-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Cl8Ll6M9FRSVVMUp1b6lD0hsptR8XZMk7KgX5DR61eoPUg3mk0tdO56NHkDgtM/+ tfdHOWzJ+fyanD726lPHGQ== 0000898430-99-001213.txt : 19990423 0000898430-99-001213.hdr.sgml : 19990423 ACCESSION NUMBER: 0000898430-99-001213 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHWEST WATER CO CENTRAL INDEX KEY: 0000092472 STANDARD INDUSTRIAL CLASSIFICATION: 4941 IRS NUMBER: 951840947 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-08176 FILM NUMBER: 99576604 BUSINESS ADDRESS: STREET 1: 225 N BARRANCA AVE STE 200 CITY: WEST COVINA STATE: CA ZIP: 91791-1605 BUSINESS PHONE: 8189151551 MAIL ADDRESS: STREET 1: 225 N BARRANCA AVENUE STREET 2: SUITE 200 CITY: WEST COVINA STATE: CA ZIP: 91791-1605 FORMER COMPANY: FORMER CONFORMED NAME: SUBURBAN WATER SYSTEMS DATE OF NAME CHANGE: 19751202 10-K405 1 FORM 10-K405 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K (Mark One) [X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1998 or ----------------- [_ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _____________ to _____________ Commission file number 0-8176 Southwest Water Company (Exact name of registrant as specified in its charter)
Delaware 95-1840947 (State or other jurisdiction of incorporated organization) (IRS Employee Identification No.) 225 N. Barranca Avenue, Suite 200 West Covina, CA 91791-1605 (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code: (626) 915-1551 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: (1) Common Shares, $.01 par value Nasdaq (2) Series A, 5-1/4%, Cumulative Preferred Shares None $.01 par value (Title of each class) (Name of each exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No[ ]. On March 22, 1999, there were 4,253,272 common shares outstanding. The aggregate market value of the voting common equity held by non-affiliates of the registrant was approximately $53,610,000 based upon the average high and low stock prices as of March 22, 1999. The registrant is unable to estimate the aggregate market value of its preferred shares held by non-affiliates of the registrant because there is no public market for such shares. Documents incorporated by reference: Form 10-K Reference ------------------ Proxy Statement dated on or about April 15, 1999 for Annual Meeting of Stockholders on Thursday, May 27, 1999 Part III Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III in this Form 10-K or any amendment to this Form 10-K. [X] SOUTHWEST WATER COMPANY AND SUBSIDIARIES
INDEX PART I Item 1. Business......................................................................... 1 Item 2. Properties....................................................................... 7 Item 3. Legal Proceedings................................................................ 9 Item 4. Submission of Matters to a Vote of Security Holders.............................. 10 Item 4a Executive Officers of the Registrant............................................. 10 PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters........ 11 Item 6: Selected Financial Data.......................................................... 12 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................ 13 Item 8: Financial Statements and Supplementary Data...................................... 19 Item 9: Changes and Disagreements with Accountants on Accounting and Financial Disclosure 38 PART III Item 10: Directors and Executive Officers of the Registrant............................... 39 Item 11: Executive Compensation........................................................... 39 Item 12: Security Ownership of Certain Beneficial Owners and Management................... 39 Item 13: Certain Relationships and Related Transactions................................... 39 PART IV Item 14: Exhibits, Financial Statement Schedule and Reports on Form 8-K................... 40 Exhibit Index.................................................................... 42 Signatures....................................................................... 46
SOUTHWEST WATER COMPANY AND SUBSIDIARIES Certain statements contained in this Annual Report on Form 10-K are "forward- looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risk, uncertainties and other factors that may cause actual results, performance or achievements of the Company to be materially different from any performance or achievements planned, expressed or implied by such forward-looking statements. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. Factors that could cause actual results to differ from expectations are discussed in Part II; Item 7, Risk Factors on pages 15-17. PART I Item 1. Business General Development of Business Southwest Water Company (hereafter, together with its subsidiaries, referred to as the "Company" or "Registrant") was incorporated under the laws of the State of California on December 10, 1954. The Company reincorporated in the State of Delaware on June 30, 1988. The Company is engaged in the water management business, providing water and wastewater services to nearly three- quarters of a million people located throughout California, New Mexico, Texas and Mississippi. Through its wholly owned subsidiary, ECO Resources, Inc. ("ECO"), the Company operates and manages water and wastewater treatment facilities owned by cities, municipal utility districts and private entities. The Company conducts regulated water utility operations through two wholly owned subsidiaries, Suburban Water Systems ("Suburban"), and New Mexico Utilities, Inc. ("NMUI"). The Company also owns an interest in Windermere Utility Company ("Windermere"); a small regulated water utility in Texas. General Information The focus of the water management industry is customer service, and it does not rely heavily on technological or proprietary manufacturing processes. The Company does not conduct significant research and development activities, and has no patents, licenses or trademarks (except for certain logos and artwork used in marketing). The Company uses certain commodities such as chemicals and supplies in its daily operations that are currently readily available from a number of suppliers. During the past year, there were no significant changes in the way the Company does business. There are no individual customers of the Company who generated revenues that exceeded 10-percent of the Company's consolidated revenues, or whose loss would have a material adverse effect on the Company's consolidated operations. The Company is subject to various regulatory agencies with respect to its water and wastewater treatment services. To date, the Company has experienced no material adverse effects upon its operations or capital expenditures resulting from compliance with governmental regulations relating to protection of the environment. At December 31, 1998, the Company employed 524 people, none of whom was represented by an employee union. A. Contract Operations ECO Resources, Inc. Product, Business and Regulation In 1985, the Company purchased all of the outstanding common stock of ECO, thereby entering into the contract water and wastewater management industry. ECO was established in 1970 and incorporated under the laws of the State of Texas in 1974. ECO provides water and wastewater operations and maintenance services as well as performing related services such as facility equipment 1 maintenance and repair, sewer pipeline cleaning, water and wastewater operations, billing and collection, and state-certified laboratory analysis. As a contract operator, ECO does not own any of the water sources, water production facilities or water distribution systems that it operates for its clients, nor does ECO own any of the wastewater collection systems or wastewater treatment facilities that it operates for its clients. Although not the owner, ECO is responsible for operating these water and wastewater facilities in compliance with all federal and local health standards and regulations. ECO has two distinct types of contractual relationships: time and material contracts primarily with municipal utility districts and fixed fee operations and maintenance contracts. Municipal Utility District Contracts A Municipal Utility District ("MUD") is a utility district created under the rules of the Texas Natural Resource Conservation Commission in order to provide water, wastewater and drainage services to areas where existing municipal services are not available. ECO has MUD contracts in the suburbs of Houston, Austin and El Paso, Texas. ECO negotiates each MUD contract with the MUD's Board of Directors. As the large Texas cities expand their boundaries, they periodically condemn MUD-owned facilities and annex them to city-owned facilities. As of January 1, 1998, ECO had 135 MUD contracts. During 1998, 18 new MUD contracts were added, two MUD contracts were canceled due to annexation and one MUD contract was canceled for competitive reasons, bringing the total to 150 MUD contracts as of December 31, 1998. Typically, a MUD contract provides for a monthly base fee that ensures a certain level of maintenance and operations services, billing, collection and customer services; and environmental monitoring and reporting. Additional services provided beyond each contract typically generate revenues on a time and materials basis as such services are rendered. Most MUD contracts are short- term contracts and are cancelable on 30 or 60-day notice by either party. Most contracts allow ECO to increase its monthly fee as the number of connections increases. Operations and Maintenance Contracts Operations and maintenance ("O&M") contracts are contracts with cities and private entities located in Texas, Mississippi, New Mexico and California. Typical O&M contracts tend to average three to five years in duration and are generally cancelable during that period only after a specific breach of the contract by either party. Typical O&M contracts provide for a specified level of services, such as facility operation and maintenance, meter reading and billing or management of the entire water or wastewater system. Most contracts provide for a fee that covers a specified level of services with contractual limitations on ECO's liability in the event of a major system failure or catastrophe. For additional billings, ECO provides services beyond the scope of the contract or provides services after a system failure or catastrophe. ECO has the ability to seek fee increases from the city or private entity and to request specific payment for services when the cost of such services exceeds a reasonable amount. Additionally, if the system being serviced undergoes rapid growth that exceeds the parameters of the contract beyond a certain level, ECO has the right to increase its fixed fee accordingly. As of December 31, 1998, ECO had 20 O&M contracts, compared to 18 O&M contracts as of December 31, 1997. Competition and Future Development ECO provides contract water and wastewater services in Texas, Mississippi, New Mexico and California. It continues to improve its market position by adding new MUD and O&M contracts and aggressively pursuing renewal of its existing contracts. The contract water and wastewater management industry continues to undergo rapid growth and change. New contracts are awarded based on both lowest cost and technical expertise. ECO's competition in the O&M portion of its business includes a number of significantly larger companies that provide O&M services on a national and international basis, as well as several regional competitors. In the Texas MUD market, competitors include two large national companies and several smaller, local companies. 2 At December 31, 1998, ECO's anticipated future revenue from firm contractual commitments was approximately $70 million. Industry renewal rates tend to be high; however, the contract water and wastewater management business is very competitive. ECO intends to continue expanding its current business base in the southwestern and southern United States. B. Regulated Utility Operations Suburban Water Systems Product and Business Suburban is a regulated public water utility that produces and supplies water for residential, business, industrial and public authority use, and for private and public fire protection service under jurisdiction of the California Public Utilities Commission (the "CPUC"). Suburban's service area contains a population of approximately 234,000 people within Los Angeles and Orange counties, California. Suburban or its predecessor entities have supplied water since approximately 1907. From the mid-1950s to the late 1960s, Suburban's operations rapidly expanded as the transition from agricultural land use to residential, business and industrial use occurred throughout its service areas. Primarily due to the population saturation of its existing service area, Suburban has experienced only modest customer growth since the late 1960s. At December 31, 1998, Suburban served 66,843 customers, including 63,148 residential customers, 2,752 business and industrial customers, 313 public authority customers and 630 other customers. During 1998, Suburban's operating revenues were 74.5% from sales to residential customers, 18% from sales to business and industrial customers, and 7.5% from sales to other customers. Seasonal temperature and rainfall variations subject Suburban's business to significant revenue and profitability fluctuations. Since most of Suburban's residential customers use more water in hot, dry weather, the third quarter of each year is usually the highest in terms of customer consumption, revenues and profitability. Wells and Other Water Sources Suburban owns 15 active wells that pump water from two of the major groundwater basins in the Southern California coastal watershed: the Central Basin and the Main San Gabriel Basin (the "Basins"). The Basins are the source of approximately 77% of the water produced from Suburban's wells. The rights to pump water from the Basins have been fully adjudicated under the laws of the State of California. These adjudications have established Suburban's right to produce water at levels prescribed each year by the Watermaster Boards (the "Boards") that manage the Basins. As the water level in the Basins increases or decreases, the Boards may adjust the amount of water that Suburban and other producers may pump without paying additional charges. When Suburban produces water from either of the Basins in excess of permitted levels, an additional payment is required to provide for the replenishment of the water supply; however, even when additional payments are required, the Basins provide Suburban with the lowest cost of water. The price that Suburban will pay for water that it produces from the Basins is established each year by the Boards. Current water levels of the Basins are sufficient to eliminate any drought concerns; however, there is no assurance that the current allowable pumping levels will continue in the future. Suburban also purchases water from two mutual water companies that also produce their water from the Main San Gabriel Basin. Suburban's ownership of shares in each of these mutual water companies has allowed it to increase its water entitlement and maintain a lower cost of water. In addition, Suburban leases basin pumping rights from other parties, which also helps reduce its cost of water. Suburban's water supply is further supplemented by water purchased at a higher cost from external sources. Suburban has the right to purchase water from the Metropolitan Water District of Southern 3 California. Suburban also has interconnections with other water purveyors that can be used as supplemental and emergency sources of supply. Water Quality Regulation A stated responsibility of the CPUC is to ensure an adequate supply of healthful, potable water to residents of the state. Accordingly, Suburban's water quality issues are under the regulatory jurisdiction of the CPUC. Suburban's water supply is also subject to regulation by the United States Environmental Protection Agency (the "EPA"), acting pursuant to the 1996 Federal Safe Drinking Water Act (the "US Act"), and by the Office of Drinking Water of the California Department of Health Services (the "DOHS"), acting pursuant to the California Safe Drinking Water Act (the "Cal Act"). The US Act establishes uniform minimum national water quality standards, as well as specification of the type of treatment processes to be used for public drinking water. The EPA has an ongoing directive to issue regulations under the US Act in order to require disinfection of drinking water, specification of maximum contaminant levels ("MCLs") and filtration of surface water supplies. The Cal Act and the mandate of the DOHS are similar to the US Act and the mandate of the EPA. In many instances the requirements of the DOHS are more restrictive than the EPA. Both the EPA and the DOHS have put into effect regulations and other pronouncements that require periodic testing and sampling of water. These regulations specify permissible levels of radio nuclides (including radon), and rules governing lead and copper levels. The regulations mandate corrosion control studies and sampling as well as specifying permissible levels of volatile organic compounds ("VOCs"), herbicides, pesticides and inorganic substances. Suburban's water quality personnel regularly sample and monitor the quality of water being distributed throughout the system. Testing, sampling and inspections by Suburban are conducted at the intervals, locations and frequencies required by EPA and DOHS regulations. Chlorination is currently performed to provide a chlorine residual required by the DOHS as a safeguard against bacteriological contamination. In addition to sampling and testing of water performed by Suburban personnel, independent engineers retained by the Boards conduct sampling and testing for certain pollutants such as VOCs. Water samples from throughout Suburban's system are tested regularly by independent, state-certified laboratories for bacterial contamination, chemical contaminant content and for the presence of pollutants and contaminants for which MCLs have been put into effect. The results of the sampling and testing are made available to all producers, with the cost of such sampling and testing covered by Board assessments to the producers. Suburban provides its customers with an annual water quality report, which, among other things, informs Suburban's customers of the source and quality of the water being provided to them. The Company believes that future incremental costs of complying with governmental regulations, including capital expenditures, will be recoverable through increased rates. However, there is no assurance that recovery of such costs will be allowed. In June 1998, Suburban detected a substance called N-nitrosodimethylamine ("NDMA") in one of its wells in excess of the EPA reference dosage for health risks. Upon detection, the well was immediately removed from service. Suburban is currently building a treatment facility that will reduce the NDMA to non- detectable levels. Suburban anticipates completion of this treatment facility in mid-1999. In 1997, the San Gabriel Basin Water Quality Authority advised Suburban that the DOHS had detected the contaminant "perchlorate" in the Main San Gabriel Basin. The contaminant was later detected in a well that is operated but not owned by Suburban. For a time, Suburban continued to blend water produced from this well with other water sources, bringing the concentration of perchlorate within the DOHS standards. Subsequently, NDMA was detected in this well in excess of the EPA reference dosage for health risks, at which time, Suburban removed the well from service. The potential impact of these contaminants on the results of operations for Suburban is not fully known at this time. Costs associated with testing of Suburban's water supplies have increased and are expected to increase further as regulatory agencies adopt additional monitoring requirements. Suburban anticipates capital expenditures of approximately $2 million to complete construction of the treatment plant described above. 4 Water supplied by Suburban meets all current requirements of the US Act, the Cal Act and the regulations put into effect under the related legislation. Suburban believes that costs associated with the additional monitoring and testing of its water will be recoverable from ratepayers in future rate increases. There can be no assurance that water sources currently available to Suburban will meet future EPA or DOHS requirements, that recovery of additional costs will be allowed, or that new or revised requirements will not require additional capital expenditures by Suburban in the future. Competition and Rate Relief Suburban operates under a Certificate of Public Convenience and Necessity granted by the CPUC and is regulated by other state and local governmental authorities having jurisdiction over water service and other aspects of its business. Suburban's water business is dependent upon maintaining this certificate and upon various governmental and court decisions affecting Suburban's water rights and service area. Under current CPUC practices, water rates may be increased through general rate increases or by offsets for certain expense increases. Typically, general rate increases are for three years and include "step" increases in the second and third years. General rate increases require formal proceedings with the CPUC in which overall rate structure, expenses and rate base are examined by CPUC staff. Public hearings are also held. General rate proceedings require approximately 12 months from the time an application is filed to the CPUC's authorization of new rates. The step increases for the second and third years are intended to compensate for projected expense increases. Prior to their approval, step increases are subject to verification that earnings levels have not exceeded the rate of return authorized at the general rate proceeding. Rate increases to offset increases in certain expenses such as the cost of purchased water and energy costs to pump water are accomplished through an abbreviated "offset" proceeding that requires approximately two months from the time of filing a request to the authorization of new rates. In 1995, Suburban filed a general rate increase application with the CPUC and negotiated with the CPUC staff a 4.25% ($1,100,000) rate increase, effective April 24, 1996. On December 3, 1996, the CPUC approved Suburban's filing for a 2.62% ($705,000) step increase, effective January 1, 1997. On December 30, 1997, the CPUC approved Suburban's filing for another 2.62% ($740,000) step increase, effective on January 1, 1998. This was the last step increase from the 1995 general rate application. As of March 1999, Suburban had not filed a rate request. In recent years, Suburban has succeeded in achieving efficiencies and cost savings that resulted in the deferral of rate requests. Suburban has been, and believes that it will continue to be, permitted to increase its rates as necessary to achieve a reasonable rate of return. However, the inability to increase rates in the event of increases for certain expenses could adversely affect Suburban's results of operations. As permitted by the CPUC, Suburban records the difference between actual and CPUC-adopted water production costs in balancing accounts in the income statement, with a corresponding adjustment on the balance sheet. Suburban believes that these amounts will be recovered from or returned to the ratepayers through future CPUC-authorized rate adjustments. Future Development In recent years, Suburban's growth has been limited to extensions into new subdivisions along the periphery of its service areas. There is little area available for new business, industrial construction or residential growth, and as such, significant increases in the number of customers in Suburban's current service area are not expected. In 1998, Suburban entered into an exclusive negotiating agreement with the City of West Covina, California, which is adjacent to its existing service area. The purpose of the agreement, which was extended to July 1999, is to enable the city and Suburban to establish a price that will allow the city to divest itself of its water distribution system and facilities. Successful negotiations would allow Suburban to either purchase or lease the city's water system, adding approximately 7,000 connections to Suburban's customer base. 5 The laws of the State of California provide that no public or private agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the public utility. Under California law, municipalities and certain other public bodies have the right to acquire private water utility plants and systems within their territorial limits by condemnation but must pay fair value for the condemned system. Suburban is not aware of any impending proceeding in relation to the condemnation of any portion of its facilities. Water utilities require substantial amounts of capital for the construction, extension and replacement of water distribution facilities. This capital is generated from Suburban's operations, from periodic debt financing by Suburban, from lines of credit of Suburban, from contributions in aid of construction received from developers, governmental agencies, municipalities or individuals, and from advances received from developers that are repaid under rules of the CPUC. During 1998, 1997 and 1996, capital expenditures approximated $5,636,000, $5,853,000 and $6,124,000, respectively. New Mexico Utilities, Inc. Product and Business NMUI is a regulated public water utility that provides water supply and sewage collection services for residential, commercial, irrigation, and fire protection customers under jurisdiction of the New Mexico Public Utility Commission ("NMPUC"). NMUI's service area is located in the northwest part of the City of Albuquerque and in the northern portion of Bernalillo County, New Mexico. NMUI's service area contains a population of about 23,000 people and covers approximately 34 square miles, of which an estimated 28% has been developed. In 1969, Suburban purchased NMUI. In 1987, NMUI became a wholly owned subsidiary of the Company after the NMPUC authorized Suburban to transfer by stock dividend all of the stock of NMUI to Southwest Water Company. Since 1969, NMUI has grown from approximately 800 customers to over 6,600 customers. Most of this growth has come from the extension of water services and sewage collection services into new residential subdivisions and from the development of commercial property. Continuing economic development in NMUI's service area is expected to further increase the number of customers. At December 31, 1998, NMUI provided water service to 6,639 customers including 6,017 residential customers, 548 commercial and industrial customers and 74 other customers. NMUI also provided sewer collection service to 6,224 customers including 5,889 residential customers and 335 commercial and industrial customers. During 1998, NMUI's operating revenues were 49% from sales to residential customers and 51% from sales to commercial and industrial customers. Seasonal temperature and rainfall variations subject NMUI's business to significant fluctuations. Since most of NMUI's residential customers use more water in hot, dry weather, the third quarter of each year is usually the highest in terms of customer consumption, revenues and profitability. The sewer operation revenues and profitability remain relatively constant throughout the year. Wells and Other Water Sources NMUI owns five wells and three reservoirs and believes that it has adequate water capacity to serve its current customer base as well as new customers in the foreseeable future. NMUI's wells produce water from the Rio Grande Underground Basin. The water supplied by NMUI to its customers is subject to regulation by the EPA and by the State of New Mexico Environmental Improvement Division ("EID"). Samples of water from throughout the system are tested regularly by independent, state certified laboratories, and the results of the tests are sent to the EID. Chlorination is performed to provide an allowable chlorine residual as a safeguard against bacteriological contamination. Water supplied by NMUI meets all current requirements of the EPA and the EID, and NMUI anticipates no significant capital expenditures to comply with those requirements. There can be no assurance, however, that water sources currently available to NMUI will meet future EPA or EID 6 requirements, or that such requirements will not require capital expenditures by NMUI. If customer growth continues in NMUI's service area as projected, NMUI may have to increase its water supply capability through additional well construction. To ensure the availability of an emergency supply of water, NMUI has one interconnection with another water purveyor. Competition, Regulation and Future Development NMUI operates under a Certificate of Public Convenience and Necessity granted by the NMPUC and is regulated by other state and local governmental authorities having jurisdiction over water and wastewater service and other aspects of its business. NMUI's water and sewer business is dependent upon maintaining this certificate and upon various governmental and court decisions affecting NMUI's water rights and service area. Requests for rate increases are submitted to the NMPUC with the test year typically being the previous year's actual results. NMUI has been, and believes that it will continue to be, permitted to increase its rates as necessary to achieve a reasonable rate of return. However, any inability to increase rates in the event of increased cost of certain expenses would adversely affect NMUI's results of operations. The laws of the State of New Mexico provide that no public or private agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the utility. Under New Mexico law, municipalities and certain other public bodies have the right to acquire private water utility plants and systems within their territorial limits by condemnation but must pay fair value for the condemned system. In recent years, the City of Albuquerque (the "City") has annexed a significant portion of NMUI's service area; however, NMUI has continued to serve the customers located in the annexed areas. Currently, 52% of NMUI's customers are located within the city limits. As discussed in the Company's 1997 Annual Report on Form 10-K, and Form 10-Q for the quarters ended March 31, June 30, and September 30, 1998, the City has initiated an action in eminent domain to acquire the operations of NMUI. The Company believes that the fair market value of NMUI is substantially in excess of the amount offered in the City's complaint. Under New Mexico state law, there are procedures which would allow the City to take possession of NMUI prior to the resolution of the fair market value issue; however, the Company believes that it has adequate defenses should the City choose to pursue these procedures. Discussions with the City are ongoing but there is no assurance that these discussions will lead to a settlement of the legal action, or that the action will be resolved quickly. NMUI's operations are capital intensive. Capital is generated from NMUI's operations; from periodic debt financing by NMUI, from lines of credit of NMUI and the Company, from contributions in aid of construction received from developers, and from advances received from developers which are repaid under rules of the NMPUC. During 1998, 1997 and 1996, capital expenditures approximated $5,727,000, $8,916,000 and $8,169,000, respectively. The decrease in capital expenditures in 1998 compared to 1997 was primarily due to the completion of a new well in 1997. Item 2. Properties The Company's corporate offices are located in West Covina, California, where the parent company leases approximately 7,500 square feet of office space for its headquarters. A. Contract Operations ECO Resources, Inc. ECO owns 4.3 acres and a 17,000 square-foot building for its fleet and maintenance operations in the Houston, Texas area, and 10 acres and a 10,000 square-foot building for its office, fleet and maintenance operations in Austin, Texas. In addition, ECO owns or leases 316 vehicles and other equipment used in daily operations. ECO leases approximately 30,000 square feet of office, warehouse and laboratory 7 space in eight facilities in the Houston, Texas area; the Rio Grande Valley, Texas area; Mississippi; New Mexico; and California. B. Regulated Utility Operations Suburban leases an office building with approximately 14,600 square feet of office space for its headquarters in Covina, California. Suburban also owns a 3,550 square foot building in La Puente, California, and a 3,200 square foot building in La Mirada, California that are used for its district operations. NMUI leases 4,012 square feet of space in an office building for its headquarters in Albuquerque, New Mexico and owns a 2,400 square foot warehouse that is used for its field supplies and equipment. Suburban Water Systems Suburban owns and operates water production and distribution systems consisting of well pumping plants, booster pumping stations, reservoir storage facilities, transmission and distribution mains, and service connections to individual customers. Suburban also owns and operates a water treatment facility, which was placed in service during 1997. Suburban has rights-of-way and easements in its service area necessary to provide water services. At December 31, 1998, Suburban owned 704 miles of transmission and distribution mains and 27 storage reservoirs with a total capacity of 56 million gallons. Suburban also owns 15 active wells with a total pumping capacity of approximately 37,000 gallons per minute. These facilities vary as to age and quality, but each is believed by Suburban to be in good condition and adequate for current operations. Suburban intends to continue its capital expenditure program and construct and replace reservoirs, wells and transmission and distribution lines in future years, as needed and approved by the CPUC. Suburban employees perform normal maintenance and construction work on these facilities, and major construction projects are performed by outside contractors chosen through competitive bidding. Ongoing maintenance and repairs performed by Suburban were approximately $1,792,000 in 1998 and constituted approximately 11% of its operating expenses. Virtually all property of Suburban other than 11.4 acres of vacant land in La Puente, California is subject to the lien of an Indenture of Mortgage and Deed of Trust dated October 1, 1986 (the "Suburban Indenture"), as amended February 7, 1990, January 24, 1992 and October 9, 1996, securing Suburban's First Mortgage Bonds. The Suburban Indenture contains certain restrictions common to such types of instruments regarding the disposition of property and includes various covenants and restrictions, including limitations on the amount of cash dividends that Suburban may pay to the Company. The vacant land in La Puente, California is neither necessary nor used for utility operations and is currently in escrow, pending completion of a sale transaction. New Mexico Utilities, Inc. NMUI owns and operates a water production and distribution system consisting of well pumping plants, reservoir storage facilities, booster pumping stations, transmission and distribution mains, and service connections to individual customers. NMUI has rights-of-way and easements in its service area necessary to provide water and sewer services. At December 31, 1998, NMUI owned five wells, 135 miles of transmission and distribution mains and three storage reservoirs with a total capacity of eight million gallons. NMUI's wells have a total pumping capacity of 9,525 gallons per minute. In addition, NMUI owns and operates a sewer collection system consisting of one lift station and 101 miles of interceptor and collector lines. Wastewater is treated at a facility owned by the City of Albuquerque. These facilities vary as to age, and each is believed by NMUI to be adequate for current and foreseeable operations. Employees of NMUI or outside contractors perform normal maintenance and construction work on these facilities. Ongoing maintenance and repair expenses were approximately $178,000 in 1998 and constituted approximately 21% of NMUI's operating expenses. Virtually all of NMUI's property is subject to the lien of an Indenture of Mortgage and Deed of Trust (the "NMUI Indenture") dated February 14, 1992, as amended May 15, 1992 and October 21, 1996, securing NMUI's First Mortgage Bonds. The NMUI Indenture contains certain restrictions common to such types of instruments regarding the disposition of such property and includes various covenants and 8 other restrictions, including limitations on the amount of cash dividends that NMUI may pay to the Company. Item 3. Legal Proceedings As discussed in the Company's 1997 Annual Report on Form 10-K, Suburban and the Company were served with a summons and an amended complaint in the Kristin Santamaria, et al vs. Suburban Water Systems, et al action ("Santamaria"). The amended complaint lists approximately 350 plaintiffs who contend, in essence, that they or deceased family members are or were long-time residents of the San Gabriel Valley ("the Valley") and that, by virtue of their residence in the Valley, they have suffered long-term exposure to various hazardous substances in their drinking water resulting in serious illness or, in some cases, wrongful death. Of that number, 77 contend that they received their water from Suburban. Suburban and the Company filed demurrers (i.e. motions to dismiss the action) which alleged that the action must be dismissed because exclusive jurisdiction of the subject matter rests with the CPUC. On August 27, 1998, the Superior Court Judge agreed and dismissed the case as to all water utility defendants. The plaintiffs have appealed that decision. As discussed in the Company's Form 10-Q Reports for the quarters ended March 31, 1998 (the "March Report"), June 30, 1998 (the "June Report") and September 30, 1998 (the "September Report"), the Company and Suburban were served with a summons and complaint in a second action entitled Christine Boswell et al vs. Suburban Water Systems, et al, in the Los Angeles County Superior Court. There are 14 plaintiffs and the allegations against Suburban are similar to those in Santamaria. Since the filing of the September Report, the Court of Appeal has issued an order setting forth a briefing schedule for a review of the plaintiffs' petition requesting that the trial court be required to terminate a stay order issued with respect to this action and rule on the demurrers filed by the defendants. The water utility defendants asked the Court of Appeal to order the trial court to dismiss these actions based on the exclusive jurisdiction of the CPUC. The Court of Appeal has now issued an order to show cause why such an order should not be issued, and this request for dismissal will be argued on April 19, 1999. A third action, Anthony Anderson, et al vs. Suburban Water Systems, et al was filed in the Los Angeles County Superior Court. The allegations of the Anderson action are virtually identical to the Santamaria action and involve approximately 180 plaintiffs. Of that number, 57 claim to be customers of Suburban. By stipulation of the parties, this case is stayed pending the outcome of the Santamaria appeal. A fourth action, Demciuc, et al vs. Suburban Water Systems, et al was filed in the Los Angeles County Superior Court and was served in September 1998. In that case, 10 consumers are making claims against Suburban. That action is similar to the Boswell action and involves two other water purveyors and five industrial defendants. All of the parties to the Demciuc action have agreed to stay that action pending the outcome of the Boswell petitions. The Company and Suburban have recently been named as Doe Defendants in the following cases: Georgiana Dominguez vs. Southern California Water Company, et al, Jeff Adler vs. Southern California Water Company, et al, Loretta Celi vs. San Gabriel Valley Water Company, et al, and Shamille A. Criner vs. San Gabriel Water Company, et al, all pending in the Los Angeles County Superior Court. These complaints are similar to the complaints in the Boswell and Demciuc cases discussed above. These complaints allege service of water to the Plaintiffs by water companies other than Suburban and it is unknown what the charging allegations would be as to Suburban and the Company. These cases are all stayed pending resolution of the above referenced writs in the Appellate Court. The Company and Suburban intend to vigorously defend all pending actions, and have requested that their liability insurance carriers defend and indemnify the Company and Suburban. Several of the liability insurance carriers are currently contributing to the costs of defense of the lawsuits. Based upon information available at this time, management does not expect that these actions will have a material effect on the Company's financial position or results of operations. 9 Suburban has applied for and received CPUC authority to establish and maintain a memorandum or tracking account to accumulate all costs and fees incurred by Suburban in defense of these actions and any similar actions which may be filed. Costs and fees incurred in legal actions against industrial potentially responsible parties, and costs and fees incurred in seeking recovery against Suburban's insurance carriers are included in this memorandum account. The Company and Suburban are unable to estimate or predict whether the CPUC will ultimately allow Suburban to recover these accumulated costs and fees from Suburban's customers or, if such recovery is allowed, how much of such costs and fees will be recoverable. In March 1998, the CPUC issued an order instituting investigation ("OII") directed to all Class A and B water utilities in California, including Suburban. Information about the OII is set forth in the June Report. At this time, the Company and Suburban are unable to predict what actions, if any, will be taken by the CPUC and/or the DOHS as the result of this investigation, or their impact on the operations or financial position of the Company and Suburban. In October 1998, the Company and ECO were served with a summons and complaint in an action entitled Patrick K. Accrocco, et al vs. ECO Resources, Inc., et al in the District Court of Fort Bend County, Texas. The action arises out of a fatal automobile accident that occurred in September 1998 and involved an ECO truck. The plaintiffs allege that the accident was caused by the driver's negligence and that ECO and the Company were negligent in hiring, training, monitoring, and supervising the driver. The plaintiffs seek damages for pecuniary loss, loss of companionship and society, loss of consortium, and mental anguish in an amount to be determined at trial. The Company and ECO maintain automobile liability insurance and umbrella liability policies in an aggregate amount that the Company believes to be greater than any award that the plaintiffs may obtain. The Company believes that its maximum exposure in this action is limited to the self-insured retention under its umbrella liability policy. The Company, ECO and the ECO truck driver are being defended in this action by legal counsel appointed by the Company's automobile liability carrier, and have answered denying any liability to the plaintiffs. Based on the information available at this time, management does not expect that this action will have a material affect on the Company's financial position or results of operations. As discussed in the Company's 1997 Annual Report on Form 10-K and in Item 1, hereof, the City of Albuquerque (the "City") initiated an action in eminent domain to acquire the operations of NMUI. At present, discussions are ongoing, and the City desires a rapid resolution to the legal action. The Company is participating in these discussions. However, there is no assurance that these discussions will lead to a settlement of the legal action, or that a resolution will be reached quickly. As discussed in the Company's 1997 Annual Report on Form 10-K, Suburban and the Company were served with a complaint in September 1995, wherein the plaintiff claimed that, while working in the 1950s and 1960s for an independent contractor hired by Suburban, he was exposed to asbestos fibers and contracted mesothelioma. Information as to the action is set forth in the March Report. In January 1999, the case was settled for an amount, which will be funded by the Company's insurance carriers after general releases are exchanged between the Company and the claimants. The Company and its subsidiaries are the subjects of certain litigation arising from the ordinary course of operations. The Company believes the ultimate resolution of such matters will not materially affect its consolidated financial position, results of operations or cash flow. Item 4. Submission of Matters to a Vote of Security Holders None. Item 4a. Executive Officers of the Registrant The Board of Directors elects the executive officers of the Company each year at its first meeting following the Annual Meeting of Stockholders. There are no family relationships among any of the executive officers of the Company, nor are there any agreements or understandings between any such officer and another person pursuant to which he or she was elected an officer. There are no legal 10 proceedings of the types required to be disclosed pursuant to the instructions to this item involving any executive officer. Information about the Chairman of the Board and President of the Company is set forth in Part III, Item 10, Directors and Executive Officers of the Registrant on page 41. The executive officers of the Company and its subsidiaries are as follows:
Name Age Position and Offices Currently Held and Business Experience Date Elected - - ------------------------------------------------------------------------------------------------------------ Peter J. Moerbeek 51 President of ECO Nov-98 Director of Suburban and ECO Oct-95 Secretary of the Company, Suburban and ECO Oct-95 Chief Financial Officer of the Company Aug-95 Previously Executive Vice President Finance and Operations of Pico Products, Inc. and Pico Macom, Inc. (1989-1995) Thomas C. Tekulve 47 Vice President Finance of the Company Jan-99 Previously Vice President, Chief Financial Officer SafeGuard Health Enterprises Inc. (1995-1999) Previously (and most recently serving as) Director of Finance, International Operations Beckman Instruments (1984-1995) Michael O. Quinn 52 President of Suburban May-96 Director of Suburban May-93 Chief Operating Officer of Suburban Apr-92 Previously President of ECO (1985-1992) Robert L. Swartwout 57 Director of NMUI May-93 President and General Manager of NMUI Mar-92 Previously Consulting Associate, Robert Witter & Associates, Inc. (1985-1992)
PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters The Company is in the process of drafting an S-3 Registration Statement to register approximately 255,000 shares held by affiliates of the Company. These shares were issued many years ago and were not registered under the Securities Act of 1933. The Company anticipates the S-3 filing will be completed by April 30, 1999. There will be no proceeds to the Company related to this filing. 11 The following table shows the range of market prices of Southwest Water Company's common shares. The prices shown reflect inter-dealer prices without retail markup, markdown or commissions and may not necessarily represent actual transactions. The price ranges shown in the table, as well as cash dividends, have been restated to reflect stock dividends of five percent on January 2, 1998, and 20 percent on January 2, 1997 as well as a 5-for-4 stock split in the form of a stock dividend on October 1, 1998. The shares are traded on the Nasdaq Stock Market symbol SWWC. The current quarterly dividend rate is $.08 per common share. At December 31, 1998, there were 2,167 stockholders of record.
1998 1997 ------------------------------------------------------------ Market Price Range Market Price Range -------------------- -------------------- Dividends High Low Dividends High Low - - ---------------------------------------------------------------------------------- 1st Quarter $0.072 $13.80 $11.70 $0.069 $11.81 $9.14 2nd Quarter $0.072 $14.00 $11.90 $0.069 $10.67 $8.86 3rd Quarter $0.080 $14.60 $10.50 $0.069 $10.86 $7.81 4th Quarter $0.080 $17.00 $12.60 $0.072 $15.05 $10.10 - - ----------------------------------------------------------------------------------
Item 6. Selected Financial Data Earnings per common share, cash dividends per common share and basic and diluted weighted-average outstanding common shares have been adjusted to reflect a 5-for-4 stock split in the form of a stock dividend on October 1, 1998, and stock dividends of five percent on January 2, 1998, 20 percent on January 2, 1997, and five percent on January 2, 1996.
