarizes stock option and
warrant activity during the three years ended December 31, 2007.
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
Weighted-
|
|
|
|
Weighted-
|
|
|
|
Weighted
|
|
|
|
Number
|
|
Average
|
|
Number
|
|
Average
|
|
Number
|
|
Average
|
|
|
|
of
|
|
Exercise
|
|
of
|
|
Exercise
|
|
of
|
|
Exercise
|
|
(In thousands, except exercise prices)
|
|
Shares
|
|
Price
|
|
Shares
|
|
Price
|
|
Shares
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at beginning of
year
|
|
1,788
|
|
$
|
10.29
|
|
2,641
|
|
$
|
8.30
|
|
2,915
|
|
$
|
7.65
|
|
Granted
|
|
345
|
|
12.83
|
|
463
|
|
16.00
|
|
327
|
|
11.06
|
|
Exercised
|
|
(228
|
)
|
6.93
|
|
(994
|
)
|
6.98
|
|
(518
|
)
|
12.33
|
|
Forfeited
|
|
(195
|
)
|
13.57
|
|
(317
|
)
|
11.48
|
|
(83
|
)
|
11.14
|
|
Expired
|
|
(23
|
)
|
9.84
|
|
(5
|
)
|
2.38
|
|
|
|
|
|
Outstanding at end of year
|
|
1,687
|
|
10.89
|
|
1,788
|
|
10.29
|
|
2,641
|
|
8.30
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of year
|
|
980
|
|
9.09
|
|
926
|
|
7.53
|
|
1,624
|
|
6.91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of options exercised was $1.6
million, $6.9 million and $3.3 million for the years ended December 31,
2007, 2006 and 2005, respectively.
F-43
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 13. Share-Based Incentive Compensation Plans
(Continued)
The following tables summarize information about
stock options outstanding and exercisable as of December 31, 2007.
|
|
|
|
Vested
and
|
|
|
|
|
|
|
|
Expected
|
|
Fully
|
|
(In thousands, except as indicated)
|
|
Outstanding
|
|
to Vest
|
|
Vested
|
|
|
|
|
|
|
|
|
|
Number of shares
|
|
1,687
|
|
1,572
|
|
980
|
|
Weighted average remaining
contractual life in years
|
|
3.66
|
|
3.57
|
|
2.53
|
|
Weighted average exercise
price per share
|
|
$
|
10.89
|
|
$
|
10.71
|
|
$
|
9.09
|
|
Aggregate intrinsic value (at
closing stock price of $12.52 per share)
|
|
$
|
3,858
|
|
$
|
3,801
|
|
$
|
3,621
|
|
|
|
|
|
|
|
Outstanding
|
|
Exercisable
|
|
|
|
|
|
|
|
|
Number
|
|
Weighted-
|
|
|
|
Number
|
|
|
|
|
|
|
|
|
|
Outstanding
|
|
Average
|
|
Weighted-
|
|
Exercisable
|
|
Weighted-
|
|
|
|
|
|
|
|
as of
|
|
Remaining
|
|
Average
|
|
as of
|
|
Average
|
|
|
|
|
|
|
|
December 31
|
|
Contractual
|
|
Exercise
|
|
December 31,
|
|
Exercise
|
|
(In thousands, except per share and life in
years data)
|
|
|
|
|
|
2007
|
|
Life
|
|
Price
|
|
2007
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range of per share exercise
prices:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4.25
|
|
to
|
|
$
|
8.44
|
|
528
|
|
1.79
years
|
|
$
|
6.75
|
|
503
|
|
$
|
6.67
|
|
$
|
8.88
|
|
to
|
|
$
|
11.39
|
|
346
|
|
3.04
years
|
|
10.35
|
|
255
|
|
10.06
|
|
$
|
11.56
|
|
to
|
|
$
|
12.77
|
|
373
|
|
5.55
years
|
|
12.55
|
|
70
|
|
11.88
|
|
$
|
12.96
|
|
to
|
|
$
|
16.48
|
|
288
|
|
4.60
years
|
|
13.37
|
|
120
|
|
13.27
|
|
$
|
17.75
|
|
to
|
|
$
|
17.75
|
|
152
|
|
5.11
years
|
|
17.75
|
|
32
|
|
17.75
|
|
$
|
4.25
|
|
to
|
|
$
|
17.75
|
|
1,687
|
|
3.66
years
|
|
10.89
|
|
980
|
|
9.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Awards
The Committee has established a straight-line vesting
schedule over a three-year period of continuous service to the Company for all
awards granted to date. Restricted stock is forfeited in the event a
participant terminates employment with the Company prior to the award vesting.
The grant date fair value of stock awarded is recognized as compensation
expense over the vesting term.
The following table summarizes all restricted stock
award activity during the year ended December 31, 2007:
|
|
|
|
Weighted-
|
|
|
|
Number
|
|
Average
|
|
|
|
of
|
|
Grant
Date
|
|
(In thousands, except weighted average grant
date fair value)
|
|
Shares
|
|
Fair
Value
|
|
|
|
|
|
|
|
Outstanding at
December 31, 2006
|
|
|
|
$
|
|
|
Awarded
|
|
27
|
|
12.76
|
|
Vested and released
|
|
|
|
|
|
Forfeited
|
|
2
|
|
12.76
|
|
Outstanding at
December 31, 2007
|
|
25
|
|
12.76
|
|
|
|
|
|
|
|
|
F-44
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 13. Share-Based Incentive Compensation Plans
(Continued)
Employee Stock Purchase Plan
(ESPP)
The Company has a stockholder-approved employee stock
purchase plan (ESPP) that allows eligible employees to purchase 1.0 million
shares of common stock through payroll deductions up to 10% of their salary,
not to exceed $25,000 per year. The purchase price of the stock is 90% of the
lower of the three-day average share price calculated at the beginning and end
of each three-month offering period. Under the ESPP, employees purchased
approximately 21,000, 21,000 and 26,000 shares in 2007, 2006 and 2005,
respectively. As of December 31, 2007, 0.6 million shares remain
available for future purchases.
