American States Water Company (AWR) Q4 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Today is March 12, 2012. Welcome to the American States Water Company Conference Call discussing the fourth quarter 2011 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 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, March 19, 2012. After logging on to the website, click the Investors button at the top of the page. The archive is located just above the Stock Quote section. [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.

Thank you, Emily. Welcome, everyone, 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 Harbor for 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. Please also refer to our earnings release in the Form 10-K issued early -- earlier today for details regards to our earnings and financial information. I'm very pleased to note that 2011 was a year of a strong financial performance with increases in revenues, net income and cash flow. For 2011, we reported net income of $45.9 million compared to $32.2 million for 2010. Net income from continuing operations was $42 million, representing an increase of $10.9 million compared to 2010. Diluted earnings from continuing operations were $2.23 per share for 2011 as compared to $1.66 per share for 2010. I would like to remind you that earnings for 2010 were impacted by a pretax charge of $0.55 per share recorded for the impairment of assets and loss contingencies resulting from regulatory matters and $0.19 per share of pretax income for contract modifications that were retroactive received by our contracted services business of American States Utility Services or ASUS. Excluding the effects of these 2 items, 2011 diluted earnings from continuing operations increased by $0.21 or 10.4% over 2010's adjusted earnings of $2.02 per share. For 2011, our operating revenues increased by $20.3 million or 5.1% to $419 million -- $419.3 million. Excluding the impact of the 2010 contract modifications received by ASUS previously mentioned, our total revenues increased by $25.9 million, partially driven by the CPUC-approved rate increases of $9.5 million for our regulated water and electric operations that were effective January of 2011. In addition, revenues from our Contracted Services business of ASUS increased by $16.4 million resulting from higher construction activities at the military bases and favorable changes in cost estimates resulting in additional construction revenues recorded under the percentage of completion method of accounting. Supply costs were $102 million for 2011, which was similar to the adopted level approved by the CPUC. Any changes in purchased water, power and pump taxes were covered by the Modified Cost Balancing Account or MCBA. Other operating expenses decreased slightly to $28.8 million in 2011 as compared to $29.2 million in 2010 due to lower water conservation and treatment costs. Administrative and general expenses for 2011 decreased by $12 million as compared to 2010. As I discussed earlier, a pretax charge was recorded in 2010 for the impairment of assets and loss contingencies resulting from regulatory matters for our water operations. This matter has since then been settled and no further charges are anticipated at this point. Excluding the impact of this charge, our A&G expenses increased by approximately $4.6 million in 2011 as compared to 2010, primarily due to increases in labor and employee benefits, as well as higher consulting and other outside services costs. Depreciation and amortization expenses increased by $944,000 to $38.3 million in 2011 due to capital additions, partially offset by asset retirements. Maintenance expense decreased by $792,000 to $17.4 million in 2011 due to a reduction in planned and unplanned maintenance work. Our construction expenses for contracted services at ASUS increased by $9.8 million for the year. This increase is due to additional construction projects at Fort Bliss and Fort Bragg military bases. In 2010, we recorded a pretax gain of $643,000 for the sale of property compared to only $128,000 pretax gain on sale of property in 2011. Interest expense increased by $2 million in 2011 as compared to 2010 was mainly due to the issuance of $62 million notes in April of 2011, $22 million of which was used to redeem notes with a higher interest rate. Interested income decreased from $2.4 million in 2010 to $859,000 in 2011 mainly due to interest income of $1.3 million recorded in 2010, resulting from a proposed settlement with the IRS related to AWR's tax refund claim. There were no similar interest income in 2011. For the year ended December 31, 2011, income tax expense increased to $30.1 million as compared to $23 million for the same period in 2010 due primarily to an increase in pretax income. As discussed in our previous earnings calls, we completed the sale of Chaparral City Water Company in May of 2011. Net income from discontinued operations for 2011 was $3.8 million or $0.20 per share, which included the net gain of on sale of $2.2 million or $0.12 per share, as well as 5 months of operating activities in 2011. I will move on to briefly discuss the fourth quarter results. For the fourth quarter, our net income from continuing operations was $6.7 million or $0.35 per diluted share as compared to $8.3 million or $0.44 per diluted share for the same period in 2010. Please keep in mind that included in the fourth quarter of 2010 was the impact of the full year rate increase from the CPUC decision for the Region II and Region III and general office rate case, which was retroactive to January 1, 2010. Excluding the impact of the rate increases for the periods January through September 2010 and the previously mentioned impairment charges recorded in the fourth