American States Water Company (NYSE:AWR) Q3 2014 Earnings Conference Call November 5, 2014 2:00 PM ET
Executives
Eva Tang – CFO
Robert Sprowls – President and CEO
Analysts
Jonathan Reeder – Wells Fargo Securities, LLC
Timothy Winter – Gabelli & Company
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company Conference Call discussing the company’s third quarter 2014 results. If you would like to listen to the replay of this call it will begin this afternoon at approximately 5 p.m. Eastern Time and run through Wednesday, November 12, 2014 on the company’s website, www.aswater.com. (Operator Instructions). As a reminder this call will be recorded and will be limited to no more than one hour.
At this time I would like to turn the conference over to Ms. Eva Tang, Chief Financial Officer of American States Water Company. Please go ahead.
Eva Tang
Thank you, Amelie. Welcome, everyone and thank you for joining us today. On the call with me is our President and CEO, Bob Sprowls.
As a reminder certain matters discussed during this conference call may be forward-looking statements intended to qualify for the Safe Harbor from the liability established by the 1995 Private Securities Litigation Reform Act. Please review a description of the company’s risks and uncertainties in our most recent Form 10-K and 10-Q on file with the Securities and Exchange Commission. With that I will now discuss the third quarter financial results.
Diluted earnings for the third quarter of 2014 were $0.54 per share compared to $0.53 per share for the same period in 2013. Net income for the quarter was $21.2 million compared to $20.8 million last year. The increase in our consolidated earnings was primarily driven by the recording of retroactive revenue based on price redeterminations approved by the U.S. government and higher construction activity at our contracted service segment. Earnings at our Water segment decreased by $0.02 per share compared to the third quarter of last year, while our earnings for the Electric segment remained flat. Additionally earnings per share at our AWR parent company decreased by $0.03 per share this quarter due primarily to a cumulative tax benefit recorded during the third quarter of last year for deduction taken related to an employee benefit program. There was no similar cumulative tax benefit recorded in 2014.
For the quarter water revenues increased by $2.8 million to $96.7 million as compared to the same period in 2013. During 2014 the CPUC approved an increase in rates to specifically cover increases in supply cost experienced in certain customer service areas. This revenue increase is offset by a corresponding increase in supply costs resulting in no impact in the water gross margin. There was also an increase in water revenue due to second year rate increases approved by the CPUC effective January 2014.
Revenue for electric operations decreased slightly to $8.6 million for the quarter pending a final decision on electric general rate case our electric revenues have been recorded using 2012 adopted levels authorized by the CPUC. Revenue for our contracted services business, American States Utility Services increased $4.9 million to $33 million for the third quarter. The increase was partially due to the resolution of price redetermination for the military subsidiaries serving Andrews Air Force base, Fort Bragg and Fort Jackson during this past quarter which resulted in the recording of retroactive revenue of $2.6 million this quarter. There was also an increase in construction activities at these bases as compared to same period in 2013.
Our water and electric supply costs were $31.6 million for the third quarter of 2014. Any changes in supply cost for both water and electric segments as compared to the adopted water supply cost and electric supply cost are tracked in balancing accounts which will be recovered from or refunded to our customers in the future.
Other operation expenses decreased by $227,000 for the third quarter of 2014 mostly due to a $203,000 increased in surcharges for recovery of costs previously incurred with a corresponding increase in revenues in the water segment. As we have mentioned before these surcharges have no impact on pretax operating income.
Administrative and general expenses for third quarter of 2014 were $20.2 million as compared to $20.1 million for the same period in 2013. During the third quarter of 2014 there was a $820,000 reduction in surcharges billed at our water segment for recovery of various A&G costs previously incurred as compared to the same period in 2013. Again surcharges have no impact on pretax operating income. Excluding this decrease in surcharges overall A&G expenses increased by $915,000 due in a large part to increases in legal and outside services cost.
