American States Water Co Q1 FY2023 Earnings Call

Ladies and gentlemen, thank you for your patience. Welcome to the American States Water Company conference call for discussing the company's First Quarter 2023 Results. The call is being recorded. A recording of this call will be available this afternoon at 5:00 p.m. Eastern Time and will remain accessible until Thursday, May 18, 2023, on the company's website, www.aswater.com. The presentation slides will also be available on the website. This call is scheduled to last one hour. Presenting today from American States Water Company are Bob Sprowls, President and Chief Executive Officer, and Eva Tang, Senior Vice President of Finance and Chief Financial Officer. Please note that some topics discussed during this call may include forward-looking statements, which are meant to qualify for the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995. For details regarding the company's risks and uncertainties, please refer to our most recent Form 10-K and Form 10-Q filed with the Securities and Exchange Commission. Additionally, this call will cover certain financial measures that are not prepared in accordance with U.S. generally accepted accounting principles, known as GAAP, and are considered non-GAAP financial measures under SEC rules. These non-GAAP measures are based on consolidated financial information but are not included in our GAAP-compliant financial statements. For further information, please check the press release. At this point, I will hand the call over to Bob Sprowls, President and Chief Executive Officer of American States Water Company.

Thank you, Gary. Welcome, everyone, and thank you for joining us today. I'll begin with some brief comments on the quarter. Eva will then discuss some financial details, and then I'll wrap it up with updates on regulatory activity, ASUS, dividends, and then we'll take your questions. I'm pleased to report that our adjusted earnings for the first quarter of 2023 were $0.13 per share higher than adjusted earnings for the first quarter of 2022. The higher earnings performance in 2023 was aided by the receipt of a proposed decision in Golden State Water Company's water General Rate Case or GRC, from the California Public Utilities Commission or CPUC, during April and strong earnings at our contracted services business, American States Utility Services or ASUS. The proposed decision allows us to continue investing in the utility infrastructure to provide safe and reliable water services for the communities we serve. It sets new water rates for the years 2022 through 2024 and is retroactive to January 1, 2022. We remain committed to spending $140 million to $160 million this year in infrastructure investments at our regulated utilities, fortifying our water and electric systems to serve our customers for generations to come. ASUS also performed $18.9 million of construction work during the quarter and is on pace to meet its targeted earnings contribution of $0.45 to $0.49 per share for 2023. Eva will discuss the quarterly earnings and liquidity and I'll turn the call over to her.

Thank you, Bob. Hello, everyone. Let me start with our first quarter results. Consolidated earnings as recorded were $0.93 per share as compared to $0.38 per share for the first quarter of 2022, an increase of $0.55 per share. Included in the results of the first quarter was $0.36 per share related to the impact of retroactive rates from the proposed decision in the water General Rate Case for the full year of 2022 of which $0.08 per share related to the first quarter of 2022. The $0.55 per share increase also included a favorable variance of $0.06 per share from investments held to fund a retirement plan. We recorded gains on the investments of $1.6 million for the quarter as compared to losses of $1.7 million in 2022. Excluding these 2 items, adjusted consolidated earnings for the quarter were $0.54 per share as compared to adjusted earnings of $0.41 per share for the first quarter of last year, an increase of $0.13 per share. For our water utility subsidiaries, Golden State Water Company, reported earnings were $0.74 per share as compared to $0.23 per share for the first quarter of 2022, a $0.51 increase. Both items as discussed affected earnings at the water segment. So factoring the same effect from the 2 items, adjusted earnings for the first quarter at the water segment were $0.35 per share, which was an increase of $0.09 per share as compared to adjusted earnings of $0.26 per share for the same period in 2022. Since 2023 is the second year of the GRC, the estimated second year rate increases effective January this year have been accounted for in the quarter. The $0.09 per share increase in 2023 adjusted earnings largely represents the difference from the 2021 adopted rate and the 2023 estimated second year increases for the first quarter, partially offset by increases in operating, interest and other expenses. Our Electric segment earnings were $0.06 per share for the first quarter as compared to $0.07 per share for the same period last year. The decrease primarily related to not having new rates in effect yet for 2023 as we await the pending electric GRC that will set new rates for 2023 to 2026 while also experiencing continued increases in overall operating expenses and interest costs. One of the decisions issued in the electric GRC new rates are expected to be retroactive to January 1, 2023, and cumulative adjustments will be recorded at that time. Earnings from our contracted services segment increased $0.07 per share for the quarter, which Bob will discuss later. Consolidated revenue for the first quarter increased by $52.8 million as compared to the same period last year. Revenue for the water segment increased by $38.8 million, which includes the impact of retroactive new rates for the full year of 2022 of $30.3 million and estimated 2023 revenue increases of $8.7 million for the 3 months ended March 31 of this year. The increase in electric revenue was partly attributed to advice letter filing and an expense allocation true-up as a result of the proposed water GRC decision. The increase in the general office expenses allocated to the Electric segment also included a corresponding offsetting increase in adopted electric revenues, resulting in no impact to earnings. In addition, there was an increase in revenue of $13 million from our contracted services. Looking at total operating expenses other than supply costs, consolidated expenses increased $12.2 million as compared to the first quarter of 2022. The increase was largely due to an increase in construction costs at our Contracted Services segment resulting from higher construction activity due to timing differences of when construction work was performed in 2023 as compared to the first quarter last year and higher overall operating, administrative and general depreciation expenses. The proposed decision in the water GRC issued in April also approved overall higher composite depreciation rates based on a revised depreciation study.