quarter of 2010, our fourth quarter earnings increased by $0.04 per share or 12.9% increase year-over-year. The $0.04 increase is primarily due to continuous growth in our contracted services business as we work closely with the government to resolve pending contract modifications and to obtain additional contract construction opportunities. A more detailed discussion of our fourth quarter results is included in our earnings release issued this morning. I want to now take a few minutes to talk about the Water Revenue Adjustment Mechanism, also known as the WRAM mechanism, and perhaps, clarify a few things. First of all, the increasing block rates were implemented as a means to help achieve the conservation goals mandated by California law and incorporate it into the CPUC's Water Action Plan. In order to comply with this policy objective, Golden State Water, along with certain other California utilities, changed the rate structure from a single volumetric rate to an increasing block rate design. At the same time, we reduced our fixed monthly service fees charged to customers. This kind of changes in rate design have increased revenue volatilities and placed a larger portion of our fixed cost at risk of not being recovered due to sales fluctuations. The CPUC approved WRAM mechanism mitigates this kind of risk by decoupling revenue from water usage, so that utilities are not adversely affected by sales reduction as a result of water conservation efforts by customers. The mechanism is designed to keep the utilities whole, thus providing shareholder with consistent returns. Next, I want to address an accounting rule that required us to collect the WRAM balances within 24 months, following the year in which they are recorded. Any WRAM balances estimated to be still outstanding 24 months after the year end must be deferred and instead will be recorded as revenue when collected. We have been assessing our WRAM balances since 2009 under the CPUC guidelines. Most of our WRAM balances or WRAM surcharges are in effect for 24 months, which under the accounting rule would allow us to record a full amount of WRAM revenue. As of December 31, 2011, the estimated WRAM balances not collectible within 24 months were immaterial. And as a result, no water revenue has been deferred thus far. We, along with 3 other water utility companies, California utility companies, filed an application in 2010 to the CPUC to modify the recovery period of the WRAM to 18 months or less. Until the CPUC issues a favorable decision on the 18-month recovery period, we will continue to assess our WRAM balances. We believe that increasing tiered rates to encourage conservation, coupled with WRAM and MCBA to keep the utility whole is still one of the lead cost alternatives to managing the water supply issues in California. It is also important to note that revenue in the WRAM balances are not necessarily due to a reduction in sales, per se, but due to a difference between actual and forecasted sales volume. So when we filed the general rate case in July of 2011 for rates effective 2013, more current customer consumption data was used to calculate rates. As a result, beginning with 2013, I don't anticipate as significant of a variance between actual and forecasted sales levels as we have experienced so far. Therefore, the recovery period for 2013 WRAM balances and beyond should not be longer than 24 months. We continue to file for recovery of our WRAM balances in a timely manner. In 2011, we billed $15 million to customers for collection of the 2009 and 2010 WRAM balances. This surcharge has decreased the WRAM balances, increased the company's cash flow and do not impact earnings. We also implemented a surcharge in early March of 2012 to collect the 2011 WRAM balances. In terms of cash flow, net cash provided by operating activities was $80.2 million for the year ended December 31, 2011, as compared to $53.8 million for the same period ended December 31, 2010. The $26.4 million increase was primarily due to rate increases approved by the CPUC for all of our regulated businesses and the collection of surcharges to recover previously recorded regulatory assets, including $15 million for prior year's WRAM balances. As discussed earlier, we received a late decision on the Region II, Region III and general offices rate case in the fourth quarter of 2010. At the time, Golden State Water reported a $19.5 million increase in regulatory assets, representing the difference between interim and final rates authorized by the CPUC. In 2011, we collected approximately $8 million of these differences. Golden State Water also invested $78 million in capital projects in 2011 as compared to $77 million for 2010. The capital expenditures were consistent with our 2011 capital improvement plan. We expect to incur approximately $70 million to $80 million of capital expenditures in 2012 primarily for upgrades to Golden State Water's water supply and distribution facilities. Impacting cash flow from financing activity was the issuance of $62 million notes in April of 2011 by Golden State Water. A portion of the proceeds from issuance were used to redeem $22 million of notes with higher interest rates. As a result of the increased cash generated from operating activities and its long-term debt issuance, Golden State Water was able to fund its $78 million capital investments and reduced the need for borrowing from American States. At December 31, 2011, Golden State have, had no intercompany borrowings. At the consolidated level, the cash proceeds from the sale of Chaparral reduced the need for short-term borrowings under our syndicated credit line. And that will help defer the need to issue equity in 2012. And with that, I'd now like to turn the call over to Bob.

