American States Water Company (AWR) Q2 2015 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 2015 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 p.m. Eastern Time and run through August 12, 2015, on the company's website, www.aswater.com. After today’s presentation, there will be an opportunity to ask question. [Operator Instructions] This call will be limited to an hour. As a reminder, certain matters discussed during these conference call maybe 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. At this time, I will turn the call over to Eva Tang, Chief Financial Officer of American States Water Company.

Welcome, everyone, and thank you for joining us today. On the call with me is our President and CEO, Bob Sprowls. I'll start with our quarterly financial result. For the second quarter of 2015, diluted earnings were $0.41 per share, compared to $0.39 per share for the same period in 2014. While earnings at our Water segment remained flat for the quarter, earnings for the Electric segment decreased by $0.01, earnings at our Contracted Services segment increased by $0.02, and our parent company’s earnings increased by $0.01. I will now discuss major items impacting the comparability of the two periods. For the quarter Water revenue increased about $1.3 million to $87.6 million as compared to the same period in 2014. The increase is primarily due to the third year rate increases and increases generated from revenue recovery on capital projects approved through advice letter filings. These increases were partially offset by an $842,000 decrease in surcharges during the quarter to recover previously incurred costs approved by the California Public Utilities Commission or the CPUC. Most of these surcharges were implemented in 2013 and expired during 2014. The decrease in revenue from these surcharges is offset by a corresponding decrease in operating expenses, largely in administrative and general expense, resulting in no impact to pretax operating income. As a reminder, a change in build consumption, which decreased 13% during the second quarter as compared to Q2 last year, does not have a significant impact on the company’s revenues or Water gross margins due to the CPUC authorized Water Revenue Adjustment Mechanism or the WRAM. The WRAM mechanism is in place for all of our Water service areas, excluding the effect of surcharges our Water gross margin approximately authorized Water margin approved by the CPUC. We expect Water consumption to continue decreasing during the remainder of 2015 as compared to the same period last year, because of mandatory Water conservation and rationing, which Bob will discuss in more detail later. Again, any continued decrease in Water consumption will not impact our earnings significantly because of the WRAM. For the second quarter of 2015, revenues from Electric operations were $7.9 million as compared to $8.3 million for the same period in 2014. The decrease is primarily due to a change in the monthly allocation of the annual base revenue requirement as stipulated in the CPUC's November 2014 final decision on our electric general rate case. Differences in the monthly allocation of the annual adopted revenue for 2015 versus 2014 are expected to reverse during the year. Revenues for our Contracted Services business, American States Utility Services, or ASUS, decreased $1.9 million to $19.1 million for the second quarter of 2015. This decrease was due to lower construction activities, as compared to the second quarter of 2014, due largely to the completion of several large capital projects during 2014, which did not recur in 2015. These decreases were partially offset by higher construction revenues during the second quarter of 2015 due to favorable changes in cost estimated for certain capital work in progress. These new capital upgrade projects and cost estimates are continuously evaluated and revised accordingly. Revenues for these projects are recognized based on the percentage of completion method of accounting. There was also increasing monthly operation and maintenance revenue due to successful price redeterminations in September 2014. Our water and electric supply costs were $27 million for the second quarter of 2015. Any changes in supply costs for both the water and electric segment as compared to the adopted supply costs are tracked in balancing account, which will be recovered from or refunded to our customer in the future. Administrative and general expenses for the second quarter of 2015 were $20.5 million, as compared to $19.4 million for the same period in 2014. Excluding surcharges which has no impact on earnings, A&G for our utility segment increased by $1.2 million during the quarter. The increase was due primarily to higher legal and other outside service costs related to condemnation and drought activities at our water segment. We will continue to incur legal costs to defend our water systems from condemnation actions. Furthermore in connection with our efforts to meet California Governor’s orders to use overall water usage by 25% as compared to 2013, Golden State Water has been authorized by the CPUC to track incremental drought-related costs incurred in a memorandum account for possible future recovery. Such incremental costs are being expensed until future recovery is approved by the CPUC. Despite higher A&G at water segment for the second quarter, on a year-to-date basis the aggregate A&G, other operations and maintenance expenses were lower in 2015 than for the same period in 2014 after excluding surcharges. In addition, A&G expenses for contracted services increased by $482,000 for the three months ended June 30, 2015 primarily due to a shift in labor and other indirect costs to A&G related activities in support of various functions for all military bases. This increase was largely offset by a decrease in such costs included in construction expenses as compared to the second quarter of 2014. ASUS construction expenses decreased by $3.4 million to $10.4 million during the second quarter of 2015, as compared to the same period in 2014, due primarily to the completion of large capital projects and programs in 2014, which did not recurred in 2015. In addition, as just discussed, there was a shift in labor and other indirect costs incurred as A&G activities. While in Q2 of last year, a higher year percentage was incurred for construction activities. Income tax expense decreased by $728,000 to $9.5 million as compared to the same period in 2014, driven by an overall decrease in the effective income tax rate. Although very effective tax rate at Golden State Water’s company was due to differences between book and taxable income that are treated as flow-through adjustments. The effective tax rate at ASUS was lower as a result of the state income taxes which vary among the jurisdictions in which it operate. There were also favorable permanent differences, not just the tax deduction related to the introduction and construction activities, which also impacted the effective tax rate this quarter. AWR’s consolidated effective tax rate was about 38% for three months ended at June 30, 2015 as compared to 40% for Q2 last year. Let’s moving on to -- move on to the liquidity and capital resources. Net cash provided by operating activities decreased by $27.9 million to $63 million for the six months ended June 30, 2016. The decrease was primarily due to a decrease 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, 2015 as compared to the same period in 2014. During the first six months of last year, significant cash payments were received at ASUS with completion of several large capital upgrade project that did not recur in 2015. Cash flow from construction activities may fluctuate due to timing differences of when the work is being performed or when the cash is received for payment of the work. There was also decrease in customer water usage resulting from conservation efforts, which lowered customer billings for Golden State Water. These decreases in the consolidated cash flow from operating activities were partially offset by lower income taxes payment made during 2015, due in large part to the implementation of the new tax repair regulation in the first quarter of 2014. In regards to Golden State Water’s capital expenditures, we spend $32.5 million in company funded capital expenditures during the six months ended June 30, 2015. We expect to invest $85 million to $90 million in capital project due in 2014. For additional details on our second quarter and year-to-date performance, please refer to our earnings release and Form 10-Q issued yesterday. With that, I will turn the call over to Bob.

