California Water Service Group (CWT) 2003 Q3 法說會逐字稿

Good day ladies and gentlemen. Welcome to the third quarter earnings conference call. At this time all participants are in a listen only mode. Later we will conduct a question-and-answer session. And instructions will follow at that time. (Caller instructions.) As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Richard Nye, Chief Financial Officer, and Peter Nelson, President and Chief Executive Officer. Gentlemen, you may begin.

Thank you very much. And good afternoon everyone. And thank you very much for joining the call for today. This is Dick Nye. And today we will be discussing the third quarter results for California Water Service Group. We also will be providing an update to several other items, such as our rate case filings, our capital expenditures, financing plans, and the dividend approved by the Board. Then we will open it up for questions from the analysts.

Before we get started, I need to take care of some legal matters and read the following statement. As an introduction to the information we will be discussing, please be aware that some of our comments can be considered forward-looking statements as defined by the Federal securities laws, and as outlined in the company’s SEC filings.

As such, the forward-looking statements are based on currently available information, and management’s assumptions, expectations and estimates. However, actual results may vary significantly. Risk factors that could cause actual results to vary from expectations are described in the company’s filings with the SEC. These factors are also available in yesterday’s news release, which can be viewed from our Web site. So with that, I’d like to talk about our third quarter results for 2003.

Our net income was $8.6m, equivalent to $0.53 per share. This compares to net income of $7.7m or $0.50 a share in the third quarter of 2002. The three major factors impacting the quarter were increases for rates, good weather, and increased costs, mainly for purchased water. Our operating revenue increased about $6.8m or 8%, to $88m.

The weather in California provided some help t our revenues. But the largest impact due to weather was in our Washington operations. Average temperatures for our California service areas were approximately 3% warmer than last year, which helped our business. Rainfall in California was a little higher than the prior year. But it was still very minimal, and had no impact to our usage for the quarter.

In our Washington State operation, rainfall was much lower than the prior year, and had a huge effect on the revenues for that operation. Here is a breakdown of the $6.8m change in revenues. Approximately $1.6m was due to increased usage by existing customers. About $3.2m was due to increases in rates. And about $2m was due to increases in usage by new customers.

Of the $1.6m increase for existing customers, about half a million dollars of that was due to Washington. For our Washington State operations, their revenues increased over 34% from last year, mainly due to the favorable weather conditions in that service area. The revenue from the rate increases has several components to it. We’ve had increases from step rate increases that were effective for the beginning of the year. We had an impact for an advice letter related to our Bakersfield Treatment Plant. We had positive impact related to recovery on balancing accounts. And we also had a favorable impact due to the 2001 General Rate Case, which was approved in September of 2003.

The 2001 General Rate Case also includes a catch-up component, which established an effective date going back to April of 2003, and with that catch-up component and the General Rate Case, it contributed about $1m to revenues for the quarter, even though it was only effective for about 20 days in the quarter. So you can see what a big impact that decision has had on our quarterly results.

The $2m increase in usage for new customers includes about $900,000 for Hawaii Water, as these operations were acquired on April 30, 2003. On a side note, this was our first full quarter for the acquisition in Hawaii. The results were very good, and they were accretive to earnings. So we’re very pleased with that operation.

Now let me discuss operating expenses. Total operating expenses were $75.6m for the quarter, versus $69.8m for the quarter last year. That’s an increase of about $5.8m, or 8%. The biggest component in our operating expenses is for water production. During the quarter, water production accounted for about 51% of these costs, for both this year and last year. Water production costs increased about 8% compared to last year.

The quantities related to water production increased only about 3%. And this was driven by the higher usage by existing customers and new customers. In breaking down where the supply comes from, our well production provided about 53% of the water supply; about 45% was from purchases from wholesale suppliers; and about 2% was through our surface water plants.

The components and changes of our water production costs are as follows. For the third quarter, purchased water was about $27.4. That’s an increase of about $2.2m, or 8%. Purchased water was $9.1m, an increase of about $600,000 or 7%. And pump taxes were about $2.3m, an increase of about $100,000 or 3%.

