American States Water Company (AWR) — Q2 2018 Form 10-Q
Business and period: Unaudited results for the quarter and six months ended June 30, 2018, compared with 2017. AWR’s regulated California utility subsidiary, Golden State Water Company (GSWC), serves about 260,000 water and 24,000 electric customers; American States Utility Services (ASUS) operates and builds water and wastewater systems at U.S. military bases.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Operating revenue | $106.9M | $113.2M | $201.6M | $212.0M |
| Operating income | $25.6M | $42.0M | $44.3M | $66.6M |
| Net income | $16.3M | $22.8M | $27.1M | $35.5M |
| Diluted EPS | $0.44 | $0.62 | $0.73 | $0.96 |
| Operating margin | 23.9% | 37.1% | 22.0% | 31.4% |
Q2 water, electric and contracted-services revenue was $76.7M, $7.8M and $22.3M, respectively. Six-month segment revenue was $141.1M, $17.7M and $42.8M. AWR’s non-GAAP water gross margin was $55.8M in Q2 and $104.7M for the half, down 9.1% and 7.8%; electric gross margin was $5.0M and $10.9M, down 2.4% year to date.
Six-month operating cash flow was $65.1M, capital expenditures were $58.8M, and cash increased to $5.6M. At June 30, total current assets were $141.2M and current liabilities $129.8M. Debt included $281.0M long-term, $40.3M current maturities and $77.0M drawn on AWR’s bank facility. The renewed $150M facility had $72.1M available and matures in May 2023. The declared quarterly dividend was $0.255 per share; the board subsequently approved $0.275 for Q3.
Changes and notable items
- Revenue fell 5.6% in Q2 and 4.9% for the first half. Net income fell 28.3% and 23.6%, respectively. Comparisons were affected by the 2017 $8.3M pretax gain from the Ojai water-system sale ($0.13 per share); adjusted diluted EPS was $0.44 versus $0.49 in Q2 and $0.73 versus $0.83 year to date.
- The Tax Act lowered AWR’s effective tax rate to 20.4% for the first half from 37.4%. Lower customer revenue requirements largely offset the lower tax expense, with no material net earnings impact attributed to the tax-related rate adjustments.
- Water earnings faced lower authorized returns, the Ojai system’s removal from operations and higher supply costs. The CPUC reduced GSWC water’s authorized return on equity to 8.90% from 9.43% and return on rate base to 7.91% from 8.34%; the company estimated about $3.6M lower 2018 annual revenue requirement, including Tax Act effects.
- ASUS contracted-services earnings declined amid lower construction revenue and the absence of prior-year retroactive Fort Bragg fees. ASUS began Fort Riley operations on July 1, 2018 under a 50-year contract initially valued at $601M. Management expects construction revenue to rise in the second half of 2018; remaining performance obligations were $3.1B, primarily under long-term U.S. government contracts.
Outlook, risks and contingencies
- GSWC estimated 2018 company-funded capital expenditures of $110M–$120M; $53.5M was spent in the first half. Management expects continued borrowing to support operations and capital spending. A $40M GSWC senior note matures in March 2019, with repayment expected through AWR intercompany borrowing and/or new long-term debt.
- Pending CPUC general rate cases could affect future revenues: the water case was expected to receive a decision in Q4 2018 for rates beginning in 2019; an electric case decision was expected in 2018, retroactive to January 1.
- Water-supply risks include drought, groundwater availability and higher purchased-water needs. California’s new permanent water-use targets begin in 2022; management said details and cost recovery remained uncertain. As of July 31, 2018, the U.S. Drought Monitor classified 21% of California in severe drought and 45% in moderate drought. State Water Project allocation was 35% of requested orders.
- Other key risks include wildfire and fire-prevention costs in GSWC’s electric territory, regulatory cost recovery, water-quality requirements, interest rates and access to financing, and the timing of U.S. government payments, contract price adjustments and construction work. Routine litigation was disclosed; management did not expect pending matters to materially affect results. The Chadron cleanup had an estimated $1.3M remaining cost, believed probable for CPUC recovery.
Investor verification priorities
- Track CPUC decisions and the earnings and rate-base effects of the water and electric rate cases and authorized-return reduction.
- Assess whether ASUS construction activity, Fort Riley contract economics and government payment timing support the expected second-half improvement.
- Verify capital-spending funding, facility availability and refinancing plans for the March 2019 $40M maturity.
- Monitor drought conditions, water sourcing costs, conservation requirements and wildfire-related costs and recoveries.
- Distinguish recurring performance from the Ojai sale gain and other prior-period adjustments when comparing EPS and margins.