American States Water Co. (NYSE:AWR) Q2 2016 Earnings Conference Call August 4, 2016 2:00 PM ET
Eva Tang - Senior Vice President, Finance, Chief Financial Officer, Corporate Secretary and Treasurer
Robert Sprowls - President and Chief Executive Officer
Jonathan Reeder - Wells Fargo Securities, LLC
Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company Conference Call, discussing the Company’s Second Quarter 2016 Results. This call is being recorded. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 5 PM Eastern Time and run through Friday, August 12, 2016 on the Company’s website, www.aswater.com.
The slides that the Company will be referring to are also available on the website. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] This call will be limited to an hour. Presenting today from American States Water Company is Bob Sprowls, President and Chief Executive Officer; and Eva Tang, Chief Financial Officer.
As a reminder, certain matters discussed during this 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.
In addition, this conference call will include a discussion of certain measures that are not prepared in accordance with Generally Accepted Accounting Principles or GAAP in the United States and constitute non-GAAP financial measures under SEC rules. These non-GAAP financial measures are derived from consolidated financial information but are not presented in our financial statements that are prepared in accordance with GAAP. For more details, please refer to the press release.
At this time, I will turn the call over to Eva Tang, Chief Financial Officer of American States Water Company.
Thank you Denise. Welcome, everyone, and thank you for joining us today. During today’s call, I will review the Company’s financial results for the second quarter and Bob will discuss some highlights for the quarter, Golden State Water’s pending rate case, California’s drought related matters, and our contracted services business segment at American States Utility Services, or ASUS.
I’ll begin with an overview of our financial results. For the second quarter, diluted earnings were $0.45 per share compared to $0.41 per share for the same period in 2015. Of the $0.45 earnings per share for the quarter, $0.36 was from our Water segment, $0.01 was from our Electric segment, $0.07 from our Contracted Services segment, and our parent company contributed $0.01.
Net income for the quarter was $16.7 million compared to $15.7 million for the same period in last year. I will discuss major items that impacted our revenues and expenses for the quarter. Water revenue were $81.1 million for the quarter as of today, Golden State Water has now received a decision on its pending water general rate case, which will set new rates for years 2016 through 2018.
As discussed in our first quarter call, we expected 2016 revenue requirements from the decision to be lower than the 2016 adopted level due to decreases in various operating expenses. As a result, we adjusted our water revenue downward by $7 million for the quarter with corresponding decreases to supply costs, depreciation, and other operating expenses to reflect the settlement position with the CPUC’s Office of Ratepayer Advocates.
The adjustments to 2016 recorded water revenue also reflects Golden State Water’s, unlitigated capital budgets and compensation related issues in the pending rate case. These adjustments do not have a specific impact to pretax operating account for the quarter. Partially offsetting this decrease in water revenue was the recognition of a portion of the 2016 water revenue adjustment mechanism that had previously been deferred.
Revenue from electric operations for the quarter was $7.7 million as compared to $7.9 million for the same period in 2015. Revenue decreased by approximately $434,000 primarily due to the August 2015 termination of a supply cost surcharge to recover previously incurred energy costs, and was offset by corresponding decreasing supply costs, resulting in no impact to pretax operating income.
This electric revenue decrease was also partially offset by CPUC-approved fourth-year rate increases for 2016 and rate increases generated from certain advice letters for canceled projects approved by the CPUC during 2015 and 2016.
Revenue for our contracted services business, ASUS, increased $4.1 million to $23.2 million for the quarter. The increase was due to an increase in construction activity along with higher OEM management fee resulting from successful resolution of price re-determination received during the third quarter of 2016.
As I mentioned earlier, for the quarter, the water segment’s gross margin was adjusted for both lower revenue and lower supply cost based on our stipulated position in the pending water rate case. Our water and electric supply costs were $21.6 million a decrease of $5.4 million for the quarter as compared to the same period in 2015. Any changes in supply costs for both the water and electric segments as compared to the adopted supply costs are attracting balancing counts which will be recovered from or refunded to our customers in the future.
