UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number: 0-8176
-------------------------------
[LOGO] Southwest Water Company
(Exact name of registrant as specified in its charter)
Delaware 95-1840947
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 North Barranca Avenue, Suite 200
West Covina, California 91791-1605
(Address of principal executive offices) (Zip Code)
(626) 915-1551
(Registrant's telephone number, including area code)
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 [ ]
On November 9, 2001, there were 9,171,339 common shares outstanding.
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
INDEX
Part I. Financial Information: Page No.
- ------- ---------------------- --------
Item 1. Financial Statements:
Condensed Consolidated Statements of Income -
Three and Nine Months ended September 30, 2001 and 2000 1
Condensed Consolidated Balance Sheets -
September 30, 2001 and December 31, 2000 2
Condensed Consolidated Statements of Cash Flows -
Nine Months ended September 30, 2001 and 2000 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk 11
Part II. Other Information:
- -------- ------------------
Item 1. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 6. Exhibits and Reports on Form 8-K 12
Signatures 13
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest Water Company and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------ ----------------------------------
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------ ----------------------------------
(in thousands except per share data) (in thousands except per share data)
Operating Revenues $ 32,035 $ 31,080 $ 83,088 $ 78,256
Operating Expenses:
Direct operating expenses 23,191 23,283 61,738 58,914
Selling, general and administrative expenses 4,358 3,388 12,046 10,185
- ------------------------------------------------------------------------------------------ ----------------------------------
27,549 26,671 73,784 69,099
Operating Income 4,486 4,409 9,304 9,157
Other Income (Expense):
Interest expense (1,046) (1,023) (2,833) (2,784)
Interest income 8 190 40 293
Other income (expense) 104 (23) 627 109
- ------------------------------------------------------------------------------------------ ----------------------------------
(934) (856) (2,166) (2,382)
Income Before Income Taxes 3,552 3,553 7,138 6,775
Provision for income taxes 1,279 1,421 2,641 2,710
- ------------------------------------------------------------------------------------------ ----------------------------------
Net Income 2,273 2,132 4,497 4,065
Dividends on preferred shares 7 7 21 21
- ------------------------------------------------------------------------------------------ ----------------------------------
Net Income Available for Common Shares $ 2,266 $ 2,125 $ 4,476 $ 4,044
- ------------------------------------------------------------------------------------------ ----------------------------------
Earnings per Common Share (Note 3):
Basic $ 0.25 $ 0.25 $ 0.49 $ 0.48
Diluted $ 0.24 $ 0.24 $ 0.47 $ 0.46
- ------------------------------------------------------------------------------------------ ----------------------------------
Cash Dividends per Common Share $ 0.05 $ 0.05 $ 0.16 $ 0.16
- ------------------------------------------------------------------------------------------ ----------------------------------
Weighted Average Outstanding Common Shares (Note 3):
Basic 9,092 8,503 9,046 8,487
Diluted 9,588 8,850 9,500 8,842
========================================================================================== ===================================
See accompanying notes to condensed consolidated financial statements.
1
Southwest Water Company and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
- --------------------------------------------------------------------------------------------------------------------
ASSETS 2001 2000
- --------------------------------------------------------------------------------------------------------------------
(unaudited)
(in thousands)
Current Assets:
Cash and cash equivalents $ 544 $ 1,379
Customers' accounts receivable, net 24,622 17,830
Other current assets 10,798 7,597
- --------------------------------------------------------------------------------------------------------------------
35,964 26,806
Property, Plant and Equipment:
Utility property, plant and equipment - at cost 215,115 206,100
Contract operations property, plant and equipment - at cost 11,334 8,394
- --------------------------------------------------------------------------------------------------------------------
226,449 214,494
Less accumulated depreciation and amortization 60,764 56,651
- --------------------------------------------------------------------------------------------------------------------
165,685 157,843
Other Assets 20,461 12,003
- --------------------------------------------------------------------------------------------------------------------
$ 222,110 $ 196,652
====================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Current portion of long-term debt and bank notes payable $ 3,808 $ 5,166
Accounts payable 5,571 5,983
Other current liabilities 17,409 14,438
- --------------------------------------------------------------------------------------------------------------------
26,788 25,587
Other Liabilities and Deferred Credits:
Long-term debt 47,100 27,100
Bank notes payable 11,744 19,251
Advances for construction 7,683 7,891
Contributions in aid of construction 52,699 50,644
Deferred income taxes 8,797 6,988
Other liabilities and deferred credits 13,785 10,580
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities and Deferred Credits 168,596 148,041
Stockholders' Equity:
Cumulative preferred stock 514 514
Common stock 91 86
Paid-in capital 37,441 35,568
Retained earnings 15,468 12,443
- --------------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 53,514 48,611
- --------------------------------------------------------------------------------------------------------------------
$ 222,110 $ 196,652
====================================================================================================================
See accompanying notes to condensed consolidated financial statements.