Thank you, Eva. Hello, ladies and gentlemen. I'm extremely pleased with our strong performance in 2011. The company was able to achieve solid financial results for the year. The company has grown its revenues from continuing operations to nearly $420 million in 2011 from $261 million in 2006, which represents a 5-year compound annual growth rate of 10%. Our net income from continuing operations has grown at a compound annual growth rate of 14% over that same 5-year period from $21.9 million in 2006 to $42.0 million in 2011. I'm also pleased to announce that on January 31, 2012, the Board of Directors of American States Water approved a quarterly cash dividend of $0.28 per share on the common shares of the company. For more than 57 consecutive years, American States Water Company shareholders have received an increase in their aggregate annual dividend. We are among only a handful of companies on the New York Stock Exchange that can boast of such a long period of dividend increases. Our focus for the dividend going forward is to achieve a 5-year compound annual growth rate of at least 5% over the long term. In 2012 and going forward, we will continue to focus on driving operational efficiency to minimize cost to our customers, maintaining a customer service culture, executing a well-managed capital expenditure and infrastructure replacement program and timely recovery of costs through rates and price redeterminations. Now, I'll discuss the status of key regulatory filings and other matters for the company. On May 2, 2011, Golden State Water Company filed its cost of capital application. On November 2, 2011, we entered into a settlement agreement with all parties in that proceeding, including the Division of Ratepayer Advocates. If approved by the PUC, the settlement will authorize a return on equity of 9.99% and a rate-making capital structure for Golden State Water of 55% equity and 45% debt. The result in weighted cost of capital were allowed return on base would be 8.64%, including an updated debt cost and the settlement return on equity and capital structure. On January 13, 2012, Golden State Water, along with DRA and the other California water utilities who are parties in the proceeding, filed joint testimony with the PUC in support of the settlement. Hearings were held on January 23, 2012. When finalized, the rate of return authorized by the PUC will be implemented into water rates retroactive to January 1, 2012. A decision on the cost of capital filing is expected in the second quarter of 2012. We believe the settlement in the cost of capital proceeding is a fair resolution for our shareholders and customers. Since the last cost of capital proceeding, we have diligently reduced our debt cost by issuing debt with lower interest rates and redeeming high interest rate debt. As a result, the debt cost in the settlement reflects our actual weighted debt cost, which is approximately 55 basis points lower than the authorized cost of debt currently in place. The reduction in debt cost will be reflected in customer rates once the filing is approved by the CPUC. In addition, a combination of a 4 percentage point higher equity ratio in Golden State Water's capital structure and a slightly lower allowed return on equity, provides an opportunity for higher earnings. Golden State Water Company has invested over $220 million over the past 3 years in its water distribution infrastructure, and we plan to continue making significant investments in the future. We are pleased that the Division of Ratepayer Advocates recognizes that California's investor-owned water utilities require a fair return in order to finance these investments. This settlement with the Division of Ratepayer Advocates also maintains the automatic adjustment mechanism called the Water Cost [ph] of Capital Mechanism, previously adopted by the CPUC to adjust the return on equity and rate of return on rate base between cost of capital proceedings. In January 2013, rates to customers will be adjusted only if there's a positive or negative change of more than 100 basis points in the average of the Moody's AA utility bond rate as measured over the period October 1, 2011 through September 30, 2012, compared to the AA rate for the period October 1, 2010 through September 30, 2011. We have an authorized return on equity of 10.5% currently for Bear Valley Electric Service, Golden State Water's electric division. The decision in the water industry cost of capital proceeding will not affect the return on equity for our electric division. That return on equity is determined separately through Bear Valley Electric's general rate case process. While we're on that subject, in February 2012, Bear Valley Electric filed a general rate case application for rates in years 2013 through 2016. If rates are approved as filed, the rate increases are expected to generate an increase of approximately $4.0 million in annual revenues starting in 2013. The proposed rate increase for 2014 over 2013 is $1.2 million. The 2015 