Thank you, Eva. I will discuss a few key regulatory matters. Earlier, I discussed the proposed decision we received in the water general rate case. Among other items, the proposed decision adopted in its entirety the settlement agreement between Golden State Water and the Public Advocates Office at the CPUC that had been filed with the CPUC in November 2021 and resolved all issues related to the 2022 annual revenue requirement in the rate case application, retroactive to January 1, 2022. Furthermore, the proposed decision addressed the 3 remaining unresolved issues related to Golden State Water's request for a medical insurance balancing account, a general liability insurance cost balancing account and consolidation of 2 of Golden State Water's customer service areas. The proposed decision approved both balancing accounts and denied Golden State Water's request to consolidate the 2 customer service areas. The settlement agreement approved in the proposed decision authorized Golden State Water to invest $404.8 million in capital infrastructure over the 3-year cycle plus $9.4 million of capital projects that have been completed and filed as advice letter projects, the revenue for which was in effect in February of 2022. It increases Golden State Water's adopted operating revenues for 2022 by $30.3 million, which includes an increase for higher adopted supply costs of $9.6 million compared to the 2021 adopted revenues, excluding the advice letter project revenues. It adopts new operating expense levels for 2022, including higher depreciation expense resulting from overall higher composite depreciation rates based on a new depreciation study adopted in the proposed decision, and it allows for potential additional increases in adopted revenues for 2023 and 2024, subject to an earnings test and changes to the forecasted inflationary index values. We're now in the process of preparing our next water general rate case for the years 2025 through 2027 to be filed in the third quarter of this year.

So first, with the proposed decision and the cost of capital, it's interesting because I don't even know when it really applies. So your best guess, is it truly retroactive to January 1 of 2022, i.e., this provision that you guys have been booking for the lower cost of debt would basically stick based on it?

Yes. So it's not entirely clear to us, Angie. One interesting item to note in the proposed decision is it does not expressly state that the lower cost of debt for 2022 and 2023 and the lower cost of equity for 2022, partially offset by the higher return on equity for 2023, all of which are set forth in the proposed decision doesn't really state that they should be retroactive to the beginning of 2022. Since the ordering paragraph solely focused on future rate changes, it could be interpreted that it was the ALJ's intent to make all these changes prospective. And we don't know what the ALJ's intent is. So more to come on that.

Okay. But if, under the assumption that those are prospective changes, meaning the rates would be adjusted starting on the basically midyear, right, after the commission signs off on it. What would be, if I were to reverse the provisions associated with the lower cost of debt, what would be the add back to 2023 from an EPS perspective?

Yes. So we have the add back for 2022 to start with. That was roughly $0.15.

$0.15.

Yes.

And it will book additional $0.03 for the first quarter of this year. So Angie, in total, up to March 31, that will be $0.18 that we'll be adding back.

It's possible we won't get a final in the second quarter, but we think we will. If we don't, hopefully, we'll have a little more clarity regarding where they're headed on this so that we can address it appropriately in the second quarter.

Okay, that addresses the first part of your question. The second part concerns when the cost of capital adjustment mechanism will take effect. There are really only two options: it could coincide with the new rates, which would be around the middle of the year, or there are three options if we consider that it might start on January 1, 2023, or mid-2023. Additionally, if we need to file and request that increase, it could be delayed until, say, September.

