American States Water Company
Q1 2014 Earnings Call Transcript

Published: 7 May 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company conference call discussing the company's first quarter 2014 results. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 5

[Eva G. Tang:]

Thank you, Nikki. 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 during this conference call may be forward-looking statements intended to qualify for the Safe Harbor from liabilities 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 will now discuss the first quarter financial results. Diluted earnings for the first quarter of 2014 were $0.28 per share compared to $0.35 per share for the same period in 2013. Net income for the quarter was $11 million compared to $13.5 million for the same period of last year. Included in the results for the first quarter of 2013 was the impact of the onetime recovery of previously incurred costs of $3.1 million or $0.05 per share approved by the California Public Utilities Commission, or the CPUC, in 2013. There was no similar item in the first quarter of 2014. Excluding this onetime nonrecurring item, earnings for the water segment increased by $0.01 per share and consolidated earnings decreased by $0.02 per share, primarily due to an expected reduction in renewal and replacement capital work at our contracted services segment. For the quarter, water revenue at Golden State Water increased by $1.5 million to $70.8 million as compared to the same period in 2013. There was an increase of $1.3 million in surcharges billed to our customers during the first quarter of 2014, with the corresponding increase in operating expenses for recovery of previously incurred costs. These surcharges have no impact to our net earnings. There were also rate increases for '14. The impact to operating revenue associated with these rate increases is anticipated to be approximately $1.6 million for 2014. Electric revenues at Golden State Water were $10.5 million as compared to $10.7 million for the same period in 2013. Pending a final decision on electric general rate case, electric revenues have been recorded using 2012 adopted levels authorized by the CPUC. Revenues for our Contracted Services business, American States Utility Services, or ASUS, decreased to $20.7 million for the first quarter of 2014, primarily driven by a planned reduction in renewal and replacement capital work at the Fort Bliss and Fort Jackson military bases. R&R construction will continue to vary from year-to-year over the remaining term of the 50-year contract with the government. However, overall construction activity is expected to increase during the remainder of 2014 as compared to the first quarter. Our water and electric supply costs were $20.2 million for the first quarter of 2014. 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 customer in the future. Other operation expenses increased by $1.5 million for the first quarter of 2014. As I mentioned earlier, the CPUC approved a onetime recovery of $3.1 million in 2013 for previously incurred costs, $1 million of which was related to operation costs. So including the $1 million credit recorded in the first quarter of 2013, there was an increase of $500,000 in 2014's first quarter, primarily due to higher chemical and other water treatment costs. Administrative and general expenses for the first quarter of 2014 were $20.2 million as compared to $17.9 million for the same period in 2013. Out of the $3.1 million onetime recovery of previously incurred costs recorded in the first quarter of last year, $1.7 million was related to previously incurred A&G expenses. There was also an increase in approximately $900,000 in water surcharges recorded as revenue during the first quarter of 2014, which had a corresponding increase of $900,000 in A&G expenses. Excluding these 2 items, A&G expenses actually decreased by $300,000 during the first quarter of 2014 due primarily to an overall decrease in company-wide outside services costs. Our maintenance expense decreased by $445,000, driven by a decrease in maintenance work at our Water segment. We expect maintenance expenses for the Water segment to be lower in 2014 as compared to 2013 as we had done additional planned maintenance work in 2013, above prior years. Depreciation and amortization expense increased by $714,000 to $10.5 million for the first quarter of 2014 as compared to the same period in 2013, driven mostly by $93 million of additions to utility plants during 2013. Property and other taxes increased by $177,000 compared to the same quarter in 2013 due to increases in property taxes and franchise fees. ASUS construction expenses decreased by $7.3 million to $13.5 million during the first quarter of '14 as compared to the same period in 2013. The decrease is primarily due to lower renewal and replacement construction activity as I discussed earlier. Other income and expenses, including interest expense, increased slightly to $5.4 million for the first quarter of '14. Income tax expense decreased by $2.9 million to $6.4 million as compared to the same period in 2013. This decrease was driven by lower pretax income and a lower effective tax rate for the quarter due to changes between booked and taxable income from a [indiscernible] benefit-related items that are treated as a flow-through adjustments. Moving on to liquidity and capital resources. Net cash provided by operating activity increased by $9.9 million to $40.9 million for the first quarter of 2014 as compared to $31 million for the same period last year. This increase was primarily due to other rate increases incremented in May 2013 and the collection of various surcharges, also implemented in mid-2013 in connection with the CPUC's final decision on the water rate case. In addition, there was an increase in cash generated by contracted services due to the timing of billing and cash receipts for construction work at military bases during the first quarter of '14. These increases in cash flow from operating activity were partially offset by tax refunds that we received during the first quarter of last year. We didn't have similar refunds received in 2014. In regards to Golden State Water's capital expenditures, we incurred $13.4 million, excluding work funded by others, during the first quarter. We still expect to invest $80 million to $90 million in capital projects during 2014. For additional details on our first quarter's performance, please refer to our earnings release and Form 10-Q issued yesterday. With that, I'll turn the call over to Bob.

