California Water Service Group (CWT) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your California Water Service Group earnings call for the third quarter of 2004. (OPERATOR INSTRUCTIONS). I would now like to introduce your host for today's conference, Mr. Dick Nye, Chief Financial Officer, and Mr. Bob Foy, Chairman of the Board. Mr. Nye, you may begin.

Thank you very much. Good afternoon, everyone, and welcome to the earnings call for California Water Service Group. Again, my name is Dick Nye, and joining me today is Bob Foy, Chairman of the Board. Today we will be discussing the third-quarter results for Cal Water. We will also be providing an update on several other items such as our rate case filings, capital expenditures, our financing plans, some information on the water industry, and the dividend that was approved by the board. Then we will open it up for questions from analysts.

But 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 law 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 at www.calwater.com.

So with that, I would like to talk about our third-quarter results. Revenue was up about $8.9 million, which is an increase of 10 percent. That increase is driven entirely by increases in rates, which was an increase of 9.9 million. Our usage from new customers was an increase of about $1.3 million, but offsetting that we saw usage from existing customers being down from last year's third quarter by about $2.3 million. So net on usage is about $1 million between new customers and existing customers.

Let me give you some breakdown on the $9.9 million in rates because it has got several components and I know causes some challenges for the analysts to figure out where we are at. 3.2 million came from the 2001 general rate case or GRC. 1.7 million was from the 2002 general rate case. I'm sorry, that was 1.7 for the 2002 general rate case. 1.6 million is from our purchase water offset. 1.4 million is for step rate increases. 1.3 million is for the Bakersfield Treatment Plant. 1.1 million is the 2001 GRC catch-up. About 200,000 for Hawthorne and then a negative 700,000 for balancing accounts.

One thing I would like to point out is we're reaching the stage where we're starting to overlap some of these rate increases, so that when we get to the fourth quarter we are not going to be seeing such hefty increases of what we have had in the third. Such as the 2001 general rate case was effective in September of 2003, so we will be overlapping those rates once we get to the fourth quarter. The 2001 general rate case catch-up amount was a surcharge that ended in September of this year, so that revenue will actually be going away or a reduction in revenue in the fourth quarter. And then we've got other changes as some of these rates start falling off. So just to let people know that there will be a pretty significant change in the fourth quarter.

On our operating costs, they are up about $6.9 million or 9 percent. And let me talk about the components on those for a little bit. Our water production cost is up 3 percent, which is about 1.3 million, and that is primarily due to increases in purchase water rate increases. So even though we had lower usage, our water production cost was actually up for the quarter.

On the breakdown of where the water comes from, about 46 percent was from purchased water. That is flat to last year. 50 percent was from wells, and that is down from 52 percent in the third quarter of 2003. And then our surface water was 4 percent of the total, and that is up from 2 percent from the prior year.

Other costs in the operations cost number is our payroll changes our payroll to operation increased about 7 percent or about $600,000. We also saw some cost increases in medical costs and workers compensation claims. Those were 500,000 and 400,000 respectively.

For those two programs, we are self-insured. So as we have large claims that come in, it does cause some cost spikes to our P&L. We do have stop loss programs, but very few of use reach those levels where the stop losses kick in.

We also see an increased costs in outside services which was primarily related to compliance with Sarbanes-Oxley Section 404, which is regarding internal controls. And then there were some other increases in cost for regulatory fees, which is related to the increase in revenue.

Our maintenance cost is up about $500,000 or 15 percent from the prior year. Depreciation and amortization is up about $700,000 or 12 percent, and that is due to our capital expenditures in 2003, primarily the Bakersfield Treatment Plant. And the depreciation on that plant started in January of 2004, which is consistent with our accounting policies on when we do depreciation, even though that plant started in operation at the tail end of the second quarter of 2003.

A big cost increase, which is actually a good one, is on our income taxes. They are up 26 percent, $1.5 million, due to the increase in taxable income. And then we also saw increases in other taxes, which is primarily property taxes and franchise which is up $300,000 or 9 percent.

