American States Water Company

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company conference call discussing the company's third quarter 2020 results. This call is being recorded. If you would like to listen to a replay of the call, it will begin this afternoon at approximately 5 p.m. Eastern time and run through Tuesday, November 10, 2020 on the company's website, www.aswater.com. The slides that the company will be referring to are also available on this website. When the question session begins, you may ask a question by pressing the star and then one on your touch-tone phone. Press star and then two to remove request. This call will be limited to one hour. Presenting today from American States Quadrant Company is Bob Sprouse, 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. Pre-review a description of the company's risks and uncertainties and the most recent 10-K and Form 10-Q, a 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 would like to turn the conference over to Bob Charles, President and Chief Executive Officer of American States Water Company.

Thank you, Keith. Welcome, everyone, and thank you for joining us today. I'll begin with a few highlights for the quarter. Eva will review some financial details. And then I'll wrap it up with some updates on regulatory activity, ASUS, and dividends. And then we will take your questions. I would like to start by thanking our employees. Through these uncertain times, the employees of American States Water once again delivered solid results. Our consolidated results for the third quarter were 72 cents per share as compared to adjusted earnings of 69 cents per share for the third quarter of 2019, an increase of 3 cents per share or 4.3%. The adjusted earnings for the third quarter of 2019 exclude a 7 cent per share retroactive adjustment in that quarter for the August 2019 electric general rate case decision for periods prior to the third quarter of 2019. I'm pleased to report that in July of this year, the company's board of directors approved a 9.8% increase in the quarterly cash dividend from 30.5 cents per share to 33.5 cents per share. This increase is in addition to dividend increases of 10.9% in 2019 and 7.8% in 2018. Along with providing essential services and assistance to our customers and communities to get through the pandemic, we are working our way through some regulatory processes with the California Public Utilities Commission, or CPUC, which I'll discuss later on. In addition, we continue to pursue new military based contracts and our service levels remain high for all three of our subsidiaries. Now that we're going on month eight of the COVID-19 pandemic, I wanted to reflect on the achievement of our personnel across the United States, both customer facing and those who provide support in a remote working environment. Since March, our field personnel have worked tirelessly to keep the water, electricity, and wastewater services operating smoothly for over 1 million customers, including 11 military bases. They've embraced more stringent safety protocols as we keep our employees and customers healthy. While doing this, we've kept our commitments to strengthen our infrastructure for the short and long-term benefit of our customers. For the nine months ended September 30, 2020, our water and electric utility segments spent $82.3 million in company-funded capital expenditures, on track to spend $105 to $120 million for the year, barring any scheduling delays resulting from COVID-19. This would be about three and a half times our expected annual depreciation expense. While we hope for a return to normal sooner rather than later, I'm proud of the resiliency that our people have shown. I will now turn the call over to Eva to review the financial results for the quarter.

