American States Water Company
Q4 2007 Earnings Call Transcript

Published: 13 Mar 2008

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company conference call discussing fourth quarter 2007 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 710, and one will be faxed or e-mailed to you. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 2

[Robert J. Sprowls:]

Good morning or afternoon, ladies and gentlemen and welcome to the presentation on American States Water Company's fourth quarter and full year 2007 results. I am Bob Sprowls, Chief Financial Officer of American States Water, and Floyd Wicks, President and CEO of the company, is also with me today. As usual, following the conclusion of our prepared remarks, the call will be opened up for questions. I would like to remind you that certain matters discussed during this conference call are forward-looking statements intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995. I ask that you review the forward-looking information disclosure in our Form 10-K and Form 10-Qs on file with the Securities and Exchange Commission. The factors underlying the company’s forward-looking statements are dynamic and subject to change. Therefore, these forward-looking statements speak only as of the date they are given. The company is under no obligation to update them; however, we may choose from time to time to update them and if we do so, we will disseminate the updates to the investing public. During our presentation today, Floyd and I may refer to American States Water Company as AWR; our flagship subsidiary, Golden State Water Company, as GSWC; and American States Utilities Services as ASUS. Having said that, let’s begin with the results for the fourth quarter. Basic and fully diluted earnings for the quarter ended December 31, 2007 were $0.36 and $0.35 per share respectively, as compared to basic and fully diluted earnings of $0.31 and $0.30 per share respectively for the same period ended December 31, 2006. Significant items that impacted the earnings for the fourth quarter of 2007 in comparison to the same period of 2006 were

[Floyd E. Wicks:]

Thank you, Bob and good morning, ladies and gentlemen. I’ll now discuss the status of key regulatory filings and important actions and those still pending. As Bob mentioned earlier, the PUC issued a favorable decision on November 16th of last year approving a general rate case increase in the region two customer service area of Golden State Water Company. In that same decision, the PUC also authorized additional rate increases in the region two and region three customer service areas to recover general office expenses at the corporate headquarters. The approved revenue increase for 2007 totals approximately $6.4 million for regions two and three -- I’m sorry, for region two and $3 million for region three, both of which are retroactive to January 1st of last year. The new rates were implemented on December 20, 2007. As a result, the company recorded a $7.2 million regulatory asset and corresponding increase in revenues during the fourth quarter of ’07. Surcharges will be implemented to recover the regulatory asset. This PUC decision also imposes an increased allocation of corporate headquarters expenses to ASUS. While this additional allocation to ASUS has no impact on the consolidated earnings based on the new rates authorized by the PUC, it should be noted that revenue requirements would be higher for Golden State regions had the allocation of corporate headquarters cost to ASUS been lower. Additionally, the PUC approved rate increases for region two and region three customer service areas effective January 1, 2008 on top of the rate increases for ’07 which I just discussed. The authorized rate increases will provide Golden State Water Company additional annual revenues of approximately $3.6 million for region two, representing the second year of a three-year rate case increase approved by the PUC last year. The increase of approximately $3 million for region three is the third year of a three-year rate increase approved in 2006. In January of 2008, the PUC also approved rate increases for the region one water service area. The authorized rate increases will provide Golden State Water Company additional annual revenues of approximately $6.4 million in 2008 based on an authorized return on equity of 10.2%. The new rates are retroactive to January 1, 2008. The combined rate increases in 2008 for regions one, two, and three are designed to generate approximately $13 million annually, based upon normalized sales levels approved by the PUC. While we continue our efforts to be good stewards of the resource and to send active conservation messages to our customers, customer conservation can result in lower water sales than would otherwise occur and lower volumes of water sold can have a negative impact on our earnings. In order to remedy the financial dis-incentive associated with water conservation, we have worked collaboratively with the PUC and the Arizona Corporation Commission to address rate structure issues which promote conservation of the resource. In February of 2007, the CPUC opened an order instituting investigation to consider policies to achieve conservation objectives -- I’ll relate this as the conservation OYI. On October 19, 2007, Golden State Water Company and the Division of Ratepayer Advocates in California, filed a settlement agreement regarding the conservation rate design and a water revenue adjustment mechanism, WRAM, to essentially decouple volume of sales from Golden State Water Company’s revenue. If this settlement is approved by the PUC, Golden State Water Company would implement an increasing block rate design as a means to encourage water conservation. Golden State Water Company would also establish a WRAM balancing account to track revenue shortfalls. The WRAM has been approved by the CPUC for other investor-owned water companies in California. In May of 2007, the CPUC issued a ruling on the conservation OYI which directed the parties in the proceeding, including Golden State Water Company, to address the issue of whether the adoption of a revenue adjustment mechanism should affect the authorized rate of return. We anticipate that the CPUC will issue a decision on this issue in the second quarter of this year. It is the company’s goal to control and recover operating expenses and to earn the authorized return on invested capital. Capital investment creates the basis for long-term earnings growth and is a key facet of our strategy to increase shareholder value. We are very focused in investing our resources on construction programs for both new improvements and replacement of aging infrastructure. Our projected construction expenditures for 2008 are approximately $55 million to $60 million. We are planning to issue equity in 2008 to fund our ongoing operational and capital needs. The proposed equity offering was included in the previously mentioned rate case filings and the positive earnings impact from the rate increases I have discussed is expected to absorb the dilutive effect of the new shares to be issued in 2008. I would like to take some time now to discuss the contracted services at American States Utilities Services. Revenues from contracted services at ASUS are comprised of the following