There were no gains to speak of from property sales in either period. Another item I would like to point out, last year in the fourth quarter we had some very large gains in property sales, and right now we really don't have anyones that are I would call active that is going on for right now. Our nonregulated pretax income is basically flat between the two periods. Interest expense is lower by about $200,000, primarily due to lower short-term borrowings in the quarter.

So to summarize, our net income is up 26 percent from last year for the quarter. Earnings per share is up about 11 percent, and that is due to having about 13 percent more shares outstanding.

Then I am going to give just a real quick summary on the nine-months results. Our revenue is up 38.7 million or 19 percent. That 19 percent growth breaks down as follows. About 13 percent growth comes from increases in rates, about 4 percent of the growth is for usage, and about 2 percent of the growth is for new customers. Our net income for the nine-month period is up about 80 percent over last year, and our diluted earnings per share is $1.27 compared to 79 cents per share, which is up about 60 percent from the prior year.

Now I'm going to turn it over to Bob Foy who is going to talk a little bit on some regulatory matters.

Thanks, Dick. Good afternoon, ladies and gentlemen. The California Public Utilities Commission, also known as the CPUC, has five commissioners. On December 31, 2004, the term for two of these commissioners will expire. These two commissioners -- Loretta Lynch and Carl Wood -- have not made in my opinion balanced decisions during their terms. A balanced CPUC also in my opinion must do two things.

First, it must protect consumers by setting reasonable rates. Second and equally important, it must enable utilities to provide vital services by allowing acceptable rates of return and issue timely rate decisions. Governor Arnold Schwarzenegger will have a major impact on our company and all California utilities by means of his appointment of replacements for these two commissioners. After the Governor makes his appointments, the California Senate has up to one year to confirm or deny them. The two new appointees will serve terms of six years each and are allowed full voting powers while the confirmation process takes place. To date there have been no public announcements as to which candidates are being considered, but we are optimistic and very confident that any appointments Governor Schwarzenegger makes will be an improvement.

In early 2003 the Office of Ratepayer Advocates, which is part of the staff at the PUC, determined that Cal Water failed to report three small acquisitions, although the systems which caused the issue cost us less than $200,000 and had a total input of 375 customers. The ORA in their wisdom proposed a $10 million fine using the convoluted logic that every bill sent to every customer every month should be assessed a fine. We believe this proposed fine was extremely unreasonable for several reasons.

First, failing to report the acquisitions was simply an inadvertent administrative error. Second, the new customers wanted to be served by Cal Water, and we in turn continued to charge the same water rates they had paid to the previous owners. Third, we immediately improved the services that we provided to these customers. And fourth, the commissioner has been encouraging us, our Company, to purchase small systems because many are not able to comply with increasingly stringent water quality standards.

After negotiating this issue for 18 months, we were able to reach a resolution. The penalty was a fine of $75,000 and a one-year reduction of 50 basis points for the return on equity for one of our districts, which we calculate to be approximately $100,000. We believe this penalty is still high, but we have decided that it is to our best interest not to appeal the decision because in doing so we would further delay our rate case in that affected district. This matter is now officially closed.

Okay, Richard. Back to you.

Okay. Thanks a lot, Bob. Now I would like to cover our recent rate filings, both what has been approved and what is pending. These are ones that have been approved in the last quarter and the third quarter.

We received a decision on our Salinas district that was for about $1.1 million. The 2003 general rate case, which had two districts in it, has a net $400,000 impact, and these are annual numbers I'm giving you. The Los Altos district we received a decision on an advice letter which was related to pump taxes and that was for about $500,000 annual number. And then we received a decision on balancing accounts for approximately $4.1 million.

That balancing accounts, it differs by district. It will be collected between -- on some districts it will be on a 12-month period. On other districts, it will be on a 24-month period. And then there is one district that is a 36-month period that is in that number. So it's a little complicated on sorting out. But basically we will be collecting that money over a 12 to 24-month period.

So those are the ones that have been recently approved. The really good news is that we are basically all caught up on our rate filings, and rates department has been working extremely hard to get through the backlog.

