American States Water Company (AWR) — Q3 2012 Form 10-Q
Business context and reporting period. This unaudited combined filing covers AWR and its wholly owned regulated utility subsidiary, Golden State Water Company (GSWC), for the quarter and nine months ended September 30, 2012, compared with 2011. GSWC provides water and electric service in California; AWR also operates American States Utility Services (ASUS), which manages water and wastewater systems at U.S. military bases under long-term contracts. The prior-year comparison includes discontinued operations from Chaparral City Water Company (CCWC), sold in May 2011.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Operating revenue | $133.5 million | $119.7 million | $354.5 million | $323.8 million |
| Operating income | $36.5 million | $32.4 million | $90.0 million | $79.6 million |
| Income from continuing operations | $18.7 million | $15.6 million | $43.9 million | $35.3 million |
| Net income | $18.7 million | $15.6 million | $43.9 million | $39.2 million |
| Diluted EPS | $0.97 | $0.83 | $2.30 | $2.08 |
Revenue, margins and earnings drivers. Q3 revenue rose 11.5%, with contracted-services revenue up 60.6% to $34.4 million as military-base construction expanded; water revenue increased 1.2% to $90.6 million, while electric revenue declined 2.2% to $8.5 million. For the first nine months, revenue grew 9.5%, primarily from contracted services, which increased 42.6% to $89.3 million. AWR’s reported water gross margin, a non-GAAP measure, was $63.4 million (69.9% of water revenue) in Q3 and $170.4 million (71.7%) year to date. Electric gross margin was $5.1 million (59.6%) in Q3 and $16.4 million (59.2%) year to date. Q3 net income increased 19.6%; nine-month net income increased 12.0%, while continuing-operations income rose 24.2%. The 2011 nine-month net income included $3.9 million from CCWC discontinued operations, including the sale gain.
Cash flow and investment. AWR generated $91.6 million of operating cash in the first nine months, versus $62.6 million a year earlier. Construction expenditures were $48.2 million, compared with $63.6 million. Cash increased to $43.1 million from $1.3 million at year-end 2011. GSWC separately reported $77.7 million of operating cash flow, $47.2 million of construction expenditures and $25.6 million of cash at September 30.
Debt and liquidity. AWR reported $344.2 million of long-term debt, plus $0.2 million current, and no bank notes payable at quarter-end; long-term debt carrying value was $344.4 million, versus estimated fair value of $469.1 million. The $100 million revolving facility had no borrowings, $18.2 million of letters of credit outstanding and $81.8 million available. S&P affirmed AWR’s and GSWC’s A+ ratings with stable outlook in July 2012. AWR estimated 2012 capital expenditures of $70–$75 million.
Material changes and management commentary
- Continuing-operations diluted EPS increased by $0.14 in Q3 and $0.42 year to date. Management attributed improvement to CPUC-approved water rate increases, higher utility margins, lower interest costs and higher ASUS construction activity. Year-to-date electric earnings also benefited from approval to recover previously incurred renewable-energy procurement costs.
- Water rates reflecting previously approved increases took effect in January 2012. A proposed settlement in GSWC’s water general rate case would add about $9.9 million in annual revenue beginning in 2013, with additional proposed increases for 2014 and 2015; CPUC approval remained pending. These are proposals, not guaranteed outcomes.
- Management expected most new military-base construction activity to occur over the next 12 months. The Fort Bragg pipeline replacement project was expected to be substantially completed by the end of 2013. Management cautioned that earnings and cash flows from additional construction modifications may not continue.
- GSWC’s water cost-of-capital decision authorized a 9.99% return on equity and an 8.64% weighted cost of capital; a subsequent formula adjustment was expected to reduce water ROE to 9.43% in 2013 rates. AWR declared a $0.355 quarterly dividend in October 2012.
Risks, contingencies and unusual items
- Regulatory recovery and audits: GSWC’s La Serena project rehearing could result in additional disallowances and customer refunds; DRA’s recommendation would affect about $2.5 million of costs and related revenues through September 30, but management could not estimate any additional loss. A separate challenge to deferred rate-case cost treatment could put approximately $1.9 million at risk. In a BVES rate case, DRA proposed a $2.0 million depreciation adjustment and shareholder responsibility for half of deferred rate-case costs; GSWC also had a $2.2 million deferred-cost regulatory asset.
- Contractor settlement: A prior CPUC settlement requires $9.5 million in customer refunds over 12–36 months and $3.0 million of rate-base and other adjustments. GSWC had refunded $2.2 million through the first nine months of 2012. Three independent procurement audits over ten years could result in further cost disallowances; any outcome was uncertain.
- Other legal and property matters: GSWC could not estimate a loss range in litigation concerning contaminated groundwater. The Chadron remediation liability was estimated at $1.2 million, with a corresponding regulatory asset recorded. Claremont, Apple Valley and Ojai had explored or considered acquiring GSWC water systems through condemnation or other processes; no formal condemnation proceeding was reported.
- Rate and operating risks: Results depend on timely CPUC rate decisions and recovery of costs, water supply availability and cost, infrastructure needs, customer demand, and ASUS price redeterminations, government audits and construction awards. Water and electric usage changes are partly mitigated by CPUC-approved balancing mechanisms, but recovery timing and surcharge limits remain relevant.
- GSWC’s newly approved RPS reporting showed no deficiencies or penalties as of September 30, 2012, and no loss provision was recorded. AWR redeemed $8.0 million of 7.55% notes on October 1, 2012 for $8.3 million, including accrued interest.
Important facts for investors to verify
- Whether the CPUC approved the proposed water general rate case settlement and resolved the WRAM issues, and the actual timing and level of future rate changes.
- Outcomes of the La Serena rehearing, deferred rate-case cost challenges, BVES rate case and procurement audits, including any additional write-offs, refunds or disallowances.
- Whether ASUS price redeterminations and equitable adjustments receive final government approval and whether military construction revenue and margins are sustainable after current projects.
- Progress in recovering WRAM/MCBA balances, customer surcharges and the effect of future surcharge caps on cash collection.
- Capital expenditure funding needs, debt and credit-facility availability, and the effect of the October 2012 debt redemption on financing costs.