AMERICAN STATES WATER CO annual report, FY2011

Business context and reporting period

American States Water Company (AWR) filed a combined 10-K with wholly owned Golden State Water Company (GSWC) for the fiscal year ended December 31, 2011. AWR operates regulated California water and electric utilities through GSWC and military-base water and wastewater services through ASUS and subsidiaries. AWR sold Chaparral City Water Company (CCWC) on May 31, 2011; its results are presented as discontinued operations.

Financial results and key metrics

Unless otherwise stated, amounts are AWR consolidated and in millions. Figures are for full-year 2011 compared with 2010.

Operating margin was approximately 22.7% of revenue in 2011, versus 18.5% in 2010. Operating cash flow less capital expenditures was approximately negative $0.1 million. AWR reported $1.3 million cash, $165.6 million current assets and $104.4 million current liabilities at year-end (current ratio approximately 1.59). Long-term debt was $340.4 million; notes payable to banks were $2.0 million. AWR had $85.6 million available under its $100 million revolving facility after outstanding letters of credit. The facility expires in May 2013.

GSWC reported revenue of $336.1 million, operating income of $83.7 million and net income of $34.8 million, compared with $326.6 million, $63.8 million and $25.1 million, respectively, in 2010. Water revenue was $299.8 million and electric revenue $36.3 million. Water consumption declined 1.9%, while approved rate increases supported revenue and the CPUC-authorized WRAM helped insulate earnings from lower usage. Water margin, a company-defined non-GAAP measure, increased 3.8% to $213.6 million; electric margin rose 4.0% to $20.5 million.

AWR’s 2011 fourth-quarter unaudited results were revenue of $95.2 million, operating income of $15.6 million, continuing-operations income of $6.7 million and diluted continuing-operations EPS of $0.35. Comparable 2010 fourth-quarter figures were $103.7 million, $16.6 million, $8.3 million and $0.44, respectively.

Material changes versus the prior comparable period

• Year-over-year earnings benefited substantially from the absence of a $16.6 million pretax regulatory-related impairment and loss-contingency charge recorded in 2010. Excluding that charge, AWR said non-supply operating costs rose, including labor, pension and depreciation expenses.
• Water segment diluted EPS increased from $1.19 to $1.66, primarily reflecting rate increases and the nonrecurrence of the 2010 charge. Electric segment diluted EPS increased from $0.11 to $0.18. Contracted-services diluted EPS was $0.38 in both years; 2010 included $6.8 million of retroactive contract-modification revenue and interest.
• Contracted-services revenue grew 15.0% to $83.2 million, mainly from increased construction activity. A $2.9 million pretax benefit was recorded after revising estimated costs on a Fort Bragg pipeline project.
• Cash from operations increased, while cash used in investing declined to $50.5 million, partly because AWR received $29.6 million from the CCWC sale. The sale generated an approximately $2.2 million gain net of taxes and transaction costs.
• GSWC issued $62.0 million of 6% notes due 2041, using part of the proceeds to redeem $22.0 million of higher-rate notes, reduce short-term borrowing and fund capital spending. Total long-term debt increased about $40.6 million year over year.

Outlook, commentary, risks and unusual items

• AWR estimated 2012 capital expenditures of approximately $70–$80 million; GSWC separately estimated approximately $75–$80 million, primarily for water supply and distribution upgrades. ASUS expected approximately $58.7 million of capital expenditures funded by the U.S. government.
• GSWC filed a consolidated water general rate case in July 2011, with rates expected from January 2013. If approved as filed, proposed increases would add about $31.3 million in annual revenue in 2013, followed by proposed increases of $9.1 million in 2014 and $11.5 million in 2015. These are requests, not approved guidance. A cost-of-capital settlement proposing a 9.99% ROE and 55% equity/45% debt capital structure was pending CPUC approval; the filing expected a decision in the second quarter of 2012.
• Key risks include CPUC rate-case timing or cost disallowances; water availability, drought and imported-water restrictions; groundwater contamination and compliance costs; aging infrastructure and substantial capital needs; and energy-price exposure. GSWC water consumption fell 1.9% in 2011, and management noted conservation and declining use per residential customer.
• ASUS’s military-base contracts are long-term but may be terminated by the U.S. government; price redeterminations and equitable adjustments have been delayed, affecting cash flow and results. A government accounting-system review identified deficiencies; ASUS reported corrective measures and was undergoing a re-audit, with some price filings postponed. Government audits may disallow contract costs.
• A CPUC-approved procurement settlement required $9.5 million of customer refunds over 12–36 months, $3.0 million of rate-base and other rate adjustments, a $1.0 million penalty paid in January 2012, and three independent procurement audits over ten years. The company had recorded a $13.5 million reserve in 2010 and reported no additional 2011 charge for this matter.
• Other significant exposures include unresolved groundwater contamination litigation and an appeal concerning the Santa Maria groundwater basin; management could not predict outcomes or quantify potential losses. GSWC accrued $1.2 million for remaining Chadron site remediation costs and considered rate recovery probable. Claremont was studying a possible acquisition of GSWC’s water system; acquisition interest was also reported in Ojai and Apple Valley, but no formal condemnation proceedings were disclosed.
• Management stated that AWR intended to continue quarterly dividends, subject to earnings, financial condition, regulatory requirements and board judgment. The 2011 dividend was $1.10 per share, versus $1.04 in 2010. Management anticipated higher future interest costs as external capital is needed for construction.
• Independent auditors gave unqualified opinions on the financial statements; management and the auditor reported effective internal control over financial reporting at year-end.

Most important facts for investors to verify

• Whether CPUC approvals and collections support recovery of WRAM/MCBA balances, other regulatory assets and planned infrastructure investment.
• Progress and final outcomes of the water and electric rate cases, the cost-of-capital proceeding, and the La Serena rehearing.
• Whether ASUS completes its government accounting-system re-audit and secures timely contract price redeterminations and equitable adjustments.
• Cash conversion and funding needs: operating cash flow was approximately equal to 2011 capital expenditures, while cash on hand was low and the revolving facility expires in May 2013.
• Exposure to contamination claims, water-supply constraints, condemnation activity and future procurement audit findings, including any amounts not recoverable from customers or responsible parties.