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, 2020. AWR’s businesses include California water and electric utilities and contracted water and wastewater services at U.S. military installations. Golden State Water Company (GSWC) is a separately reporting subsidiary. Unless noted, amounts below are AWR consolidated and in millions of dollars; per-share amounts are dollars.
On July 1, 2020, GSWC transferred its electric utility assets and liabilities to Bear Valley Electric Service, Inc. (BVESI), which became directly owned by AWR. Management said the reorganization was not expected to substantively change AWR’s operations or segments.
Financial results and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Operating revenue | $121.3 | $124.6 | $230.4 | $226.4 |
| Operating income | $35.7 | $39.4 | $61.4 | $59.6 |
| Net income | $25.6 | $26.8 | $39.7 | $39.6 |
| Diluted EPS | $0.69 | $0.72 | $1.07 | $1.07 |
| Operating margin | 29.5% | 31.6% | 26.7% | 26.3% |
| Net margin | 21.1% | 21.5% | 17.2% | 17.5% |
Margins are calculated from reported revenue and income. Q2 2020 water gross margin, a company-defined non-GAAP measure, was $62.9 million, up 1.3%; electric gross margin was $5.5 million, up 22.4%. For the first half, water gross margin was $116.5 million, up 5.4%, and electric gross margin was $13.3 million, up 24.8%.
- Cash flow: First-half operating cash flow was $46.3 million versus $44.7 million. Capital expenditures were $62.6 million versus $81.2 million, leaving operating cash flow less capital expenditures of negative $16.3 million versus negative $36.5 million. Cash ended at $6.5 million.
- Debt and liquidity: At June 30, AWR had $200.0 million of long-term bank borrowings and $49.0 million classified as current, plus $280.9 million of long-term debt and $0.4 million current long-term debt. Current assets were $137.0 million and current liabilities $158.7 million. GSWC separately reported $199.2 million of intercompany borrowings from AWR, classified current.
- Equity and dividends: AWR shareholders’ equity was $619.3 million at June 30, compared with $601.5 million at year-end 2019. Q2 dividends declared were $0.305 per share. On July 28, the board approved a 9.8% increase to $0.335 per share for the third quarter.
Material changes versus prior comparable period
- Q2 revenue declined 2.7% and net income fell 4.4%; diluted EPS decreased from $0.72 to $0.69. Water revenue was lower year over year partly because Q2 2019 included retroactive rate-case revenue, while contracted-services revenue fell with lower construction activity. Q2 2019 also included a $0.08-per-share retroactive water-rate-case benefit and a $1.1 million reduction in previously tracked costs.
- Management attributed a Q2 water-segment earnings benefit of about $0.04 per share to higher investment gains on retirement-plan assets. Excluding the noted unusual comparison items, water-segment EPS increased about $0.01 year over year. Higher utility expenses, including depreciation and maintenance, weighed on Q2 operating income.
- For the first half, revenue rose 1.8%, operating income rose 3.0%, and net income was essentially unchanged. Water rate increases lifted water gross margin; lower electric supply costs and new rates lifted electric gross margin. Maintenance expense increased 42.0%, while contracted-services revenue declined 4.1% amid lower construction activity.
Outlook, commentary, risks and unusual items
- Rates and investment: The 2020 water rate step increase is expected to add $10.4 million to 2020 water gross margin. A further approximately $11.4 million increase in 2021 is subject to an earnings test and inflation-index changes. GSWC estimated 2020 company-funded capital expenditures of $105–$120 million, subject to possible COVID-related delays, and filed a 2022–2024 water rate case requesting approximately $450.6 million in capital budgets.
- COVID-19 and collections: Utility service disconnections for nonpayment were suspended through April 2021 under CPUC orders. Management could not predict the pandemic’s financial impact for the remainder of 2020. Customer receivables and expected credit losses increased; the customer doubtful-account allowance was $1.603 million. GSWC recorded $669,000 in COVID-related costs as a regulatory asset for potential future recovery through a Catastrophic Event Memorandum Account.
- Regulatory uncertainty: A July 2020 proposed CPUC decision could replace the water utilities’ full-decoupling WRAM with a limited price adjustment mechanism in a future rate case. Management said the outcome and potential effects were uncertain; a change could increase revenue variability and affect recovery of authorized revenues. The water cost-of-capital filing was deferred to May 2021, with the current 7.91% authorized rate of return continuing through 2021.
- Financing after quarter-end: On July 8, GSWC issued $160 million of unsecured notes: $85 million at 2.17% due 2030 and $75 million at 2.90% due 2040. Proceeds were used mainly to repay intercompany borrowings; AWR used its proceeds to reduce credit-facility borrowings. AWR’s facility capacity returned to $200 million effective July 15, down from a temporary $260 million. BVESI established a $35 million revolving credit facility effective July 1. Management expected interest expense to rise following GSWC’s note issuance.
- Other risks and contingencies: California drought and limited water supplies, wells out of service, PFAS monitoring and treatment costs, wildfires and power shutoffs, pension-asset market volatility, and the timing of regulatory cost recovery remain relevant risks. ASUS’s military contracts are long-term but may be terminated by the U.S. government; construction activity and contract adjustments affect results. GSWC estimated $1.3 million of additional environmental cleanup costs, which it believes are recoverable in rates. Management said pending routine litigation was not expected to have a material effect.
Important facts for investors to verify
- Whether COVID-related customer delinquencies, suspended disconnections and bad-debt expense materially affect cash collections, and whether the CPUC ultimately permits recovery of CEMA costs.
- The outcome and timing of the proposed WRAM rule and the pending 2022–2024 water rate case, including implications for revenue stability and capital recovery.
- Whether GSWC’s stated capital program proceeds on schedule despite COVID-related delays, and the resulting need for external financing.
- Post-issuance debt levels, credit-facility availability and compliance with the new notes’ leverage and distribution covenants.
- Changes in drought conditions, water availability, PFAS-related requirements and wildfire exposure, including potential costs not recoverable from customers, insurance or other parties.
- ASUS construction activity, government payment and contract-adjustment timing, and any changes to its long-term military contracts.