AMERICAN STATES WATER CO quarterly report, Q3 FY2016

American States Water Company (AWR) — 2016 Q3 Form 10-Q

Business context and reporting period. This unaudited combined filing covers AWR and its subsidiary Golden State Water Company (GSWC) for the quarter and nine months ended September 30, 2016. GSWC provides regulated water service to approximately 261,000 California customers and electricity to approximately 24,000; AWR’s ASUS subsidiary operates and maintains water and wastewater systems at U.S. military bases under long-term contracts. Unless stated otherwise, financial amounts below are AWR consolidated and in U.S. dollars.

Key financial results and position

• Q3 operating margin was approximately 32.0% versus 31.0%; nine-month operating margin was approximately 28.1% versus 27.7%. Net margin was approximately 17.5% and 14.7%, respectively, compared with 15.9% and 14.0%.
• For the nine months, cash used in investing was $101.4m, including $99.9m of capital expenditures, up from $61.3m of investing outflow and $59.8m of capital expenditures in 2015. Operating cash flow less capital expenditures was negative $22.4m (calculated).
• At September 30, cash was $2.8m; current assets were $136.9m and current liabilities $179.8m. Long-term debt was $320.9m, current maturities $0.3m, and bank notes payable $77.0m. AWR reported a 55% equity / 45% debt capitalization ratio, including short-term borrowings.
• The $100m syndicated credit facility had $77.0m outstanding and $10.4m of letters of credit at quarter-end. AWR increased the facility commitment to $150m in October 2016. The filing says management considers internal cash and borrowing capacity sufficient for normal operations and financing needs.
• AWR paid $0.672 per share in dividends during the first nine months, versus $0.650 in 2015. On November 1, the board approved an 8% increase in the quarterly dividend, to $0.242 per share.

Material changes versus prior periods

• Q3 revenue fell 6.9%; nine-month revenue fell 5.5%. Water revenue declined 6.8% for Q3 and 7.2% year to date, mainly reflecting lower anticipated rate-case revenue requirements. Electric revenue was slightly higher in Q3 but lower year to date; contracted-services revenue declined year to date by 0.7%.
• Despite lower revenue, Q3 net income increased 2.7% and diluted EPS increased from $0.56 to $0.59, helped by lower tax expense and fewer weighted-average shares following 2015 share repurchases. Nine-month net income declined 0.7%, while diluted EPS rose 2.3% to $1.32.
• Water gross margin was $68.4m in Q3, down 1.0%, and $183.2m year to date, down 2.1%. Electric gross margin increased 7.7% to $5.1m in Q3 and 6.6% to $16.7m year to date.
• Operating cash flow declined year over year, while capital spending rose sharply. The company attributed the cash-flow change partly to timing of military-base construction billing and receipts, tax payments, and working-capital movements.
• Q3 contracted-services results lacked the $3.5m of retroactive management-fee revenue recorded in Q3 2015; the comparable nine-month 2015 amount was $3.0m. Improved construction activity and cost efficiencies partly offset the absence of those prior-period items.

Outlook, commentary, risks and unusual items

• Water rate case: A proposed CPUC decision on GSWC’s 2016–2018 water general rate case was expected in Q4 2016. Rates would be retroactive to January 1, 2016. Management said the final decision could cause a material adjustment to first-nine-month results; the outcome remained uncertain. GSWC had recorded lower water revenue, largely offset by related lower supply, depreciation and other expenses.
• Investment and funding: GSWC estimated 2016 company-funded capital expenditures of approximately $105m–$115m; it had incurred $94.5m through September. Management expected capital spending to remain above depreciation and anticipated continued revolving-credit borrowings to fund operations and some capital spending.
• Contract growth: ASUS was awarded a 50-year Eglin Air Force Base contract, estimated at approximately $510m over its term, with an 8–10 month transition underway. The U.S. government awarded ASUS approximately $21m in new construction projects during the first nine months, most expected to be completed in 2017. Contract prices depend on periodic adjustments, and construction activity and government payments may vary.
• Water supply and conservation: California drought conditions continued to pose supply and cost risks, including declining groundwater levels in some basins and possible further mandatory restrictions. The filing cited approximately 62% of California in “Severe Drought” as of October 25, improved from 74% in April. GSWC’s billed water consumption increased approximately 12% in Q3, but the WRAM limits the earnings effect for most conservation-rate customers.
• Regulatory balances: GSWC recorded a $65.4m net WRAM/MCBA regulatory asset at September 30, including a $69.8m WRAM under-collection and $4.4m MCBA over-collection. Recovery depends on regulatory mechanisms and timing. Total regulatory assets, net of regulatory liabilities, were $154.1m for GSWC.
• Legal and other contingencies: Eminent-domain proceedings involving GSWC’s Claremont and Ojai water systems remain unresolved; their net book values were approximately $49.3m and $22.4m, respectively. Management could not predict the outcomes. A separate complaint concerns a 2014 water-main break and property damage; GSWC stated it believed insurance coverage was sufficient for any civil judgment, but outcomes of litigation and insurer disputes were uncertain. Estimated remaining environmental cleanup costs were $1.4m, recorded as a liability and regulatory asset; recovery was considered probable by management.
• Other items: A $5.6m unrealized loss on purchased-power contracts was deferred in a CPUC-authorized regulatory account and did not affect earnings. AWR reported an increase in other income, primarily from gains on retirement-plan investments. Management reported disclosure controls as effective and no material change in internal control over financial reporting.

Important facts for investors to verify

1. Track the final CPUC water rate-case decision, retroactive rate adjustments and the recoverability and collection timing of WRAM/MCBA balances.
2. Assess whether operating cash generation and available credit can sustain the elevated capital program, dividends and debt requirements.
3. Monitor drought, groundwater availability, purchased-water costs and any further conservation or supply restrictions.
4. Follow developments in the Claremont and Ojai condemnation cases and the water-main-break litigation and insurance dispute.
5. Evaluate execution, transition costs, price adjustments and future construction opportunities under the Eglin and other military contracts.