The fair value of ESPP shares purchased is estimated
using a Black-Scholes option pricing model with the following weighted average
assumptions:
|
|
Year
Ended December 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Dividend yield
|
|
1.6
|
%
|
1.4
|
%
|
Expected volatility
|
|
35.1
|
%
|
33.6
|
%
|
Risk-free interest rate
|
|
4.9
|
%
|
4.8
|
%
|
Expected life in years
|
|
0.25
|
|
0.25
|
|
The Companys expense related to this plan was less
than $0.1 million for the years ended December 31, 2007, 2006 and 2005.
Note 14. Employee Benefit Plans
401(k) Retirement Plans
Substantially all employees are eligible to
participate in one of the 401(k) retirement plans the Company sponsors,
which are defined contribution plans satisfying the requirements of the
Employee Retirement Income Security Act of 1974. The Company makes
discretionary matching contributions to the plans that vest over a period of
one to six years. The Companys expense related to its matching contributions
was $0.9 million, $0.8 million and $0.7 million for the years ended December 31,
2007, 2006 and 2005, respectively.
Supplemental Executive
Retirement Plan (SERP)
The Company has a non-qualified supplemental
executive retirement plan (SERP) for certain key executive officers for the
purpose of providing supplemental income benefits to plan participants or their
survivors upon retirement or death. The plan measurement date is December 31
st
of each year.
F-45
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 14. Employee Benefit Plans (Continued)
Two executive officers of the Company were selected
by the compensation committee of the Board of Directors to participate in the
SERP and as of December 31, 2007, there is only one remaining participant
in the SERP. Under the SERP, in most cases, a vested participant with five to
ten years of service will be eligible for a yearly benefit for his or her
lifetime beginning at age 65 equal to: (1) the participants average
annual compensation multiplied by (2) the applicable compensation
percentage as defined by the SERP less (3) the Social Security benefit for
the most recent five years of employment. Compensation under the SERP is the
participants base salary and excludes bonus and other forms of compensation.
As discussed in Note 1, the Company adopted the balance sheet recognition
requirements of SFAS 158 on December 31, 2006 and began recognizing
the unamortized portion of actuarial gains and prior service costs in
accumulated other comprehensive income.
The following table details the components of the net
periodic benefit costs and actuarial assumptions:
|
|
Years Ended December 31,
|
|
(In thousands, except
percentage data)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Net periodic benefit costs:
|
|
|
|
|
|
|
|
Service cost
|
|
$
|
|
|
$
|
66
|
|
$
|
64
|
|
Interest cost
|
|
64
|
|
75
|
|
78
|
|
Amortization of actuarial (gains) losses
|
|
(76
|
)
|
15
|
|
52
|
|
Amortization of prior service cost
|
|
87
|
|
37
|
|
37
|
|
Net periodic benefit costs
|
|
$
|
75
|
|
$
|
193
|
|
$
|
231
|
|
|
|
|
|
|
|
|
|
Actuarial assumptions:
|
|
|
|
|
|
|
|
Discount rate pre-retirement
|
|
5.25
|
%
|
5.00
|
%
|
5.50
|
%
|
Discount rate post-retirement
|
|
3.00
|
%
|
2.75
|
%
|
2.75
|
%
|
Rate of compensation increases
|
|
|
%
|
|
%
|
5.00
|
%
|
The sole remaining participant in the SERP has
reached retirement and is not receiving any further compensation increases. The
discount rate selected in 2007 and 2006 reflects the Companys estimate of an
interest rate at which the benefit obligations can be settled and is a
short-term rate, given the 2008 retirement date of the sole remaining
participant.
Summarized in the table below is information about
the changes in the projected benefit obligation and the liability recognized in
our consolidated balance sheets as of December 31, 2007 and 2006.
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Projected benefit
obligation:
|
|
|
|
|
|
Balance at beginning of the year
|
|
$
|
1,224
|
|
$
|
1,506
|
|
Service cost
|
|
|
|
66
|
|
Interest cost
|
|
64
|
|
75
|
|
Actuarial gains
|
|
(9
|
)
|
(423
|
)
|
Payment of benefit obligation
|
|
(174
|
)
|
|
|
Balance at end of the year
|
|
1,105
|
|
1,224
|
|
|
|
|
|
|
|
Plan assets
|
|
|
|
|
|
Net amount recognized in
consolidated balance sheets
|
|
$
|
1,105
|
|
$
|
1,224
|
|
F-46
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 14. Employee Benefit Plans (Continued)
|
|
December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Amounts recognized in
accumulated other comprehensive income:
|
|
|
|
|
|
Actuarial gains
|
|
$
|
(131
|
)
|
$
|
(198
|
)
|
Prior service cost
|
|
|
|
87
|
|
Related deferred income taxes
|
|
46
|
|
39
|
|
Net amount recognized
|
|
$
|
(85
|
)
|
$
|
(72
|
)
|
The SERP is an unfunded plan. However, to assist in
funding the benefit obligations, the Company has invested in a corporate-owned
life insurance policy. The cash surrender value of the policy is designed to be
equal to the net present value of the aggregate SERP benefit obligations.
However, there is no direct relationship between the aggregate participants
SERP benefits and the policy coverage. The cash surrender value of the policy
was $1.4 million as of December 31, 2007 and $1.4 million as of December 31,
2006, and is included in non-current assets in the accompanying consolidated
balance sheets (Note 5).