[Robert J. Sprowls:]

Thank you, Eva. Hello, everyone. I appreciate all of you joining us today. Our regulated water business continues to be our flagship subsidiary. We are currently working on our next general rate case filing. And we intend to file for all of our water rate making areas in the general office in July of this year for new rates effective in January 2016. With regard to our electric division, we have been in settlement negotiations with all of the parties in the general rate case. Those negotiations have resulted in an agreement, in principle, and we anticipate that a settlement agreement will be filed with the California Public Utilities Commission in the second quarter. A final decision on this rate case is expected in late 2014. We continually look for ways to improve efficiency and manage our operating expenses to mitigate future rate increases. Over the past few years, we have stabilized costs and decreased expense volatility, such as redeeming certain long-term notes and replacing them with lower rate notes and closing the company's defined benefit pension plan to new hires and implementing a defined contribution retirement plan instead. Certain functions that had been performed in-house were outsourced at reduced costs because the outside vendors had economies of scale that we could not match. In addition, we have reduced staff by about 4% and continue to adjust while balancing customer service and costs. We are committed to continuously evaluating our processes to reduce rate increases to our customers while allowing us to make prudent capital investments. As you may know, in March, our Board of Directors approved a stock repurchase program authorizing the repurchase of up to 1.25 million common shares through June 30, 2016. The intent of this program is to enable the company to achieve a shareholders' equity ratio for the consolidated company that is more reflective of appropriate equity ratios for our 2 subsidiaries

[Operator:]

[Operator Instructions] Our first question comes from Ryan Connors with Janney Capital Markets.

[Kenneth J. Dorell:]

This is actually Ken standing in for Ryan. My first question is regarding ASUS, and I'm just curious, as far as the large projects are concerned, are they still on track to roll off in the second quarter? And if so, can we expect a similar level of construction activity from them in the second quarter as we saw in the first?

[Robert J. Sprowls:]

Yes. They are expected to get those projects. The projects, I guess, we're talking about is the $58 million water, wastewater pipeline replacement project, the backflow preventer meter project and the work at Patriot Point. The plan is for all of them to be completed by the end of the second quarter. And we expect to see, I guess, with the pickup in the renewal and replacement that, that we should see an increase in construction the rest of the year. So the work from -- the construction work from those projects, that will drop off a little bit, but we believe the renewal and replacement work will pick up.

[Kenneth J. Dorell:]

Perfect. And then just shifting to the price redetermination that you mentioned in your prepared remarks, Bob. I recall reading in the -- I think it was in the 10-K, that they're expected to be completed in the first quarter, and now you're hearing, kind of second, third quarter area. I'm just curious, as far as them related to your expectations for ASUS, what's the level of materiality with that as far as the ASUS contribution? Does that impact your expectations for ASUS as it stood 4 months ago? How should we think about that?

[Robert J. Sprowls:]

Well, there's significant contributors to the overall performance of ASUS. In some cases or in many cases, there are components associated with retroactive back to when the price redetermination should have been completed. In other words, it's sort of predetermined when you take over a contract when you're supposed to have your redeterminations completed and any redetermination you get, generally, is retroactive back to that point. So these are behind schedule. Some of that, a lot of that has to do with the fact that the government, well you recall what sort of transpired the last year during sequestration, et cetera, and governments got, in fact, probably less people working on this, and it is taking longer than what we had originally thought, but we are seeing progress. So though it's been delayed a bit, we know we do think we're going to get it -- get to the finish line in 2014.

[Eva G. Tang:]

And Ken, most of those pending price redeterminations also has interim rates in place, so go back to the effective day. So we do have some increases along the way. It's just, we're waiting for the final decision to see what the impact will be.

[Robert J. Sprowls:]

Yes. So if we do have some retroactive recognition, it will be above the interim increase. It's a good point, Eva.

[Kenneth J. Dorell:]

That's great color, I appreciate that. And then just my final question, it's more big picture strategy, I guess. Obviously, ASUS has garnered a lot of attention from the investment community because of your success there in kind of the amount of projects coming on, but if you kind of look outside of that, what are you guys most excited about from a growth opportunity? Would it be something like expanding to wastewater in your regulated business or perhaps electrics, offering electric services on military bases?