Thank you Eva. I appreciate everyone joining us today. The company delivered solid earnings in the second quarter. During the quarter, we implemented water conservation measures and through the month of July, all of our service areas are meeting the mandated reductions. In addition, we continue to support our positions in the general rate case application that we filed with the CPUC for the water segment of Golden State Water. We also recently received the CPUC's approval to acquire all of the operating water assets of Rural Water Company. Let me address the drought situation in California. As you're aware, on April, 1st of this year, the Governor of California issued an executive order, directing mandatory conservation measures to achieve a statewide 25% reduction in urban water use as compared to 2013 levels. State Water Resources Control Board adopted emergency regulations in early May of this year to meet the governor’s executive order. The State Board also set reductions, which vary by area, depending on the historical per capita water use for the area in order to achieve the 25% reduction goal. In June 2015, Golden State Water filed updated drought response actions with CPUC for each service area to meet the new mandates. In July, the CPUC approved the filings. As a result, all of our water service areas have implemented our mandatory water conservation and rationing plan, which outlines restrictions for outdoor irrigation for water customers. If these restrictions are deemed insufficient to achieve the water use reductions, water allocations and additional mandatory rationing maybe implemented. Through the month of July, each of our service areas are meeting the mandatory reductions. During the second quarter, billed water consumption decreased by 13% as compared to the same period in 2014, due to our customers’ conservation efforts. As Eva mentioned, a change in consumption does not have the significant impact on the company's results due to the CPUC authorized water revenue adjustment mechanism in place for all of our water service areas. The commission has also authorized a drought memorandum account to track incremental costs incurred in promoting conservation and implementing restriction measures for possible future recovery. In other regulatory matters, we continued to work with the PUC on the pending general rate case for all of our water regions and the general office. The rate case will determine new rates for the years 2016, 2017 and 2018. Golden State Waters’ requested capital budgets in the application averaged approximately $90 million a year for the three year period. For 2016, water gross margin is expected to decrease as compared to the currently adopted levels, due in part to a decrease in annual depreciation expense, resulting from an updated depreciation study and other expenses. Hearings for the rate case were completed in June and settlements for certain items and legal briefs were filed in July. A final decision on this rate case is expected by the end of 2015, with new rates effective January 1, 2016. Now moving onto other regulated business. As you may recall sometime ago, Golden State Water entered into an asset purchase agreement to acquire all of the operating water asset of Rural Water Company. This transaction was subject to commission approval. In June of this year, the commission approved the acquisition, including recovery of the purchase price through customer rates. A confirmation of the transaction, contemplated by the purchase agreement is subject to customary conditions, including, among other things adjustments to the $1.7 million purchase price for changes in utility plant since entering into the agreement in 2013. On completion of this transaction, Golden State Water will serve approximately 960 customers in the City of Arroyo Grande in the county of San Luis Obispo, California, which is near Golden State Water, Santa Maria customer service area and Coastal California. Under the terms of the purchase agreement, Golden State Water will take over operations 30 days after remaining conditions to closing are satisfied. Turning to our contracted services business at American States Utility Services, or ASUS, we continue to work closely with the U.S. government on the remaining price redeterminations. Just last week we received final resolution on the third price redetermination for Andrews Air Force Base in Maryland. We expect the second price redetermination for Fort Jackson in South Carolina and the second and third price redeterminations for the military bases in Virginia to also be completed during the third quarter of 2015. Filings for these price redeterminations, requests for equitable adjustment, and contract modifications awarded for new projects provide ASUS with additional revenues and margin and the opportunity to consistently generate positive earnings. We also continue to work closely with the U.S. government for contract modifications relating to potential capital upgrade work as deemed necessary for improvement of the water and wastewater infrastructure at the military bases. In addition, we are actively engaged in new proposals and expect the U.S. government to release additional bases for bidding over the next several years. We remain optimistic about the future of our contracted services business. I would like to turn our attention to dividends. On Tuesday of last week, our Board of Directors approved a third quarter dividend of $0.224 per share on the common shares of company, a 5.2% increase. We are pleased with our Board’s decision to once again increase the dividend, which reflects their ongoing confidence in the company while balancing the need for continued investment in our systems for our customers. American States Water Company has paid dividends every year since 1931, increasing the dividend received by shareholders each calendar year for 61 years. Given American States current payout ratio compared to the companies that we compete with for capital and our high shareholders equity ratio as a percent of total capitalization, there is room to grow the dividend in the future. Additionally, pursuant to the first stock repurchase program approved by the Board in March 2014, we have completed the repurchase of 1.25 million shares of AWR stock on the open market. On May 19th, 2015, our board approved a new stock repurchase program, authorizing the repurchase of up to 1.2 million shares of our common stock from time to time. We have repurchased 387,000 common shares on the open market through June 30th under this program. The repurchase programs are intended to enable the company to achieve a consolidated shareholder's equity ratio as a percentage of total capitalization that is more reflective of appropriate equity ratios for Golden State Water and ASUS. As of June 30, 2015, our current equity ratio is 59%. Before I close with my prepared remarks, I'd like to thank you for your interest in American States Water. And I’ll now turn the call over to the operator for questions.

