American States Water Company (NYSE:AWR) Q2 2022 Earnings Conference Call August 2, 2022 2:00 PM ET
Company Participants
Bob Sprowls – President and Chief Executive Officer
Eva Tang – Senior Vice President of Finance and Chief Financial Officer
Conference Call Participants
Angie Storozynski – Seaport
Jonathan Reeder – Wells Fargo
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company Conference Call discussing the company’s Second Quarter 2020 Results. The call is being recorded. If you would like to listen to the replay of this call, it will begin this afternoon at 5 p.m. Eastern Time and run through Tuesday, August 9, 2022, on the company’s Web site www.aswater.com. The slides that the company will be referring to are also available on the Web site. After today’s presentation, there will be an opportunity to ask questions [Operator Instructions].
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 and 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 would like to turn the call over to Bob Sprowls, President and Chief Executive Officer of American States Water Company. Sir, you may begin.
Bob Sprowls
Thank you, Chad. 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 some further thoughts on the quarter, updates on regulatory activity, California’s drought, ASUS, dividends and then we’ll take your questions. Before I provide some highlights on the second quarter results, I’m pleased to report that last week, our Board approved another sizable dividend increase. The annualized dividend rate after this increase is $1.59 per share, which represents nearly a 9% increase from the current annualized dividend rate of $1.46 per share. This action marks the 345th consecutive dividend payment by the company. American States has paid dividends every year since 1931, increasing the dividends received by shareholders each calendar year now for 68 consecutive years.
Now on to the second quarter results. Like the first quarter of this year, this was a unique quarter with earnings per share decreasing from the prior year second quarter. This was in large part due to losses incurred on our investments to fund one of the company’s retirement plans as compared to gains in the same period of 2021, as well as timing issues with receiving a final decision from the California Public Utilities Commission, or CPUC, on our water general rate case at Golden State Water. Excluding the gains and losses on investments from both periods and including the additional revenues and water supply caused from the delay in the water general rate case in our second quarter results, adjusted consolidated diluted earnings for the second quarter of 2022 were $0.71 per share as compared to adjusted diluted earnings of $0.69 per share for the same period in 2021, an adjusted increase of $0.02 per share. Eva will discuss these results in detail.
We continue to deliver high quality water, wastewater and electric services to customers during the quarter. We’re making good progress on our goal to spend the $140 million to $160 million this year in infrastructure investments at our regulated utilities that we discussed during previous calls, strengthening the critical infrastructure that our customers require for the long term. Along with a waiting a decision from the CPUC and Golden State Water’s general rate case, we are also actively involved in processing our cost of capital application. Hearings on this proceeding occurred in May of this year and briefs were filed one month later in June. Also in June, Standard & Poor’s affirmed its A+ credit rating for both American States Water Company and Golden State Water Company. Although both ratings continue to carry a negative outlook. With the company’s sound capital structure and A+ credit ratings, it will enable us to continue accessing debt financing on reasonable terms, which we expect to do over the next year. Eva will provide an update on our financing plans, and I’ll now turn the call over to her.
Eva Tang
Thank you, Bob, and hello, everyone. Again, thank you for joining us today. Let me start with our second quarter financial results. Consolidated earnings recorded were $0.54 per share compared to $0.72 per share last year, a decrease of $0.18 per share. This included losses of $3.5 million or $0.07 per share on investments held to fund a retirement plan as compared to gains of $1.6 million or $0.03 per share for Q2 last year. This item alone resulted in an unfavorable variance of $0.10 per share. Furthermore, due to the delay in receiving a final decision on the pending water general rate case, while the revenues for 2022 were based on 2021 adopted rates. Has the new rates being approved and implemented on January 1, 2022, consistent with November 2021 settlement agreement reached between Golden State Water and the public office of the CPUC, we would have recorded additional revenues and water supply costs that will have resulted in higher earnings of $0.10 per share for the second quarter of 2022. So excluding the gains and losses on investments from both periods and including the additional revenues and water supply cost caused by the delays in the water general rate case in the results, adjusted consolidated earnings for the second quarter of 2022 were $0.71 per share as compared to adjusted earnings of $0.69 per share for Q2 of 2021, that’s an increase of $0.02 per share.
