California Water Service Group (CWT) 2004 Q2 法說會逐字稿

Good day ladies and gentlemen. Welcome to California Water Service Group 2004 second quarter earnings results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer sessions. Instructions will be given at that time. If anyone should require assistance during the call, please press star then zero. As a reminder, this conference call is being recorded. Introducing your hosts from California Water Service Group, Mr. Richard Nye, Vice-President, Chief Financial Officer and Treasurer and Mr. Pete Nelson, President and Chief Executive Officer. Gentlemen, you may begin.

Great. Thank you Jim. Good afternoon everyone. Welcome to the earnings call. Today we will be discussing the second quarter results for Cal Water. We will also be providing an update on several other items including our rate case filings, capital expenditures, our financing plans, water supply, and the dividend recently approved by the broad. Then we'll open it up for questions from our 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 website at www.calwatergroup.com or via the wire services available off several avenues.

With that, I'd like to make some comments on our financial results for the second quarter. Revenue was up substantially. It increased $20.9m or 31% over the same period last year. The cause of change for the revenue increases were 9.7 million increase due to rates, 9.5 million due to increased usage of our current customers, and 1.7 million of increased revenue from new customers. On the usage front, the weather for second quarter was very favorable to us from a business standpoint compared to last year. Rainfall was much lower. That drier weather increased our water production substantially, which increases our water sales.

On the rates, let me give you some of the major components that are within that $9.7m. About $5.6m of the increase came from general rate case filings and for step rate increases. About 1.5 million came from purchased water offset increases, 1.2 million from what is called an advice letter that was filed for our Bakersfield treatment plants-actually that is several advice letters. There is 1.3 million for the catch-up component related to the 2001 general rate case. That surcharge for the catch-up component will last until about mid September of 2004. Then there were some other minor items making up the full difference. Those are the major variances on the revenue side.

Now let me talk about the cost side for a little bit. Overall our operating expenses increased 24%, increasing $14.3m. The major components are listed on our P&L. One line on there is called operations expense. Included in there is our water production cost and general operating expenses. The biggest component is water production cost. They are up about $7.3m or 28%. That is primarily due to increases in our purchased water. Our overall usage was up about 18% for the quarter. Where our water comes from is a mixture between what is purchased, well production, and surface water. For our subsidiaries outside of California - Washington, New Mexico, and Hawaii - all their water comes from wells.

I am going to talk about just the California water supply, which is the lion's share of the business. Our purchased water was about 48% of our production, which is the same percentage of the total amount compared to the second quarter of last year. The water that we get from wells was 48% of the total. That is down from 51% from the quarter of last year. The water that we get from surface sources was 4%. That is up from 1% from last year.

The other component of our operations costs-I'll just call them general operating costs - were up about $2.4m or 12%. One component was payroll that is charged to operations. It increased about 8% or $600,000. Our medical costs were up fairly substantially. That is medical for both current employees and retirees. It increased about $400,000, or an increase of 19%. We saw increases in costs for water treatment and water quality, increasing 32% or $300,000. We also had a big increase in the quarter for our workers' compensation, which increased about $400,000. Then costs related to regulatory items, mainly the fee that we paid to the California Public Utility Commission increased about $300,000 or 30%. That is a function of the revenue increasing.

Moving down the P&L, you can see that maintenance cost is essentially flat-actually down a little bit from the prior period. Depreciation and amortization is up about $700,000 or 12%. That is due to our capital expenditures in 2003. A big component was our Bakersfield treatment plant that went into service in the middle of 2003. That is increasing our depreciation costs. Federal and state income taxes are up due to the large increase in pre-tax incomes. It has increased about 3.5 million. The effective tax rate for the quarter was about 41% and year-to-date it's about 40%, which is both state and federal. Then on the other line, property and other taxes, which includes the property, payroll taxes, and franchise taxes - it's up about 400,000 or about 15%. A big component of that is the increases in our property. That increases our tax base. That is from our capital expenditure program.

On gains from property sales, we did not have any within the quarter. Last year we had about $1m in gains from property sales. On our interest costs, the net interest cost is up above the prior year. This is principally due to interest that is capitalized for our construction in progress capital expenditures. Last year the Bakersfield treatment plant was a construction in progress through a good part of the year. We don't have that in 2004. That lowers the credit that we receive on capitalized interest. On just the pure interest, the long-term and short-term interest costs, that is actually down from last year due to the lower borrowings on our short-term credit facilities and also lower interest costs on our long-term debt.

