Southwest Water Q3 2007 Earnings Call Transcript

Southwest Water Co. (SWWC)

Q3 2007 Earnings Call

November 09, 2007 3:00 pm ET

Executives

DeLise Keim - Vice President of Communications

Mark Swatek - Chief Executive Officer and Chairman

Cheryl Clary - Chief Financial Officer

Analysts

Debra Coy - Janney Montgomery Scott

Michael Gaugler - Brean Murray Carret

Noah Hugenberger - Harpswell Capital

Presentation

Operator

Ladies and gentlemen, welcome to your Third Quarter 2007 Southwest Water Earnings Conference Call. My name is Mike. I'll be your operator today. At this time, all participants are in a listen-only mode (Operator Instructions).

Please be advised that the call is being recorded for replay purposes and we will be taking questions at the conclusion of today's presentation. I would now like to turn the call over to your host, DeLise Keim, Vice President of Communications. Ma'am, please proceed.

DeLise Keim

Thank you, Mike. Good afternoon, everyone, and welcome to Southwest Water Company's conference call for the third quarter ended September 30th of 2007.

We did issue our earnings release this morning, a copy which of can be found on our website at www.swwc.com. A replay of this conference call will also be available on the same website. With me today are Mark Swatek, our Chief Executive Officer and Chairman; and Cheryl Clary, our Chief Financial Officer.

Mark will begin our call today with some comments about the quarter and then Cheryl will talk in detail about our financial results, followed by additional remarks by Mark and then an open question-and-answer period.

Before I turn the call over to Mark I want to make you aware that our discussion today may include forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those projected.

Information concerning factors that could cause actual results to differ from those in the forward-looking statements may be found in our 2006 annual report on Form 10-K under the Risk Factors section and in our other SEC filings. A copy of these filings are also available on our website.

Now I'm pleased to introduce the Chief Executive Officer and Chairman of Southwest Water Company, Mark Swatek. Mark?

Mark Swatek

Thanks, DeLise. Good afternoon, everyone. In a moment Cheryl will be discussing our financial results in detail. The third quarter was disappointing as both revenues and net income were down as compared to the same period last year.

Overall, we finished the quarter with revenues of $57.4 million, down $1.6 million from last year's third quarter revenues of $58.9 million. Operating income was $5.3 million, down $2.5 million from the third quarter of last year at $7.8 million. Finally net income for the quarter was $2.1 million, down $1.6 million from the same period last year.

Overall our results were impacted by four factors during the quarter. Rainfall in Texas was nearly 40% higher than the 30-year average and almost double last year's third quarter rainfall. This had an impact on both our Texas utility water sales, which were down 9% from this time last year. And our Services Group's abilities to conduct construction or repair and maintenance projects.

The nationwide slowdown in housing also impacted our business. In Texas we saw field orders associated with new home construction drop nearly 40% from 2005 and 2006 levels. Our utility organic growth in both New Mexico and Texas has dropped from 3% annually to about 1% this year.

Unfortunately, we don't see the slowdown improving in the near future. We took one-time hits of $1.1 million for non-recuring events in the quarter. And finally our investments in the future of Southwest Water, specifically the ramp-up of our Cornerstone business reengineering program, added significant costs across the quarter.

I'll provide some details on our progress for this effort later in today's call. Unfortunately, our numbers are small, and differences would be considered minor for larger companies result in substantial percentage differences for us.

A few details on the results for the third quarter. Our Utility Group increased revenues in a modest amount in the quarter through rate increases and acquisitions since the third quarter of last year. These revenue gains were offset by lower consumption in Texas due to the record rain there.

Obviously, when it rains every day, customers don't use as much water. Income from the Utility Group decreased primarily due to increased depreciation expense across the portfolio, some of which we expect to recover in future rates.

We also had increased operating costs in New Mexico and Texas. Cheryl will walk you through greater detail in our Utility Group third quarter performance in a few minutes. But I'd like to give you a quick update on our pending rate cases.

We are currently working on several cases, the largest being the Monarch rate case in Texas where we requested a 40% water rate increase and a multiyear wastewater increase of about 30% in each of the next three years.