For our water utility subsidiary, Golden State Water Company, earnings were $0.40 per share as compared to $0.57 per share last year, a $0.14 decrease. Both items as discussed affected earnings at the water segment. So factoring the same effect from the two items, adjusted earnings for the second quarter at water segment were $0.57 per share, which was an increase of $0.03 per share as compared to adjusted earnings of $0.54 per share for the same period in 2021. Also included in the water segment’s results for the quarter were a $1.7 million reduction in revenues or $0.03 per share to reflect our best estimate at this time of revenue subject to refund from Golden State Water’s pending cost of capital application, which includes the impact of a lower cost of debt requested in this application. We cannot predict the ultimate outcome of the cost of capital application and associated impact on 2022 revenues. Any changes in estimate will be made necessary as more information if proceeding becomes available. There were also increases in operating expenses and effective income tax rate, partially offset by increasing the other income net of other expenses.
Our electric segment’s earnings for the three month period ending June 30, 2022 and 2021 were $0.04 per share. The increase in electric revenues and lower effective income tax rate were offset by higher interest expense. Earnings from our contracted services segment decreased $0.01 per share for the quarter, which Bob will discuss later in the call. Consolidated revenue for the second quarter of 2022 decreased by $5.2 million as compared to the same period in 2021. The decrease was mostly due to lower construction activities at our contracted services segment due to timing and other delays, as well as well the cost of debt that have been expected from the cost of capital proceeding at the water segment. Also, as mentioned previously, while the revenue for the second quarter of 2022 were based on 2021 adopted revenue due to the CPUCs delayed on the pending water general rate case, the increase in [Indiscernible] revenues were largely due to the CPUC approved rate increases effective January 1, 2022, partially offset by a decrease in customer usage as compared to the same period in 2021.
Turning to Slide 9. Our water and electric supply costs were $28.6 million for the quarter, an increase of $600,000 from same period last year. Any changes in supply costs for both the water and electric segments as compared to the adopted supply costs are [Indiscernible] in balance [Indiscernible]. Looking at total operating expenses, other than supply costs, consolidated expenses decreased $2.9 million as compared to the second quarter of 2021. This was primarily due to a decrease in construction costs at our contracted services segment resulting from lower construction activity, partially offset by increase in other operation and maintenance costs and depreciation expense. Other income, net of other expenses, decreased by $4.2 million due to losses on investments held for retirement benefit plan as discussed. This was partially offset by a decrease in the non-service cost component related to Golden State Water’s benefit plan, resulting from lower actuarial losses recognized for the second quarter of 2022. Slide 10 shows the EPS bridge comparing the second quarter of 2022 with last year’s second quarter.
Moving on Slide 11. This slide reflects our year-to-date earnings per share by segment as reported. Fully diluted earnings for the six months ended [June] 30, 2022 were $0.92 compared to $1.24 for the same period in 2021, a decrease of $0.32 per share. Again, an unfavorable variance of $0.14 per share was due to losses of $5.2 million on the retirement planning investments this year as compared to gains of $2.2 million for the same period of last year. In addition, as previously discussed, has a new water rate in the GRC segment has been approved by the CPUC and implemented on January 1, 2022, our earnings would have increased by $0.19 per share. Excluding the gains and losses on the retirement plan investments from both periods, including the result of the new water rate fund settlement agreement for the first half of 2022, adjusted consolidated earnings for the six months ended June 30, 2022 were $1.21 per share, which were higher than the adjusted earnings of $1.20 per share for the same period last year. For more details on the year-to-date results, please refer to yesterday’s press release and Form 10-Q.
