American States Water Company - Earnings Call - Q1 2011

Transcript

Speaker 6

Thank you for standing by. Today is May 6th, 2011. Welcome to the American States Water Company conference call discussing first quarter 2011 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 651, and one will be faxed or emailed to you. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 2:00 P.M. Pacific Time and run through Friday, May 13th, 2011. After logging onto the website, click the Investors button at the top of the page. The archive is located just above the stock quote section. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session.

If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad. As a reminder, this call will be recorded and will be limited to no more than one hour. At this time, I would like to turn the call over to Eva Tang, Chief Financial Officer of American States Water Company.

Speaker 3

Thank you, Andrew. Thank you, everyone, for joining us today. With me here is Robert Sprowls, President and CEO. Before I start the quarterly result discussion, I would like to remind you that 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. All forward-looking statements are made as of today. The company is under no obligation to update such statements. With that, I would like to discuss our financial results for the quarter.

Basic and fully diluted earnings for the quarter ended March 31, 2011, were $0.40 per share as compared to basic and fully diluted earnings of $0.46 and $0.45 per share, respectively, for the first quarter of last year. I'll begin with the earnings from continuing operations. For the first quarter of 2011, basic and fully diluted earnings from continuing operations were $0.37 per share as compared to basic and fully diluted earnings of $0.45 and $0.44 per share for the first quarter of 2010. Included in earnings for the first quarter of 2010 was $6.1 million of pre-tax income, or $0.19 per share, related to retroactive revenues resulting from contract modifications received at American States Utility Services. These contract modifications reflect approval from the U.S. government primarily for managing more infrastructure than originally estimated by the government at the Fort Bragg and Fort Bliss military bases.

Excluding the impact of the two contract modifications, adjusted fully diluted earnings per share from continuing operations for the three months ended March 31, 2010, would have been $0.25 per share. When compared to the first quarter of 2010's adjusted earnings, earnings for the first quarter of 2011 increased by $0.12 per share. I will now discuss the items that resulted in the $0.12 per share increase. First of all, the dollar water margin at Golden State Water Company increased by $6.3 million, or $0.20 per share, for the three months ended March 31, 2011, as compared to the same period in 2010. The increase is due primarily to higher water rates authorized by the California Public Utilities Commission, or the CPUC, in the fourth quarter of 2010.

Rate increases for Golden State Water Company's Region 2, Region 3, and the General Office were approved in November of 2010, and retroactive revenue were not recorded until the fourth quarter of 2010. Rate increases for Region 1 were approved in December of 2010 and were effective January 1 this year. For Golden State Water Company's Electric Division, we recorded $958,000 of revenue, or $0.03 per share, in the first quarter of last year for a memorandum account authorized by the CPUC, which tracks the difference between the 2007 adopted General Office allocation and 1996 adopted allocation. Excluding the impact of this, the electric margin increased by $528,000, or $0.02 per share, during the first quarter of this year due to electric rate increases approved by the CPUC. Next item is related to all the other operating expenses for our utility businesses.

Excluding supply costs, operating expenses for our utility businesses increased by $492,000, or $0.02 per share, due primarily to an increase in depreciation expense as a result of additions to the utility plant and higher composite depreciation rate approved by the CPUC, partially offset by lower legal and other offsite services costs. Moving on to our contracted services business, excluding the two contract modifications discussed previously, pre-tax income for American States Utility Services increased by $0.04 per share, due primarily to pre-contract costs for design and engineering labor incurred for potential new projects, higher allocation of costs from business offices, and lower margin on construction projects.

Lastly, an increase in effective tax rate at the Golden State Water Company for the three months ended March 31, 2011, as compared to the same period in 2010, negatively impacted earnings by $0.01 per share due to changes between books and taxable income that are treated as flows through adjustments in accordance with regulatory requirements and other non-deductible permanent items. I'll briefly discuss the quarterly result from discontinued operations related to Chaparral City Water Company. Diluted earnings from discontinued operations for the first quarter of 2011 were $0.03 per share as compared to $0.01 per share for the same period in 2010. The increase in earnings is primarily due to lower depreciation expense as a result of reporting Chaparral City Water Company as a discontinued operation beginning in the second quarter of 2010. No depreciation expenses have been recorded since then in accordance with GAAP.