In summary, our net income more than doubled compared to prior year. Our diluted earnings per share was 59 cents for the quarter compared to 30 cents - nearly double. It doesn't have quite the same relationship as the net income due to a stock offering that was done in August of 2003. Obviously we are very pleased with our results for the second quarter.

For the six months, the story line is about the same thing as what's happened in the second quarter. I am not going to go through and repeat everything, but just give you the highlights through the six months ended June. Revenue is up close to $30m, up 25%. That increase comes about-60% of the increase comes from increases from rates. 30% is increases due to usage and 10% from new customers. Our net income is triple over that same timeframe over last year. Diluted earnings per share was 67 cents per share compared to 25 cents per share, up a factor of about 2.5 times.

That's the financial results for the quarter and for the six months. Now I'd like to turn it over to Pete Nelson.

Thanks very much Dick. I am going to cover the regulatory matters part of the conference call today. I'll break this into three pieces. First, some overall comments about the regulatory situation in California. Second I'll talk about our most recent rate decision, which just happened this month. Third, I'll look ahead to two significant rate cases we have and one other that is more routine.

First, the overall regulatory picture in California. As most people know, we've been through a very difficult regulatory environment here. All the water companies have for the last three years. For us in late 2003, we were finally granted rate relief of a major filing we had made way back in the middle of 2001. In fact, some of those costs that we were asking for recovery in that 2001 filing were electric cost increases from the electric crisis in California back in April 2001. For us that, what I call logjam, of backed up rate relief was finally broken through in late 2003. As Dick mentioned that is finally being reflected on our financial results here in 2004.

Moving to our most recent rate decision would be our 2001 general rate case for our Salinas district. We were granted $1.1m in additional annual revenue. This rate case was important for a couple reasons. One is long, of course, the long overdue $1.1m in additional revenue. That goes back to 2001 filing. Also important is that this rate case put to bed the exposure we had to a potential fine from the California Public Utilities Commission. That potential fine was for failing to file some administrative reports advising the Commission of three small acquisitions that we did make back in the late 1990s. You may recall that The Office of Ratepayer Advocates, which is an arm of the California Public Utilities Commission staff had recommended that we be fined $9.6m for failure to file these administrative reports. That was seen by many people as a ridiculous proposed fine and reflective of the regulatory environment in California. Nonetheless we finally have a decision in that rate case. That fine has now been levied on us. The fine is in two pieces. One is a $75,000 fine, which we booked in the second quarter. That is included in the results. The second part of the fine is a 50-basis-point reduction in the allowed rate of return on equity for the Salinas district. I'll note that the 50-basis-point penalty on allowed ROE will be in place until the next general rate case for Salinas is in place. We will be filing that Salinas district rate case this September. We expect our 2004 Salinas general rates to take about a year before that case is processed and new rate of return on equity and rates are in place, which is a long way to say that we expect that 50-basis-point penalty in that one district of ours to be in effect for about one year.

Looking ahead, we have two significant cases and then one more routine case on the horizon. The first is a significant rate case, which is our balancing account recovery to recover purchased water, purchased power for producing water and pump taxes. This is a balancing account recovery for the 2002 and 2003 periods. The total recovery is $7.9m. We do expect a decision shortly. There is no controversy with the Commission staff on the number or the timing. The recovery of the $7.9m is reflective of several districts. That $7.9m will be collected incrementally over the next 12 to 24 months. Once we have a decision we can give you more detail about the specific recovery timing.

The next rate case that we are expecting shortly is our 2003 general rate case, which is a smaller rate case. That is only a net increase of about $300,000 in annual revenue. As I mentioned, we expect that decision shortly too.

Lastly, our next filing coming up is our 2004 general rate case, which we will be filing in September this year. This will be for about a third of our districts, but it will cover more than 40% of our customer base and our general office, which is all the corporate engineering, water quality-all the common costs. I can't give you a number yet for that filing because it hasn't filed yet, obviously. That number will be made public when it's at the proper time.

In summary, for us three-year logjam rate relief has finally been broken through. The '04 results are reflecting the rate relief that has been long overdue. Our exposure to a potential fine in Salinas district has been cleared up and is behind us. We're looking ahead to some decisions shortly and also to a major general rate case being filed this September.

