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American States Water (NYSE:AWR)

Q2 2012 Earnings Call

August 06, 2012 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

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company, AWR, conference call discussing the second quarter of 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 emailed to you. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 2 p.m. Pacific time and run through Monday, August 13, 2012. After logging on 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 will be recorded and will be limited to no more than 1 hour. At this time, I would like to turn the call over to Eva Tang, Chief Financial Officer of American States Water Company.

Eva G. Tang

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

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

Before I discuss the results for the quarter, Bob would like to say a few words. Bob?

Robert J. Sprowls

Thank you, Eva, and thank you, everyone, for joining our call. As many of you know, our Board of Directors last week approved a $0.075 increase in the quarterly cash dividend to $0.355 per share. This represents a 27% increase in the quarterly dividend. This substantial increase reflects our board's confidence in the sustainability of the company's earnings and the prospects for the future at all of our business segments: our water utility, the electric utility and contracted services.

The dividend increase is also an indication of just how much our contracted services business has grown over the past several years as we have not historically paid a dividend on these earnings. We believe that long-term, sustainable earnings from this business will have a continued -- will be a continued source of dividends for our shareholders and we have adjusted our dividend accordingly.

I will discuss ASUS in more detail later and its contribution to the current dividend. Although we do not have a set dividend payout ratio, we believe that prudently increasing dividend enhances our ability to attract capital in the future. For 58 consecutive years, American States Water Company shareholders have received an increase in their annual dividend payments. I'm pleased to say that we are one of only a handful of companies on the New York Stock Exchange that can claim this kind of record. With that, I'll turn the call back over to Eva to discuss the results from the quarter.

Eva G. Tang

Thank you, Bob. I'm very pleased to report that we continue to deliver strong quarterly results with an increas in earnings from continuing operations of 15% to $0.79 per fully diluted share compared to $0.68 per share for the second quarter of 2011. Net income from continuing operations for the quarter increased by $2.4 million or 18.5% increase compared to the same period in 2011. The increase is driven by increases in earnings from all 3 of our business segments.

For the second quarter of 2012, our operating revenues increased by $4.5 million or 4.1% to $114.3 million. The main driver of this increase continues to be our contracted services segment, American States Utility Services, or ASUS. ASUS' revenue increased by $3.1 million to $25.1 million compared to the same period last year, primarily due to increased construction activity and favorable changes in cost estimates for water and wastewater pipeline replacement project at the Fort Bragg military base.

Water and electric utility revenue at Golden State Water increased by $1.4 million due to rate increases approved by the California Public Utilities Commission, effective January 1, 2012. 2012 is the final year of the current rate case cycle for both our water and electric utility business segments. Typically rate increases are the lowest during the last year of the rate cycle.

Our water electric supply costs were $26.7 million accounting for 31.7% of total operating expenses for the second quarter of '12. As you know, any changes in purchased water, power purchased for pumping, pump taxes for the water utility segment as compared to the adopted supply costs, are covered by Modified Cost Balancing Account. The electric utility segment also has a full cost balancing account to track the changes in purchased power and transmission-related costs. Other operation expenses remained constant as compared to the same period last year. Increases in conservation-related expenses, water treatment costs and employee-related costs at the water segment were offset by a lower precontract cost incurred at ASUS.

Administrative and general expenses for the quarter stayed relatively flat as compared to the second quarter of '11. The increases in labor and employee benefit costs were mostly offset by decreases in outside services cost. We are very mindful of our costs and now striving to stay within our operating budget.

Depreciation and amortization expenses increased by $859,000 to $10.4 million for the second quarter of '12 as compared to the same quarter in 2011 due to capital additions made due in 2011. Maintenance expense decreased by $771,000 to $3.9 million for the second quarter of '12 as compared to the same period last year, mainly due to lower maintenance work at our water facilities, as well as a decrease in the need for maintenance at the military bases served by ASUS. We do expect our plant maintenance expenses for water operations to increase during the second quarter of 2012.

Property and other taxes for the quarter increased by $310,000 due to increases in property and payroll taxes. ASUS' construction expenses increased by $2.4 million to $14.9 million during the second quarter of 2012 as compared to the same period last year. This increase is primarily due to increased construction activities performed at Fort Bragg military base.

Moving on to interest expense. Interest expense, net of interest income for the second quarter of 2012 decreased by $1.5 million as compared to the same period in 2011. The decrease was mainly driven by lower short-term borrowings and the recording of a $381,000 reduction through interest expense in connection with the CPUC's final decision on the water cost of capital proceedings that was approved in July.