Turning to liquidity on Slide 12. Net cash provided by operating activity was $56.9 million for the first six months of the year as compared to $41.1 million for the same period in 2021. In early this year, our regulated utility received a total of $9.8 million in COVID-19 relief funds from the State of California to provide assistance to customers for delinquent water and electric water customer bills incurred during the COVID-19 pandemic. The increase in operating cash was also due to differences in the timing of income tax installment payments between the two periods and the timing of billing of and cash receipts for construction work at military basis. Our regulated utility invested $78.3 million on company funded capital projects during the first half of 2022 and we are on target to meet $140 million to $160 million of capital expenditures for the year.
In April 2022, AWR’s credit facility was amended and increased the borrowing capacity from $200 million to $280 million. The overall increase in total borrowing capacity will support, among other things, the capital expenditure program at Golden State Water. This credit facility expired in May next year with a maturity of less than a year, the outstanding borrowings have been classified as the current liability in the company consolidated the balance sheet as of June 30, 2022. We expect to renew and extend its credit facility prior to expiration dates. In addition, we expect to issue long term debt to Golden State Water prior to May 2023 and use the debt proceeds payoff portion of the outstanding borrowings under this facility. We believe the company’s sound capital structure and A+ credit rating, combined with its financial discipline, will enable us to access the [debt] market and put in place a new credit facility with reasonable terms before May 2023. At this time, we do not expect American States Water to issue additional equity for the next three years to fund its current businesses. So with that, I’ll turn the call back to Bob.
Bob Sprowls
Thank you, Eva. Before I get into regulatory matters, I would just like to reiterate a few key factors impacting our second quarter and year-to-date earnings. At 2022, water rates been approved, consistent with the settlement agreement in the general rate case and implemented on January 1, 2022, Golden State Water’s earnings contribution for the second quarter would have been $0.10 per share higher and $0.19 per share higher for the first half of 2022. Once a final decision is issued by the CPUC in the general rate case, the new rates will be retroactive to January 1, 2022. Therefore, we will record the cumulative retroactive impact at the time a decision is issued. While it’s unfortunate that the delay in the general rate case has negatively affected our earnings thus far in 2022, we view this as a timing difference for the year.
We also recorded a reduction to water revenues, which decreased the quarterly and year-to-date per share earnings by $0.03 and $0.06, respectively, to reflect our best estimate at this time based on our accounting assessment of revenues subject to refund from the pending cost of capital proceeding filed in May 2021, which includes primarily the impact of Golden State Water’s lower cost of debt requested in its application. However, at this time, we cannot fully predict the ultimate outcome of the cost of capital application and the associated impact on 2022 revenues. Changes in estimates will be made, if necessary, as more information in this proceeding becomes available. The investment losses on one of our retirement plans during the second quarter and year-to-date periods of 2022 negatively impacted earnings per share by $0.10 and $0.14 respectively as compared to the same period last year. We also expect ASUS to catch up on its construction activity during the second half of 2022, and we reaffirm our projection that ASUS will contribute $0.45 to $0.49 per share for 2022.
With regards to our water general rate case, as you know, we filed in July 2020 to set new rates for the years 2022, 2023 and 2024. As mentioned in previous earnings calls, we reached a settlement agreement with the Public Advocates Office in November of last year on this general rate case. Only three issues remain. For more details on this settlement, please refer to yesterday’s filing of our Form 10-Q. We are disappointed. We have not seen a proposed decision from the CPUC. As we mentioned, the delay negatively impacted our earnings by a net of $0.10 per share for the quarter. But since the new water rates will be effective January 1, 2022, we will record the retroactive revenues and expenses during the quarter in which the final decision is issued by the CPUC. A proposed decision is expected in the second half of this year. Furthermore, Golden State Water completed $9.4 million of capital projects from the prior rate case approved by the CPUC for revenue recovery through advice letters earlier this year and also included in the pending general rate case. Additional annual revenue requirements generated from these capital investments of $1.2 million and became effective February 15th of this year.