[Robert J. Sprowls:]

Well, over time you will see that the rate base for Golden State Water will continue to grow as we replace the needed pipes. So we are going to see the water utility continue to grow, probably at the kinds of rates we've seen in the past. Beyond that, we are considering possibly offering electric opportunities at the military bases that we serve. We have to -- we do have that expertise because of our Bear Valley electric component and a lot of times when you get into these businesses -- a bit like the -- a bit like the utility business in that you need to know the operating side of things, but you also need to know how you get price increases, et cetera, and we feel like we do know that for ASUS, so we know we're very interested in expanding that business, both from a water and wastewater standpoint. And we'd like to sort of test the market on the electric side and see if that's something we can expand the company with.

[Operator:]

The next question comes from Jonathan Reeder with Wells Fargo.

[Jonathan Reeder:]

I was wondering if you could talk a little about what's being done to address the water supply shortage in California and the fact that it's kind of been an ongoing situation now for a few years on the supply side and how that might relate to potentially accelerate a rate base growth for you.

[Robert J. Sprowls:]

Well, we are trying to -- I mean, we continue to make sure that we can pump all of our water rights, first of all. And that means we have to make sure that all of our pumps are working and our wells are working like they're supposed to. And you've done a good job with that in the past, but it is a continued focus. And as you know, Jonathan, the cost to customers for pumped water is less expensive than us buying water from MWD. Now on the sort of the wholesale front, MWD has been spending money to expand sort of their regional portfolio of water storage capability in Southern California, which I believe has helped them during this particular drought situation because they have expanded their sort of local inventory from maybe where it was 5-or-so years ago. Beyond that, we haven't done -- we haven't really haven't done much beyond that other than trying to pump what we can pump. And obviously, we're 1 company that is, I think distinguish itself from others in making sure that we have perfected water rights and that allows us then to continue to pump when we need to.

[Jonathan Reeder:]

I mean is there any, I guess, opportunity for you guys to build your own water storage capabilities or what about desalination plants and how close are those to being basically economic? I know the lead time on them are fairly long, so I would think as you would need to get, kind of, the ball rolling to address the problem in the next 5 to 7 years or something.

[Robert J. Sprowls:]

Right. We have had discussions with Poseidon Resources, which I think as you know is the company that's putting the desal plant in Carlsbad. They also are looking to put one in Huntington Beach and are trying to go through the permitting process there. It does take a long time though to go through that process. Permitting is difficult in California, probably more so than other places. But I think as you see water supply issues continuing to gain ground in California, you might see more relaxation, sort of pushback on permitting such desalination plants. And you are right, the crossover point between what we can buy wholesale water for and what desal water sells at getting closer every day, so it is a possibility. We have not subscribed for the water from Poseidon at this point. In addition, there's this Cadiz project that's in the desert that we have been -- we have an option on at this point and we're working through with Cadiz. Some of the other water utilities in Southern California are also looking into that project. So beyond that, we don't have any plans to build additional infrastructure at this point to sort of solve the water supply shortages.

[Jonathan Reeder:]

And so far from, I guess, the legislature, the governor or, I guess, the commission, there hasn't been an effort to, I guess, kind of promote things on the supply side, it's all kind of demand side related?

[Robert J. Sprowls:]

Well, it's...

[Jonathan Reeder:]

And I guess, the State Water Project?

[Robert J. Sprowls:]

Did you say except for the State Water Project?

[Jonathan Reeder:]

Right, right. I mean, you're not encouraging the investor on utilities to pursue projects necessarily then?

[Robert J. Sprowls:]

Yes. No, we haven't seen that. If we bring a big -- if we bring a, I think, a reasonable, a well-thought out plan to the commission, I have no reason to think that they wouldn't approve something like that.

[Eva G. Tang:]

Each rate case, Jonathan, if we have a potential to drill a new well that will have the water right to meet that demand, then we're filing our rate case and justify for it. So as consumption comes down from customers, our supply has a bigger portion from our own well water than purchased from MWD. So we would -- to the extent we could justify drilling new wells in certain service areas, we'll do.

[Jonathan Reeder:]

Okay. And then the last question I had just kind of curious going through the Q, you said that the parent borrowed like $24 million under the credit facility to provide to ASUS. Is that just the funds from working capital or what that might be related to?

[Robert J. Sprowls:]

Yes. It wasn't really an additional demand from ASUS, but in fact, what we did was borrowed money from the line and loaned it to ASUS. And previously, we had money loaned from the company to ASUS. This will then create some cash for the parent company to then use for the repurchase program.

[Eva G. Tang:]

It is for the working cash of ASUS.