Right. And we...

So that would be fair.

Yes. There's also that...

So that would be fair.

There's also that 2022 adjustment, although it's very small for 5 basis points, but...

So your current guess would be that it happens, that it coincides with the reduction in the cost of debt, meaning roughly mid-year.

Yes. I mean, to be fair, we've had this for 1.5 days. But yes, we think that you would be sort of move in lockstep although we may know more as we move through time here, probably will.

And so now the last one, that's what I promise. So now assuming that we are doing it starting midyear, so the cost of debt down, cost of equity up well, whatever, by that 51 bps, minus the 5 bps, right? So right, I mean, if I get it right, 46 bps increase in the ROE starting midyear. So how big an increase does that have been an impact on an annualized basis? Does it have from an EPS perspective?

Okay. I'll take that one, Angie. Well, you booked through the 5.1% debt, right? So that's reflecting our recording number. So will be the upside from the 8.9% to the 9.36%, 46 basis points. 46 basis points on our $1.2 billion rate base, I think it translates about $0.08 to $0.09 for the full year. So it depends on this to be for the full year perspective. So you have to count that into your increase.

Well, it's complicated, but we are significantly further along in this process than we were during the fourth quarter call, which is quite remarkable since both the GRC and this issue are nearly resolved.

Yes. So it's possible that we could get something in 2023, but I would say unlikely.

Okay. And my last question, this $0.02 drag at the corporate level I mean, yes, we did expect an increase in the interest expense there. But now that you will have a true-up in revenues, should I assume that this quarterly drag is actually slightly slower because I get actually cash recognition of some of the deferred revenues?

You're talking about the unfavorable variance of $0.02 at the parent?

Yes. Yes. So I'm basically asking is it a recurring $0.02 per quarter or now that...

It is a result of the borrowings we have at the parent that are not linked to the borrowings at the utility.

Congrats on getting the two PDs long awaited, but I guess when it rains, it pours in California, right?

That is true in a lot of different for us.

So just wanted to keep going on the cost of capital proposed decision a little bit. So obviously, it took a lot of time to get this proposed decision don't know if you have any sense how much maybe influence the commission might have had on this proposed decision and kind of like what the thoughts are on the likelihood of the commission adopting the proposed decision as it is or whether like some past cost of capital proceedings on the water side, whether they modify the PD before adopting something.

Yes. Our company is currently evaluating the proposed decision and deciding our stance on it. I'm sure the other three utilities are doing the same, along with public advocates. The key question now is whether anyone will be advocating for changes to the commission's decision. It's still early to make any definitive statements. I’m not certain that the other commissioners would have an issue with this decision on their own, but there's a lot more to unfold since we are still at the beginning of the process. We don’t fully understand the implications of the decision regarding retroactivity yet, so we will need to seek more clarity on that. I apologize for not having a more conclusive answer. Jonathan, I know you have a report about this, what are your thoughts?

Well, I don't know. History that he presented, then they'll modify it some, but no. I mean you certainly raise a good point. I mean, if you guys are, if they don't raise issues with it, then why wouldn't the commission, I guess, kind of adopt it. So I guess...

I’m unsure about the stance of public advocates on this matter. I'm not clear on their feelings regarding it. They had lower recommended adopted ROEs for 2022, but that discussion took place back in 2021 when everyone submitted their filings. Now we know the interest rates for 2022, and typically, one should try to forecast where interest rates are headed. However, we have the data now. I apologize for not being more helpful. This situation is distinctly different from 2018, which I know you remember; that was a particularly challenging time, as the proposed decision was quite poor.

Right, no, right. That one was very one-sided where your point I mean this one, the ROEs proposed seem to kind of in the middle to some degree and everything and then you have the cost of capital mechanism kind of resets and everything. So I just know if you have any thoughts or if there was any early onboarding or just because it did take so long if there was some sort of messaging that this is very much indicative of where the commission wants to come out, whereas past ones maybe that hasn't been the case.

Is it just the perspective of the ALJ and the assigned commissioner, or have the other commissioners had an opportunity to weigh in at this stage? I don't know the answer to that, and I apologize. I always get anxious when these matters arise, as you know, and this situation doesn't feel as severe. I was here in 2018, and compared to that, this is a bit of a relief.