Years Ended December 31, 1998 1997 1996 1994 - - ----------------------------------------------------------------------------------------------------------- (in thousands except per share amounts and numbers of customers) Summary of Operations Operating revenues $ 72,146 $ 71,005 $ 66,145 $50,932 Operating income $ 8,055 $ 7,215 $ 5,734 $ 3,849 Gain on sales of land $ 110 $ - Net income $ 3,349 $ 2,601 $ 1,923 $ 1,057 Net income available for common shares $ 3,322 $ 2,574 $ 1,896 $ 1,029 - - ----------------------------------------------------------------------------------------------------------- Common Share Data Earnings per common share: Basic $ 0.79 $ 0.62 $ 0.46 $ 0.26 Diluted $ 0.77 $ 0.61 $ 0.46 $ 0.25 Cash dividends per common share $ 0.30 $ 0.28 $ 0.26 $ 0.24 Weighted average outstanding common shares: Basic 4,198 4,135 4,088 3,982 Diluted 4,307 4,224 4,104 4,038 - - ----------------------------------------------------------------------------------------------------------- Statistical Data Working capital (deficit) $ (2,678) $ 473 $ (4,079) $(1,951) Capital additions $ 11,921 $ 15,202 $ 15,212 $ 8,684 Property, plant and equipment, net $109,238 $102,136 $ 91,414 $72,136 Total assets $129,927 $123,100 $111,416 $86,834 Long-term debt - First Mortgage Bonds $ 28,900 $ 29,800 $ 30,700 $20,500 Stockholders' equity $ 35,143 $ 32,427 $ 30,400 $28,532 Return on average common equity 10.0% 8.3% 6.5% 3.7% Number of utility customers 73,482 72,319 70,976 69,012 - - -----------------------------------------------------------------------------------------------------------
12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations LIQUIDITY AND CAPITAL RESOURCES: Liquidity and capital resources of the Company are influenced primarily by construction expenditures at Suburban for the replacement and renovation of existing water utility facilities and by construction expenditures for new water and wastewater utility facilities at NMUI. The Company's cash flow may also be influenced by new business development and acquisition costs. At December 31, 1998, the Company had cash and cash equivalent balances totaling $394,000 and unused lines of credit of $10,721,000, with a total line of credit capacity of $16,000,000. The Company has three lines of credit from three commercial banks, one of which expires in 1999. The other two lines of credit were renewed in September 1998 and expire in 2000. The Company expects to renew its lines of credit in the normal course of business. During 1998, the Company repaid $1,852,000 on its lines of credit. In addition to its lines of credit, the Company has existing borrowing capacity under its First Mortgage Bond Indentures. Under these indentures, the Company has remaining borrowing capacity of approximately $36,965,000. However, the amount of additional borrowing available to the Company under its current bank lines of credit is limited by financial covenants that restricted additional borrowing at December 31, 1998 to the unused credit line amount. As of December 31, 1998, the Company was in compliance with all applicable financial covenants as required by its line of credit agreements. The Company's additions to property, plant and equipment totaled $11,921,000 during 1998 representing a decrease of $3,281,000 when compared to the additions in 1997. The decrease was attributable to the completion of major projects in 1997. Capital expenditures are estimated to be approximately $10,000,000 in 1999. Developers made contributions in aid of construction ("CIAC"), and advances totaling $5,169,000, of which $3,394,000 was received in cash. The cost of Company-financed capital additions was $6,752,000, which was paid for primarily by cash flow from operations. The Company anticipates that cash flow from operations will be sufficient to fund Company-financed additions to property, plant and equipment during the next year. However, short-term borrowing is available to meet construction requirements not funded by operations, advances by developers or CIAC. The Company anticipates that its available short-term borrowing capacity and its cash flow generated from operations will be sufficient to fund its activities during 1999. If additional cash were needed, the Company would consider alternative sources, including long-term financing. The amount and timing of any future long-term financing would depend on various factors, including the timeliness and adequacy of rate increases, the availability of capital, and the Company's ability to meet interest and fixed charge coverage requirements. Regulatory approval is required for any long-term financing by Suburban or NMUI. If the Company were unable to renew its existing lines of credit or unable to obtain additional long-term financing, capital spending would be reduced or delayed until new financing arrangements were secured. Such financing arrangements could include seeking equity financing through a private placement or a public offering. Similarly, if the Company were to need additional cash to fund an acquisition, financing arrangements could include long-term borrowing or equity financing. REGULATORY AFFAIRS AND INFLATION: Regulation: ECO's pricing is not subject to regulation by a public utilities commission. Most contracts with MUDs are short-term contracts and do not generally include inflation adjustments. ECO's longer-term water and wastewater service contracts, primarily with cities, typically include inflation adjustments. Changes in prices are negotiated on a contract-by-contract basis The CPUC and the NMPUC regulate the rates and operations of Suburban and NMUI, respectively. The rates allowed are intended to provide the utilities an opportunity to recover costs and earn a reasonable return on common equity. Although the Company is not currently seeking any rate increase, future construction expenditures and increased direct operating expenses may require periodic requests for rate increases in the future. 13 Regulatory Developments Legislative and CPUC developments are closely monitored by the Company and by the various water industry associations in which the Company actively participates. Whether legislative or CPUC changes will be enacted, or, if enacted, what the terms of such changes would be, are not known by the Company. Therefore, management cannot predict the impact, if any, of final legislative or CPUC developments on the Company's financial condition or results of operations. In 1996, the residents of the State of New Mexico passed a constitutional amendment to combine the NMPUC and the New Mexico Corporation Commission ("NMCC") and create the New Mexico Public Regulatory Commission ("NMPRC"). The NMPRC became effective under the enacted legislation on January 1, 1999 and consists of five elected officials. Also, a legislative committee is currently reviewing proposed changes to the Public Utilities Act (the "PUA"). The Company cannot predict if or when changes to the PUA will ultimately occur or, if changes are enacted, the impact on NMUI's financial position or results of operations. ENVIRONMENTAL AFFAIRS: Suburban and NMUI operations fall under the regulatory jurisdiction of the CPUC and the NMPUC, respectively. The Company's operations are also subject to water and wastewater pollution prevention standards and water and wastewater quality regulations of the EPA and various state regulatory agencies. The EPA and state regulatory agencies continue to promulgate new regulations mandated by the Federal Water Pollution Control Act, the Safe Drinking Water Act (as reenacted in 1996), and the Resource Conservation and Recovery Act. To date, the Company has not experienced any material adverse effects upon its operations resulting from compliance with governmental regulations. Costs associated with the testing of the Company's water supplies have, however, increased and are expected to increase further as the regulatory agencies adopt additional monitoring requirements. The Company believes that future incremental costs of complying with governmental regulations, including capital expenditures, if any, will be recoverable through increased rates and contract operations revenues. However, there is no assurance that recovery of such costs will be allowed. YEAR 2000 COMPUTER COMPLIANCE: The Year 2000 ("Y2K") issue is the result of software applications using a two-digit code instead of a four-digit code to identify the year. Such applications may be unable to interpret dates beyond 1999, which could result in system failure or erroneous data in the year 2000 causing potentially serious disruptions in operations. The Company began evaluating the Y2K issue in 1997 and has implemented a five-phase plan to assess its exposure from potential Y2K related failures in its internal systems and those of its significant suppliers, vendors and customers. The first phase of the plan is to conduct an inventory of all systems and programs to determine which might be affected by the Y2K issue. The second phase involves assessment and determination as to the correction of any Y2K issues that are identified in the first phase of the Company's plan. The third phase of the plan involves implementation and testing of the corrective measures. The fourth phase of the plan is to ensure that all significant Y2K issues have been properly corrected and all critical internal systems are Y2K compliant. The final phase of the plan is to assess whether the Company's principal suppliers, vendors and material customers have Y2K issues that could adversely affect the Company. The first phase of the plan, conducting an inventory of systems and programs that may be affected by Y2K, has been substantially completed. The Company's billing and general ledger systems are already substantially Y2K compliant. For those systems that are not compliant, the second phase of the plan, identifying corrective measures, has been substantially completed with solutions identified to correct the existing system problems. The third phase of the plan, implementation and testing of corrective measures was substantially completed in the first quarter of 1999. Final critical internal systems are expected to be Y2K compliant without material deviation by July 1999 (phase four). In the event compliance is not possible, the Company will consider replacing non- compliant software. Costs to be 14 incurred in order for the Company to be Y2K compliant are not expected to have a material effect on the Company's financial position or results of operations. The fifth phase of the plan involves the Company contacting principal suppliers and vendors, all single source suppliers and vendors, and material customers including local governments and municipal utility districts to assess their readiness for Y2K. The Company is currently making inquiries with respect to Y2K compliance of these other systems; however; the Company has not received assurance that those other systems are Y2K compliant. If the systems of principal suppliers and vendors are found to be non-compliant, the Company will evaluate and consider appropriate contingency plans. The Company is unable to predict whether there will be a material adverse effect on the Company's financial position or results of operations since the final determination of the Y2K compliance of principal suppliers, vendors, and material customers is not known at this time. The Company relies on relatively low technological equipment and processes for its water and wastewater treatment operations. If necessary, the Company has the ability to operate its water and wastewater systems manually should internal computer systems fail. On January 1, 2000, the Company plans to have operations personnel on site and available to operate the systems manually in the event that any internal computer systems fail. However, a long-term loss of electrical power would have a material adverse effect on the operations of the Company, the Company's financial position and the results of operations. NEW ACCOUNTING STANDARDS In 1999, the Company will be required to implement SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and for hedging activities. Currently, the Company does not have any derivative instruments which require disclosure under SFAS No. 133 and it is not expected to have any effect on the Company's financial position or results of operations. RISK FACTORS Certain statements contained in this Annual Report on Form 10-K are "forward- looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the Company to be materially different from any performance or achievements planned, expressed or implied by such forward- looking statements. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. The forward-looking information referred to above includes but is not limited to revenue backlog information, expectations regarding sales growth and new contracts, and potential acquisitions, weather conditions, changes in business conditions, legal and other contingencies among other matters. Weather There is seasonality to the water services industry; thus the results of operations for one period do not necessarily indicate results to be expected in another period. Rainfall and weather conditions affect utility operations, with most water consumption occurring during the second and third quarters of each year when weather tends to be hot and dry. Drought conditions would have the effect of lowering revenue due to conservation efforts of the consumer and less water available to the utilities. The Company's contract operations business can also be seasonal in nature. Heavy rainfall tends to hamper the Company's ability to perform billable work such as pipeline maintenance, manhole rehabilitation and other outdoor services. Moderate rainfall by contrast may create additional opportunities for additional billable work outside the scope of existing contracts. Drought conditions would not necessarily affect the Company's contract operations because of the base fee and fixed fee contracts, but could affect the Company's opportunities for additional billable work outside the scope of the contracts. 15 Contract Operations The water and wastewater management business is highly competitive. In the United States, municipal employees perform the majority of water and wastewater utility operations. As a result, a significant portion of ECO's sales and marketing efforts require convincing elected officials and city staff persons that outsourcing of the utility operations is beneficial to the city or the MUD. There is no assurance that the city will choose to outsource, or will select ECO as its operator at the end of the sales effort. While industry renewal rates tend to be high, periodically, cities change operators or terminate outsourcing at the end of a contract. An inability to renew its existing contracts could have a material adverse impact on the Company. In addition, a city or MUD could cancel a long-term contract without notice, and in breach of the contract. This would not only result in loss of revenue and operating profits, but could potentially involve the Company in litigation. Risk of Failure to Manage Growth The Company continues to expand its business and is actively seeking acquisitions and joint ventures to improve the Company's position in the contract water and wastewater business. This kind of growth demands experienced and qualified personnel to manage the transition as the Company expands. The success of future business development and growth relies heavily on the Company's ability to retain qualified personnel to operate and manage its new business ventures. There can be no assurance that the Company will successfully manage this growth and failure to do so could have a material adverse effect on the Company. Water Quality and Contamination As previously discussed in Item 1, in June 1998, Suburban detected a substance called NDMA in one of its wells in excess of the EPA reference dosage for health risks. Upon detection, the well was immediately removed from service. As set forth in Item 1, Suburban is building a treatment facility that will reduce the NDMA to non-detectable levels. In 1997, the San Gabriel Basin Water Quality Authority advised Suburban that the DOHS had detected the contaminant "perchlorate" in the Main San Gabriel Basin. The contaminant was later detected in a well that is operated but not owned by Suburban. Subsequently, NDMA was detected in this well, at which time, Suburban removed the well from services. Suburban has instituted corrective measures with respect to these contaminants; however, the potential impact of these contaminants on the results of operations for Suburban is not fully known at this time. Costs associated with testing of Suburban's water supplies have increased and are expected to increase further as regulatory agencies adopt additional monitoring requirements. The EPA has conducted numerous studies of underground water in the Main San Gabriel Basin (the "Main Basin") and in 1984 named the Main Basin as a Super- fund site. Several large industrial companies were named as potentially responsible parties ("PRPs") for allegedly causing the contamination. Suburban's facilities were not named as sources of the contamination in the Main Basin. However, individual government officials have suggested that, because of their pumping operations, the Main Basin water producers may have clean-up liability under certain environmental statutes. The EPA is expected to continue to identify sources of contamination in order to establish legal responsibility for clean-up costs. Currently, neither the EPA nor any other governmental agency has identified Suburban or other water producers as PRPs. However, the Company currently is involved in litigation concerning the quality of the Main Basin groundwater as described in Item 3, Legal Proceedings. In 1979, volatile organic compounds ("VOCs") were discovered in the Main Basin. While most of the VOC contamination was found outside Suburban's service areas, subsequent underground water sampling resulted in the discovery of four large areas of groundwater VOC contamination. One of the areas includes Suburban's Bartolo Well Field, which contains four of Suburban's producing wells. Suburban produces approximately 26% of its total water production from these wells. Currently, the water delivered to Suburban's customers wells does not contain VOCs in excess of established MCLs. To date, water produced from the Bartolo Well Field and other wells owned by Suburban in the Main Basin meets all applicable governmental requirements. Suburban has taken measures to ensure that it has an adequate supply of potable water 16 that meets all applicable governmental standards. Technology exists to remove VOC contaminants from basin water. However, there is no assurance that either such technology will be adequate in the future to reduce the amounts of VOCs and other contaminants in the Main Basin to acceptable levels or the costs of such removal will be fully recoverable from Suburban's customers. To date, Suburban has been permitted to recover all expenses associated with water quality maintenance from its ratepayers. In addition to these matters set forth, there can be no assurance that other water quality and contamination issues exist but are not known to the Company at this time. There is no assurance that, in the future, governmental authorities will not seek to recover clean-up costs from Suburban or that PRPs will not seek contributions from water producers for clean-up costs. If Suburban were required to pay clean-up costs, it would seek to recover such costs through increased rates to its customers. This practice has been permitted by the CPUC in the past; however, there can be no assurance that Suburban would be allowed to recover such costs in the future. RESULTS OF OPERATIONS: Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997 Diluted earnings per common share (adjusted for a 5-for-4 stock split in the form of a stock dividend on October 1, 1998 and a 5% stock dividend on January 2, 1998) were $.77 in 1998 compared to $.61 in 1997. Operating income increased $840,000 or 12%, and, as a percentage of operating revenues, was 11% in 1998 compared to 10% in 1997. ECO's operating income increased $615,000 due to increased revenue from new contracts, additional billable work performed outside the scope of the existing contracts, and aggressive cost containment measures that reduced operating costs as a percentage of revenue. Operating income at the utilities increased $87,000. The increase in operating income was primarily due to the addition of new customers and increased customer water consumption at NMUI. The increase was offset by decreased water sales at Suburban because of inclement weather in California as a result of El Nino-generated storms. Parent company expenses decreased $138,000, primarily due to decreases in compensation-related expenses. Operating revenues Operating revenues increased $1,141,000 or 2%. ECO's revenues increased $1,859,000, primarily as a result of revenues from new contracts and additional work performed outside the scope of existing contracts. ECO's net increase in revenue reflects a loss of approximately $2,400,000 in revenue with respect to an O&M contract in New Mexico, which was not renewed in 1998. Water utility revenues decreased $718,000, primarily due to 10% reduction in water consumption by Suburban's customers due to El-Nino-generated storms. The decrease was partially offset by the positive effects of a rate increase, and also by the addition of new customers at NMUI. Direct operating expenses Direct operating expenses increased $317,000. As a percentage of operating revenues, these expenses decreased to 73% in 1998 from 74% in 1997. ECO's direct operating expenses increased $855,000, due primarily to higher expenses associated with new contracts and increased billable work. Water utility direct operating expenses decreased $538,000, due primarily to the decrease in water consumption by Suburban's customers. The decrease was partially offset by additional direct operating expenses in NMUI as a result of new customers. Selling, general and administrative Selling, general and administrative expenses decreased $16,000. As a percentage of operating revenues, these expenses were 15% in 1998 and 16% in 1997. ECO's selling, general and administrative expenses increased $389,000, due primarily to expanded marketing efforts. General and administrative expenses at the utilities decreased $267,000, primarily due to cost containment measures 17 intended to offset the effect of reduction in revenue. Parent company expenses decreased $138,000, primarily due to decreases in compensation-related expenses. Other income and expense Interest expenses decreased $241,000, primarily due to a reduction in the line of credit balances, and lower interest rates during the year. In October 1998, Suburban sold two parcels of land not used in or useful to utility operations, and recorded a gain of $110,000. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Diluted earnings per common share (adjusted for a 5-for-4 stock split in the form of a dividend on October 1, 1998 and stock dividends of 5% on January 2, 1998 and 20% on January 2, 1997) were $.61 in 1997 as compared to $.46 in 1996. Operating income increased $1,481,000 or 26%, and, as a percentage of operating revenues, increased from 9% in 1996 to 10% in 1997. ECO's operating results improved $713,000, due to increased revenue from new contracts, aggressive cost containment measures, and restructuring of marketing responsibilities. Operating income at the utilities increased $1,311,000, due primarily to increased water sales at Suburban and the positive effects of a water rate increase. Parent company expenses increased $543,000, primarily due to increases in insurance expenses, legal reserves and compensation-related expenses. Operating revenues Operating revenues increased $4,860,000 or 7%. ECO's revenues increased $2,612,000, primarily as a result of revenue from new contracts and additional work performed outside the scope of existing contracts. Water utility revenues increased $2,248,000, primarily due to warmer weather in Southern California resulting in a 4.6% increase in water consumption by Suburban's customers. Suburban also benefited from a water rate increase. Direct operating expenses Direct operating expenses increased $2,337,000 or 5%. As a percentage of operating revenues, these expenses decreased from 76% in 1996 to 74% in 1997. ECO's direct operating expenses increased $1,778,000, resulting primarily from higher expenses associated with new contracts and increased billable work. Water utility direct operating expenses increased $559,000, primarily reflecting the increase in water consumption by Suburban's customers. Selling, general and administrative Selling, general and administrative expenses increased $1,042,000 or 10%. As a percentage of operating revenues, these expenses increased from 15% in 1996 to 16% in 1997. ECO's selling, general and administrative expenses increased $121,000, due to insurance, legal, compensation-related benefits, consulting expenses and increased sales and marketing expenses. General and administrative expenses at the utilities increased $378,000, primarily due to increased legal reserves, insurance, compensation-related benefits, and outside services. General and administrative expenses of the parent company increased $543,000, primarily due to the increases in insurance expenses, legal reserves and compensation-related expenses. Other income and expense Interest expenses increased $376,000, primarily due to increased line of credit balances during the year. 18 Item 8. Financial Statements and Supplementary Data Index to Financial Statements and Financial Statement Schedule Independent Auditors' Report ............................................................................. 20 Consolidated Statements of Income-Three Years Ended December 31, 1998..................................... 21 Consolidated Balance Sheets-December 31, 1998 and 1997.................................................... 22 Consolidated Statements of Changes in Common Stockholders' Equity- Three Years Ended December 31, 1998................................................................... 23 Consolidated Statements of Cash Flows-Three Years Ended December 31, 1998................................. 24 Notes to Consolidated Financial Statements................................................................ 25-38 Schedule II- Valuation and Qualifying Accounts-Three Years Ended December 31, 1998........................ 41
19 INDEPENDENT AUDITORS' REPORT To The Board of Directors and Stockholders of Southwest Water Company: We have audited the consolidated financial statements of Southwest Water Company and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the supplementary financial statement schedule II, as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southwest Water Company and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Los Angeles, California January 27, 1999 20