We do have balancing accounts related to three districts for 3.6 million that is pending. We have a few data requests for issues we have to work out on that, but I think we can get resolved -- those issues resolved in the next two months here. We have recently filed our 2004 general rate case, and I need to give lots of caveats with this number I'm going to provide.

The total number is 26.5 million. That is the amount that we filed, and in the past history has shown that we have not received the total amount that we have asked for. I cannot predict what that amount is going to be, but that is the amount that we have had filed.

We also have filings in two of our subsidiaries -- New Mexico and Hawaii. While those filings are not going to be real large numbers to the company, we do have those in process for right now.

So with that, I am going to turn it back over to Bob to cover a couple of other items that are germane for the water industry for those folks that maybe are not quite up to speed on some particulars.

Thank you. In January 2006, as many of you have realized, the Environmental Protection Agency's, EPA, limit for arsenic will change from 50 parts per billion to 10 parts per billion. We have been working towards compliance with this EPA regulation and feel very confident we will meet the standard. Currently only four out of our 24 districts have arsenic issues that need to be addressed.

Our approach has been to identify the most efficient means of meeting the standard in each district. Doing so will require a combination of blending water supplies, securing new sources of supply, and treating existing supplies. We estimate the capital cost compliance to around $25 million. We expect to recover these costs in current and future rates.

And now to another significant subject that I thought was important to reaffirm with you. The California Supreme Court ruling in Hartwell versus Superior Court in 2002 provides Cal Water and other California investor-owned water utilities a Safe Harbor from water quality lawsuits in which the plaintiff claims he or she has been harmed despite the fact that the utility has met all water quality standards. Hartwell does not apply, and this is very significant, Hartwell does not apply to municipal water suppliers because muni water suppliers are not regulated by the CPUC. The court relied upon Section 1759-A of the Public Utilities Code. The court reasoned that lawsuits cannot undermine the policies of the CPUC or interfere with the CPUC's performance of its duties.

The Public Utilities Commission in partnership with the California Department of Health services enforces state drinking water standards. The court noted that state drinking water standards are an integral part of the CPU's broad and continuing program of regulating water utilities. This is certainly a very very significant liability protection unique for California investor-owned water utilities. Your turn, Dick.

Thanks, Bob. Now I would like to talk a little bit about our capital projects and our financing plans. For capital expenditures, our year-to-date spending through the nine months is $36 million. That compares to last year's nine-month number of 39.8 million. Our budget for the year for 2004 is $65.8 million for capital expenditures, so you can see that we are not really spending quite up to that level.

There is a lag between when we actually get pipes in the ground and tanks in place of when the dollars come in, but looking at the rate that we have been doing and also knowledge of some projects, it looks like we want spend up to that budget level in 2004. It is probably going to be, my estimate is somewhere between $55 and $60 million on actual cash that goes out the door.

For 2005 that is going to be a much higher year for us, principally due to the arsenic rule that Bob had mentioned. We are going through our budget process right now, but it looks like we're going to be budgeting somewhere between $80, $85 million for the year 2005. And then capital spending for the next five years, our estimate is somewhere between the $60 million and $70 million range.

For the balance of 2004, as far as financing needs go, I don't expect any financing that we will need to do. If you notice on the balance sheet, there is about $31 million of cash that we have, and that should be plenty sufficient to fund our capital expenditures and our cash needs for the balance of the year.

For 2005 we are estimating that we will require financing to front the capital expenditures, and the funds that we will need are going to be -- we are estimating between $20 to $40 million of additional long-term debt that will need to be placed. Right now I cannot give a good estimate on the exact timing of that, and it will really will be dependent on the timing of our capital expenditures. After 2005 the financing that we will need to do, we plan on having an equal split between debt and equity and doing a 50-50 ratio for those years after 2005.

And now I would like to turn it back to Bob one more time so he can cover off on a couple more issues we would like to cover.

