American States Water Company (AWR) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company conference call discussing the Company's second quarter 2013 results. If you would like to listen to the replay of this call, it will begin after noon, at approximately 2 p.m. Pacific Time and run through Thursday, August 15, 2013, on the company's website at www.aswater.com. [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, Yusef. 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 in 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. With that, I am pleased to report another strong quarter, with an increase in earnings of 7.6% to $0.85 per diluted shares compared to $0.79 per share for the same period of 2012. Net income for the quarter increased by $1.5 million or 10.1% compared to the second quarter of last year. For the quarter, our operating revenue increased by $6.1 million or 5.3% to $120.7 million. Water revenues at Golden State Water increased by $2.9 million or 3.6% to $84.1 million as compared to the same period in 2012. This was mainly due to approval of our water rate case in May for rate increases effective January 2013. Electric revenue remained relatively unchanged at approximately $8.4 million. Electric revenues for 2013 were based on 2012 adopted rates, pending a decision on the electric general rate case. Revenues for American States Utility Services, or ASUS, increased by $3.1 million to $28.2 million compared to the second quarter last year. The 12.7% increase in revenues were due -- was due to new construction activities at Fort Bragg and Fort Bliss military bases. Our water and electric supply costs for the quarter were $25.3 million or 28.9% of total operating expenses. Any changes in supply costs for both the water and electric segments as compared to the adopted supply costs are tracked in balancing accounts, which will be recovered from or refunded to our customers in the future. Other operation expenses for the total company decreased by $232,000 compared to the same period in the prior year. The decrease is driven by decreases in conservation cost and labor and other employee-related benefit at Golden State Water due to fewer employees. We expect conservation cost to catch up during the remaining months of 2013. Administrative and general expenses were relatively unchanged at $18.1 million for the quarter. In May of 2013, the CPUC approved the recovery of legal and on-site [ph] service costs previously expensed in connection with Golden State Water's efforts to procure renewable energy resources. As a result, the electric segment recorded a $834,000 reduction in legal expenses. Excluding the impact of this reduction, NG [ph] expenses for the second quarter increased by $900,000. This increase was primarily driven by an increase in labor-related costs at our Contracted Services segment of ASUS. This is in connection with pursuing new military utility privatization opportunities. There was also an increase in regulatory outside service costs incurred for the pending general rate case at our electric segment. Depreciation and amortization expenses decreased by $639,000 to $9.8 million for the second quarter driven by lower composite rates for depreciation approved in the water rate case. The decrease in the overall composite rate was partially offset by additions to utility plants. Maintenance expense increased by $1.1 million, primarily at our water segment as a result of the increase in trans [indiscernible] maintenance work. We anticipate the increase will continue throughout the year as additional maintenance work is scheduled. Though maintenance expense for Golden State Water is higher than 2012, we do not anticipate maintenance expense for the year to exceed the amount being approved in rates. ASUS' construction expense increased by $4.2 million to $19.1 million during the second quarter as compared to the same period of last year. This increase is primarily due to an increase in new capital upgrade construction projects at Fort Bragg and Fort Bliss, as previously discussed. Interest expense stayed relatively flat for the quarter. However, interest income decreased by $355,000 as compared to the same period in 2012 due to interest income recorded last year related to refund claims approved by the Internal Revenue Service. Income tax expense increased by $1.3 million to $11.1 million as compared to same period in 2012 driven by an increase in pretax income and a slight higher effective tax rate. For additional details on our second quarter and year-to-date performance, please refer to our earnings release and Form 10-Q issued earlier today. Moving on to liquidity and capital resources. In May of 2013, we renewed our $100 million credit facility, extending the maturity date to May 2018. We are very pleased that we will not only be able to extend the maturity date by 5 years but we will also be able to significantly reduce the LIBOR spread on our borrowings as well as other fees associated with the credit line. This lower borrowing cost will benefit both our customers and shareholders. Net cash provided by operating activities decreased by $30.3 million to $33.6 million for the 6 months ended June 30, 2013, as compared to $63.9 million in the same period in 2012. The decrease was at our contracted services segment. It was due to timing differences of when payments to subcontractors for construction work are made and when the work is billed to the U.S. government. The billing for certain major construction work generally occurred at completion of the work or are based on a billing schedule contractually agreed to with the government. This timing difference can cause cash flow from construction-related activity to fluctuate from period-to-period. However, even with this decrease in cash flow from operating activities, we had $8.5 million of cash on a consolidated basis and no borrowings under our revolving credit facility at the end of second quarter. And we just learned that S&P recently affirmed our A+ ratings for both American States Water and Golden State Water. In regards to our capital expenditures, Golden State Water invested $41 million in capital project during the 6 months ended June 30, 2013, as compared to $28.7 million for the same period of last year. We continue to invest capital to provide central services to our regulated customers, while working with the California Public Utilities Commission to have the opportunity to earn a fairer rate of return on investment. Golden State Water is still on track to spend approximately $85 million per year in capital expenditures for the years 2013 through 2015, which is consistent with the approved capital dollars in the water rate case. With that, I'll turn the call over to Bob.