I think with that I'll turn it back to Dick.

Thanks Pete. Now I'd like to talk a little bit about our capital spending and financing plans. Our capital expenditures through the six-month period ended in June for company-funded capital expenditures was about $21.4m. That compares to $32.2m for the six-month period last year. The budget for the total year is $65.8m. We are running a little behind on some of our projects in the water quality/water treatment area. We may not get the design and get the projects implemented in this year. Some funds may spill over to next year as far as when we actually spend the money or cash goes out the door. We're still planning on executing against all those projects. Over the next timeframe, we're still at the same opinion that the capital expenditure will be somewhere in the range around $70m to $80m per year for the next five years still. Still a very high level of capital expenditure that we see on the horizon.

Now for our financing plan, in June of this year we did a common stock offering and issued approximately 1.4 million shares. That was in increase in our shares of about 8% and provided approximately $37m of cash after expenses to the company. That brings our ratio for equity as compared to our equity and long-term debt at 51% of equity, which is good for business because the higher equity component means that's a higher rate of return than we earn off of our capital expenditures. We used the cash that we received from the equity offering to pay down short-term debt. We also have a fair amount of cash on hand as of today. At the end of June it was about $24m. We'll utilize that cash for our capital expenditure program between now and the end of the year. I don't expect us to do any more financing between now and the end of the year. If we need to do a little bit, we'll just borrow off our credit facility as we need to.

As I mentioned, we were able to pay down all of our current lines. That gives us a very high liquidity. In addition to the cash we have pretty much full access to both of our credit facilities, which is $45m for the California Water Service subsidiary. There is a $10m facility for all the other subsidiaries. For 2005 right now the plan is to utilize long-term debt for our financing needs. Beyond 2005 we'll have a fairly balanced approach by using debt and common stock to fund the cash that is needed for our capital expenditure program that cannot be funded with internal funds.

On the acquisition front, we did close on one small acquisition that was previously announced - National Utility Company in New Mexico. That was closed in May. The purchase price was about $1m for that acquisition.

Now I'd like to turn it back over to Pete who will talk about water supply.

This is our last subject for today. I will talk about water supply. I'll talk about this for our California systems. We've included this in the conference call today for a couple reasons. One is, for some reason supply and the word drought tend to be a media magnet word, especially in California where there are photographs of lakes and rivers. The word drought comes up all the time. There is always a debate in the winter and spring about - is this a drought year? Is this not a drought year? It's a big subject for the media in California and across the country.

The second reason this is probably the most frequently asked question of Dick and me - what is the supply situation for California today, tomorrow, and looking out into the future? Oddly enough, this is not a subject-the supply in California-not a subject that causes me to lose any sleep at night. That is a disconnect.

I'll talk about first where our water comes from-what is our source of supply in California, and then talk about the current situation and then end with talking about the Colorado River Basin. That seems to be the subject of the most media attention in the last few months.

Beginning with where we get our water. Keep in mind, Cal Water serves pretty much the entire state of California. We have districts in the Central Valley, in the Bay area, in the Salinas Valley and Los Angeles basin. We pretty much serve the entire state. There are only two sources of water supply. We are split about 50/50 as Dick mentioned earlier. The first source is ground water, which is aquifers under the ground. We have our own wells. We operate our own wells, pump water out of the ground, treat it, put it into our system. That's about half our supply. The other half is called surface water. This would be water in lakes and streams that stays on the surface. This is about half our supply too. We get this surface water either from treatment plants that we own, like in Bakersfield or more significantly water we purchase from either the Hechechi [ph] system from San Francisco or from the Metropolitan Water District in southern California who is a huge player in the state water supply.

The Metropolitan Water District-I'll refer to them as The Met from now on - they have a diverse supply of sources. They take water from in-state. They also take water from the Colorado River. They have a very diverse supply mix. In fact, we, California Water, has a very diverse supply mix too. We're not dependent on one source or another. We do a good job of mixing up the supply of sources-having diversity there. Each of our 24 operating districts has a 20-year supply plan. As we look out 20 years, when we see the potential for demand exceeding supply, we'll plan for that and secure more supply in one way or another, depending on the district. I am going to give you a couple of statistics. Here is the first one. This is important for California. In California 80% of the water that is used is used by the agricultural community or the environment. That is important to keep in mind.

