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American States Water (NYSE:AWR)

Q4 2012 Earnings Call

February 28, 2013 2:00 pm ET

Executives

Eva G. Tang - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance, Treasurer and Corporate Secretary

Robert J. Sprowls - Chief Executive Officer, President, Director, Member of Asus Committee, Chief Executive Officer of Golden State Water Company, Chief Executive Officer of Chaparral City Water Company, President of Golden State Water Company and President of Chaparral City Water Company

Analysts

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company conference call discussing the company's fourth quarter and full year 2012 results. If you have not received a copy of this morning's earnings release, please call (909) 394-3600 extension 651, and one will be faxed or e-mailed to you.

If you would like to listen to the replay of this call, it will begin this afternoon at approximately 2:00 p.m. Pacific Time and run through Thursday, March 7, 2013. After logging onto the website, click the Investors button at the top of the page. The archive is located just above the Stock Quote section.

[Operator Instructions]

As a reminder, this call is being recorded and will be limited to no more than 1 hour. At this time, I would like to turn the call over to Ms. Eva Tang, Chief Financial Officer of American States Water Company. Ms. Tang, the floor is yours, ma'am.

Eva G. Tang

Welcome, everyone, and thank you for joining us today. On the call with me is our President and CEO, Bob Sprowls.

Before I start with the fourth quarter results, I would like to remind you that certain matters discussed during the conference call may be forward-looking statements intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995. Please review a description of the company's risks and uncertainties in our most recent Form 10-K and Form 10-Q on file with the Securities and Exchange Commission.

With that, I will now discuss the fourth quarter financial results. As noted in our earnings release this morning, we again delivered exceptionally strong quarterly earnings due to capital construction work at several military bases operated by our contracted services segment, American States Utility Services, or ASUS in short. Our fourth quarter earnings from continuing operations increased by 51.4% to $0.53 per fully diluted share as compared to $0.35 per share for the fourth quarter of '11. Net income for the quarter increased by 53.4% or $3.6 million compared to the same period in 2011. ASUS contributed $0.23 per share to the consolidated earnings as compared to $0.06 for the same period in '11.

Now I would like to discuss the various components of our earning -- of our income from continuing operations, starting with revenues. For the fourth quarter of 2012, our operating revenues increased by $16.3 million or 17.1% to $111.5 million. The main driver of this increase continues to be ASUS. ASUS' revenue increased by $14.1 million or 68.6% to $34.7 million compared to the same period of 2011 due to an increase in renewal and replacement work and the new construction activities.

We continue to make progress on major construction projects at the various military bases. These projects are expected to be completed by the end of 2013 into 2014. Compared to the fourth quarter of 2011, we have also increased the level of renewal and replacement capital work, particularly at Fort Bliss, Fort Jackson and Fort Bragg. We anticipate such work to slow down a little bit at certain military bases in 2013.

Water revenues at Golden State Water increased by $2 million or 3% to $67.6 million for the fourth quarter, primarily due to rate increases effective January 1, 2012 to recover infrastructure improvements and operating costs. Electric revenue at Golden State Water increased by about $200,000 to $9.3 million due to rate increases as well.

Our water and electric supply costs were $22.5 million or approximately 24.9% of total operating expenses for the fourth quarter of 2012. As you know, any changes in purchased water, power purchased for pumping and pump taxes for the water utility segment as compared to the adopted supply costs are covered by the Modified Cost Balancing Account. The electric utility segment also has a balancing account to track the changes in purchasing power and transmission-related costs.

Other operations expenses increased by $892,000 compared to the same period in 2011, primarily due to increases in water treatment cost, better [ph] expenses and higher labor and related employee benefits as a result of the company's annual performance-based salary review program.

Meanwhile, administrative and general expenses for 2012 decreased by $951,000 due to a decrease in outside service cost and the lower overhead cost. Driven by increased construction activities at ASUS, more overhead dollars were allocated as indirect cost to our construction project as construction expense.

Depreciation and amortization expenses increased by $738,000 to $10.3 million for the fourth quarter of 2012 as compared to the same quarter's in 2011 due to capital additions.

Maintenance expense decreased slightly by $190,000 primarily in the contracted services segment due to the need to perform capital work to renew and replace infrastructures in lieu of performing routine maintenance or repair of assets.