Southwest Water Company and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, - - ------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------ (in thousands except per share data) Operating Revenues (Note 12) $72,146 $71,005 $66,145 Operating Expenses: Direct operating expenses 53,011 52,694 50,357 Selling, general and administrative 11,080 11,096 10,054 - - ------------------------------------------------------------------------------------------------------------------------ 64,091 63,790 60,411 - - ------------------------------------------------------------------------------------------------------------------------ Operating Income (Note 12) 8,055 7,215 5,734 Other Income (Expense): Interest expense (2,984) (3,225) (2,849) Interest income 91 94 100 Gain on sale of land 110 0 0 Other 268 367 313 - - ------------------------------------------------------------------------------------------------------------------------ (2,515) (2,764) (2,436) Income Before Income Taxes 5,540 4,451 3,298 Provision for income taxes (Note 7) 2,191 1,850 1,375 - - ------------------------------------------------------------------------------------------------------------------------ Net Income 3,349 2,601 1,923 Dividends on Preferred Shares (Note 9) 27 27 27 - - ------------------------------------------------------------------------------------------------------------------------ Net Income Available for Common shares $ 3,322 $ 2,574 $ 1,896 - - ------------------------------------------------------------------------------------------------------------------------ Earnings per Common Share (Notes 8 and 9) Basic $0.79 $0.62 $0.46 Diluted $0.77 $0.61 $0.46 - - ------------------------------------------------------------------------------------------------------------------------ Cash Dividends per Common Share (Note 9) $0.30 $0.28 $0.26 - - ------------------------------------------------------------------------------------------------------------------------ Weighted Average Outstanding Common Shares (Notes 8 and 9): Basic 4,198 4,135 4,088 Diluted 4,307 4,224 4,104 - - ------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 21
Southwest Water Company and Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, - - --------------------------------------------------------------------------------------------------- Assets 1998 1997 - - --------------------------------------------------------------------------------------------------- (in thousands) Current Assets: Cash and cash equivalents $ 394 $ 1,237 Customers' accounts receivable, less allowance for doubtful accounts $895 in 1998 and $711 in 1997) 8,630 7,286 Other current assets 2,586 2,976 - - ---------------------------------------------------------------------------------------------------- 11,610 11,499 Property, Plant and Equipment: Utility property, plant and equipment -- at cost (Note 3) 144,690 133,936 Contract operations property, plant and equipment -- at cost 4,678 4,854 - - ---------------------------------------------------------------------------------------------------- 149,368 138,790 Less accumulated depreciation and amortization 40,130 36,654 - - ---------------------------------------------------------------------------------------------------- 109,238 102,136 Other Assets (Note 2) 9,079 9,465 - - ---------------------------------------------------------------------------------------------------- $129,927 $123,100 - - ---------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity - - ---------------------------------------------------------------------------------------------------- Current Liabilities: Current portion of long-term debt and bank notes payable (Notes 4 and 6) $ 1,679 $ 900 Accounts payable 2,782 1,214 Other current liabilities (Note 5) 9,827 8,912 - - ---------------------------------------------------------------------------------------------------- 14,288 11,026 Other Liabilities and Deferred Credits: Long-term debt (Note 6) 28,900 29,800 Bank notes payable (Note 4) 4,500 7,131 Advances for construction 8,049 7,931 Contributions in aid of construction 31,706 27,822 Deferred income taxes (Note 7) 4,430 4,130 Other liabilities and deferred credits 2,911 2,833 - - ---------------------------------------------------------------------------------------------------- Total Liabilities and Deferred Credits 94,784 90,673 Commitments and Contingencies (Note 13) Stockholders' Equity (Notes 8, 9 and 10): Cumulative preferred stock 517 517 Common stock 42 33 Paid-in capital 30,127 29,469 Retained earnings 4,457 2,420 Unamortized value of restricted stock issued 0 (12) - - ---------------------------------------------------------------------------------------------------- Total Stockholders' Equity 35,143 32,427 - - ---------------------------------------------------------------------------------------------------- $129,927 $123,100 - - ---------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
22
Southwest Water Company and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 1996, 1997 and 1998 - - ---------------------------------------------------------------------------------------------------------------------------------- (in thousands) Common Stock Preferred Number of Paid-in Retained Stock Shares Amount Capital Earnings - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at January 1, 1996 $ 517 2,576 $ 26 $ 18,715 $10,045 Dividend reinvestment and employee stock purchase plans 25 287 Stock options exercised 1 8 20% stock dividend 520 5 7,149 (7,154) Net income 1,923 Cash dividends declared (1,086) - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1996 517 3,122 31 26,159 3,728 Dividend reinvestment and employee stock purchase plans 29 383 Stock options exercised 20 194 5% stock dividend 159 2 2,733 (2,735) Net income 2,601 Cash dividends declared (1,174) - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1997 517 3,330 33 29,469 2,420 Dividend reinvestment and employee stock purchase plans 28 1 432 Stock options exercised 20 226 5 -for-4 stock split in the form of a stock dividend 843 8 (8) Net income 3,349 Cash dividends declared (1,304) - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 $ 517 4,221 $42 $30,127 $4,457 - - ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 23 Southwest Water Company and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, - - ------------------------------------------------------------------------------------------------------- 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------- (in thousands) Cash Flows from Operating Activities: Net income $ 3,349 $ 2,601 $ 1,923 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,265 4,162 3,887 Deferred income taxes 300 732 160 Gain on sale of land 110 0 0 Changes in assets and liabilities: Customers' accounts receivable (1,344) 930 (431) Other current assets 390 (890) 442 Accounts payable 1,568 (299) (756) Other current liabilities 916 1,343 550 Other, net 108 (210) 204 - - ------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 9,662 8,369 5,979 - - ------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Additions to property, plant and equipment (10,146) (9,384) (11,775) Proceeds from sale of land 116 0 0 Investment in Windermere Utility Company (Note 2) 0 0 (3,000) Other investments, net 120 (338) 0 - - ------------------------------------------------------------------------------------------------------- Net cash used in investing activities (9,910) (9,722) (14,775) - - ------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Contributions in aid of construction 2,799 1,501 1,960 Advances for construction 595 447 89 Net proceeds from dividend reinvestment and employee stock purchase plans 506 370 271 Net borrowings on (repayments of) bank notes payable (1,852) 1,942 (2,986) Dividends paid (1,266) (1,155) (1,050) Payments on long-term debt (900) (900) (900) Payments on advances for construction (477) (405) (582) Proceeds from issuance of long-term debt 0 0 12,000 - - ------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (595) 1,800 8,802 - - ------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (843) 447 6 Cash and cash equivalents at beginning of year 1,237 790 784 - - ------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 394 $ 1,237 $ 790 - - ------------------------------------------------------------------------------------------------------- Supplemental Disclosure of Cash Flow Information: Cash paid during the year for: Interest $ 3,029 $ 3,189 $ 2,776 Income taxes $ 1,355 $ 805 $ 1,573 Non-cash contributions in aid of construction and advances for construction conveyed to Company by developers $ 1,775 $ 5,818 $ 3,437
See accompanying notes to consolidated financial statements. 24 Southwest Water Company and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SIGNIFICANT ACCOUNTING POLICIES Description of Business: Southwest Water Company and its subsidiaries ("the Company") provide water management services through contract and utility operations. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The principal subsidiaries are ECO Resources, Inc. ("ECO"), Suburban Water Systems ("Suburban") and New Mexico Utilities, Inc. ("NMUI"). All significant intercompany transactions have been eliminated. Regulation: Suburban and NMUI conform to the Uniform System of Accounts prescribed by the California Public Utilities Commission ("CPUC") and the New Mexico Public Utility Commission ("NMPUC"), respectively. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period could be affected. Actual results may differ from these estimates. Recognition of Revenues: Revenues from contract operations are recognized as services are performed. Water utility revenues include amounts billed to customers and an estimated amount of unbilled revenue for water used to the end of the accounting period. Cash and Cash Equivalents: The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Financial Instruments: The carrying value of financial instruments such as cash and cash equivalents, accounts receivable, accounts payable, and short and long- term debt approximates fair value. At December 31, 1998, the Company had no derivative financial instruments, financial instruments with off-balance sheet risk or financial instruments with concentrations of credit risks requiring disclosure. Property, Plant and Equipment: Property, plant and equipment used in contract operations are depreciated on the straight-line method over estimated useful lives ranging from five to 30 years. The cost of additions to utility plant includes labor, material and capitalized interest. Capitalized interest of $147,000, $63,000 and $141,000 was capitalized in 1998, 1997 and 1996, respectively. The cost of utility plant retired, including net removal costs, is charged to accumulated depreciation. Depreciation expense on utility plant is recorded using the straight-line method. Depreciation expense on average gross depreciable plant was 3.1% in 1998 and 3.2% in both 1997 and 1996. Other Assets: Included in other assets is the Company's investment in Windermere Utility Company ("Windermere") as described in Note 2. Regulatory assets representing amounts that will be recovered from utility customers through rate adjustments authorized by the CPUC and NMPUC are also included in other assets along with land no longer used in utility operations. Additionally, other assets include deferred debt expenses that are being amortized over the lives of the related debt issues. The Company regularly reviews its long-lived assets for impairment. This review includes regulatory assets and assets excluded from rate base by regulators. Potential impairment of assets held for use is determined by comparing the carrying amount of an asset to the future undiscounted cash flows expected to be generated by that asset. If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less cost to sell. 25 Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. The most significant items are in the tax effects of accelerated depreciation, advances for construction and contributions in aid of construction. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that the enactment occurs. When the Company adopted SFAS No. 109, "Accounting for Income Taxes," Suburban and NMUI recorded additional deferred income taxes, as well as corresponding regulatory assets and regulatory liabilities as permitted by the CPUC and NMPUC. The regulatory assets and regulatory liabilities are expected to be recovered from, or refunded to utility customers through future authorized rate adjustments. Unamortized investment tax credits have been deferred and are amortized over the estimated productive lives of the related assets as allowed by the CPUC and the NMPUC. Production Cost Balancing Accounts: Suburban records the difference between actual water production costs incurred and CPUC-adopted water production costs in balancing accounts in the income statement with a corresponding liability or asset on the balance sheet. Under current regulations, the differences recorded will be refunded to or recovered from utility customers through future CPUC- authorized rate adjustments. Advances For Construction and Contributions In Aid of Construction: Advances for construction represent amounts advanced by developers primarily for water pipeline extensions. Advance contracts issued after June 1982 are refundable to the depositor at a rate of 2.5% each year over a 40-year period. Advance contracts issued prior to July 1982 are refundable over a 20-year period. Contributions in aid of construction represent contributions in the form of cash, services or property received from developers, governmental agencies, municipalities or individuals for the purpose of constructing utility plant. Depreciation expense related to utility plant additions from contributions in aid of construction is charged as a reduction to contributions in aid of construction instead of depreciation expense. Other Liabilities and Deferred Credits: Other liabilities and deferred credits include unamortized investment tax credits recorded by Suburban and NMUI and authorized by the CPUC and the NMPUC. Also included are regulatory liabilities representing amounts that will be refunded to utility customers through rate adjustments authorized by the CPUC and the NMPUC. New Accounting Standards: In 1999, the Company will be required to implemented SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and for hedging activities. Currently, the Company does not have any derivative instruments which require disclosure under SFAS No. 133 and it is not expected to have any effect on the Company's financial position or results of operations. Reclassifications: Certain reclassifications have been made to the 1997 and 1996 consolidated financial statement presentation to conform to the 1998 presentation. NOTE 2. INVESTMENTS In 1996, the Company purchased a 49% interest in Windermere for an investment of $3,000,000. The agreement, as amended, permits the majority shareholder to acquire the Company's interest in Windermere at an agreed-upon price. If the majority shareholder does not exercise his purchase option, then the Company has the right to acquire 100% of Windermere for an agreed upon price. The Company also has a consulting agreement with Windermere and an additional agreement by which the Company 26 may receive an annual payment based upon Windermere's financial performance. The amended agreement extends to March 31, 1999 the date by which the majority shareholder may exercise his purchase option and also increases the agreed-upon purchase price for the majority shareholder. The majority shareholder has expressed intention to acquire the Company's interest, however discussions are ongoing. The investment is carried at cost and is included in Other Assets in the Company's consolidated balance sheets. The Company also has an investment of $698,000 in two not-for-profit mutual water companies ("mutuals"), which entitles the Company to certain water rights. The Company's investment in one of these mutuals is approximately 32% of the outstanding stock. However, the Company does not exercise significant operating and financial control over either of these mutuals. The investments are recorded at cost and are reflected in the general utility property account (Note 3). The Company purchased water from these mutuals at a cost of approximately $1,747,000, $1,835,000 and $1,600,000 in 1998, 1997 and 1996, respectively. NOTE 3. UTILITY PROPERTY, PLANT, AND EQUIPMENT The components of utility property, plant and equipment at December 31, 1998 and 1997 are as follows:
- - -------------------------------------------------------------------------------- 1998 1997 - - -------------------------------------------------------------------------------- (in thousands) Land and land rights $ 598 $ 598 Source of supply 11,440 11,532 Pumping and purification 14,710 12,806 Transmission and distribution 105,690 98,180 General (including Intangibles) 8,045 7,843 Construction work in progress 4,207 2,977 - - -------------------------------------------------------------------------------- $144,690 $133,936 - - --------------------------------------------------------------------------------
At December 31, 1998, substantially all of the Company's utility plant and equipment was pledged as collateral for the First Mortgage Bonds issued by the Company (Note 6). NOTE 4. LINES OF CREDIT At December 31, 1998, the Company had three unsecured lines of credit from three commercial banks with a total borrowing capacity of $16,000,000. The Company renewed two of the lines of credit in September 1998 and they expire in 2000. The third line of credit expires in 1999. The Company expects to renew and update these lines of credit in the normal course of business. Under two of the lines of credit, interest is charged at the banks' prime rates. These two line of credit agreements also allow the Company to borrow at an interest rate that is lower than the banks' prime rate; however, certain minimum borrowing requirements must be maintained for a fixed period of time. Interest charged under the third line of credit is lower than the bank's prime rate and contains no restrictions as to minimum borrowing or borrowing for a fixed period of time. Two of the line of credit agreements require a commitment fee of 1/2-percent per year of the unused portion of the available lines of credit, calculated and payable on a quarterly basis. The third line of credit agreement requires a $6,000 annual fee. Each of the line of credit agreements contains certain financial restrictions. The Company was in compliance with all applicable restrictions at December 31, 1998. 27 A summary of borrowing on the lines of credit is presented below:
- - -------------------------------------------------------------------------------------- 1998 1997 - - -------------------------------------------------------------------------------------- (in thousands) Notes payable to banks at December 31 $5,279 $7,131 Weighted average interest rate at December 31 7.03% 7.40% Maximum amount of borrowings outstanding at any month end $7,840 $8,340 Average borrowings $6,283 $6,910 Weighted average interest rate 7.11% 7.30% - - --------------------------------------------------------------------------------------
NOTE 5. OTHER CURRENT LIABILITIES Included in other current liabilities at December 31, 1998 and 1997 are the following:
- - -------------------------------------------------------------------------------------- 1998 1997 - - -------------------------------------------------------------------------------------- (in thousands) Accrued salaries, wages and benefits $ 2,748 $ 2,567 Purchased water 1,569 1,969 Franchise and other taxes 943 441 Drafts payable 696 315 Accrued interest payable 671 680 Current portion of advances for construction 399 431 Accrued dividends payable 344 307 Accrued income taxes payable 227 0 Other 2,230 2,202 - - -------------------------------------------------------------------------------------- $ 9,827 $ 8,912 - - --------------------------------------------------------------------------------------
NOTE 6. LONG-TERM DEBT The long-term debt outstanding at December 31, 1998 and 1997 is as follows:
- - -------------------------------------------------------------------------------------- 1998 1997 - - -------------------------------------------------------------------------------------- (in thousands) Suburban First Mortgage Bond, Series A, due 2006, at 8.93% interest rate, with semi-annual interest payments $ 7,800 $ 8,700 Suburban First Mortgage Bond, Series B, due 2022, at 9.09% interest rate, with semi-annual interest payments 8,000 8,000 Suburban First Mortgage Bond, Series C, due 2006, at 7.61% interest rate, with semi-annual interest payments 8,000 8,000 NMUI First Mortgage Bond, Series A, due 2002, at 8.86% interest rate, with semi-annual interest payments 2,000 2,000 NMUI First Mortgage Bond, Series B, due 2006, at 7.64% interest rate, with semi-annual interest payments 4,000 4,000 - - -------------------------------------------------------------------------------------- Long-term debt before current maturities 29,800 30,700 Less current maturities (900) (900) - - -------------------------------------------------------------------------------------- Long-term debt $28,900 $29,800 - - --------------------------------------------------------------------------------------
Suburban's First Mortgage Bond, Series A, requires annual sinking fund payments of $900,000. The bond is nonrefundable and may not be redeemed prior to October 2, 2000. After October 1, 2000, the bond may be redeemed at the option of the Company at a price of par plus a call premium. Suburban's First Mortgage Bonds, Series B and C, and NMUI's First Mortgage Bonds, Series A and B, do not require annual sinking fund payments. These bonds are nonrefundable and may be redeemed at any time by the Company at a price of par plus a call premium. Additional mortgage bonds may be issued subject to the 28 provisions of the existing indentures. Substantially all of the Company's utility plant is pledged as collateral for these bonds (Note 3). Each indenture limits the amount of cash and property dividends that Suburban and NMUI may pay to the Company. At December 31, 1998 and 1997, the combined indenture limits for dividends totaled $15,605,000 and $12,946,000, respectively. Aggregate annual maturity and sinking fund requirements of all long-term debt are $900,000 for the three years ending December 31, 2001 and for the year ended December 31, 2003. Annual maturity and sinking fund requirements are $2,900,000 for the year ended December 31, 2002, and include NMUI's Series A Bonds, which mature in 2002. NOTE 7. INCOME TAXES The components of the current and deferred income tax provisions are as follows:
- - --------------------------------------------------------------------------------------------- 1998 1997 1996 - - --------------------------------------------------------------------------------------------- (in thousands) Current tax expense: Federal $ 1,683 $ 978 $ 795 State 306 371 509 - - --------------------------------------------------------------------------------------------- 1,989 1,349 1,304 - - --------------------------------------------------------------------------------------------- Deferred income taxes (benefits): Depreciation 568 640 713 Contributions in aid of construction and advances for construction 227 242 (405) Investment tax credits 25 26 25 Reserves (243) (440) (318) Pension expense (193) 0 0 Gains on condemnation of land (50) (51) (25) Production cost balancing accounts (39) 342 185 Deferred debt expenses (7) (7) (6) Other, net 12 (19) (10) - - --------------------------------------------------------------------------------------------- 300 733 159 - - --------------------------------------------------------------------------------------------- Change in regulatory assets and regulatory liabilities, net (49) (183) (39) Investment tax credit amortization (49) (49) (49) - - --------------------------------------------------------------------------------------------- Provision for income taxes $ 2,191 $ 1,850 $ 1,375 - - ---------------------------------------------------------------------------------------------
A reconciliation of the statutory federal income tax rate to the Company's effective tax rate is as follows:
- - --------------------------------------------------------------------------------------------- 1998 1997 1996 - - --------------------------------------------------------------------------------------------- (in thousands) Provision computed at statutory rates 34% 34% 34% Depreciation 1% 1% 2% Goodwill amortization and other non deductible expenses 2% 3% 4% State income taxes, net of Federal tax benefit 1% 2% 3% Investment tax credits (1%) (1%) (1%) Other, net 3% 3% 0% - - --------------------------------------------------------------------------------------------- 40% 42% 42% - - ---------------------------------------------------------------------------------------------
29 Net deferred income taxes consist of the following at December 31, 1998 and 1997:
- - ------------------------------------------------------------------------------------------------------------ 1998 1997 - - ------------------------------------------------------------------------------------------------------------ (in thousands) Deferred income tax assets: Contributions in aid of construction and advances for construction $ 3,329 $ 3,556 Reserves 1,194 951 Investment tax credits 531 556 Production cost balancing accounts (278) (317) Other 162 232 - - ------------------------------------------------------------------------------------------------------------ 4,938 4,978 - - ------------------------------------------------------------------------------------------------------------ Deferred income tax liabilities: Depreciation (8,463) (7,895) Gains on condemnation of land (756) (806) Deferred debt expenses (105) (112) Other (44) (295) - - ------------------------------------------------------------------------------------------------------------ (9,368) (9,108) - - ------------------------------------------------------------------------------------------------------------ Net deferred income taxes $(4,430) $(4,130) - - ------------------------------------------------------------------------------------------------------------
Management regularly reviews the recoverability of deferred income tax assets and has determined that no valuation allowances were necessary at December 31, 1998 or 1997. NOTE 8. EARNINGS PER SHARE The Company records earnings per share ("EPS") in accordance with SFAS No. 128, "Earnings per Share", which became effective for periods ending after December 15, 1997. SFAS No. 128 requires the computation of basic EPS and diluted EPS. The objective of basic EPS is to measure the performance of the Company over the reporting period by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. The objective of diluted EPS is to measure the performance of the Company over the reporting period after giving effect to all dilutive potential common shares that would have been outstanding if the dilutive common shares had been issued. All EPS amounts for the periods reported have been restated to conform to SFAS No. 128. The following table is a reconciliation of the numerators and denominators used in both basic and diluted EPS calculations.
