SouthWest Water Company Q1 2008 Earnings Call Transcript

SouthWest Water Company (SWWC)

Q1 2008 Earnings Call Transcript

May 12, 2008 4:00 pm ET

Executives

DeLise Keim – VP of Corporate Communications

Mark Swatek – CEO and Chairman

Cheryl Clary – CFO

Analysts

Heike Doerr – Janney Montgomery Scott

Presentation

Operator

Good day and welcome to the first quarter 2008 SouthWest Water financial results conference call. My name is Candice and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session after the prepared remarks. (Operator instructions) I would now like to turn the presentation over to your host for today's conference, Ms. DeLise Keim, Vice President of Communications. Ma'am, you may proceed.

DeLise Keim

Thank you, Candice. Good afternoon, everyone. Welcome to SouthWest Water Company's Conference Call for the first quarter ended March 31, 2008. We issued our earnings release this morning, a copy of which can be found on our web site at www.swwc.com. A replay of this conference call will also be available on the web site.

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 on 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 SEC filings, including our 2007 annual report on Form 10-K and our first quarter 10-Q under the Risk Factors section. A copy of these reports and other SEC filings are also available on our web site.

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

Mark Swatek

Thanks, DeLise, and good afternoon everyone. Our field operations did an excellent job in the first quarter, which is historically our slowest quarter, by posting improved numbers in both revenue and operating income. However, our bottom line results were impacted by temporary increases in corporate overhead of $1.8 million. These increases included $800,000 Cornerstone costs, which will continue to impact our overhead through final implementation next year, a one-time increase of $700,000 in professional fees due to the evaluation of a unique strategic opportunity that did not come to fruition, and $300,000 in other temporary increases in costs associated with our restructuring and business reengineering projects. These expenses led to a net loss for the quarter, but I want to emphasize that the underlying business is performing well.

Utility revenues increased despite the January and February rain in California that reduced consumption in our largest utility. Revenues associated with the interim rate increases in Texas and wastewater facility we purchased in Alabama at the beginning of the quarter more than offset the California reductions. Utility operating income improved on the strength of these revenues.

Several of you have asked what we expect to happen in California due to the political situation of the aqueduct system and the continued drought. We believe we are in good position as we generate most of our water needs from wells we own and our local basin has maintained its water level so far. We use small amounts of imported water and generally, only during the driest time of the year. Most of the additional water we need is supplied by other sources in the area and we actively manage this to insure that we utilize the most cost effective sources first. We would need to experience a severe multi-year drought before we will be facing both finding more extensive supplies elsewhere and implementing more restrictive conservation efforts than we already have in place.

We have a couple of large rate cases pending. We filed our next general rate case in California with a requested increase of about $6.8 million in annual revenues. We expect a decision from the PUC by the end of the year and will implement new rates in January 2009.

In Texas, we are in negotiations with interveners in our Monarch rate case and expect to reach a settlement before the end of the year. Our interim rates will remain in place until then.

In New Mexico, Public Regulatory Commission has indicated its support of our proposal to establish a regulatory asset for amounts paid relating to our disputed wastewater treatment charges in that state, including legal fees and late penalty payments, if [ph] we would then be able to recover this asset prospectively through a rate surcharge to our customers. As I'm sure you recall our wastewater service provider is the same entity that has filed for condemnation of our utility there. So clearly, these two cases are linked. The wastewater fee trial is set for fall this year, while the condemnation trial has been postponed until April of next year.

I again would like to say how pleased we are with the Riverview wastewater system in Birmingham that we purchased in January. This asset serves more than 12,000 residents in high-population growth area along a major commercial corridor. It was immediately accretive to our financial results, plus it's adjacent to our Shelby County wastewater system, which will allow us to realize synergies through cross-connections and by combining the operations of these two systems.

As indicated in today's other press release, we've had some difficulty auditing the historic financials of the Riverview system. This was a very tiny portion of the Birmingham water and wastewater system, and they never broke out the wastewater element from their operations. The State of Alabama allows for the destruction of documents after seven years, so we weren't able to audit the historical basis of these assets. Even with these technical challenges to meet SEC requirements, this has been an excellent acquisition and we would do a similar deal tomorrow if there was one available at similar terms.