2
Southwest Water Company and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
September 30,
- ---------------------------------------------------------------------------------------------------------
2001 2000
- ---------------------------------------------------------------------------------------------------------
(in thousands)
Cash Flows From Operating Activities:
Net income $ 4,497 $ 4,065
Adjustments to reconcile net income to net cash
used in operating activities (3,049) (2,196)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,448 1,869
- ---------------------------------------------------------------------------------------------------------
Cash Flows From Investing Activities:
Additions to property, plant and equipment (11,446) (13,612)
Acquisition of businesses, net of cash acquired (3,530) (5,716)
- ---------------------------------------------------------------------------------------------------------
Net cash used in investing activities (14,976) (19,328)
- ---------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities:
Gross proceeds from issuance of long-term debt 20,000 --
Contributions in aid of construction and advances for construction 2,254 1,203
Net proceeds from dividend reinvestment plan,
employee stock purchase plan and stock option plans 533 758
Advances for construction 14 325
Net proceeds from (repayment of) bank notes payable (8,422) 12,904
Dividends paid (1,464) (1,184)
Payments on advances (222) (160)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 12,693 13,846
- ---------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (835) (3,613)
Cash and cash equivalents at beginning of period 1,379 4,146
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 544 $ 533
=========================================================================================================
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 1,690 $ 2,582
Income taxes $ 1,630 $ 867
Depreciation and amortization $ 4,392 $ 3,775
Non-cash investing and financing activities:
Purchase of businesses
Fair value of assets acquired $ 9,119 $ 7,476
Cash paid (3,530) (2,380)
Note issued (3,000) (2,000)
Stock issued (1,300) --
------------------------------------
Liabilities assumed $ 1,289 $ 3,096
====================================
Non-cash contributions in aid of construction
conveyed to the Company by developers $ 899 $ 1,517
See accompanying notes to condensed consolidated financial statements.
3
SOUTHWEST WATER COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(Unaudited)
1. Southwest Water Company (Southwest Water, the Company, or "we", "us" or
"our") was incorporated in California in 1954 and reincorporated in
Delaware in 1988. Southwest Water is a publicly traded holding company.
All business operations are conducted through our subsidiaries which
provide a broad range of services including water production and
distribution, wastewater collection and treatment, public works
services and utility submetering. We serve more than 1.5 million people
in 29 states nationwide. Our business is segmented into non-regulated
and regulated operations.
We operate non-regulated businesses. Through our wholly owned
subsidiary, ECO Resources, Inc. (ECO), we operate and manage water and
wastewater treatment facilities owned by cities, public agencies,
municipal utility districts and private entities. On August 31, 2001,
we acquired a 90% interest in Operations Technologies, Inc. (OpTech),
also a provider of contract water, wastewater and public works services
in the southeastern United States. Nationwide, we provide utility
submetering and billing and collection services through our 80%-owned
subsidiary, Master Tek International, Inc. (MTI). These companies may
be subject to regulatory oversight; however, the pricing of our
services is not subject to regulation.
We own rate-regulated public water utilities. State regulatory agencies
oversee the operations of our utilities as well as establish the rates
that we can charge for our services. We own and operate water and
wastewater utilities through four subsidiaries. Suburban Water Systems
(Suburban), New Mexico Utilities, Inc. (NMUI) and Hornsby Bend Utility
Company (Hornsby) are wholly owned, and we also own 80% of Windermere
Utility Company (Windermere).
The unaudited condensed consolidated financial statements reflect all
adjustments which, in our opinion, are necessary to present fairly the
financial position of Southwest Water as of September 30, 2001, and our
results of operations for the three and nine months ended September 30,
2001 and 2000. These adjustments are of a normal recurring nature.
Certain reclassifications have been made to the 2000 financial
statements to conform to the 2001 presentation.
2. Certain information and footnote disclosures normally included in our
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America (US GAAP) have been
condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission (the SEC). Our condensed
consolidated financial statements should be read in conjunction with
the financial statements and related notes contained in our Annual
Report on Form 10-K for the year ended December 31, 2000 (the 2000
Annual Report). Except as otherwise disclosed in Note 6, we are not
aware of any new accounting standards that would have a material impact
on our financial position, results of operations or cash flows.