[Robert J. Sprowls:]

Yes. The amount we have loaned to ASUS is for working capital for ASUS. ASUS is not a capital-intensive business, but because it's got substantial contracts with the government, it does have to have working capital to balance, sort of, receivables.

[Operator:]

[Operator Instructions] The next question comes from Richard Verdi with Ladenburg.

[Richard A. Verdi:]

Most of my questions have already been answered, but I have a follow-up question to one already asked. If ASUS decides to pursue the electric opportunity, there are a lot of bases going to be auctioned here in the next couple of years, what would be the strategy? Could you just talk a little bit about how the company might pursue that opportunity?

[Robert J. Sprowls:]

Sure. I think where it would start probably would be at a base that we're currently at from a water and wastewater standpoint and kind of get our feet wet in doing that. And there's been -- I won't go into specifics here, but at least one base has come out and asked us to consider operating the electric system. And so if we can maybe do that on a, I don't want to say a pilot basis because you don't do pilots for 50 years, but do it on a small -- smaller base and just make sure that it works for us because we are a pretty conservative company, then we can be looking at possibly bidding on water, wastewater and electric in some of the bids that should be coming out here soon.

[Operator:]

The next question comes from Tim Winter with Gabelli & Company.

[Timothy M. Winter:]

Just following up on clarify the water supply situation. You've asked for a 20% reduction. Is that because you're following the state's request or is that -- are you yourselves having supply issues?

[Robert J. Sprowls:]

We're following the state's request and currently not having any major supply issues. There's a couple of smaller areas that we serve with underground basins that it's possible that we may have to do some rationing there, but generally, we're in fairly good shape for 2014.

[Timothy M. Winter:]

Okay, okay. And then as far as your share buyback and your cash flow situation, what is your CapEx budget over the next few years? How much is being allocated to water supply?

[Robert J. Sprowls:]

Of our capital plan?

[Timothy M. Winter:]

Yes.

[Robert J. Sprowls:]

Well, the capital budget for 2014 is $80 million to $90 million. A lot of that is pipe replacement. Offhand, I can't tell you exactly what the water supply piece of that is, but we'd be happy to get back to you with that.

[Timothy M. Winter:]

Okay. And then as far as your just operating cash flow and the dividend, are you up to the point where you're basically self-funding? That's why you're in a position to repurchase shares?

[Robert J. Sprowls:]

The repurchase of the shares really is driven by the fact that we have too much equity at the company. And whenever you, sort of, your overall equity ratio gets out of whack with what's appropriate for your 2 subsidiaries, makes sense to sort of -- we feel like we're leaving money on the table, so we feel like we need to buy some shares back and get the equity ratio down. With that said, our net cash at the overall company is, I think, $51 million at the end of the first quarter. If you take the cash balance of, I want to say $75 million and our borrowings are $24 million. So we also have substantial cash, but it's mostly an equity issue rather than a cash, too much cash.

[Timothy M. Winter:]

Okay. Is it primarily stemming from the $30 million from Chaparral or do you think...

[Robert J. Sprowls:]

That's right. And it's really the equity left over from Chaparral. We have, I want to say, $25 million to $30 million of shareholders' equity that we basically had in that company and then when we sold the company, we got that in the form of cash and equities. And at this point, we still have the equity. So the goal is to -- because our cash is strong too, is to reduce the equity balance for the overall company.

[Eva G. Tang:]

As Bob mentioned, Tim, ASUS has been a low capital need operation for us. So at the time we sold Chaparral, we didn't feel comfortable to do anything right away just to make sure ASUS grows. It's there, we can support it. But it turn out they really just need a lot of -- probably 90-day working cash kind of a turnover. So I think we should do this rather than leave cash on the table.

[Timothy M. Winter:]

Okay, okay. And just 1 last follow-up, I mean given the situation, are there smaller utilities contiguous to you, that are being stressed with the water supply issues that are coming to you for help or was that...

[Robert J. Sprowls:]

We really haven't seen that at this point. A lot of our service territory is in Southern California, as you know, a lot of the areas that have been impacted by the drought, interestingly enough, is in the Northern part of the state. And so -- and we're in good shape there, so I think in and around Sacramento is probably the only area where we've probably seen situations where we've had areas contiguous to us that are having water issues.

[Operator:]

[Operator Instructions] As there are no further questions, that does conclude the question-and-answer session. I will now hand back to Mr. Sprowls for any closing remarks.

[Robert J. Sprowls:]

Okay, thank you, Nikki. Again, I just wanted to thank everyone for their participation today and their continued interest and investment in American States Water Company, and wish you all a good day. Thank you.

[Operator:]

Thank you. 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 Wednesday, May 7, 2014, at 5