Table of Contents
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x
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Quarterly Report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
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For the quarterly period
ended March 31, 2010
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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)
None
(Former name,
former address and former fiscal year, if changed since last report)
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
whether the registrant has submitted electronically and posted on its corporate
website, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (
§
232.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post
such files). Yes
o
No
o
Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. (Check one):
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Large accelerated filer
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o
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Accelerated filer
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x
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Non-Accelerated filer
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o
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Smaller reporting
company
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o
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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
Indicate the number of
shares outstanding of each of the issuers classes of common stock, as of the
latest practicable date.
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Class
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Outstanding as of
April 30, 2010
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Common Stock,
$.01 par value per share
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27,518,707 shares
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Table of
Contents
PART I
FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
SOUTHWEST WATER COMPANY
CONDENSED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
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March 31,
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December 31,
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(In thousands)
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2010
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2009
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ASSETS
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Current assets:
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Cash and cash
equivalents
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$
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815
|
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$
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2,874
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Accounts receivable, net
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25,454
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26,968
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Prepaid expenses and
other current assets
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13,378
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12,909
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Total current assets
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39,647
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42,751
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Property, plant and
equipment, net
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312,747
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313,716
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Other assets:
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Goodwill
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16,434
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16,434
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Intangible assets
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2,880
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2,966
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Other assets
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24,307
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24,228
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Total assets
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$
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396,015
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$
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400,095
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LIABILITIES
AND STOCKHOLDERS EQUITY
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Current liabilities:
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Accounts payable
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$
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12,059
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$
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14,130
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Current portion of
long-term debt
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2,216
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2,171
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Other current
liabilities
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19,301
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21,213
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Total current
liabilities
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33,576
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37,514
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Other liabilities and
deferred credits:
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Long-term debt, less
current portion
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140,990
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152,820
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Deferred income taxes
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12,931
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13,100
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Advances for
construction
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8,681
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8,784
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Contributions in aid of
construction
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53,408
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53,841
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Other liabilities and
deferred credits
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18,629
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18,122
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Commitments and
contingencies
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Stockholders equity:
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Preferred stock
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458
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458
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Common stock
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275
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249
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Additional paid-in
capital
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164,575
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148,407
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Accumulated deficit
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(37,508
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)
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(33,200
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)
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Total stockholders
equity
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127,800
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115,914
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Total liabilities and
stockholders equity
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$
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396,015
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$
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400,095
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See accompanying
notes to condensed consolidated financial statements.
2
Table of
Contents
SOUTHWEST WATER COMPANY
CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS (UNAUDITED)
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Three
Months Ended
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March 31,
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(In
thousands, except per share data)
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2010
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2009
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Operating revenue
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$
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46,846
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$
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50,092
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Expenses:
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Operating expenses
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45,312
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49,907
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Depreciation and
amortization
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3,867
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3,833
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Total operating expenses
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49,179
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53,740
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Operating loss
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(2,333
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)
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(3,648
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)
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Other income (expense):
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Interest expense
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(2,370
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)
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(1,887
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)
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Interest income
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33
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36
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Loss from continuing
operations before income taxes
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(4,670
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)
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(5,499
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)
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Benefit from income
taxes
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(1,742
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)
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(2,094
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)
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Loss from continuing
operations
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(2,928
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)
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(3,405
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)
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Income from discontinued
operations, net of tax
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|
172
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Net loss
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(2,928
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)
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|
(3,233
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)
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Preferred stock
dividends
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|
(6
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)
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|
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Net loss applicable to
common stockholders
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$
|
(2,934
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)
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$
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(3,233
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)
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|
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Loss per common share -
basic and diluted
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Loss from continuing
operations
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$
|
(0.12
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)
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$
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(0.14
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)
|
Income from discontinued
operations
|
|
|
|
|
|
0.01
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|
Net loss applicable to
common stockholders
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$
|
(0.12
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)
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$
|
(0.13
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)
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Weighted average common
shares outstanding:
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Basic
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25,105
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24,600
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Diluted
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25,105
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24,600
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See accompanying
notes to condensed consolidated financial statements.
3
Table of
Contents
SOUTHWEST WATER COMPANY
CONDENSED CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED)
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Preferred
Stock
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Common
Stock
|
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Additional
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|
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|
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Number of
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Number of
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Paid-in
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Accumulated
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Shares
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Amount
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Shares
|
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Amount
|
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Capital
|
|
|
|
Deficit
|
|
|
|
Total
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(In
thousands)
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
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|
|
|
|
|
|
|
|
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|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Balance
- December 31, 2009
|
|
9
|
|
|
|
$
|
458
|
|
|
|
24,887
|
|
|
|
$
|
249
|
|
|
|
$
|
148,407
|
|
|
|
$
|
(33,200
|
)
|
|
|
$
|
115,914
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,928
|
)
|
|
|
(2,928
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock awards
cancelled
|
|
|
|
|
|
|
|
|
|
(94
|
)
|
|
|
(1
|
)
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issuance
|
|
|
|
|
|
|
|
|
|
2,700
|
|
|
|
27
|
|
|
|
16,092
|
|
|
|
|
|
|
|
16,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issuances
from employee benefit plans, net of repurchases
|
|
|
|
|
|
|
|
|
|
20
|
|
|
|
|
|
|
|
134
|
|
|
|
|
|
|
|
134
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Share-based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(59
|
)
|
|
|
|
|
|
|
(59
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividends declared:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock - $0.66
per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock - $0.05 per
share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,374
|
)
|
|
|
(1,374
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
- March 31, 2010
|
|
9
|
|
|
|
$
|
458
|
|
|
|
27,513
|
|
|
|
$
|
275
|
|
|
|
$
|
164,575
|
|
|
|
$
|
(37,508
|
)
|
|
|
$
|
127,800
|
|
See accompanying
notes to condensed consolidated financial statements.
4
Table of
Contents
SOUTHWEST WATER COMPANY
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
(In thousands)
|
|
2010
|
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
Cash flows from
operating activities of continuing operations:
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,928
|
)
|
|
|
$
|
(3,233
|
)
|
Adjustments to reconcile
net loss to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
Income from discontinued
operations, net of tax
|
|
|
|
|
|
(172
|
)
|
Depreciation and
amortization
|
|
3,867
|
|
|
|
3,833
|
|
Deferred income taxes
|
|
(1,922
|
)
|
|
|
974
|
|
Provision for doubtful
accounts
|
|
45
|
|
|
|
408
|
|
Share-based compensation
expense
|
|
(59
|
)
|
|
|
80
|
|
Post-vest cancellations
of non-qualified stock options
|
|
|
|
|
|
(118
|
)
|
Loss on disposal of
property, plant & equipment
|
|
106
|
|
|
|
|
|
Other, net
|
|
220
|
|
|
|
63
|
|
Changes in assets and
liabilities, net of effects of acquisitions
|
|
|
|
|
|
|
|
Accounts receivable
|
|
1,469
|
|
|
|
59
|
|
Other current assets
|
|
1,284
|
|
|
|
(948
|
)
|
Other assets
|
|
(204
|
)
|
|
|
171
|
|
Accounts payable
|
|
(1,396
|
)
|
|
|
(369
|
)
|
Other current
liabilities
|
|
(1,912
|
)
|
|
|
1,720
|
|
Other liabilities
|
|
(70
|
)
|
|
|
1,144
|
|
Net cash provided by
(used in) operating activities
|
|
(1,500
|
)
|
|
|
3,612
|
|
|
|
|
|
|
|
|
|
Cash flows from
investing activities of continuing operations:
|
|
|
|
|
|
|
|
Additions to property,
plant and equipment
|
|
(3,297
|
)
|
|
|
(3,843
|
)
|
Proceeds from sales of
equipment
|
|
2
|
|
|
|
|
|
Net cash used in
investing activities
|
|
(3,295
|
)
|
|
|
(3,843
|
)
|
|
|
|
|
|
|
|
|
Cash flows from
financing activities of continuing operations:
|
|
|
|
|
|
|
|
Borrowings under lines
of credit
|
|
4,700
|
|
|
|
5,500
|
|
Repayments under lines
of credit
|
|
(16,200
|
)
|
|
|
|
|
Payments on long-term
debt
|
|
(553
|
)
|
|
|
(644
|
)
|
Capital improvement
reimbursements
|
|
324
|
|
|
|
210
|
|
Proceeds of stock
issuance
|
|
16,200
|
|
|
|
|
|
Proceeds from employee
benefit plan stock issuances, net of repurchases
|
|
134
|
|
|
|
|
|
Contributions in aid of
construction
|
|
|
|
|
|
71
|
|
Dividends paid
|
|
(1,380
|
)
|
|
|
(629
|
)
|
Repayment of advances
for construction
|
|
(370
|
)
|
|
|
|
|
Deferred financing costs
|
|
(119
|
)
|
|
|
(753
|
)
|
Net cash provided by
financing activities
|
|
2,736
|
|
|
|
3,755
|
|
|
|
|
|
|
|
|
|
Cash flows from
discontinued operations:
|
|
|
|
|
|
|
|
Operating activities
|
|
|
|
|
|
(1,990
|
)
|
Investing activities
|
|
|
|
|
|
(143
|
)
|
Financing activities
|
|
|
|
|
|
78
|
|
Net cash used in
discontinued operations
|
|
|
|
|
|
(2,055
|
)
|
|
|
|
|
|
|
|
|
Net increase (decrease)
in cash and cash equivalents
|
|
(2,059
|
)
|
|
|
1,469
|
|
Cash and cash
equivalents at beginning of period
|
|
2,874
|
|
|
|
1,112
|
|
Cash and cash
equivalents at end of period
|
|
$
|
815
|
|
|
|
$
|
2,581
|
|
See accompanying notes to condensed consolidated financial statements.
5
Table of
Contents
SOUTHWEST WATER COMPANY
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis
of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
These condensed
consolidated interim financial statements of SouthWest Water Company are
unaudited. We believe the interim financial statements are presented on a basis
consistent with the audited consolidated financial statements for the year
ended December 31, 2009 and include all adjustments necessary for a fair
presentation of the financial condition, results of operations and cash flows
for such interim periods. Unless context indicates otherwise, references to we,
us, our, the Company or SouthWest Water mean SouthWest Water Company and
its subsidiaries.
The December 31, 2009
condensed consolidated balance sheet data were derived from the audited
financial statements, but do not include all disclosures required by accounting
principles generally accepted in the United States of America (GAAP).
Certain information and
disclosures normally included in financial statements prepared in accordance
with GAAP have been omitted in accordance with Securities and Exchange Commissions
(SEC) rules and regulations for interim financial reporting. These
condensed consolidated interim financial statements should be read in
conjunction with the audited financial statements and related notes included in
our 2009 Annual Report on Form 10-K. Our businesses are seasonal because
they are affected by weather; as a result, operating results for interim
periods are not necessarily predictive of the operating results for any other
interim period or for the full year.
Merger Agreement and
Long-Term Infrastructure Investment
On March 2, 2010, we
entered into an agreement and plan of merger (the Merger Agreement) with SW
Merger Acquisition Corp. (Parent) and SW Merger Sub Corp., a direct
wholly-owned subsidiary of Parent (Merger Sub). Parent and Merger Sub are
jointly owned by IIF Subway Investment LP and USA Water Services, LLC, which
are sponsored by J.P. Morgan IIF Acquisitions LLC and Water Asset Management,
LLC. Under the terms of the Merger
Agreement, all of our outstanding common stock would be converted into a right
to receive $11.00 per share in cash. The
completion of the merger is subject to customary closing conditions, including
stockholder approval and regulatory notice and approvals.
If the Merger Agreement is
adopted by our stockholders and all closing conditions are met, we will be the
surviving corporation of the merger and a wholly owned subsidiary of Parent.
Upon completion of the merger, our common stock will cease to be traded on the
NASDAQ Global Select Market and we will no longer be a publicly held
corporation. The Merger Agreement
contains restrictions on our operations prior to the closing of the merger,
including restrictions related to capital expenditures, the incurrence of debt,
acquiring and disposing of assets, entering into material contracts and capital
transactions.