Thank you, Eva, and hello, everyone. I'm pleased with our continued strong earnings performance for the second quarter of 2013. The improvement in our earnings can be attributed to our regulated water business as a result of the approved water rate case. We continue to focus on our ongoing infrastructure improvements, operational efficiency and evaluating various cost-containment measures to minimize costs to our customers while still providing the highest standard of service. With regard to our electric division, we continue to work with the California Public Utilities Commission to move forward with a review of our electric general rate case. A proposed decision is expected in late 2013. Under the Renewables Portfolio Standard Law, or the RPS Law in California, our electric division must procure sufficient eligible resources to meet RPS procurement requirements for the 2011 through 2013 compliance period by no later than December 31, 2013. In July of this year, the California Public Utilities Commission approved an agreement between Golden State Water and a third party for us to purchase 582,000 renewable energy credits over a 10-year period. We believe this arrangement will allow our electric division to meet the RPS requirements for the next 10 years, eliminating the risk of potential penalties for noncompliance. The cost of these renewable energy credits will be recovered through purchased power costs. As Eva mentioned earlier, we've been able to recover costs incurred through December 31, 2012, in connection with our efforts to procure these renewable energy resources. Now, let's discuss the company's contracted services business, ASUS. For the 3 months ended June 30, 2013, earnings from ASUS declined by $0.05 per share as compared to the same period in 2012. The decrease was due in large part to a contract modification received in April 2012 for a major water and wastewater pipeline replacement project at Fort Bragg, resulting in additional pretax operating income of $820,000 or $0.03 per share for the 3 months ended June 30, 2012. There was no similar contract modification during the second quarter of 2013. Additional factors contributing to the decrease in earnings for the second quarter of 2013 were lower-profit margins on construction projects, which can fluctuate from project to project as a result of negotiations with third-party contractors and/or the U.S. government. During 2012, we were able to achieve higher-than-normal margins on some of our construction projects. These margins has been more normal in 2013. There was also an increase in administrative costs associated with the pursuit of new military base opportunities. We remain aggressively engaged with new proposals and expect the U.S. government to release many more bases for bidding over the next several years. At the Fort Bragg military base, we continue to work on the $58 million water and wastewater pipeline replacement project and expect the project to be completed in the first quarter of 2014. The backflow preventer and meter project, totaling $23 million, is also underway and is expected to be completed by mid-2014. We have also mobilized on the $18 million water and wastewater infrastructure project required to serve a new area of Fort Bragg, which will be completed by the end of 2013. We are somewhat behind on these large projects in 2013 at Fort Bragg due to weather. During the second quarter, Fort Bragg experienced 19 consecutive days of rain, making it difficult to do construction work. We will be working hard to make up some of the ground we lost during the last 6 months of the year. In addition, there are various construction upgrade projects of a smaller magnitude expected to take place in 2013 at various military bases. ASUS continues to work closely with the government on the various price redeterminations pending. We expect negotiations on the first redetermination at Fort Bragg in North Carolina to be completed during the fourth quarter of 2013. We currently have an interim operations and maintenance fee increase in place pending final resolution of this matter. Negotiations have commenced for the first price redetermination for Fort Jackson in South Carolina and are expected to be completed by the end of this year. An interim operations and maintenance fee increase is also in place pending final resolution of these negotiations. In addition, the second price redeterminations for the military bases in Virginia are expected to be completed late in 2013. The third price redetermination for Fort Bliss in Texas was finalized in October 2012 and provides for an annual increase of approximately $450,000 to the operations and maintenance fee, compared to the amounts previously in effect. The first price redetermination for Andrews Air Force Base was issued in August 2012. It provides an increase of 7% to the operations and maintenance fee and an increase of 15% to the renewal and replacement fee compared to the interim adjustment. A modification to fund the retroactive portion of this increase to February 2008 was issued in May 2013. In regard to sequestration, as we've noted during previous calls, we have not experienced any earnings impact to our existing operations in maintenance and renewal and replacement services provided by ASUS, as such contracts are not subject to the provisions of the Budget Control Act. As for overall corporate matters, you'll recall that in May of this year, our Board of Directors approved a $0.05 per share increase in the third quarter cash dividend to $0.405 per share. This represents a 14.1% dividend increase in the quarterly dividend. Dividends will be paid on September 3, 2013, to shareholders of record at the close of business on August 15. Our Board of Directors also approved a 2-for-1 stock split of the company's common shares. These additional shares will also be received by shareholders on or about September 3. The double-digit increase in our quarterly dividend and the stock split reflect our Board of Directors' confidence in the company's ability to continue to deliver solid results and its desire to have a payout ratio that's more in line with our peers. I also hope the stock split will enable us to attract a broad range of investors. Before I turn the call back to the operator, I'd like to thank you all for your time and interest in American States Water. I will now turn the call over to questions.