[Operator:]

(Operator Instructions) Our first question comes from the line of Debra Coy with Janney.

[Debra Coy:]

Thank you. Good afternoon, Floyd and Bob, or good morning to you. A couple of questions; one going back to the water usage in the quarter, I have to admit that I’m a little confused. When you issued your pre-announcement press release a month or so ago, you talked about a reduction of I think it was around 5% in billed water sales for the fourth quarter, due to weather and conservation. And Bob, I think you just said in your prepared remarks that water usage ended up being relatively flat in the quarter, and indeed revenue was better than we expected. Can you just talk through your sense of how that ended up?

[Robert J. Sprowls:]

Sure. Let me go back to my notes.

[Debra Coy:]

Unless I misunderstood your prepared remarks, I thought that you said in your remarks that the revenue increase that we saw in the quarter was almost entirely due to rates and that usage was flat, but not down. If you can just give a sense of how that looks.

[Robert J. Sprowls:]

I think when the dust settled, the water consumption was relatively unchanged compared to the same period in ’06, so what we do, Debra, I think what we put in our press release a month or so ago, we talked about billed water consumption and this then gave us a chance to look at where our -- you know, we have to recognize the unbilled as well, and by the time that rolled in, the water consumption was relatively unchanged.

[Debra Coy:]

Okay, so that’s the difference -- it’s the billed and unbilled and the timing of when you rolled up the quarter?

[Robert J. Sprowls:]

That’s right.

[Debra Coy:]

Okay. All right.

[Floyd E. Wicks:]

We keep modifying the unbilled amount based on a day-to-day change. Some of the previously forecasted unbilled accounts every day become billed and so on, and over time as you get closer to the final release of the information, you have more actual numbers than you did originally as unbilled, if that make sense.

[Debra Coy:]

Kind of. Okay, I think I understand that. In any case, what matters is where it ended up. So that being the case then, looking across at the expense side, it sounds like you had an unusually high level of well maintenance expense in the quarter. Was that a -- that’s almost like a one-time level of emergency spending or where was that coming from?

[Floyd E. Wicks:]

There are some unusual costs. We could break it down further than what we have here but -- for example, there are a number of wells that we put online recently to remove arsenic from the ground water and when you have a new treatment technology like that, where you are really not sure of how long the media inside the pressure filters will last, for example, and that media gets changed out, it’s an immediate expense, whereas initially when you first capitalized the treatment plant, the media is part of the capital project itself and gets put in the rate base. But when you only replace the media on a go-forward basis, that cost is very high by comparison to other treatment techniques that we are using at other various well sites. That’s one thing. And then of course we do take as many of the wells down as we possibly can during the winter months when the expected demand is low, in anticipation of getting them prepared for spring and summertime demands, so you’ll see a higher expense on a go-forward basis during the winter months on that. And I’m not -- I don’t know -- I don’t have a further breakdown in front of me right now.

[Debra Coy:]

Well, and that’s helpful, Floyd. What I was just trying to get a sense of is whether the operating costs, which were relatively high in the quarter, are things that are likely to continue or whether there was some unusual items. It sounds like it was a mix of both.

[Floyd E. Wicks:]

It is a mix of both and I think one thing we didn’t mention is that we are going to be filing another rate case in May of this year and it will incorporate any and all of the more recent higher numbers at least on the maintenance side. Because as you go forward on water quality, especially when the Safe Drinking Water Act was passed in 1974, just by example, they only had about 20 to 25 constituents in the water that were required to test for. Now we’re testing today after two subsequent amendments to the Safe Drinking Water Act, we’re testing for more than 150 constituents and that obviously will have more impact as we go forward and we want to make sure we build all those costs into our three-year forward-looking rate cases.