In connection with the
Merger Agreement, we entered into a Securities Purchase Agreement and Investor
Rights Agreement (collectively, the Investment Agreements). Pursuant to the Investment Agreements, Parent
purchased 2,700,000 shares of our common stock (the Purchased Stock) at a
price of $6.00 per share, for an aggregate purchase price of $16.2 million and
we incurred related specific incremental transactional costs of $0.1 million. As permitted under the terms of the
Investment Agreements, the Company applied the proceeds derived from the sale
of the Purchased Stock to reduce our revolving line of credit, the borrowings
of which are used for capital expenditures and working capital purposes. The Investment Agreements entitle Parent to
appoint a designee to serve on our board of directors (which right Parent has
not exercised to date), and also to certain registration rights with respect to
the Purchased Stock in the event of the termination of the Merger
Agreement. The Investment Agreements
restrict Parents ability to sell or otherwise transfer the Purchased Stock
prior to the earlier of the consummation or termination of the Merger
Agreement. Except as contemplated by the
Merger Agreement, Parent and Merger Sub are also prohibited from acquiring any
additional shares of our common stock until the termination of the Merger
Agreement.
As the offering and sale
of the Purchased Stock pursuant to the Investment Agreements was not registered
under the Securities Act of 1933 or applicable state securities laws, the
Purchased Stock may not be offered or sold in the United States absent
registration or an applicable exemption from such registration requirements.
Recent Accounting Pronouncements
We only discuss recent
accounting pronouncements that will or could have a significant effect on our
financial statements or disclosures currently or in the near term.
In February 2010, the
Financial Accounting Standards Board (FASB) issued accounting standards update
(ASU) No. 2010-09,
Subsequent Events
(Topic 855)Amendments to Certain Recognition and Disclosure Requirements
(ASU No. 2010-09). Among other amendments to Topic 855, ASU No. 2010-09
reiterates that SEC filers are required to evaluate subsequent events through
the date the financial statements have been issued and eliminates the
requirement that SEC filers disclose the date through which subsequent events
have been evaluated. ASU No. 2010-09 became effective upon issuance.
Adoption of ASU No. 2010-09 had no impact on our consolidated financial
statements.
In January 2010, the
FASB issued ASU No. 2010-06,
Fair Value
Measurements and Disclosures (Topic 820)Improving Disclosures about Fair
Value Measurements
(ASU No. 2010-06). ASU No. 2010-06
requires: (1) fair value disclosures of assets and liabilities by class; (2) disclosures
about
6
Table of
Contents
SOUTHWEST WATER COMPANY
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
significant transfers in
and out of Levels 1 and 2 on the fair value hierarchy, in addition to
Level 3; (3) purchases, sales, issuances and settlements be disclosed
on gross basis on the reconciliation of beginning and ending balances of
Level 3 assets and liabilities; and (4) disclosures about valuation
methods and inputs used to measure the fair value of Level 2 assets and
liabilities. ASU No. 2010-06 became effective for the first financial
reporting period beginning after December 15, 2009, except for disclosures
about purchases, sales, issuances and settlements of Level 3 assets and
liabilities, which will be effective for fiscal years beginning after December 15,
2010. Adoption of the currently effective provisions of ASU No. 2010-06
had no impact on our consolidated financial statements. Presently, we are
assessing what impact, if any, Level 3 disclosure requirements regarding gross
presentation of purchases, sales, issuances and settlements will have on our
consolidated financial statements.
Other Comprehensive Income
We had no accumulated other comprehensive income as
of March 31, 2010 and December 31, 2009.
Accounting Adjustments Impacting Other Periods
For the quarter ended March 31,
2010 we recorded a $0.1 million expense, net of tax, related to prior periods.
Management has determined that the effect of recognizing this adjustment is not
material to our results of operations for the three months ended March 31,
2010 or for any prior period.
Fair Value Measurements
We use a valuation
hierarchy for disclosures of fair value measurement. The three levels are
defined as follows:
·
Level 1 Inputs Unadjusted quoted market prices for identical assets and
liabilities in an active market that the Company has the ability to access.
·
Level 2 Inputs Inputs, other than the quoted prices in active markets,
that are observable either directly or indirectly.
·
Level 3 Inputs Inputs based on prices or valuation techniques that are
both unobservable and significant to the overall fair value measurements.
Our revolving credit
facility and long-term debt with aggregate book values of $143.2 million and
$155.0 million had fair values of approximately $134.7 million and $145.5
million at March 31, 2010 and December 31, 2009, respectively. The estimated fair values are based on
current rates for similar issues for debt of the same remaining maturities
(Level 2). 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 (Level 1). At March 31,
2010 and December 31, 2009, we had no derivative financial instruments,
hedging activities, financial instruments with off-balance sheet risk or
financial instruments with concentrations of credit risks.
Note 2. Dispositions
As more
fully described in Note 4, Commitments and Contingencies - Legal Proceedings,
as part of a settlement of eminent domain proceedings against our New Mexico
utility, New Mexico Utilities Inc. (NMUI), we completed the sale of NMUI in May 2009. As of March 31, 2010 and December 31,
2009, no assets were held for sale.
The
results of operations of our NMUI operations have been reclassified as
discontinued operations for the three months ended March 31, 2009 in the
consolidated statements of operations and are summarized as follows:
|
Three
months ended
|
|
March 31, 2009
|
(In thousands)
|
|
|
|
Operating revenue
|
|
$
|
2,304
|
|
|
|
|
|
Operating
expenses
|
|
1,851
|
|
|
|
|
|
Operating
income
|
|
453
|
|
|
|
|
|
Interest expense
|
|
(189
|
)
|
|
|
|
|
Income
before taxes
|
|
264
|
|
|
|
|
|
Provision
for income taxes
|
|
92
|
|
|
|
|
|
Income
from discontinued operations, net of tax
|
|
$
|
172
|
|
7
Table of Contents
SOUTHWEST WATER COMPANY
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 3. Long-Term
Debt
Long-term
debt consists of the following as of March 31, 2010 and December 31,
2009:
|
|
March 31,
|
|
|
|
December 31,
|
|
(In thousands)
|
|
2010
|
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Revolving credit
facility
|
|
$
|
63,000
|
|
|
|
$
|
74,500
|
|
|
|
|
|
|
|
|
|
6.85% convertible
subordinated debentures due 2021
|
|
11,787
|
|
|
|
11,839
|
|
|
|
|
|
|
|
|
|
Capital leases
|
|
3,136
|
|
|
|
3,138
|
|
|
|
|
|
|
|
|
|
Term Loans:
|
|
|
|
|
|
|
|
Monarch
Utilities, Inc.:
|
|
|
|
|
|
|
|
7.37% fixed rate
term loan due 2022
|
|
9,304
|
|
|
|
9,497
|
|
5.77% fixed rate
term loan due 2022
|
|
640
|
|
|
|
654
|
|
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
|
|
|
|
|
|
|
|
|
|
Economic Development
Revenue Bonds:
|
|
|
|
|
|
|
|
6.0% series 1998A
due 2018
|
|
1,690
|
|
|
|
1,690
|
|
|
|
|
|
|
|
|
|
Acquisition-related
indebtedness and other
|
|
78
|
|
|
|
78
|
|
Total long-term debt
payment obligations
|
|
142,635
|
|
|
|
154,396
|
|
Unamortized Monarch term
loan fair value adjustments
|
|
571
|
|
|
|
595
|
|
Total long-term
debt
|
|
143,206
|
|
|
|
154,991
|
|
Less current
portion of long-term debt
|
|
(2,216
|
)
|
|
|
(2,171
|
)
|
Long-term debt,
less current portion
|
|
$
|
140,990
|
|
|
|
$
|
152,820
|
|
Our revolving line of
credit reflects 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 Bank Group). The credit agreement provides for a $110.0
million revolving credit facility.
We pay commitment fees
under the facility and must maintain customary financial ratios, prescribed
cash flow results and meet other restrictive covenants. We were not in
compliance with certain covenants due to our failure to timely file our March 31,
2009 and June 30, 2009 Quarterly Reports on Form 10-Q. In addition, we were in violation of our
debt-to-capitalization ratio at March 31, 2009. However, we received
amendments from the Bank Group which waived existing and anticipated defaults,
primarily granting additional time to complete our financial filings and
waiving the debt-to-capitalization ratio for the periods of non-compliance. The
May 28, 2009 amendment secured the facility with substantially all assets
of the Company not previously encumbered and significantly increased our
borrowing margins. Fees and expenses charged by the Bank Group for all the
amendments were $3.4 million, of which $0.1 million was incurred during the
three months ended March 31, 2010. These fees were capitalized and are
being amortized over the remaining life of the facility which extends through February 2013.
Borrowings under the
credit facility bear interest, at our option, based on either a margin over the
designated LIBOR rate or the prime rate. As of March 31, 2010 our
debt-to-capitalization ratio is 54%; therefore, the applicable margins are
3.50% over the LIBOR rate and 2.50% over the prime rate. The margins decline on
a sliding scale as our debt-to-capitalization ratio improves. The weighted
average annual interest rates, excluding bank amendment and waiver fees, on all
credit facility borrowings outstanding were 4.2% as of March 31, 2010 and
4.3% as of December 31, 2009.
As of March 31, 2010,
we had irrevocable standby letters of credit in the amount of $5.0 million
issued and outstanding under our revolving credit facility and our available
borrowing capacity was $42.0 million.
8
Table of Contents
SOUTHWEST WATER COMPANY
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 4. Commitments
and Contingencies
Legal Proceedings
Class Action
Litigation
Perrin v. SouthWest Water
Company, et al., Case No. CV 08-07844 (Central District of California) and
related, consolidated cases: On November 26, 2008, an alleged purchaser of
our publicly traded common stock filed a securities class action lawsuit in the
United States District Court for the Central District of California. The
complaint generally alleges that from May 10, 2005 through November 9,
2008, we made false statements or omitted to state facts necessary to make our
disclosures not misleading. Five additional and substantially similar
cases were filed in the same court. On January 26, 2009, motions for
consolidation and for the appointment of lead plaintiff and lead counsel were
filed by the plaintiffs. On February 12, 2009, the court granted the
motion for consolidation and for the appointment of lead plaintiff and lead
counsel. Pursuant to stipulation of the parties, the lead plaintiff on October 15,
2009, filed a consolidated complaint. On January 12, 2010, the Company
filed a motion to dismiss the consolidated amended complaint on the grounds
that it failed to allege a valid claim and a motion for partial summary
judgment on certain claims alleged in it on the grounds that the plaintiffs
lack standing to bring those claims. On
March 8, 2010, the plaintiffs filed oppositions to the Companys
motions. On April 15, 2010, the
Company filed reply briefs in support of its motions. A hearing on the motions is scheduled for
May 17, 2010. The Company is defending against the amended complaints as
of this date and no final complaint is on file. Given the nature and
preliminary status of these cases, we cannot yet determine the amount or even a
reasonable range of potential loss in these matters, if any.
Derivative
Litigation
Sherman v. Christie, et
al., Case No. BC404946 (Los Angeles County Superior Court) and related
cases: On January 2, 2009, an alleged shareholder of our publicly traded
common stock filed a shareholder derivative case, alleging breach of fiduciary
duty arising from the announcement of our intent to restate financial
statements against certain present and former members of our Board of
Directors. Two additional, substantially similar cases were filed.
Stipulations were entered extending the time to respond to the
complaints. On April 23, 2009, the court found that the three
derivative suits were complex and related and transferred the cases to a
single judge for all purposes and ordered an initial status conference for December 3,
2009. The cases were consolidated on May 19, 2009. The lead
plaintiff by stipulation of the parties filed a consolidated complaint on October 8,
2009. On December 7, 2009, the Company filed a demurrer to the
consolidated complaint on the grounds that the consolidated complaint failed to
allege sufficient facts to state a valid cause of action and failed to allege
facts showing that presuit demand on the board of directors should be excused
as futile. On January 21, 2010, the
plaintiffs filed an opposition to the demurrer.
On March 4, 2010, the plaintiffs filed an amended consolidated
complaint to add claims on behalf an alleged class of the Companys
shareholders related to the proposed merger.