3. We record earnings per share (EPS) by computing basic EPS and diluted
EPS in accordance with US GAAP. Basic EPS measures our Company's
performance over the reporting period by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted EPS measures our Company's
performance over the reporting period after giving effect to all
potentially dilutive common shares that would have been outstanding if
the dilutive common shares had been issued. Stock options, convertible
debentures and warrants give rise to potentially dilutive common
shares. On September 25, 2001 our Board of Directors declared a five
percent stock dividend payable on October 22, 2001 to stockholders of
record on October 1, 2001. Per share amounts and shares outstanding in
this report on Form 10-Q for the period ended September 30, 2001 have
been restated to reflect the dividend.
4. On August 31, 2001, we purchased 90% of the outstanding shares of
OpTech, a provider of contract water, wastewater and public works
services in the southeastern United States, for a purchase price of
$7,830,000. The purchase price consisted of a $3,530,000 cash payment,
91,981 shares of Southwest Water common stock with a value of
$1,300,000 and $3,000,000 of promissory notes. In addition, we entered
into an employment agreement and a non-compete
4
agreement with the owner of the remaining 10% of OpTech. In 2000,
OpTech generated more than $10,000,000 in revenue. See also Note 6.
5. On July 20, 2001, we issued $20,000,000 of 6.85% fixed rate convertible
subordinate debentures due July 1, 2021, and we received proceeds of
$19,200,000 from the sale after the underwriting discounts and
commissions. The final net proceeds from the sale of these debentures
were approximately $18,890,000 after deducting the remaining expenses
of the offering. We used the net proceeds from the sale of these
debentures to reduce borrowings on our revolving lines of credit and
for working capital.
6. Effective June 2001, we became subject to Statement of Financial
Accounting Standards (SFAS) No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
all business combinations be recorded using the purchase method of
accounting. SFAS No. 141 also requires the separate recognition of
intangible assets that can be identified and named, and requires that
they be recognized apart from goodwill. Under the provisions of SFAS
No. 142, goodwill is no longer subject to amortization over its
estimated useful life. Instead, goodwill is assessed for impairment on
an annual basis (or more frequently if circumstances indicate a
possible impairment) by means of a fair-value-based test. SFAS No. 142
requires that existing goodwill as of June 30, 2001 continue to be
amortized through the end of the current calendar year, after which no
further amortization of goodwill will be permitted. Goodwill incurred
subsequent to June 30, 2001 will not be amortized over a fixed period,
but rather, periodically assessed for impairment. When we acquired
OpTech as described in Note 4 above, we recorded approximately
$8,000,000 of goodwill. The purchase price allocated in accordance with
SFAS No. 141 has not yet been completed. At this time, we believe there
has been no impairment of our existing goodwill, and that the
implementation of SFAS No. 142 will not have a material adverse effect
on our future results of operations.
Effective January 2002, we will be subject to SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144
supercedes the requirements of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of. SFAS No. 144 retains the requirement that long-lived
assets be tested for recoverability when events or changes in
circumstances indicate carrying amounts may not be recoverable. SFAS
No. 144 further clarifies the methods of accounting for assets that are
disposed of. We regularly review assets for impairment and we do not
believe that the implementation of SFAS No. 144 will result in any
material adverse effect on our future results of operations or
financial condition. SFAS No. 144 does not apply to goodwill impairment
which is accounted for under SFAS No. 142 as described above.
5
7. We have two reportable segments as defined under the requirements of
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. We have not changed the basis of segmentation or the basis
of measurement of segment profit or loss from the information reported
in our 2000 Annual Report.
The following table sets forth disclosure about our reportable segments
as required by SFAS No. 131.
