Business context and reporting period
American States Water Company (AWR) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. AWR’s principal operations are regulated California water and electric utility Golden State Water Company (GSWC), plus military-base water and wastewater contractor ASUS. AWR completed the sale of Arizona utility Chaparral City Water Company (CCWC) on May 31, 2011; CCWC’s results are reported as discontinued operations.
Financial performance and position
Amounts below are in millions of dollars except per-share amounts. AWR consolidated results include continuing and discontinued operations where indicated.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Operating revenue | $109.8 | $95.5 | $204.1 | $183.9 |
| Operating income | $29.1 | $21.2 | $47.1 | $40.3 |
| Income from continuing operations | $12.7 | $8.9 | $19.7 | $17.2 |
| Net income, including discontinued operations | $16.0 | $9.0 | $23.6 | $17.5 |
| Diluted EPS, continuing operations | $0.68 | $0.47 | $1.05 | $0.91 |
| Diluted EPS, total | $0.85 | $0.48 | $1.25 | $0.93 |
- Revenue increased 15% in Q2 and 11% year to date; operating income rose 38% and 17%, respectively. Revenue growth was led by CPUC-approved water rate increases. Water consumption nevertheless declined 5% in Q2 and 3% year to date.
- Q2 non-GAAP water margin was $57.2 million, up 12.6%, with a 71.3% margin rate versus 69.7%. Electric margin was $4.6 million, up 14.2%, with a 60.0% margin rate versus 51.6%. For the first half, water margin rose 13.8% to $104.9 million and electric margin rose 1.4% to $10.2 million. Management cautions these margin measures are non-GAAP.
- Net cash from operations was $32.9 million for the first half, versus $29.5 million. Capital expenditures were $37.3 million. The $29.0 million CCWC sale proceeds largely offset investing cash outflow; dividends paid were $10.1 million.
- At June 30, cash was $11.3 million; long-term debt was $340.4 million, with $12.0 million of bank notes payable and $0.4 million of current long-term debt. AWR reported $75.6 million available under its $100 million revolving credit facility and $12.4 million of outstanding letters of credit.
- GSWC issued $62 million of unsecured 6% notes due 2041, using part of the proceeds to redeem $22 million of 7.65% notes. The redemption premium and debt-cost write-off added $553,000 to Q2 interest expense. The remaining lower-rate debt is expected to reduce interest costs by about $182,000 in the second half of 2011.
- GSWC standalone net income was $10.0 million in Q2 versus $8.1 million, and $16.4 million for the first half versus $11.7 million.
Material changes versus prior periods
- Higher regulated water rates drove much of the increase in utility revenue and earnings. Q2 water revenue rose 10%; first-half water revenue rose 12%.
- Contracted-services revenue rose 48% in Q2, partly reflecting construction activity and a $2.9 million pretax benefit from revised Fort Bragg pipeline-project cost estimates. First-half contracted-services earnings declined: the prior-year period included $5.6 million of contract-modification revenue and interest income, partly offsetting current-year construction growth.
- First-half depreciation and amortization increased 15% to $19.3 million, primarily due to higher depreciation rates and utility-plant additions. Interest expense increased 9% to $12.6 million.
- CCWC’s sale generated a reported after-tax gain of about $2.3 million. Total discontinued-operations income was $3.9 million for the first half, versus $0.3 million in 2010; this is not a recurring continuing-operations contribution.
Outlook, commentary, risks and contingencies
- Management estimated 2011 capital expenditures of approximately $75–$80 million, principally for utility infrastructure. It expects depreciation expense to continue rising with construction and says approved utility-plant additions are expected to be recovered through rates.
- GSWC filed a general rate case in July 2011 seeking annual revenue increases of about $31.3 million starting in 2013, followed by proposed increases of $9.1 million in 2014 and $11.5 million in 2015. These are requests, not approved rates. A cost-of-capital decision was expected in Q1 2012.
- Management cited risks from regulatory timing and rate recovery, water supply and weather, higher operating and capital costs, and delayed federal contract price redeterminations or equitable adjustments. ASUS contract construction revenue and related earnings may vary with project awards and estimates. Fort Monroe service was scheduled to end September 3, 2011 as anticipated under its contract.
- A proposed CPUC settlement of a procurement investigation would provide $9.5 million in customer refunds over 12–36 months, $3.0 million in rate-base and other rate adjustments, and a $1.0 million penalty. A 2010 reserve had been recorded; CPUC approval was pending. Three independent audits over ten years could lead to further cost disallowances, and their outcome and cost were not predictable.
- Other exposures include water-contamination litigation with an uncertain outcome, possible municipal acquisition or condemnation efforts affecting Apple Valley and Ojai systems, and a $1.2 million estimated remaining environmental cleanup liability. Management also noted potential renewable-energy compliance penalties but recorded no provision, believing waivers were likely under CPUC flexible-compliance rules.
- Water supply conditions improved: MWD ended its regional allocation plan in April 2011, and the state raised projected 2011 State Water Project deliveries to 80% of requests. GSWC continued monitoring supply risks. AWR declared a $0.28-per-share quarterly dividend payable September 1, 2011, subject to the stated conditions on future dividends.
Most important facts for investors to verify
- Separate recurring continuing earnings from the CCWC sale gain and other discontinued-operation items; assess the sustainability of the $2.9 million Fort Bragg estimate benefit.
- Track CPUC decisions on the pending rate case, cost of capital, procurement settlement, and recovery of regulatory-account balances.
- Monitor water usage, supply costs, water availability, and the collection timing of regulatory assets, including WRAM/MCBA balances.
- Review ASUS contract price redeterminations, equitable adjustments, project margins, and federal payment timing.
- Assess funding needs against planned $75–$80 million capital expenditures, debt service, available credit, and dividend commitments.
- Follow litigation, environmental remediation, renewable-energy compliance, and any further procurement-audit or cost-disallowance developments.