Thank you, Bob. Hello, everyone. Let me start with a more detailed look at our third quarter financial results on slide seven. As Bob mentioned, consolidated earnings for the quarter were $0.72 per share compared to $0.69 per share at the adjusted percent period in 2019. Earnings at our long segment increased $0.04 per share for the quarter. There continues to be volatility in the financial market. due at least in part to COVID-19 pandemic. This volatility resulted in an increase in gains on investments held to fund one of Golden State Water's retirement plans, contributing a $0.02 per share increase in the water segment earnings for the quarter. The remaining increase in the water segment's earnings for the third quarter of 2020 was due to a higher water growth margin from new water rates. partially offset by increasing operating expenses, interest expense, and effective income tax rates, as well as lower interest income earned on regulatory assets. Excluding the $0.07 per share retroactive impact from the August 2019 CPUC decision, our electric segments earning for the third quarter were $0.04 per share as compared to $0.03 per share as adjusted for the third quarter of 2019, largely due to an increase in the electric growth margin resulting from new rates authorized by the CPUC, partially offset by increases in legal and other outside service costs. The final August 2019 decision to approve the recovery of previously incurred incremental tree trimming costs totaling $302,000. which resulted in a reduction in maintenance expense that was recorded in the third quarter of last year. There was no equivalent item in 2020. Earnings from our contracted services segment were 10 cents per share for third quarter of 2020, as compared to 12 cents per share for same period in 2019. There was an overall decrease in construction activity resulting from weather delays and slowdowns in permitting for construction projects and government funding for new coastal upgrades, caused in part by the impact of COVID-19. The company expected construction activity to pick up during the fourth quarter relative to the first three quarters, barring any further delays due to the weather conditions. This decrease was partially offset by an increase in maintenance revenue and lower travel related costs. Water revenues increased $3.5 million during the third quarter of 2020 due to full second year debt increases for 2020 as a result of passing earnings test. The decrease in electric revenues were largely due to $3.7 million in retroactive revenues recording the third quarter of 2019 for periods prior to that. Contracted services revenue for the quarter decreased to $500,000 for reasons previously discussed. The decrease was partially offset by increases in mansions due to the stressful resolution of various economic price adjustments. Looking at slide nine, Our water and electric supply costs were $32.3 million for the third quarter of 2020, as compared to $31.8 million for the third quarter of 2019. Any changes in the supply costs as compared to the adopted supply costs are tracked in balancing counts for both the water and electric segments. Total operating expenses, excluding supply costs, increased $1.5 million versus the third quarter of 2019. There was an increase in construction costs at our contracted service business, American States Utility Services, or ASUS, due to higher costs incurred on certain projects, as well as increases in depreciation expense and property and other taxes as a result of additions of utility plans and fixed assets. at all of our segments. There was also a $302,000 reduction to maintenance costs to reflect CPUC's approval in August of 2019 for recovery of previously incurred tree trimming costs, as previously mentioned. There was no similar reductions in 2020. Interest expense, net of interest income, and others, including investment held in a trust to fund a retirement venture plan, decreased $1.1 million due to higher gains because of the recent market conditions. This was partially offset by lower interest income on regulatory assets and lower interest income earned on certain NSUS construction projects. Slide 10 shows the EPS bridge. comparing the third quarter of 2020 with the same quarter of 2019. The slides reflect our year-to-date earnings per share by segment. Fully diluted earnings for the first nine months of 2020 were $1.79 per share as compared to $1.79 per share as adjusted for the same period of 2019. The 2019 adjusted earnings exclude a 4 cents per share retroactive impact, book the last year resulting from the 2019 electric GRC decision for the full year of 2018, which is shown on a separate line in the table on this slide. For more details, please refer to yesterday's press release and our form thank you. In terms of the company's liquidity, Net cash provided by operating activities for the first nine months of 2020 was $7.8 million compared to $84.3 million for the same period in 2019. The increase was largely due to a $7.2 million refund to the water customers in 2019 related to the 2017 tax law changes. partially offset by a decrease in cash flow from higher accounts receivable from utility customers due to the economic impact of COVID-19 and the suspension of service disconnections of customers for non-payments. Our regulated utilities invested $82.3 million in company-funded capital projects in the first nine months of 2020, The Water Utilities Capital Program has been somewhat affected by COVID-19, resulting in certain project delays. However, our regulated utilities plan to spend $105 to $120 million in company-funded capital expenditures for the year, following further delays due to the pandemic. As we mentioned last quarter, Golden State Water issued unsecured private placement notes totaling $160 million in July, and repaid a large portion of its intercompany note issued to AWR parents. Currently, American States Water has a credit facility of $200 million to support water and contractor services operations. We also put in place a separate $35 million revolving credit facility for the electric segment that is not guaranteed by the parent. At this time, we do not expect American State Water to issue additional equity. With that, I'll turn the call back to Bob.