With this filing, we look to recover the capital expenditures we've invested in this system over the past few years. Our interim rates went into effect in October, which will represent an approximate $6 million increase in annualized revenues.

However, these rates can be adjusted after Texas regulators reach their final ruling, which is often the product of settlements with customer groups, and we've had a couple of communities register protest. We don't have any indication how soon this will be finalized, but we are hoping for resolution by mid-2008.

We also filed three smaller rate cases on recently purchased utilities in Texas during the quarter. These interim rates will go into effect by year-end and should allow us to start recouping our capital investments at a rate of about $200,000 of additional revenue in 2008.

In the first part of 2008, we'll receive our contracted annual increase at our Alabama wastewater utility and we'll be filing for new rates at our southern California utility, our largest, which is six months earlier than our previous scheduling for filing in California.

Looking at the Services Group when we compare the third quarter to the same period last year, revenues were impacted by the wet weather in Texas. The housing market slowdown in both Texas and New Mexico and the loss of contracts were not renewed in the Southeast at the end of last year.

The group generated a loss on income in the quarter. The slowdown in customer construction projects due to weather and housing played a significant role, as this is a higher margin business. But we also had operational issues. The largest impact came from a $650,000 reserve we took in the quarter in anticipation of a settlement on fines for violation that occurred at a customer system that we operated prior to 2006.

Historically, we may not have focused enough on permit compliance. We've hired a senior leader this year who is responsible for companywide compliance and made permit compliance a corporate function rather than at the operational level. Since restructuring our compliance reporting in management, we’ve seen a significant drop in permit compliance issues.

Our Southeast services region had not been profitable for several years, and we made management changes last year that were discussed with you last fall. Some contracts were not renewed late last year, which caused our contract revenues in the Southeast to drop by $2.6 million for the quarter.

However, thanks to the efforts of the new management in the region, losses have narrowed considerably as we effectively reduced operating cost and cut project overtime by more than 80%. Bottom line, this region improved by over $0.5 million compared to the same period last year.

I'm confident this team will make this region a winner, but it will probably take several more quarters for to us secure new more profitable contracts. We continued to see improvement in the margins of the Houston region due to ongoing efforts to improve operational efficiencies and reprice contracts as they come up for renewal.

Work orders in this region were down by almost 40% from this time last year due to the housing slowdown, but revenues remain solid and operational margins actually improved. This is our largest margin in the Services Group and therefore, its contributions are significant. I'd also like to recognize the efforts of our California services division, where management has significantly improved results this year.

By tightening up its operating performance the region has gone from a breakeven operation to one producing operating margins well above 15%. We continue to evaluate all aspects of the business and we've identified several business segments that are neither core businesses nor profitable at even the gross margin level.

For example, in Colorado we've elected to shut down an electrical contracting business and incurred costs during the quarter associated with severance and retention agreements to complete one last contract.

We continue to evaluate and monitor other non-core business segments, but you've got to remember, we've got contractual obligations in these segments that we must meet which will impact the timing when we might take corrective action.

It's not a business like owning gas stations where we can just make a decision to shut down a gas station. We do have contractual obligations that we do have to meet and timing of when we can take action is of consideration as we look at these business segments.

The service group serves three distinctly different customer sets, the Texas municipal districts or MUDs, municipal clients that we serve through operations and maintenance contracts, and our own Utility Group.

We'll be refocusing the Services Group in early 2008 along these business lines to better serve the unique demands of each customer base, to focus business development efforts for each unique market and to eliminate structural redundancies that may exist.

I can't give you any more details today, but we'll be announcing our plans in the near future. I'm also confident that our Cornerstone business, reengineering program will have a significant effect on the company's performance as a whole in the service group margins in particular.

As I've highlighted in past calls, we have numerous disconnected legacy operating data and communications systems that we currently maintain, and we've selected an Oracle-based integrated system to move the company to a shared financial and operational platform.