Revenue in the service business was up slightly over last year's first quarter which, when you consider the reduction in new home construction, is indicative of the efforts we've made to focus on our base contracts. For example, our MUD business in Texas increased revenues through new business and reworking contracts as it came up for renewal. This is a big shift in a business that was heavily reliant on new home construction revenues a year ago.

We also saw strong new business growth in Alabama, and a significant impact in our western O&M business due to repricing efforts. Operating income in the services business also improved at a greater rate than revenue growth. Operating margin is up 0.5% over this time last year, so really beginning to see the effects of local management's focus on improving the performance of the operation. This is directly related to the restructuring that we did in last year in creating a very focused management structure, looking at this business in a different way.

In spite of the housing slowdown, which has impacted some of our more profitable lines of business, we are seeing results of the hard work needed to improve our basic business. To update you on our Cornerstone business reengineering project, we went live in January as planned on our new Oracle financial platform for the entire company. This is the first time that Southwest Water was on a single platform for consolidated financial accounting system and I'm very pleased with the results so far. Keep in mind, we did this at the same time that we brought a new auditor online as well, so it was an interesting quarter to close the books on.

We closed the books on the Oracle and are now generation new expanded management reporting capabilities that provide our managers with the information needed to monitor and improve their performance. We're now in the process of consolidating our back-room functions, such as AP, payroll, accounting, and procurement, into a financial services center which will allow us to better utilize the capabilities of our new system, streamline our business processes, and reduce our administrative costs.

We are gearing up for implementation of other phases of Cornerstone, including Customer Care and Billing, Work and Asset Management, and Mobile Workforce Management. Because of the complexity of the numerous billing rate structures we deal with, these phases will take longer to implement. We'll roll out the new systems location by location in 2009, beginning with our California utility. This rollout will not be fully implemented across the enterprise until towards the end of 2009 and we anticipate our overhead expenses will continue to be at a higher level than our historic trends through that time frame. As we get parts of the project implemented, we expect to begin to see savings come in from increased efficiencies this year, but significantly more by the end of 2009.

Now, I'd like to turn the call over to Cheryl Clary, our Chief Financial Officer who will provide detailed information on our financial results for the first the quarter. Cheryl?

Cheryl Clary

Thank you, Mark, and welcome everyone. Please note we sent out a correction on our financial press release from this morning to reflect operating expense intersegment eliminations in our services business.

Now, looking at the quarter, for the three months ended March 31, 2008, SouthWest Water reported revenues of $50.8 million, operating income of $1.8 million, a loss from continuing operations of $314,000 or $0.01 per diluted share, and net loss of $601,000 or $0.02 per diluted share. This compares with revenues of $47.9 million, operating income of $3.1 million, income from continuing operations of $840,000 or $0.03 per diluted share and net income of $614,000 or $0.03 per diluted share in the first quarter of 2007.

Our weighted average diluted shares outstanding were 24.4 million shares. Let me give you some of the details concerning our results. Companywide first quarter revenues increased $2.9 million or 6% from prior year's first quarter results. Revenue in the utility business increased by $2.3 million or 12% to $22.3 million from $20 million in the first quarter of 2007. This increase was primarily due to a fourth quarter 2007 interim rate increase in Texas and acquisitions principally the wastewater treatment plant in Birmingham, Alabama, which we completed in the first quarter of 2008. The increased revenues were partially offset by reduced consumption in California due to January and February rain.

The service business revenues, which includes intersegment revenues from our utility business, increased by $102,000 to $33.6 million for the quarter, up from $33.5 million in the same period last year. This increase was due to new business, including our Birmingham acquisition, and our ongoing efforts to reprice renewing contracts, partially offset by reduced construction projects for our Texas and New Mexico utilities.

For the first quarter of 2008, companywide operating income decreased $1.3 million from the same quarter last year. Utility business operating income in the first quarter of 2008 was up 11% to $6.4 million versus $5.8 million in the first quarter of 2007. This was primarily due to the revenue increases. As a percentage of utility revenues, operating income remained consistent at 29%.

The service business operating income increased $159,000 to $860,000 compared with $701,000 in the first quarter of 2007. This increase primarily was due to the increased revenues. As a percentage of services revenues, operating income increased to 2.6% in the quarter, up from $2.1 million in the prior year period.