Thank you, Eva. I'd like to provide an update on our recent regulatory activity. In July, Golden State Water filed a general rate case application for all of its water regions and the general office. This general rate case will determine new water rates for the years 2022, 2023, and 2024. Among other things, 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. On August 27, 2020, the CPPUC issued a final decision in the first phase of the CPPUC's order instituting rulemaking, evaluating the low-income ratepayer assistance and affordability objectives contained in the CPUC's 2010 Water Action Plan, which also addressed other issues, including matters associated with the continued use of the Water Revenue Adjustment Mechanism, or RAM, by California Water Utility. The final decision also eliminates the Modified Supply Cost Balancing Account, or MCBA, which is a full cost balancing account used to track the difference between adopted and actual water supply costs, including the effects of changes in both rates and volume. Based on the language in the final decision, any general rate case application filed by Golden State Water and the other California water utilities after the August 27, 2020 effective decision may not include a proposal to continue the use of the RAM or MCBA, but may instead include a proposal to use a limited price adjustment mechanism of the Monterey style RAM and an incremental supply cost balancing account. This decision will not have any impact on Golden State Waters RAM or MCBA balances during the current rate cycle, which runs from 2019 through 2021. In addition, the language in the decision supports Golden State Water's position that it does not apply to its general rate case application filed in July of this year, which will set new rates for the years 2022 through 2024. At this time, we cannot predict the potential impact of this decision, if any, on the pending water general rate case. On or prior to October 5, 2020, Golden State Water, three other California water utilities, and the California Water Association filed separate applications for rehearing on the decision in the low-income proceeding. As you know, there are water utilities in the state that have been under the Monterey-style an incremental supply cost balancing account since 2008, and they seem to be able to successfully manage the effects of these mechanisms. While we are disappointed by this PUC decision, we believe we are well positioned to strategize and adapt to the new requirements. As you'll see from this slide, the weighted average water rate base as adopted by the CPUC has grown from $717 million in 2017 to $916 million in 2020, which is a compound annual growth rate of 8.5%. The rate base amounts for 2020 do not include the $20.4 million of advice letter projects approved in Golden State Waters' last general rate case. Let's move on to ASUS on slide 17. ASUS's earnings contribution for the quarter was $0.10 per share versus $0.12 per share in the year prior. The decrease was mainly due to a reduction in construction activity due to weather delays, as well as slowdowns in permitting for construction projects and in government funding for new capital upgrades that has occurred throughout 2020. The company expects construction activity to be stronger in the fourth quarter relative to the first three quarters, barring any further delays due to weather conditions. But because of the previous delays, we now estimate ASUS' 2020 earnings contribution to be at the low end of the 46 cents to 50 cents per share range. we have previously provided. In light of continued uncertainty associated with the effects of COVID-19, we project ASUS to contribute 45 cents to 49 cents per share for 2021. We are still involved in various stages of the proposal process at a number of military bases, considering privatization of their water and wastewater systems. The U.S. government is expected to release additional bases for bidding over the next several years. While we are disappointed that ASUS was not awarded with the most recent military base water and wastewater privatization contract, we are confident that we will win a fair share of the future award. I would like to turn our attention to dividends outlined on slide 18. We believe achieving strong and consistent financial results along with providing a growing dividend allows the company to continue to attract capital to make necessary investments in the utility infrastructure for the communities and military bases that we serve and return value to our shareholders. American States Water 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. The company's current dividend policy is to achieve a compound annual growth rate in the dividend of more than 7% over the long term. I'd like to conclude our prepared remarks by thanking you for your interest. interest in American States water. I'll now turn the call over to the operator for questions.

Yes, thank you. We will now begin the question and answer session. To ask a question, you may press the star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To try your question, please press the star then 2. At this time, we will pause momentarily to assemble the roster. And the first question comes from Andy Straczynski with Seaport Global.

Thank you. The first question about the military services business. So I understand the slowdown associated with COVID and permitting for this year. I'm a little bit surprised that you currently expected to have a negative impact on 21 as well because I would have thought there's going to be like a catch-up of those projects which were delayed in 2020. So do you basically assume that COVID persists beyond the end of this year and has a negative impact and hence that low guidance?

Yes. We do think it will continue past the end of this year and will continue to impact somewhat our ability to get new capital upgrades as well as permitting on effective permitting on our jobs that we would like to do. Not entirely sure. I mean, it's difficult to look into the crystal ball and see when this will all end, but we're not really back to normal yet.

But does it mean that there will be a year like this, the system 2022, where where you have a disproportionate number of those upgrades, and so then the step-up in earnings would be above the trend for that business in 2022?