[Operator Instructions] Our first question comes from Jonathan Reeder with Wells Fargo.

Just wondering on the ASUS construction projects. It sounds like a lot of the larger activity, the big projects are going to be wrapping up over the next 12 months. Do we have any clarity on other potential large construction projects that might come up? Are there any RFPs out there that you're bidding on for construction as opposed to the new bases?

Well, in terms of projects, the size of maybe the $58 million project or the $23 million project, we don't have projects at this point of that size that we know of. But you should understand that on these sort of new capital upgrade projects that we get at these bases, we'll get a call and then things get put in motion very quickly. So it's difficult to predict what new projects we're going to have. But right now, we don't have anything in the pipeline the size of the $58 million project. With that said, we do believe that the last 6 months of the year for ASUS will be much improved over the first 6 months of the year. We've got the delay on the projects at Fort Bragg and additionally, we're seeing smaller projects coming our way.

And also Jonathan, government's fiscal year ends at September 30. So the funding will be determined then. We probably have more clarity after that.

Okay. So typically, once they get their funding for the next, I guess, year is when they might say, "We want to go forward with these projects."

Yes, that's been our experience. We'll have a better appreciation for what work needs to get -- or whatever work will actually get funded after September 30.

Okay. And then can you just go into maybe a little more detail on your comments on the profit margin on the construction projects? I think you said 2012 -- I don't know if it was larger than normal or if just 2013 has now kind of come in a little bit. Where should we expect that to shake out going forward?

Yes, it's not -- it wasn't a huge item for the quarter and the year-to-date. It's a $0.01 or $0.02 for the quarter. Generally what we've seen is 2012 was -- we were able to negotiate some pretty good prices with our subcontractors. And prices are up a little bit from that. There's a slight increase there and it's affecting our margins a little bit there. So it's -- I don't want you to think it's a huge amount. But it is a reconciling item for the quarter, $0.01 or $0.02, right, Eva?

Yes. And you know for those large projects, Jonathan, those are firm, fixed-price contract with the government. So we negotiate very hard with our subcontractors to get that pricing. So timing make a differences, this year versus last year.

Okay. And then just kind of going forward, how should we be looking at the dividend in terms of payout ratio increases, things of that nature, Bob?

Yes. I think you can think about -- that we're going to maintain a payout ratio that's sort of comparable to our peers in the industry. And then as we're able to grow earnings, we are going to grow the dividend. We are very focused on making sure we continue to grow the dividend at 5% or better. And there is room to grow the dividend because our -- even with these recent increases, our payout ratio is -- there's still room to grow it.

