Business context and reporting period
American States Water Company (AWR) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. AWR’s principal businesses are California-regulated water and electric utility operations through Golden State Water Company (GSWC), and contracted water and wastewater services at U.S. military bases through ASUS. AWR sold Chaparral City Water Company (CCWC) on May 31, 2011; its results are reported as discontinued operations.
Unless otherwise noted, financial amounts below are AWR consolidated and in millions of dollars. GSWC is separately identified where relevant.
Financial results and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Operating revenue | $119.9 | $111.3 | $324.0 | $295.2 |
| Operating income | $32.4 | $16.9 | $79.6 | $57.2 |
| Continuing-operations income | $15.6 | $5.7 | $35.3 | $22.8 |
| Net income | $15.6 | $6.7 | $39.2 | $24.1 |
| Diluted EPS | $0.83 | $0.35 | $2.08 | $1.28 |
- For the first nine months, revenue increased 9.8%, operating income 39.1%, and net income 62.3%. Continuing-operations diluted EPS was $1.88, versus $1.21.
- Q3 revenue growth was led by water: water revenue rose 8.6% to $89.8 million, primarily reflecting CPUC-approved rate increases. Electric revenue rose 10.5% to $8.7 million, and contracted-services revenue rose 3.1% to $21.4 million.
- Water margin, a company-defined non-GAAP measure of revenue less supply costs, was $62.2 million in Q3, up 14.1%; its margin percentage increased to 69.3% from 66.0%. Nine-month water margin rose 13.9% to $167.1 million. Electric margin increased 17.4% in Q3 to $5.2 million and 6.3% year to date to $15.4 million.
- Q3 diluted EPS from continuing operations improved by $0.53 year over year. A $9.0 million pretax regulatory-related charge recorded in Q3 2010 did not recur; higher water margins from rate increases also contributed. Year-to-date contracted-services EPS declined to $0.31 from $0.42, despite higher revenue, partly because 2010 included retroactive government contract modifications.
- Operating cash flow was $62.6 million for the nine months, versus $37.1 million. Construction expenditures were $63.6 million, so operating cash flow was slightly below capital spending before asset-sale proceeds. Investing cash outflow was $34.0 million, including $29.6 million of CCWC sale proceeds.
- At September 30, AWR had cash of $5.2 million, current assets of $160.1 million, and current liabilities of $116.4 million. Bank notes payable were $4.5 million, down from $60.9 million at year-end 2010. Long-term debt was $340.4 million, up from $299.8 million. Shareholders’ equity was $405.1 million.
- AWR had $83.1 million available under its $100 million revolving credit facility, with $12.4 million of letters of credit outstanding. The filing cites AWR and GSWC’s S&P rating as A+ with stable outlook.
- GSWC issued $62 million of 6% unsecured notes due 2041. Proceeds funded capital spending, reduced short-term borrowings, and redeemed $22 million of 7.65% notes; related redemption costs increased interest expense.
- AWR declared $0.28 per share for Q3 and $0.82 per share for the first nine months. A further $0.28 quarterly dividend was declared October 25, payable December 1, 2011.
Material changes versus the prior comparable period
- Water rate increases approved in late 2010 drove much of 2011’s utility revenue and margin growth. Water consumption nevertheless declined 3.3% in Q3 and 2.6% for the nine months.
- The prior-year Q3 included a $9.0 million pretax charge tied to regulatory matters; no similar charge was recorded in Q3 2011. Depreciation and amortization rose 14.8% year to date, primarily due to utility plant additions and higher authorized depreciation rates.
- CCWC’s sale produced a $2.2 million after-tax gain in 2011 and removed its operating results from continuing operations after May 31. Discontinued operations contributed $3.85 million to nine-month net income, versus $1.29 million in 2010.
- ASUS recorded a $2.9 million pretax benefit in Q2 from a lower estimated cost to complete a Fort Bragg pipeline project. This estimate change and construction activity helped offset lower year-to-date management-fee revenue compared with 2010.
- Capital spending increased to $63.6 million from $57.7 million year to date. AWR’s lower short-term bank borrowings were supported in part by long-term debt issuance and CCWC sale proceeds.
Outlook, commentary, risks and contingencies
- No company-wide earnings guidance is provided. Management estimated 2011 capital expenditures of approximately $75–$80 million and expects capital spending to remain elevated relative to depreciation.
- GSWC filed a general rate case in July 2011. If approved as filed, it would provide estimated annual revenue increases of $31.3 million in 2013, a further $9.1 million in 2014, and $11.5 million in 2015, compared with the preceding year’s adopted revenues. Additional 2012 escalation increases were expected to add about $5 million in annual revenue. These are proposed amounts, not approved outcomes.
- A November 2011 cost-of-capital settlement proposed a 9.99% return on equity and a 55% equity/45% debt rate-making capital structure; CPUC approval was pending. The company also stated it intended to seek future rate relief to recover costs and earn a reasonable return.
- Key exposures include CPUC decisions and timing of rate recovery; water supply availability, drought and weather; water quality and environmental requirements; infrastructure costs; power prices; and government contract price redeterminations, audits, payment timing and performance. Military-base contracts may be terminated under specified conditions, and AWR guarantees ASUS contract performance.
- ASUS postponed certain price-redetermination filings pending resolution of accounting-system deficiencies and a DCAA re-audit expected in Q1 2012. Management said the delays could affect recovery of rising contract costs.
- A proposed CPUC procurement-practices settlement would require $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, and three independent audits over ten years. CPUC approval was pending; the company had recorded a reserve in 2010. Future audit outcomes and potential further disallowances were uncertain.
- The CPUC granted rehearing of the La Serena plant-cost matter; management could not predict the outcome or estimate a possible loss. Groundwater contamination litigation and appeals, and possible municipal acquisition efforts involving GSWC systems in Apple Valley and Ojai, remain uncertainties.
- GSWC accrued $1.2 million for remaining remediation costs at its Chadron site; actual costs could differ. It also reported a $6.4 million unpaid Aerojet note receivable, which management considered fully collectible. BVES had not met renewable-energy interim targets, but management expected potential penalties to be waived under CPUC flexible-compliance rules; no loss provision was recorded.
- Water supply conditions improved: MWD ended its allocation plan in April 2011, and the State Water Project’s projected 2011 deliveries rose to 80% of requests. Supply, weather and conservation remain material variables.
Important facts for investors to verify
- Whether the CPUC approves the proposed procurement settlement, cost-of-capital agreement, and pending rate cases, and the timing and amount of any resulting rate recovery or customer refunds.
- Whether the reported earnings improvement is sustainable after accounting for the nonrecurrence of the prior-year $9.0 million charge, the CCWC sale gain, and ASUS’s $2.9 million project-estimate benefit.
- Actual capital expenditures and funding needs against the $75–$80 million 2011 estimate, including the balance between operating cash generation, debt and credit-facility capacity.
- Progress and financial impact of ASUS’s DCAA review and delayed military-contract price redeterminations, including any changes to contract costs or revenue recognition estimates.
- Recoverability of regulatory assets, including the $39.9 million net WRAM/MCBA asset, and outcomes of the La Serena rehearing, procurement audits, environmental remediation and water-contamination litigation.