- - ------------------------------------------------------------------------------ Dividends on Effect of Preferred Dilutive Net Income Shares Basic EPS Options Diluted EPS - - ------------------------------------------------------------------------------ (in thousands except per share amounts) 1998 ----- Income (numerator) $ 3,349 $ (27) $3,322 $ 0 $3,322 Shares (denominator) 4,198 109 4,307 Per share amount $ 0.79 $ 0.77 ====== ====== 1997 ---- Income (numerator) $ 2,601 $ (27) $2,574 $ $2,574 Shares (denominator) 4,135 89 4,224 Per share amount $ 0.62 $ 0.61 ====== ====== 1996 ---- Income (numerator) $ 1,923 $ (27) $1,896 $ 0 $1,896 Shares (denominator) 4,088 16 4,104 Per share amount $ 0.46 $ 0.46 ====== ====== - - ----------------------------------------------------------------------------
30 NOTE 9. STOCKHOLDERS' EQUITY The Company is currently authorized to issue 25,000,000 common shares and 250,000 preferred shares at a par value of $.01 per share. At December 31, 1998 there were 4,220,743 common shares and 10,359-1/4 preferred shares outstanding, and at December 31, 1997, there were 3,330,207 common shares and 10,359-1/4 preferred shares outstanding. Series A-preferred stockholders are entitled to annual dividends of $2.625 per share. Series A-preferred shares may be called by the Company for a price of $52 per share and have preference in liquidation of $50 per share. In September 1998, the Company declared a 5-for-4 stock split (or 842,474 shares), payable in the form of a stock dividend to stockholders of record on October 1, 1998. In December 1997 and 1996, the Company declared stock dividends of 5% and 20% (or 158,581 and 520,317 shares), respectively to stockholders of record on January 2, 1998 and 1997, respectively. At December 31, 1997 and 1996, retained earnings were charged approximately $2,735,000 and $7,154,000, respectively, which represents the market value of the shares issued using the closing price of the Company's common stock on January 2, 1998 ($14.00) and 1997 ($10.58). Corresponding entries of approximately $2,733,000 and $7,149,000, respectively, were recorded to paid-in-capital. The weighted-average number of outstanding common shares and dividends per common share have been restated to reflect the 5-for-4 stock split in the form of a stock dividend and the 5% and 20% stock dividends. The Company has a dividend reinvestment and stock purchase plan ("DRIP" plan) that allows common stockholders the option of receiving their dividends either in cash or in common stock at a 5% discount from the market value. The DRIP plan permits optional cash purchases of stock at current market values up to a maximum of $3,000 per quarter. At December 31, 1998, 269,459 shares were reserved for issuance under this plan. NOTE 10. STOCK COMPENSATION PLANS At December 31, 1998, the Company had three stock-based compensation plans: the Stock Option Plan, the Director Stock Option Plan, and the Employee Stock Purchase Plan. The Company accounts for these plans under APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. If compensation expense for the Company's three stock-based compensation plans had been determined using the alternative method described under SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's net income and earnings per share would have been as follows:
- - ------------------------------------------------------------------------------------------- 1998 1997 1996 - - ------------------------------------------------------------------------------------------- (in thousands except per share data) Net income available for common shares As reported $3,322 $2,574 $1,896 Pro forma $3,233 $2,516 $1,857 - - ------------------------------------------------------------------------------------------- Basic earnings per common share As reported $ 0.79 $ 0.62 $ 0.46 Pro forma $ 0.77 $ 0.61 $ 0.46 - - ------------------------------------------------------------------------------------------- Diluted earnings per common share As reported $ 0.77 $ 0.61 $ 0.46 Pro forma $ 0.75 $ 0.60 $ 0.45 - - -------------------------------------------------------------------------------------------
31 In the table below, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1997, and 1996:
- - ------------------------------------------------------------------------------------ 1998 1997 1996 - - ------------------------------------------------------------------------------------ Dividend yield 2.3% 2.6% 3.3% Expected volatility 32.4% 33.1% 37.5% Risk free interest rate 5.5% 6.0% 6.5% Expected life in years 6 8 8 - - ------------------------------------------------------------------------------------
Stock Option Plan ("the Plan"): In 1988, the stockholders approved the Plan and reserved 150,000 shares for issuance under the Plan, and in 1993 approved an amendment to the Plan which increased the shares reserved for issuance to 250,000. The amendment also extended the future grant date to February 17, 2003 and eliminated any future grants of restricted stock as well as amending certain provisions for the restricted stock already issued. In 1997, the stockholders approved another amendment to the plan, which provided for an increase of 200,000 shares reserved for issuance, bringing the total to 675,937 of shares (adjusted for the stock split and stock dividends) authorized for issuance under the plan. Of the total shares authorized, 257,831 are available for issuance. Under the Plan, the Company may grant non-qualified stock options to officers and employees at an exercise price not less than the fair value of the stock on the last trading date preceding the date of grant. Prior to the approval of the Director Option Plan discussed below, the Company granted non-qualified options to certain non-employee directors of the Company. Options vest equally over a period of five years and expire 10 years and one day from the date of grant. Restricted stock was issued under the Plan prior to 1993 and must be held in escrow until restrictions lapse. The Company released 8,877 shares of restricted stock from escrow in 1998, with the remainder to be released in 1999, providing all restrictions have been satisfied. Unearned compensation of $238,000 resulted from the issuance of 27,755 shares of restricted stock and has been amortized over the vesting period. Compensation expense recognized was approximately $12,000 in 1998 and $24,000 in both 1997 and 1996 for the restricted stock issued under the plan. A summary of the status of the Plan and changes during the years ended as of December 31, 1998, 1997, and 1996 is presented below:
- - ---------------------------------------------------------------------------------------------------- 1998 1997 1996 - - ---------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Fixed Options Shares Price Shares Price Shares Price - - ---------------------------------------------------------------------------------------------------- Outstanding at beginning of year 279,592 $ 8.51 259,466 $ 8.10 205,679 $ 8.31 Granted 89,375 12.64 50,662 10.31 55,869 7.25 Exercised (19,511) 9.89 (20,502) 8.74 (882) 5.52 Forfeited 0 0 (10,034) 6.44 (1,200) 7.22 ------ ------- ------- Outstanding at end of year 349,456 $ 9.49 279,592 8.51 259,466 8.10 ======= ======= ======= Options exercisable at year-end 168,063 8.53 156,493 $ 8.88 147,307 $ 9.31 ======= ======= ======= Weighted average fair value of options granted during the year $ 3.82 $ 3.15 $ 2.32 ======= ======= =======
32 The following table summarizes information about fixed stock options outstanding at December 31, 1998:
- - -------------------------------------------------------------------------------------------- Options Outstanding Options Exercisable - - -------------------------------------------------------------------------------------------- Weighted Average Number Remaining Weighted Number Weighted Range of Outstanding Contractual Life Average Exercisable Average Exercise Prices at 12/31/98 in Years Exercise Price at 12/31/98 Exercise Price - - -------------------------------------------------------------------------------------------- $ 6 to $10 172,046 4.5 $ 7.46 120,558 $ 7.46 $10 to $12 94,285 5.3 10.31 47,505 $10.31 $12 to $14 83,125 9.0 12.80 0 $12.80 ------- ------- $ 6 to $14 349,456 6.3 $10.19 168,063 $10.19 - - --------------------------------------------------------------------------------------------
Director Option Plan ("DOP"): In 1996 the stockholders approved the DOP for non- employee directors and reserved 65,625 shares (after restatement for a stock dividend and stock splits) for issuance under the DOP. At December 31, 1998, 43,575 shares were available for issuance under the plan. The DOP provides for an automatic grant of options to purchase 1,575 of the Company's common stock to eligible non-employee directors of the Company on the date of the Company's Annual Meeting of Stockholders through 2006. New directors are granted an initial option to purchase 1,575 shares of the Company's common stock upon appointment to the Board of Directors. The DOP options become exercisable in equal installments over two years and expire 10 years and one day after the date of grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the assumptions described above. A summary of the status of the Plan and changes during the years ended as of December 31, 1998 and 1997 is presented below:
- - ------------------------------------------------------------------------------------- 1998 1997 - - ------------------------------------------------------------------------------------- Weighted Weighted Average Average Exercise Exercise Fixed Options Shares Price Shares Price - - ------------------------------------------------------------------------------------- Outstanding at beginning of year 11,025 9.62 0 $ - Granted 11,025 12.90 11,025 9.62 Exercised 0 0 0 0 Forfeited 0 0 0 0 ------ ------ Outstanding at end of year 22,050 11.26 11,025 9.62 ====== ====== Options exercisable at year-end 5,509 9.62 0 $ 0 ====== ====== Weighted average fair value of options granted during the year $ 2.55 $ 1.94 ====== ======
Employee Stock Purchase Plan ("ESPP"): The Company has a stockholder approved ESPP that allows eligible employees to purchase common stock through payroll deductions up to 10% of their salary (not to exceed $25,000 per year). The purchase price of the stock is 90% of the lower of the share price as calculated at the beginning and end of the three month offering period. Under the ESPP, the Company issued 5,181 shares, 5,013 shares and 4,877 shares to employees in 1998, 1997 and 1996, respectively. At December 31, 1998, 264,600 shares were reserved for issuance under the ESPP (after adjustment for stock dividends) and 225,621 were available for issuance. Using the alternative method described under SFAS No. 123, compensation cost is recognized for the fair value of the employees' purchase rights, which was estimated using Black-Scholes option- pricing model with the assumptions shown in the table on page 32. The weighted- average value of those purchase rights granted in 1998, 1997 and 1996 was $3.22, $3.19, and $3.97, respectively, which resulted in compensation expense of 33 $16,702, $16,016 and $23,240, and is included in the pro forma net income available for common shares shown in the table on page 32. NOTE 11. EMPLOYEE PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS Defined Benefit Plan: The Company has a non-contributory pension plan ("the Pension Plan") under which employees of the parent company, Suburban and NMUI who have one or more years of service and have attained the age of 21 years are qualified to participate. Each year, the Company funds the minimum required statutory amount. In 1998, no contribution was required. In 1997 and 1996, the Company contributed $560,000 and $556,000, respectively to the Pension Plan. Benefits to employees are based upon their years of service and their average compensation during the highest five consecutive years of the last ten years before retirement. Benefits are reduced if a participant retires before a certain age. Approximately 86% of Pension Plan assets are invested in two mutual funds consisting of investments in stocks, bonds and money market investments, in addition to a group retirement policy consisting of a guaranteed insurance contract. The remaining 14% of Pension Plan assets are invested primarily in the Company's common stock. The Pension Plan owns 105,945 common shares of the Company, which had a market value of approximately $1,642,147 and $1,483,230 at December 31, 1998 and 1997, respectively. The Pension Plan received dividends on these shares of approximately $32,000 and $30,000 in 1998 and 1997, respectively. The Company adopted SFAS No. 132, "Employer's Disclosures about Pension and Other Post-retirement Benefits", which was effective for financial statements issued after December 15, 1997. The following tables provide the actuarial assumptions used in determining the Pension Plan Valuation, the reconciliation of the Projected Benefit Obligation and the reconciliation of Pension Plan assets:
Weighted-Average Assumptions 1998 1997 - - ----------------------------------------------------------------- Discount rate 6.5% 7.5% Expected return on plan assets 8.0% 8.0% Rate of compensation increase 3.0% 3.5% - - -----------------------------------------------------------------
34
Pension Benefits - - ------------------------------------------------------------------------------- 1998 1997 - - ------------------------------------------------------------------------------- (in thousands) Change in benefit obligation Benefit obligation at beginning of year $ 8,422 $ 7,798 Service cost 440 416 Interest cost 632 584 Actuarial gain (loss) 1,058 (81) Benefits paid (287) (295) -------------------- Benefit obligation at end of year $10,265 $ 8,422 -------------------- Change in plan assets Fair value of plan assets at beginning of year 11,414 9,441 Actual return on plan assets 1,905 1,707 Employer contribution 0 561 Benefits paid (287) (295) -------------------- Fair value of plan assets at end of year $13,032 $11,414 -------------------- Funded status 2,766 2,991 Unrecognized net actuarial gain (1,747) (1,853) Unrecognized prior service cost (143) (154) Unrecognized net asset (496) (622) -------------------- Prepaid benefit cost $ 380 $ 362 ==================== Components of net periodic benefits Service cost $ 440 $ 416 Interest cost 632 584 Expected return on plan assets (915) (756) Amortization of prior service costs (10) (10) Recognized actuarial gain (39) 0 Recognized net initial asset (124) (124) Net periodic benefit cost ------------------- $ (16) $ 110
==================== Defined Contribution Plans: The Company has established a 401(k) profit sharing plan (the "ECO Plan") covering employees of its contract operations business. The ECO Plan provides for monthly enrollment by employees after completion of three months of service. Participants may elect to contribute up to 15% of their salary to the ECO Plan. The Company matches a participant's contribution for an amount up to 50% of the first 4% of the participant's salary. Company contributions vest immediately. Company contributions to the ECO Plan were $152,000, $133,000 and $141,000 in 1998, 1997 and 1996, respectively. The assets of the ECO Plan are invested at the discretion of the individual employees in mutual funds consisting of stocks, bonds, and money market investments. The Company also established a 401(k) plan ("Utility Plan") covering employees of the parent company, Suburban and NMUI. The Utility Plan provides for monthly enrollment by employees after completion of three months of service. Participants may elect to contribute up to 15% of their salary to the Utility Plan. The Utility Plan does not provide for Company contributions. The assets of the Utility Plan are invested at the discretion of the individual employees in mutual funds consisting of stocks, bonds, and money market investments. 35 NOTE 12. SEGMENT INFORMATION Under FASB No. 131, Southwest Water Company has two reportable segments: non- regulated and regulated operations. The utility segment provides water and wastewater services through regulated water utility operations, and derives revenue from the sales of these services to the consumer. The contract operations segment operates and manages water and wastewater treatment facilities owned by cities, municipalities and private entities. Revenue is derived through municipal utility district contracts, and operations and maintenance contracts. Southwest Water Company`s reportable segments are strategic business units that offer different services. They are managed separately since each business requires different operating and marketing strategies. The utility operations are governed by the regulatory bodies of the respective states and by the federal government. The service areas in which they operate constitutes a monopoly with allowable rates of return determined by state agencies. The contract operations segment, while subject to certain environmental standards, is not regulated in its pricing or marketing, or rates of return. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1. The following table presents information about each reported segment profit or loss and segment assets. These items are the measures reported to the chief operating decision-maker for purposes of making decisions about allocating resources to the segment and assessing its performance. In addition to the segment information, a reconciliation between reported segment information and consolidated information reported for the Company has been prepared and is included as part of this disclosure. 36
- - ------------------------------------------------------------------------------------------------------------------------------------ Total Non- Total Segment Consolidated Regulated Regulated Information Other Information - - ------------------------------------------------------------------------------------------------------------------------------------ As of December 31, 1998 - - ----------------------- Revenues from external customers $36,844 $ 35,302 $ 72,146 $ 0 $ 72,146 Interest income 66 8 74 17 91 Interest expense 14 2,742 2,756 228 2,984 Depreciation and amortization 736 3,477 4,213 52 4,265 Segment operating profit 848 10,493 11,341 (3,286) 8,055 Income tax provision (benefit) 192 2,588 2,780 (589) 2,191 All other 15 99 114 264 378 Other significant non-cash items: Non-cash contributions in aid of construction 0 1,775 1,775 0 1,775 Segment assets 10,157 115,515 125,672 4,255 129,927 Expenditures for segment assets 430 11,363 11,793 128 11,921 As of December 31, 1997 - - ----------------------- Revenues from external customers $34,985 $ 36,020 $ 71,005 $ 0 $ 71,005 Interest income 67 2 69 25 94 Interest expense 7 2,891 2,898 327 3,225 Depreciation and amortization 808 3,311 4,119 43 4,162 Segment operating profit (loss) 147 10,407 10,554 (3,339) 7,215 Income tax provision (benefit) (39) 2,344 2,305 (455) 1,850 All other 4 53 57 310 367 Other significant non-cash items: Non-cash contributions in aid of construction - 5,818 5,818 0 5,818 Segment assets 9,765 109,167 118,932 4,168 123,100 Expenditures for segment assets 404 14,365 14,769 433 15,202 As of December 31, 1996 - - ----------------------- Revenues from external customers $32,373 $ 33,772 $ 66,145 $ 0 $ 66,145 Interest income 48 21 69 31 100 Interest expense 17 2,231 2,248 601 2,849 Depreciation and amortization 831 3,018 3,849 38 3,887 Segment operating profit (loss) (589) 9,096 8,507 (2,773) 5,734 Income tax provision (benefit) (197) 2,136 1,939 (564) 1,375 All other 153 32 185 128 313 Other significant non-cash items: Non-cash contributions in aid of construction 0 3,437 3,437 0 3,437 Segment assets 10,725 96,800 107,525 3,891 111,416 Expenditures for segment assets 882 14,293 15,175 37 15,212
NOTE 13. COMMITMENTS AND CONTINGENCIES The Company leases certain equipment and office facilities under operating leases that expire through 2004. Aggregate rental expense under all operating leases approximated $2,384,000 in 1998, $2,225,000 in 1997 and $2,220,000 in 1996. At December 31, 1998, the future minimum rental commitments under existing non-cancelable operating leases are as follows: 1999 - $2,441,000, 2000-$2,030,000, 2001- $1,593,000, 2002- $865,000, 2003 - $247,000, and $87,000 thereafter. 37 NOTE 14. SELECTED UNAUDITED QUARTERLY FINANCIAL INFORMATION The fluctuations in operating revenues and operating income between quarters reflect the seasonal nature of utility and contract operations. Earnings per basic and diluted share have been adjusted to reflect a 5-for-4 stock split in the form of a stock dividend on October 1, 1998, and stock dividends of five percent on January 2, 1998 and 20-percent on January 2, 1997. Selected unaudited quarterly financial information of the Company is presented in the table below.
