American States Water Co Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company Conference Call discussing the company's Fourth Quarter and Full Year 2020 Results. The call is being recorded. If you would like to listen to a replay of this call, it will begin this afternoon at approximately 5:00 p.m. Eastern Time and run through Tuesday, March 2, 2021 on the company's website www.aswater.com. The slides that the company will be referring to are also available on the website. After today’s presentation, there will be an opportunity to ask questions. This call will be limited to one hour. Presenting today from American States Water Company is Bob Sprowls, President and Chief Executive Officer; and Eva Tang Senior Vice President of Finance and 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 10-K and Form 10-Q on file with the Securities and Exchange Commission. In addition, this conference call will include 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 now turn the call over to Bob Sprowls, President and Chief Executive Officer of American States Water Company. Please go ahead.

Welcome everyone, and thank you for joining us today. I'll begin with some brief comments on the quarter and some highlights for the year; Eva will then discuss some financial details; and then I'll wrap it up with some updates on regulatory filings, American States Utility Services or ASUS, and dividends. I would like to start by commenting on our fourth quarter performance. We had a strong quarter with consolidated earnings of $0.54 per share versus $0.45 per share earned during the fourth quarter of 2019, a 20% increase. You can see from this slide that each of our three operating segments contributed to the substantially improved performance. Eva will discuss this slide in more detail in a few minutes. Now, let's turn our attention to highlights for the full year, where we also had strong financial results in addition to providing essential uninterrupted services to our customers. For the year, we reported diluted earnings per share of $2.33, as compared to $2.28 reported for 2019, or $2.24 per share after excluding the $0.04 per share retroactive impact of the electric general rate case decision from 2019 related to the full year of 2018. In 2020, American States Water achieved a consolidated return on equity of 13.9%. During the year, we also filed a new Golden State Water Company general rate case for the years 2022 through 2024, continued our capital improvement work at our regulated utilities, continued to improve water and wastewater systems on the military bases we serve, raised the dividend by nearly 10% and reached 66 consecutive years of annual dividend increases. This was a unique and challenging year as a result of the COVID-19 pandemic. First and foremost, we are proud that we were able to maintain essential safe and reliable services for our regulated customers and military service personnel across the country. In order to do this, starting in March of last year, we made adjustments for our field workers to keep them safe and instructed our office staff to telecommute. At the local level, we worked closely to manage changes and delays in construction schedules, balancing the needs of keeping the water, wastewater, and electric systems running well with the uncertainty and needed flexibility that the pandemic has brought to communities. In addition, the California Public Utilities Commission, or CPUC, has issued orders on service shutoffs due to non-payment helping those households who are unable to keep up with water or electric bills during this unprecedented time. Recently, the CPUC extended the suspension of service shutoffs due to non-payment through June 30 of this year. We continue to invest in the reliability of our systems spending $123.4 million in company-funded infrastructure at our regulated utilities during the year. At ASUS, we continue to perform necessary construction work on the military bases we serve and are well positioned to win more contracts in the coming years. We remain committed to our communities. Golden State Water continued to spend with diverse business enterprises, achieving results that were well above the CPUC's requirements for the eighth consecutive year. Additionally, ASUS continued to exceed the US government's requirements to hire small businesses to perform work on the bases it serves. In addition to these fiscal 2020 highlights, we have received positive news at our water segment to start 2021 related to the continued use of the water revenue adjustment mechanism or WRAM as well as third year rate increases, both of which I'll discuss later during the call. We, at American States Water Company, continue our steadfast commitment to our customers, broader communities, military personnel, shareholders, employees, and suppliers. Our financial results are just one part of our efforts and success. I will now turn the call over to Eva to review the financial results for the quarter.