One aspect of the business addressed by Cornerstone is in our call centers. We've had call center functions in five different locations on four different phone call center systems. We're consolidating these functions across the company. This process requires to invest in new call center software and hardware as well as to migrate the functions to a centralized call center.

During the quarter this consolidation began, starting with a combination of our Austin and Houston call centers into a single group in Houston. We anticipate having this combined center up on the new hardware and software system by mid-December, which will significantly improve customer service and call center wait times.

As we implement this new system across the rest of the company and couple it with our Cornerstone integrated platform, we fully expect to realize significant customer service improvements at a lower delivery cost.

Also during the quarter, significant process was made in improving data redundancy. We've moved our data center to a secure outside provider with redundant real time backup at a distant location.

This change alone provided significant performance improvements from our old data center and more importantly has improved security and provided redundancy to assure business continuity. This is part of the backbone development needed to realize the benefits of our Cornerstone program.

Year-to-date we've capitalized $6 million for Cornerstone and expensed another $870,000, which shows up in our corporate overhead. This project is scheduled to last until the end of 2009. And therefore, we anticipate our overhead expenses will continue to be at a higher level than our historic trends through that timeframe.

We'll capitalize between $27 million and $30 million, including the investments already capitalized this year to implement the financials, billing, customer service, asset management, dispatch, workforce management systems along with our IT and data upgrades. This project is imperative for our future growth.

Our legacy systems cannot contain our current operations and, in fact, restrict the amount of growth we could effectively handle. Our customer service is negatively impacted by incompatible systems. Our main utility billing system is so outdated it's no longer supported. Our financial consolidation is time consuming, manual, and costly and our Services Group is not realizing any economies of scale with today's systems.

We expect to get a portion of this investment back in rate across our utility portfolio due to the customer service enhancements, and the rest of the investment will drive savings in the Services Group, which we'll see in improved margins and across the company in reduced SG&A costs. We expect a 10% internal rate of return over the life of the project.

And now I'd like to turn the call over to Cheryl to discuss our financial results for the third quarter in more detail. Cheryl?

Cheryl Clary

Thank you, Mark, and welcome, everyone. For the three months ended September 30th, 2007, Southwest Water reported revenues of $57.4 million, operating income of $5.3 million, and net income of $2.1 million or $0.08 per diluted share.

This compares with revenues of $58.9 million, operating income of $7.8 million, and net income of $3.7 million or $0.16 per diluted share in the third quarter of 2006. Our weighted average diluted shares outstanding increased 4% to 24.5 million shares versus 23.4 million shares for the third quarter of 2006.

Company-wide third quarter revenues decreased $1.6 million from prior year third quarter results. Revenue in the Utility Group, which includes inner segment revenue from our Services Group, increased by $200,000 to $26.5 million from $26.3 million in the third quarter of 2006.

This increase was primarily due to rate increases in our California, Alabama and our Windermere utility in Texas, as well as our recent acquisitions in Texas and Mississippi, offset by significantly lower consumption for the quarter due to unseasonably wet and cool temperatures in Texas and a milder September in California.

The Services Group revenues, which includes inner segment revenues from our Utility Group, decreased by $3.1 million to $37.7 million for the quarter, down from $40.9 million for the same period last year.

This decrease was due to reduced construction projects performed for our Texas and New Mexico utilities, reduced fieldwork due to the housing slowdown and the wet Texas weather, as well as a reduction in our contract base in our Southeast region.

These more than offset our new contracts combined with our successful efforts to increase pricing on several of our current contracts. Year-to-date, company-wide revenues decreased $2.4 million from prior year results.

Utility Group revenues are up $5.2 million year-to-date, but this was more than offset by decreased revenues in the Services Group. For the third quarter of 2007 company-wide operating income decreased $2.5 million from the same quarter last year.

As a percentage of revenue, operating income decreased to 9% from 13% last year. Utility Group operating income in the third quarter of 2007 was down to $9.2 million versus $9.5 million in the third quarter of 2006. This decrease is primarily due to increased depreciation expense across the portfolio and increased operating costs in New Mexico and Texas for higher contract operation fees and sewage treatment expenses.

