American States Water Company (AWR) — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; unaudited interim results. The combined filing covers AWR and its regulated utility subsidiary, Golden State Water Company (GSWC). AWR also operates American States Utility Services (ASUS), which provides water and wastewater services at U.S. military installations.
Business context and financial results
GSWC serves approximately 257,000 water customers and 24,000 electric customers in California. Its rates are regulated by the California Public Utilities Commission (CPUC). ASUS operates under long-term, generally 50-year, U.S. government contracts.
Unless otherwise noted, financial amounts below are AWR consolidated and in millions of dollars. Comparisons are with the corresponding 2013 period.
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Operating revenue | $115.6 | $120.7 | $217.6 | $231.2 |
| Operating income | $31.0 | $33.3 | $53.8 | $61.3 |
| Net income | $15.4 | $16.6 | $26.4 | $30.1 |
| Diluted EPS | $0.39 | $0.43 | $0.67 | $0.77 |
- Revenue and profit: Q2 revenue fell 4.2% and net income 7.5%; first-half revenue fell 5.9% and net income 12.3%. Lower ASUS construction activity was the main consolidated revenue and earnings headwind.
- Segments: Q2 water revenue rose 2.6% to $86.2 million, while electric revenue was nearly flat at $8.3 million and contracted-services revenue fell 25.3% to $21.1 million. First-half contracted-services revenue declined 28.9% to $41.8 million. Projects at Fort Bliss, Fort Bragg and Fort Jackson were completed or nearing completion.
- Utility gross margins: Q2 water gross margin was $63.8 million, up 3.0%, and electric gross margin was $5.1 million, down 0.8%. First-half water gross margin rose 2.8% to $118.7 million; electric gross margin rose 1.3% to $11.2 million. These are company-defined, non-GAAP measures and exclude several operating expense categories. Surcharges included in revenue and corresponding expenses did not increase earnings.
- Cash flow: First-half operating cash flow was $90.9 million versus $33.6 million, largely reflecting timing of ASUS construction billings and collections, as well as GSWC rate increases and surcharge collections. Investing cash use was $35.8 million, including $35.6 million of construction expenditures; financing cash use was $15.4 million. Cash ended the period at $77.8 million, versus $38.2 million at year-end 2013.
- Debt and liquidity: At June 30, AWR reported $310.9 million of long-term debt and $21.3 million current debt. The $100 million revolving credit facility had no borrowings, $17.5 million of letters of credit and $82.5 million available. Current assets were $197.9 million and current liabilities $127.5 million.
- Margins and costs: Higher depreciation, administrative and general costs, groundwater assessments, and other water operating costs weighed on results. Depreciation and amortization rose 7.5% in the first half, partly reflecting prior-year utility plant additions. Water use was down 6.1% in Q2, though the CPUC-approved revenue adjustment mechanism substantially limits the earnings effect of consumption changes.
Material changes, outlook and key risks
- Management expected GSWC’s 2014 capital expenditures to be approximately $80–$85 million; $26.9 million had been incurred in the first half, excluding work funded by others. Management anticipated 2014 second-year rate increases would add about $1.4 million to gross margin versus 2013 adopted levels.
- ASUS construction activity was expected to increase in the second half of 2014 relative to the first half. Several contract price redeterminations were expected to be resolved in Q3 2014 and could produce retroactive revenue; timing and outcomes were uncertain.
- GSWC filed a water general rate case in July 2014 for 2016–2018, seeking capital budgets averaging about $90 million annually. The application anticipates new rates effective January 2016 and an authorized return on rate base of 8.34%; these remain subject to CPUC review.
- In July 2014, GSWC redeemed $15 million of 6.87% and 7.00% notes at par and planned to replace them with lower-rate debt. S&P revised AWR and GSWC outlooks to positive and affirmed their A+ ratings; Moody’s had affirmed GSWC’s A2 rating with a stable outlook.
- AWR announced a 5.2% increase in its quarterly dividend, from $0.2025 to $0.2130 per share, beginning with the third-quarter payment. A share repurchase program authorizes repurchases of up to 1.25 million shares through June 30, 2016.
- Drought and supply: California’s drought, low State Water Project allocations and falling groundwater levels could require additional conservation or rationing, increase supply costs, and affect service areas dependent on smaller groundwater basins. Mandatory state restrictions took effect in July 2014.
- Regulatory, legal and environmental matters: Recovery of GSWC costs depends on CPUC rate decisions. The first of three required procurement audits is underway and could result in cost disallowances; management could not estimate any loss. Claremont pursued potential condemnation of a system serving about 11,000 customers, and GSWC appealed a court ruling concerning efforts to acquire its Ojai system, serving about 3,000 customers. New water-quality and discharge requirements could raise compliance costs.
- Other uncertainties: ASUS faces risks from delayed government payments, contract price redeterminations, audits, cost disallowances and variable construction work. Management noted that future capital-market conditions could affect financing or require temporary capital-spending reductions. No material change to previously disclosed risk factors was reported.
Investor facts to verify
- Whether second-half ASUS construction work and anticipated contract redeterminations materialized as expected.
- CPUС decisions and timing for the BVES electric rate case and the 2016–2018 water general rate case.
- Drought conditions, water availability, conservation or rationing requirements, and related supply costs.
- Results of the procurement audit, condemnation developments in Claremont and Ojai, and any resulting financial exposure.
- GSWC’s refinancing of the $15 million notes, planned capital spending, and AWR’s dividend and share-repurchase execution.