On April 2, 2010, the plaintiffs filed a motion to consolidate the
four class action suits pending in the Los Angeles Superior Court related to
the proposed merger. On April 2,
2010, the Company filed a motion to sever the alleged class action claims
related to the proposed merger from the amended consolidated complaint and a
demurrer to the entire complaint on the grounds that the consolidated complaint
failed to allege sufficient facts to state a valid cause of action and failed
to allege facts showing that presuit demand on the board of directors should be
excused as futile. On April 2,
2010, the Company also filed an opposition to the motion to consolidate. On April 15, 2010, the court denied the
plaintiffs motion to consolidate. On
April 20, 2010, the plaintiffs filed oppositions to the motion to sever
and demurrer. On April 27, 2010,
the Company filed replies in support of the motion to sever and demurrer. On May 3, 2010, the plaintiffs agreed to
sever and dismiss without prejudice claims on behalf of an alleged class of the
Companys shareholders related to the proposed merger from the amended
consolidated complaint. On May 4,
2010, the court entered an order dismissing without prejudice claims on behalf
an alleged class of the Companys shareholders related to the proposed merger
from the amended consolidated complaint.
Also on May 4, 2010, the court sustained the Companys demurrer to
the amended consolidated complaint and gave the plaintiffs 20 days to file a
further amended complaint. The Company is defending against the amended
complaints as of this date and no final complaint is on file. Given the nature
and preliminary status of these cases, we cannot yet determine the amount or
even a reasonable range of potential loss in these matters, if any.
Litigation
Related to the Merger Agreement
We are aware of seven
purported class action lawsuits related to the proposed merger filed against
the Company, some or all of our directors, Parent, and Merger Sub in the
Superior Court of the State of California, County of Los Angeles, the Court of
Chancery of the State of Delaware, or the United States District Court for the
Central District of California.
The complaints are
substantially similar and allege, among other things, that the merger proposed
under the Merger Agreement is the product of a flawed process and that the
consideration to be paid to our stockholders in the merger would be unfair and
inadequate. The complaints further allege, among other things, that our
officers and directors breached their fiduciary duties by, among other things,
taking actions designed to deter higher offers from other potential acquirers
and failing to maximize the value of SouthWest Water stock for the benefit of
our stockholders. The complaints further allege that Parent and Merger Sub
aided and abetted the actions of our officers and directors in breaching their
fiduciary duties. The complaints seek, among other relief, an injunction
preventing consummation of the merger, an order rescinding the merger or any of
the terms of the merger to the extent already implemented, costs and
disbursements of the lawsuits, including attorneys and experts fees, and such
other relief as the court might find just and proper. The Company will defend
itself against the purported lawsuits. Given the nature and preliminary status
of these cases, we cannot yet determine the amount or even a reasonable range
of potential loss in these matters, if any.
New
Mexico Utilities, Inc.
NMUI, one of the Companys
wholly-owned regulated utilities, had an agreement with the Albuquerque
Bernalillo County Water Utility Authority, a political subdivision of the State
of New Mexico (the ABCWUA), whereby the ABCWUA treated 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
supplemented NMUIs existing water rights, enabling it to pump additional water
from the basin.
In August 2004, the
ABCWUA increased the fee charged to NMUI, using a different formula than had
been used to calculate fee increases since 1973. The Company believed the
increase violated the terms of a 1973 written agreement between the parties.
Subsequently, the ABCWUA also claimed ownership of the return flow credits. On September 13,
2004, the Company filed a Complaint for Declaratory Judgment in the Second
Judicial District Court, County of Bernalillo, State of New Mexico (the Court),
requesting that the Court settle these disputes.
In addition, in January 2007,
the ABCWUA 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 Court (the Petition). The Petition sought to acquire, by
condemnation, all of the assets of NMUI, including all real property, through
the stated power of eminent domain. The Petition also alleged 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 contested the Petition.
In October 2008, the
Company attempted to settle the sewer rate and return flow credit issues with
an $8.0 million cash offer. The settlement offer was not accepted by
ABCWUA.
9
Table of Contents
SOUTHWEST WATER COMPANY
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On January 29, 2009,
NMUI and the ABCWUA entered into a Settlement, Arbitration Award, and
Acquisition Agreement (the Agreement) to resolve all outstanding claims,
demands and existing lawsuits between them. Under the Agreement, the ABCWUA
acquired certain of the assets of NMUI necessary for the ABCWUA to own, operate
and maintain the water and wastewater system of NMUI in settlement of
condemnation. In consideration of the assets acquired, the ABCWUA agreed to pay
to NMUI at the Closing as full, final and complete consideration the sum of: (i) $60.0 million;
(ii) an amount equal to the NMUI accounts receivable at the date of
Closing; and (iii) an amount equal to the unbilled services at the date of
Closing. The Agreement closed on May 8, 2009.
NMUI also received the
right to customer billings previously placed into escrow. The total amount
received by the Company on May 12, 2009 from these escrow funds was $0.9
million.
In addition, the
settlement resolves all other legal issues between NMUI and ABCWUA, including
the dispute over the sewer fee the ABCWUA charged NMUI for the treatment of
wastewater and the ownership of the return flow credits from that treated
wastewater, as well as all other disputed amounts of the ABCWUA. As part of the
settlement, NMUI agreed to pay $7.0 million to the ABCWUA at the time of
closing to resolve the sewer fee issue. This amount was accrued prior to the
closing of the Agreement.
Net cash proceeds from
settlement were $53.9 million and the resulting gain, net of direct
transactional costs of $0.1 million, was $26.1 million. Substantially all
of the utility plant assets of NMUI were pledged as collateral for $12.3
million in first mortgage bonds with an original maturity of 2024 and related
accrued interest. We repaid these bonds in full, including accrued
interest of $0.3 million. The remaining cash proceeds of $41.6 million were
used to pay the balance of liabilities of NMUI, and to pay down our revolving
credit facility. The sale reflects a $107.2 million reduction in assets, offset
by a reduction in liabilities of $79.5 million, which includes a $69.0 million
reduction in contributions in aid of construction.
Investigations
On May 18, 2005, the
Environmental Protection Agency (EPA) executed a search warrant at our
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 EPAs investigation and have provided
the records requested. We remain in close cooperation and coordination with
both Department of Justice (DOJ) and EPAs counsel in an attempt to resolve
the matter favorably. In April 2009, we submitted our formal request that
the DOJ not pursue criminal sanctions. By letter dated November 10, 2009,
that request was granted. Civil action by the government is still possible but
we have not been made aware that any action will be pursued. As a result, no
amounts have been accrued related to any possible civil fines, penalties or
liabilities.
We received a letter dated
January 28, 2008 from the California State Water Resources Control Board
Office of Enforcement (the Board). The letter indicated that the Board has
conducted an investigation of the operations of one of our subsidiaries 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. Since receipt of the letter, we have conducted an
internal investigation and worked in cooperation with the Board to resolve the
matter favorably. We have reached a preliminary settlement, requiring that we
implement an acceptable compliance program valued at $0.5 million and pay fines
and penalties of up to $0.75 million, all of which we have accrued.
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 continued to receive payments until the 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. 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 expenses. The reimbursements were $0.2 million and $0.1 million
for the three months ended March 31, 2010 and 2009, 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 $0.1 million for the three months ended March 31, 2009
and were recorded as contributions in aid of construction. There were no
contributions for the three months ended March 31, 2010. On April 20,
2010 a mediation was conducted at which the parties resolved all outstanding
issues without further costs to our California water utility, essentially
ending all disputes.
Other
Matters
We are also involved in
other routine legal and administrative proceedings arising during the ordinary
course of business. We believe that the ultimate disposition of such matters
will not have a material adverse effect on our consolidated financial position,
results of operations or cash flows. Any related legal costs are expensed
when incurred.
10
Table of Contents
SOUTHWEST WATER COMPANY
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Certain
Contractual Commitments and Indemnities
During the 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 contract services
businesses. 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 the Company
could be obligated to make and is not quantifiable. The Company has not
recorded any liability for these indemnities.
Note
5. Earnings per Share
The
following table is a reconciliation of the numerators (income) and denominators
(shares) used in both the basic and diluted earnings per share calculations.
|
|
Three Months Ended
|
|
|
|
|
March 31,
|
|
|
(In thousands)
|
|
2010
|
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NumeratorsNet
loss applicable to common stockholders:
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$
|
(2,928
|
)
|
|
|
$
|
(3,405
|
)
|
|
|
Less
preferred stock dividends
|
|
(6
|
)
|
|
|
|
|
|
|
Loss
from continuing operations applicable to common stockholders
|
|
(2,934
|
)
|
|
|
(3,405
|
)
|
|
|
Income
from discontinued operations, net of tax
|
|
-
|
|
|
|
172
|
|
|
|
Loss
applicable to common stockholders
|
|
$
|
(2,934
|
)
|
|
|
$
|
(3,233
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominators
|
|
|
|
|
|
|
|
|
|
Basic
weighted average common shares outstanding
|
|
25,105
|
|
|
|
24,600
|
|
|
|
Diluted
weighted average common shares outstanding
|
|
25,105
|
|
|
|
24,600
|
|
|
|
The
Company has $11.8 million of 6.85% fixed-rate convertible subordinate
debentures outstanding as March 31, 2010. The debentures are convertible
into common stock at any time prior to maturity, unless previously redeemed, at
a conversion price of $11.018 per share which totals 1.1 million shares at March 31,
2010. 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.
Note 6. Consolidated Statements of Cash Flows
The
following information supplements the Companys consolidated statements of cash
flows.
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
(In thousands)
|
|
2010
|
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
2,155
|
|
|
|
$
|
1,677
|
|
|
Income
taxes paid
|
|
11
|
|
|
|
67
|
|
|
Non-cash
investing and financing activities:
|
|
|
|
|
|
|
|
|
Non-cash
contributions in aid of construction and advances for construction
|
|
|
|
|
|
|
|
|
|
|
conveyed
to Company by developers
|
|
$
|
88
|
|
|
|
$
|
|
|
|
Note 7. Dividend Reinvestment and Direct Stock
Purchase Plan (DRIP / DSPP)
We have 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. As of March 31,
2010, there are 3.7 million shares authorized for issuance under the plan,
of which 0.7 million shares remain available for issuance. However, under
the terms of the Merger Agreement, we have agreed that we will not issue any
additional shares of common stock or other equivalent interest until the
consummation of the Merger, at which time the plan will be terminated.
11
Table of Contents
SOUTHWEST WATER COMPANY
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 8. Segment Information
The Companys principal business activity is to operate
and maintain water and wastewater infrastructure. Through its operating subsidiaries, the
Company owns 144 systems and operates hundreds more under contract to cities,
utility districts and private companies. The Company has four reporting
segments. The Company separates its segments first by whether it owns the
utility or provides contract services to others. Its owned water and wastewater
utilities are referred to as its Utilities operations. In its financial
statements the Company reports its Texas Utilities operations as a separate
reporting segment because of different economic characteristics. This is
principally due to the fact that Texas Utilities are under-recovering their
current cost of service as the Company has made large investments in these
operations that are not yet being recovered through rates it charges. The
Companys contract operations are segmented by contract type into those that
are generally larger, stand-alone operations (O&M Services) and those
that are small, full service contracts operated by a common team of personnel
resulting in a model that proportions a fractional cost to each client (Texas
MUD Services).
The following table
presents information about the operations of each segment for the three-month
periods ended March 31, 2010 and 2009:
|
|
|
|
|
|
Texas
|
|
|
|
O&M
|
|
|
|
Texas
MUD
|
|
|
|
|
|
|
|
Consol-
|
|
(In
thousands)
|
|
Utilities
|
|
|
|
Utilities
|
|
|
|
Services
|
|
|
|
Services
|
|
|
|
Corp.