As a percentage of group revenues, operating income was 35% compared to 36% in 2006. Services Group operating income decreased $1.2 million to a loss of $255,000, compared with income of $922,000 in the third quarter of 2006. This decrease was primarily due to the one time legal reserve of $650,000 that Mark mentioned as well as increased medical insurance costs of $450,000.

Again, the slowdown in the housing market and the unseasonably wet weather in Texas more than offset the new business and contract price increases we experienced during the quarter. Year-to-date company-wide operating income decreased $2 million from prior year results.

Utility Group operating income is up $479,000 year-to-date, but this is offset by decreased operating income in the Services Group of $1.8 million and increased corporate costs of $682,000.

Looking now at company-wide expenses, SG&A during the quarter were $8.4 million or 15% of revenues versus $7.1 million or 12% of revenues in the third quarter of last year. The $1.3 million increase in SG&A is primarily related to an increase of approximately $700,000 due to the upgrade in staffing that we have put in place in both the corporate office and the Services Group, since this time last year, which includes salary, wages and related benefits.

This increase also includes $500,000 of expenses for our Cornerstone Project. As Mark mentioned earlier, due to the Cornerstone Project, we anticipate SG&A as a percentage of revenues will continue to be higher than it has been historically. However, beginning with the second quarter of 2008, we anticipate being able to see some of the benefits of our Cornerstone and business process reengineering efforts.

At that time, the company will be transitioning some of its backbone functions such as accounts payable, payroll, accounting and procurement into a central financial services center, which will streamline these processes and reduce costs.

In addition, other functions such as billing and collections, call center and dispatch will be in a shared services center as well. Year-to-date SG&A was $26.3 million or 16% of revenue versus $24.7 million or 15% of revenues in the prior year.

Included in this amount is $900,000 relating to the expense portion of our Cornerstone Project. Interest expense for the third quarter was $2.2 million versus $2.1 million in the prior year. This increase was due to an increase in borrowings on a revolving line of credit.

The net effective interest rate on total borrowings came down to 6% from 6.4% during the third quarter of last year. Year-to-date interest expense was $6.4 million versus $6.3 million in the same period last year.

Our net income for the third quarter decreased $1.6 million to $2.1 million versus $3.7 million in the third quarter of 2006. Fully diluted earnings per share decreased from $0.06 to $0.08 from $0.16 in the third quarter last year on 4% more shares outstanding. On a year-to-date basis, our net income is down from last year by $1.3 million.

Moving to the balance sheet, our company funded capital expenditures were $9.9 million during the third quarter. The majority of this investment was in regulated utility plant assets in order to continue to provide high quality service to our customers. We also invested $3.9 million in the Cornerstone Project, which we believe will have a positive effect on our efficiencies going forward.

We maintain a syndicated credit facility of $100 million, which gives us flexibility to finance our future growth. At September 30th, 2007, we had $52 million of outstanding borrowings at a weighted average borrowing rate of 6.3%. Our liquidity remains strong as we have $46 million of total borrowing capacity available on our credit facility as of quarter end.

We use our lines to handle seasonal cash flow needs, fund our capital expenditures and to finance future small acquisitions. We ended the quarter with $144.6 million of debt versus $130 million at year-end 2006, with total debt comprising 46% of total capitalization, which is on target with our goal of a debt to equity ratio of approximately 50/50.

We ended the quarter with $2.4 million in cash, and with that I would like to turn the back call to Mark. Mark?

Mark Swatek

Thanks, Cheryl. Texas rainfall and the housing slowdown significantly impacted our operations on both the utility and contract services side this quarter. As Texas is the largest contributor of our service business and the second largest on the utilities side, these factors had a considerable effect on our consolidated numbers.

We feel the housing slowdown is still in its early stages and therefore we anticipate a lower organic growth rate through at least 2008. On a positive note, we believe that the same economic slowdown will cause small utility owners to become more realistic about the valuation and outlook for their assets, which should improve the opportunities for acquisition.

We are putting the right tools in place to improve our results for the Cornerstone program, but implementation with significant effort will take at least 18 months. We appreciate your patience and support in these matters, as we firmly believe we will show meaningful bottom-line improvement as we complete the project.