For the purchased water, increases were due both to customer usage and increases in rates in several of our districts. The districts in the Bay Area saw increases in their wholesale water rates, and also in our Stockton, where the districts with the major increase. We have filed advice letters to the California Public Utility Commission to recover these costs for higher wholesale water rates. And these will show up in our revenues in the future.

The purchase power, which is mainly used for pumping equipment at wells and distribution line, increased mainly due to Hawaii Water, which accounted for about half of the increase. And the rest of the increase was due to costs related to distribution of water within our systems.

In looking at some of the other cost changes, I’ll go through these briefly. Our labor cost was up about 5%, or $300,000. Benefits was up about 10%, about $400,000. And that’s principally driven by the changes that were made in the pension plan that were effective on January 1 of 2003. Water costs are up about 40%, or $300,000, for doing increased testing for additional contaminants.

We’re also doing testing in relation to the new standards that come into effect for 2006. And we’ve had increased costs for filters and for chemicals. Our maintenance costs are up about 5%, or $200,000, mainly related to maintenance on our mains and service lines. Depreciation and amortization is up about 11%, due to our capital expenditure levels. And that’s about $600,000 increase. Federal and state taxes are up about 11%, due to the increased income. And taxes other than income are up about 15%. And that’s related to property taxes.

Moving down the P&L, our non-regulated income is up substantially on a percentage basis, but is not a major portion of our business. It’s up about 18% or about $100,000. And the drivers on that is our operation and maintenance contracts, meter reading services, and antenna leases. The property sales, as you can see on the P&L, were pretty much nil for both this year and last year.

Interest expense is up about $100,000. And that’s driven by the higher debt levels that we have incurred to fund the capital expenditures. Offsetting a large increase in the interest has been the benefits of our refinancing program, which we estimate to be a savings of about half a million dollars for the quarter.

In summary, our net income is up about 12%. Earnings per share is up about 6%, as the earnings per share impacted by the additional shares of common stock that were issued during the quarter. Overall we’re very pleased with the results. And we’re delighted to have finally received a decision on our 2001 General Rate Case filing, and the other recent decisions that we have received.

Now let me briefly cover the results for the nine months ended September 30. Net income for this period was about $12.4m, equivalent to $0.79 a share, compared to $16.2m, or $1.06 per share earned for 2002. As we’ve noted in prior calls, and also through our SEC filings, the main reason for the decrease was due to the heavy rainfall that was in our California service areas in the March through May timeframe, and also due to delays in receiving a decision on the 2001 General Rate Case, which impacted our first half earnings.

So with that, I’d like to turn it over to Pete Nelson, President and CEO, to talk about our Rate Case filings.

Thanks Dick. Dick has suggested that I talk about California rate making for a couple of reasons. One is, of course, California rate making has a major impact on our financial results. And secondly, rate making in California for the last three years or so has really been plagued by delays in processing and making decisions on rate cases, and changes in the rules for how rate cases are processed.

The regulatory climate really has affected all California water utilities, and not just Cal Water. This can be a very complicated and confusing subject. In fact, I can’t think of anything more confusing, except maybe the process we followed to select a governor in California. But I’ll take up that subject at the end of the conference call.

First, let me talk about the big picture. Because of delays in changing how the processes for rate recovery worked, you will notice as I go through this, that we’ve had a lot of rate cases really kind of unstuck. But we’re nowhere near any kind of routine or predictable rate case processing yet in California. I am going to go through this pretty methodically. But these are fairly technical issues. So you may have questions at the end of the call or later. And feel free to call Dick or me after the call is over.

So first I am going to cover what the major rate making categories are. And there’s four of them. Then I’ll talk about the new revenue that’s what was approved thus far this year, 2003, in each category. And third I will talk about what’s in processing – what have we filed for collection for future periods.