On April 7, 2011, the Arizona Corporation Commission issued a final order approving the sale of Chaparral City Water Company to EPCOR Water USA. The transaction is expected to close in the second quarter of this year. Therefore, no gain on disposal of Chaparral City Water Company has been recorded during the quarter ended March 31, 2011. A more detailed discussion of our results for the quarter is included in our earnings release issued this morning and will be provided in our Form 10-Q, which will be filed later today. Moving on to our capital expenditure program, we continue to focus on our core strategies of prudently investing in our infrastructure and controlling our costs. Golden State Water Company's capital expenditure was about $17 million in the first quarter of 2011 as compared to $16 million for the same period in 2010.

We anticipate annual capital expenditures in 2011 for Golden State Water Company to be in the $75 million to $85 million range. On April 14, 2011, Golden State Water Company issued $62 million of 30-year unsecured notes at a coupon rate of 6%. The net proceeds from this debt issuance were used to pay down short-term borrowings and to redeem certain long-term debt, which had a higher coupon rate. Again, we do not anticipate an equity issuance this year, due to the proceeds from the potential sale of Chaparral City Water Company. I will now turn the call over to Bob.

Speaker 5

Thank you, Eva. Good afternoon, ladies and gentlemen. I'm pleased to announce that, last week on April 26, the Board of Directors of American States Water Company approved a $0.02 per share increase in the company's quarterly cash dividend to $0.28 per share on the common shares of the company. This represents a 7.7% increase in the quarterly dividend and marks the 300th consecutive dividend payment by the company. By approving this increase, the Board of Directors have affirmed their continued confidence in the company and its growth prospects by rewarding our shareholders who have supported us for many years. For more than 56 consecutive years, American States Water Company shareholders have received an increase in their aggregate annual dividend. We look at our payout ratio over several years, and we believe there is room for continued growth in the dividend.

Now I'll discuss the status of key regulatory filings and other matters for the company. In March of this year, Golden State Water Company filed for recovery of its 2010 Water Revenue Adjustment Mechanism, or WRAM, net of the Modified Cost Balancing Account for a total of $19.6 million. Surcharges are currently in place to recover this amount in addition to balances from 2009. Please note that the implementation of the surcharges increases the company's cash flow and does not impact earnings. Based on the California Public Utilities Commission's guidelines, recovery periods related to the prior year's balances will range between 12 and 36 months. In September 2010, Golden State Water Company, along with other California water utilities, filed an application with the CPUC to modify the recovery period to 24 months or less. A decision is expected in 2011.

For the three months ended March 31, 2011, approximately $1.6 million of surcharges were billed to customers for collection of the WRAM balance net of the Modified Cost Balancing Account. As of March 31, 2011, Golden State Water Company has a net aggregated regulatory asset of $34.0 million related to the WRAM and Modified Cost Balancing Accounts. I'd like to discuss rate increases for 2011 as compared to 2010 adopted rates for Golden State Water Company. The increase in 2011 revenues is expected to be $1.9 million for Region 1, $4 million for Region 2 and Region 3 combined due to escalation year increases, and $1.6 million for our Bear Valley Electric Division. A general rate case will be filed for all of Golden State Water Company's water regions and the General Office in July 2011, with rates expected to be effective January 2013.

As you may know, the cost of capital proceeding is separate from the general rate case applications with the CPUC. On May 2 of this year, Golden State Water Company, along with three other California water utilities, filed its cost of capital application. When approved, the rate of return authorized by the California Public Utilities Commission will be implemented in rates on a company-wide basis. Regarding the sale of Chaparral City Water Company, as Eva mentioned, the Arizona Corporation Commission issued a final order on April 7 of this year approving the transaction, and the sale is expected to close in the second quarter of this year.