Right. I guess how comfortable do you feel with the earnings level of ASUS, I guess, kind of being similar to last year and this year on a going forward basis? In terms of how that plays into the -- than the overall dividend payout ratio? I know you're paying out some dividends on the ASUS business expressing confidence that it will be profitable, but kind of, to what extent, maybe?

Yes. Well, last year, of course, we achieved $0.78 a share for the year. I would say our dividend isn't based on that $0.78. But it's -- we can -- we think we can get close to that $0.78 on a sort of an ongoing basis.

With the current portfolio of bases that you're operating?

Well, and including some wins on the new bases that are coming out. Because there -- we believe there is going to be substantial bases put out for privatization. There's 33 Air Force bases, where there's both a water and wastewater contract there that's still to be privatized. There's also a substantial number of Army bases still to be privatized. So there's a lot of bases still to be privatized and we expect to get our share of those. It'll be very competitive, of course, but we think we do that business very well and we have, we believe, a very good reputation with the Department of Defense and it's a business the Company is committed to.

Jonathan, when we and the Board decide to have increase in dividend, we look at our sustainable earnings going out, not just based on our current. So we are looking at what we can do in the next 3 and 5 years and make sure we can keep go -- keep maintaining the increases of our dividend records. So...

Right. We do not want to get in a situation where we, ultimately, that we'd ever have to cut the dividend. So we do look down the road quite a ways. And as Eva says, it's based upon sustainable earnings not just on earnings for the year.

Okay. And I apologize if I missed it, did you throw out a payout ratio, like a target payout ratio? Or...

The only thing we've talked about is a payout ratio that's comparable to what the industry is doing.

Okay. And that would be on a consolidated, kind of consolidated, sustainable earnings?

Yes, consolidated, sustainable earnings, yes. At this point, with ASUS, the business -- the earnings there are not as predictable as the utility. However, it is a business that hasn't required sort of as much capital to achieve the same amount of earnings and, as a result, we feel comfortable paying a dividend on those earnings.

Our next question comes from Heike Doerr with Robert W. Baird. Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division: I might have missed it. Did the project at Fort Lee, the pump station replacement, get completed as scheduled in this quarter?

I believe we're still working on that project, Heike. So it's not completely done at this point. Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division: Okay. I think Jonathan covered most of my questions on ASUS. I know we just have the rate case completed in May so it feels a little funny to be asking this, but can you remind us what the timeline is for when you will file the next rate case?

Sure. Because we're already spending lots of time on it, I can tell you that. We will prefile that case in May of 2014 and then officially file it in July of 2014. And that would then be for rates effective 2016 through 2018. Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division: And before then are you going to go in for a cost of capital? I can't remember when that cost of capital proceeding got done and took so long?

Right. The cost of capital application is due in March of 2014. Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division: So you would file in March or they would give you a decision in March?

No, we would file.

File. Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division: And it would take effect January 15?

January 1, typically. Yes, the expectation would be then, if it gets done on time. Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division: Okay. And are there any regulatory filings that we should be thinking about? I know that the Bear Valley case isn't done yet. Is there anything else on the electric side?

No. The only outstanding issue we have is we had this rehearing of our Region II, Region III general office rate case related to some La Serena project issues. We have a settlement there with DRA. We filed the settlement, we're just waiting for a proposed decision there. We expect to have a proposed decision that's consistent with our settlement given that it's a settlement and given that the judge canceled the hearings after we achieved the settlement. So it's just a matter of processing -- well, getting the proposed decision from the administrative law judge. Let's see, was there anything else? Yes, the only other application we have is we have filed our latest Brown power purchase -- Brown purchase power contracts at BVE for approval by the commission. The idea there would be to get approval of those contracts and also get approval of the continuing -- continuation of having the derivative accounting done just on the balance sheet.

[Operator Instructions]

Okay, Yusef, are we -- no questions are coming in?

No, sir.

Okay. Let me just wrap up by again thanking everyone on the call today for your participation and for your continued interest and investment in American States Water Company. Everyone, have a good day.