Thank you, Bob, and hello, everyone. Let me start with an overview of our fourth quarter financial results on slide 9. As Bob mentioned, consolidated diluted earnings for the quarter were $0.54 per share compared to $0.45 per share, again a 20% increase over the same period last year. Earnings at our water segment increased $0.04 per share for the quarter. The increase in the water segment's earnings was largely due to a higher water gross margin from new water rates. In addition, a decrease in interest expense and an increase in gains earned on investments held to fund a retirement plan were partially offset by the impact of a higher effective income tax rate. Overall, operating expenses other than supply costs were relatively flat for the water segment. Earnings from the electric segment for the fourth quarter of 2020 were $0.07 per share as compared to $0.05 per share recorded for the same period in 2019. The increase was due to rate increases authorized by the CPUC as well as lower overall operating and interest expenses. Earnings from the contracted services segment were $0.17 per share as compared to $0.12 per share for the fourth quarter of 2019. This was largely due to an increase in construction activity as well as an overall decrease in operating expenses. Consolidated revenue for the three months ended December 31, 2020 increased by approximately $11.2 million as compared to the same period in 2019. The decrease was due to rate increases at both of our water and electric utilities and an increase in construction work at our contracted services business. Turning to slide 11. Our water and electric supply costs were $24.1 million for the quarter, an increase of $900,000 from the same period last year. Any changes in supply cost for both the water and electric segments as compared to the adopted supply costs are tracked in balancing account. Looking at total operating expenses, excluding supply costs, consolidated expenses increased approximately $5.8 million versus the fourth quarter of 2019, mostly due to an increase in construction costs at ASUS as a result of a higher construction activity and the property and other taxes, partially offset by lower maintenance expenses resulting from timing differences and a decrease in outside service costs. Other income and expense for the fourth quarter of 2020 was a net expense of $2.1 million, which was $1.8 million lower in the same period of last year, due to lower interest rates as well as the increase in gains generated on investments held in a trust to fund the retirement benefit plan. Slide 12 shows the EPS bridge comparing the fourth quarter of 2020 with the same quarter of 2019. This slide shows the full year results. Consolidated earnings for 2020 were $2.33 per share as compared to $2.28 per share for 2019. The 2019 CPUC final decision on the electric general rate case was retroactive to January 2018. And as a result, the cumulative retroactive earnings impact related to 2018 of $0.04 per share was recorded as part of the 2019's results. Excluding this retroactive impact, consolidated earnings for 2020 increased $0.09 per share as compared to $2.24 per share for 2019 as suggested. Earnings from the water segment increased by $0.05 per share as compared to 2019, mostly due to new water rates as a result of the full second year step increase effective January 1, 2020 which added $10.4 million in water gross margins for 2020. The increase in earnings from the higher gross margin was partially offset by an increase in operating expenses and a higher effective income tax rate due to changes in flow-through adjustments. Moving on to the electric segment. Earnings were $0.05 per share higher than in 2019 after excluding the retroactive impact for 2018 from the 2019 CPUC final decision. The higher electric earnings were due to new rates authorized in the final decision as well as lower interest expenses and a lower effective income tax rate due to changes in certain flow-through taxes as compared to the year before. These increases to earnings were partially offset by an overall increase in operating expenses. For both 2020 and 2019, diluted earnings from contracted services were $0.47 per share, excluding a retroactive price adjustment of $0.01 per share recorded in 2019 related to periods prior to 2019. Earnings from the contracted services segment for 2020 increased by $0.01 per share, largely due to an increase in management fees and construction revenue. There's also an overall lower operating expenses partially offset by higher construction costs. AWR parent earnings decreased $0.01 per share compared to 2019 due to higher state unitary taxes recorded at the parent level. Turning to liquidity. Net cash provided by operating activities were $122.2 million as compared to $116.9 million in 2019. The increase was primarily due to the refunding of $7.2 million to customers in 2019 related to the Tax Cuts and Jobs Act with no similar refund in 2020 and an increase in water customer usage. These increases were partially offset by decreases in cash flows from accounts receivable from utility customers, due to the economic impact of the COVID-19 pandemic and the CPUC mandated suspension of service disconnection, and from the timing of billings of and cash receipts for construction work at military bases. As Bob mentioned, our regulated utility invested $123.4 million in company-funded capital projects in 2020. We expect to invest $120 million to $135 million in 2021. At this time, we do not expect American States Water to issue additional equity. And with that let me turn the call back to Bob.