proposed rate increase over 2014 amounts to $900,000, and the 2016 proposed rate increase over 2015 amounts to $1.0 million. As Eva had mentioned earlier, Golden State Water filed a general rate case in July 2011 for all of our water regions and the general office. This is our first consolidated water rate case. We expect these rates to become effective on January 1, 2013. If rates are approved as filed, the rate increases are expected to generate approximately $31.3 million in additional annual revenues based on normalized sales starting in 2013 as compared to 2011 adopted revenues. The proposed rate increases for 2014 over 2013 are $9.1 million and the 2015 proposed increases over 2014 amount to $11.5 million. DRA has issued its report on Golden State Water's application. The difference between our application and DRA's report is primarily attributable to DRA's recommended reductions in capital spending and changes in supply mix. We disagree with DRA's proposal to reduce infrastructure investment, and we believe their proposed supply mix is unrealistic. We will be filing our rebuttal to the DRA report with the PUC in early April. We are scheduled to have evidentiary hearings on the application in the first week of May. With regard to our current rates, in January 2012 the PUC approved the third-year escalation increases for Golden State Water's Region II and Region III and the second-year increases for the rate-making areas in Region I. The authorized increases are approximately $5.0 million. In addition, in January of 2012 the PUC also approved final year rate increases for Bear Valley Electric, effective January 1, 2012. The authorized rate increase is expected to provide us with additional annual revenues of approximately $681,000 for Bear Valley Electric. Let's turn our discussion to the company's contracted services segment that provides water and wastewater services for military bases throughout the country under American States Utility Services or ASUS. 2011 marked the third consecutive year that ASUS has posted strong financial returns. ASUS' substantial earnings contribution in 2011 was driven by significant construction at nearly all the bases we manage, but most particularly, at Fort Bragg in North Carolina and Fort Bliss in Texas. Like Golden State Water, ASUS is focused on maintaining a customer service culture, and we continue to build on our relationship with the U.S. government. ASUS also continues to respond to solicitations from the U.S. government on military bases where the water and wastewater utilities are in the process of being privatized. We anticipate continued expansion of privatizations by the U.S. government over the next 5 years and expect ASUS to be successful on growing its business as a result. We also believe successful price redetermination and Requests for Equitable Adjustment filings will provide added revenues prospectively to help offset increasing costs and provide ASUS the opportunity to consistently generate positive operating income at its subsidiaries that serve military bases. We are still working to finalize certain price redeterminations and Requests for Equitable Adjustment at various bases, which include adjustments to reflect inflation in costs and changes in operating conditions and infrastructure levels from that assumed at the time of the execution of the contracts. To summarize, I'll quickly talk about the status of each of our more significant price redeterminations. During 2011 and early 2012, ASUS received final resolutions to its first-price redeterminations at that bases we operate in Virginia. We managed the Virginia bases under 2 separate contracts for the U.S. government, and redeterminations were completed on both contracts. We received a net overall increase on top of our interim increases as a result of the resolution of these price redeterminations. We continue to work with the U.S. government to resolve our first price redetermination request at Andrews Air Force Base in Maryland and expect to complete this during the second quarter of 2012. An interim price redetermination is currently in place. As part of our 2010 settlement with the U.S. government, we waived our first and second price redeterminations for managing the assets at Fort Bliss. The next price redetermination at Fort Bliss is scheduled to be filed by July 1, 2012. Our first price redetermination request was filed at Fort Bragg, Camp MacKall and Pope Air Force Base during the fourth quarter of 2011. An interim increase is in place pending a final resolution. And we filed our first price redetermination request at Fort Jackson last month and interim price increases in place pending resolution to our price redetermination request at Fort Jackson. ASUS is working closely with the U.S. government to provide timely resolution to these price redeterminations. Before I turn the conference over to the operator to entertain questions, just like to take a minute to thank you again for your continued support and interest in the company.