(1)
|
|
|
|
idated
|
|
Three
Months Ended March 31, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
13,223
|
|
|
|
$
|
8,675
|
|
|
|
$
|
9,047
|
|
|
|
$
|
15,901
|
|
|
|
$
|
|
|
|
|
$
|
46,846
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
and maintenance
|
|
8,682
|
|
|
|
6,571
|
|
|
|
8,827
|
|
|
|
15,484
|
|
|
|
5,748
|
|
|
|
45,312
|
|
Depreciation
and amortization
|
|
2,045
|
|
|
|
1,180
|
|
|
|
147
|
|
|
|
179
|
|
|
|
316
|
|
|
|
3,867
|
|
Total
expenses
|
|
10,727
|
|
|
|
7,751
|
|
|
|
8,974
|
|
|
|
15,663
|
|
|
|
6,064
|
|
|
|
49,179
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income (loss)
|
|
2,496
|
|
|
|
924
|
|
|
|
73
|
|
|
|
238
|
|
|
|
(6,064
|
)
|
|
|
(2,333
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
(2)
|
|
(400
|
)
|
|
|
(624
|
)
|
|
|
(24
|
)
|
|
|
(83
|
)
|
|
|
(1,239
|
)
|
|
|
(2,370
|
)
|
Interest
income
|
|
30
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33
|
|
Income
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations
before income taxes
|
|
$
|
2,126
|
|
|
|
$
|
303
|
|
|
|
$
|
49
|
|
|
|
$
|
155
|
|
|
|
$
|
(7,303
|
)
|
|
|
$
|
(4,670
|
)
|
|
|
|
|
|
|
Texas
|
|
|
|
O&M
|
|
|
|
Texas
MUD
|
|
|
|
|
|
|
|
Consol-
|
|
|
|
Utilities
|
|
|
|
Utilities
|
|
|
|
Services
|
|
|
|
Services
|
|
|
|
Corp.
(1)
|
|
|
|
idated
|
|
Three Months Ended March 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
13,379
|
|
|
|
$
|
8,591
|
|
|
|
$
|
9,147
|
|
|
|
$
|
18,975
|
|
|
|
$
|
|
|
|
|
$
|
50,092
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations
and maintenance
|
|
8,388
|
|
|
|
5,052
|
|
|
|
8,877
|
|
|
|
18,327
|
|
|
|
9,263
|
|
|
|
49,907
|
|
Depreciation
and amortization
|
|
1,953
|
|
|
|
1,160
|
|
|
|
133
|
|
|
|
214
|
|
|
|
373
|
|
|
|
3,833
|
|
Total
expenses
|
|
10,341
|
|
|
|
6,212
|
|
|
|
9,010
|
|
|
|
18,541
|
|
|
|
9,636
|
|
|
|
53,740
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income (loss)
|
|
3,038
|
|
|
|
2,379
|
|
|
|
137
|
|
|
|
434
|
|
|
|
(9,636
|
)
|
|
|
(3,648
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
(2)
|
|
(460
|
)
|
|
|
(587
|
)
|
|
|
(90
|
)
|
|
|
(77
|
)
|
|
|
(673
|
)
|
|
|
(1,887
|
)
|
Interest
income
|
|
27
|
|
|
|
4
|
|
|
|
1
|
|
|
|
3
|
|
|
|
1
|
|
|
|
36
|
|
Income
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations
before income taxes
|
|
$
|
2,605
|
|
|
|
$
|
1,796
|
|
|
|
$
|
48
|
|
|
|
$
|
360
|
|
|
|
$
|
(10,308
|
)
|
|
|
$
|
(5,499
|
)
|
(1) Reflects corporate
headquarters, general and administrative expenses and interest expense, net of
interest income charged on intercompany debt.
(2) Segment
interest expense includes inter-segment interest expense or income on related
inter-segment payables and receivables.
Note 9. Subsequent Events
Monarch Utilities, Inc. (Monarch), a Texas
utility company, filed a rate increase application with the TCEQ in July 2007
which resulted in an all party settlement on December 12, 2008 which
provided for a 2-year phase-in of the settled rates. Monarch also agreed
to provide a market valuation for and to negotiate the sale of our Blue Mound,
Texas; Kyle, Texas; and Southmayd, Texas water and wastewater assets to the
respective municipalities. Management discussed the sale with officials
of each city; however, as of March 31, 2010 no terms had been agreed
upon. In April
12
Table of Contents
SOUTHWEST WATER COMPANY
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2010, Blue Mound and Southmayd provided purchase
proposals and management now believes that sale agreements may be reached with
these two municipalities for the respective assets. Any such sale will be
contingent upon the municipalities raising financing and will require the
approval of the Parent, Monarchs lender and the TCEQ. Should agreements
be reached on the proposals provided, the sale transactions may be consummated
by the end of 2010.
13
Table of Contents
ITEM
2.
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
Managements
Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
is intended to help the reader understand the results of operations, financial
condition and cash flows of SouthWest Water Company and is provided as a
supplement to, and should be read in conjunction with our consolidated
financial statements and the accompanying notes to the financial statements
included in this report. This MD&A also contains forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. All statements contained
herein that are not clearly historical in nature are forward-looking, and the
words anticipate, believe, belief, expect, estimate, project, plan,
intend, continue, predict, may, will, should, strategy, will
likely result, will likely continue, and similar expressions are generally
intended to identify forward-looking statements. Forward-looking statements are
subject to risks and uncertainties that could cause actual results to differ
materially from our historical experience and our present expectations or
projections. A detailed discussion of these and other risks and uncertainties
that could cause actual results and events to differ materially from such
forward-looking statements is included in the section entitled Item 1A. Risk
Factors in our 2009 Annual Report on Form 10-K. Caution should be taken
not to place undue reliance on any such forward-looking statements since such
statements speak only as of the date when made. Other than as required by
applicable law, we undertake no obligation to publicly update or revise
forward-looking statements whether as a result of new information, future
events, or otherwise.
OVERVIEW
SouthWest Waters
principal business activity is to operate and maintain water and wastewater
infrastructure. Through our operating subsidiaries, we own 144 systems and
operate hundreds more under contract to cities, utility districts and private
companies. SouthWest Water was incorporated in California in 1954 and
reincorporated in Delaware in 1988. We maintain our corporate offices in Los
Angeles, California.
Merger Agreement and Long-Term Infrastructure
Investment
On March 2, 2010, we
entered into an agreement and plan of merger (the Merger Agreement) with SW
Merger Acquisition Corp. (Parent) and SW Merger Sub Corp., a direct
wholly-owned subsidiary of Parent (Merger Sub). Parent and Merger Sub are
jointly owned by IIF Subway Investment LP and USA Water Services, LLC, which
are sponsored by J.P. Morgan IIF Acquisitions LLC and Water Asset Management,
LLC. Under the terms of the Merger
Agreement, all of our outstanding common stock would be converted into a right
to receive $11.00 per share in cash. The
completion of the merger is subject to customary closing conditions, including
stockholder approval and regulatory notice and approvals.
If the Merger Agreement is
adopted by our stockholders and all closing conditions are met, we will be the
surviving corporation of the merger and a wholly owned subsidiary of Parent.
Upon completion of the merger, our common stock will cease to be traded on the
NASDAQ Global Select Market and we will no longer be a publicly held
corporation. The Merger Agreement
contains restrictions on our operations prior to the closing of the merger,
including restrictions related to capital expenditures, the incurrence of debt,
acquiring and disposing of assets, entering into material contracts and capital
transactions.
In connection with the
Merger Agreement, we entered into a Securities Purchase Agreement and Investor
Rights Agreement (collectively, the Investment Agreements). Pursuant to the Investment Agreements, Parent
purchased 2,700,000 shares of our common stock (the Purchased Stock) at a
price of $6.00 per share, for an aggregate purchase price of $16.2 million and
we incurred related specific incremental transactional costs of $0.1
million. As permitted under the terms of
the Investment Agreements, the Company applied the proceeds derived from the
sale of the Purchased Stock to reduce our revolving line of credit, the borrowings
of which are used for capital expenditures and working capital purposes. The Investment Agreements entitle Parent to
appoint a designee to serve on our board of directors (which right Parent has
not exercised to date), and also to certain registration rights with respect to
the Purchased Stock in the event of the termination of the Merger
Agreement. The Investment Agreements
restrict Parents ability to sell or otherwise transfer the Purchased Stock
prior to the earlier of the consummation or termination of the Merger
Agreement. Except as contemplated by the
Merger Agreement, Parent and Merger Sub are also prohibited from acquiring any
additional shares of our common stock until the termination of the Merger
Agreement.
As the offering and sale
of the Purchased Stock pursuant to the Investment Agreements was not registered
under the Securities Act of 1933 or applicable state securities laws, the
Purchased Stock may not be offered or sold in the United States absent
registration or an applicable exemption from such registration requirements.
Segments
We separate our four
reporting segments first by whether we own the utility or provide contract
services to others. Our owned water and wastewater utilities are referred to as
our Utilities operations (Utilities). In our financial statements the Company
reports our Texas Utilities operations (Texas Utilities) as a separate
reporting segment because of different economic characteristics. This is
principally due to the fact that Texas Utilities are under-recovering their
current cost of service as the Company has made large investments in these
operations that are not yet being recovered through rates it charges. Our
contract operations are segmented by contract type into those that are
generally larger, stand-alone operations (O&M Services) and those that
are small, full service contracts operated by a common team of personnel
resulting in a model that proportions a fractional cost to each client (Texas
MUD Services).
14
Table of Contents
Utilities
consist of our owned water and wastewater
utilities located in California, Alabama, and Mississippi. In previous periods,
the utilities segment included the business activities of our New Mexico
Utility (NMUI) that was sold on May 8, 2009. The NMUI activities are now
included in discontinued operations for all periods presented. See Note 2 -
Dispositions included in Item 1 Financial Statements for the summary of
the historical results of discontinued operations. Residential customers make
up the largest component of our Utilities customer base, with these customers
representing approximately 94% of our water and wastewater connections.
Substantially all of our Utilities customers are metered which allows us to
measure and bill for each customers water consumption. Each of the operations
in this segment has a unique service territory that is subject to state and
federal regulations regarding standards of water quality, safety, environmental
and other matters. The rates that we can charge for water and wastewater
service include the opportunity to earn a reasonable rate of return on
investments in these utilities. Except for some of our Alabama wastewater rates
which are governed by our service agreements; the rates our utilities charge
are subject to the approval of state regulatory agencies. Some of these
governmental agencies approve a forward looking recovery of costs and some
approve recovery of costs based on a historical test year. Our Utilities operations
require ongoing capital investments to maintain and enhance the reliability and
quality of the service we provide, as well as the opportunity for revenue
growth from rate increases and new connections.
Texas
Utilities
consists
of 123 small, mostly rural systems that are grouped into nine jurisdictional
utilities across Texas and one small system in Oklahoma. Residential customers
represent approximately 98% of our Texas water and wastewater connections.
Substantially all of our Texas Utilities customers are metered which allows us
to measure and bill for each customers water consumption. These systems are
broadly dispersed geographically. The majority of the systems are organized as
one utility, known as Monarch Utilities, with a single tariff. The Monarch
systems, as well as two smaller systems acquired in 2007, were in various
stages of disrepair at the time of acquisition and we continue to spend
significant capital to maintain regulatory compliance and to improve the
quality of service. We are not yet recovering all of these costs in our rates
and, as a result, the Texas Utilities have a lower rate of return than
typically expected from a utility. We intend to actively pursue recovery of
these costs in the rate setting process. All other aspects of operations for
these utilities are the same as our Utilities operations; therefore, as soon as
we are recovering our costs, including a reasonable rate of return on
investment, we expect to aggregate this segment with our Utilities segment.
O&M
Services
generally
consists of operations that are project-specific contracts with cities, public
agencies and private owners. Most contracts are stand-alone operations staffed
with project-specific personnel, with an average contract life of two to three
years. Under a typical O&M contract, we charge a fee that covers a
specified level of service that includes facility operations and maintenance
and may include other water or wastewater related services. Services are
typically provided evenly throughout the contract period and are billed on a
monthly basis. If we provide services beyond the scope of a contract, we bill
for the additional services on a time-and-materials basis or negotiate a unique
price. These contracts are largely located in California, Colorado, Alabama,
Mississippi, and Georgia.
Texas MUD
Services
is a full
service provider of utility services to a large number of small utilities in
Texas that are mostly owned by municipal utility districts (MUD). A MUD is
created to provide water supply, wastewater treatment and drainage service to
areas where municipal services are not available. We service over 270 MUD
clients with a common team of client managers, operators, customer service and
billing personnel. Therefore these contracts are allocated a proportional
amount of each cost center creating a business model that is significantly
different from that of
O&M Services. Under a
typical MUD contract, we bill a monthly base fee to provide a specified level
of service; usually water and/or wastewater facility inspections, routine
operations, equipment maintenance, and utility customer service including meter
reading, call center, dispatch, billing and collection services. We 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. The majority of our MUD contracts are
cancelable with 30 to 60 day prior notice by either party, but tend to
last for long periods due to the close working relationships between the
operators and the clients.