Total Total
Non- Segment Consolidated
Regulated Regulated Information Other Information
--------------------------------------------------------
(in thousands)
Nine Months Ended September 30, 2001
- ------------------------------------
Revenues from external customers $ 46,174 $ 36,914 $ 83,088 $ 0 $ 83,088
Segment operating profit 1,836 10,721 12,557 (3,253) 9,304
As of September 30, 2001
- ------------------------
Segment assets $ 46,296 $172,244 $218,540 $ 3,570 $222,110
Nine Months Ended September 30, 2000
- ------------------------------------
Revenues from external customers $ 45,051 $ 33,205 $ 78,256 $ 0 $ 78,256
Segment operating profit 2,387 9,671 12,058 (2,901) 9,157
As of September 30, 2000
- ------------------------
Segment assets $ 30,191 $132,184 $162,375 $ 7,011 $169,386
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Our liquidity, capital resources and cash flows from operations are
influenced primarily by construction expenditures at Suburban, NMUI, Windermere
and Hornsby for the addition, replacement and renovation of water and wastewater
utility facilities. Our capital resources are also influenced by investments in
new business opportunities, including the acquisition of companies, funding of
projects and acquisition of contracts. As fully described in our 2000 Annual
Report, ECO financed and built a reverse osmosis water treatment plant. In
connection with this project, ECO recorded a receivable in the amount of
approximately $6,000,000 for the work done and expects to receive payment for
the full amount in the fourth quarter of 2001.
As of September 30, 2001, we had cash and cash-equivalent balances
totaling $544,000 and aggregate lines of credit totaling $24,000,000 consisting
of three separate unsecured lines of credit from three commercial banks. Two of
the lines of credit expire in 2003 and the remaining line expires in 2002. As
of September 30, 2001, we had $14,298,000 outstanding on these lines of credit.
During the first nine months of 2001, our outstanding line of credit borrowing
decreased $8,422,000. On July 20, 2001, we received net proceeds of
approximately $18,890,000 from our 20-year fixed rate convertible subordinate
debenture offering and a portion of the proceeds was used to reduce the
outstanding balances on our bank lines of credit. As part of the debenture
offering, our aggregate borrowing capacity on our bank lines of credit was
reduced from $30,000,000 to $24,000,000.
We expect to maintain our lines of credit in the normal course of
business. Each of the line of credit agreements contains certain financial
covenants. As of September 30, 2001, we were in compliance with all applicable
covenants of the line of credit agreements. As of September 30, 2001, we were
also in compliance with all restrictions under the convertible subordinate
debentures.
6
In addition to our lines of credit, we have existing borrowing capacity
under our First Mortgage Bond Indentures of approximately $52,000,000 as of
September 30, 2001. However, our additional borrowing available under our
current commercial lines of credit is limited by financial covenants that
restrict additional borrowing at September 30, 2001 to an amount no greater than
the remaining unused credit line amount.
During the first nine months of 2001, our additions to property, plant
and equipment were $12,345,000, representing an increase from the same period in
2000 of $6,616,000. The increase was due primarily to the addition of utility
plant at Suburban, NMUI, Windermere and Hornsby, including a new well at NMUI
and a wastewater treatment plant at Windermere, among other projects. In
addition, ECO is expanding an office building in Austin, Texas. Developers made
contributions in aid of construction (CIAC) and advances totaling $3,167,000
during the nine months ended September 30, 2001, of which $2,268,000 was
received in cash and $899,000 was received as non-cash contributions of
property. Company-financed capital additions were $9,178,000, funded primarily
by cash flow from operations and borrowing on the lines of credit. We estimate
that our total capital additions in 2001 will be approximately $13,000,000,
primarily for utility plant, and that our cash flow from operations, borrowings
on our lines of credit and CIAC will fund these additions.
As discussed in our 2000 Annual Report, we assumed a note payable of
approximately $800,000 in connection with our acquisition of Windermere in
October 2000. We paid off the note in May 2001.
We anticipate that our available line of credit borrowing capacity and
cash flows generated from operations will be sufficient to fund our activities
during the next 12 months. If we are unable to renew our existing lines of
credit, our capital spending or acquisitions will be reduced or delayed until
new financing arrangements are secured. Such financing arrangements could
include seeking debt or equity financing through a private placement or a public
offering. Similarly, if additional cash is needed to fund an acquisition,
financing arrangements could include long-term borrowing or equity financing.
RECENT ACCOUNTING PRONOUNCEMENTS:
As discussed in Note 6 to the condensed consolidated financial
statements, in June 2001 the FASB issued SFAS No. 141, Business Combinations,
and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. SFAS No. 141 specifies that identifiable
intangible assets acquired in a purchase method business combination must be
recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill
and intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. For intangible assets with definite useful lives,
SFAS No. 142 requires amortization over their estimated useful lives to their
estimated residual values, and requires review for impairment in accordance with
SFAS No. 121. SFAS No. 141 became effective for business combinations initiated
after June 30, 2001. SFAS No. 142 becomes effective for fiscal years beginning
after December 15, 2001.