Maintenance expense decreased by $276,000 driven by a higher level of planned maintenance performed in 2013 at our water segment. We expect maintenance expense for the water segment to be lower in 2014 as compared to 2013. Depreciation and amortization expense increased by $796,000 to $10.5 million for the third quarter of 2014 due mostly to approximately $93 million of addition to utility plants during 2013.
Property and other taxes increased by $251,000 compared to the same quarter in 2013 as a result of increases in property taxes for the Water segment. ASUS’ construction expenses increased by $1.2 million to $20.4 million during the third quarter of 2014 due to an increase in construction activity. Other income and expenses, including interest expense decreased slightly to $5.3 million for this quarter.
Income tax expense increased by $3.6 million to $13.5 million as compared to the third quarter of 2013, driven by an increase in pretax income and a higher effective income tax rate.
Moving on to liquidity and capital resources, net cash provided by operating activities increased by $32.8 million to a $120.1 million for the nine months ended September 30, 2014. This increase was primarily due to an increase in cash generated by contracted services, resulting from the timing of billing and cash receipts for construction work at military bases.
In addition there were water rate increases in May 2013 and January 2014 and the collection of various surcharges implemented in mid-2013 in connection with CPUC’s final decision on the water rate case. These increases in cash flow for operating activities were partially offset by tax refunds received during the first quarter of last year for which no similar refund amounts were received in 2014. The timing of cash receipts and dispersions related to other working capital items also affected the change in that cash provided by operating activities.
In regards to Golden State Water’s capital expenditures we spent $44 million on company-funded capital work during the nine month ended September 30, 2014. The capital expenditures were lower than we expected mainly due to delays in certain pipeline projects as a result of [accepted paving] requirements and permissions on local cities and delays in our new ground water well project due to difficulties in finding suitable hot water in the area. As a result capital expenditures for the full year of 2014 are now estimated to be between approximately $70 million and $75 million.
Most of the capital work delayed in 2014 are now expected to be completed in 2015. We estimate 2015 capital expenditures to be $85 million to $90 million. For additional details on our third quarter and year-to-date performance please refer to our earnings release and Form 10-Q issued this morning.
With that I’ll turn the call over to Bob.
Robert Sprowls
Thank you, Eva. I appreciate everyone joining us today. I’ll begin with an update on our water and electric general rate cases. First, for our water segment, as we discussed during last quarter’s call Golden State Water Company filed a general rate case in July for all of our water regions in the general office. The application will determine the water rates for the years 2016, 2017 and 2018. Golden State Water requested overall capital budgets in the application which average approximately $90 million a year for the three-year period. 2016 adopted water gross margin is expected to decrease by approximately $700,000 as compared to the currently adopted levels due in part to decreases in annual depreciation expenses resulting from an updated depreciation study. New water rates are expected to become effective in January 2016.
Our electric general rate case which was filled in 2012 for new rates in years 2013 through 2016 the CPUC issued a proposed decision in September 2014 adopting a settlement agreement reached with all parties on a revenue requirement. A final decision is expected in the fourth quarter of 2014. We do not expect this proposed decision, if approved in its current form by the CPUC to have a significant impact on Golden State Waters net income for 2014.
Before I move on to our contracted services business at ASUS, let me address the company’s water supply and drought situation in California and provide an update on our potential combination of one of our water systems. As we discussed in our previous calls the State Water Resources Control Board in July approved emergency regulations that implement mandatory restrictions on certain outdoor urban water use to further reduce water use throughout the state. The regulations call for mandatory water use restrictions such as eliminating hosing driveways, prohibiting irrigation run off et cetera.
We are regulated by the CPUC on such matters and our water conservation rationing plan approved by CPUC is aligned with the emergency regulations. If dry conditions continuing on our service areas we may implement additional steps as outlined in our CPUC approved plans consistent with the water supply situation for a particular service area. These steps may include mandatory rationing with penalties for non-compliance. Also in the event of water supply shortages in certain of our service areas Golden State Water would need to transfer additional water from other areas increasing the cost of water supply. Since water supply cost is a pass-through expense to our customers these additional cost would result in higher cost to customers which taken together with mandatory water rationing may lead to customer criticism.
