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American States Water Co. (NYSE: AWR ) Q1 2016 Earnings Conference Call May 5, 2016 2:00 PM ET Executives Eva Tang – Senior Vice President, Finance, Chief Financial Officer, Corporate Secretary and Treasurer Robert Sprowls – President and Chief Executive Officer Analysts Jonathan Reeder – Wells Fargo Richard Verdi – Ladenburg Thalmann Operator Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company Conference Call, discussing the company’s First Quarter 2016 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 PM Eastern Time and run through Thursday, May 12, 2016 on the company’s website, www.aswater.com. Besides that the company will be referring to are also available on the website. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] This call will be limited to an hour. Presenting today from American States Water Company is Bob Sprowls, President and Chief Executive Officer; and Eva Tang, Chief Financial Officer. As a reminder, certain matters discussed during 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. In addition, this conference call will include a discussion of certain measures that are not prepared in accordance with Generally Accepted Accounting Principles or GAAP in the United States and constitute non-GAAP financial measures under SEC rules. These non-GAAP financial measures are derived from consolidated financial information but are not presented in our financial statements that are prepared in accordance with GAAP. For more details, please refer to the press release. At this time, I will turn the call over to Eva Tang, Chief Financial Officer of American States Water Company. Eva Tang Thank you, Terry. Welcome, everyone, and thank you for joining us today. In today’s call, I’ll review the company’s financial results for the first quarter, and Bob will discuss the liquidity and capital resources. Golden State Water’s pending rate case, California drought-related matters, and our contracted services business segment at American States Utility Services or ASUS. I’ll begin with an overview of our financial results. For the first quarter, diluted earnings were $0.28 per share, compared to $0.32 per share for the same period in 2015. Of the $0.28 per share earnings for the first quarter, $0.22 was from our water segment and our electric and contracted services segment each contributed $0.03. Net income for the quarter was $10.2 million compared to $12.1 million for the first quarter last year. I’ll discuss major items that impacted our revenues and expenses for the quarter. In the first quarter of 2016, water revenues decreased by $5.2 million to $66.3 million, as compared to the same period in 2015. As of today, Golden State Water has now received a decision on its pending water general rate case, which will set new rates for 2016 through 2018. The revenue requirements for 2016, once the CPUC issues a final decision on the current GRC are expected to be lower than the 2015 adopted levels. Major items impact – impacting the decrease in revenue requirements for 2016, includes a significant increase in supply costs caused by lower consumption, much lower depreciation expense resulting from an updated depreciation study filed with the rate case, and decreases in other operating expenses, due to the company’s improvement in operating efficiency. As a result of anticipated reduction in the 2016 revenue level, we adjusted our water revenues downward by $5.8 million for the three months ended March 31, 2016, with corresponding decreases to supply cost, depreciation, and other operating expenses to reflect the sale of the position with with CPUC’s Office of Ratepayer Advocates. The adjustments to 2016 recorded while revenue also reflects Golden State Water’s position on litigate the capital budget and compensation-related issue in the pending GRC. These adjustment did not have a significant impact to pre-tax operating income for the first quarter of 2016. As the overall reduction in the water gross margin is mostly offset by the lower depreciation and other operating expenses, partially offsetting this decrease in water revenue, where rate increases generated by advice letter filing for capital projects approved by the CPUC in 2015. Revenue for electric operations for the quarter were $10.6 million as compared to $11 million for the same period in 2015. The decrease was primarily due to determination July 2015, of a supply surcharge to recover previously incurred energy costs. The decrease in revenues from this surcharge totaled approximately $700,000 for the quarter and was offset by corresponding decrease in supply costs, resulting a no impact to pre-tax operating income. The decrease in electric revenue were partially offset by CPUC approved fourth year rate increases for 2016, and the rate increases generated from advice letters for capital projects approved by the CPUC during 2015. Revenues for our contracted services business, ASUS decreased $1.8 million to $16.6 million for the quarter. The decrease in revenue was due to lower construction work in the first quarter of this year, driven largely by the timing of engineering and bidding activities. Construction activity is expected to increase in the remainder of 2016, as compared to the first quarter of 