Thank you, Eva. I'd like to provide an update on our recent regulatory activity. As you may know, the water segment has an earnings test it must meet before implementing the second and third year step increases in the third year rate cycle. I'm pleased to report that we have timely invested our capital projects and achieved capital spending consistent with the amount authorized by the CPUC. As a result, substantially all of the third year step increases have been authorized and effective January 1, 2021. These new rates are expected to generate an additional $11.1 million of water gross margin. We continue to make prudent and timely capital investments. In July 2020, Golden State Water filed a general rate case application for all of its water utilities for new water rates for the years 2022, 2023 and 2024. Golden State Water requested capital budgets in this application of approximately $450.6 million for the three-year rate cycle and another $11.4 million of capital projects to be filed for revenue recovery through advice letters when those projects are completed. A decision in the water general rate case is scheduled for the fourth quarter of 2021 with new rates to become effective January 1, 2022. In a procedural hearing held earlier this month on this pending general rate case, the assigned administrative law judge confirmed that Golden State Water is authorized to continue using the Water Revenue Adjustment Mechanism or WRAM and the modified cost balancing account also known as the MCBA until its next general rate case application covering the years 2025 through 2027. If you recall, the CPUC issued a final decision in the first phase of its Order Instituting Rulemaking evaluating the low-income ratepayer assistance and affordability objectives contained in the PUC's 2010 Water Action Plan. This final decision among other things removes the continued use of the WRAM and MCBA by California water utilities in any general rate case application filed after the August 27, 2020 effective date of this decision. Golden State Water's pending water rate case application was filed in July 2020 prior to this effective date. As a result of this procedural hearing, we will continue using the WRAM and MCBA mechanisms through the year 2024. In January 2021, Golden State Water along with the three other large California water utilities requested a one-year deferral of the date by which each of them must file their next cost of capital applications. Just yesterday afternoon, the CPUC rejected the request for deferral. Golden State Water will file its cost of capital application by May 1 of this year with an effective date of January 1, 2022. Turning our attention to slide 17. This slide presents the growth in Golden State Water's rate base as authorized by the CPUC for 2018 through 2021. The weighted average water rate base has grown from $752.2 million in 2018 to $980.4 million in 2021, a compound annual growth rate of 9.2%. The rate base amounts for 2021 do not include any rate recovery for advice letter projects. Let's move on to ASUS on Slide 18. After adjusting the 2019 financial results for the $0.01 per share retroactive earnings impact related to periods prior to 2019 that Eva discussed earlier, ASUS' earnings contribution for 2020 increased by $0.01 per share as compared to 2019. This was accomplished despite weather delays and slowdowns in permitting for construction projects and government funding for new capital projects experienced throughout 2020. We continue to work closely with the US government for contract modifications relating to potential capital upgrade work for improvement of the water and wastewater infrastructure at the military bases we serve. During 2020, the US government awarded ASUS $15.5 million in new construction projects for completion in 2020 and 2021. Completion of filings for economic price adjustments, request for equitable adjustment, asset transfers and contract modifications awarded for new projects provide ASUS with additional revenues and dollar margin. We are actively involved in various stages of the proposal process at a number of other bases considering privatization. The US government is expected to release additional bases for bidding over the next several years. Due to our strong relationship with the US government as well as our expertise and experience in managing bases, we are well positioned to compete for these new contracts. In light of our continued uncertainty associated with the effects of COVID-19, we reaffirm our projection that ASUS will contribute $0.45 to $0.49 per share for 2021. I would like to turn our attention to dividends outlined on Slide 19. In 2020, we increased the annual dividend by 9.8% to $1.34 per share. American States Water Company has paid dividends to shareholders every year since 1931, increasing the dividends received by shareholders each calendar year for 66 consecutive years, which places it in an exclusive group of companies on the New York Stock Exchange that have achieved that result. On February 2, our Board of Directors approved a quarterly dividend of $0.335 per share. As a reminder, our dividend policy is to achieve a compound annual growth rate in the dividend of more than 7% over the long-term. Our strength and attractiveness to customers and shareholders alike is our ability to execute on our business strategies, stability, continued timely investment in our systems and customer service, our regulated operations and a constructive regulatory environment in California, a growing contracted service business with strong market share, and an unwavering commitment to reliability and safety. Our capital investment includes replacing and upgrading critical infrastructure as well as ensuring we can meet our customers' needs for generations to come all while driving operational efficiency and delivering outstanding customer service. I'd like to conclude our prepared remarks by thanking you for your interest in American States Water. And we'll now turn the call over to the operator for questions.