Yes. No, I agree. I agree. So yes, we'll stay tuned and good luck on getting it across the finish line. The other topic I wanted to touch on and Eva, I know you discussed in your prepared remarks a bit, but the discussion in the queue around the credit facility and the need to do a 2-month extension, I mean, it just really struck me at that. I mean, it seems like most companies extend or renew the facilities well in advance of the expiration date. So I mean I know you mentioned in the prepared remarks that it takes additional time to do the 2 credit facilities. But again, I would have thought that this could have been done well in advance of the current facility kind of expiring. So I guess the question is, do you think the 2-month extension, is that going to be enough time to get the new ones in place and have these efforts been impacted in any way by the upheaval in the banking industry the last few months?

Yes, we extended the timeline by 2 months, but we expect to complete everything well before that deadline. We don’t want to be in a situation where we’re waiting until the last day of the credit facility, as that limits our options. This is a more cautious approach. We anticipate finishing much earlier than the 2-month extension. This plan emerged when Bob and I met with S&P in December to discuss obtaining a separate rating for Golden State Water, which involved extensive research and discussions. We aimed to set up two facilities, with a larger amount allocated to the new credit facility, as we previously had $280 million. The last rate case involved significantly higher capital expenditures, and we project that the rate base will increase when we submit the next rate case in August. To accommodate the upcoming years of capital expenditures amid the uncertainty surrounding PFAS, we are requesting a larger credit line, which will require a coordinated effort to establish two credit facilities. This is why the process is taking longer.

So just to add in there, I mean, we are a bigger company than we were 5 years ago, and we now have to have larger financing capabilities because of that and because of our CapEx program, and I do think the upheaval in the banking industry probably didn't help us at all here. So just a number of things. But splitting the credit facility into 2 pieces, I think long term, that's going to be a real advantage to the company. And it takes more time to do that. And should we have started earlier? Maybe. But I don't think this is anything for people to be worried about the facility. All it is, is a function of the size and we did increase the complexity a bit, I would say.

Okay. Yes, I mean the credit rating is very strong where it currently stands, so I wouldn't have expected that obtaining a new facility would pose an issue. I appreciate the additional comments regarding the circumstances surrounding it. It seems like we might have something new in place in the coming weeks if I'm interpreting the situation correctly, which is positive. Regarding PFAS, I know other companies have been addressing it, but how significant of an issue is it in your service territory, and how might it affect the CapEx budget or the upcoming rate filing?

Yes. I can give you a little bit of detail on that. So at this point, we've tested 78 wells at the company, basically at the state's direction, they identify sort of what areas you need to be doing these tests on. And then we have found 25 of the 78 that are over the state's notification levels and 9 over the state's response levels. Now these notification and response levels are actually higher than what the EPA of 4 parts per trillion is. And so we're going through the process. So we've got 34 wells of the 78 to have issues and cost between $2 million and $5 million per well to retrofit them for this issue. We also have more wells than the 78. We've got a total of 170. So we can't really estimate at this point what the cost of getting everything sort of up to where the standards are for the 4 parts per trillion. But it's going to be a sizable CapEx. I don't know, Jonathan, whether the 4 parts per trillion is going to stick or not. I know it came in a bit lower than what the industry was expecting.

Yes. How does the 4 parts per trillion compare to the state levels? The $2 million to $5 million cost you mentioned is just to retrofit them to meet the state standards, or would that also...?

It is, but it doesn't jump considerably when you reduce down to the 4 parts per trillion. Not a big jump there because you're kind of putting in the materials at that point.

Okay. And so out of those 78 that you test, I know the 34 have issues with the state standards. Do you know how many of those would have issues with the four parts per trillion standard?

Yes, all of them.

So it could extend beyond those 78 even, and that's why you threw out the 170, I guess.

It is possible, yes, because the current state standard is either lower or higher than the federal standard.

Okay. All right. Are you going to try to encapsulate this at all in the upcoming rate case filing? Or would this be potentially something separate until you see what the EPA settles on if it is 4 parts per trillion and kind of what the compliance time frame is and everything.

So we're still working on the rate case at this point, Jonathan, we're looking at the possibility of putting a strong testimony on additional CapEx and the water supply mix impact, et cetera. So we don't have a number at this point, but what is goes back really let it file, we filed the decision, I think, by all the folks.

Thank you, Gary. So I just want to wrap it up today by thanking you all for your participation, and we look forward to speaking with you next quarter. So have a good rest of your week, and good start to your summer. Thank you.

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