1998 Quarters Ended March 31 June 30 September 30 December 31 - - --------------------------------------------------------------------------------------------------- (in thousands except per share amounts) Operating revenues $15,946 $18,332 $19,960 $17,908 Operating income 1,022 2,184 3,088 1,761 Net income 182 926 1,448 793 Net income available for common shares 175 919 1,441 787 Basic earnings per common share 0.04 0.22 0.34 0.19 Diluted earnings per common share 0.04 0.21 0.34 0.18 1997 Quarters Ended March 31 June 30 September 30 December 31 - - --------------------------------------------------------------------------------------------------- (in thousands except per share amounts) Operating revenues $15,432 $18,469 $19,975 $17,129 Operating income 804 2,104 2,727 1,580 Net income 64 807 1,192 538 Net income available for common shares 57 800 1,186 531 Basic earnings per common share 0.01 0.19 0.29 0.13 Diluted earnings per common share 0.01 0.19 0.28 0.13
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 38 PART III Item 10. Directors and Executive Officers of the Registrant Information relating to the directors of the Company is set forth in the Company's definitive Proxy Statement, to be filed with the Securities and Exchange Commission ("Commission") dated on or about April 15, 1999, under the caption "Information about the Board of Directors and Committees of the Board," and is hereby incorporated by reference. In addition, information appearing under the heading "Compliance with Section 16(a) of the Securities Exchange Act of 1934, as Amended" is in the Company's definitive Proxy Statement, dated on or about April 15, 1999, and is also hereby incorporated by reference. Item 11. Executive Compensation Information related to executive compensation is contained in the Company's definitive Proxy Statement, to be filed with the Commission dated on or about April 15, 1999, under the captions "Executive Compensation and Other Information," and "Information About the Board of Directors and Committees of the Board," and is hereby incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Information with respect to security ownership of certain beneficial owners and management of the Company's voting securities is set forth in the Company's definitive Proxy Statement, to be filed with the Commission dated on or about April 15, 1999, under the caption "Beneficial Ownership of the Company's Securities," and is hereby incorporated by reference. Item 13. Certain Relationships and Related Transactions Information with respect to certain relationships and related transactions is set forth under the captions "Information About the Board of Directors and Committees of the Board," "Executive Severance Compensation Agreements," and "Certain Transactions" in the Company's definitive Proxy Statement, to be filed with the Commission dated on or about April 15, 1999, and is hereby incorporated by reference. 39 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)(1) The financial statements listed below are filed as part of this report: Independent Auditors' Report Consolidated Statements of Income Three Years Ended December 31, 1998, 1997 and 1996 Consolidated Balance Sheets December 31, 1998 and 1997 Consolidated Statements of Changes in Common Stockholders' Equity -- Three Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows -- Three Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements (a)(2) The supplementary financial statement schedule required to be filed with this report is as follows:
Page ---- Schedule II - Valuation and Qualifying Accounts.................... 41 Schedules not listed above are omitted because of the absence of conditions under which they are required, or because the information required by such omitted schedules is included in the consolidated financial statements or notes to consolidated financial statements thereto. (a)(3) Exhibit Index....................................................... 42-45 (b) Reports on Form 8-K:
There were no reports on Form 8-K filed for the three months ended December 31, 1998. 40 SOUTHWEST WATER COMPANY AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1998, 1997 and 1996
Balance at Provision Accounts Balance at Beginning of Charged to Recoveries Written Off End of Year --------------------------------------------------------------------------------- (in thousands) 1998 Allowance for Doubtful Accounts $ 711 $ 319 $ 0 $ (135) $ 895 --------------------------------------------------------------------------------- 1997 Allowance for Doubtful Accounts $ 512 $ 247 $ 0 $ (48) $ 711 --------------------------------------------------------------------------------- 1996 Allowance for Doubtful Accounts $ 192 $ 614 $ 0 $ (294) $ 512 ---------------------------------------------------------------------------------
41 SOUTHWEST WATER COMPANY AND SUBSIDIARIES EXHIBIT INDEX
Exhibit No. and Applicable Section of Item 601 of Regulation S-K: - - ----------------------------------------------------------------- 2 Agreement and Plan of Merger of Registrant dated May 25, 1988 (incorporated by reference to Exhibit 2 to Registrant's Form 10-K Report for the year ended December 31, 1988). 3.1 Registrant's Restated Certificate of Incorporation dated April 4,1988 (incorporated by reference to Exhibit 3.1 to Registrant's Form 8-B Report filed with the Commission on July 5, 1988). 3.1B Certificate of Amendment of Article Four of Articles of Incorporation dated March 30, 1995 incorporated by reference to Exhibit 3.1B to Registrant's Form 10-Q Report for the quarter ended March 31, 1995). 3.1C Certificate of Amendment of Restated Certificate of Incorporation dated June 4, 1998 (incorporated by reference to Appendix A of Registrant's 1998 Proxy Statement filed with the Commission on April 20, 1998). 3.2 Registrant's Bylaws as amended April 4, 1988 (incorporated by reference to Exhibit 3.2 to Registrant's Form 8-B Report filed with the Commission on July 5, 1988). 3.2A Amendment to Registrant's Bylaws dated March 15, 1991 (incorporated by reference to Exhibit 3.2A to Registrant's Form 10-K Report for the year ended December 31, 1990). 3.2B Amendment to Registrant's Bylaws dated June 27, 1995 (incorporated by reference to Exhibit 3.2A to Registrant's Form 10-Q Report for the quarter ended June 30, 1995). 3.2C Amendment to Registrant's Bylaws dated December 12, 1996 (incorporated by reference to Exhibit 3.2C to Registrant's Form 10-K Report for the year ended December 31, 1996). 4.1 Indenture of Mortgage and Deed of Trust between Suburban Water Systems and U.S. Bank Trust National Association, formerly First Trust of California, N.A. dated October 1, 1986 (incorporated by reference to Exhibit 4.3 to Registrant's Form 10-K Report for the year ended December 31, 1986). 4.1A First Amendment and Supplement to Indenture of Mortgage and Deed of Trust between Suburban Water Systems and U.S. Bank Trust National Association, formerly First Trust of California, N.A. dated February 7, 1990 (incorporated by reference to Exhibit 4.2A to Registrant's Form 10-K Report for the year ended December 31, 1989). 4.1B Second Amendment and Supplement to Indenture of Mortgage and Deed of Trust between Suburban Water Systems and U.S. Bank Trust National Association, formerly First Trust of California, N.A. dated January 24, 1992 (incorporated by reference to Exhibit 4.2B to Registrant's Form 10-K Report for the year ended December 31, 1991). 4.1C Third Amendment and Supplement to Indenture of Mortgage dated October 9, 1996, between Suburban Water Systems and U.S. Bank Trust National Association, formerly First Trust of California, N.A. (incorporated by reference to Exhibit 4.7 to Registrant's Form 10-Q Report for the quarter ended September 30, 1996). 4.2 Bond Purchase Agreement dated October 1, 1986, for Suburban Water Systems (incorporated by reference to Exhibit 4.4 to Registrant's Form 10-K Report for the year ended December 31, 1986). 4.2A Bond Purchase Agreement dated February 20, 1992, for Suburban Water Systems (incorporated by reference to Exhibit 4.3A to Registrant's Form 10-K Report for the year ended December 31, 1991).
42 4.2B Bond Purchase Agreement dated October 21, 1996, for Suburban Water Systems (incorporated by reference to Exhibit 4.3B to Registrant's Form 10-K Report for the year ended December 31, 1996). 4.3 Indenture of Mortgage dated February 14, 1992, between New Mexico Utilities, Inc., and Sunwest Bank of Albuquerque, N.A. (incorporated by reference to Exhibit 4.4 to Registrant's Form 10-K Report for the year ended December 31, 1991). 4.3A First Supplement to Indenture of Mortgage dated May 15, 1992, between New Mexico Utilities, Inc. and Sunwest Bank of Albuquerque, N.A. (incorporated by reference to Exhibit 4.4A to Registrant's Form 10-K Report for the year ended December 31, 1996). 4.3B Second Amendment and Supplement to Indenture of Mortgage dated October 21, 1996, between New Mexico Utilities, Inc. and Sunwest Bank of Albuquerque, N.A. (incorporated by reference to Exhibit 4.8 to Registrant's Form 10-Q Report for the quarter ended September 30, 1996). 4.4 Bond Purchase Agreement dated March 12, 1992, for New Mexico Utilities, Inc. (incorporated by reference to Exhibit 4.5 to Registrant's Form 10-K Report for the year ended December 31, 1991). 4.4A Bond Purchase Agreement dated November 8, 1996, for New Mexico Utilities, Inc. (incorporated by reference to Exhibit 4.5A to Registrant's Form 10-K Report for the year ended December 31, 1996). 4.5 Article Four of the Restated Certificate of Incorporation of the Registrant as to the rights, preferences, privileges and restrictions of all classes of stock (incorporated by reference to Exhibit 3.1 to Registrant's form 8-B Report filed with the Commission on July 5, 1988). 4.5A Registration Statement for the Second Amendment to the Amended and Restated Southwest Water Company Stock Option and Restricted Stock Plan (incorporated by reference to Registrant's Form S-8 Registration Statement filed with the Commission October 29, 1997). 4.7 Stockholder's Rights Plan dated April 6, 1998 (incorporated by reference to the Registrant's Form 8-K Report filed with the Commission April 23, 1998). 10.1 Fourteenth Amendment to the Utility Employees' Retirement Plan dated December 12, 1996 (incorporated by reference to Exhibit 10.1 to Registrant's Form 10-K Report for the year ended December 31, 1996). 10.1A Fifteenth Amendment to the Utility Employees' Retirement Plan dated December 31, 1997 (incorporated by reference to the Registrant's Form 10-Q Report for the quarter ended June 30, 1998). 10.2 Amended and Restated Employee Stock Purchase Plan dated May 28, 1998 (incorporated by reference to Appendix B to Registrant's 1998 Proxy Statement filed with the Commission on April 20, 1998). 10.3 Dividend Reinvestment and Stock Purchase Plan Dated December 1, 1992 (incorporated by reference to Registrant's Form S-3 Registration Statement filed with the Commission on December 1, 1992). 10.4 Amended and Restated Stock Option and Restricted Stock Option and Restricted Stock Plan dated November 11, 1991, and First Amendment to the Amended and Restated Stock Option and Restricted Stock Plan dated March 21, 1993 (incorporated by reference to Registrant's Form S-8 Registration Statement filed with the Commission on December 21, 1993). 10.5 Stock Purchase Agreement and First Amendment to Stock Purchase Agreement dated August 13, 1993, between ECO Resources, Inc., and Robert E. Hebert (incorporated by reference to Exhibit 10.11 to Registrant's Form 10-K Report for the year ended December 31, 1993).
43 10.6 Utility Employees' 401(k) Plan dated January 7, 1994 (incorporated by reference to Exhibit 10.13 to Registrant's Form 10-K Report for the year ended December 31, 1993). 10.6A First Amendment to Utility Employees' 401(k) Plan (incorporated by reference to Exhibit 10.8A to Registrant's Form 10-K Report for the year ended December 31, 1994). 10.8 Comprehensive Amendment to the Profit Sharing 401(k) Plan for the Southwest Water Company's Related Companies dated March 10, 1994 (incorporated by reference to Exhibit 10.14 to Registrant's Form 10-K Report for the year ended December 31, 1993). 10.8A First Amendment to the Profit Sharing 401 (k) Plan for the Southwest Water Company's Related Companies (incorporated by reference to Exhibit 10.9A to Registrant's Form 10-K Report for the year ended December 31, 1994). 10.9 Form of Severance Compensation Agreement between Registrant and certain executive officers approved by the Compensation Committee of the Board of Directors on February 21, 1995, (incorporated by reference to Exhibit 10.11 to Registrant's Form 10-Q Report for the quarter ended March 31, 1995). 10.9A Form of Severance Compensation Agreement between Registrant and certain executive officers approved by the Compensation Committee of the Board of Directors on August 5, 1998, filed herewith. 10.10 Equity Investment Agreement dated May 23, 1996, between the Registrant and RTNT, Inc., covering Windermere Utility Company, together with two First Refusal Agreements and Call Purchase Agreements between the Registrant and RTNT, Inc. (incorporated by reference to Exhibit 10.12 to Registrant's Form 10-K Report for the year ended December 31, 1996). 10.10A First Amendment of RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement between the Registrant and RTNT, Inc. dated May 22, 1998 (incorporated by reference to Exhibit 10.12A to Registrant's Form 10-Q Report for the quarter ended June 30, 1998). 10.10B Second Amendment of RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement between the Registrant and RTNT, Inc. dated January 15, 1999, filed herewith. 10.10C First Amendment of SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement between the Registrant and RTNT, Inc. dated May 22, 1998 (incorporated by reference to Exhibit 10.12B to Registrant's Form 10-Q Report for the quarter ended June 30, 1998). 10.10D Second Amendment of SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement between the Registrant and RTNT, Inc. dated January 15, 1999, filed herewith. 10.11 Amended and Restated Credit Agreement dated December 23, 1997 between Registrant and Wells Fargo Bank (incorporated by reference to Exhibit 10.15 to Registrant's Form 10-K Report for the year ended December 31, 1997). 10.11A First Amendment to the Amended and Restated Credit Agreement dated September 1, 1998 between Registrant and Wells Fargo (incorporated by reference to Exhibit 10.4H to Registrant's Form 10-Q Report for the quarter ended September 30, 1998). 10.11B Letter of Waiver to the Amended and Restated Credit Agreement dated September 18, 1998 between Registrant and Wells Fargo Bank (incorporated by reference to Exhibit 10.4I to Registrant's Form 10-Q Report for the quarter ended September 30, 1998). 10.12 Amended and Restated Credit Agreement dated December 23, 1997 between Suburban Water Systems and Wells Fargo Bank (incorporated by reference to Exhibit 10.16 to Registrant's Form 10-K Report for the year ended December 31, 1997).
44 10.12A First Amendment to the Amended and Restated Credit Agreement dated September 1, 1998 between Suburban Water Systems and Wells Fargo (incorporated by reference to Exhibit 10.13D to Registrant's Form 10-Q Report for the quarter ended September 30, 1998). 10.13 Amended and Restated Credit Agreement dated December 23, 1997 between Registrant and Mellon Bank, N.A. (incorporated by reference to Exhibit 10.17 to Registrant's Form 10-K Report for the year ended December 31, 1997). 10.13A First Amendment to the Amended and Restated Credit Agreement dated September 1, 1998 between Registrant and Mellon Bank, N.A. (incorporated by reference to Exhibit 10.17A to Registrant's Form 10-Q Report for the quarter ended September 30, 1998). 10.13B Letter of Waiver to the Amended and Restated Credit Agreement dated September 18, 1998 between Registrant and Mellon Bank, N.A. (incorporated by reference to Exhibit 10.17B to Registrant's Form 10-Q Report for the quarter ended September 30, 1998). 10.14 Amended and Restated Credit Agreement dated December 23, 1997 between Suburban Water Systems and Mellon Bank, N.A. (incorporated by reference to Exhibit 10.18 to Registrant's Form 10-K Report for the year ended December 31, 1997). 10.14A First Amendment to the Amended and Restated Credit Agreement dated September 1, 1998 between Suburban Water Systems and Mellon Bank, N.A. (incorporated by reference to Exhibit 10.18A to Registrant's Form 10-Q Report for the quarter ended September 30, 1998). 10.15 Business Loan Agreement dated December 10, 1997 between New Mexico Utilities, Inc. and First Security Bank of New Mexico, N.A. (incorporated by reference to Exhibit 10.19 to Registrant's Form 10-Q Report for the quarter ended March 31, 1998). 21.1 Listing of Registrant's subsidiaries. 23.1 Consent of KPMG Peat Marwick LLP. 27 Financial Data Schedule.