2016. The decrease in construction work was partially offset by increase in management fee revenues, as a result of successful resolutions on price redetermination received during the third quarter of 2015. As mentioned previously for the first quarter of 2016, the water segments gross margin was adjusted for both lower revenue and lower supply costs in articulated position in the pending water rate case. Our water and electric supply costs were $17.6 million, a decrease of $4.4 million for the first quarter of 2016. Any changes in supply costs for both the water and electric segments as compared to this office supply costs are tracked in balancing account, which will be recovered from always subject to our customers in the future. Other operating expenses increased by $806,000 for the first quarter of 2016, due primarily to outside service costs at electric segment, in response to power outages caused by severe winter storm experienced in January. In addition, there was an increase in conservation and drought-related costs and higher wages. Administrative and general expenses for the first quarter of 2016 were $20.8 million, as compared to $19.5 million for the same period in 2015. The increase was mainly due to higher legal and outside service costs at water segment incurred on the condemnation matters due to this first quarter. Depreciation and amortization expense decreased by $757,000, due primarily to the reduction in composite rate is related [ph] in the pending water GRC resulting from updated depreciation study. As discussed earlier, the lower depreciation had also been reflected in the lower water revenue. The decrease was partially offset by an increase at both the water and the electric segments due to additions to utility plant during 2015. Maintenance expense increased by $593,000, due to a higher level of maintenance performed in 2016 at a water segment. ASUS’s construction expense decreased by $1.3 million to $8.7 million during the first quarter of 2016, as compared to the same period in 2015, due primarily to a reduction in construction activity, as mentioned previously, again, we expect the construction activity will increase during the remainder of 2016 as compared to the first quarter of 2016. Interest expense increased to $5.6 million for the first quarter of 2016, as compared to the $5.2 million for the same period in 2015. This was due largely to capitalize the interest recorded at water segment during Q1 of 2015, resulting from the approval of an additional allowance for funds used during construction from advice letter filings. There was no similar filing during the first quarter of 2016. Income tax expense decreased by – $2.1 million to $5.8 million, driven by a decrease in pretax income, and lower overall effective income tax rate. This slide show the ETS bridge by business segment, comparing the first quarter of this year with the first quarter of 2015. For more details, please refer to the press release. With that, I’ll turn the call over to Bob. Robert Sprowls Thank you, Eva. I appreciate everyone joining us today. Moving on to Liquidity and Capital Resources, net cash provided by operating activities for the quarter, decreased by $10.9 million to $27.6 million as compared to the first quarter of 2015. The decrease in operating cash flow was primarily due to a reduction in cash generated by contracted services, due to the timing of billing and cash receipts for construction work at military basis during the three months ended March 31, 2016. There was also a decrease in customer water usage for Golden State Water, increasing the Water Revenue Adjustment Mechanism or WRAM regulatory assets. We implemented surcharges in March to recover our net WRAM balances for 2015. In addition, tax payments during the three months ended March 31, 2015 were lower, due enlarge part to the implementation of the tax repair regulation. In regard to Golden State Water’s capital expenditures, we are pleased with our first quarter spending of $29 million on company funded capital work. Our water and electric utilities continue to invest and maintain and improve the reliability of our systems. Our capital investment program in the critical factor in delivering consistent high quality services to our customers. We are on track to invest $85 million to $95 million in capital projects during 2016, which may change somewhat once the decision issued by the CPUC on the pending water rate case. In addition, Standard & Poor’s rating services recently affirmed an eight plus credit rating on both American States Water Company and Golden State Water Company. S&P also affirm the stable reading outlook on both companies. You were pleased with the affirmation as these ratings are some of the highest in the U.S. Water Utility Industry. While we continue to produce solid financial results in the first quarter performance was impacted by higher outside services and legal costs at our water segment, encouraged to defend ourselves against condemnation related actions and lower construction activity at our contracted services segment. However, we do expect construction activity at ASUS to increase during the next few quarters. In addition, we still wait to CPUC decision on our water rate case for years 2016 through 2018. As we discussed in previous