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American States Water Company (NYSE:AWR)

F1Q10 (03/31/2010) Earnings Call

May 6, 2010 5:00 PM ET

Executives

Eva Tang - CFO

Bob Sprowls - President & CEO

Analysts

Christopher Purtill - Janney

Vishal Khetriwal - Longbow Research

Operator

Ladies and gentlemen, thank you for standing by. Today is May 6, 2010. Welcome to the American States Water Company conference call, discussing first quarter 2010 results. If you have not received a copy of this morning’s news release, announcing earnings for the quarter, please call 909-394-3600, Extension 651 and one will be fax or e-mail to you.

If you would like to listen to the replay of this call, it will begin this afternoon at approximately 2:30 pm Pacific Time and run through Thursday, May 13, 2010. The phone number for the replay is 800-203-1112 and the conference ID number is 9324991. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a remainder, this call will be recorded and will be limited to no more than one hour.

At this time, I would like to turn the call over to Eva Tang, Chief Financial Officer of American States Water Company.

Eva Tang

Thank you, [Miranda]. Good afternoon. Thanks to everyone for joining us today. I also have Bob Sprowls, President and CEO here with me on the call. Before we start the discussion, I would like to remind you that certain matters discussed during this conference call, maybe 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. All forward-looking statements are made as of today. The company’s under no obligation to update such statements. During our presentation today, Bob and I may refer to American States Water Company as AWR, Golden State Water Company as GSWC, Chaparral City Water Company as CCWC and American States Utility Services as ASUS.

With that, I would like to discuss our financial results for the first quarter of 2010. Basic and fully diluted earnings for the quarter ended March 31, 2010 were $0.46 and $0.45 per share respectively as compared to basic and fully diluted earnings of $0.28 per share for the first quarter of 2009. The $0.17 per share increase in diluted earnings for the first quarter of 2010 is due to the following items.

First of all, the water gross margin increased by $828,000, or $0.03 per share, during the first quarter of 2010, primarily due to higher water revenues, water revenues for the first quarter of 2010 increased by about $1.1 million over the first quarter of 2009 water revenue. Due to the implementation in September of ‘09 of the water revenue adjustment mechanism or WRAM account for Golden State Water Region I and an increased in customer rates at Chaparral City Water Company approved by the Arizona Corporation Commission at October.

Due to the delay in Golden State Water Region II, Region III and general office rate case, water revenues for Regions II and III have being recorded based on the 2009 adopted revenue. A final decision is anticipated in September 2010. The electric gross margin increased by $2.5 million, or $0.08 per share, during the first quarter of 2010.

The increase is due to increases in electric rates approved by the California Public Utilities Commission or CPUC in October 2009. The decision added approximately $1.5 million to electric revenues during the first quarter of ‘10. We also recorded $320,000 to the base rate revenue adjustment mechanism account, which was implemented in November, 2009 to the Bear Valley Electric revenue to adopted level.

The base rate revenue adjustment mechanism is to be top hold revenues from sales, similar to the WRAM for water. The increases were partially offset by decrease of 6.1% in actual customer usage as compared to the same period of 2009. In addition, in March 2010 the CPUC approved the recovery of $958,000 included in a memorandum account, which tracked the difference between the 2007 adopted general office cost allocation to Bear Valley Electric and the 1996 general office allocation. This is a one-time item in 2010’s first quarter.

Operating expenses other than supply cost increased at the company’s utilities businesses by $1.9 million or $0.06 per share. Due to increases in labor related cost, legal and consulting service cost and depreciation expense as compared to the first quarter of ‘09.

Legal cost increased by $1 million or $0.03 per share in 2010’s first quarter, primarily due to cost incurring from trading for trail and finalizing a settlement agreement with two former officers of Golden State Water.

Pre-tax operating income at ASUS increased by $6.8 million or $0.23 per share during the first quarter of 2010, as compared to the first quarter of ‘09, the increase is due to increased constructing activities; and contract modifications received from US government resolving two requests for equitable adjustments. The contract modifications increased revenues and pre-tax operating income by the total of $5.6 million, or $0.19 per share.

As I discussed with you, during our 2009 fourth quarter earnings call, ASUS received a contract modification from the US government in January of this year, approving $6.5 million equitable adjustment for Fort Bragg. We recorded $3.1 million of pre-tax income during the first quarter of 2010. Approximately, $2.8 million of the $3.1 million is retroactive from the commencement of the contract in March of ‘08 to December ‘09. The remaining $3.4 million is related to renewal and replacement funds. We have recorded this $3.4 million as deferred revenue, which will be recognized in construction revenues when the work is performed and cost are incurred.