First, a quick word on the dollar amount. So I am going to talk about California only here. And I’ll be rounding off the dollars. But you’ll be able to see the magnitude of the dollars we’re talking about. And most of the rate making dollars – and I’ll talk about our annual revenue. And I’ll refer to those as ongoing annual base rates, to keep that fairly clear.

But there are some of these numbers that we’ll collect over one time. So they’re not really in base rates. And I’ll refer to those as one time collections. And I’ll talk about the period over which we’ll collect them.

So here are the four categories. First is General Rate Cases. We file for these every year for a selected number of our 24 districts. And I will refer to these by the year – 2001 General Rate Case, 2002, 2003. These are ongoing annual base rates.

The second category I will call expense offsets. These really are designed to make us whole for the increasing cost of producing water. These costs are ones that really are impossible to predict. And typically the utilities don’t have much control over these costs. And there are three groups of costs. One is wholesale water costs. We do buy a lot of water from the [Hechechi] [ph] system, and from the Metropolitan Water District. Second is electricity cost to produce water. And third is pump taxes. And again, these are ongoing annual-based rate revenue.

The third category is balancing accounts, which is related to expense offset. They’re really grouped in the same three categories of how we produce water – wholesale costs, electric costs to pump, and pump tax. But balancing accounts are really designed because there is always a timing lag between costs from our suppliers go up, and when we change the rates to cover those costs. So balance accounts really are designed to collect – I’ll call the timing lag costs.

A couple of things about balancing accounts. They are one-time revenue. They’re not included in the base rates. And each – we file for each year’s balance account. So I will refer to it as 2001 balance accounts, 2002 balance accounts. And balancing account recovery is spread over a fixed period, usually a year or two. And I will tell you what the periods are.

The fourth category is what I will call rate base or capital offsets, as opposed to expense offsets, which was the second category. This is a fairly new group of – or a fairly new type of rate case that we have in California for water utilities. And it’s really designed to place into rates gradually large capital projects. So we’re allowed to file for what I will call progress rates for large projects as they’re under construction. Our example is our Bakersfield Treatment Plant, a large capital project, phased in over time. And these rates are also ongoing annual base rates.

So now I’ll go back to those four categories, and talk about what’s been approved thus far in 2003. First, General Rate Cases. As Dick mentioned, we did get approval for our 2001 General Rate Case, which is our largest rate case ever, and also the largest water rate case in California ever. The annual revenue is $12.8m. And this is ongoing annual base rates. We began phasing those in September 9 of this year.

Also, in addition to the ongoing rates starting September 9, we’re also allowed to recover a total of $5m, in what I’ll call catch-up. I think Dick may have mentioned that’s a catch-up from the date that the rates were effective. Let me explain that. Because the Commission set a start date for that General Rate Case as April 3, but didn’t make the actual decision until September, there is five months of lag there in collecting the General Rate Case revenue. So there is $5m in what we’ll call catch-up. And it’s collected over the next 12 months – September, 2003 to September, 2004.

The second category – expense offsets – this is again ongoing annual base rates. $2m was recently approved. And we’ve begun to collect that. The third category – balancing accounts. This is, again, one-time. We did get approval this year to collect our 2001 balancing accounts. That’s $4.6m one-time, spread over two years.

Fourth category – rate-based offsets. This is, again, ongoing annual base rates. There were two decisions this year, both on our Bakersfield Treatment Plant. In April we were allowed to collect $1.8m ongoing annual base rates. And just recently we were allowed to collect $4.2m ongoing annual base rates. The $4.2m, we really see it’s full effect in January 2004.

Now I’ll back to the same four categories and talk about what we have filed for, for rate cases. And this is in processing. And first I’ll put in a huge disclaimer here, because the actual amount and the timing of these decisions is anyone’s guess. If I had – if I was doing this on a slide projector, I would take the focus button and put this totally out of focus, because there is no way anyone knows how much of these dollars will actually be approved, or when decisions will be made.