quarters, we filed our general rate case in mid 2014 for all of our water regions and general office. The application will determine in rates charge to customers for the years 2016, 2017 and 2018. Golden State Water has settled with the CPUC’s Office of Ratepayer Advocates and nearly all of the company’s operating expenses, as well as the consumption levels used to calculate rates for 2016 through 2018, which reflect the State mandated in conservation targets. The primary litigated issues relate to our capital budget requests and compensation for managerial level employees. There are not certain win in 2016, the final decision will be issued. Once issued, rates will be retroactive to January 1, 2016. As Eva mentioned earlier, adopted revenues for 2016 are expected to be lower then the 2015 adopted levels. As you may know, a big part of the utilities revenue requirement is the recovery of projected expenses. By projected expenses for 2016 in the rate case were lower than the 2015 adopted expense levels. In particular, there was a decrease in supply costs, resulting from lower consumption projected, lower depreciation expense resulting from a new study and decreased in other operating expenses in 2016 through 2018 rate case cycle, due to our cost control efforts and improvement in operation efficiency. Because of the company’s efforts, we were able to propose significant increases in our capital investment with little to know effect on rates. As a reminder, we have also received approval by the CPUC to defer our electric general rate case and the cost of capital proceeding by one additional year. Both will now be filed in 2017. In regard to the drought situation in California, in February, the State Water Resources Control Board extended the governor of California’s executive order in possessing mandatory restrictions through October 31, 2016. In addition, the State Board amended the required reductions allowing limited allowances or warmer climate regions increased population growth as well as credit for certain drought resilient water supply investment. Currently all, but one of our water systems has met the revised conservation standards. Based on our drought response actions and customers conservation efforts to-date, we do not believe we will be subject to the State Board’s penalties for failure to implement a water shortage contingency plan. Golden State Water has been authorized by the CPUC to track incremental drought related costs, incurred in a memorandum account for possible future recovery. We are in the process of preparing to file for recovery of drought related items of $1.3 million incurred mostly in 2015. Incremental of drought related costs expensed until recovery is approved by the CPUC. Lastly as of April 26 of this year, the U.S. drought monitor estimate 70% – 74% of California in the rank of severe drought. This is down from 86% reported at the end of February. Increased rainfall and higher snow pack levels over the last few months that help the drought situation. Turning to our contracted services business that ASUS, construction activity in the first quarter, a year was lower due largely to the timing of engineering and bidding activity on both renewal and replacement and new capital upgrade work. We believe construction activity will pickup during the next few quarters. We are still projecting an EPS contribution from ASUS of $0.28 to $0.32 per share for 2016. As discussed with you during our year end call. We continue to work closely with U.S. government on outstanding price redeterminations. We expect the fourth quarter price redetermination for forklift to be finalize in the second quarter of 2016 and the third price redetermination for the brag to be finalized during the third quarter of 2016. 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 or contract modifications we are waiting to potential capital upgrade work as deemed necessary for improvement of the water and waste water infrastructure at military basis. In additional 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’ve remain optimistic about the future of our contracted services business. Finally, I would like to turn our attention to dividends. On Monday of this week, our Board of Directors approved the second quarter dividend of $0.224 per share on the Common Shares of the company. Dividends on the Common Shares will be payable on June 1, to shareholders of record at the close of business on May 18. American States Water Company has paid dividends every year since 1931, increasing the dividends received by shareholders each calendar year for 61 consecutive years. We are among less than a handful of companies on the New York Stock Exchange that can both of such a level of dividend increase. For the five years ended December 31, 2015, our calendar year dividend has grown at a compound annual growth rate of about a 11%, given American States current low payout ratio compared to our peers and our earnings growth prospects, there is room to grow the dividend in the future. I’d like to thank you for your interest in American States Water, and we’ll now turn the call over to the operator for questions. Question-and-Answer Session Operator We will now take your questions. [Operator Instructions] We will begin with Jonathan Reeder with Wells