45 SOUTHWEST WATER COMPANY AND SUBSIDIARIES SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized. SOUTHWEST WATER COMPANY By: /s/ Anton C. Garnier -------------------- ANTON C. GARNIER President and Chief Executive Officer (Principal Executive Officer) March 22, 1999 By: /s/ Peter J. Moerbeek --------------------- PETER J. MOERBEEK Chief Financial Officer (Principal Financial and Accounting Officer) March 22, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ H. Frederick Christie /s/ Donovan D. Huennekens - - ------------------------- ------------------------- H. FREDERICK CHRISTIE DONOVAN D. HUENNEKENS Director Director March 22, 1999 March 22, 1999 /s/ Michael J. Fasman /s/ Richard Kelton - - ------------------------ --------------------- MICHAEL J. FASMAN RICHARD KELTON Director Director March 22, 1999 March 22, 1999 /s/ Anton C. Garnier /s/ Maureen A. Kindel - - ------------------------ --------------------- ANTON C. GARNIER MAUREEN A. KINDEL Director Director March 22, 1999 March 22, 1999 /s/ Monroe Harris /s/ Richard G. Newman - - ------------------------ --------------------- MONROE HARRIS RICHARD G. NEWMAN Director Director March 22, 1999 March 22, 1999 46 EX-10.9A 2 FORM OF SEVERANCE COMPENSATION AGREEMENT EXHIBIT 10.9A SEVERANCE COMPENSATION AGREEMENT --------------------- THIS SEVERANCE COMPENSATION AGREEMENT (the "Agreement") is made and entered into as of the 5th day of August, 1998 by and between SOUTHWEST WATER --- ------ - COMPANY, a Delaware corporation (the "Company"), and ---------------- ("Executive"), with respect to the following: RECITALS -------- A. The Company, through its subsidiaries Suburban Water Systems ("Suburban"), ECO Resources, Inc. ("ECO") and New Mexico Utilities, Inc. ("NMU"), is engaged in the business of producing and delivering water and providing water and wastewater services. Executive is employed by Southwest --------- Water Company as its - - ------------- -----------------------. B. The Company's Board of Directors has determined that it is appropriate to reinforce and encourage the continued attention and dedication of members of the Company's management, including Executive, to their assigned duties without distraction in potentially disturbing circumstances arising from the possibility of a change in control of the Company and/or the subsidiary of the Company which employs Executive. C. This Agreement sets forth the severance compensation which the Company agrees it will pay to Executive if Executive's employment with the Company or, if applicable, the subsidiary which employs Executive, terminates under one of the circumstances described herein following a Change in Control, as defined herein, of the Company or the subsidiary of the Company which employs Executive. AGREEMENT --------- IN CONSIDERATION OF the foregoing recitals and the mutual promises and covenants contained herein, the Company and Executive agree as follows: 1. Term. The term of this Agreement shall commence upon the last ---- execution and delivery of this Agreement by the Company and shall continue until the first to occur of: (a) The second anniversary of any Change in Control, as defined in paragraph 2 below, of the Company or the subsidiary which employs Executive. For the purposes of this provision, the two year period provided for herein, whether commenced by a Change in Control of the Company or a change in control of a subsidiary, shall not be extended by a subsequent Change in Control of either the Company or, if applicable, the Subsidiary which employs Executive. (b) The Retirement, as defined in paragraph 2 below, of Executive. (c) The death of Executive. (d) Termination by the Company (or the subsidiary which employs Executive, if applicable) of Executive's employment for Cause, as defined in paragraph 2 below. (e) Termination by Executive of Executive's employment with , whether or not for Good Reason, as defined in paragraph 2 - - -------------------- below. Provided, however, that upon any termination by Executive for Good Reason, or any termination of Executive by the Company (or the subsidiary which employs Executive, if applicable) other than for Cause, the obligations of the Company pursuant to paragraph 4 below shall survive such termination. Provided further, that the rights of Executive pursuant to paragraph 7 below shall survive any termination of this Agreement, including termination by Executive of Executive's employment other than for Good Reason and a termination by the Company (or the subsidiary which employs Executive, if applicable) of Executive's employment for Cause. 2. Definitions. As used in this Agreement, the following terms ----------- shall have the meanings given to them in this paragraph 2: (a) Cause. The term "Cause" shall mean, and the Company (or the ----- subsidiary which employs Executive, if applicable) shall be entitled to terminate the employment of Executive for (i) fraud, misappropriation or embezzlement of money or property by Executive, (ii willful and continued failure of Executive to substantially perform Executive's duties with the Company (or the subsidiary which employs Executive, if applicable) (other than any such failure resulting from incapacity of Executive due to physical or mental illness), after a demand for substantial performance is delivered to Executive by the Chief Executive Officer of the Company or the Compensation Committee of the Board, which demand specifically identifies the manner in which Executive has not substantially performed Executive's duties and (ii willful engagement by Executive in misconduct which is materially injurious to the Company (or the subsidiary which employs Executive, if applicable), monetarily or otherwise. For purposes of this subparagraph, no act, or failure to act, on Executive's part shall be considered "willful" unless done, or omitted to be done, by Executive not in good faith and without reasonable belief that Executive's action or omission was in the best interest of the Company (or the subsidiary which employs Executive, if applicable). Notwithstanding the foregoing, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Company's Board of Directors at a meeting of the Board called and held for the purpose (after reasonable notice to Executive and an opportunity for Executive, together with Executive's counsel, to be heard before the Board), finding that in the good faith opinion of the Board Executive was guilty of conduct set forth in this subparagraph and specifying the particulars thereof in detail. 2 (b) Change in Control. The term "Change in Control" shall mean, ----------------- with respect to the Company or the subsidiary which employs Executive, as applicable, each of the following: (i) A change in control of the Company or the subsidiary which employs Executive, as applicable, of a nature that would be required to be reported in response to Item 6(e)of Schedule 14A, Regulation 240.14a-101, promulgated under the Securities Exchange Act of 1934, as amended, as in effect on the date of this Agreement, or, if Item 6(e) is no longer in effect, any regulation issued by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 which serves similar purposes (i.e., a change in the person or persons owning, directly or indirectly, sufficient voting stock to elect the Board of Directors or to take other significant shareholder actions for the Company or the subsidiary which employs Executive, as applicable). Provided that, without limitation, a Change of Control shall be deemed to have occurred if and when: (A) Any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) who is not at the date hereof a beneficial owner, directly or indirectly, of securities of the Company (or the subsidiary which employs Executive, if applicable) representing fifty percent (50%) or more of the combined voting power of the Company's (or the subsidiary which employs Executive, if applicable) then outstanding securities becomes such a beneficial owner, or (B) During any period of two (2) consecutive years, individuals who were members of the Board of Directors of the Company at the beginning of such period cease for any reason (other than death or disability) to constitute at least a majority thereof unless the election, or the nomination for election by the Company's stockholders, of each new director, was approved by vote of at least two-thirds of the directors then still in office who were directors at the beginning of such period. The provisions of this clause (B) shall apply only at the Company level and not at the subsidiary level. (ii) Consummation of (A) any reorganization, consolidation or merger of the Company (or of the subsidiary which employs Executive, if applicable) in which the Company (or of the subsidiary which employs Executive, if applicable) is not the continuing or surviving corporation or pursuant to which shares of the Company's (or of the subsidiary which employs Executive, if applicable) Common Stock would be converted into cash, securities or other property, other than a merger of the Company (or of the subsidiary which employs Executive, if applicable) in which the holders of the Company's (or of the subsidiary which employs Executive, if applicable) common stock immediately prior to such transaction, immediately following such transaction, own more than fifty percent (50%) of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged or consolidated company's then outstanding, voting securities or (B) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of 3 all or substantially all of the assets of the Company (or of the subsidiary which employs Executive, if applicable). For the purpose of applying the foregoing definition, (x) if Executive is an employee of the Company, then the term Change in Control shall mean, as to Executive, only a change in control of the Company and (y) if Executive is an employee of a subsidiary of the Company, then the term Change in Control shall mean, as to Executive, either a change in control of the Company or a change in ------ -- control of the subsidiary which employs Executive. (c) Date of Termination. The term "Date of Termination" shall ------------------- mean: (i) If this Agreement is terminated by the death of Executive, the date of death of Executive; or (ii) If Executive's employment is terminated by the Company (or the subsidiary which employs Executive, if applicable) for any reason, the date on which a Notice of Termination is given; provided that if within thirty (30) days after any Notice of Termination is given to Executive by the Company (or the subsidiary which employs Executive, if applicable) Executive notifies the Company (or the subsidiary which employs Executive, if applicable) that a dispute exists concerning the termination, the Date of Termination shall be the date the dispute is finally determined, whether by mutual agreement by the parties or upon final judgment, order or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected). (d) Good Reason. The term "Good Reason" shall mean, with respect ----------- to any termination by Executive of Executive's employment with the Company (or the subsidiary which employs Executive, if applicable), each of the following which occurs subsequent to a Change in Control without the express written consent of Executive: (i) The assignment to Executive by the Company (or the subsidiary which employs Executive, if applicable) of duties inconsistent with Executive's position, duties, responsibilities and status with the Company (or the subsidiary which employs Executive, if applicable) immediately prior to a Change in Control of the Company (or the subsidiary which employs Executive, if applicable), or a change in Executive's title or offices as in effect immediately prior to a Change in Control of the Company (or the subsidiary which employs Executive, if applicable), or any removal of Executive from or any failure to reelect Executive to any of such positions, except in connection with the termination of Executive's employment for Retirement or Cause or as a result of Executive's death or by Executive other than for Good Reason; (ii) A reduction by the Company (or the subsidiary which employs Executive, if applicable) in Executive's base salary as in effect on the date hereof or as the same may be increased from time to time during the term of this Agreement or the 4 Company's (or the subsidiary which employs Executive, if applicable) failure to increase (within twelve (12) months after Executive's last increase in base salary) Executive's base salary after a Change in Control of the Company (or the subsidiary which employs Executive, if applicable) in an amount which at least equals, on a percentage basis, the average percentage increase in base salary for all officers of the Company (or the subsidiary which employs Executive, if applicable) effected in the preceding twelve (12) months; (iii) Any failure by the Company (or the subsidiary which employs Executive, if applicable) to continue in effect any benefit plan or arrangement in which Executive is participating at the time of a Change in Control of the Company (or the subsidiary which employs Executive, if applicable) (or any other plans providing Executive with substantially similar benefits) (hereinafter referred to as "Benefit Plans"), or the taking of any action by the Company (or the subsidiary which employs Executive, if applicable) which would adversely affect Executive's participation in or reduce Executive's benefits under any such Benefit Plan, expressed as a percentage of his base salary, by more than ten (10) percentage points in any fiscal year as compared to the prior fiscal year or deprive Executive of any material fringe benefit enjoyed by Executive at the time of a Change in Control of the Company (or the subsidiary which employs Executive, if applicable); (iv) Any failure by the Company (or the subsidiary which employs Executive, if applicable) to continue in effect any bonus or incentive plan or arrangement in which Executive is participating at the time of a Change in Control of the Company (or the subsidiary which employs Executive, if applicable) (or any other plans or arrangements providing him with substantially similar benefits) (hereinafter referred to as "Incentive Plans") or the taking of any action by the Company (or the subsidiary which employs Executive, if applicable) which would adversely affect Executive's participation in any such Incentive Plan or reduce Executive's benefits under any such Incentive Plan, expressed as a percentage of his base salary, by more than ten (10) percentage points in any fiscal year as compared to the immediately preceding fiscal year; (v) Any failure by the Company (or the subsidiary which employs Executive, if applicable) to continue in effect any plan or arrangement to receive securities of the Company in which Executive is participating at the time of a Change in Control of the Company (or the subsidiary which employs Executive, if applicable) (or plans or arrangements providing him with substantially similar benefits) (hereinafter referred to as "Securities Plans") or the taking of any action by the Company (or the subsidiary which employs Executive, if applicable) which would adversely affect Executive's participation in or materially reduce Executive's benefits under any such Securities Plan; (vi) Any requirement by the Company (or the subsidiary which employs Executive, if applicable) that Executive be based anywhere other than within fifty (50) miles of Executive's office location as of the date of a Change in Control, except for required travel by Executive on the Company's (or the subsidiary which employs Executive, if applicable) business to an extent substantially consistent with Executive's business travel 5 obligations at the time of a Change in Control of the Company (or the subsidiary which employs Executive, if applicable); (vii) Any failure by the Company (or the subsidiary which employs Executive, if applicable) to provide Executive with the number of paid vacation days to which Executive is entitled at the time of a Change in Control of the Company (or the subsidiary which employs Executive, if applicable); (viii) Any material breach by the Company of any provision of this Agreement; (ix) Any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company; or (x) Any purported termination by the Company (or the subsidiary which employs Executive, if applicable) of Executive's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of subparagraph (e) below, and for purposes of this Agreement, no such purported termination shall be effective. (e) Notice of Termination. Any termination of Executive's employment --------------------- by the Company (or the subsidiary which employs Executive, if applicable) for Retirement or Cause shall be communicated by a Notice of Termination. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific ground for such termination relied upon and which sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment. For purposes of this Agreement, no such purported termination by the Company (or the subsidiary which employs Executive, if applicable) shall be effective without such Notice of Termination. (f) Retirement. The term "Retirement" as used in this Agreement shall ---------- mean termination by the Company (or the subsidiary which employs Executive, if applicable) or Executive of Executive's employment based on Executive's having reached age sixty-five (65) or such other age as shall have been fixed in any written agreement between Executive and Executive's employer entity. (g) Termination of Employment. The term "Termination of Employment" ------------------------- shall mean any termination of Executive's employment with the Company (or the subsidiary which employs Executive, if applicable), however effected or caused. (h) Involuntary Termination of Employment. The term "Involuntary ------------------------------------- Termination of Employment" shall mean (i) any termination by the Company (or the subsidiary which employs Executive, if applicable) of Executive's employment with the Company (or the subsidiary which employs Executive, if applicable) effected after a Change in Control other than a termination for Retirement, death or Cause and (ii) any termination of 6 Executive's employment with the Company (or the subsidiary which employs Executive, if applicable) by Executive after a Change in Control for Good Reason. 3. Services by Executive. In consideration for the Company's --------------------- execution and delivery of this Agreement, Executive agrees that Executive will render services to the Company (or to any subsidiary thereof or successor thereto, as applicable) during the period of Executive's employment to the best of Executive's ability and in a prudent and businesslike manner and that Executive shall devote substantially the same time, efforts and dedication to Executive's duties as heretofore devoted. 4. Severance Obligations Upon any Involuntary Termination. Upon any ------------------------------------------------------ Involuntary Termination of Executive's employment with the Company (or the subsidiary which employs Executive, if applicable) subsequent to a Change in Control and during the term of this Agreement, Executive shall be entitled to the benefits provided in this paragraph (subject to any applicable payroll taxes or other taxes required to be withheld and employee benefit premiums): (a) The Company shall pay (or shall cause the employer subsidiary to pay) to Executive Executive's full base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given plus credit for any vacation earned but not taken and the amount, if any, of any bonus for a past fiscal year which has been awarded to Executive but not yet paid to Executive pursuant to any bonus plan of the Company (or the subsidiary which employs Executive, if applicable). Such payment shall be made within five (5) days after the Date of Termination. (b) The Company shall pay (or shall cause the employer subsidiary to pay) to Executive, as severance pay, an amount equal to two and ninety-nine one hundredths (2.99) times Executive's annual base compensation, as defined herein (the "Severance Payment"). As used herein, annual base compensation shall mean the average aggregate annual amount paid by the Company (or any subsidiary of or successor to the Company) to Executive for the five (5) full calendar years preceding the date of Change of Control for salaries, bonuses and automobile allowances (or the amount reported by Executive as taxable income for personal use of a car provided by the Company (or the subsidiary which employs Executive, if applicable) in lieu of an automobile allowance) together with the amounts, if any, of insurance premiums paid by the Company (or the subsidiary which employs Executive, if applicable) with respect to Executive and reported as taxable income by Executive and any other amounts paid or provided by the Company (or any successor to or subsidiary of the Company and reported as taxable income by Executive. If Executive has not been employed by the Company (or the subsidiary which employs Executive, if applicable) for five (5) full calendar years preceding the date of Change of Control, the Severance Payment shall be computed based on the average aggregate annual amount paid by the Company (or the subsidiary which employs Executive, if applicable) to Executive for the full term of Executive's employment with the Company (or the subsidiary which employs Executive, if 7 applicable). The Severance Payment shall be paid in cash in a single lump sum within five (5) days after the Date of Termination. (c) The Company shall cause Executive to continue to be covered, without any cost to Executive in excess of the cost borne by Executive prior to the Change of Control, under health, medical and dental benefits ("Benefits") comparable to those in effect immediately prior to the Change of Control, including, but not limited to, medical, dental, life insurance, accidental death and dismemberment, and long term disability benefits. Such continuation shall (i) also apply to Executive's dependents (including Executive's spouse) who were covered under such Benefits immediately prior to the Change of Control and (ii apply for twenty-four (24) months after the Date of Termination; provided, however, that such coverage shall terminate if and to the extent Executive becomes eligible for Benefits coverage from a subsequent employer; provided further, however, that if Executive (and/or Executive's spouse) would have been entitled to retiree Benefits under the Company's benefit plans (or those of the subsidiary which employs Executive, if applicable) had Executive voluntarily retired on the Date of Termination, then such coverage shall be continued as provided under such plans. (d) Provide a full service outplacement service for Executive as selected by Executive for a period not exceeding three (3) months and at a cost not exceeding $15,000 in the aggregate. Any payment due by the Company pursuant to this paragraph 4 which is not made as and when due shall bear interest from the date due until date of payment at the maximum rate which Executive may charge for the loan or forbearance of money under the then applicable usury law of the State of California. 5. No Obligation to Mitigate Damages. Executive shall not be --------------------------------- required to mitigate damages or the amount of any payment provided for under paragraph 4 of this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by Executive as the result of employment by another employer after the Date of Termination, or otherwise. Any indebtedness of Executive to the Company (or to any subsidiary of or successor to the Company) as of the Date of Termination may be offset against the Company's payment obligations pursuant to paragraph 4 above. 6. Parachute Payment Limitation. Notwithstanding anything to the ---------------------------- contrary in this Agreement, the payments and benefits otherwise provided in paragraphs 4(b), (c) and (d) of this Agreement shall be reduced if and to the extent that such payments and benefits, when added to any payments and benefits provided by the Company (and the subsidiary which employs Executive, if applicable) other than under this Agreement, would result in any such payments being nondeductible to the Company or would subject Employee to an excise tax pursuant to the golden parachute payment provisions of Section 280G or Section 4999 of the Internal Revenue Code of 1986, as amended. Any reduction of payments 8 and benefits under this Agreement resulting from the foregoing limitations shall be applied to the payments and benefits due to be otherwise provided to Executive latest in time. 7. Other Benefits. The provisions of this Agreement, and any -------------- payment provided for in paragraph 4 hereof, shall not reduce any amounts otherwise payable, or in any way diminish Executive's existing rights, or rights which would accrue solely as a result of the passage of time, under any Benefit Plan, Incentive Plan or Securities Plan, employment agreement or other contract, plan or arrangement. The provisions of this paragraph 7 shall apply to any Termination of Employment with the Company (or the subsidiary which employs Executive if applicable), whether or not such Termination of Employment results in payments due to Executive pursuant to paragraph 4 above. 