Deferred Compensation Plan (DCP)
The Company has a non-qualified deferred compensation
plan (DCP) that permits key employees to annually elect to defer a portion of
their compensation until their retirement. The retirement benefit to be
provided is based upon the amount of compensation deferred. Deferred
compensation expense was $0.1 million, $0.1 million and $0.1 million in 2007,
2006 and 2005, respectively. Total deferred compensation liabilities were $1.6
million and $1.7 million at December 31, 2007 and 2006, respectively.
To assist in funding the deferred compensation liability,
the Company has invested in company-owned life insurance policies. The cash
surrender value of these policies were $1.7 million and $1.6 million at December 31,
2007 and 2006, respectively, and is included in other long-term assets in the
accompanying consolidated balance sheets (Note 5).
F-47
SOUTHWEST WATER COMPANY AND
SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 15. Segment Information
The 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. The Company owns regulated
public utilities and also serves cities, utility districts and private
companies under contract. The Companys businesses are segmented into two
operating groups: the Utility Group, which is comprised of the Companys
regulated public utilities; and the Services Group, which is comprised of the
Companys non-regulated operations.
The Utility Group owns and operates public water and
wastewater utilities in Alabama, California, New Mexico, Mississippi, Oklahoma
and Texas. State and federal agencies issue regulations regarding standards of
water quality, safety, environmental and other matters which affect these
operations. In the regulated utility subsidiaries, the rates that we charge for
water and wastewater services are established by state or local authorities.
The Services Group operates and manages water and
wastewater treatment facilities owned by cities, public agencies, municipal
utility districts, private entities and investor-owned utilities, including
some of the companies in the Utility Group. Revenue is also derived through
operations and maintenance contracts with smaller municipalities. The Services
Group also provides construction and construction management services, and
certified water and wastewater laboratory services.
F-48
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 15. Segment Information (Continued)
The reportable segments are strategic business units
that offer different services. They are managed separately since each business
requires different operating and growth strategies. The Services Group, while
subject to certain environmental standards, is not regulated in its pricing,
marketing or rates of return. The Utility Group subsidiaries are primarily
governed by the federal, state and / or county regulatory bodies. The service
areas in which the Utility Group operates constitute monopolies with allowable
rates of return determined by state or county regulatory agencies. The
accounting policies of the segments are described in the summary of significant
accounting policies in Note 1.
As more fully described in Note 1, effective January 1,
2007, the Company elected to allocate a portion of its Services Groups
operating expense overhead between affiliated and unaffiliated customers for
segment reporting purposes and reclassified certain expenses associated with
common business functions to operating expenses. Prior year amounts have been
reclassified to conform to the 2007 presentation.
The following table presents information about the
operations of each segment for the three years ended December 31, 2007.
(In thousands)
|
|
Utility
Group
|
|
Services
Group (1)
|
|
Corporate
(2)
|
|
Eliminations
(3)
|
|
Consolidated
|
|
Year ended December 31,
2007:
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated customers
|
|
$
|
93,370
|
|
$
|
119,254
|
|
$
|
|
|
$
|
|
|
$
|
212,624
|
|
Intersegment (1) (3)
|
|
|
|
31,467
|
|
|
|
(26,744
|
)
|
4,723
|
|
Total revenues
|
|
93,370
|
|
150,721
|
|
|
|
(26,744
|
)
|
217,347
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Operating expensesunaffiliated customers
|
|
52,765
|
|
107,884
|
|
|
|
|
|
160,649
|
|
Operating expensesintersegment (3)
|
|
|
|
26,744
|
|
|
|
(26,744
|
)
|
|
|
Selling, general and administrative expenses
|
|
8,051
|
|
12,678
|
|
15,895
|
|
|
|
36,624
|
|
Impairment of goodwill
|
|
17,215
|
|
|
|
|
|
|
|
17,215
|
|
Total expenses
|
|
78,031
|
|
147,306
|
|
15,895
|
|
(26,744
|
)
|
214,488
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
15,339
|
|
3,415
|
|
(15,895
|
)
|
|
|
2,859
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
(5,688
|
)
|
(757
|
)
|
(1,251
|
)
|
|
|
(7,696
|
)
|
Interest income
|
|
91
|
|
476
|
|
51
|
|
|
|
618
|
|
Other income (expense)
|
|
(97
|
)
|
|
|
91
|
|
|
|
(6
|
)
|
Income (loss) from continuing operations before income taxes
|
|
$
|
9,645
|
|
$
|
3,134
|
|
$
|
(17,004
|
)
|
$
|
|
|
$
|
(4,225
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other information:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
9,572
|
|
$
|
1,726
|
|
$
|
336
|
|
$
|
|
|
$
|
11,634
|
|
Additions to property, plant and equipment
|
|
35,340
|
|
465
|
|
5,543
|
|
|
|
41,348
|
|
Total assets as of period end date
|
|
441,464
|
|
61,138
|
|
21,786
|
|
(7,979
|
)
|
516,409
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to the
segment information following these tables.