[Debra Coy:]

Okay, good. Thanks. My other couple of questions are related to the ASUS business. It sounds to me like sort of looking through what you’ve outlined here that essentially the operations and maintenance core contracts are still not making money and the construction projects, which are lumpier, are a lot more profitable. I guess my question is how do you think we’re going to remedy that going forward? And just taking a step back and looking at the structure of it, are these determinations made on a base by base set of discussions, or is there some sort of more regional level discussions with the Army? Or how are you thinking about this strategically? You’re several years into this business and it certainly looked like up until this quarter in ’07 that it was making money. We understand that was mostly or entirely related to the Fort Bliss construction contract. How does this business look to you over the next one to two years, particularly as you have new large contracts now starting to ramp up?

[Floyd E. Wicks:]

Well, those are good questions and of course, we’re fairly new at this side of the business. We’ve been in the business of maintaining water systems for a long, long time so that part is not the issue. I think frankly what it boils down to, Debra, is we’re experiencing a different kind of regulation. We’re used to the Public Utilities Commission regulations at the various states. They are tried and true for many, many years. And what we have here is we end up negotiating at each base with a certain person at the base, so their uniformity of how the negotiations take place really isn’t there yet and there is some indication from the fellow that runs that side of our business, Bud Harris, you know Bud --

[Debra Coy:]

I do.

[Floyd E. Wicks:]

And he’s indicated very recently that there’s some move afoot to attempt to have more of a consolidated or at least regional look at doing these price re-determinations, so that they are done more uniformly as opposed to a base by base. I think that will be a good thing. We are looking forward to getting through one of these so that we can assess in terms of what we need to do to tweak the process, to improve it, as we’ve done on the regulated side. It’s just to me another way of looking at -- we’re in a similar business. It’s got a different kind of regulator but the regulator needs to understand we’ve got to stay financially viable as well in order to provide the expectations of service that the military has.

[Debra Coy:]

Yes. And looking into ’08, assuming that we don’t know about any one-off special construction projects at this time, can you say whether we expect that business to have a negative or break-even or positive effect on income in the coming year?

[Floyd E. Wicks:]

You’re talking about the construction side?

[Debra Coy:]

No, just the whole -- the entire ASUS piece. In other words, if we don’t assume that there will be anymore one-off construction projects this year, is this business going to lose money this year or is it not?

[Robert J. Sprowls:]

Debra, we really haven’t given guidance with regard to where our expectations are for ASUS. I think with the addition of both Fort Bragg and Fort Jackson, that’s going to help because we are covering a certain amount of overhead costs there and -- it’s also obviously a business that we have to be successful in our price re-determinations and requests for equitable adjustments. A lot of moving parts there and we just really haven’t given guidance at this point on the -- where we expect ASUS to come out in 2008.

[Debra Coy:]

Okay, but so far we haven’t gotten any assignments on special construction projects yet for this year, similar to what you did at Fort Bliss last year? Nothing like that yet?

[Floyd E. Wicks:]

We should be able to report during our next call at least on maybe a little more cogent status of where we are in that regard. And by the way, with regard to the Fort Bragg contract, a lot of people don’t realize that some of these military bases are essentially like a small city. Fort Bragg has 80,000 people in their confines and that’s a pretty good sized system to operate and we think it’s going to add value over the ensuing years.

[Debra Coy:]

All right, thanks. I’ll get back in line.

[Operator:]

(Operator Instructions) Your next question comes from the line of Francesca Mccann with Stanford Financial.

[Francesca Mccann:]

Thank you for the good detail in the call and just a couple of other questions. Perhaps I missed this but I’m not sure; what is your thought on timing of WRAM implementation for American State?

[Robert J. Sprowls:]

Well, we have a case pending with the CPUC on the WRAM. At this juncture -- the way they’ve done this process is they’ve divided the companies into two groups, the phase 1A and phase 1B companies. And I believe at this point we are part of 1B and some of the other companies are part of 1A. The 1A companies are getting -- I believe there’s final decisions out on the 1A companies where they have gotten the WRAM approval. They haven’t talked about whether there will be a rate of return adjustment there, because that’s sort of part of the phase 1B company approach. But we are hoping by mid-year we’ll have all this resolved and have the WRAM in rates going forward.

[Francesca Mccann:]

Okay, so relatively soon then for the --

[Robert J. Sprowls:]

Yeah.

[Francesca Mccann:]

Perfect.