During the first quarter, ASUS also received a contract modification for Fort Bliss resulting from requests for equitable adjustments. As a result, we recorded $2.5 million in pre-tax income and $510,000 in interest income during the first quarter of 2010. The modification also provides for $3 million in renewal and replacement funds, which was recorded as a deferred revenue liability and will recognize and will recognize in construction revenues whereas US performed the work.

Next item is income tax expense for the first quarter of 2010, was $6.1 million, as compared to $1.4 million for the same period in 2009. The increase is primarily due to an increase in pre-tax income and an increase in the effective income tax rate. The effective tax rate for the first quarter of 2010 was 41.7%, compared to 21.7% for same period of 2009. The increase in the effective tax rate was due to a cash benefit of $918,000 or $0.05 per share, recorded in the first quarter of 2009.

Resulting from changes in the California apportionment law, which did not recurred in 2010. This is also due to changes between book and taxable income that are treated flow-through adjustments in accordance with regulatory requirements, which negatively impacted earning by another $0.03 per share, compared to the first quarter of 2009.

Lastly, the issuance of 1.15 million shares of AWR’s common stock in a public offering completed in May of ‘09, diluted earnings by $0.03 per share for the first quarter of 2010. A more detailed discussion of our results for the quarter is included in our earnings release issued at this morning and will be providing our Form 10-Q, which is expected to be filed tomorrow.

Moving on our capital expenditure program, we continued to focus on our core strategies of prudently investing our infrastructure in controlling our cost. Capital expenditures were approximately $16 million in the first quarter of 2010, as compared to $17.7 million for the same period in 2009. We still anticipate capital expenditures in 2010, for Golden State Water to be in the $80 million to the $85 million range.

Our current syndicated credit facility expired in June of this year we are in the process of securing a new facility before June. We do not expect to raise cash by issuing the long term debt or equity in 2010 at this point.

I will now turn the call over to, Bob.

Bob Sprowls

Thank you, Eva and good afternoon ladies and gentlemen. I’d like to take a brief moment to address the water supply issue as currently facing the State of California. On April 13, 2010 the Metropolitan Water District of Southern California, MWD approved an allocation plan that will continue to water supply reductions to its member agencies for second year.

As during the 2009 water year, MWD plans to achieve 10% reduction in deliveries, over the average deliveries for the 2004 to 2006 period, by imposing significant penalty charge for those purveyors, they don’t reduce their deliveries by the required amount. In addition, MWD plans to implement 7.5% rate increase effective January 1, 2011.

To avoid the supply allocation penalties imposed by MWD during the July 1, 2009 through June 30, 2010 water year. Golden State Water implemented mandatory and voluntary water conservation and allocations in the certain of our service areas. To instant, Golden State Water customers have been successful reducing their overall water supply demand. Based on current and estimated future demand, Golden State Water Company has implemented voluntary conservation in those areas that were under mandatory conservation in 2009.

Water consumption was down approximately 13% during the first three months of 2010, when compared to the same period in 2009. Though we have received some welcome rain in California and large amount of snow in this winter, several of states major reservoirs are still at levels below their historical average. Every year the California Department of Water Resources, DWR establishes the State Water project allocation or water deliveries to the State Water contractors.

The Department of Water Resources generally establishes a percentage allocation of delivery requests based on a number of factors, including weather patterns, snowpack levels and reservoir levels. The DWR also much factor in the pumping restrictions imposed on the San Joaquin Sacramento Delta by the federal judge. The present allocation given to state contractors can vary throughout the year as weather and other factor change. DWR recently announced that it would increase the 2010 State Water project allocation to 40% to match 2009’s allocation’s percentage.

Now I’ll discuss the status of key regulatory filings and other matters for the company. First, in March 2010, Golden State Water Company filled an advice letter with the CPUC of recovery of Region II and Region III under collections associated with the Water Revenue Adjustment Mechanism or WRAM. Net of the modified cost balancing accounts or MCBA of $18.3 million as of December 31, 2009, a surcharge was put in place in March 2010, which is expected to recover the amounts accumulated

In April 2010 Golden State Water Company filed advice letters with the CPUC will recovery or $2.8 million, which represents the net under recovery of the WRAM, MCBA for Region I as of December 31, 2009. Going forward, Golden State Water Company will seek recovery of its WRAM, net of the MCBA on an annual basis. As of March 31, 2010 Golden State Water Company has a net aggregate regulatory asset of $26.2 million, which is comprised of $30.9 million under collection in the WRAM accounts and $4.7 million over collection in the MCBA accounts

Second in June 2009 the California Public Utility Commission authorized Golden States Water Company to track the difference between the 2007 adapted Golden State Water Company general office classed allocation to Bear Valley Electric in the 1996 adapted Golden State Water Company general office allocation to Bear Valley Electric, in a memorandum account, effective and retroactive to June 4, 2009.