Next, I’ll discuss the cost of capital case. Golden State Water filed across the capital application with the CPUC in May 2021, requesting a capital structure of 57% equity and 43% debt, a return on equity of 10.5% and embedded cost of debt of 5.1% and a return on rate base of 8.18%. The cost of capital will be effective for the years 2022 through 2024. Once approved by the CPUC, the revenues will be reset based on the new cost of capital. Hearings on this proceeding occurred in May of this year and briefs were filed in June. The proposed decision is expected in the second half of 2022. In the second quarter, we recorded a reduction to revenues of $1.7 million or $0.03 per share and $3.1 million or $0.06 per share for the year-to-date 2022 to primarily reflect the estimated revenue impact of a lower cost of debt of 5.1% as requested in our cost of capital application as compared to 6.6% included in 2021 rates currently being billed to water customers. Our electric utility subsidiary is scheduled to file its general rate case in August to set new rates for the years 2023 through 2026.
I will now discuss the drought situation in California. As of July 26th of last month, the U.S. Drought Monitor reported that 60% of California was an extreme drought as compared to 89% one year ago and 90% of California was in severe drought as compared to 95% a year ago. California is experiencing a record drought in 2022 thus far and the calendar year is projected to end as one of the three driest years on record. As I mentioned in our last earnings call due to deteriorating conditions, the California Department of Water Resources reduced the allocation of State Water Project or SWP water from 15% to 5% on March 18th of this year. In April, the Metropolitan Water District of Southern California or MWD declared a water supply emergency condition for the state water project dependent areas that impacts Golden State Water’s Simi Valley and Claremont service areas, which utilize a portion of their supply from the State Water project. This action also includes a phased emergency conservation program that limits outdoor watering in those areas to one day per week. In June, Golden State Water moved all the other water systems to the second stage of its water rationing plan that limits outdoor watering to two days per week. Golden State Water will continue to work with its local suppliers to assess water supply conditions and water use restrictions in its service areas and make appropriate adjustments as needed. Golden State Water has been authorized to track incremental drought related costs in a memorandum account for future recovery.
Turning our attention to Slide 17, we present the growth in Golden State Water’s average 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. Based on the general rate case settlement agreement, the 2022 rate base amount is [$1,152.3 billion], which, if approved, would result in a compound annual growth rate of 11.3% since 2018. The rate base amounts shown for 2021 and 2022 do not include any rate recovery for advice letter projects. Let’s move on to ASUS, which had earnings of $0.10 per share for the second quarter of 2022 as compared to $0.11 per share for the same period in 2021. The decrease was largely due to timing differences in construction activity between the two periods, as well as the slowdown caused by longer material supply lead times, weather conditions and other delays, partially offset by increased management fees. Again, we reaffirm our projection that ASUS will contribute $0.45 to $0.49 per share for 2022.
The completion of filings for economic price adjustments, requests for equitable adjustment, asset transfers and contract modifications awarded for new projects provide ASUS with additional revenues and dollar margin. We are disappointed that we didn’t win the award for operating the wastewater system at Naval Station Mayport recently issued but we remain confident that we can effectively compete for new military based contract awards in the future based on our proven track record of managing water and wastewater related services for military bases since 2004. I’d like to turn our attention to dividends, which I already touched on earlier in the call. Last week, we announced an 8.9% increase in the third quarter dividend. Our quarterly dividend rate has grown at a compound annual growth rate of 9.3% over the last five years. These increases are consistent with our policy to achieve a compound annual growth rate in the dividend of more than 7% over the long term. Our strong dividend history is something that the company is proud of and is a continuing asset to our shareholders. This strong track record has allowed us to achieve a 9.2% growth rate in our calendar year dividend payments to shareholders over the last 10 years from 2012 through 2022. 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.
Question-and-Answer Session
Operator
[Operator Instructions] And the first question will come from Angie Storozynski from Seaport.