Let me provide you an update on potential condemnation of our water system. In yesterday’s general election a Bond Measure was passed in the city of Claremont within our service territory which authorizes the city to issue up to $135 million in water revenue bonds to fund a potential acquisition of our water system in Claremont. For the acquisition of public utility property the laws of the State of California provide that we may contest in court whether the condemnation is actually necessary and in the public interest and then we are entitled to receive the fair market value of our water system if it is ultimately taken. While are disappointed with the outcome of the vote we are committed to providing excellent service to our customers and will continue to defend our Claremont system from condemnation and work with the city to address their concerns.
Now let’s turn our attention to the company’s contracted services business at ASUS. As Eva mentioned, in September 2014, the U.S. government issues contract modifications to ASUS approving price redeterminations related to the operations at Fort Bragg or Fort Jackson and Andrews Air Force Base. As a result of these contract modifications ASUS recorded approximately $2.6 million in retroactive revenues and pretax operating income during the three and nine months ended September 30, 2014. Also approximately $6 million of renewal and replacement funds were also recorded as billings in excess of cost on balance sheet. This $6 million will be recognized in construction revenues along with the related construction cost when the work is performed. ASUS continues to work closely with their government on the remaining redeterminations.
We expect the third price redetermination for Andrews Air Force Base in Maryland and the second price redeterminations for the military bases in Virginia to be completed during the fourth quarter of 2014. Additionally we expect the second price redetermination for Fort Jackson in South Carolina to be completed in the first quarter of 2015. Items for these price redeterminations requests for affordable adjustment and contract modifications awarded for new projects provide ASUS with additional revenues and margins and the opportunity to consistently generate positive earnings.
We also continue to work closely with the U.S. government for contract modifications relating to potential capital upgrade work as deemed necessary to improve the water and waste water infrastructure at military bases. During the third quarter of 2013 the U.S. government awarded ASUS approximately $27 million in new construction projects, majority of which are expected to be completed during the next 12 months. In addition, we are actively engaged in new proposals and expect the U.S. government to release additional bases for bidding over the next several years. In regard to ASUS’ outlook for the remainder of 2014 we are still anticipating that earnings per share for the full year 2014 could come out close to ASUS’ 2013 results of $0.27 per share after the removal of the one-time tax benefit from 2013 earnings.
Finally I would like to turn our attention to dividend. On October 28, 2014, the Board of Directors approved our fourth quarter dividend of $0.2103 per share for shareholders of record after close of business on November 14, 2014, American States Water Company has paid dividends every year since 1931 increasing the dividend received by shareholders each calendar year since 1954. Given American States’ current payout ratio compared to our peers there is room to grow dividend in the future.
Before I finish my prepared remarks I’d like to thank you for interest in American States Water and we’ll now turn the call over to the operator for questions.
Question-and-Answer Session
Operator
Thank you. We’ll now take your questions. (Operator Instructions). We’ll begin with Jonathan Reeder of Wells Fargo. Please go ahead.
Jonathan Reeder – Wells Fargo Securities, LLC
Hey, Bob and Eva, got a couple of questions. First Eva did I hear correctly that the CapEx shortfall in 2014 you are essentially shifting that to 2015 and there should no change overall for the two years cumulatively?
Eva Tang
I believe so.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay. And then Bob maybe you can drill down a little more on the $2.6 million of retroactive price re-determinations. How much of that was for periods prior to 2014? Was that the majority of it or how would you kind of I guess parse out what it wouldn’t be for ‘14?
Robert Sprowls
I would say majority of it is for periods prior to 2014.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay, so that’s...
Robert Sprowls
Some of it of course is related to 2014 as it’s retroactive back to basically when the re-determination, if it was done on time would have been done.
Eva Tang
It’s like our vacate cycle, Jonathan. Everything you’re into [filer] if the government delaying giving us the rate increases than it’s retroactive to the date supposed to be effective.