On the same day, the Arizona Corporation Commission also issued a decision allowing Chaparral to retain 50% of the $1,520,000 total proceeds received from a settlement agreement reached in 2005 with the Fountain Hills Sanitary District, in addition to recovering $100,000 of rate case expenses we incurred in our appeal of our 2006 general rate case and the subsequent remand proceeding before the Arizona Corporation Commission. Let's turn our discussion to the company's military subsidiaries under American States Utility Services, or ASUS. Excluding the contract modifications discussed earlier by Eva, and as Eva mentioned, earnings for ASUS decreased by $0.04 per share for the first quarter of 2011 as compared to the same period in 2010, mainly due to the pre-contract costs for design and engineering labor incurred for potential new construction projects, a higher allocation of costs from administrative offices, and lower margins on construction projects.

We believe successful price redeterminations and Requests for Equitable Adjustment for REA filings will provide added revenues prospectively to help offset increased costs and provide ASUS the opportunity to consistently generate positive operating income at its subsidiaries that serve military bases. We are still working to finalize prospective price redeterminations and REAs at various bases, which include adjustments to reflect inflation in costs and changes in operating conditions and infrastructure levels from that assumed at the time of the execution of the contracts. The timing of the conclusion of such filings is somewhat unpredictable, but to summarize, I'll quickly talk about the status of each of our price redeterminations. First, we continue to negotiate permanent price redeterminations for the four Virginia military bases which are covered under two contracts.

We received a contract modification in February of this year resolving the operations and maintenance portion of the first price redetermination for the Fort Lee contract, which reduced an interim rate adjustment to 14.6%. A proposed settlement of the renewal and replacement components of the Fort Lee price redetermination is expected to be resolved in the second half of this year. The first price redetermination for the other contract, which covers the other three bases in Virginia, has been submitted to the government, resolution expected by the end of the year.

Speaker 1

Excuse me, Andrew. You're getting a lot of static on our end.

Speaker 6

Yes. Just one moment, please. There is a technical difficulty with the speaker's line. I'm going to place the parties on hold while we reestablish their connection. Thank you. Mr. Sprowls, please continue.

Speaker 5

Okay. Obviously, my apologies to everyone. Continue with my remarks. The second price redetermination activity I wanted to talk about is we are currently in negotiations with the U.S. government on the first price redetermination for Andrews Air Force Base. In August 2010, the government approved an 18.93% interim increase to contract rates. We anticipate the operation and maintenance portion of the price redetermination to be resolved during the second half of this year. A proposed settlement for the renewal and replacement portion of the price redetermination is expected to be submitted during the second quarter of 2011. Third, in April 2009 and December 2010, American States Utility Services filed REAs at Fort Bragg with the government in connection with costs associated with initial capital work. Resolution of these requests is expected in 2011.

The first price redetermination for the Fort Bragg contract is expected to be filed in the second quarter of 2011. An interim increase of 3.6% is currently in effect. Fourth, American States Utility Services filed an REA at Fort Jackson in connection with the substandard condition of the inventory assumed at the base. Resolution of this REA is expected in 2011. The first price redetermination for Fort Jackson will be filed in the second quarter of this year. An interim increase of 3.4% is currently in effect. Lastly, in connection with an inventory settlement reached in January 2010 for Fort Bliss, American States Utility Services and the government agreed to waive the first and second price redeterminations under the original 50-year contract. The third price redetermination is expected to be filed in 2012.

Before I turn the conference over to the operator to entertain questions, I would like to thank you again for your continued support and interest in the company.

Speaker 6

We will now entertain any questions you may have about the information presented today. If you would like to ask a question during this time, simply press the star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the star, then the number two on your telephone keypad. Once again, if you have a question, please press star one on your telephone keypad. The first question comes from Garrick Schmois of Longbow Research. Please go ahead.

Speaker 0

Hi. Thank you. I just have a question on the 50% of the $1.52 million proceeds that Chaparral receives as a result of the settlement agreement. Does Golden State get to keep that, or how is this handled, and does this impact the closing price at all from the sale of Chaparral?