Unplanned maintenance work was also lower at Golden State Water. It's difficult to predict the timing and scope of any emergency work that may arise. We attempt to minimize the need for such unplanned work through our routine maintenance and infrastructure repair.

Property and other taxes for the quarter remained about the same as compared to the same period in 2011.

ASUS's construction expenses increased by $10.6 million to $23.4 million during the fourth quarter of 2012 as compared to the same period of 2011. This increase, again, is primarily due to increased construction activities and renewal and replacement work at various military bases.

Interest expense net of interest income and other nonoperating items increased by $425,000 to $4.8 million for the fourth quarter of 2012 compared to the fourth quarter of '11. The increase was mostly due to the reversal in the fourth quarter of 2011 of redemption costs incurred associated with high interest rate notes that we redeemed during 2011. The redemption costs were capitalized in the fourth quarter of 2011 to be amortized over the life of new notes, consistent with the cost of capital preceding settlement at that time. There was no similar reversal in 2012.

Income tax expenses increased by $1.6 million to $6.1 million as compared to the same period in '11. This increase was primarily driven by an increase in pretax income for the quarter as a result of ASUS' stellar financial performance.

Having discussed the quarterly results, I will briefly go over our 2012 financial performance. 2012 was a year of record financial results with continued increase in revenue, net income and cash flow. Our year-to-date 2012 diluted earnings from continuing operations were $2.82, which represent an increase of $0.59 per share or a 26.5% increase over 2011. ASUS contributed $0.78 per share to the consolidated earnings, that is an increase of $0.40 per share or more than 100% as compared to 2011.

For additional details on our year-to-date performance, please refer to our earnings release issued earlier today.

We plan to -- auditors are still wrapping up the audit, so we plan to issue our Form 10-K later today.

Turning our attention to liquidity and capital resources. I'm pleased to report that net cash provided by operating activities increased significantly by $21.3 million to $101.5 million for 2012 as compared to $80.2 million in 2011. This increase was primarily due to lower tax payments as a result of accelerated depreciation in connection with the tax law changes, which you see approved the rate increases for all of our regulated businesses, surcharges collected to recover the water revenue adjustment mechanism imbalances and the higher construction activities and the timely collection of amount field for construction work at ASUS. As a result of this increase in cash generated from operations, we had no borrowings under our credit facility at the end of 2012.

Moving on to our capital expenditures. Golden State Water invested $66.8 million in capital projects in 2012 as compared to $78.4 million for 2011. The decrease was as a result of uncertainties surrounding the pending water and electric general rate cases, both of which were originally expected to be finalized by the CPUC by the end of 2012. However, Golden State Water expects to sustain an average of approximately $85 million a year in capital expenditures for the years 2013 through 2015, if the settlement for the water rate cases are approved.

As previously discussed in our third quarter call, in October 2012, Golden State Water redeemed it's $8 million 7.55% medium term notes. We continue to evaluate the need to reduce the cost of borrowings by redeeming debt with higher coupon rate. These reductions in borrowing costs result in cost savings for our customers. And we do not plan to issue equity in the near future.

With that, I will turn the call over to Bob.

Robert J. Sprowls

Thank you, Eva. Good afternoon, ladies and gentlemen. I am extremely pleased with our strong operating and financial performance for the year.

In 2012, the company was able to achieve record financial results, announced a significant dividend increase and provide one of the highest total shareholder returns among all publicly traded utilities. These improved results were due in large part to our operating successes in our contracted services business, which continues to make significant contribution to the company's earnings. ASUS accounted for approximately 27% of the company's consolidated revenues in 2012 compared to 20% in 2011.

As Eva mentioned, the company's earnings from continuing operations increased to $2.82 per share for 2012, a 26.5% increase from 2011. The company has grown its revenues from continuing operations to nearly $467 million in 2012 from $294 million in 2007, which represents a 5-year compound annual growth rate of 10%. Our net income from continuing operations has grown at a compound annual growth rate of 15% over the same 5-year period from $27.1 million in 2007 to $54.1 million in 2012.

As you recall, in July 2012, our Board of Directors approved a 27% increase in the quarterly cash dividend. This substantial increase reflects our board's confidence in the sustainability of our earnings, prospects for our future and the desire to have a payout ratio more in line with our peers.