Jonathan Reeder – Wells Fargo Securities, LLC
Right, so I guess you want us to think of it similar to I guess ASUS’ $0.27 last year this year, think of it is ASUS less this $0.04 amount. Is that kind of fair?
Robert Sprowls
I guess where I would sort of parse it, it would probably be $0.27 less maybe $0.03 because somewhere it is related to first nine months in 2014, but if that helps?
Jonathan Reeder – Wells Fargo Securities, LLC
Yeah, okay and then you said the government awarded $27 million of new construction projects expected to be done mostly over the next 12 months. That seems to be a step up from what you had last year. I guess we introduce that two and then what do you expect the full year 2015 construction budget will look like at ASUS.
Robert Sprowls
Well, it’s generally the company works with – it’s partnered public works at each of the bases to try to determine what additional work needs to be done at the base and so we worked very closely with this group and we’re able to convince the government that additional work needed to be done. So that $27 million is a bit of step up from last year because I think it was $18 million last year if I’m not mistaken it Evan?
Eva Tang
Yeah, that’s correct.
Robert Sprowls
Yeah, so it’s an effective 50% increase when we think about construction work going forward, so we’ve the $27 million. However in 2014 of course we have some major projects that were completed, the water and waste water project at Fort Bragg, the additional projects at Fort Bragg. So as we look out into the future and we really hesitate to try to give revenue estimates for construction because it’s pretty unpredictable as to the timing of this. I guess we’re not ready to sort to give a revenue estimate on the construction side.
Jonathan Reeder – Wells Fargo Securities, LLC
Well maybe you can talk a – I guess the $27 million of construction projects awarded that’s not the only construction projects we’ll see in 2015 right there is another component like kind a base component to the construction projects is that.
Robert Sprowls
Yeah the renewal and replacement work that sort of ongoing. This $27 million is not renewal or replacement it’s other types of projects. So it’s really on top of renewal and replacement. We also have the $6 million of the retroactive renewal and replacement that would go into over the next 12 months that we got as part of the price redetermination.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay so that’s $6 million you would think would be something you recognize and get done in 2015.
Robert Sprowls
Yeah maybe even little bit in the fourth quarter ‘14 but it would and good part of it, most of it would roll over in 2015.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay, and then I guess have you guys said what you believe the fair market value of Claremont is I guess just wondering where the city came up with the 135 and what that might mean for you.
Robert Sprowls
Yeah, I mean we have not we’ve not put a value out there. I think the 135 is part of the city’s way of trying to determine an amount that would not only cover their cost of the system but sort of getting through the process between now and then and maybe, reimbursing the city for litigation and that sort of things but we’ve not put a valuation out at this point and do not plan to until October till we’re basically forced to in the court process if it comes to that.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay, alright I think that’s well I guess last question and – to what extend the other bases that you currently have RFPs out there that you’re pursuing or ones that you come up. Any sense when we might see another government decision.
Robert Sprowls
Very hard to predict Jonathan, government is seems to be moving very slowly on this particular area. We are out there bidding though on a number of basis and hopefully we can break through with a win here soon, but it’s a really hard to predict.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay and the last one they have made a determination on was that one, I believe it was last January in Utah that was last time the government made a decision on a privatization contract.
Robert Sprowls
Well you sort to have to look at the various branches of Department Of Defense. You’ve got the army bases that seem to be sort of moving down to path a little more quickly or have moved more quickly down the path and the air force bases are more slowly but I believe one of our competitors want a base in New Jersey. It was army bases on the call, more recently than last January if I am not mistaken.
Eva Tang
And but we’ve been participating the bidding process for all the bases.
Robert Sprowls
That’s right those were not bases that we had on our list, but so army seems to be moving more quickly than air force at this point.
Jonathan Reeder – Wells Fargo Securities, LLC
Okay. I appreciate the additional color.
Robert Sprowls
Thank you Jonathan.
Operator
(Operator Instructions). And our next question is from Tim Winter of Gabelli. Please go ahead.
Timothy Winter – Gabelli & Company
Good afternoon Bob and Eva.