It's difficult to predict. It's possible. I mean, it's because we, you know, we have a number of projects in front of the government to do on the basis we currently serve, and just the funding of these projects has has slowed down a bit from what we've seen in the past years. Does that mean that in the future years we'll make that up? It's possible, but, you know, we're kind of in unchartered territory at this point, so it's hard to really predict.

Great. And then on the change to the decoupling mechanism and the request for the hearing, So could you give us a sense when we will know if the Commission will rehear the case or decision on the case? And then what are the other options if the Commission denies those requests?

Yeah, so I believe the Commission has some flexibility in terms of deciding whether the decision needs to be reheard. So it's don't know if there's any hard and fast deadlines that they have to decide by. In terms of the second part of your question, the company or companies, the water utilities have the ability to take this issue directly to the California Supreme Court. Currently in the legislation, we do not have the ability to go to the appellate court on this, but we do have the ability to go to the California Supreme Court, the California Supreme Court has to first decide whether they're willing to hear the case.

Okay. And you are, in a sense, hedging on potential changes to the full round in your current pending rape case because you were being conservative, or is it because you have heard something from the Commission that might suggest that they would enact those changes earlier than the decision would require, meaning the decision would suggest that only the cases following the I think the August 2020, the filing after August 2020 would be impacted by that RAM change, but I'm just wondering why you you're being so cautious about the potential impact on your pending rate case?

Well, as you know, we're pretty conservative around here. So this is really just, you know, we're just being cautious. In the proposed decision in the low-income proceeding, public advocates put forth comments suggesting that it should apply to our rate case. In their protest of our rate case filing, they did put forth comments that it should apply to the rate case. But I will tell you that their comments on the proposed decision, I think the language in the final decision was actually clearer that it doesn't apply than it was in the proposed decision. So so that was an improvement. At this point we don't have anything further than that that sort of base our caution on. We understand that California Water received a proposed decision that said that the ruling in the low income decision did not apply to their rate case. So that's a good fact. Another good fact is we have not had a pre-hearing conference yet in the rate case. It would be quite difficult for our company to have to pull our rate case filing and refile it. We've already noticed our customers on the proposed rate increase. So there's a number of things that are stacking up in favor of it. yet not applying to the 2022 through 2024 rate case. But we, you know, there is still a chance, and so we wanted to make sure that the folks that we speak to know that.

Very good. Thank you.

Thank you, Angie.

Thank you. And the next question comes from Ryan Carnes. His name is from Scattergood.

Hey, thanks. Thanks for taking my questions this afternoon. So at risk of Hello. At risk of beating the dead horse here, obviously it's a hot topic with the decoupling, but I wanted to get your take on the other side of this, which is cost of capital and ROE. I mean, obviously the ORA has strenuously argued over the years that decoupling reduces risk, and that's why they argue for a lower ROE. It seems based on the ROEs that they have successfully argued that. you kind of more or less affirm that concept when you say you think your earnings will be more volatile going forward. So how do you see this all impacting the cost of capital side going forward?

Well, I think we and maybe the other REM companies will make an argument for the fact that it perhaps increases the risk of utility. in future cost of capital proceedings. Now for us, just to sort of line up the periods a little bit here, we are, we and the three other large water utilities in California are required to file our next cost of capital on May 1st, 2021. And that's for the, that is typically for the period 2022 through 2024, given that it's going to be your cost of capital. We don't think that the elimination of the RAM applies to our 2022 through 2024 rate cycle, so it makes it a little difficult for us to then use it in the cost of capital proceeding because it really, you know, the period doesn't fit. However, I'm sure that others will think about it. We'll think about it as well in terms of it being a something that we perhaps could argue in the cost of capital.

Okay. Okay. Well, I mean, I think you could maybe educate them that we and others are going to value your stock based on the long-term volatility profile of the earnings. So it actually is relevant to the day it takes hold, right? But anyway, the other question I had was, you know, you noted that the peer company's that do use a Monterey-style RAM have adapted pretty well to that, so it can be done. And so my question is, even if there's a chance that you could enhance your negotiating position on the cost of capital side, why would you not welcome the elimination of decoupling if, in fact, you do believe, as you said, that ultimately Monterey is workable? And especially, why would you – You talked about the California Supreme Court. These are some pretty nuclear options in terms of spending political capital taking it that far. Why would you want to do that if, in fact, you think the system is workable and you get a little bump on the ROE?