Impacts to Results of Operations 2010 and 2009
Utilities & Texas Utilities:
Our Utilities segments results of
operations are influenced by factors that are similar to the industry in
general. A more complete understanding of these factors can be gained by
reviewing this section along with the Risk Factors section in Part 1, Item
1A, in our 2009 Annual Report on Form 10-K. As we review and discuss
performance, the general areas of impact we evaluate are as follows:
·
Growth related
: Growth in our utilities segments is
generally characterized by the following drivers: 1) growth in the number of
connections served within existing utility certified service areas and
2) acquisition of new service areas. In our Utilities segment, our largest
utility is our California utility which is a substantially built-out system
that does not generally see much change in connection count. The majority of
our other utilities are in markets that experienced significant new home
construction in the past (ranging from 2% to 8% annual growth). We have seen
this significantly decline with growth averaging less than 1% across all
systems throughout 2009 and the first three months of 2010.
·
Rate
related
: Each of
our utilities will increase rates from time to time to recover expenses and
realize a return on invested capital as allowed by the regulator or governing
contract. Rate cases can take months or years to impact results due to the time
needed to prepare, present and ultimately receive approval from the regulator.
In each of our utilities, we have a long-term rate strategy that matches our
expectation for growth, regulatory change and demand. Our California utility
benefited from a 1.5% step-rate increase implemented January 1, 2010. Our
Texas Utilities benefited from step-rate increases at one utility in late 2009
and two in the first quarter of 2010. In Alabama our Shelby County and
Riverview wastewater utilities have contractual agreements with the local
government that provide us with the ability to request rate increases annually.
Accordingly, we requested and received increases in January 2010 of 10.8%
at our Shelby County utility and an approximate 2.5% increase at our Riverview
utility.
·
Demand related
: The demand for our water, a major driver
of our operating results, reflects seasonal rainfall and temperature fluctuations,
which vary not only season to season, but from year to year. The uniform rate
design that regulators require for our utilities can result in unrecovered
fixed costs and lower earnings during periods
15
Table
of Contents
of abnormally low water use. This can occur during
abnormal weather conditions, such as when temperatures are cooler than normal,
when there is greater than normal precipitation, during mandatory restrictions
on water use because of drought, consumer conservation and socio-economic
events. Demand related changes often impact both the revenue of the utility and
the cost of production. We experienced lower demand at our California utility
in the first three months of 2010, largely due to weather but also due to
conservation.
·
Supply related
: The cost of water and related
commodities is a major driver of our results. Utilities that pump and purchase
water are subject to changes in operations due to the amount and cost of that
water. Pumped and purchased water supply changes are typically driven by longer
term climate issues such as extended drought but can also be driven by
short-term maintenance needs. In California the unit cost of water increased in
the first three months of 2010. This is related to the increased price of
Metropolitan Water District and other supply purchases and the increased cost
of locally produced water following the
Main San Gabriel Watermaster action of lowering the safe yield in the basin and
raising the rate for replacement water for water pumped in excess of water
rights held. This caused an additional increase in cost of pumped and purchased
water sources. It should be noted that in California pricing changes from price
levels adopted in rate cases receive balancing account treatment and the cost
variance is deferred and charged or credited to customers in a future period at
cost. However, due to reduced demand in the first three months of 2010, we
pumped and purchased less water resulting in lower supply costs.
·
Operation &
Maintenance related
:
Our operation and maintenance costs include fuel, power, labor, labor benefits,
facility costs, and other ordinary costs of producing or treating water. These
costs are impacted by compliance with environmental and health safety
standards. They are also typically subject to inflation effects and while we
can file for recovery after inflation effects are incurred in backward looking
rate making jurisdictions, we often experience a lag between the time we incur
these costs and when we receive the rate increase to cover these costs. In
California, which is a forward looking rate making environment, we estimate the
impacts of inflation in our rate filings and must absorb any costs that are
different than our estimates.
·
General &
Administrative related
: Our general and administrative costs include management expenses
directly incurred by the segment as well as costs for services performed by
centralized support functions that are allocated to each segment. These support
function costs include IT, shared financial services, and environmental health
and safety. We anticipate that in the near term we will continue to experience
higher costs due to the remediation of our material internal control weaknesses
(see Item 4 Controls and Procedures for a detailed discussion of our
material internal control weaknesses.
·
Other
: Other is reserved for unusual items that
may impact results from time to time.
O&M Services Segment
: Our O&M Services segment results of
operations are generally influenced by a variety of events. As we review and
discuss performance, the general areas of impact we evaluate are as follows:
·
Contract
growth:
Growth is generally due to new contracts, additional
project work under existing contracts and contract price increases. Our primary
driver of contract growth in the first three months of 2010 has been from new
contracts and expanding the scope of work provided to existing customers.
·
Lost work:
Lost work is generally driven by lost contracts or a
reduction in project work for existing contracts. The primary driver, in the
first quarter of 2010, was reduced project work.
·
General &
administrative related
: Our general and administrative costs include management expenses directly
incurred by the segment as well as costs for services performed by centralized
support functions that are allocated to each segment. These support function
costs include IT, shared financial services and environmental health and
safety.
·
Other:
Other is reserved for unusual items that may impact
results from time to time.
Texas MUD Services Segment
: Our Texas MUD Services segments results
of operations are influenced by contract growth or loss and changes in contract
scope:
·
Contract
growth:
New
contracts, additional project work and contract price increases are offset by
lost contracts, reductions in project work, or a reduction in other ancillary
services such as new taps and inspection services for new home construction. We
lost a number of contracts between March 31, 2009 and March 31, 2010
due to increased competition in our service territories.
·
General &
administrative related:
Our general and administrative costs include expenses directly incurred
by the segment such as management expense as well as costs for services
performed by centralized support functions that are then allocated to each
segment. These support costs include information technology costs, shared
financial services and environmental health and safety.
·
Other:
Other is reserved for unusual items that may impact
results from time to time.
Corporate Segment
: Our corporate segment includes costs related to
executive management, investor relations, human resources, general legal and
insurance and public company needs, audit costs, and other expenses generally
related to the parent organization. Most of the costs are general and
administrative in nature and not subject to much variation. In the first
quarter of 2010, costs were primarily impacted by expenses associated with our
proposed Merger Agreement and severance expenses.
16
Table of Contents
Discontinued Operations
As
discussed in Note 2, Dispositions in Part I, Item 1 Financial
Statements, we completed the sale of NMUI in May 2009 and the operating
results of NMUI are included in discontinued operations for the three months
period ended March 31, 2009.
RESULTS OF OPERATIONS
Three months ended March 31,
2010 Compared to 2009
Consolidated
operating revenue decreased $3.2 million, or 6.5%, to $46.8 million for the
three-month period ended March 31, 2010 from $50.1 million for the same
period in the prior year. Consolidated operating expenses decreased $4.6
million, or 8.5%, to $49.2 million for the three-month period ended March 31,
2010 from $53.7 million for the 2009 period. Resulting operating loss decreased
$1.3 million to a loss of $2.3 million for the three-month period ended March 31,
2010, from an operating loss of $3.6 million for the same period in the prior
year. The first quarter of 2010
operating loss includes the impact of $1.2 million of costs associated with
proposed Merger Agreement, as well as other costs described below while the
2009 operating loss includes $5.3 million of costs associated with the
restatement process.
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
Percent of Revenue
|
|
|
|
2010
|
|
2009
|
|
Increase
(Decrease)
|
|
2010
|
|
2009
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
|
$
|
13,223
|
|
$
|
13,379
|
|
$
|
(156
|
)
|
|
|
|
|
Operating
Expense
|
|
10,727
|
|
10,341
|
|
386
|
|
81.1%
|
|
77.3%
|
|
Operating
Income
|
|
$
|
2,496
|
|
$
|
3,038
|
|
$
|
(542
|
)
|
18.9%
|
|
22.7%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Texas Utilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
|
$
|
8,675
|
|
$
|
8,591
|
|
$
|
84
|
|
|
|
|
|
Operating
Expense
|
|
7,751
|
|
6,212
|
|
1,539
|
|
89.3%
|
|
72.3%
|
|
Operating
Income
|
|
$
|
924
|
|
$
|
2,379
|
|
$
|
(1,455
|
)
|
10.7%
|
|
27.7%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
O&M Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
|
$
|
9,047
|
|
$
|
9,147
|
|
$
|
(100
|
)
|
|
|
|
|
Operating
Expense
|
|
8,974
|
|
9,010
|
|
(36
|
)
|
99.2%
|
|
98.5%
|
|
Operating
Income
|
|
$
|
73
|
|
$
|
137
|
|
$
|
(64
|
)
|
0.8%
|
|
1.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Texas MUD Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
|
$
|
15,901
|
|
$
|
18,975
|
|
$
|
(3,074
|
)
|
|
|
|
|
Operating
Expense
|
|
15,663
|
|
18,541
|
|
(2,878
|
)
|
98.5%
|
|
97.7%
|
|
Operating
Income
|
|
$
|
238
|
|
$
|
434
|
|
$
|
(196
|
)
|
1.5%
|
|
2.3%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
|
$
|
|
|
$
|
|
|
$
|
|
|
|
|
|
|
Operating
Expense
|
|
6,064
|
|
9,636
|
|
(3,572
|
)
|
|
|
|
|
Operating
Loss
|
|
$
|
(6,064
|
)
|
$
|
(9,636
|
)
|
$
|
3,572
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Revenue
|
|
$
|
46,846
|
|
$
|
50,092
|
|
$
|
(3,246
|
)
|
|
|
|
|
Operating
Expense
|
|
49,179
|
|
53,740
|
|
(4,561
|
)
|
105.0%
|
|
107.3%
|
|
Operating
Loss
|
|
$
|
(2,333
|
)
|
$
|
(3,648
|
)
|
$
|
1,315
|
|
(5.0%)
|
|
(7.3%)
|
|
17
Table
of Contents
Utilities
|
|
Operating
|
|
|
|
Operating
|
|
|
|
Operating
|
|
(in
thousands)
|
|
Revenue
|
|
|
|
Expense
|
|
|
|
Income
|
|
Three
months ended March 31, 2009
|
|
$
|
13,379
|
|
|
|
$
|
10,341
|
|
|
|
$
|
3,038
|
|
Rate
related
|
|
262
|
|
|
|
|
|
|
|
|
|
Demand
related
|
|
(564
|
)
|
|
|
|
|
|
|
|
|
Balancing
account
|
|
146
|
|
|
|
146
|
|
|
|
|
|
Supply
related
|
|
|
|
|
|
(446
|
)
|
|
|
|
|
O&M
related
|
|
|
|
|
|
272
|
|
|
|
|
|
G&A
related
|
|
|
|
|
|
238
|
|
|
|
|
|
Other
|
|
|
|
|
|
176
|
|
|
|
|
|
Three months ended March 31,
2010
|
|
$
|
13,223
|
|
|
|
$
|
10,727
|
|
|
|
$
|
2,496
|
|
Operating
revenue decreased $0.2 million, or 1.2 %, to $13.2 million for three months
ended March 31, 2010 from $13.4 million for the same period in the prior
year. The net decrease was primarily due
to the following events:
·
Rate related: A $0.3 million increase due to rate
increases in California and Alabama, of which approximately half is due to our
California utility implementing a step rate increase in January 2010 and
the remainder is primarily due to rate increases in our Shelby County and
Riverview utilities.
·
Demand related: A $0.6 million decrease primarily due
to lower consumption at our California utility resulting from higher
precipitation in the first quarter of 2010 compared to the first quarter of
2009 and from continuing customer conservation efforts.
·
Balancing account: A $0.1 million increase related to
balancing account surcharges approved by the CPUC and collected in California
to recover certain deferred water supply costs which is offset by the same
amount in balance account expenses. No return is earned on surcharges.
Operating
expenses increased $0.4 million, or 3.7%, to $10.7 million for the three months
ended March 31, 2010, from $10.3 million for same period in the prior
year. The net increase was primarily due
to the following events:
·
Balancing account: A $0.1 million increase in costs
recognized related to the balancing account surcharges described above.
·
Supply related: A $0.4 million decrease primarily due
to lower volume of delivered water in California.