Looking now at companywide expenses, on January 1, 2008, we implemented the Oracle-based, integrated financial module of Cornerstone throughout the entire organization. As a result, the methodology of capturing and reporting certain operating, and selling and general and administrative expenses, as well as the classification of expenses between business segments, has changed.

For the first quarter of 2008, consolidated SG&A expenses were $9.6 million, representing 19% of revenues. Prior year amounts have not been reclassified to conform to the 2008 presentation because the information to do so was not available and the cost to develop that would be excessive, so I don't have a comparable number for you. The classification and changes primarily affected the services group business by lowering its SG&A cost and increasing its operating expenses. The utility business and corporate SG&A expenses were not significantly affected by the reclassification. Corporate SG&A expenses were $5.4 million compared with $3.4 million in the first quarter of 2007. The increase includes $800,000 relating to Cornerstone which began late in the second quarter of 2007, $700,000 in professional fees associated with a strategic business opportunity that Mark spoke about, and $300,000 in other temporary increases associated with business process reengineering projects.

Interest for the first quarter increased to $2.4 million versus $1.9 million in the prior year period. This increase was primarily due to an increase in borrowings on our revolving line of credit, principally associated with our Birmingham acquisition, and a $268,000 write-off of unamortized deferred financing costs associated with the refinancing of our $100 million line of credit to a new $150 million line of credit during the quarter. The net effective interest rate on all borrowings was 6% compared to 6.5% during the first quarter of last year. Average borrowings were $165.5 million versus $133.6 million in the first quarter of 2007.

Moving on to the balance sheet, total company funded capital expenditures were $6.9 million compared to $6.7 million in the first quarter of 2007. 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 $1.9 million in the Cornerstone project. In 2008, we expect to spend approximately $43 million on company-funded CapEx, including approximately $14 million of Cornerstone-related expenses.

We maintain a syndicated credit facility which gives us flexibility to finance our growth, handle seasonal cash flow needs and fund our capital expenditures. In January 2008, we used the line to fund the $23.3 million acquisition of the Riverview wastewater system in Birmingham, which reduced our borrowing capacity. However, in February 2008, we entered into a new credit agreement with several lenders that provides for $150 million revolving credit facility. At March 31, 2008, we have $88 million of outstanding borrowings on the line at a weighted average borrowing rate of 3.9 %. We have the ability to elect to increase the credit facility up to an additional $75 million during the term of the agreement.

Also, in December 2007, we obtained a $30 million equipment leasing line of credit to help with the financing of our Cornerstone project. At quarter-end, we have leased $4.6 million of equipment on this line with a weighted average interest rate of 4.4%. I'm pleased we were successful incompleteing these new agreements, especially in light of today's difficult credit markets.

Our liquidity remains strong as we had $60 million of total borrowing capacity available on the $150 million line of credit facility as of quarter end and $25.4 million available on the equipment leasing facility. We ended the quarter with $184 million of debt with total debt comprising 54% of total capitalization, which is on target with our goal of a debt-to-equity ratio of approximately 50/50. Our cash at the end of the quarter was $2.2 million.

With that, I would like to turn the call back to Mark.

Mark Swatek

Thanks, Cheryl. Our efforts to restructure the company, improve our business process, are showing results. The margins in our service business are improving, permanent overhead costs have been reduced, and our revenue mix is becoming more balanced between our utility and service businesses. Our goal is to become a more efficient organization with sustainable bottom line growth. Our Cornerstone project is a big step towards improving our operational efficiencies. This is not an easy task, but I'm confident that as we follow this path, we will continue to unlock shareholder value. We expect to see continuing incremental progress in all fronts over the coming quarters as our efforts come to fruition.

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

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question will come from the line of Heike Doerr of Janney Montgomery Scott. Please proceed.

Heike Doerr – Janney Montgomery Scott

Thank you. Good afternoon, everyone.

Mark Swatek

Hi, Heike.

Cheryl Clary

Good afternoon, Heike.

Heike Doerr – Janney Montgomery Scott

A couple of questions; I'll try not to monopolize your time too much. This Birmingham acquisition, is there a long-term financing plan? I understand it was done with revolving credit. If I think back to the Monarch acquisition, that was done with revolving credit and then some equity and some debt. Is this too small for that to be the way you are going to handle it?