Eva Tang
Hi Tim.
Timothy Winter – Gabelli & Company
I was wondering can you give a little more background or metrics associated with Claremont I mean how many customers served or property plant and equipment and what the issue is with the folks.
Robert Sprowls
Sure, 11,000 customers in that – of our 11,000 more customers in that challenge. So the issue generally has been rate levels and the fact that rates have been going up overtime because we’ve been replacing capital. And the city generally compares our rates to municipalities surrounding the city of Claremont and our rates are higher according to the city. Couple of things going on there. One is the in many cases municipalities do not necessarily reflect in the water bill the true cost of operating the water system. Sometimes that can be in other forms like property tax bills et cetera.
Secondly, our company has felt that we need to consistently replace infrastructure to keep a very good system operating. And I’m not sure other municipalities have been doing that. As you know Tim I think that the rate setting process for a city becomes very political, city council folks in many cases have a difficult time approving rate increases then they use to replace infrastructure. So we’ve always sort of have the view that if you have total regular small rate increases to keep your system upgraded that’s been the best way to run the water system and that’s the way we’ve done things.
The other things that have sort of come through here is we did implement the tiered rates in late 2008, early 2009, customers are not all that happy with the fact that as they use less water, in some cases their bills go up and that’s been a sort of bone of contention in the city of Claremont. As our system is such that 70% of our costs are fixed and 30% are variable. However to really be able to get conservation to kick in our rates are designed sort of just the opposite. Rates are sort of designed assuming 70% are variable and 30% are fixed. And as a result that customers use less water our costs do not go down as great as one might expect. And so because of the water revenue adjustment mechanism company has kept hold through that.
However the customers are not happy with the fact that gee I use less and so having to pay the surcharges even though their next door neighbor is not using less, the next door neighbor also has to pay the surcharges. So they are in fact better off than their neighbor. Anyway that’s really some concern there, City of Claremont I think understands it’s going to cost them considerably more to buy the system and run it and what their situation is with our company. However it no longer according to the more vocal people at Claremont it’s no longer an issue of rates it’s more of an issue of local control. So maybe that maybe more of the nuance though, but.
Timothy Winter – Gabelli & Company
No, that’s helpful and just is there anything extraordinary about the property plant equipment, you want any extra facilities there or is it just sort of do the math with 11,000 customers out there, customer base to try to get a rate base number.
Robert Sprowls
Nothing real, no there is really nothing unique about Claremont.
Eva Tang
We do have [inaudible] in Claremont that is not
Timothy Winter – Gabelli & Company
Yeah the water rights would become I– would also be considered market value perhaps.
Robert Sprowls
We believe that would be yes.
Timothy Winter – Gabelli & Company
So that would be a considerable dollar amount.
Robert Sprowls
It would be yes. And the $135 million is not our number, I can tell you that.
Timothy Winter – Gabelli & Company
Okay and then can you quantify what the water rights are associated with that property.
Robert Sprowls
I cannot.
Timothy Winter – Gabelli & Company
Understood okay. Thanks Bob, thanks Eva.
Operator
(Operator Instructions).
Robert Sprowls
Just a comment here. I don’t really want our analysts to get really concerned about the Claremont situation we believe ultimately that if this gets condemned that the valuation we get will be at least what we have what’s currently in our stock price. So this is not something that’s kind of would be of financial harm to the company. It is though from a strategy standpoint I mean our goal and why this to be get bigger not smaller so and we told to city that. So from that perspective we’re going to of course fight the condemnation.
Operator
At this time we’re not showing any additional questions.
Robert Sprowls
Okay. You can go and wrap it up if that’s okay Emily.
Operator
This concludes today’s American States Water Company conference call. As a reminder the call will be archived on our website and be replayed beginning Wednesday November 5, 2014 at 5 PM Eastern time 2 PM Pacific Time and will run through Wednesday November 12, 2014. Thank you for your participation. You may now disconnect.
Robert Sprowls
Thank you everyone.
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