So first category – General Rate Cases. Our 2002 General Rate Cases, we’ve requested $9m ongoing annual revenue. And our 2003 General Rate Case, we’ve requested $15m, again ongoing annual base revenues. Second category – expense offsets. We have asked for $4.3m in ongoing annual base revenues.

Third category – balancing accounts. Remember, one time, collected over usually a two year period. We’ve asked for our 2002 balancing account, which is about $6m. And finally, rate-based offsets, we have no filings in processing for rate-based offsets.

So I hope that’s helpful. This was a fairly high level summary, the types of rate cases and the magnitude of numbers we’re talking about that were decided in 2003, and we have in processing for future periods. And my guess is you will have questions as you go back to your notes. So feel free to call Dick Nye or me back. Back to Dick.

All right. Thank you Pete. That was a great summary. Now I’d like to cover our capital expenditures and financing plans. Capital expenditures for the first nine months of this year were about $40m. Our estimate for the full year of 2003 is $50-55m for company-funded capital expenditures. During the first half of the year, we held back some of our capital expenditures, due to the delay in the 2001 General Rate Case.

And in the third quarter, with that decision approval, and the equity offering, we’ve changed our strategy and changed our internal policy, and are going full steam ahead on those capital projects to the budgeted levels for 2003.

Let me share with you a little bit on management’s philosophy and also, if you’re not familiar with a regulated company, kind of how capital expenditures work in the equation. We manage our capital expenditures to be in alignment with approved rate case filings. If a decision is made by the Commission to lower the amount of the request on specific projects, we lower our expenditures or cancel the project.

In being a publicly regulated utility, capital expenditures work similar to acquisitions. The capital expenditures lead to increased revenues and profits, because they are built into our rate structure. Therefore, our high level of capital expenditures will be one of the main growth components for the company, for both revenue and net income in the future.

Over the next five years, we expect our capital expenditures to remain high, similar to the last two years. At this time, we’re still working on finalizing our budgets for the year 2004. A preliminary estimate for the capital budgets for 2004, I would put in the $60-65m range.

Our projections are for capital expenditures to be between $60m and $70m per year for the next five years. A large component of these expenditures is related to complying with increased water quality standards that become effective in the year 2006, and also for our replacement program for mains. These levels of capital expenditures will require financing, as funds from operations are not expected to generate sufficient funds for all planned capital expenditures.

Our financing plan is to obtain additional capital, using roughly a 50/50 split between equity and debt for the next several years. As we reported in a previous press release, we recently completed an equity offering for 1,750,000 shares, which brought in capital of about $44m to the company. We used these funds to pay down our short-term debt that had been used to fund capital expenditures. And excess funds are being used for these planned capital expenditures that I mentioned.

In the next two weeks we expect to complete two refinancing transactions for $20m each to further reduce our interest costs. This will complete our refinancing program that in total was for $100m out of our $270m in long-term debt. The total savings from the refinancing program will be approximately $2m on an annual basis. Now I’d like to turn it back over to Pete.

Thanks Dick. As everyone knows, California has a new Governor Elect, Arnold Schwarzenegger. And he will be taking office once the election is certified, which we expect to happen some time next month. My most frequently asked question is what impact will the new Governor have on the California Public Utilities Commission and rate making in California. And here is the impact.

California has five Public Utility Commissioners. And each one is appointed by the Governor. In fact, the Governor also names which of the five will be president of the Commission. Each of the five serves a six year term. And two of those Commissioners’ terms are expiring the end of 2004, Commissioner Lynch and Commissioner Wood.

We expect the Governor to make appointments to those two seats at that time, which is the end of 2004. And that really is the only expected impact we can see of the new Governor on the California Public Utilities Commission and rate making in California. Back to Dick.

Okay. Last comment is to reemphasize what was in the press release. The Board approved a dividend of 28-1/8 cent per share for common shareholders. The date of record is October 31. And the payment date is November 14. As we’ve noted in previous calls, we have a very long history of paying dividends. We have paid consecutive dividends since 1944. And we have increased the annual dividend every year for the past 36 years.