So, how does the supply look in California? Last year was a wet year. It showed up in our results. This year the water supply, water precipitation has been a fairly normal year, depending on the part of the state you are in. Our aquifers are in good shape. In fact, it takes a sustained two-to-three year major drought-two or three years in a row to have any impact on our aquifers. In California you probably realize that a drought is not an unusual event. It's not a crisis. We've been through at least two significant droughts - the 1988 to '91 drought. There was drought in the late 1970s. We and our suppliers and our regulators have been through droughts in the past. They are planned for. They are accommodated in our supply planning and our regulatory schemes.

Now moving to the Colorado River Basin, which has probably got the most publicity. This where there has been a drought and there is a drought in the Colorado River Basin. This is one of the supply sources for the Metropolitan Water District, the California aqueduct coming from the Colorado River. Here is my second statistic. This is, of all the water that leaves the Colorado River bound for California through the aqueduct, 70% of that water stops in the Imperial Valley and is used for farming. That leaves 30% coming through the pipeline to the southern part of the state to be used for retail water suppliers-tap water suppliers like us. You can probably imagine that this creates an opportunity. There have been arrangements most recently set up between the farmers in the Imperial Valley and the retailers in the southern part of the state where the farmers will reduce their take of the river water and essentially sell the water that they are not using for farming to Southern California, principally San Diego at the moment.

In my observation The Metropolitan Water District has done an excellent job planning to take less water from the Colorado River. The Met's planning horizon is 50 years out. They have a mix of sources, as I mentioned, and have been very effective at planning and building storage, having conjunctive use programs to mix ground water and surface water, securing more sources of supply. There is no indication from The Met that there is going to be any interruption in the supply. So, very impressed with the Metropolitan Water District.

In conclusion, each of our operating districts has a 20-year supply plan that looks out. Currently our aquifers look very good. Metropolitan is very effective at planning and building supply sources and conveyance systems. There have been sustained droughts. That is something that has happened in California in the past. The retailers, the wholesalers, and the Commission-the California Public Utilities Commission all have experience here and, with the last two droughts that we've seen, have moved to treat the water utilities fairly through those periods.

I think that wraps up the water supply. I think I'll go back to Dick before we take questions.

OK. Just one final comment. The board did approve a dividend of 28.25 cents, which gives a yield of about 4.1% at our current stock price level, which is we believe a very attractive yield, especially considering the 15% maximum tax rate on dividends.

With that, I'd like to turn it over to our moderator and open it up for questions.

Ladies and gentlemen, if you wish to ask a question, please press the one key on your telephone keypad. You may remove yourself from the question queue at any time by pressing the pound key. If you are using a speakerphone, please lift the handset before asking your question. Once again if you have a question please press the one key at this time. Our first question comes from David Schanzer with Janney Montgomery Scott. Your question please.

Good afternoon. Congratulations on a really strong quarter. I was curious. You mentioned a small increase in surface water from about 1% to 4% of your supply. Could you talk about the opportunity for-I realize that is probably not where you are going. To what extent can you rely on additional acquisitions of surface water? What is the highest percent you could ever get, do you think?

I guess I'll take that. I think the increase probably is a result of our Bakersfield's treatment plant, which is a surface water plant, which is now in operation. I think that will be the----

Do you think that's the limit?

Oh, no. That plant is operating at about one-third its rate of capacity.

That's what I was getting at. How much further do you think that plant can go to supplying your needs?

That plant, of course, serves the Bakersfield district, operating now at about 20 million gallons a day. Its rated capacity and our water supply arrangements with the supplier there, which is the City of Bakersfield for the river water would allow that to go from 20 million gallons a day to 60 million gallons a day.

OK. OK, great. Second question has to do with that settlement of the Salinas case. I realize it's relatively small. Could give us some idea of what a 50-basis-point penalty on ROE translates to in terms of earnings for the company on an annual basis?

Yes. Ballpark number, that translates to about $100,000 of pre-tax earnings. So, not a real big number for us.

Yes, that's right. Lastly, you've talked a little bit about water supply and this subject, I guess in inherent in it. Could you talk a little bit about particularly with the renewed focus on arsenic and perchlorate and nitrates and stuff, where do you stand on that? Give us some color as to costs and what your plans are going forward.