Mark Swatek

We're looking at options at this point. I think that we did the deal off of the line today. We're constantly looking at what's the best way to structure our overall capital arrangement.

Heike Doerr – Janney Montgomery Scott

Is that something that would get decided in the next six months or so then, how this will be financed long term?

Cheryl Clary

Depends upon the credit markets in part.

Heike Doerr – Janney Montgomery Scott

Okay, that's fair. And as we look at these Cornerstone costs, I believe you mentioned that it was $14 million of CapEx. How is this being treated as far as what gets capitalized and what's getting expensed?

Mark Swatek

The $14 million is a capital piece. If you take a look at what we have spent, there is an expense piece as well. So the $14 million is all the capital expenditure piece. A piece gets capitalized and a piece gets expensed under the accounting regulation. We capitalize a piece and we have to expense a piece.

Heike Doerr – Janney Montgomery Scott

And you've built in the part that you're capitalizing into the rate case; correct?

Cheryl Clary

That we will be in the future.

Heike Doerr – Janney Montgomery Scott

So the rate case that happened in January, does that include Cornerstone outlays?

Cheryl Clary

It does not.

Heike Doerr – Janney Montgomery Scott

Okay.

Cheryl Clary

We will be filing for an interim rate to capitalize on those Cornerstone costs.

Heike Doerr – Janney Montgomery Scott

And how would that work? I guess the Cornerstone costs would need to be filed in each of your rate jurisdictions, right? Not just in the suburban quarter?

Cheryl Clary

Yes, that's correct. And remember, pertaining to – as far as it relates to suburban, a large benefit is going to come from the new CC&B, the customer billing system. Right now, all that's been implemented is really the financial system and that was primarily the reason for waiting, and doing it all at once. We didn't want to piecemeal it with the Commission.

Heike Doerr – Janney Montgomery Scott

Okay. Mark, you threw off a lot of things as far as the things that still need to get done on Cornerstone. What's the next step and what's the next date that we should be looking for as far as what hurdles you're looking to get done here in 2008?

Mark Swatek

2008, the rest of 2008, I think from Cornerstone standpoint, the big thing that will happen in 2008 will be the complete stand up of the financial service center and that's a transition of functions. We're centralizing some of those functions. We're moving some functions around the company and that should all be complete by the end of the third quarter. Otherwise, what we'll really see happening will be occurring early in 2009, which is when we'll start to roll out the new billing system, the work order and project management system and a mobile workforce management system, will all go out coincident to each other and that will happen – again, it will be a rollout location by location and we are going to start with suburban and then move it to different parts of the country as we work through the year.

Heike Doerr – Janney Montgomery Scott

Okay, that's helpful. As we look at the SG&A as a percentage of revenue, that 19% that you quoted for the first quarter, is that an appropriate level going forward? How should we be looking at that?

Cheryl Clary

I think it will come down a little bit. If you take a look at some of the one-time costs that we talked about and back that out, I mean Cornerstone will continue as we talked about it, but there's also $1 million in the percentage that will come out and are not recurring types of cost.

Heike Doerr – Janney Montgomery Scott

Okay. And just as a final question, as we look at the economy and what's been happening, can you maybe talk to in particular California and Texas, what you're seeing on the commercial and industrial side? Have you seen a usage decline out of those customer bases?

Mark Swatek

No. Our commercial side is a fairly small portion of our flow, as well as industrial is a very, very small portion of our customer base. What we have seen is a very, very slight uptick in disconnections and it's really negligible from the overall impact and it's something we're monitoring very closely. We're also looking at our deadbeat accounts and to be honest with you, so far so good. We haven't really seen a significant impact from the economy-related issues right now. Where we are seeing that impact is in growth and clearly organic growth has slowed down for us.

Heike Doerr – Janney Montgomery Scott

Thanks. That's helpful. I appreciate you taking the time.

Operator

(Operator instructions)

Mark Swatek

Well, sounds like you're all eager to get on to the Basin Water call, and I'll turn it over to De Lise.

DeLise Keim

All right, well, thank you all for joining us today. Remember, there will be a replay of the call available shortly on our web site, www.swwc.com. And this does conclude our first quarter 2008 conference call. Thank you. Goodbye.

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