I'd like to thank you all for your attention this afternoon. I'd be happy to answer any questions at this time. Operator, please open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Debra Coy with Janney Montgomery Scott. Please proceed.

Debra Coy - Janney Montgomery Scott

Yes. Good afternoon all.

Cheryl Clary

Good afternoon, Debra.

Debra Coy - Janney Montgomery Scott

Thanks. A couple of questions. One on Cornerstone. Thanks for the detail on that. Mark, you said of the total amount $27 million to $30 million that you'd be capitalizing on that, that you thought a portion would be recoverable through the utilities system.

Can you hazard some guess? Would be it relative to the total revenue breakdown of the company or is more of this related to the utility business? How should we think about this in terms of the services versus the utility business?

Mark Swatek

Debra, we're still working through the various ways that we apportioned. We have a pretty sophisticated methodology of apportioning our corporate costs to the different utilities that we have.

You also need to keep in mind that the different utilities in the states have different timeframes. Some are forward-looking. Some are backward looking.

Debra Coy - Janney Montgomery Scott

Right.

Mark Swatek

So, we haven't fully decided yet how much that we're looking to get, but obviously we're going to be pushing as much as we can into it.

Debra Coy - Janney Montgomery Scott

Okay. So, we'll find out more about that going forward. Looking ahead on the SG&A side, in future quarters, Cheryl, can you give us some sense of how this will play out? You said SG&A will continue to be higher, but is this $500,000 run rate that we saw in the Q going to continue for a few more Qs? Is it going to drop off? About what size of impact is this going to have in the next several quarters?

Cheryl Clary

Yes. It will have different impacts. Let's talk about it. We did talk about $500,000 in the third quarter and we're working on implementation of four separate modules. We started off with the first one as the financial and we started that in July.

So, basically you had an entire quarter of those implementation costs and initiation costs in the quarter. We're also going to work on three other modules including the customer care and billing system. But really in terms of the life cycle the way it really works is initially when you start off you're pretty high in expense because you don't get to capitalize the initial design phase.

And then in the middle you get to capitalize the majority of that and at the end you have your training and that has to be expensed. So, I think that the run rate on may be fair. It will increase probably over the next few quarters as we continue to finalize the financial module, but then we'll be working on the implementation of our second, third and fourth module.

So, you'll see it fly probably a pretty good run rate in 2008 and you'll really see it coming down in 2009. Now having said that, you're also going to see some of those benefits from the implementation like of the financial module starting with the second quarter.

Because one of the things that we're going to do is go to a shared services concept both in the financial arena, but also for some of the operational folks, things like in the financials accounts payable is going to a shared services concept as will the accounting as will the accounts receivable as will procurement.

And then on the operational side you're looking at call centers. Mark talked about the call centers and dispatch and the customer billing. All of those are going to shared services concepts. So, you'll have the expense, but you'll start to see some of the benefits of those beginning with 2008.

Debra Coy - Janney Montgomery Scott

Okay. So, my reading between those lines is that we could expect maybe something on the order of $2 million or so in net costs with it being a little higher than current minus some cost savings toward the second half of the year?

Cheryl Clary

Yes. That's probably in the ballpark.

Debra Coy - Janney Montgomery Scott

In the ballpark, okay. That's helpful. And, Mark, coming back to the services business, a couple of interesting things you mentioned. One, trying to sort out the weather versus the housing market. Obviously weather shortfalls are usually opportunities to buy stocks in this industry.

But it seems that the persistent piece of this on the housing side is the harder one to pin down. When you say your order book is down 40% in the quarter in Texas, can you give a sense of how much of that is weather and so therefore, the projects will come right back and how many of them won't come back?

In other words, it sounds like we're looking at a further reduction in revenues over the next several quarters.

Mark Swatek

Debra, I think there's a couple things you need to consider when you look at our service business in Texas. A portion of the business is related to new housing starts and a large portion of the business is related to just normal operations of those systems that are already in place.