[Robert J. Sprowls:]

But you know, you never can tell.

[Francesca Mccann:]

No, of course. And then what about progress in building, kind of your in-house construction and maintenance bath and the impact of that on CapEx?

[Floyd E. Wicks:]

Can you say that again? I’m sorry.

[Francesca Mccann:]

Sure. What progress or any changes that you’ve made in terms of building your in-house construction and maintenance bath and how that impacts your ability to actually build and kind of spend the CapEx?

[Floyd E. Wicks:]

That’s an excellent point and we’ve really focused our efforts in this area quite a bit over the last year or so. And as you know, we’re in the business of providing customer service and many of the same people that are out in the field operations in the 75 cities in California where we operate have a dual role, or have had for many years in terms of meeting with city council members and city engineers and planners to make sure we get the right information from them. And then they have to put another hat on to make sure they put in an ever-accelerating capital budget construction program. So we’ve really focused our efforts in separating organizationally a group known as the asset management group and I believe on a go-forward basis, it will really give us a leg up in getting projects done in a more timely manner and provide more assurance that we’ll stay on schedule regarding our construction program. Does that respond to your question okay?

[Francesca Mccann:]

Sure, and I’ll follow-up with any others, so thank you. Those are my only questions for now.

[Operator:]

Your next question comes from the line of [Link Werden] with H.D. Wellington.

[Link Werden:]

Hello. I was wondering whether you could specify the amount of your equity offering ahead and the timing of it.

[Robert J. Sprowls:]

Well, we can talk a little bit about that. The last offering we did was in the $35 million range. We are probably going to be in the $20 million to $30 million range, and the timing of it is -- you know, we’re looking at obviously 2008. You know, the stock price is lower than obviously where we’d like it, so we are going to keep an eye on that as well. So timing will be sort of a function of where the stock price is. We’re also keeping an eye on the American Water deal, the IPO that’s out there. We’re sort of debating internally whether we want to be out there the same time they are, given the size of that offering.

[Floyd E. Wicks:]

The other thing I -- that’s a good question because it does give another opportunity to talk about the forward-looking regulation, at least in California where most of our asset are. Golden State Water Company still represents more than 90% of the asset base of the entire company. As such, California regulation allows forecasting your need for capital, as well as new debt issuances as well. They look at forecasted interest rates and so the equity offering that Bob just spoke of will be actually, or is already in certain of the rate cases that have been approved by the PUC already and it will also enter the three-year rate case that we are going to file in May of this year. So having that ability to forecast the need for new equity into the rates on a go-forward basis does in fact help our shareholder base, in our opinion.

[Link Werden:]

Okay. Thanks.

[Operator:]

(Operator Instructions) You have a follow-up question from Debra Coy with Janney.

[Debra Coy:]

Yes, my follow-up question, Floyd, is related to the asset base that you mentioned. We’ve talked about this in the past. Can you give us any update on how you are thinking about your water rights asset base? I know you’ve been doing some assessment of what you’ve got. Can you tell us what your thinking is on that currently in terms of what’s there and how you might be utilizing those assets or valuing those assets going forward?

[Floyd E. Wicks:]

Yes, I -- as you know, what we’ve talked about in the past is that we have been looking at our company in a different manner in terms of how our systems may in fact be more integrated than what we had looked at in the past. And that integration frankly comes in a number of physical ways. Physically, 32 of our 40 water systems in California are connected, even though they are standalone systems, they are interconnected by virtue of our taking water from the metropolitan water district of Southern California, its significant network of pipes in Southern California. So 32 of our 40 systems, or 75% of our water systems in California are really networked in terms of having local groundwater basins providing water, as well as imported water interconnections through this network I mentioned. The water rights that you’ve brought up, actually as you’ll find out in our filing tomorrow, or it may be Monday when we file the 10-K, we have identified by class of water right just exactly what we have in terms of thousands of acre feet of water rights. It’s just an identification of what we believe we own in terms of the water right itself. And as you know, in western states, water rights are every bit as valuable as having property and they are considered a property right that can be leased and sold and we have already identified 5,000 acre feet we currently own and are leasing to the City of Folsom, bringing in revenues of about $1.3 million a year, 100% of which goes to the benefit of the shareholder. Of course, after Uncle Sam gets its benefit. But it’s -- we’re still constantly looking at how we can maximize the value of those water rights, which we have in excess of the 100,000 acre feet of ground water rights, two-thirds of which are adjudicated through the courts, which I believe does give us a very strong position from a sustainability point of view of the resource. We have, as I’ve mentioned during past meetings, more adjudicated water rights through the courts than any other pumper of ground water in the entire state of California. We’re still working on what that means in terms of future value to shareholders. I wish we had more answers than we do but we just don’t have them yet. But keep asking.