I would like to take some time now to provide you with an update on the regulatory activities at our water and electric utility business segments.

In June 2012, Golden State Water Company filed a motion to adopt a settlement agreement between the company, the Division of Ratepayer Advocates, or DRA for short, and The Utility Reform Network in connection with the water general rate case filing made in July 2011. The proposed settlement, if approved by the CPUC, would resolve almost all of the issues in the general rate case application and would generate approximately $14.5 million in additional annual water gross margin starting in 2013 as compared to 2012 adopted, a 6.7% increase. We are expecting a proposed decision from the CPUC during the first quarter of 2013. A final decision is expected in the second quarter of 2013 with new rates retroactive to January 1, 2013. Therefore, we expect the accumulative earnings effect of the final decision to be reflected in our second quarter results.

In February 2012, Golden State Water Company filed its electric rate case for rates in years 2013 through 2016. If rates are approved as filed, the rate increases are expected to generate approximately $1.3 million in additional annual revenues. A decision on the general state rate case is expected later in 2013.

In July 2011, the CPUC issued an order granting the request of DRA to rehear certain issues from the Region II, Region III and General Office Rate Case approved in November 2010. Among the issues in the rehearing is the La Serena plant improvement project included in rate base totaling approximately $3.5 million.

In January 2013, Golden State Water Company and the DRA entered into settlement discussions to resolve all issues on this rehearing. If the settlement agreement is reached, it would be subject to CPUC approval. As a result of these settlement discussions, Golden State Water Company recorded a pretax charge of $416,000 for 2012, representing plant improvement project costs and related revenues earned on those costs, that Golden State Water company expects to be refunded to customers based upon the terms of the settlement being discussed. Any settlement, if finalized and approved, would resolve all issues arising from the rehearing.

Now let's take a moment and discuss the company's contracted services business, ASUS. As previously noted, ASUS continues to be a strong performer as we have seen an increase in our construction activities at each of the various military bases for both the quarter and the year, especially at Fort Bliss and Fort Bragg where we have seen the most activity.

At the Fort Bragg military base, we are making significant progress on the $58 million water and wastewater pipeline replacement project and expect the project to be completed by the end of 2013. A backflow preventer and meter project totaling $23 million at Fort Bragg is also underway and is expected to be completed by mid-2014. We just began working on an $18 million water and wastewater infrastructure project required to serve a new area at Fort Bragg, which will be completed by the end of 2013.

At Fort Bliss, there was significant amount of renewal and replacement capital work performed in 2012. While we expect to continue doing such work in 2013, we anticipate the renewal and replacement activity at Fort Bliss to be at a slower pace than in 2012.

Construction activity at the military bases in Virginia has also increased, primarily due to a pipeline and pump station replacement project expected to be completed by September of 2013.

As I've discussed on previous calls, filings for price redeterminations, requests for equitable adjustments and contract modifications awarded for new projects provide ASUS with additional revenues and the opportunity to cover its costs and consistently generate positive operating income. We currently have no significant requests for equitable adjustment outstanding with the U.S. government. Various price redeterminations for managing the assets at the military bases are in negotiation with the government. We also continue to work closely with the government for contract modifications relating to potential capital upgrade work as deemed necessary for improvement of the water and wastewater infrastructure at the military bases.

In August 2011, Congress enacted the Budget Control Act, which committed the U.S. government to significantly reducing the federal deficit over 10 years. The Budget Control Act called for very substantial automatic spending cuts known as sequestration. We do not believe there would be any immediate earnings impact to our existing operations and maintenance and renewal and replacement services provided by ASUS resulting from sequestration. Such contracts are not subject to the provisions of the Budget Control Act.

And the new construction projects currently in progress, as I discussed earlier, are all approved projects. Any such impact from sequestration will likely be limited to the timing of funding for these services, a possible delay in the timing of payments, potential delays in the processing of price redeterminations and the issuance of contract modifications, renewed construction work not already funded by the U.S. government and/or delays in the solicitation and awarding of new utility privatization opportunities.

Before I turn the conference over to the operator to entertain questions, I would like to thank you again for your continued support and interest in the company.

Question-and-Answer Session

Operator

[Operator Instructions] The first question we have comes from Jonathan Reeder of Wells Fargo.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

I was just wondering that if you could give us some kind of indication that based on the 3 major projects outlined and I guess there is even a fourth one kind of added in there that wasn't in the release. Is it fair to assume a similar level of construction work in 2013 for ASUS as in 2012 or might it even be higher?

Robert J. Sprowls

Well, first of all, thank you, Jonathan, and hello. Yes, regarding the outlook for 2013 for ASUS, as you know, a key component of ASUS' earnings over the past several years has been this new construction work, both with the government and through either prime contractors at the bases where ASUS operates. And as we've mentioned earlier today, we have a number of funded construction projects currently underway, which we expect will continue to contribute to earnings in 2013. So we're -- we think we'll have a strong 2013. However, I did want to mention that during 2012, there was a significant amount of renewal and replacement work being done at Fort Bliss, consistent with the requirements of our 50-year contract there. We expect that work to continue in 2013 but at a slower pace than in 2012. So if you're looking for 2013 to outstrip 2012, we don't see that happening given that we're going to have a slowdown in this renewal and replacement work at Fort Bliss. Also, it's difficult at this time to really estimate the possible impact of sequestration on any new construction activity beyond those projects that are currently funded. That help?

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Yes, that's very helpful. And then did you mention, Bob, what the value of the project was at the Virginia base?

Robert J. Sprowls

I did not.

Eva G. Tang

I think those are a few smaller magnitude kind of the dollar amount, Jonathan, unlike Fort Bragg's big project. Virginia base's usually run from $3 million to $5 million smaller projects. So that's why we don't call it out as a single project like that.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. But there's a bunch of smaller projects that are underway at the Virginia bases?

Robert J. Sprowls

That's right.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. And then I was thinking before with the GRC and the settlement agreement that you had, you had indicated the gross margin impact was going to be $18 million versus the $14.5 million now. What accounts for that change?

Eva G. Tang

I think one reason could be because we factored the cost of capital preceding the adjustment to the return on equity, Jonathan. So before, we're probably using the 9.99 ROE and we adjusted with the 9.43 ROE to our new calculation. That's probably one of the major reasons.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

That makes sense, yes, because the $18 million that I was talking about was from, I think, the Q2 call, so that's probably exactly what it is. And then, if you could just touch upon the dividend and maybe what sort of growth we might expect going forward following the big increase last year, what do you think the sustainable growth rate is.

Robert J. Sprowls

Yes. We really haven't put out there what the sustainable growth rate is, but we have talked about our desire to have a growth rate of at least 5%. Now at this point, our earnings have ramped up considerably from where they've been in the past. And historically, we've taken a look at where our peer group is regarding payout ratio and then sort of done of an evaluation of where we think we should be relative to that peer group based upon the businesses that we manage. As we've said in the past, the timely replacement of infrastructures is important to our ability to provide service to our customers. Given that we've got ASUS as an increasing component to the overall mix, the government contracting-type firms do not provide as high a payout ratio on their earnings. But -- I mean, we think there's a substantial potential here to continue to increase the dividend going forward. And we continue to look sort of out into the 3-, 4-, 5-year period to see what our sustainable earnings are and then derive our dividends from that. But again, the goal is to have a compound annual growth rate of over -- of 5% or over a 5-year period.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay, that makes sense. And, Bob, if you figure out what that sustainable earnings growth rate is, let me know. It's always a challenge figuring out the ASUS, and this year is just an amazing year and figuring out what the base line is going forward is the challenge for all of us out there. So appreciate the additional commentary.

Robert J. Sprowls

Yes. I mean, there's -- on sort of both sides of the ledger, there's significant issues going on, of course. You've got the sequestration, its impact could be a negative on future construction projects. On the other hand, there's a lot of bases being bid out there, and we're obviously very interested in acquiring additional bases, so we're in the hunt there. So that is what sort of makes it difficult going forward. And we're trying to, I guess, help as much as we can -- help you guys as much as we can in terms of giving you transparency here.

Operator

[Operator Instructions] Next question we have comes from Heike Doerr of Robert W. Baird.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Eva, I wanted to follow up on something you said about the CapEx program. I'm trying to understand why your 2012 spending levels would decline as it relates to the 2011 general rate case, which is looking for 2013 through '15?

Eva G. Tang

Well, Heike, the rate case cycle for new rates start in 2013. So 2012 become a transitional year because that's the year that we project to spend a lot of capital, expenditures with different projects submitted to the PUC. So when we go into the rate case, we really have to project our capital expenditure for '12, '13 and '14. Given that we don't really have the rate settlement for -- going forward for '13 at this point, so we're trying to judge what kind of project is at the higher certainty that we can start performing. And the things that -- at the time, we were in negotiation with DRA, there were quite a few projects that had some kind of uncertainties, and we don't want to start working on those projects and end up facing challenge from the commission and writing off things in the future. So transition year is always a tough year for us to figure out how much we can start doing. And so we're kind of waiting to see where the settlement discussion will end up with before we start doing big projects.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

So that spending that wasn't done in 2012 is spending that would have -- or will continue into 2013?

Eva G. Tang

Yes, and we try to catch up. If we -- if the settlement is approved by the commission, you can see, we will catch up those spending as the settlement allow us to do about $85 million a year for 3 years in the next 3 -- I mean, from '13 on. So we'll catch up the things that we left off in 2012.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Would we see 2013 a little higher from -- a little higher than that $85 million if you're -- because there was spending that got deferred from 2012, so maybe it's $88 million or $90 million and then $85 million, $85 million?

Eva G. Tang

I think it's possible, Heike. We try to do as much as we can when the settlement is approved by the PUC. So we hope that would resolve in the first quarter, we're really going to ramp up our expenditures. So it's possible we'll spend more than $85 million in '12 -- in '13.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Okay. And just so we understand the process, we're -- the next step is a proposed decision, correct?

Robert J. Sprowls

That's right.

Eva G. Tang

Yes.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

And then what happens between then and when you get rates implemented?

Robert J. Sprowls

There are opportunities for commissioners to sponsor alternate decisions in that there's usually a 30-day period between when the proposed decision is and -- when the proposed decision comes out and when the final decision is voted on. And during that period, they can -- the different parties can seek commission -- like a DRA could go to a commissioner and ask them to sponsor an alternate decision or we could if we didn't like the proposed decision and then the alternate and the ALJ's decision would get voted on at the commission's hearing -- or the commission meeting. Generally, they have a commission meeting once or twice a month where they take up the decision -- proposed decisions that are out there.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

And, Bob, could you maybe help us understand information flow for ASUS. If a project is large enough, would we see an 8-K, or is this something that you guys would wait and share with us on an earnings call or in the 10-Q, 10-Ks?

Robert J. Sprowls

Yes. In the past, we've shared during the earnings call and the 10-Qs and 10-Ks. So we've -- there's stops and starts on these projects, and we really want to be sure that it's a go before we alert the market to it. We don't want any sort of premature notification.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

And there's no trigger then? If you got everything all squared away, let's say, tomorrow, there's no trigger that you would need to put out an 8-K on that?

Robert J. Sprowls

Generally, no. I mean, it's a -- if we got like a special project depending upon the size, of course, we would alert the market, but if it's not a substantial project, of course, we wouldn't. Eva, if you have anything to add?

Eva G. Tang

Yes. I mean, generally, if the project, $10 million or so is a small percentage to our total revenue. So we'll make a judgment whether as to the mature level that we need to alert the market. But definitely, we'll put in our disclosures as much as we can.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Okay. And, Eva, you said the 10-K is going to come out this afternoon?

Eva G. Tang

Yes, probably later this afternoon. The last few points the auditors are trying to wrap up, and so, we expect to issue later this afternoon.

Operator

[Operator Instructions] It appears that we have no further questions at this time. I would like to hand the conference back over to Mr. Bob Sprowls for any closing remarks. Sir?

Robert J. Sprowls

Yes, thank you, Mike. Again, thank you all for your participation today, and we really appreciate your continued interest and investment in American States Water Company. And have a great day, everybody.

Operator

And we thank you, sir, and you also have a great day, and also to Ms. Tang. This concludes today's American States Water Company Conference Call.

As a reminder, the call will be archived on our website and can be replayed beginning Thursday, February 28, 2013, at 5:00 p.m. Eastern Time, 2:00 p.m. Pacific time and will run through Thursday, March 7, 2013. After logging on to the website, click the Investors button at the top of the page. The archive is located just above the Stock Quote section.

Again, we thank you all for your participation, and please have a great day. At this time, you may disconnect your lines. Thanks again.

Robert J. Sprowls

Thank you.

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