·
O&M related: A $0.3 million increase primarily due
to an increase in depreciation expense resulting from capital additions, and
from higher repairs and maintenance expenses and vehicle costs.
·
G&A related: A $0.2 million increase primarily due
to increases in salaries and wages and insurance expenses.
·
Other: A $0.2 million increase due to legal fees and
severance expenses.
As a
result of the above events, operating income decreased $0.5 million, to $2.5
million for the three months ended March 31, 2010, from $3.0 million for
the same period in the prior year.
Texas Utilities
|
|
Operating
|
|
|
|
Operating
|
|
|
|
Operating
|
|
(in
thousands)
|
|
Revenue
|
|
|
|
Expense
|
|
|
|
Income
|
|
Three
months ended March 31, 2009
|
|
$
|
8,591
|
|
|
|
$
|
6,212
|
|
|
|
$
|
2,379
|
|
Growth
related
|
|
115
|
|
|
|
|
|
|
|
|
|
Rate
related
|
|
79
|
|
|
|
|
|
|
|
|
|
Demand
related
|
|
(110
|
)
|
|
|
|
|
|
|
|
|
O&M
related
|
|
|
|
|
|
940
|
|
|
|
|
|
G&A
related
|
|
|
|
|
|
599
|
|
|
|
|
|
Three
months ended March 31, 2010
|
|
$
|
8,675
|
|
|
|
$
|
7,751
|
|
|
|
$
|
924
|
|
Operating
revenue increased $0.1 million, or 1.0%, to $8.7 million for three months ended
March 31, 2010 from $8.6 million for the same period in the prior year.
The net increase was primarily due to the following events:
·
Growth related: A $0.1 million increase primarily due
to an increase in connection count and tap fees.
18
Table
of Contents
·
Rate related: A $0.1 million increase primarily due to
a step-rate increase in rates at two of our utilities.
·
Demand related: A $0.1 million decrease due to lower
volume of delivered water as a result of more normalized weather patterns in
the first quarter of 2010 compared to hotter and drier climatic conditions in
the corresponding period of 2009.
Operating
expenses increased $1.5 million, or 24.8%, to $7.8 million for the three months
ended March 31, 2010, from $6.2 million for the same period in the prior
year. The increase was primarily due to
the following events:
·
O&M related: A $0.9 million increase primarily due
to higher repairs and maintenance costs, increases in salaries and wages
associated with increased personnel in operations, higher fuel and supply
costs, and the retirement of a well and a tank.
·
G&A related: A $0.6 million increase due to
increases in salary and wages associated with increased financial services
head-count as well as information technology costs and professional fees.
As a
result of the above events, operating income decreased $1.5 million, to $0.9
million for the three months ended March 31, 2010, from income of $2.4
million for the same period in the prior year.
O&M Services
|
|
Operating
|
|
|
|
Operating
|
|
|
|
Operating
|
|
(in
thousands)
|
|
Revenue
|
|
|
|
Expense
|
|
|
|
Income
|
|
Three
months ended March 31, 2009
|
|
$
|
9,147
|
|
|
|
$
|
9,010
|
|
|
|
$
|
137
|
|
Contract
growth
|
|
587
|
|
|
|
425
|
|
|
|
|
|
Lost
work
|
|
(687
|
)
|
|
|
(366
|
)
|
|
|
|
|
G&A
related
|
|
-
|
|
|
|
(251
|
)
|
|
|
|
|
Other
|
|
|
|
|
|
156
|
|
|
|
|
|
Three
months ended March 31, 2010
|
|
$
|
9,047
|
|
|
|
$
|
8,974
|
|
|
|
$
|
73
|
|
Operating
revenue decreased $0.1 million to $9.0 million for the three months ended March 31,
2010 compared to $9.1 million for the same period in the prior year:
·
Contract growth: A $0.6 million increase due to new
contracts and increased project work, primarily in California.
·
Lost work: A $0.7 million decrease due to decreased
project work and lost contracts.
Operating
expenses also remained consistent at $9.0 million for the three months ended March 31,
2010 and 2009:
·
Contract growth: A $0.4 million increase due to new
contracts and project work identified above.
·
Lost work: A $0.4 million decrease due to lost
contracts and reduced project work.
·
G&A related: A $0.3 million decrease due to lower
salary and wages, associated with lower head-count, and insurance expenses.
·
Other: A $0.2 million increase related to legal
expenses.
As a
result of the above events, operating income was $0.1 million for both the
three months ended March 31, 2010 and 2009.
Texas MUD Services
|
|
Operating
|
|
|
|
Operating
|
|
|
|
Operating
|
|
(in
thousands)
|
|
Revenue
|
|
|
|
Expense
|
|
|
|
Income
|
|
Three
months ended March 31, 2009
|
|
$
|
18,975
|
|
|
|
$
|
18,541
|
|
|
|
$
|
434
|
|
Contract
growth
|
|
(3,074
|
)
|
|
|
(1,369
|
)
|
|
|
|
|
G&A
related
|
|
|
|
|
|
(1,741
|
)
|
|
|
|
|
Other
|
|
|
|
|
|
232
|
|
|
|
|
|
Three
months ended March 31, 2010
|
|
$
|
15,901
|
|
|
|
$
|
15,663
|
|
|
|
$
|
238
|
|
Operating
revenue decreased $3.1 million, or 16.2%, to $15.9 million for three months
ended March 31, 2010 from $19.0 million for the same period in the prior
year. The decrease was primarily due to the following:
19
Table
of Contents
·
Contract growth: A $3.1 million decrease in revenue due
to $1.9 million from lost contracts, $0.5 million related to the sale of our
environmental testing laboratory on April 1, 2009, and $0.5 million
primarily related to a reduction in pass-through revenue from materials
purchased for clients.
Operating
expenses decreased $2.9 million, or 15.5%, to $15.7 million for the three
months ended March 31, 2010, from $18.5 million for the same period in the
prior year. The net decrease was
primarily due to the following events:
·
Contract growth: A $1.4 million decrease due to $0.6
million from lost contracts, $0.2 million due to the sale of our environmental
testing laboratory, and $0.6 million primarily related to a reduction in
pass-through costs from materials purchased for clients.
·
G&A related: A $1.7 million decrease, primarily due
to decreases in salary and wages expenses, associated with lower head-count,
and other savings and efficiency gains in general and administrative costs,
particularly in the customer service center.
·
Other: A $0.2 million increase due to legal and
severance expenses.
As a
result of the above events, operating income decreased $0.2 million to $0.2
million for the three months ended March 31, 2010, compared to $0.4
million in the same period of the prior year.
Corporate
Operating
expenses decreased $3.6 million, or 37.1%, to $6.1 million for the three months
ended March 31, 2010, from $9.6 million for the same period in the prior
year.
·
General & administrative related: A $0.3
million increase primarily due to increases in professional fees, related to
the preparation and audit of our annual financial statements and internal
control remediation efforts offset by decreases in salaries and wages,
information technology costs and stock based compensation expense.
·
Other: A $3.9 million decrease primarily driven by a reduction
of $5.3 million related to the financial restatement expenses in the first
quarter of 2009 offset by a $1.2 million increase in costs associated with the
proposed Merger Agreement and a $0.3 million increase related to severance
costs.
Other Income (Expense)
Aggregate other expenses increased $0.5 million, or
34.5% to $2.3 million for the three months ended March 31, 2010, compared
to $1.9 million for the same period in the prior year as follows:
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
|
2010
|
|
|
|
2009
|
|
|
|
Change
|
|
Interest
expense
|
|
$
|
(2,370
|
)
|
|
|
$
|
(1,887
|
)
|
|
|
$
|
(483
|
)
|
Interest
income
|
|
33
|
|
|
|
36
|
|
|
|
(3
|
)
|
Total
|
|
$
|
(2,337
|
)
|
|
|
$
|
(1,851
|
)
|
|
|
$
|
(486
|
)
|
Interest Expense
Interest
expense increased by $0.5 million, or 25.6%, to $2.4 million for the three months
ended March 31, 2010 from $1.9 million for the same period during the
prior year as a result of an increase in the effective interest rate to 6.1% in
the first quarter 2010 from 3.9% in the same period in the prior year, offset
by a reduction in the average interest-bearing debt outstanding from $197.8
million to $154.6 million in the same periods.
The
increase in the effective interest rate in 2010 over 2009 reflects the
increased borrowing margins on our credit facility due to the 2009 credit
facility amendments discussed in the
Financial Condition
section below as well as increased amortization of debt financial fees of $0.2
million.
Provision for Income Taxes
Our effective consolidated income tax rate on
continuing operations was a benefit of 37.3% for the three months ended March 31,
2010 compared to a benefit of 38.1% for the same period in 2009. The slight
variance of our effective tax rate from expected statutory rates reflects
non-recurring adjustments in both periods.
Income from Discontinued Operations
Income
from discontinued operations during the three month period ended March 31,
2009, which pertains to NMUI, which was sold in May 2009, was $0.2
million.
20
Table
of Contents
RECENT ACCOUNTING PRONOUNCEMENTS
See the
discussions under the caption Recent Accounting Pronouncements contained in
Note 1 to the consolidated financial statements included in Part I, Item 1
of this report.
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:
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
|
2010
|
|
|
|
2009
|
|
|
|
Change
|
|
Net
cash provided by (used in):
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations:
|
|
|
|
|
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
(1,500
|
)
|
|
|
$
|
3,612
|
|
|
|
$
|
(5,112
|
)
|
Investing
activities
|
|
(3,295
|
)
|
|
|
(3,843
|
)
|
|
|
548
|
|
Financing
activities
|
|
2,736
|
|
|
|
3,755
|
|
|
|
(1,019
|
)
|
Total
continuing operations
|
|
(2,059
|
)
|
|
|
3,524
|
|
|
|
(5,583
|
)
|
Discontinued
operations:
|
|
|
|
|
|
|
|
|
|
|
|
Operating
activities
|
|
|
|
|
|
(1,990
|
)
|
|
|
1,990
|
|
Investing
activities
|
|
|
|
|
|
(143
|
)
|
|
|
143
|
|
Financing
activities
|
|
|
|
|
|
78
|
|
|
|
(78
|
)
|
Total
discontinued operations
|
|
|
|
|
|
(2,055
|
)
|
|
|
2,055
|
|
Increase
(decrease) in cash and cash equivalents
|
|
$
|
(2,059
|
)
|
|
|
$
|
1,469
|
|
|
|
$
|
(3,528
|
)
|
Revolving
lines of credit were primarily used to fund our investing activities and, to a
lesser extent, to fund operations. Additional borrowing availability under our
revolving credit facility was $42.0 million as of March 31, 2010.
Cash Flows
from Operating Activities of Continuing Operations.
Net cash used by operating activities was
$1.5 million for the three months ended March 31, 2010; net cash provided
by operations was $3.6 million for the same period last year. Operational
aspects of our businesses that affected working capital in 2010 versus 2009 are
highlighted below:
·
$2.3 million increase in the net loss adjusted for
non-cash items;
·
$2.6 million increase in cash used for balance sheet
management, primarily related to the timing of payments for other liabilities.
Cash Flows
from Investing Activities of Continuing Operations.
Cash used in investing activities
representing purchases on property, plant and equipment, principally within our
utility segments, decreased by $0.5 million, or 14.3%, compared to the prior
year period.
Cash Flows
from Financing Activities of Continuing Operations.
During the three months ended March 31,
2010, we reduced our total borrowing and financed our capital expenditures,
working capital and dividend payments.
·
We received $16.2 million from the issuance of
2,700,000 shares of common stock sold through the Investment Agreements in
connection with the Merger Agreement and used the proceeds from the stock sale
to pay down our revolving credit facility by $16.2 million;
·
We borrowed $4.7 million under our revolving line of
credit, a reduction of $0.8 million in borrowings compared to comparable period
last year;
·
Borrowings were used for the purchase of property,
plant and equipment, as well as working capital needs, including paying $1.4
million in dividends, an increase of $0.8 million over dividends paid in the
comparable period last year.
21
Table
of Contents
CONTRACTUAL OBLIGATIONS
The following table summarizes our known contractual
obligations to make future cash payments as of March 31, 2010, as well as
an estimate of the periods during which these payments are expected to be made.