Bob will discuss of the cost of capital decision in more detailed later on the call. In addition, included in the second quarter last year's results were interest charge totaling $553,000 incurred in connection with the redemption of $22 million of 7.65% notes in May of 2011.

Income taxes increased by $395,000 to $9.8 million as compared to the same period last year. This increase was due to an increase in pretax income for the quarter, partially offset by a lower effective income tax rate at Golden State Water as compared to the same period in 2011.

Turning our attention to cash flow. Our net cash provided by operating activities increased by $31 million to $63.9 million for the 6 months ended June 30, 2012 as compared to $32.9 million for the same period in '11. The increase was primarily due to the timely collection of amounts billed for construction work at ASUS; CPUC approved rate increases for all of our regulated businesses; accelerated depreciation, which reduced income tax payments; and surcharges collected to recover the Water Revenue Adjustment Mechanism or WRAM balances.

For the first 6 months of 2012, we collected $7.6 million in the WRAM surcharges. Due to an increase in billed customer consumption, our year-to-date 2012 WRAM on the collection, net of the modified cost balancing account, is accumulating at a much slower rate as compared to the same period in 2011. The water consumption increased by 6% for the first 6 months of the year and 5% for the second quarter compared to the same period in 2011. We have experienced a much drier year and, as a result, have seen an increase in customer consumption.

There are 2 results from the increase in consumption: one, we have a lower on the collection of the balances, the WRAM balances; and two, we have been collecting more surcharges during the first 6 months of the year. The collection of surcharges that was actually outpacing the other collection, we accumulated in the WRAM balances.

Moving on to our capital expenditures. Golden State Water invested $28.7 million in capital projects during the 6 months ended June 30, 2012. We expect to increase our capital expenditure during the second half of the year, which would put us on track to spend $70 million to $80 million in capital improvements for 2012. We have been using our internally generated cash to fund our capital needs. So as of June 30, 2012, we had no borrowings under our revolving credit facility.

I'm also pleased to report that S&P recently affirmed our A+ ratings for both American States Water Company and Golden State Water, which makes us one of the highest-ranked water utilities by S&P from a credit quality standpoint. The strong credit allows us to borrow at a low rate to fund our capital and operational needs.

Our year-to-date diluted earnings per share from continuing operations were $1.32 per share, which represent a 26% increase over the same period of the prior year. For additional details, please refer to our earnings release and our Form 10-Q issued earlier today. And with that, I'd now like to turn the call back over to Bob.

Robert J. Sprowls

Thank you, Eva. As you can tell from our press release earlier today and Eva's comments, we experienced another strong quarter of growth in earnings in each of our business segments. In addition, we've had a very strong cash flow for the year thus far.

I would like to take some time now and provide you with an update on regulatory activities at our water and electric utility business segments. In June of this year, we filed a motion to adopt a settlement agreement between Golden State Water Company, the CPUC's Division of Ratepayer Advocates, also known as DRA, and The Utility Reform Network, also known as TURN, in connection with Golden State's general rate case for water. You will recall that we filed this rate case in July 2011. The proposed settlement, if approved by the CPUC, resolves almost all the issues in the rate case application and would generate approximately $9 million in additional annual revenues starting in 2013 as compared to 2012 adopted revenues. The proposed rate increases for 2014 over 2013 are $8.0 million and the 2015 proposed rate increases over 2014 amount to $6.5 million. While the increase in 2013 revenues would be $9 million under the settlement agreement, the increase in the adoptive water gross margin is approximately $18 million or 8.4% when compared to the 2012 adopted water gross margin due to a decrease in adopted supply cost of $9 million in 2013 as compared to the 2012 amount. The administrative law judge in charge of the case requested that Golden State Water, DRA and TURN file additional testimony to address the reasonableness of the WRAM mechanism. Last month, the 3 parties filed additional testimony. The settlement agreement for this general rate case is subject to an acceptable resolution regarding the WRAM. New rates, once approved by the CPUC, will be effective January 1, 2013.

In other significant regulatory matter was the cost of capital decision issued in June. Actually, this decision was issued in July. The decision approves the settlement agreement entered into between Golden State Water, 3 other California water utilities and DRA in November 2011. The approved settlement authorizes a return on equity of 9.99% and a rate-making capital structure for Golden State Water of 55% equity and 45% debt. The resulting weighted cost of capital or rate of return on rate base is 8.64%. The new rate of return authorized by the CPUC's final decision will be implemented into water rates retroactive to January 1, 2012. The decision also authorizes the continuation of the Water Cost of Capital Mechanism, which adjusts the adopted return on equity if there's 100-basis-point change in the average of the Moody's Aa utility bond index. If the Water Cost of Capital Mechanism is triggered, the adopted return on equity is adjusted by 1/2 the change in the bond index. The benchmark period in place was from October 1, 2010 to September 30, 2011, with an average interest rate of 5.05%. Considering where interest rates are currently, we anticipate that the adopted return on equity may be reduced by 50 to 60 basis points, effective January 1, 2013. Since the measurement period runs from October to September each year, we'll be able to report any adjustment to the 2013 return on equity when we discuss our 2012 third quarter results.

For your information, a reduction of 50 basis points in the adopted return on equity would reduce Golden State's 2013 earnings per share by approximately $0.10 and decrease revenues by about $3.3 million.

In July 2012, Golden State Water filed with the CPUC an application requesting authorization for it to issue by public offering or private placement securities not exceeding $225 million in aggregate offering amount. Golden State Water expects the CPUC to approve this application in late 2012 or early 2013. Upon approval, Golden State Water will attempt to capitalize on the current low cost of capital by issuing new debt and redeeming old debt at higher coupon rate, thus generating future savings for our customers.

With that, I would like to recap the general rate case application for Golden State Water Company's Bear Valley Electric division that was discussed last quarter. In February 2012, we filed our general rate case application for Bear Valley Electric 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 annual revenues starting in 2013. The proposed rate increases for 2014 over 2013 are $1.9 million, the 2015 proposed rate increases over to 2014 amount to $1.3 million and the 2016 proposed rate increases over the 2015 amount are $1.3 million. This general rate case application is in the process of review with the CPUC. Once approved, we expect new electric rates to become effective in the first quarter of 2013.

Let's turn our discussion to the company's contracted services segment, American States Utility Services or ASUS. ASUS is focused on maintaining a customer service culture and we continue to build our relationship with the U.S. government. Earnings from ASUS have grown significantly over the past 3.5 years and we have not historically paid a dividend on those earnings. On July 31, 2012, ASUS' Board of Directors approved, for the first time, a dividend of $6.7 million to American States Water Company to completely fund our upcoming dividend payable to shareholders on September 1, 2012. With the solid outlook for ASUS, we anticipate ASUS to continue providing partial funding of dividends that American States Water Company pays out to its shareholders.

For the second quarter of 2012, ASUS continued to report strong earnings as we increased our construction activities at the various military bases ASUS serves, especially at Fort Bragg, as we progress with the water and wastewater pipeline replacement project, along with other capital upgrades. We have made more progress than we anticipated on the pipeline replacement project and expect the project will be completed in early 2014. There are many variables that affect the timing of construction work. Some of these variables, such as weather, worked in our favor during the first 6 months of the year, but may not necessarily be a benchmark to project earnings for the remainder of 2012. We have also been awarded new contract modifications by the U.S. government or the various military bases ASUS operates. While it is difficult at this time to quantify the earnings impacts of these new projects, we expect the majority of these new construction work to be completed by the end of 2013.

As I discussed with you previously, we believe successful price redetermination and requests for equitable adjustment or REA filings will provide added revenues perspectively to help offset increasing cost and provide ASUS the opportunity to consistently generate positive operating income at its subsidiaries that serve military bases. We currently have no significant requests for equitable adjustment outstanding with the U.S. government. However, various price redeterminations for managing the assets at the military bases are currently in negotiation with the government.

To summarize, the U.S. government is currently reviewing the first price redeterminations for Fort Bragg in North Carolina and Fort Jackson in South Carolina, which were filed in December 2011 and February 2012, respectively. Interim price increases are in place for both military bases. We have reached an agreement with the U.S. government on our first price redetermination for Andrews Air Force Base in Maryland. Final contract modification is pending government funding approval, which we expect to receive later in 2012. We have completed our first price redetermination for Fort Lee, Fort Eustis and Fort Story in Virginia. The second price redetermination for Fort Lee was filed with the U.S. government in May of this year. The second price redetermination for the other military bases in Virginia was filed with the U.S. government last month. The price redetermination for Fort Bliss for the 3-year period beginning October 1, 2012, was filed on July 16 of this year. ASUS is working closely with the U.S. government to provide timely submittal and resolution to these price redeterminations.

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]

Robert J. Sprowls

Well, Valerie, if there's no questions, we can wrap up the call.

Operator

I'm showing no questions at this time.

Robert J. Sprowls

Okay. Well let me again thank you, all, for your participation today and for your continued interest and investment in American States Water Company.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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