[Debra Coy:]

That’s helpful. And somewhat related to that, it’s been in the news this week that the metropolitan water district is raising rates 14% I think for next year. Do those kind of rate increases get built into your rate cases or will that have to be something that would be addressed in balancing accounts and would impact water supply costs beyond your current rate?

[Floyd E. Wicks:]

Well, we’ve solved the issue of being able to collect increases in the cost per unit of imported sources. In other words, if the water rates go up 14% and let’s say they are at $500 an acre foot currently, that difference of $70 per acre foot would be captured and recovered later through water rates through surcharges. That $70 differential would go into what you referenced as the balancing account. If there is a change in the mix, if prices stay the same but we buy more than what’s in the rate case, say we have 45% of our supply coming from MWD, and we use 50% because wells are down or what have you, that will not flow to the balancing account. That will actually be a hit on earnings and it will be a positive impact on earnings if we end up buying less imported water than what’s in the rate case. So there’s a balance there but at least if there’s a price increase, we are protected to the extent that we don’t have to provide the PUC with an earnings test to get that cost recovery anymore. We did during the I’d say bad regulation era of a few years ago. That has been taken care of since and I am pleased to report that.

[Debra Coy:]

And other companies have talked about working with the PUC on being a little bit more flexible on the mix shifts as well. Is that something that you are incorporating into your rate cases and discussions too?

[Floyd E. Wicks:]

There are some discussions ongoing because of the conservation theme. That’s part of the California PUC’s water action plan. There will be some more discussions about what is referred to as a full cost balancing account, so that you are not compromising your decision making as to meeting a certain mix but spending more money to get that mix, as opposed to doing what’s really right for the system at that point in time. So there’s a lot going on in the area of water supply as well. As you know, the state is looking at a multi-billion bond issue to be on the ballot for more water storage. Metropolitan water district’s board chairman, he and I are co-chairing a water task force in Southern California known as the Southern California Leadership Council, and the council has a water task force and Tim Brick is the chairman of MWD. He and I are chairing that task force to determine what’s in the best interest of Southern California as a whole and a lot of that may relate to better use of ground water basins, more conjunctive use, utilizing the facilities owned by metropolitan water district, in more what I would refer to as local projects as opposed to continuing to rely so heavily on exported or imported sources. So there’s going to be a lot of changes I think in the next decade in terms of dollars spent locally to enhance already existing water rights or other local facilities in the area of reclaimed waste water that gets reused even more so. Other states have already addressed this. In Arizona, for example, reclaimed waste water rights that are injected into the ground water basin recently sold for over $25,000 an acre foot, which tells you that reclaimed waste water has tremendous value and the State of California is recognizing that currently and I think you’ll see a lot of local projects starting to hit the engineering companies and we’ll get more dollars invested in California in the water field in the next decade.

[Debra Coy:]

Good. That’s interesting. I’m glad you’re involved. Last point there -- there’s been so much talk about conservation and water shortages. We have had a relatively wet winter. As all of these new longer term planning mechanisms are being put in place, is it looking like supplies are relatively normalized as we enter the spring season, and the conservation efforts are kind of voluntary and at a low roar, if you will? We wouldn’t expect to see any significant changes in supplies or usage patterns outside of normal in the next quarter or so, would we?

[Floyd E. Wicks:]

I would say your assessment is pretty right on target and the metropolitan water district did very recently release an allocation plan but I don’t believe -- I think because the reservoirs in California are at normal or above and the snow pack is significant, 2008 appears to be a fairly decent year in terms of not requiring that allocation plan to be implemented on any kind of an emergency basis. 2009 has yet to materialize, of course, but we’ll certainly have more and more reports on that as the year goes on.

[Debra Coy:]

All right. Thanks, Floyd. Appreciate it.

[Robert J. Sprowls:]

Thank you. And I wanted to just correct something that was said earlier about the drop in sales. In further review, our prepared remarks were incorrect and the sales were down 5% for the fourth quarter, so that’s I think consistent with what we said in February.

[Floyd E. Wicks:]

Good catch. Thank you, Debra.

[Robert J. Sprowls:]

My apologies.

[Operator:]

There are no further questions at this time.

[Floyd E. Wicks:]

Again, thank you all for participating today in such a lively way and for your continued interest in investment in American States Water Company. Thank you very much.

[Operator:]

This concludes today’s conference call. You may now disconnect.