Fargo. Please go ahead. Jonathan Reeder Hey, good morning, Bob and Eva. I guess, on the West Coast, it’s still the morning. But I know, Bob, in your prepared ASUS remarks, you didn’t seem to indicate that this is the case, however, your main competitor indicated, they expect the slowdown on construction projects during the remainder of the year, due to military budget constraints. Is this anything that you’re seeing or expecting? Robert Sprowls It is not. We – our projects are funded. The slowdown in the first quarter was largely due to the fact that we have to do the engineering and the bidding on the work that we have lined up. So, we’re expecting to really get the construction activity going here in the last three quarters of the year. Jonathan Reeder Okay. And I guess in the same vein you aren’t seen anything that would perhaps put downward pressure on the – the construction projects you would be awarded for the next one-year period in the fall this year? Robert Sprowls We haven’t seen that. I will tell you we have a lot of projects in front of the government for the upcoming year. We’ve done our – but I think there’s a really good job of scoping out a lot of projects and getting that in front of the decision-makers at the military. So far we haven’t got the indication that we’re going to see a slowdown. Jonathan Reeder Okay. And then, I think, previously you said final GRC decision was likely in Q2. Are you implying that it slips further into the year now or just not really sure? Robert Sprowls Yes, we’re just –we’re not really sure. We do know that the judge that’s on our case has a couple of cases ahead of this. And hopefully, you will get through those. I think is on the simper case and you probably know. Jonathan Reeder Okay. That’s fair enough. Robert Sprowls We’re confident on it, maybe, but our sense is that that may come out before ours does. And so, we don’t want to get everyone’s sort of hopes up. And so, I understand the ALJs are a bit understaffed at this point. And so, they’re being challenged to do a lot of decisions. So we’re trying to be patient with them. Jonathan Reeder Sure. Okay. And then I don’t know, if you can go into a little more detail, but what do you think Golden State Water and ORA weren’t able to see eye-to-eye on CapEx levels, because it kind of looks like, the request of about $90 million a year of annual spend wasn’t all that different from the amount that you’ve expanded over the 2013 to 2015 period? Robert Sprowls Yes, we were quite surprised that, particularly given the situation where we weren’t asking for, in fact, in many rate making areas, it was a revenue requirement – small revenue requirement decrease. As you know, that’s ORA’s role is to work hard to kind of reduce your request and that’s what they are doing in this case. So I understand other – some of our other colleagues at other companies are having similar issues though. So we are – we went to litigation on our entire capital budget and we think we put in a – put on a very good chase and hopefully the judge will recognize that. Jonathan Reeder Was there, I mean, were there any projects in there that were kind of unusual or different than the spend that you’ve been, I guess, undertaken in the past few years, or was it all similar type of spend? Robert Sprowls Yes, really there weren’t really any out of the ordinary type project. So I think our spend historically had been, I wanted to say, $70 million to $75 million range. And so, we came in and asked for 90 and thought that was a reasonable request, particularly given the need to do pipe replacement and reduce unaccounted for in the State, so we’re – the company’s decision was to take our risk with the ALJ and the commission. So it was quite surprising to us to be honest, because for a company to come in with a flat rate request and then to have ORA push back on it is substantially just a little bit of a head scratcher. But sometimes either a function of the analyst you get at ORA on your capital projects. Eva Tang It’s not unusual, I think the differences between the company and ORA’s position. Robert Sprowls Yes, sure. Eva Tang The rate case we experienced before. So we’ll say that we’ve made a good showing of the need for the project and provide the solid support, as Bob mentioned. So we will see hopefully judge will see that. Jonathan Reeder Okay. And then last question, I’ll hop out. What do you expect 2016 drought expenses will be in? Robert Sprowls Just for the calendar year 2016? Jonathan Reeder Yes. Yes, just trying to get an idea of, I mean, I think you said you’re going to be filing for a little over million dollars of recovery from previous expenses. And our understanding is those, I guess, get turned around pretty quickly, kind of, like a 90-day period. So how that would, if that’s going to offset whatever your drought expenses would be this year? Robert Sprowls I definitely expect it to offset whatever drought expenses we have this year. Jonathan Reeder Okay. Robert Sprowls These are – we are not adding to the account as much as we did in 2015, as we are getting our arms around the whole thing, so… Jonathan Reeder Okay. So the heavy lifting is kind of over on that and just stay in the course, I guess? Robert Sprowls Yes, I know we still have additional costs associated