F-49
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 15. Segment Information (Continued)
(In thousands)
|
|
Utility
Group
|
|
Services
Group(1)
|
|
Corporate
(2)
|
|
Eliminations
(3)
|
|
Consolidated
|
|
Year ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated
customers
|
|
$
|
86,321
|
|
$
|
125,558
|
|
$
|
|
|
$
|
|
|
$
|
211,879
|
|
Intersegment
(1) (3)
|
|
|
|
40,424
|
|
|
|
(33,501
|
)
|
6,923
|
|
Total revenues
|
|
86,321
|
|
165,982
|
|
|
|
(33,501
|
)
|
218,802
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Operating expensesunaffiliated customers
|
|
48,540
|
|
113,916
|
|
|
|
|
|
162,456
|
|
Operating expensesintersegment (3)
|
|
|
|
33,501
|
|
|
|
(33,501
|
)
|
|
|
Selling, general and administrative expenses
|
|
7,609
|
|
12,006
|
|
13,383
|
|
|
|
32,998
|
|
Impairment of goodwill
|
|
|
|
929
|
|
|
|
|
|
929
|
|
Total expenses
|
|
56,149
|
|
160,352
|
|
13,383
|
|
(33,501
|
)
|
196,383
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
30,172
|
|
5,630
|
|
(13,383
|
)
|
|
|
22,419
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
(5,344
|
)
|
(1,923
|
)
|
(269
|
)
|
|
|
(7,536
|
)
|
Interest income
|
|
46
|
|
299
|
|
111
|
|
|
|
456
|
|
Other income (expense)
|
|
(3
|
)
|
|
|
61
|
|
|
|
58
|
|
Income (loss) from continuing operations
before income taxes
|
|
$
|
24,871
|
|
$
|
4,006
|
|
$
|
(13,480
|
)
|
$
|
|
|
$
|
15,397
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other information:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
8,038
|
|
$
|
2,167
|
|
$
|
333
|
|
$
|
|
|
$
|
10,538
|
|
Additions to property, plant and equipment
|
|
41,596
|
|
1,648
|
|
9
|
|
|
|
43,253
|
|
Total assets as of period end date
|
|
419,867
|
|
71,107
|
|
11,050
|
|
(10,331
|
)
|
491,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
2005:
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated customers
|
|
$
|
78,884
|
|
$
|
114,515
|
|
$
|
|
|
$
|
|
|
$
|
193,399
|
|
Intersegment (1) (3)
|
|
|
|
31,324
|
|
|
|
(27,119
|
)
|
4,205
|
|
Total revenues
|
|
78,884
|
|
145,839
|
|
|
|
(27,119
|
)
|
197,604
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Operating expensesunaffiliated customers
|
|
44,827
|
|
103,547
|
|
|
|
|
|
148,374
|
|
Operating expensesintersegment (3)
|
|
|
|
27,119
|
|
|
|
(27,119
|
)
|
|
|
Selling, general and administrative expenses
|
|
7,448
|
|
10,779
|
|
12,529
|
|
|
|
30,756
|
|
Total expenses
|
|
52,275
|
|
141,445
|
|
12,529
|
|
(27,119
|
)
|
179,130
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
26,609
|
|
4,394
|
|
(12,529
|
)
|
|
|
18,474
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
(3,828
|
)
|
(1,890
|
)
|
(783
|
)
|
|
|
(6,501
|
)
|
Interest income
|
|
60
|
|
322
|
|
52
|
|
|
|
434
|
|
Other income (expense)
|
|
(48
|
)
|
13
|
|
33
|
|
|
|
(2
|
)
|
Income (loss) from continuing operations
before income taxes
|
|
$
|
22,793
|
|
$
|
2,839
|
|
$
|
(13,227
|
)
|
$
|
|
|
$
|
12,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other information:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
6,737
|
|
$
|
2,631
|
|
$
|
424
|
|
$
|
|
|
$
|
9,792
|
|
Additions to property, plant and equipment
|
|
31,146
|
|
1,402
|
|
92
|
|
|
|
32,640
|
|
Total assets as of period end date
|
|
372,139
|
|
68,547
|
|
12,896
|
|
(8,857
|
)
|
444,725
|
|
See accompanying notes to the
segment information following these tables.
F-50
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 15. Segment Information (Continued)
Notes
(1)
Some companies
in the Services Group provide construction, operations and maintenance services
to companies in the Utility Group and recognize a profit on those services. In
accordance with SFAS 71, the Company does not eliminate the intersegment
profit recognized on these services because the Company 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. The Company does, however,
eliminate the Services Groups revenues to the extent of its cost.
Consequently, Services Group revenues reflected in the consolidated statements
of income include intersegment gross profits as follows:
|
|
Years
Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
Services Group revenues:
|
|
|
|
|
|
|
|
From unaffiliated customers
|
|
$
|
119,254
|
|
$
|
125,558
|
|
$
|
114,515
|
|
Intersegment profits
|
|
4,723
|
|
6,923
|
|
4,205
|
|
Total revenues
|
|
$
|
123,977
|
|
$
|
132,481
|
|
$
|
118,720
|
|
(2)
Reflects
corporate headquarters general and administrative expenses and interest
expense, net of interest income charged on intercompany debt. Corporate and
other assets reflect corporate headquarters assets, excluding investments in
and receivables from subsidiaries.
(3)
Reflects the
elimination of Services Group revenues derived from the Utility Group, to the
extent of costs as described in (1) above. In addition, a company in the
Utility Group provides services to a company in the Services Group.
Intersegment revenues and expenses, including all profit, associated with these
services are fully eliminated upon consolidation.
F-51
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
Note 16. Selected Quarterly Financial Information
(Unaudited)
Selected unaudited quarterly consolidated financial
information is presented in the tables below. The fluctuations in revenues,
operating income and net income between quarters reflects the seasonal nature
of the Companys operations.
(In thousands, except per share data)
|
|
1st
Quarter
|
|
2nd
Quarter
|
|
3rd
Quarter
|
|
4th
Quarter
|
|
Year Ended December 31,
2007:
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
47,869
|
|
$
|
54,896
|
|
$
|
57,173
|
|
$
|
57,409
|
|
Operating income (loss)
|
|
3,088
|
|
5,648
|
|
5,412
|
|
(11,289
|
)
|
Income (loss) from continuing operations
|
|
840
|
|
2,421
|
|
2,291
|
|
(10,572
|
)
|
Loss from discontinued operations
|
|
(226
|
)
|
(198
|
)
|
(216
|
)
|
(2,386
|
)
|
Net income (loss)
|
|
614
|
|
2,223
|
|
2,075
|
|
(12,958
|
)
|
Net income (loss) applicable to common stockholders
|
|
608
|
|
2,217
|
|
2,069
|
|
(12,964
|
)
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per common share:
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
0.03
|
|
$
|
0.10
|
|
$
|
0.09
|
|
$
|
(0.44
|
)
|
Loss from discontinued operations
|
|
|
|
(0.01
|
)
|
|
|
(0.09
|
)
|
Net income (loss) applicable to common stockholders
|
|
$
|
0.03
|
|
$
|
0.09
|
|
$
|
0.09
|
|
$
|
(0.53
|
)
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per common share:
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
0.03
|
|
$
|
0.10
|
|
$
|
0.09
|
|
$
|
(0.44
|
)
|
Loss from discontinued operations
|
|
|
|
(0.01
|
)
|
(0.01
|
)
|
(0.09
|
)
|
Net income (loss) applicable to common stockholders
|
|
$
|
0.03
|
|
$
|
0.09
|
|
$
|
0.08
|
|
$
|
(0.53
|
)
|
During the fourth quarter
of 2007, the Company recorded goodwill impairment charges total $17.2 million
related to its Texas Utilities (Note 5) and reduced the carrying value of
assets held for sale by $3.4 million to expected realizable value (Note 2).
Year Ended December 31,
2006:
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
49,446
|
|
$
|
54,148
|
|
$
|
58,796
|
|
$
|
56,412
|
|
Operating income
|
|
3,077
|
|
5,018
|
|
7,817
|
|
6,507
|
|
Income from continuing operations
|
|
885
|
|
1,972
|
|
3,843
|
|
3,309
|
|
Loss from discontinued operations
|
|
(184
|
)
|
(156
|
)
|
(171
|
)
|
(170
|
)
|
Net income
|
|
772
|
|
1,816
|
|
3,672
|
|
3,139
|
|
Net income applicable to common stockholders
|
|
766
|
|
1,810
|
|
3,666
|
|
3,133
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share:
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
$
|
0.04
|
|
$
|
0.09
|
|
$
|
0.17
|
|
$
|
0.14
|
|
Loss from discontinued operations
|
|
(0.01
|
)
|
(0.01
|
)
|
(0.01
|
)
|
(0.01
|
)
|
Cumulative effect of change in accounting principle
|
|
|
|
|
|
|
|
|
|
Net income applicable to common stockholders
|
|
$
|
0.03
|
|
$
|
0.08
|
|
$
|
0.16
|
|
$
|
0.13
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per common share:
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
$
|
0.04
|
|
$
|
0.08
|
|
$
|
0.16
|
|
$
|
0.14
|
|
Loss from discontinued operations
|
|
(0.01
|
)
|
|
|
|
|
(0.01
|
)
|
Cumulative effect of change in accounting principle
|
|
|
|
|
|
|
|
|
|
Net income applicable to common stockholders
|
|
$
|
0.03
|
|
$
|
0.08
|
|
$
|
0.16
|
|
$
|
0.13
|
|
F-52
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 17. Subsequent Events
Acquisition
On January 31, 2008, the Company purchased the
assets of a wastewater collection system and related treatment plant (commonly
referred to as the Riverview System) from the Shelby County Governmental
Utility Services Corporation. The purchase price was $22.5 million in cash at
closing.
The cash required to fund the acquisition was
borrowed under the Companys $100 million revolving line of credit.
$150 million Revolving Credit
Facility
On February 15, 2008, the Company entered into a
credit agreement with several lenders including Bank of America, as lender and
Administrative Agent, KeyBank, CoBank, U.S. Bank, JPMorgan Chase Bank, Comerica
Bank, Bank of the West, Citibank and Union Bank of California. The credit
agreement provides for a $150.0 million revolving credit facility. The Company
may elect to increase the amount of the credit facility by an amount not to exceed
$75.0 million during the term of the agreement provided certain conditions are
met.
The revolving line of credit commitment ends on February 15,
2013, at which time all borrowings must be repaid. Borrowings under the credit
facility bear interest, at the Companys option, based on a margin either over
the LIBOR rate or under the prime rate. The margins vary depending upon the
Companys consolidated debt to equity ratio. Proceeds from the initial $84.5
million borrowing under the credit agreement were used to repay borrowings
under the $100.0 million revolving line of credit which was terminated upon
repayment.
Currently, the applicable margins are 0.750% over the
LIBOR rate or 0.25% under the prime rate. The Company is subject to commitment
fees under the facility as well as the maintenance of customary financial
ratios, cash flow results and other restrictive covenants.
F-53
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
SCHEDULE ICONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE
SHEETS
|
|
December 31,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,451
|
|
$
|
1,825
|
|
Receivable from subsidiaries, net
|
|
74,599
|
|
68,235
|
|
Other current assets
|
|
6,220
|
|
5,746
|
|
Total current assets
|
|
82,270
|
|
75,806
|
|
|
|
|
|
|
|
Property, plant and
equipment, net
|
|
10,668
|
|
569
|
|
Investments in subsidiaries
|
|
147,315
|
|
148,745
|
|
Other assets
|
|
4,897
|
|
4,734
|
|
|
|
$
|
245,150
|
|
$
|
229,854
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS
EQUITY
|
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,297
|
|
$
|
357
|
|
Current portion of long-term debt
|
|
919
|
|
|
|
Other current liabilities
|
|
7,960
|
|
5,350
|
|
Total current liabilities
|
|
11,176
|
|
5,707
|
|
|
|
|
|
|
|
Long-term debt:
|
|
|
|
|
|
Revolving line of credit
|
|
51,000
|
|
36,000
|
|
Convertible subordinated debentures
|
|
12,053
|
|
12,610
|
|
Capital leases and other indebtedness
|
|
3,759
|
|
|
|
Total long-term debt
|
|
66,812
|
|
48,610
|
|
|
|
|
|
|
|
Deferred income taxes
|
|
3,596
|
|
4,630
|
|
Other liabilities
|
|
4,372
|
|
4,380
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders Equity:
|
|
|
|
|
|
Cumulative preferred stock
|
|
458
|
|
458
|
|
Common stock
|
|
243
|
|
238
|
|
Additional paid-in capital
|
|
145,072
|
|
138,728
|
|
Retained earnings
|
|
13,336
|
|
27,031
|
|
Accumulated other comprehensive income
|
|
85
|
|
72
|
|
Total stockholders equity
|
|
159,194
|
|
166,527
|
|
|
|
$
|
245,150
|
|
$
|
229,854
|
|
See
accompanying notes to condensed financial information of registrant.
F-54
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
SCHEDULE ICONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENTS
OF OPERATIONS
|
|
Years Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
|
|
$
|
|
|
$
|
|
|
Selling, general and
administrative expenses
|
|
3,228
|
|
1,389
|
|
1,283
|
|
Operating loss
|
|
(3,228
|
)
|
(1,389
|
)
|
(1,283
|
)
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
Interest expense
|
|
(1,251
|
)
|
(269
|
)
|
(783
|
)
|
Interest income
|
|
51
|
|
111
|
|
53
|
|
Other, net
|
|
91
|
|
61
|
|
32
|
|
|
|
|
|
|
|
|
|
Loss from continuing
operations before income taxes
|
|
(4,337
|
)
|
(1,486
|
)
|
(1,981
|
)
|
Income tax benefit
|
|
1,452
|
|
520
|
|
681
|
|
|
|
|
|
|
|
|
|
Loss from continuing
operations
|
|
(2,885
|
)
|
(966
|
)
|
(1,300
|
)
|
Cumulative effect of change
in accounting principle, net of tax
|
|
|
|
71
|
|
|
|
Loss on sale of
discontinued operations, net of tax
|
|
|
|
|
|
(3,624
|
)
|
|
|
|
|
|
|
|
|
Loss before equity in net
income of subsidiaries
|
|
(2,885
|
)
|
(895
|
)
|
(4,924
|
)
|
|
|
|
|
|
|
|
|
Equity in net income (loss)
of subsidiaries
|
|
(5,161
|
)
|
10,294
|
|
7,323
|
|
Net income (loss)
|
|
$
|
(8,046
|
)
|
$
|
9,399
|
|
$
|
2,399
|
|
See
accompanying notes to condensed financial information of registrant.
F-55
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
SCHEDULE ICONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENTS
OF CASH FLOWS
|
|
Years
Ended December 31,
|
|
(In thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Cash flows from operating
activities:
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(8,046
|
)
|
$
|
9,399
|
|
$
|
2,399
|
|
Adjustments to reconcile net income to net cash provided
by operating activities:
|
|
|
|
|
|
|
|
Equity in net (income) loss of subsidiaries
|
|
5,161
|
|
(10,294
|
)
|
(7,323
|
)
|
Cumulative effect of change in accounting principle
|
|
|
|
(71
|
)
|
|
|
Loss on sale of discontinued operations, net of tax
|
|
|
|
|
|
3,624
|
|
Depreciation and amortization
|
|
336
|
|
333
|
|
424
|
|
Deferred income taxes
|
|
(4,541
|
)
|
1,877
|
|
1,738
|
|
Share-based compensation expense
|
|
1,861
|
|
1,079
|
|
966
|
|
Changes in assets and liabilities, net of effects of acquisitions:
|
|
|
|
|
|
|
|
Other current assets
|
|
2,778
|
|
2,488
|
|
3,594
|
|
Other current liabilities
|
|
3,895
|
|
(1,310
|
)
|
(2,102
|
)
|
Other, net
|
|
(343
|
)
|
(27
|
)
|
(138
|
)
|
Net cash provided by operating activities
|
|
1,101
|
|
3,474
|
|
3,182
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities:
|
|
|
|
|
|
|
|
Acquisition of businesses, net of cash acquired
|
|
(8,069
|
)
|
(1,719
|
)
|
(12,312
|
)
|
Additions to property, plant and equipment
|
|
(5,543
|
)
|
(9
|
)
|
(90
|
)
|
Dividends received from subsidiaries
|
|
5,187
|
|
4,875
|
|
4,383
|
|
Purchase of minority interest
|
|
|
|
(1,013
|
)
|
|
|
Cash proceeds from sale of discontinued operations
|
|
|
|
|
|
9,206
|
|
Net cash provided by (used in) investing activities
|
|
(8,425
|
)
|
2,134
|
|
1,187
|
|
|
|
|
|
|
|
|
|
Cash Flows from financing
activities:
|
|
|
|
|
|
|
|
Borrowings under lines of credit
|
|
15,000
|
|
6,000
|
|
10,000
|
|
Proceeds from share-based equity incentive plans and stock purchase
plans
|
|
3,545
|
|
10,598
|
|
12,131
|
|
Excess tax benefit from stock options exercised
|
|
414
|
|
1,478
|
|
|
|
Net change intercompany receivables and payables
|
|
(6,301
|
)
|
(19,315
|
)
|
(19,554
|
)
|
Dividends paid
|
|
(5,649
|
)
|
(5,000
|
)
|
(4,221
|
)
|
Payments on long-term debt
|
|
(59
|
)
|
|
|
|
|
Repurchase of preferred stock
|
|
|
|
(2
|
)
|
|
|
Deferred financing costs
|
|
|
|
|
|
(900
|
)
|
Net cash provided by (used in) financing activities
|
|
6,950
|
|
(6,241
|
)
|
(2,544
|
)
|
|
|
|
|
|
|
|
|
Net increase (decrease) in
cash and cash equivalents
|
|
(374
|
)
|
(633
|
)
|
1,825
|
|
Cash and cash equivalents
at beginning of year
|
|
1,825
|
|
2,458
|
|
633
|
|
Cash and cash equivalents
at end of year
|
|
$
|
1,451
|
|
$
|
1,825
|
|
$
|
2,458
|
|
See
accompanying notes to condensed financial information of registrant.