8. Not a Contract of Employment. This Agreement shall not be deemed ---------------------------- to constitute a contract of employment. Further, no portion of this Agreement shall affect (a) the right of the Company (or any subsidiary of or successor to the Company) to discharge Executive at will or (b) the terms and conditions of any other agreement between the Company (or the subsidiary which employs Executive, if applicable) and Executive, except as expressly provided herein. 9. Successors to the Company. ------------------------- (a) The Company shall require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance reasonably satisfactory to Executive, expressly, absolutely and unconditionally to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. Any failure of the Company to obtain such agreement prior to the effectiveness of any such succession or assignment shall be a material breach of this Agreement and shall entitle Executive to terminate Executive's employment for Good Reason. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any successor or assign to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this paragraph 9 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. If at any time during the term of this Agreement Executive is employed by any corporation a majority of the voting securities of which is then owned by the Company, "Company" as used herein shall include such employer. In such event, the Company agrees that it shall pay or shall cause such employer to pay any amounts owed to Executive pursuant to paragraph 4 hereof. (b) This Agreement shall inure to the benefit of and be enforceable by Executive's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If Executive should die while any amounts are still payable to Executive hereunder, all such amounts, unless otherwise provided herein, shall be paid in 9 accordance with the terms of this Agreement to Executive's devisee, legatee, or other designee or, if there be no such designee, to Executive's estate. 10. Notices. All notices required or permitted hereunder shall be in ------- writing and shall be personally delivered or sent by first class mail, registered or certified with return receipt requested to the parties at their respective addresses set forth after their signatures to this Agreement. Any notice which is personally served shall be effective upon delivery; any notice sent by first class mail, registered or certified, postage prepaid, return receipt requested and properly addressed shall be effective upon the date of delivery or refusal indicated on the return receipt. Either party may change his, her or its address for notices hereunder by written notice to the other given in the manner specified in this paragraph. 11. General Provisions. ------------------ (a) The Company's obligation to pay (or to cause one of its subsidiaries to pay) Executive the amounts and to make the arrangements provided for in paragraph 4 hereof, shall be absolute and unconditional and, except as provided in paragraphs 5 and 6 hereof, shall not be affected by any circumstances, including without limitation, any set-off, counterclaim, recoupment, defense or other right which the Company (or any subsidiary of or successor to the Company) may have against Executive. All amounts payable by the Company (or any subsidiary of or successor to the Company) shall be paid without notice or demand. (b) No provisions of this Agreement may be modified, amended, waived or discharged unless such waiver, modification or discharge is agreed to in a writing signed by Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of any similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. (c) This Agreement contains each and every agreement of every kind and nature whatsoever between the parties hereto concerning the subject matter hereof, and all preliminary negotiations and agreements of whatsoever kind with respect to the subject matter hereof are superseded and of no further force or effect. If Executive is entitled to and receives the benefits provided in paragraphs 4 and 7 hereof, performance of the obligations of the Company thereunder shall constitute full settlement of all claims which Executive might otherwise assert against the Company on account of termination of Executive's employment. (d) This Agreement shall be governed by and construed in accordance with the laws of the State of California. (e) This Agreement may be executed in two (2) or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 10 (f) The invalidity or unenforceability of any provision of this Agreement as to any jurisdiction, fact or circumstance shall not affect the validity or enforceability of any other provision of this Agreement or of such provision as to any other jurisdiction, fact or circumstance, and each provision of this Agreement shall be enforced and complied with to the maximum extent possible. (g) Executive shall not have any right to pledge, hypothecate, anticipate or assign this Agreement or the rights hereunder, except by last will and testament. (h) The obligation to pay amounts under this Agreement is an unfunded obligation of the Company, and no such obligation shall create a trust or be deemed to be secured by any pledge or encumbrance on any property of the Company (or any subsidiary of or successor to the Company). (i) In the event of any legal action between the Company and Executive to enforce the provisions of this Agreement, to prevent the breach or continued breach of this Agreement, to recover damages on account of the breach or alleged breach of this Agreement, to seek a judicial determination of the obligations and rights of the parties hereunder or in which this Agreement is asserted as a defense, the prevailing party shall be entitled to recover from the other party its attorneys' fees incurred in such amount as the court shall determine to be reasonable, in addition to its costs and all other relief which the court determines such prevailing party is entitled to receive. For the purposes of this provision, the term "legal action" shall exclude an action by Executive as the result of any termination of Executive's employment. Except as provided in the immediately preceding sentence, all legal expenses which are reasonable and necessary and which are associated with any such termination shall be paid by the Company. (j) In the event Executive is employed by a subsidiary of the Company rather than the Company itself, all references herein to the Company shall, as and when required by the context of this Agreement, be deemed to refer to such subsidiary employer. The provisions of this subparagraph shall not, however, be deemed or construed to relieve the Company of any of the Company's obligations or to deprive the Company of any of its rights pursuant to this Agreement. 11 IN WITNESS WHEREOF, Executive and the Company have executed and delivered this Severance Compensation Agreement as of the day and year first above written. SOUTHWEST WATER COMPANY, a Delaware - - -------------------------------- corporation "Executive" Address for Notices: By /s/ MONROE HARRIS ---------------------------------- Monroe Harris Southwest Water Company Title: - - ---------------------------------- -------------------------------- 225 N. Barranca Avenue - Suite 200 Chairman Compensation Committee - - ---------------------------------- "Company" West Covina, CA 91791-1605 - - ---------------------------------- Address for Notices: Southwest Water Company 225 North Barranca Avenue, Suite 200 West Covina, California 91791-1605 Attn: Corporate Secretary 12 EX-10.10B 3 2ND AM. OF RTNT RIGHT OF 1ST REFUSAL AGREEMENT Exhibit 10.10B Second Amendment of RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement This Second Amendment of RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement is made and entered into by RTNT, Inc., a Texas Corporation ("RTNT') and Southwest Water Company, Inc., a Delaware Corporation ("SWWC") to be effective the 30th day of December 1998. RECITALS WHEREAS, SWWC and RTNT have previously entered into an RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement ("RTNT Call Agreement") which was executed as of May 23, 1996; and WHEREAS this RTNT Call Agreement placed certain restrictions on stock in Windermere Utility Co., Inc. ("WUC") held by SWWC; and WHEREAS SWWC AND RTNT have previously entered into a "First Amendment of RTNT Right of First Refusal Agreement and RTNT Call purchase Agreement" ("RTNT First Amendment") which was effective the 22nd of May 1998; and WHEREAS this RTNT Call Agreement and RTNT First Amendment gave RTNT certain rights to the WUC stock held by SWWC; and WHEREAS the RTNT Call Agreement and RTNT First Amendment had certain time periods in which the rights of RTNT were exercisable; and WHEREAS SWWC and RTNT also entered into a "SWWC Right of First Refusal and SWWC Call Purchase Agreement" ("SWWC Call Agreement"); and WHEREAS SWWC AND RTNT also entered into a "First Amendment of SWWC Right of First Refusal Agreement and SWWC Call purchase Agreement" ("SWWC First Amendment"); and WHEREAS the parties hereto being the parties to the SWWC Call Agreement, the SWWC First Amendment, the RTNT Call Agreement, and the RTNT First Amendment for various reasons wish to extend all the time periods for the exercise of the various rights of RTNT under the RTNT Call Agreement and the RTNT First Amendment; and NOW, THEREFORE, for and in consideration of the premises and the mutual covenants and ten dollars ($10.00) and other good and valuable consideration hereinafter set forth and for other good and valuable consideration including but not limited to the promises of the parties, the parties hereby agree as follows: 1. (a) The first sentence of Paragraph 1 of the RTNT Call Agreement which is entitled "Restriction on SWWC Stock" shall be amended to read as follows: 1 "SWWC shall not sell, transfer, assign, or otherwise dispose of the SWWC WUC stock or any portion thereof to any person or entity for period ending on March 31, 1999 plus the period of closing which may be required pursuant to this RTNT Call Agreement for RTNT to close the purchase of thc SWWC WUC stock upon which it exercises its right to purchase within said period ending on March 31. 1999." (b) The last sentence of Paragraph 1 of the RTNT Call Agreement which Is entitled "Restriction on SWWC Stock" shall be amended to read as follows: "Any pledge of the SWWC WUC stock shall specifically state that it can be released within the first twelve (12) months for the Three Million Six Hundred Thousand Dollar ($3,600,000.00) call amount and in the thirteenth (13th) through the twenty-fourth (24th) month for the Three Million Seven Hundred Twenty Thousand Dollar ($3,720,000.00) call amount and within the months June 1998 through March 1999 for a call amount of Three Million Nine Hundred Thirty Thousand Dollar ($3,930,000.00) " 2. The provisions of Paragraph 2 of the RTNT Call Agreement which is entitled "Call by RTNT," specifically, the first two sentences of Paragraph 2 of the RTNT Call Agreement shall be amended to read as follows: "RTNT shall have, for a period ending on March 31, 1999, the right to require SWWC to sell all of the SWWC WUC stock to RTNT. The purchase price for a sale that is initiated (under the closing procedure set out below) within the first three hundred sixty-five (365) days after the date hereof shall be Three Million Six Hundred Thousand Dollars ($3,600,000.00) and the purchase price for a sale that is initiated (under the closing procedures set out below) within the period beginning on the three hundred sixty-sixth (366th) day and ending on the seven hundred thirtieth (730th) day after the date hereof shall be Three Million Seven Hundred Twenty Thousand Dollars ($3,720,000.00) and for an option price after the seven hundred thirtieth (730th) day and continuing until March 31, 1999, the price shall be as follows: Three Million Nine Hundred Thirty Thousand Dollars ($3,720,000.00)." 3. The first two sentences of Paragraph 5 of the RTNT Call Agreement which is entitled "Offer to SWWC" shall be amended to read a follows: "In the period following the expiration of the RTNT Call Purchase Provision on March 31, 1999, RTNT shall have a Right of First Refusal as set forth below. SWVWC shall, after the expiration of such period terminating on March 31, 1999, not sell, transfer, assign, or otherwise dispose of the SWWC WUC Stock or any portion thereof to any person and/or entity except as provided herein." 4. The RTNT Call Agreement, the RTNT Call Agreement, the First Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement, the First Amendment to RTNT Right of First Refusal Agreement, and the Equity Agreement and the documents referred to therein, (a) constitute the entire agreement among the parties and supercede all prior agreements and understanding, both written and oral, among the parties with respect to the subject matter hereof, (b) may be executed in several counterparts, each of which shall constitute one and the same instrument, (c) except as expressly set forth herein, shall inure to the benefit of, and be binding upon, the successors, assigns. legal representatives, administrators, and heirs of each party and are not intended to confer upon any person other 2 than the parties and their successors assigns, legal representatives, administrators, and heirs any rights or remedies hereunder, and (d) shall be governed in all respects, including validity, interpretation, and effect by the laws of the state of Texas. The captions in this Second Amendment to RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement are for convenience of reference only and shall not affect its interpretation in any respect. 5. Any notice consent or communication required or permitted to be given under this First Amendment to RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement must be in writing and delivered to a person or by confirmed facsimile or by registered mail, return receipt requested, postage prepaid addressee restricted as follows: To: RTNT, Inc., P.O. Box 161173 Austin Texas 78716 (tel.) 512-327-0869 (fax) 512-327-0869 To: Southwest Water Company 225 North Barranca Avenue Suite 200 West Covina California 91791-1605 (tel.) 626-915 1551 (fax) 626-915-1558 ANY SUCH NOTICE CONSENT OR OTHER COMMUNICATION SHALL BE DEEMED GIVEN WHEN DELIVERED IN PERSON OR SENT BY CONFIRMED FACSIMILE OR IF MAILED, FIVE (5) DAYS AFTER MAILING. 6. Any provision of this Second Amendment to RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement which is prohibited or unenforceable in any jurisdiction as to such jurisdiction be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions of this Second Amendment to RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. 7. This Second Amendment to RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement shall be subject to the RTNT and SWWC Arbitration Agreement dated to be effective the 23rd of May 1996. 8. This Second Amendment to RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement shall be binding upon and inure to the benefit of SWWC and RTNT and their respective successors, representatives and assigns. 9. For purposes hereof, a facsimile copy of this Second Amendment of RTNT Right of First Refusal and RTNT Call Purchase Agreement including the signature pages hereto shall be deemed to be an original. Notwithstanding the forgoing, the parties shall deliver original execution copies of this First Amendment of RTNT Right of First Refusal and RTNT Call Purchase Agreement to one another immediately after execution. 3 Executed as of the 15nd day of January 1999, to be effective the 30th day of December 1998. RTNT, INC., a Texas Corporation By: /s/ Thom W. Farrell -------------------- THOM W. FARRELL, PRESIDENT SOUTHWEST WATER COMPANY By: /s/ Anton C. Garnier --------------------- ANTON C. GARNIER, PRESIDENT ATTEST: /s/ Peter J. Moerbeek - - --------------------- PETER MOERBEEK, VICE PRESIDENT AND SECRETARY 4 EX-10.10D 4 2ND AM OF SWWC RIGHT OF 1ST REFUSAL AGREEMENT Exhibit 10.10D Second Amendment of SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement This Second Amendment of SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement is made and entered into by RTNT, Inc., a Texas Corporation ("RTNT') and Southwest Water Company, Inc., a Delaware Corporation ("SWWC") to be effective the 30th day of December 1998. RECITALS WHEREAS, SWWC and RTNT have previously entered into an SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement ("SWWC Call Agreement") which was executed as of May 23, 1996; and WHEREAS this SWWC Call Agreement placed certain restrictions on stock in Windermere Utility Co., Inc. ("WUC") held by RTNT; and WHEREAS SWWC AND RTNT have previously entered into a "First Amendment of SWWC Right of First Refusal Agreement and SWWC Call purchase Agreement" ("SWWC First Amendment") which was effective the 22nd of May 1998; and WHEREAS this SWWC Call Agreement gave SWWC certain rights to the WUC stock held by RTNT; and WHEREAS the SWWC Call Agreement had certain time periods in which the rights of RTNT were exercisable; and WHEREAS SWWC and RTNT also entered into a "RTNT Right of First Refusal and RTNT Call Purchase Agreement" ("SWWC Call Agreement"); and WHEREAS SWWC AND RTNT also entered into a "First Amendment of RTNT Right of First Refusal Agreement and SWWC Call purchase Agreement" ("RTNT First Amendment"); and WHEREAS the parties hereto being the parties to the SWWC Call Agreement and the RTNT Call Agreement, for various reasons wish to extend all the time periods for the exercise of the various rights of SWWC under the SWWC Call Agreement; and NOW, THEREFORE, for and in consideration of the premises and the mutual covenants and ten dollars ($10.00) and other good and valuable consideration hereinafter set forth and for other good and valuable consideration including but not limited to the promises of the parties, the parties hereby agree as follows: 1. The first sentence of Paragraph 1 of the SWWC RTNT Call Agreement which is entitled "Restriction on RTNT Stock" shall be amended to read as follows: 1 "RTNT shall not sell, transfer, assign, or otherwise dispose of the RTNT WUC stock or any portion thereof to any person or entity for period ending three hundred (300) days after the third anniversary of the date hereof." 2. The provisions of Paragraph 2 of the SWWC Call Agreement which is entitled "Call by SWWC," specifically, the first sentence of Paragraph 2 of the SWWC Call Agreement shall be amended to read as follows: SWWC shall have, for a period beginning on the day after March 31, 1999 and ending three hundred (300) days after the third anniversary date of this SWWC Call Agreement, the right to require RTNT to sell all of the RTNT WUC stock it owns in WUC at that time." 3. Paragraph 3 of the SWWC Call Agreement which is entitled "Offer to RTNT" shall be amended by amending the first sentence to read as follows: "RTNT shall, after such three hundred (300) days following the third anniversary hereof, not sell, transfer, assign, or otherwise dispose of the RTNT WUC Stock or any portion thereof to any person and/or entity except as provided herein." 4. The first sentence of Paragraph 4 of the SWWC Call Agreement entitled "RTNT Call Agreement: shall be amended as follows: "The provisions of Paragraphs 1, 2, and 3 above have no further effect if prior to March 31 1999 exercises its right to call upon SWWC to sell all of its stock in WUC pursuant to the RTNT Right of First Refusal Agreement and RTNT Call Purchase Agreement of even date herewith and closes and funds said purchase." 5. The SWWC Call Agreement, the RTNT Call Agreement, the SWWC First Amendment, the RTNT First Amendment, the Second Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement, the Second Amendment to RTNT Right of first Refusal Agreement and the Equity Agreement and the documents referred to therein, (a) constitute the entire agreement among the parties and supercede all prior agreements and understanding, both written and oral, among the parties with respect to the subject matter hereof, (b) may be executed in several counterparts, each of which shall constitute one and the same instrument, (c) except as expressly set forth herein, shall inure to the benefit of, and be binding upon, the successors, assigns. legal representatives, administrators, and heirs of each party and are not intended to confer upon any person other than the parties and their successors assigns, legal representatives, administrators, and heirs any rights or remedies hereunder, and (d) shall be governed in all respects. including validity, interpretation, and effect by the laws of the state of Texas. The captions in this First Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement are for convenience of reference only and shall not affect its interpretation in any respect. 6. Any notice consent or communication required or permitted to be given under this First Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement must be in writing and delivered to a person or by confirmed facsimile or by registered mail, return receipt requested, postage prepaid addressee restricted as follows: 2 To: RTNT, Inc., P.O. Box 161173 Austin Texas 78716 (tel.) 512-327-0869 (fax) 512-327-0869 To: Southwest Water Company 225 North Barranca Avenue Suite 200 West Covina California 91791-1605 (tel.) 626-915 1551 (fax) 626-915-1558 ANY SUCH NOTICE CONSENT OR OTHER COMMUNICATION SHALL BE DEEMED GIVEN WHEN DELIVERED IN PERSON OR SENT BY CONFIRMED FACSIMILE OR IF MAILED, FIVE (5) DAYS AFTER MAILING. 6. Any provision of this Second Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement which is prohibited or unenforceable in any jurisdiction as to such jurisdiction be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions of this First Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. 7. This Second Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement shall be subject to the RTNT and SWWC Arbitration Agreement dated to be effective the 23rd of May 1996. 8. This Second Amendment to SWWC Right of First Refusal Agreement and SWWC Call Purchase Agreement shall be binding upon and inure to the benefit of SWWC and RTNT and their respective successors, representatives and assigns. 9. For purposes hereof, a facsimile copy of this Second Amendment of SWWC Right of First Refusal and SWWC Call Purchase Agreement including the signature pages hereto, shall be deemed to be an original. Notwithstanding the forgoing, the parties shall deliver original execution copies of this Second Amendment of SWWC Right of First Refusal and SWWC Call Purchase Agreement to one another immediately after execution. Executed as of the 15th day of January 1999, to be effective the 30th day of December 1998. RTNT, INC., a Texas Corporation By: /s/ Thom W. Farrell ------------------- THOM W. FARRELL, PRESIDENT SOUTHWEST WATER COMPANY 3 By: /s/ Anton C. Garnier ---------------------- ANTON C. GARNIER, PRESIDENT ATTEST: /s/ Peter J. Moerbeek - - --------------------- PETER MOERBEEK, VICE PRESIDENT AND SECRETARY 4 EX-21.1 5 LIST OF REGISTRANT'S SUBSIDIARIES Exhibit 21.1 SOUTHWEST WATER COMPANY SUBSIDIARIES OF THE REGISTRANT As of March 31, 1999
Jurisdiction of Name of Subsidiary Incorporation Parent - - -------------------------------------------------------------------------------------- Suburban Water Systems California Southwest Water Company Water Suppliers Mobile Communication Service California Suburban Water Systems New Mexico Utilities New Mexico Southwest Water Company ECO Resources, Inc. Texas Southwest Water Company Southwest Environmental Labs Texas ECO Resources, Inc. Wastewater Rehabilitation, Inc. Texas Southwest Water Company SW Utility Company Texas Southwest Water Company Southwest Resource Management Delaware Southwest Water Company SOCI, Inc. (1) Delaware Southwest Water Company SW Operating Services Co. (1) Delaware Southwest Water Company
All above listed subsidiaries have been included in the Registrant's consolidated financial statements. (1) Inactive EX-23.1 6 CONSENT OF KPMG PEAT MARWICK LLP Exhibit 23.1 KPMG LLP (Company Letterhead) 725 South Figueroa Street Los Angeles, CA 90017 To the Board of Directors and Stockholders Southwest Water Company We consent to incorporation by reference in the registration statement (No. 33- 21154) on Form S-3 and the registration statements (Nos. 33-28918, 33-28919, 33- 73174 and 333-38935) on Form S-8 of Southwest Water Company of our report dated January 27, 1999, relating to the consolidated balance sheets of Southwest Water Company and subsidiaries as of December 31,1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity and cash flows and related schedule for each of the years in the three-year period ended December 31, 1998, which report appears in the December 31, 1998 annual report on Form 10-K of Southwest Water Company. /s/ KPMG LLP Los Angeles, California March 25, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 394,000 0 9,525,000 895,000 0 11,610,000 149,368,000 40,130,000 129,927,000 14,288,000 28,900,000 0 517,000 42,000 34,046,000 34,584,000 0 72,146,000 0 64,091,000 (378,000) 319,000 2,984,000 5,540,000 2,191,000 3,349,000 0 0 0 3,322,000 0.79 0.77
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