Now with that, I’d like to turn it back over to our moderator, and open it up for questions.

Thank you. (Caller instructions.) And our first question comes from Neil Kalton of A.G. Edwards. Please go ahead sir.

Good afternoon. Thanks for the rate discussion. Very helpful. Just to follow-up, would you guys care to take a guess as to when you think the pending General Rate Cases might be decided by the Commission? Are we talking Summer ’04, or a little bit later?

As you might guess, we have a real difficult time estimating when decisions will be made. We are working very hard with the Commission in getting decisions out on a timely basis. And we’re working on the 2002 Rate Case now, and going through that process.

Things do seem to be accelerating since receiving the 2001 General Rate Case filing. But Neil, for me to predict exactly when those are going to happen, it’s kind of a coin toss. And obviously I feel uncomfortable giving you a date on that. We do expect it to be much faster than the 2001 rate case. We think that was an anomaly. And we do expect the commission to get back towards their more normal cycle, which was around a 12 month decision cycle. But again, that’s a guideline, not an absolute in the equation.

Okay. And a second question – it’s just a housekeeping. You mentioned the water production mix in the third quarter being about 53% well and 45% purchase. Do you have that data for third quarter of 2002?

Yes I do. Let me get that. And if there is another question, then I’ll answer that at the tail end here Neil.

Okay. Thanks.

Thank you. And that is currently the only question that we have at this time.

Neil, you wanted the breakdown between wells and purchase water? I’m sorry, I don’t think you can hear me. This is for California Water Service Company, our California operations. And for 2002, purchase water was about 45%. Wells was about 54%. And surface water rounded up is about 1%. So hopefully that answers your question. If not, ring in again.

Thank you. (Caller instructions.) One moment for any further questions. And our next question comes from [Salmon Ocoyo] of [Stiefel Nichols]. Please go ahead.

Thank you. I also appreciated the rate-based discussion. A couple quick questions. First of all, could you go over again on the $3.2m that you received, you said 20 days in this quarter was in effect, and how much revenue that generated for you?

Okay. That generated about $1.2m in revenue for the 20 days. And that includes both the impact of the 12.8 annual number, and the amount related to that catch-up, the $5m annual number that Pete talked about. And that was effective on September 9. So we got approximately 20 days of revenue for both those components. Again, the $5m we’ll collect over 12 months. But that’s more of a one-time item, where the $12.8m will be in our base revenue number. Does that make sense?

It does. Maybe I’m just doing something wrong here. But if I look at it real simplistically, and I just divide it out by 365 days, and multiply it by 20, I’m not quite coming up to that 1.2.

The math won’t work. It’s kind of two different maths on the pieces. And also, on the 12.8, it’s related to the volumes that we have for the month. So there is seasonality in the equation.

Okay. Thank you.

Go ahead.

Then also, what was your cap ex number in the quarter?

Four – we did about $40m through the nine months. And it was approximately $32m for the first six months. So it would be approximately $8m.

Eight million dollars. Okay.

I am excluding the developer funded capital expenditures, because those are pretty much cash neutral.

All right. And then does that – when you forecasted the sort of $60m going forward, does that also exclude developers too?

Yes. That’s company funded capital expenditures.

All right. Thank you very much.

Thank you. And that was all we currently have for questions at this time. I would like to take an opportunity to leave the replay information, for those of you wishing to call in and listen to this conference again. For those dialing toll numbers, it would be (703) 326-3020, with a replay code of 266638. For those dialing in our toll free lines, the number is 1-800-615-3210, with the same replay code of 266638.

I would now like to turn the conference back over to your host for any further comments that they may have.

Thank you very much [Chris]. I just wanted to say Pete and I would like to thank everyone for your time in listening to our report for California Water Service Group, and to have a great day. Thanks everyone. Bye-bye.

Ladies and gentlemen, thank you for your participate in today’s conference. And this concludes your conference. You may disconnect at this time, and have a good day.