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
|
|
Remainder
|
|
2011
|
|
2013
|
|
2015
|
|
|
|
|
|
of
|
|
and
|
|
and
|
|
and
|
|
(In
thousands)
|
|
|
Total
|
|
2010
|
|
2012
|
|
2014
|
|
Beyond
|
|
Long-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
Principal
payment obligations
(1)
|
|
$
|
142,635
|
|
$
|
1,720
|
|
$
|
4,027
|
|
$
|
65,084
|
|
$
|
71,804
|
|
Interest
payments on fixed rate debt
(2)
|
|
74,459
|
|
3,914
|
|
10,054
|
|
9,674
|
|
50,817
|
|
Interest
payments on bank line of credit
(3)
|
|
7,691
|
|
2,006
|
|
5,350
|
|
334
|
|
|
|
Repayment
of advances for construction
(4)
|
|
9,117
|
|
274
|
|
1,157
|
|
665
|
|
7,020
|
|
Water
purchase commitment
(5)
|
|
116,279
|
|
852
|
|
7,718
|
|
9,448
|
|
98,261
|
|
Operating
lease obligations
(6)
|
|
20,383
|
|
3,569
|
|
6,956
|
|
3,129
|
|
6,729
|
|
Total
obligations as of March 31, 2010
(7)
|
|
$
|
370,564
|
|
$
|
12,336
|
|
$
|
35,262
|
|
$
|
88,335
|
|
$
|
234,632
|
|
(1)
|
Excludes interest
payments, which are described in the following notes. The terms of the
long-term debt are more fully described in the notes to the consolidated
financial statements included in this report and in our 2009 Annual Report on
Form 10-K.
|
|
|
(2)
|
Reflects
scheduled interest payments on all fixed rate debt obligations.
|
|
|
(3)
|
As of March 31,
2010, there was $63.0 million of borrowings outstanding under our $110.0
million bank line of credit which is scheduled for repayment in 2013. The
line of credit bears interest at variable rates and the principal amount
outstanding will vary from time to time in future periods. As a result, the
amount of future interest payments is uncertain. Borrowings bear interest, at
our option, based on a margin a) over the LIBOR rate, or b) over the prime
rate. The margins also vary based on our consolidated debt-to-capitalization
ratio. The interest obligations reflected in the table were computed based on
$63.0 million of borrowings outstanding at the 4.2% weighted average annual
interest rate in effect on our bank line of credit borrowings as of
March 31, 2010.
|
|
|
(4)
|
Advances for
construction are non-interest bearing. Our repayment assumptions on certain
obligations are based upon forecasted connection growth. If forecasted
connections do not materialize, the related payments are not due and
corresponding amounts become contributed property.
|
|
|
(5)
|
Reflects the minimum
annual contractual commitments in the Texas Utilities segment to purchase
water through 2037. 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.
|
|
|
(6)
|
As of March 31,
2010, leased office commitment is $16.3 million of which $2.1 million is
payable during the remainder of 2010. The vehicles and machinery lease
commitment at March 31, 2010 is $4.0 million of which $1.5 million is
payable during the remainder of 2010.
|
|
|
(7)
|
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 at March 31, 2010. The preferred stock is redeemable by the
Company at any time for $52.00 per share and, from time to time, we have
elected to repurchase shares offered to us by preferred stockholders at
prices less than $52.00 per share.
|
FINANCIAL CONDITION
We believe our existing
sources of liquidity are adequate to meet our anticipated needs in the coming
year. Our business is capital intensive, requiring significant resources to
fund operating expenses, construction expenditures, and interest and dividend
payments. During 2010 and in subsequent years, we may from time to time satisfy
these requirements with a combination of cash generated by operations,
borrowings under our revolving credit facility or funds from the capital
markets as conditions allow. We expect that borrowing capacity under our
revolving credit facility will continue to be available to manage working
capital during those periods.
At March 31,
2010, we had working capital of $6.1 million compared to working capital of
$5.2 million at December 31, 2009.
We have access to $110.0
million in financing under our credit facility that expires February 15,
2013. A total of nine banks participate in the facility. As of March 31,
2010, we had $42.0 million of borrowing capacity available under our credit
facility. The impact of the prior period restatement on our retained earnings,
combined with the additional borrowings on the facility during 2008, and the
lack of timeliness of SEC financial filings created a number of defaults under
our credit facility agreement at March 31, 2009. The defaults were cured
with several amendments to the credit facility agreement dated from November 28,
2008 through July 31, 2009. Under the amendments, our credit facility was
reduced from $150.0 million to its current availability of $110.0 million. The
facility was also secured with certain assets of the Company and our borrowing
margins were significantly increased. As of March 31, 2010 our
debt-to-capitalization ratio is 54%, therefore, the applicable margins are
3.50% over the LIBOR rate and 2.50% over the prime rate. Fees and expenses
charged by the Bank Group for all the amendments were $3.4 million, of which
$0.1 million were charged during the three months ended March 31, 2010.
These fees were capitalized and are being amortized as interest expense over
the remaining life of the facility which extends through February 2013.
Our ability to comply with
financial covenants, pay principal or interest and refinance our debt
obligations will depend on our future operating performance as well as other
factors that may be beyond our control.
The continued opportunity for operating improvements, enhanced cash
22
Table of Contents
management and suspension
of elective capital expenditures should improve our ability to comply with the
revised covenants in the revolving credit facility.
As part of the amended
credit agreement for our credit facility, we have agreed to utilize only $12.5
million under our capital lease facility.
Our California mortgage bond indentures permit the issuance of an
additional $40.8 million of first mortgage bonds as of December 31, 2009.
However, the terms of our revolving 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 utility company pays to the parent Company.
Dividends have averaged $5.0 million to $5.6 million per year and are less than
the aggregate cumulative dividend restriction threshold by $19.9 million as of March 31,
2010. The dividend payments in 2010 may represent a return of capital as the
Company is in a negative accumulated earnings and profit position as of December 31,
2009. We were in compliance with, or had obtained waivers for, all loan
agreement covenants during the three months ended March 31, 2010.
In connection with the
execution of the Merger Agreement, we executed Investment Agreements under which
we sold 2,700,000 shares of our common stock at a purchase price of $6.00 per
share, for an aggregate purchase price of $16.2 million. The Investment
Agreements were consummated on March 16, 2010. With the related proceeds,
we paid down our credit line which increased our available credit under the
line.
We have previously filed a
shelf registration statement with the SEC for the issuance of up to $50.0
million aggregate principal amount of common stock, debt securities and
warrants. We issued approximately $43.6 million of common stock under the shelf
registration. However, under terms of the Merger Agreement, we have agreed not
to sell additional shares of common stock or other equity interests in the
Company until the termination of the Merger Agreement.
CERTAIN CONTRACTUAL COMMITMENTS AND INDEMNITIES
At March 31,
2010, we had irrevocable standby letters of credit in the amount of $5.0
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 contracts entered into by our
contract services businesses. 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.
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.
ITEM
3.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of March 31,
2010, we had $143.2 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 $63.0
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
annual interest rate of 4.2% as of March 31, 2010. A hypothetical one
percent (100 basis points) increase in the average annual interest rates
charged on our variable-rate debt would reduce our pre-tax earnings by
approximately $0.6 million per year.
Our
fixed-rate debt, which has a carrying value of $80.2 million, has a fair value
of $71.7 million as of March 31, 2010. 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 annual interest rate of 6.6% as of March 31, 2010. A
hypothetical ten percent decrease in annual interest rates, from 6.6% to 5.9%,
would increase the fair value of our fixed-rate debt by approximately $4.7
million.
We do
not use derivative financial instruments to manage or reduce these risks
although we may do so in the future. We do not enter into derivatives or other
financial instruments for trading or speculative purposes.
ITEM
4.
CONTROLS
AND PROCEDURES
This report includes the
certifications attached as Exhibits 31.1 and 31.2 of our CEO and CFO
required by Rule 13a-14 of the Exchange Act. This Item 4 includes
information concerning the controls and control evaluations referred to in
those certifications.
23
Table of Contents
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities
Exchange Act of 1934, as amended (Exchange Act) are
designed to provide reasonable assurance that information required to be
disclosed in reports we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the rules and
forms of the SEC and that such information is accumulated and communicated to
our management, including the CEO and CFO, as appropriate to allow timely
decisions regarding required disclosures.
Our management, under the
supervision and with the participation of our CEO and CFO, evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures as of March 31, 2010. Based on our evaluation and the
identification of the material weaknesses in internal control over financial
reporting described below, our CEO and CFO concluded that, as of March 31,
2010, our disclosure controls and procedures were not effective.
INHERENT LIMITATIONS OF DISCLOSURE CONTROLS AND PROCEDURES
We do not expect that our
disclosure controls and procedures or our internal control over financial
reporting will prevent or detect all errors. A control system, no matter how
well designed and operated, can provide only reasonable, not absolute,
assurance that the control systems objectives will be met. Further, the design
of a control system must acknowledge the fact that there are resource
constraints and the benefits of controls must be considered relative to their
costs. These inherent limitations include the realities that judgments in
decision making can be faulty and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the deliberate acts of
one or more persons. The design of any system of controls is based, in part,
upon certain assumptions about the likelihood of future events and there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions. Over time, controls may become inadequate
because of changes in conditions or deterioration in the degree of compliance
with associated policies or procedures. Because of the inherent limitations in
a cost-effective control system, misstatements due to error or fraud may occur
and not be detected.
MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL
REPORTING
Management is responsible
for establishing and maintaining adequate internal control over financial
reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under
the Exchange Act. 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 (GAAP). Internal
control over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets; (ii) provide
reasonable assurance that our transactions are recorded as necessary to permit
preparation of financial statements in accordance with GAAP, and that our
receipts and expenditures are being made only in accordance with authorizations
of management and our directors; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of our 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.
Under the supervision and
with the participation of our management, including our CEO and CFO, we
conducted an assessment of our internal control over financial reporting as of March 31,
2010. In making this assessment, we used the criteria set forth in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
A material weakness is a
deficiency, or a combination of deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a
material misstatement of our annual or interim financial statements will not be
prevented or detected on a timely basis. In connection with managements
assessment of our internal control over financial reporting described above,
management has identified control deficiencies that constituted material
weaknesses in our internal control over financial reporting as of December 31,
2009 as described below:
1. We did not maintain an effective control
environment because of the following material weaknesses:
·
We did not maintain an environment that consistently
emphasized strict adherence to GAAP. This control deficiency, in certain
instances, led to inappropriate accounting decisions and audit adjustments that
have been recorded in 2009 and 2008.
This control deficiency was magnified in prior years by the
decentralized nature of the accounting function that existed at our various
operating locations.
·
In certain areas (internal audit,
finance, tax and accounting departments), we did not maintain a sufficient
complement of resources with an appropriate level of accounting knowledge,
experience and training commensurate with our structure and financial reporting
requirements.
·
We did not maintain complete and accurate
business documentation to support certain transactions and accounting records.
The controls in these areas with respect to the creation, maintenance and
retention of complete and accurate business records were not effective.
2. We did not maintain effective monitoring of
controls in certain areas, including period end financial reporting process,
goodwill, regulatory accounting, stock-based compensation, lease accounting,
property, plant and equipment, estimates and accruals. This deficiency resulted
in either not having adequate controls designed and in place or not achieving
the intended operating effectiveness of controls.
24
Table of Contents
3. We did not maintain effective controls over
risk assessments. Specifically, we did not maintain processes to evaluate
certain business and fraud risks. This deficiency resulted in either not having
adequate controls designed and in place or not achieving the intended operating
effectiveness of controls.
The material weaknesses in
our control environment, monitoring of controls and risk assessments described
above contributed to the material weaknesses set forth below:
4. We did not maintain effective controls over
accounting policies and application of GAAP.
Specifically, we did not maintain and communicate sufficient and
consistent accounting policies, which limited our ability to make accounting
decisions and to detect and correct accounting errors. This deficiency contributed to other control
deficiencies, some of which have resulted in material weaknesses, as further
described below.
5. We did not maintain effective controls over
the recording of journal entries, both recurring and non-recurring.
Specifically, effective controls were not in place to ensure that journal
entries were properly prepared with sufficient supporting documentation or were
reviewed and approved to ensure the accuracy and completeness of the journal
entries. This deficiency contributed to other control deficiencies, some of
which have resulted in material weaknesses, as further described below.
