American States Water Company (AWR) — Q3 2014 Form 10-Q
Business and period: Unaudited results for the three and nine months ended September 30, 2014, compared with 2013. AWR’s principal subsidiary, Golden State Water Company (GSWC), provides regulated water and electric service in California; American States Utility Services (ASUS) operates and performs construction on military-base water and wastewater systems under long-term U.S. government contracts. Amounts below are in millions of dollars except per-share data.
Financial performance
| Consolidated AWR | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $138.3 | $130.9 | $355.9 | $362.2 |
| Operating income | $39.9 | $36.2 | $93.7 | $97.4 |
| Net income | $21.2 | $20.8 | $47.5 | $50.9 |
| Diluted EPS | $0.54 | $0.53 | $1.22 | $1.31 |
| Operating margin | 28.8% | 27.6% | 26.3% | 26.9% |
Q3 revenue rose 5.7% and operating income rose 10.3%; net income increased 1.6%, with higher income tax expense limiting the gain. For the first nine months, revenue declined 1.7%, operating income 3.9%, and net income 6.6%. Water revenue increased in both periods, while lower contracted-services revenue drove the year-to-date decline. AWR paid dividends of $0.213 per share in Q3 and $0.618 per share for the nine months.
Margins and segment trends
- Water gross margin was $68.7 million, or 71.0%, in Q3, versus $67.8 million, or 72.2%, a year earlier. For nine months it was $187.4 million, or 73.9%, versus $183.3 million, or 74.1%. Rate increases helped, while increased expenses and supply-cost pass-throughs affected margin percentages.
- Electric gross margin was $5.0 million, or 58.6%, in Q3, versus $5.2 million, or 59.2%; year-to-date it was $16.3 million, or 59.3%, essentially flat in dollars with 2013.
- Contracted-services revenue increased 17.3% in Q3 to $33.0 million, but declined 13.9% for nine months to $74.8 million as major construction projects wound down. Q3 results included $2.6 million of retroactive revenue and pretax operating income from military-contract price redeterminations, about $0.04 per diluted share.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $120.1 million, up from $87.3 million in 2013, principally reflecting timing of construction billings and collections at military bases, utility rate increases and surcharge collections.
- Investing cash outflow was $55.4 million, including $53.7 million of construction expenditures, compared with $70.5 million of investing outflow in 2013.
- Financing cash outflow was $45.0 million, versus $14.1 million, including $15.0 million of debt redemption, $7.1 million of share repurchases and $23.9 million of dividends paid. Cash ended the period at $57.9 million, up from $38.2 million at year-end 2013.
- At September 30, AWR reported $310.8 million of long-term debt and $6.3 million current maturities. Current assets were $186.6 million versus current liabilities of $120.6 million. AWR had no borrowings under its $100 million revolving facility and $82.5 million available after letters of credit.
- GSWC redeemed $15 million of notes bearing 6.87% and 7.00% interest in July and planned to replace them with lower-rate debt in Q4. S&P affirmed A+ ratings and revised the outlook to positive; Moody’s affirmed GSWC’s A2 rating with a stable outlook.
Outlook, commentary and material risks
- GSWC estimated company-funded capital expenditures of $70–$75 million in 2014 and $85–$90 million in 2015; its 2016–2018 water rate-case application requested capital budgets averaging about $90 million annually. Management expects future capital needs and potentially higher interest expense; it said utility construction costs are expected to be recovered through rates.
- GSWC filed a water general rate case in July 2014 for 2016–2018. A final CPUC decision on the electric rate case was expected in Q4 2014; meanwhile, electric revenues used 2012 adopted levels. Rate-setting timing and cost recovery remain important uncertainties.
- California’s drought was severe: GSWC asked customers to reduce use voluntarily by 20%, implemented Stage II water-shortage plans in August 2014, and warned that continued dry conditions could require mandatory rationing, raise supply costs and affect reputation. The filing noted reduced State Water Project allocation and declining groundwater levels in some basins.
- Regulatory and legal contingencies include potential condemnation of GSWC systems in Claremont, Ojai, Apple Valley and Artesia; GSWC’s appeal concerning the Ojai acquisition effort; and CPUC procurement audits that could result in cost disallowances. Management could not estimate any loss from the audits.
- The Sutter Pointe service-area approval faced an application for rehearing. A proposed statewide discharge permit and new water-quality requirements could increase costs; management could not predict some impacts or future monitoring results.
- ASUS contracts are subject to price redeterminations, audits, cost disallowances, government payment timing and possible termination. The U.S. government awarded ASUS about $27 million in new construction projects in Q3, most expected to be completed within 12 months; future construction activity may vary.
Other notable items: AWR authorized repurchases of up to 1.25 million shares through June 30, 2016; 231,298 shares had been repurchased under the program through September. The board approved a Q4 dividend of $0.213 per share. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Subsequent outcomes of the CPUC water and electric rate cases, the Sutter Pointe rehearing, and GSWC’s procurement audits.
- Whether drought conditions lead to mandatory rationing, higher purchased-water costs or additional supply constraints.
- Timing and profitability of ASUS construction work, government price redeterminations, collections and project completions.
- Execution of the planned $15 million debt refinancing, capital spending plans and the effect of financing needs on cash flow and dividends.
- Developments in threatened or proposed condemnations, particularly the status and outcome of the Claremont and Ojai matters.