F-56
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO SCHEDULE
ICONSOLIDATED FINANCIAL INFORMATION OF REGISTRANT
Note 1. Summary of Significant Accounting
Policies
Basis of Presentation
In accordance with the requirements of Regulation S-X
of the Securities and Exchange Commission, the financial statements of the
Registrant (the Company) are condensed and omit many disclosures presented in
the consolidated financial statements and the notes thereto.
Other Income
Other income consists of management fees charged by
the Company to its subsidiaries.
Share-Based Compensation
The Company has a plan which allows for the granting
of stock options. As more fully described in Note 13 to the consolidated
financial statements, effective January 1, 2006 the Company adopted the
provisions of SFAS No. 123 (revised 2004),
Share-Based
Payment
(SFAS 123(R))
,
using the
modified prospective method. The Company applies SFAS 123(R) to
accounting for its stock option grants. Accordingly, compensation expense is
recognized for the fair value of the stock options as of the grant dates over
the vesting period.
Supplemental Executive
Retirement Plan
As more fully described in Note 14 to consolidated
financial statements, the Company has a supplemental executive retirement plan.
In September 2006, the 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. In addition, the
measurement date (the date at which plan assets and the benefit obligation are
measured) is required to be the same as a companys fiscal year end.
SFAS 158 is effective for publicly-held companies for fiscal years ending
after December 15, 2006, except for the measurement date provisions, which
are effective for fiscal years ending after December 15, 2008. The Company
has historically used December 31
st
as the measurement date for
its postretirement benefit plan. The adoption of SFAS 158 reduced total
liabilities and increased total stockholders equity by less than $0.1 million,
net of taxes. The adoption of SFAS 158 did not have a material effect on
the consolidated financial statements for 2006 and the Company believes it will
not have a material effect in 2007 and beyond.
Income Taxes
Income taxes are accounted for using the asset and
liability method. Deferred tax assets and liabilities are recorded in order to
recognize future tax effects attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, as well as the recognition of operating losses and tax
credit carryforwards. Deferred tax assets and liabilities are recorded using
enacted tax rates expected to apply to taxable income in the years in which the
temporary differences are recovered or settled. The effect of a change in tax
rates on deferred tax assets and liabilities is recognized in the period that
the enactment occurs. The Company files a consolidated U.S. federal income tax
return which includes all of its subsidiaries.
F-57
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO SCHEDULE
ICONSOLIDATED FINANCIAL INFORMATION OF REGISTRANT
Note 2. Long-Term Debt
During 2001, the Company issued $20.0 million in
long-term convertible subordinate debentures. The debentures bear a fixed
interest rate of 6.85% and mature in 2021. Approximately $7.9 million of the
debentures have been converted into the Companys common stock in accordance
with their terms and $12.1 million remain issued and outstanding as of December 31,
2007. The Company also had $51.0 million and $36.0 million of borrowings
outstanding under its $100.0 million long-term revolving credit facility as of December 31,
2007 and 2006, respectively. In December 2007, the Company obtained a
$30.0 million equipment leasing line of credit and the Company leased $4.6
million of equipment pursuant to this agreement.
In January 2008, the Company borrowed $22.5
million under the credit facility to fund the closing of an acquisition and in February 2008,
the Company entered into a new $150.0 million revolving credit facility and
used the initial borrowing under the new facility to repay borrowings
outstanding under the $100.0 million credit facility; the $100.0 million credit
facility was terminated upon repayment (Note 17).
Note 3. Commitments and Contingencies
Legal Proceedings
New Mexico Utilities, Inc.
New Mexico Utilities, Inc. (NMUI), one of the
Companys wholly-owned regulated utilities, has an agreement with the
Albuquerque Bernalillo County Water Utility Authority, a political subdivision
of the State of New Mexico (the Water Authority), whereby the Water Authority
treats the effluent from NMUIs wastewater collection system for a fee. The
treated effluent is returned to the Rio Grande Underground Basin, creating
return flow credits. Return flow credits supplement NMUIs existing water
rights, enabling it to pump additional water from the basin.
In August 2004, the Water Authority increased
the fee charged to NMUI, using a different formula than had been used to
calculate fee increases in prior years. The Company believes the increase
violates the terms of a written agreement between the parties. Subsequently,
the Water Authority also claimed ownership of the return flow credits. The
Company filed a Complaint for Declaratory Judgment in the Second Judicial
District Court, County of Bernalillo, State of New Mexico, requesting that the
Court settle these disputes. In a letter ruling dated May 2, 2007, the
Court ruled that the Water Authority could use a new formula to set fees for
NMUI. The Company filed a motion for reconsideration and that motion was denied
on October 2, 2007. The matter has now been set for trial in the fall of
2008. The Court has not ruled on whether the new rate was appropriate; has made
no determination as to any amount NMUI may owe to the Water Authority, or ruled
on the ownership of the return flow credits.