Speaker 5

Yes. We had envisioned that this was going to take some time to get resolved, and we had included in the stock purchase agreement that if, in fact, the order we get from the Arizona Corporation Commission becomes non-appealable, then it gets added to the purchase.

Speaker 0

Is this already factored in?

Speaker 5

Yes, the appeal period is still running, so we're waiting to see whether it gets appealed at all.

Speaker 0

Okay, thank you very much.

Speaker 6

Once again, if you would like to ask a question, please press star, then one on your touch-tone phone. We have a question from Heike Durr of Robert W. Baird. Please go ahead.

Speaker 4

Thank you. I wonder, Bob, if you could quantify what the dollar amount is for some of these price redeterminations at ASUS, either in their entirety or perhaps what some of the individual requests are?

Speaker 5

We haven't really done that at this point. Giving kind of the guidance associated with that is difficult.

Speaker 4

Are these public documents where we could be finding them? If I think about how it works for the California rate case, for example, we can go track down what the request is.

Speaker 5

No. These are not public filings. I'm not sure going and looking, even if you had access to that, would be all that helpful because it is, you know, there's sort of a wide range of conclusions on these redeterminations.

Speaker 4

Can you maybe then give us some parameters on what kind of revenue growth in 2011 we could expect to see out of this subsidiary?

Speaker 5

All I can tell you, Heike, is the revenue growth at ASUS is dependent upon a number of things. One thing in particular is we're still waiting to break through on an initial capital upgrade project at Fort Bragg, which could be substantial. It's unclear as to whether that's going to, you know, we hope to have it break through in 2011, but we're always a little hesitant to be too optimistic here because things have actually gone slower than what we have thought them to go. That could actually drive revenues up at ASUS. These redeterminations, you know, in many cases, we have interim increases already in place.

Though these are going to help cover our costs, you know, we tend to not be too optimistic here about, we don't want to project to the market too much optimism here because it has been a bit of a struggle getting these redeterminations through.

Speaker 4

I guess then maybe a different way to phrase the question. We see a 4% year-over-year drag from the subsidiary in the first quarter. Do we think that you'd be made whole by year-end so that we would see flat performance in a total 2011 compared to 2010?

Speaker 5

In 2010, we had this $0.19 REA. If you carve that out, the general view by the company is that we'll be as strong as last year or better.

Speaker 4

Okay, that's helpful. Thanks.

Speaker 6

The next question comes from Jonathan Reeder of Wells Fargo. Please go ahead.

Speaker 2

Hey, Bob. Sorry if I missed it on the prepared remarks, but could you elaborate on what the dividend policy is going forward following this $0.08 annual increase?

Speaker 5

Sure, Jonathan. The company tends to look at a dividend payout ratio of about 60%, but it isn't something that every year we expect to hit 60%. It's an approach where we like to continue to grow the dividend. We are a company that we're among a handful of companies on the New York Stock Exchange that have grown their dividend for 56 consecutive years. We look down the road, and we want to see that we still have room for growth in the dividend. I think it would be a mistake to take our current dividend divided by 60% and come up with the projected earnings because we look at it over three to five years, and our earnings tend to be a little bit choppy because of the rate process in California.

You get a substantial increase in year one and then much smaller increases in year two and year three of the rate filing. Hope that answers your questions.

Speaker 2

I think it does for the most part. 60% is kind of the target right now. You guys are below that. We might be able to anticipate, I guess, a little bit of above-average dividend growth going forward over, call it, the next three to five years to kind of get closer to the 60% range. Is that fair?

Speaker 5

I think that's probably a fair appreciation of what our policy is and where we're headed.

Speaker 2

Okay, thank you.

Speaker 6

Again, if you have a question, please press star, then the number one on your telephone keypad. This concludes our question and answer session. I would like to turn the conference back over to Robert Sprowls for any closing remarks.

Speaker 5

Again, thank you all for your participation today and for your continued interest in investment in American States Water Company. Everybody have a good weekend, and those of you that are mothers have an excellent Mother's Day.

Speaker 6

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 Friday, May 6, 2011, at 2:00 P.M. Pacific Time and will run through Friday, May 13, 2011, after logging on.