As discussed in Note 6, in August 2001, SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets was issued and becomes effective
January 2002. SFAS No. 144 supercedes SFAS No. 121; however, it retains the
requirement that long-lived assets be tested for recoverability when events or
changes in circumstances indicate carrying amounts may not be recoverable. SFAS
No. 144 further clarifies the methods of accounting for assets that are disposed
of. SFAS No. 144 does not apply to goodwill impairment which is accounted for
under SFAS No. 142 as described above.
REGULATORY AFFAIRS:
The California Public Utilities Commission (CPUC), the New Mexico
Public Regulatory Commission (NMPRC) and the Texas Natural Resources
Conservation Commission (TNRCC) regulate the rates and operations of Suburban,
NMUI and Windermere and Hornsby, respectively. The rates allowed are intended to
provide the utilities an opportunity to recover costs and earn a reasonable
return on common equity. As discussed in our 2000 Annual Report, Suburban has
been directed by the CPUC to file a general rate application by March 2002.
Windermere filed for a general rate increase in May 2001 and new rates under the
pending filing became effective June 4, 2001, subject to final regulatory
approval. A date for the hearing has been set by the TNRCC for November 2001.
NMUI and Hornsby are not
7
currently seeking any rate increase; however, future construction expenditures
and increased operating expenses may result in periodic requests for rate
increases.
Southwest Water closely monitors legislative, Environmental Protection
Agency (EPA), CPUC, NMPRC and TNRCC developments. The various water industry
associations in which we actively participate also monitor these developments.
We do not know the possible legislative, EPA, CPUC, NMPRC or TNRCC changes that
will be enacted or the terms of such changes if enacted. Therefore, we cannot
predict the impact, if any, of future legislative changes, EPA, CPUC, NMPRC or
TNRCC developments or changes on our financial position or results of
operations.
Our non-regulatory business pricing is not subject to regulation by any
public regulatory commissions. Most contracts with municipal utility districts
are short-term contracts and do not generally include inflation adjustments.
Changes in prices are negotiated on a contract-by-contract basis. Our operations
and maintenance contracts are generally longer-term water and wastewater service
contracts, primarily with cities, and may include inflation adjustments. Most
contracts with management companies and owners of apartment or condominium
communities are short-term contracts and do not generally include inflation
adjustments. Changes in prices are negotiated on a contract-by-contract basis.
SEASONALITY:
There is seasonality to the water utility and utility management
industry; thus, the results of operations for the nine months ended September
30, 2001, do not necessarily indicate the results to be expected for the full
year. Rainfall and weather conditions affect utility operations, with most water
consumption occurring during the third quarter of each year when weather tends
to be hot and dry. Drought conditions could have the effect of lowering revenue
due to anticipated conservation efforts. Our contract operations business can
also be seasonal in nature. Heavy rainfall hampers the ability of ECO and OpTech
to perform billable work such as pipeline maintenance, manhole rehabilitation
and other outdoor services. Conversely, moderate rainfall may create additional
opportunities for billable work outside the scope of existing contracts. Drought
conditions would not necessarily adversely affect ECO's or OpTech's
opportunities for additional billable work.
ENVIRONMENTAL AFFAIRS:
Operations of Suburban, NMUI and Windermere and Hornsby fall under the
regulatory jurisdiction of the CPUC, the NMPRC and the TNRCC, respectively. The
primary responsibility of these regulatory agencies is to ensure an adequate
supply of affordable, healthful, potable water to residents of their respective
states. Our operations are also subject to water and wastewater pollution
prevention standards and water and wastewater quality regulations of the EPA and
various state regulatory agencies. Both the EPA and state regulatory agencies
require periodic testing and sampling of water. Costs associated with the
testing of water supplies have increased and are expected to increase further as
the regulatory agencies adopt additional monitoring requirements. In November
2001, the EPA administration announced a decision to lower the arsenic standard
in drinking water from 50 parts per billion to 10 parts per billion. We cannot
predict the impact that the change in standards will have on our water utility
operations at this time; however, we do not expect it to have a material adverse
impact on our financial position or operations. We believe that future
incremental costs of complying with government regulations, including any
capital expenditures, will be recoverable through increased rates and contract
operations revenues. However, we cannot assure you that recovery of such costs
will be allowed. To date, we have not experienced any material adverse effects
upon our financial position or operations resulting from compliance with
government regulations.