And our focus on our re-pricing has been on that base business is to get that base business up to the point where it is a sustainable business that generates the kinds of returns that we're looking for that's irrespective of growth in the marketplace or really irrespective of weather.

The work that we do for the new housing which is basically related to inspection of connections or making those connections, inspecting the plumbing in the house, that kind of stuff. That's tied to the new housing. And that's in the past has been a pretty good margin business for us and we've seen that drop off.

Now, what we saw in the quarter is while that side of the business dropped off, revenues actually remained the same quarter-over-quarter. And so that's the impact of really our ability to drive our rate structure up in the area and as a result, our bottom line actually improved significantly over quarter-over-quarter in the Houston, Texas operation.

So I'm real pleased with what we're seeing there. I think that we're probably at a stable revenue base. I don't know that it's going to grow a lot for the next year, but when we see the housing market come back, then we should really be able to see that thing pop up significantly.

But we tried to restructure the business to make sure that the core base business is self-sustaining and that we get the benefit from upswings.

Debra Coy - Janney Montgomery Scott

Okay. So you kind of made up the losses, then, if you will, if you've kept revenues stable and by getting pricing and some of this other base business. So …

Mark Swatek

I would say more than kind of made up for it, Debra. I think, we actually did a pretty good job of making up for it.

Debra Coy - Janney Montgomery Scott

Okay. All right, understood. And so that means, we can continue to see that going forward. And on the margin side, you mentioned the improved margins on that base business.

And then you, I think said that your California group had rebounded to operating margins of 15%?

Mark Swatek

That's correct.

Debra Coy - Janney Montgomery Scott

That's operating margins, not gross margins?

Mark Swatek

That's operating margins after local overhead. That does not include our corporate costs, SG&A costs.

Debra Coy - Janney Montgomery Scott

Okay. But still those are very nice margins.

Mark Swatek

That's still, where we're looking for from an operational level at each individual unit.

Debra Coy - Janney Montgomery Scott

So that is and, of course, we've had this conversation a few times with me trying to get a sense of what the potential is in this business. So everything running the way it's supposed to that we can look at this as a double-digit margin business at some point.

Or do you think California has some characteristics that are not going to be applicable to Texas?

Mark Swatek

Actually, I think all of our businesses, for them to be sustainable, we need to get their operating margins before we hit them with any type of an SG&A or corporate allocation, something in that range.

Debra Coy - Janney Montgomery Scott

So that's positive. And then …

Mark Swatek

You bet it is.

Debra Coy - Janney Montgomery Scott

My final question on that business, you mentioned realignment and said there would be more to talk about on that going forward. But can you give us some sense for why you need to do the realignment along these three customer lines?

Is it some lack of focus among the Services Groups on their end customers? Is it some excess capacity that you want to get capacity more focused on where the opportunities are?

What is driving that and what do you think you get out of doing a realignment?

Mark Swatek

Let's just talk about the O&M business in the U.S., which we actually see as picking up in terms of market activity, but today we don't have a national focus on that business. It's a very localized business.

And by realigning our business there to make sure we're getting the appropriate national focus on the business, we think, we're going to be able to go head on head and compete with our buddies at Suez and OMI and Veolia and American much more effectively. I actually like our pricing structure better than theirs.

The MUD business is real unique to Texas and what you do in the MUD business in Texas doesn't apply much beyond that. And so you really have to make sure that business is focused in that area. And then our integrated model is one that, while a part of it is the revenue side is owned by the utility and the cost side is owned by the services.

We really need to bring those two aspects more into alignment together, so that that integrated model is functioning with a common goal of improving and maximizing shareholder value through the work that we do there.

Debra Coy - Janney Montgomery Scott

Okay. Interesting. Last quick question, I'll get back in line. Is we talked about the weather in Texas impacting the utility business.

But as the other California utility companies have reported, they've talked about the impact of conservation finally starting to take a little bit of a bite on demand in California.

Are you seeing that? Cheryl, you mentioned weather in September being a little more mild.

Cheryl Clary

Yes.

Debra Coy - Janney Montgomery Scott

What's your sense on conservation?