Other operations expenses decreased by $445,000 for the second quarter of 2016 due to a decrease in conservation and drought related costs. Golden State Water has been authorized by the CPUC to track incremental drought related costs incurred in [indiscernible] for possible future recovery.
In the second quarter, we filed a full recovery of drought related costs of approximately $1 million, which has been previously incurred. Incremental drought related costs are being expensed until recovery is approved by the CPUC.
Administrative and general expenses for the quarter were $21.3 million, as compared to $20.5 million for the same period in 2015. The increase was mainly due to increases in comps at ASUS resulting from higher labor costs, higher allocation of A&G expenses from corporate headquarters as stipulated in the pending water rate case, and an increase in OpEx service costs.
For Golden State Water, there was a corresponding decrease in the allocation of A&G costs as stipulated in the pending water rate case. This decrease as well as decreases in other miscellaneous A&G items were mostly offset by increasing costs associated with descending against compensation related actions.
Depreciation and amortization expense decreased by $935,000, due primarily to the reduction in composite rate stipulated in the pending water rate case resulting from updated depreciation study. The decrease from the lower composite rate were partially offset by depreciation from net addition to electricity plant associated with Golden State Water’s capital expenditure program. The lower net depreciation expense has been accepted in the water revenue requirements.
Maintenance expense decreased by $570,000, due to a lower level of maintenance performed in the second quarter of 2016. Different factors contribute to the timing of when maintenance activity occurs. ASUS construction expense increased by $2.5 million to $12.9 million during the quarter as compared to the same period last year, due primarily to an increase in overall construction activity.
Interest and other income increased due to higher gains on investments held for a retirement benefit plan as compared to the second quarter of 2015. Income tax expense increased by $522,000 to $10.1 million due to an increase in pretax operating income partially offset by an overall lower effective income tax rate.
Slide 10 shows the EPS bridge by business segment comparing the second quarter of this year with the second quarter of 2015.
Moving on to the next Slide, diluted earnings per share were $0.73 from the six months ended June 30, 2016 and 2015. For more detail, please refer to the press release and the Form 10-Q issued yesterday.
Next, I will briefly discuss our liquidity. Net cash provided by operating activities for the six months ended June 30, 2016 decreased by $14.5 million to $48.5 million as compared to the same period in 2015. The decrease in operating cash flow was primarily due to lower tax payments made in 2015, largely as a result of the implementation of new federal tax repair regulation in 2014. There was also a reduction in cash generated by contracted services due to the timing of billing and cash receipts for construction work at military bases during the six months ended June 30, 2016.
With that, I will turn the call over to Bob.
Thank you, Eva. Hello everyone. I appreciate everyone joining us today. The Company delivered solid earnings in the second quarter. In addition, our water and electric utilities continue to invest to maintain and improve the reliability of our systems. For the six months ended June 30 this year, Golden State Water invested $63 million on Company funded necessary infrastructure work. We are on track to invest approximately $95 million in capital projects during 2016, which may change somewhat once a decision is issued by the CPUC on the pending water rate case.
I’m also very pleased to report that ASUS was awarded a 50-year contract by the U.S. government to operate, maintain and provide construction management services for the water and wastewater systems at Eglin Air Force Base located in Florida. The value of the contract is estimated at approximately $510 million over the 50-year period, and is subject to annual economic price adjustments. ASUS will assume operations at Eglin following the completion of a 10-month transition period. This contract is a result of years of focus and hard work from our ASUS team, who remain committed to winning new base proposals.
Our team is involved at various stages of the proposal process at a number of bases considering privatization. We are not able to share more about the status of these proposals because of the competitive nature of this business. The U.S. government is expected to release additional bases for bidding over the next several years, and we believe we are well-positioned to compete for these contracts.
As we’ve discussed in previous quarters, we filed a general rate case in mid-2014 for all of our water regions and the general office. The application will be determine rates charged to customers for the years 2016, 2017, and 2018. Golden State Water has settled with the CPUC’s Office of Ratepayer Advocates on nearly all the Company’s operating expenses as well as the consumption levels used to calculate rates for years 2016 through 2018, which reflect the 2015 state-mandated conservation targets.