Angie Storozynski
So just wondering, I mean what do you think is the reason why you haven’t heard from the CPUC at either on the settlement for your rate case or the cost of capital proceeding? I appreciate that you’d still expect decisions in both cases in the second half. Well, the time is running out. And again, I’m just wondering if you have an idea what’s been going on?
Bob Sprowls
So with regard to the general rate case, we were told earlier this year that the assigned administrative law judge was involved in several weeks of evidentiary hearings and another general rate case proceeding. Fortunately, those hearings are now over and we understand that the ALJ is now focused on preparing the proposed decision in our water general rate case. So that covers the general rate case. The cost of capital is a little harder to understand, although we just completed the hearings in May and the briefing in June, and so we’ll just have to see how long it takes for the commission to get out a proposed decision in that hearing.
Angie Storozynski
Do you think that there could be some link between — on the cost of capital side, between when the commission plans to issue — the ALJ plans to issue a proposed decision and that’s end of September, October 1st mark for the cost of capital adjustment mechanism on the water side? I mean is it possible that the commission is waiting to see if an adjustment, upward adjustment could happen and based on that rule in this pending cost of capital proceeding?
Bob Sprowls
Angie, I think it is possible that they may wait until after September 30th to see where the adjustment mechanism comes out, because it’s pretty close as to whether it’s going to trigger or not. But the general rate case, they’re behind on that, so I think they’re just behind too. Although you could craft some strategy behind why they might want to wait until after September 30th.
Angie Storozynski
And could you remind us what is the benchmark against, which I’m measuring that 100 bps band for that adjustment? What’s the — I mean…
Bob Sprowls
AA utility bond rate…
Eva Tang
Yes, and the benchmark right now is at 2.89%, Angie. And so you have to be 100 basis points in over so that’s trigger 50% of that change.
Bob Sprowls
And it is an average for the period…
Angie Storozynski
12 month average…
Bob Sprowls
Yes, 12 month average.
Angie Storozynski
Well, so lately, the pullback in rates is not helpful, to hit that mark. I mean as you said, it’s a close call at this point..
Bob Sprowls
Yes, it’s going to be close.
Angie Storozynski
But [Multiple Speakers] impact on the rates in 2023, right? So in a sense, if they were to lower the base ROE in anticipation of that 50 bps increase that would happen in ’23, ’22 is still being impacted downwards, no?
Bob Sprowls
Correct. So the ROE and the decision covers the period 2022 through 2024, but the adjustment mechanism would apply to 2023. And so theoretically, they need to establish the proper ROE for 2022 and then let the adjustment of mechanism do what it’s going to do.
Angie Storozynski
And then just separately from — so basically just assuming that the cost capital proceeding is just the adjustment of the cost of debt as you’re currently reflecting in your results. And assuming that ASUS does catch up for the remainder of the year to have at least — well, to have, say, flat earnings year-over-year. Given this drag that you were seeing from the pension accounts I mean, is there any chance you could actually get to flat earnings year-over-year? I mean, I’ve been actually looking at it. I mean it’s — I understand that you have no control over the pension — of the performance of your pension funds, but then again, you did account for benefits from those pension funds and prior earnings from kind of torn — if that drag should be excluded. And again, knowing of the drag that we see thus far, any way you can be flat year-over-year in earnings?
Bob Sprowls
Well, so far, as you know, the retirement plan is $0.10 under — $0.10 of losses to date. I don’t recall what the gain was last year in the $2 — what was it $2.55. So we’d have to not only make up the loss of the $0.10, we’d also have to make up the gain that we had last year, which I think the S&P was up 30% in 2021. The rest of the businesses would need to make up for that difference for us to get back there. I mean it’s possible. The market’s been better lately. These are June 30 numbers, of course. So it’s possible. I mean we think ASUS will make up some ground and we think both of our utilities are doing fine, but for the delay in the various proceedings.