[Operator Instructions] We will begin with Michael Roomberg of Ladenburg.

So, Bob and Eva, just a quick question on the outlook for construction in your ASUS business in 2012. Clearly, an elevated level of construction was the key driver of earnings growth in that business in 2011. Can you just give us an idea of what your expectations are for activity levels going forward in 12?

Sure. We think it will be consistent with what we saw in 2011, at least. These things are a bit unpredictable, but it seems like we've worked out some of the bugs in terms of getting these things moving. So I think that's a good sign.

Okay. And then on the mandatory audits that you have agreed to. Can you talk about the expenses for those audits? How they've -- where in the quarter compared to your expectations and kind of how we should think about that going forward?

This is as a result of the settlement with the ...

The settlement agreement, yes.

Right. Well those audits have not started at this point. The PUC will need to do an RFP to select outside auditing group to come in. So we did not incur any costs related to those audits in the fourth quarter. And it may be at least the second quarter, before we start to see any expenses. The entire cost of the audits will be borne by the shareholders.

Right. So do you have an expectation of how much on an annual basis that might run?

Probably, I would think around $500,000. $250,000 to $500,000. That's just based on our experience with auditors. But with the CPUC, it's a little bit hard to predict at this point, which is based on our prior experience with our other audits that we had, and that's the range. But no...

Sure. Okay, so it's not overly material? Now, will this lie in the other operating expenses or the administrative in general?

It will be in the administrative and general, I think.

[Operator Instructions] And our next question comes from Heike Doerr of Robert W. Baird.

I wonder if you could remind us, as we look for 2012, what revenue increases for each of the regions we would expect? Can you refresh our memory what that year 2 and year 3 -- that increases?

You want -- I mean, I gave you that in total, but you want it broken down further, I guess?

Yes, if it's not too much trouble. I mean I know that the 23 GO is going to be larger than the Region I.

Right.

Because one's in year 2, right, and the other one is in year 3?

Yes. 2 and 3 are in year 3 and Region I is in the final year, but it's the second year.

Yes, they only have 2-year rate cases.

Oh, right. As we get into one schedule.

Right. You want to break it down I think we have $2 million for Region II, $3 million for Region III and the rate increases for Region I are not material. So in total, it's like $5 million for water regions for 2012.

Okay. And that doesn't that include any advice letters from -- I know the commission is leaning more towards carving out some of these larger capital expenditure programs into advice letters. Is there any additional revenue that's going to come from advice letters that we should be taking into account?

I think it probably be -- as you may recall that we in our last case with the Region I, we have about $18 million advice letter project. So some of them will be completed in 2012, and we'll file a rate increase right after. So, the $5 million I give you, Heike, does not include the advice letter revenue increases there.

Okay. And in the GRC, can you tell me what the capital forecast that you've assumed? You said it was going to $70 million to $80 million in 2012. What did you put in the rate case for your CapEx program?

I think we're putting a little bit over $80 million for our water regions.

Okay. And that's approximately the same -- it's consistent throughout those 3 years?

Yes.

Okay. And what's the next step that we would see in the GRC? Are we at the point where now we would get a proposed decision? What's the next data point we're looking for?

Okay. So we'll file our rebuttal to DRA's report by the first part of April. Then what you'll see is a negotiation session between sessions between us and the DRA. And then to the degree things are not settled, which hard to say how that's going to go, there would be evidentiary hearings beginning in May.

And in the best case you're able to settle and instead of evidentiary hearings, we would see a settlement filed? Is that how to think about that in the best case?

Yes, I think that's probably correct.

Yes. But usually, we have some items that we -- are going to be litigated.

Right. So if we have evidentiary hearings in -- did you say April, Bob?

Those would be in May.

Oh, in May. And then after the evidentiary hearings, then we would see a proposed decision some time this summer?

No. It's likely the proposed decision will be closer to -- it's going to be maybe 30 to 60 days prior to year end, I would guess.

Okay. So we wouldn't see a proposed decision until late third quarter, early fourth quarter?

I think that's probably a fair estimation.

And we have a follow-up question from Michael Roomberg of Ladenburg.

Just a quick follow-up on the -- on Bear Valley. As I'm sure you're aware, the electric utilities will be filing for their cost of capital in 2013. I'm just wondering, will Bear Valley be a part of that filing or...

No, they will not. Theirs will be the sort of the more traditional where it's still part of the general rate case.

[Operator Instructions] Having no further questions, I'd like to turn it over to Mr. Sprowls for any closing remarks.

Sure, thank you, Emily. Again, I just wanted to thank you all for your participation today and for your continued interest and investment in American States Water Company. Everyone have a good day.

This concludes today's American States Water Company Conference Call. As a reminder, the call will be archived on our website and can be replayed beginning Monday, March 12, 2012 at 2 p.m. Pacific time and will run through Monday, March 19, 2012. After logging on to the website, click the Investors button at the top of the page. The archive is located just above the Stock Quote section. Thank you for your participation. You may now disconnect.