Primary litigated issues relate to our capital budget, and compensation for managerial level employees. We are not certain when in 2016 the final decision will be issued. Once issued, rates will be retroactive to January 1, 2016. As Eva mentioned earlier, adopted revenues for 2016 are expected to be lower than the 2015 adopted levels. As you may know, a big part of a utility’s revenue requirement is the recovery of projected expenses. Our projected expenses for 2016 in the rate case were lower than the 2015 adopted expense levels.
In particular, there was a decrease in supply costs resulting from lower consumption projected, lower depreciation expense resulting from a new depreciation study, and a decrease in other operating expenses in this 2016 through 2018 rate case cycle due to our cost control efforts and improvements in operation efficiency. Because of the Company’s efforts, we were able to propose necessary increases in our capital investment with little to no impact on customer rates.
As a reminder, we received approval by the CPUC to defer our electric general rate case for a year and the cost of capital proceedings by one additional year. Both will now be filed in early 2017. In regard to the drought situation in California, the State Water Resources Control Board issued revised emergency regulations in May, allowing for self-certification of conservation standards based upon supply conditions by water system.
In June, Golden State Water provided an analysis to the State Board indicating there was no supply deficit predicted for our large urban water systems. At this time, all of our large systems are in voluntary conservation, using the previously assigned mandatory targets and three days per week watering limitation. The State Board could modify its requirements as drought conditions change throughout the State.
Golden State Water has been authorized by the PUC to track incremental drought related costs incurred in memorandum account for possible future recovery. During the second quarter of this year, we filed for recovery of drought related items of approximately $1.3 million incurred mostly in 2015. Incremental drought related costs are being expensed until recovery is approved by the CPUC.
Lastly, as of August 2, the U.S. Drought Monitor estimates 60% of California in their rank of severe drought. This is down from 74% reported at the end of April. Increased rainfall and higher snowpack levels during the winter months have helped the drought situation.
Turning to our contracted services business at ASUS, I am proud to say that, after we complete the Eglin Air Force Base transition ASUS will be providing water and/or wastewater utility services to 10 military bases, including three of the largest military installations in the United States. Fort Bragg in North Carolina, Fort Bliss in Texas, and Eglin Air Force Base in Florida, and to one of the most high-profile basis and Andrews Air Force Base, which is located in Maryland.
With regard to the second quarter, construction activity picked up during the quarter, and we believe we are still on track to achieve our projected earnings-per-share contribution from ASUS of $0.28 to $0.32 per share for 2016, as discussed during our year-end and first quarter earnings calls.
We continue to work closely with the U.S. government on outstanding price re-determinations. We expect a third price re-determination for Fort Bragg and the fourth price re-determination for Fort Bliss to be finalized this quarter. And the third price re-determination for Fort Jackson to be finalized during the fourth quarter of this year.
Filings for these price re-determinations requests for equable adjustment asset transfers and contract modifications awarded for new projects provide ASUS with additional revenues and margin. We also continue to work closely with the U.S. 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.
Finally, I’d like to turn our attention to dividends. Our Board of Directors just approved a third quarter dividend of [$0.2214] per share on common shares of the Company. Dividends on the common shares will be payable on September 1 to shareholders of record at the close of business on August 15.
American States Water Company has paid dividends every year since 1931. For the five years ended December 31, 2015 our calendar year dividend has grown at a compound annual growth rate of about 11%. Given American States current low payout ratio compared to our peers and our earnings growth prospects, there’s room to grow the dividend in the future.
I’d like to thank you for your interest in American States Water and will now turn the call over to the operator for questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Jonathan Reeder of Wells Fargo. Please go ahead.
Hey Bob and Eva. How are you all doing today?
Good. Thanks, Jonathan.
Good. Thank you.