We will now begin the question-and-answer session. And our first question comes from Angie Storozynski of Seaport Global. Please go ahead.

Thank you. I wanted to start by asking about the visibility you have regarding the use of full WRAMs, as you have been seeking a rehearing of the decision to remove full WRAMs beyond 2024. Could you provide an update on how this request is progressing?

Yes. With regard to the request for rehearing we have not heard back from the CPUC at this point on that. Hope I understood your question, Angie?

Yes exactly. Yes. So, we're basically waiting for their decision. If they decide not to rehear it, should we expect that you will challenge this decision in courts?

Yes. So that was something we and others have given a lot of thought to. Unfortunately, in California, the only option we have is to challenge it at the California Supreme Court level. And then of course, the Supreme Court would need to be able to hear the case. They would have to choose to hear the case. So we're still kind of thinking through that. There are positives and potential negatives to doing that.

Okay. Thank you. And then separately given yesterday's decision and that's the requirements to file your cost of capital application by early May and the fact that then your treasury yield is almost 100 bps lower now versus where it was when the current ROEs were set, could you maybe talk us through, your thought process or your expectations of what those returns are going to be like now given that you already earned or your allowed ROE is already below average for water utilities across other states?

Right. Yes, there's a lot that goes into the mix when determining an appropriate cost of capital and specifically the authorized return on equity. It's difficult to predict how things are going to move forward there. The fact that California's ROEs are already low relative to the rest of the country, I think is would be an advantage to us going forward. There will also be comments about losing the WRAM and that creates perhaps some additional risk that we could make. And throughout the period where the application is filed and you go through the hearing process, we and others do keep a pretty close tab on where interest rates are and where they're headed. So, pretty difficult to speculate at this point whether our ROE will be adjusted up or down or remain the same.

I appreciate your comments about hoping for additional contract awards from ASUS. We were expecting to see some awards in late 2020, but they didn't materialize. I understand that the change in administration complicates this situation. Do you have any idea when we might hear about more contracts, possibly in which quarter?

Hard to predict. I would say it's going to probably at least be the second quarter before we hear anything on those bases where we've submitted a bid and it's gotten to the final bid process. I think you hit the nail on the head with the change in administration always seems to delay things and it's very understandable. But that's, yes we're patient in this business and you have to be. And we think we've got good things ahead of us for that business.

Thank you.

Thank you, Angie.

And the next question will come from Jonathan Reeder of Wells Fargo. Please go ahead.

Hey, Bob and Eva, how are you all?

Okay, Jonathan.

Doing well, Jonathan.

I apologize for any background noise as I have some work being done at the house today, so it might be a bit noisy. Hopefully, you can hear me clearly. Following up on that last question, how many bases do you think could be awarded in the next 12 months? Is it still the case that you were anticipating around two to three in the final stage?

Yes. I would say you might think about two. There was one base in Hawaii that the government decided not to privatize ultimately, and that was on the list of bases folks were bidding on. So that's why I would say two rather than three.

What total level of ASUS construction expenses do you expect for the full year 2021? I recall you were previously in the $50 million to $55 million range before this increase in 2020. However, the $15 million award is somewhat lower than the $23 million to $24 million you received in the last couple of years. Should we anticipate that it will return to the $50 million to $55 million range in 2021?