The 1996 general office allocation was included in Bear Valley Electric rates at the time of the most recent rate case that was filed. In that rate case filing, the 2007 general office allocation was proposed to be included in the Bear Valley Electric rates in 2009 as part of the rate case. The amount in the memorandum account was about $958,000 as of December 31, 2009.

In March 2010, The California Public Utilities Commission approved for recovery, this memorandum account through a surcharge over 24 month period, effective May 1, 2010. Accordingly, during the first quarter of 2010, Home State Water Company recorded a regulatory asset in a corresponding increase to earnings four amounts included in this memorandum account.

Third, as a result of the decision from the Arizona Corporation Commission in October 2009, as part of Chaparral City Water Company’s rate case, Chaparral City Water was ordered to return to customers 100% of a settlement reached in 2005 with a local Sanitary District resulting in the recording of $760,000 loss in the third quarter of 2009.

In 2005, the Sanitary District paid Chaparral City Water Company $1.520 million, when Chaparral City Water Company originally accounted for this settlement, we maybe assumption that 50% of the settlement would go to shareholders, consistent with the Arizona Corporation Commission past practice. In November 2009, Chaparral City Water filed an application for rehearing on several issues decided in this rate case, including that 50% of the settlement proceeds should go to shareholders.

The Arizona Corporation Commission graded Chaparral City Water’s request to whole the rehearing on the issues. In January 2010, a procedural conference was held with the Judge and the staff of the Arizona Corporation Commission involved in the right case to address this issues. The final decision by the ACC is expected in the third quarter of 2010.

Now, I’d like to take a moment to discuss the status of the pending general rate case proceedings and other recent filings for the company. As you’ll recall, California Public Utility Commission issue a proposed decision on Golden State Waters, Region II, Region III and General Office rate case in November 2009, which it subsequentially withdrew in December, due to the complexities of certain issues?

The PUC has reopened the general rate case proceeding to receive supplemental information from the company on a number of items in the rate case. I would like to remind you that depending upon how the commission ultimately rules two of the issues good results in a write-off.

The first issue has to do with the review of the dollars, Golden State Water Company spent on a plant improvement project. The debate is whether the cost incurred was necessary to serving incumbent customers, new customers or both. The division of ratepayer advocates or DRA is arguing that the cost were incurred to expand the system to serve new customers and cost recovery for the improvements, therefore should have been received from the developer that brought these new customers online.

We believed the dollars had to be spent anyway to properly serve the current customers. If DRA is successful, in arguing this point Golden State Water Company could be forced to write-off up to $3.5 million. So on rate base and provide a credit backed customers or rates that Golden State Water Company has received today.

The second issue concerns Golden State Water Company’s approach to recovering rate case cost. Golden State Water has incurred $2.4 million of rate case related expenses during the preparation and processing of this rate case. These are direct cost consisting primarily of outside consulting in legal cost. The company and DRA are essentially in agreement about the amount of rate case cost to be recovered rates.

Historically, we’ve deferred rate case cost as a regulatory asset, which are then recovered rates and amortized over the terminal rate cycles once the new rates going to effect. In this case, the DRA has challenged this historical practice and believe that rate case cost should be projected for future years then recovered prospectively. We believe that DRA’s rational is inconsistent with our historical practices and that the CPUC has authorized our historical practice in prior rate proceedings.

If DRA prevails, and the PUC determines that the cost represent future cost and not deferred costs, Golden State Water will have to write-off $2.2 million of the deferred rate case cost that are included in our regulatory assets at March 31, 2010, plus the additional costs incurred processing remainder of this case.

In January 2010, the PUC approved in-memories for Golden State Water Companies Region II and Region III of rate making areas, pending the final decision on the general rate case. While the increase for interim rates were zero, it’s important to establish the effective date, so that the rates once approved by the PUC will be retroactive to January 1, 2010, a final decision is expected in September of 2010. We expect the new rates to be retroactive to January 1, 2010.

At this time we cannot predict the outcome of the final decision. We filed the general rate case for Region I on January 4, 2010 for two year rate cycle with rates effective 2011 and 2012. If approved as filed, region one is expected to generate approximately $57.1 million in annual revenues in 2011 and 58.3 million in 2012. A general rate case will be filed for all three water regions in July 2011, with rates effective January 2013.