6. We did not maintain
effective controls over the completeness and accuracy of key spreadsheets and
system-generated reports. Specifically, effective controls were not designed
and in place to ensure that key spreadsheets and system-generated reports were
properly reviewed for accuracy and completeness. This deficiency contributed to other control
deficiencies, some of which have resulted in material weaknesses, as further
described below.
7. We did not maintain effective controls over
the completeness and accuracy of our accounting for acquisitions. Specifically,
we did not design and maintain effective controls with respect to the
application of relevant GAAP and the deficiency resulted in errors, including
audit adjustments in 2008, in the allocation of the purchase price to the
underlying assets acquired, including goodwill and liabilities assumed. This deficiency affected property, plant and
equipment, deferred income tax and liabilities, goodwill and long-term
liability accounts.
8. We did not maintain effective controls over
the completeness and accuracy of our accounting estimates related to
self-insurance. Specifically, we did not design and maintain effective controls
with respect to the maintenance and reconciliation of claims and the review of
actuarial valuations. This deficiency
affected accrued liabilities and expense accounts in prior years. This control deficiency resulted in
adjustments identified through additional procedures performed by management in
2009 and audit adjustments in 2008.
9. We did not maintain effective controls over
the completeness and accuracy of our accounting for the impairment of goodwill.
Specifically, we did not design and maintain effective controls to ensure
proper identification of reporting units, triggering events and fair value
estimates. This control deficiency
resulted in audit adjustments in 2008.
10. We did not maintain effective controls over
the completeness and accuracy of our accounting for regulated entities.
Specifically, we did not design and maintain effective controls with respect to
the application of relevant GAAP in the areas of regulatory assets and liabilities. This control deficiency resulted in audit
adjustments in 2009 and 2008.
11. We did not maintain effective controls over
the accuracy and valuation of stock-based compensation. Specifically, we did
not maintain effective controls over the assumptions used in the calculation of
stock-based compensation. This control
deficiency resulted in audit adjustments in 2008.
12. We did not maintain effective controls over
the completeness and accuracy of property, plant and equipment and related
depreciation expense. Specifically, we did not design and maintain effective
controls to ensure that there was timely transfer of property, plant and
equipment additions from construction work in progress; that retirements were
properly recorded; that depreciation expense was accurately recorded based on
appropriate useful lives assigned to the related property, plant and equipment;
that assets are capitalized properly; that contributions of cash were timely
transferred to CIAC for amortization; and that impairment losses are timely
identified and determined. This control
deficiency resulted in adjustments identified through additional procedures
performed by management in 2009 and audit adjustments in 2008.
13. We did not maintain effective controls over
the completeness and accuracy of unbilled revenue. Specifically, we did not
maintain effective controls to standardize a process and methodology of
calculating and recording unbilled revenue in the proper period. This control deficiency resulted in audit
adjustments in 2009 and 2008 and adjustments identified through additional
procedures performed by management in 2009.
14. We did not maintain effective controls to
ensure the completeness of the recording of accounts payable and accrued
liabilities on a timely basis. Specifically, we did not review and approve
invoices and their supporting documentation on a timely basis. This control deficiency resulted in audit
adjustments in 2008.
15. We did not maintain effective controls to
ensure the completeness, accuracy and valuation of the revenue recorded by our
Southeast Utility operation.
Specifically, we did not maintain appropriate controls over the design
or identify appropriate controls over the systems, invoicing, and other
processes performed at the Southeast Utilities.
This control deficiency could result in a misstatement of accounts
receivable and revenue that would result in a material misstatement in our
annual or interim consolidated financial statements that would not be prevented
or detected in a timely manner.
16. We did not maintain effective controls over
the completeness, accuracy and valuation of our deferred tax assets and
liabilities. Specifically, we did not
design and maintain effective controls with respect to accounting for the
difference between book and tax basis of the companys property,
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plant and equipment and
intangible assets. This control deficiency could result in a misstatement of
deferred tax assets and liabilities, and the tax provision that would result in
a material misstatement in our annual or interim consolidated financial
statements that would not be prevented or detected in a timely manner.
17. We did not maintain effective controls over
the segregation of duties related to the initiation and approval of wire
transfers. Specifically, we did not
maintain adequate segregation of duties allowing a single individual exclusive
right to execute wire transfers without independent confirmation or review.
This control deficiency could result in unauthorized or inappropriate cash
disbursements.
The material weaknesses
described above could result in misstatements of substantially all of the
accounts and disclosures related to it that would result in a material
misstatement in our annual or interim consolidated financial statements that
would not be prevented or detected in a timely manner. Although the
deficiencies did not result in the identification of a material misstatement in
the first quarter of 2010, management has not performed comprehensive testing
of the controls in place as of March 31, 2010 and, therefore, is not able
to conclude that they are sufficiently designed and effectively operating to
prevent or detect such misstatement. Accordingly, management has determined
that each of the control deficiencies above constitutes a material weakness and
concluded that we did not maintain effective internal control over financial reporting
as of March 31, 2010.
Based on the performance
of additional procedures by management designed to ensure the reliability of
our financial reporting, we believe the consolidated financial statements
included in this report as of and for the periods ended March 31, 2010 are
fairly stated in all material respects.
PLANS FOR
REMEDIATION OF MATERIAL WEAKNESSES
We have engaged in and are
continuing to engage in efforts to improve our internal control over financial
reporting and our disclosure controls and procedures. Specific initiatives to
date have been focused on the following:
(i)
Communicating, both internally and
externally, our commitment to a strong effective control environment, high
ethical standards and financial reporting integrity, emphasizing a strict
adherence to GAAP accounting;
(ii)
Implementing a comprehensive review and
approval of all material accounting decisions by the Principal Financial
Officer, including the documentation of key accounting issues which are used to
train our accounting staff;
(iii)
Taking certain personnel actions including
supplementing existing accounting staff with additional permanent or contract
employees;
(iv)
Improving and standardizing
system-generated financial reports, developed to support operations management
and financial reporting;
(v)
Specific training for Finance and
Accounting Department personnel to reinforce the importance of our control
environment in addition to internal controls training to all Managers across
the Company which reinforced the importance of controls;
(iv)
Implementing of policies and procedures to
ensure that we retain business and accounting records and documenting the
application of GAAP for business transactions;
(vi)
Implementing period end reporting
processes including a consolidated monthly close checklist, journal entry
approval, account reconciliations with supporting documentation, documentation
supporting accruals and estimates, additional processes for the valuation and
recognition of utility unbilled revenue and additional processes around
manually prepared spreadsheets; and
(vii)
Implementing formal procedures over
valuation of our accounting estimates related to our claims process associated
with medical, automobile and workers compensation self-insurance, including
the increased use of outside actuarial experts, the systematic review of claims
by the appropriate department manager and the review and roll forward of
actuarial analyses.
We have also implemented a
remediation plan (the Plan) to address the material weaknesses for each of
the affected areas presented above. The Plan ensures that each area affected by
a material weakness is put through a comprehensive remediation process. The
remediation process entails a thorough analysis which includes the following
phases:
(a)
Define and assess the control deficiency:
ensure a thorough understanding of the as is state, process owners, and gaps
in the control deficiency;
(b)
Design and evaluate a remediation action
for each weakness for each affected area: validate or improve the related
policy and procedures, evaluate skills of the process owners with regards to
the policy and adjust as required;
(c)
Implement specific remediation actions:
train process owners; allow time for process adoption and adequate transaction
volume for next steps;
(d)
Test and measure the design and
effectiveness of the remediation plan, and test and provide feedback on the
design and operating effectiveness of the updated controls; and
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(e)
Management review and acceptance of
completion of the remediation effort.
The Plan is administered
by a Controls Committee comprised of key leaders from cross functional portions
of the organization, including the CFO. The Committee reports on progress
quarterly (or more frequently, as needed) to the Audit Committee of our Board
of Directors.
We believe the steps taken
to date have improved the effectiveness of many of our internal controls over
financial reporting; however, we have not completed all of the corrective
processes, procedures and related evaluation or remediation identified herein,
that we believe are necessary. As we continue to monitor the effectiveness of
our internal control over financial reporting in the areas affected by the
material weaknesses described above, we will perform additional procedures
prescribed by management, including the use of manual mitigating control
procedures, to ensure that our financial statements continue to be fairly
stated in all material respects.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
Although we have begun to
take other specific actions to improve the overall effectiveness of our internal
controls over financial reporting during the quarter ended March 31, 2010,
there were no changes to our internal controls over financial reporting that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.
Furthermore, the design or operating effectiveness of any changes in
internal control over financial reporting have not yet been evaluated through
our remediation process.
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Table
of Contents
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Other
than those stated in Part 1- Item 1- Note 4. Commitments and
Contingencies Legal Proceedings, there have been no new, material
developments to or terminations of legal proceedings, other than ordinary
routine litigation incidental to the business, to which the Company or any of
its subsidiaries is a party or of which any of their property is the subject
during the period covered by this Quarterly Report.
ITEM 1A. RISK FACTORS
There
have been no material changes in our risk factors since we last reported under Part I,
Item 1A, in our Annual Report on Form 10-K for the year ended December 31,
2009.
ITEM 2 UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS
(a)
In connection with the Merger Agreement, we entered
into a Securities Purchase Agreement and Investor Rights Agreement
(collectively, the Investment Agreements).
Pursuant to the Investment Agreements, Parent purchased 2,700,000 shares
of our common stock (the Purchased Stock) at a price of $6.00 per share, for
an aggregate purchase price of $16.2 million and we incurred related specific
incremental transactional costs of $0.1 million. As permitted under the terms of the
Investment Agreements, the Company applied the proceeds derived from the sale
of the Purchased Stock to reduce our revolving line of credit, the borrowings of
which are used for capital expenditures and working capital purposes. The Investment Agreements entitle Parent to
appoint a designee to serve on our board of directors (which right Parent has
not exercised to date), and also to certain registration rights with respect to
the Purchased Stock in the event of the termination of the Merger
Agreement. The Investment Agreements
restrict Parents ability to sell or otherwise transfer the Purchased Stock
prior to the earlier of the consummation or termination of the Merger
Agreement. Except as contemplated by the
Merger Agreement, Parent and Merger Sub are also prohibited from acquiring any
additional shares of our common stock until the termination of the Merger
Agreement.
(b)
Not applicable
(c)
Not applicable
ITEMS 3, 4
AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
ITEM 6. EXHIBITS
Exhibit
|
|
|
Number
|
|
Exhibit Description
|
|
|
|
3.1
|
|
Certificate of Amendment
to Restated Certificate of Incorporation of SouthWest Water Company
(incorporated by reference to Exhibit 3.1 included in the Companys Form 8
K filed with the Commission on May 22, 2008)
|
3.1.1
|
|
Certificate of Amendment
to Certificate of Incorporation of SouthWest Water Company (incorporated by
reference to Exhibit 3.1 included in the Companys Form 8-K filed
on May 22, 2008
|
3.2
|
|
Amended and Restated
Bylaws of SouthWest Water Company dated August 20, 2009 (incorporated by
reference to Exhibit 3.2 included in the Companys Form 10-Q filed
with the Commission on September 18, 2009)
|
10.17.6
|
*
|
Amendment No. 6 to
Amended and Restated Credit Agreement dated as of March 2, 2010
|
10.18
|
|
Agreement and Plan of
Merger, dated March 2, 2010, by and among SouthWest Water Company, SW
Merger Corp. and SW Merger Sub Corp. (incorporated by reference to Exhibit 2.1
included on the Companys Form 8-K filed with the Commission on March 3,
2010.
|
10.18.1
|
|
Securities Purchase
Agreement, dated March 16, 2010, by and between SouthWest Water Company
and SW Merger Acquisition Corp (incorporated by reference to Exhibit 10.1
included on the Companys Form 8-K filed with the Commission on March 16,
2010.
|
10.18.2
|
|
Investor Rights
Agreement, dated March 16, 2010, by and between SouthWest Water Company
and SW Merger Acquisition Corp (incorporated by reference to Exhibit 10.2
included on the Companys Form 8-K filed with the Commission on March 16,
2010.
|
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
28
Table of Contents
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: May 7, 2010
|
/s/ BEN SMITH
|
|
|
Ben Smith
|
|
Chief Financial Officer
(Principal Financial
Officer)
|
29
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