As discussed in our 2000 Annual Report, and in Part II, Item 1, below,
Southwest Water and Suburban have been named in several lawsuits alleging water
contamination in the Main San Gabriel Basin in Southern California. In September
1999, the California 2nd District Court of Appeal ordered that certain of the
lawsuits be dismissed. A three-judge panel ruled that the CPUC has final
regulatory authority in water quality matters. The plaintiffs petitioned the
California Supreme Court for review of this decision and the petition was
granted. The California Supreme Court is scheduled to review this decision in
November 2001 and we expect a ruling within 90 days following the hearing.
8
As contract operators, ECO and OpTech do not own any of the water
sources, water production facilities, or water distribution systems that they
operate for their clients, nor do they own any of the wastewater collection
systems or wastewater treatment facilities that they operate for their clients.
Although not the owners, ECO and OpTech are responsible for operating these
water and wastewater facilities in compliance with all federal, state and local
health standards and regulations.
MTI is a utility submetering, billing and collection services company
and does not own or operate any water or other production or treatment
facilities.
RISK FACTORS:
Certain statements contained in this Quarterly Report for the period
ended September 30, 2001 (the September Report) that are not based on historical
fact are "forward-looking" statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements are only projections.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors that may cause actual results, performance or achievements of
Southwest Water to differ materially from any performance or achievements
planned, expressed or implied by such forward-looking statements. Although we
believe that our expectations are based on reasonable assumptions within the
bounds of our knowledge of our business and operations, we cannot assure you
that actual results will not differ materially from our expectations.
In the wake of the September 11, 2001 terrorist attacks on the World
Trade Center and the Pentagon, our water utilities are operating on a heightened
state of alert. We continue to inspect and test our water daily. We have also
taken extra precautions, and we have added certain security measures regarding
the delivery of certain chemicals. We have the ability to seal off our
reservoirs should contamination of the water supply occur. We do not expect our
increased security measures to have a material adverse effect on our operations
or financial position. We are not aware of any specific threats to our water
utility operations or any of our other operations; however, we cannot control
the outcome of such events should they occur.
The September Report should be read in conjunction with our 2000 Annual
Report and with our Form S-3 Registration Statement filed with the SEC on July
16, 2001 for a more detailed description of the risk factors affecting Southwest
Water. These include, but are not limited to, revenue backlog information,
expectations regarding sales growth and new contracts, potential acquisitions,
weather conditions, changes in business conditions, and legal and other
contingencies.
RESULTS OF OPERATIONS:
Three Months Ended September 30, 2001 Compared To Three Months Ended September
30, 2000
Diluted EPS was $0.24 for both of the quarters ended September 30, 2001
and 2000, respectively (after adjustment for a 5% stock dividend on October 1,
2001 and a 5-for-4 stock split in the form of a stock dividend on January 1,
2001). As discussed in Note 4 to the condensed consolidated financial
statements, we acquired a 90% ownership of OpTech on August 31, 2001.
All revenue, expense and income items reflect one month of operating results
for OpTech.
Operating income
Third quarter 2001 operating income increased $77,000, or 2%, and, as a
percentage of operating revenues, was 14% in 2001 and 2000. Non-regulated
operating income decreased $225,000. During 2000, ECO had the benefit of a one-
time construction project of a large water treatment plant in El Paso, Texas,
and recognized the related revenue and operating income. There was no comparable
project in 2001. In addition, MTI had increases in its operating expenses in
connection with an installation contract that began in late 2000. Operating
income at the utilities increased $646,000, due primarily to the acquisition of
Windermere and Hornsby in October 2000. Parent company expenses increased
$344,000 due to compensation related items, health insurance costs, professional
services and charitable contributions.
9
Operating revenues
Our operating revenues increased $955,000 in the third quarter of 2001
compared with the same period in 2000. Non-regulated revenues decreased
$583,000, or 3%, due primarily to a decrease in ECO's revenues resulting from
the benefit in 2000 of a construction project as described above. The project
contributed approximately $2,000,000 of revenue in the third quarter of 2000.
Utility revenues increased $1,538,000 or 11%, primarily as a result of the
addition of Windermere and Hornsby customers following the acquisition in
October 2000.
Direct operating expenses
During the three months ended September 30, 2001, direct operating
expenses decreased $92,000. As a percentage of operating revenues, these
expenses were 72% in 2001 and 75% in 2000. Non-regulated direct operating
expenses decreased $430,000, due primarily to a reduction in expenses at ECO as
a result of the 2000 construction project described above. The decrease was
partially offset by MTI's operating expenses incurred in connection with an
installation contract that began in late 2000. The utilities' direct operating
expenses increased $338,000, primarily as a result of the acquisition of
Windermere and Hornsby in October 2000.
