AMERICAN STATES WATER CO quarterly report, Q2 FY2013

American States Water Company (AWR) — Q2 2013 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2013. Unaudited combined filing for AWR and its subsidiary Golden State Water Company (GSWC). AWR’s operations are primarily regulated California water and electric utilities; its ASUS subsidiary provides water and wastewater services under U.S. military-base contracts.

Financial performance

Consolidated AWR	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Operating revenue	$120.7 million	$114.6 million	$231.2 million	$221.5 million
Operating income	$33.3 million	$30.1 million	$61.3 million	$53.5 million
Net income	$16.6 million	$15.1 million	$30.1 million	$25.2 million
Diluted EPS	$0.85	$0.79	$1.54	$1.32

Q2 revenue grew 5.3%, operating income 10.5%, and net income 10.1%. Six-month revenue rose 4.4%, operating income 14.5%, and net income 19.3% year over year.
Q2 revenue by segment: water $84.1 million, electric $8.4 million, and contracted services $28.2 million. Water and contracted-services revenue drove most of the increase.
Q2 water gross margin, a non-GAAP measure, increased 7.4% to $62.0 million; water margin was 73.8% versus 71.1%. Electric gross margin was $5.2 million, up 1.3%.
For six months, water gross margin increased 7.4% to $115.5 million (75.3% margin); electric gross margin declined 2.2% to $11.1 million (57.9% margin).
Cash from operations for six months was $33.6 million, down from $63.9 million. Investing used $41.4 million, principally construction expenditures of $41.2 million; financing used $7.2 million. Cash fell to $8.5 million at June 30 from $23.5 million at year-end.
At June 30, total long-term debt was $332.4 million, plus $3.4 million current maturities. Shareholders’ equity was $465.4 million. AWR’s $100 million revolving facility had no borrowings; $18.1 million of letters of credit left $81.9 million available. Current assets were $181.1 million versus current liabilities of $102.4 million.
Six-month dividends paid were $13.7 million, or $0.71 per share. AWR declared a third-quarter dividend of $0.405 per share and approved a two-for-one stock split, expected on or about September 3, 2013. Reported EPS is pre-split; the filing also provides split-adjusted pro forma EPS.

Material changes and management commentary

The CPUC’s May 2013 water rate-case decision established rates for 2013–2015, retroactive to January 1. Management expects about $10 million of additional 2013 annual revenue versus 2012 adopted revenue and a roughly $14 million, or 6.6%, increase in adopted water gross margin. 2014–2015 increases are subject to an earnings test and market-index adjustments.
Water segment results benefited from new rates and recovery of previously expensed costs. Q2 billed water consumption rose 8.5%, but the WRAM mechanism limits the earnings effect of consumption changes. Higher purchased-water expense reflected increased usage, wells out for maintenance, and higher wholesale costs.
Contracted-services revenue increased, but segment diluted EPS fell year over year: Q2 $0.14 versus $0.19; six months $0.27 versus $0.34. The comparison reflects a Fort Bragg project modification that boosted 2012 results, higher administrative costs, and lower construction margins. Fort Bragg pipeline work was delayed by weather and is now expected to finish in early 2014.
Management expects water maintenance expense to increase for the remainder of 2013. Capital expenditures are expected to average approximately $85 million annually over the next three years; AWR anticipates higher future interest costs as external capital needs and market rates increase.
AWR agreed to acquire Rural Water Company’s operating assets, serving more than 900 customers, subject to CPUC approval. AWR’s credit facility was extended to May 2018 and its borrowing capacity may be increased by up to $50 million.

Risks, contingencies, and unusual items

Water-supply conditions are a material risk. California had a second year of below-average precipitation; the State Water Project’s projected 2013 allocation was reduced to 35%. Management said continued dryness could lead to mandatory conservation measures in some service areas, though it believed MWD could meet demand for the year.
GSWC faces four Barstow perchlorate toxic-tort lawsuits. Management considers them without merit, does not believe a loss is probable, and cannot estimate any loss or range.
Claremont has expressed interest in acquiring GSWC’s local water system, and the Casitas Municipal Water District is pursuing steps that could fund acquisition of GSWC’s Ojai system by eminent domain. GSWC is challenging the Ojai funding approach; outcomes are uncertain.
The pending Bear Valley Electric Service rate case includes DRA proposals that could result in a $2.0 million depreciation adjustment and a write-off of half of deferred rate-case costs. GSWC disputes the proposals; the outcome is uncertain.
GSWC accrued $1.2 million for remaining cleanup at its Chadron site and believes CPUC rate-base recovery is probable. The Santa Maria groundwater settlement was approved by the CPUC in May 2013; a request for U.S. Supreme Court review was filed by non-stipulating parties.
AWR recorded a $3.2 million reduction in certain operating expenses in Q1 after CPUC approval of previously tracked memorandum-account costs. A separate $834,000 recovery of electric renewable-procurement costs reduced Q2 expenses. These regulatory recoveries boosted reported earnings.
Management reported disclosure controls as effective and no material change in internal control over financial reporting during the quarter. No significant changes to the risk factors in the 2012 Form 10-K were reported.

Most important facts for investors to verify

Progress and cash recovery of WRAM/MCBA balances, including the $38.0 million net water regulatory asset and the planned surcharge for retroactive 2013 rate differences.
Final CPUC outcome and timing for the Bear Valley electric rate case, and any resulting effects on rates, depreciation, or deferred costs.
Actual cash conversion and working-capital trends: operating cash flow fell sharply year over year, partly because of ASUS construction payments and billing/collection timing.
Water availability, drought developments, wholesale supply costs, and any mandatory conservation measures or changes in purchased-water reliance.
Outcomes of the Barstow lawsuits, Ojai/Claremont acquisition efforts, and other regulatory or environmental proceedings.
Execution of the $85 million annual capital program, financing needs, and the impact of the approved dividend increase and stock split on per-share comparisons.