Although the Company cannot give any assurances as to
the ultimate resolution of this matter, the Company does not believe that it is
probable it will be required to pay the disputed fees and related late payment
penalties, which totaled $4.9 million as of December 31, 2007, and has not
recognized a reserve for any potential liabilities in the accompanying
consolidated financial statements. In addition, should the Court rule against
NMUI, the New Mexico Public Regulation Commission has indicated its support of
NMUIs proposal that it be permitted to establish a regulatory asset for any
amounts paid, including late payment penalties, and recover that asset
prospectively through a rate surcharge to its customers. The Company is unable
to predict the impact the resolution of the return flow credits ownership
dispute will have on its consolidated financial statements.
F-58
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO SCHEDULE
ICONSOLIDATED FINANCIAL INFORMATION OF REGISTRANT
Note 3. Commitments and Contingencies (Continued)
In September 2007, NMUI received a $0.7 million
retroactive billing adjustment from the Water Authority covering the period
from August 2003 through April 2006 for the volume of wastewater it
believes NMUI discharged into the treatment system versus the amount reported
by NMUI. The amounts reported by NMUI were based on a calculation methodology
that had been agreed to by both parties and used for approximately 30 years.
NMUI is contesting the billing adjustment. Although the Company cannot give any
assurances as to the ultimate resolution of this matter, the Company does not
believe that it is probable it will be required to pay the retroactive billing
and therefore has not recognized a reserve for any potential liability for this
amount in the accompanying consolidated financial statements.
On February 26, 2008, the Company was made aware of a
Claim of Lien filed by the Water Authority against NMUI in the sum of $5.8
million, allegedly for delinquent sewer charges. This lien is related to the
above described matters currently being litigated in New Mexico State Court.
In addition, on January 19, 2007, the Water
Authority and the City of Rio Rancho, a home-rule municipal corporation,
as Petitioners, filed a Petition for Condemnation against NMUI and others, as
Defendants, in the Second Judicial District Court, County of Bernalillo, State
of New Mexico (the Petition). The Petition seeks to acquire, by condemnation,
all of the assets of NMUI, including all real property, through the stated
power of eminent domain. The Petition also alleges that the Petitioners need to
acquire the NMUI assets for the public purposes of providing water and
wastewater services to NMUI customers and that the acquisition of NMUI is
necessary, appropriate and in the public interest. The Company is contesting
the Petition and the matter is scheduled for trial in the fall of 2008. If the
Company does not prevail, the Petitioners must pay fair market value for the
utility 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, the
Company believes that the fair market value of NMUI exceeds its recorded net
book value as of December 31, 2007.
Suburban Water Systems
Suburban Water Systems, one of the Companys wholly
owned subsidiaries, and the Company were named as defendants in several
lawsuits alleging various injuries as a result of water contamination in the
San Gabriel Valley Main Basin. The California Supreme Court ruled in February 2002
that the plaintiffs could not challenge the adequacy of the water quality
standards established by California Department of Health Services. In August 2004,
the case against SouthWest Water and its subsidiary was dismissed; however, the
plaintiffs appealed the dismissal to the Court of Appeals for the State of
California, First Appellate District (1DCA Civil No. B178283). Oral
arguments for the appeal were presented on June 20, 2007 and the Company
(and the other defendants) prevailed at the appellate level. The Court ruled
that the only time a regulated water utility or public water company can be
held liable in tort for water quality issues is when they have violated a
numerical standard set by the Department of Health Services or other similar
regulatory agency. Liability insurance carriers have absorbed all costs related
to the lawsuits and appeals. The parties have entered into a settlement
agreement which provides, in part, that no further appeals will be filed, effectively
ending this litigation.
F-59
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
NOTES TO SCHEDULE
ICONSOLIDATED FINANCIAL INFORMATION OF REGISTRANT
Note 3. Commitments and Contingencies (Continued)
Other Matters
The Company and its subsidiaries are also involved in
other routine legal and administrative proceedings arising during the ordinary
course of business. The Company believes the ultimate disposition of such
matters will not have a material adverse effect on its business, consolidated
financial position, results of operations or cash flows.
Commitment Under Long-term
Service Contract
The Company was 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). The Company now operates and maintains the facility
under a 20-year contract. As part of the financing for this project, the CVWD
sold insured municipal bonds. The Company entered into an agreement with the
bond insurer to guarantee the Companys 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.
Limitations on Dividends at
our California and New Mexico Utilities
Two of the Companys wholly-owned subsidiaries,
Suburban Water Systems and New Mexico Utilities, Inc., are limited by
their mortgage bond agreements as to the amount of cash and property dividends
they may distribute to the Company. Dividends over the last three years have
ranged between $4.4 million to $5.2 million per year and are less than the
dividend restriction threshold by $50.4 million as of December 31, 2007.
F-60
SOUTHWEST
WATER COMPANY AND SUBSIDIARIES
SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS
(In thousands)
|
|
Balance
at Beginning of Year
|
|
Provision
Charged to Expense
|
|
Recoveries
and / or Acquisitions
|
|
Accounts
Written Off
|
|
Balance
at
End of
Year
|
|
Allowance for doubtful
accounts:
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2007
|
|
$
|
1,832
|
|
$
|
280
|
|
$
|
21
|
|
$
|
(758
|
)
|
$
|
1,375
|
|
Year ended December 31, 2006
|
|
2,152
|
|
713
|
|
4
|
|
(1,037
|
)
|
1,832
|
|
Year ended December 31, 2005
|
|
2,170
|
|
1,009
|
|
43
|
|
(1,070
|
)
|
2,152
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-61
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