Mark Swatek

One of the things that you got to remember that's different for us from the other public utilities in California is we're single utility in a defined area and it's all contiguous. I think that's the number one thing.

During two-thirds of the year, we get all the water we need out of our own supplies. And it's only during the summer that when we hit peaking that we've actually got to go out and tap into some of our outside supply resources, which really starts to us get into the net water which has been curtailed now by the I think it's whatever, yes, the smelt.

So right now we're okay. The projections of the water supplies in our principal basin through 2008 are still pretty positive. We've got adequate water there. So if the drought continues for another year, then I think we're going to get concerned about it by next summer.

Even if we just get some normal rainfall here in California during the winter, we're going to be fine. And so I don't think that we're nearly as impacted as the other utilities are by mandated rationing or mandated conservation measures, as others would be.

Debra Coy - Janney Montgomery Scott

Well, it's a demand issue as well as a supply issue, of course and in terms of reducing revenues if people actually do use less water.

Mark Swatek

Yes. There's a psychological impact, when everybody is working on it.

Debra Coy - Janney Montgomery Scott

You wouldn't say you're seeing that to date?

Mark Swatek

Not really. Maybe a little bit but just a little bit.

Debra Coy - Janney Montgomery Scott

Okay. All right.

Mark Swatek

You also have to look at the demographics that you got within your service area. And where you really see big impacts of conservation is in areas quite honestly of more affluent areas.

People got big yards and all of a sudden when their water bills start to get real big, they make a decision, geez, maybe I need to go to a different approach in how I'm managing my landscape.

We have a lot of more modest income customers in our service area. And they tend to be more frugal anyway with their dollars and they watch what they're doing. And so, we really think we've got a pretty good conservation program across our customer base in California as it is.

Debra Coy - Janney Montgomery Scott

Okay. That's helpful. Thanks.

Operator

(Operator Instructions) And we have a question from the line of Michael Gaugler with Brean Murray Carret. Please proceed.

Michael Gaugler - Brean Murray Carret

Good afternoon, everyone.

Cheryl Clary

Good afternoon, Michael.

Michael Gaugler - Brean Murray Carret

Most of my questions have been answered. Cheryl, I noticed the tax rate ticked up a little bit in the quarter, anything behind that?

Cheryl Clary

No. Nothing other than it's due to state tax apportionment reasons. It only ticked up a very small little bit.

Michael Gaugler - Brean Murray Carret

You think, you'll go back to 36.5 range going forward?

Cheryl Clary

No. Probably not, look for 37 or so.

Michael Gaugler - Brean Murray Carret

All right. Thank you.

Cheryl Clary

You're welcome.

Operator

(Operator Instructions) And we have a question from the line of Noah Hugenberger (ph) with Harpswell Capital. Please proceed.

Noah Hugenberger - Harpswell Capital

Hello, everyone.

Cheryl Clary

Hello.

Noah Hugenberger - Harpswell Capital

Are there any updates that you could provide us with on the New Mexico Utility and the condemnation proceedings there?

Mark Swatek

We have a trial date set for next fall on the condemnation. There has been a court mandate mediation that probably will occur next year sometime. We also now have trial dates set on the parallel activities that we've got going on there.

So we're really in the litigation mode. Most of this will start to see the activity next summer and into the fall and we're in the middle of it.

Noah Hugenberger - Harpswell Capital

And do you still have run rates for legal expenses that you've had in previous quarters? I think it was $200,000 or so maybe the last two quarters or so?

Cheryl Clary

Yes. It was $100,000 this quarter and $200,000 the previous quarter.

Noah Hugenberger - Harpswell Capital

Thank you very much.

Cheryl Clary

You're welcome.

Operator

And currently, no other questions.

DeLise Keim

All right. Well, if we have no further questions, we'd like to thank you all for joining us today. Remember there will be a replay of this call available shortly on our website, which is www.swwc.com and this does conclude Southwest Water Company's, third quarter 2007 conference call.

Operator

Ladies and gentlemen, thank you very much for your participation today. You may now disconnect. Have a great weekend. Thank you.

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