Selling, general and administrative expenses
Selling, general and administrative expenses for the third quarter of
2001 increased by $970,000, or 29% compared with the same period in 2000. As a
percentage of operating revenues, these expenses were 14% in 2001 and 11% in
2000. General and administrative expenses of our non-regulated businesses
increased $72,000 due primarily to increased sales expenses from an expanded
marketing effort at ECO, additional lease expenses with respect to
telecommunications equipment and compensation-related items including workers'
compensation insurance, medical insurance and wages. General and administrative
expenses at the utilities increased $554,000, primarily as a result of the
acquisition of Windermere and Hornsby in October 2000. General and
administrative expenses of the parent company increased $344,000.
Interest expense
Interest expense increased by $23,000 for the quarter ended September
30, 2001. Interest expense increased primarily because of the issuance of our
$20,000,000 debentures in July 2001. The increase was partially offset by a
reduction in our line of credit borrowing, generally lower interest rates on
short-term borrowings and interest capitalized at Windermere on utility
construction projects.
Nine months ended September 30, 2001 Compared To Nine Months Ended September 30,
2000
Diluted EPS was $0.47 for the first nine months of 2001, an increase of
2% compared to diluted EPS of $0.46 during the same period in 2000 (after
adjustment for a 5% stock dividend on October 1, 2001 and a 5-for-4 stock split,
in the form of a stock dividend, on January 1, 2001).
Operating income
Operating income for the nine months ended September 30, 2001 increased
$147,000 or 2%, compared to the same period in 2000 and, as a percentage of
operating revenues, was 11% in 2001 and 12% in 2000. Non-regulated operating
income decreased $551,000. During 2000, ECO had the benefit of a one-time
construction project of a large water treatment plant in El Paso, Texas, and
recognized the related revenue and operating income. There was no comparable
project in 2001. In addition, general and administrative expenses at ECO
increased in 2001 compared to the same period in 2000 as described below. The
decrease in operating income was partially offset due to the acquisition of MTI
in April 2000 and OpTech on August 31, 2001. Operating income at the utilities
increased $1,050,000, due primarily to the acquisition of Windermere and Hornsby
in October 2000. Parent company expenses increased $352,000 due primarily to
compensation related items health insurance costs, professional services and
charitable contributions.
10
Operating revenues
Our operating revenues for the nine months ended September 30, 2001
increased $4,832,000 compared with the same period in 2000. Non-regulated
revenues increased $1,123,000, or 2%, due primarily to the acquisition of MTI in
April 2000 and OpTech on August 31, 2001 The increase was partially offset by a
decrease in ECO's revenues due to the benefit in 2000 of a construction project
as described above. The project contributed approximately $6,000,000 of revenue
during the first nine months of 2000. Utility revenues increased $3,709,000, or
11%, primarily as a result of the addition of Windermere and Hornsby customers
following the acquisition in October 2000.
Direct operating expenses
During the nine months ended September 30, 2001, direct operating
expenses increased $2,824,000, or 5%. As a percentage of operating revenues,
these expenses were 74% in 2001 and 75% in 2000. Non-regulated direct operating
expenses increased $865,000, due primarily to the acquisition of MTI in April
2000 and OpTech on August 31, 2001. This increase was partially offset by a
reduction in expenses at ECO due to the 2000 construction project described
above. The utilities' direct operating expenses increased $1,959,000, primarily
as a result of the acquisition of Windermere and Hornsby in October 2000 and to
increases in energy costs and other water-volume-related expenses at Suburban.
Selling, general and administrative expenses
Selling, general and administrative expenses for the first nine months
of 2001 increased by $1,861,000, or 18%, compared with the same period in 2000.
As a percentage of operating revenues, these expenses were 14% in 2001 and 13%
in 2000. General and administrative expenses of our non-regulated businesses
increased $809,000 due primarily to the acquisition of MTI in April 2000 and
OpTech on August 31, 2001. General and administrative expenses also increased at
ECO due to increased sales expenses from an expanded marketing effort,
additional lease expenses with respect to telecommunications equipment and
compensation-related items including workers' compensation insurance, medical
insurance and wages. General and administrative expenses at the utilities
increased $700,000, primarily as a result of the acquisition of Windermere and
Hornsby in October 2000. General and administrative expenses of the parent
company increased $352,000.