Let’s share our discussion to ASU assets performance. ASU assets continue to record positive earnings for the quarter even excluded the effect of the two approved request for equitable adjustment of $0.19 per share during this quarter as discussed by earlier by Eva.

ASU assets show an improved financial performance and operating income by $0.04 per share in the first quarter of 2010, that’s compared to the same period in 2009, due to an increase in construction activities. We believe successful price redeterminations and request for equitable adjustment or REA filings will provided added revenues prospectively to help offset increased costs and provide ASUS the opportunity to consistently generate positive operating income at its military subsidiaries.

We are still working to finalize prospective price redeterminations and request for equitable adjustment at various bases, which include adjustments to reflect inflation in costs and changes in operating condition and infrastructure levels from that assumed at the time of the execution of the contract. The timing of the conclusion of such filings is some what unpredictable.

To summarize, I will quickly talk about the status of each of our price redeterminations. First, price redeterminations for the four Virginia bases have been submitted in our under review by the US government. The price redeterminations are expected to be completed in 2010; we have received interim management increases at the four Virginia bases.

Second, the first price redetermination for Andrews Air Force Base is under discussion with the government regarding the status of the redetermination filing, as well as an interim inflation adjustment to the monthly fees under the contract. We are unable to predict the outcome of these discussions with the US government or the timing of the finalizations of price redetermination in Andrews.

Third, we have two requests for equitable adjustment outstanding at Fort Jackson for emergency construction cost mostly incurred in 2008 and for infrastructure at Fort Jackson which is in poor condition than originally presented under the 50-year contract. The first price re-determination for Fort Jackson is scheduled to be filed in the second quarter of 2010. We’ve requested an interim increase in the monthly fee at Fort Jackson, while the permanent price re-determination is pending. Lastly, the first price re-determination for Fort Bragg is scheduled to be field in the second quarter of 2010.

Finally, American States shareholders should know that using the SEC guidelines for reporting financial performance, $10,000 invested in the shares of the American States Water at December 31, 2004 would be worth $15,461 at March 31, 2010 and this amounts to an annual compound growth in shareholder value of 8.65%.

Before I turn the conference over to the operator to entertain questions, I’d first like to thank you again for your continued support and interest in the company. And I’ll turn it back over to you, Miranda.

Question-and-Answer-Session

Operator

Thank you. (Operator Instructions) We will go first to Christopher Purtill with Janney.

Christopher Purtill - Janney

Just a quick question for you on the rate cases, we have the delayed region two and three case expected in September and the region one case planned for mid 2011, so I’m wondering if there is any reason to expect that there could be a delay in the region one case based on what’s happening with the review of the region two and three cases. So what’s you outlook there, are they kind of on a parallel track at the commission or could there be a delay in the region one case because of the review that two and three is going through?

Bob Sprowls

Well, first of all the region one case is scheduled to be settled by the end of 2010, with rates effective January 1st of 2011.

Christopher Purtill - Janney

Okay.

Bob Sprowls

Okay. And it is on a different path than the region two, region three general office case. These things can only slow down, but I don’t think the two are all tied together. I think the delay in the region two, region three general office case had to do with certain complexity of issues that we should get behind this is part of that particular case. So, we are expecting the region one case to be on schedule. And just say, what we are doing mid 2011 that will be the first time that we file a complete Home State Water company rate case with rates effective 2013.

Eva Tang

Water region.

Bob Sprowls

For water regions.

Christopher Purtill - Janney

And the just a bigger picture questions, can you talk a little bit about how your viewing the potential divided tax increases that could come about in 2011 and what impact, if there is any that you think it could have on the dividend policy or your payout ratio, is there a way to use those funds internally investing in capital as opposed to paying them out if investors are going to be facing this higher tax rate?

Eva Tang

I think what you mention was the qualified dividend preferential rate expired 1.1.2010 or at the end of this year. So, I don’t think it will affect AWR the issuer of the dividend ties more of the shareholders who investing our side. So, to that end I don’t think that will impact on dividend policy controller (inaudible).

Bob Sprowls

Yeah, I agree Eva, we have no plans to change our policy, and we’re very proud of the fact that we’ve increased our dividends for I think going on 56 consecutive years. We’re one of the few companies with a record like that and we take that very seriously. So, we do recognize that shareholder may have to pay more tax on the dividends they received, but at this point we have no plans to change our policy. And we generally focus on a payout ratio of about 60%, which already were maybe towards lower end of the utility industry, but we feel that we can still continue to increase our dividend and be in that 60% range.

Christopher Purtill - Janney

Okay, just one house keeping item, is there anyway that you can breakout the water supply cost in terms of purchased water and power?

Bob Sprowls

I mean that will be broken out of course in the Q that we file tomorrow.

Eva Tang

Right, you’ll have detailed information in the Q tomorrow.

Operator

(Operator Instructions) Your next question comes from the line of Vishal Khetriwal with Longbow Research.

Vishal Khetriwal - Longbow Research

Could you give us some color on the overall profitability of the military base business if you exclude the special construction work that you do?

Bob Sprowls

Well, a difficult question to answer, because the construction work has been very helpful in terms of driving the profitability and there is a lot of construction work to be done at the various military bases and then I know we come in and we say that ASUS did better than last year because of increased construction work, but that’s a key component to the profitability of the business. So we really haven’t given any guidance on ASUS and also we’re hesitant to discus margins on the construction business component, but it is a business that the construction component there is plenty of work to be done, particularly at Fort Bragg that’s a business, that particular base has got quite a backlog of construction work and we’re just trying to get some contract modifications to get going there.

Vishal Khetriwal - Longbow Research

But just equitable adjustment that you noticed in recently and you know the more, but and you will see more of these down the line, these must be improving the profitability of the business in general like excluding the special contract construction which is more in which there is a lot of variance?

Bob Sprowls

Yes, the REAs are way to sort of compensate us for a variety of things. Fort Bragg, we got an REA because we took over more inventories there than what was included in the original RFP and the same could be said for Fort Bliss so for both of those bases we do have like as a larger amount of assets that we’re managing than what was included in the RFP.

The REAs that we’ve gotten at Fort Jackson had to do with some emergency work that we had done there and we sort to had a internal debate whether to do the emergency work ahead of getting contract modifications, the plan is to get contract modifications before we go loud and do something that isn’t in the contract, but we have an emergency situation you want to be sure and take care of those things first, so we do feel like we’ve learned a lot in terms of getting understanding how to operate this business.

Eva Tang

Vishal, for the first quarter our construction activity increased compared to last year, the same period of time, so our revenue of construction actually increased as a result, but our construction expenses, if you look at earnings really is actually pretty flat something for the last year and mainly because during this quarter we have a lot of firm fixed contract to which we actually incurred higher margin during the first quarter, because when you guys are line that you can help labors and cost contentment methodology, so hopefully that’s helpful to your question.

Bob Sprowls

We are focused internally when we look at the profitability of the various revenue stream at ASUS. We are focused on trying to be profitable not only on the construction side, but also on the operations and mid side. One of the key components that being profitable on the O&M side is getting timely price redeterminations and that’s been a little bit of a problem for us, as we try to go through this first round of price redetermination.

Vishal Khetriwal - Longbow Research

Okay and just my last question, could you give us any update on the status of bids for additional military base contracts and are you seeing more contracts opening up for bidding?

Bob Sprowls

Well, the government is moving fairly slowly in the privatization of the military bases and you tend to divide the Department of Defense into the various branches of the military, the Army, the Air Force and the Navy. It seems like the Army and the Air Force had headed down the path hereof sort of getting on board with the military privatization activity or the Navy has not, but there are still plenty of Army bases and Air Force bases to privatize so there is a more work to be gotten out there, but it is sort of slow going. It is not like we’re well, Fort Meade was contract that went to one of our competitors, but my knowledge that’s the last base, only base that’s been let our since probably in the last year, there is a lot more bases to be done, it’s just slow going.

Operator

We have no further questions at this time. (Operator Instructions) It appears we have no further question from the phone audience. I will turn the conference back over to Mr. Sprowls for any additional or closing remarks.

Bob Sprowls

Thanks, Miranda. I just want to mention that our shareholder meeting is on May 27 and the company would like to encourage all shareholders who have not already voted their proxies to do so. Again, thank you all for your participation today and for your continued interest and investment in American States Water Company.

Operator

Thank you. This concludes today’s American States Water Company conference call. Ladies and gentlemen we do have a correction to the replay number for today’s call. The corrected phone number to dial-in on 888-203-1112, again that is the corrected number, it is 888-203-1112 and again that replay will be starting approximately at 2.30 pm Pacific Time today and the conference ID that you’ll need is 9324991, so again the dial-in number 888-203-1112, conference ID number 9324991. You may also access the replay at www.aswater.com. Thank you for your participation. You may now disconnect.

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