I'll start on that. Arsenic is the next significant contaminant we need to treat by the year 2006. I think I'll defer to Dick on the total amount of capital that we expect to spend. I think it's about $20m or $25m to treat that contaminate. The capital costs and treatment costs to do that have been included in our rate cases. Either they are or they will be included in the 2004 general rate case filings. So we fully expect to have rate recovery-or rates to cover the capital and treatment costs for arsenic in the future. We do occasionally have wells-because we have 100s of wells in the system - that do meet a contaminant that exceeds the standard. Of course, we turn it off before it ever gets in the distribution system and then find other sources of supply more or for treatment to remove the contaminant. It's a difficult question to answer. I think the big issue for us is arsenic. That is fully in our rate case filings. We expect that to be recovered.

Just to add onto that. We are seeing some increases in our operating costs due to water treatment and water quality issues. It's not a significant part of our cost component. As I mentioned, just for the quarter our water treatment/water quality costs went up about 32%. As far as being in the grand scheme of things, our total water treatment costs - it runs at a ballpark guess maybe around $2m a quarter. Even if that is increasing, it's not a huge part of our cost structure. I think we will continue to see some operating costs go up for that for the additional chemicals that we have to do and additional labor that is involved with the treatment of contaminants.

Right. Is it environmentally acceptable in most of the jurisdictions in which you operate to blend water that has perhaps a little bit higher arsenic parts per billion than the standards at the state level require with water that has significantly less than that part. I guess in California now it's going to be 5 parts per billion. Can you do any blending?

That's a long question. The short answer is yes. Of course, we work with the California Department of Health Services to make sure that whatever treatment and supply that we have is approved by them. We always work with the health officials to make sure that whatever supply source is, meets standard.

In looking at the problem, are any wells-or any significant number of wells is a better question - identified for closure permanently because of this?

Because of arsenic?

Yes, or any other contaminants.

I am going to have to call you back on that. I don't think we have any wells that are scheduled to be closed or shut down and retired because of arsenic. It is a treatment issue rather than a supply issue.

OK. Lastly on that same generic subject, if we put arsenic aside and we put all other things as a category, would that materially increase quarterly cap ex that you are looking at for just taking care of bad stuff in the water?

Let me answer first of all for general. Then I'll have Dick talk about the financial part of it. I think the best example for us is our Salinas district, which is a heavily agricultural area. In the last year or two we've seen a fairly significant number of those wells exceed standard for some contaminant. It's a variety of things, actually. We were able to approach the California Public Utilities Commission and establish a memorandum account to capture the costs of additional treatment and additional well supply for ultimate recovery so we're made whole on those. I think looking at our system in California, probably Salinas is the area that we spend the most time on as far as fairly large-scale supply and treatment. That changes regularly. It's not one thing. There is not nitrates. It's a whole variety of things in that valley.

Leeching into the water?

Basically, yes. Some of it is naturally occurring.

One other question just popped into my mind. Has there been any attempt to finance the removal of the stuff with capital equipment that you would use, let's say, industrial revenue bonds-pollution control bonds for?

The answer to your question is no. We really haven't pursued those avenues as far as getting revenue bonds to help in that area.

OK, great. Thanks a lot.

If there are any further questions, please press the one key on your telephone keypad at this time. We have a question from Selman Akyol with Stifel Nicolaus. Your question please.

Thank you. I know in terms of your upcoming filings, you didn't want to talk about numbers at all. Would it be reasonable to expect or think that they might be somewhere along the lines of the impact or magnitude from the 2001 general rate case?

I guess I'll say-I'll just compare the two rate cases. 2001 was-we filed 15 districts plus our general office. This time we're filing eight districts, although they are larger districts than average, plus our general office. I don't have the number yet on the total.

Thank you very much.

If there are any further questions, please press the one key on your telephone keypad. At this time I show no further questions.

OK, well great. Thank you everybody for your time this afternoon in listening to our report. The next teleconference is scheduled for October 28. If you will, check our website at www.calwatergroup.com to confirm the date and time. There is also a reminder service you can subscribe to if you so choose. Again, thank you very much for listening to the report. Have a very good day. Bye-bye.

Thank you ladies and gentlemen. This does conclude the conference call. You may now disconnect.