American States Water Company (AWR) — Q3 2013 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2013; results are unaudited. AWR owns Golden State Water Company (GSWC), a California water and electric utility, and American States Utility Services (ASUS), which operates water and wastewater systems at U.S. military installations. AWR’s results are primarily driven by GSWC. Unless noted, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Operating revenue | $130.9 | $133.9 | $362.2 | $355.4 |
| Operating income | $36.2 | $36.5 | $97.4 | $90.0 |
| Net income | $20.8 | $18.7 | $50.9 | $43.9 |
| Diluted EPS | $0.53 | $0.48 | $1.31 | $1.15 |
| Operating margin | 27.6% | 27.2% | 26.9% | 25.3% |
Q3 revenue declined 2.2%, primarily because contracted-services revenue fell 18.1% to $28.1 million on lower military-base construction activity. Water revenue rose 3.2% to $93.9 million, reflecting CPUC-approved rates; electric revenue increased 3.5% to $8.8 million. Net income rose 11.7%, helped by lower income-tax expense, including a parent-level tax benefit. For the first nine months, revenue increased 1.9% and net income increased 16.1%.
Water gross margin was $67.8 million in Q3, up 6.4%, and $183.3 million year to date, up 7.1%. Electric gross margin was $5.2 million in Q3, up 2.8%, and $16.3 million year to date, down 0.7%. These are company-defined, non-GAAP measures and exclude several operating expenses.
For the first nine months, operating cash flow was $87.3 million, versus $91.6 million a year earlier; capital expenditures were $69.1 million, versus $48.2 million. Cash increased to $26.2 million from $23.5 million at year-end 2012. Long-term debt was $332.1 million, with $3.4 million current; no borrowings were outstanding on AWR’s $100 million revolving facility, although $18.1 million of letters of credit left $81.9 million available. AWR total assets were $1.35 billion and shareholders’ equity $486.9 million at quarter-end. GSWC reported $25.7 million cash and $332.1 million long-term debt; management notes its current liabilities may exceed current assets at times.
Material changes and management commentary
- CPUC’s May 2013 water rate-case decision set rates for 2013–2015, retroactive to January 1, and was expected to add about $10 million in 2013 revenue versus 2012 adopted levels. The adopted water gross margin was forecast to rise about $14 million, or 6.6%; 2014–2015 increases remain subject to an earnings test and market indices.
- GSWC’s water capital spending is expected to average about $85 million annually over 2013–2015, excluding work funded by others. AWR’s capital program and higher future interest rates may increase financing needs and interest expense.
- ASUS’s Q3 results were affected by reduced construction activity, weather-related delays and lower work at Fort Bliss. The U.S. government awarded about $18.5 million of new construction projects in Q3, most expected to be completed within 12 months; such work and related earnings may not recur. A major Fort Bragg pipeline project was expected to finish in early 2014.
- Management reported California precipitation and snowpack below normal, reduced State Water Project allocation to 35%, and declining groundwater levels in some basins. Continued dry conditions could lead to mandatory conservation in some service areas.
- AWR recorded a $1.5 million cumulative tax benefit related to employee-benefit-plan deductions; about $1.4 million related to prior periods and depends in part on management’s intention to amend open-year tax returns. This benefit boosted parent-segment earnings and lowered AWR’s reported effective tax rate.
- In September, methane gas and water flowed from an out-of-service well being destroyed. Nearby residents were evacuated and returned after the well was capped; costs were recorded, but management could not predict whether further claims would arise.
Risks, contingencies and other notable items
- Rate recovery, CPUC decisions and timing, potential cost disallowances, procurement audits, and the pending Bear Valley electric rate case could affect earnings. The first of three independent procurement audits was expected to begin in early 2014; management could not estimate any resulting loss.
- ORA’s positions in the electric rate case could require a $2.0 million depreciation adjustment and a write-off of half of $1.9 million in deferred rate-case costs. Management disputed those recommendations and could not predict the outcome.
- Claremont and an Ojai-area water district have expressed interest in acquiring GSWC systems through condemnation. GSWC rejected Claremont’s offers and challenged the Ojai district’s proposed funding mechanism; outcomes are uncertain.
- Four Barstow perchlorate lawsuits were dismissed on summary judgment on October 23, 2013; plaintiffs could appeal. The Chadron remediation estimate included $1.0 million of additional cleanup costs, which management considered likely recoverable in rates.
- The CPUC-approved renewable-energy credit agreement covers about 582,000 credits over ten years. BVES’s August 2013 report showed no RPS procurement deficiencies or potential penalties.
- AWR completed a two-for-one share split in September 2013. The board approved a Q4 dividend of $0.2025 per share, payable December 2, 2013. AWR also reported a stable S&P A+ rating; Moody’s affirmed GSWC’s A2 rating with stable outlook.
Most important facts for investors to verify
- Whether the water-rate decision and surcharge collections translate into sustainable earnings and timely recovery of regulatory assets, including the $29.2 million net WRAM/MCBA asset.
- Whether drought, supply costs and groundwater conditions require conservation measures or raise operating costs.
- Progress and final outcomes in the BVES rate case, procurement audits, condemnation matters and any claims arising from the well incident.
- ASUS project timing, military contract price redeterminations and the level of construction activity supporting contracted-services earnings and cash receipts.
- Capital-spending funding needs, access to financing, and the effect of higher interest rates on debt costs and dividends.
- The sustainability of reported earnings growth after separating the one-time tax benefit and CPUC-approved recoveries of previously incurred costs.