Just a couple of minor questions. Consumption levels in the GRC, you’re saying they reflect the 2015 mandatory reduction usage levels. Does that mean you could be I guess over-collecting in the WRAM accounts during the rest of the year, since the mandatory reductions are backed off and now they are just voluntary, assuming the usage kind of bounces back a little?
Yes, that’s right. We’re using 2015 approximately the mandated consumption level. But you know, this year, year-to-date, our consumption is still 8% less than last year in the same period, six months. So we don’t expect over-collection in the WRAM balancing account. We think the WRAM balance will decrease, but it’s hard to say. It depends on how the remaining months are going to be, but hopefully the WRAM balances will be less than what we experienced in 2015.
Though what was included in the rate case was based upon 2015 mandatory reduction levels, I believe they did back those down by roughly 3% off the mandatory reduction. So the average is 25%. I think they were looking more into 22%. But as Eva says, what happens the rest of the year will tell the tale, I guess. And then of course you don’t know what kind of action the State Board is going to take if a lot of these systems put in no reductions, and there’s some speculation that it’s going to be difficult to avoid sort of new reductions coming out in the future. So it is definitely a work in process.
Okay. So let me just make sure I understand. Your WRAM balance, where is it at, at this point, in terms of the under collection in aggregate?
For this year, for 2016, we had about $22 million accumulated. However, once the decisions come about, because we have a higher base rate in the 2016 adopted revenues appropriately, a partial - a portion of the $22 million will become another regulatory memo account to collect the retroactive revenue back to January 1. So even though the $22 million represents the WRAM balance right now but we will replace by another regulatory memo account once the decision is issued. Does that make sense?
Yes, I think so. And then I guess my other question on ASUS, I didn’t know if, Bob, you felt in position to try to estimate what the impact to EPS power could be from the addition of Eglin, or is it still too early since you haven’t had a lot of time to get in there and see the base and the amount of assets and all that stuff?
We know it would be helpful for you folks to have some sort of estimate, so we going to try to give you one. The contract award included both O&M and R&R and a little bit of initial capital upgrade work. And if you just look at those items, we think it’s going to be on a sort of full-year run rate basis $0.02 to $0.03 per share. However, if we get substantial initial capital upgrades or later new capital upgrades, that amount could go up.
Okay. So, it’s kind of $0.02 to $0.03, but then if you have any I guess of the special projects or just the projects that are awarded on kind of an annual basis related to Eglin, that would be incremental? Is that right?
Yes. That’s a good way to look at it. Just so you understand, there is a 10-month transition here. So the $0.02 to $0.03 we wouldn’t see that completely in 2017. We would see about half of it, I would guess, and then the annual run rate $0.02 to $0.03.
Right, and the timing of the special construction projects, I’m assuming that wouldn’t start until 2018 as you wouldn’t I guess get the budget until September 2017 for Eglin. Is that right?
There’s a lot of things to be worked out with the military on the base in terms of special construction. But the initial capital upgrades, it’s hard to say when we will start to see those, but it’s possible 2018.
During the transition period of this 10 months, it’s more like a due diligence period, so we can work on the inventory level to make sure we have the inventory correct compared to when we submitted it. So there is opportunity to make sure we have the right inventory level to go forward with every year price adjustment mechanism on the military base.
So, we will be going through with our GIS systems to identify both where – make sure the pipe that we are taking over is consistent with the maps we will be given as well as the age of the pipe. So there will be a lot of work done in that particular area to make sure that the inventory that we are taking over is – has been substantiated and that it’s accurate.
Okay. We’ll wait for your update regarding that. And congratulations on adding the 10th base, and I guess we will look forward to the 11th one, right?
We’ve got some momentum now.
There you go. Take care. I appreciate the time today.
Thank you, Jonathan.
End of Q&A
[Operator Instructions] At this time, I’m showing no additional questions. I would like to hand the conference back over to Bob Sprowls for any closing remarks.
Yes, I just wanted to close with just passing along my thank you for all your participation today, and I look forward to speaking with everyone next quarter if not before.
Thank you. Ladies and gentlemen, this concludes our conference for today. Thank you for your participation. You may now disconnect your lines.
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