with notifying customers and making sure that everybody is completely up to speed. But I wouldn’t expect the expense to be – I would expect them to be less than they were in 2015. Eva Tang And, Jonathan, Bob mentioned that we are going to file about $1.3 million scholars job for all related costs for 2014 and 2015 pretty shortly. So once that got approved, for accounting we have a reason to book our drought-related costs to a balance sheet as a regulatory act on that point on. So not only will get recover reverse expense we booked before and also we will probably reverse what we booked to-date to the reg act, so that’s a point. Robert Sprowls Yes, good point, Eva. Eva Tang Yes. Robert Sprowls Once you’ve done it, once you’ve then can – you’ve convinced the accountants that it’s going to happen again. Eva Tang Yes, it’s a probable [Multiple Speakers] Robert Sprowls Programs recurring [ph.] Jonathan Reeder All right. Well, I appreciate the additional clarity. Robert Sprowls Yes, thank you, Jonathan. Operator Our next question comes from Richard Verdi of Ladenburg. Please go ahead. Richard Verdi Hi, Bob and Eva, how are you guys doing? Robert Sprowls We’re doing good. Eva Tang Good, good. Thank, Verdi. Richard Verdi Good, here you go. I just wanted to focus a real quick on ASUS here. At least in my view that $0.28 to $0.38 or $0.32 guidance is kind of wide. Bob, can you give me some sort of idea of what you see maybe swinging closer to the top versus to the bottom? And also, is there any chance that that figure could be outperformed on the outside? Robert Sprowls Sure. Yes, so the amount of construction that we do will dictate how well we do within that range. Additionally, we do have some price redetermination request and there is – though nothing like we’ve had in the past, there is some retroactivity to that, which could push us more to the upper end or slightly above the upper end. So it’s – that’s about as good – good a range as we can give at this point. I know you would like to see it a little tighter, but that that’s as good as we can do. Richard Verdi Okay, sure. And then on the proceeded new contracts, and I understand that for competition sake you need to keep the commentary somewhat limited, but we’ve been pursuing contracts here for a few years and of course there is going to be as you mentioned some new contracts or I should say new basis being option to you in the next few years? I’m wondering can you give us a sense of maybe how deep you are in negotiations on maybe some of these contracts that you’ve been pursuing for so many years. Robert Sprowls Well, I will tell you and it probably doesn’t completely speak to your question. But we view this business as a real important part of our business going forward. We’ve institutionalized our response to RFPs and we’re working through the process. But I will tell, Richard, there was one contract that – then I took five years. So it’s something you have to have a lot of patience for and our company does and so you got to hang in there until you can get it across the finish line. So we are at various stages I would say on some of the contracts. Richard Verdi Okay, that’s great color. It’s actually great, thank you. And then the last question is this, if you look at some of the legislation, it’s been past couple of years as I say, it’s been very favorable for the privatization movement and you guys obviously do a good job, managing the company there. Any thought about pursuing a growth acquisition strategy and really trying to move outside account one year. Robert Sprowls Are you talking about from the utilities – on the utility side… Richard Verdi Yes, for the water side. Yes, for the water side. Robert Sprowls Yes, sure. We look at that and of course the things that we look at is that a favorable regulatory environment and to the degree there are businesses for sale in those particular states, we of course will look at that. And I’ll tell you though when those things due come up for sales. There is lot of folks that like that business. So it becomes a pretty competitive process and we’re not afraid of that. It’s just – you’ve got a look at these situations and make sure there is enough scale to attract you. You recall, Rich and this may have been a little bit before your time we sold our business in Arizona. That was largely because of the commission in Arizona. And it didn’t make sense for us to continue to spend all the time that we had on a 13,000 customer business there. However, if there is other businesses for sales and other states that have fair regulatory environment, we’re definitely considered those. Richard Verdi Okay, that’s great. Okay. I guess that’s it for me, thank you. I appreciate the time guys. Robert Sprowls Thanks, Rich. Eva Tang Thank you. Operator And this concludes our question-and-answer session. I would now like to turn the conference back over to Bob Sprowls for any closing remarks. Robert Sprowls Yes, I just want to close today by thanking everyone for their continued interest in American States Water and wish you everybody a good. Operator This concludes today’s American States Water Company conference call. You may now disconnect your lines. Have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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