Well, first of all, I didn't say we were going to take it to the California Supreme Court. It is an option. We'd have to think through that depending on how the commission decides. I think for us, you know, we're just used to the full RAM at this point. The Monterey RAM, like we said, other companies have done well with that, and we're just a bit unfamiliar, but we have plenty of years to get our arms around it, and I'm sure we'll do as well with it as we have with the full RAM. There potentially could be a little more volatility is what we're saying.

Got it. Okay. Very helpful comments. I appreciate it. Thanks for your time.

All right. Thank you. Thank you. And once again, if you would like to ask a question, please press star, then 1 on your touchstone phone. And the next question comes from Jonathan Reeder with Wells Fargo.

Hey, good morning, Bob and Eva. How are you all doing?

Good, Jonathan. Doing okay, Jonathan? How about you?

Oh, not too bad. Not too bad at all things considered. We got a little summer weather and, yeah, so. That was a curve ball thrown in there and stuck out for some time, so I haven't gotten a chance to dig as deep into your earnings as I want, so I got two softballs for you. You'll like that.

That's true.

That's the whole purpose. Can you all comment how Q3 yielded results compared to your internal expectations at the end of the corner? Were there any, like, headwinds, perhaps COVID-related, that prevented quarterly EPS growth from being higher than you anticipated, but, you know, perhaps are not expected to impact, you know, your longer-term EPS growth trajectory as the regulated segment?

Yeah, no, it was not a – I mean, we weren't taken by surprise or anything, if that's what you're asking about.

Yeah, no, I mean, just trying to get a sense of, you know, where things came in for the quarter on the regulated side. Obviously, you know, excluding the market gains, you know, the benefit plan, like if everything else is kind of right where you were expecting it to be or, you know, were there some, you know, COVID expense pressures or anything like that that maybe shamed, you know, a couple pennies off?

I don't believe so for the regulated utilities. They're pretty much on target on their expenses, you know, to the expenses that's incremental due to the COVID-19. We do book through the FEMA account. So not much impact to the utility side of it. We do incur some more treatment costs, but, you know, as the other expenses decrease, they offset each other. So I don't think there's surprises to our utilities earnings for the quarter.

Okay. And then I know it's kind of already brought up earlier, but, you know, when and how do you expect to gain the clarity, you know, with regards to whether that August decoupling order will be applied to the 2022-24 GRC? You know, obviously it would be going against the date specified in the order. Does the ALJ respond specifically to, you know, CAO's protests that were filed, like when the ALJ issues the scoping order or, you know, is there a specific date or does it just kind of linger out there until you get a proposed decision?

You know, we believe that we'll get some clarity on this when there's a pre-hearing conference and when a scoping memo is issued by the administrative law judge.

He has not done that yet.

Right. We haven't had the pre-hearing conference yet. I will tell you we do have the same administrative law judge that Cal Water has in their case. And the case has been assigned to Commissioner Sharoma. Okay.

When is the pre-hearing conference and scoping memo due? Is there like a due date on that or when do you expect it?

Well, it is behind schedule. You're already behind schedule? Well, the three-year conference, I mean, I believe it's behind schedule. I mean, I think we were thinking it was going to, you know, perhaps it's not significantly behind schedule, but I think we were perhaps expecting it in October, and it's You know, the commission, of course, has got their hands full with a lot of issues these days.

Sure, sure. Okay, so with something perhaps later this month or certainly by the end of the year, you would hope to have the clarity to figure out whether or not you need to kind of pull the case and refile it or something like that?

That's my understanding. It's likely to happen before year end.

And that's it for me. Thanks very much for the time. Appreciate it. Okay, Jonathan.

Thank you. And that concludes our question and answer session, so I'd like to return the conference back to Bob Sprouse for any closing remarks.

Thank you, Keith. Well, I just want to thank you all for your participation today and let you know we look forward to speaking with you next quarter and just want to wish everyone a happy holiday season. Well, thank you very much.

Thank you. The conference is now concluded. Thank you for attending today's presentation.