I like the term one more time, that is good news. (multiple speakers) Thanks, Richard. Over the past four months the city of Selma, a city located in the ever-growing California Silicon Valley, had indicated their intent to purchase from Cal Water our Selma water franchise operation. At a public hearing on October 18, 2004, last week to be exact, the Selma City Council voted unanimously not to adopt a resolution of necessity, thus abandoning its efforts to take over the company's water system. Hundreds of customers wrote, telephoned and attended the hearing to speak on behalf of the company. We are extremely pleased to receive such overwhelming customer support and will work to build a stronger relationship with the city government in Selma.

Plus, this indicates that other cities up and down the state of California that customers respect investor-owned water utilities and prefer them over municipal water distributors.

You know, sometimes during these analyst teleconferences we can get pretty darn serious in presenting facts about our company and facts about the issues that affect us. For a change of pace, let me share with you an interesting sidelight about this life sustaining substance that we provide our customers throughout California, Washington, New Mexico and Hawaii.

Here goes. The average charge for 1 gallon of Cal Water is 1/5 of a cent. Now if you compare that to 1 gallon of bottled water, their charge would be -- you ready for this -- $16. And on top of that the agencies that set our water standards are far more strict on us than the agencies that set the water standards for bottled water.

Now let us move on with my final bit of information this afternoon. At yesterday's Cal Water Board of Directors meeting, the directors declared a dividend of 28.25 cents per common share. It will be payable on November 19 to stockholders of record on November 8, 2004. This is the 59th year that Cal Water has paid dividends and it is the 37th consecutive year we have increased our dividend.

Okay. Let us go on to questions that are distinguished guests this afternoon might have. Ladies and gentlemen, questions please.

(OPERATOR INSTRUCTIONS). Jim Lykins. Hilliard Lyons.

I just wanted to make sure I have got something straight with your rate case filings. It is just the 1.1 million 2001 GRC that will drop off in Q4, or was there another one?

There is really another one. There is a 2001 GRC that, I would not say drops off, but stays in the revenue stream, so we want have a positive overlap. It will be equal. But the 2001 GRC catch-up, that is more of a surcharge. Surcharge goes away in the fourth quarter. Those are the ones that will have the biggest decrease.

There is also a couple of others -- the purchase water offset and the Bakersfield Treatment Plant. Those amounts will be lower in our first quarter because even though it sounds like there is one number, there is actually I would call them layers between on the advice letters. So some of those roll off or, I guess maybe roll off is the wrong word. More it gets into the overlap, so we will have an equal revenue between the quarters on some of those.

I know it is kind of confusing to try to figure that all out. But there's a lot of moving pieces on the rate side as you can tell.

And also with your operations expense as a percentage of revenue, there is about 190 basis points of improvement this quarter. Could you just make some comments on that?

Of improvement on operation expense?

As a percentage of revenue.

Okay. I normally don't look at it that way. You are saying our operation expense is lower as a percentage revenue?

Yes, it went from -- 66.2 to 64.3 percent.

That would be principally driven by the increases in rates in our revenue number. That would be driving a lower percentage there. So am I understanding your question correctly?

Yes.

Debra Coy. Schwab Capital Markets.

Good afternoon, Dick and Bob as well. Bob, first I wanted to tell us how you really feel about the two retiring commissioners at the CPUC?

Well, let me say this, at my home on December 31, it is not going to be a New Year's party, it is going to be a celebration of the changeover in San Francisco.

I think you are going to have a lot of company.

Yes, a lot of company from all the different utilities. Thanks for asking that question and let me spout off a little.

Actually what I wondered, you did say that there have been no announcements on who it will be yet. Do you have any -- are there any indications of even what sort of -- (multiple speakers) they are looking at in in terms of their background?

No public releases from the Governor's office in Sacramento. However, we have heard that there are a number of people that are interested in these two vacancies, upcoming vacancies, and that these people that are interested have excellent backgrounds as to objectively understanding PUC's interworkings. In fact, some people are so interested that they are actually running campaigns to get the appointment from the Governor.

I have so much respect relative to Governor Schwarzenegger that I really feel, and I have been told, that he feels that these two appointments are very very important for the future economic health of the state of California, and that he is going to be very careful in his appointments and we view this as very positive. So I think, and I might be so bold to anticipate, I think we will be pleased with two appointments that he will make.

When do you expect to know?

I have no idea.

It's not like it will be by December 31 necessarily. It could be after that?

I would think our Governor is a pretty aggressive guy, and I don't think that -- I think he wants to get the new people in on a timely basis because as soon as he makes the appointment, they take office on January 1, and as I mentioned here before, even though they have to be confirmed by our Senate, they can (multiple speakers)

They can go ahead and act .

Right off the bat.

Okay. Great. We will look forward to that.

We all will. Thanks, Debra.

I have another quick question regarding your reference to the upcoming arsenic deadline and the large CapEx that you're having to make. What I'm wondering is whether this might turn out to be a potential business opportunity for you. I presume that there's a lot of municipal governments that are also facing large capital expenditures and small private systems as well. Are you seeing some people that might be interested in turning over their systems as a result of not wanting to get involved in doing that kind of expenditures and whether that as an opportunity for you to expand?

That is a good entrepreneurial question. We are always looking out for areas of expansion, and because of the way our company is organized, 24 districts and we serve over 100 communities, we think of each one of these districts as a marketing area for us. And it is unique for Cal Water because we're spreadout so uniformly up and down the state. So we're watching very carefully.

And there could be -- right now, Debra, there could be some smaller municipalities or districts that could be become available. We have not heard to be very candid about any, but we are out there ever watchful.

If I could add on to that, we really have not been getting requests from municipalities. We are working very hard to make sure we are in compliance, and if I had to guess, I would think some of these municipalities are going to be out of compliance once we get to 2006 and then they may really have to decide how they are going to go solve their problem then.

That is right. It is usually the way it is.

Because they have got to start working on it. They really should have started working on it about a year or two ago to make the changes that is required on some of these systems. Because like for us, in a couple of our districts, we're having to lay a lot of mains to move water from one part of the city to another part of the city to mix it appropriately. It is not something you can put in overnight.

And you know that brings up -- Dick makes a good point -- and to second Dick's motion, interesting we get our rate relief investor-owned companies in California from the California Public Utilities Commission. Districts and municipalities have to get their rate increases by making decisions themselves and going (multiple speakers)

They have to go to city counsel or whatever.

It becomes very political, and I don't know a city counsel or a district board that wants to go to their customers and say, I'm sorry I have got to raise your rates. It's like a tax increase, and they are very hesitant in doing that. So to back up what Dick says, there could be some distribution entities that are not going to meet this January 1, 2006 EPA standard.

That usually seems to be the case with municipalities. Last question and then I will get off-line. On the rate cases, Richard, that you mentioned, the large $26 million filing with "lots of caveats," am I remembering correctly that a reasonable expectation would be somewhere in the 40 percent of that range? Sort of in the ballpark?

I cannot even put a number on it. It really varies year by year on what sort of actual decision we get out of the process, and there is so much gives-and-takes I could not even give you an estimate.

Okay, well, let me ask it one other way then. What sort of ROE does that imply?

We have an ROE in there that we are requesting which is higher than what we have been receiving.

Of course.

In the 12 percent range.

Okay, well that helps.

(inaudible). But obviously that will go through lots of discussions before we sign -- (multiple speakers)

Most of the stuff that you have been getting lately has been right around 10, even a couple that have come in slightly under as I can remember.

Yes, that is correct.

All right. Thanks a lot.

Debra, we have heard a rumor that you are passing it around back in Washington that next year's Washington Senators are going to meet the Boston Red Sox. True?

Yes, that's right. We need a new entrant into the World Series.

Sorry about you folks from St. Louis.

Dave Kantor. Janney Montgomery Scott.

Good afternoon and congratulations on the solid quarter. A couple of questions. First of all, let me reask the operations and maintenance expense question. Was that -- your actual quarter was up about 7.5 percent, and you had made allusion to the fact that that was mostly from health benefits and things like that. My curiosity was whether or not those were things that you could lock in a better contract with your health provider, or what was being done to address that?

We are taking a look at it. We do think that on the health benefits that over the long run it is cheaper to be self-insured versus going to an insurance company, because they are going to basically charge us for the cost and then add a profit on top of that. But when you go that route, that does cause you to have -- you are exposed to some cost spikes in the equation.

On the workers compensation, that is one we have to take even a harder look on, and we got hit with a couple of big claims in there, and we do need to improve our education process that we do to employees and we are going to look to improve that. But for right now we are not looking to increase our insurance premiums on it to get rid of the cost spikes. Because we think overall that's going to raise our costs in the long run. We do have stop loss policies, though, as I mentioned, so.

All right. And then the Selma California situation, are there any other imminent domain potentials out there in your territory or for that matter your knowledge of the rest of the states? We noticed that in states where you started to see takeovers, municipal takeovers, that it becomes kind of an endemic thing. Are you noticing anyplace else other than Selma?

Well, Dave, good question. And that is why I made the comment that we thought that this victory, overwhelming victory in Selma, was important for the rest of the state of California, not only for our company but other investor-owned waters. But there are a couple of (technical difficulty)-- where their communities have come out and said that they want to purchase their franchises. One is in Felton, California, a very very -- it is just north of Santa Cruz -- a very very small system. Then there is one down in Southern California. I cannot think of the name of the city. It's in the Pomona area. It is in a service area owned by Southern California Water. I do know enough instances that the owners of those service areas are going to fight this to the very end, and we will spend whatever money it takes to defend their franchises.

Other than that, that is it. California is a pretty big state, and if there are only two active examples of takeovers now, I think that is pretty minimal. And I think it is going to shake these other communities up relative to Selma.

Okay. On the balance sheet, I noticed receivables were up considerably, somewhere in the 25 to 33 percent. I take it that is more of a timing issue?

Some. Also with our increased rates in there, but actually our receivable aging that we look at it is a little better than what it was at year-end, or actually compared to the same period last year at the end of September. So I don't really have concerns that we have got any receivable issues.

All right. And then you were talking about arsenic control and financing it. I think we talked about this in the past. Have you thought further about industrial revenue bonds and the possibility of locking in or getting grandfathered into do some IRBs for that kind of thing? Customer revenue bonds.

That is a good question. I guess we really have not explore it. These are tax-exempt?

Yes. I mean if you are going to do that, you might as well do IRBs. IRBs are available for pollution control, and I think arsenic control would be interpreted more broadly as being pollution control. It is not polluting the air, but it is polluting water that is for sure.

In California it has been difficult to get into the tax-exempt bond as (multiple speakers)

Let's say it would just be an interesting avenue. I mean I would think that if you got the right lawyers, they certainly could try.

We could get into it.

Yes.

Good suggestion.

And then lastly, more of a general question to do with financing, bank lines, what are your current amounts of bank lines and commercial paper lines if you have any? And how much have you used so far?

We have got a total of 55 million on the bank lines. That is broken into 45 million for our California subsidiary and then 10 percent or 10 million at the holding company, and there is no borrowings on either of those lines.

Okay, great. Thank you.

Mr. Nye, I am showing no further questions at this time.

Okay. Alright. Well, we would -- I would like to say that our next teleconference is scheduled for January 27, 2005. If you would, please check our Web site at www.calwater.com to confirm the date and time. There is also a service that you can subscribe to an e-mail so you to get a reminder of couple of days before the call.

I would like to thank everybody for their time today and listening to our report on California Water Service Group, and I wish everybody a great day. Thank you.

Ladies and gentlemen, this conference will be available for reapply after 7:00 PM Eastern time today through January 27, 2005 11:59 PM. You may access the replay system at any time by dialing 1-703-925-2533 or 1-888-266-2081 and entering the access code 558049. (Repeats numbers.)

That does conclude our conference for today. Thank you for your participation. You may now disconnect.