Operator
[Operator Instructions] Our next question will come from Jonathan Reeder from Wells Fargo.
Jonathan Reeder
So just to clarify one of your earlier comments, Bob. Do you believe like a proposed decision from the ALJ and the GRC is imminent then, or did the ALJ just kind of start working on it? What’s kind of the timing of the — how far into this drafting of the PD ALJ is?
Bob Sprowls
I don’t think we’ve heard the word imminent. And it always seems to take longer than what one would expect. But there’s two parties in this not to get on my soap box, but there’s two parties in this general rate case. And we have — the two parties have signed a settlement agreement, sort of frustrating is to okay, where is the difficulty here. But hopefully, we can see something in the next few months, I would say. I don’t think we’re talking about days. I think perhaps we’re talking a couple of months.
Jonathan Reeder
And so then, I mean, it sounds like it’s probably not going to be approved in Q3, but assuming that’s the case. Do you know like how much of an EPS it would be to the Q3 EPS along the lines of the $0.09 in Q1 and $0.10 in Q2 like how that distribution goes?
Bob Sprowls
Yes, typically, third quarter is higher than the second quarter.
Eva Tang
Annual impact, Jonathan, the GRC is about $0.40 higher compared to our current, but then you have to decrease that by $0.15 of cost of debt adjustment. So the annual impact is about $0.25 a net impact. So we already incurred 19 minus 6 so 13. So we have about another $0.12 to $0.13 for the third and fourth quarter.
Jonathan Reeder
Another $0.12 to $0.13 for the back half of the year from…
Eva Tang
And this is net of the cost of debt adjustment.
Bob Sprowls
So $0.19 is not net, the 19 is…
Jonathan Reeder
So I guess we should be looking at it as $0.21 still for the second half of the year just purely from the GRC.
Bob Sprowls
Yes, correct…
Jonathan Reeder
And the bulk of that being Q3 or maybe 75% or something of it.
Bob Sprowls
Yes, the third quarter is typically greater than the second quarter in terms of usage.
Jonathan Reeder
Just I like you, I’m hopeful, I guess, the settlement is approved by the end of the year and then the full year number kind of is what it is. But in the meantime, just trying to figure out how to adjust Q3, so appreciate that. And then my last question, shifting over to ASUS. I think the construction activity during the first six months was only like two thirds of what it was during the same period last year due to the delays. And I know you reiterated the guidance range, 45 to 49 and last year, ASUS contributed $0.48. So it just kind of seems like potentially a lot of ground to make up in ’22 on the construction side. Should we be thinking more the low end of the range for this year just due to those delays?
Bob Sprowls
Well, just a couple of comments on that. The first quarter of 2021, that was a very strong quarter from a construction activity standpoint relative to other first quarters. So when we look sort of versus last year, that strong first quarter last year was a hard benchmark to hit. The other point I’ll make is we have had strong construction in the third and fourth quarter historically. So we’re looking at making up the difference here in the last two quarters, although the world is a bit different than it was last year, given material pricing and lead times, et cetera. So I mean, we’re going to try to bring out as much construction as we can here in the last two quarters. I don’t know where that’s going to put us in that 45 to 49 that range.
Jonathan Reeder
But I mean…
Eva Tang
We will provide an update in Q3 to you, Jonathan, how we do there…
Jonathan Reeder
But I guess, the way you’re seeing it today, I mean, if things go well, you got the materials ordered stuff like that, like you could still execute as you were anticipating for the full year…
Bob Sprowls
Yes.
Jonathan Reeder
Well, good luck getting some proposed decisions and constructive ones out of the CPUC. We’re eagerly awaiting them.
Operator
[Operator Instructions] Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Bob Sprowls for any closing remarks.
Bob Sprowls
Thank you, Chad. I just want to wrap it up today by thanking everyone for their participation and let you know that we look forward to speaking with you the next quarter. Thanks, everybody. Good rest of your summer.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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