Interest and other expenses
Total interest and other expenses decreased by $216,000 for the nine
months ended September 30, 2001. Interest expense increased $49,000, reflecting
the issuance of our debentures, offset by decreases in our line of credit
borrowing and generally lower interest rates on short-term borrowings. In
addition, we capitalized interest at Windermere on utility construction
projects. Interest income decreased $253,000 primarily due to interest income
recognized by Suburban in 2000 on cash held by an accommodator in connection
with the sale of property formerly used in utility operations. The cash was
later used to purchase the City of West Covina water distribution system. Other
income increased $518,000 primarily due to the recognition of deferred lease
income associated with a construction project at ECO as described above.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
We have certain indebtedness that is subject to variable interest
rates. As a result, Southwest Water's interest expense is affected by changes in
the general level of interest rates. Changes in interest rates affect the
interest expense paid on the line of credit borrowings, which is determined
based upon an agreed rate with the banks. Contractually, the highest interest
rates charged on the lines of credit cannot exceed the banks' prime rate plus
one-quarter percent.
Southwest Water is utilizing the favorable low interest rates in the
current market. In part to mitigate future market interest rate risk, we
completed a $20,000,000, 20-year convertible debenture offering in July 2001
which bears a fixed interest rate of 6.85% per annum. A portion of the proceeds
was used to pay down our variable rate indebtedness. Our long-term bonds were
sold with a fixed interest rate, and are not subject to market fluctuation of
interest rates.
11
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As discussed in our 2000 Annual Report, ECO was named as a defendant in
four lawsuits alleging injury and damages as the result of a sewage spill which
occurred at an Austin, Texas, sewage pumping station operated by ECO. In 2000, a
hearing was held and a summary judgment motion is pending in one action. A trial
for a second action is pending and expected to take place in late 2001. The
other two lawsuits remain pending at this date. Southwest Water and ECO intend
to vigorously defend against these claims, and we have requested defense and
indemnification by our insurance carrier. At this time, we do not believe this
matter will have a material adverse effect on our financial position, results of
operations or cash flow.
As discussed in our 2000 Annual Report, Southwest Water and Suburban
have been named as defendants in several lawsuits alleging water contamination
in the Main San Gabriel Basin. In September 1999, the California 2nd District
Court of Appeal ordered that certain of the lawsuits be dismissed. The
California Supreme Court agreed to review this decision, and a hearing was
conducted in November 2001. We anticipate that the California Supreme Court will
issue its ruling within 90 days of the hearing. Southwest Water and Suburban
have requested defense and indemnification from our liability insurance carriers
for these lawsuits. Several of the liability insurance carriers are currently
absorbing the costs of defense of the lawsuits. In April 2000, approximately 240
plaintiffs filed two additional lawsuits similar to the actions described above.
Defendants include Southwest Water, Suburban and other water producers in the
Main Basin and a number of alleged industrial polluters. We expect to defend the
new actions on the same basis as the earlier actions. Based upon information
available at this time, we do not expect that these actions will have a material
adverse effect on our financial position or results of operations.
As discussed in the 2000 Annual Report, in 1998 the City of Albuquerque
(Albuquerque) initiated an action in eminent domain to acquire the operations of
NMUI. At the time of the original complaint, Southwest Water believed that the
fair market value of NMUI was substantially higher than the amount offered in
Albuquerque's complaint. In September 2000, the Albuquerque City Council voted
eight-to-one in favor of withdrawing the condemnation proceeding. In September
2001, we received a formal withdrawal of the lawsuit and Albuquerque has paid us
approximately $115,000 to cover costs incurred as a result of the condemnation
proceedings.
Southwest Water and its subsidiaries are the subjects of certain
litigation arising from the ordinary course of operations. We believe the
ultimate resolution of such matters will not materially affect our financial
position, results of operations or cash flows.
Item 4: Submission of Matters to a Vote of Security Holders
None
Item 6: Exhibits and Reports on Form 8-K:
(a) Exhibits furnished pursuant to Item 601 of Regulation S-K:
None
(b) Reports on Form 8-K
Form 8-K describing the acquisition of OpTech and the Agreement and
Plan of Merger, filed with the SEC on September 19, 2001.
12
SIGNATURES
Pursuant to the requirements 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)
Dated: November 13, 2001 /s/ PETER J. MOERBEEK
- ------------------------ ---------------------
Peter J. Moerbeek
Chief Financial Officer
(Principal Financial Officer)
Dated: November 13, 2001 /s/ THOMAS C. TEKULVE
- ------------------------ ---------------------
Thomas C. Tekulve
Vice President Finance
(Principal Accounting Officer)
13