[Operator Instructions] The first question comes from Jonathan Reeder from Wells Fargo. Please go ahead.

Good afternoon, Eva and Bob. With the WRAM in place to protect your margins at the utility, I was just wondering if you could give us a little bit of guidance how we should be thinking about the distribution of GSWC’s adopted gross margin throughout 2015? Such as maybe what percentages fall in each quarter?

Jonathan, we usually just look back three to five years history to determine that allocation. So if you look through the quarterly sales in the past few years and average those out, that should give you pretty good allocations for the quarter.

Do you have any idea like roughly what percentage of the margin, I guess, remains for Q3 and Q4, is it 50% greater than that?

We think more than 50% because the third quarter is our highest sales quarter in summer. First is the lowest usually and then…

Third will be greater than the second, and fourth will be greater than first. So it’s more than 50% of the last half of the year.

Half of the year, yes.

Okay. Fourth is greater than the first still. Okay. That’s helpful. And then have your expectation for ASUS increase the bid now for 2015 due to these favorable changes in the cost estimates for the projects, or are we still thinking about maybe $0.26 or so, I think that’s what you cited last, Bob, kind of for the full year expectation?

Yeah. We think that $0.26 is still a pretty good number for the entire year. And you will recall we got to that $0.26 by taking last year’s $0.31 and backing out about a nickel fourth of sort of items that were not perspective but were impacted by prior year as well. But we had a retroactive price, re-determination for instance that contributed I believe $0.03.

Correct. Yeah. Okay. And then just kind of last question. On that front with the projects that I guess, you booked those favorable changes, were those like -- at all those multi-year large projects, were they some of the projects that were awarded? I think it was at the end of September of last year. When did those projects kind of get completed just kind of wondering a little more detail on that?

Jonathan, I think majority of our current projects are not multi-year projects. We finished quite a few multi-year projects last year. So most of the projects, we are currently working on is probably 12 to 18 months project I would say.

Okay. And then the next kind of update on, where you stand with the projects we should be thinking Q3, that’s when the government I guess kind does the budget.

Yes. That’s usually in sort of that September -- late September timeframe, early October, the amount of additional capital work that we can do, sort of through the next 12 months, next 12 to 15 months.

And we usually work with them, what kind of projects and we can do on the base and September 30 is really when funding comes down that we would know which paths to go forward.

Yeah. I mean that’s consistent with the government’s budget. I’m sure there is more dollars being asked more than we’re going to get but it's usually a very sizable chunk. Last year, I think we got $27 million, yes.

Okay. And then are there any -- I guess, kind of large multi-year project somewhere to the three that you recently completed that might be in the near future or nothing you are aware of at this point?

Yeah. Nothing we are of at this point. There are a lot of small projects that we are working on and that should keep a good solid revenue stream.

Okay. Great. I appreciate the additional clarity. Thanks.

Thank you, Jonathan.

Thank you.

[Operator Instructions] This concludes the question-and-answer session. I’d now like to turn the conference back over to Bob Sprowls for closing remarks.

Thank you, Danielle. Again, thank you all for your participation today and for your continued interest and investment in American States Water Company. Everyone have a good day.

Thank you.

Thank you. This concludes today's American States Water Company Conference Call.