We do think the $15.5 million was an outlier and largely a result of COVID-19. We expect that number to improve in 2021.

Yes, Jonathan, it all depends on construction activity and the type of work we undertake. If we have more awarded on our new capital upgrades, then I believe we will continue to incur construction expenses. To us, the higher construction expenses could indicate higher revenue as long as everything goes well. Therefore, I wouldn't consider construction expenses as a key factor for your projections.

Jonathan, I want to highlight that we have new leadership at ASUS with Stuart Harrison, who joined us in July last year. He has a strong background working with the Department of Defense, which is influencing our strategy. We're exploring different approaches to get more projects approved. However, our success in 2021 is uncertain due to the lengthy process involved with the federal government. While we remain optimistic, the new administration is still in the process of filling positions, which takes time. We're hopeful about 2021, though our earnings guidance of $0.45 to $0.49 is similar to what we experienced in 2020. Our company prefers not to overstate expectations to the market, so we anticipate a good year ahead, but this year's landscape seems more challenging to predict than in recent years due to the new administration and COVID-19, among other factors.

Okay. So I mean when you say this is your guidance based on the COVID uncertainties like if things kind of clear up and maybe you are able to get some more of the construction work that's where we could see either something above the midpoint of that range or something like that for ASUS? That's where the uncertainties are not kind of on the expense side of the equation. It's more on the construction activity.

It is.

Yes.

Yes. That's a fair statement. If things clear up, we could be more on the higher end of that range than around the midpoint.

Okay. I haven't seen that the CPUC denied the extension, so I’m sorry to hear that. Did they provide any explanation for the denial, or was it simply a matter of the application not being lucky?

I will read you a paragraph from the letter. It mentions that with the one-year extension you have already received, it has been four years since your last cost of capital filings. During this time, interest rates have decreased significantly, a change that should be reflected in your authorized cost of capital and the rates ultimately established in your general rate cases. This is a very concise letter, and that was the key point. The other paragraph addressed the denial of the deferral.

Okay. They mentioned that interest rates are currently lower, which is interesting. In your efforts to obtain the extension, did you engage with the PAO or have any discussions about a potential settlement, or did you simply file and they submitted their opposition, leaving it in the hands of the CPUC?

Yeah. So it's kind of an industry effort. I mean, it was interesting public advocates. Their opposition to the deferral request was largely a function of, you're getting money and rates to file this application. And therefore, you should. So it wasn't a very strong opposition. But I know other companies have done things in terms of working to try to meet with the PUC. I'm not sure if there was reaching out to the public advocates to get them to change their view. It is a little surprising, given that the commission can't seem to get anything done on time. But you want to add one more thing to the plate. But I don't know.

I wasn't sure if there was a precedent on the electric side where they collaborated with the consumer advocate to propose a two-year extension, which included a slight reduction in the return on equity. I know you are looking to negotiate a similar deal with the public advocates, but it seems like that hasn't been successful and you might not be pursuing it further.

Historically, we have approached things differently in the water sector compared to the electric sector. The electric sector typically engages public advocates early in the request for deferral, whereas we have not traditionally followed that practice in the water space.

Okay. And then, Eva maybe this one is for you. What kind of consolidated tax rate do you expect in 2021? I think 2018 and 2019 were closer to 22%, before jumping up to like 24% this year.

I believe we will likely return to a lower effective tax rate. This year, certain factors have influenced the income tax rate. Therefore, if you consider 2019 and the years before that, it would serve as a better benchmark for your projections.

Okay. And then, finally, the comment about not seeing the need to issue equity. What kind of period does that cover? Is that like a three-year forward outlook? Is it five years?

It is three years, I would say, Jonathan.

Okay. Okay, great. All right. Thank you. That's all the questions I have. I appreciate you taking them and congrats on a good year, despite it being a challenging year.

Thanks, Jonathan.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Bob Sprowls, for any closing remarks.

Yes. Thank you, Andrea. I just want to thank everyone for their participation today. And let them know, that we look forward to speaking with them next quarter. So thank you everyone.

The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect.